High interest certificate of deposit

SAVINGS | The high rates on CALLABLE CDS come with a string attached.

ANTHONY LEO of Albrightsville, Pa., puts his savings in certificates of deposit for one reason: safety. He says he's a "fellow who was never willing to take a risk." He has never bought a share of stock or a corporate bond. In fact, for a decade he routinely rolled over a $100,000 CD from East Stroudsburg Savings Association, in Stroudsburg, Pa.

But in February 1999 he balked at the skimpy 5% interest rate. That's when an employee told him about a CD paying 7.5% that was being offered through the bank by PrimeVest Financial Services, a brokerage in St. Cloud, Minn. The 7.5% rate was good for one year, after which it would fall to 6%--still better than the bank rate. Leo says he was told the CD would probably be called after a year and in the event that it wasn't, he could redeem it by paying a penalty of 1% or 1.5% of the principal.

Leo bit.

But when the year ended last February, the "one-year callable" CD was not called. When Leo tried to cash it in, he was horrified to learn that it was worth just $80,000. The $1,000 to $1,500 penalty he expected had soared to $20,000.

That's when, Leo says, he learned for the first time that his CD didn't mature for 20 years. He also discovered to his surprise that, because it was a brokered CD, its value could rise or fall based on changes in market interest rates. (PrimeVest won't comment specifically on Leo's complaint, but says it makes both oral and written disclosures about its CDs.)

Protecting yourself. Leo is not the only saver to get such a rude awakening. Higher-than-market rates have been increasingly used to lure consumers into buying callable CDs. Many savers apparently think "one year" means they can redeem the CD after a year. In fact, such CDs can't be redeemed until maturity, which could be 20 or more years down the road. The trick is that it is the issuing institution that can redeem the CD at any time after the first year. If rates have dropped, the bank will exercise that right and give savers back their cash to reinvest at lower yields.

But if rates have risen, the bank will keep the CD in force at what then amounts to a below-market rate. If the saver wants to go for a higher yield, he or she will face the same dilemma that confronted Leo. You can sell the CD back to the broker, but you may get back far less than you originally invested.

In fact, buying a CD from a broker is similar to purchasing a bond. You are guaranteed the return of your principal at maturity. But if you want your money before then, the value of your investment depends on market interest rates. If rates have risen, the value of your CD may have plummeted. Susan Ferris Wyderko, director of the SEC's Office of Investor Education and Assistance, says, "We are seeing people who redeem early losing 20% to 30% of their principal." Of course, with bonds this is a two-way street. If interest rates drop, the value of a bond rises and you can cash it in for more than you paid for it. Unfortunately, you don't have that opportunity with a callable CD. When rates drop, the issuing institution can call the CD and issue a new one with a lower yield. "There is a limit on the upside, but not the downside," says Douglas Wilburn, securities commissioner of Missouri. "These savers are getting the worst of both worlds."

If you're offered a CD rate that seems too good to be true, check it out carefully. Be sure you know when the certificate matures and whether it can be called before that date. If you buy a CD from a broker and discover it's not what you expected, Wyderko recommends that you complain vociferously to the brokerage. If that fails, take your complaint to the SEC; there is a complaint form on its Web site, at www.sec.gov. The SEC has been successful in getting reimbursements for savers who were misled into buying callable CDs, says SEC spokesman John Nestor. --Reporter: COURTNEY MCGRATH