Financial Stocks and Bonds: Dot.com Bust Redux

Given that Wall Street peddles securities as if they were microwave ovens, it should come as no surprise that brokers are given aggressive sales pitches to constantly move inventory, regardless of whether it is in the best interest of their customers.  In the mid- to late 90s, the dubious inventory being unloaded was high technology and dot.com stocks whose share prices were artificially driven up by Wall Street’s conflicted and fraudulent research.  Most recently, financial and bank stocks were the touted “sure thing” and customers of the big Wall Street firms who bought the sales pitch have sadly come to realize they were duped once again.

Despite ample risk warnings, virtually all major Wall Street firms in recent months were actively peddling the stocks and bonds of now failed or troubled financial institutions, including Fannie Mae, Freddie Mac, Wachovia, Merrill, Countrywide, Washington Mutual and, of course, Lehman.  Although these companies had real businesses and posted sizeable revenues, they also had mounds of toxic mortgage-related assets hidden on their balance sheets.  Not surprisingly, the stocks of many of these companies are worthless, or worth just a fraction of what they were a year ago.  It has become clear that the earnings they reported - if I may borrow an infamous phrase from Lehman Brothers - “had no basis in fact.”

I garnered the first dot.com settlement from Merrill Lynch that prompted former New York Attorney General Eliot Spitzer to investigate Wall Street’s fraudulent research practices, so I speak with a certain authority about the wrongdoing from that era.  In the dot.com era retail investors were told to bulk up their technology holdings and have a disproportionate amount of their stocks in this sector because they had “nowhere to go but up.”  Similarly, I’m finding that retail investors were encouraged by their brokers to heavily load their portfolios with financial services stocks because they, too, were supposedly undervalued and carried little downside risk.

Sadly, Wall Street specifically targeted retirees and the elderly who were especially attracted to financial stocks because they carried considerably higher yields than those paid by municipal bonds, CD’s and money market accounts.  The preferred stocks of Fannie, Freddie, Wachovia, etc. carried yields as much as 8 to10%. Because they carried the “preferred” moniker, investors mistakenly were told that the securities were safer than common stocks and therefore inherently less risky.  In the case of Fannie and Freddie, investors also were erroneously led to believed that the stocks of these government sponsored entities had the full faith and backing of Uncle Sam.

The financial firms who were paying inordinately high yields on their preferred stocks and bonds were doing so for a reason: they badly needed capital to shore up their battered balance sheets.  But considerable doubt about the health of these institutions was already swirling in the marketplace, hence the reason they had to pay higher rates of interest on their paper.  The very fact that a firm must pay a comparatively higher rate of interest to attract capital is on its own a sufficient warning sign that its securities are inherently risky. Investors who were not told of these inherent risks, particularly those who list “preservation of capital” as their primary investment objective, may have viable legal claims against their stockbrokers.

I’ve also heard from investors whose brokers recently advised them to buy the common stocks of financial institutions and banks on the argument that they were badly undervalued.  Which leads to another issue Congress should investigate: the appallingly bad research that Wall Street peddles to its retail clients.  It’s astounding that nearly all of the analysts at major Wall Street firms failed to foresee the collapse of Lehman. The global $1.4 billion settlement that came in the wake of the dot.com collapse was supposed to ensure that Wall Street dramatically improve the quality of research it provided to retail investors.  There isn’t an iota of evidence to suggest that’s happened.

Auction-Rate Anger Turns into Arbitration

Investor Says He Was Misled by Bear Stearns Fund

Credit Default Swaps (CDS)

In a “credit default swap” the investment bank pays the investor a fee which is like the margin on a loan.  In return, the investor agrees to indemnify the bank against losses if the company fails to meet its obligations or goes bankrupt.  If that occurs, then the investor pays the bank.

The payment is compensation to the investment bank for its losses on its loan when the company failed to pay.

The credit default swaps market is estimated to be a multi-trillion dollar problem.  Even TIME Magazine is sounding the alarms on these products:

A meltdown in the CDS market has potentially even wider ramifications nationwide than the subprime crisis. If bond insurance disappears or becomes too costly, lenders will become even more cautious about making loans, and this could impact everyone from mortgage-seekers to municipalities that need money to fix roads and build schools.

One of the biggest issues of concern is some credit default swaps contracts are anonymous.  This is a problem because one counterparty might not know what the risk exposure is on the other side of the transaction, which could potentially affect their ability to make good on payments.

Zamansky and Associates is investigating several claims regarding credit default swaps.  We offer free consultations.

Subprime Bond Funds Arbitration

From 2007 - 2008 investors have suffered tremendously based on their brokers’ recommendation to purchase various fixed income funds which were pitched as fairly conservative but, in fact, have either blown up or suffered substantial losses as a result of the funds holding significant exposure to subprime mortgage related collateralized debt obligations (CDOs), collateralized mortgage obligations (CMOs) or residential mortgage backed securities (RMBS).

The first hedge funds to fail and cause a litigation fall out were the Bear Stearns High Grade and Enhanced Leverage Fund.  On August 1, 2007, Zamansky & Associates filed the first arbitration case on behalf of a group of investors who claimed that Bear Stearns misled them about the extent of subprime exposure in the hedge funds, misrepresented the “risk controls” which were in place purportedly to mitigate losses and misrepresented the performance of the fund during conference calls held with investors from January to June 2007, which were designed to keep investors in the fund and dissuade them from redeeming their shares.  In July 2008, the two Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin were indicted by the U.S. Attorney for the Eastern District of New York on charges of securities fraud relating to their activities relating to the hedge funds.

The Regions Morgan Keegan Select High Income fund run by Jim Kelsoe, a top-ranked junk bond fund manager since 2000, dropped significantly in value in 2007 - 2008 causing massive losses to investors.  The funds contained assets backed by mortgage loans as well as CDOs which resulted in significant losses to the fund after the subprime and general mortgage market fell dramatically.  Investors have claimed that the Morgan Keegan fund was marketed as a fairly conservative investment and that they were unaware of the extent of mortgage related assets or CDOs in the funds.

The Schwab Yield Plus Select Fund and Schwab Yield Plus Fund were sold to investors as safe alternatives to money market funds and cash holdings.  These funds also had high concentration of collateralized mortgage obligations (CMOs) and related mortgage investments which resulted in significant losses to investors.  Investors claimed that these investments were significantly more aggressive than cash alternatives and that there were alleged misrepresentations in the marketing of these funds and the disclosure of the risks of investing in these funds.

Citigroup also marketed the Falcon Strategies Two LLC which was purportedly a “multi-strategy” fixed income hedge fund which suffered significant losses for investors.  Citigroup marketed Falcon Two as a fairly conservative fixed income hedge fund which was diversified and engaged in diligent analysis and hedging to prevent risks.  The Falcon Two had a stated goal of “achieving attractive risk-adjusted returns while providing liquidity and cash flow.”  It purportedly was a “multi-strategy fixed income alternative that seeks to provide investors with absolute returns, current income and portfolio diversification.”

In reality, the Falcon Two hedge fund invested in numerous structured investments such as asset-backed securities (ABS), mortgage backed securities (MBS) and collateralized debt obligations (CDOs) which were all highly correlated to each other and to the credit markets as a whole.  As the credit markets experienced a severe crisis so have all of Falcon Two’s underlying investments which lacked real diversification.

The case is similar with regard to Citigroup’s MAT and ASTA Funds.  Perhaps most shocking are accusations that fund manager Reaz Islam, continually assured brokers and investors that the funds would bounce back while the funds swooned.

It is likely that other similar funds containing mortgage related securities will suffer significant losses decimating investors’ portfolios.

Brokers and financial advisors have a fiduciary responsibility to only recommend products that are suitable for a clients’ risk profile.  Fund managers have a responsibility to provide investors with clear, accurate performance information and to invest in accordance with strategies they promised to investors.

Zamansky & Associates offers free consultations to investors in subprime bond funds.

Variable Rate Annuities Arbitration

Zamansky & Associates helps investors recover losses who were victimized by brokers who sold their customers unsuitable variable rate annuities.  We have filed claims against many Wall Street and insurance firms involving the sale of unsuitable variable rate annuities.

Variable rate annuities are usually broken down into two broad categories: immediate and tax-deferred annuities. With an immediate annuity, you make a lump-sum deposit and the insurance company guarantees an immediate monthly payment until your death. The monthly amount is based on your life expectancy. This is the type of payout option that most states offer for lottery winnings.

With a tax-deferred annuity, you invest your money and watch it grow tax-deferred until you decide to take out your money. A tax-deferred annuity can have a fixed rate, or it can be a variable product with sub-accounts.

Last year, the SEC issued guidance to ensure that Wall Street and other financial services firms only market variable rate annuities to customers that had a suitable risk tolerance.  Yet clearly brokers and financial advisors ignored this and went ahead and sold these products to many retirees and other investors who relied on their investments to support their lifestyles.

Zamansky & Associates offers free consultations to investors who have experienced losses or potentially fraudulent treatment with regard to variable rate annuities.

Structured Products Arbitration

Zamansky & Associates has filed the leading investor securities arbitration case involving the multi-billion dollar market of so-called “structured products” and we are investigating many Wall Street firms who have sold structured investments to retail investors.

Structured products are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security, such as a conventional investment-grade bond, and replacing the usual payment features (e.g. periodic coupons and final principal) with non-traditional payoffs derived not from the issuer’s own cash flow, but from the performance of one or more underlying assets.

It’s become clear that many retail investors have suffered losses associated with structured products.  Many brokerage firms peddled structured products using monikers such as PACERS, STRIDES, SPARQS, and ELEMENTS.

One dubious structured product developed by Citigroup is called the ELKS, or equity linked security.  Citi’s ELKS (equity linked security) product is a risky derivative instrument where an investor is offered a specified return on a structured security tied to an individual stock. Providing the stock maintains a minimum value, the guaranteed return is paid. If the stock ever falls below the minimum value (sometimes around 80 percent), the ELKS immediately convert into shares of that stock. Then if the price of the underlying stock declines, the investor could receive a stock worth much less than the initial investment.

Here’s the catch: ELKS offer potentially higher returns, but the downside risk is unlimited if the stock goes south. If the underlying stock happens to dramatically increase in value, the investor only gets the guaranteed return.

For Citigroup, it’s a classic case of “heads I win, tales you lose.” The bank charges investors an upfront commission to buy ELKS and likely earns additional profits through hedging. Not surprisingly, brokerage firms were aggressively peddling structured derivative products like ELKS to unsophisticated retail investors a few years back, prompting FINRA to warn member firms of concerns that customers didn’t understand the inherent risks.

There’s evidence that FINRA’s warnings weren’t heeded. We represent a retired couple over 80 whose Citi broker last year bought $300,000 worth of ELKS on their behalf. The ELKS were highly unsuitable for retirees simply looking to preserve capital. The highly volatile stocks our client’s ELKS were derived from included Yahoo!, Cemex and Sandisk. The couple has lost nearly a third of their principal as the underlying stock’s value plummeted.

The vast majority of structured products are from high investment grade issuers only - mostly large global financial institutions such as Barclays, Deutsche Bank or JP Morgan Chase. These products come with hidden liquidity risks, not to mention the credit quality of the issuer.  So in other words, without good credit, the investor stands to lose based on the ability of the Wall Street firm to pay-up on the promised return - a fact that comes into question as more financial services firm face questions about their capitalization.

Because of these risks, structured products are not suitable for most retail investors and for many institutional investors they may have unwittingly become exposed to hidden risks. Zamansky & Associates offers free consultations.

Money Market Mutual Funds Arbitration

Bank and mutual fund customers have parked nearly $3 trillion into money market mutual funds and most mistakenly believe the investments are entirely risk-free despite not being insured by the FDIC. But in fact, some money market funds in recent years quietly began investing in Fannie Mae and Freddie Mac, mortgage-backed securities, and even harder to value assets such as timber and highways.  According to the Los Angeles Times, many banks mistakenly believed that if money market funds contained a diversified portfolio of high risk items, the overall portfolio would remain secure.

Signs of trouble are now looming. Legg Mason Inc., Sun Trust and Bank of America have all announced they are injecting huge swaths of emergency capital into their swooning money market funds.   Experts are saying that because Wall Street pumped out so many kinds of new customized instruments, they no longer know the value of what’s tied to money market funds.

It’s been said that no bank would ever let their money market funds break the buck, but this market has taught us that savvy investors must expect the unexpected.  Investors in auction rate securities also thought they were investing in risk free cash equivalents.

It’s not hard to predict that investors may claim they were defrauded by investing in money market mutual funds without having any disclosure about such funds holding toxic mortgage backed securities and other speculative asset backed securities.  Banks and brokers who did not disclose such risks should expect to hear from investors through securities arbitration claims.

Zamansky and Associates offers free consultations for investors to help them determine their next course of action.  We are investigating high profile money market funds including the Charles Schwab Advisor Cash Reserves and similar funds from Morgan Stanley, Barclays, UBS, Duetsche Bank among others.

Articles and blogs about money market mutual funds.

Citi Settles Auction Rate Mess

The Decision to Sue a Financial Advisor is not so Cut and Dry

A recent Money Magazine columnist, who carries the nom de plume of “The Mole” and is an undercover financial planner, wrote a column entitled “Should I sue my advisor?”

“The Mole” relates a common situation where a broker is asked to review another broker’s performance and finds that unsuitable investments were made and excessive fees were charged. Indeed, many of the cases referred to Zamansky & Associates’ are from these “second” brokers, who are often the best ones to determine whether the previous advisor abused the client, yet as The Mole asserts, only a qualified securities arbitration attorney should be trusted with this advice.

But I do disagree with The Mole on some of his/her points. The Mole writes that “the award is typically a small fraction of what’s requested, sometimes not enough to cover the cost of the suit.” Many lawyers, including our firm, take cases on a contingency or success fee basis so that if there is a successful arbitration or more commonly a financial settlement, only then are legal fees incurred. In other words, the financial interests of the aggrieved investor and his/her counsel are aligned.

Secondly, The Mole takes a look at disclosure documents, such as the investment advisory agreement and the prospectus, and sees the fine print as iron clad. True enough, while arbitration panels will be presented with disclosure documentation, that’s not dispositive of a case. Securities arbitration panels will hear testimony from both broker and client and make judgments based upon the credibility of the witnesses. If an arbitration panel thinks that a broker made a material misrepresentation to a client, the fact that documents contain disclosures may be ignored by the panel which could issue a monetary award against the broker. Furthermore, where a broker has a number of customer complaints on their record, arbitration panels may find it more likely abuse has occurred.

The Mole and I may disagree on some things, after all he’s a financial planner and I am a securities arbitration attorney, but we both agree that the best policy is to not buy a “financial product or [do] business with an adviser unless you understand what you’re buying and what you’re paying in total fees.”