Wealthy Individuals Have Been Victimized By Wall Street’s CDO Fraud

 

Merrill Lynch and other Wall Street firms sold the riskiest tranches of collateralized debt obligations (“CDOs”), not just to institutions, but to individual investors, as safe investments, according to a recent Wall Street Journal article by Dan Fitzgerald titled “Didn’t See Risk, and Got Stung.” Now that the CDOs have imploded, and investors are seeking recovery of their losses, Merrill is telling them that risk disclosure documents and the investors’ supposed sophistication mean they cannot recover. Merrill is wrong for a number of reasons.

First, wealth does not equate to financial sophistication. Merrill apparently targeted investors with more than $5 million in net worth to take advantage of how the SEC defines an “accredited investor,” which is generally having a net worth $1 million or more and an annual income of $200,000 or more. But selling to “accredited investors” only allows Merrill to avoid filing a registration statement with the SEC; it does not allow Merrill to avoid liability or mean the investors were not misled by Merrill.

“Because you have $5 million doesn’t mean you are a sophisticated investor,” Fordham University law professor Constantine Katsoris, was quoted as saying. Katsoris leads a group that makes recommendations to the Financial Industry Regulatory Authority (“FINRA”). FINRA is responsible policing broker sales practices and provides the forum for most securities arbitration claims. Katsoris added that he expects more Main Street investors to bring CDO lawsuits and arbitration claims.

In a 2005 notice issued to brokerage firms, FINRA said the SEC’s “accredited status” is “not necessarily an indicator of sophistication” and added that newer investment products “are often complex or have unique features that may not be fully understood by the retail customers to whom they are frequently offered.” Similar notices were issued in 2007 and 2010.

The purpose of these notices was to ensure that firms understood their obligations and “not rely too heavily or solely on a customer’s status as an accredited investor,” the article quoted Gary Goldsholle, FINRA vice president and associate general counsel, as saying.

Second, FINRA rules do not permit brokers to make misleading statements, and do not allow important disclosures to be omitted from a sales presentations. Rather FINRA rules specifically require that a broker’s presentation be fair, balanced and complete. Moreover, FINRA has repeatedly issued notices to brokers stating that they cannot cure verbal misrepresentations and omissions to disclose important facts and risks by giving investors a prospectus or other written disclosures.

Third, the written disclosures that are given to investors in these cases are usually insufficient as a matter of law. The kind of bare-bones description of important risk factors that is usually offered to investors does nothing to correct the impression of safety and security in the brokers’ presentations. One court compared it to warning that there might be a pothole in the road when one knows to a certainty that the grand canyon lies a few feet ahead.

Merrill Lynch had the largest sales force and sold more CDOs to individual investors than any other brokerage firm, according to the article. “It was common practice for Merrill to pitch retail clients the lowest-rated CDO slices ‘ while it sold the higher-rated tranches to larger institutions, according to people familiar with the matter.”

“We were just lambs being led to the slaughter,” said Michael Slomak, a member of a Cleveland family that invested $2.65 million in several Merrill-issued CDOs. The Slomak family lost all but $16,500, and has filed an arbitration claim against Merrill with FINRA.

The increased scrutiny of Wall Street sales practices by Congress and the Securities and Exchange Commission has led to a surge in lawsuits and arbitrations filed by investors. Many legal experts predict more to come.

In a 2005 note, FINRA, an independent securities regulator overseen by the SEC, said the SEC’s “accredited status” is “not necessarily an indicator of sophistication” and added that newer investment products “are often complex or have unique features that may not be fully understood by the retail customers to whom they are frequently offered.” Similar notes were issued in 2007 and 2010.

The purpose of these warnings, said Gary Goldsholle, FINRA vice president and associate general counsel, was to make sure firms understood their obligations and “not rely too heavily or solely on a customer’s status as an accredited investor.”

In addition to the Slocum family, the article tells how Boston area businessman Russell Stephens bought a $400,000 CDO from his Merrill Lynch adviser. The 56-year-old said he was sold the tranche most vulnerable to losses in the event of default, yet was told the CDO would be an appropriate replacement for a municipal bond. His investment dwindled to $80,000. The deal “wasn’t fully explained to me’.It’s been a nightmare,” he said.

Another burned investor, Stanley Klein, the owner of a company called Multi-Flow Dispensers of Ohio that makes soft-drink-fountain syrups, told the Wall Street Journal how “overzealous” Merrill was in its salesmanship, even hosting citing a local party where potential investors mingled with CDO managers. He said he has lost about $250,000. “It was a risky investment,” he said, “but they didn’t portray it as that.”

In yet another example, Merrill persuaded a hair-salon owner and his family to invest $2.65 million from the sale of the family business in CDOs as a nest egg for his four daughters. Merrill brokers reportedly assured him that the CDOs were “very safe with little or no risk,” according to his FINRA claim pending against Merrill. A Merrill Lynch Vice President visited came down from New York and recommended he put even more money in CDOs, saying they had “zero risk,” according to the article. He reportedly said, “This was a great chance to participate with the big boys” and to act fast. “We felt flattered.” The family says it never knew that “the minute there was a loss, we would be wiped out completely.” “Because you have a few million dollars doesn’t mean you are a sophisticated investor.”

J. Boyd Page, senior partner of Page Perry in Atlanta, observed “This is further evidence of how much Wall Street banks have lost perspective and abandoned their legal obligations. They seem to think that our capital markets are a Barbary Coast where ‘securities piracy’ is acceptable. That simply is not the case. These banks are required to adhere to high standards and deal fairly with their clients. They should be held accountable if they failed to do so.”

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing investors in CDO cases. For further information, please contact us.