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Archive for November, 2009


InvestmentNews — LPL Sues Pac Life Over Purchase of Broker Dealers

Indemnification dispute with the insurer won’t affect their businesses, firm insists
By Bruce Kelly

At the same time that LPL Holdings Inc. and the three broker-dealers it bought from Pacific Life Insurance Co. were filing suit against the insurer, LPL was reaching out to its advisers to reassure them that the dispute wouldn’t affect their businesses.
On Nov. 20, LPL sued Pacific Life, claiming that the latter was in breach of contract and trying to duck paying potentially millions of dollars of settlements and awards stemming from rogue brokers at the three subsidiaries, which were sold to LPL in 2007 for about $100 million in cash and stock.

In its lawsuit, filed in New York State Supreme Court in Manhattan, LPL said that “it is apparent that Pacific Life is merely seeking to avoid its express contractual obligations” over the payment stemming from arbitration claims.

Kathy TarantolaBill Dwyer: “We do not expect this legal matter to have any bearing on your business, your access to Pacific Life products or how you serve your clients,” he wrote in a note to advisers. The same day, LPL sent a note to its network of 12,000 advisers, telling them about the legal development.
“We do not expect this legal matter to have any bearing on your business, your access to Pacific Life products or how you serve your clients,” wrote Bill Dwyer, LPL’s president for national sales and marketing.

Not ‘an issue’

“I don’t see this as an issue,” said Frank Congemi, an LPL adviser. Pacific Life needs the broker-dealers and reps to sell its products, he said.
Mr.Congemi also doesn’t see how annoying LPL would be good for Pacific Life.

He was formerly affiliated with Mutual Service Corp., one of the former Pacific Life firms. Along with about 1,700 other advisers, his securities license was transferred to LPL Financial, the biggest broker-dealer in the network, in September.

That was when LPL moved the former Pacific Life brokers onto its platform entirely, and industry observers have said that the move may have added to the legal dispute between the two sides.

Although many advisers have no reason to worry about the matter, LPL has set aside money as a result of the transfer of representatives and client accounts from the Pacific Life broker-dealers to LPL. Regulators required LPL to put the cash aside, LPL said.

“As a requirement for the regulatory approval for the transfer, the affiliated broker-dealers were required to deposit $12.8 million into escrow accounts pending the resolution of certain matters,” LPL said in its quarterly earnings report this month.

According to the LPL lawsuit, Pacific Life, as part of the deal’s purchase-and-sale agreement, agreed to indemnify LPL from settlements, judgments, awards and defense costs from investor claims against the three firms for actions occurring prior to the closing of the deal.

So far, Pacific Life has ponied up “millions of dollars of settlement and defense costs related to” investor claims, the lawsuit states. However, the firm has suddenly switched tactics, the lawsuit claims, and refused last month to pay $57,000 to fund a settlement involving one of the broker-dealers LPL acquired, Associated Securities Corp.

In addition to that firm and Mutual Service, Pacific Life sold Waterstone Financial Group Inc. to LPL.

The dispute over which company is responsible for paying investors first came to light in LPL’s quarterly earnings report this month. In the report, LPL made veiled references to the dispute.

Caving in

According to the lawsuit, Pacific Life has been searching for a way to cut its liabilities for months. In March, it told LPL that it had no obligation to cover an arbitration award of $8.4 million that had been issued against Associated Securities, according to the lawsuit.
When LPL and Associated Securities challenged that position, Pacific Life “abandoned” its argument and paid for the settlement. Representatives of LPL and Pacific Life said that the lawsuit wouldn’t affect their continued relationship.

“As happens from time to time in the best of business relationships, LPL and Pacific Life disagree on the interpretation of a certain contractual provision,” Pacific Life spokeswoman Milda Goodman wrote in an e-mail. “This dispute will now be resolved by the courts, and will not disrupt the ongoing favorable business relationship between LPL, their financial advisers and Pacific Life.”

Likewise, an LPL spokesman, Joseph Kuo, said that the company doesn’t expect the dispute to have an effect on the relationship between the company and Pacific Life.

Regulators crack down on Oxford Global Ponzi scheme

Federal regulators announced Tuesday that they have charged a Minneapolis money manager and a Burnsville radio personality with running a Ponzi scheme that defrauded at least 1,000 people out of more than $190 million in a bogus currency investment scheme.

The U.S. Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) issued statements about separate lawsuits the agencies filed Monday in Minneapolis that were made public Tuesday.

The agencies said they had obtained emergency orders freezing the assets held by “self-proclaimed” money manager Trevor Cook, 37, of Apple Valley, and conservative radio talk show host Patrick Kiley, 71, of Burnsville, as well as four of their business entities and 13 “relief defendants” related to the alleged scheme, including two of Cook’s in-laws.

Chief U.S. District Judge Michael Davis in Minneapolis issued the order freezing the assets of the defendants and appointing a receiver to oversee them. He scheduled a hearing on a motion for a preliminary injunction in the matter for Dec. 4. According to the complaints, Cook and Kiley sold unregistered investments through shell companies and misled investors into thinking their money would be held in separate accounts and used to trade in foreign currencies. They promised returns of 10 to 12 percent and said there was no risk to their capital, which could be withdrawn anytime.

Former Stratton Oakmont Executive Charged in Securities Fraud Case

Irving Stitsky, a former executive at Stratton Oakmont, along with Mark Alan Shapiro and William B. Foster, have been found guilty of committing securities fraud. The crime involved more than 150 investors who together entrusted Stitsky with $18 million.

The three convicted perpetrated their illegal activity under an umbrella corporation known as, “Cobalt.” The company claimed to acquire and develop real-estate properties, some of which were never under its ownership. The three also lied to investors about the history of their company. In addition to these misrepresentations, Stitsky and Shapiro failed to disclose that they were convicted felons.

Stitsky is most known for his boiler room operations in the 1990s, actions that caused him to lose his securities licenses. Shapiro, on the other hand, served 30 months in prison after pleading guilty to bank fraud and conspiracy to commit tax fraud.

After the three-week trial, Stitsky, Shapiro, and Mr. Foster were found guilty of securities fraud, wire fraud, mail fraud and conspiracy charges.

The Devolution of DBSI

Investors in DBSI Inc. are only now getting a clear idea of what was going on at the Idaho-based commercial real estate investment company. There was little indication to investors that financial issues existed at DBSI until a notice they received six weeks prior to the company filing for Chapter 11 bankruptcy proceedings. However, problems at DBSI appeared long this, and started becoming apparent to those within the company as early as 2004.

It was in 2004 that DBSI accountants first noted cash shortages. It was also around that time that DBSI began in earnest to operate like an elaborate ponzi-scheme. By 2005, DBSI was dependent on new investor funds in order to provide cash for operations and provide the guaranteed 7% dividend to prior investors. The company came up with two ways to keep new funds coming in to pay off old investors.

It appears that the first strategy involved the use of hidden markups. DBSI would buy a commercial property at a given price, and then sell it to new investors at a profit. The amount of the markup was not disclosed in many cases; a violation of securities law provided the properties were sold as a security. One disturbing characteristic of this practice was the amount of time between DBSI buying an investment property and selling it to investors; sometimes it was as short as one day.

The second strategy came from a seemingly benign concept known as, “accountable reserves.” Starting in 2005, every new project had an accountable reserves fund which set aside money for tenant improvements and repairs. Well, that was the stated goal anyways. In actuality, only 18% of the money in those funds went towards tenant improvements and repairs. The other 82% of the over $99 million dollars available in accountable reserves went towards other DBSI funds.

Even with hidden markups and diverted tenant funds, DBSI was not able to maintain a financially viable enterprise. By 2007, the company was losing $3 million a month on its properties. That number increased to $8 million by 2008. Unfortunately, investors were kept in the dark until six weeks before DBSI filed for bankruptcy.

South Florida Attorney at Center of Fraud Scheme

Scott Rothstein, partner of South Florida law firm Rothstein Rosenfeldt Adler, has found himself at the center of an FBI investigation. The Bureau is alleging that Rothstein may be the linchpin of an investment scam that could top $1 billion. Rothstein, who is out of town at an undisclosed location, is not yet being charged with a crime.

FBI Special Agent in Charge, John Gillies, notes that this investigation is ongoing, adding that, “We’re far from over.” The government is asking for investors who have invested with Rothstein to come forward. Their hope is that they will be able to create a concrete and complete list of victims, thereby strengthening the case against Rothstein. The largest victims will be contacted first, with those who lost smaller amounts to follow.

The actual scheme involves Rothstein gleaning hundreds of millions of dollars from investors who purchased legal settlements from him since 2005. Some of these purchased legal settlements, however, may never have existed. In a move to pay off unrelenting investors in his alleged scheme, it appears that Rothstein may have even resorted to taking advantage of family friend and auto magnate, Ed Morse.

Those with information pertaining to this investigation may call: 800-CALLFBI (225-5324) or email: Rothstein.investment@ic.fbi.gov.

Senate Banking Committee Releases Discussion Draft on Financial Reform Legislation

The Senate Banking Committee has released a discussion draft of proposed financial reform legislation (see Investor Protection Act) titled, “Restoring American Financial Stability Act of 2009.” The discussion draft varies from the version recently approved House Financial Services Committee in one key respect: it is better for investors. The Senate version provides wide-ranging protections for investors that are more inclusive than the House approved version.

The difference is best exemplified in certain key reform areas, perhaps most notably in relation to redefining fiduciary duty. Fiduciary duty is simply the duty one owes a client to always invest with the client’s interests being the main concern. Currently there exists a two-tiered system between independent broker-dealers and registered investment advisers. The hope of many is for this system to become more streamlined, and both version attempt to accomplish this.

The Senate discussion draft proposes a simple solution to this problem. The Senate solution is to eliminate the broker-dealer exclusion from the definition of, “investment adviser.” This would make broker-dealers held to the same standards as investment advisers; a definitive win for investors and a vote towards increasing investor confidence.

The House approved version takes a more hands-off approach. Their version would require the Securities and Exchange Commission (SEC) to draft rules to synchronize the current two-tiered system. The likelihood that such a move would create as stringent a standard as the current fiduciary duty to which investment advisers are held is unlikely.

Either version, House or Senate, may become part of the finalized version of the financial reform legislation. It remains to be seen which will win out, but one thing is for sure, the debate will carry on.

Florida Government Agency Target of SEC Fraud Investigation

The St. Petersburg Times has reported today that a Florida government agency is the subject of a Securities and Exchange Commission (SEC) fraud investigation. The Florida State Board of Administration (FSBA), an agency charged with managing over $100 billion in public investments including that of local governments and one million current and future retirees, is at the center of the inquiry.

The SEC is investigating whether the FSBA, in conjunction with JPMorgan Chase, Credit Suisse, and Lehman Brothers, misled the public with false statements about the liquidity and risk of some FSBA investments. The involvement of a government agency on the receiving end of an SEC inquiry is an unusual occurrence.

Though the investigation has been ongoing for over a year now, the FSBA never made public its involvement in any such SEC inquiry. The only reason it is now being reported is because of a St. Petersburg Times public records request.

The FSBA has been subpoenaed to hand over documents in connection with this ongoing investigation.

Madoff Auditors Consent to Partial Judgment According to Securities and Exchange Commission

The Securities and Exchange Commission today announced that Bernard Madoff’s auditors have agreed not to contest the SEC’s charges that they enabled Madoff’s fraud by falsely stating they audited the convicted fraudster’s financial statements in accordance with the relevant accounting and auditing standards.

On November 3, 2009, the SEC submitted to the Honorable Judge Louis L. Stanton, a federal judge in the Southern District of New York, the consents of David G. Friehling and Friehling & Horowitz, CPA’S, P.C. (“F&H”) to a proposed partial judgment imposing permanent injunctions against them. Friehling and F&H consented to the partial judgment without admitting or denying the allegations of the SEC’s complaint, filed on March 19, 2009. If the partial judgment is entered by the Court, the permanent injunction will restrain Friehling and F&H from violating certain antifraud provisions of the federal securities laws.

The proposed partial judgment would leave the issues of the amount of disgorgement, prejudgment interest and civil penalty to be imposed against Friehling and F&H to be decided at a later time. For purposes of determining Friehling’s and F&H’s obligations to pay disgorgement, prejudgment interest and/or a civil penalty, the proposed partial judgment precludes Friehling and F&H from arguing that they did not violate the federal securities laws as alleged in the Complaint.

In its complaint, the SEC alleges that Friehling and F&H enabled Madoff’s Ponzi scheme by falsely stating, in annual audit reports, that F&H audited Bernard L. Madoff Investment Securities LLC’s (“BMIS”) financial statements pursuant to Generally Accepted Auditing Standards (GAAS). F&H also made representations that BMIS’ financial statements were presented in conformity with Generally Accepted Accounting Principles (GAAP) and that Friehling reviewed internal controls at BMIS. The complaint alleges that all of these statements were materially false because Friehling and F&H did not perform a meaningful audit of BMIS and therefore had no basis to form an opinion about the firm’s financial condition or internal controls.

CIT Group Seen as Lost Cause by Government, Even After Move to Generate Capital

Though taxpayer money has thus far kept embattled financial institution CIT Group, Inc. alive, the government is faced with the reality that it has made a bad investment. The company has finally filed for bankruptcy after unsuccessfully attempting to generate capital from the government, and generating capital from individual investors.

The reality that the government has lost over $2 billion in taxpayer TARP funds though its investment in CIT Group is regrettable. What is increasingly disturbing is the loss that individual investors have taken in this entire debacle. As noted in other articles on this site, CIT had traditionally looked to institutional investors for capital. As their finances become more and more questionable, institutional funds dried up and CIT was forced to look to other venues for much needed capital. That venue was retail investors, and third party broker-dealers are how investors were convinced to invest their funds.

Third party broker-dealers did an exceptional job at convincing individuals, especially those in and reaching retirement, to invest in CIT InterNotes. These notes were marketed as investment grade products, and had a much publicized, “death put,” or “survivor’s option,” feature. This feature, in theory, allows the beneficiary of a recently passed bondholder to sell that bond back to the lender at face value. InCapital, the firm who underwrote CIT InterNotes, even put a feature on its website allowing prospective clients to zoom in on the content of the offering.

The positive characteristics of this investment product were touted to investors by broker-dealers. The possible drawbacks of CIT InterNotes, however, were often left out. This marketing strategy worked and more than $800 million in CIT backed debt was sold to clients.

Even with the capital raised through broker-dealers, CIT was unable to stave off bankruptcy. With this bankruptcy filing, millions in individual investors’ funds are virtually guaranteed as being lost. With such a large loss, many are looking to their brokers and asking, how did this happen?

CIT Bankruptcy Filing

CIT’s move will wipe out current holders of its common and preferred stock, likely meaning the U.S. government and taxpayers will lose the $2.3 billion sunk into CIT last year to prop up the ailing company. Goldman Sachs however, will gain $1 billion because of CIT’s bankruptcy, according to a report published Oct. 4 by theFinancial Times.

The $2.3 billion lost in taxpayer funds is the largest amount lost since the government began infusing banks with capital, according to the Financial Times.

CIT made the filing in New York bankruptcy court Sunday, after a debt-exchange offer to bondholders failed. CIT said in a statement that its bondholders have overwhelmingly approved a prepackaged reorganization plan which will reduce total debt by $10 billion while allowing the company to continue to do business.

The Chapter 11 filing is one of the biggest in U.S. corporate history. CIT’s bankruptcy filing shows $71 billion in finance and leasing assets against total debt of $64.9 billion. Its collapse is the latest in a string of huge cases driven by the financial crisis over the past two years, as bailed out industry heavyweights like General Motors and Chrysler both entered bankruptcy court.

CIT has been trying to fend off disaster for several months and narrowly avoided collapse in July. It has struggled to find funding as sources it previously relied on, such as short-term debt, evaporated during the credit crisis.

It received $4.5 billion in credit from its own lenders and bondholders last week, reportedly made a deal with Goldman Sachs to lower debt payments, and negotiated a $1 billion line of credit from billionaire investor and bondholder Carl Icahn. But the company failed to convince bondholders to support a debt-exchange offer, a step that would have trimmed at least $5.7 billion from its debt burden and given CIT more time to pay off what it owes.

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