Securities Regulation Daily SEC fines broker-dealer, former VP over $24.5M for sale of risky synthetic CDOs to school districts
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Thursday, December 8, 2016

SEC fines broker-dealer, former VP over $24.5M for sale of risky synthetic CDOs to school districts

By Joseph Arshawsky, J.D.

The SEC announced that St. Louis, Missouri-based broker-dealer, Stifel, Nicolaus & Co., Inc., and its former Senior Vice President David W. Noack agreed to admit wrongdoing and pay more than $24.5 million to resolve an SEC enforcement action involving the sale of synthetic collateralized debt obligations (CDOs) to five Wisconsin school districts (SEC v. Stifel, Nicolaus & Co., Inc., December 6, 2016, Clevert, C.).

In 2006, Stifel and Noack recommended that five school districts invest in synthetic CDOs, and sold them $200 million worth, funded largely with borrowed money. In connection with their recommendations, Stifel and Noack made material misstatements to the school districts that overstated the safety and downplayed the risks of investing in CDOs. Stifel and Noack understood the investment history and risk tolerance of the school districts, namely that they had a history of making low-risk investments such as U.S. Treasuries, certificates of deposit, highly rated commercial paper, and the like, and had no prior experience with CDOs or similar investments. They also understood that safety of principal was an important objective of the school districts. Stifel and Noack recommended the CDO investments which, as structured, were leveraged and had the potential to – and ultimately did – suffer a total loss. They failed to perform any meaningful suitability analysis with respect to the investments they recommended to the school districts.

Inaccurate statements and omissions. Stifel and Noack told the school district that the investments were "conservative" and involved "very little risk." Noack said it would take 15 defaults (expressed as "15 Enrons") to start to lose money, and gave the impression that the CDOs were as safe as U.S. Treasuries. Noack represented that the portfolios for one of the deals would include only investment-grade companies.

Sanctions. The court entered a final judgment permanently enjoining Stifel and Noack from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act, and ordering Stifel and Noack to jointly pay disgorgement and prejudgment interest of $2.44 million and to pay civil penalties of $22.5 million and $100,000, respectively. The judgment also requires Stifel to distribute $12.5 million of the ordered disgorgement and penalties to the injured school districts. This distribution, along with the prior Fair Fund distribution of $30.4 million in a related case instituted in September 2011 and settlements obtained in the school districts' private lawsuit, will fully compensate the five Wisconsin school districts for their cash losses.

The case is No. 2:11-cv-00755-CNC.

Attorneys: Alyssa A. Qualls for the SEC. Brian G. Cahill (Gass Weber Mullins LLC) and Hal Goldsmith (Bryan Cave LLP) for Stifel Nicolaus & Co., Inc.

Companies: Stifel Nicolaus & Co., Inc.

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