Stifel, Nicolaus & Co. and a former executive at the brokerage defrauded five eastern Wisconsin school districts through the sale of $200 million in risky investments in 2006 that turned out to be a complete bust, securities regulators said.
The St. Louis-based company, along with former senior vice president David Noack, promised the districts that it would take “15 Enrons” or “that 100 of the top 800 companies in the world would have to go under” before the school districts would lose their principal, the Securities and Exchange Commission said in its civil complaint.
Stifel and Mr. Noack knew the school districts didn't have the sophistication or experience to evaluate the risks of the program they created to fund retiree benefits through investing in notes tied to the performance of synthetic collateralized debt obligations, the SEC said in its suit, filed Wednesday in U.S. district court in Milwaukee.
“Let this be a teaching moment for sellers of complex financial products,” said Robert Khuzami, director of the SEC's enforcement division. “The sale of these products to school districts or similar investors must meet well-established standards of suitability and accurate disclosure.”
The SEC in recent months has been cracking down on firms that sold complex products to individual and otherwise unsophisticated investors before the financial collapse of 2008. Last month, the commission recommended broker-dealers boost disclosure about structured securities products after a sweep examination of 11 broker-dealers pointed out deficiencies in sales practices.
Stifel says the SEC's complaint takes statements out of context and ignores that the school districts said in writing that they were accredited investors, that they read the offering materials and that they could withstand the total loss of their investment, said
Stifel spokesman Dan Callahan.
“
Stifel went by the book in terms of disclosure,” Mr. Callahan said. “Based on what we knew in 2006, the investments were suitable.”
Stifel said the product, created by Royal Bank of Canada (RBC), had inherent structural problems that RBC hid from
Stifel and the school districts, Mr. Callahan said. Additionally, RBC made millions in undisclosed profits from the investments, many times the amount that
Stifel made in fees, he said.
“Rather than focusing on the fundamental flaws in the creation and management of the product, the SEC is unfairly blaming
Stifel as the placement agent,” Mr. Callahan said.
An RBC written statement said Stifel's claims are without merit. “We never misrepresented our estimated profit to
Stifel or the school districts. Stifel's math is flat out wrong. These transactions were not profitable for RBC,” the statement said.
A call to Mr. Noack's attorney, Ron Kane, was not returned.
The regulator alleges that
Stifel and Mr. Noack misrepresented the risk of the investments and failed to tell the school districts that the portfolio in the first transaction was performing poorly from the beginning. In fact, the SEC says that certain CDO providers had expressed concerns about the risks of Stifel's program and declined to participate.
Additionally, reliance on leverage and the structure of the CDOs exposed the districts to “a heightened risk of catastrophic loss,” the commission said. The school districts — Kenosha Unified School District No. 1, Kimberly Area School District, School District of Waukesha, the School district of West Allis-West Milwaukee, and School District of Whitefish Bay — lost their full investment and suffered credit rating downgrades, the SEC said.
Additionally, reliance on leverage and the structure of the CDOs exposed the districts to “a heightened risk of catastrophic loss,” the SEC said. The school districts borrowed $36 million of the $37.3 million paid to the investments and the trusts created to make the investments borrowed $162.7 million of the $200 million investment total, according to the complaint.
Five Wisconsin school districts named
Stifel in a Sept. 2008 lawsuit that alleged fraud and negligence from the $200 million in investments. In that case,
Stifel filed a cross-claim against RBC, alleging it intentionally misrepresented the CDOs and failed to disclose material conflicts of interest.
“Had RBC disclosed its true profit and its material conflicts of interest, based upon information and belief, S&P would not have assigned the CDOs a rating of AA-,” and without a rating of at least AA, the school district trusts would not have purchased the products,
Stifel said in its claim against RBC.
As a firm,
Stifel has quintupled its revenue since 2005 with nine acquisitions, including Legg Mason Inc.'s capital-markets business and Thomas Weisel
Partners Group Inc. It has been discussed as a possible buyer for Regions Financial Corp.'s Morgan Keegan & Co., which itself has been the subject of SEC complaints over sales of sub-prime mortgage-backed securities.
Mr. Noack worked for
Stifel from 2000 to 2007. He's been a registered representative with Robert W.
Baird & Co. Inc. in Milwaukee since February 2007, according to broker registration records kept by the
Financial Industry Regulatory Authority Inc.
Robert W.
Baird & Co. had no immediate comment and would not confirm that Mr. Noack still works there. Its website lists him as a managing director and part of the Wisconsin public finance team
