U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 22064 / August 10, 2011
Securities and Exchange Commission v. Stifel, Nicolaus & Co., Inc. and David W. Noack, Civil Action No. 2:11-cv-00755-AEG, United States District Court, Eastern District of Wisconsin
SEC CHARGES STIFEL, NICOLAUS AND FORMER EXECUTIVE WITH FRAUD IN SALE OF INVESTMENTS TO WISCONSIN SCHOOL DISTRICTS
The Securities and Exchange Commission today charged Stifel, Nicolaus & Co., Inc., a St. Louis-based broker-dealer, and former Stifel Senior Vice President David W. Noack with defrauding five Wisconsin school districts by selling them unsuitably risky and complex investments funded largely with borrowed money.
Filed in the U.S. District Court for the Eastern District of Wisconsin, the SEC’s complaint alleges that Stifel and Noack created a proprietary program to help the school districts fund retiree benefits by investing in notes linked to the performance of synthetic collateralized debt obligations (CDOs). The school districts established trusts that invested $200 million in three transactions from June to December 2006, paid for largely with borrowed funds. According to the SEC’s complaint, Stifel and Noack misrepresented the risk of the investments and failed to disclose material facts to the school districts. In the end, the investments were a complete failure, but generated significant fees for Stifel and Noack.
According to the SEC’s complaint, the five school districts are the Kenosha Unified School District, Kimberly Area School District, School District of Waukesha, West Allis-West Milwaukee School District, and Whitefish Bay School District. The SEC alleges that Stifel and Noack made sweeping assurances to the school districts, misrepresenting that it would take “15 Enrons” – a catastrophic, overnight collapse – for the investments to fail. They also misrepresented that 30 of the 105 companies in the portfolio would have to default and that 100 of the top 800 companies in the world would have to fail before the school districts would suffer a loss of their principal.
The SEC alleges that among material facts that Stifel and Noack failed to disclose were the portfolio in the first transaction performing poorly from the outset, credit rating agencies placing 10 percent of the portfolio on negative watch within 36 days of closing, and certain CDO providers expressing concerns about the risks of Stifel’s proprietary program and declining to participate in it.
According to the SEC’s complaint, Stifel and Noack sold the school districts an unsuitable product that did not meet their investment needs. The school districts had no prior experience with investing in CDOs and related instruments. Stifel and Noack knew that the school districts lacked the requisite sophistication and experience to independently evaluate the risks of the investment, and knew that the school districts relied on Stifel and Noack’s recommendations. The school districts contributed $37.3 million toward the $200 million investment and borrowed the remaining $162.7 million.
The SEC alleges that the heavy use of leverage and the structure of the synthetic CDOs exposed the school districts to a heightened risk of catastrophic loss. The investments steadily declined in value in 2007 and 2008 as the CDO portfolios suffered a series of downgrades. By 2010, the school districts learned that the second and third investments were a complete loss and that the lender had seized all of the trusts’ assets. The school districts suffered a complete loss of their investment and suffered credit rating downgrades for failing to provide additional funds to the trusts they established.
The SEC alleges that Stifel and Noack violated Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The SEC also alleges that Stifel violated and Noack aided and abetted violations of Section 15(c)(1)(A) of the Securities Exchange Act of 1934. The SEC seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties.
The SEC’s investigation is continuing.