Investors: Do You Know How to Recognize these Risky Investments?
Junk bonds are high-risk investments that are likely to result in a loss for the investor. Indebted companies issue high-yield bonds as a last-ditch effort to remain solvent. Junk bonds offer a high yield, also known as a high coupon, because the risk of default is high. All junk bonds are speculative, and retail investors who purchase junk bonds should be prepared to lose their entire principal.
Brokers trying to sell junk bonds might refer to these securities as “high-yield bonds,” which is misleading since the high yields are far from guaranteed. You may also hear them referred to as “non-investment grade bonds.” In addition to referring to the bonds as “high-yield bonds,” fraudulent brokers might call the issuers “fallen angels” or “rising stars.”
- “Fallen angel” is a euphemism for a company that was once a reliable borrower but has since become a significant credit risk.
- A “rising star” is a company that might eventually get out of junk bond status — the operative word here is might.
What Makes a Bond a “Junk Bond”?
Junk bonds are debt instruments issued by a company or governmental entity with a low credit rating. Generally, a bond is considered “junk” if the issuer has a credit rating of BB[+] or lower from Standard & Poor’s, or a credit rating of Ba or lower from Moody’s. Junk bonds are not considered investment-grade bonds, which is why issuers have to offer such high yields.
High-Yield Bond Risks
There are many risks associated with junk bonds, even beyond the risk of default on yield payments. Brokers should carefully consider if these risks make the bonds unsuitable for their investors. The Financial Industry Regulatory Authority (FINRA) has warned investors about the following junk bond risks:
- The credit rating agency could downgrade the already-low rating of the bond issuer, reducing the value of the bond.
- Bonds are illiquid, meaning that they are difficult to convert to cash. If you decide to sell your junk bond, you may have a hard time finding a buyer. Additionally, many high-yield bonds do not mature for at least a year.
- Issuing companies can easily default on their bonds. This is not unlikely since the issuing companies are probably facing financial problems.
- Investors might purchase bonds to diversify their portfolios since bonds tend to offer safe returns when stocks plummet. But investors should know that junk bonds move in the same direction as stocks, and therefore do not diversify a portfolio of stocks.
High-Yield Bond Scams
Investors typically get into junk bonds in a few different ways. In addition to their inherent risks, outright junk bond scams are common. Investors may see ads for junk bonds online or receive solicitations via email online. Boiler room scams in previous decades often involved junk bonds sold over the phone using high-pressure sales tactics. These solicitations are often scams—or at the very least unscrupulous offerings that involve undisclosed risks. Investors may also receive recommendations from their brokers or advisors who do not disclose the high commissions they receive in exchange for their recommendations.
Why Do Investors Buy High-Yield Bonds?
Brokers may recommend junk bonds based on conflicts of interest or an inadequate understanding of the risks involved. This goes against FINRA Rule 2111, which requires brokers to only recommend investments that suit their investor’s financial goals. FINRA also requires that brokers perform their due diligence and research any company that issues a junk bond. They should pass along any information about the issuing company’s financial situation so that their investor can make an informed decision.
Investors may also invest in junk bonds through high-yield bond funds. These funds pool money from investors to purchase a portfolio of bonds issued by companies with low credit ratings. While this approach can mitigate investors’ risk of loss, it remains a high-risk investment strategy.
When Can Investors Recover Junk Bond Losses?
Given the inherent risks of junk bond investing, investors might have more than one reason to file a fraud claim to recover their junk bond losses. Some examples of common claims in junk bond fraud cases include:
- Unlicensed and unregistered sale of high-yield bonds
- Excessive fees
- Broker negligence and misconduct
- Unsuitable investment advice
- Overconcentration (failure to diversify)
Speak with Our Junk Bond Attorneys Team in Confidence
Investors who lose money due to broker or investment advisor fraud can seek to recover their losses through FINRA arbitration. Those who lose money in high-yield bond scams may have options as well. To discuss your legal rights with our junk bond attorneys team in confidence as soon as possible, call 877-600-0098 or request a free consultation online now.