LANSING, Mich. — A Financial Industry Regulatory Authority panel awarded CASE CU more than $1 million in a legal battle about alleged misrepresentation and omission of investments in CMOs and interest-only strips it purchased from Prudential.
In 2002, CASE CU executives attended a "boot camp" presented by Prudential's Credit Union Strategy Group, headed by Mark Wickard, and following the session they asked Wickard to review the CU's portfolio. Wickard recommended the credit union invest in collateralized mortgage obligations, "which was something they had never purchased before," said Samuel Edwards, the attorney representing CASE CU.
CU Believed It Was Safe
"They really didn't understand it, they understood it to be safe because it was being marketed as a hedge against the rest of their portfolio," he said, noting the case went beyond a broker failing to explain a product correctly. "It's not a very good hedge, but even if it was a good hedge, they got charged $1 million more than what it was worth."
In the arbitration hearing, Edwards alleged Prudential brokers misled the CU on a number of occasions and even possibly made unauthorized and misleading changes to investment documents presented to CASE. The case turned, Edwards said, on a few pieces of hard evidence and expert testimony on the overpayment. The fact that the brokerage also convinced the $186-million credit union to buy the I/O strips, an even riskier product than CMOs, after it started to get cold feet and confused on the CMO investment may have also played a major factor. The panel does not release an opinion or explanation when it settles a case, even when an award is made.
CASE CU was able to sell the multi-million dollar product at a loss of about $1.3 million - very nearly the sum they were awarded by the FIRA panel. Edwards believes that brokers pushed exotic products like CMOs and I/Os to institutions like credit unions that did not have portfolios suited for such risky investments simply to get huge commissions.
If the CEO of a credit union, or any other institution feels it has been mislead over an investment and begins to make noise, the first thing brokers do is send a letter to the top claiming that the individual who had the obligation to ensure that the investment was sound and appropriate. But Edwards dismissed that notion, especially in cases where even the brokers don't understand the products they are marketing and just looks at the money they can make from the sale.
Even Savvy People Can Be Misled
"We had very intelligent, very weathered people that had been doing this for a long time; but no matter how sophisticated you are you can be lied to and you can be misled. If the advisor breaches that trust, that's not on you," he said. "If a broker loaded [an institution] up on 50% CMOs and didn't really describe the risk that was going on because they're big ticket item for the broker then you do have a problem. There's a suitability issue ... You can't sell clients something because it makes a nice commission for you."
Though many states bar credit unions from investing in CMOs, enough CUs were able to invest in the products and the "frenzy" that took place at the height of the housing bubble likely means that there will be a number of CMO or I/O cases in the next three to four years.
