The Securities and Exchange Commission on Wednesday charged St. Louis-based brokerage firm Stifel, Nicolaus & Co and a former senior executive with defrauding five Wisconsin school districts by selling them risky investments funded largely with borrowed money.
The SEC said Stifel, a unit of Stifel Financial Corp, and former Senior Vice President David 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 invested $200 million in three transactions from June to December 2006, paid for largely with borrowed funds. The investments were a complete failure, but generated significant fees for Stifel and Noack, the SEC said in its complaint, filed in federal court in Milwaukee.
Stifel and Noack abused their long-standing relationships of trust with the school districts by fraudulently peddling these inappropriate products to them. They were clearly aware that the school districts could ill afford to bear the risk of catastrophic loss if these investments failed, said Elaine Greenberg, Chief of the SEC Division of Enforcement's Municipal Securities and Public Pensions Unit.
According to the SEC's complaint, the five school districts are Kenosha Unified School District No. 1, Kimberly Area School District, School District of Waukesha, West Allis-West Milwaukee School District, and School District of Whitefish Bay.
The SEC alleges that Stifel and Noack made sweeping assurances to the school districts, telling them that it would take 15 Enrons -- a catastrophic, overnight collapse -- for the investments to fail.
But they failed to disclose material facts to the schools, including that the portfolio in the first transaction performed poorly from the outset and that credit rating agencies placed 10 percent of the portfolio on negative watch within 36 days of closing.
In addition, certain CDO providers expressed concerns about the risks of the program and declined to participate in it, but Stifel did not inform the schools of that fact.
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.
Near midday, Stifel Financial shares were down $5.37 or 18.8 percent at $23.23 on the New York Stock Exchange, as the market declined broadly.
(Reporting by Andrea Shalal-Esa, editing by Gerald E. McCormick)