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.

Securities America has fired off an angry letter to the Massachusetts Securities Division over its lawsuit against the broker/dealer for allegedly misleading investors who bought high-risk private placements in Medical Capital Holdings. The story was first reported Feb. 17 by Investments News.

According to the article, Securities America is outraged by the charges and contends Massachusetts regulators don’t understand the workings of private placements and Regulation D offerings.

The complaint that Securities America is referencing accuses the broker/dealer of misleading investors who bought nearly $700 million of private placements issued by Medical Capital from 400 Securities America representatives. The Massachusetts lawsuit also alleges that between 2003 and 2008, a group of Securities America executives repeatedly failed to heed the warning of an outside due-diligence analyst regarding the risks of the Medical Capital investments.

In July 2009, the Securities and Exchange Commission (SEC) charged Medical Capital with securities fraud. A number of lawsuits and arbitration claims have since been filed by investors who allege that various securities firms, including Securities America, failed to disclose the risks associated with the investments. As for Medical Capital, it currently is in receivership.

Investments in Medical Capital Holdings have resulted in millions of dollars in losses for investors across the country and, in turn, ignited a rash of lawsuits and arbitration claims. The focus of investors’ complaints is on the broker/dealers that sold the investments - known as Medical Capital Notes - and the information they allegedly kept hidden.

Securities America is one of the broker/dealers facing legal action in connection to Medical Capital Holdings. Massachusetts regulators sued the Omaha-based company on Jan. 26, claiming it misled investors about the risks involved in the Medical Capital Notes and the financial health of the issuer, Medical Capital Holdings. According to the complaint, 400 Securities America advisers allegedly sold $700 million of the private placements, half of which are now in default.

One of the advisers is William Glubiak, who was named in a December 2009 complaint involving Medical Capital Holdings. The suit alleges causes of action as unsuitability, misrepresentation and omission of material facts, according to records with the Financial Industry Regulatory Authority.

Paula Dorion-Gray is another adviser for Securities America. She also is facing a lawsuit over private placement deals gone wrong. As reported Feb. 3 by Investment News, Dorion-Gray was named in a $254,000 complaint in November that accuses her of recommending alternative investments in Medical Capital and another private placement, Provident Royalties LLC.

Medical Capital Holdings and Provident Royalties were both charged with fraud this past summer by the Securities and Exchange Commission (SEC).

If you have a story to tell involving Medical Capital Holdings, Securities America and/or Provident Royalties, please contact a member of our securities fraud team.

Former Bank of America CEO Ken Lewis is in a category all by himself. Following the Feb. 4 filing of civil fraud lawsuit by New York Attorney General Andrew Cuomo filed, Lewis became the highest ranking banking official to face charges of wrongdoing as part of the financial industry’s meltdown.

Cuomo’s lawsuit accuses Lewis, former Bank of America CFO Joe Price (who now runs the bank’s consumer banking division) and Bank of America itself of manipulating both investors and the government by not disclosing the full extent of massive financial losses occurring at Merrill Lynch before shareholders voted on the firm’s pending acquisition. The suit says Bank of America then used Merrill’s financial predicament to get additional bailout funds from the government.

“Ken Lewis is the poster child - or scapegoat - for the excesses of the past,” said Mark Williams, executive-in-residence at Boston University and a former bank examiner in a Feb. 5 article in Bloomberg. While Lewis didn’t push as deeply as some rivals into mortgage-backed securities, “he made bad strategic decisions” by overpaying for Merrill Lynch and subprime home lender Countrywide Financial Corp., Williams said.

According to Cuomo’s complaint, Bank of America was given advice by its own legal counsel, Timothy Mayopoulos - as well as outside counsel - as early as November to tell investors about the current and predicted financial losses of Merrill Lynch. Deloitte and Touche, Merrill’s auditing firm, also suggested disclosure, the complaint says.

“ . . . Bank management failed to disclose that by December 5, 2008, the day Bank of America shareholders voted to approve the merger with Merrill Lynch, Merrill had incurred actual pretax losses of more than $16 billion. Bank management also knew at this time that additional losses were forthcoming and that Merrill had become a shadow of the company Bank of America had described in its Proxy Statement and other public statements advocating the merger,” the complaint reads.

Corporate Treasurer Jeffrey Brown also “urged Price to make a disclosure to no avail,” according to the complaint. “When Price dismissed the Treasurer’s advice, the Treasurer warned, ‘I didn’t want to be talking [about Merrill’s losses] through a glass wall over a telephone.’ ”

“Astonishingly, Price seemed to have forgotten this dramatic exchange,” according to the lawsuit.

Lewis also was aware of the disclosure issues, because Price updated him on disclosure and loss issues.

More of what Lewis did or didn’t know will likely come to light in the coming days and weeks ahead. In the meantime, however, the opening summary of Cuomo’s lawsuit may sum up the situation best: “Throughout this episode, the conduct of Bank of America, through its top management, was motivated by self-interest, greed, hubris, and a palpable sense that the normal rules of fair play did not apply to them. Bank of America’s management thought of itself as too big to play by the rules and, just as disturbingly, too big to tell the truth.”

State Street Corporation gave some “preferred” investors key information about its Limited Duration Bond Fund back in 2007, allowing them to jump ship and subsequently avoid millions of dollars in losses. As it turns out, the Limited Duration Bond Fund was almost entirely invested in mortgage-related securities. Investors who were not privy to State Street’s pre-warnings paid the price.

As reported Feb. 4 by the New York Times, State Street’s selective disclosure became public after agreed to pay more than $310 million in penalties and restitution to settle accusations by the Securities and Exchange Commission (SEC) and Massachusetts officials that it misled investors about the risks associated with the Limited Duration Bond Fund and other funds that invested in it.

According to a complaint filed by the SEC, State Street created the Limited Duration Bond Fund in 2002 and marketed it as an alternative to a money-market fund. Five years later, however, the fund was almost entirely invested in mortgage securities. State Street not only misled many investors about the fund’s exposure, but also provided certain investors with more complete information regarding the fund’s investing strategies, the SEC says.

“State Street gave preferential treatment to some investors over others, leaving many investors, including dozens of Massachusetts charities and retirement funds, completely unaware of key facts about the funds,” said Massachusetts Attorney General Martha Coakley in a statement.

Investors who received more accurate information from State Street included clients of State Street’s internal advisory groups, which advised some investors in the fund. The advisory groups recommended that their clients, including State Street’s own pension plan, redeem their investments. State Street sold the most liquid holdings to meet these redemptions, according to the SEC. As for the remaining investors, they were left with largely illiquid holdings.

The funds, which were managed by State Street Global Advisors, accounted for about $13 billion of State Street’s funds under management in 2007.

State Street’s settlement will be allocated among about 270 investors who lost money. It includes a $50 million fine and $8 million in forfeited advisory fees and interest. The payment is in addition to $350 million that State Street will pay to settle private claims. The bank also will pay an additional $20 million to settle with Massachusetts authorities.

State Street does not admit or deny the allegations.

Bank of America execs, including former CEO Ken Lewis, are gearing up for a heated legal battle with New York Attorney General Andrew Cuomo. On Feb. 4, Cuomo charged Lewis of defrauding investors and the U.S. government when he helped put the wheels into motion for Bank of America to buy financially troubled Merrill Lynch & Co.

Specifically, Cuomo alleges that Lewis, as well as BofA’s former chief financial officer Joe Price, failed to tell shareholders about the $16 billion in losses that Merrill had incurred before it was bought by Bank of America. After shareholders approved the acquisition, Cuomo says Lewis then demanded government bailout funds to keep the deal afloat.

In total, the government injected $45 billion into Bank of America via the purchase of preferred shares, including $20 billion approved after the merger in January 2009.

“We believe the bank management understated the Merrill Lynch losses to shareholders, then they overstated their ability to terminate their agreement to secure $20 billion of TARP money, and that is just a fraud,” Cuomo said today at a press conference. “Bank of America and its officials defrauded the government and the taxpayers at a very difficult time.”

Separately, the Securities and Exchange Commission (SEC) announced that it had reached an agreement with Bank of America over the company’s decision to pay $3.6 billion of bonuses to former Merrill employees for fiscal year 2008. BofA agreed to pay a $150 million fine to settle the matter.

A complaint against Securities America contains a lengthy and potentially damaging list of allegations against the Omaha broker-dealer and its sales of private offerings in Medical Capital Holdings. The complaint, which was filed Jan. 26 by Massachusetts Secretary of State William Galvin, accuses Securities America of not only misleading investors but also intentionally making material misrepresentations and omissions in order to get them to purchase investments in Medical Capital Notes.

Medical Capital was sued by the Securities and Exchange Commission (SEC) in July 2009 and placed into receivership one month later. Since then, its collapse has resulted in about $1 billion in losses for investors throughout the country.

Massachusetts’ securities division launched an investigation into Securities America in December 2009, after receiving complaints from investors who had placed their life savings into Medical Capital based on recommendations by Securities America. According to the complaint, many of these investors were unaware of the risks involved in the offerings. Securities America, on the other hand, was fully aware of these risks, the complaint says.

“Year after year, the due diligence analyst hired 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.

Many investors who purchased Medical Capital Notes had no idea as to how the notes were actually structured. In reality, the offerings were highly complex, speculative securities and considered suitable only for the most sophisticated of investors. In addition, many investors believed they were buying “fully secured” investments when they purchased Medical Capital Notes. As it turns out, that was not the case.

Other information that Securities America allegedly kept from investors included Medical Capital’s lack of audited financials. It was a concern that even Securities America’s own president, Jim Nagengast, felt. In a 2005 email, Nagengast wrote the following:

“My big concern is the audited financials. At this point, there is no excuse for not having audited financials . . . it is a cost they simply have to bear to offer product through our channel. We simply have to tell them if they don’t have financials by XXXX date, we will stop distributing the product on that date. Then they can decide if it’s worth to spend $50,000 to have it done. If they won’t spend the money, that should give us concerns.”

Concerns aside, Securities America ignored its president’s recommendation and continued selling millions of dollars worth of Medical Capital Notes. They did this knowing full well that no audited financials had ever been conducted on any of the Medical Capital entities issuing the notes

If you have a story to tell involving Securities America and/or Medical Capital Notes, please contact a member of our securities fraud team.

In an ironic twist, just two days after the state of Massachusetts filed charges against Securities America for allegedly misleading investors about sales of Medical Capital notes, the Omaha-based broker/dealer issued a press release announcing new members for its 2010 Advisory Council. The irony is the council itself. According to the release, its purpose is to provide an “opportunity for advisors to give feedback on the strategy, tactics and marketing message of Securities America.”

Considering the recent allegations against Securities America, those messages might need some serious review indeed.

Massachusetts Secretary of State William Galvin sued Securities America on Jan. 26, accusing the company of committing securities fraud on a “massive scale.” In the complaint, Galvin alleges that Securities America committed “acts of material omissions and misleading statements” when it sold nearly $700 million of promissory notes to Medical Capital investors.

According to the complaint, Securities America kept investors in the dark about various risks and other information concerning MedCap notes. “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.

Those risks included Medical Capital’s lack of audited financials.

The Massachusetts investigation also uncovered evidence that top executives at Securities America enjoyed vacation trips to Pebble Beach and Las Vegas resorts courtesy of Medical Capital.

From 2003 through 2009, Medical Capital issued more than $1.7 billion in notes; Securities America placed $697 million of that amount. In return, Securities America took in more than $26 million in compensation, according to the complaint.

Securities America has denied all charges levied by Massachusetts regulators.

Medical Capital currently is in receivership. It was sued by the Securities and Exchange Commission (SEC) in July 2009 for allegedly defraudeding investors out of at least $18.5 million. On Aug. 3, 2009, the SEC obtained an emergency court order halting a $77 million offering fraud perpetrated by the company.

If you suffered investment losses in Medical Capital notes sold by Securities America, please contact us. A member of our securities fraud team will help you determine if there is a viable claim for recovery.