Thursday, April 14, 2011

FINRA Press Release: Auction Rate Securities

FINRA Fines Jefferies $1.5 Million for Failing to Disclose Additional Compensation Paid and Conflicts in Sale of Auction Rate Securities

The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that
it has fined Jefferies & Company, Inc. $1.5 million for failing to disclose additional compensation received and conflicts in connection with the sale of auction rate securities (ARS). FINRA also ordered Jefferies to repay $425,000 in fees and commissions earned from the sale of ARS to the affected customers.
The settlement is detailed in the FINRA AWC No. 2008013863701.

Auction rate securities (ARS) were first issued in the mid-1980s by corporations. The market for ARS grew rapidly over the next two decades and widely issued by a diverse range of institutions such as closed-end mutual funds, municipalities and student loan trusts. ARS were long-term floating rate securities whose coupon payments were determined at auctions that were typically held every 7 to 35 days, making ARS long-term securities with short-term floating rates. Broker dealers marketed ARS as liquid, short-term cash equivalents. However, ARS auctions failed en masse in February 2008 and proved to be illiquid and unsellable in the short-term.

SLCG has written papers on the ARS that describes the ARS, what they are, how their auctions worked, and why they failed. SLCG was also recently hired by the State of North Carolina to advise on the liquidity solutions to ARS investors who have yet been able to redeem these illiquid securities.

Investors can use our dedicated website for other in-depth analyses of security products.

Monday, April 11, 2011

FINRA Press Release: Principal Protected Notes

FINRA Fines UBS Financial Services $2.5 Million; Orders UBS to Pay Restitution of $8.25 Million for Omissions That Effectively Misled Investors in Sales of Lehman-Issued 100% Principal-Protection Notes

The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that
it has fined UBS Financial Services, Inc., $2.5 million, and required UBS to pay $8.25 million in restitution for omissions and statements made that effectively misled some investors regarding the "principal protection" feature of 100% Principal-Protection Notes (PPNs) Lehman Brothers Holdings Inc. issued prior to its September 2008 bankruptcy filing.
The settlement is detailed in the FINRA AWC No. 2008015443301.

FINRA has also published an investor alert informing investors of their eligibility for restitution from UBS, after it recently ordered UBS to pay $8.25 million in restitution for misstatements and omissions regarding principal protected notes issued by the now-bankrupt Lehman Brothers Holdings Inc.

Structured products are debt securities that often have unconventional and complex payoff structures. They are often linked to a security or index, such as the S&P 500 or the Russell 2000, with asset classes ranging from equity, commodities, currencies to debt. A principal protected note returns at least the face value of the note at maturity. If the reference asset – an asset to which a principal protected note is linked – increases over the term of the note, the note will return higher than the face value. Another principal protected note, branded as an absolute return barrier note, returns the absolute value of the return of the underlying index provided the index stays within pre-specified barriers during the life of the note. If the index exceeds the barriers then the note returns its initial face value.

Furthermore, structured products often have high fees, high transaction costs, and are priced well above their fair market price, see for example Henderson and Pearson (2011). Moreover, structured products depend on the solvency of the issuer, as was very clear when Lehman Brothers collapsed. SLCG has written several papers on the topic including a paper that describes structured products after the collapse of Lehman Brothers.

Investors should be careful when considering principal protected notes, for they can be quite complex and risky and their complexity can mask their riskiness to investors. Since they can be replicated by traditional securities and derivatives, investors should also consider the fees they pay for purchasing such structured products. SLCG has written a paper on principal protected absolute return notes. Investors can find other related papers and notes at our dedicated website.

Thursday, April 7, 2011

FINRA Press Release: Private Placements

FINRA Sanctions Two Firms and Seven Individuals for Selling Private Placements Without Conducting a Reasonable Investigation

The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that 
it has sanctioned two firms and seven individuals for selling interests in private placements without conducting a reasonable investigation. The companies whose securities were sold in these private placements were unrelated to the firms and individuals FINRA sanctioned. The companies ultimately failed, resulting in significant investor losses.
A private placement is an offering of securities, such as common and preferred stock of a company, to private investors. It is exempt from registration with the Securities and Exchange Commission though it must follow the rules of Regulation D. FINRA has published a Regulatory Notice 10-22 on the obligations of broker-dealers conducting private placement offerings.

Investing in securities in private placements requires as much caution as investing in publicly offered securities. Because detailed financial information and the prospectus might not be available, investors must look and read the private placement memorandum, understand the risk section, and review all other supplemental documents.

Tuesday, April 5, 2011

SEC Press Release: Mortgage Backed Securities

SEC Announces Securities Laws Violations by Wachovia Involving Mortgage-Backed Securities

The Securities and Exchange Commission (SEC) issued a press release today announcing that 
Wells Fargo Securities LLC [had] agreed to settle charges that Wachovia Capital Markets LLC engaged in misconduct in the sale of two collateralized debt obligations (CDOs) tied to the performance of residential mortgage-backed securities as the U.S. housing market was beginning to show signs of distress in late 2006 and early 2007.
The SEC Order against Wells Fargo Securities can be found here. It was found that Wachovia Capital Markets sold a CDO to the Zuni Indian Tribe with excessive mark-ups and deceived investors in another CDO when it told investors that it acquired assets “at an arm’s-length basis” and “at fair market prices” when these assets were transferred at above fair market prices.

A mortgage backed security (MBS) is a debt security whose cash flows come from, and are backed by, the principal and interest payments of borrowers on the mortgage loans. The pooling of mortgages into a debt security is called securitization and is performed by a trust. Mortgages are originated by public and private agencies, they are then securitized into MBS by a trust, and then the MBS is issued to public investors by the trust. An MBS investor is subject to a multitude of risks such as interest rate and prepayment risk (of the mortgage by the borrower) and the credit risk of the borrower.

We have already seen related cases whereby brokerages misrepresent mortgage delinquencies to MBS investors in order to hide the increased downside risks of subprime MBS.

SLCG has written a paper describing the market and history of CMOs (a type of MBS) in the wake of the collapse of Brookstreet Securities and two Bear Stearns hedge funds.