Now that analysts and economists have finally acknowledged the gravity of the residential real estate market in Southern California, the bottoming-out can get underway already. Over the last few months, words such as “cautionary” and “leveling” have given way to “ominous” and “dire.” In San Diego County, existing home sales fell in September by 35 percent from last year, marking the biggest drop since 1991.
A drying loan pipeline is just one of the problems mortgage lenders have to manage in this new environment. Lenders also face a confluence of two factors that will wreck havoc on the industry like it has never seen before. First, on September 29, federal agencies released their final guidance curbing the use of creative, payment-option loans. This guidance not only casts a further pall on loan volumes by tightening lending standards, but also creates a legal and compliance minefield that will lead to significant changes in the way home loans are marketed and sold. Second, the Wall Street firms who bought and bundled these high-risk loans into securities are beginning to attack past underwriting practices and force lenders to buy-back bad loans. The nation’s largest home lenders have started boosting reserves to account for the buy-backs that are sure to come. This will cause massive hits to earnings in an industry already reeling from a drastic market correction.
The bell has rung signaling the end of the heady days where even a bad loan is a good loan. It is time for underwriters and compliance professionals to roll-up their sleeves, adapt to this new environment and implement tougher underwriting standards and internal controls.
The NYSE’s risk-assessment unit just released an “Informed Investor” piece warning investors on exchange-traded funds (EFTs). EFTs are a type of mutual fund that invests in securities included on a selected market index. The NYSE raises what it calls some of the “distinct risks” associated with investing in ETFs as opposed to mutual funds. Specifically, the NYSE calls attention to some of the misconceptions investors have about the expenses related to ETFs.
ETFs are appealing because of the low annual expense ratio. According to Morningstar, Inc., the annual fees for ETFs are about a third of mutual funds. However, unlike mutual funds, investors pay trading commissions each time they trade an ETF. For investors who make small investments on a regular basis, the low annual fee is an illusion. By year’s end, the fees associated with the investment will greatly exceed those for a commission-free mutual fund. ETFs, then, are really only suitable for investors who make one large purchase.
In addition, the number of ETFs has increased three-fold since 2000. Many of the new ETFs track narrow segments which increases volatility. This results in more transactions and even higher costs. The NYSE’s publication, entitled “What You Should Know About Exchange Traded Funds,” is meant as an educational piece. In a practical sense, it should be viewed as a warning to brokers offering up the products as a suitable alternative to mutual funds.
Congress passed the Sarbanes-Oxley Act (SOX) in July 2002 in the wake of corporate scandals that rocked the equity markets and precipitated the collapse of the stock market bubble. The legislation imposed onerous auditing, corporate governance and corporate reporting requirements on public companies in an attempt to give more protection to investors. If we know anything about SOX now four years later, it is that SOX compliance is expensive. Particularly with respect to the Section 404 internal controls requirement. Section 404 requires publicly-traded companies to establish, document and maintain internal controls and procedures for financial reporting. It also requires that companies consistently check and maintain the effectiveness of these controls. Depending on the size of the company, SOX compliance easily can range from $500,000 to $1 million per year.
These higher costs, together with the increased disclosure and tighter controls mandated by SOX, are driving many tight-budgeted public companies to simply withdraw their listings with the major stock exchanges. Many go private to avoid the SOX headache, but more and more are now “going dark,” or voluntarily de-registering their shares with the SEC. These companies just move to the Pink Sheets, which historically has been considered the dungeon of failed ventures. Once on the Pink Sheets, these companies do not need to meet listed companies’ disclosure requirements.
So the irony of SOX is that in many cases it has resulted in shareholders getting even less information about a companies’ operations. The SEC has smartly recognized this, and it is taking action to remedy the problem. On August 9, 2006, the Securities Exchange Commission (SEC) granted smaller public companies extra time to comply with the the Section 404 internal control reporting requirements. Specifically, the SEC has proposed to bifurcate the compliance dates for the management report on internal controls and the auditor attestation report. The report on the effectiveness of a company’s internal control over financial reporting is delayed 6 months, or until the filing of the Form 10-K for its first fiscal year ending on or after December 15, 2007. The auditor attestation report is delayed 18 months, or until the filing of the Form 10-K for its first fiscal year ending on or after December 15, 2008. The grace period applies to companies with a public float of less than $75 million (defined as a “non-accelerated filer”).
This delay will give the SEC a chance to issue some interpretive guidance regarding the internal control evaluation process for these smaller companies. Expect this guidance to significantly scale-back the compliance requirements for small to mid-size issuers.
Annuities are being sold in record numbers and attracting the attention of both regulators as well as the plaintiffs’ securities bar. The biggest abuses involve elderly, retired persons who are being sold annuities through “free” financial seminars and telemarketers. Annuities abuse appears to be the new, growing wave of complaints, both private and public.
What Are Annuities
Annuities essentially are insurance products wrapped around an investment account. There are two basic types of annuities products. Fixed annuities carry a “guaranteed” rate of return and protection of principal. The other form of annuity, variable annuities, generally consists of insurance plus a portfolio of mutual funds that rise and fall as the stock market fluctuates and the value of the annuity, consequently, will and does fluctuate.
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