WASHINGTON — State securities regulators in Indiana and Colorado yesterday filed separate but similar administrative complaints against Stifel, Nicolaus & Co. for allegedly taking care of favored institutional clients over retail customers holding auction-rate securities, in the latest enforcement action against so-called downstream brokerages.
While the Denver-based firm’s institutional sales force was highly trained in selling ARS to institutional clients, its retail sales force received practically no training and routinely told clients that ARS were liquid and cash equivalent, both Indiana and Colorado said in their complaints.
The states are seeking a variety of sanctions for the alleged fraudulent sales practices, including possible fines, restitution, and removal of Stifel’s securities licenses. They are each charging the firm with one count of securities fraud, one count of supervisory and training failure, and one count of “unsuitability.”
“This action sends a strong message that our state will not tolerate unethical and unlawful behavior and that my office will hold the securities industry accountable for any violations of the securities laws of Indiana,” said Secretary of State Todd Rokita.
Stifel did not immediately respond to a request for comment. The complaints follow similar suits filed earlier this year against the firm by state securities regulators in Missouri and Virginia.
In a letter Stifel sent recently to the Colorado Division of Securities, a unit of the Colorado Department of Regulatory Agencies, the firm argued that it did not have access to the same information available to the largest underwriters of ARS, according to Gerald Rome, the state’s deputy securities commissioner. The firm is trying to say that they did not know the market was going to collapse, he said.
“And that may be accurate, but our issue is that at least there was the potential for the market to collapse, and investors should have been advised of that fact,” Rome said.
Colorado is giving Stifel 30 days to respond to its complaint and requiring it to appear before an administrative law judge in Denver on Nov. 17, while Indiana is giving the firm 15 days to respond and ordering it to appear before an administrative law judge the following day in Indianapolis.
Stifel began selling auction-rate securities in the 1990s and in 2004 it began underwriting issues of ARS as a co-manager. In total, it co-managed underwritings of at least 12 separate issues from five issuers.
ARS underwritten by the firm were sold through its fixed-income capital markets group, a sales force trained to sell ARS only to institutional clients that had experience in dealing with the securities.
The group held weekly conference calls to discuss the risks associated with ARS, including the so-called auction process, failure rates, support bids, and default rates, as well as the potential for illiquidity resulting from a failed auction and the suitability of the product, both securities regulators said in their administrative complaints. The institutional sales force never referred to ARS as a liquid investment akin to cash or money market funds, they noted.
But unlike its institutional sales force, Stifel’s retail sales representatives did not receive any training regarding the risks associated with purchasing ARS, the complaints said.
Also unlike the institutional force, the retail sales reps never reviewed the prospectuses or “blue sheets” of any of the ARS issues, the complaints said. And even if they did, they failed to disclose to their retail customers the potential for auction failures and the risk of holding illiquid securities.
The complaints stated that the firm became aware of the ARS market failures during the summer of 2007, and that, in December, it also knew that one of its issuer clients, the Missouri Higher Education Loan Authority, had temporarily waived the maximum rate for its ARS issue to increase liquidity for the product at the request of large broker-dealers who were providing cover bids to sustain the issue’s liquidity.
At the time, one of Stifel’s largest institutional clients held about $8.5 million of the MOHELA issue, and the firm considered whether to make a support bid in the auction to prevent it from failing and to take over the client’s position.
“Stifel made the decision not to provide a support bid, and the auction ultimately failed,” according to the Colorado complaint. “Nevertheless, on the same day the auction failed, Stifel made the decision to buy back this institutional client’s MOHELA issue as Stifel believed this client was large and important.”
As both complaints argue, “Stifel’s approach to the sale of ARS to its retail customers was dramatically different” than the institutional client in the MOHELA issue. The complaints identify multiple examples of retail clients who purchased ARS and were told that the securities were safe, liquid investments. They also identify by name the retail sales reps who received no formal training on ARS, had no knowledge of auction failures, and did not disclose any risks associated with their clients when they sold the securities as cash substitutes.