While private companies are gradually withdrawing from their addiction to risky investments, public pension funds have been slow to follow suit. Following the market’s downturn - which produced about $1 trillion in losses - state and local governments faced a Catch 22 situation: Slash retirement benefits or try to boost returns with high-risk investments.

As it turns out, the latter option is becoming the option of choice for more public pension funds.

“In effect, they’re going to Las Vegas,” said Frederick E. Rowe, a Dallas investor and the former chairman of the Texas Pension Review Board, in a March 8 article in the New York Times. “Double up to catch up.”

Among the strategies public pension funds are gambling on with workers’ retirement money: Commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. Hedge funds, which were once cast aside as an investing strategy, are now gaining favor, as well.

Examples of public pension funds in crisis because of risky investments are not hard to find. Last month, the Atlanta firefighters’ pension fund sued the custodian managing its plan, Chicago-based Northern Trust, accusing it of making several risky investments that could cost the fund millions of dollars.

The lawsuit claims that Northern Trust breached its contract and fiduciary duty with mortgage-backed securities investments - investments that ignored the warnings of the company’s chief economist. The Chicago Public School Teachers’ Pension and Retirement Fund also joined lawsuit, which was filed Jan. 29 in a federal court in Chicago.

Investment giant Morgan Stanley also is the subject of a high-profile case involving pension funds and risky investing strategies. A December 2009 article in the New York Times first reported the story. According to the article, a Virgin Islands pension fund sued Morgan Stanley based on allegations it defrauded investors by marketing $1.2 billion of risky mortgage-related notes that it expected to fail.

The lawsuit, which was filed Dec. 24 in a Manhattan federal court, also accused Morgan Stanley of collaborating with the credit rating agencies Moody’s Investors Services and Standard & Poor’s to obtain AAA ratings for notes sold in 2007 as part of a collateralized debt obligation known as “Libertas.”

Financial reform is a hot topic on Capitol Hill, with legislation designed to rein in broker/dealers through new oversight measures currently being contested on the Senate floor. At the heart of the debate is a bill containing a provision to strengthen the protection of consumers by requiring stock brokers and insurance agents to act in the best interest of their clients. As it turns out, the provision may never see the light of day.

As reported March 8 by the Washington Post, certain Senators are in disagreement over the provision, prompting some insiders to predict that new legislative language will ultimately be inserted into the bill that directs the Securities and Exchange Commission (SEC) to study the rules currently governing brokers and registered investment advisers.

As it is, investment advisers operate under fiduciary standards. That means they are legally and ethically bound to put their clients’ interests ahead of their own. By comparison, brokers adhere to suitability standards, meaning they only need to have “reasonable grounds” to believe that the financial products they recommend to clients are suitable for their needs. In some instances, however, those investments could be lucrative for the broker at the expense of clients.

In addition, broker/dealers usually do not have to make as many disclosures regarding conflicts of interest, fees or previous infractions as investment advisers.

And therein is the problem. The services that broker/dealers and investment advisers provide are almost indistinguishable. Case in point: In 2008, the SEC commissioned a study by the Rand Corp., which showed that investors were equally confused about the differences between the two groups.

It would seem commonsense that investment advisers, broker/dealers and any and all financial professionals connected in some way to investment-related services and products should be subject to a consistent, uniform fiduciary standard. The operative word, however, is commonsense.

Popular retirement-plan products known as target date funds are facing regulatory scrutiny from both the Securities and Commission (SEC) and the Department of Labor. The criticism comes after target date funds, which entail a combination of stocks, bonds and other investments and are designed for people nearing retirement, suffered massive losses following the market collapse of 2008. Even some of the most conservative target date funds have lost 30% to 40% of their value.

Critics of target date funds contend too many investors simply have the wrong perception of the products. A survey conducted by the research firm Behavioral Research Associates LLC last March showed that 61% of respondents thought target date funds made some type of “promise.” Other investors said target date funds meant a “secure investment with minimal risk,” while some stated that target date funds provided a “guaranteed return.”

All three assumptions are incorrect. Target date funds typically invest in other funds, making them subject to those underlying holdings and, at the same time, the potential for volatility and risk.

Moreover, there is no one-size-fits-all approach to target date funds. The mix of stocks, bonds and other securities varies from fund to fund. That means two funds with the same target date could easily have a vastly different underlying mix of holdings. A Feb. 27, 2009, article by SmartMoney illustrates this point. Oppenheimer’s 2010 fund (OTTAX) had 65% in stocks and lost 41% in 2008. By comparison, the NestEgg 2010 portfolio (NECPX) had about 32% in stocks and lost less than 10%.

Another issue for regulators concerns the costs of target date funds. According to Morningstar, more than half of target date funds have an annual management fee of 1% or more. By the time someone retires, that 1 percentage point in fees will add up, reducing an investor’s total accumulation by up to 20%.

A March 7, 2010, article in Investment News reports that the SEC and the Labor Department plan to issue a joint consumer alert on the use of target date funds in retirement plans.

First Allied Securities Firm will pay $2 million to settle allegations from the Securities and Exchange Commission (SEC) that it failed to properly supervise one of its independent contrators, Harold H. Jaschke. Jaschke, who worked for First Allied from 2005 to 2008, was accused of allegedly duping two institutional investors by making trades without their knowledge or authorization.

The SEC initially charged Jaschke in December 2009, accusing the former First Allied rep of churning client accounts and making unauthorized and unsuitable trades for the city of Kissimmee, Florida, and the Toho Water Authority of Florida. According to the complaint, Jaschke’s alleged actions netted commissions of more than $14 million.

As reported March 5 by Investment News, when First Allied’s former vice president of supervision, Jeffrey C. Young, was first notified of “abnormal trading” in the two clients’ accounts, he stated that he was “unsure” of whether to contact them with the information. Ultimately, no one at First Allied ever did.

The SEC says Jaschke routinely used his personal e-mail account to correspond with clients. This means First Allied should have been aware of the Jaschke’s conduct because he used the same e-mail account to correspond with supervisors and senior management, according to the SEC.

First Allied is owned by Advanced Equities Financial Corp.

Momentum continues to build over Medical Capital Holdings, as more MedCap investors file arbitration claims against the healthcare lender for the millions of dollars in losses suffered as a result of alleged questionable sales in Medical Capital private placement securities. Among the allegations investors cite in their claims: Misrepresentation on the part of Medical Capital, misuse of investors’ funds to pay administrative fees, and omission of critical facts concerning the track record of Medical Capital entities and the backgrounds and qualifications of the people responsible for running the companies.

Based in Tustin, California, Medical Capital raised approximately $2.2 billion from 20,000 lenders in the past six years. In July 2009, the Securities and Exchange Commission (SEC) sued the company and its top officers, Sidney M. Field and Joseph “Joey” Lampariello, for defrauding investors. A court-appointed receiver, Thomas A. Seaman, was appointed one month later.

In its lawsuit, the SEC accused Medical Capital - which raises money from investors then loans that money to hospitals - of misappropriating some $18.5 million from investors to pay administrative costs. The agency contends that when the company raised $77 million from investors it promised that none of the money would be used for such expenses.

In addition, the SEC claims Medical Capital misrepresented its financial track record. Contrary to the claims it made, three of its offerings programs had defaulted and a fourth was making late payments.

Since then, a number of lawsuits and arbitration claims have been filed by investors against various brokers/dealers that marketed and sold investments in Medical Capital. Then, in January 2010, the Commonwealth of Massachusetts filed a regulatory action against Securities America, accusing the broker/dealer of committing securities fraud on a “massive scale.”

As with other claims related to Medical Capital, the Massachusetts complaint accuses Securities America of failing to conduct proper due diligence of Medical Capital and its related entities, of ignoring red flags and making material omissions and misleading statements in connection to $700 million of promissory notes that were sold to Medical Capital investors.

“…All material risks and information regarding MC Notes were not disclosed to investors. These risks were known to [Securities America]. Year after year, the due diligence analyst, retained by [Securities America] to conduct a review of the various Medical Capital offerings, specifically requested and at many times pleaded that investors be informed of certain heightened risks,” the complaint reads.

Maddox Hargett & Caruso P.C. continues to file arbitration claims with the Financial Industry Regulatory Authority (FINRA) on behalf of investors who have suffered investment losses in their Medical Capital investments. If you purchased Medical Capital Notes from a broker/dealer and wish to discuss your potential rights for recovery, contact us today.

New Jersey broker David Steven Forman has been barred by the Financial Industry Regulatory Authority (FINRA) following allegations he ran an insurance scheme involving the sale a $5 million life insurance policy to a trust, which Forman - a former representative with the Private Consulting Group - then allegedly took control of. Forman didn’t admit nor deny FINRA’s finding, but consented to the regulator’s decision to ban him from the securities industry.

According to FINRA, Forman and another unnamed person netted nearly a $1 million from the scam.

As reported March 3 by Investment News, the case is similar to the action cited in a Illinois civil suit filed against both Private Consulting and Forman in 2000 and settled in 2008.

According to that lawsuit, Forman and an associate, Alan Gottlob, recommended that Ken and Norma Spungen buy a $5 million life insurance policy on Mrs. Spungen, with the idea to use the policy as a way pay taxes upon her death. In order to buy the policy and leave it to the benefit of her descendants, records show that Forman and Gottlob suggested that Mrs. Spungen created an irrevocable trust.

Through 2001 and 2002, the trust paid some $501,400 in premiums on the policy, according to the lawsuit. The following year, Mr. Spungen allegedly asked Forman and Gottlob if it made sense to continue paying on the premiums for the policy, in light of upcoming changes to estate tax laws. Allegedly, the two men recommended a sale of the policy for the benefit’s trust, selling it to Coventry First LLC for $900,000 plus a commission.

The Investment News article says that Forman and Gottlob did not advise Mr. Spungen of the sale and, instead, pocketed the proceeds. The client also alleged that the signed documents showing Mr. Spungen gave the men permission to keep the proceeds were fake. The case was settled for $506,000, according to Finra records, and dismissed in 2008.

Both Forman and Gottlob have been named in other civil suits.

Unsuitable investments in Inland American Real Estate Trust and the Inland Western Retail Real Estate Trust have become a growing source of concern for more investors these days. In many cases, sales of Inland REITs were appropriate from the start for some investors. Why? Because the broker/dealers behind the deals failed to disclose all of the necessary information associated with the products, including the high commissions that the REITs commanded. In some instances, those fees exceeded 15%.

The Inland REITs are considered unlisted REITs; they do not trade on national stock exchanges. Redemptions in unlisted REITs are limited and almost always have a minimum holding period. If investors want to exit an unlisted REIT entirely, they usually can only do so at specified times.

Perhaps the biggest criticism of unlisted REITs has to do with their lack of transparency. Unlisted REITs also typically come with no independent source of performance data. Moreover, critics of unlisted REITs cite the often vague prospectus language regarding their formal exit strategies.

In recent months, we’ve heard from several investors who say their broker/dealer never discussed the various risks that investors take on when they purchase shares of an unlisted REIT. In reviewing these complaints, we’ve also discovered that some investors were kept in the dark about the fact that their investment in an unlisted REIT could literally be tied up for an undetermined amount of time in the event the REIT suspends its share-repurchase program.

That’s exactly what happened with Inland American, which suspended its buyback program in March 2009. Investors had two options: Hold onto their shares until buybacks become re-instated or attempt to sell their share, at a significant loss, on the secondary market.

If you believe your broker/dealer failed to provide adequate information concerning investments in the Inland American Real Estate Trust, the Inland Western Retail Real Estate Trust or another unlisted REIT, contact us.

Investors are continuing to come forth with fraud allegations against various broker/dealers in the Medical Capital case. According to investors’ complaints, certain brokerage firms allegedly marketed and sold private placement offerings in Medical Capital Holdings without first disclosing important facts about the company’s deteriorating financial health and the risks attached to the investments they were pushing. In July 2009, the Securities and Exchange Commission (SEC) charged Medical Capital with fraud.

One broker/dealer at the center of the arbitration claims is Securities America. In February 2010, the Massachusetts Securities Division filed a lawsuit against Securities America, which already was facing a pending class action in California, for allegedly misleading investors over sales tied to a series of Medical Capital’s private offerings.

According to the Massachusetts complaint, Securities America ignored red flags and deliberately failed to disclose the risks involved when selling millions of dollars worth of Medical Capital Notes to unsophisticated investors. The complaint further alleges that investors had been told the notes were secured and low risk when, in reality, they were “unregistered, speculative, high-risk securities.”

Based on the Massachusetts Securities Division’s complaint, 400 Securities America advisers allegedly sold $700 million of the private placements in Medical Capital, about half of which are now in default.

If you experienced investment losses related to Medical Capital investments, please contact us. A member of our securities fraud team will evaluate your situation to determine if you have a viable claim for recovery.

Credit default swaps are blamed for instigating the nation’s financial crisis, helping to bring companies like American International Group (AIG) to its knees after it could no longer pay the many claims it owed on the swaps contracts. Nearly three years after the fact, credit default swaps and other complex derivative instruments are still a booming fixture on Wall Street and, unexplainably, largely untouched by financial reform efforts.

This irony is the subject of Gretchen Morgenson’s Feb. 28 column in the New York Times. In the article, she writes that Congressional reform plans for credit default swaps are “full of loopholes,” a fact that almost guarantees “that another derivatives-fueled financial crisis” is right around the corner.

According to the Bank for International Settlements, credit default swaps with a face value of $36 trillion were outstanding in the second quarter of 2009.

Morgenson’s article includes comments from Martin Mayer, a guest scholar at the Brookings Institution and a noted author on banking and finance-related issues. On the subject of credit default swaps, Martin says the following:

“Credit default swaps are a way to increase the leverage in the system, and the people who were doing it knew that they were doing something on the edge of fraudulent… They were not well-motivated.

Mayer’s criticism of credit default swaps dates back several years. On May 20, 1999, he penned an Op-Ed piece in the Wall Street Journal, titled The Dangers of Derivatives. Some of his selected comments include the following:

“These over-the-counter derivatives - created, sold and serviced behind closed doors by consenting adults who don’t tell anybody what they’re doing - are also a major source of the almost unlimited leverage that brought the world financial system to the brink of disaster last fall. These instruments are creations of mathematics, and within its premises mathematics yields certainty. But in real life, as Justice Oliver Wendell Holmes wrote, “certainty generally is an illusion.” The derivatives dealers’ demands for liquidity far exceed what the markets can provide on difficult days, and may exceed the abilities of the central banks to maintain orderly conditions. The more certain you are, the more risks you ignore; the bigger you are, the harder you will fall.

“Meanwhile the rules of this game - adopted and enforced by the world’s banking supervisors - further shrink what are already low time horizons in the financial markets. Measuring their positions every day through the algorithms of “value at risk” analysis, players must make constant adjustments of hedges and options to control the losses they may suffer from unanticipated volatility of market prices. In real markets, often enough, you can’t do that.

“The current [plat du jour] - the credit derivative - is the most dangerous instrument yet, and neither the risk controllers at the big banks nor the bank examiners seem to have any good ideas about how to handle it. A vehicle by which banks can swap loans with each other apparently gives everybody a win - banks can diversify their portfolios geographically and by category with the click of a mouse.

“But the system is easily gamed, and it sacrifices the great strength of banks as financial intermediaries - their knowledge of their borrowers, and their incentive to police the status of the loan.

“When a loan is securitized, nobody has the credit watch. Researchers at the Federal Reserve Bank of New York concluded that in the presence of moral hazard - the likelihood that sloughing the bad loans into a swap will be profitable - the growth of a market for default risks could lead to bank insolvencies.”

Fast forward to 2008 and 2009 and Mayer’s predictions became reality. Morgenson contacted Mayer for her Feb. 28 column, asking for his thoughts on solutions to the problems that credit default swaps have produced. Among his recommendations:

• Companies that trade in credit default swaps should be required to put up more capital to back them, Mayer says. That way, if a client asks for payment, the issuer actually has the funds available to make good on the payment.

• Increased regulatory oversight of credit default swaps needs to become the rule, according to Mayer. In addition, he suggests that credit default swaps must be exchange-traded so that their risks are more transparent.

“The insistence that you mustn’t slow the pace of innovation is just childish,” Mayer said in the NYT’s article. “Innovation has now cost us $7 trillion,” a price tag that refers to the loss in household wealth resulting from the financial crisis. “That’s a pretty high price to pay for innovation.”

Two Virginia insurance agents - Julius Everett “Bud” Johnson and Walter Ray Reinhardt - face accusations by the Virginia State Corporation Commission (SCC) of misleading investors regarding $1.7 million in sales of promissory notes.

Last fall, the SCC ordered Johnson, Reinhardt and their companies to stop selling the notes for 120 days, alleging that they were illegal securities because neither the notes nor the sellers were registered with the state of Virginia. As for investors - many of whom were reportedly told that their money was guaranteed - they want answers.

“All I got was a runaround,” said James Kelley, a Chesterfield County, Virginia, man who invested $25,000 that was supposed to be repaid in January but wasn’t, according to a Feb. 3 article in the Richmond Times Dispatch.

Kelley said he went to speak with Johnson at his office, where he was told Johnson was out. When Kelley waited in the parking lot, however, he says he saw Johnson leave a few minutes later out of a back entrance of the building.

Gerald Crant is another investor who placed $100,000 with Johnson. He claims Johnson told him the promissory notes were insured by the Federal Deposit Insurance Corp. Now he’s worried because he hasn’t received his January interest payment.

According to the Times Dispatch article, Kelley says that Johnson told him he would get more information in the coming weeks, while Crant says he received a letter from Johnson’s lawyer stating that the slow economy was the reason he had to stop making interest payments.

The SCC, which regulates securities transactions in the state of Virginia, lists a litany of allegations against both Johnson and Reinhardt and the 12 companies they operate, including:

· Making material misrepresentations and material omissions;

· Failing to provide financial disclosures;

· Failing to provide investment-risk disclosures;

· Failing to provide a litigation or compliance disciplinary disclosure;

· Failing to disclose that the securities offered were not registered; and

· Falsely stating that the securities were exempt from registration.

In addition, the SCC’s records accuse Johnson and his companies of operating as a fraud. The allegations include issuing corporate promissory notes for one issuer then transferring the money to another entity and using new investors’ money to pay interest to previous investors - something typically associated with a Ponzi scheme.

In September 2009, SCC records show that Johnson and Reinhardt stated they had sold $1.7 million of notes to 38 Virginians, and that the notes were private offerings and complied with federal regulations. A senior investigator with the SCC says he found documents showing Johnson guaranteed $3.2 million of the companies’ debt, while Johnson declared he did not know the outstanding balance on the notes.

The companies that the SCC cites as those operated by Johnson are: Benefit Contract Administrators, MHC Linen Service LLC, River City Cleaners LLC, Roberts Awning Restoration and Renewal LLC (formerly known as Roberts Awning LLC).

Other defendants in the case include Benefit Contract Administrators LLC, Mid Atlantic Insurance Agencies, LivingWell Healthcare of Virginia LLC, Everett Awnings doing business as Roberts Awnings, and FIC Financial Group.

Reinhardt operates three businesses: First Fidelity Financial of Richmond LLC, Commonwealth Assurity LLC and Capital Investor Group.

Reinhardt is accused of selling illegal securities between 2005 and now. He also is accused of operating as the broker-dealer in offerings and selling the illegal promissory notes of Benefit Contract Administrators, MHC Linen Service, River City Cleaners, Mid Atlantic Insurance Agencies, LivingWell Healthcare of Virginia, Roberts Awning Restoration and Renewal and FIC Financial Group.

As an aside, if the securities in the Johnson and Reinhardt case had been registered, investors might have learned some important information about the people and companies behind their investments. Specifically, Reinhardt had previously been barred twice from selling securities in North Carolina.

If you suffered investment losses in connection to either Julius Everett Johnson or Walter Ray Reinhardt, contact us to tell your story.