Complaints Rise as ‘Callable’ CDs Tie Up Needed Money

All they wanted was a higher rate of interest on their savings.

Instead, some investors--many of them elderly--may have inadvertently locked their money up for decades by buying what are known as “callable” certificates of deposit.

There’s a rising chorus of complaints about these investments, which are a risky twist on traditional bank certificates of deposit. And that has prompted investigations by federal regulators who fear some investors were duped into buying CDs with maturity periods longer than their life expectancies.

The Securities and Exchange Commission received more than 300 complaints about callable CDs last year, five times the number of a year ago, said Susan Wyderko, SEC’s director of investor education.

Typical was the letter from an elderly resident of Astoria, Ore., who wrote to the SEC after he tried to redeem what he thought was a one-year, $25,000 CD. He was told that the CD, purchased in 1998, wouldn’t mature for another 14 years. Getting his hands on the money any earlier would require that he sell the CD to another investor at a heavy discount.

“I would never have put my money in such a long-term certificate,” the man wrote. “My broker knew I was 84 years old and that I didn’t want it for longer than a year.”

In another complaint, a wife in Greenwood, S.C., wrote on behalf of her husband, who discovered after buying a callable CD “that his money is tied up until May 28, 2019. He is 79 years old, which makes this a cruel joke.”

Regular CDs allow savers to lock in an interest rate for a set period of time--typically three months to five years--after which the savers’ money is returned.

Callable CDs, by contrast, are often issued for much longer terms--10, 15 or 20 years. But the issuing bank has the right to “call,” or terminate, the CD and return the money after a certain period--usually after the first year.

Sometimes the call feature is a one-time-only option, meaning that the investor is locked in if the bank chooses not to terminate the CD after the first year. Other times, the bank has an ongoing ability to call the CD, typically at six-month or one-year intervals.

Callable CDs generally pay a higher interest rate than regular CDs to compensate investors for the risk that their money might not be promptly returned, or that if it is returned, it will be during a period of lower interest rates. That would force investors to reinvest their money at less attractive rates.

Regulators worry that many investors were confused about the “call” period and thought they would get their money back in a year or two.

In reality, only the bank has the right to terminate the CD early. Otherwise, investors who want out usually must try to sell the CD. Since buyers tend to be few and far between, the investors often must sell the CDs for far below their face value.

In some cases, regulators question whether brokerages deliberately misled investors by downplaying the risk of rising interest rates or not explaining the call feature at all. Although issued by banks, callable CDs are often sold through brokerage firms, which make commissions on their sale.

The SEC is examining marketing materials from a fleet of large and small brokerages, including Merrill Lynch & Co., PaineWebber, A.G. Edwards and Edward D. Jones & Co., among others.

Last month, Edward Jones agreed to a censure and $200,000 fine by the New York Stock Exchange over allegations that the brokerage failed to adequately supervise callable CD sales. The firm did not admit or deny guilt in consenting to the discipline.

An Edward Jones spokeswoman said fewer than one out of 1,000 purchasers complained about their investments. A Merrill Lynch spokesman declined comment; PaineWebber did not return calls for comment; and an A.G. Edwards spokeswoman said the company has “reemphasized the importance of the disclosure and suitability issues we make to our clients before they purchase this type of investment.”

In another complaint, a Bradenton, Fla., woman said she alerted her brokerage shortly after her account statement revealed that what she thought was a short-term, $17,000 investment actually would not mature until 2019. She said the brokerage assured her the CD would be called after a year.

“Now 18 months have passed and the bank did not call the CD,” the woman wrote in October. She added that she specifically advised the broker that she couldn’t tie the money up for more than a year, “since it was money I needed to have accessible due to personal health problems.”

“To read letter after letter from elderly investors . . . they’re absolutely heartbreaking,” Wyderko said.

In the past, most complaints about broker-sold CDs came from investors who bought certificates from small operators, regulators said.

In 1998, for example, the California Department of Corporations shut down three small Orange County brokers, saying the companies charged commissions of up to 43% on brokered CDs and misled older customers into buying long-term investments that paid no interest.

Last year, the National Assn. of Securities Dealers filed a fraud complaint against Orange County’s San Clemente Securities Inc., saying investors were misled about the fees, returns and safety of the CDs the firm sold. In November, the company was expelled from NASD membership and several of its executives were censured and fined $10,000 to $50,000 each.

This time, however, regulators are looking at brokerages both small and large, Wyderko said.

“We have gotten complaints about every large investment firm--every one you’d find that markets itself to the public based on the concept of trust,” Wyderko said. “That’s why it’s so disappointing.”

No one knows how many callable CDs have been sold. The Federal Deposit Insurance Corp., which insures the nation’s bank deposits, says the outstanding amount of CDs sold through brokerages has nearly tripled to $168 billion since 1995--although many brokerage-sold CDs are not callable, and not all callable CDs are sold by brokers; some are sold directly by the issuing banks.

When banks and brokerages began hawking callable CDs in the mid-1990s, interest rates were generally headed down, which meant that many issuing banks did indeed call their CDs after the first year. As interest rates rose last year, however, banks had little reason to call back the lower-paying CDs, and complaints from investors spiked.

Some investors in callable CDs could be bailed out if the Federal Reserve continues cutting rates, and banks once again begin terminating the investments. There are no guarantees, however.

Wyderko said investors who are considering purchasing callable CDs should review SEC warnings about the investments, available at the agency’s Web site at https://www.sec.gov/consumer/certific.htm or by calling (800) 732-0330.

Investors who believed they were misled when purchasing callable CDs can talk to an SEC investment specialist at (202) 942-7040.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at http://161.35.110.226/moneytalk.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Callable CDs

Federal regulators received five times as many complaints about callable certificates of deposit last year as in 1999.

2000*: 309 complaints

* Through Dec. 14

Source: Securities and Exchange Commission

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Higher Rates, Higher Risks

Callable CDs typically offer higher interest rates than traditional CDs, but they come with added risks. If interest rates drop, the issuing bank may choose to terminate the CD and return the money to the investor, who will be faced with investing at lower rates. If interest rates rise, the bank typically will choose not to terminate the CD, which means the money could be tied up for 10 to 20 years.

Regular CD Yields

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Current average Term yield 1 year 6.20% 2 years 6.20% 5 years 6.14%

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Callable CD Yields

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Non-callable Possible Current term term average yield 1 year 10 years 7.12% 1 year 15 years 7.23% 2 years 15 years 7.23%

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Note: The non-callable term is the period when the issuing bank is not allowed to call, or terminate, the CD. The possible term is the length of time before the CD matures if it isnt called.

Sources: Bankrate.com, Times research