Citing Stifel, SEC's Zehner Says: Read Carefully Before Signing

SAN ANTONIO — Attorneys must read transaction documents carefully and think before signing them, Securities and Exchange Commission officials warned Thursday, citing an ongoing enforcement case against Stifel Nicolaus & Co. and one of its former executives.

“Be careful what you get your clients into,” Mark Zehner, deputy director of the SEC’s muni and public pension enforcement unit, told those attending the National Association of Bond Lawyers’ Bond Attorneys’ Workshop here. He spoke during a panel discussion about current issues in municipal securities law.

The SEC filed a securities fraud case against Stifel and its former senior vice president David W. Noak in August. The SEC charged the firm and former officer fraudulently misled five Wisconsin school districts by steering them into unsuitably risky and complex investment products to fund their non-pension retirement obligations. The investments failed but generated significant fees for Stifel, the SEC charged.

According to the complaint, the school districts established trusts to begin funding their other post-employment liabilities and in 2006, on advice from Stifel and Noak, invested $200 million in three transactions between June and December under the firm’s proprietary program.

The now-worthless investment products were linked to the performance of synthetic collateralized debt obligations that included non-investment-grade credits — information concealed from the districts, which were told the investments were sound, the SEC charged.

The districts borrowed $36 million to cover a $37.3 million cash investment to participate in the transactions and their trusts issued a collective $162.7 million of asset-backed notes supported by the districts’ moral obligation.

According to Zehner, the school districts signed closing certificates, reviewed by outside counsel, saying the districts were sophisticated investors.

But the transactions were “incredibly complicated investment packages,” Zehner said, and the school districts “lost their shirts.”

Another SEC official, who participated in the panel discussion by phone, also had a blunt message for the lawyers.

Amy Meltzer Starr, chief of the office of capital market trends in the SEC’s corporation finance division, said if you see a collateralized debt obligation, “you really want to think hard on that.”

Zehner agreed, saying he does not think the closing certificates in the Wisconsin school matter were accurate.

According to the SEC’s complaint, the transaction documents said the CDOs were only suitable for investors such as investment banks, pension funds, insurance companies, securities firms, large international or supranational organizations or other entities, including treasuries and finance companies of large enterprises “which are active on a regular and professional basis in the financial markets for their own account.”

Zehner also suggested attorneys should play a more active role than reviewing transaction documents for stylistic errors.

“I don’t care whether the language was grammatically correct,” he said. “You’ve still got to lift your head and say, why is my client being asked to sign these big-boy kind of certificates?”

In an interview, Zehner said he wanted to send a message that attorneys must focus on taking care of their clients – meaning state and local governments.

“At some time, think about what you sign,” Zehner said. “That’s the bottom line.” 

Last month, RBC Capital Markets LLC agreed to pay $30.4 million to settle SEC charges accusing the firm of misconduct for its role in selling unsuitably risky investment products to the districts.

While Stifel is fighting the SEC’s charges, RBC agreed to settle the matter without admitting or denying the commission’s findings.

In 2008, the school districts filed a lawsuit in state court against Stifel and RBC alleging the firms fraudulently misrepresented the investments as sound and hid the risks associated with the transactions. The districts are seeking to void the transactions on the ground they were not qualified buyers of the products. The districts say “there was no way” for them “to evaluate the credit risk exposure” based on the documents they received from the defendants prior to or after the closing.

The districts also allege the unregistered securities were designed only for sophisticated buyers – those meeting the criteria of qualified institutional investors or accredited investors based on their capital and other factors – and that the duty fell on Stifel, as the placement agent, and RBC, as the seller, to disclose that information.

In their complaint, the districts contend that their trusts signed an “acknowledgement letter,” drafted by Stifel, in which each certified that their trust was “financially sophisticated” and an “accredited investor.” The complaint said no explanation of what was required to actually meet the requirements of a qualified investor was provided.

“Had it been disclosed to the trustees that their trusts could not be considered accredited investors … none of the trustees would have signed the acknowledgement,” the complaint reads. The complaint does not address what advice the districts’ legal counsel provided or whether they reviewed the documentation.

Still, the districts blame RBC and Stifel.

“The acknowledgement letter in no way absolves the defendants of their responsibilities not to offer or sell unregistered securities to non-qualifying investors, which they willfully violated in this case,” the complaint reads.

The districts’ attorney in the lawsuit and finance officials could not be reached Thursday to provide more information on the firm or firms that served as legal counsel to the trusts on the transactions.

Stifel has argued the district knew of the risks.

“Each trust had both a corporate trustee and individual trustees, all of whom had fiduciary responsibilities to the OPEB trust. The trusts, the trustees, and the districts each had legal representation during the transactions, as did DEPFA Bank,” Stifel has said in response to the lawsuit.

Separately, Zehner cautioned bond attorneys about three recent SEC enforcement actions stemming from an ongoing probe by state and federal regulators into bid-rigging in the muni markets.

In particular, Zehner encouraged the lawyers to adopt a cynical view and assume everyone is taking money under the table.

Paraphrasing former president Ronald Reagan, Zehner said: “Trust but verify.”

“Think it through,” he said. “Think who is getting paid and who isn’t getting paid.”

Zehner noted that federal criminal trials stemming from the bid-rigging probes start next year.

“So there’s a lot still going on in this whole area,” he said.

In December, Bank of America agreed to pay more than $137 million to settle charges from federal officials, including the SEC and the Department of Justice, and state attorneys general over bid rigging alleged to have occurred between 1997 and 2005. In May, UBS agreed to pay more than $160 million to settle similar charges involving at least 100 reinvestment transactions in 36 states between 2001 and 2006. And in July, JPMorgan agreed to pay $228 million to settle similar charges involving at least 141 muni-bond related investment contracts involving state and local issuers and conduit borrowers in at least 31 states between 1997 and 2005.

The firms neither admitted nor denied the charges.

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