For most people, the word bond sounds safe. That’s because, for a very long time, American consumers traditionally bought federal government bonds and U.S. Treasury bonds, which are extremely safe. This feeling of security is how bond fund fraud happens.
However, in recent years, brokerage firms and stockbrokers have been recommending investors buy bond funds, instead of bonds. Bond funds are mutual funds invested in bonds instead of stocks. Some of these funds could be good investments; however, many of them are far riskier than they appear.
The problem is, Wall Street brokerage firms have been obscuring the high level of risk associated with certain bond funds by giving them misleading names like “high yield bond fund” or “short-term bond fund.” Dishonest or negligent stockbrokers then push these risky funds onto unsuspecting ultra-conservative investors.
Millions of senior citizens, retirees, and conservative investors have fallen prey to lies, misrepresentations, and scams relating to bond funds. If you suspect that you’re the victim of bond fund fraud, and you suffered financially because of it, you may be able to file an FINRA arbitration claim to try and get your money back.
How Bond Fund Fraud Happens
Stockbrokers and brokerage firms have been exploiting conservative investors’ perception that “all bonds are safe” and tricking them into purchasing unsuitably risky bond funds for years. Combine this with the fact that many stockbrokers are misrepresenting risky bond funds as investments that are just as secure as CDs, and you can see how bond fund fraud has gotten completely out of hand.
Sometimes brokerage firms will even rate these unsafe bond funds with AAA ratings. They’re doing this partly because they want to fill their pockets with cash from the commissions and bonuses they receive from “making the sale.”
In other cases, firms have far more despicable motives for misrepresenting these funds. During the subprime mortgage crisis, for example, some brokerage firms and financial institutions were unloading their own holdings of “toxic mortgage debt assets” by bundling them up inside bond funds without disclosing that fact to the conservative investors buying the funds.
A prime example of bond fund fraud happened with the Charles Schwab Yield Plus Funds. These were highly rated, short-term bond funds and stockbrokers aggressively and fraudulently sold them to unsuspecting conservative investors as an “alternative” to CDs, cash, and money market funds. Countless ultra-conservative investors agreed to buy Yield Plus funds because stockbrokers were touting them as their best and safest option.
However, Yield Plus funds were heavily invested in very risky subprime mortgages. When the real estate markets collapsed in 2007 and 2008, Yield Plus investors lost a massive percentage of their investment, which was supposed to be “just as safe as cash.”
Bringing Bond Fund Fraud into Perspective
When it comes to mutual funds, no matter what the fund is called, safety is all about the investments and trading activity that happens inside the fund. For example, a bond fund that’s invested 100 percent in federal and municipal bonds is going to be a lot safer than a bond fund invested in subprime mortgages.
However, even safe bond funds are a not the same as regular bonds — they have different risks associated with them. A municipal bond fund has risks that a regular municipal bond (a bond issued by a city, state or governmental organization) doesn’t have. This is because, if the bond fund falls in market value, the bond fund investor doesn’t have the option to hold his bond note until maturity to get all his money back.
Let’s take a look at the main risks associated with normal bonds and then see how they differ from bond funds. Here’s what you should know about normal bonds:
- The safety of your bond largely depends on the financial well-being of the bond issuer. Bonds are guaranteed investments. As long as the issuer (i.e., the government, city, or corporation that issued it) remains financially viable and doesn’t go bankrupt, you’ll receive the full amount you invested when the bond matures. The more stable the issuer, the safer the bond.
- Bonds can rise and fall in value with the bond markets. You can sell your bond before it matures; however, you may not get the same amount of money you initially paid for it. You could lose money by selling a bond that has declined in value before its maturity date.
- Bond value fluctuations are not important if you plan to hold your bond until maturity. This is the important difference between bonds and bond funds. If you hold your bond to maturity, you’ll get your full principal back.
Here’s how bond funds are different:
- Your bond fund will rise and fall in value with the bond markets, and you will not have the option of holding a bond fund until maturity to get all your money back. Bond fund managers are constantly buying and selling the bonds inside a bond fund. Rarely do they hold the bonds until maturity. If your bond fund loses market value, you will lose money on your investment.
- Bond funds might contain risky bonds inside them. Most investors do not look up the contents of a bond fund. They simply trust what their stockbroker tells them about it. This makes it easy for dishonest stockbrokers and brokerage firms to sell risky bond funds to ultra-conservative investors who don’t know what they’re getting into. However, even savvy investors who diligently research a bond fund could be misled by a fraudulent prospectus and marketing data published by the fund or a brokerage firm which lies about the investment.
As you can see, bond funds are not “safe like bonds” no matter what they contain inside them. That’s because bond funds are always subject to the volatility of the bond markets. Nor do bond fund investors have the option of getting their full principal back upon maturity. These differences are rarely explained to bond fund investors.
When a stockbroker doesn’t fully explain the risks involved with an investment he sells to an investor, he has committed fraud by omission and misrepresentation. Even worse, when a dishonest stockbroker invests his conservative client into a “junk bond” fund he has recommended an unsuitable security and breached his fiduciary obligation to look after his client’s best interest.
Discovering the Fraud
Here’s how some investors discover they’re the victims of bond fund fraud:
- A diligent investor discovers the fraud himself: A 60-year-old, ultra-conservative investor notices big losses in his bond fund and assumes there’s been a mistake. How could something as safe as CDs decline by 40 percent? He calls his stockbroker and discovers the truth about his investment.
- An honest stockbroker saves the day: A lot of times, stockbrokers themselves are deceived by false AAA ratings and misleading prospectuses about bond funds, and they truly believe that a risky bond fund is safe. In such cases, a good stockbroker will get his clients out of the fund as soon as he discovers the truth, curbing as much of the losses as possible.
- The fraud remains undiscovered and the damages get worse: Sometimes a brokerage firm will give false excuses for a bond fund’s decline, urging you not to sell and telling you its value is about to correct. In such cases, when a problematic bond fund goes undiscovered and isn’t immediately liquidated, it can be financially devastating.
Know Your Rights
If you’re a conservative investor and your brokerage firm or stockbroker recommended you invest in a bond fund that wasn’t suitable for your needs, you may be able to recoup all or some of the financial losses that happened as a result.
Here are the most important legal concepts involved in a typical bond fund case:
Federal and state laws prohibit stockbrokers and brokerage firms from misleading consumers and lying to them when offering and selling an investment.
Try and Get Your Money Back
If you suffered investment declines due to the fraudulent actions of your stockbroker or brokerage firm, you deserve financial compensation. Depending on the case, victims may qualify for a full or partial refund of the original amount invested.
While financial damages can be economically crippling, the realization you were lied to and played for a ‘sucker’ can be emotionally devastating. If you have fallen victim to bond fund fraud, it’s important to remember this is not your fault!
Pursuing an investor fraud claim will teach Wall Street brokerage firms that it’s unacceptable to prey upon innocent consumers. Your claim may even prevent others from suffering as you have by forcing Wall Street brokerage firms to conduct business with honesty and integrity.
Contact Us
You may be eligible to receive compensation regardless of whether you sold or continue to hold the securities at issue. Contact us today to set up a free consultation. We will listen to your story, answer any questions you may have and discuss your legal rights and options.