FinancialCounsel

FINRA Steps In To Caution Firms Not To Thwart Customers' Efforts To Liquidate Their Auction-Rate Securities

FINRA, the Financial Industry Regulatory Authority, should be given credit for stepping in to prevent a practice that was reported in Bloomberg.coma few weeks ago.  In that article, Bank of America, UBS, AG, Wachovia Corp. and at least four dozen other firms reportedly were thwarting attempts to create a secondary market that would allow investors to access their cash, according to investors who had talked to the press.  Dealers had claimed that they were saving customers from needless losses on securities that they had marketed as similar to cash-like instruments.

In Regulatory Notice 08-30 issued just last week regarding illiquid investments, FINRA clearly puts firms on notice not to interfere with the customer rights to sell their securities.  It says,

Recently, questions have been raised regarding a firm's obligations when it receives a customer's unsolicited instruction to liquidate a position in an illiquid security when the customer is aware of specific buying interest in that security.  There is no FINRA rule that would require a firm to refuse to follow the customer's instruction under these circumstances, even if the firm believes the market or price for the security is not favorable at that time.  In those instances, the firm should fully disclose the pricing risks to the customer and receive a written acknowledgment that the customer understands those risks.

FINRA also recognizes that there may be valid reasons for a firm to delay, or obtain more information before following a customer's instructions (e.g., if the firm has reason to doubt the identity of the person giving the instruction).  However, a firm's refusal to follow the customer's unsolicited instruction to sell to a specific buyer may violate NASD Rule 2110.  When the following conditions are present, firms should not delay or decline executing such a transaction in an illiquid security:

(1)  the customers on both sides of the transaction have indicated their understanding that the firm is not recommending the transaction or making a suitability determination;

(2)  the customers understand that the firm cannot reach a view as to the sufficiency or competitiveness of pricing; and

(3)  there are no legitimate concerns as to the ability of both sides to settle the proposed transaction.

Customers may also learn of buy interest from their firm.  In informing customers of buy interest, firms should also consider appropriate disclosure, including, as applicable, information regarding the firm's inability to make a representation as to the nature, fairness or sufficiency of the pricing; and any pecuniary interest the firm may have in the transaction.  If the firm recommends the transaction to a customer, the firm has additional obligations and must ensure that the transaction is suitable pursuant to NASD Rule 2310.

 Sources:  FINRA, Bloomberg.com

SNSFE Investigates Fidelity Ultra-Short Bond Fund

A class action lawsuit has been filed in the United States District Court for the District of Massachusetts on behalf of purchasers of the Fidelity Ultra-Short Bond Fund who purchased the fund between June 6, 2005 and June 5, 2008.  The complaint alleges that Fidelity Management & Research Company, among others, violated the Securities Act of 1933.

The complaint alleges that on or about August 23, 2002, the defendants began offering shares of the Ultra-Short Bond Fund pursuant to an initial registration statement filed with the SEC.  The complaint alleges that the defendants solicited investors to purchase shares of the Ultra-Short Bond Fund by making statements that described the Fund as a fund that: (1) seeks a high level of current income consistent with the preservation of capital; (2) allocates its assets across different market sectors and maturities; (3) has a similar overall interest rate risk to the Lehman Brothers 6 Month Swap Index; and (4) is geared toward the preservation of capital. 

As alleged in the complaint, these statements were materially false and misleading because the defendants did not adequately disclose the risks associated with investing in the Fund, including, for example, that the Fund was: (1) failing to compete with the Lehman Brothers 6 Month Swap Index; and (2) so heavily invested in high-risk mortgage-backed securities.

As alleged in the complaint, by June 11, 2007, the defendants slowly began lowering the value of the share price for the Fund.  By November 15, 2007, the value of the per-share price was reduced below $9.  Since then the shares were trading as low as $8.25.

In a companion announcement, there was announced that Fidelity Management & Research Company has been accused of securities fraud and that if someone is a current or former employee or are a member of any Fidelity Management & Research Company investment plans or profit sharing retirement plans, they may be included in the possible Fidelity Management & Research Company 401K or Employee Retirement Income Security Act class action. 

SNSFE is continuing to investigate claims brought against Fidelity and its Ultra-Short Bond Fund.  Those with information should contact SNSFE attorneys.

Source:  Online Legal Marketing

Schwab May Settle YieldPlus Mutual Fund Class-Action Litigation

Charles Schwab may pay about $260 million to win public-relations points by settling investors' claims over losses in a bond fund with subprime holdings.

The San Francisco-based company is accused in eight proposed class-action suits of misleading investors by describing its YieldPlus mutual fund in prospectuses as only "marginally" riskier than cash.  From last July 1 through April 30, investors lost about $1.3 billion, according to Boston-based Financial Research Corp., which tracks investment flows for 35,000 funds.  This amount represents about 20 percent of what investors have lost. 

Schwab said in a May regulatory filing that it may settle suits "because of the uncertainty and risks of litigation."  A settlement "could be material to the company's operating results" for a particular period without harming its overall financial condition.

Schwab separately faces some arbitration claims and individual investors' suits.

Attorneys at SNSFE are advising clients as to whether or not they should participate in class-actions and whether or not they should participate in any other settlement offers by Schwab.  Those investors may contact attorneys at SNSFE.

Source:  Bloomberg.com

SEC Investigates The Falcon Strategies LLC Hedge Fund Redemption Offer By Citigroup

Citigroup, the biggest U.S. bank by assets, has said that the Securities and Exchange Commission has requested records relating to the firm's hedge funds as part of an informal inquiry. 

Citigroup disclosed the review in a document filed May 28 in federal court in Manhattan, where investors in the bank's Falcon Strategies LLC fund have sued to halt a tender offer for their shares.  Citigroup is trying to liquidate the fund, which has lost 80 percent of its value, according to court papers.  The investors say they haven't been given enough information to gauge the value of their stakes.

Citigroup has offered 45 cents per share in the Falcon Strategies LLC tender offer, which began May 8.  The net asset value of the shares was $1 when the fund got started in 2004.  The NAV is now between 19 and 21 cents, Citigroup has said in court papers.

On March 20, Citgroup said it was suspending redemptions and distributions from the Falcon fund, and has since been liquidating it.

Investors who have purchased Falcon strategies and wish guidance as to whether or not to accept the redemption offer should contact attorneys at SNSFE.

Source:  Bloomberg.com 

Documents Show UBS Knew About Risks Of Auction-Rate Securities But Cautioned Only Some Of Its Clients As Other Clients Purchased Auction-Rate Securities

The latest news in the auction-rate securities debacle is that UBS Financial Services might have known as early as December that a segment of the municipal bond business was in trouble, but the Wall Street firm kept selling the investments to some clients without warning them of the risk.  This is according to documents reviewed by The Boston Globe. 

By February, the $330 billion auction-rate securities market had collapsed, locking out the nonprofits and municipalities that had used the market for years to issue inexpensive debt, as well as the investors who had purchased it.  UBS brokers have said they were as surprised as anyone about the market's shutdown.

But on the other side of the firm, UBS was advising some large investment banking clients of the looming problems at least three months before all trading had stopped, according to a letter to investors by one of those clients, a New Hampshire bond issuer.

Attorneys at SNSFE continue to investigate the role of investment banking firms, such as UBS, in the marketing and sale of auction-rate securities to investors.  Those with information should contact attorneys at SNSFE. 

Source:  The Boston Globe

SNSFE Continuing Its Investigation Of Harbor Financial Services And James Kleinkopf Of Mobile, AL

SNSFE securities attorneys are continuing their investigation of Harbor Financial Services and its registered representative, James Kleinkopf of Mobile, Alabama for excessive trading and unsuitable investments in the account of at least one elderly person.  Those with information should contact attorneys at SNSFE.

Securities Regulator Urges Great Caution In Using 401(k) Debit Cards

Many Americans tap into their retirement savings before they retire, potentially harming their efforts to provide for a financially secure future according to a recent Investor Alert issued by FINRA.

With the advent of a recent product, the 401(k) debit card, borrowing from a retirement savings account is as easy as swiping and spending.  These cards are often marketed as ideal for employers whose workforce include young, seasonal, transitory, or union workers.

FINRA has issued this Alert to inform investors about the potential pitfalls of 401(k) debit cards.  Although they may seem to be an attractive feature of some 401(k) plans, taking money out of your retirement savings, even for a short period of time, can have enormous repercussions for your retirement security - particulary if you never put the money back.

The Alert is available at www.FINRA.org.  The bottom line, FINRA states, is borrow as a last resort.  Regardless of how easy it might be to do, borrowing against your retirement savings should be a last, not a first, resort - and done only in emergency situations.  If the 401(k) debit card is one of your options, be particularly mindful of the pitfalls that come with the card's use - from a smaller nest egg to a potential loan default that can deal a serious financial blow.  Remember that with every swipe comes the potential to wipe out a portion of your hard-earned retirement savings.

Source:  FINRA Investor Alert

Auction-Rate Securities Failures Due In Part To Lack Of DisclosureThat Financial Services Firms Sometimes Have Had To Intervene In Auctions Just To Prop Up Auctions According To SEC Official

The collapse of the roughly $330 billion auction-rate securities market this year was fueled by a lack of transparency and may have been avoided if investors had a comprehensive source for disclosures that showed the extent to which successful auctions were dependent on broker-dealer intervention, the Securities and Exchange Commission's municipal securities chief said recently. 

Martha Mahan Haines said that one of the biggest problems in the ARS market was its opacity, which may have kept investors from knowing that a small group of broker-dealer firms that bid on the auctions were critical to preventing widespread failures.  Even though broker-dealers disclosed that they were bidding on auctions, the extent of the participation was unknown, she said.  "If investors could see that broker-dealers were so active in this market...perhaps it wouldn't have grown so large, well beyond the broker-dealers' ability to hold it up," Haines said, speaking at the Securities Industry and Financial Markets Association's legal and compliance conference in New York.  "We may not have gotten into this mess had there been transparency," she said.

Haines' remarks were echoed by John Cross III, an attorney with the Treasury Department's office of tax policy, who said that there is a lack of basic information about auction-rate securities that likely confused many investors.  At a fundamental level, he said, market participants did not understand the difference between auction-rate securities - which have no liquidity facilities but were nonetheless widely considered highly liquid, short-term investments - and money-market eligible VRDOs, which have liquidity features and are thus eligible for investment by money market funds under the SEC's Rule 2A-7.

Liquidity facilities include lines of credit, standby bond puchase agreements, or other arrangements in which an entity, typically a bank, promises to purchase securities that cannot be immediately sold or remarketed to new investors.  Demand for ARS was fueled at least in part by the fact that they were cheaper than VRDOs, which usually include pricey letters of credit, he said.

"One of the biggest, broadest themes right now is basically efforts to dress up auction-rate securities so that they have liquidity facilities so that they can be sold to the money market funds," Cross said, referring to the push by issuers to convert their ARS to VRDOs or fixed-rate bonds.  "That unfortunately comes at a time when the financial positions and balance sheets of all the banks are equally challenged and the silver bullet of adding liquidity facilities...still faces ongoing business challenges."

In the past, banks and broker-dealers put in bids of their own for these securities to prevent auctions from failing.  But in June 2006, 15 firms agreed to pay $13 million to settle charges that they violated the securities laws by not disclosing these and other auction-rate practices.  Some firms began disclosing their practice of putting in bids to prevent auctions from failing.  But the credit crunch led banks and dealers to tighten their lending standards and in February they stopped bidding on auctions.

Source:  The Bond Buyer

SEC Reveals “Top 10” Compliance Issues for Investment Advisers

Recently, the Securities and Exchange Commission (SEC) revealed its current examination priorities for investment advisers.  Speaking before the 10^th Annual IA Compliance Best Practices Summit, Lori Richards, Director of the SEC’s Office of Compliance Inspections and Examinations, detailed the “Top 10” issues.  Let’s overview each of these ten issues.

Preliminarily, a shortage of SEC staff examiners to oversee nearly 11,000 investment advisers has forced the SEC to adopt a risk-based approach to examining investment advisory firms.  Nonetheless, the SEC is quick to point out that it continues to conduct “random” examinations, to which all investment advisory firms are subject.  Moreover, the SEC recently has emphasized that it “targets” newly-registered investment advisers.  In these examinations, according to Ms. Richards, “our goal is to obtain information about the adviser’s compliance program and evaluate the overall compliance culture of the firm.”

In all examinations, the SEC is interested in determining the adviser’s “risk-assessment process.”  The “Top 10” areas of SEC focus should be considered in an adviser’s risk assessment.

1. Controls Over Valuation.  Valuing securities is a “Top 10” issue because clients need to know the value of their investments and advisers should not overstate the value in order to overcharge their investment advisory fees (based on a percentage of the value of the investments).  The SEC particularly wants to ensure that an advisory firm has “controls and is implementing those controls when pricing structured products, illiquid securities or other difficult-to-price securities.”

2. Controls Over Non-Public Information / Personal Trading / Code of Ethics.  Ms. Richards reveals that the instances of suspicious trading have increased.  Ms. Richards states that, generally, examiners will focus on “whether a firm has identified the source and type of non-public information that they and employees may be privy to, whether the firm has crafted and implemented adequate procedures to maintain the confidentiality of that information, and is implementing those procedures.”  The SEC also will inquire as to “whether the firm has guidelines with respect to when and to whom it will provide information, for example, information about its portfolio or its trading.”

3. Dealing With Senior Investors.  Protecting seniors, through effective supervisory and compliance programs, is a high priority at the SEC.  According to Ms. Richards, the SEC is focusing on: “marketing and advertising to seniors; account opening; product and account review; ongoing review of the relationship and appropriateness of products; discerning and meeting the changing needs of customers as they age; surveillance and compliance reviews; and training for firm employees.”

4. Compliance and Supervision.  Advisers must tailor their programs to identify and effectively mitigate their particular compliance risks and conflicts of interests.  According to Ms. Richards, the conflicts that the SEC is seeing “include new revenue-sharing payment streams from advisers to broker-dealers for obtaining space on the broker-dealers’ ‘recommended adviser’ lists, and other undisclosed compensation and gifts for business (e.g., to solicitors, fund consultants, and municipal consultants).”  The SEC also is examining for adequate supervision of “dispersed offices and independent advisory contractors.”

5. Portfolio Management.  The SEC continues to review whether investment recommendations are consistent with the adviser’s disclosures and the client’s investment objectives and restrictions.  More recently, the SEC has focused on “client investments in structured products and other complex derivative instruments.”

6. Brokerage Arrangements and Best Execution.  Investment advisers owe fiduciary obligations to their clients. Fiduciary obligations include seeking best execution for trades and “periodically and systematically” evaluating the costs and benefits of their brokerage arrangements.  Along those lines, the SEC is examining for “any inappropriate and/or undisclosed use of soft dollars for the benefit of the adviser, and use of any affiliated or preferenced broker-dealers for excessive commission payments, kickbacks to the adviser, or other undisclosed arrangements.”

7. Allocation of Trades.  Advisers must disclose its policies and procedures and must test them for fairness with respect to allocating IPOs, block trades and investment opportunities among clients and proprietary accounts.

8. Performance Advertising, Marketing, and Fund Distribution Activities.  Advisers must ensure that their claims about their past performance, their advertisements, and other marketing materials contain accurate information.

9. Safety of Clients’ and Funds’ Assets.  The SEC is interested in whether funds and investment advisers have “effective policies and procedures for safeguarding their clients’ assets from theft, loss and misuse.” Notably, Ms. Richards reveals that examiners “assess whether there is a process for regularly reconciling client and fund balances of securities owned with those shown by custodians and ensuring that the books reconcile.”

10. Information Processing and Protection.  This large examination area covers required books and records, disclosures and filings.  It includes effective policies and procedures for capturing, compiling and maintaining email and instant messages.  Moreover, the SEC “will be looking for controls that protect this information from hackers or other unauthorized persons, and from being destroyed in a disaster as part of the firm’s business continuity plan.”

As one can see, investment advisers face a great deal of scrutiny in complying with SEC requirements!

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SNSFE Investigates LPL Broker Stephen Walker For Failed Aspen Exploration Investments

Lawyers at SNSFE are investigating financial adviser Stephen Walker of Rock Island, Illinois.  Walker, who has been temporarily banned from selling investment securities in the state, used to be an investment adviser for Linsco Private Ledger.  He maintained an office in Sterling. 

According to sources, Walker sold $25 million worth of oil and gas investments to at least 25 Illinois, Iowa and Wisconsin residents.  According to sources, clients got virtually nothing back.  Walker reportedly began soliciting clients in 2005 to invest in oil wells run by Aspen Exploration Inc., based in Plano, Texas.  According to sources, Walker sold investments in the oil and gas venture without disclosing the risks involved.  The clients claim the investments were unregistered securities.  Walker allegedly told his clients that investing in Aspen was an "excellent opportunity" and a "very rare opportunity."  Walker told one investor he could expect a return of 20 times his original investment, and the investments were not speculative.  He used high-pressure tactics, according to sources, such as telling clients that they had only 24 hours to invest.  The broker also allegedly told investors to take out loans to invest in Aspen.

Those with information or questions about this investigation should contact lawyers at SNSFE.

More Bad News For Auction-Rate Securities Market

There has been more bad news in the auction-rate securities market. 

First, according to a study of earnings reports conducted by securities-valuation firm Pluris Valuation Advisors LLC, 402 public companies disclosed that they held variations of auction-rate securities.  Half had written down the value of their holdings.  Of those that did write down the value of their holdings, the average markdown was 13.2%, the study shows.

Second, about 25% of the $330 billion auction-rate market has been bought back by municipalities or refinanced with a different kind of debt, says Alex Roever, fixed-income analyst at J.P. Morgan Chase & Co.   Those left, approximately 75% of the $330 billion auction-rate market, probably aren't worth their face value, he adds.

Source:  The Wall Street Journal

J.P. Morgan Analyst Paints Bleak Picture For Investors In Student Loan Auction-Rate Securities

News continues to be most bleak for those who were sold student loan auction-rate securities. 

Last month, a research report issued by J.P. Morgan credit analyst Alex Roever said, "We think it is highly unlikely SLARS issuers will call or restructure any of their existing debt in the way that many municipal ARS issuers are attempting to do...As a result, we estimate $65 billion to $70 billion of SLARS bought as short-term debt may not be saleable, and current investors are at risk of having to hold positions until maturity, which in a few cases may be almost 40 years away."

Source:  FinancialWeek

300 Companies Struggling Over Auction-Rate Securities With One-Half Of Them So Far Reporting Losses Totaling $1.8 Billion

Auction-rate securities woes continue. More than 300 companies are struggling to value auction-rate bonds after dealers battered by subprime-related losses abandoned the $330 billion market in February. About half of the companies reported losses totaling $1.8 billion as the market for the securities, sold as higher-yielding alternatives to money markets, seized up.

It's a "who's who" of corporations who have reported losses: United Parcel Service; Google; Royal Bank of Canada; Hill-Rom Holdings of Batesville, Indiana; HCA Inc., the largest U.S. hospital chain; JPMorgan Chase & Co.; and, Teva Pharmaceutical Industries, among others.

SNSFE continues to assist corporations in monitoring class actions, in attempting to negotiate settlements, and, of course, in arbitrating and litigating over the investment losses and redemptions.

Source: Bloomberg

SNSFE Investigating Massive Fraud Perpetrated By American Elder Group, John Tencza, Michael E. Kelly and Others

The Securities and Exchange Commission has convinced a District Court for the Northern District of Illinois to enter an order permanently enjoining John Tencza, of Meridian, Idaho and formerly of Scottsdale, Arizona, as well as American Elder Group, L.L.C., Tencza's business, from violating certain of the antifraud and registration provisions of the federal securities laws. 

The SEC's complaint in this matter charges that Michael Kelly and 25 other defendants, including Tencza and American Elder Group, participated in a massive fraud on U.S. investors that involved the offer and sale of securities in the form of Universal Leases.  Universal Lease investments were structured as timeshares in several hotels in Cancun, Mexico, coupled with a pre-arranged rental agreement that promised investors a high, fixed rate of return. 

The SEC's complaint alleges that from 1999 until 2005, Kelly and others, including Tencza and American Elder Group, raised at least $428 million through the Universal Lease scheme from investors throughout the United States, with more than $136 million of the funds invested coming from IRA accounts.

The SEC further alleges that a nationwide network of unregistered salespeople who sold the Universal Leases, including Tencza and American Elder Group, collected undisclosed commissions totaling more than $72 million.  These commissions sometimes amounted to as much as 27%.

SNSFE is investigating this massive fraud and welcomes information and comments from investors.

Source:  SEC Digest

Investors Beware As Bank Of America And RBC Dain Rauscher Added To The List Of Firms Sued In Class Actions Over Auction-Rate Securities

Previously, we've cautioned investors to monitor class actions because they may be unsuitable for most investors who have invested several thousands of dollars in those investments.  We've added a few names to the list since our last publication. 

Bank of America as well as RBC Dain Rauscher have now been sued in class actions by various law firms across the country.  Investors need to be careful so as not to receive pennies-on-the-dollar by unwittingly being placed in such class actions.

SNSFE Investigating Wachovia's Firing Of Its Financial Specialists At Banks Over Customer Checking Accounts

SNSFE is investigating claims of financial specialists who Wachovia Bank fired recently. 

Acting on a tip, SNSFE has learned that Wachovia Bank fired employees after they had given customers what Wachovia had offered to them for free, mainly -- accounts with interest and free checking.

Those with information about these firings should contact SNSFE.

Plug Power Sues UBS As Auction-Rate Securities Woes, Failed Auctions And Big Discounts On Redemptions Continue

Auction-rate securities continue to trouble investors.  According to Bloomberg data, failures in the auction-rate preferred share market, which are sold by mutual funds, and debt sold by student loan providers, continue to run at about a 99 percent failure rate for auctions.

In other news, the Missouri student loan agency, known as MOHELA, does plan to redeem securities for investors.  The problem is, however, at a steep discount - about 25 percent below their value.

Finally, Plug Power has filed an arbitration claim against UBS Financial Services for $62.8 million, claiming the brokerage firm improperly invested that sum in so-called auction-rate securities.  The auction-rate securities UBS bought for Plug were backed by federally insured student loans, and Plug said in the lawsuit that student loan-backed ARS are the hardest to sell, with discounts of 25 percent or more.  We certainly know that to be true.

"Throughout the fall of 2007, other brokers and investment advisers began advising clients to liquidate their ARS holdings, in light of the failed auctions and increased liquidity risks...UBS did not notify Plug Power of these risks."

Those with information concerning the preferential treatment of certain large clients to disadvantage others should contact SNSFE.

Sources:  Bloomberg; Times Union; Tribune

SNSFE Issues Warning To Investors Who May Be Trapped In A Class Action Relating To Schwab YieldPlus Fund Select Shares And Schwab YieldPlus Investor Shares

SNSFE is issuing a warning to investors to beware of a pending class action concerning Schwab YieldPlus Fund Select Shares and the Schwab YieldPlus Investor Shares. 

SNSFE is investigating those funds and the investigation centers on the allegations that Charles Schwab omitted or misrepresented important information to investors -- including the YieldPlus funds' safety, composition and risk level.  Investors should beware of class actions as they often return only pennies-on-the-dollar. 

Investors who have claims against Schwab should carefully weigh their options, including whether or not to participate in the class action or to file an individual arbitration claim.  Those with information or questions should feel free to contact lawyers at SNSFE.

SNSFE Investigating Massachusetts Hedge Fund River Stream And Its Manager Michael Regan

SNSFE is investigating a Massachusetts hedge fund manager.  Massachusetts' top securities regulator, William Galvin, on Monday charged a hedge fund manager, who had promised to earn as much as 20 percent for his clients, with improperly soliciting investors.

William Galvin, the state's secretary of the commonwealth, said that Michael Regan did not check whether investors in his River Stream fund were wealthy enough to be legally invested with him.

Galvin's office also found documents that suggests that most of the money clients entrusted to Regan may be lost.  Investigators found River Stream client data thrown into a dumpster near an empty office where Regan said he worked.

The money manager wooed friends and social contacts with false Ivy League credentials and promises of healthy returns between 10 percent and 20 percent a year.  He claimed to have an MBA in Finance from Columbia University which he did not earn, Galvin's office said.

Galvin's investigators also found a brokerage statement showing a River Stream fund had lost $1,625.00 at the end of April, a fraction of the $15 million Regan claimed to be managing earlier in the month.  One client said he put roughly $1.5 million with Regan in 1996.

Those who have information about this fund or this manager should contact attorneys at SNSFE.

Source: Reuters

SNSFE Investigating Implosion Of Bear Stearns High Grade Structured Credit Strategies Fund And Its Managers

Lawyers at SNSFE are investigating the Bear Stearns High Grade Structured Credit Strategies Fund, as well as Ralph Cioffi, Jr.  and Matthew Tannin.   

Bear Stearns recently disclosed that the events leading up to the demise of the Bear Stearns High Grade Structured Credit Strategies Fund -- and the management of the fund by those managers -- are the subject of a number of criminal and civil regulatory investigations by the Office of the United States Attorney for the Eastern District of New York, as well as the Securities and Exchange Commission.

The Bear Stearns hedge fund last year imploded and caused investors to have all of their capital wiped out.

Those with information about this hedge fund please contact SNSFE.

Key Guidance On Hedge Fund Investing

On Tuesday, May 13th, I presented Key Guidance On Hedge Fund Investing, a webinar highlighting important information contained in the "Report of the Investors' Committee to the President's Working Group on Financial Markets, Principles and Best Practices for Hedge Fund Investors." 

This report was released last month and is comprised of the material prepared by two committees, the Asset Managers' Committee and the Investors' Committee.  Given the voluminous size of the report, I primarily focused on the key advice noted by the Investors' Committee, including the topics of hedge fund investments and allocations, investment policy, and best practices in due diligence, risk management, legal and regulatory concerns, valuation, fees and expenses, and reporting. 

We recorded the program.  You can replay the presentation or listen to the podcast using the buttons below or by clicking on their links in the left side bar.

Investors Should Avoid Exchange-Traded Notes

Investors need to avoid exchange-traded notes according to columnist John Waggoner of USA Today.  It's good advice. 

Wall Street has created a new generation of investments, called exchange-traded notes, or ETNs, and they go by names such as BOXES, LUNARS, MITTS, PERQS and PISTONS.  "Except for the plainest of plain-vanilla ETNs," Waggoner advises that investors should "handle them like XPLOSIVs."

"ETNs are a relatively new development.  The value of an ETN depends on the movements of a stock index or, sometimes, even an indiviudal stock.  And, as you might have guessed," according to Waggoner, "ETNs trade on the stock exchange - typically, the American Stock Exchange."

"In those respects, ETNs are fairly similar to their cousins, exchange-traded funds.  But ETNs have a big difference:  They are debt securities, not equity securities.  When you buy an exchange-traded fund, you're buying a slice of a diversified portfolio of stocks.  When you buy an ETN, you're buying a promise - specifically, the promise that the issuer will pay the note according to the terms laid out in the ETN's prospectus."

"Those terms can be simple or complex," according to Waggoner.  "Let's start with a simple one," he suggests:  The iPath Dow Jones-AIG Commodity Index Total Return ETN.  This trades under the ticker DJP.  "The note pays no interest, but the issuer, Barclays, will pay a cash payment at maturity equal to the gain on the Dow Jones-AIG Commodity Index total return.  The maturity date is June 12, 2036.  You can sell the note before it matures, at which point you'll get whatever other investors feel it's worth."  As of last week, its value was up 9.2% in 2008.

"Jeffrey Ptak, Morningstar's director of ETF research, likes DJP because it does a better job tracking the index than an ETF can.  A fund has to use futures and other investments to track the commodity index.  Because a note isn't a fund, it doesn't have to line up investments that mirror the index.  All it needs is the promise to pay according to the index's movements. 

As a way to get broad exposure to commodities, Ptak says, DJP isn't bad.  The index the note uses is well-diversified, and the overall cost to investors is decent.  However, the more complex ETNs can be complex indeed.  Consider the Capital Protected Notes based on the Morgan Stanley Capital International Europe, Austral-asia and Far East stock index.  The notes trade under the ticker EEC." 

According to Waggoner, "Here's the deal:  Like DJP, EEC pays no interest over its term, which began May 23, 2005.  Each note was issued at $10.  When the note matures on December 30, 2008, the underwriters will pay note holders $10 per note. This is where the 'capital protected' part comes in: If you hang on to the note, you'll get your money back." 

The trade-off is that you give up some of the potential capital gains from the EAFE index in return for the capital protection.  "In this case, you give up quite a bit.  The note takes the index level at four different dates and averages them together.  The percentage difference between the average of the four dates and the starting date is your return.  In a rising market, your gains from this ETN will be considerably lower than if you had simply bought an ETF that tracked the index.  (The average will be smaller than the differnce between the start and the end point.)  Given this snakebit market, you might think that the smaller returns are a good trade for preserving your capital.  Should the market soar, however, you'll probably feel considerable buyer's remorse."

According to Waggoner, ETNs have a few other considerations:

First, counterparty risk.  "An ETN is backed by a promise.  Although the issuers of these notes are large, financially strong firms, you should be aware that, at least until recently, everyone thought that investment back Bear Stearns was financially strong, too."

Second, tax risk.  "The IRS is reviewing the tax treatment of ETNs and may consider taxing ETN profits as interest, rather than at lower capital gains rates.  Already, the IRS has ruled that single-currency ETNs will be taxed at ordinary income rates."

Third, commissions and expenses.  "ETNs are generally cheaper than mutual funds, but you'll have to pay a commission.  Your broker may tell you that you can buy an ETN on its initial offering with no commission, but that's not entirely true:  The commission is part of the initial offering price."

Waggoner concludes that, "Generally speaking, the more complex the deal, the more you should avoid it."  That's good advice.

Source: USA Today

Citigroup's Settlement Offer To Falcon And ASTA/MAT Investors May Not Be Sufficient

Recently, the Wall Street Journal ran an article focusing on Citigroup's push on hedge funds known as Falcon and ASTA/MAT.  The losses by these two hedge funds are the latest examples of the credit crunch hammering retail, or individual, investors who believed they were holding low-risk securities. 

These funds have plunged more than 75% or more.  The mess is another black eye for Citigroup according to the Wall Street Journal.  But interestingly, this time, the sales machine shifted into overdrive, pitching these funds as ideal investments for conservative retirees.  While Citigroup defends its handling of the hedge funds, saying they were offered only to clients with large diversified portfolios, that appears to have been belied by brokers who sold the funds.  According to some brokers, Citigroup brokers and fund managers assured prospective investors that the new hedge funds were low-risk, with Falcon likely to post losses of no more than 5% a year in the worst-case scenario. 

Falcon invested in municipal bonds, mortgage-backed securities, bank loans and other debt instruments, while ASTA/MAT emphasized municipal bonds.  Each was comprised of different funds that were launched periodically.  Until turmoil rocked financial markets last summer, the funds racked up strong returns, boosted by heavy doses of leverage. 

Last year, as Citigroup was gearing up to launch new Falcon and ASTA/MAT funds, it encouraged brokers at Smith Barney and in Citigroup's private bank to pitch the funds to their best customers.  One reason for the push:  Initial market tremors caused the Falcon family to decline by more than 10%, and Citigroup hoped to stabilize it with an infusion of cash.

By September, the new Falcon fund had raised about $71 million and the new ASTA/MAT fund raised about $800 million.  As of March 31st, the new Falcon fund was worth just 25% of its initial value, according to internal documents.  The ASTA/MAT fund had shriveled by February 29 to less than 10% of its original value, the documents show. 

According to the Wall Street Journal, even as their performances deteriorated, the 41-year-old manager of the funds reassured uncertain brokers and clients that the funds were likely to rebound, according to people familiar with the matter. 

Under a compromise that Citigroup has reached with investors, and is offering to them as we speak, Citigroup's wealth-management unit has agreed to spend $250 million to allow Falcon investors to exit from their positions without absorbing the fund's full losses, if investors would agree to forfeit all legal claims against the funds.  Some ASTA/MAT investors will get a similar offer.

SNSFE continues to investigate whether such settlement is appropriate and fair to investors.

Meanwhile, according to the Wall Street Journal, in the future, Citigroup will scale back its marketing of hedge funds to retail customers.  It's about time.

Source:  Wall Street Journal 

Investor Angst, Regulatory Probes And Litigation Intensify Over Auction Rate Securities

Investor angst concerning auction rate securities (ARS) continues, and indeed has worsened over the last few months. In May 2008, the New York Times reported that $300 billion worth of investors’ funds were “still locked up” and that 70% of all weekly auctions still were failing.  Additionally, ARS investors, especially those subject to class action filings, must be on guard to protect their rights.  Let’s discuss why.

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Securities Regulator Cautions Investors To Avoid Funds Investing In Catastrophe Bonds Or Other Event-Linked Securities

The Financial Industry Regulatory Authority (FINRA) has issued an Investor Alert warning investors about the risks of speculating on natural disasters with event-linked securities, such as catastrophe bonds or "cat bonds."  Cat bonds offer high yields but can quickly lose most or all of their value if a triggering event, such as a hurricane, earthquake or pandemic, occurs in specified geographical regions.

According to Mary Schapiro, FINRA CEO, "Event-linked securities are complex products that can lose their value if a triggering catastrophe occurs.  While they are typically marketed to institutional investors, retail investors should know that they could be vulnerable by virtue of owning shares in funds that invest in event-linked securities."

FINRA has issued a new Investor Alert entitled, "Catastrophe Bonds and Other Event-Linked Securities."  It describes how event-linked securities work and helps investors determine whether and to what extent the funds they hold invest in these securities.  The Alert explains that prices, yields and ratings of cat bonds rely almost exclusively on complex computer modeling techniques that determine the probabilities and the potential financial damage of natural disasters.  If a  catastrophic or "triggering" event occurs, holders could lose most or all of their principal.

Investors are encouraged to check their funds' prospectuses to see whether any fund is authorized to invest in event-linked securities - including collateralized debt obligations and derivatives.  And investors should make sure that if a fund is invested in event-linked securities, it is diversified in terms of type of risk and geographic location, and event-linked securities comprise only a limited portion of the portfolio.

That's good advice.

Source:  FINRA News Release

Regulators' Inquiries As Well As Auction-Rate Fire-Sale Discounts Increase Amid Renewed Allegations Of Collusion, Especially In the Area Of Student Loan Auction-Rates

Concerns about investor abuse in auction-rate securities continues.  New York Attorney General Mr. Cuomo is joined now by at least a dozen different authorities at the state and national level investigating aspects of the $330 billion auction-rate securities market. 

The Securities and Exchange Commission has been working closely with the Financial Industry Regulatory Authority.  Regulators say probes are still continuing but some appear to be narrowing their search.  One focus is on disclosures made to issuers.  But the area that may be more fertile is how the securities were sold to investors and whether they were informed of the risk that the market could become illiquid, say some regulators.

One enforcement official says:  "As the market started to show signs of stress... did [firms] start changing who they sold to?  Did they start taking themselves and preferred sellers out of the market?  Did they start overplaying or underplaying the cash-like aspect of the securities?  What did they know and when did they know it?"

That person adds that firms or broker-dealers who intentionally placed customers into products they knew "would not act as they had before" given the market dislocation would be in breach of the rules.

Professor Coffee, law professor at Columbia University, says, "It was anomalous that the market suddenly dried up.  The question is, was there any collusion that led to people suddenly moving out of the market?  What would be most suspicious is if you see any kind of discussions between banks."

On another note, the Restricted Securities Trading Network began listing auction-rates last month on its electronic trading network.  Transactions were slow to begin, but now average between seven and ten per day, according to its CEO.  That said, to date, municipal auction-rate securities are seeing discounts of up to 10 percent.  Auction-rate preferred securities are between 10 percent and 20 percent discounts, and student loan auction-rates are discounted 25 percent and up.

With respect to student loan auction-rate securities, several student loan authorities say broker-dealers including UBS, Citigroup and Bank of America requested late last year that these authorities issue waivers that would make the auction-rate securities easier to sell.  A broker-dealer is the firm responsible for recruiting buyers for the securities at the auctions.

The behind-the-scenes moves show broker-dealers were struggling to keep auctions afloat as some more sophisticated investors such as corporate treasurers, spooked by problems in the credit markets, became reluctant to buy.  The moves, according to the Wall Street Journal, raise questions about what Wall Street firms told their brokerage clients about risks emerging in the auction-rate security market.  While alerting investors to warning signs could have accelerated the market's ultimate failure, firms' lack of action suggests Wall Street may have grappled with conflicted loyalties leading up to the collapse, according to the Wall Street Journal.

SNSFE continues to investigate and assist investors in this area of possible, if not probable, investor abuse.

Sources: Wall Street Journal; CFO.com; Financial Times

Securities Regulator Issues Warning Regarding Investors’ Use of Reverse Mortgages

For many individuals, their largest asset is their home, and it is their most precious source of retirement security.

Unfortunately, over the years financial advisers have convinced homeowners that they should tap into their home equity to purchase investments.  In 2004, the NASD (National Association of Securities Dealers), now known as FINRA (Financial Industry Regulatory Authority) issued an investor alert entitled, “Betting the Ranch: Risking Your Home to Buy Securities.”  That alert addressed the use of new mortgages, refinanced mortgages and lines of credit secured by the home.  The NASD expressed its concern that “investors who must rely on investment returns to make their mortgage payments could end up defaulting on their home loans if their investments decline and they are unable to meet their monthly mortgage payments.”

More recently, homeowners (over the age of 60) have been the target of those who wish to sell them a “reverse mortgage.”  While reverse mortgages may be appropriate in some circumstances (such as when homeowners cannot meet their monthly mortgage payments or cannot pay bills or meet unexpected expenses), FINRA has alerted investors to stay clear of reverse mortgages to finance a lifestyle that they otherwise cannot afford or to pay for investments.  FINRA warns in its recent alert entitled, “Reverse Mortgages: Avoiding a Reversal of Fortune”, that “as more Americans near retirement age, some financial institutions are aggressively marketing reverse mortgages as an easy, cost-free way for retirees to finance lifestyles – or to pay for risky investments – that can jeopardize their financial futures.”  Let’s examine FINRA’s guidance.

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Managers Replaced at Poorly-Performing Regions Morgan Keegan Funds; SNSFE Continues to Investigate

The nation's two worst-performing bond-focused mutual funds over the past year are booting their in-house management in favor of outsiders.  Morgan Asset Management Inc., a unit of Regions Financial Corp., announced that it had been replaced to oversee these two and five other bond funds for Regions, based in Birmingham, Alabama.  All the funds were managed by James Kelsoe.

"Coming aboard is Hyperion Brookfield Asset Management Inc., which manages $22 billion.  New York City-based Hyperion Brookfield, a unit of Brookfield Asset Management Inc., would take over the portfolios, and new boards of directors would be nominated.  Hyperion Brookfield had been serving as an independent valuation consultant for the funds.

Two of the funds with the worst returns were the Regions Morgan Keegan Select Intermediate Bond Fund, which is down 73% in the past 12 months, and the Regions Morgan Keegan Select High Income Fund, which is down 70% in the same period.  The biggest reason was their investment in mortgage-backed securities, including low-quality mortgages, and complex securities like collateralized debt obligations.

In the past, these funds were doing well, partly because of these exotic investments.  However, as the housing slowdown got under way last summer, hurting mortgage securities, these funds quickly started losing value.  As the net asset value of the funds declined, investors started pulling out, forcing the managers to sell securities in an illiquid market to meet redemptions.  It dragged down the funds further.

In December, investors in Tennessee filed a lawsuit against two of the funds.  The firm also settled an arbitration claim with an Indiana charity, which said it had bought the Intermediate Bond Fund on the understanding that it was a safe investment."

SNSFE continues to investigate the Morgan Keegan Funds to determine whether or not they were suitable for investors and whether or not investors received all information pertinent to making their investment in those funds.

Source:  The Wall Street Journal

SNSFE Investigates Claims That Brokerage Firm Employees In 401(k) Plans And Other Qualified Plans Were Not Advised Of The Risk Of Owning Company Stock In Light Of Subprime And CDO Exposure

Employee plaintiffs are lining up to sue the major brokerage firms over losses in company stock.  A number of proposed class actions have been filed against Citigroup, Merrill Lynch and Morgan Stanley.

According to the lawsuits, the companies made inadequate disclosures about their subprime and collateralized-debt-obligation exposure.  The suits allege that by including company stock in 401(k) and other savings plans, and encouraging employees to buy shares, the firms violated their fiduciary duties to participants under ERISA.

The suits cover the firms' 401(k) plans, other savings plans and employee stock option programs.  The claims don't involve deferred-compensation plans for brokers.  Deferred-pay plans for producers also hold substantial amounts of stock. 

The suits - all fairly similar - run down a long list of alleged violations by the firms and plan administrators.  They claim that executives and board members who oversaw the retirement plans knew that the companies were in trouble from CDO and subprime losses but failed to make adequate disclosures to plan participants. 

Plan fiduciaries have a number of avenues to reduce risk to participants, such as encouraging diversification and withdrawing or limiting company stock as an investment option.  Officials and board members of the companies didn't want to suspend employee purchases of stock, according to the lawsuits, because their compensation relied on maintaining a high stock price.

One of the cases against Citigroup acknowledges that Section 404(c) of ERISA, which eliminates liability for poor performance if participants have adequate investment choices, could be a defense.  However, the plaintiff's attorney states, "Our argument would be [that 404(c)] only applies when participants are given full disclosure."

SNSFE continues to investigate claims regarding 401(k) and other savings plans.

Source:  InvestmentNews