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Securities Fraud: 2011 in Review

Some familiar and some not-so-familiar names, topics and trends became prime fodder for securities-related fraud in 2011. Among those that made the 2011 list: Private placements, non-traded REITs, synthetic exchange-traded funds, MF Global, Medical Capital Holdings, Provident Royalties, and structured notes.

Private placements were big news in 2009, when the Securities and Exchange Commission (SEC) charged Medical Capital Holdings and Provident Royalties with fraud. The two entities continued to make headlines in January 2011 and in the months that followed as a number of prominent broker/dealers were forced to close shop because of legal issues tied to soured Med Cap and Provident deals. Among the B-Ds that either made an exit in 2011 or had to pony up big bucks to settle investor disputes involving Medical Capital and Provident Royalties: Capital Financial Services, Apple REITs, QA3 Financial Corp., Workman Securities, Next Financial, Securities America, Wells Investment Securities, Securities Network LLC and WFP Securities.

In February, complaints from investors about non-traded real estate investment trusts dominated the financial headlines. Names like Behringer Harvard REIT and Inland Western in particular proved to be a familiar focus of arbitration claims by investors, who alleged that the products failed to deliver on the promises of touted by brokers.

Legal issues involving mortgage giants Fannie Mae and Freddie Mac reached a boiling point in March 2011, as more investors who purchased preferred shares in Fannie Mae and Freddie Mac stock came forth with claims that that they never knew about the deteriorating financial health of Freddie Mac and Fannie Mae. The financial decline of the two companies was brought on by an every-growing appetite for risky lending, excessive leverage and investments in toxic derivative products. When Fannie Mae and Freddie Mac eventually were placed in conservatorship by the federal government, investors holding preferred shares now owned essentially worthless investments.

In April 2011, the big story was a highly leveraged municipal arbitrage fund known as MAT/ASTA and its creator, Citigroup Global Markets. On April 11, a Denver, Colorado-based Financial Industry Regulatory Authority (FINRA) arbitration panel awarded more than $54 million to two clients represented by the laws firms of Aidikoff, Uhl & Bakhtiari and Maddox, Hargett & Caruso.

The MAT/ASTA fund was sold through Smith Barney and Citigroup Private Bank to high net worth clients between 2002 and 2007. According to investors, the returns and risks of the funds were represented as “slightly greater” than a typical municipal-bond portfolio. In reality, however, the funds were highly leveraged, borrowing approximately $8 for every $1 raised.

In May, the Financial Industry Regulatory Authority (FINRA) announced the creation of a new database designed to provide more information about its disciplinary actions for investors and others.  The proliferation of problems surrounding private placements and the lack of due diligence by some brokers who sold the products to unsuspecting investors served as an impetus for the database’s creation.

Non-traded REITs again became news in June 2011 when a lawsuit was filed on behalf of investors against David Lerner Associates. In the complaint, investors claimed that Lerner acted negligently in the sale and underwriting of more than $6.8 billion in shares of Apple Real Estate Investment Trusts.

In July, a new study by MetLife highlighted increasing incidences of elder fraud. According to the study’s findings, elder fraud victims suffer losses of more than $3 billion each year. Experts say the figure actually may be much higher, because some 80% of the cases are never reported to authorities.

Plagued by lawsuits and arbitration claims over Medical Capital Holdings and Provident Royalties, broker/dealer Securities America was sold in August 2011 to Ladenburg Thalmann Financial Services for at least $150 million in cash. Securities America was one of the largest sellers of the troubled private placements in Medical Capital and Provident, with clients suffering an estimated $400 million in losses from the investments.

The onset of fall shined a new light on exchange-traded funds (ETFs). In September 2011, regulators expressed new concern that investors did not fully understand the hidden risks associated with ETFs or how the investments actually worked. At a Senate Banking subcommittee hearing held one month later, the Securities and Exchange Commission (SEC) would announce a sweeping review of exchange-traded funds, including investor disclosures, transparency of the underlying instruments in which ETFs invest, liquidity levels, fair valuations, and the potential impact of ETFs on market volatility.

On October 31, MF Global filed for Chapter 11 bankruptcy, leaving some 33,000 customers unable to access their money. MF Global, which billed itself as a “leading cash and derivatives broker/dealer,” was now the subject of a federal investigation after regulators discovered hundreds of millions of dollars in customer money allegedly missing from the company. The missing money came to light just as MF Global was preparing to sell a major stake of its firm to a rival brokerage. Instead, the deal went south, and MF Global filed for bankruptcy.

Next Financial Group joined the growing list of broker/dealers to face the legal music over sales of private-placements when in November 2011 it agreed to pay $2 million in restitution to customers who purchased oil and natural gas private placements of Provident Royalties. According to the Financial Industry Regulatory Authority (FINRA), Next Financial sold $20 million of three separate Provident private placements from July 2008 to January 2009. During that period, FINRA said that Next Financial’s due diligence was lacking.

Variable annuities rounded out the year of 2011 with the exit of several well-known life insurance carriers from the variable annuities business. Two of those VA players included Genworth Financial and Sun Life Financial.

And, finally, there’s Dec. 11 – the three-year anniversary of Bernie Madoff’s arrest. The mastermind behind the $65 billion Ponzi scheme is now serving a 150-year prison sentence. Meanwhile, investors who were caught in Madoff’s web of deceit continue to hold out hope of somehow recouping a portion of their financial losses.


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