Investor Lawyers Blog

Citigroup to Pay $285M to Settle SEC Lawsuit Alleging Securities Fraud in $1B Derivatives Deal

Published on: October 20, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Citigroup has consented to pay $285 million to settle a Securities and Exchange Commission complaint accusing the bank of misleading investors in a $1 billion derivatives deal—a collateralized debt obligation called Class V Funding III. It was Citigroup that chose the assets for the portfolio that it then bet against. Investors were not told that Citigroup’s interests were contrary to theirs. The $285 million will go to the deal’s investors.

According to the SEC, Citigroup had significant influence over the $500 million of portfolio assets that were selected. It then took a short position against the assets, standing to profit if they dropped in value. All 15 investors were not made aware of any of this and practically all of their investments (in the hundreds of millions of dollars) were lost when the CDO defaulted in under 9 months after it closed on February 28, 2007. Credit ratings agencies had downgraded over 80% of the portfolio.

Financial instrument insurer Ambac, which was the deal’s biggest investor and had taken on the role of assuming the credit risk, was forced to pay those who bet against the bonds. In 2009, Ambac sought bankruptcy protection.

Meantime, Citigroup made about $126 million in profits from the short position and earned about $34 million in fees. S.E.C.’s division of enforcement director Robert Khuzami says that under the law, Citigroup was required to give these CDO investors “more care and candor.”

Per the SEC’s civil action, Citigroup employee Brian Stoker is the one that mainly put the deal together, while Credit Suisse portfolio manager Samir H. Bhatt was primarily in charge of the transaction. Credit Suisse was the CDO transaction’s collateral manager.

Stoker is fighting the SEC’s case against him. Meantime, Bhatt has settled the SEC’s charges by agreeing to pay $50,000. He has also been suspended from associating with any investment adviser for six months. Credit Suisse Group AG settled for $2.5 million.

As part of this settlement, Citigroup will pay a $95 million fine. It was just last year that the financial firm agreed to pay $75 million over federal claims that it purposely didn’t let investor know that their subprime mortgage investments were losing value during the financial crisis. Citigroup has said that since then, it has revamped its risk management function and gone back to banking basics.

Last year, Goldman Sachs Group Inc. agreed to settle for $550 million allegations that it did tell investors that the hedge fund that helped choose a CDO’s assets also was betting against it. JPMorgan Chase & Co. settled similar allegations earlier this year for $153.6 million.

Citigroup to Pay Millions to Close Fraud Complaint, NY Times, October 19, 2011

Related Blog Resources:
Goldman Sachs Settles SEC Subprime Mortgage-CDO Related Charges for $550 Million, Stockbroker Fraud Blog, July 30, 2010

JPMorgan Chase to Pay $211M to Settle Charges It Rigged Municipal Bond Transaction Bidding Competitions, Stockbroker Fraud Blog, July 9, 2011

Ex-Lehman Brothers Holdings Chief Executive Defends Request that Insurance Fund Pay Legal Bills

Published on: October 19, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Once again, former Lehman Brothers Holdings Inc. executives want an insurance fund to cover their expenses stemming from securities-related misconduct they are accused of committing. This time, they want to use the money to cover their legal bills. On Monday, former Lehman Chief Executive Richard Fuld and other ex-executives submitted a filing in US Bankruptcy Court to responded to an objection made by the former owners of Maher Terminal Holdings Corp. objecting to this fund use.

Basil Maher and M. Brian Maher claim that the paperwork submitted by the former executives doesn’t support use of the insurance monies. The brothers have been in opposition with Lehman since the investment bank filed for bankruptcy in 2008. The Mahers contend that in 2007 when they wired $600 million for their sale of Maher Terminal Holdings Corp. to Lehman, the financial firm allegedly placed their money in investments that were riskier than what they had wanted. The Mahers are still trying to recoup their losses form Lehman.

The former Lehman executives want the court to give them access to a diminishing $250 million insurance fund. They say that not only would this prevent a protracted court battle with local governments that they’ve already settled with, but also, they don’t believe this will impact the investment bank’s creditors. The ex-executives had settled for $1.05 million a dispute with six California municipalities that had invested $35 million into Lehman in the two years before it failed. The municipalities later filed their securities case accusing Lehman of making misrepresentation and omissions in their offering documents, which is what the governments used as reference when making the decision to invest in the financial firm.

The former Lehman executives just recently made another request to use $90 million from the insurance fund to settle a securities lawsuit filed by Lehman shareholders. They also have asked the bankruptcy court for $8.25 million in insurance money to settle a securities case filed by the state of New Jersey.

Should the bankruptcy judge grant the ex-Lehman officials’ requests, then Fuld and the others won’t have to put out any out-of-pocket expenses for their alleged misconduct. Apparently, it is not unusual for insurance money to cover corporate officers and directors that are the target of shareholder lawsuits.

Says Shepherd Smith Edwards & Kantas LTD LLP founder and securities fraud attorney William Shepherd, “Amazing that those who put Lehman into bankruptcy can now use the first dollars available to pay their own legal bills rather than to pay their victims, including investors and the subordinates they led down the garden path to disaster. Apparently, it is again nice to be part of the ‘one-percent’ on Wall Street.”

Fuld Leads Ex-Lehman Officials in Defending Insurance Use, The Wall Street Journal, October 17, 2011
Ex-Lehman Officials to Pay $90 Million to Settle Suit, NY Times, August 25, 2011
Fuld, Lehman Executives Settle Lawsuit by California Cities, Businessweek, September 28, 2011

More Blog Posts:
Lehman Brothers’ “Structured Products” Investigated by Stockbroker Fraud Law Firm Shepherd Smith Edwards & Kantas LTD LLP, Stockbroker Fraud Blog, September 30, 2008
FINRA Orders UBS Financial Services to Pay $8.25M for Misleading Investors About Security of Lehman Brothers Principal Protected Notes, Stockbroker Fraud Blog, April 15, 2011
European Leaders Work to Get a Grip on Debt Crisis, Institutional Investors Securities Blog, October 19, 2011 Continue Reading ›

European Leaders Work to Get a Grip on Debt Crisis

Published on: October 19, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Leaders from all over Europe will meet this Sunday with the intention of coming up with a plan to overcome the sovereign debt crisis. 17 nations, who all share the euro currency, are trying to reach a deal to strengthen its EFSF (European Financial Stability Facility) fund (which has already assisted in bailing out Ireland and Portugal), present a strategy to bolster European banks, and agree on a new aid package for Greece, which is in financial trouble.

This is not the first time euro zone leaders have gathered in the last year and a half to try to solve the debt problem. During their last effort in July, they reached a deal to give Greece about 110 billion euros and aid while the nation’s private creditors were to sustain an approximately 20% loss on their bond holdings. That deal, however, has since fallen apart, which is why there is a summit in Brussels this Sunday. Meantime, in an attempt to make the Sunday gathering a success, Euro-area leaders are meeting in Frankfurt meeting now to try to resolve certain disagreements in advance.

According to the Washington Post, the specter of the Lehman Brothers bankruptcy has been hanging over European leaders, who are committed to not making the same mistakes made by the Federal Reserve and the Bush Administration that led to the US’s economic crisis in 2008. Although that was a domestic emergency here, the ripples were felt globally and the Europeans don’t want that to happen again this time around. Per the Post, when European Central Bank President Jean-Claude Trichet warned US officials against letting Lehman file for bankruptcy, he’d cautioned that doing so would be “something…exceptionally grave.”

Reverberations soon followed. For example, after one market mutual fund’s shares dropped to under $1 because it had invested heavily in short-term loans to Lehman, others then pulled their investments out of money market funds. Because no one knew what other banks might be at risk of failing, lending between them stopped. Global markets then went into upheaval.

US leaders have learned much from the 2008 economic crisis. The Washington Post says that now it is the Obama Administration’s that is pressing Europe to take aggressive action to solve its debt crisis. If Greece fails, Portugal, Ireland, Spain, and France may follow. Who knows what would happen next.

Shepherd Smith Edwards & Kantas LTD LLP founder and Stockbroker Fraud Attorney William Shepherd offers this analysis:

After the financial crash of 1929, U.S. legislation was passed, including securities laws and regulations and the Glass Steagall Act (banks, brokerage and insurance companies were separated). Barriers were enforced to prevent unfair trade acts and policies. For the next seven decades the U.S. economy boomed and our financial system became the envy of the world.

Those changes made in the 1930’s were implemented despite cries that such legislation, regulation and protection for our economy would doom capitalism. Generation after generation of so-called “free-traders” and “free marketers” continued their drones to return to yesteryear – an era in which globalists could do as they pleased in their race to the bottom for the sake of profit for the few at the expense of the rest of us.

By the 1990’s, billions financed a lopsided body of “thought” that a return to the 1920’s would cure world problems and lead us into a new and better future. Wise folks screamed that a return to “deregulation” of the financial system and instantly forcing Western World workers into competition with near-slave labor in third-world nations would lead to dire consequences. But true wisdom was overwhelmed by the bought-and-paid-for-voices that occupied major political parties.

Reversal to the 1920’s … fait accompli. The result was both predictable and predicted. Welcome back the 1930’s … except, where is an “FDR” who can reverse the insanity of the last decade?

Ghost of Lehman Brothers haunts European politicians and bankers, Washington Post, October 18, 2011

Europe’s leaders take another swing at debt crisis, Reuters, October 19, 2011

More Blog Posts:
UBS to Pay $2.2M to CNA Financial Head for Lehman Brothers Structured Product Losses, Stockbroker Fraud Blog, January 4, 2011

Lehman Brothers Lawsuit Claims Its Bankruptcy Was In Part Due to JP Morgan Chase’s Seizure of $8.6 Billion in Cash Reserves, Stockbroker Fraud Blog, June 14, 2010

Claims for Losses at Lehman Brothers and in Investments into Lehman Brothers Financial Instruments Gain New Life as Court Uncovers Stunning New Evidence, Stockbroker Fraud Blog, March 21, 2010

Dallas Mavericks Owner Mark Cuban’s Allegations of Misconduct Against the SEC Enforcement Staff are Without Merit, Says Inspector General’s Report

Published on: October 18, 2011 | by Shepherd Smith Edwards & Kantas, LLP

According to the US Securities and Exchange Commission’s Inspector General, billionaire Mark Cuban’s allegations of misconduct against the federal agency’s enforcement staff are unfounded. The Dallas Mavericks basketball team owner’s accusations stem from the insider trading case that the SEC had filed against him.

In its 2008 Texas securities lawsuit against Cuban, the SEC accused him of selling his stake in Mamma.com after being told in confidence that the search engine company was planning a private investment in public equity transaction. The PIPE transaction was likely going to cause the company’s stock to drop in value, and SEC says that although Cuban had agreed to keep the information confidential he went ahead and sold his shares. This caused him to avoid losing more than $750,000.

The Commission considered this a breach of his confidentiality agreement and an act of insider trading. The SEC based its insider trading theory against the billionaire on its rule defining duties of confidence and trust to include a person agreeing to keep information confidential. In 2009, a federal judge dismissed the case against Cuban on the grounds that he hadn’t been an “insider” in this instance.

Last year, however, the U.S. Court of Appeals for the Fifth Circuit in Texas revived the securities case against him. The court said it was “plausible” that Cuban knew he wasn’t supposed to sell his shares in order to avoid losing money. However, it refrained from deciding whether the billionaire entrepreneur was wrong to sell his stock. A lower court in Dallas has been ordered to review the case for additional discovery.

Cuban has responded with complaints to SEC Inspector General H. David Kotz. He contends that the enforcement agency’s lawyers treated him unfairly and had been “biased and improper.” He also claims that investigators abused the “Wells notice” process and sent one out before finishing his investigation, as well as intimidated one of his witnesses. Cuban also is accusing the SEC of closing its probe into Mamma.com to get the company’s executives to help in the agency’s investigation into the insider trading allegations against him.

Kotz’s office, in its 101-page report following its investigation into Cuban’s allegations against the SEC, said that there is not enough evidence to support the billionaire’s accusations. The OIG included also included its findings into the conduct of ex-SEC trial lawyer Jeffrey Norris, who was suspended after sending emails that may have been politically charged to Cuban (Norris was later fired for similar misconduct). Kotz’s office says that Norris hadn’t been involved in the SEC’s investigation into the Cuban case.

SEC lawsuit against billionaire Cuban revived, Salt Lake Tribune, September 21, 2010
US sports magnate charges against SEC unfounded, Reuters, September 17, 2011
Mark Cuban’s Grudge Match With the S.E.C., NY Times, April 30, 2011
SEC Watchdog Finds Little to Support Cuban’s Allegations of Improper Conduct, BNA Securities Law Daily, October 3, 2011
Read the OIG Report (PDF)

Mamma.com

Related Web Resources:
After District Court Dismisses Texas Securities Fraud Against Billionaire Mark Cuban, SEC Appeal Can Now Move Forward, Stockbroker Fraud Blog, August 17, 2009
Ex-Goldman Sachs Board Member Accused of Insider Trading with Galleon Group Co-Founder Seeks to Have SEC Administrative Case Against Him Dropped, Institutional Investor Securities Blog, April 19, 2011
Houston Judge Overturns $9.2M Securities Fraud Ruling Against Morgan Keegan, Stockbroker Fraud Blog, October 11, 2011 Continue Reading ›

SIFMA Offers Up Best Practices for How Financial Firms Can Interact with Expert Networks

Published on: October 16, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The Securities Industry and Financial Markets Association is recommending a number of best practices for financial firms that work with Expert Networks and their Consultants.
According to SIFMA, expert networks are entities that receive a fee to refer industry professionals, known as consultants, to third parties. Although the acknowledges how helpful these networks can be in helping broker-dealers implement and design investment strategies while offering advice, information, market expertise, analysis, or other expertise in making investment decisions, SIFMA General Counsel Ira Hammerman said in a release that these best practices should help with compliance while helping avoid what could like “impropriety.” The government has recently targeted them when investigating insider trading.

Among the recommendations:
1) Establishing policies and procedures for how to use Expert Networks and Consultants. SIFMA is recommending a risk-based approach for figuring out what controls should be put in place.

2) Providing training for associated persons that deal with Expert Networks and Consultants on matters such as insider training, information barriers, confidential information, conflicts of interest, or material, non-public information (MNPI).

3) Ensuring that supervisory oversight is integrated into a financial firm’s use of Expert Networks and associated consultants.

4) Setting up policies and procedure that mandate that financial firms act quickly on “red flags” that may indicate there is a possibility of disclosure of confidential information of conflicts of interest or MNPI.

5) Establishing written agreements with Expert Networks over arrangements that are substantial or repeating in nature, such as those involving making sure that Consultants are checked for securities law violations, preventing Consultants from revealing MNPI or Confidential Information, requiring that Consultants undergo periodic training or communication about certain restrictions, and requiring that Consultants are periodically certified as to the adherence of these limits.

6) Setting up procedures on how to advice Expert Networks-affiliated Consultants about Confidential Information and MNPI.

7) Establishing procedures for getting non-confidential, relevant information from an Expert Network or one of its Consultants about employment and arrangements where a Consultant may have access to Confidential Information or MNPI, as well as setting up appropriate controls for assessing risks of dealing with Consultants that work with Expert Networks that have Confidential Information or MNPI.

In providing these best practices, however, SIFMA wants to make clear that these are only intended as guidance and are not mandates for how financial firms must work with Expert Networks and Consultants.

If you are an investor that has suffered losses you believe were caused by broker misconduct, you should talk to a securities fraud attorney right away.

Galleon Group LLC Co-Founder Raj Rajaratnam Sentenced to 11 Years in Prison Over Insider Trading Scam

Published on: October 13, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Raj Rajaratnam, a billionaire investor and co-founder of Galleon Group LLC, has been ordered to pay a $10 million fine and serve 11 years in jail for his key role in an insider trading scam that resulted in $63.8M in illegal profits. He must now forfeit $53.8M.

A jury had found the hedge fund tycoon guilty of nine counts of securities fraud and five counts of conspiracy. Rajaratnam would obtain illegal tips from bankers, executives, traders, consultants, and directors of public companies (Goldman Sachs is one). He would then use that insider information to make trades prior to public announcements about mergers, forecasts, earnings, and spinoffs involving a number of companies, including Hilton Hotels, Integrated Circuit, Akamai, and Xilinix)

Rajaratnam’s attorneys are planning to appeal. For now, however, they are requesting that he be confined at the Butner Federal Correctional Complex, which is where Bernard Madoff is in jail. Madoff was sentenced to 150 years behind bars for his multibillion-dollar Ponzi scam.

Rajaratnam, who is originally from Sri Lanka was educated in England and the US. He established the Galleon hedge fund in the 1990’s and it became one of the biggest in the world. In 2008, Galleon was managing about $7 billion.

Federal securities investigators began to suspect trouble when, in the Rajaratnam gave the SEC documents for another investigation into the activities of his younger brother-no charges were ever brought t here-a text message was included from an ex-Intel Corp. employee warning to hold off on purchasing Polycom’s stock. The former employee, Rommy Khan, was already suspected of giving out insider information.

In 2007, Khan consented to help the authorities with their probe. He and several others served as cooperating witnesses that helped the government convict Rajaratnam, who was arrested in 2009.

The 11-year sentence against him is shorter than the 24 years and five months that prosecutors wanted. That said, it is still the longest prison sentence ever issued for insider trading.

Still under investigation in connection with the scam is Rajat Gupta, who used to work as a Goldman Sachs director. According to the Wall Street Journal and Bloomberg, criminal charges against him seem likely. Prosecutors consider him a “co-conspirator” in the insider trading case against Rajaratnam.

The SEC, which dropped its civil administrative proceeding against Gupta, plans to refile its charges in federal court. Meantime, Kamal Ahmed, who was also linked to the insider trading scam, has been fired by Morgan Stanley because he had disclosed confidential information. The government has not accused him of wrongdoing.

The SEC also filed a number of securities lawsuits against at least two dozen individuals and businesses in light of the Galleon investigation.

Trader Draws Record Sentence, The Wall Street Journal, October 14, 2011
U.S. Prosecutors ‘Close to Charging’ Rajat Gupta, Bloomberg, September 20, 2011
Accused Rajaratnam Tipster Fired By Morgan Stanley, FIN Alternatives, October 7, 2011

More Blog Posts:
Ex-Goldman Sachs Board Member Accused of Insider Trading with Galleon Group Co-Founder Seeks to Have SEC Administrative Case Against Him Dropped, Institutional Investor Securities Blog, April 19, 2011
A Texan is Among Those Arrested in Insider Trading Crackdown Involving Apple Inc., Dell, and Advanced Micro Devices’ Confidential Data, Stockbroker Fraud Blog, December 16, 2010
3 Hedge Funds Raided by FBI in Insider Trading Case, Stockbroker Fraud Blog, November 23, 2010 Continue Reading ›

SEC Issues Emergency Order to Stop $26M “Green” Ponzi Scam

Published on: October 13, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has received an emergency order to stop a Ponzi scam that bilked victims of about $26 million. Investors in PermaPave Companies were promised significant returns if they would place their money behind water-filtering natural stone pavers. According to the SEC, which has filed a securities complaint, Eric Aronson, a convicted felon, is the mastermind behind the scheme.

Aronson, who pleaded guilty to fraud in another case more than 10 years ago, is now accused of persuading about 140 people to buy promissory notes from PermaPave Companies and promising up to 33% in returns. Between 2006 and 2010, Aronson and company executives Robert Kondratick and Vincent Buonauro Jr., allegedly used new investor money to pay older clients while spending some of the Ponzi funds on gambling trips to Las Vegas, jewelry, and expensive cars. He also allegedly misappropriated about $2.6 million to repay victims of the earlier securities scam to which he entered a guilty plea.

Some of the investors’ funds that went into the Ponzi scam were also allegedly used to buy Interlink-US-Network, Ltd., which was a publicly traded company. Interlink later put out a Form 8-K falsely stating that LED Capital Corp. had said it would put $6 million into it. LED Capital did not have the money and never made such an agreement.

The SEC says that when investors began demanding that they be paid the money they were owed, Aronson accused them of committing a felony because they lent PermaPave Companies money at interest rates that were exorbitant—even though he was the one who promised them such high percentages. The Commission is accusing both Aronson and attorney Frederic Aaron of making false statements to get investors to change their securities into ones that would defer payments owed for several years.

U.S. District Court Judge Jed S. Rakoff is granting the SEC’s request that the defendants and relief defendants’ assets be frozen. Meantime, the Commission wants to bar Aronson, Buonauro, and Kondratick from being able to work as directors and officers of public companies and keep them from taking part in penny-stock offerings. The SEC also wants permanent and preliminary injunctions against the defendants, the return of illicit profits plus prejudgment interest, and civil monetary penalties.

Aronson, Kondratick, and Buonauro have been arrested in connection with the Ponzi scam.

Ponzi Scams
To succeed, Ponzi schemes need to bring in new clients so that their money that they invest can be used to pay older clients their promised returns. Unfortunately, with hardly any legitimate earnings, Ponzi scams can fall apart when it becomes a challenge to recruit new investors or too many investors ask to cash out.

SEC Files Emergency Action to Halt Green-Product Themed Ponzi Scheme, SEC.gov, October 6, 2011

SEC Claims Author Used Ponzi Scheme to Repay Prior Fraud Victims, Bloomberg Businessweek, October 6, 2011

More Blog Posts:
SEC Chairman Criticized For Allowing Ex-Commission Official that Benefited from the Bernard Madoff Ponzi Scam to Help Craft Policy Regarding Victims’ Compensation, Institutional Investor Securities Blog, September 23, 2011

Merrill Lynch Faces $1M FINRA Fine Over Texas Ponzi Scam by Former Registered Representative, Stockbroker Fraud Blog, October 10, 2011

SEC Says Former United Commercial Bank Executives Concealed Millions of Dollars in Losses that Caused Bank’s Failure

Published on: October 12, 2011 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has filed securities fraud charges against former United Commercial Bank executives accusing them of concealing loss from assets and loans from auditors that resulted in UCBH Holdings Inc., its public holding company, to understate its operating losses in 2008 by at least $65 million. As the bank’s loans continued to go down in value, the financial firm went on to fail and the California Department of Financial Institutions was forced to shut it down. This resulted in a $2.5 billion loss to the Federal Deposit Insurance Corporation’s insurance fund.

Per the SEC’s complaint, former chief operating officer Ebrahim Shabudi, chief executive officer Thomas Wu, and senior officer Thomas Yu were the ones that hid the bank’s losses. All three men are accused of delaying the proper recording of the loan losses and making misleading and false statements to independent auditors and investors and concealing from them that there had been the major losses on a number of large loans, property appraisals had gone down, property appraisals had been reduced, and loans were secured by worthless collateral.

Also accused of securities fraud by the SEC is former United Commercial Bank chief financial officer Craig On. The Commission said that he aided in the filing of false financial statements and misled outside auditors. To settle the SEC charges, On has agreed to pay a $150,000 penalty. He also agreed to an order suspending him from working before the SEC as an accountant for five years. He is permanently enjoined from future violations of specific recordkeeping, reporting, anti-fraud, and internal controls provisions of federal securities laws.

Criminal charges have also been filed against Shabudi and Wu. A grand jury indicted both men of conspiring to conceal loan losses, misleading regulators and investors, and lying to external auditors. Wu and Shabudi allegedly used accounting techniques and financial maneuvers, including concealing information that would have shown its decline, understating loan risks, and falsifying books, to hide the fact that that the bank was in trouble.

This is the first time such charges have been made against executives who worked at a bank that obtained government money—$298 million from TARP—to keep it running during the economic collapse.

Prior to its demise, United Commercial Bank, which was the first US bank to acquire a bank in China was considered a leader in the industry. It amassed assets of up to $13.5 billion in 2008. However, it also soon $67.7 million—way down from its $102.3 million profit in 2007. East West Bank acquired United Commercial Banks after regulators took it over in 2009.

Meantime, the FDIC is taking steps to bar 10 former United Commercial Bank officers from ever taking part in the banking industry.

SEC Charges Bank Executives With Hiding Millions of Dollars in Losses During 2008 Financial Crisis, SEC, October 11, 2011

Read the SEC Complaint (PDF)

Feds file charges against execs of failed United Commercial Bank, Mercury News, October 11, 2011

More Blog Posts:

Merrill Lynch Faces $1M FINRA Fine Over Texas Ponzi Scam by Former Registered Representative

Published on: October 10, 2011 | by Shepherd Smith Edwards & Kantas, LLP

Two years after San Antonio broker was sentenced to prison for Texas securities fraud, FINRA has fined Merrill Lynch $1M for not properly supervising its former employer. These failures allegedly allowed Bruce Hammonds to run a Ponzi scam that defrauded investors of $1.4M.

Hammonds persuaded 11 people to invest in the Texas Ponzi scam, which he operated under the name B&J Partnership. It was supervisors at Merrill Lynch that gave the green light for him to open an account for B & J. The supervisors also are accused of not monitoring the funds that moved between customers and Hammonds.

Rather than putting investors’ money in a Merrill Lynch fund, he put $1.4 million of their funds in his working capital account. He even gave clients charts showing how the B & J fund was performing even though the fund wasn’t real. Hammonds used the money to pay for his personal spending, including a supposed house-flipping business.

He later pleaded guilty to federal securities charges. In addition to five years behind bars and three year supervised release. Hammond has been barred from the securities industry. All investors have been paid back in full for their losses.

In deciding to fine Merrill Lynch, FINRA found that the financial firm did not have a supervisory system that did a satisfactory enough job of monitoring accounts of employees for signs of possible misconduct. The system was only able to immediately capture accounts opened by an employee if he/she used his/her social security number as the main tax identification number. The SRO also said that between 1/06 and 6/10 Merrill Lynch did not monitor another 40,000 employee/employee-interested accounts.

By agreeing to settle, Merrill is not denying or admitting to the charges.

Failure to Supervise
It is a brokerage firm’s responsibility to establish written procedures for how to properly supervise its employees’ activities. These procedures must then be implemented to prevent broker fraud. When misconduct does arise and failure to supervise played a role in allowing the incident to happen, the financial firm can be held liable for securities fraud.

Brokerage companies have to supervise every broker that they license to work for them. Even if an accused broker is later found not liable, there is still a possibility that the brokerage firm or supervisor can be held liable for failure to supervise and be ordered to pay damages. For example, a broker may not have received the proper training or was given the wrong information by the financial firm, and this resulted in Texas securities fraud that caused an investor to suffer losses.

FINRA Fines Merrill Lynch $1 Million for Supervisory Failures That Allowed a Registered Representative to Operate a Ponzi Scheme, FINRA, October 4, 2011
Shepherd Smith Edwards & Kantas LTD LLP is Investigating Merrill Lynch in Light of Recent FINRA Fines Against the Firm for Failure to Supervise, MarketWatch, October 5, 2011
More Blog Posts:
Former Merrill Lynch Employee, Guilty of $1.4 Million Texas Securities Fraud Scheme, Receives Prison Term, Stock Broker Fraud Blog, October 5, 2009
Wedbush Securities Ordered by FINRA to Pay $2.8M in Senior Financial Fraud Case Over Variable Annuities, Stock Broker Fraud Blog, August 31, 2011
Actions of Former Ferris, Baker Watts, Inc. General Counsel Accused of Supervising Rogue Broker to be Reviewed by SEC, Institutional Investors Securities Blog, December 9, 2010 Continue Reading ›

Don’t Create Uniform Fiduciary Standard for Broker-Dealers and Investment Advisers, Say Some Republicans to the SEC

Published on: October 7, 2011 | by Shepherd Smith Edwards & Kantas, LLP

House Financial Services subcommittee Chairman Scott Garrett (R-N.J.) is encouraging the Securities and Exchange Commission to refrain from rulemaking for establishing a uniform fiduciary standard that would apply to both broker-dealers and investment advisers unless the federal agency can come up with adequate evidence to support this action. Garrett made his views known at a Subcommittee on Capital Markets and Government Sponsored Enterprises oversight hearing. Committee Chairman Spencer Bachus (R-Ala.) and Rep. Ed Royce (R-Calif.) also echoed these same sentiments.

Says Shepherd Smith Edwards & Kantas LTD LLP Founder and Securities Fraud Attorney William Shepherd, “Washington is again bowing to Wall Street pressure to exempt them from liability for their wrongful acts. It is incredible that, considering the unmitigated investment fraud perpetrated on the American public in the last decade, Congress would even consider thwarting the very investors who elected them from receiving the justice they deserve!”

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act’s Section 913, the SEC has the authority to start up the rulemaking for this uniform fiduciary standard but is under no obligation. Earlier this year, the SEC put out a report recommending that it take up this rulemaking.

While Garrett questioned whether “hard factual data” existed demonstrating that a suitability standard is not enough to protect investors, others noted that it is a fiduciary standard and not a suitability standard that addresses cost, which impacts investors’ long-term performance. The majority of those that testified at the hearing also supported a uniform fiduciary standard that would apply to both investment advisers and broker-dealers. Consumer Federation of America director of investor protection Barbara Roper said that investors lose money when the person giving them investment advice must only meet a suitability standard and not a fiduciary one.

Meantime, while financial industry representatives have expressed support for a uniform fiduciary standard for investment advisers and broker-dealers, they don’t believe that it could be properly executed under the 1940 Investment Advisers Act.

Securities Industry and Financial Markets Association senior managing director and general counsel Ira Hammerman has said that the Act is unable to work with the business models for broker-dealer, while Financial Services Institute government affairs director and general counselor David Bellaire said that imposing a 1940 Act fiduciary duty on broker-dealers would decrease investor choice and decrease services, which would all significantly affect the market.

Currently, broker-dealers have to abide by a suitability standard, which is more lenient than the fiduciary duty standard for investment advisers. SEC Chairman Mary Schapiro has told staff that they need to recommend a proposal before the year is over.

Also up for discussion was the draft that Senator Bachus released last month mandating that there be at least one self-regulatory organization tasked with overseeing investment advisers. The Financial Industry Regulatory Authority is a top candidate for the role and has expressed interest in taking on this new responsibility. However, not everyone is a supporter of FINRA becoming SRO.

More Blog Posts:
Most Investors Want Fiduciary Standard for Investment Advisers and Broker-Dealers, Say Trade Groups to SEC, Stockbroker Fraud Blog, October 12, 2010

Fiduciary Standard in Securities Industry Doesn’t Need New Definition, Stockbroker Fraud Blog, November 26, 2010

FINRA Will Customize Oversight to Investment Adviser Industry if Chosen as Its SRO, Stockbroker Fraud Blog, April 8, 2011