SEC Sues Brokerage Firm for Allegedly Defrauding Wisconsin School Districts

(August 11, 2011) — The Securities and Exchange Commission (SEC) has charged St. Louis-based brokerage firm Stifel, Nicolaus & Co. and its former executive with allegedly defrauding the pension funds of five Wisconsin school districts by selling them unsuitably risky and complex investments funded largely with borrowed money.

The brokerage firm’s parent — Stifel Financial Corp. — disputed the SEC’s allegations and said it will challenge them in court.

“Let this be a teaching moment for sellers of complex financial products,” Robert Khuzami, Director of the SEC’s Division of Enforcement, said in a statement. “The sale of these products to school districts or similar investors must meet well-established standards of suitability and accurate disclosure. Stifel and Noack violated these standards and jeopardized the ability of the school districts to fund operations and provide a quality education to students.”

The SEC’s complaint, filed in federal court in Milwaukee, alleges that Stifel and Senior Vice President David W. Noack created a proprietary program to help the school districts fund retiree benefits by investing in notes linked to the performance of synthetic collateralized debt obligations (CDOs). According to the SEC, Stifel and Noack misrepresented the risk of the investments, failing to disclose material facts to the school districts. The investments were a complete failure, the SEC said, and generated significant fees for Stifel and Noack.

Elaine C. Greenberg, Chief of the SEC Division of Enforcement’s Municipal Securities and Public Pensions Unit, added: “Stifel and Noack abused their longstanding relationships of trust with the school districts by fraudulently peddling these inappropriate products to them. They were clearly aware that the school districts could ill afford to bear the risk of catastrophic loss if these investments failed.”

Furthermore, the SEC claims that Stifel and Noack made sweeping assurances to the school districts, misrepresenting that it would take a catastrophic, overnight collapse for the investments to fail.

According to the US regulator, the heavy use of leverage and the structure of the synthetic CDOs exposed the school districts to a heightened risk of loss. As the CDO portfolios suffered a series of downgrades, the investments steadily declined in value in 2007 and 2008. By 2010, the school districts learned that the second and third investments were a complete loss and that the lender had seized all of the trusts’ assets.

The SEC’s investigation against Stifel Nicolaus & Co., which is ongoing, is the latest SEC case targeting questionable brokerage firms’ sales that contributed to the financial crisis. Last year, for example, Goldman Sachs agreed to pay $550 million — the largest penalty against a Wall Street firm in SEC history — to settle a civil fraud suit brought by the regulator.

“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” Robert Khuzami, director of the SEC’s Division of Enforcement, said in a statement last year. The charges, filed April 16, 2010, had pushed the firm’s market value down by more than $25 million at one point.