Litigation A-Go-Go

Shareholders, borrowers and institutions are not the only disgruntled parties; there may have been some trickling down of CDOs or CMOs into individual investors’ accounts. Recently, the Financial Industry Regulatory Authority (FINRA) started its own investigation, sending a sweeps letter to a number broker/dealers on December 14 asking for detailed information “regarding sales of principal only (“PO”), interest only (“IO”), and inverse floater (“IF), tranches of collateralized mortgage obligations,” from “June 30, 2006 to July 31, 2007,” according to a copy of the letter obtained by IA. The letter states that the information request does not necessarily mean that FINRA enforcement “has determined that any violations of the federal securities laws or NASD rules has occurred,” though it says firms must respond fully or face potential sanctions. FINRA spokesman Herb Perone explains in an e-mail that though FINRA has “seen an increase in the number of complaints,” about mortgage-related or other structured securities, “the sweep wasn’t prompted by the complaints–we typically do informational sweeps whenever a product that’s commonly the province of institutional investors works its way down to the retail market.”

FINRA wants details on, among other things, sales practices, the “suitability review process,” copies of holdings pages of the customers who bought the securities from the five “registered representatives who generated the largest amount of commissions,” “presentation materials,” and “customer communications,” according to the sweep letter. They’ve also asked for “all daily CMO offering sheets or similar documents, used to indicate CMO’s that your firm had available for sale that were created, used or distributed during the month of March 2007 and the month of June 2007.”

What does all this have to do with independent B/Ds? Just this: while the majority of independents may have had no direct exposure in terms of issuance of CMOs and CDOs, what firm does not have clients invested in bank, brokerage, or insurance company securities? If there were sales of mortgage-related securities, perhaps with the exception of something like a GNMA, a review of firm or practice policies may be necessary. How widespread are holdings of CMOs among retail? “I personally believe that it was not widespread–it may have been done in isolated circumstances,” says Brian Rubin, partner at Washington D.C.-based Sutherland Asbill & Brennan LLP, a firm that does “regulatory counseling” and represents financial services firms in “enforcement matters.” But B/Ds of all stripes should take note: “Even if they are not the subject of the sweep there are often second rounds of the sweeps,” Rubin explains, “it is in their best interest to review their policies, procedures and disclosures of these products.”

E-mail Senior Editor Kathleen M. McBride at [email protected].