FINRA Issues Investor Alert Regarding Reverse Convertibles

FINRA has issued a warning on its website to investors of Reverse Exchangeable Securities ("Reverse Convertibles").

Although often described as debt instruments, Reverse Convertibles are debt obligations of the issuer that are tied to the performance of an unrelated security or basket of securities. The Alert describes Reverse Convertibles as far more complex than a traditional bond and involve elements of options trading. In addition, Reverse Convertibles expose investors not only to risks traditionally associated with bonds and other fixed income products—such as the risk of issuer default and inflation risk—but also to the additional risks of the unrelated assets, which are often stocks.

FINRA issued the alert to inform investors of the features and risks of reverse convertibles that can be difficult for individual investors and investment professionals alike to evaluate. According to FINRA, if investors are considering purchasing Reverse Convertibles, it is critical that they look beyond the high coupon rate and focus on the risks of the underlying asset. FINRA warns ivnestors that even if the issuer of the reverse convertible is able to meet its obligations on the note—and even if the yield keeps pace with or surpasses inflation—investors could wind up, when the note matures, with shares of a depreciated—or even worthless—asset. Click here for the Full Investor Alert.

If you have suffered losses in Reverse Convertibles and would like more information, or would like to consult with an attorney on a confidential basis, contact SLG at 415-217-7300 or fill out our contact form.

SEC proposes new disclosures for target-date funds

On Wednesday June 16, 2010, Federal regulators proposed new disclosure rules for target-date retirement funds that would require sponsors to spell out how they are investing the money and to warn about risks.
Click here for entire article.

Under the SEC proposal, target-date funds' marketing materials would have to include a prominent table, chart or graph showing the allocations among the various assets over the life of the fund. A statement would have to explain that the asset allocation changes over time, and tell prospective investors that they should consider their financial situation and tolerance for risk before going into a fund.

Target-date funds came under criticism during the market meltdown of 2008 and in its aftermath. Among 31 funds with a 2010 target date, the average loss in 2008 was nearly 25 percent.

Before the vote on the proposed rules, SEC Chairman Mary Schapiro stated: "It's clear that investors need more information than just the date in a fund's name."

Target Date Funds Can Be "Way Off Target"

Tom Brakke, CFA, offers new criticism today on Morningstar of Target-Date Mutual Funds, despite this investment vehicle's reputation as one of the hottest investment products of the last decade.

According to Brakke, many target date funds were structured based upon questionable assumptions about asset classes and how they perform over time. "Historical returns, the variability of those returns, and the correlations among the returns of different types of assets were used in asset allocation models as if they were facts of nature." Brakke says many target date funds with a reference date of 2010 have received much attention, "since many who held the funds on the verge of retirement saw large losses in their account balances during 2008 (with some drops exceeding 30%)." Click here for the entire article. (Subscription may be required).

In Brakke's opinion the main flaw is that deciding that someone should have X% in equities and other risky assets without regard to the valuation of those assets ignores an important relationship: The probability that stocks will perform worse than their historical average return increases as valuations rise.

Merrill's "Penalty Box"

Barry Ritholtz of the Big Picture has the interesting story of two brokers who run managed accounts at a large firm that "[r]hymes with Schmerrill." It should be a warning to all investors--brokerages compensate their brokers for investing your money, not for saving your money by pulling it out of failing investments. In fact, brokers who saved their clients' money by putting them in cash are being punished.

These two gents run a few $100 million dollars in managed accounts. They are mostly stock jockeys, but they have a smattering of bonds as well. Their assets are spread out amongst stocks they selected, in house managers, and other mangers on their firm’s platform. Typically, the clients are charged 1.0-1.25% on their assets. Various products (I hate that word) will pay the broker more or less depending upon the fund manager’s arrangements with the house.

As is typical of brokers with this size asset base and seniority, their payout was about ~43%.

Let’s do some quick math before we get to the heart of the conflict: On $300 million in assets, let’s call it $3.3 million dollars in gross revenue to the firm. That’s about $1.4 million to them, from which they pay a few sales assistants, T&E, etc. Thus, they each should be making about half million dollars annually before Uncle Sam takes his.

Here’s where things get interesting: Early in 2008, they moved aggressively into cash. (Obviously they are TBP readers). For most of the year, they run about 20% bonds, plus 5% percent stocks (some client would not sell). All told, about 75% of their asset base is in money market funds, which pays out essentially nothing to the broker — but preserves the clients investments. Late in the year, they put a toe back in the water.

Overall, the clients do very well. In a year where the markets are practically cut in half, their clients lose about 10%. The investors are ecstatic, and while the two brokers annual compensation was schmeissed — they went from over $3 million gross to under $1 million — they have happy, referral making clients to rebuild their business upon. Its a short term income hit that should generate gains over the long term. And, they got there by doing the right thing.

Now, that drop in income alone raises conflict issues. I tell clients who ask why they are paying 1% to sit in Cash that they are not — they are paying 1% to not be losing 45% in equities, and to have us tell them when to go back into stocks. We think that’s worth 1%, and if you disagree, well talk to your friends who have seen their investments destroyed.

Here’s where things get completely misaligned. When 2009 rolls around, their manager calls them into his office, and says: “Bad news, boys. Your revenues dropped so much last year you are in the Penalty Box. As per your contract, your payout for this year is 30%.”

Sparer Law Group Files Class Action Against Oppenheimer Bond Fund

The Sparer Law Group has filed the first class action lawsuit on behalf of investors who purchased the Oppenheimer California Municipal Fund (Symbols: OPCAX, OCABX, OCACX) between September 27, 2006 and November 28, 2008. The case was filed on February 4, 2009 in the United States District Court for the Northern District of California, case number C 09-00567 SI. See our press release here.


The lawsuit alleges that the Fund's Registration Statements and Prospectuses misled investors about the Fund's investment objectives and underlying risk by describing the Fund as seeking current income "consistent with preservation of capital." The Fund lost over 41% of its net asset value ("NAV") in 2008. By comparison, the average loss for funds within the same Lipper peer group over this period was only 11.5%.

"The promise that a municipal bond fund follows a strategy designed to preserve capital cannot be just a sales pitch. It has to be reflected in an objective investment approach," said Alan W. Sparer, lead counsel. "Investors put their 'safe' money and retirement savings in muni bonds. These funds are not the place for speculative strategies or junk bond investments."

The lawsuit alleges that the Oppenheimer California Municipal Fund policies and operations ignored the preservation of capital objective by concentrating 78% of its assets in bonds rated at the lowest investment grade or below, and concentrating 60% in bonds that were not rated by any independent rating agency. In addition, 33% of the Fund's investments were placed in Dirt Bonds, which are based on contracts for land developments that have not been built yet and were especially vulnerable to the recent declines in California's real estate market.

In addition, the lawsuit alleges that Oppenheimer failed to disclose that, because of the Fund's overconcentration in lower rated bonds and bonds that had not been rated by any independent agency, there was a significant risk that more than 25% of its assets were in junk bonds, a violation of the Fund's fundamental investment policy.

The NAV of the Oppenheimer California Municipal Fund decreased by more than $1.1 billion in 2008.

A copy of the complaint is available here.

Investors who lost money in the Oppenheimer bond funds should contact the Sparer Law Group to investigate potential avenues for recovery.

Morningstar Flunks Oppenheimer Bond Fund

Morningstar gives Oppenheimer an 'F' for failing to disclose the additional risks it had taken on in its bond funds:

""The managers bought complex, off-balance-sheet swap contracts that created a leveraging effect on the funds," Gogerty said. The managers made no attempt to tell investors that the funds were taking on additional risk, he said."

The article states that "Oppenheimer failed investors by not telling them that two of its bond funds had recently taken on extra risk." The end result was that "Oppenheimer's normally stable Champion Income and Core Bond funds saw huge losses in 2008, dropping 78% and 36% respectively."

Oregon Investigating Oppenheimer Bond Funds

Officials demand financial data from OppenheimerFunds:

Oregon State officials are investigating Oppenheimer, which managed Oregon's College Savings Network:

"The bond funds in question contributed to exorbitant losses in the network's conservative portfolios. OppenheimerFunds' Core Bond fund declined about 35 percent last year. The short-term government fund lost 6 percent last year. By comparison, a benchmark measure of its peers -- Barclays Capital U.S. 1-3 Year Government Bond Index -- gained 6.7 percent."