September 20, 2013
To some extent, we may be looking at the heyday of mortgage refinance in the rear-view mirror of the purported recession recovery, but, even so, we see a lot of wrecks on the road behind us. In this recent regulatory settlement, we look back at a failed refi strategy that left two elderly couples in a ditch. It is a sobering tale worth reading -- and make sure your parents and grandparents are aware of similar dangers of shuttling mortgage proceeds into insurance or stocks.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Maurice Joseph Chelliah submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Maurice Joseph Chelliah, Respondent (AWC 2011029747001, September 11, 2013).
Since 2001, Chelliah was registered with several FINRA member firms. The AWC asserts that Chelliah had no prior disciplinary history in the securities industry.
The AWC alleges that in 2006, a 75-year-old wife and her 80-year-old husband ("Couple1") had an outstanding mortgage balance of approximately $30,000 on their $500,000 home. Couple1 were struggling to pay monthly bills and they advised Chelliah of their interest in a reverse mortgage in order to obtain a little extra monthly income for home repairs. In October 2006, Chelliah presented the elderly couple with a mortgage loan application for a 40-year adjustable rate mortgage ("ARM") in the amount of $450,000. The AWC asserts that Couple1 (who are characterized in the settlement as "unsophisticated" investors) did not understand the mortgage documents that they were signing and relied upon Chelliah's representations that they were applying for a reverse mortgage.
The mortgage purportedly had negative amortization provisions, monthly-payment-caps-and a maximum interest rate cap of 10.355%. After refinancing expenses, and paying off a pre-existing mortgage, Couple1 cleared $412,575. The elderly couple's initial ARM monthly payment was $1,247, which increased to approximately $1,600 within one year of the initial teaser rate period.
SIDE BAR: The principal balance in a negative amortization loan does not reduce because the payments do not cover the applicable interest costs, and, accordingly, the unpaid interest balances are added to the outstanding principal balance. In the case of Couple1, the mortgage had a 125% maximum outstanding principal clause, which added the amount of outstanding principal above the 125% cap to each mortgage payment in order to ensure full repayment of principal on the maturity date.
In October 2006, Chelliah recommended that Couple1 use the mortgage loan proceeds to purchase
The AWC asserts that Chelliah's employer brokerage firm's written supervisory procedures had prohibited the acceptance of mortgage proceeds for investment purposes.
- two Equity Index Universal Life insurance policies ("EIULs"), and
- invest $345,000 in a mutual fund.
The AWC asserts that Couple1 had neither "requested nor required life insurance," but had relied upon Chelliah's representations that they could afford these products. Although the customers allegedly had a combined annual income of only $40,000, the monthly EIUL insurance premiums were $1,600 for wife and $2,000 for husband -- which amounted to $3,600 a month or $43,200 per annum, resulting in some $3,200 a year in premiums in excess of their combined income. Also, the couple were required to make those monthly premium payments until each reached the age 100.The AWC asserts that Chelliah received $5,000 in combined EIUL commissions.
On 13 separate occasions, between October 22, 2007, and April 28, 2010, Chelliah recommended that Couple1 liquidate jointly-held mutual fund shares in order to meet certain of their financial obligations. Following these liquidations, $90,000 in were transferred via checks made payable to one of three outside businesses that Chelliah controlled. Purportedly, the liquidated proceeds were transferred to Chelliah in order for him to pay Couple1's monthly bills and expenses; however, Chelliah allegedly converted the funds to his personal benefit, in violation of NASD Rule 2110 and FINRA Rule 2010. Chelliah has not returned the converted funds to these customers.
By 2009, as a result of Chelliah's investment recommendations, Couple1 were unable to
In July 2011, the mortgagee on their residence initiated foreclosure proceedings, and on October 16, 2012, the elderly couple were forced to short-sell their home to the mortgagee. The AWC asserts that Chelliah's unsuitable recommendations, resulted in over $330,000 in losses for Couple1.
- keep their mortgage current,
- pay their EIUL premiums, or
- meet their basic living expenses.
In October 2005, Chelliah recommended that elderly, retired husband and wife ("Couple2") refinance their residence and a rental property utilizing ARMs. The AWC asserts that these unsophisticated investors with no prior securities related experience had about a $200,000 net worth consisting of their rental property and approximately $20,000 in cash. Couple2's annual income was $60,000, which included $30,000 from social security and $200 a month from rental income.
In reliance upon Chelliah's advice, Couple2 mortgaged their primary residence and rental property for a combined total of $1,308,000, netting approximately $471,000 after expenses and paying off the existing mortgages. The ARMs had monthly payment caps that could result in significant negative amortization.
In November 2005, Chelliah recommended that Couple2 invest $200,000 of the refinance proceeds in a mutual fund; and in December 2005, Chelliah also recommended that they purchase a $600,000 universal life insurance policy with a $24,000 annual premium. The AWC alleges that the combined monthly mortgage and insurance premium payments far exceeded Couple2's monthly income. Finally, in 2007, Chelliah recommended that Couple2 withdraw funds from the mutual fund they had previously purchased in order to meet their monthly mortgage, interest, and premium payments.
By August 2009, the mutual fund was depleted and Couple2 were unable to keep their residential and rental mortgages current. By 2012, their combined mortgage debt had doubled, exceeding $1.7 million, at which time the mortgagee foreclosed. Couple 2 incurred about $450,000 losses as a result of Chelliah's strategy.
Universal Life From Re-Fi
n 2006, Customer3, characterized in the AWC as an unsophisticated investor with a net worth of about $20,000 and annual income of $70,000, was having difficulty meeting his monthly financial obligations. Chelliah advised Customer3 to refinance his home and use the proceeds to purchase a universal life insurance policy with an annual premium of $30,000 for the first five years. Although Customer3 purportedly never requested or needed life insurance, he followed Chelliah's advice and mortgaged his $475,000 home with a $240,000 negative amortization ARM. As a result of the refi, Customer3 netted about $170,000 in mortgage proceeds after paying certain loans. Customer3's initial mortgage payment was approximately $1,000 per month.
In 2006, Chelliah recommended that Customer3 invest $50,000 of the mortgage proceeds in a mutual fund. Chelliah represented that after 20 years, Customer3 would have sufficient funds to pay off his mortgage. Although Customer3 withdrew funds from his mutual fund to satisfy his monthly payment obligations, by 2008, his monthly mortgage payment had risen from $1,000 per month to over $1,800. By 2009, Customer3:
After a request for a loan modification was denied, the mortgagee foreclosed on Customer3's home.
- was unable to keep his mortgage current,
- could not pay his insurance premiums, and
- had depleted his mutual fund.
The AWC asserts that Chelliah's conduct as set forth above was in violation of NASD Rules 2310 and 2110, and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Chelliah a Bar from association with any member of FINRA in any capacity.
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