QA3 Financial Corp. faces bankruptcy because of a dispute with its insurance carrier over the amount of coverage that the independent broker-dealer has for legal claims stemming from its sale of high-risk private placements over the past decade.
The company claimed that it has coverage for $7.5 million of legal claims, damages and expenses stemming from the sale of private placements. Its carrier, Catlin Specialty Insurance Co., said that the coverage is capped at $1 million.
In a lawsuit filed in U.S. District Court for the Southern District of Florida in September, QA3, which houses about 400 independent representatives and advisers, said that it is facing bankruptcy because of the dispute with Catlin.
“As a result of Catlin's erroneous coverage position[s] and failure to fully and properly defend and indemnify QA3 as required under the policy, QA3 has suffered, and continues to suffer, damages and is facing bankruptcy,” QA3's lawsuit stated.
QA3 pulled the suit against Catlin in early November due to a legal technicality but intends to file another lawsuit, executives of the firm said.
Catlin sued QA3 in U.S. District Court for the Southern District of New York in late November, asserting that private-placement claims under the policy were limited to $1 million. That suit is pending.
Catlin issued the insurance policy in question Nov. 1, 2008. The premium for the policy was $548,250 and it expired a year later, according to QA3's lawsuit.
Catlin didn't issue a new policy to QA3 in 2009, according to Catlin's lawsuit.
Broker-dealers face higher premiums on liability insurance — known as errors-and-omissions coverage — because of investor complaints associated with the market crash. Another concern is policy renewal restrictions that seek to exclude certain types of alternative investments, such as private placements.
At least one broker-dealer, AFA Financial Group LLC, closed last year in part because it couldn't afford its premiums anymore and because it was facing an increasing number of investor complaints from the sale of private placements, the company said.
ARBITRATION CLAIMS
QA3 is enmeshed in arbitration claims filed by clients who bought private placements that later went belly up.
The amount of claims either settled or adjudicated isn't clear, but an exhibit in Catlin's lawsuit lists 59 separate
Financial Industry Regulatory Authority Inc. arbitration claims and lawsuits against QA3, and its executives and brokers. The private placements listed included DBSI Inc., Medical Capital Holdings Inc. and Provident Royalties LLC.
In July 2009, the Securities and Exchange Commission charged Medical Capital and Provident with fraud, alleging that both were Ponzi schemes. Both are in receivership.
QA3 was a leading seller of Provident deals.
On June 21, the liquidating trustee for the Provident receivership, Milo H. Segner Jr., filed a lawsuit in U.S. Bankruptcy Court in Dallas against almost 50 broker-dealers, including QA3. The lawsuit alleged that the firms “failed miserably in upholding their fiduciary obligations” when selling the series of Provident private placements.
According to court filings in that case, QA3 sold $32.6 million in Provident notes, collecting almost $7 million in commissions. The sales numbers may be misleading because it isn't clear in the filing if they represent the firm's total sales of the product or sales of private placements that defaulted.
"NO ACTION WAS TAKEN'
Stephen Wild, QA3's chief executive and principal owner, has maintained that his firm did nothing wrong in relation to the sale of the private placements. He said that regulators have looked into QA3 and its practices, and nothing has come of it.
“When this issue with Provident first surfaced two years ago, we had the SEC investigators in our office, and they spent a good week in the office. We provided them with every document that we had for Provident, and no action was taken,” Mr. Wild said.
“We feel we exceeded all [due-diligence] standards from a regulatory standpoint. There's nothing we're concerned about from a regulatory point of view,” Mr. Wild said.
“We do everything by the book, for starters, and generally exceed regulatory standards,” he said.
In July, Mr. Wild said that QA3 was indemnified from potential liabilities stemming from Provident, which was a series of oil and gas investments.
He declined to comment about the litigation with the firm's insurance carrier.
“On advice of counsel, I can't respond to anything that's in the lawsuit,” Mr. Wild said.
LAWYERS WEREN'T PAID
Greg Bolton, the firm's general counsel, said that at one point, Catlin was refusing to pay for QA3's legal representation.
“At the time the complaint was filed, Catlin hadn't paid law firms representing QA3 and its advisers. The lead firm was threatening to quit because they hadn't been paid anything,” Mr. Bolton said.
“A partial payment has been made,” he said.
Catlin's spokesman, James Burcke, is based in London and did not respond to an e-mail requesting comment.
When asked if QA3 faces bankruptcy, Mr. Bolton said: “There are multiple claims and multiple parties involved. We are actively managing the litigation [stemming from private-placement lawsuits]. We feel that there will be a positive outcome for all the parties.”
The fallout from sales of private deals has taken its toll. A number of broker-dealers that sold private placements issued by Medical Capital and Provident have folded.
The most prominent is Gunn- Allen Financial Inc., which sold $22.3 million of Provident private placements, according to the court filings. GunnAllen filed for bankruptcy protection in April.
E-mail Bruce Kelly at [email protected].
