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Archive for October, 2009


Ameriprise Reaches Settlement in Broker Misconduct Case

Ameriprise Financial has reached a settlement with the Commonwealth of Massachusetts in connection with allegations of deceptive sales practices. The settlement requires the Minnesota-based broker-dealer to pay fines in the amount of $200,000. The government complaint contended that Ameriprise failed to adequately supervise its financial representatives, thus allowing this instance of broker misconduct to take place..

The government alleged that financial representatives were charging fees for financial plans that were never delivered to clients. Further, the financial reps failed to disclose the fees associated with the aforementioned financial plans in the first place.

This instance of misconduct was limited to six Ameriprise representatives, some of whom had had prior customer complaints. At this time, five of those six have either resigned or been terminated, with the sixth remaining on suspension. In addition to paying the fine, Ameriprise must compensate customers who were affected by these deceptive sales practices and develop new procedures that will hopefully prevent this type of situation from arising in the future.

New Provision in Investors Protection Act to Provide FINRA with Additional Power

In a recently added amendment to the Investor Protection Act (IPA) of 2009, the Securities and Exchange Commission (SEC) would have the power to allow the Financial Industry Regulatory Authority (FINRA) to carry out oversight on investment advisers working at broker-dealer firms.

Though some agree with this move while others oppose, it came as a shock to both sides that the amendment was added so easily to the language of the bill. If the IPA passes in its current iteration, FINRA would in essence have the power to oversee any adviser associated with a registered broker-dealer. That power, if exercised, would include a major percentage of the investment advisory business.

The amendment was submitted by Republican Representative Spencer Bachus, R-Alabama. The entire bill, which also includes a single fiduciary standard for registered investment advisers and independent broker-dealers, is one part of a move by Congress to reform the financial industry. The complete bill is expected to be approved for full House consideration by Wednesday.

SEC Chairman Shapiro on the Future of Investment

Mary Shapiro, Chairman of the U.S. Securities and Exchange Commission (SEC), gave a speech at the Securities Industry and Financial Markets Association (SIFMA) annual meeting yesterday signaling the agency’s priorities in the coming months and years. Key issues raised by Chairman Shapiro include revitalizing enforcement efforts, the need for forthrightness in consumer products, as well as filling gaps in regulation, among others. The message for her audience was clear, reforms are coming, they are going to be game changers, and investors are to be the raison d’etre of each and every change.

Enforcement is a key feature in Chairman Shapiro’s drive to restore investor confidence in the financial sector. The SEC is currently in the process of internal restructuring, the goal of which is to increase the SEC’s capacity to investigate wayward broker-dealers and investment advisors. Rob Khuzami, head of enforcement at the SEC has removed an entire layer of management, thus allowing the redistribution of dozens of attorneys back to the, “front lines.”

In addition to the need for greater enforcement, Chairman Shapiro clearly has her eye on new rules and regulations aimed at helping investors understand the very products in which they are putting their hard-earned capital. All too often, new and innovative financial products are failing to provide simple, clear disclosures of risk to investors. In Chairman Shapiro’s words, “America’s investors and future retirees deserve products that they can understand and evaluate.” Specifically, target date funds and securitized life settlements will be thoroughly scrutinized.

Regulatory gaps are one issue that many advocates for investor’s rights hope Chairman Shapiro will address posthaste. Hedge funds have been largely unregulated in the past, and many have been hit with sharp declines in assets in response to the current economic crisis. Sadly, due to lack of regulation, it has been next to impossible to monitor the risk and potential illicit activity perpetrated by hedge fund managers. Recent headlines, such as the Galleon Group scandal, may have been avoided if sufficient regulations existed.

The SEC also sees a need for a common fiduciary standard for broker-dealers and independent advisors. As Chairman Shapiro points out, “investors don’t make a distinction between the two [brokers and advisors] – and neither should we.” While many have echoed such sentiments, among them Richard Ketchum, Chairman of the Financial Industry Regulatory Authority (FINRA) as well as countless securities attorneys, it remains to be seen if words will beget action. Her words were forceful, however, and being that her audience included many leaders of the very financial firms she hopes to greater regulate, one can hope they take note.

SEC Charges Three Men in South Florida with Operating a Ponzi Scheme and Committing Affinity Fraud

Three South Florida men have been charged with operating a Ponzi scheme as well as committing affinity fraud through their two companies: HomePals Investment Club LLC and HomePals LLC.

Ronnie Eugene Bass Jr., Abner Alabre, and Brian J. Taglieri are charged with defrauding investors in the amount of $14.3 million. As with many Ponzi schemes, the terms of this, “investment opportunity,” turned out to be too good to be true. The aforementioned individuals promised investors that their money would be doubled every 90 days. Such stellar returns were purportedly possible due to Bass’ expertise in trading stock options and commodities. Contrary to such assertions, the scheme only invested $1.2 million of the capital made available to them, and even then, operated at a 19% trading loss.

As is typical with Ponzi schemes, HomePals used the majority of investor funds to repay earlier investors. In addition to this regrettable activity, the proprietors of HomePals embezzled over $500,000 of available investment funds.

As was stated above, Bass, Alabre, and Brian are also charged with affinity fraud. This is a particularly damaging activity where an identifiable group is targeted and exploited on the basis of the mutual trust between members of that group. In this case, the alleged criminals preyed on the Haitian American community, both in South Florida and New Jersey.

Taglieri has already agreed to settle the SEC’s charges against him. He has consented to the judgment of the court and consented to returning ill-gotten gains as well as being subject to yet to be determined financial penalties.

Raj Rajaratnam and Six Others Charged in Insider Trading Case

Seven hedge fund managers and executives were arrested yesterday in connection with an insider trading case investigated by the Securities and Exchange Commission (SEC), the U.S. Attorney’s Office, and the Federal Bureau of Investigation (FBI). Among those arrested was heavyweight portfolio manager Raj Rajaratnam of the Galleon Group. He and the others are charged with conspiring to use insider information to trade securities in several publicly traded companies, among them Google Inc. Authorities say that because of their actions, these arrested individuals generated upwards of $25 million in illegal profits.

This case is the first where authorities used court-authorized wiretaps to capture conversations in connection to an insider trading case. Officials see this as a game changer in an unapologetically secretive industry.

The SEC’s complaint charges the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, the laws which, in essence, bar insider trading and similar activities. The others charged in connection with this investigation are as follows:

• Danielle Chiesi of New York, N.Y. — a portfolio manager at New Castle Funds.

• Rajiv Goel of Los Altos, Calif. — a managing director at Intel Capital, an Intel subsidiary.

• Anil Kumar of Saratoga, Calif. — a director at McKinsey & Company.

• Mark Kurland of Mount Kisco, N.Y. — a Senior Managing Director and General Partner at New Castle.

• Robert Moffat of Ridgefield, Conn. — a senior vice president at IBM.

• New Castle Funds LLC — a New York-based hedge fund

Bankruptcy Threat amid Investor Loss

CIT Group Inc. failure to secure a second government bailout has prompted renewed bankruptcy fears. The New York based lender who traditionally looked to institutional investors for capital is coming under increased scrutiny from retail investors for its offering of corporate notes marketed under the name, “InterNotes.”

Some have wondered what a company that traditionally looked to institutional investors for capital was doing looking to retail investors for capital. The reality is, CIT Group needed capital badly, and the institutional investors that customarily were the source of CIT’s business were wary of the U.S. lender. While under CEO Jeffrey Peek, CIT went from a profitable entity to one that has seen nine quarters of consecutive loss totaling more than $3 billion.

Unfortunately for investors, third party broker-dealers were given the task of selling the CIT-backed debt, InterNotes. Trusting investors, not knowing what many institutional investors had known for quite some time, were sold this debt by their brokers while CIT was already heading for trouble. When the troubles facing CIT became more public, InterNote investors looking to sell were faced, and continue to face, difficulty in find buyers and negative returns when they do.

Though the U.S. lender was able to secure $2.3 billion in TARP funds in the last weeks of President Bush’s administration, it has still failed to emerge from the red. With the recent failure of the company to gain additional taxpayer funds from the government, many are certain that bankruptcy protection is in the foreseeable future. Though small and medium-sized businesses could loss a longtime lender if such an action took place, the damage to InterNote holders has already been done.

Prosecution begins Opening Statements in Case Against Former Bear Sterns Hedge Fund Managers

Opening statements by the prosecution began today in the trial of one time Bear Stern employees Ralph Cioffi and Matthew Tannin. The former hedge fund managers are the first to be tried in connection with a federal probe into the subprime market collapse.

The men are charged with misleading clients who invested into two separate hedge funds that collapsed. The collapse resulted in losses amounting to somewhere in the area of $1.4 billion. The charges against Cioffi and Tannin include conspiracy, securities fraud, and wire fraud. If convicted, the men face up to 20 years in prison.

Cioffi, the individual who managed the two defunct hedge funds, and Tannin, his chief operating officer, followed an investment policy heavily reliant on the performance of subprime mortgage and related securities. In July 2007, when collateralized debt obligations tanked in response to market conditions, this strategy proved deadly for those invested in these funds.

As investors became anxious, Cioffi and Tannin allegedly lied to investors, stating that they were still putting their personal money into the funds. Cioffi, however, had in actuality withdrawn $2 million of his own money. Prosecutors allege that he did this via the use of nonpublic information, making his actions tantamount to insider trading.

The hedge funds, which filed for bankruptcy in July 2007, were the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. and the Bear Stearns High- Grade Structured Credit Strategies Master Fund Ltd.

Citigroup Fined by FINRA for Tax Evasion Strategies

The Financial Industry Regulatory Authority (FINRA) has fined Citigroup Global Markets Inc. $600,000 and censured the brokerage firm for tax evasion trading strategies found to be operating among its affiliates. The first scheme involved international clients of Citigroup circumventing US tax laws, allowing them to increase their respective returns. The second scheme was a complex trading strategy that allowed Citigroup to increase its own after tax profits. Citigroup, for its part, failed to supervise its brokers who were involved in these illicit trading strategies.

Further, Citigroup failed to adequately monitor Bloomberg messages and report to an exchange, trades executed under these complex trading strategies. If the firm had in place procedures designed to detect and prevent improper trades between itself and others, this situation may never have developed.

The first trading strategy operated in the following manner:

1. Citigroup’s equity finance desk in New York purchased U.S. equities (stock) from foreign Citigroup clients, acting as custodian of this dividend-earning stock for Citigroup’s London affiliate.
2. The London affiliate would then use the US equity as the underlying equity hedge in a total return swap agreement with the client.
3. The client would be paid a total return under the swap agreement, including any appreciation of the stock as well as the amount equivalent to the dividend.
4. The client would then pay Citigroup’s London affiliate interest as well as any decline in the share price, if applicable.
5. Once these actions had been completed, the swap was terminated and Citigroup’s equity finance desk in New York sold the stock on behalf of the London affiliate.

The legal issue this trading strategy brings about is that when dividends on U.S. equities are paid to foreign investors, these dividends may be subject to withholding taxes. This is subject to the applicable treaty between the U.S. and the foreign investor’s home country. The, “dividend equivalent,” (# 3) however, allowed Citigroup bypass any U.S. withholding taxes, regardless of applicable treaties.

Approximately two years after this trading strategy was implemented, Citigroup finally produced written procedures to govern it. However, trading staff committed actions in violation of these procedures. In addition to the aforementioned strategy, Citigroup was doubly fined for conducting a second strategy aimed at enhancing Citigroup’s own after-tax yield on Italian stocks.

The Italian trading strategy operated as follows:

1. Citigroup’s London affiliate corresponded with the New York equity finance desk as to which Italian companies were likely to pay out dividends in the near future.
2. The New York desk then loaned stock in those Italian companies, and then turned around and loaned that stock to their Swiss affiliate.
3. The Swiss affiliate would then sell that stock back to New York.
4. The New York desk would then sell this stock to a third-party inter-dealer broker, who would then sell the stock to the London affiliate.
5. The London affiliate would then enter into a swap agreement with the Swiss affiliate, with one taking a long position and the other taking the short position, in essence covering the risk on the stock.
6. The dividend would then be paid out, and the trades would be reversed.

By having the London affiliate hold the Italian stocks and therefore collect the dividend (in conjunction with the Swiss swap agreement), Citigroup was able to take advantage of favorable tax treaties between the United Kingdom and the Republic of Italy.

The legal issue raised is that Citigroup failed to prevent improper relationships from developing between its affiliated units. In addition to this, Citigroup failed to establish policies and procedures in order to regulate this type of trading strategy.

Both of these trading strategies involving the New York office, in addition to their respective legal pitfalls, at times involved trades that were not reported to an exchange, a requirement under securities regulations.

In its imposition of fines, FINRA took into consideration the fact that Citigroup discovered and then reported the abovementioned violations. Also, the firm sought outside counsel to review the devious trading strategies, as well as to assist in reconciliatory efforts. Citigroup neither admitted nor denied the validity of the charges brought against them in this matter.

New Suit Alleges Securities America Sold Notes it Knew to be Questionable

In a recently filed lawsuit, Securities America Inc. is charged with continuing to sell offerings of a faulty private placement after an executive at the firm sounded the alarm bell concerning the problem investment last year.

In addition to this allegation, the lawsuit further charges that Securities America sold millions of dollars’ worth of notes of Medical Capital Holdings, Inc. In July, the SEC charged Medical Capital with fraud in the sale of $77 million of private securities in the form of notes. Since that time, a court-appointed receiver has questioned the value of the company’s assets, throwing into question the structure of the six deals it sold from 2003 to 2008.

W. Thomas Cross, an executive at Securities America, wrote to a Medical Capital official that he feared a run on the bank because of issues at Medical Capital. Allegedly, this written comment was made months before Securities America ceased selling the now infamous private placement.

An official with Securities America said the claim that the company continued selling Medical Capital notes after Mr. Cross’ raised concerns is preposterous.
In total, Medical Capital raised $2.2 billion from investors. Given the legal circumstances surrounding Medical Capital Holdings Inc, this is undoubtedly only the beginning salvo of lawsuits brought about by defrauded investors.

FINRA Supports Mandatory Arbitration Clause Removal

Richard Ketchum, Chairman and Chief Executive of FINRA, testified before the House Financial Services Committee today in support of allowing the SEC to ban mandatory arbitration clauses in securities contracts. It is common practice for broker dealers to stipulate a mandatory dispute resolution forum in the event of a broker/client dispute. Such clauses, normally found within new brokerage account applications, have become a contentious subject as Congress and the SEC move to reform the securities industry in the wake of the subprime meltdown.

FINRA, who counts among its member many in the securities industry, does not object to a proposal spearheaded by the Obama administration and undertaken by House Capital Markets Subcommittee Chairman Paul Kanjorski, D-Pa., that would give the SEC the authority to prohibit or limit mandatory arbitration clauses.

As expected, the securities industry has seen the move to ban such clauses as a negative development, bad for both broker and client. For those that hold such a view, these arbitration clauses are touted as ensuring fairness and cost effectiveness for all involved.

The move by FINRA to support allowing the SEC this new power greatly weakens the position of the securities industry. Indeed, the proposal is far more likely to be enacted by Congress with Ketchum’s support, where some want an outright ban on all mandatory arbitration clauses.

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