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 LLC 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 LLC offers free consultations to investors in subprime bond funds.