Investor Lawyers Blog

Seven Mutual Fund Horror Stories for Investors!

Published on: August 12, 2008 | by Shepherd Smith Edwards & Kantas, LLP

A recent Morningstar article outlines seven mutual fund horror stories. In addition to the Legg Mason Value Fund (symbol LMVTX) and Schwab YieldPlus Fund (symbol SWYPX) and the Regions Morgan Keegan funds, which are the subject of stories we have reported recently, several other hard-hit mutual funds are discussed.

For example, the Eaton Vance Greater India fund (symbol ETGIX) has lost over 44%! The article, found in the Morningstar Fund Investor’s “Annual Guide on Where Not to Invest”, reminds investors to be especially wary of international funds, particularly those focusing on securities issued in China and India.

Also mentioned in the report is the Kinetics Market Opportunities fund (symbol KMKNX) which has lost over 30% this year. While this same fund gained 34% the previous year, its very narrow focus made it particularly susceptible to volatility. Large holdings of NASDAQ, CME, NYSE, and Legg Mason caused the fund to plummet.

Mutual Funds Misrepresented as Safe: SSgA Yield Plus, Fidelity Ultra-Short Bond (FUSFX) & Regions Morgan Keegan Select High Income (MKHIX)

Published on: August 11, 2008 | by Shepherd Smith Edwards & Kantas, LLP

Just as auction rate securities were sold by most investment firms as safe alternatives to money market funds which paid a higher rate, so also were a number of mutual funds. Packaged and sold as ultra-short term bond funds and a safe haven for funds which were to be secure and assessable, many of these funds were really invested into high-risk and or potentially far from liquid assets.

Three of these funds are the SSgA Yield Plus fund, which was liquidated in June, the Fidelity Ultra-Short Bond (symbol: FUSFX), and Regions Morgan Keegan Select High Income (symbol MKHIX). All three, it has been learned, were actually actually “junk bond” funds. As problems in the credit markets surfaced over the past year, these funds have lost up to 80% of their value

The portfolios of these funds had structured debt instruments tied to subprime mortgages and other assets that do not trade frequently. This prevented the volatility of the assets from being properly reflected, consequently masking the risks of investing into the funds. The recent changes in the values have greatly altered the risk parameters, but too late for those invested in the funds who have sustained significant losses.

Connecticut Attorney General Sues Moody’s, McGraw Hill, & Fitch Over Municipal Bond Issues

Published on: August 10, 2008 | by Shepherd Smith Edwards & Kantas, LLP

Connecticut Attorney General Richard Blumenthal has filed a lawsuit against Fitch Inc., Moody’s Corp., and McGraw-Hill Companies. He is charging them with deliberately giving lower credit ratings to bonds issued by public entities, such as municipalities, in comparison to corporate and other kinds of debt.

Blumenthal says that by purposely giving artificially low credit ratings to municipalities, taxpayers have been forced to unnecessarily incur millions of dollars in higher interest rates and bond insurance. The lawsuit is part of a probe into bond insurers, credit rating agencies, and related entities and their potential violations, including those involving consumer protection and antitrust.

The Connecticut AG says that the state is holding the defendants responsible for “millions of dollars that have been illegally exacted from the state’s taxpayers.” The lawsuit, filed in coordination with Department of Consumer Protection (DCP) Commissioner Jerry Farrell, Jr., accuses the agencies of violating the Connecticut Unfair Trade Practices when they purposely left out or misrepresented material facts that lead bond issuers to buy bonds at higher interest rate.

Moody’s, Fitch, and McGraw Hill say they will combat the charges against them. McGraw-Hill, Standard & Poor’s parent company, claims that the state of Connecticut is using the lawsuit to dictate the kind of bond rate it gets. Moody says it will push to get the case dismissed.

The way that credit rating agencies deal with municipal bonds was addressed earlier this year in a letter sent to executives at Standard and Poor’s, Fitch, and Moody’s. Sent by the state treasurers of 11 US states, including Connecticut and California, and a number of municipal officials, the letter called on the firms to change their municipal bond rating system so it better reflects the bonds’ default risks. The treasurers say this would save municipalities billions of dollars in interest costs.

Read the Complaint (PDF)

Department of Consumer Protection, Ct.gov
Ct Ag Richard Blumenthal
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Securities Law Firm Shepherd Smith Edwards & Kantas LTD LLP Investigates Investor Claims Related to Short Term Bond Funds

Published on: August 9, 2008 | by Shepherd Smith Edwards & Kantas, LLP

SSEK law firm, which specializes in investor claims, is investigating compliants over the liquidity and security of so-called “ultra-short term” bond funds. Because these funds were sold as cash alternatives, any loss of principal is not acceptable. Recently, investors have experienced subtantial losses on a number of these funds, including:

SSgA (STATE STREET) Yield Plus Fund: Investors have accused this fund of violating Federal Securities laws. Usually considered a diversified portfolio with high quality credit and debt securities, and “sophisticated credit analysis” and decisions made by a team of investment professionals, the Fund was actually heavily invested in high-risk mortgage-related securities and mortgage backed securities.

Fidelity Ultra-Short Bond Fund: Investors claim that they were told the fund’s goal was to seek a high level of current income that was in line with preserving capital. The plaintiffs’ litigation, however, allege that such statements were misleading and false because the fund failed to properly disclose that it was heavily invested in high risk mortgage-backed securities.

Evergreen Ultra Short Bond Fund: According to recent litigation, investors bought shares because they were told that the fund’s investment goal was to “provide current income consistent with the preservation of capital and low principal fluctuation.” Statements such as these are now being called misleading and materially false because the fund used a high-risk strategy (which it did not reveal to investors) that resulted in realized losses of about 18%.

Charles Schwab YieldPlus Funds — Schwab YieldPlus Select, Schwab California Tax Free YieldPlus, Schwab YieldPlus: Charles Schwab has been accused of violating industry regulations and state securities laws when it allegedly mislead investors about the fund’s underlying risks. All three Schwab funds’ losses have been magnified by mass redemptions.

Oppenheimer Rochester National Municipals: Although not technically an ultra short term bond fund, this high-yield municipal bond can experience short-term volatility. These kinds of bonds are thinly traded and investors could suffer when the bonds are sold into an unreceptive marketplace.

Related Web Resources:

Shepherd Smith Edwards & Kantas LTD LLP Investigate Short Term Bond Funds, PrimeNewswire.com
Shepherd Smith Edwards & Kantas LTD LLP
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FINRA Pilot Program Offers Up All-Public Arbitration Panel to Hear Investor Claims

Published on: August 8, 2008 | by Shepherd Smith Edwards & Kantas, LLP

Citigroup Global, Merrill Lynch, Wachovia Securities, UBS, Charles Schwab, and Morgan Stanley have volunteered to participate in a Financial Industry Regulatory Authority pilot program that would allow investors to have their cases heard by a panel consisting of three public arbitrators. Currently, investors have the option of having their cases dealt with by a panel made up of two public arbitrators and one non-public arbitrator.

Investors that choose to participate in the pilot plan and the firm they have filed a claim against will be given the same three arbitrator lists that those involved in regular arbitration proceedings would receive. The parties can strike the same number of names from the lists and rank according to preference the names of arbitrators they are willing to have on the panel. Parties participating in the pilot can cross out the names of all non-public arbitrators.

Except for Charles Schwab, all of the firms will submit 40 arbitration cases annually for the duration of the two-year program. Schwab will refer 10. However, the decision of whether to avail of this new panel model will be left to the investor. The pilot is available for eligible claims filed after October 6.

The program’s results will be assessed, including who decides to participate in the pilot, who decides to avail of an all-public panel, the duration of the hearings, and the outcomes of both pilot and non-pilot claims. FINRA CEO Mary Shapiro says the pilot “better serves and protects the interests” of investors.

“This is really a political move,” says Securities Arbitration attorney WIlliam Shepherd. “An outcry from consumer advocates has resulted in a bill Congress to make ‘pre-dispute arbitration’ clauses in consumer contracts un-enforceable. Some lawmakers want investors to be included as consumers protected by the bill.

“Wall Street brokerage firms are lobbying hard to exempt themselves from this mandatory arbitration ban,” adds Shepherd. “Despite its name, FINRA is the former National Association of Securities Dealers, a non-profit corporation owned by brokerage firms. FINRA is attempting to show Congress it is willing to reform securities arbitration rather than end it. Doing away with the ‘industry arbitrator’ is one of the so-called reforms it is proposing.”

Related Web Resources:

Test Lets Investors Pick Form of Arbitration Panel, The Wall Street Journal, July 25, 2008
FINRA to Launch Pilot Program to Evaluate All-Public Arbitration Panels, BusinessWire.com, July 24, 2008
FINRA
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Pluris Valuation Survey Finds Auction-Rate Securities Write-Downs Totaling $2.1 Billion

Published on: August 7, 2008 | by Shepherd Smith Edwards & Kantas, LLP

In its most recent survey of auction-rate securities holders, Pluris Valuation Advisors LLC found that 281 out of 460 public companies have taken write-downs on auction-rate securities worth $2.1 billion (a total par value of $32.2 billion). However, the remaining 179 companies still have to file 10-Q second quarter reports, and Pluris estimates that approximately 100 more companies will take impairments this month.

The filings with write-downs have increased from 40% to about 80%. The increasing write-downs signify a definite trend, but there is no consistency in the size of discounts, which have ranged from 98% to close to 0.

The survey also provides information about write-downs by audit-firms. For example, Deloitte and Touche, LLP’s fraction with write-down was 77% with an average 7% discount, KPMG write-down was 80% with a 13%average discount, Ernst & Young’s fraction-write down was 83%, with a 12% average discount. PricewaterhouseCoopers average discount was 12% with a fraction with write-down of 93%.

Pluris Valuation Advisors says that overall, the data from the survey indicates that all holders have not realized the full impact resulting from the loss of liquidity of the auction-rate securities market.

Auction-Rate Securities
Auction-rate securities include corporate bonds, municipal bonds, and preferred stocks with interest rates or dividend yields that re-set periodically through auctions. Prior to the crisis in 2008, the ARS market grew to over $300 billion. Many investors were told that ARS were “equivalent to cash,” and have been dismayed that they have been unable to access their money since the market collapse. Continue Reading ›

Massachusetts Slaps Merrill Lynch with Auction-Rate Securities Fraud-Related Charges

Published on: August 4, 2008 | by Shepherd Smith Edwards & Kantas, LLP

The Massachusetts Secretary of the Commonwealth has filed securities fraud-related charges against Merrill Lynch for allegedly promoting the sale of auction rate securities while providing misleading information about market stability.

According to Secretary William Galvin, Merrill Lynch aggressively sold ARS to investors while telling research analysts to downplay market risks in its reports until the moment the company had to pull” the plug on its auctions.” The majority of auctions failed a day later. Galvin says that Merrill Lynch’s investors had no idea that potential trouble was brewing with their investments until it was too late for them to take action.

Galvin is also accusing Merrill Lynch of pressuring its research analysts, who are supposed to be neutral, into redacting or rewriting any reports that did not profile ARS positively. His complaint alleges that Merrill Lynch made approximately $90 million from the auction-rate securities market between 2006 and 2007. He wants Merrill Lynch to “make good” on the sales of the securities by making restitution to investors that sold their securities at below par.

Merrill Lynch issued a statement expressing disappointment that Massachusetts had filed its complaint. The company maintains that its advisers sold ARS because they thought that the securities would provide a higher return to investors.

Last week, Merrill Lynch said it would sell over $30 billion in toxic mortgage-related assets at a huge loss to help alleviate its own debt issues. A question to consider is whether Merrill Lynch, a large investment firm known for its powerhouse brand, can recoup its once solid reputation.

Related Web Resources:

Secretary Galvin Charges Merrill Lynch with Fraud in Auction Rate Securities Dealings (The Complaint)

Massachusetts sues Merrill Lynch over auction securities, USA Today, August 1, 2008
Merrill Lynch
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SEC Issues “ComplianceAlert Letter” Citing Common Weaknesses and Deficiencies of Registered Firms

Published on: July 29, 2008 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has issued a staff letter reporting on the “common weaknesses and deficiencies” shared by SEC-registered companies. The findings were based on examinations given to the firms.

The “ComplianceAlert Letter” is intended to provide key information, encourage compliance officer to address these issues, and foster “robust compliance” within the industry. The letter, the second one sent in as many years by the SEC, is sectioned into distinct areas focusing on broker-dealers, investment advisers/mutual funds, and transfer agents.

Among the deficiencies:

• Failure to comply with procedures and polices
• Questionable personal trading practices
• Proxy service provider issues • Proxy voting • Valuation and liquidity issues • “Free lunch” seminars
Examiners recently finished a review of a number of big broker-dealers to evaluate their “valuation and collateral management practices” and how these impact subprime mortgage-related products. The SEC examiners noted that it had become increasingly difficult for firms to confirm inventory valuations because of insufficient market liquidity.

Issues of concern included:

• Inadequate staff and supervisory procedures • Insufficient documentation standards
• Pricing inconsistencies
• Lack of margin call processes
The agency also expressed concern that transfer agents may be engaged in a conflict of interest because they receive a partial search fee related to the search process for “lost” security holders and using third-party search companies.

Related Web Resources:

Read the SEC ComplianceAlert, July 2008
SEC Compliance Alert Warns Investment Advisers on Ethics, Hedgeco.net Continue Reading ›

Auction-Rate Securities Crisis Impacts Hospital Industry

Published on: July 28, 2008 | by Shepherd Smith Edwards & Kantas, LLP

Hospitals across the US are experiencing the downside of depending on auction-rate securities to raise capital at a low rate. With the collapse of the auction-rate securities market, the interest rates that hospitals had to pay for capital increased from 2-3% to 9-15%.

While many hospitals tried to obtain letters of credit to refinance their debt, costs for these letters of credit also increased-even doubling in many instances-and fixed-rate loan expenses also grew. In the meantime, credit rating agencies downgraded bond insurers and banks.

One area in which hospitals may have to make cuts to help them get through the financial squeeze is in the areas of expansion and new construction. Investment income has suffered because of the market’s collapse, and many hospitals have had to decrease their bottom line.

While certain publicly traded hospitals systems, such as Universal Health Services and Tenet Healthcare, are able to access equity markets when they need to raise funds, this source of money has also been severely hampered by problems affecting the stock market.

This is the ‘flip side’ of the auction-rate securities debacle: Many issuers were persuaded to issue auction-rate securities and are now forced to pay higher rates on these securities than they would be paying if traditional bonds had instead been issued. If these issuers now attempt to refinance this debt they must do so at a rate much higher than when the auction-rate securities were issued. Furthermore, many of these issuers, including hospitals and municipalities, are being forced to pay Wall Street firms repeatedly for auctions they know will fail. Our law firm is currently reviewing the legal position of such issuers. Continue Reading ›

Judge Approves Citigroup Falcon Fund Investors’ Decision to Withdraw Lawsuit

Published on: July 25, 2008 | by Shepherd Smith Edwards & Kantas, LLP

In New York, a judge has approved the decision by investors of a Citigroup Falcon Fund to drop their lawsuit asking for more data about how the bank plans to liquidate the fund.

On February 22, Citigroup announced it was providing the Falcon Funds a $500 million line of credit and consolidating $10 billion in liabilities and assets.
Citigroup began suspending distributions and redeptions and started closing down the fund in March. The fund’s value dropped by 80% and Citigroup offered to pay investors 45 cents for every dollar.

The investors had been asked to tender shares of Falcon Strategies Two LLC, but they wanted corrections made to the offering memo because misleading and missing information made it impossible for them to value their stakes. U.S. District Judge Sidney Stein, who this week approved the withdrawal of the investors’ class action suit, rejected their motion to push forward the lawsuit about the tender offer. He said the plaintiffs were trying to turn the securities laws’ anti-fraud provisions into provisions of broad disclosure.

The Falcon Funds mainly invested in fixed-income securities and other debt instruments, and they may have been exposed to weaknesses in the mortgage, credit, and bond markets. Citigroup brokers are accused of recommending the funds to investors looking for conservative investments when, in fact, the funds may have been accompanied by a high level of risk.

Related Web Resources:

The Law Firm of Shepherd Smith Edwards & Kantas LTD LLP Investigates Losses in Falcon Hedge Funds, Primenewswire.com, July 2, 2008
Citigroup Alternative Investments LLC : Falcon Strategies Two B LLC Hedge Fund, Stanford Law School Continue Reading ›