What Are CMO's?
Collateralized mortgage obligations ("CMOs") are securities issued by the Federal National Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corp. ("Freddie Mac"), or the Government National Mortgage Association ("Ginnie Mae"). Inverse floaters are structured so that interest payments move in the opposite direction of a floating rate index, such as the London Interbank Offered Rate. They typically are highly leveraged and vulnerable to a high degree of price volatility as interest rates move. Increases in interest rates also may extend the expected maturity date of an inverse floater.
Inverse floaters trade in the over-the-counter market, and are among the most thinly traded and volatile types of CMOs. Inverse floaters are complex, volatile, and risky securities. As stated in the Fannie Mae prospectus for a tranche of inverse floaters sold by some brokers to retail customers:
Market and Liquidity Considerations
We cannot be sure that a market for resale of the certificates will develop. Further, if a market develops, it may not continue or be sufficiently liquid to allow you to sell your certificates. Even if you are able to sell your certificates, the sale price may not be comparable to similar investments that have a developed market. Moreover, you may not be able to sell small or large amounts of certificates at prices comparable to those available to other investors.
These risks will be greatest in the case of certificates that are especially sensitive to interest rate or market risks, that are designed for specific investment objectives or strategies or that have been structured to meet the investment requirements of limited categories of investors. Such certificates are more likely to have a limited market for resale, little or no liquidity and more price volatility than other similar mortgage-backed securities. Limited liquidity may have a severely adverse effect on the market value of these types of certificates.
The interest rate of an inverse floating rate class of certificates will change in the opposite direction of changes in the specified interest rate index. The prices of such certificates typically are more volatile than those of other similar floating rate mortgage-backed securities based on the same index with otherwise comparable terms. Increased volatility occurs because an increase in the index not only decreases the interest rate (and consequently the value) of the certificate, but also reflects an increase in prevailing interest rates, which further diminishes the value of such certificate.
You should not purchase certificates unless you understand and are able to tolerate the risk that certain certificates may not be resold easily, that the value of certificates will fluctuate over time, and that these fluctuations may be significant and could result in losses to you. This risk is greatest if your circumstances do not permit you to hold the certificates until maturity.
The NASD previously has advised its members that inverse floaters "are only suitable for sophisticated investors with a high-risk profile and the investor must be made aware of the risks and characteristics" of the inverse floater being purchased. See NASD Notice to Members 93-73:Member's Obligations to Customers When Selling Collateralized Mortgage Obligations (CMO'S).
Inverse floaters are not suitable investments for retail customers with conservative to moderate investment objectives due to the volatile and highly risky nature of inverse floaters.
Did My Broker Breach His Fiduciary Duty to Me?
Your broker likely breaches his fiduciary duty if:
a. Your broker tells you, a retail customer whose investment objectives are conservative to moderate, that inverse floaters were suitable investments for you;
b. Your broker tells you that there was relatively little risk associated with inverse floaters because their principal was guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae, without adequately disclosing to these customers that (I) this principal guarantee only applied if they held their inverse floater positions until maturity, or that (ii) the performance of interest rates could extend the expected maturity date of the inverse floaters they purchased;
or
c. Your broker assured you, a retail customer, that his expertise would allow him to profitably manage their portfolios of inverse floaters in both falling and rising interest rate environments.
There are other considerations, but these are some typical examples of why CMO's (eg. Invese Floaters) may not be suitable for you, and may give you the right to sue your broker. The law firm of Sonn & Erez represents investors nationwide in claims against investment firms. We have represented investors in claims against Brookstreet Securities and have a number of new clients who recently lost in their accounts at that firm. To learn more whether we can assist you or inquire about us, contact us to arrange a free confidential consultation with one of our attorneys. 1-866-372-8311. (1-866- FRAUD 11).
From offices in Fort Lauderdale, the Florida investment fraud lawyers of Sonn & Erez represent clients throughout South Florida, including the cities of Boca Raton, Palm Beach, Delray Beach, Orlando, Tampa, Sarasota, Jacksonville, Fort Myers, and Naples, and the residents of Broward County, Miami-Dade County, and Palm Beach County. They represent clients nationwide, including investors in New York, (NY), Connecticut, (CT), Texas, (TX), California, (CA), Arizona, (AZ), New Jersey, (NJ), Pennsylvania, (PA), and Michigan, (MI).
