Wall Street brokerage firms are being ordered to pay millions to investors who incurred significant losses on what they thought were low-risk investments, but were, in fact, leveraged municipal arbitrage hedge funds, according to a Wall Street Journal article by Randall Smith (“Crisis-Era Munis Haunt Wall Street,” July 27, 2010).
One such fund was sold by First Republic Securities Co., formerly owned by Merrill Lynch & Co. The First Republic fund raised $34 million and acquired about $200 million of bonds, according to the article.
The funds issued tax-exempt short-term debt and used the proceeds to buy longer-term municipal bonds that offered higher tax-exempt yields. Derivatives such as interest-rate swaps were used purportedly to hedge against adverse moves in both short- and long-term interest rates. Investors were promised higher yields than municipal bonds, according to the article.
This month, a Financial Industry Regulatory Authority (FINRA) arbitration panel awarded a California family $2.1 million, which was the full amount of their loss on a $3 million investment.
When First Republic lawyers tried to argue in the arbitration that proper disclosure was made about the risks and rewards, the arbitration panel criticized the “glibness” of First Republic in touting the fund’s “upsides,” such as higher yield and higher fees, without “any realistic advance recognition [of] any specific risks or patterns of risk,” according to the article.
The Securities and Exchange Commission and federal prosecutors are reportedly examining First Republic’s risk disclosures, which understated the funds’ risk, according to the article.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. Page Perry continues to investigate and pursue FINRA arbitrations on behalf of investors who suffered losses in fixed income alternative investments. For further information, please contact us.