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Monthly Archives: June 2010

Group Of Broker/Dealers Face Lawsuit Over Provident Royalties Private Placements

Forty-nine broker/dealers have been named in a lawsuit involving sales of Provident Royalties private placements. The lawsuit, which was filed June 21 by the trustee now overseeing Provident – Milo H. Segner Jr. – charges the broker/dealers of failing to uphold their fiduciary obligations when selling a series of Provident Royalties LLC private placements.

The lawsuit hopes to recover $285 million in claims and commissions from the firms named in the lawsuit. As reported June 29 by Investment News, the leading sellers of the private placements in Provident Royalties were Capital Financial Services, with $33.7 million in sales; Next Financial Group, with $33.5 million; and QA3 Financial Corp., with $32.6 million.

Investment News provides a complete list of the broker/dealers named in the lawsuit, as well as the commissions they collected.

“The commissions, fees and payments received from Provident Royalties encouraged and played a substantial role in the negligent and/or grossly negligent conduct of the broker-dealers,” according to the lawsuit.

In July 2009, the Securities and Exchange Commission (SEC) filed a fraud lawsuit against Provident Royalties and several high-ranking executives for running an alleged $485 million Ponzi scheme tied to fake oil-and-gas investments. From June 2006 to January 2009, many independent broker/dealers sold private placements in Provident to some 7,700 investors.

Another Broker/Dealer Goes Out Of Business

Weighed down by sales in Medical Capital Holdings and other failed private placement deals, more broker/dealers are closing their doors. At least nine B-Ds have gone out of business this year.

In 2005, 5,111 broker-dealers were registered with the Financial Industry Regulatory Authority (FINRA); today, the number of firms has declined by 8.2% to 4,693.

A number of reasons are behind the recent broker/dealer closures, including the current economy, as well as regulatory pressure from FINRA and the Securities and Exchange Commission (SEC). For many of the recently shuttered brokerages, however, their fate has been sealed by sales in Medical Capital Holdings.

In July 2009, the SEC charged Medical Capital with fraud in connection to the sale of private placements. In total, the Tustin, California, lender raised $2.2 billion in investor money and sold private placements known as Medical Capital notes through dozens of broker/dealers. More than half of investors’ money is now gone.

Chicago Investment Group, a broker/dealer with approximately 90 brokers and $200 million in client assets, is the latest broker/dealer set to close its doors. As reported June 29 by Investment News, the company revealed last week it did not have enough capital on hand to meet industry rules to remain open for business.

Tough Times Ahead For Small Broker/Dealers

GunnAllen Financial. Cullum & Burks Securities. Okoboji Financial Services. Jesup & Lamont Securities. All are independent broker/dealers that have either faced net-capital violations or been shut down by regulators after their capital levels were deemed too inadequate to continue doing business.

Jesup & Lamont Securities is one of the latest broker/dealers facing a capital crunch. On June 18, FINRA ordered the company and its 300 reps to cease business operations other than liquidating transactions. According to a June 27 Investment News article, the problem may stem to pressure from the SEC regarding sales of $11 million in private shares of Jesup & Lamont’s stock.

Jesup & Lamont is not alone. As reported in the Investment News story, a number of broker/dealers are dealing with capital requirement issues these days as a result of the market downturn of 2008 and early 2009. Broker/dealers also share something else in common: Many are facing legal liabilities from private-placements deals that have gone bust. Two of the most prominent cases involve Medical Capital Holdings and Provident Royalties LLC.

Last summer, the Securities and Exchange Commission (SEC) brought a fraud lawsuit against Provident Royalties and its related business entities. In the complaint, the SEC charged Provident with selling fraudulent private-placement offerings from September 2006 through January 2009. According to SEC documents, Provident raised $495 million from at least 7,700 investors throughout the country.

That same summer the SEC also initiated a fraud lawsuit against Medical Capital Holdings. In its fraud complaint, the SEC alleges that Medical Capital had more than $543 million in phony receivables on its books and had lost more than $315 million on various loans. Meanwhile, the company reportedly collected $323 million in fees for managing the money-losing loans.

The SEC also accuses Medical Capital of running a Ponzi scheme operation. According to the SEC complaint, Medical Capital was selling receivables at a markup among the various funds it controlled and then using money from newer investors to pay investors in the older funds.

Reverse Convertibles Can Spell Financial Disaster For Investors

Reverse convertibles, also known as reverse exchangeable securities, are complex structured investment products linked to the performance of an unrelated asset. The asset can be a single stock or a basket of stocks, an index or some other asset.

When investors purchase a reverse convertible, they are getting a yield-enhanced bond. They do not own, and do not get to participate in any upside appreciation of the underlying asset. Instead, in exchange for higher coupon payments during the life of the note, investors give the issuer a “put option” on the underlying asset. In other words, investors are betting that the value of the underlying asset will remain stable or go up, while the issuer is betting that the price will fall.

In the best case scenario, if the value of the underlying asset stays above the knock-in level or even rises, an investor can receive a high coupon for the life of the investment and the return of the full principal in cash. In the worst case, if the value of the underlying asset drops below the knock-in level, the issuer can pay back the principal in the form of the depreciated asset – which means investors can wind up losing some, or even all, of their principal.

That’s exactly what happened to Lawrence Batlan, an 85-year-old retired radiologist. Batlan, who suffered a loss of almost 20%, says his Citigroup broker talked him into shifting out of preferred stocks in 2007 and buying $400,000 of reverse convertibles, which promised higher interest and safety.

As reported June 16, 2009, by the Wall Street Journal, Batlan’s reverse convertibles were linked to four well-known stocks and paid between 6.25% and 13% at a time when 10-year Treasurys were yielding around 5% yearly. Then the financial crisis appeared, and the share prices of the four underlying stocks fell below the 20% knock-in threshold. Batlan suddenly found himself the owner of stocks worth $75,000 less than he initially invested.

“I had no idea this could happen,” said Batlan in the article. “I have no desire to own Yahoo stock or the others.” Batlan has since filed a complaint with the Financial Industry Regulation Authority (FINRA) in an attempt to recover the $75,000 back from Citigroup.

Harvey Goodfriend, 77, has a similar story. The retired mechanical engineer says he was told by his broker that there was no risk in reverse convertibles. Goodfriend soon discovered otherwise. He says he lost 36% of the almost $250,000 that his Stifel Nicolaus & Co. broker placed into reverse convertibles two years ago.

If you have suffered losses in Reverse Convertibles, please contact our securities fraud team. We can evaluate your situation to determine if you have a claim.

Regulators Take Aim At Reverse Convertibles

Complex investments known as reverse convertibles face growing scrutiny from regulators for their hidden risks, lack of transparency and, in some instances, because of the manner in which they are represented to investors by certain brokers.

As reported in a June 24 story by Bloomberg, brokers for JPMorgan Chase & Co., Royal Bank of Scotland Group Plc, and Barclays Plc have been charging fees on some structured notes that equal or exceed the securities’ highest possible yield.

“It seems inconceivable that the commission could be more than the potential return to clients,” said Durraj Tase in the Bloomberg article. Tase, who is an adviser with First Liberties Financial in New York, added: “If you are paying more fees than your potential return, as an adviser, I would not be able to suggest that note.”

On June 15, RBS gave brokers a 2.75% commission to sell a three-month reverse-convertible note with a 2.56% potential yield, according to the Bloomberg story. In May, JPMorgan charged 5.25% in fees and commissions on a three-month Citigroup-linked note that paid 5% interest, and Barclays offered brokers a 2% commission on a security paying 2% interest.

In February 2010, the Financial Industry Regulatory Authority (FINRA) issued an alert to investors on the risks associated with reverse convertibles. Among things, FINRA warned that reverse convertibles expose investors not only to risks traditionally associated with bonds and other fixed income products – such as the risk of issuer default and inflation risk – but also to the additional risks of the unrelated assets, which are often stocks.

In the case of JPMorgan’s reverse convertibles, investors are exposed to losses if Citigroup declines by more than 20%.

If you have suffered losses in Reverse Convertibles, please contact our securities fraud team. We can evaluate your situation to determine if you have a claim.

Magnetar Warrants A Closer By The SEC

Investment deals involving Magnetar Capital are garnering renewed interest from the Securities and Exchange Commission (SEC), as the regulator steps up its investigation into how hedge funds like Magnetar made huge profits on instruments that produced billions of dollars in losses for investors.

The investments in question are mortgage-related collateralized debt obligations (CDOs). As reported June 19 by the Wall Street Journal, the hedge fund known as Magnetar played a key role in the CDO market, keeping sales growing even as cracks began to appear in the housing market.

Magnetar also worked with most of Wall Street’s top banks in its deals, including Merrill Lynch, Lehman Brothers, Citigroup, UBS and JPMorgan Chase.

Magnetar bought the riskiest portion of CDOs, while simultaneously placing bets that portions of its own deals would fail. Along the way, Magnetar allegedly did something to enhance the chances of that happening. According to an April 10 article by ProPublica, Magnetar pressed to include riskier assets in its CDOs so as to make the investments even more prone to failure.

Apparently Magnetar acknowledges that it bet against its own deals but says the majority of those short positions involved similar CDOs that it did not own. Magnetar says it never selected the assets that went into its CDOs.

The bottom line is Magnetar ended up making big profits when the CDOs collapsed. Meanwhile, investors in the supposedly safer parts of the CDO suffered big losses.

Now the SEC wants to know how the assets that were put into the CDOs were valued at the time, the terms of the deal, what triggers were put in place to determine whether investors would incur losses and at what point did the banks that were involved in the deal bet against the assets in the CDO.

‘Stranger-Originated Life Insurance’ (STOLI) Policies: Buyer Beware

Stranger-Originated Life Insurance (STOLI) policies may be the new mortgage-related investment debacle of the year, creating havoc for unsuspecting investors and a financial bonanza for brokers and insurance agents who unload them.

Stranger-Originated Life Insurance policies, also known as stranger-initiated life insurance or STOLI for short, are controversial investment arrangements in which a stranger initiates an insurance policy against someone’s life and then resells the policy to an investor. The investor pays the premiums and collects the proceeds when the original owner of the STOLI dies.

The middleman in the process is a broker or insurance agent. And, in recent months, regulators have been cracking down on both. Sales agents in Florida, Ohio, Minnesota and California all have been arrested and/or had their professional licenses revoked for allegedly exaggerating the wealth of an elderly client to take out a STOLI policy and then selling the policy to an investor.

One STOLI sales agent who specialized in stranger-originated life insurance policies is Steven Brasner. As reported June 22 by the Wall Street Journal, before the financial crisis hit, Brasner connected untold numbers of aging retirees in need of money with hedge funds looking for STOLI investments.

Today, many of those policies are worthless. In April, Brasner was arrested by Florida authorities on 22 counts of alleged grand theft, fraud and other offenses tied to $78 million of policies that earned him nearly $2 million in commissions. According to the Florida Attorney General, Branser lied to insurers about applicants’ financial status and their reasons for buying the coverage.

Brasner also faces a number of civil suits filed by insurers trying to void many of the policies, as well as lawsuits by investors who allege they lost money buying their now-worthless policies.

In March, Ohio regulators revoked the license of an agent who allegedly promised a 74-year-old Cleveland woman $8,000 to let him take out $9 million of insurance on her life. According to the Wall Street Journal, the application to Prudential Financial listed her net worth at $12.5 million. In reality, she and her husband had a net worth of $2,000 and combined monthly income of $950, according to Ohio officials and Prudential.

A similar scenario played out in Minnesota where regulators penalized an agent who had secured 44 policies totaling $127.8 million on the life of one man. The agent’s license ultimately was revoked, and he had to pay a $250,000 fine. According to regulators, the agent misrepresented the total amount of insurance outstanding as his client applied for additional coverage over a several year period.

Allegations of wrongdoing by agents and brokers are common in more than 200 civil lawsuits filed by insurers around the United States involving alleged stranger-originated policies, according to the Wall Street Journal article.

LPL Faces Class Action Lawsuit Over Broker’s Annuities Sales

Two Nebraska investors have filed a class-action lawsuit against LPL Financial, alleging that one of the company’s brokers – Bob Bennie – misrepresented the costs and benefits of variable annuities.

As reported in a June 17 article by the Associated Press, more than $365,000 of the products had been sold to investors Richard and Carol Ripley. The Ripley’s lawsuit, which was originally filed last month in a Nebraska state court and which seeks class-action status, has been transferred to a Nebraska federal court.

In their lawsuit, the Ripleys contend that Bennie failed to disclose the unsuitable nature of the annuities and misled them about withdrawing money without facing a penalty and the costs of the annuities.

Boston-based LPL provides trading and support services to 16,000 independent brokers. Bennie is the owner of Bob Bennie Wealth Management.

Variable annuities have faced growing scrutiny lately, with regulators initiating enforcement actions against annuity sellers for unsuitable sales and lack of disclosure.

In the simplest terms, a variable annuity is a tax-deferred investment that comes with an insurance contract in which earnings grow tax-deferred.

At the same time, variable annuities come with a high commission fee – up to 9% in some instances. Moreover, many investors are often unaware of the early withdrawal penalties associated with variable annuities.

Steven Caruso Joins SIPC Taskforce

The Securities Investor Protection Corporation (SIPC) has announced the appointment of Steven Caruso of Maddox, Hargett, & Caruso to its SIPC Modernization Task Force. A total of 13 individuals – including representatives from the securities industry, investors, government regulators and academia – will serve on the task force.

The SIPC, which was formed by Congress to help customers of insolvent and failed brokerage firms, also launched a new Web site that will gather input from the public via online comments, as well as provide live interactive forums and national Webcasts.

According to the SIPC, the newly formed task force will provide statutory amendments to the SIPC board, as well as information to assist the SIPC board and members of Congress when it comes to enacting investor reforms.

The SIPC was created in 1970. As of 2009, it has advanced $1.2 billion in order to make possible the recovery of $108 billion in assets for an estimated 763,000 investors.

Merrill Lynch & The ‘Sophisticated Investor’ Defense

A June 11 blog by the Wall Street Journal illustrates a growing trend on Wall Street – the sophisticated investor defense. The premise is simple: If the complex financial products that Wall Street markets and sells go south, it’s the investor’s problem. After all, the products are geared to those who are financially savvy. They should have therefore known the risks involved.

In reality, even the most sophisticated investor may be unaware of the complexities and risks surrounding some of today’s investments. Moreover, even the “average” investor gets burned in these deals, usually through pension funds that participate in the investments.

A recent case involving Merrill Lynch and collateralized debt obligations (CDOs) is a perfect example. Merrill Lynch’s CDO deals were sold to institutional and retail investors. In other words, so-called sophisticated and less-than-sophisticated investors were part of the sales pitch. It also apparently was common fare for Merrill Lynch to sell retail investors the lowest-rated CDO slices of the deals.

Investors like the Slomacks ultimately paid the price, according to the WSJ article. The Slomacks invested $2.65 million in several Merrill-issued CDOs, losing all but $16,500. They have since filed an arbitration claim against Merrill Lynch with the Financial Industry Regulatory Authority (FINRA).

Another investment firm looking to employ the “sophisticated investor” defense over CDO deals gone bad is Goldman Sachs. For more than a year, Goldman has faced intense questioning by the U.S. Senate Permanent Subcommittee on Investigations about its CDO dealings, while investors contend Goldman used deceptive sales practices to market billions of dollars’ worth of the products. To date, the probes have cost Goldman $25 billion in market capitalization, according to a June 14 article by Reuters.

In April, the Securities and Exchange Commission (SEC) filed a civil fraud lawsuit against Goldman Sachs over a CDO called Abacus 2007. The Abacus transactions were synthetic collateralized debt obligations – financial products that many financial analysts say were largely responsible for the worst collapse in financial markets since the Great Depression.


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