Complex investments known as reverse convertibles face growing scrutiny from regulators for their hidden risks, lack of transparency and, in some instances, because of the manner in which they are represented to investors by certain brokers.

As reported in a June 24 story by Bloomberg, brokers for JPMorgan Chase & Co., Royal Bank of Scotland Group Plc, and Barclays Plc have been charging fees on some structured notes that equal or exceed the securities’ highest possible yield.

“It seems inconceivable that the commission could be more than the potential return to clients,” said Durraj Tase in the Bloomberg article. Tase, who is an adviser with First Liberties Financial in New York, added: “If you are paying more fees than your potential return, as an adviser, I would not be able to suggest that note.”

On June 15, RBS gave brokers a 2.75% commission to sell a three-month reverse-convertible note with a 2.56% potential yield, according to the Bloomberg story. In May, JPMorgan charged 5.25% in fees and commissions on a three-month Citigroup-linked note that paid 5% interest, and Barclays offered brokers a 2% commission on a security paying 2% interest.

In February 2010, the Financial Industry Regulatory Authority (FINRA) issued an alert to investors on the risks associated with reverse convertibles. Among things, FINRA warned that 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.

In the case of JPMorgan’s reverse convertibles, investors are exposed to losses if Citigroup declines by more than 20%.

If you have suffered losses in Reverse Convertibles, please contact our securities fraud team. We can evaluate your situation to determine if you have a claim.

Investment deals involving Magnetar Capital are garnering renewed interest from the Securities and Exchange Commission (SEC), as the regulator steps up its investigation into how hedge funds like Magnetar made huge profits on instruments that produced billions of dollars in losses for investors.

The investments in question are mortgage-related collateralized debt obligations (CDOs). As reported June 19 by the Wall Street Journal, the hedge fund known as Magnetar played a key role in the CDO market, keeping sales growing even as cracks began to appear in the housing market.

Magnetar also worked with most of Wall Street’s top banks in its deals, including Merrill Lynch, Lehman Brothers, Citigroup, UBS and JPMorgan Chase.

Magnetar bought the riskiest portion of CDOs, while simultaneously placing bets that portions of its own deals would fail. Along the way, Magnetar allegedly did something to enhance the chances of that happening. According to an April 10 article by ProPublica, Magnetar pressed to include riskier assets in its CDOs so as to make the investments even more prone to failure.

Apparently Magnetar acknowledges that it bet against its own deals but says the majority of those short positions involved similar CDOs that it did not own. Magnetar says it never selected the assets that went into its CDOs.

The bottom line is Magnetar ended up making big profits when the CDOs collapsed. Meanwhile, investors in the supposedly safer parts of the CDO suffered big losses.

Now the SEC wants to know how the assets that were put into the CDOs were valued at the time, the terms of the deal, what triggers were put in place to determine whether investors would incur losses and at what point did the banks that were involved in the deal bet against the assets in the CDO.

Stranger-Originated Life Insurance (STOLI) policies may be the new mortgage-related investment debacle of the year, creating havoc for unsuspecting investors and a financial bonanza for brokers and insurance agents who unload them.

Stranger-Originated Life Insurance policies, also known as stranger-initiated life insurance or STOLI for short, are controversial investment arrangements in which a stranger initiates an insurance policy against someone’s life and then resells the policy to an investor. The investor pays the premiums and collects the proceeds when the original owner of the STOLI dies.

The middleman in the process is a broker or insurance agent. And, in recent months, regulators have been cracking down on both. Sales agents in Florida, Ohio, Minnesota and California all have been arrested and/or had their professional licenses revoked for allegedly exaggerating the wealth of an elderly client to take out a STOLI policy and then selling the policy to an investor.

One STOLI sales agent who specialized in stranger-originated life insurance policies is Steven Brasner. As reported June 22 by the Wall Street Journal, before the financial crisis hit, Brasner connected untold numbers of aging retirees in need of money with hedge funds looking for STOLI investments.

Today, many of those policies are worthless. In April, Brasner was arrested by Florida authorities on 22 counts of alleged grand theft, fraud and other offenses tied to $78 million of policies that earned him nearly $2 million in commissions. According to the Florida Attorney General, Branser lied to insurers about applicants’ financial status and their reasons for buying the coverage.

Brasner also faces a number of civil suits filed by insurers trying to void many of the policies, as well as lawsuits by investors who allege they lost money buying their now-worthless policies.

In March, Ohio regulators revoked the license of an agent who allegedly promised a 74-year-old Cleveland woman $8,000 to let him take out $9 million of insurance on her life. According to the Wall Street Journal, the application to Prudential Financial listed her net worth at $12.5 million. In reality, she and her husband had a net worth of $2,000 and combined monthly income of $950, according to Ohio officials and Prudential.

A similar scenario played out in Minnesota where regulators penalized an agent who had secured 44 policies totaling $127.8 million on the life of one man. The agent’s license ultimately was revoked, and he had to pay a $250,000 fine. According to regulators, the agent misrepresented the total amount of insurance outstanding as his client applied for additional coverage over a several year period.

Allegations of wrongdoing by agents and brokers are common in more than 200 civil lawsuits filed by insurers around the United States involving alleged stranger-originated policies, according to the Wall Street Journal article.

Two Nebraska investors have filed a class-action lawsuit against LPL Financial, alleging that one of the company’s brokers – Bob Bennie – misrepresented the costs and benefits of variable annuities.

As reported in a June 17 article by the Associated Press, more than $365,000 of the products had been sold to investors Richard and Carol Ripley. The Ripley’s lawsuit, which was originally filed last month in a Nebraska state court and which seeks class-action status, has been transferred to a Nebraska federal court.

In their lawsuit, the Ripleys contend that Bennie failed to disclose the unsuitable nature of the annuities and misled them about withdrawing money without facing a penalty and the costs of the annuities.

Boston-based LPL provides trading and support services to 16,000 independent brokers. Bennie is the owner of Bob Bennie Wealth Management.

Variable annuities have faced growing scrutiny lately, with regulators initiating enforcement actions against annuity sellers for unsuitable sales and lack of disclosure.

In the simplest terms, a variable annuity is a tax-deferred investment that comes with an insurance contract in which earnings grow tax-deferred.

At the same time, variable annuities come with a high commission fee – up to 9% in some instances. Moreover, many investors are often unaware of the early withdrawal penalties associated with variable annuities.

The Securities Investor Protection Corporation (SIPC) has announced the appointment of Steven Caruso of Maddox, Hargett, & Caruso to its SIPC Modernization Task Force. A total of 13 individuals – including representatives from the securities industry, investors, government regulators and academia – will serve on the task force.

The SIPC, which was formed by Congress to help customers of insolvent and failed brokerage firms, also launched a new Web site that will gather input from the public via online comments, as well as provide live interactive forums and national Webcasts.

According to the SIPC, the newly formed task force will provide statutory amendments to the SIPC board, as well as information to assist the SIPC board and members of Congress when it comes to enacting investor reforms.

The SIPC was created in 1970. As of 2009, it has advanced $1.2 billion in order to make possible the recovery of $108 billion in assets for an estimated 763,000 investors.

A June 11 blog by the Wall Street Journal illustrates a growing trend on Wall Street – the sophisticated investor defense. The premise is simple: If the complex financial products that Wall Street markets and sells go south, it’s the investor’s problem. After all, the products are geared to those who are financially savvy. They should have therefore known the risks involved.

In reality, even the most sophisticated investor may be unaware of the complexities and risks surrounding some of today’s investments. Moreover, even the “average” investor gets burned in these deals, usually through pension funds that participate in the investments.

A recent case involving Merrill Lynch and collateralized debt obligations (CDOs) is a perfect example. Merrill Lynch’s CDO deals were sold to institutional and retail investors. In other words, so-called sophisticated and less-than-sophisticated investors were part of the sales pitch. It also apparently was common fare for Merrill Lynch to sell retail investors the lowest-rated CDO slices of the deals.

Investors like the Slomacks ultimately paid the price, according to the WSJ article. The Slomacks invested $2.65 million in several Merrill-issued CDOs, losing all but $16,500. They have since filed an arbitration claim against Merrill Lynch with the Financial Industry Regulatory Authority (FINRA).

Another investment firm looking to employ the “sophisticated investor” defense over CDO deals gone bad is Goldman Sachs. For more than a year, Goldman has faced intense questioning by the U.S. Senate Permanent Subcommittee on Investigations about its CDO dealings, while investors contend Goldman used deceptive sales practices to market billions of dollars’ worth of the products. To date, the probes have cost Goldman $25 billion in market capitalization, according to a June 14 article by Reuters.

In April, the Securities and Exchange Commission (SEC) filed a civil fraud lawsuit against Goldman Sachs over a CDO called Abacus 2007. The Abacus transactions were synthetic collateralized debt obligations – financial products that many financial analysts say were largely responsible for the worst collapse in financial markets since the Great Depression.

The Financial Industry Regulatory Authority (FINRA) has issued a Regulatory Notice on a proposed rule to improve oversight of broker/dealers’ back-office operations. Specifically, the new rule would expand registration requirements to individuals who engage or supervise activities related to sales, trading support and/or handling of customer assets.

Previously, FINRA’s registration requirements only applied to brokers, investment bankers, traders or other financial professionals who gave advice to customers and handled securities transactions. Individuals who could be required to register under the new proposed rule include those who develop and approve valuation models; manage trade confirmations, account statements, trade settlement and margin; or oversee stock loan/securities lending, prime brokerage, receipt and delivery of securities, and/or financial regulatory reporting.

According to a statement from FINRA, the proposal is designed to provide “reasonable assurance” that these individuals understand their professional responsibilities, including key regulatory and control themes, as well as the importance of identifying and escalating red flags that may harm a firm, its customers, or the integrity of the marketplace or the public.

The Securities and Exchange Commission (SEC) must approve the rule change before it becomes effective.

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.

Goldman Sachs is facing yet another lawsuit involving toxic synthetic collateralized debt obligations (CDOs). Australian hedge fund manager Basis Capital’s Yield Alpha Fund claims it was defrauded by Goldman when it purchased $78 million of the Timberwolf CDOs in June 2007 and that Goldman knew at the time of the sale the securities were destined to fail as the mortgage market began to decline.

Basis Capital is seeking more than $1 billion in damages.

The lawsuit comes on the heels of another fraud lawsuit against Goldman Sachs. In April, the Securities and Exchange Commission (SEC) filed a civil suit against Goldman in connection to the sale of a synthetic CDO known as Abacus. As reported June 9 by the Wall Street Journal, Goldman and the SEC are reportedly working to settle that case, which could cost Goldman between $500 million and $1 billion in fines.

Emails will likely play a central role in the Basis Capital case. According to complaint, one email from a former Goldman executive describes the $1 billion Timberwolf CDO as “one s—-y deal.”

Basis Capital was forced to liquidate the Basis Yield Alpha Fund in late 2007 after sustaining heavy losses betting on the subprime mortgage market, including buying instruments like Timberwolf.

“Goldman was pressuring investors to take the risk of toxic securities off its books with knowingly false sales pitches,” said Eric L. Lewis of Baach Robinson & Lewis PLLC, Basis Yield Alpha Fund’s lead counsel, in the Wall Street Journal article. “Goldman should be called to account for its deception of BYAFM and other investors who were misled.”

Goldman Sachs is accused of trying to hide key information and bypassing a congressional investigation into the causes of the financial crisis, according to the Financial Crisis Inquiry Commission (FCIC). On June 4, the FCIC issued a subpoena to Goldman for failing to comply with the panel’s request back in January for documents and interviews over Goldman’s synthetic and hybrid collateralized debt obligations.

The deadline to provide the information was Feb. 26. The FCIC later gave Goldman several deadline extensions. Still, the requested information never materialized.

“They stretched us out thinking they played the game cleverly,” FCIC Vice Chairman Bill Thomas said in a June 8 article in USA Today. “They may have more to cover up than we thought.”

Phil Angelides, chairman of the FCIC, had similar comments for Goldman. In a June 7 story on CNBC, he stated the following:

“We are not going to let the American people be played for chumps here. We should not be forced to play ‘Where’s Waldo’ on behalf of the America people.”

Goldman Sachs also is facing a civil fraud lawsuit by the Securities and Exchange Commission (SEC) in connection to a mortgage-related investment that it created and sold in 2007.