WASHINGTON – Stifel, Nicolaus & Co. has preliminarily agreed to pay a penalty and disgorge ill-gotten gains to settle SEC charges that it misled five Wisconsin school districts, which ultimately lost $200 million from investments that failed during the financial crisis.
The settlement also involves David Noack, a former Stifel vice president, who the SEC alleged was involved with the fraudulent sale of the complex financial instruments to the school districts.
The five districts whose investments failed in 2007 and 2008 are the: Kenosha Unified School District; Kimberly School District; Waukesha School District; West Allis-West Milwaukee School District; and Whitefish Bay School District.
The SEC and the defendants announced their intention to settle last week, only days before the trial was to start on Sept. 12. The news was made public in a court filing that contained notes on a telephone conference between the parties in the case.
The proposed settlement, which still must get approval from the SEC's commissioners, also requires that Stifel admit certain facts of wrongdoing. The payment amount and the facts that Stifel will have to admit to were not listed in the filing. The lawyers for the parties believe the commissioners' decision will take about two months, according to the documents.
St. Louis-based Stifel as well as the SEC declined to comment on the settlement. Noack's attorney could not be reached for comment. C.J. Krawczyk, a Milwaukee lawyer who is representing the school districts in private litigation over the failed investments, said the districts are refraining from comment until a settlement is approved.
The SEC first filed its complaint against Stifel in August 2011, seeking a jury trial, fines, and disgorgement of ill-gotten gains, among other things.
The charges relate to the districts' investments in notes linked to the performance of synthetic collateralized debt obligations (CDOs) made up of a portfolio of 100 or more credit default swaps on corporate bonds. The investments were part of the Government OPEB Asset and Liability Program (GOAL Program) that Stifel and Noack created in late 2005 and early 2006, according to the SEC. The program was designed to have the school districts make investments through specially-created trusts to generate funds to pay their other post-employment benefits (OPEB) liabilities. The districts also entered into a moral obligation to repay the notes as part of the investment plan.
The districts invested $37.3 million of their own funds, $36 million of which was borrowed, and the specially created trusts borrowed an additional $162.7 million from Depfa Bank, which served as lender for the new program.
The SEC found that the school districts had no prior experience with investing in CDOs, which usually draw interest from hedge funds, insurance companies, and investment banks. Additionally, Noack had little or no experience with CDOs, the SEC said in its complaint.
Stifel and the former vice president convinced the districts to invest through "a series of falsehoods and misrepresentations." They also knew the districts were risk averse and that the preservation of capital was of paramount importance, the SEC said.
The commission cited examples of the misrepresentations, including Noack's statement that it would take "15 Enrons" for the district's investments to fail and that the investments were safe and similar to U.S. treasury bonds. The defendants also said that 30 of the 105 companies in the portfolio would have to go bankrupt and that 100 of the top 800 companies in the world would have to go under before the districts would lose their principal.
The two defendants also did not disclose material facts such as that certain CDO providers were concerned about the heavy use of leverage and the school district's lack of sophistication when compared to other, more regular investors.
The proposed settlement in this case would join a separate settlement the SEC entered into with RBC Capital Markets LLC in September 2011. RBC, which declined to comment for this article, agreed to pay $30.4 million to settle SEC charges that it put together and sold the CDOs to the school districts' trusts despite its own concerns over the suitability of the product for the districts. The firm also did not adequately explain the risks associated with the investments, the SEC found.
The five districts pursued private litigation against Stifel and RBC. Stifel settled the private litigation in 2012, agreeing to pay $13 million to the districts along with a standby letter of credit for an additional $9.5 million when the firm and SEC resolve their dispute. The private litigation against RBC is ongoing.
The districts' settlement with Stifel in the private litigation came after Stifel purchased the remaining $154 million of notes issued by the district's OPEB trusts and relieved the districts of their moral obligations to repay the notes.
