One of RCS Capital Corp.'s newest broker-dealers, VSR Financial Services Inc., recently was part of an unusual and costly $3.74 million settlement in Texas state court over the sale of high risk, illiquid alternative investments dating back to the credit crisis.
Filed in 2012 by a client of a former VSR adviser Charles Chapman in Dallas County district court, the suit stems from losses from $1.05 million invested in DBSI 2006 Secured Notes Corp.
Formerly a top real estate syndicator that raised almost $1 billion by selling private placements through dozens of independent broker-dealers, Diversified Business Services & Investments Inc. — DBSI — declared bankruptcy in 2008. It was later revealed that DBSI acted like a Ponzi scheme. Four top executives of DBSI were convicted by a federal jury in Idaho earlier this year on multiple counts of fraud.
The lawsuit by investor Gordon B. McLendon Jr. alleged that Mr. Chapman and his firms, Chapman Hext & Co. and CH Wealth Management, “failed to conduct proper due diligence associated with VSR before recommending and causing plaintiffs to make investments with VSR, including the DBSI investment.”
Mr. McLendon invested a total of $7.1 million in various alternatives such as private placements and nontraded real estate investment trusts the industry calls “direct investments.”
At the end of August, the two sides reached a settlement in the matter, weeks before it was set to go to trial. VSR's portion of the settlement was $1.88 million, the insurance portion was $1.6 million, and Mr. Chapman was on the hook for $250,000, according to the settlement.
RCAP spokesman Tony DeFazio said the company had no comment on the complaint or settlement. RCAP entered a deal to acquire VSR in August. Gregory Hext, CEO of Chapman Hext, said Mr. Chapman had retired and could not be immediately reached because he was traveling outside the country. Mr. Chapman left VSR in 2009 and is no longer affiliated with a broker-dealer.
J. Michael Stanfield, CEO of VSR, said the settlement was preferable to a potentially long and complex trial. As part of the agreement, VSR received some of the alternative investment securities owned by Mr. McLendon with a value of $1.6 million.
“It wasn't as bad as it sounds,” Mr. Stanfield said. “We were happy to take these securities.”
“VSR and other brokers need to learn that rubber stamping high risk, high commission investments should not be their business model,” said Alan Loewinsohn, Mr. McLendon's attorney. The prospect of a Texas jury hearing the case pushed VSR to obtain the settlement, he said. “My client hoped the settlement sent the message that a client's trust is a demand, not a request,” Mr. Loewinsohn said.
It is unusual for investor complaints against financial advisers and brokerage firms to wind their way through state court. Brokerage contracts have a mandatory arbitration clause, so the vast majority of individual investor complaints against brokerage firms never go to court.
The lawsuit did not wind up in front of a Financial Industry Regulatory Authority Inc. arbitration panel even though VSR tried to compel arbitration, Mr. Stanfield said. The court made a ruling not to compel arbitration because it found that agreement to arbitrate was with VSR's clearing firm, First Clearing, and not VSR, Mr. Stanfield said.
“We think we are in the tail end of litigation” stemming from the financial crisis and collapse of 2007 and 2008, Mr. Stanfield said.