Securities America Inc. and the Massachusetts Securities Division locked horns last week over the regulator's charges that the firm misled 60 investors in the state who bought $7.2 million in Medical Capital notes from the firm's reps.
The case is the first major legal skirmish involving an independent broker-dealer that sold Regulation D offerings such as those from Medical Capital Holdings Inc., a lender to hospitals and health care facilities that is now in receivership.
The battle is being closely watched by the plaintiff's bar, class action attorneys and securities attorneys who are seeking insight into Securities America's legal strategy in the matter.
In total, 400 Securities America reps and advisers sold about $700 million of the private-placement notes from 2003 to 2008. Investors are estimated to have lost more than $1 billion through their purchases of notes from Medical Capital, which raised about $2.2 billion in total.
Last Thursday, attorneys for Securities America appeared at an administrative hearing in Boston to answer allegations brought in January by Massachusetts regulators that the firm failed to reveal potential red flags to advisers and clients about Medical Capital, which used the note proceeds to purchase medical receivables.
“If there's a problem here, Medical Capital is to blame, not Securities America,” Bruce Bettigole, a partner at Sutherland Asbill & Brennan LLP who is serving as lead attorney for the broker-dealer said, at the hearing.
Massachusetts officials argue otherwise.
According to their lawsuit, a due-diligence analyst at Securities America raised several points of concern about the MedCap notes, including the lack of audited financials for the series of offerings. In 2005, Jim Nagengast, then the firm's president and now its chief executive, wrote in an e-mail that he was concerned about the lack of audited financials.
At the hearing, Mr. Bettigole argued that the private-placement memorandum distributed by Medical Capital to investors clearly stated the risks of investing in the notes.
“The private-placement memorandum is the offering document; there's no obligation to provide the due-diligence file. The private-placement memorandum is critically important,” Mr. Bettigole said.
“It's a short document, six pages long. Each investor got the PPM,” he said.
“There's no allegation investors did not get it,” Mr. Bettigole said.
He said that the Massachusetts complaint had taken the due-diligence analyst's concerns out of context and that Mr. Nagengast has said that his questions about Medical Capital's lack of audited financials were answered. As a member of the firm's compliance committee, Mr. Nagengast voted to sell the latest offering, Mr. Bettigole said.
Richard Khalife, an attorney for the Massachusetts Securities Division, said that the firm had deceived investors.
“Massachusetts investors were sold unsuitable, fraudulent notes by fraudulent means,” he said. “Unlawful conduct can't go unpunished.”
Securities America told investors the MedCap notes were safe, secure and guaranteed, and failed to inform investors the true nature of the risk of the notes, Mr. Khalife said. “This case is about one of Medical Capital's biggest distributors,” Securities America, he said.
Mr. Khalife said that the MedCap notes, which were to be sold to sophisticated and accredited investors, were sold to unsophisticated investors.
Mr. Bettigole denied that the firm committed fraud, saying that it never did anything intentional to harm investors and acted within industry standards. He also appeared surprised when Mr. Khalife charged that unsophisticated investors were sold the notes.
In July 2009, the Securities and Exchange Commission charged Medical Capital and its two top executives with fraud. After raising $2.2 billion in capital during much of the last decade, the firm is now in the hands of a federal receiver, who has discovered that MedCap assets included not only medical receivables and loans but also a 118-foot yacht — “The Home Stretch” — and a $20 million stake in the movie “Perfect Game,” about a Mexican team that won the Little League World Series in 1957.
In August, Montana regulators also sued Securities America over its sale of MedCap notes, alleging that the firm and executives “withheld material information regarding heightened risks” from its representatives and their clients regarding notes issued by MedCap Holdings.
The Massachusetts lawsuit is seeking restitution for investors, a censure for Securities America and an administrative fine.
More than 40 other independent broker-dealers sold the MedCap notes, but Securities America was by far the largest seller.
As a unit of Ameriprise Financial Inc., the broker-dealer has a parent company with deep pockets, something that the vast majority of other broker-dealers that sold MedCap notes don't.
About a half dozen class action and plaintiff's attorneys representing potentially hundreds of Securities America clients in actual and possible lawsuits over MedCap sales attended the opening of the hearing in Boston on Thursday.
“This hearing is an opportunity to hear strong presentations from both sides, particularly Securities America,” said Jay Salamon, an attorney with Hermann Cahn & Schneider in Cleveland.
“Securities America continues to assert that information it had could not be disclosed to investors unless Medical Capital said so. That's preposterous,” Mr. Salamon said.
“Securities America is saying, "We told investors what we were allowed to tell them [through the private-placement memorandum], and if we knew other material information, it wasn't for us to tell them; it was up to Medical Capital,” he said.
E-mail Bruce Kelly at email@example.com.