Articles Posted in Securities Fraud

Securities Roundup: FINRA Tells Broker Dealer to Cease-a-Desist Its Allegedly Fraudulent Sales, SEC Supports Creation of Variable Annuities Summary Prospectus, & US Supreme Court Hears Amgen & Comcast Appeals to Shut Down Class Action Lawsuits

Published on: November 15, 2012 | by Shepherd Smith Edwards & Kantas, LLP

FINRA has filed a temporary cease-and-desist order barring WR Rice Financial Services Inc. and Joel I. Wilson, its owner, from taking part in allegedly fraudulent sales activities and the conversion of assets or funds. The SRO is also filing a securities complaint accusing both the Michigan based-brokerage firm, Wilson, and other registered representatives of selling over $4.5 million in limited partnership interests to approximately 100 investors while leaving out or misrepresenting material facts.

Per the broker fraud case, the broker-dealer and Wilson got investors to participate by promising them that their funds would be placed in land contracts in Michigan on residential real estate and that the interest rate they would get would be 9.9%. The money was instead allegedly used for unsecured loans to companies under Wilson’s ownership or control.

In other securities news, the SEC’s Division of Investment Management director Norm Champ recently stated that the Commission’s report on retail investors and their financial literacy gives basis for creating a summary prospectus for variable annuities. Speaking via teleconference at the American Law Institute-Continuing Legal Education Group conference on life insurance products on November 1, Champ reported that investors in the study agreed that the mutual fund summary prospectuses were user-friendly. He expressed optimism that a summary prospectus for variable annuities could give significant disclosures and related benefits if designed and implemented well and that the framework used for the mutual fund summary prospectus should prove to be an effective model.

California Securities Lawsuit Claiming Negligent Misrepresentation Over Allegedly Flawed Bond Offering Documents May Proceed, Says District Court

Published on: November 13, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. District Court for the Northern District of California is allowing a securities lawsuit by an investor claiming negligent misrepresentation over allegedly flawed offering documents in bonds to raise money for a private school to proceed. The plaintiff is Lord Abbett Municipal Income Fund Inc. and the defendants are board of trustee members of the Windrush School.

Per the court, the defendants authorized the California private school to seek financing for the renovation and expansion of its facilities through the issuance of $13 million in bonds, which took place pursuant to a July 1, 2007 indenture between Wells Fargo Bank NA (WFC), serving as indenture trustee, and California Statewide Communities Development Authority, as the bond issuer. (Per the indenture terms, the trustee was the bondholders’ representative.) The bonds were secured by a mortgage on the facility and repayment was to be made through gifts, tuition, and grants. Lord Abbett bought more than $9 million of the bonds.

Now, the New Jersey-based mutual fund is contending that the bond offering documents left out key information about Windrush’s ability to pay back the bonds. For example, Windrush allegedly was reliant upon Making Waves Foundation, a charitable organization that historically puts 10-15 kids at the school every year, to pay it a substantial tuition for each student. Lord Abbett, however, claims that even before the bonds were issued the defendants had already found out that the charitable group was going to open its own school and would no longer be sending kids to study at Windrush and that this would cause lose the latter to not just lose the substantial tuition subsidies but also have to compete with Making Waves for state funding. Despite allegedly knowing that the loss of tuition for so many students would reduce Windrush’s revenue, making it harder for the school to pay back the bonds, the defendants did not make this known on the bonds’ official statement. When Windrush found that it could not make an interest payment that was due in July 2011, it filed for bankruptcy protection.

Federal Sentencing Judges Cannot Later Reopen Fraud Cases to Add Restitution, Rules Fifth Circuit

Published on: November 13, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. Court of Appeals for the Fifth Circuit says that federal sentencing judges who initially withhold restitution in complex or large fraud cases because the amounts are too hard to calculate cannot choose to later open up the case and add that in should the government later come up with more information. The appeals court was not convinced by a district judge’s dependence on the US Supreme Court’s ruling in Dolan v. United States allowing sentencing judges to go back and include restitution after the 90-day post-sentencing deadline.

In this case, United States v. Murray, the defendants were convicted for mail fraud, securities fraud and other offenses stemming from a financial scam involving hundreds of investors and high valued collateralized loans. Rather than investing the victims’ funds in the loans, the defendants used the funds for their personal spending, made other investments, and also made good on the high returns that were promised to earlier investors. For purposes of determining sentencing, the district court calculated that the investors lost $84 million.

Yet during sentencing the sentencing judge and the federal probation department invoked a Mandatory Victims Restitution Act provision that lets the judge refuse to order restitution in cases where there are too many victims to determine exactly how many there are that it makes restitution “impracticable” or if figuring out certain complex issues of fact related to amount or cause of the losses would prolong or complicate the sentencing process to a point that this burden overrides the need to provide any victim with restitution. A few months after these defendants received their sentences, even though federal law places limits on when a district court can reopen or amend a sentence, prosecutors convinced the judge to open up the sentencing and conduct a hearing on information from hundreds of victim impact statements.

Following the hearing, the judge found that denying the investors restitution for their losses because the government had a hard time figuring out how much harm they suffered is a violation of MVRA’s main purpose, which is to make sure compensation where owed is given. She told the defendants they now had to pay restitution of millions of dollars.

Now, however, Fifth Circuit has said that in the event that a district court invokes §3663A(c)(3), §3663A(a)(1)’s provision that the court shall order for restitution to be made by the defendant to the victim is not applicable, which means that a district court cannot open a final sentence judgment. The fifth circuit said that while the sentencing judge in Dolan gave herself the option to revisit the matter of restitution in the future, the sentencing judge in US v. Murray did not.

United States v. Murray

Dolan v. United States

Mandatory Victims Restitution Act

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Louisiana-Based Hedge Fund Manager Charged by SEC with Securities Fraud Related for Allegedly Concealing RMBS Losses

Published on: November 8, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has filed charges against hedge fund manager Walter A. Morales and his Baton Rouge-based firm Commonwealth Advisors with allegedly defrauding investors by concealing the millions of dollars in losses sustained from investments linked to residential mortgage-backed securities during the economic crisis. The SEC wants a jury trial and it is seeking permanent enjoinment, penalties, disgorgement, and prejudgment interest.

According to the Commission’s RMBS lawsuit, Morales and his financial firm caused the hedge funds that they oversaw to purchase Collybus, which were the most risky and lowest tranches of a collateralized debt obligation. They then sold MBS into the CDO at prices they had received four months prior while being fully aware that during this time the RMBS market had declined. As the CDO investments continued to not do well, Morales allegedly told firm employees to engage in cross-trades by conducting manipulative trades with the hedge funds they advised so that a $32 million loss sustained by one of the funds in the Collybus investment could be hidden. Morales and his firm then allegedly lied to investors, which included individuals and pension funds, about the worth and quantity of the mortgage-backed assets in the funds and created bogus internal documents so that their false valuations could be justified.

Also, even though Morales and Commonwealth likely knew that the losses would continue for some time, the SEC contends that the two of them conducted over 150 cross-trades between two hedge funds they provided advice to and another one of their hedge funds at prices under Commonwealth’s valuation for those securities in June 2008. After the trades were made, Morales is said to have instructed an employee to designate the securities as having fair market value, creating a $19 million gain for the acquiring hedge fund that was fraudulent and at cost to the funds that were sold. The cross-trades were conducted even though Morales had represented that it would not make such trades.

The SEC also claims Morales deceived a prime brokers by representing the transactions as legitimate and at current market prices, as well as its largest investor by misrepresenting the latter’s exposure to the CDO. Although he had promised that the investor’s exposure to Collybus would be limited, by the middle of 2008 its exposure was almost double. Morales also allegedly made up false minutes after the investor found out that Commonwealth was not going along with its valuation procedures that it had stated.

SEC Charges Baton Rouge-Based Investment Adviser with Hiding Losses From Mortgage-Backed Securities Investments, SEC, November 8, 2012

Read the SEC Complaint (PDF)

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Plaintiff Must Arbitrate Faulty Investment Advice Claim With TD Ameritrade But Can Proceed With Litigation Against Oakwood Capital Management

Published on: October 29, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The California Court of Appeals says that while investor Irene Mastick can proceed with her securities litigation against Oakwood Capital Management LLC, she has to arbitrate her securities claim against TD Ameritrade Inc. Mastick had sued representatives of the two financial firms, along with M.E. Safris & Co. and her accountant Michael Safris alleging that she had been provided with poor investment counsel.

Mastick claims that after meeting the defendants in 2008, she was advised to take the proceeds from her life insurance policies and invest them. Contending that she was given bad advice regarding this strategy’s tax consequences, she filed her fraud lawsuit.

Safris, who is a New Jersey resident, had the securities case removed to federal court and Mastick amended her complaint to include the firm representatives. Oakwood and TD Ameritrade then sought to compel arbitration but the federal court then denied their petitions and remanded the lawsuit due to lack of diversity. TD Ameritrade and again sought to compel arbitration.

Morgan Stanley Must Pay CFTC $200K for Supervisory Violations, Sued for Bias by Detroit Owners Over New Century Loans

Published on: October 26, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The CFTC is ordering Morgan Stanley Smith Barney LLC (MS) to pay a civil monetary penalty of $200,000 for alleged supervisory failures related to customer account handling by employees, which is a violation of CFTC regulation 166.3. Its Order maintains that Morgan Stanley did not have adequate supervisory and internal controls in place that would have allowed it to successfully discourage and detect CFTC and CEA regulation violations.

Per the CFTC, the financial firm had a customer that acted as a futures commission merchant even though it wasn’t registered as one. (This is a Commodity Exchange Act violation.) The agency contends that by failing to look into suspect transactions that indicated this client was engaging in unlawful behavior, Morgan Stanley was committing a CFTC regulation 166.3 violation.

The CFTC says that even after Morgan Stanley discovered in January 2010that the client had been improperly carrying its proprietary futures trading account since 2006, it let the customer keep on in the role as a futures commission merchant through May 2010.

In other Morgan Stanley related news, five Detroit, Michigan homeowners are suing the financial firm for what they are claiming is racial bias over the way the firm finances and funds mortgage loans. They believe that this statistically increased African Americans’ exposure to foreclosure. The case, which is being presented as a class action lawsuit, could involve up to 6,000 plaintiffs.

The lead plaintiffs are alleging Michigan civil rights statute and federal anti-bias law violations in Morgan Stanley’s securitizing of mortgage loans that it was aware would expose borrowers to a higher foreclosure risk. Per their lawsuit, the investment bank’s sale and packaging of New Century loans to investors was closely linked to how it funded and financed New Century even before the loans were made.

Between 2004 and 2007, Morgan Stanley gave New Century billions of dollars in credit lines and issued procedures and policies that resulted in loans with high debt-to-income ratios, teaser rates that were low, hardly, if any, income verification, and other features. The plaintiffs believe that the financial firm dictated the kinds of loans that New Century issued, even requiring, as a condition of their profitable business relationship, that a huge percentage of the loans come with “dangerous” traits. Such obligations, they contend, negatively impacted African-American borrowers in the Detroit area who got their loans from New Century. In 2007, New Century sought bankruptcy protection.

According to the attorneys that filed the complaint, this is the first lawsuit to claim a connection between racial discrimination and securitization, as well as the first one involving homeowners accusing an investment bank, rather than the lender, of causing borrowers harm.

CFTC Orders Morgan Stanley Smith Barney LLC to Pay $200,000 for Supervision Violations, CFTC, October 22, 2012

Adkins, et al. vs. Morgan Stanley, ACLU, October 15, 2012

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Broadway Musical “Rebecca’s” Producers File $100M New York Fraud Lawsuit Against Broker Accused of Scamming Them

Published on: October 23, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The producers of the Broadway musical “Rebecca” have filed a $100 million fraud lawsuit against former Oppenheimer & Co. broker Mark Hotton because they say he scammed them by pretending to raise $4.5 million from investors for the play while they paid him and his entities $60,000. Hotton was arrested earlier last week and charged with wire fraud not just in this alleged financial scam, but also for his supposed involvement in a separate scheme in which he is accused of using similar deceptive practices to con a real estate company into paying $750,000 to him and the entities.

In the financial fraud involving “Rebecca,” which is based on Daphne Du Maurier’s novel, Hotton allegedly made fake investors and businesses to deceive the producers, who were about $4 million short of making their budget. They signed a deal with his TM Consulting Inc. earlier this year in an agreement that gave Hotton a $7,500 fee and an 8% guarantee on any money he raised above $250,000.

Hotton made it seem as if he had found four investors to put in the $4.5 million-yet these supposed individuals didn’t actually exist. Instead, he allegedly pretended to be them. When the producers asked him for the money, Hotton even claimed that one of the investors, Paul Abrams, had died abruptly from malaria.

Securities Fraud Roundup: EKN Financial Services Expelled from FINRA, SRO’s CEO Says Complex Products Should Be Subject to Stricter Scrutiny, and Federal Regulators Now Paying Closer Attention to Securities Law Violations that Lead to Victim Hardships

Published on: October 20, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority has expelled EKN Financial Services for a number of compliance violations and for letting firm CEO Anthony Ottimo act in the capacity of supervisor even after the Securities and Exchange Commission had barred him from doing so in 2008. FINRA has barred Ottimo from the securities industry, in addition to barring ex-EKN President Thomas Giugliano from working in a principal role. The SRO contends that through Ottimo and Giugliano, EKN violated a number of SEC and NASD/FINRA rules and federal securities laws, including those involving net capital deficiencies, anti-money laundering violations, and reporting failures.

According to FINRA, from 2008 to 2011 Ottimo took on a supervisory role despite the SEC bar. He also continued to serve as CEO even though he wasn’t a registered principal. Meantime, Giugliano and the financial firm are accused of misrepresenting to FINRA that Ottimo wasn’t serving in these roles. The SRO also found that EKN made numerous anti-money laundering violations, such as not setting up a satisfactory AML compliance program to identify and report suspect activity, preparing net capital computations that were not accurate, failing to properly report net capital deficiencies, not accurately detailing liabilities and cost in its records and books, and neglecting to tell FINRA that Giugliano and Ottimo had hundreds of thousands of dollars in liens and judgments that hadn’t been satisfied.

Federal regulators have lately been more alert to potential securities law violations because of the devastating effect such misconduct can have on the lives of victims. Other examples include boiler room scams, affinity fraud, accounting fraud, misappropriation, and Ponzi schemes, which are just some of the violations that target individual investors, including the elderly and the sick, draining many of them of their life savings. Many such violations that impact investors directly are ones generally involving more low profile incidents that the public doesn’t usually hear about.

JPMorgan Chase Must Pay Oil Heiress’s Trust $18M For Derivatives Investments, Account Mismanagement, and Unsuitable Investment Advice

Published on: October 12, 2012 | by Shepherd Smith Edwards & Kantas, LLP

JPMorgan Chase (JPM) must pay the trust of oil heiress Carolyn S. Burford $18 million for the “grossly negligent and reckless” way that the financial firm handled the account. In Tulsa County District Court in Oklahoma, Judge Linda G. Morrissey said that beneficiary Ann Fletcher was persuaded to invest in derivatives that were unsuitable for the trust, causing it to sustain significant losses. The judge is also ordering punitive damages to be determined at a later date, as well as repayment of the trust’s legal expenses.

Fletcher, now 75, is the daughter of Burford, who passed away in 1996. The trust was set up in 1955 by Burford’s parents. Burford’s dad is the founder of Kelly Oil and her mother had connections to another oil company.

Between 2000 and 2005, the trust and JPMorgan, which gained management over the trust after a number of bank mergers and oversaw it until 2006, got into a number of variable prepaid forward contracts. These derivatives were pitched to the trust as way for it to make more income. However, according to the court, Fletcher was cognitively impaired and experiencing medical problems when the bank recommended that the trust buy the derivatives. A year before, she even expressed in a written letter to the bank that she was scared about getting involved in “puts & calls.” She eventually chose to trust their recommendation that she buy them.

Judge Morrisey believes that the bank failed to properly explain the product to its client while neglecting to reveal that it stood to benefit from the transaction. She also says that when JPMorgan invested the contracts’ proceeds in its own investment products, which she described as “double dipping,” it was in breach of fiduciary duty. JPMorgan also billed the trust transaction investment fees and corporate trustee fees.

Morrisey said that because the bank gives employees incentives to make it revenue, this creates a conflict of interest for those that are advising and managing fiduciary accounts. She said that the financial misconduct that occurred in this securities case exhibits JPMorgan’s disregard of its clients, especially when it knew, or if it didn’t then was reckless in not knowing, that such conduct was occurring.

Investors that purchase variable prepaid contracts generally consent to give a number of the stock shares to the brokerage firm in the future. Such a deal can protect investors from certain losses and can be accompanied by tax benefits. However, they can also lead to additional fees. With Burford’s trust, however, the trustee is not allowed to sell its original stocks. The court said that JPMorgan failed to tell Fletcher that getting involved in the contracts could lead to the sale of that stock.
JPMorgan says it disagrees with the court’s ruling and it may appeal.

JPMorgan Must Pay $18 Million to Heiress Over Derivatives, Bloomberg, October 10, 2012

JP Morgan Ordered to Pay $18 Million to Oil Heiress’s Trust, New York Times, October 10, 2012

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FINRA Securities Fraud Roundup: Guggenheim Securities Fined $800K For Failure to Supervise CDO Traders, Brokerage Firm Managing TIC Securities Doesn’t Have to Arbitrate Investor Claims, & Investor Award in Morgan Keegan Funds is Upheld

Published on: October 12, 2012 | by Shepherd Smith Edwards & Kantas, LLP

FINRA is fining Guggenheim Securities, LLC $800,000 for allegedly not supervising two collateralized debt obligation traders accused of hiding a trading loss. The traders are Alexander Rekeda and Timothy Day. Rekeda, who is the financial firm’s ex-CDO Desk head, has to pay $50,000 and is suspended for a year. Day’s fine is $20,000 and he received a four month suspension. By settling, none of the parties are denying or admitting to the FINRA securities charges.

Due to a failed trade, the CDO Desk at Guggenheim acquired a €5,000,000 junk-rated tranche of a CLO in October 2008. When the desk was unable to sell the position, Rekeda and Day convinced a hedged fund client to buy the collateralized loan obligation for $950,000 more than it had initially agreed to pay by misrepresenting the CLA. FINRA said that to conceal the CLO position’s trading loss, the two traders gave the customer order tickets that upped the CLO position’s price and lowered the price of other positions. Day, allegedly at Rekeda’s order, is accused of lying to the client when the latter asked about the price modifications by saying that the CLO position had a third-party seller that had settled the trade at a higher price and wanted the customer to pay this rate. The client agreed, and, in exchange, Day and Rekeda said that they would compensate the customer via other transactions, including waiving the fees owed related to resecuritization transactions, adjusting the prices on several other CLO trades, and providing a payment in cash. No records, however, indicate that these transactions were related to the CLO overpayment.

In other FINRA securities news, the U.S. Court of Appeals for the Eighth Circuit has affirmed a district court’s ruling that a broker-dealer that acted as the managing broker-dealer in a Tenant in Common securities cannot be compelled to arbitrate claims filed by investors of the failed enterprise. In Berthel Fisher & Co. Financial Services Inc. v. Larmon, Judge Michael Melloy agreed that for the SRO’s purposes, the investors are not the financial firm’s “customers.”