Overconcentration in certain preferred stocks has devastated the portfolios of thousands of investors. Problems first began when already fiscally troubled companies such as Fannie Mae (FNM), Freddie Mac (FRE), Lehman Brothers (LEH) and Citigroup (C) issued shares of preferred stocks as a way to raise capital. In turn, a number of brokerage firms marketed the preferred stocks of these companies and the preferred shares of other companies in the banking, insurance and financial sectors as safe and stable investments for income-minded investors, causing investors to over-concentrate their portfolios.
Diversification is the No. 1 rule of investing. When an investor places his or her money into one asset class or market sector, the potential for increased and unnecessary risk of loss goes up dramatically. In the case of certain preferred shares, many brokers failed to disclose not only the potential risks associated with the investments but also failed to provide an accurate picture of the financial health of the issuing companies. In reality, many of these companies were in dire financial straits, having already taken huge financial hits on their balance sheets as a result of losses connected to the mortgage meltdown.
A preferred stock essentially is a security issued by companies to raise capital from investors. The advantage of owning a preferred stock is it pays fixed dividends. Banks and other financial institutions are among the main issuers of preferred stocks, accounting for approximately 80% of the S&P U.S. Preferred Stock Index.
In the past year, however, when share prices of preferred stocks suffered massive losses because of the health of the issuing companies, investors quickly discovered that their preferred shares were not working out as planned. Case in point: Fannie Mae, Freddie Mac and Citigroup.
All three companies were forced to seek financial bailouts from the federal government in order to stabilize their business. This in turn caused the price of their preferred stock to plummet. In other cases, such as with Lehman Brothers Holdings, the company’s financial health was beyond repair, making bankruptcy the only option. As a result, preferred stock holders were left with millions of dollars in investment losses.
On April 9, 2009, a class action lawsuit was filed on behalf of purchasers of Citigroup’s 8.50% Non-Cumulative Preferred Stock, Series F. Among the allegations, the complaint alleges that when Citigroup announced its May 2008 offering of the Preferred Stock, it did so with a false and misleading Registration Statement and Prospectus. Once the offering was complete, Citigroup announced billions of dollars in write-downs because of exposure to debt securities. Investors holding Citigroup’s preferred stock subsequently watched the share prices of their investment fall dramatically.
Preferred shares in Fannie Mae and Freddie Mac also have caused financial devastation for preferred shareholders. On Sept. 8, a mountain of losses forced both companies into a government conservatorship run by the Federal Housing Finance Agency. The government’s seizure of the two lenders essentially wiped out any value that common and preferred stockholders had in the two companies.
Many preferred shareholders in Fannie Mae and Freddie Mac had been told that the risk of investing in either company was minimal, prompting them to over-concentrate their holdings in the companies. When the government’s takeover was announced, they watched helplessly as large percentages of their investments essentially vanished overnight.
Brokers have a fiduciary duty to recommend investments that are within a client’s risk tolerance. They also must provide accurate, material facts regarding those investments. When this duty is breached, investors have the right to hold them accountable by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).
If you are a preferred shareholder who suffered investment losses because a brokerage or financial advisor misrepresented the risks of certain preferred stocks, please contact us. We want to hear your story, and advise you of your legal rights.