Institutional Investor Securities Blog

Two securities lawsuits have been filed on behalf of shareholders and investors of JPMorgan Chase & Co. (JPM) over the financial firm’s $2 billion trading loss from synthetic credit products. According to CEO Jamie Dimon, the massive loss is a result of “egregious” failures made by the financial firm’s chief investment office and a hedging strategy that failed. Both complaints were filed on Tuesday in federal court.

One securities case was brought by Saratoga Advantage Trust -- Financial Services Portfolio. The Arizona trust is seeking to represent everyone who suffered losses on the stock that it contends were a result of alleged misstatements the investment bank had made. Affected investors would have bought the stock on April 13 (or later), which is the day that Dimon had minimized any concerns about the financial firm’s trading risk during a conference call.

Per Saratoga Advantage Trust v JPMorgan Chase & Co., the week after the call, losses from the trades went up to about $200 million a day. The Arizona Trust is accusing Dimon and CFO Douglas Braunstein of issuing statements during that conversation that were misleading and “materially false,” as well as misrepresenting not just the losses but also the risks from major bets placed on “derivative contracts involving credit indexes reflecting corporate bonds interest rates.” As a result, when the derivate bets faltered “horribly,” the company suffered “billions of dollars in lost capital,” as well as additional losses in the billions for JPMorgan shareholders in terms of market capitalization. The securities fraud lawsuit is seeking unspecified damages for investors.

The second complaint, submitted by plaintiff James Baker, is a shareholder derivative lawsuit. He is an individual investor seeking damages on behalf of JPMorgan Chase from Dimon, Braunstein and members of the bank’s board. In JPMorgan Chase & Co. v James Dimon, Baker accuses the CEO of publicly disputing that any investment safety regulation was warranted on the grounds that JPMorgan of its own accord was “purportedly so careful” with its investments. Baker says the financial firm failed to disclose that the losses were because of a “marked shift” in its “allowable risk model” and the “clandestine conversion” of a company unit, which was supposed to provide a “conservative risk-reduction function,” into one that touted high risk, short-term trading that ended up exposing JPMorgan to huge losses.

Baker who is charging bank officers and directors with waste of corporate assets, breach of fiduciary duty, and unjust enrichment, is seeking unspecified damages from the bank officers and directors. He also wants a court order mandating that JPMorgan install two shareholder representatives on its board, let shareholders vote on proposals regarding enhancing board supervision, and test internal audit and control policies to make sure that they immediately notify management about trading risks that are not acceptable.

If you are an investor that has lost money because of JPMorgan’s $2 Billion trading loss, please contact our securities fraud lawyers at Shepherd Smith Edwards and Kantas, LTD, LLP today.

JPMorgan Shareholders Sue Dimon Over $2 Billion Loss, Bloomberg, May 16, 2012

Saratoga Advantage Trust v JPMorgan Chase & Co., Justia.com

JPMorgan Chase & Co. v James Dimon

Dimon: Investment Portfolio is 'Very Conservative’, Bloomberg, April 13, 2012

More Blog Posts:
JPMorgan Chase $2B Trading Loss Leads to Probes by the SEC, Federal Reserve, and FBI, Institutional Investor Securities Blog, May 15, 2012

Investors Want JP Morgan Chase & Co. To Explain Over $95B of Mortgage-Backed Securities, Institutional Investor Securities Blog, December 17, 2011

JP Morgan Chase To Pay $150M to Settle Securities Lawsuit Over Lending Program Losses of Union Pension Funds, Stockbroker Fraud Blog, March 26, 2012

In the wake of JPMorgan Chase’s (JPM) announcement that it lost $2 billion in a trading portfolio that is supposed to hedge against the risks that it takes against its own money, the Securities and Exchange Commission, the Federal Bureau of Investigation, the Federal Reserve and other regulators are launching their respective investigations to find out exactly what happened. JPMorgan is the largest bank in the US.

As the financial firm’s stock plummeted nearly 7% in after-hours trading after the announcement, its CEO, Jamie Dimon, attributed the losses to “many errors, sloppiness and bad judgment." He also said that the portfolio, which consisted of derivatives, ended up being “riskier” and not as effective as an economic hedge as the financial firm had previously thought. Also seeing drops in their stocks following JPMorgan’s announcement of its massive trading loss were other banks, including Bank of America (BAC), Morgan Stanley (MS), Citigroup (C) and Goldman Sachs (GS)http://www.securities-fraud-attorneys.com/.

Now, the SEC and other regulators are looking into whether possible civil violations were involved in JPMorgan’s massive loss. The Commission had recently opened a preliminary probe into the financial firm’s public disclosures about its trades and accounting practices. According to The New York Times, questions regarding JP Morgan’s chief investment office, which is in charge of its hedging activities, were raised in April following reports that a trader in London was taking large bets that were “distorting the market.” Dimon, at the time, dismissed worries about the bank’s trading activities.

The FBI is also looking into potential wrongdoing related to the $2 trading loss.

Known for its excellence in trading until now and earning up to $5.4 billion of securities gains last year, JPMorgan’s chief investment office has now seen a reversal of fortune. Per The New York Times, the financial firm’s problems may have begun with its bond portfolio, which was valued at $379 billion in March. Just 30% of the portfolio had been invested in securities that the federal government had guaranteed—a change from 2010 when government guaranteed bonds made up 42% of the portfolio.

Signs of trouble with JPMorgan’s trading strategy started to brew at the end of March when the market went against corporate bonds. Yet during its first-quarter earnings call in mid-April, Dimon did not give any indication that there were problems with the bank’s trading.

Last week, however, Dimon told a different story by announcing the $2 billion trading loss. He said the investment bank’s problems were caused in part by its value-at-risk measure, which underestimated the losses on hedge funds that depended on credit derivatives. Yet were the trades even actual hedges? Banks have been known to perform elaborate trades that at first seemed to be a hedge but eventually become a bad bet.

SEC Opens Review of JP Morgan, The Wall Street Journal, May 11, 2012

F.B.I. Begins Preliminary Inquiry Into JPMorgan, The New York Times, May 15, 2012

JPMorgan Chase Discloses $2 Billion Trading Loss, NPR/AP, May 11, 2012

More Blog Posts:
Investors Want JP Morgan Chase & Co. To Explain Over $95B of Mortgage-Backed Securities, Institutional Investor Securities Blog, December 17, 2011

Washington Mutual Bank Bondholders’ Securities Fraud Lawsuit Against J.P. Morgan Chase & Co. is Revived by Appeals Court, Institutional Investor Securities Blog, June 29, 2011

JP Morgan Chase To Pay $150M to Settle Securities Lawsuit Over Lending Program Losses of Union Pension Funds, Stockbroker Fraud Blog, March 26, 2012

Continue reading "JPMorgan Chase $2B Trading Loss Leads to Probes by the SEC, Federal Reserve, and FBI" »

The U.S. Court of Appeals for the Second Circuit has affirmed a lower court’s decision to not grant the petition of two pension funds asking to certify a class action of investors that allegedly suffered financial losses in mortgage-backed securities. The Second Circuit said that the Lower Court did not abuse its discretion by denying the motion for class certification.

The institutional investment fraud cases were argued together at both the district court and appeals court levels but have never been officially consolidated. In both mortgage-backed securities lawsuits, the lead plaintiffs—both pension funds—are accusing their respective defendants of making misleading and false statements in the different MBS prospectuses. They are seeking to recover their losses.

Although the MBS that the plaintiffs had purchased were given AAA credit ratings for the majority of the tranches, the delinquency and default rates in the underlying mortgages would go on to dramatically go up. The ratings agencies then went on to downgrade most of these tranches.

The plaintiffs are claiming that the defaults are an indicator that the subcontractors and issuers failed to follow underwriting guidelines. If this is true, then there were false statements in the registration statements at the time the MBS were bought.

While the plaintiffs had made their claims under the 1933 Securities Act’s Sections 11, 12, and 15, the appeals court said that only claims under Section 11 needed to be discussed, as the claims under the other two sections were derivatives of the Section 11 claims. Under Section 11, a prima facie case has to have proof that a registration statement included material misstatements or omissions. However, since it isn’t a fraud provision, a culpable mental state on the issuer’s part is not required.

Section 11 claims are subject to an affirmative defense in that the issuer can show that when the acquisition took place the buyer had knowledge about a specific omission or untruth. The district court held that to determine whether each buyer had knowledge of specific untruths or omissions at the time of purchase, individual inquiries overriding the common issues would be needed. This holding was affirmed by the appeals court. The second circuit also said that the district court only looked at the facts “on the limited record available on this case.” It noted that district court judge, Harold Baer Jr. has since this decision not to certify the plaintiffs in these two cases granted class certification in similar litigation. (Public Employees’ Retirement System of Mississippi v. Goldman Sachs Group)

The appeals court said that its review was limited to the class definition rejected by the lower court judge and to the record the way it was when the motion to certify was made. It said the appeals determination was “without prejudice to further motion practice in the district court on the matter.”

New Jersey Carpenters Health Fund v. RALI Series 2006-QO1 (PDF)

Boilermaker Blacksmith National Pension Trust v. Harborview Mortgage Loan Trust 2006-4 (PDF)

More Blog Posts:
Morgan Stanley Sued by MetLife for Securities Fraud Over $757 Million in Residential Mortgage-Backed Securities, Institutional Investor Securities Blog, April 28, 2012

H & R Block Subsidiary Option One Mortgage Corporation to Pay $28.2M to Residential Mortgage-Backed Securities Investors, Institutional Investor Securities Blog, April 25, 2012

FDIC Objects to Bank of America’s Proposed $8.5B Settlement Over Mortgage-Backed Securities, Stockbroker Fraud Blog, August 30, 2011

$63 Million Mortgage-Backed Securities Lawsuit Against Bank of America is Second One Filed by Western and Southern Life Insurance Co. Against the Financial Firm, Institutional Investor Securities Blog, August 29, 2011

Continue reading "Court Rules that Victims of Fraudulent Sales of Derivative Securities Must File Separate Claims - No Class Action Allowed" »

Speaking before the Private Equity International Private Fund Compliance Forum, Securities and Exchange Commission Office of Compliance Inspections and Examinations Director Carlo di Florio reminded the audience that investment advisers are fiduciaries to advisory clients, including client funds. He made his comments just as the SEC is preparing to start overseeing large private equity firm advisors. Di Florio was careful to emphasize that the views he was sharing were his own.

Per the Dodd Frank Wall Street Reform and Consumer Protection Act, private equity fund advisors must now register with the SEC. In the wake of this requirement, there are now nearly 4,000 investment advisers registered with the SEC. These private fund advisers offer advise on nearly 31,000 private funds with $8 trillion in assets.

Di Florio talked about how it was the responsibility of advisors of private equity firms to fairly allocate their expenses and fees. He said must pinpoint any conflicts related to the structure and kinds of investments that their funds usually make and ensure that these conflicts are correctly “mitigated and disclosed.” Regarding the need for pooled investment vehicle advisors to make sure that material facts are disclosed to current and potential investors, he said that to do otherwise could constitute securities fraud.

Compliance obligations that large private equity firm advisors must fulfill include:
• Per the “Compliance Rule,” implement written procedures and policies designed to stop violations of the Advisers Act and the rules adopted by the SEC under that act.

• Per the “Books and Records Rule,” ensure that books and records are accurate.

• Annual completion of Form ADV registration forms

• As designated by the “Code of Ethics Rule,” adopt an ethics code that establishes standards of business conduct

• Abide by the “Advertising Rule” and not issue any false or misleading advertisements with any statements of material fact that are not true.

Di Florio also spoke about how it was the responsibility of private equity fund advisers to assess their risk management processes. This includes determining whether the firm has an assurance program that is independent, the business units are able to effectively handle risks at the fund level, and the organization has the proper structure and staff in place to adequately establish its risk parameters. He said that it was important to develop a culture of effective risk management, supervise risk-based compensations systems, and ensure that essential compliance, control, and risk management functions are properly integrated into the organization’s structure while still retaining the necded autonomy to be able to manage, identify, and mitigate risk.

Regarding National Exam Program's risk-based approach in looking at registered advisers, he spoke of several “risk characteristics” that would likely be examined, including key personnel changes, the regulatory history of a firm or its staff, and material changes involving business activities. As risk-based analysis might apply to private equity during an examination, he said that the strategy of the fund, investor disclosures about “ancillary fees, and the reliability and sophistication of the funds’ processes would be among the factors likely examined.

Contact Shepherd Smith Edwards and Kantas, LTD LLP today. Our securities fraud attorneys represent investors that have suffered losses because a broker-dealer, broker, or investment adviser did not meet their fiduciary obligations to these clients.

Address at the Private Equity International Private Fund Compliance Forum by Carlo V. di Florio, SEC, May 2, 2012

More Blog Posts:
FINRA May Put Forward Another Proposal About Possible SEC Rule Regarding Fiduciary Duty, Institutional Investor Securities Blog, November 28, 2011

Don’t Create Uniform Fiduciary Standard for Broker-Dealers and Investment Advisers, Say Some Republicans to the SEC, October 7, 2011

AARP, Investment Adviser Association, Among Groups Asking the SEC to Make Brokers Abide by 1940 Investment Advisers Act’s Fiduciary Duty, Stockbroker Fraud Blog, April 14, 2012

The 11th U.S. Circuit Court of Appeals has revived the US Securities and Exchange Commission’s fraud lawsuit against Morgan Keegan & Co. accusing the financial firm of allegedly misleading investors about auction-rate securities. The federal appeals court said that a district judge was in error when he found that alleged misrepresentations made by the financial firm’s brokers were immaterial. The case will now go back to district court. Morgan Keegan is a Raymond James Financial Inc. (RJF) unit.

The SEC had sued Morgan Keegan in 2009. In its complaint, the Commission accused the financial firm of leaving investors with $2.2M of illiquid ARS. The agency said that Morgan Keegan failed to tell clients about the risks involved and that it instead promoted the securities as having “zero risk” or being “fully liquid” or “just like a money market.” The SEC demanded that Morgan Keegan buy back the debt sold to these clients.

In 2011, U.S. District Judge William Duffey ruled on the securities fraud lawsuit and found that Morgan Keegan did adequately disclose the risks involved. He said that even if some brokers did make misrepresentations, the SEC had failed to present any evidence demonstrating that the financial firm had put into place a policy encouraging its brokers-dealers to mislead investors about ARS liquidity. Duffey pointed to Morgan Keegan’s Web site, which disclosed the ARS risks. He said this demonstrated that there was no institutional intent to fool investors. He also noted that a “failure to predict the market” did not constitute securities fraud and that the Commission would need to show examples of alleged broker misconduct before Morgan Keegan could be held liable.

Citing the US Supreme Court’s ruling in Basic v Levinson, the circuit court found that the misleading statements made by Morgan Keegan brokers and the alleged failure to reveal the known risks involving ARS could have easily been perceived by a reasonable investor to be a modification of the information about ARS that Morgan Keegan had made available. The 11th circuit panel also said that seeing as Morgan Keegan knew there were auctions that were failing in 2007 and early 2008, giving clients "general cautionary language" about the debt behind trading confirmations was not enough. (Although the panel agreed that a written disclosure of the risks involved could trump any sales pitch omissions, it pointed to circuit precedent, which did not allow this “as a matter of law.”)

The appeals court rejected the district judge’s narrow focus on how many alleged victims there might have been, as well as his emphasis on the Commission having to prove institutional intent.

Investors were left in a financial bind when the $330 billion ARS market froze in February 2008. They could not get their now frozen money from this largely, illiquid debt, which was a shock to them seeing as most of them were told that auction-rate securities were liquid, like cash. Morgan Keegan and other financial firms have since been pursued by regulators, as well as investors seeking financial recovery.

Over the last few years, a number of financial firms have had to pay back billions in dollars of ARS to their clients. Our auction-rate securities lawyers have been helping investors recover such losses. Contact Shepherd Smith Edwards and Kantas, LTD, LLP today.

Broker Omissions Could Doom Morgan Keegan, Courthouse News Service, May 7, 2012

Fraud lawsuit vs Morgan Keegan revived, Chicago Tribune, May 2, 2012

SEC v. Morgan Keegan & Co., 11th U.S. Circuit Court of Appeal (PDF)

More Blog Posts:
Oppenheimer & Co. Must Buyback $6M in Auction-Rate Securities from Investor, Says FINRA Arbitration Panel, Institutional Investor Securities Blog, January 11, 2012

Raymond James Financial to Buy Morgan Keegan from Regions Financial for $930 Million, January 14, 2012

Texas Securities Fraud: Raymond James Financial Services Pays Elderly Senior Investor About $1.8M Following Loss of Appeal, Stockbroker Fraud Blog, December 2, 2011

According to Securities and Exchange Commission Enforcement Director Robert S. Khuzami, the restructuring that has recently taken place at that agency’s division is allowing the SEC to not just improve the quality of its efforts but also its results. He spoke at a Practicing Law Institute conference earlier this month.

Not only has the enforcement division set up several specialized units that are each assigned a specific area of enforcement to focus on, but also market specialists from the private sector have been hired. Khuzami also said that the SEC has improved its handling of complex securities cases and is now detecting signs of alleged wrongdoing sooner.

In the last fiscal year, the Commission has opened 735 enforcement cases—a record number—and imposed $3 billion in penalties and disgorgement against alleged offenders. Moving forward, the Commission intends to continue placing a lot of its attention on going after parties that committed securities laws violations related to the economic crisis of 2008. The SEC has so far initiated 107 such securities cases. 74 of these are against individuals.

Khuzami also noted that non-prosecution agreements, deferred prosecution deals, and cooperation agreements, which were first created in early 2010, have been helpful in not just resolving some securities cases more swiftly, but also in allowing investigators to pinpoint certain complex fraud cases. (Deferred prosecution and non-prosecution agreements are deals in which the SEC agreed not to issue an enforcement action in exchange for those suspected of wrongdoing agreeing to work with the SEC, as well as executing any stipulated actions. Cooperation agreements are deals involving where parties that helped with enforcement actions and investigations are given credit). The Commission has entered into over three dozen cooperation agreements already, and more deals, involving deferred prosecution, are expected.

Khuzami also touted the SEC’s whistleblower program, which he says has been getting several quality submissions a day from parties with what appear to be valid claims. David Rosenfeld of the SEC’s New York regional office, who also spoke at the conference, said that pursuing those involved in insider trading was another SEC priority.

Also presenting at the conference were US Department of Justice officials. They said that they are continuing to look for leads in areas of securities law that were considered high priority (insider trading, Ponzi scams, large investment fraud, bank fraud, and market manipulation.) The Justice Department is using a number of tools, including wiretaps and court-ordered telephone surveillance techniques, as part of their enforcement efforts.

At Shepherd Smith Edwards and Kantas, LTD, LLP, we consider it our job to help investors of securities fraud to recoup their losses. Working with an experienced securities fraud law firm increases your chances of financial recovery and of getting back as much of your investment loss as is possible. Contact our SEC securities fraud lawyers today.

SEC Restructuring, DOJ Tactics Improving Securities Enforcement Results, Officials Say, Bloomberg/BNA Daily, April 19, 2012

Enforcement 2012: Multi-Agency Enforcement Efforts, Practicing Law Institute, May 2, 2012

More Blog Posts:
Montford Associates to Pay $650,000 in Securities and Exchange Commission Penalties Over Failure to Disclose Payments from Hedge Fund, Institutional Investor Securities Blog, April 30, 2012

Goldman Sachs to Pay $22M For Alleged Lack of Proper Internal Controls That Allowed Analysts to Attend Trading Huddles and Tip Favored Clients, Institutional Investor Securities Blog, April 14, 2012

In SEC v. SinoTech Energy Ltd., Securities and Exchange Commission is suing SinoTech Energy Ltd. (CTESY), a Chinese oil field services company, for securities fraud. According to the Commission, SinoTech allegedly made misrepresentations about how its IPO proceeds were used, as well as misrepresented its assets’ value. The company also is accused of repeatedly deceiving both investors and the SEC, the latter with filings it submitted to the Commission in 2010 and 2011.

Per the SEC’s complaint, SinoTech claimed that $120 million of its IPO proceeds would be used to purchase lateral hydraulic drilling units when it spent less than $17 million to buy them. Also, its chairman, Qingzeng Liu, has admitted to skimming $40 million from a company bank account. This monetary withdrawal allegedly was not noted in SinoTech’s records or books. The Commission wants injunctive relief, disgorgement, and penalties from SinoTech and its chairman.

In other Global investment news, the 11th Circuit Appeals Court has decided to reinstate the unjust enrichment and racketeering claims made by investors over an alleged financial fraud involving City Group, which is based primarily in India, and the company’s affiliates in the US. The plaintiffs, Virendra Rajput and Mansingh Rajput, are claiming that they suffered financial losses after investing in a network of firms with ties to the Masood family. Rajput and Rajput are accusing the family of keeping the investments, running a financial racket, and never having intended to issue the payouts of high return rates that they promised investors. The two of them are also alleging that City Group’s US branches were set up to launder money from the scam in India.

The district court had dismissed the plaintiffs’ claims, but the appeals court vacated and remanded that decision. The 11th circuit found that dismissal of the claims is prevented by the plaintiffs’ pleadings, which “sufficiently” link the defendants to the alleged financial scam in India and their unjust enrichment.

Meantime, the European Commission wants to delay the implementation of new derivatives dealer registration rules over US swaps. According to the EC, the rules are causing confusion for European Union banks with operations in this country. The EC is seeking clarity regarding how the swap dealer registration rules would work with new EU rules that are pending. Concerns certain reforms potentially conflicting with one another and the potentially repercussions this might create.

Also in Europe, the Swiss government is looking to implement new rules regarding collective investment scams with the hope that these regulations will help brings its practices in alignment with the EU. The proposal would amend the country’s Collective Investment Schemes Act, which govern collective capital investment assets managers, and align them with the EU’s Directive on Alternative Investment Funds Managers.

The proposed amendments have been sent to Switzerland’s parliament. If all goes as planned, it would win lawmakers’ approval in the fall, be subject to a national referendum, and go into effect next year.

Contact Shepherd Smith Edwards and Kantas, LTD, LLP today to speak with an experienced institutional investment fraud lawyer.

SEC v. SinoTech Energy Ltd. (PDF)

Rajput v. City Trading LLC (PDF)

European Commission Calls for Delay in Implementation of U.S. Derivatives Regulationshttp://www.globallawwatch.com/2012/04/european-commission-calls-for-delay-in-implementation-of-u-s-derivatives-regulations/, Bloomberg/BNA, April 30, 2012

Amendment of the Collective Investment Schemes Act in response to the EU's AIFM Directive, News.Admin.Ch, November 3, 2011

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Stockbroker Fraud Roundup: SEC Issues Alert for Broker-Dealers and Investors Over Municipal Bonds, Man Who Posed As Investment Adviser Pleads Guilty to Securities Fraud, and Citigroup Settles FINRA Claims of Excessive Markups/Markdowns, Stockbroker Fraud Blog, April 10, 2012

Commodities/Futures Round Up: CFTC Cracks Down on Perpetrators of Securities Violations and Considers New Swap Market Definitions and Rules, Stockbroker Fraud Blog, April 20, 2012

SEC Institutional Round Up: Whistleblower Bounty Program May Be Reviving Internal Fraud Reporting Mechanisms and Investor Advocacy Group Wants Ban on Accounts Allowing Dually Registered Advisers and Brokers to Give Advice, Institutional Investor Securities Blog, April 20, 2012

The SEC has ordered investment adviser Montford Associates and Ernest Montford Sr. to pay $650K in penalties for failing to disclose that it had received $210K from an allegedly fraudulent hedge fund that it had recommended to clients. The name of the fund is SJK Investment Management. Its owner, Stanley Kowalewski, is accused of using the fund to commit a $16.5 million fraud. Investors that put their money in the fund included the Tallulah Falls School’s endowment program, St. Joseph’s/Candler Hospital System, Georgia Ports Authority, Sea Island Co. Retirement Plan, and Savannah Country Day School Foundation.

Although Montford Associates and Ernest Montford are not accused of involvement in Kowalewski’s securities fraud, the two of them allegedly lied to investors by not telling them about the compensation they were getting for the referrals. Montford and his investment adviser firm were paid "marketing and syndication fees” and “consulting services.”

The SEC contends that failure to disclose the payments for the recommendations violates federal securities laws. The Commission also says that even though Montford was aware that these nonprofits, many of them charitable organizations and schools, were run by part-time volunteers that depended on his investment advice and he knew they wanted consistent, stable investments, he still pushed them to move their investments to SJK so that Kowalewski could manage their money.

In addition to the $650,000 penalty, Montford Associates and Montford must pay disgorgements of $130,000 and $80,000, each with prejudgment interest. They also must set up a Fair Fund so that their clients that were harmed can use the penalties and disgorgement. Both must also cease and desist from committing/causing future violations of the Advisers Act and Advisers Act Rule 204-1(a)(2). Montford also is barred from associating with brokers, investment advisers, municipal securities dealers, dealers, transfer agents, municipal advisors, and nationally recognized statistical rating organizations.

As for the SEC’s hedge fund fraud case against Stanley Kowalewski, the Commission is accusing the hedge fund manager of using millions of dollars in client funds to buy his residence and a beach home and directing $10 million in unfounded fees to his investment management company and himself. He allegedly tried to hide his financial scam by sending fraudulent account statements to investors each month. These updates grossly exaggerated the actual values of assets and returns.

SEC Fines Adviser Over Ties To Hedge Fund Accused Of Fraud, FINalternatives.com, April 30, 2012

Securities and Exchange Commission v. Stanley J. Kowalewski, et al, Case No. 1:11-cv-00056-TCB (N.D. Ga.), SEC.gov, August 29, 2011

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Institutional Investor Fraud Roundup: SEC Seeks Approval of Settlement with Ex-Bear Stearns Portfolio Managers, Credits Ex-AXA Rosenberg Executive for Help in Quantitative Investment Case; IOSCO Gets Ready for Global Hedge Fund Survey, Institutional Investor Securities Fraud, March 29, 2012

Insider Trading: Former FrontPoint Partners Hedge Fund Manager Pleads Guilty to Criminal Charges, Institutional Investor Securities Fraud, August 20, 2011

Silicon Valley Man Faces SEC Securities Fraud Charge After Allegedly Bilking Internet Start-Up Investors of the “Next Google” of Millions, Stockbroker Fraud Blog, April 19, 2012

Continue reading "Montford Associates to Pay $650,000 in Securities and Exchange Commission Penalties Over Failure to Disclose Payments from Hedge Fund " »

Metlife (MET) is suing Morgan Stanley (MS) for securities fraud. According to Bloomberg, the insurance company bought over $757 million in residential mortgage-backed securities from the financial firm in 2006 and 2007. In the institutional investment fraud lawsuit, Morgan Stanley had vouched that the properties behind the loans were “accurately appraised” and that the loans met underwriting guidelines. The insurer, however, contends that the loans’ originators were actually some of the subprime lending industry’s “worst culprits.”

The RMBS lawsuit comes right after MetLife agreed to pay half a billion dollars to settle a probe by a number of states over its payment practices. The investigation involves the Social Security "Death Master" file, which includes a list of names of people who have recently passed away. Insurance companies are accused of using the list to stop issuing to dead clients their annuity payments and not using the list to confirm that life insurance policyholders had died.

MetLife announced on Thursday that it was leaving the reverse mortgage industry. Nationstar Mortgage LLC (NSM) will buy its portfolio. The move is a big change for the insurance company, which had been the market leader.

Meantime, Morgan Stanley has been battling other residential mortgage-backed securities lawsuits. Earlier this year, Sealink Funding Ltd. filed a case against it over more than $556 million in RMBS that it purchased. Sealink Funding, a European fund, was set up to manage Landesbank Sachsen AG’s most high-risk assets.

The fund bought the securities from Morgan Stanley after the financial firm said it had done its due diligence on the lenders of the investments and that the loans satisfied underwriting standards and merited their AAA ratings. Sealink called the loans’ originators among the subprime lending industry’s “worst culprits.”

Last year, Allstate Insurance Co. (ALL) filed its RMBS lawsuit against Morgan Stanley over more than $104 million in RMBS it bought in several offerings. The insurer’s contention over reassurances the financial firm made about the securities is similar to the allegations made by Sealink and Metlife. Allstate has also filed RMBS lawsuits against other financial firms, including Merrill Lynch (MER) units, Citigroup Inc. (C), and Bank of America Corp.'s (BAC) Countrywide.

As previously noted by SEC Enforcement director Robert Khuzami, mortgage products played a crucial role in the financial crisis that began a few years ago. Unprecedented losses resulted when mortgage-backed securities failed. Many institutional investors are still trying to recover. They claim they were misled about the risks involved and they want their money back.

MetLife Pays $500 Million To Settle Probe Into Unpaid Claims For Dead Policy Holders, Huffington Post, April 23, 2012

MetLife to pay $500 million in multi-state death benefits probe, Los Angeles Times, April 23, 2012

Morgan Stanley Sued by Allstate on Mortgage Claims, Bloomberg, August 18, 2011

More Blog Posts:
H & R Block Subsidiary Option One Mortgage Corporation to Pay $28.2M to Residential Mortgage-Backed Securities Investors, Institutional Investor Securities Blog, April 25, 2012

Bank of New York Mellon Corp. Must Contend with Pension Fund Claims Over Countrywide Mortgage-Backed Securities, Institutional Investor Securities Blog, April 10, 2012

Continue reading "Morgan Stanley Sued by MetLife for Securities Fraud Over $757 Million in Residential Mortgage-Backed Securities" »

In the wake of criticism that the Securities and Exchange Commission has not done enough to assess its rules’ economic impact, its Office of the General Counsel and Risk, Strategy, and Financial Innovation Division is providing staff with guidance that it needs to conduct a more thorough economic analysis during the entire rule writing process. One of the requirements is that there must be a cost-benefit evaluation when rules that are congressionally mandated or discretionary are involved. This guidance is now binding.

However, SEC Chairman Mary Schapiro was quick to point out to the House Oversight Subcommittee on TARP and Financial Services that many of the rules that are written already follow this guidance. Now, staff will assess the cost-benefits of 28 rules that the Commission is proposing in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The guidance comes following a report that was issued in January. In it, the Office of the Inspector General blamed the SEC for not conducting cost-benefit analysis when writing Dodd-Frank mandated rules. In addition to providing more comprehensive cost-benefit analysis, the SEC must also note the justification for the proposed rule, identify reasonable options to the rule, evaluate any economic repercussions, and find a baseline point for beginning the analysis. The SEC will be hiring more than three dozen economists to join its staff. If the Commission ends up being able to properly implement this guidance, then Congress may have to legislate.

Commenting on this recent development, Shepherd Smith Edwards and Kantas, LTD, LLP Partner and Institutional Investment Fraud Lawyer William Shepherd said, “How high should the cost of regulations be on a mega-billion dollar industry with record profits in a recession after just ripping off investors worldwide for trillions of dollars because of lack of regulations? Wall Street is an industry of whiners who thinks they are the victims because the cops say slow down in a construction zone or school district.”

Rep. Scott Garrett (R-NJ), who authored HR 2308, the SEC Regulatory Accountability Act that similarly seeks to enhance the Commission’s cost-benefit analysis in similar fashion as the guidance, still plans to keep pushing for his bill’s passage. HR 2308 made it through the House Financial Services Committee a couple of months ago.

Garrett would prefer for the cost-benefit mandate to become statute so that the requirements that the SEC must meet are clear, which should hopefully ensure that any rules the Commission does end up writing doesn’t slow economic growth. Garrett’s spokesperson sent BNA an email stressing that another reason it was important for the order to become law rather than mandated SEC guidance is that that future SEC chairmen might choose not to adhere to it.

Our securities fraud attorneys at Shepherd Smith Edwards and Kantas, LTD, LLP represent institutional and individual investors throughout the United States.

New SEC Guidance Directs Staff to Enhance Cost-Benefit Analysis in Rulewriting Process, Bloomberg/BNA, April 18, 2012

Garrett Urges SEC Chairman to Support Cost-Benefit Analysis, US Congressman Scott Garrett, Congressman Garrett, April 25, 2012

Office of the General Counsel and Risk, Strategy, and Financial Innovation Division

More Blog Posts:
Broker Fiduciary Rule Delayed by Cost-Benefit Analysis, SEC Says, Institutional Investor Securities Blog, March 7, 2012

FINRA May Put Forward Another Proposal About Possible SEC Rule Regarding Fiduciary Duty, Institutional Investor Securities Blog, November 28, 2011

Advisory Performance Fee Rule Limit Adjusted by the SEC, Stockbroker Fraud BLog, July 30, 2011

H & R Block (HRB) subsidiary Option One Mortgage Corporation has agreed to pay $28.2 million to settle Securities and Exchange Commission charges that it misled investors in over $4B in residential mortgage-backed securities when it failed to let them know that the company’s financial health was deteriorating. According to the SEC, Option One, which is now called Sand Canyon Corporation, promised these investors that it would replace or buy back mortgages that breached warranties or misrepresentations, even though it was unlikely that the mortgage lender would be able to fulfill these obligations.

Leading up to the 2007 fiscal year, Option One had originations of $40 billion during the year prior and was among the country’s largest mortgage lenders, originating and selling subprime loans through whole loan pool sales and market securitization in the secondary market. During this period, to be able to fulfill its buyback commitments and margin calls, it needed for H & R Block to give it financing under a credit line. However, Block wasn’t obligated to give Option One this funding, which is a fact that the mortgage lender neglected to tell its RMBS investors. When its revenues started to drop and it sustained substantial losses as the subprime mortgage market began to fail during the summer of 2006, Option One’s creditors started to ask for hundreds of millions of dollars in margin calls. (The SEC also claims that the mortgage lender’s losses were a threat to H & R Block’s credit rating while the tax service provider was negotiating its sale. Option One was sold by H & R Block to Wilbur Ross for about $1 billion.)

To settle the SEC allegations over RMBS fraud, Option One will not only pay the $28.2 million (A $10 million penalty, $14,250,558 in disgorgement, and $3,982,027 in prejudgment interest), but also, it has consented to a permanent order entry enjoining it from Securities Act of 1933 Sections 17(a)(2) and 17(a)(3) violations. The mortgage lender isn’t, however, denying or admitting to the charges.

Commenting on this RMBS case, SEC Division of Enforcement’s Structured and New Products Unit Chief Kenneth Lench spoke about the Commission’s commitment to act against parties that neglect to reveal pertinent facts that up an investment’s risk, even if the risks never becomes a reality. The SEC has been pursuing those believed to engaged in misconduct related to RMBS and other complex financial instruments.

The SEC isn’t the only one to sue Option One. In 2011, the mortgage lender settled Massachusetts securities charges against it by agreeing to pay $9.8 million in restitution and $115 million in loan modifications.

Read the SEC's complaint (PDF)

Ex-H&R Block Unit Agrees To Pay $28.2 Mln To Settle SEC Charges, The Wall Street Journal, April 24, 2012

More Blog Posts:
Residential Mortgage-Backed Securities Working Group Brings Federal Investigators and State Law Enforcement Officials Together to Investigate How MBS Abuses Contributed to 2008 Financial Crisis, Institutional Investor Securities Blog, January 30, 2012

Federal Home Loan Banks Say Countrywide Financial Corp Mortgage Bond Investors May Be Owed Way More than What $8.5B Securities Settlement with Bank of America Corp. is Offering, Institutional Investor Securities Blog, July 22, 2011

FDIC Objects to Bank of America’s Proposed $8.5B Settlement Over Mortgage-Backed Securities, Stockbroker Fraud Blog, August 30, 2011

Continue reading "H & R Block Subsidiary Option One Mortgage Corporation to Pay $28.2M to Residential Mortgage-Backed Securities Investors " »

Per BDO Consulting and Network Inc.’s Quarterly Corporate Fraud Index, the Securities and Exchange Commission's new whistleblower bounty program may be indirectly leading to a resurgence in corporate internal reporting mechanisms. The index recently reported that during 2011’s fourth quarter, there was a jump in internal reports from employees about fraud incidents. This represented about 21.6% of all compliance issues that are reported internally.

Reports related to fraud involve possible asset misuse, audit and accounting improprieties, and violations of the Foreign Corrupt Practices Act. Network CEO Luis Ramos told BNA that these high reporting numbers may be a result of overhauled processes that the organizations implemented in the wake of the establishment of the whistleblower bounty program, which was mandated by the the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act mandated. Changes have included revisions to anti-retaliation policies and better communication with the employees making the complaints. Many organizations also have now implemented predetermined investigative templates and processes, which allow them to more swiftly respond to a complaint.

Fear of punishment by an employer is one reason many employees prefer to report alleged wrongdoing to an outside source rather than internally. Also, the whistleblower bounty program aims to reward 10-30% of monetary penalties to the person who filed the initial report when the penalty against the offending party is greater than $1 million, which is proving to be additional incentive for going to the SEC. However, it is not a good idea to attempt to pursue your whistleblower case on your own. Our whistleblower recovery lawyers at Shepherd Smith Edwards and Kantas, LTD, LLP will be happy to provide you with a no obligation consultation. You can also visit our SEC Whistleblower Recovery Center online today.

In other SEC-related news, The Derivatives Project, which is an investor advocacy group, is petitioning the Commission to get brokerage firms to stop offering wrap accounts in which investment advisers and broker-dealers that are dually registered are both allowed to offer investment advice. The group says that this is leading to an “abuse of legal rights” for retail retirement investors, who are left “without a legal due process” that would allow them to use the Investment Advisers Act to make valid breach of fiduciary duty claims. It wants the SEC to bar mandatory arbitration clauses for any retail retirement accounts and implement a private right of action for account holders.

The Derivatives Project also believes that there are deficiencies in the Financial Industry Regulatory Authority’s enforcement structure and that this has led to securities law violations. For example, the investor advocacy group has problems with the SRO’s “arbitrary” decision to stop enforcing the fiduciary standard when it comes to investment advice involving Wrap Accounts that are dually registered. They believe that FINRA’s position is a violation of an appeals court’s ruling in Financial Planning Association v. SEC. There, the DC court found that the SEC went outside its authority when it introduced a rule that exempts broker-dealers that give investment advice to fee-based account clients from regulation under the Advisers Act.

SEC Whistleblower Recovery Center

Quarterly Fraud Index

The Derivative Project's Petition (PDF)

The Derivative Project

More Blog Posts:
SEC’s Office of the Whistleblower In Early Phase of Evaluating Reward Claims, Institutional Investor Securities Blog, March 23, 2012

SEC Looking at Other Ways to Communicate with Whistleblowers, Institutional Investor Securities Blog, September 14, 2011

ISS Probes Allegations that a Boston Employee Sold Shareholder Information, Stockbroker Fraud Blog, February 21, 2012