Archive for October, 2008

Birds of a feather flock together, or so the saying goes. Apparently in the case Ramond P. Mecherle and James Kelsoe it really is true. Mecherle is a managing partner at Valhalla Capital Partners, which serves as the co-manager of the First Trust Strategic High Income Funds. Kelsoe was the portfolio manager of the Morgan Keegan mutual fund disasters known as the “RMK Funds.”

Both the First Trust Funds and the RMK Funds are the subjects of ongoing arbitration claims and class-action filings by disgruntled investors who say the funds’ management used deceptive marketing practices to pass off risky subprime mortgage-backed mutual funds to them - funds that ultimately plummeted in value following the collapse of the housing market.

It turns out Mecherle and Kelsoe are connected, as well. Before he founded Valhalla Capital Partners, Mecherle was employed by Morgan Keegan Asset Management for seven years. During his tenure there, Mecherle held the position of assistant portfolio manager for three high-yield funds, including the Regions Morgan Keegan Select High Income Fund (MKHIX); the RMK High Income Fund (RMH); and the RMK Strategic Income Fund (RSF). Mecherle’s direct boss would have been the portfolio manager of those funds, which was none other than Jim Kelsoe.

Because of Kelsoe’s intoxication with high-risk financial products - i.e. collateralized debt obligations, collateralized mortgage obligations and collateralized loan obligations - thousands of investors ultimately lost millions of dollars after Kelsoe was forced to sell the illiquid assets in the RMK Funds at the worst possible time in order to meet a torrent of shareholder redemptions.

Many investors saw their retirement funds, savings for college and large portions of the future net worth vanish almost overnight. More important, the RMK Funds themselves were pitched as safe, secure and diversified funds. In reality, they were over-concentrated in highly vulnerable collateralized debt obligations and other risky debt - key facts that Kelsoe and Morgan Keegan failed to disclose to investors.

Now it appears the same scenario is being played out with the First Trust Strategic High Income Funds. The funds in question - which are collectively known as the “First Trust Funds” - include the First Trust Strategic High Income Fund (FHI), the Strategic High Income Fund II (FHY), and the Strategic High Income Fund III (FHO). According to recently filed class-action lawsuits and arbitration complaints, investors allege that the manager and advisors of the funds - including Ramond P. Mecherle of Valhalla Capital Partners - made false and misleading statements regarding the portfolio composition of the funds, as well as misstated the extent to which they were exposed to high-risk mortgage-backed assets.

As in the case of the RMK Funds, the combination of poor communication from the funds’ managers, combined with the large investments made in exotic and illiquid asset-backed securities, have caused individual investors in the First Trust Funds to sustain unexpected and massive financial losses. Had investors been told the truth about the funds - which were miles apart from the plain-vanilla, low-risk bond funds they thought them to be - they no doubt would have looked elsewhere for financial advice.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

Conflicts of interest and gross incompetence were just two of the descriptions that lawmakers used to characterize credit rating agencies for their off-base assessments regarding the risks of Wall Street investment products backed by subprime mortgage loans.

At an Oct. 22 meeting on Capitol Hill, the House Committee on Oversight and Government Reform had harsh words for Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, with one lawmaker quoting from a compilation of e-mail messages sent by an S&P employee that said “a product would be rated even if it were structured by cows.”

The cow comment was just one of several accusations levied by members of Congress throughout the day-long hearing in which the three credit rating agencies were grilled on how and why they assigned top AAA ratings to complex mortgage-related securities without first thoroughly understanding the risks of the products. Later, a number of those products turned out to be totally worthless.

The answer may have to do with money. Moody’s Investors, Standard & Poor’s, and Fitch all raked in huge profits by giving various Wall Street products superior ratings. During the Oct. 22 testimony, Henry Waxman, who is chairman of the House Committee on Oversight and Government Reform, said total revenue from the three firms doubled from $3 billion in 2002 to more than $6 billion in 2007.

Meanwhile, investors who relied on the so-called “objective” ratings of certain financial products lost millions upon millions of dollars when the agencies’ assessments proved to be categorically wrong.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Lehman Brothers CEO Richard Fuld can’t catch a break - and with good reason. The embattled executive is at the center of controversy for his role in the financial troubles that ultimately led to the firm’s bankruptcy filing on Sept. 15. Now, federal prosecutors are turning up the heat on Fuld and Lehman, issuing subpoenas to a number of Wall Street securities firms and individual analysts for information to determine if investors were intentionally misled about the state of Lehman’s financial health.

As the supposed “eyes and ears” of investors, any information obtained from analysts could play a key role in getting to the truth on whether Lehman valued its assets at artificially high levels before filing for bankruptcy protection, according to an Oct. 22 story in the Wall Street Journal.

Fuld also has receiveded a subpoena to testify before a grand jury.

In a conference call held less than one week before Lehman Brothers filed for bankruptcy protection, the company told analysts it was financially sound. Twenty-four hours prior to that call, however, Lehman’s own executives stated the firm needed at least $3 billion in new capital.

On Sept. 15, when Lehman filed for Chapter 11 bankruptcy, the 158-year-old firm mad e history as becoming the largest bankruptcy in the United States. It had $613 billion of debt.

Meanwhile, the company’s CEO Richard Fuld pocketed more than $45 million in salary and bonuses in 2007, as well as directed that millions of dollars be given to Lehman executives even though at the time the company was pleading for a federal bailout.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

In what’s become a juggling act on the part of the government to reinvigorate the frozen state of the credit markets, the Federal Reserve will now provide $540 billion in financing to help money-market mutual funds swamped by investor redemptions.

Following the collapse of Lehman Brothers in September, along with other major financial upsets, nervous investors have withdrawn some $500 billion from money-market funds. On Sept. 16, one of the first and biggest money-market funds - the $63 billion Reserve Primary Fund - broke the buck after the net asset value of its shares fell below $1.

The Fed’s latest move to shore up money-market funds - a $3.3 trillion industry - entails an initiative called the “Money Market Investor Funding Facility” which, as its name implies, will provide liquidity to money-market fund investors. As part of the program, JP Morgan Chase will run five special facilities, with the Federal Reserve Bank of New York lending the facilities 90% of the purchase price of the assets that they buy. Among the assets eligible for purchase are certificates of deposit and commercial paper issued by highly rated financial institutions that has 90 days or less remaining until the mat urity date is reached.

The Federal Reserve says the Money Market Investor Funding Facility will remain in place until at least April 30.

Meanwhile, in a Bloomberg Television interview, Jim Bianco, president of Bianco Research LLC, called the government’s effort to back securities purchases from money-market funds a sign “that policy makers are trying to prevent Great Depression II.”

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

The plot continues to thicken in the legal saga involving Ameriprise Financial Services and a money-market fund that broke the buck recently. Ameriprise, which is suing Reserve Management Company’s Primary Fund, wants a federal judge to hand over audio tapes that reportedly contain conversations of sales reps alerting large institutional investors in the fund to redeem their shares at full value before it was too late.

If the allegations are true, the selective disclosure would have financially devastated thousands of Ameriprise investors. As reported Oct. 21, 2008, in the New York Times, Ameriprise and its clients had more than $3.3 billion in the Primary Fund when it “broke the buck” on Sept. 16 by falling below a dollar a share. Two smaller funds broke the buck, as well.

The Primary Fund is calling the selective disclosure charge by Ameriprise “outrageous.”

Our affiliation of securities lawyers is actively involved in advising individual and in stitutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

First there were auction-rate securities, then collateral debt obligations (CDOs). Now, credit-default swaps are making news. On Oct. 20, U.S. federal prosecutors and New York Attorney General Andrew Cuomo jointly announced that their two agencies had launched an investigation into the $58 trillion credit-default swaps market and whether Wall Street investment firms manipulated the instruments for their own financial gain.

Among other things, regulators are looking to determine if traders used the credit swaps to artificially lower share prices of various financial companies, which then resulted in large sell-offs and a downward spiral of company stock.

According to an Oct. 20 article in the New York Times, the New York Attorney General’s office issued subpoenas to stock exchanges, investment firms and three companies involved in processing trades in swaps and stocks. The firms are: the Depository Trust Clearing Corporation, Markit and Bloomberg.

Credit-default swaps have been the source of problems for several high-profile companies recently, including Bear Stearns, Lehman Brothers, American International Group (AIG), Morgan Stanley and others.

A credit-default swap is a contract for insurance on certain types of debt. Buyers of credit swaps pay a fee in exchange for having their losses covered in the event the debt defaults. The problem is the credit-default swap market itself. It is unregulated. That means contracts are regularly traded without any oversight to ensure buyers actually can cover losses.

That may be changing in the future, however. Joint investigations between federal prosecutors and the New York attorney general are a rarity. That fact alone suggests the investigation into credit-default swaps is going to be a big one - and that fundamental changes involving transparency and oversight could be coming sooner rather than later.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

The web of lies continues to grow for former Bear Stearns executives Ralph Cioffi and Matthew Tannin. At a recent court hearing in Brooklyn, New York, prosecutors claim that one of the two disgraced hedge fund managers tried to influence potential witnesses last summer during an internal investigation of the Wall Street institution. Prosecutors would not say which of the two men attempted to interfere with witness statements.

The collapse of 85-year-old Bear Stearns in March 2008 has been referred to as the trigger that propelled the nation’s credit crunch and ignited the onset of what continues to be a financial mess for banks and investment firms whose losses on investments in subprime mortgage-related securities now total $500 billion and counting.

Cioffi and Tannin were at the center of Bear Stearns’ downfall when the hedge funds they managed collapsed in June 2007, leaving investors with $1.4 billion in losses. Prior to shutting down the funds, both men continued to extol their solid financial state to investors, while privately stating the funds’ collapse was imminent. On June 19, 2008, Cioffi, 52, and Tannin, 46, were both arrested by the Federal Bureau of Investigations (FBI) and charged with conspiracy, securities fraud, insider trading and wire fraud. If convicted, the two men could be sentenced for up to 20 years or more in prison.

By the time Bear Stearns assets were taken over by JP Morgan Chase in March 2008, the company had lost more than 90% of its market value.

Conflicts of Interest

Meanwhile, H. David Kotz, the inspector general of the Securities and Exchange Commission (SEC), is blasting the Miami office of the SEC for its role in dropping a three-year-old investigation into whether Bear Stearns improperly valued some $60 million worth of collateralized bond obligations sold to W. Holding Co.’s Puerto Rico bank unit.

After months of legal wrangling, Bear Stearns agreed to pay $500,000 to settle the matter. Before that could happen, however, the SEC suddenly abandoned the case.

According to testimony given by Michael Trager, the lawyer representing Bear Stearns, the head of the SEC’s Miami office, David Nelson, told Trager in a telephone call that “Christmas is coming early this year,” and that “Bear Stearns can keep their money.”

Underlying the events is the fact that Trager, the Bear Stearns lawyer, once worked at the SEC with Nelson in the 1980s.

Kotz is now calling for disciplinary actions against Nelson for his decision to close the investigation.

The SEC’s report, “Failure to Vigorously Enforce Action Against W. Holding and Bear Stearns at the Miami Regional Office,” was issued on Sept. 30, 2008. It has yet to be posted on the SEC’s Web site. A copy can, however, be viewed at the Miami Herald: http://media.miamiherald.com/smedia/2008/10/14/20/Report_of_Investigation.source.prod_affiliate.56.pdf.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

Ill-fated financing arrangements concocted back in 2002 by JPMorgan Chase and other Wall Street banks for a sewer project in Jefferson County, Alabama, are causing havoc once again - this time for school districts in Pennsylvania.

As reported Oct. 17 on Bloomberg.com, the Securities and Exchange Commission (SEC) is reviewing records from the Bethlehem Area School District in Pennsylvania over interest-rate swaps that the district entered into with JPMorgan and Morgan Stanley.

As in the case of Jefferson County, Alabama - which continues to teeter on the brink of bankruptcy as a result of the flawed financing deals put together by JP Morgan and others - the SEC inquiry in Pennsylvania is part of a larger investigation concerning at least $8 million in fees that Bethlehem and other school districts paid to various Wall Street banks that sold the interest-rate swaps.

Interest-rate swaps are tied to variable interest rates. The swap itself is much like a bet between the purchaser and a bank: If interest rates remain favorable, the purchaser is the winner. If market conditions create an unfavorable interest rate environment, the bank that sold the swap receives higher payments from the purchaser.

In the case of the Bethlehem Area School District, the bank is now winning. In September, the district’s weekly debt costs increased by $250,000 - nearly $1 million a month.

Just like in Jefferson Country, Alabama, Bethlehem school board members say they failed to fully understand the ramifications of interest-rate swaps at the time they approved the deal with JP Morgan and others. Only now do they realize their mistake, they say, and just how risky and speculative the derivatives market can be.

Unfortunately, hindsight is 20/20. Now, it’s left to taxpayers to pick up the pieces and pay for the error in judgment by school board members of the Bethlehem Area School District. Students, too, are going to be affected by those bad decisions. As debt costs continue to mount for the district, tough choices will need to be made, including cutbacks to educational programs and reduced services in schools.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

Safe havens in the investing world have become an oxymoron. Amid the dismantling of Wall Street and other centers of financial engineering, investments once characterized as “cash alternatives” are vanishing overnight. What investors thought was a safe, secure liquid-as-cash investment is no more.

Case in point: Ultra short bond funds. Ultra short bond funds are mutual funds that typically invest in fixed-income securities with short maturity dates before they become due for payment. Like other bond funds, ultra short bond funds can invest in a wide range of securities, from corporate debt, to government securities, to mortgage-backed securities and other asset-backed securities.

Often described as a cash-alternative investment, ultra short bond funds are attractive to investors who want higher yields than traditional cash accounts with only marginally higher risk. That’s the theory, anyway. In the past year, the average ultra short bond fund has lost about 5% versus a 2.6% average gain for taxable money funds. And, in some cases, investors have seen their ultra short bond fund investments obliterated entirely.

The Schwab YieldPlus Fund is one example. Marketed by Charles Schwab as an alternative to cash, the one-time $14 billion fund has seen its value plummet, falling nearly 34% in 2008 alone. Another ultra short bond fund to implode this year is Evergreen Investments Ultra Short Opportunities Fund. That ultra short bond fund has lost than 20% of its value and was deemed the second-worst performing - behind the Schwab YieldPlus Fund - of the ultra-short bond funds tracked by Morningstar Inc.

So how did it go so wrong for these supposed “cash-like” investments? In a word: subprime.

In addition to mischaracterizing their funds and failing to offer adequate explanations of their potential risks, the companies behind the Schwab YieldPlus Fund and the Evergreen Ultra Short Opportunities Fund apparently omitted key information about what their managers really were investing in. In short, the words, subprime or high concentrations of mortgage-related investments, came up missing entirely at the time the funds were marketed and sold to investors.

As a result, investments made in risky illiquid mortgage-backed securities caused many ultra short bond funds to tank in value following the onset of the subprime crisis. Making the carnage even worse was the fact that the funds’ managers had to get rid of the toxic securities at fire-sale prices in order to come up with the cash for investors wanting to bail out.

The bottom line: With the country’s financial crisis playing out before us, safe, conservative investments are becoming harder and harder to find. One thing is for sure: In today’s market, investors who are considering ultra short bond funds may want to think long and hard. Lessons of the past year concerning fallen funds like the Schwab YieldPlus Fund, Evergreen Investments Ultra Short Opportunities Fund and others serve as definitive proof that ultra short in no way means ultra safe.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

The basic principle of investing relies on it: diversification. In almost every instance, but especially during times of market turmoil, a diversified investment portfolio serves as a prerequisite to help limit risks and mitigate potential losses for investors. Unfortunately for those who have gone the other investing route, the lesson learned can be costly - and one that many investors are now discovering as they face severe financial losses as a result of portfolios overly concentrated in one type of investment.

A prime example is an investor’s whose portfolio is heavy in preferred stocks only. Bought and sold like common stocks, preferred stocks actually are more similar to bonds. Investors who hold preferred shares means the issuing company pays them any dividends before paying common stock shareholders. In the event a company goes bankrupt, preferred shareholders again move to the front of the line and have first rights to claim the liquidation proceeds of a company’s assets.

At the same time, investors with investment portfolios solely concentrated in preferred shares can open themselves up to significant financial risks. If a portfolio includes investments in several asset sectors versus a single one, the chances that all of those sectors will sustain losses simultaneously is relatively slim. On the other hand, the likelihood an investor might encounter financial losses by holding only one type of security or asset class certainly is not hard to fathom.

In addition, many preferred stocks come with their own set of rules and regulations - both of which can translate into more profits or extra risks.

Stories involving investors who have suffered sizeable financial losses because their brokerage firm over-concentrated their accounts with preferred stocks are becoming more and more visible. Case in point: Freddie Mac and Fannie Mae. On Sept. 8, when the federal government took control of the two mortgage giants to prevent them from going under, investors who had been sold various series of the companies’ preferred shares as “safe, stable fixed-income investments” were shocked to learn the truth. In the week following the takeover by the government, Fannie Mae’s 8.25% preferred stock dropped to $2.65 from $13.70, while Freddie Mac’s 5.57% preferred stock fell to $1.50 from $9.15.

As of late September, investors holding certain series of preferred shares in Freddie Mac and Fannie Mae have seen their investments decline in value by more than 90%. Many of these investors say they were never advised of the risks associated with preferred shares by their brokers. Moreover, some investors were holding preferred shares of Freddie Mac and Fannie Mae as their sole investment, thus leaving the doors of their portfolios wide open for potential financial disaster.

To make matters worse, some investors believed that because Fannie Mae and Freddie Mac were considered “quasi-governmental enterprises,” any defaults on their preferred shares in the companies would be covered by Uncle Sam. They came to that conclusion because that’s what they were told by their brokerage firm.

The fact of the matter is that holders of preferred shares in Fannie Mae or Freddie Mac are in no way covered or protected by the U.S. federal government. Any financial losses these investors sustain are theirs alone.

There are other examples, as well, documenting what can happen to investors whose portfolios are overly concentrated with preferred shares in a single sector or company - from Lehman Brothers’ bankruptcy filing, to the bailout of American International Group Inc. (AIG), to the acquisition of Bears Stearns by JP Morgan Chase at a fire-sale price. As in these and other cases that are coming to light this year, investors who took the advice of their investment bank and bought preferred shares as a “sure bet” and a safe, fixed-income investment are learning an entirely different story as they watch their life savings literally vanish before them.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.