Stoltmann Law Offices
Recovering Fannie Mae & Freddie Mac Investment Losses
Financial advisors and brokers at firms like Merrill Lynch, Citigroup Smith Barney, Wachovia and AG Edwards pitched preferred stocks in Fannie Mae and Freddie Mac to over 1 million investors nationally as an ultra safe investment that was appropriate and suitable for elderly clients or clients in or nearing retirement. There were two major misrepresentations brokers and financial advisors made when selling Fannie Mae and Freddie Mac preferred stocks. First, full service brokerage firm clients nationally were pitched the preferred investments as a “safe” and “secure” investment. Clients were often told that they either could not lose money, or would not lose investment principal in the Fannie Mae and Freddie Mac preferred stocks. These types of representations were made to investors as an inducement to invest significant sums into these preferred stocks.
Secondly, investors were told by their full service brokers that in the unlikely event Fannie Mae or Freddie Mac defaulted, the U.S. government would step in and make investors whole or otherwise cover their investment losses. This simply wasn’t the case. While bond holders in Fannie Mae and Freddie Mac would be protected, the common share holders and the preferred shareholders would not be offered any protections. To state otherwise is highly misleading and a misrepresentation under most state security laws.
The real, undisclosed risks to Fannie Mae and Freddie Mac preferred stocks holders were extreme. While pitched as ultra safe and secure and as a defacto government backed bond in many instances, in reality, this was not the case. Preferred stocks of Fannie Mae and Freddie Mac carried extreme risks and these risks were either glossed over or downplayed by brokers and financial advisors at major brokerage firms and banks.
Since 1900, preferred stocks have returned a 7.4% average annual compound rate of return. This falls short of stocks’ long-term returns of about 10%, but it tops the average 6.4% return of corporate bonds. It was this investment “sweet spot” that stockbrokers and advisors at full service brokerage firms and banks pitched to clients. The common solicitation was “You get the upside of stocks with the downside protection of bonds.” This simply was not true and these sorts of misrepresentations are actionable under many state securities acts in many instances. Depending on the client’s financial circumstances, these may also have been unsuitable investment recommendations and the clients may have an actionable FINRA arbitration lawsuit suitability claim.
Preferred stocks never have been, and never will be, the “safe and secure” bond alternative that over one million investors were pitched. All preferred stocks are risky and speculative, having characteristics very similar to individual stocks. What many clients weren’t told by their full service stockbroker or financial advisors was that preferred stocks are much more volatile than bonds. Historical statistics indicate preferred stocks lose value about 24% of the time, while corporate bonds only fall one in five years, or 20%. And when they do fall, preferred stocks lose about 5.6% of their value, vs. a 3.5% average decline by corporate bonds. Of course, these are just averages. As is clear from the Fannie and Freddie Mac, the drops can be dramatically greater.
An example in 2007, preferred stock investors in general had a rocky year. Even if financial advisors honestly believed the Fannie Mae and Freddie Mac preferred stocks weren’t risky, 2007 should have made it clear that they were indeed risky. The Winans International Preferred Stock Index (or WIPSI), which tracks the value of preferred stock, lost 13.8% of its value in 2007. That was the index’ worst year since 1994. The Vanguard Total Bond Market index fund, meanwhile, gained 6.97% in 2007. The Vanguard index owns government bonds in addition to corporate bonds, so it is not a perfect benchmark, but it does give a pretty good proxy.
Brokerage firms also took advantage of the confusion surrounding preferred shares. These investments are a mix of stocks and bonds, which help contribute to investors’ confusion. Like bonds, preferred shares are commitments (but not guarantees) by a company to pay a set amount of interest to shareholders. And like bonds, in most cases, the payments investors get from preferred stocks are taxed at a client’s ordinary income tax rate. Preferred stock payments, most of the time, do not qualify for the lower capital gains tax rates.
But preferred shares have some characteristics that make them unique and much riskier than the guaranteed status as they were pitched. First, just as with common stock, preferred stockholders in Fannie Mae and Freddie Mac are behind bond holders in line for the company’s assets when it runs into a financial problem. If a company like Fannie or Freddie fails, money is repaid to bondholders first. This adds extreme default risk to preferred stock holders. Bond holders in Freddie Mae and Fannie Mac are fully protected but not preferred and common stock holders. And, just as with dividends paid on common stock, Fannie Mae and Freddie Mac can (and indeed did) decide it no longer wants to pay the preferred dividend. Investors are left holding the bag.
What Firms Pitched The Fannie Mae and Freddie Mac Preferred Stocks?
Financial advisors and stockbrokers at every major U.S. brokerage firm, regional brokerage firm and banks sold Fannie Mae and Freddie Mac preferred stocks to clients. These firms include, but are not limited, to the following: Merrill Lynch, Morgan Stanley, Wachovia, LPL Linsco Private Ledger, AG Edwards, Edward Jones, Goldman Sachs, ING, Northern Trust, National City, Morgan Keegan and JP Morgan.
We have represented investors in FINRA securities arbitration claims involving preferred stocks in the past. We have represented over 500 investors in FINRA /NASD arbitration claims and lawsuits and have recovered millions for clients.
Do You Have A FINRA Arbitration Case?
It depends. Not everyone who has investment losses in Fannie Mae and Freddie Mac has a case against their brokerage firm or bank. The two major FINRA arbitration claims clients who sustained investment losses in Fannie Mae and Freddie Mac may have are suitability claims and misrepresentations/omission claims. The client’s investment assets, investment objectives and financial resources all must be factored in to determine if there is an actionable case.
There are many instances where the financial advisor may have made an unsuitable investment recommendation by purchasing Fannie Mae or Freddie Mac preferred stocks. Suitability claims and unsuitable investment recommendations often are a function of many factors. Some states (like Illinois) exclusively define an unsuitable investment recommendation based on the financial resources of the client. Other states like Michigan, Indiana, Texas, Arizona and Wisconsin define suitable investments in the context of the client’s financial resources and investment objectives. Please note there are no costs or charges for a review of the client’s facts to determine if there is an actionable claim in FINRA securities arbitration.
Who Is Our Target For Recovery?
We are not naming the brokers and advisors in the FINRA arbitration lawsuits who recommended the preferred stocks of Fannie Mae and Freddie Mac. Our targets are the brokerage firms and banks who sold these investments for making unsuitable investment recommendations and various misrepresentations and omissions. This means we will not be naming the investment advisors and brokers who sold the Fannie Mae and Freddie Mac preferred shares.