Oakes & Fosher is currently investigating FINRA–licensed stockbrokers who have sold GNMA, FNMA, FHLMC, and other mortgage bonds as short-term investments based on early payoff assumptions.
With the rise in interest rates, many investors are now stuck in long-term mortgage bonds sold as short-term investments. Stockbrokers pushed these long-term bonds since they could earn more in commission than selling a short-term bond or Certificate of Deposit (CD).
Mortgage Bonds Explained
Mortgage bonds are a type of investment backed by real estate loans. These loans are packaged into a pool by financial institutions and sold to investors as a bond. The money obtained from the sale of these bonds is then used to fund more mortgage loans, creating a continuous cycle.
The way mortgage bonds work is relatively straightforward. The interest and principal payments from the individual mortgage loans in the pool are passed on to the investors who hold the bonds. As the borrowers pay off the underlying mortgages, the investors receive their share of the repayments.
This regular cash flow is what makes mortgage bonds an attractive investment option. However, if interest rates rise, as they are currently, these bonds can become long-term investments, contrary to what some investors might expect.
Mortgage Bonds in a High-Interest-Rate Economy
In a high-interest-rate environment, the dynamics of mortgage bonds change significantly. When interest rates rise, homeowners are less likely to refinance their mortgages. This extends the life of mortgage bonds, effectively making them long-term investments. As such, bondholders may find themselves locked into a lower yield for longer than initially anticipated.
Additionally, mortgage bonds lose market value in a high-interest-rate environment. This decrease in value occurs because newly issued bonds come with a higher yield to reflect the increased rates, making the older, lower-yield bonds less attractive to investors. As demand for these older bonds decreases, their prices drop accordingly. This can create a challenging situation for investors who must sell their bonds before maturity.
Stockbrokers Failing to Disclose Vital Information
There have been instances where stockbrokers, in a bid to earn higher commissions, have failed to fully disclose the potential risks associated with mortgage bonds in a high-interest-rate economy. Investors, particularly those seeking short-term investments, are often led to believe that these bonds are a safe and profitable option.
The reality, however, can be vastly different. In a high-interest-rate environment, the value of these bonds can severely diminish, and investors can find themselves locked into long-term obligations with lower yields.
The Importance of Disclosure
It is incumbent upon stockbrokers to provide comprehensive, accurate information about the potential risks and rewards of any financial product they recommend, including mortgage bonds. They should thoroughly explain how interest rate changes impact these investments’ value and duration.
Failure to adequately disclose this critical information can lead to significant financial losses for the investor and potentially result in legal consequences for the stockbroker and their affiliated brokerage firm.
A Fiduciary Duty
Stockbrokers have a fiduciary duty to their investors, which means they are obligated under the law to put their clients’ interests ahead of their own. This fiduciary duty extends to the complete and transparent disclosure of all information materially impacting the investor’s decision-making process. This includes but is not limited to, potential risks, fees, commissions, and conflicts of interest associated with any recommended investment product.
In the context of mortgage bonds, this duty requires that stockbrokers accurately communicate how economic shifts, such as fluctuations in interest rates, can affect the bond’s value and duration. Stockbrokers must not oversimplify or sugarcoat these details to make a sale. If a stockbroker fails in this duty, they not only violate the trust placed in them by their clients but also risk severe legal ramifications, including fines, suspension, or even expulsion from the securities industry.
Oakes & Fosher Pursuing FINRA Arbitration
Oakes & Fosher recently filed FINRA arbitration on behalf of an investor told that these bonds would be redeemed within one to two years and offered a better yield than a two-year CD. When rates began to rise, the investor found themself stuck in bonds with a long-term maturity of 30 years.
When the investors inquired about selling these bonds, they were told they had lost one-third of their value. Stockbrokers and money managers must disclose all the risks and potential pitfalls of any investment they recommend to a client.
Get a No-Cost Consultation
If you or someone you know has suffered losses due to this type of investment, please contact the attorneys at Oakes & Fosher, LLC. Our FINRA arbitration lawyers serve investors nationwide and handle the representation on a contingency fee basis. This means that if you do not recover any of your losses, you don’t pay anything in attorney fees. Please contact us now for a no-cost consultation.
