Mortgage REITs have often been recommended by brokerage firms as safe investments that generate consistent income.  However, during the recent market turmoil the bottom has fallen out for many Mortgage REITs.  For example, AGNC Investment and Annaly Capital are down over 50% in the last month or so, a way larger drop than the general equities markets.  Another Mortgage REIT, AG Mortgage, is down 75%.  Many of these mortgage REITs do not expect to be able to meet upcoming margin calls.

How did these mortgage REITs end up here?  Well, first of all, a REIT is a real estate investment trust which is a security that invests in real estate directly either through properties or in this case, mortgages or mortgage-related bonds.  The mortgage REITs listed above are publicly held and sold on exchanges. There are also what are called non-traded REITs which are often sold through broker-dealers and are not traded publicly.  Mortgage REITs invest and own property mortgages. They also loan money for mortgages to real estate owners, buy existing mortgages and purchase complicated MBS (mortgage-backed securities). Mortgage REITs generate revenue by collecting interest on the mortgage-related products.

As reported widely this week, the Mortgage REITs often fund themselves by pledging bonds in return for cash in the repo markets.  They are highly leveraged which in good times allowed them to pay dividends at higher yields than most bonds.  Brokers often recommend to investors to reach for yield in low yielding time periods and many brokers sold Mortgage REITs to investors without fully disclosing the risks associated with them.  In recent weeks, many Mortgage REITs found that the mortgage bonds they held dropped in value which triggered margin calls which then forced the Mortgage REITs to sell bonds into a falling market.

Margin call disputes often arise during times of market turmoil such as now.  Knowing what to do and whom to speak to when a margin call is issued is vitally important to an investor’s financial well-being.  Here is a little primer on what to do.

A margin call often occurs when the value of an investor’s margin account falls below the broker dealer’s required amount. A margin call is the broker dealer’s demand that an investor deposit additional money or securities so that the value of the account is brought up to the minimum value, which is known as the maintenance margin.  Some margin calls are small and an investor simply has to move securities in from another account or write a check to the broker.  However, in other situations, the acts by the broker dealer prior to the margin call being issued may have played a role in the margin call itself.

For example, a conservative investor often should not be holding any securities on margin at a brokerage firm.  If the firm recommended an unsuitable investment strategy that contained a significant amount of margin, and the market turned bad, and the investor sustained losses, said investor may have a potential FINRA arbitration claim against the broker.  In these situations, when a margin call is issued on the account, we highly recommend that the investor call a law firm such as ours who regularly represents investors in disputes with the financial industry.  It is paramount that the investor receives legal advice as soon as possible.  Most broker dealers have very broad powers in how to handle margin calls pursuant to onerous margin agreements.  The brokers sometimes even blow out investors’ portfolios without providing any notice (though they are supposed to exercise good faith in any decision they implement).  Time is usually of the essence.  It is important to have counsel engage with the broker dealer as soon as possible to potentially work out any issues.

Many firms, such as TD Ameritrade, Charles Schwab and Fidelity, whose business model includes or is tailored primarily to investors who want the benefits of a self-directed account also offer to introduce investors who wish independent investment advice to professional investment advisors who are technically “unaffiliated” with the firm.  Such investment advisors are often small SEC Registered Investment Advisors (“RIA”s) who are thinly capitalized and have supervisory systems that are well below FINRA broker dealer standards. The brokerage firms contract with such RIAs to be on their platforms and available to provide advice to customers that the firm introduces them to.   Those contracts are often designed to, among other things, insulate the brokerage firm from liability for investment advice given to the investor. This is so even though the brokerage firms vet such advisors, who become part of a “platform” they market to investors. Investors who are “introduced” by their firm to an RIA who will provide them investment advice may not realize that the firm’s position is that if the advice is inappropriate the RIA and not the firm is legally responsible.  Indeed, the firms structure their contracts with the customer as well as the RIA to give them this protection. Customers can be easily misled by such “introductions” into believing that the firm stands behind the RIA. Although the legal documents, couched in legalese, may so specify, the customer, who often does not read all the legalese in these documents, can be forgiven for believing that the firm that recommended the advisor and investment plan should have some responsibility if that advisor acts improperly. Investors at such firms need to know that they are taking a risk that if their firm recommended RIA gives them unsuitable advice they may be stuck suing a potentially judgment proof RIA in court (rather than the more cost effective FINRA arbitration).

Rich, Intelisano & Katz, LLP (RIK) continues its investigation into UBS’ sale of its Yield Enhancement Strategy or the “YES” options program. Many investors around the country have filed arbitrations against UBS alleging that UBS misrepresented the risks of the options program, failed to implement appropriate risk controls, and failed to supervise the YES options program.

The Yield Enhancement Strategy is run by two UBS registered representatives, Matthew Buchsbaum and Scott Rosenberg. UBS recruited both gentlemen from Credit Suisse in 2015 when Credit Suisse closed its private wealth management business. Messrs. Buchsbaum and Rosenberg ran the YES options program at Credit Suisse for many years.

UBS allowed its financial advisors other than Messrs. Buchsbaum and Rosenberg to market and sell the YES options program to their own clients. Cases filed by aggrieved investors allege that UBS represented that its YES options program was a low-risk strategy to generate modest income. However, the program is actually a complex investment strategy that carried significant risk and caused substantial investor losses.

The so-called  “Yield Enhancement Strategy,”  or “YES,” has seen a major rise in popularity at large investment firms, especially UBS,  as a vehicle for investors  to “enhance” returns relatively safely.  “YES” has been pitched as a relatively safe way to generate enhanced returns on a consistent basis, especially when markets are flat.   Fairly stable markets have been norm for many years, until recently, making  this approach attractive  to many  investors.  However, because of this historic stability,  the inherent risks of the investment have not been widely known to investors.

As a result, because “YES” relies on stability in the market place,  when significant volatility does hit, as it has at various times in the last 18 months, particularly last December, it can cause major losses to unsuspecting investors who were not prepared for them.

The “YES” Strategy is not only risky, but exceedingly complicated, involving an exotic options play, which is difficult for all but the most sophisticated investors to understand.  YES is only appropriate for the most experienced and sophisticated investors, those with a high risk tolerance and who understand options strategies, and only when accompanied with proper and specific disclosure of all the underlying risks.  Unfortunately, it appears that this product may have been sold to many investors without proper risk disclosure who did not meet the above criteria.

RIK filed a FINRA arbitration against TD Ameritrade last week on behalf of a New Jersey family. A former TD Ameritrade broker named Ralph Wood, Jr., acted as an unregistered advisor to numerous customer accounts in the Short Hills, New Jersey branch (including our client’s), and lost tens of millions of dollars trading the SVXY for various clients of the firm. It is believed former TD broker Rushi Patel introduced Wood to the customers and knew that the accounts were being traded by Wood, an unregistered, unapproved third party advisor. If you invested with TD Ameritrade through Ralph Wood, Jr. or Rushi Patel, please contact us as we are actively investigating this improper activity.

Allowing an unregistered advisor to trade customer accounts without express written authority and oversight is a violation of FINRA Rules, including rules concerning account documentation and supervision. Investors who lost money with Wood in this strategy may have claims against TD Ameritrade for their losses.

Morgan Stanley, UBS and Citigroup recently left the Protocol for Broker Recruiting (“Protocol”), which established procedures allowing advisors to switch firms and bring their clients with them. The Protocol helped protect such advisors from legal liability to their old firm for soliciting clients and using certain client information, provided the Protocol was followed. It remains to be seen how many other major firms will follow suit. But for advisors employed by the above firms and planning to move, this significantly alters the playing field, making them legally vulnerable for taking steps to move their business that were protected under the Protocol. Advisors planning to move from firms still subject to the Protocol need to take into account that by the time they leave, their old firm may have withdrawn from the Protocol. In either event, careful planning and legal advice every step of the way is crucial.

Unlike a typical Protocol move, advisors at non-Protocol firms now have to budget for possible court litigation, in which their old firm would seek to obtain an order precluding them from soliciting clients and from using or removing client records or information. Generally speaking, under the Protocol advisors are allowed to take client lists containing certain limited information and to solicit clients once they move to their new firm. Without the Protocol, a major legal factor governing transitions will be the advisors’ employment agreements with their old firm, which often broadly restrict solicitation of clients and other firm employees, and the use or removal of client or firm confidential information. There is also legal precedent imposing liability under common law and state statutes for conduct constituting unfair competition and theft of trade secrets.

Such court litigation, while often of short duration, is expensive. It requires the parties to appear for an evidentiary hearing before a judge on a expedited schedule usually not much longer than a couple of months. This means the lawyers typically work almost around the clock to be prepared for the hearing. After resolution of the court proceeding, the dispute may continue in FINRA arbitration.

In a very high profile private share litigation, Theranos, a privately held health-technology and medical-laboratory-services company worth $9 billion as of 2014, has been sued this Monday by one of its largest and trusted financial backers, San Francisco hedge fund Partner Fund Management, LP (PFM).  It will be a widely watched, difficult case.

In its lawsuit in the Delaware Court of Chancery, PFM has accused Theranos Inc. and its founder Elizabeth Holmes of deceiving their fund to attract a $100 million in investment. PFM has sent a letter to investors accusing Theranos of “a series of lies, material misstatements, and omissions” and also “engaged in securities fraud and other violations by fraudulently inducing PFM to invest and maintain its investment in the company.” Furthermore, PFM makes the claim that Theranos intentionally lied about having developed “proprietary technologies” that would work and also lied about being in the process of receiving regulatory clearance and approval.

The Theranos case highlights the risks of even institutional investors like hedge funds investing in private companies. It is very difficult for investors to do proper due diligence on private companies. If things go poorly as they have here, a securities fraud case in Delaware court is challenging. There are strenuous pleading requirements and dispositive motion practice. Major investors are actually better off in arbitration where there are no pleading requirements and very limited dispositive motion practice. However, Theranos isn’t looking down a clear path to victory because the Securities and Exchange Commission is investigating the allegations that Theranos misled investors. The SEC has subpoenaed PFM in the case and PFM will likely be more than willing to cooperate with authorities.

This week, a Florida appeals court partially reversed a ruling denying Bank of America’s efforts to arbitrate various claims related to the Scott Rothstein Ponzi scheme. Bank of America, N.A. v. Beverly, Nos. 4D14-3167, 4D14-3168 (Fla. Dist. Ct. App. June 10, 2015). The appellate court ordered arbitration in a case brought by Douglas Von Allmen, a long-time customer of Bank of America, who alleged that the bank’s improper advice led him to invest in a feeder fund to the Rothstein Ponzi scheme. Von Allmen had entered into a loan agreement with the bank that had a broad arbitration clause, which the court found to be enforceable.

In a second case consolidated for purposes of appeal, the Florida court refused to order arbitration in a case against Bank of America brought by plaintiffs who had no relationship to Bank of America, but who alleged that the bank’s advice to Von Allmen propped up Rothstein’s Ponzi scheme. The court found that these plaintiffs, who were non-signatories to any agreement with Bank of America, could not be forced into arbitration.

For a potential plaintiff, knowing whether your dispute arises from an agreement and whether that agreement has an enforceable arbitration clause can save not only time but also legal costs.

Deutsche Bank has agreed to pay a fine of $55 million to settle charges by the SEC that it filed misstated financial reports during the height of the global financial crisis relating to a multibillion dollar portfolio of derivatives.

The SEC’s multi-year investigation culminated in an Order Instituting a Settled Administrative Proceeding, available on the SEC’s website. According to investigators, the bank overvalued a portfolio of derivatives consisting of Leveraged Super Senior (“LSS”) trades, through which it purchased protection against credit default losses. This leverage created a “gap risk”, which the bank initially took into account in its financial statements, by adjusting down the value of the LSS positions. However, according to the SEC’s Order, when the credit markets started to deteriorate in 2008, Deutsche Bank steadily altered its methodologies for measuring the gap risk. Each change in methodology reduced the value assigned to the gap risk until Deutsche Bank eventually stopped adjusting for gap risk altogether. In other words, the bank slowly tweaked its formula over the months so that the risk didn’t show in its financial reports.

Therefore, “at the height of the financial crisis, Deutsche Bank’s financial statements did not reflect the significant risk in these large, complex illiquid positions”, according to Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.