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OppenheimerFunds will pay $35 million to settle charges by the Securities and Exchange Commission (SEC) that it failed to adequately inform investors about using derivatives to add leverage to the Oppenheimer Core Bond Fund (OPIGX) and the Oppenheimer Champion Income Fund (OPCHX).  

According to the SEC’s investigation, Oppenheimer used derivative instruments known as “total return swaps” to add substantial commercial mortgage-backed securities (CMBS) exposure in a high-yield bond fund called the Oppenheimer Champion Income Fund and an intermediate-term, investment-grade fund known as the Oppenheimer Core Bond Fund.

The 2008 prospectus for the Champion Fund, however, never sufficiently revealed the fund’s practice of assuming such leverage in using derivative instruments, the SEC said in a statement. And when declines in the CMBS market triggered large cash liabilities on the total return swap contracts in both funds and forced Oppenheimer to reduce CMBS exposure, Oppenheimer disseminated misleading statements about the funds’ losses and their recovery prospects.

“Mutual fund providers have an obligation to clearly and accurately convey the strategies and risks of the products they sell,” said Robert Khuzami, director of the SEC’s Division of Enforcement. “Candor, not wishful thinking, should drive communications with investors, particularly during times of market stress.”

The Oppenheimer Core Bond Fund lost nearly 40% in 2008, while the average intermediate-term-bond fund lost 5%. Later, the fund became the focus of several lawsuits because of its role in state Section 529 college savings plans. The suits were settled for an undisclosed amount last year.

Meanwhile, the Oppenheimer Champion Income Fund lost 78% of its value, more than 50 percentage points worse than the average high-yield-bond fund.

Elder fraud and abuse is a growing crime – and one that in recent months has garnered heightened scrutiny from securities regulators. Last week, the Financial Industry Regulatory Authority (FINRA) fined broker-dealer Brookstone Securities $1 million in connection to sales of risky tranches of collateralized mortgage obligations (CMOs) to elderly clients. The firm, its top executive and a broker also were ordered to pay $1.62 million in restitution to affected customers.

According to FINRA’s decision, Brookstone Securities made “fraudulent misrepresentation and omissions of material fact in selling complex, esoteric and risky tranches of [CMOs] to unsophisticated, elderly and retired investors.”

As part of the ruling, Brookstone’s owner, Antony Lee Turbeville, and a broker, Christopher Dean Kline, have been barred from working with a FINRA-registered broker/dealer.

In addition, Brookstone and Turbeville were jointly ordered to pay clients restitution of $440,600, while the firm and Kline were jointly ordered to pay $1,179,500.

Another Brookstone executive and minority owner, former chief compliance officer David Locy, was suspended from the securities industry for two years, barred from working as a supervisor in the future and fined $25,000.

Brookstone plans to appeal FINRA’s decision.

FINRA says that from July 2005 through July 2007, Turbeville and Kline intentionally made fraudulent misrepresentations and omissions to elderly and unsophisticated customers about the risks associated with investing in CMOs. All of the affected customers were retired investors looking for safer alternatives to equity investments.

Turbeville and Kline “preyed on their elderly customers’ greatest fears,” such as losing their assets to nursing homes and becoming destitute during their retirement and old age, in order to induce them to purchase unsuitable CMOs, FINRA said in announcing its decision against Brookstone.

By 2005, when interest rates began to rise and the negative effect of CMOs became evident to Turbeville and Kline, the men never explained the changing conditions to their customers, FINRA says. Instead, they led their clients to believe that the CMOs were “government-guaranteed bonds” and would preserve capital and generate returns of 10% to 15%.

During that two-year period, Brookstone made $492,500 in commissions on CMO bond transactions from seven customers who were named in a December 2009 complaint. Meanwhile, those same customers lost $1,620,100.

Two of Kline’s customers were elderly widows who had very limited investment knowledge. Following the death of their husbands, the women were convinced to invest their retirement savings in risky CMOs. FINRA says that Kline told the widows that they could not lose money in CMOs because they were government-guaranteed bonds, and Kline further increased their risk by trading on margin.

Low interest rates and a rebounding stock market have caused more investors to seek out a highly risky investing tool: The margin loan. As reported May 29 by the Wall Street Journal, margin accounts let investors borrow against the value of the securities held in their brokerage portfolios. While appealing, borrowing on margin can be a dangerous investing strategy.

Says the Wall Street Journal article:

“When investors put borrowed money in the stock market – the traditional use for margin loans – it magnifies gains and losses. For example, by borrowing $50,000 against a stock portfolio of $100,000, and investing it back in the market, an investor boosts potential returns by half. If the market climbs 10%, he gains $15,000 (minus the cost of interest on the loan), rather than $10,000. But the losses would be just as large if the stock dropped.”

Moreover, many investors are unaware that a brokerage firm or bank can sell their stocks and other securities at rock-bottom prices in order to satisfy a margin call, and they can do so without giving any notice to the investor. Indeed, in certain emergency situations, brokerages can cash out customers’ stocks with little or no notice to protect themselves.

Earlier this month, Green Mountain Coffee Roasters disclosed that founder Robert Stiller had sold $120 million worth of the company’s stock in a single day in order to meet a margin call. Green Mountain shares had plunged by nearly 50% to $25 from $50.

As of the end of March, margin accounts totaled more than $330 billion, according to the Financial Industry Regulatory Authority (FINRA). That’s a 65% increase since 2009.

The first in what may be a slew of similar decisions to follow in cases involving sales of non-traded Apple REITs by David Lerner Associates has been decided in favor of the claimants. As reported May 23 by Investment News, an arbitrator of the Financial Industry Regulatory Authority (FINRA) ordered Lerner to pay the claimants – Joseph Graziose and Florence Hechtel – $24,450 after they return their shares of Apple REIT Nine to the firm.

The claimants in the case alleged that David Lerner misrepresented the product in question when it was marketed, and that the broker was in breach of contract and fiduciary duty, among other charges. Apple REIT Nine is the 14th-largest non-traded REIT in the United States.

In addition, FINRA ordered Lerner Associates to reimburse the claimants for the $425 filing fee associated with their claim.

In May 2011, FINRA filed an enforcement action against David Lerner Associates over sales of Apple REITs. In February 2012, FINRA amended that filing with new allegations against Lerner’s firm. Specifically, the February amendment focused on statements that Lerner allegedly made to investors following the regulator’s actions against his company in May. According to FINRA, Lerner made misleading and exaggerated statements to investors during a seminar that his brokerage firm hosted, including statements suggesting that the closed Apple REITs were a potential “gold mine.”

As reported in a May 23 story in the Wall Street Journal, Lerner Associates is run by former municipal bond trader David Lerner. Known as “Poppy” in commercials featuring the Apple REITs, Lerner has sold around $6.8 billion of the products since 1992. The firm gets 10% in fees and commissions from the sales, which have generated approximately $600 million in total revenue for Lerner. In total, Apple REIT sales account for 60% to 70% of Lerner’s business since 1996.

The latest decision by FINRA could be a potentially worrisome sign for Lerner in the future. Hundreds of similar arbitration claims have been filed by investors in connection to sales of Apple REITs.

A number of non-traded real estate investment trusts (REITs) continue to be a losing investment for investors. Most recently, it’s been Inland Western Real Estate Trust to cause many investors to lose sleep.

In early April 2012, Inland Western went public at $8 a share. For investors who bought Inland Western at its original share price of $10 a decade ago, their investment is now worth approximately $2.90.

The dismal public debut of Inland Western (now renamed Retail Properties of America) doesn’t bode well for future IPOs of non-traded REITs.  As a retail investment, non-traded REITs have taken a beating in the financial media over the past year, with regulators – including the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) – launching repeated inquiries into the broker/dealers who sold the investments to investors.

In addition, FINRA has issued several investor notices on non-traded REITs. In those notices, FINRA highlights a number of concerns: the products’ limited valuation transparency, illiquidity, potential conflicts of interest, risks to an investor’s principal, and the high fees and commission they command.

If you’ve suffered significant losses in non-traded REITs, including Inland Western/Retail Properties of America, Inland American or Behringer Harvard REIT I, contact us to tell your story.

Investors who put their money into Inland Western REIT are just realizing the extent of losses they’ve actually suffered. That’s because the non-traded real estate investment trust (REIT) just went public, giving investors a first-time look at its true worth.

In April, the initial public offering price was set at $8 a share for the Inland Western REIT, now known as Retail Properties of America. The price was well below the expected $10 to $12 pre-offering price. Moreover, some highly complicated reverse-stock-split engineering was required to even reach the $8 mark.

For investors who initially purchased the investment at $10 share a decade ago, the split-adjusted value of their investment following the IPO is less than $3. In other words, those investors lost some 65% of their original investment.

In another unexplained move, Retail Properties decided to offer only a quarter of the shares during Inland Western’s initial public offering. Three follow-up stock sales are planned over the next 18 months.

After the IPO, company president and chief executive Steven Grimes stressed in a letter to shareholders the impact of the economic recession on the real estate industry.

“It is uncertain if and when we will see a full recovery,” he states in the letter.

If you’ve suffered losses in Inland Western/Retail Properties of America, tell us your story. Maddox Hargett & Caruso currently is investigating unsuitable sales of non-traded REITs, including Inland Western, Inland American and Behringer Harvard REIT I.

Inverse and leveraged exchange-traded funds (ETFs), which have faced ongoing scrutiny by regulators in recent months, are now garnering the attention of lawmakers on Capitol Hill.

As reported May 3 by Investment News, Sen. Jack Reed, D-R.I., chairman of the Senate Banking Subcommittee on Securities, Insurance and Investment, announced that he is continuing to monitor the complex financial products and plans to follow up on a hearing he held last year with another one in the near future.

Earlier this week, leveraged and inverse ETFs took center stage when the Financial Industry Regulatory Authority (FINRA) levied $9.1 million in penalties on four major banks – Citigroup Global Markets, Morgan Stanley & Co., UBS Financial Services and Wells Fargo Advisors – for their role in selling the risky investments to retail clients who, because of their conservative risk profiles, should never have purchased them.

According to FINRA, the brokerages failed to adequately educate their own representatives about the complexities – and inherent risks – of leveraged and inverse ETFs. The same representatives then marketed and sold the products to investors who were uneducated about the potential dangers that inverse and leveraged ETFs hold.

Exchange-traded funds are essentially baskets of investments – stocks, bonds, commodities, currencies and options – that track market indexes. In recent years, however, traditional ETFs have grown increasingly complex, delving into esoteric and risky areas that involve swaps, futures contracts and other derivative instruments.

Leveraged and inverse ETFs are two of the most risky ETFs. Leveraged ETFs are designed to deliver “multiples” on the performance of the index or benchmark they track. Its cousin, the inverse ETF, works in the reverse way by trying to deliver returns that are opposite of an index’s returns.

The problem that many investors make with leveraged and inverse ETFs is that they hold these investments for longer than one single trading day. Leveraged and inverse ETFs are not designed for long-term returns. Rather, their goal is to try and achieve their stated performance objectives on a daily basis. Holding a leveraged or inverse ETF for a longer period of time may result in a financial nightmare.

Several of the nation’s leading banks – including Citigroup, Morgan Stanley, UBS and Wells Fargo – were recently sanctioned by the Financial Industry Regulatory Authority (FINRA) for more than $9.1 million over their failure to supervise retail sales of leveraged and inverse exchange-traded funds (ETFs). In addition to supervisory failures, FINRA said the banks failed to have “a reasonable basis” for recommending the products to investors in the first place.

“The added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers,” said J. Bradley Bennett, FINRA enforcement chief, in a statement.

“Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products,” he added.

 The break-down of the fines is as follows: 

• Wells Fargo – $2.1 million fine and $641,489 in restitution;
• Citigroup – $2 million fine and $146,431 in restitution;
• Morgan Stanley – $1.75 million fine and $604,584 in restitution; and
• UBS – $1.5 million fine and $431,488 in restitution.

Both the Securities and Exchange Commission (SEC), the North American Securities Administrators Association and FINRA have issued separate and joint warnings to investors about leveraged and inverse exchange-traded funds in recent months. Specifically, regulators are concerned about the increasing complexity of the products, their lack of transparency and their potential to cause significant financial losses to investors who do not thoroughly understand how inverse and leveraged funds actually work.

Leveraged ETFs seek to deliver “multiples” of the performance of the index or benchmark they track. Inverse ETFs do the reverse. They try to deliver the opposite of the performance of the index or benchmark being tracked.

The past year has been a rocky roller coaster ride for many broker/dealers, as the fallout from soured private-placement deals in Medical Capital Holdings, Provident Royalties and DBSI Inc. caused more than 50 broker/dealers that sold those products to close up shop.

According to findings in a new report by the Compliance Department consulting group, 93 broker/dealers closed their doors during the first three months of 2012, while 137 B-Ds shut down in the first quarter of 2011. Meanwhile, fewer new B-Ds are opening.  Forty-four new broker/dealers opened in the first quarter of 2012, compared to 57 for the same time period in 2011.

As reported May 1 by Investment News, the Financial Industry Regulatory Authority (FINRA) shows 4,428 broker/dealers were open in March, compared to 5,005 in 2007. That’s an 11% decline over five years.

Many of the problems facing broker/dealers are the result of legal and regulatory issues over private-placement investments involving Medical Capital Holdings and Provident Royalties, as well as tenant-in-common exchanges manufactured by DBSI.

In July 2009, the Securities and Exchange Commission (SEC) charged both Medical Capital and Provident Royalties with fraud. On Nov. 8, 2010, DBSI filed for bankruptcy. Since then, many investors have filed arbitration claims with FINRA against the broker/dealers that sold them the failed products.

More recently, sales of private placements were responsible for the shuttering of broker/dealer Cambridge Legacy Securities LLC. On April 13, after losing a $1.5 million arbitration claim in March, Cambridge Legacy Securities filed its withdrawal request with FINRA.  A few days later, the firm sought bankruptcy protection.

Proponents of the Jump-Start Our Business Start-Ups, or JOBs Act, contend the legislation will create more jobs by increasing the number of initial public offerings. Critics, however, say the Act is a sure-fire path to more investment fraud.

Under the JOBS Act, regulations would be lessened for emerging growth companies. In loosening those regulations, the doors are opened wide for potential abuse by companies to pump up their financials in order to lure new investors.

The Act also allows something called crowd funding, which permits companies to raise up to $1 million via online solicitations. Another provision in the JOBS Act lessens regulatory oversight by the Securities and Exchange Commission (SEC) and removes certain restrictions designed to protect investors from financial abuse and fraud.

“That is tantamount to putting up a sign saying ‘Swindlers Welcome,’ says an April 5 story in the Huffington Post on the JOBS Act.

The bottom line: Everyone is in favor of creating more jobs and jumpstarting the economy. And while the JOBS Act may sound good on surface, when you peel back the layers, many troubling questions remain.