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Monthly Archives: December 2012

The Potential Risks of Short-Term Bond Funds

Got short-term bonds? For a growing number of investors, the answer is “yes.” And that could be a problem in the making.

As reported Dec. 28 by the Wall Street Journal, more short-term bond funds are loading up on riskier securities lately. The 95 short-term bond funds tracked by Morningstar have increased their average exposure to high-yield “junk” bonds – as well as other securities rated below investment grade – to 6.4% of total assets this year from 5.8% in 2009 and 3.7% in 2008.

One warning sign regarding short-term bonds concerns the annual yield and if it is much greater than the category’s average of 2%, according to the WSJ article. Generally, funds yielding more than double that amount are likely to have a higher exposure to lower-grade investments.

During the 2008  financial crisis, several short-term bond funds that had previously been posting good returns but held large positions in bonds with poor credit quality suffered as much as a 25% drop in value as a result of the economic downturn, said Craig McCann, president of the Securities Litigation & Consulting Group, in the Wall Street Journal story.

“The highest-performing funds are also the most risky ones,” McCann said. “It just might not be apparent to investors right away.”

Experts advise investors to do their homework before investing in short-term funds – and that means thoroughly researching a fund’s holdings, investigating the fund’s marketing literature and even reviewing filings with the Securities and Exchange Commission (SEC).

One key piece of information to know concerns the yield and from where it is coming. Like many investments, if it’s too good to be true, it probably is.

Says the WSJ story: “If a fund does have a large position in higher-yielding or lower-rated securities, investors should make sure they know which individual bonds the fund is buying – as well as its total exposure to each type of bond and its rating – before determining whether the risk is manageable.”

2012: A Year in Review, Part 1

Non-traded REITs. Elder fraud. LPL Financial. Medical Capital Holdings. Tim Durham. Provident Royalties. Tenant-in-Common investments. Those were just a few of the investment topics to dominate the financial headlines in 2012.

In January, elderly investors found themselves caught up in scams involving Provident Royalties and Medical Capital Holdings. Both firms had previously been the subject of fraud charges by Securities and Exchange Commission (SEC) for scamming investors, many of whom were senior citizens, out of millions of dollars through bogus private placement deals.

A number of broker/dealers that sold investments in either Provident or Medical Capital found themselves facing regulatory investigations, as well as arbitration claims by investors. In late January, the Financial Industry Regulatory Authority (FINRA) ordered CapWest Securities to pay $9.1 million in damages and legal fees stemming from sales of private investments in both Medical Capital and Provident Royalties. The $9.1 million award is thought to be one of the single largest arbitration awards based on sales of failed private placements.

In February, tenant-in-common (TIC) investments and DBSI were big news. A one-time leader in the TIC industry, DBSI was now the focus of a criminal probe. DBSI founder and CEO Doug Swenson also faced charges of tax evasion, money laundering, racketeering and securities fraud.

DBSI, which filed for bankruptcy protection in 2008, left many of its 10,000-plus investors minus their life savings, while others took devestating financial losses. James Zazzaili, the court-appointed examiner in DBSI’s bankruptcy, stated that DBSI executives ran “an elaborate shell game, one that included improper and fraudulent use of investor money to prop up the company, to spend on pet projects, and to enrich themselves.”

In March, investors in several non-traded real estate investment trusts (REITs) received an unwelcome wake-up call when their investments unexpectedly declined sharply in value. Pacific Cornerstone Core Properties REIT fell by than 70%; investors in the non-traded REIT learned of the news via a letter from the REIT’s chairman that shares of Cornerstone, once priced at $8, were now worth $2.25.

Other REITs that followed down similar paths Cornerstone in 2012 included the Behringer Harvard Short-Term Opportunity Fund I LP and the Behringer Harvard Opportunity REIT I.

In April, shoddy private placements deals and the lawsuits that later ensued were behind the shuttering of yet another broker/dealer. On April 13, after losing an arbitration claim in March for $1.5 million, Cambridge Legacy Securities LLC filed its withdrawal request with FINRA. Several days later, the company sought bankruptcy protection.

April also witnessed the less-than-desirable IPO of Inland Western REIT. The REIT, now called Retail Properties of America, went public at $8 a share on April 5. The $8 per share price fell well below the expected price of $10 to $12. But that $8 valuation was the result of a 10-to-1 reverse stock split and distribution plan that may have cost pre-IPO investors as much as 70% of their initial investment.

In May, non-traded REITs again reared their ugly head when a FINRA arbitration panel ruled in favor of an investor’s claim against David Lerner Associates and the company’s Apple REIT Nine. FINRA further stepped up its scrutiny of the non-traded REIT sector in May by launching inquiries into several broker/dealers and their sales of the products.

In June, the SEC put life insurers on notice by instructing them to improve their product disclosures, protect legacy variable annuity clients and ensure that swapped benefits were indeed suitable for certain clients.

Investment scams involving financial aid, health insurance and Ponzi schemes also saw significant increases across the country in June.

Check back for Part 2 of our 2012 Year in Review wrap-up!

Morgan Stanley Fined $5M Over Handling of Facebook IPO

Fallout from its management of Facebook’s initial public offering continues to haunt Morgan Stanley. Today, Massachusetts Secretary of the Commonwealth William Galvin fined the investment bank $5 million for violating securities laws governing how investment research can be distributed.

Galvin accused Morgan Stanley – the lead underwriter for Facebook’s initial public offering – of improperly influencing the IPO process.

As reported Dec. 17 by the New York Times, a consent order alleges that an unnamed senior investment banker at Morgan Stanley coached Facebook on how to share information with stock analysts covering the social media company, a potential violation of a landmark Wall Street settlement in 2003. Those actions put ordinary investors who did not have access to the research at a disadvantage.

In agreeing to the $5 million fine, Morgan Stanley did not admit to any wrongdoing.

Facebook’s initial public offering was one of the most highly anticipated stock launches of the past decade. The tide quickly turned, however, with the stock’s first day of trading plagued with problems. Shares of Facebook fell below its $38 offering price and continued to struggle in the months that followed. At one point, the stock was as low as $17.55. It’s currently trading at $26.70.

Meanwhile, in a press statement, Galvin called Morgan Stanley’s “improper influence” “yet another example of an unlevel playing field, whereMain Street investors are put at a significant disadvantage to Wall Street.”

Wells Timberland Investors See Share Value Plunge 35%

The non-traded real estate investment trust known as the Wells Timberland REIT recently lowered its stock valuation by 35% to $6.56 per share. When shares of the REIT were offered to the public in 2006, the price was $10 a share.

As reported Dec. 17 by Investment News, the company blames the REIT’s 35% drop in value on the economic downturn and continued problems in the housing industry.

Wells Timberland REIT is sponsored by Wells Real Estate Funds, one of the biggest players in the non-traded REIT industry. According to Wells’ corporate Web site, the company has invested more than $11 billion in real estate for more than 300,000 investors.

As noted in a letter sent to stockholders last week by Wells President Leo Wells III, the $6.56 estimate for common shares was based on information as of Sept. 30. However, investors in the Wells Timberland REIT might find it hard to actually get that price in the market based on the illiquid nature of non-traded REITs.

Last October, the trust suspended redemptions of shares until the new estimate of share values was completed. Beginning in January, shareholders should theoretically be able to redeem shares for 95% of the estimated value – or $6.23. The REIT, however, funds redemptions out of its “distribution reinvestment plan,” and because it has made no cash distributions, it also has not made any ordinary share redemptions, according to the Investment News article.



LPL In Hot Water With Regulator Over Non-Traded REIT Sales

It’s more bad news for non-traded real estate investment trusts (REITs) and the broker/dealer firms that market and sell them to investors. Yesterday, Massachusetts securities regulators filed a complaint against LPL Financial, charging the B-D of failing to supervise registered reps who sold the non-traded REITs in violation of both state limitations and the company’s rules.

As reported Dec. 12 by Investment News, the charges stem from sales of $28 million of non-traded REITs to almost 600 Massachusetts clients from 2006 to 2009. Nearly all of the transactions in question violated state securities regulations or LPL’s own compliance practices, the Massachusetts Securities Division says.

Secretary of the Commonwealth William Galvin also charged LPL with dishonest and unethical business practices. He is seeking restitution to investors who bought the REITs, a fine and other sanctions, according to the complaint.

LPL reps sold $28 million in investments in non-traded REITs and collected about $1.8 million in fees as a result, Galvin’s office alleges.

“Non-traded REITs present risks to investors,” Galvin said in a statement. “Massachusetts recognizes those risks and requires limits on an investors’ exposure to the high fees, potential illiquidity, and risky nature of non-traded REIT products.”

REITs own and manage income-producing property or are involved in real estate financing.  Non-traded REITs are more difficult to get one’s money out of, and tend to carry high fees and commissions, Galvin said.

Of the REITs listed in the complaint, the largest amount of sales was for Inland American Real Estate Trust. Inland American is the biggest non-traded REIT in the industry, with more than $11 billion in real estate assets. Massachusetts investors put more than $20 million in Inland American, which currently is the focus of a probe by the Securities and Exchange Commission (SEC).

LPL calls Galvin’s claims “substantially overstated.”


FINRA Investigates B-Ds That Sold Variable Annuities With Investments in Hedge Funds

After clients saw $18 million in financial losses tied to variable annuities with subaccounts invested in hedge funds, the Financial Industry Regulatory Authority (FINRA) wants answers from the broker/dealers behind the sales.

As reported Dec. 5 by Investment News, the variable annuity was issued by Sun Life Financial Inc., while the two hedge funds were the Foresee Strategies Insurance Fund and the Foresee Strategies 3(c)(1) Insurance Fund LP. Both funds were related to a group called the SALI Multi-Series Fund LP.

The broker/dealers facing FINRA arbitration complaints from investors regarding the Sun Life annuities include: Geneos Wealth Management Inc., Lincoln Financial Network, National Planning Corp., SagePoint Financial Inc. and FSC Securities Corp.

Another broker/dealer that sold the product reportedly has been shut down.

Last week, a FINRA arbitration panel issued a $284,000 award to a SagePoint client, Phillip Sherrill, who filed a claim against the firm one year ago. In his complaint, Sherrill alleged actions of unsuitability, common law fraud, breach of fiduciary duty and negligence related to investments in the SALI Multi-Series Fund and the SALI Multi-Series Fund 3(c) (1) LP.

Hedge Fund Advertising: Opening Door to Investor Fraud?

Could a potential door for investment fraud be opening in the near future courtesy of the Jumpstart Our Business Startups (JOBS) Act? That very well may be the case unless the Securities and Exchange Commission (SEC) intervenes and comes up with new regulations to protect investors.

The JOBS Act was signed into law in April, with the idea to make it easier for small companies to raise capital. The law also allows private placements and hedge funds to advertise, for the first time, their products to the public.

As reported Dec. 4 by Bloomberg, the JOBS Act essentially means underperforming hedge funds can now market themselves with no serious restrictions or regulations regarding what they say or to whom they say it. In other words, some funds could easily tout themselves on the “airwaves, on websites and in the pages of the financial press to unsophisticated investors eager to get the same fabulous returns as the Wall Street elite,” the Bloomberg article said.

The potential risks to hedge-fund investors are considerable given the fact that the funds lack transparency, are extremely opaque and entail a compensation structure that encourages managers to bet big in order to claim their share of profits.

Moreover, many hedge funds hold thinly traded or illiquid investments, so investors are unable to easily withdraw their money.

The bottom line: Allowing hedge-fund advertising with no oversight attached does little to promote investor confidence in Wall Street. Indeed, it does the opposite.

Victims Speak Out in Tim Durham Fraud Case

Five thousand victims, 50 years in prison. That’s what it came down to when a federal judge sentenced Indianapolis businessman and owner of Ohio-based Fair Finance Tim Durham to 50 years in prison for swindling investors out of $250 million.

Durham was convicted of using investors’ life savings to fund his own lavish lifestyle, which consisted of classic cars, mansions in California and Indiana, luxury gambling trips and other extravagant items. On Nov. 30, Durham and the judge responsible for determining his fate heard from several former clients who once trusted Durham with their life savings.

U.S. District Judge Jane Magnus-Stinson received more than 1,000 letters from investors of Fair Finance. One of the investors was Jane Kalina, who told the court that her father had invested everything with Durham’s company – only to lose his life savings of $170,000.

“My father’s been a farmer for many, many years and as soon as he had his farm paid off, he started investing in Fair Finance. When he sold the farm, he put some of that money in, too. Basically this is his life savings. He’s been devastated. He has no retirement, no 401(k) and this is his life savings for him and my mother,” said Kalina.

Then there’s 74-year-old Barbara Lukacik, an Ohio nun who lost more than $125,000 to Durham’s scam.

In speaking to the court, the 74-year-old looked Durham squarely in the face and said: “Shame on you!”

Two of Durham’s co-conspirators also learned their fate on Nov. 30. Fair Finance co-owner James Cochran was sentenced to 25 years in prison, while Rick Snow was sentenced to 10.

“Mr. Durham will never spend another day of his life in anything other than a federal prison,” said Joe Hogsett, U.S attorney, following Friday’s hearing.

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