Merrill Lynch’s sales of risky collateralized debt obligations (CDOs) have come back to haunt Main Street, with many investors alleging they didn’t thoroughly understand the dangers that the complicated products present.
“We were just lambs being led to the slaughter,” said investor Michael Slomak in a June 11 story in the Wall Street Journal.
Slomack is part of a Cleveland family whom he says invested $2.65 million in several Merrill-issued CDOs. According to the WSJ article, the structured securities had a level of risk that was never adequately explained to Slomack and other family members. The family lost all but $16,500 and has since filed arbitration claim against Merrill Lynch with the Financial Industry Regulatory Authority (FINRA),
Merrill Lynch, which is now part of Bank of America, may be especially susceptible to the wrath of investors because it has sold the biggest inventory of CDOs and had the industry’s biggest brokerage force to sell them in the years leading up to the financial crisis. As the Wall Street Journal article points out, 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.
At issue in the Merrill case – and in other cases and arbitration claims related to CDO deals – is the idea of investor sophistication. Even though there are certain regulatory rules in place regarding the types of investors who can purchase higher-risk financial products like CDOs, newer investment products have become more complex in recent years. As a result, the complexities and risk levels of these products may not be fully understood by even the most sophisticated retail customer.
Boston businessman Russell Stephens knows this only too well. Stephens, who considers himself a “sophisticated” investor, bought a $400,000 CDO from a Merrill Lynch adviser in Virginia. Stephens, 56, said he was sold the tranche most vulnerable to losses in the event of default, yet was told that the CDO would be an appropriate replacement for a municipal bond. As fate would have it, the CDO hit a wall, and Stephens faced an unexpected tax charge. Ultimately, the value of his investment plummeted to $80,000.
“It’ been a nightmare,” Stephens said in the Wall Street Journal, adding that the deal “wasn’t fully explained” to him.
Lack of disclosure also was a problem for investor Alan Lipson. Lipson lost $20,000 in a Merrill Lynch CDO. He attributes the loss to the fact that he missed a key section of the prospectus, which cited information on how banks that provide the CDO assets could stop paying interest at any time.
For Ralph Cortell, a former Ohio hair salon business owner, the issue regarding his CDO losses was alleged misrepresentation. Cortell, who died in 2008, invested $2.65 million as a nest egg for his four daughters. In late 2004, Cortell and his son-in-law sought the advice of two local Merrill brokers on how they should invest proceeds from the sale of 200 hair salons.
The brokers allegedly assured them that CDOs were “very safe with little or no risk.” Later, a former Merrill Lynch vice president told Cortell to put even more money into CDOs, stating that they had “zero risk.”
A complaint with FINRA is now pending in Cortell’s case.