Institutional Investor Securities Blog: Putnam Advisory Accused of Massachusetts Securities Fraud in $3B CDO Offerings, SEC Claims Yorkville Advisors Fixed Books To Attract Investors, and FINRA Seeks Comments on Revised Proposal Over Bond Market Research

The Massachusetts Securities Division is claiming that Putnam Advisory Co. deceived investors about its actual involvement in Pyxis 2006 and Pyxis 2007, two $1.5 billion collateralized debt obligations comprised of midprime and subprime mortgage-backed securities. In its administrative complaint, the state contends that Putnam represented to investors that it would act as an independent advisor when to the Pyxis CDOs when, in fact, Magnetar Capital, a hedge fund, was also involved creating in and structuring key aspects of both and even recommended that certain collateral to be included in them while then proceeding to take a substantial short position on that collateral. Putnam denies the allegations.

The state says that Magnetar proceeded to benefit from the downgrades of subprime assets in the two CDOs while making a net gain of about $67 million on aggressive positions and equity investments linked to the two of them. Meantime, Putnam earned $8.81 million in collateral management fees for the Pyxis CDOs. Massachusetts Secretary of Commonwealth William F. Galvin says that his office will continue to look at how banks misled the buyers of subprime mortgage-backed securitized debt instruments.

In other securities news, the SEC is accusing Yorkville Advisors LLC, its president and founder Mark Angelo, and CFO Edward Schinik of revising certain books to appeal to potential investors and succeeded in getting pension funds and funds of funds to invest $280 million into two Yorkville hedge funds. This allegedly let Yorkville charge at least $10 million in excessive fees. All three three defendants are denying the allegations.

Per the SEC, Yorkville, Angelo, and Schinik allegedly misrepresented the assets’ liquidity and safety of the funds’ assets and charged excessive fees to investors by fraudulently inflating the investments’ value. This included “falsely” presenting Yorkville as a firm that “employed a robust valuation procedure” and was in charge of an investment portfolio that was highly collateralized.

The Commission’s allegations stem from its Aberrational Performance Inquiry, which employs analytic data to determine risk and look for hedge funds with returns that are “suspicious.” The SEC claims that the defendants did not abide by Yorkville’s valuation practices, disregarded negative data about specific investments, failed to disclose adverse information from an auditor, and misled investors about the funds’ liquidity and the role played by a third-party valuation firm.

Meantime, the Financial Industry Regulatory Authority wants comments on a revised proposal that tackles conflicts of interest stemming from bond market research. While current FINRA rules are imposed on research analysts and research reports for equities research, the modifications, which the SEC must approve, would impose requirements on research analysts and research reports that examine debt securities.

Per the proposed revisions, brokerage firms would set up, maintain, and put into effect procedures and policies that would identify and deal with conflicts of interest having to do with debt research analysts’ public appearances, the preparation and distribution of debt research reports, and interactions between the analysts and others. Also, a “higher tier” of institutional investors that would be able to get institutional debt research without having to affirmatively elect to do so in writing would be set up. Institutional investors would qualify for this tier by satisfying the “qualified institutional buyer” definition and other requirements. Also, firms that have limited principal debt trading activity would, for the first time, obtain an exemption.

The revised proposal was developed following comments criticizing the original one as being too “burdensome.” As with the first proposal, this one continues to “treat retail investors and institutional investors as customers and counterparties, respectively,” said FINRA chairman and CEO Richard Ketchum, while retail debt research and equity research will get equal protections and institutional debt research becomes exempt from a lot of structural provisions.

SEC v. Yorkville Advisors, Mark Angelo, and Edward Schinik (PDF)

Text of Proposed New Finra Rule: Debt Research Analysts and Debt Research Reports, FINRA

More Blog Posts:

FINRA Arbitration Panel Tells Merrill Lynch to Pay $1.34M to Florida Couple Over Allegedly Misrepresenting Fannie Mae Preferred Shares’ Risks, Stockbroker Fraud Blog, October 17, 2012