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Monthly Archives: September 2010

Financial Fraud Cases Against Broker/Dealers On The Rise

Financial fraud is growing, and more broker/dealers are at the center of the scams. According to data from the Securities and Exchange Commission (SEC), the number of cases brought by the regulator involving broker/dealers rose significantly last year.

In 2009, 16% of the financial fraud cases generated by the SEC involved broker/dealers, compared with 9% in 2008. In 2007, 14% of cases involved broker/dealers.

The percentage of cases involving securities offerings also escalated last year – to 21% from 18% in 2008.

Is Your Bond Fund Really Safe?

Investors’ once-safe bond funds may not be so safe anymore. That’s because the research firms responsible for assessing the safety of bonds have changed their methodology as of Sept. 1. For many investors, the move means that the investment-grade bond fund they thought they were investing in could now have a credit risk similar to a junk-bond fund.

Before the change, research firms like Morningstar determined the safety of bond funds on the credit ratings issued by rating agencies like Moody’s or Standard and Poor’s. The new methodology is based on default risk.

As reported Sept. 27 by the Wall Street Journal, more than half of the domestic taxable bond funds tracked by Morningstar saw their average credit-quality ratings fall under the new methodology. About 43% of bond funds fell by one credit grade and about 13% dropped by two credit grades, according to the Wall Street Journal article.

Several bond funds, including Federated Real Return Bond Fund, Cavanal Hill Intermediate Bond Fund, Neuberger Berman Short Duration Bond Fund and TCW Short Term Bond Fund, dropped by even more. In some instances, the funds fell to non-investment-grade ratings, such as BB, from investment-grade ratings of AA.

The new methodology comes on the heels of research from Securities Litigation & Consulting Group, a consulting firm that provides expert witnesses to regulators, law firms, banks and brokerages. The company’s study, published in November 2009, revealed that the mutual fund industry often reported average credit-quality ratings that were at least one whole letter credit-rating higher than the portfolios’ true credit risk.

According to Craig McCann, one of the study’s authors, Morningstar’s change is likely to “have a significant impact on bond portfolios that spread out their credit quality.”

FINRA Sides With Investor In Fidelity Case

Fidelity Brokerages Services LLC has been ordered to pay $110,000 to an elderly client whose account suffered major losses because it was repeatedly shuffled from agent to agent.

According to an arbitration panel of the Financial Industry Regulatory Authority (FINRA), the claimant in the case, Viola McNeill, 79, had a $700,000 account in Fidelity’s Portfolio Advisory Services (PAS) fee-based management program. In 2007, brokers at Fidelity recommended that McNeill convert her retirement and brokerage accounts into the fee-based account. She agreed, stating her investment objectives as preservation of capital and income.

As reported Sept. 24 by Investment News, McNeill suffers from Parkinson’s disease. Her PAS portfolio was weighted 60% stocks to 40% to fixed income. However, when her account was shuffled between various Fidelity brokers the allocation was never altered.

In 2009, McNeil became aware that her accounts had lost more money than she was withdrawing for living expenses, according to the Investment News article.

Ponzi Scheme Operator Brad Eisner Gets Probation

Justice was blind recently when it came to sentencing a broker who defrauded investors out of more than $66 million. New York broker Bradley D. Eisner received five years’ probation for his role in a Ponzi scheme that convinced investors they were putting money in a foreign-exchange market when, in reality, the funds were being spent by Eisner and his business partner, Michael R. MacCaull.

The court apparently showed leniency toward Eisner because he turned himself in 2008 and began cooperating with the government. MacCaull, in the other hand, was sentenced to 15 years and eight months in prison in March.

As reported Sept. 20 by Bloomberg, Eisner and MacCaull operated their scam from January 2001 to January 2008.

At MacCaull’s sentencing, MacCaull called Eisner the mastermind of their Ponzi scheme and the one who benefited the most financially. According to MacCaull, Eisner kept the majority of the more than $110 million that their company, Razor FX, stole from investors. Prosecutors say both men used investors’ funds for their personal use, buying lavish homes, cars, and artworks by Picasso and Willem De Kooning.

To conceal the scheme, MacCaull and Eisner created fake customer account statements and returned tens of millions of dollars to investors with money from new ones. Both men must pay back $66.3 million to their victims.

According to prosecutors, a total of 272 investors found themselves victims of MacCaull and Eisner’s scheme. Two of those individuals were David B. Dringman and Evi Remp- Dringman.

“We lost our future financial security to Mr. Eisner, the public face of Razor FX,” said David B. Dringman and Evi Remp-Dringman, in the Bloomberg article. “Ultimately we were forced to make the decision to sell our home in California that we had hoped to keep for our future.”

Leveraged, Inverse ETFs Back In News

Concerns about the suitability of leveraged, inverse exchange-traded funds (ETFs) for individual investors may cause Morningstar to stop its 1-to-5 rating of the products. The company may remove the ETFs from broader fund categories altogether and instead place them in a separate group, according to a Sept. 20 story in Bloomberg.

The reason for the possible change is that the ratings are designed for investment vehicles, and leveraged ETFs are trading vehicles. The products use derivatives and debt to amplify the returns of a market index, while inverse funds profit from declines in an underlying benchmark.

In an effort to determine whether investors needed additional protections regarding leveraged ETFs, the Securities and Exchange Commission (SEC) stopped approving new ETFs that made significant use of derivatives in March. Several months later, both the SEC and the Financial Industry Regulatory Authority (FINRA) issued a notice to investors on leveraged ETFs.

Among other things, the regulators cautioned investors about the products and stated that they may be inappropriate for long-term investors because returns can potentially deviate from underlying indexes when held for longer than a trading day.

Behringer Harvard REIT I A Blow To Investors

Behringer Harvard REIT I, which raised $2.9 billion from its 2003 launch to the end of its final offering in December 2008, has reduced its share value as of May 17 to $4.25, plus cut its annualized dividend rate to 1%, according to a regulatory filing. For countless investors, this revaluation has been a crushing blow financially.

Nontraded real estate investment trusts (REITs) are now capturing the attention of regulators, who want to know exactly what brokers did and did not disclose to investors about the products. In March 2009, the Financial Industry Regulatory Authority (FINRA) officially opened an investigation into nontraded REITs with an examination of documentation and data from various brokers who sell the investments.

Among other things, FINRA’s focus is on whether the sales were suitable and whether the firms made misleading statements to investors regarding fees, dividends and liquidity.

As reported June 1 by Bloomberg, nontraded REITs often appeal to unsophisticated investors who may not understand the extent of risks that the products present. Those risks can include huge broker fees and commissions, unexpected share devaluation, dividend cuts and suspension of buyback programs.

Many investors with nontraded REITs have experienced significant financial losses because of the fraudulent representations made by their broker. Specifically, investors who’ve filed arbitration claims allege that the products were presented as low risk and that critical information was never disclosed.

Behringer Harvard REIT I and Inland Western Retail Real Estate Trust are among a number of nontraded REITs that have reduced dividends to shareholders in the past year. Other firms such as Cole Credit Property Trust II, Hines Real Estate Investment Trust Inc. and Wells Real Estate Investment Trust II suspended or limited redemptions this year and in 2009.

Maddox Hargett & Caruso currently is investigating sales of nontraded REITs on behalf of investors. If you believe your broker/dealer or financial adviser misrepresented the facts concerning a nontraded REIT, please Contact Us.

Behringer Harvard, Other REITs = Financial Disaster For Many Investors

Highly leveraged REITs like Behringer Harvard REIT I, Inland Western Retail Real Estate Trust and others have produced hundreds of thousands of dollars in losses for investors in the past year. As non-traded REITs, the products are not listed on an exchange; they also come with high commissions and fees. Many investors bought into non-traded REITs based on their broker’s sales pitches, which touted steady dividends and a stock price that wouldn’t fluctuate with the market.

That didn’t happen, however. Instead, investors like Robert and Davida Wendorf lost big. As reported June 1 by Bloomberg, the Wendorfs invested $100,000 in 2004 in Inland Western Retail Real Estate Trust. In 2009, Inland cut its payout by 70%. Prior to that, the company had suspended a program under which the Wendorfs could have sold back their shares at the same $10 apiece they initially paid. By the end of 2009, however, the company had reset the stock price to $6.85.

“You can say I was stupid,” said Robert Wendorf, 69, a retired psychotherapist in San Juan Capistrano, California, in the Bloomberg article. “In all honesty you don’t think people sit down and really read all of those papers? Most people do what I did. They trust the guy as he points where to sign.”

The Wendorfs eventually sold their shares in Inland Western at a $45,000 loss.

Regulators are now taking a closer look at the brokers who sell unlisted REITs – which have raised nearly $60 billion since 2000. Specifically, regulators want to know if investors are being properly informed about the products at the time they buy into them.

Maddox Hargett & Caruso is investigating sales of non-traded REITs on behalf of investors. If you believe your broker/dealer or financial adviser misrepresented the facts concerning non-traded REITs, please Contact Us.

Lehman’s Funds of Funds Accounting Under Scrutiny

The Security and Exchange Commission’s investigation into the collapse of Lehman Brothers Holdings is gaining momentum and, specifically, into the accounting practices that the company allegedly used to give the appearance of a robust financial picture.

As reported Sept. 10 by the Wall Street Journal, Lehman’s method of accounting was denounced in March as “misleading” by a court-appointed examiner. The practice, known as Repo 105, allowed Lehman to shift as much as $50 billion in assets off of its balance sheets. In using Repo 105, Lehman was able to give the appearance, albeit a false one, that it had reduced its debt levels.

Meanwhile, Lehman allegedly never told its board, regulators or even investors about Repo 105.

According to the Wall Street Journal article, questionable accounting isn’t Lehman’s only problem. The SEC also is reportedly looking into whether former Lehman executives failed to adequately mark down the value of a real-estate portfolio acquired during the firm’s takeover of apartment developer Archstone-Smith Trust or to disclose the resulting losses to investors.


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