Brokered CDs:


Finra Arbitration: Is it Fair ?


Unlike a Certificate of Deposit that is bought directly from a bank, a brokered CD is sold by stock brokers (and others). And unlike a bank-bought CD, a brokered CD is marketable on a secondary market. It is FDIC insured up to $100,000 and it is often marketed as a suitable alternative to Treasury issues. But there are pitfalls that I discovered recently by bitter experience.

I bought a total of $40,000 in 10-year CD's in January and February of 2003 from one of the best known, best respected security dealers in the country (Vanguard). Before I bought, the broker assured me that if I wanted to sell before maturity, I could do so in the secondary market. Of course, I understood that if interest rates go up, the market value of these securities would go down. That is elementary to anyone who has ever been interested in fixed-income investments.

Immediately after I bought these securities, the prevailing interest rates in fact went DOWN, so I would have expected the value of the securities to go UP. But that is not what happened. In the secondary market, the value of these CD's in fact went down the minute I bought them, more or less like the value of a new car the minute you drive out of the dealer's lot. The immediate loss was about 6.5%, in an environment of FALLING interest rates, i.e. in an environment in which fixed-income securities appreciated in value.

After many weeks of investigating and discussions with other people, I learned much. The bank issuing these CDs was rated 3 stars out of five by BauerFinancial, and it seems that the secondary market doesn't like this kind of bank. Yes, these CDs were FDIC insured. But apparently the market doesn't like long-term CDs from banks rated lower than four stars.

At the time of purchase, I had no idea of the risk related to the credit worthiness of FDIC-insured banks. The broker didn't tell me; I wasn't even aware of the system of rating banks.

The worst part is the following: there is evidence that on the very day these securities were sold to me, I could have bought similar CDs on the secondary market at a discount of about 6.5%. The broker didn't tell me. In effect, the broker sold me securities at 100 when the market value of these securities was only about 93.5. He misrepresented the value of these securities to me.

There is another way of looking at the broker's misrepresentation. The CD that was represented as yielding 4.15% actually yields only about 3.38%, once the immediate loss of about 6.5% is factored in.

Well, to make a long story short, I have taken the matter to NASD arbitration, and I have, of course, also complained to the SEC and the Attorney General of New York. I trust, but do not know, that these regulatory agencies will take a serious interest. The average time for an NASD arbitration to be decided is a year. I am in my 3rd month of submitting discovery requests, etc. The broker is stalling.

And here is something I found out only very recently: For small investors in CDs, there is FDIC insurance for amounts under $100,000. But it seems that the larger players in the field invest much higher sums at a time. So if the small investor wishes to sell his $10,000's worth of brokered CDs on the secondary market, the larger players, who seem to dominate this market and who apparently bunch smaller amounts, would not be very interested if the issuing bank is only so so. They would look for high-ranking banks, because for large investors, these CDs are essentially uninsured. If such players make a bid for lower-ranked CDs such as mine, they will offer less to compensate them for the higher risk. That's why the little guy needs to look at the credit worthiness of the issuing bank. The number of stars of the issuing bank is worth concrete dollars on the secondary market. If your bank has only three stars, you will lose serious money if you need to sell before maturity. This is not something my broker warned me about. Does your broker disclose these facts of life of the CDs he offers you ?

I do not suggest that brokered CDs should never be bought. But I would strongly suggest that a prospective buyer inform himself of the hidden risks. By the nature of such securities, the risks are higher the longer the term. The highest risks are for CDs running for ten or more years.

When you are offered one of these securities, here is what you need to do:

1. Check the rating of the bank. This can be done without cost at either of the following rating agencies (it's best to check both, in case there is a discrepancy):

2. Get the broker to check the value of a similar issue on the secondary market.

3. If the secondary-market value is less than par, offer the broker this lower price. That may result in a good deal for you. For instance, an issue with a coupon rate of 4.15%, if it sells on the secondary market for 93.5, will yield 4.98%.


Werner Cohn

November 25, 2003


October 2006 Update

Finra Arbitration: Is it Fair ?


The arbitrator (Mr. John F. Tague III, who is currently suspended from the practice of law -- see below) decided against us in this case in the summer of 2004.

I thought that our case was clear-cut and that the facts were all on our side. It is my opinion that the arbitrator's decision was arbitrary and capricious.

But be that as it may, the case exposed weaknesses in procedure that should be of great concern to all customers of security dealers.

As a condition for establishing an account with a dealer, a customer is required to sign an agreement in which he waives the right to sue. All disputes are to be arbitrated under the auspices of the National Association of Security Dealers, which has since been absorbed by the Financial Industry Regulatory Authority (Finra).

Arbitration awards (decisions) cannot, except in the rarest of circumstances, be appealed to the courts.

Hearings in arbitration are not open to the public. In my case, the arbitrator also required me to sign a confidentiality agreement as a condition for approving my discovery requests. As a result, I cannot reveal the most significant evidence that I was able to introduce at the hearing. This evidence would be of crucial importance to anyone contemplating a business relationship with the dealer. After the case was decided, the top legal officer of the company (Vanguard) sent me a letter saying that he "expects" me to keep the evidence from the public. I took this to be a threat to sue if I reveal what I have learned about the practices of his company.

In contrast, court hearings are public as a matter of principle, and evidence introduced in court trials almost always become public documents.

The arbitrator's decision was "bare," i.e. it consisted of the word "denied" without explanation.

In the course of the arbitration proceedings, the arbitrator, in my view, showed disdain and discourtesy to our side. Many months elapsed between the preliminary procedures and the scheduled date of the hearing. When this date finally arrived, I appeared at the designated office but the arbitrator did not. Apparently he had given a few hours notice to NASD (which was relayed to the other side but never reached me) citing a conflict with his schedule. He then set another date that involved yet another delay of several months, disregarding my request for speedier proceedings. (I assume here that Finra, which has absorbed NASD arbitration, operates under the old NASD rules).

Unlike procedures in other arbitration schemes, NASD arbitration awards cannot be appealed to a master arbitrator.

In sum, the secretive NASD procedure concludes with the say-so of a single person, unexplained, unappealable, unchallengeable. (In cases involving more than $50,000, more than one arbitrator will sit in a case.) Perhaps justice is done some of the time in these procedures, perhaps it is even done most of the time. But justice is certainly not seen to be done. The system has no apparent way of avoiding bias, caprice, sloth, or worse.

NASD has not responded to my written suggestions for more transparency and more accountability.

On August 15, 2006, some two years after the events recounted here and apparently unrelated to them, Mr. Tague, the NASD arbitrator in our case, was found guilty of multiple breaches of fiduciary duties as well as of "the extraction of unreasonable and unconscionable compensation." He was suspended from the practice of law for a period of two years, commencing September 15, 2006. 2006 NY Slip Op 06234



October 16, 2004

revised October 4, 2006 and (slightly) on August 12, 2007.


UPDATE, February 13, 2009:

Mr. John F. Tague III, according to the website of New York State's Attorney General, is still suspended from the practice of law.




The Behavior of FDIC-Insured CDs in the Secondary Market


Seniors are the most vulnerable



Send an e-mail to Werner Cohn This e-mail link may not work for you if you use a web-based e-mail service. If so, please use my direct e-mail address as follows:


Click here to go to home page of Werner Cohn


Have you heard about my Early Companions ?