According to the Financial Industry Regulatory Authority (FINRA), 2009 witnessed a significant increase in arbitration filings and complaints by mutual fund investors. Contrary to past experience, mutual funds now make the largest single product source for customer complaints, outpacing claims arising from investments in common stocks and corporate bonds. Overall, FINRA reports that the total number of new arbitration claims filed in 2009 approached the level of activity last witnessed in the ‘‘tech wreck’’ era of 2001–2004.
One likely reason for this surge of claims by fund investors is alleged losses from funds with exposure to structured finance products often associated with the subprime, ‘‘Alt-A’’ or commercial real estate markets. By 2006, the market for issuance of mortgage-backedsecurities (MBS) swelled to the point that it eclipsed the municipal bond market in dollar amount. Many of these securities carried investment grade ratings issued by the credit rating agencies, and later were purchased by mutual fund portfolio advisors.
Beginning in 2007, the mortgage markets in the United States buckled under the weight of the subprime mortgage sector. It has been estimated that by January 2008 more than half of the structured finance securities issued in the United States in 2006 and 2007 had been downgraded by the rating agencies. Former Securities and Exchange Commission (SEC) Chairman Christopher Cox has noted that, as of February 2008, Moody’s Investors Service had downgraded at least one portion, or tranche, of more than 94% of the subprime residential mortgage-backed securities it rated in 2006. These downgrades caused a precipitous drop in the credit markets and adversely affected the values of both investment grade and non-investment grade instruments, including the holdings in mutual funds. The net asset value (NAV) of many mutual funds holding MBS eroded, and litigation followed soon thereafter as plaintiffs initiated class action lawsuits as well as FINRA arbitrations. This article will examine the common law claims filed by these investors, along with causes of action arising under the federal securities laws, and the most common defenses available to these claims.
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