Investor Lawyers Blog

The Volcker Rule May Already Be Affecting Financial Markets & The Economy

Published on: December 17, 2013 | by Shepherd Smith Edwards & Kantas, LLP

According to The Wall Street Journal, it’s just been a week since regulators approved the Volcker Rule and already investors and financial institutions are looking for new ways to finance municipal bond investments. The Volcker rule limits how much risk federally insured depository institutions can take, prohibiting proprietary trading, setting up obstacles for banks that take part in market timing, and tightening up on compensation agreements that used to serve as incentive for high-risk trading.

Now, says Forbes, Wall Street and its firms are undoubtedly trying to figure out how to get around the rule via loopholes, exemptions, new ways of interpreting the rule, etc. (One reason for this may be that how much executives are paid is dependent upon the amount they make from speculative trading.) The publication says that banks are worried that the Volcker Rule could cost them billions of dollars.

For example, with tender-option bond transactions, hedge funds, banks, and others employ short-terming borrowings to pay for long-term muni bonds. The intention is to make money off of the difference in interest they pay lenders and what they make on the bonds. While tender-option bonds make up just a small section of the $3.7 trillion muni debt market, it includes debt that has been popular with Eaton Vance (EV), Oppenheimer Funds, and others.

Merrill Lynch Settles with SEC Over CDO Disclosures for Almost $132M

Published on: December 16, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission says that Merrill Lynch Pierce Fenner & Smith Inc. (MER) will pay $131.8M to settle charges involving allegedly faulty derivatives disclosures. The regulator claims that the firm, which is the largest broker-dealer by client assets, misled investors about certain structured debt products before the economic crisis. By settling, Merrill is not denying or agreeing to the allegations. Also, the brokerage firm was quick to note that the matter for dispute occurred before Bank of America (BAC) acquired it.

According to the Commission, in 2006 and 2007 Merrill Lynch did not tell investors that Magnetar Capital impacted the choice of collateral that was behind specific debt products. The hedge fund purportedly hedged stock positions by shorting against Norma CDO I Ltd. and Octans I CDO Ltd., which are two collateral debt obligations that the firm was selling to customers.

The SEC contends that Merrill used misleading collateral to market these CDO investments. According to Division of Enforcement co-director George Canellos, the materials depicted an independent process for choosing collateral that benefited long-term debt investors and customers did not know about the role Magnetar Capital was playing to choose the underlying portfolios.

Moody’s Reassessment of Puerto Rico Bonds Does Nothing to Relieve Investor Worries

Published on: December 14, 2013 | by Shepherd Smith Edwards & Kantas, LLP

One day after Moody’s Investor Service placed Puerto Rico’s general obligation bonds rating of Baa3 on review for downgrade to junk status, the credit rating agency affirmed the ratings it had earlier in the year given four banks: Banco Santander Puerto Rico, Popular Inc. and its subsidiaries, FirstBank Puerto Rico, and Doral Financial Corporation, as well as the ratings for senior bonds put out by Doral Financial and Banco Santander Puerto Rico through the Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority. The ratings outlook for First Bank, Popular, and Doral Financial stayed negative, as did Banco Santander Puerto Rico’s BFSR/BCA. (However, the outlook on that bank’s supported deposit and debt ratings are stable due to the bank’s affiliation with Santander Bank NA, which is a US affiliate.)

Puerto Rico, which is a major municipal bond issuer, has been close to or in recession for nearly a decade and has over $70 billion in debt. Moody’s said it is worried about the territory’s growing dependence on outside short-term debt, “weakening liquidity,” limited market access, and its poor economy. The credit rater believes that the fiscal and economic challenges that the territory continues to face will keep threatening the “health of the banking system.” Noting that the banks’ non-performing assets continue to remain negative relative to banks in the US mainland, the agency said that this could result in more losses if things don’t get better.

Unfortunately, many investors who got involved in Puerto Rico muni bonds were not apprised of the risks or could have never handled the high risks to begin with. Some investors have lost their retirement or life savings as a result.

Fannie Mae Sues UBS, Bank of America, Credit Suisse, JPMorgan Chase, Citigroup, & Deutsche Bank, & Others for $800M Over Libor

Published on: December 14, 2013 | by Shepherd Smith Edwards & Kantas, LLP

Fannie Mae is suing nine banks over their alleged collusion in manipulating interest rates involving the London Interbank Offered Rate. The defendants are Bank of America (BAC), JPMorgan Chase (JPM), Credit Suisse, UBS (UBS), Deutsche Bank (DB), Citigroup (C), Royal Bank of Scotland, Barclays, & Rabobank. The US government controlled-mortgage company wants over $800M in damages.

Regulators here and in Europe have been looking into claims that a lot of banks manipulated Libor and other rate benchmarks to up their profits or seem more financially fit than they actually were. In its securities fraud lawsuit, Fannie Mae contends that the defendants made representations and promises regarding Libor’s legitimacy that were “false” and that this caused the mortgage company to suffer losses in mortgages, swaps, mortgage securities, and other transactions. Fannie May believes that its losses in interest-rate swaps alone were about $332 million.

UBS, Barclays, Rabobank, and Royal Bank of Scotland have already paid over $3.6 billion in fines to settle with regulators and the US Department of Justice to settle similar allegations. The banks admitted that they lowballed their Libor quotes during the 2008 economic crisis so they would come off as more creditworthy and healthier. Individual traders and brokers have also been charged.

Oppenheimer Told by FINRA to Pay $675,000 Fine, $246,000 Restitution over Municipal Securities Transaction Pricing, Supervisory Violations

Published on: December 12, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority says Oppenheimer & Co., Inc. (OPY) must pay a $675,000 fine purportedly charging customers unfair prices in municipal securities transactions and not having a proper supervisory system in place to detect such activities. The firm must pay $246,000 in restitution, in addition to interest, to customers that were affected. The SRO is ordering David Sirianni, the head municipal securities trader at Oppenheimer, to pay a $100,000 fine and serve a 60-day suspension.

According to FINRA, from 7/1/08 through 6/30/09, Oppenheimer, via Sirianni, charged 89 customer transactions at 5.01% to 15.57% over its contemporaneous cost. (The markup was over 9.4% in over 50 of these transactions). The SRO said that it was Sirianni’s job to decide what prices the customers paid for these transactions. He was the one who bought the municipal securities for Oppenheimer, kept them in inventory, and then resold them to Oppenheimer clients.

FINRA contends that Oppenheimer should have but did not notice that customers were being charged prices that were unfair. The regulator believes it is because the firm has an inadequate supervisory system and that personnel only depended on a surveillance report showing intra-day transactions when assessing whether municipal securities transactions were fairly priced. It said that from around 2005 through the middle of 2009, sales made to some Oppenheimer customers were not included in the report or reviewed for fair pricing.

Three Ex-GE Bankers Convicted of Municipal Bond Bid Rigging Are Set Free

Published on: December 12, 2013 | by Shepherd Smith Edwards & Kantas, LLP

In a 2-1 ruling, the U.S. Circuit Court of Appeals in New York panel has decided that three ex-General Electric Co. bankers charged with conspiring to bilk cities in a muni bond bid rigging scam can go free because the US government waited too long to prosecute them. Reversing last year’s convictions of Dominick Carollo, Steven Goldberg, and Peter Grimm, the court dismissed the criminal case against them and ordered that they be released from prison.

According to prosecutors, the three men worked with guaranteed investment contracts that allowed municipalities to make interest on money made from bond sales until they wanted to spend on local projects. The government believes that between August 1999 and May 2004 Carollo, Goldberg, and Grimm gave three brokers, including UBS PaineWebber, kickbacks to win actions for the contracts even if it meant the bank would make interest payments that were artificially low.

A federal jury convicted the former GE bankers of defrauding the country and conspiracy to commit wire fraud. They appealed, appealed, contending that the indictment on July 27, 2010 exceeded the statute of limitations, which is six years for conspiracy to bilk the US via tax law violations and five years for conspiracy. The government disagreed, arguing that the limitations’ statute went on as long as GE was paying rates that were not competitive.

FINRA Orders J.P. Turner to Pay $707,559 in Exchange-Traded Fund Restitution to 84 Clients

Published on: December 10, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority Inc. says that J.P. Turner & Co. has to pay restitution of $707,559 to 84 clients over the sale of inverse and leveraged ETFs that were unsuitable for them, as well as for excessive mutual fund switches. The SRO says that the broker-dealer did not set up and keep up a supervisory system that was reasonable but instead oversaw inverse and leveraged ETFs the same way it did traditional ones. It also accuses the financial firm of providing inadequate training regarding ETFs. By settling, J.P. Turner is not denying or admitting to the charges.

Leveraged and Inverse Exchange Traded-Funds

Inverse and leveraged ETFs “reset” every day. They are supposed to meet their objectives daily so their performance can rapidly diverge from that of the benchmark or underlying index. Unfortunately, even if long-term index performance exhibits a gain, investors can be susceptible to substantial losses. Markets, when they are volatile, can only exacerbate the situation. Also, leveraged and inverse ETFs are not suitable for all investors.

Volcker Rule is Approved by SEC, FDIC, Federal Reserve, CFTC, and OCC

Published on: December 10, 2013 | by Shepherd Smith Edwards & Kantas, LLP

Five regulatory agencies in the US have voted to approve the Volcker Rule. The measure establishes new hurdles for banks that engage in market timing and will limit compensation arrangements that previously provided incentive for high risk trading.

While the Federal Reserve Board and the Federal Deposit Insurance Corporation voted unanimously to approve the Volcker Rule, the Securities and Exchange Commission approved it in a 3-2 vote, the Commodity Futures Trading Commission approved it in a 3-1 vote, and the Office of the Comptroller of the Currency’s sole voting member also said yes. President Barack Obama praised the rule’s finalization. He believes it will improve accountability and create a safer financial system.

Named after ex-Federal Chairman Paul Volcker, the rule sets up guidelines that impose risk-taking limits for banks with federally insured deposits. It mandates that they show the way their hedging strategies are designed to function, as well as set up approval procedures for any diversions from these plans. Per the rule’s preamble, banks have to make sure hedges are geared to mitigate risks upon “inception” and this needs to be “based on analysis” regarding the appropriateness of strategies, hedging instruments, limits, techniques, as well as the correlation between the hedge and underlying risks.

Puerto Rico Reportedly Among Those that Engaged in “Scoop & Toss” Tactic with Municipal Bonds

Published on: December 7, 2013 | by Shepherd Smith Edwards & Kantas, LLP

According to The Wall Street Journal, Puerto Rico has been engaging in a budget-stretching maneuver, known as the “scoop & toss” for some time now. The tactic, which has been employed by financially strapped local governments, including states, municipalities and other entities for years, is now under closer examination.

Scoop and toss consists of selling new long-term debt to raise money to pay off bonds that are maturing. This lengthens the timetable for municipal bonds that are retiring. Such debt sales frequently provide interest rates that are above market. Many bond buyers can find this attractive, especially when the economy is growing slowly and rates on other bonds are low.

Now, however, observers are cautioning that refinancings using the scoop and toss approach is increasing interest costs and letting civic managers ignore structural economic problems. Meantime, the debt buyers end up taking on the risk that the securities could lose their worth. Critics of the scoop and toss describe it as a short-term solution and not a permanent one.

SEC Considers Imposing Proxy Adviser Rules

Published on: December 7, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The US Securities and Exchange Commission is looking at whether proxy advisers have become so influential when it comes to corporate elections that rules should be imposed in them to create greater transparency. At a recent SEC-hosted meeting, brokers, institutional investors, business groups, and unions debated about the role that proxy advisors Glass Lewis & Co. LLC and Institutional Shareholder Services Inc. have played in shareholder voting.

According to Bloomberg, research from non-profit organization Conference Board reports that with the growth in institutional investors’ percent of voting shares going up by over 50% there has been a growing demand for proxy research. However, there is concern by some that proxy advisors have a lot of power over the governance decisions of public companies yet they don’t have to contend with much Commission oversight. Critics think proxy advisors influence shareholders to vote blindly on proxy measures without getting disclosures about possible conflicts. Meantime, supporters of proxy advisors say that they provide an important service—especially to small institutional investors that lack the resources to assess every vote they make.

Mutual funds, pensions, and other mutual funds tend to be proxy advisers’ typical clients. SEC Commissioner Daniel Gallagher attributes proxy advisers’ “outsized role” to policy guidance issued by the agency in 2009 telling investment advisers they could fulfill an obligation to vote in the best interests of shareholders by depending on third party research.