CLO Fraud Lawyer: Recovering Losses from Collateralized Loan Obligation Investments

Collateralized loan obligations (CLOs) have grown into a multi-trillion-dollar market. While institutional investors and hedge funds understand the complex risks involved, many retail and high-net-worth investors have suffered substantial losses after being steered into CLO funds, CLO ETFs, and CLO-related products by brokers who prioritized commissions over suitability. If your financial advisor recommended CLO investments that resulted in substantial losses, a CLO fraud lawyer can evaluate whether you have grounds to recover your investment through Financial Industry Regulatory Authority (FINRA) arbitration.

What Are Collateralized Loan Obligations?

A collateralized loan obligation is a type of structured security that pools together leveraged corporate loans and packages them into different investment tranches. These leveraged loans are typically made to companies with lower credit ratings or significant existing debt, making them inherently riskier than traditional investment-grade bonds. According to the Securities and Exchange Commission’s (SEC’s) analysis of CLO structures, the complexity of these products makes them difficult for even sophisticated investors to fully evaluate.

Direct CLO tranches are primarily institutional products, typically sold under Rule 144A to qualified institutional buyers (QIBs). Retail investors generally access CLO exposure through registered CLO exchange-traded funds (ETFs), closed-end funds, and interval funds — distinct products from direct CLO tranches but subject to the same broker suitability and disclosure obligations when recommended.

The CLO structure divides the pooled loans into tranches ranked by seniority and risk:

CLO managers actively manage the loan portfolios, buying and selling loans to maintain certain criteria. Covenant protections for leveraged loans have declined significantly in recent years — a trend that reduces investor protections when borrowers experience financial distress. Investors relying on brokerage recommendations should verify the specific covenant profile of any CLO product they were sold.

How CLO Fraud and Misconduct Occurs

Financial advisors and broker-dealers commit CLO-related misconduct in several ways. Understanding these practices helps investors recognize when their losses resulted from broker negligence or fraud rather than normal market conditions.

Warning Signs of CLO Investment Fraud

Recognizing red flags early can help you understand whether your CLO losses resulted from broker misconduct. If your experience matches these warning signs, you may have grounds for a FINRA arbitration claim.

Legal Claims Available to CLO Investors

Investors who suffered CLO-related losses may pursue several legal theories through FINRA arbitration or litigation. The specific claims depend on the facts of your case and how the investment was recommended and managed.

Claims Against Brokers and Financial Advisors

The most common claims involve the broker or advisor who recommended the CLO investment:

• Unsuitability: FINRA Rule 2111 imposes three suitability obligations — reasonable-basis suitability (the product is appropriate for at least some investors), customer-specific suitability (the recommendation fits this particular customer’s investment profile, objectives, and risk tolerance), and quantitative suitability (the overall pattern of recommendations is not excessive). For CLO recommendations made to retail customers on or after June 30, 2020, Reg BI (17 C.F.R. § 240.15l-1(a)(2)) imposes four component obligations on broker-dealers: Disclosure, Care, Conflict of Interest, and Compliance. The Conflict of Interest obligation is particularly relevant for CLO recommendations, where differential compensation structures may have influenced the broker’s recommendation. CLO recommendations — particularly to mezzanine or equity tranches — are difficult to justify under Rule 2111’s customer-specific suitability prong or Reg BI’s Care Obligation for retail customers with conservative profiles, limited liquidity tolerance, or short time horizons. The suitability analysis is conducted customer-by-customer against the documented investment profile.
• Misrepresentation and Omission: Brokers who described CLOs as “safe” or “guaranteed,” or failed to explain the risks of tranche structures and potential total loss, may be liable for securities fraud. 17 C.F.R. § 240.10b-5 (Rule 10b-5), promulgated under 15 U.S.C. § 78j(b) (Securities Exchange Act of 1934 § 10(b)), prohibits any manipulative or deceptive device or contrivance in connection with the purchase or sale of a security. FINRA Rule 2020 separately prohibits members from using manipulative, deceptive, or other fraudulent devices in securities transactions. FINRA rule violations — including violations of Rule 2020 and Rule 2010 — are typically asserted in FINRA arbitration as evidence of broker misconduct supporting common-law and statutory claims, not as standalone private causes of action. State securities laws also apply.
• Breach of Fiduciary Duty (RIA conduct): Registered investment advisers owe their clients a federal fiduciary duty under the Investment Advisers Act of 1940, 15 U.S.C. § 80b-1 et seq., comprising a duty of care and a duty of loyalty. Where an advisory relationship existed, recommending unsuitable CLO investments may breach this fiduciary duty. Broker-dealers are not subject to that fiduciary duty; instead, Reg BI (17 C.F.R. § 240.15l-1(a)(2)) imposes a separate, distinct best-interest standard — not a fiduciary standard — composed of the four obligations at 17 C.F.R. § 240.15l-1(a)(2)(i)–(iv) for recommendations to retail customers. Where FINRA Rule 2111 suitability applied to pre-June 30, 2020 recommendations, Reg BI raises the standard for retail-customer recommendations above Rule 2111 suitability after that date; FINRA Rule 2111 itself was not repealed and continues to apply to recommendations outside Reg BI’s scope (including institutional customers). The applicable standard depends on whether the financial professional is registered as an investment adviser, a broker-dealer, or dually registered.
• Negligent Supervision: Brokerage firms must supervise their representatives under FINRA Rule 3110. Although Rule 3110 is a self-regulatory standard, a firm’s failure to meet it commonly grounds investor claims for negligent supervision, respondeat superior liability, or control-person liability under Securities Exchange Act § 20(a) (15 U.S.C. § 78t(a)).

Churning in CLO Accounts

Churning refers to a broker’s excessive trading of your account to generate commissions without regard to your investment interests. In CLO contexts, churning most commonly occurs when a broker repeatedly rotates among CLO ETFs, closed-end funds, or other CLO-related products at a frequency inconsistent with your stated objectives. As a fraud theory, churning violates FINRA Rule 2010, which requires members to observe high standards of commercial honor and just and equitable principles of trade in the conduct of their business. Establishing a churning claim requires showing: (1) trading was excessive in light of the customer’s investment objectives; (2) the broker exercised actual or de facto control over the account; and (3) the broker acted with intent to defraud or with willful and reckless disregard for the customer’s interests. Mihara v. Dean Witter Reynolds, Inc., 619 F.2d 814 (9th Cir. 1980). Separately, FINRA Rule 2111(c) addresses the same conduct as a suitability matter through its quantitative suitability prong — a series of recommendations is unsuitable if excessive in light of the customer’s investment profile. Whether excessive trading occurred is measured by turnover rate and the cost-equity ratio (the percentage annual return required to break even on trading costs). Both the fraud theory (Rule 2010) and the suitability theory (Rule 2111(c)) are typically pleaded together in FINRA arbitration.

Claims Against CLO Managers and Arrangers

In some cases, investors may have claims against the parties who structured and managed the CLO:

• Manipulation of Investment Criteria: CLO managers who manipulated portfolio metrics or overcollateralization tests — in breach of indenture obligations or through fraudulent misrepresentation to investors — may face claims under the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6 (anti-fraud provision), Exchange Act § 10(b) (15 U.S.C. § 78j(b)), or breach of contract, depending on the structure and facts.
• Misrepresentation in Offering Documents: Historical cases have alleged that arrangers represented expected performance projections that were unrealistic or unsupported.
• Breach of Contractual Requirements: CLO managers must adhere to the terms of governing documents; violations can create liability.

The FINRA Arbitration Process for CLO Claims

Most CLO investment fraud claims are resolved through FINRA arbitration rather than court litigation. This is because brokerage account agreements typically contain mandatory arbitration clauses requiring that investor disputes be heard through FINRA’s arbitration forum.

How FINRA Arbitration Works

FINRA arbitration functions like a private trial but with streamlined procedures:

According to FINRA Dispute Resolution Statistics, settlement is the most common pre-hearing resolution for customer arbitration cases. Of customer cases that proceeded to a decision in 2024, 26% resulted in a customer award. Check the most current FINRA annual statistics report for updated figures.

Our Approach to CLO Fraud Cases

Gary Varnavides brings a unique perspective to CLO fraud cases. Before founding Varnavides Law, PC, Gary spent a decade at Sichenzia Ross Ference LLP defending broker-dealers and financial institutions against investor claims. This experience provides critical insight into how financial firms build their defenses and where their arguments are most vulnerable.

Gary’s prior experience representing broker-dealers in FINRA matters gives him deep familiarity with how the industry approaches these disputes — the documents firms rely on, the arguments they make, and the positions they typically take. Gary has been recognized as a New York Super Lawyers Rising Star from 2015 through 2023, an honor given to the top 2.5% of attorneys in the New York Metro area. He is licensed to practice in California and New York.

Varnavides Law’s approach to CLO fraud cases focuses on thorough investigation, careful claim development, and vigorous advocacy on behalf of investors. We analyze account statements, communications, and suitability documentation to build a comprehensive case demonstrating broker misconduct.

The Case Evaluation Process

If you believe your CLO investment losses resulted from broker misconduct, the first step is a thorough case evaluation. Learn more about common investment fraud theories that apply to structured product claims. Here is what to expect when you contact our firm:

Learn more about the FINRA arbitration process and what to expect when pursuing your claim.

Recent CLO Market Developments

Understanding recent market conditions helps contextualize CLO investment losses and strengthen fraud claims:

The leveraged loan default rate in late 2024 reached elevated levels not seen in prior years, contributing to significant CLO investment losses for investors holding subordinated tranches, particularly those in mezzanine and equity positions. The default-rate environment in 2024–2025 continued to affect CLO portfolio performance, particularly for managers with higher concentrations in lower-rated credits.

Types of Investors Who May Have Claims

CLO fraud claims are not limited to individual retail investors. Various types of investors may have grounds to pursue recovery:

Frequently Asked Questions

Take Action to Recover Your CLO Investment Losses

Time limits apply to CLO fraud claims, and multiple deadlines may run simultaneously. If you believe your broker recommended unsuitable CLO investments that resulted in significant losses, schedule a free consultation with a CLO fraud lawyer who understands these complex products and the FINRA arbitration process.

Gary Varnavides leverages his insider understanding of broker-dealer defense strategy to build informed cases for investors. He understands how financial firms operate, how they defend against claims, and where their defenses are most susceptible to challenge. Varnavides Law, PC serves investors across California and represents clients nationwide in FINRA arbitration proceedings.