In a lawsuit filed yesterday in the US Southern District Court of Florida, the SEC alleges the brokers presented the CMOs as suitable products for retirees and conservative investors. In some cases, the CMOs were also mis-represented as being guaranteed by the US government. The SEC claims that - contrary to what the brokers represented - the investments were in fact illiquid and suitable only for sophisticated investors seeking high-risk products.
Furthermore, the brokers are accused of heavily margining customer's accounts, resulting in losses of more than $36 million. Between 2004 and 2007, the brokers are alleged to have defrauded more than 750 customers, while reaping a total of $18 million in commissions for the sales.
"These brokers disguised the risks of investing in these derivatives of mortgage-backed securities, exposing their customers to substantial losses. They disregarded their customers' needs, and used deceptive and misleading tactics to enrich themselves at their clients' expense," stated Robert Khuzami, director of the SEC's enforcement division.
The lawsuit has echoes to the recent scandal involving the sale of Canadian non-bank asset-backed commercial paper to retail investors. Over 2,500 retail investors - many of whom were retirees - lost money on what they thought were safe AAA instruments, which they had purchased on the advice of brokers. The case was brought to a close earlier this year after brokers agreed to repay retail clients their initial investment in full.