Some of the broker-dealers that sold allegedly fraudulent private placements appear to have allowed their net-capital positions to fall dangerously low, a situation that could threaten their existence if they have to pay large legal claims.
The firms — and some of their executives — face mounting legal liabilities from investors seeking to claw back losses over the sale of Provident Royalties LLC private-placement securities.
Broker-dealers facing millions of dollars in lawsuits could be “in a world of hurt,” said Carrie Wisniewski, president of B/D Compliance Associates Inc., which provides consulting services to broker-dealers and investment advisers. “It's a big problem,” she said.
The Financial Industry Regulatory Authority Inc. has made it very clear over the past 18 months that it is watching the financial statements of broker-dealers, Ms. Wisniewski said.
“They do have this fear of firms' operating without sufficient capital,” she said.
The Securities and Exchange Commission last summer charged Provident with civil fraud, saying its private-placement deals were really a $485 million Ponzi scheme based on allegedly phony oil and gas investments. Between June 2006 and January 2009, dozens of independent broker-dealers sold the Provident investments to some 7,700 investors.
(Click here to see a list of broker-dealers that sold these investments, plus their commissions collected.)
Last month, the trustee overseeing the receivership of the Provident private placements sued 49 broker-dealers, seeking $285 million in alleged damages. Meanwhile, hundreds of individual investors have filed arbitration claims against broker-dealers and their representatives.
According to SEC filings, some of those firms don't appear to have enough capital on hand if they are forced to pay out substantial legal claims.
One of the defendants in the suit, Capital Financial Services Inc., the biggest seller of Provident private placements, had only $390,000 in excess net capital at the end of last year. Another big seller, CapWest Securities, had $70,000 in excess net capital.
Neither firm had reserved cash to pay for legal settlements or claims.
QA3 Financial Corp., which also sold the private placements, had $244,000 in net capital and $118,000 in excess net capital at the end of last year. But QA3 has had problems with net capital: In 2008, it told the SEC that it was in violation of the net-capital rule.
Next Financial Group Inc., the No. 2 seller of the failed oil and gas deals, had $3.1 million in excess net capital at the end of last year, including $1.1 million reserved to pay contingent legal liabilities.
It isn't clear if any of the firms in question are in violation of the SEC's net-capital requirements. Net capital varies from firm to firm, based on the broker-dealer's size, the risk of its business model and the amount of litigation each faces.
Because it hinges on transactions, a firm's net capital is also a fluid figure. For many small broker-dealers, net-capital requirements can be as low as $5,000 to $15,000.
If lawsuits, along with potential fines and claw-backs from regulators, turn into actual losses, broker-dealers will need to show on their balance sheets enough capital on hand to pay those losses and meet overall industry standards in order to stay open.
Although the amount of claims facing individual firms isn't known, Capital Financial Services sold $33.7 million of the Provident product, more than any other firm. QA3 was the third-biggest seller, with $32.6 million in sales, and CapWest was the sixth-biggest seller, with sales totaling $21.7 million.
The claims filed against the firms' executives — which were disclosed on the Finra's BrokerCheck system — are another indicator of potential liabilities.
Brian Boppre, president of Capital Financial Services, has nine pending arbitration claims against him, totaling $10.8 million in damages.
Stephen Wild, the owner, chairman and chief executive of QA3 Financial Corp., faces eight pending arbitration claims, totaling $12.4 million.
In both cases, according to Finra records, the claims stem from the sales of private placements and other investments.
Neither Mr. Boppre not Mr. Wild returned calls seeking comment.
Dale Hall, chief executive of CapWest Securities, also didn't return calls seeking comment.
In the securities industry, violating the SEC's net-capital rule can be the equivalent of a death notice, and this year, some of the firms that sold Provident Royalties private placements went out of business because of net-capital issues.
For example, Okoboji Financial Services Inc., the fifth-largest seller of the Provident private placements, said in May it was closing.
The firm had excess net capital of $32,048 at the end of last year and had made no provisions for legal liabilities.
Likewise, GunnAllen Financial Inc., another leading seller of Provident deals, shut down in March when its capital on hand dropped below the amount needed to meet industry rules.
Ten other firms that sold the private placements have also shut down.
E-mail Bruce Kelly at [email protected].
