Securities Fraud

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

More Blog Posts:
Texas Securities Roundup: Morgan Stanley Smith Barney Sued Over Financial Adviser’s Ponzi Scam, Judge Dismisses Ex-GE Executive Whistleblower’s Lawsuit Over His Firing, & Ex-Stanford Financial Group CIO Pleads Guilty to Obstructing the SEC’s Probe, Stockbroker Fraud Blog, July 3, 2012

Why Were Two Former Morgan Stanley Smith Barney Brokers Not Named As Defendants in Securities Lawsuit by State Regulators Over $6M Now Missing From Wisconsin Funeral Trust?, Stockbroker Fraud Blog, September 27, 2012

Ex-Morgan Stanley Smith Barney Broker Settles with FINRA for Allegedly Failing to Notify Firm of Previous Arrest, Stockbroker Fraud Blog, June 16, 2012 Continue Reading ›

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

More Blog Posts:
New York’s Attorney General Sues JP Morgan Chase & Co. Over Alleged MBS Financial Fraud by Its Bear Stearns Unit, Stockbroker Fraud Blog, October 4, 2012
Ex-Employee Accuses Bank of America of Securities Fraud Involving Complex Derivatives Products, Stockbroker Fraud Blog, October 29, 2010

Barclays LIBOR Manipulation Scam Places Citigroup, Credit Suisse, Deutsche Bank, JP Morgan Chase, and UBS Under The Investigation Microscope, Institutional Investor Securities Blog, July 16, 2012 Continue Reading ›

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.”

$18.7M Securities Fraud Case Involving Former Linkbrokers Derivatives Brokers is A Prime Example of How Trade Markups Involving Pennies Can Eventually Cost Investors Millions

Published on: October 10, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Two former Linkbrokers Derivatives brokers have been arrested on criminal charges of securities fraud, wire fraud, and conspiracy to commit securities fraud. Benjamin Chouchane and Marek Leszczynski, along with others, are accused of taking part in a securities scam that cost customers $18.7 million. It involved the brokers secretly raising the price of trades, in some instances by just pennies, or lowering them, and then concealing the actual cost from clients. The Securities and Exchange Commission, which is also filing civil charges against the two men, as well as against brokers Henry Condron and Gregory Reyftmann, says that they executed over 36,000 trades with these types of price discrepancies between 2005 and 2009. Condron has already pleaded guilty to criminal charges of conspiracy and securities fraud.

The alleged manipulations usually occurred when the market was more volatile and the prices were more likely to fluctuate, which made it easier for the mispricings to go undetected. While profits may have been minimal-for example, in one trade Leszczynski allegedly marked up 20,000 shares’ buying price by 1.2 cents/share, resulting in a $240 profit-pennies do add up. As SEC Division of Enforcement Director Robert Khuzami noted, by overcharging clients for stock trades, the brokers ultimately bilked customers of millions of dollars.

Linkbrokers executes high-volume trades for institutional clients. It is an interdealer broker firm that usually executes these large trades for low commissions. However, institutional investors are not the only ones to be impacted by such scams.

CFTC Securities Fraud Roundup: Commissioner Bart Chilton Wants Financial System to Adopt Risk-Based Compensation System, Agency Nets $3M in Four Speculative Limits Cases, & Two Registered Futures Entities Pay $539K Over Inadequate Supervision Allegations

Published on: October 9, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to Commodity Futures Trading Commission Bart Chilton, the financial system needs to undergo a “cultural shift” that should include employing a risk-based compensation structure instead of one that is “purely profit-based.” Speaking at the Hard Assets Investment Conference last month, Chilton said that bonus systems and incentives create a “poisonous” system in “our financial corporate culture,” compelling individuals to make earning as money as they can as quickly as they can their main priority.

Chilton also talked about how the system inadequately, if at all, uses “puny penalties” to deal with “bad behaviors” and that short-term profiteering is rewarded. He blames both results on the current compensation system employed by many financial firms. Risk management comes second under profit motive, with inducements generated to increase high risk trading, leverage, and the exploitation of funds. Chilton is recommending the implementation of a compensation system based on risk tolerance, with additional compensation and bonuses to be rewarded gradually. He believes that this will lead to longer-term strategies and actions, as well as “longer-serving employees.” He said that while the government may not be able to obligate financial firms to practice morality, it can takes steps to discourage misconduct by creating rules and laws that mandate good behavior.

In other CFTC news, the agency recently settled four separate speculative limits violation cases for $3 million. On September 21, Citigroup Inc. (C) and affiliate Citigroup Global Markets Ltd. consented to pay $525K to settle allegations that on the Chicago Board of Trade they went beyond the speculative position limits in wheat futures contracts. Four days later, Sheenson Investments Ltd., which is located in China, and its owner Weidong Ge consented to pay $1.5 million over allegations that they violated speculative limits in soybean and cotton futures.

Securities Roundup: SLUSA Bars Investors’ State Securities Case Alleging Trust Account Management Negligence, Blocks Investors From Remanding Fraud Case to Puerto Rico & FINRA Enhances Proposed Rules’ Cost-Benefit Analysis, Looks at Non-Traded REIT Ads

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

According to the U.S. Court of Appeals for the Sixth Circuit, the Securities Litigation Uniform Standards Act bars state law breach of contract and negligence claims related to the way the plaintiffs’ trust accounts were managed. The appeals court’s ruling affirms the district court’s decision that the claims “amounted to allegations” that the defendants did not properly represent the way investments would be determined and left out a material fact about the latters’ conflicts of interest that let them invest in in-house funds.

SLUSA shuts a loophole in the Private Securities Litigation Reform Act that allows plaintiffs to sue in state court without having to deal with the latter’s more stringent pleading requirements. In Daniels v. Morgan Asset Management Inc., the plaintiffs sued Regions Trust, Morgan Asset Management, and affiliated entities and individuals in Tennessee state court. Per the court, Regions Trust, the record owner of shares in a number of Regions Morgan Keegan mutual funds, had entered into two advisory service agreements with Morgan Asset Management, with MAM agreeing to recommend investments to be sold or bought from clients’ trust accounts. The plaintiffs are claiming that MAM was therefore under obligation to continuously assess whether continued investing in the RMK fund, which were disproportionately invested in illiquid mortgage-backed securities that they say resulted in their losses, was appropriate.

The defendants were able to remove the action to federal district court, which, invoking SLUSA, threw out the lawsuit. The appeals court affirms this dismissal.

Wells Fargo and Wachovia Sued by LBBW Luxemburg Over Alleged $1.5B Securities Fraud

Published on: October 6, 2012 | by Shepherd Smith Edwards & Kantas, LLP

LBBW Luxemburg SA has filed a securities fraud lawsuit against Wells Fargo & Co. (WFC) and its unit Wachovia Corp. over an alleged $1.5 billion securities fraud scam. The case involves transaction in 2006 involving Wells Fargo selling what they allegedly touted as securities with high ratings to LBBW and other customers. LBBW, a Landesbank Baden-Wurttemberg subsidiary, bought $40 million of these residential mortgage-backed securities.

Now, the European bank is contending that the underlying mortgages were riskier than represented and not worth their buying price. Within a year, the securities had defaulted. LBBW is alleging common law fraud, breach of contract, constructive fraud, negligent misrepresentation, and breach of fiduciary duty.

Per the plaintiff’s attorneys, the alleged financial fraud was discovered after the SEC investigated a $5.5 million investment that the Zuni Indian Tribe’s employee pension fund made. The Securities and Exchange Commission had accused Wachovia of selling overpriced equity in Grant Avenue II, a collateralized debt obligation, to the tribe and another investor. The Commission contended that after marking down some of the equity to 52.7 cents on the dollar, Wachovia charged 90 cents and 95 cents on the dollar. The bank was also accused of misleading investors in Longshore 3, another CDO, by saying that assets had been acquired from affiliates at prices that were fair market when, actually, claims the regulator, 40 securities had been moved at prices that were above market and Wachovia moved assets at prices that were stale so it wouldn’t have to report the losses.

The SEC said that while it did not consider Wachovia to have acted improperly in the way it structured the CDOs, the bank violated investment protection rules by using stale prices, even as buyers were being told the prices were fair market value, and charging excessive markups in secret. The Commission found that the Zuni Indians and other investors suffered financial losses as a result. Last year, Wachovia agreed to pay $11 million to settle charges accusing it of violating federal securities laws in its sale of MBS leading up to the collapse of the housing market.

European Bank LBBW Sues Wells Fargo Over Alleged $1.5 Billion Securities Fraud, The Sacramento Bee, October 1, 2012

German bank sues Wells Fargo alleging $1.5 billion securities fraud, San Francisco Business Times, October 2, 2012

Wells Fargo Settles Case Originating At Wachovia, The New York Times, April 5, 2012

More Blog Posts:
Lehman Brothers Australia Found Liable in CDO Losses of 72 Councils, Charities, and Churches, Institutional Investor Securities Blog, September 25, 2012

REIT Retail Properties of America’s $8 Public Offering Results in Major Losses for Fund Investors, Institutional Investor Securities Blog, April 17, 2012

Texas Securities Fraud: Investor Sues Behringer Harvard REIT I, Stockbroker Fraud Blog, September 26, 2012

Institutional Investment Fraud Roundup: Ex-Hedge Fund Managers’ Guilty Plea Over Bilking Investors of Almost $1M Get 3-Year Prison Term, SEC Sues Investment Adviser Over Alleged $37M Ponzi, and SEC Files Lawsuit Over Purported “Fund of Funds” Scam

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

Ex-hedge fund managers Christopher Fardella and Michael Katz have been sentenced to three years in prison after they pleaded securities fraud and conspiracy charges for defrauding investors of nearly $1 million. Per court documents, between April 2005 and November 2006, the two men, along with two co-conspirators, were partners in KMFG International LLC, which is a hedge fund.

They cold called investors throughout the US and provided them with misleading information about the fund, its principals, and financial performance even though KMFG actually lacked a track record and never generated any profit for investors. The defendants and co-conspirators lost and spent $981,000 of the $1,031,086 that was given to them by investors.

Meantime, another hedge fund manager, Oregon-based investment advisor Yusaf Jawad, is being sued by the Securities and Exchange Commission over an alleged $37 million Ponzi scam. The securities lawsuit against him and attorney Robert Custis was filed in the U.S. District Court for the District of Oregon.