Message to Investors: Don’t Ignore Losses in Your Investment Accounts

According to a recent article on InvestmentNews.com, a study commissioned by Charles Schwab revealed that a significant percentage of investors are unaware of the losses sustained in their accounts. To make matters worse, more than one-third of the investors surveyed did not know which mutual funds they owned and less than one-third spoke with their financial advisor or stockbroker on a regular basis.

In the article, a Charles Schwab executive was quoted as stating that “some investors tend to be overwhelmed or intimidated by investing.” This is interesting because it confirms the important role that stockbrokers and financial advisors play in investors’ financial decisions. While this seems elementary, it astonishes me as to how many broker-dealers take the position in arbitration cases that the stockbroker or financial adviser played a passive role in the losses sustained in the investor’s accounts.

The survey also reported that 60% of the investors surveyed do not plan to make any changes to their investment allocations following the stock market’s rapid post-September descent. Stockbrokers and financial advisers often tell their clients to “stay the course.” In addition (or alternatively), many advisers and stockbrokers will show their clients charts or other documents that show how following a decline in the stock market a large portion of the recovery often occurs on select days — thus reinforcing their recommendation to stay the course, otherwise taking the risk that the investor will miss those few opportunities to participate in the recovery. Following this recommendation, clients feel forced to hold the same investments that created their losses.

It is important not to ignore losses in your investment accounts for many reasons, including but not limited to the following:

1. It is more difficult to recover from a significant loss than it is to sustain the loss in the first place. For example, if you start with $100,000 in an investment account and you sustain losses of 50%, the value of your account would be $50,000. Therefore, you would need a gain of 100% of this reduced amount ($50,000) in order to recover from the 50% loss you sustained.

2. If you are sustaining losses that cause you to lose sleep (or suffer other emotional distress), your investment accounts are probably invested in an unsuitable manner. This is something that you need to discuss with your stockbroker or financial adviser. If your adviser is unwilling to make significant changes to the accounts, or worse yet, if the stockbroker tries to reassure you that the investments are appropriate, you should seek a second opinion. In addition, you may want to consult with a securities attorney to discuss whether you have a legal claim.

3. If you decide to file a claim related to your losses, any failure to act could reduce or diminish your ability to succeed in arbitration or litigation. Whenever legal action is initiated, there are several issues related to the timing of the investor’s actions and the claim itself that must be considered (including statutes of limiations, equitable defenses, and arbitration eligibility rules).

When a stockbroker or financial adviser makes a recommendation to his or her client, they (and the firms they represent) may be liable for losses resulting from the recommendation. The Kueser Law Firm represents investors in securities arbitration. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

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Do You Understand the Fees Charged by Your Mutual Funds? Probably Not.

In a July 31, 2009 article, Sam Mamundi of Marketwatch.com discussed the hidden sales fees charged by mutual funds. As noted in the article, “[t]he majority of retail funds are sold through brokerages, and each brokerage firm levies a range of charges to the fund for every sale. The cost of these agreements is passed on to investors.” These charges come in a variety of forms, including “revenue sharing agreements” and 12b-1 fees.

Many broker-dealers have revenue sharing agreements with mutual fund companies. Under these agreements, the broker-dealers are paid a percentage of the mutual fund sales they generate by the mutual fund companies. Each firm negotiates its own rates of revenue sharing with each mutual fund company.

Over the past few years, there have been lawsuits involving revenue sharing agreements. These cases were brought against broker-dealers and were largely based upon the premise that these undisclosed fees created a conflict of interest because the firms’ brokers (and also the broker-dealers) had a financial incentive to push the funds managed by the companies with whom the broker-dealer had an agreement, and not based upon their clients’ best interests.

Although mutual fund companies specifically report the amount of 12b-1 fees they charge against shareholders in their annual and semi-annual reports, the amount of money charged to shareholders for these revenue sharing agreements are not specifically disclosed. In fact, as noted in the Marketwatch.com article:

“There’s no direct rule requiring funds or brokerage firms to disclose revenue-sharing deals. Funds simply have to state that they pay for these deals, and often that’s tucked away at the back of a prospectus — which many investors don’t read before they buy into a fund.”

The Securities and Exchange Commission is also reportedly looking into the issue of hidden mutual fund sales fees. In her testimony before the Subcommittee on Financial Services and General Government on June 2, 2009, SEC Chairperson Mary Schapiro stated:

I also have asked the staff to prepare a recommendation on rule 12b-1, which permits mutual funds to use fund assets to compensate broker-dealers and other intermediaries for distribution and servicing expenses. These fees, with their bureaucratic sounding name and sometimes unclear purpose, are not well understood by investors. Yet in 2008, rule 12b-1 was used to collect over $13 billion in investors’ funds out of fund assets. It is essential, therefore, that the SEC engage in a comprehensive re-examination of rule 12b-1 and the fees collected pursuant to the rule. If issues relating to these fees undermine investor interests, then we at the SEC have an obligation to step in and adjust our regulations.

President Obama is also focusing on this issue. In a June White Paper (will open in Adobe Acrobat), the President noted that for the country “[t]o rebuild trust in our markets, we need strong and consistent regulation and supervision of consumer financial services and investment markets.” To that end, President Obama recommended “[s]tronger regulations to improve the transparency, fairness, and appropriateness of consumer and investor products and services.” In order to accomplish this goal, the President has set out to increase the power of the SEC so that the agency is better equipped to protect consumers and investors. Whether this will be enough is yet to be determined.

Undisclosed fees and revenue sharing agreements are another example of conflicts of interest between Wall Street firms and Main Street investors. Unfortunately, stockbrokers and financial advisors often lose sight of their clients’ goals and, as a result, their clients suffer unnecessary losses in the value of their IRAs, 401(k)s, college savings plans, or other investments accounts. The Kueser Law Firm represents investors who have suffered losses in their investments as the result of stockbroker or financial adviser misconduct. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

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Fidelity Cautions Investors on Leveraged ETFs?

On August 4, 2009, the Wall Street Journal reported that Fidelity Investments had joined other broker-dealers in warning its customers about the risks of investing in Leveraged ETFs (see other blawg posts on this topic here and here). The article, written by Daisy Maxey, states that Fidelity’s website warned investors that “Leveraged products are complex, carry substantial risks and are intended for short-term trading,” and that “[m]ost reset daily and seek to achieve their objectives on a daily basis. Due to compounding, performance over longer periods can differ significantly from the performance of the underlying index.”

The author of this blog spent several minutes searching Fidelity’s website (including searching the site for “leveraged ETF” and “leveraged product”) and could not find this warning. The website did contain an article from The Motley Fool entitled “Leveraged ETFs: Buyer Beware!” This brief article contained some discussion and examples of how leveraged ETFs work.

Last month, the Financial Industry Regulatory Authority (FINRA) declared that leveraged ETFs are typically unsuitable for retail investors. In addition, Massachusetts securities regulators have issued subpoenas to four firms in order to obtain information related to their sales practices involving leveraged ETFs.

Leveraged ETFs are unsuitable for retail investors because of their level of risk. The financial website Investopedia.com defines a leveraged ETF as “an exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index.” The fund essentially borrows money and combines this money with investors’ money to purchase derivatives such as options, futures, or swaps. Because of the use of debt and derivatives, these ETFs carry a significant amount of risk. These funds also generally charge higher expenses to shareholders, which results in reduced returns (or increased losses if the market goes against the investment objective of the fund).

The most popular of these investments are managed by Rydex, Direxion, and ProShares. If your stockbroker or financial advisor has sold you any leveraged ETFs, or purchased any leveraged ETFs in your accounts, and you have lost money on these investments, you may be entitled to recover these losses. The Kueser Law Firm represents investors in securities arbitration. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

More Broker Dealers Restrict Sales of Leveraged ETFs

Weeks after Edward D. Jones, Ameriprise, Linsco Private Ledger (LPL) and UBS announced that they were restricting the sale of leveraged ETFs (see here), two more broker-dealers have decided to take action related to their sales of these risky, and often misunderstood investments.

As reported by the Wall Street Journal, Morgan Stanley Smith Barney announced that it is reviewing its sales procedures related to leveraged ETFs. In addition, Charles Schwab issued an “unusual” warning to its clients that have purchased leveraged ETFs. This warning provides investors with some background discussion related to these risky investments, as well as examples of how hypothetical leveraged ETFs would perform in a few hypothetical situations.

Although many broker-dealers have instituted these measures, some broker-dealers continue to do nothing. For example, as reported in the Wall Street Journal article, Fidelity Investments continues to make leveraged ETFs available to their customers and leveraged ETFs remain available through TD Ameritrade’s web trading platform.

As previously stated in this blawg, the Financial Industry Regulatory Authority (FINRA) has declared that leveraged ETFs are typically unsuitable for retail investors. In addition, Massachusetts securities regulators have issued subpoenas to four firms in order to obtain information related to their sales practices involving leveraged ETFs.

Leveraged ETFs are unsuitable for retail investors because of their level of risk. The financial website Investopedia.com defines a leveraged ETF as “an exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index.” The fund essentially borrows money and combines this money with investors’ money to purchase derivatives such as options, futures, or swaps. Because of the use of debt and derivatives, these ETFs carry a significant amount of risk. These funds also generally charge higher expenses to shareholders, which results in reduced returns (or increased losses if the market goes against the investment objective of the fund).

The most popular of these investments are managed by Rydex, Direxion, and ProShares. If your stockbroker or financial advisor has sold you any leveraged ETFs, or purchased any leveraged ETFs in your accounts, and you have lost money on these investments, you may be entitled to recover these losses. The Kueser Law Firm represents investors in securities arbitration. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

Firms Asked to Account for Sales of Leveraged ETFs

According to an article on InvestmentNews, Massachusetts securities regulators have subpoenaed four brokerage firms for information related to their sales practices of leveraged ETFs. The subpoenas come only a few weeks after Edward D. Jones, Ameriprise, Linsco Private Ledger (LPL) and UBS restricted the sale of the products or stopped selling leveraged ETFs altogether. This also comes approximately three weeks after FINRA advised firms that leveraged ETFs “typically are unsuitable for retail investors.”

The most widely traded leveraged ETFs are managed by Direxion Funds, ProShares, and Rydex. Because these funds are “leveraged,” they are designed to provide market returns that significantly exceed market indices. For example, the Rydex Inverse Dow 2x Strategy Fund “seeks to provide investment results that inversely correspond to 200% of the daily performance of the Dow Jones Industrial Average.” (from Rydex Funds’ website.*) Therefore, if the Dow Jones Industrial Average increases by 10%, this fund is designed to lose 20%. Conversely, if the DJIA declines by 10%, this fund is designed to gain 20%. Another example is the Direxion S&P 500 Bull 2.5x Fund, which is designed to provide “daily investment results, before fees and expenses, of 250% of the price performance of the S&P 500 Index.” (from the Direxion Funds’ website.*) Therefore, if the S&P 500 Index declines by 10%, this fund is designed to lose 25%. What most investors are not told is that these funds are designed to produce the stated returns on a daily basis. Therefore, these funds are not designed to be bought and held.

The truth is that leveraged ETFs are unsuitable for retail investors because of their level of risk. As stated on Investopedia.com, a leveraged ETF is “an exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index.” The fund essentially borrows money and combines this money with investors’ money to purchase derivatives such as options, futures, or swaps. Because of the use of debt and derivatives, these ETFs carry a significant amount of risk. These funds also generally charge higher expenses to shareholders, which results in reduced returns (or increased losses if the market goes against the investment objective of the fund).

From January 2, 2008 through March 6, 2009, the S&P 500 Index declined from 1,447.16 to 683.38. This represents a loss of 52.8% during a 14-month period. As you can imagine, leveraged ETFs that were focused on growth (bullish funds) suffered tremendous declines during this period.

If your financial advisor or stockbroker sold you funds that are managed by Direxion, ProShares, or Rydex and you suffered losses, you may have a claim for recovery of those losses. The Kueser Law Firm represents investors in securities arbitration. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

* This blog intentionally refuses to link to the websites of companies that manage and sell leveraged ETFs because of the riskiness of these funds. If you would like to learn more about these funds, use Google to search for the information. If your adviser has recommended these funds to you, get a new adviser or at least a second opinion.

SEC Charges Morgan Keegan for Fraudulent Marketing and Sales of Auction Rate Securities

On July 21, 2009, the Securities and Exchange Commission (SEC) charged Morgan Keegan & Company. In its Complaint, the SEC seeks an injunction for violation of the federal securities laws, as well as equitable relief for Morgan Keegan investors. Included in this equitable relief is a request for a court order requiring Morgan Keegan to repurchase illiquid ARS from its customers. More about the SEC’s case, including a link to the Commission’s Litigation Release and Complaint can be found here.

The SEC’s Complaint alleges that Morgan Keegan misled thousands of investors about the liquidity risks related to auction rate securities (ARS). This is another example of the massive fraud related to Auction Rate Securities that was perpetrated by financial services firms across the country. To date, several firms, including UBS, Wachovia, TD Ameritrade, Fidelity, and Stifel Nicolaus have entered into settlements with federal and/or state securities regulators. Some of these settlements have broader relief for investors, while others have left many investors still holding onto these illiquid investments.

If you were sold Auction Rate Securities and your positions have not been redeemed or repurchased, you should contact an attorney to discuss your rights. The Kueser Law Firm represents investors in securities arbitration and litigation. Feel free to contact us if you have any questions or would like additional information.

SEC permanently changes rules related to “naked” short selling

In a much anticipated move, the Securities and Exchange Commission (SEC) made permanent a rule that it hopes will curb abusive “naked” short selling practices in the securities markets.

Short selling is the practice of selling a security that a person does not own. In essence, the person (the “short seller”) “borrows” the security from their broker (or another third party) and sells it to a buyer. This strategy is implemented where the short seller anticipates that the value of the security will drop. As the value of the security goes down, the short seller makes money. Conversely, if the value of the security increases, the short seller loses money. At some point in the future, the short seller will purchase an amount of shares equal to the amount borrowed. This is referred to as “covering” the short position. Often the short seller has to pay a fee to borrow the securities and has to pay interest on the value of the securities until the short position is covered.

The new rule (Rule 204T) requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale. In addition, the SEC is working with self-regulatory organizations to make public information related to short sale volume. Lastly, the SEC is planning to hold a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures. According to the SEC’s press release, “the roundtable will consider, among other topics, the potential impact of a program requiring short sellers to pre-borrow their securities, possibly on a pilot basis, and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities.”

Madoff Sentenced to 150 Years

This morning, U.S. District Court Judge Denny Chin sentenced Bernard Madoff to the maximum sentence of 150 years of prison for his role in a “historic” multi-billion dollar fraud.

Judge Chin stated “Here the message must be sent that Mr. Madoff’s crimes were extraordinarily evil and that this kind of manipulation of the system is not just a bloodless crime that takes place on paper, but one instead that takes a staggering toll.”

Mr. Madoff’s “error of judgment” or “tragic mistake” (as he referred to his fraud) devastated the lives of thousands of people. While it is unlikely that Mr. Madoff’s former clients will receive any significant restitution, it is comforting to see that he was not able to buy leniency and that the maximum sentence was ordered.

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Another day, more advisers alleged of fraud

On June 11, 2009, the Securities and Exchange Commission filed two fraud actions against different financial/investment advisers.

Morgan European Holdings ApS, et al.

On June 11, the SEC obtained an emergency court order and asset freeze to shut down a fraudulent prime bank scheme. The action was filed in the United States District Court for the Middle District of Flordia against Morgan European Holdings ApS, a/k/a Money Talks, Inc. ApS, John Morgan, Marian Morgan, Bowman Marketing Group, Inc., Stephen E. Bowman, and Thomas D. Woodcock, Jr.

According to the Litigation Release, the SEC has alleged that the Defendants solicited investments in fictitious prime bank trading programs. As noted in the Release,

the Complaint alleges that, during 2006 and 2007, the defendants raised millions of dollars from investors to participate in a fictitious investment program involving the trading of financial instruments among top financial institutions. The defendants told investors that their principal was guaranteed or never placed at risk. However, according to the Complaint, the defendants used investor funds for various undisclosed purposes, including Bowman’s gambling expenses, mortgage payments by the Morgans, and Ponzi payments to some investors. The SEC claims that John Morgan, Marian Morgan, and Stephen Bowman have continued to lull investors into remaining complacent by promising the imminent payment of their principal and returns. None of the relevant offerings was registered with the Commission, nor were any of the defendants registered as a broker-dealer or associated with a registered broker-dealer.

The SEC claims that the Defendants’ actions violated Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In addition the individual defendants were charged with violation of Section 15(a) of the 1934 Act. A hearing on the preliminary injunction is scheduled for June 25.

Aura Financial Services, Inc.

The SEC also charged an Alabama Broker-Dealer, Aura Financial Services, Inc., with engaging in fraudulent sales practices and high pressure sales tactics to convince customers to open an account and invest money with the firm. The SEC alleges that the firm and six of its representatives unfairly enriched themselves by more than $1 million in commissions and fees. At the same time, the customers’ accounts were largely depleted “through trading losses and excessive transaction costs.”

More information about this matter can be found by reading the SEC’s Litigation Release.

What Guidance Will SCOTUS Give on the Statute of Limitations in Securities Cases?

In a recent article published on Law.com, Sarah S. Gold and Richard L. Spinogatti conduct a thorough analysis of the issues in In re Merck & Co. Secs. Deriv. & ERISA Litig.., a Third Circuit Court of Appeals case. The Supreme Court granted certiorari in In re Merck to resolve when an investor is on inquiry notice of a potential fraud claim for purposes of determining when the statute of limitaions begins to run..

The authors note that in In re Merck, the Third Circuit held that “an investor is not on inquiry notice of a potential fraud claim until the investor has knowledge of a possible fraud, including scienter.” The authors also note that the Ninth Circuit recently came to a similar conclusion in Betz v. Trainer Wortham & Co., for which a certiorari petition is currently pending.

The article is a good read for anyone interested in securities fraud litigation.