Collateralized mortgage obligations (CMOs) are among the most complex fixed-income products ever sold to retail investors — and they have produced some of the largest investor losses in securities history.
From the $1.69 billion Orange County bankruptcy in 1994 to the trillions lost during the 2008 financial crisis, CMOs and mortgage-backed securities (MBS) have repeatedly devastated investors who were never told the full truth about what they were buying. Despite over three decades of enforcement actions and regulatory warnings, brokers continue recommending unsuitable CMO tranches to conservative, elderly, and retirement-account investors — because the hidden compensation structures on these products generate outsized profits for the firms that sell them.
If you or someone you know has suffered losses in CMOs, mortgage-backed securities, inverse floaters, or other complex structured products, you may have a claim for recovery through FINRA arbitration or other legal channels. The Law Offices of Robert Wayne Pearce, P.A. has more than 45 years of experience representing investors who have been harmed by stockbroker fraud and unsuitable investment recommendations, recovering more than $185 million for our clients.
What Are Collateralized Mortgage Obligations and How Do They Work?
A collateralized mortgage obligation is a type of mortgage-backed security created by pooling thousands of residential mortgage loans and then dividing the resulting cash flows into multiple classes — called tranches — each with different risk, return, and maturity characteristics. The word “tranche” comes from the French word for “slice,” and that is precisely what happens: the predictable monthly payments that homeowners make on their mortgages (principal, interest, and prepayments) are sliced apart and redistributed to different groups of investors according to a complex set of rules known as a “waterfall.”
Freddie Mac developed the first CMO in 1983 to address the prepayment instability that plagued simple pass-through mortgage-backed securities. While a pass-through MBS gives every investor a pro-rata share of all cash flows — making returns unpredictable because homeowners can prepay at any time — CMOs restructure those same cash flows to create customized risk profiles. Some tranches receive payments first and carry less uncertainty; others absorb all the volatility and can experience devastating losses.
Today, CMOs are typically structured as Real Estate Mortgage Investment Conduits (REMICs) for tax efficiency. The Tax Reform Act of 1986 created the REMIC structure, and the terms “CMO” and “REMIC” are now used interchangeably. The U.S. mortgage-backed securities market is enormous — approximately $12.1 trillion in total outstanding MBS as of 2024–2025, with agency MBS alone accounting for roughly $9.4 to $9.7 trillion. Agency CMOs represent approximately $1 trillion of the broader agency MBS market.
The Broader MBS Landscape
CMOs exist within a larger ecosystem of mortgage-backed securities. The simplest form of MBS is the pass-through certificate, where investors receive a proportional share of all monthly mortgage payments. Pass-throughs dominate the MBS market and trade in the highly liquid TBA (To-Be-Announced) forward market. CMOs are constructed from pools of these pass-throughs — multiple pass-through pools are combined and their cash flows restructured into tranche-based securities with very different characteristics.
The key entities in this market include the three government-sponsored agencies that issue or guarantee the vast majority of MBS: Ginnie Mae (Government National Mortgage Association, backed by the full faith and credit of the U.S. government), Fannie Mae (Federal National Mortgage Association), and Freddie Mac (Federal Home Loan Mortgage Corporation). Private financial institutions — including Goldman Sachs, JPMorgan, Morgan Stanley, and others — also issue non-agency or “private-label” CMOs backed by mortgages that do not meet agency standards.
Total MBS issuance reached $1.6 trillion in 2024, up 21.4% year over year, according to SIFMA. Private-label RMBS issuance has been surging, reaching approximately $132 to $145 billion in 2024 and projected to hit $160 billion in 2025 — the highest level since the financial crisis. Trading volumes have also set records, with MBS average daily volume reaching $355.7 billion in 2025.
Understanding CMO Tranches: From Conservative to Catastrophic
Not all CMO tranches are created equal. The tranching process creates a spectrum of risk — from relatively stable bonds to instruments so volatile they can lose virtually all their value in a single interest rate cycle. Understanding this hierarchy is essential for any investor who holds or has been recommended CMOs.
Sequential Pay and PAC Tranches
The most basic CMO structure is the sequential pay (or “plain vanilla”) CMO. Monthly interest is distributed to all tranches, but all principal payments — both scheduled and prepayments — flow first to the shortest tranche (Tranche A) until it is fully retired, then to Tranche B, and so on. This gives shorter tranches more predictable average lives while exposing longer tranches to greater uncertainty.
Planned Amortization Class (PAC) tranches offer even more stability. PACs are structured with a defined “PAC band” — a range of prepayment speeds (for example, 100 to 300 PSA) within which the tranche pays according to a near-certain schedule. PAC tranches are protected from prepayment variability by companion or support tranches, which absorb excess or deficient prepayments. As long as actual prepayments stay within the band, PAC holders receive predictable cash flows. Targeted Amortization Class (TAC) tranches are similar but provide protection against only one direction of prepayment risk, typically contraction risk.
Z-tranches (accrual bonds) receive no cash payments for an extended initial period. Instead, their accrued interest is used to pay down earlier tranches, and the Z-tranche’s face amount grows at a compound rate. Only after all prior tranches are retired does the Z-tranche begin receiving payments — functioning much like a zero-coupon bond that converts to a current-pay instrument.
The Most Dangerous Tranches: Inverse Floaters, IO Strips, and PO Strips
The tranches that have caused the most devastating investor losses — and generated the most enforcement actions — are inverse floaters, interest-only (IO) strips, and principal-only (PO) strips. FINRA has warned since 1993 that these instruments are suitable only for sophisticated investors with high-risk tolerance, yet they continue to be sold to retirees, conservative investors, and unsophisticated retail customers.
Inverse floaters are created when a fixed-rate CMO tranche is split into a floating-rate tranche and its mathematical counterpart. The inverse floater’s coupon moves in the opposite direction of prevailing interest rates — and critically, it does so with leverage. A typical inverse floater formula might be: Coupon = 36% – (3 × SOFR). At SOFR of 5%, this pays an attractive 21%. But at SOFR of 8%, the coupon drops to 12% — a 43% income reduction from a 300-basis-point rate move. At SOFR of 12%, the coupon falls to zero. The leverage multiplier — often 3x or higher — amplifies every basis point of rate movement by a factor of three or more. Simultaneously, rising rates slow prepayments, extending the bond’s duration and locking investors into a low- or zero-paying instrument for far longer than expected. During the 1994 interest rate shock, inverse floaters traded at discounts of up to 26% of face value.
Interest-only (IO) strips receive only the interest portion of mortgage payments — no principal whatsoever. IOs exhibit negative effective duration, meaning they behave opposite to virtually all other bonds: their value rises when rates increase and falls when rates decrease. When rates fall and homeowners refinance, prepayments accelerate, the underlying principal disappears faster, fewer interest payments remain, and the IO’s value collapses. IO investors can receive less cash back than they initially invested. As one major investment manager has noted, IOs are “a natural fit nowhere” — they are priced cheaply because their risk profile is so unusual and extreme.
Principal-only (PO) strips receive only the principal portion of mortgage payments. They are purchased at a deep discount to par — perhaps $70 per $100 of face value — and the investor’s return depends on how quickly principal is returned. When rates rise, prepayments slow dramatically, and a PO strip expected to return principal over 7 years might take 15 or more years, severely reducing the investor’s yield and causing significant price declines. POs have very high effective duration and extreme price volatility in rising rate environments.
The Philadelphia Federal Reserve’s research has concluded that IOs, POs, inverse floaters, and certain other CMO structures have risks that cannot be controlled with “traditional tools” and require “sophisticated bond-by-bond cash flow analysis.”
Companion Tranches: The Shock Absorbers That Can Devastate Investors
Companion or support tranches are created alongside PAC and TAC structures to absorb prepayment variability. They receive principal payments only after PAC/TAC requirements are satisfied. When prepayments are faster than expected, support tranches are paid down rapidly; when slower, they extend dramatically. A companion tranche expected to mature in 5 years can extend to 15 or even 20+ years. These tranches offer higher yields to compensate for their unpredictability, but the risks are often not adequately explained to retail investors.
Agency Versus Private-Label CMOs: Different Risks, Both Dangerous
Agency CMOs
Agency CMOs are issued or guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac. They carry virtually no credit or default risk because the agency guarantee absorbs borrower defaults. Ginnie Mae securities carry the full faith and credit of the U.S. government; Fannie Mae and Freddie Mac carry an implicit government guarantee and have been in government conservatorship since 2008. The underlying mortgages are “conforming” — meeting strict underwriting standards for loan size, documentation, and borrower creditworthiness.
However, the absence of credit risk does not mean agency CMOs are safe. Prepayment risk, extension risk, and interest rate risk remain fully present — and in certain tranches, these risks are amplified to extreme levels. As the 2024 SEC enforcement action against BMO Capital Markets demonstrated, even agency CMO bonds can be manipulated and mis-marketed. BMO sold approximately $3 billion in agency CMO bonds using misleading offering sheets that inflated weighted-average coupon rates by adding tiny “slivers” of higher-interest mortgages to pools, making bonds appear more attractive than they actually were.
Non-Agency (Private-Label) CMOs
Non-agency CMOs are issued by private financial institutions — investment banks, commercial banks, and mortgage lenders — without any government guarantee. Investors bear direct credit and default risk in addition to interest rate and prepayment risk. The underlying mortgages may be non-conforming: jumbo loans, Alt-A (reduced documentation), or subprime loans. Non-agency CMOs use credit tranching for protection — losses are absorbed by the most junior subordinated tranche first — but during severe housing downturns, losses can cascade through multiple tranches.
Non-agency CMOs played a central role in the 2008 financial crisis. Many were backed by subprime mortgages with fundamentally defective underwriting, and the resulting catastrophic losses triggered the worst economic downturn since the Great Depression. The Department of Justice’s RMBS Working Group ultimately recovered over $36 billion from 18 major financial institutions for fraud in the packaging and sale of these securities. Non-agency RMBS issuance collapsed after the crisis but has been recovering strongly, reaching an estimated $132 to $145 billion in 2024 — driven largely by non-QM (non-qualified mortgage) and home equity securitizations.
How CMO Risks Devastate Investors
Prepayment and Extension Risk: The No-Win Scenario
CMO investors face a phenomenon often described as a “no-win” scenario. When interest rates fall, homeowners refinance, prepayments accelerate, and investors receive their principal back at the worst possible time — when reinvestment opportunities offer lower yields. If an investor purchased a CMO at a premium (say, $105 per $100 of face value), every dollar prepaid at par produces a direct loss. Conversely, when rates rise, prepayments slow to a crawl, the bond’s average life extends far beyond expectations, and investors are locked into below-market coupon rates for years longer than anticipated. As one investment manager has summarized: an MBS “has a habit of doing what its investor least wants it to do.”
This risk is particularly acute in the current market environment. With mortgage rates at approximately 6.2% to 6.5% as of March 2026, the vast majority of existing mortgages originated during the 2020–2021 low-rate era (at 2.5% to 3.5%) remain deeply “out of the money” to refinance. Prepayment activity is running well below historical norms, creating significant extension risk for CMO holders. The Federal Reserve, which still holds approximately $2.1 trillion in agency MBS, has seen monthly prepayments running at only $15 to $20 billion against its $35 billion monthly runoff cap — illustrating how slowly principal is being returned.
Complexity and Opacity: Why Retail Investors Cannot Evaluate CMOs
Proper valuation of CMO tranches requires prepayment models, interest rate scenario analysis, option-adjusted spread (OAS) calculations, and Monte Carlo simulations — tools that are simply unavailable to retail investors. Each CMO tranche is unique, with structural features that make comparison to other securities nearly impossible for non-specialists. Offering documents run to hundreds of pages of dense legal and financial language. Even brokers themselves frequently lack adequate understanding of the products they sell. FINRA has found that registered representatives who recommend CMOs often cannot explain the product’s characteristics, risks, or likely performance under different market scenarios.
Securities arbitration attorneys have observed that brokers sometimes manipulate yield tables to optimize the appearance of a CMO’s performance, presenting optimistic prepayment assumptions without adequately disclosing the sensitivity of returns to changes in those assumptions. A mere 1% change in the conditional prepayment rate (CPR) can add or subtract a full percentage point of yield for the life of an IO investment — a level of model sensitivity that is virtually impossible for a retail investor to assess.
Hidden Fees and Compensation Conflicts
CMOs are primarily sold through principal transactions, where the dealer buys the bond into its own inventory and resells it to the customer at a higher price. The markup — the dealer’s profit — is the difference between the acquisition cost and the sale price, and it need not be disclosed to the customer. The customer sees only the purchase price, with no visibility into what the dealer paid.
FINRA Rule 2232 requires markup disclosure for certain fixed-income transactions when the dealer executes offsetting trades on the same day, but securitized products — including CMOs — are excluded from the “agency debt security” definition for markup disclosure purposes. This means CMO markups operate in relative darkness. For illiquid, complex tranches such as inverse floaters, IO strips, and companion bonds, bid-ask spreads can be extremely wide, and the customer cannot easily verify fair market value.
The compensation structures on CMOs create powerful conflicts of interest. Complex, illiquid products generate larger markups than simple, transparent instruments like Treasuries or agency pass-throughs. Broker-dealer trading desks profit from inventory markups, and internal “sales credits” incentivize brokers to push products that generate the most trading revenue. The most toxic tranches — those that institutional investors refuse to buy — face the greatest distribution pressure toward less sophisticated retail investors who do not fully understand what they are purchasing.
Why CMOs Are Often Unsuitable for Conservative and Elderly Investors
Retired and elderly investors typically need predictable income and capital preservation — exactly what most CMO tranches cannot provide. The unpredictable cash flows, potential for principal loss, and complexity of inverse floaters, IO strips, PO strips, and companion tranches make them fundamentally unsuitable for retirement accounts, conservative portfolios, and investors with limited financial sophistication.
FINRA has stated since its landmark 1993 notice (NASD NTM 93-73) that inverse floaters and IO strips are suitable “only for sophisticated investors with a high-risk profile.” Despite this decades-old warning, enforcement actions reveal a persistent pattern of brokers recommending these exact products to seniors, retirees, and conservative investors — often describing them as “secured government bonds” where investors “could not lose money.”
Common suitability violations in CMO cases include excessive concentration in a single product type, use of margin to amplify already-risky positions, failure to supervise broker activity in complex products, and misrepresentation of risks to obtain customer agreement.
Enforcement Actions: A 30-Year Pattern of CMO Fraud
The 1994 Interest Rate Crisis: Billions Lost on Inverse Floaters
The Federal Reserve’s six consecutive rate hikes in 1994 exposed the catastrophic downside of leveraged CMO positions and triggered billions in losses across the financial system.
Orange County, California remains the most infamous case. County Treasurer Robert Citron invested approximately 26% of the county’s $7.5 billion investment pool in inverse floaters and other interest-rate-linked derivatives, leveraging the portfolio through reverse repurchase agreements. When rates rose, the portfolio lost $1.69 billion, forcing the county into Chapter 9 bankruptcy on December 6, 1994 — the largest municipal bankruptcy in U.S. history at the time. The SEC charged Citron with securities fraud; he pleaded guilty to six felony counts and was sentenced to a $100,000 fine and house arrest. Merrill Lynch, which sold many of the derivatives, settled with the county for $400 million in June 1998. Total settlements from approximately 30 firms reached $864 million.
Piper Jaffray’s Institutional Government Income Portfolio was marketed as a conservative government bond fund but was secretly loaded with CMO derivatives. Under portfolio manager Worth Bruntjen, inverse floaters grew to between 30.9% and 47.4% of the fund’s CMO holdings, and total CMO derivatives exceeded 90% of net assets by March 1993. The fund was leveraged to 149% of net assets. When rates rose, the fund suffered approximately $700 million in paper losses. Bruntjen received a five-year suspension and $100,000 fine from the SEC. Piper Capital Management paid a $2 million SEC civil penalty and a $1.9 million NASD fine. Class action settlements totaled approximately $110 million.
David Askin Capital Management operated three hedge funds — Granite Partners, Granite Corporation, and Quartz — that made heavily leveraged bets on CMO derivatives, particularly principal-only strips. When rates rose in March 1994, the funds collapsed virtually overnight, losing approximately $600 to $700 million in fund assets. The collapse triggered forced selling that cascaded through CMO markets, deepening losses for other investors across the industry.
2007–2009 Financial Crisis: The Largest Fraud Settlements in History
The financial crisis produced enforcement actions of unprecedented scale, as federal investigators uncovered systematic fraud in the packaging, marketing, and sale of mortgage-backed securities.
Bank of America/Countrywide paid the largest single-entity civil settlement in American history: $16.65 billion in August 2014, including a $9.65 billion cash penalty and $7 billion in consumer relief. The DOJ described Countrywide as “the worst of the worst” in underwriting securities backed by defective loans. Bank of America ultimately paid more than $50 billion total to resolve all regulatory investigations related to its Countrywide and Merrill Lynch acquisitions.
JPMorgan Chase settled for $13 billion in November 2013 — at the time, the largest settlement with a single entity in American history — resolving claims arising from RMBS fraud by JPMorgan, Bear Stearns, and Washington Mutual. The government alleged all three entities securitized billions of dollars of defective mortgages and misled investors about loan quality.
Citigroup paid $7 billion to the DOJ in July 2014 for RMBS fraud, plus $285 million to the SEC for a CDO (Class V Funding III) where Citi took a proprietary short position against assets it was simultaneously selling to investors. Deutsche Bank settled for $7.2 billion in January 2017. Credit Suisse settled for $5.28 billion in January 2017. Morgan Stanley paid approximately $3.2 billion in February 2016.
Goldman Sachs paid $550 million to settle SEC charges over the ABACUS 2007-AC1 synthetic CDO. Goldman allowed hedge fund Paulson & Co. to select the reference portfolio of subprime RMBS while simultaneously shorting it — a fact not disclosed to investors who lost approximately $1 billion. Fabrice Tourre, the Goldman trader at the center of the deal, was found liable by a jury and ordered to pay approximately $825,000.
The DOJ’s RMBS Working Group concluded in August 2023 with a $1.435 billion settlement with UBS — the last of 18 major institutions to settle, bringing total recoveries to over $36 billion.
Recent Enforcement Actions (2023–2025)
CMO-related enforcement continues. In September 2024, the SEC ordered Macquarie Investment Management Business Trust to pay $79.8 million ($70 million civil penalty plus $9.8 million in disgorgement) for overvaluing approximately 4,900 largely illiquid CMOs held across 20 advisory accounts, including 11 retail mutual funds. Macquarie used a third-party pricing service that only priced institutional-size lots, not the smaller “odd lot” CMOs it held, resulting in systematically inflated valuations. When facing redemptions, Macquarie arranged 465 internal cross-trades at above-market prices, causing retail mutual funds to absorb losses.
In January 2025, the SEC ordered BMO Capital Markets Corp. to pay $40.66 million ($19.4 million disgorgement, $2.2 million prejudgment interest, $19 million civil penalty) for failure to supervise employees who sold approximately $3 billion in agency CMO bonds using misleading offering materials. BMO representatives structured bonds by adding tiny “slivers” of higher-interest mortgages to pools — sometimes as little as $1,000 — to inflate weighted-average coupon rates that made bonds appear far more attractive than their actual collateral warranted. Over 400 bonds were marketed using altered collateral information.
Retail Suitability Enforcement: A Persistent Pattern
FINRA and the SEC have brought multiple enforcement actions specifically targeting the unsuitable sale of complex CMO tranches to retail investors — and these cases reveal a strikingly consistent pattern of misconduct:
In September 2008, FINRA sanctioned three brokers at SAMCO Financial Services in what FINRA described as its “first enforcement action arising from FINRA’s ongoing investigations into abuses in marketing and sales of mortgage-backed securities.” The brokers — two of whom were permanently barred from the industry — misrepresented inverse floaters as “secured government bonds” where investors “could not lose any money,” causing approximately $535,000 in customer losses.
In August 2010, FINRA fined HSBC Securities $375,000 and ordered $320,000 in restitution after six brokers made 43 unsuitable sales of inverse floating-rate CMOs to unsophisticated retail customers. Twenty-five of the 43 sales exceeded $100,000. HSBC failed to train brokers that inverse floaters were suitable only for sophisticated, high-risk-tolerant investors, and the firm’s educational materials failed to even mention inverse floaters.
In June 2011, FINRA fined Northern Trust Securities $600,000 for failing to supervise CMO sales. The firm’s exception reporting system failed to capture all CMO transactions — meaning 43.5% of the firm’s business was excluded from supervisory review for over a year, leaving “vulnerable investors exposed to the risk of losing if not all then a significant part of their principal through potential over-concentration in CMOs.”
In April 2015, the FINRA National Adjudicatory Council affirmed sanctions against Brookstone Securities — including a $1 million fine and $1.62 million in restitution — for fraudulent misrepresentations and unsuitable CMO recommendations to senior and retired customers. Two brokers were permanently barred. The respondents recommended high-risk CMOs including inverse floaters and IO strips on margin to elderly customers with conservative objectives. The NAC rejected the defense that customers would have recovered if they had held on, establishing the principle that “suitability is determined at the time the recommendation is made; unsuitable recommendations do not become suitable if they later result in a profit.”
The firm’s own case results include an early landmark: a $3,266,200 FINRA arbitration award in Friedlander et al. v. Margaretten Securities (Case No. 90-01044), involving misrepresentations and unsuitable recommendations of stripped coupon mortgage-backed securities and pass-through certificates, with punitive damages and attorney fees awarded.
FINRA’s CMO-Specific Rules and Guidance
FINRA maintains several layers of regulation specifically targeting CMO sales practices. NASD Notice to Members 93-73 (1993), which remains in effect, established that members must be “conversant in all of the characteristics of CMOs” and explicitly declared that inverse floaters and IO strips are suitable “only for sophisticated investors with a high-risk profile.” The notice warned that “certain tranches may be structured in such a way that investors are at substantial risk and may lose all or a substantial portion of their principal.”
FINRA Rule 2216 governs all communications with the public about CMOs. Before selling a CMO to any non-institutional investor, a member must offer educational material covering the nature and characteristics of CMOs, tranche structures, the relationship between mortgage loans and mortgage securities, and questions investors should ask before investing. Advertising materials must disclose that CMO yield and average life will fluctuate depending on prepayment rates and interest rate changes.
FINRA Regulatory Notice 12-03 (2012) established heightened supervision requirements for complex products, explicitly listing asset-backed securities secured by mortgage pools as examples of complex products. Firms must perform reasonable diligence to understand complex products before recommending them, including analysis of likely performance across a wide range of normal and extreme market conditions. The notice encourages firms to consider prohibiting CMO recommendations to retail investors whose accounts are not approved for options trading. Firms must also consider whether less complex or less costly products could achieve the same objectives.
Regulation Best Interest and the Care Obligation
SEC Regulation Best Interest (Reg BI), effective since June 30, 2020, imposes a heightened standard on broker-dealers recommending securities to retail customers. For CMO recommendations, the four component obligations are particularly demanding. The Care Obligation requires brokers to exercise reasonable diligence, care, and skill, and to have a reasonable basis to believe the recommendation is in the customer’s best interest. The SEC’s April 2023 Staff Bulletin on Care Obligations specifically stated that firms recommending complex or risky products should apply “heightened scrutiny” and consider whether “less complex, less risky or lower cost alternatives can achieve the same objectives.”
The Disclosure Obligation requires full and fair disclosure of all material facts and conflicts of interest. The Conflict of Interest Obligation requires written policies to identify and address compensation-related conflicts, and prohibits sales contests, quotas, and bonuses tied to specific securities. Given the hidden markup structures and compensation conflicts inherent in CMO sales, these obligations impose significant compliance burdens on firms that recommend CMOs.
Current Regulatory Priorities
The SEC’s FY 2026 Examination Priorities (published November 17, 2025) specifically list “structured products” and products with “complex fee structures or return calculations” among areas of examination focus for retail investment recommendations. Fixed-income trading practices — including markup disclosures, best execution, and pricing of illiquid instruments — remain a stated Division priority.
FINRA’s 2026 Annual Regulatory Oversight Report (published December 9, 2025) flagged an increase in Reg BI care, conflicts, disclosure, and compliance failures, with “particular scrutiny around complex products.” The report noted that speculative fixed-income investments are specifically a duty-of-care concern, and emphasized the need for training associated persons on features of complex or risky products. FINRA’s examination program continues to employ a risk-based approach to identify problematic activity involving complex products including CMOs.
Legal Recourse for Investors Who Have Lost Money in CMOs
Investors who have suffered losses in CMOs, mortgage-backed securities, or related structured products may have strong legal claims. The most common causes of action in CMO cases include:
Unsuitable recommendations — the foundation of most CMO investor claims. If a broker recommended inverse floaters, IO strips, PO strips, or other complex CMO tranches to a conservative investor, a retiree, an elderly investor, or someone without the sophistication to understand the product, the recommendation likely violated FINRA suitability rules and Regulation Best Interest. Negligence and breach of fiduciary duty claims arise when financial advisors fail to exercise the care required by law.
Misrepresentation and omission of material facts — brokers who describe inverse floaters as “government-backed bonds” with “no risk of loss,” or who fail to disclose leveraged interest rate exposure, prepayment sensitivity, or the product’s complexity, may be liable for securities fraud under Section 10(b) of the Securities Exchange Act and Rule 10b-5, as well as state law.
Failure to supervise — brokerage firms have an independent obligation under FINRA Rule 3110 to establish and maintain supervisory systems reasonably designed to detect and prevent violations. When firms fail to monitor CMO sales, fail to train representatives on CMO risks, or exclude CMO transactions from exception reporting systems — as in the Northern Trust case — the firm itself is liable. The BMO Capital Markets enforcement action demonstrates that failure-to-supervise claims remain viable and can result in penalties exceeding $40 million.
Excessive concentration — loading a customer’s account with CMOs or other mortgage-backed securities, particularly complex tranches, may constitute a lack of diversification claim. FINRA enforcement actions have specifically targeted firms that allowed customers to become dangerously concentrated in CMO positions.
Excessive trading or churning — in accounts where CMO positions are frequently traded, the cumulative transaction costs (markups, markdowns, and bid-ask spreads) can consume a significant portion of any return, particularly given the wide spreads on illiquid tranches.
Most investor claims against brokerage firms are resolved through FINRA arbitration — a mandatory process established by the customer agreements that virtually all brokerage customers sign. FINRA arbitration can result in awards of compensatory damages, interest, and in cases of egregious misconduct, punitive damages and attorney fees — as demonstrated by the $3.27 million award in Friedlander v. Margaretten Securities. According to FINRA’s dispute resolution statistics, 2,469 arbitration cases were filed in 2024, with customers receiving damages in 26% of decided cases. Mediation achieved an 87% settlement rate in 2024.
Statutes of limitations apply to CMO claims, and these deadlines vary by the type of claim and jurisdiction. FINRA eligibility rules generally require that claims be filed within six years of the events giving rise to the dispute. Investors who suspect they have been harmed should seek legal counsel promptly to preserve their rights.
If you have suffered losses from CMO, MBS, or other complex mortgage-backed securities investments, contact the Law Offices of Robert Wayne Pearce, P.A. for a free consultation. With more than 45 years of experience in securities law and FINRA arbitration, attorney Robert Wayne Pearce has the expertise to evaluate your claim and pursue full recovery of your investment losses.
