SEC's Levitt Cautions Against Immoral CDs

If you think certificates of deposit (CDs) are always safe bets for short-term investments, think again.

Arthur Levitt, chairman of the U.S. Securities and Exchange Commission (SEC), wants AARP members to know that his agency has seen "a dramatic increase" in complaints about a new breed of CDs.

The problem, Levitt tells the AARP Bulletin, is that "certain brokerage firms and scamsters" are selling CDs that won't mature for 10 to 20 years—to elderly Americans.

"Really, that's shameless," Levitt says. "It may not be illegal, but I think it's immoral."

Many of these CDs cannot be redeemed before maturity. The only way to get out of the deal is to sell the CD back to the broker, often at a loss of as much as 30 percent.

The complaints flowing in to the SEC reflect a whole new ball game in the world of CDs.

Traditional CDs—which are still available at banks and savings and loan institutions—have a longstanding reputation as low-risk investments. They offer higher interest rates than regular savings accounts, are federally insured up to $100,000 and can be easily converted to cash. And, if necessary, the investor may withdraw the principal before the CD matures by paying a modest penalty.

But in today's market, Levitt says, banks are "desperately anxious for deposits" and are issuing CDs to brokerage firms that can harness a huge amount of capital by attracting multiple investors. The brokerage firms leverage volume to negotiate higher interest rates, then advertise those rates "to dazzle investors," Levitt says.

The new so-called brokered CDs have features that differ widely from traditional CDs. Some have variable interest rates. Some take decades to mature. Some give the bank the right to "call"—or terminate—the CD after a certain amount of time but do not give that right to investors.

And, if the investor needs money before the CD matures, the only option is to sell the CD back to the broker, often at significant loss.

Susan Wyderko, director of the SEC's Office of Investor Education and Assistance, says her office has received three times as many complaints about CD sales this year as in the previous three years combined. Almost all the letters are from older Americans who bought brokered CDs not realizing they could not withdraw the principal if they needed money unexpectedly.

While the problem cuts across economic lines, people with the least to lose are often hardest hit. In some cases, people with as little as $5,000 in liquid assets invested it all in brokered CDs and learned too late—when they needed a new roof, for example, or had unexpected medical bills—that they could not get all their money back.

Some of the letters are "just heartbreaking," Wyderko says.

Brokerage firms and independent brokers are marketing these CDs through direct mail, telephone solicitations and newspaper advertisements, which are fraught with buzzwords consumers may not understand, Wyderko says.

Some advertisements tout "no penalty for early withdrawal" when in fact there is no provision for early withdrawal.

Some say "noncallable for one year," and many consumers mistakenly assume that means that they can withdraw the principal after a year. In fact, it means the bank can terminate the CD after a year.

The ads also tout high interest rates. But according to the SEC, if the market takes a dive, the bank would probably exercise its right to "call" these CDs, thereby cutting off the interest rate that attracted investors in the first place.

Levitt advises older investors to protect themselves by being sure they understand the features of any CDs they are thinking about buying.

"Know that there's a relationship between risk and reward," he says. If one CD offers an interest rate that is several points higher than another, you can count on the one with the higher interest rate to involve greater risks.

"Your job is to determine what the risk is," Levitt says, "and are you willing to take it?"

His recommendations to AARP Bulletin readers:

• Don't buy a CD over the phone from someone you don't know.
• Don't buy a CD just because its features sounded good in an ad.
• Be familiar with the bank that issued the CD.
• Read the fine print, and be sure you understand the lingo. Learn the difference between " call " features and maturity.
• Ask if the CD has a variable interest rate, and be sure you know what that means.
• Find out how much you'll lose if you need your money before the CD matures.
• If you're having problems with a CD you have already purchased, contact your state security regulator or the SEC.

For more CD information, contact the SEC's Office of Investor Education and Assistance, P.O. Box 50234, Washington, DC 20091, or visit their website at www.sec.gov/investor/pubs/certific.htm.