Financial Institution Preferred Stocks Blow-Up: Individual Investor’s Next Nightmare

Based on the calls we are receiving, an alarming trend is emerging that equals - if not trumps - the magnitude of the auction rate securities scandal.  I’m referring to a growing number of investors with complaints that their broker improperly recommended purchasing preferred shares of financial firms over the past few months.

Financial institutions such as Fannie Mae, Freddie Mac, Washington Mutual, Merrill Lynch, AIG, Wachovia, among many others, issued preferred shares which offered significant dividend payments.  Brokers pitched them as a fixed-income equivalents which attracted retirees seeking stable investments to generate revenue for living expenses.  But after the credit crisis started in mid-2007, financial stocks turned obviously speculative.

The losses sustained by mom-and-pop investors could be staggering.  According to the Wall Street Journal, the combined market cap of the top 15 S&P financial companies was $1.3 trillion, which has been reduced to $1 trillion.  That’s an evaporation of about $300 billion, and it appears we haven’t hit bottom yet.  Many of the so-called experts don’t understand that for every shot-gun wedding or emergency liquidation the Federal government orchestrates on Wall Street, retail investors wake up to gaping holes in their retirement nest eggs.

At a minimum, these investors should have been told to diversify out of preferred shares of financial firms; the fact that some retirees were told to buy more in recent months is truly a horrifying breach of trust.

I can already hear the cat calls.

“Investors should have known better,” they like to say.

But I’ve seen this over-and-over again.  First it was the dot-com stocks, then it was auction rate securities; now its time to worry whether preferred shares of financial firms are next.

Loyalty Pays a Bitter Dividend

Wextrust’s Local Holdings on Ice; ‘Food Fight’ Over Area Properties Predicted

Paulson Proposal Neglects Individual Investors

By any measure, Paulson’s plan shows a certain disregard for individual investors, who have suffered the brunt of Wall Street’s extensive wrongdoings of the past few years. The plan neglects the pressing need to bolster investor protections for individual investors and threatens to usurp the authority of state regulators, who have a very impressive record of pursuing Wall Street wrongdoing. The plan’s only beneficiary is Wall Street, which has long wanted more streamlined regulation because it would ease their regulatory burdens.

Another area that Paulson neglected to cover was investor arbitration, which many have argued favors brokerage firms. It would have been helpful for him to propose reforms that would level the playing field for investors who are required to arbitrate disputes with their brokers.

But there also needs to be in place a regulatory mechanism that protects investors from wrongdoing before it occurs. Though in theory I have no problem with the creation of a “supercop” role for the Fed, Congress should insist that the expanded agency have a very senior investor advocate with extensive powers and authority. This advocate should have bona fide credentials representing individual investors and not be someone with close ties to Wall Street firms.

Finally, state regulators should continue to be allowed to regulate Wall Street firms doing business within their borders. State regulators such as state attorney generals have an important role to counterbalance federal regulators.

Ironically, I’m in Washington today to attend the North American Securities Administers Association (NASAA) annual meeting, an organization comprised of state regulators. I know I don’t have to tell you the dominant topic of conversation. NASAA’s comments on Paulson’s plan can be seen here.

Harvey Pitt on Individual Investors: Let Them Eat Cake

Former SEC chairman Harvey Pitt was no champion of individual investors. Pitt was in charge of the agency when the former New York Attorney General put the SEC to shame and took the lead in exposing Wall Street’s conflicted research. Pitt was also among the regulators who signed off on Spitzer’s wrist-slapping $1.4 billion global settlement.

So I guessed I should not have been surprised to hear Mr. Pitt tell CNBC viewers today that the Supreme Court’s recent Stoneridge decision, which prevents investors from suing all parties involved in a fraudulent transaction and not just those who directly initiated it, would have no bearing on investors seeking legal recourse relating to the subprime mortgage meltdown. Mr. Pitt said that there were already enough primary violators to sue.

Mr. Pitt is badly mistaken. The Stoneridge decision will adversely affect the legal recourse available to subprime investors, as many potential avenues for discovery – where “smoking guns” are often discovered &ndash are now closed. My guess is that if CNBC had also asked Mr. Pitt about the Supreme Court’s Tellabs decision, which requires “a strong inference of fraud” before a class action suit can be certified, he wouldn’t have had any issues with that ruling either.

Credit Mr. Pitt at least for one thing: at least the regulatory lightweight’s longstanding indifference to the issues and concerns of individual investors remains intact.

Regulation: The Burden and the Backlash