Category Archives: SEC Investigation

As expected, H. David Kotz, Inspector General of the Securities and Exchange Commission (SEC), has delivered a scathing report on the agency’s mishandling of the Bernie Madoff scandal. The much-anticipated report is 450 pages in length, and blasts the SEC for never conducting “a thorough and competent investigation or examination” of Madoff and his investment advisory businesses. The inspector general goes on to reveal how the agency’s “inexperienced” attorneys remained oblivious to Madoff’s $65 billion Ponzi scam, accepting Madoff’s answers to their questions even when the responses were “seemingly implausible.”

The report also notes that during the course of several examinations by SEC staff members into Madoff, the financier made overt efforts to “impress and even intimidate the junior examiners from the SEC.” According to the report, Madoff emphasized his role in the securities industry, emphasizing his ties with high-ranking members at the agency. One of the examiners characterized Madoff as “a wonderful storyteller” and “very captivating speaker” and noted that he had “an incredible background of knowledge in the industry.”

Read the executive summary of the report here.

In March, Madoff was sentenced to 150 years in a North Carolina federal prison for his role in masterminding what is considered the biggest Ponzi scheme in history. Investors, including ordinary citizens, hedge funds, charities, famous names in the entertainment world and others, lost more than $65 billion to Madoff’s scheme.

Leveraged and inverse exchange-traded funds (ETFs) have come under fire recently for the potential dangers these complex financial products may hold for individual investors. ETFs are designed to capture two or three times the movement in a particular stock index or, in the case of an inverse ETF, provide results that are 100% opposite. In the current economic climate, however, many investors are discovering huge distortions in the stated performance objectives of these investments.

The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) both issued investor alerts recently on leveraged and inverse ETFs, cautioning individuals about the investing pitfalls these highly specialized and complex products can create.

Specifically, leveraged and inverse ETFs provide leverage on a daily basis. Many investors fail to understand this concept and, instead, wind up buying an ETF and holding it for a year, which can put them at a huge financial risk.

In a recent SEC alert, two real-life examples were depicted of how returns on a leveraged or inverse ETF over longer periods of time can be widely different from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time.

Example 1: Between December 1, 2008, and April 30, 2009, a particular index gained 2%. However, a leveraged ETF seeking to deliver twice that index’s daily return fell by 6% – and an inverse ETF seeking to deliver twice the inverse of the index’s daily return fell by 25%.

Example 2: During that same period, an ETF seeking to deliver three times the daily return of a different index fell 53%, while the underlying index actually gained around 8%. An ETF seeking to deliver three times the inverse of the index’s daily return declined by 90% over the same period.

The SEC’s advice to individual investors who may be considering a leveraged or inverse ETF is to thoroughly do their homework. Make sure to understand the ETF’s stated objectives, as well as its potential risks. It’s also important to know that leveraged or inverse ETFs may be more costly in terms of fees than traditional ETFs. FINRA’s Fund Analyzer can estimate the impact of fees and expenses on your investment.

In addition, there can be significant tax consequences associated with leveraged or inverse ETFs that are less tax-efficient than traditional ETFs.

Former BusinessWeek writer Matthew Goldstein hit the nail on the head in his Aug. 11 blog about the Securities and Exchange Commission’s so-called “scared-straight” campaign to clean up Wall Street. Goldstein appropriately calls the SEC’s latest round of enforcement actions, including those against Bank of America, General Electric and former American International Group CEO Hank Greenberg, “an attempt by regulators to clean-up the docket so the litigation papers can be sent to cold storage.” 

The Bank of America/SEC settlement is a perfect example of what Goldstein is talking about. Under the agreement announced Aug. 3, Bank of America would pay $33 million to settle charges by the SEC that it lied to shareholders about billions of dollars in bonuses promised to Merrill Lynch executives. Judge Jed Rakoff, the federal judge overseeing the case, has now nixed that deal, and on Monday, got BofA’s lawyer to reveal that in agreeing to the SEC’s settlement it didn’t believe it did anything wrong by deceiving shareholders. 

And therein lies the problem – and a very basic flaw in how the SEC operates. By allowing entities like Bank of America and others to simply pay a fine for an alleged offense without also publicly admitting their wrong doing, accountability becomes non-existent. The message is sent loud and clear that actions really don’t have consequences when it comes to Wall Street, and bad behavior, fraud and the like can continue on in full force.

The SEC and its new chairman, Mary Schapiro, purport to have a renewed sense of urgency for righting the wrongs of Wall Street. If that is the case, then the regulator needs to get serious about accountability. That means issuing a new mandate, one that requires individuals to admit liability before the SEC will sign off on any civil enforcement action. If the individuals in question refuse to admit their alleged offenses, then the SEC needs to put tough talk into action and proceed with legal recourse.

A federal judge is saying “no” to the $33 million settlement between Bank of America (BofA) and the Securities and Exchange Commission (SEC), refusing to sign off on the agreement and demanding answers as to why the regulator accepted what he calls a “small penalty.” Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York made his remarks at an Aug. 10 hearing, where he also asked Bank of America for the names of the executives allegedly involved in lying to investors about plans to pay billions of dollars in bonuses at Merrill Lynch, which BofA acquired during the height of the financial crisis.

“If Bank of America misled the shareholders, as you assert about a multibillion dollar matter, isn’t there something strangely askew in a fine of $33 million?” Rakoff asked the SEC’s lawyers during the Aug. 10 hearing. “It is very difficult for me to see how the proposed settlement is remotely reasonable.”

Without Judge Rakoff’s consent, the BofA/SEC settlement cannot move forward. As it stands, the judge has asked for further filings and information by Aug. 24, and says a settlement wouldn’t be approved before Sept. 9. 

On Aug. 3, Bank of America, without admitting or denying the SEC’s allegations, agreed to pay $33 million to settle charges that it misled investors about Merrill Lynch’s plans to pay executive bonuses as it prepared to report fourth-quarter losses totaling more than $15 billion. In turn, those losses affected the fiscal health of Bank of America, which acquired Merrill Lynch in January 2009.

The SEC alleges that Bank of America promised shareholders that Merrill Lynch would not pay year-end bonuses and incentives without first getting BofA’s consent. In reality, however, the SEC says the bank already had given that approval, authorizing Merrill Lynch to pay nearly $6 billion in extra compensation. 

As reported Aug. 10 by the Washington Post, Judge Rakoff had harsh words for BofA lawyers during the hearing, demanding to know the names of the individual or individuals who decided what to reveal to shareholders in a November proxy statement. According to the article, the judge specifically asked whether Bank of America chief executive Kenneth D. Lewis and former Merrill Lynch chief executive John Thain were involved.

“Was it some sort of ghost?” Rakoff asked. “Who were the people? . . . If you are correct that this proxy statement was materially misleading, then at a minimum Mr. Thain and Mr. Lewis would seem to be responsible for that, yes?”

Regions Financial Corp., whose brokerage arm is Morgan Keegan & Company, has revealed in its Aug. 5 10-Q filing with the Securities and Exchange Commission (SEC) that Morgan Keegan, Morgan Asset Management Company and three employees each received a Wells notice in July from the SEC’s office in Atlanta, alerting them to prepare for future enforcement actions for possible violations of the federal securities laws. 

A 10-Q is a quarterly report required by the SEC for publicly traded companies. Generally, firms file a 10-Q 45 days after the end of a quarter. The document itself contains similar information found in a company’s annual 10-K filing, but the 10-Q information usually is less detailed; moreover, in most cases, the financial statements in a 10-Q are based on assumptions, which typically require revisions in future accounting periods.

In addition to the SEC’s notice, Morgan Keegan received a second Wells notice in July – this one from the Financial Industry Regulatory Authority (FINRA). According to that notice, a preliminary determination had been made by FINRA, recommending discipline actions against Morgan Keegan for violating various NASD rules in connection to sales of certain investment products.

In both the SEC and FINRA notices, the “products” in question include a group of seven proprietary mutual funds that are facing a slew of arbitration claims by investors who suffered sizable losses in 2007 and 2008 because of investing gambles made by Morgan Keegan in risky debt and other mortgage-related holdings. 

In their claims, investors allege that Morgan Keegan misrepresented the funds as low-risk and high-yield products, when in reality the funds were tied to the most volatile components of the mortgage loan industry.

When that industry ultimately collapsed, investors lost 90% and more of their money in the RMK funds. According to the pending arbitration cases against Morgan Keegan, investor losses related to the RMK mutual funds total more than $2 billion.

The Securities and Exchange Commission (SEC) has charged Bank of America (BofA) of lying to investors and misleading them about billions of dollars in bonuses being paid to Merrill Lynch executives at the time of its acquisition of the firm. Bank of America, which bought Merrill earlier this year, agreed to settle the SEC’s charges and pay a penalty of $33 million.

According to the SEC’s complaint, Bank of America was in violation of securities laws when it allegedly told shareholders in November 2008 that year-end bonuses would not be paid without its consent.

“In fact, Bank of America had already contractually authorized Merrill to pay up to $5.8 billion in discretionary bonuses to Merrill executives for 2008,” the SEC said in a statement. “The disclosures in the proxy statement were rendered materially false and misleading by the existence of the prior undisclosed agreement allowing Merrill to pay billions of dollars in bonuses for 2008.”

As reported Aug. 3 by the Washington Post, New York Attorney General Andrew Cuomo and Bank of America have been at odds with each over the bonus payments. In February, Cuomo subpoenaed the bank to obtain the names of all bonus recipients, contending that Merrill Lynch accelerated the payments before the announcement of a $9.8 billion fourth-quarter loss.

The possibility that Morgan Keegan will face civil charges from the Securities and Exchange Commission (SEC) is welcome news for thousands of investors who have filed arbitration claims against the Memphis-based brokerage for losses in a group of collapsed bond funds.  

Regions Financial Corp., the parent company of Morgan Keegan, announced in early July it had received a Wells Notice from the SEC for possible violations of securities laws involving certain mutual funds. The SEC sends a Well Notice to people or firms as a way to formally alert them to the possibility that enforcement action will be brought against them.  

For investors, the Wells Notice could be a boon to their legal cases against Morgan Keegan. According to a July 31 article in the Wall Street Journal, securities arbitrators may now be more inclined to order Morgan Keegan to provide investors with copies of certain documents that could assist in their claims. 

“That notification has to influence arbitrations when the issue of discovery of regulatory documents comes up,” said Steven Caruso, a New York-based attorney with Maddox Hargett & Caruso, in the Wall Street Journal.  

Even though the Wells Notice did not specifically name the funds in question, the SEC said they were managed by Morgan Asset Management Inc., which is part of Morgan Keegan. Seven former Morgan Keegan funds suffered massive financial losses in 2007 and 2008 because of their exposure to risky subprime securities and even more risky collateralized debt obligations. 

Between March 31, 2007, and March 31, 2008, losses in the RMK funds totaled more than $2 billion. 

In July 2008, Regions transferred management of several of the RMK funds in question to New York-based Hyperion Brookfield Asset Management.

At least 440 investors, many of whom were elderly individuals and retirees, found themselves duped in a $50 million real estate investment deal that turned out to be a Ponzi scheme. On July 28, the Securities and Exchange Commission (SEC) obtained a court order to halt the alleged scam, freezing the assets of the alleged perpetrators – John J. Bravata and Richard J. Trabulsy of Michigan – as well as the companies they formed, own, and control: BBC Equities LLC and Bravata Financial Group, Inc. 

According to the SEC, the two men raised more than $50 million from investors by offering them membership interests in a purported real estate investment fund with promised annual returns of 8 to 12%.  However, less than half of the money raised was actually spent acquiring real estate. Instead, Bravata and Trabulsy used money from new investors to make Ponzi-like payments to earlier investors. They also spent several million dollars of investors’ money on themselves, financing exotic vacations, gambling debts and other extravagant items. 

The SEC’s complaint, filed in U.S. District Court for the Eastern District of Michigan, also charges Bravata’s son, Antonio Bravata of Brighton, of selling the unregistered securities and acting as an unregistered broker.

Region Financial Corp.’s brokerage arm, Morgan Keegan, was sued on July 21 by the Securities and Exchange Commission (SEC) on charges that the Memphis-based firm left clients stranded with more than $1 billion in auction rate securities.

According to the SEC, Morgan Keegan failed to tell customers about the growing risks associated with auction rate securities. Instead, it reportedly encouraged brokers to ramp up their efforts to sell the instruments prior to the market’s collapse in February 2008.

The SEC is demanding that Morgan Keegan buy back any auction rate securities sold before March 2008 from retail investors and small businesses, as well as pay fines. In addition, the regulator wants Morgan Keegan to forfeit any proceeds from its auction-rate business. From June 2007 to February 2008, the SEC says Morgan Keegan earned more than $4 million in underwriting, brokerage and distribution fees.

 “Morgan Keegan was clearly aware that the ARS market was deteriorating, but it went so far as to actually accelerate its ARS sales even after other firms’ ARS auctions began to fail,” said SEC Enforcement Director Robert Khuzami in a statement.

In an agreement with the Securities and Exchange Commission (SEC), Morgan Stanley will pay a $500,000 penalty to settle charges that it misled customers in its Nashville office about various money management firms recommended to clients and from which Morgan Stanley later profited via large commissions. 

Contrary to its disclosures and corporate policies, Morgan Stanley recommended some money managers who were not approved for participation in the firm’s advisory programs and therefore had not been subject to the firm’s due diligence review.

The SEC also charged William Keith Phillips, a former Morgan Stanley investment advisor in Nashville, of steering investors to the unapproved money managers so that he could receive financial kickbacks. The SEC says Phillips’ use of unapproved money managers earned Morgan Stanley at least $3.3 million in extra commissions.

The SEC’s case with Phillips is still pending. 

This isn’t the first time complaints have been lodged against Phillips. As reported July 21 in The Tennessean, Phillips apparently has a lengthy history of previous misconduct accusations, including those from the Chattanooga Pension Fund, the Nashville Electric Service and Metro Nashville Pension Plan. In 2004, the Chattanooga Pension Fund accused him of costing the fund $20 million in losses, undisclosed commissions and fees.

Ultimately, UBS Financial Services, which acquired Phillips’ employer PaineWebber, paid $675,000 to settle the case in 2006, according to the Financial Industry Regulatory Authority (FINRA), according to the article. A much larger payout was made by the Swiss-based bank in 2002 after Metro Nashville complained about the way in which Phillips handled its pension.

UBS paid more than $10 million to settle those issues. UBS also settled with the Nashville Electric Service, agreeing to pay $440,000 for similar accusations levied against Phillips.