Madoff Executive is Charged in Ponzi Scheme

The long-time director of operations for convicted Ponzi schemer Bernard Madoff's defunct firm was arrested and charged criminally Thursday with allegedly directing that false accounting entries be made in the firm's books to conceal Mr. Madoff's fraud.

Prosecutors from the U.S. Attorney's Office in Manhattan charged Daniel Bonventre, former operations director at Bernard L. Madoff Investment Securities LLC, with conspiracy, securities fraud, falsifying books and records of a broker-dealer, false filings with the U.S. Securities and Exchange Commission and four counts of filing false federal tax returns.

A lawyer for Mr. Bonventre declined to comment Thursday.

Bonventre, 63 years old, is expected to appear before a U.S. magistrate judge in Manhattan later Thursday. He faces as much as 20 years each on the fraud, falsifying-books-and-records and false-filings charges.

He is the sixth person to be charged criminally in the case, including Mr. Madoff himself.

The SEC also separately brought civil accounting fraud charges against Mr. Bonventre, alleging he helped disguise Mr. Madoff's fraud and financial losses at the Madof firm by misusing and improperly recording investor money to create the false appearance of legitimate income.

Two Arbitration Awards Against Morgan Keegan & Co. Bond Funds in One Week

A recent arbitration panel has awarded three holding companies over $1 million for losses sustained by investments in various Morgan Keegan & Co. bond funds. The funds in question were heavily backed by mortgage-related securities, experiencing a near total loss in the subprime mortgage crisis of two years past.

This is the second time in a week that an arbitration panel has ruled in favor of investors against Morgan Keegan & Co.’s bond funds. Earlier this week an investor was awarded $2.5 million for losses experienced due to investment in such funds. Over 400 cases are pending against Morgan Keegan & Co. relating to their bond funds. Investors affected by these bond funds state that such funds were promoted as conservative investments with low risks, when in reality they involved a high degree of risk and volatility.

FINRA Seeks Expansion of Brokercheck Tool

The Financial Industry Regulatory Authority (FINRA) is currently seeking to expand its Brokercheck tool. Brokercheck gives individuals access to professional information regarding registered brokers and firms. The hope is that investors will use this tool to better get to know the people and companies with whom they are placing their money.

FINRA is seeking to expand this information to include customer complaints reported publicly and to extend the public disclosure period for the full record of a broker who leaves the industry from two to ten years. Also, in a move to go beyond the financial world, FINRA seeks to add to Brokercheck criminal convictions and civil and arbitration judgments involving former brokers.

Richard Ketchum, Chairman and CEO of FINRA, believes that the additional information will help investors, “who are considering whether to conduct, or continue to conduct, business with a particular securities firm or broker. Just as important, they will provide valuable information about persons who have left the securities industry, often not of their own accord, but who can still cause great harm to the investing public.” The new information would include complaint made back from 1999 when electronic filing of broker information began.

Charges Settled for Former UBS Broker who Sold Auction-Rate Securities

David Shulman, the former UBS executive who was suspended by UBS in July 2008, has agreed to pay a $2.75 million fine over insider trading charges connected to auction-rate securities sales and be suspended from employment by a broker or dealer until next January.

“While thousands of UBS customers received no warning about the auction-rate securities market’s serious distress, David Shulman - one of the company’s top executives - used insider information to take the money and run,” said New York Attorney General Cuomo in a press statement. “From the start, our prime goal has been to get investors their money back. But let there be no mistake - when corporate executives unlawfully take advantage of their positions, we will hold them accountable.”

Cuomo announced the settlement with Shulman on Feb. 18, 2010 Shulman is the second UBS executive to settle with Cuomo’s office thus far. To date, Cuomo’s investigation into auction-rate securities has reached agreements with 13 broker/dealers and produced more than $60 billion in repurchases of investors’ ARS holdings.

Shulman was accused of selling off $1.45 million of his personal investments in auction-rate securities in December 2007 after he learned that UBS’ own auctions were hitting a snag. On Dec. 11, 2009 one of Shulman’s employees emailed him that the group was “very concerned” about certain issues related to UBS’ student loan auction-rate program and its continuing support for that program. In that e-mail, the employee stated that “the auction product is flawed.”

On Dec. 12, 2009 records show that one of Shulman’s employees forwarded an email to Shulman with a subject line of “stud loans,” and warned Shulman that “the auction product does not work … our options are to resign as remarketing agent or fail or ?” In another e-mail that same day, the employee advised Shulman in no uncertain terms that with respect to UBS’ student loan auctionrate securities, “the entire book needs to be restructured out of auctions.” Finally, on Dec. 13, Shulman instructed his broker to immediately sell his holdings in student loan auction-rate securities, before the upcoming auctions could occur. Later that day, Shulman’s ARS holdings were sold via inter-auction directly to the UBS Short Term Trading desk.

Coincidentally, the Short Term Trading desk was under Shulman’s supervision. Shulman’s broker mentioned Shulman by name when he called the desk to place the trades. This was the first and only time Shulman sold auction rate securities inter- auction.

FINRA Announces Enforcement Action Relating to Reverse Convertible Notes

The Financial Industry Regulatory Authority (FINRA) recently announced an enforcement action against H&R Block Financial Advisors relating to its sale of reverse convertible notes (RCNs). RCNs usually offer an attractive yield when compared to other stocks and bonds, in part because of their highly risky nature. FINRA charged H&R Block Financial with failing to establish adequate supervisory systems and procedures for overseeing the sales of RCNs to retail investors.

In addition to the enforcement action that fined H&R Block Financial with a $200,000, FINRA also fined and suspended H&R Bock Financial broker Andrew MacGill for making unsuitable sales of RCNs to a retired couple. The couple will receive $75,000 in restitution for their investment loss.

While fining H&R Block for a failure which may well have led to multiple other investors incurring investment losses, FINRA also issued an Investor Alert titled, “Reverse Convertibles – Complex Investment Vehicles.” The goal of this alert is to educate investors on the risk associated with RCNs. Also, FINRA issued Regulatory Notice 10-09 as a reminder to broker/dealers of their obligations to clients when recommending and selling RCNs to their clients.

As stated by FINA Chairman and CEO Richard Ketchum, “Firms selling reverse convertibles [RCNs] or similar products must ensure that their brokers understand the risks and costs associated with these products and perform adequate suitability analyses before recommending them to any customer. Fimrs must also have procedures in place to monitor customer accounts for potentially unsuitable concentration levels of these products.”

The enforcement action announced today by FINRA provides hope for other investors who were not properly advised by their brokers concerning RCNs and who have likewise suffered an investment loss, much like the retired couple referenced in the current action

Oppenheimer's Role in Oregon 529 Plan's Losses

It now appears that Oregon state officials may also be to blame for the $35-million loss suffered by Oregon investors, despite having sued OppenheimerFunds in April of 2009 for the recovery of more than $35 million. According to state officials investors lost out because OppenheimerFund misrepresented the risk of its Oppenheimer Core Bond Fund. However, state officials may have also failed to reel in managers of OppenheimerFunds and stop the risky investments they were making in the Oregon College Savings Plan with money labeled as ‘conservative’ and ‘ultra-conservative’.

According to a May 6, 2009 article in The Oregonian, e-mails between the state treasurer’s office and OppenheimerFunds reveal state officials failed to closely monitor the Oppenheimer Core Bond Fund and didn’t take action to prevent additional losses until it was too late. Instead, documents show the state relied on information from OppenheimerFunds that the money was being wellmanaged. Even more troubling: E-mails point to a possible conflict of interest between OppenheimerFunds and Oregon state officials. In addition to OppenheimerFunds buying meals for state executives at expensive Portland restaurants, the Oregonian article reports that when problems surrounding the Oppenheimer Core Bond Fund were made public, OppenheimerFunds provided the state with a talking points document, and a state official gave the company a heads-up about a pending state investigation.

The central issue concerning the Oppenheimer Core Bond Fund focuses on the investing strategies used by Oppenheimer’s managers. According to a February 2008 filing with the Securities and Exchange Commission (SEC), OppenheimerFunds changed the investment focus of the fund in 2007 by dramatically increasing its holdings in the complex investing arena of derivatives. When the state initially hired OppenheimerFunds, the fund held three derivatives in the form of total-return swap contracts. By the end of 2007, the Core Bond Fund held 150 derivative contracts. At the close of 2008, the Oppenheimer Core Bond Fund - at one time a $1.4 billion fund - had lost 41% of its value. As reported in the May 6, 2009 Oregonian article, OppenheimerFunds first disclosed its exposure to the crisis on Wall Street in a Sept. 24, 2008 letter to Oregon 529 College Savings Network Executive Director Michael Parker. The letter, however, failed to accurately portray the amount of the Core Bond Fund’s exposure and lacked other important details. Moreover, OppenheimerFunds reportedly marked the letter as “not for public disclosure.”

An additional board meeting was held on Oct. 23, 2008 to discuss the financial status of the Oregon College Savings Plan. Randall Edwards, former Oregon State Treasurer, reportedly did not call for making any changes to the investments according to the Oregonian story, yet he did express concern about the deep losses in the Oppenheimer CoreBond Fund. Following this meeting in January 2009, Oregon voted to replace the Core Bond Fund from the Oregon College Savings Plan, it wasn’t until March, however, that the plan went into effect. Although Red flags were waving loud and clear when it came to OppenheimerFunds’ mismanagement of the Oregon College Savings Plan, Oregon’s state officials were slow in and ineffective when the time came to act on their concerns and ultimately failed to protect their investors.

Collapsing Hedge Funds Halt Investor Redemptions

The hedge-fund community is in crisis mode after crashing and burning in the aftermath of the global credit crisis. 1861 Capital Management, ASTA/MAT, Tontine Partners LP, and The Ospraie Fund, are just a few of the hedge funds who have suffered a fate tied to investor redemptions and illiquid assets, which ultimately has left thousands of individual investors, charities and pension fund holders facing some huge and unforeseeable financial losses.

The past year has seen hundreds of hedge funds go out of business. In 2008, some 920 funds were shuttered - a figure that eclipses the prior record set in 2005 when 848 hedge funds closed down. On average, hedge funds lost more than 18% last year. The previous worst performance by hedge funds occurred in 2002, posting a loss of 1.5%. In 2007, hedge funds returned 9.9%. As hedge funds literally fought for survival in 2008, many would lose the battle altogether.

Among them: The Ospraie Fund, which posted nearly a 40% loss in2008. An even worse performance came from the Tontine Partners LP hedge fund, which ended the year down an astonishing -91.5%. Other funds such as Tudor Investment Corp. and Citadel Investment Group LLC have been forced to limit investor redemptions or risk implosion. Earlier this month, Citadel, whose flagship hedge fund lost 55% in 2008, announced plans to resume payouts to investors. Investors’ access to their money, however, will occur no sooner than April 1.

Hedge funds that trade municipal bonds also are experiencing a rough time these days. As reported Feb. 29, 2008, by MarketWatch, problems with bond insurers and other disruptions borne out of the global credit crunch have pushed yields on municipal bonds close to, or above, those of comparable Treasury bonds. For hedge funds that try to make money from the difference, called the spread, between the yields, the end result translates into the likelihood of margin calls.

That’s exactly what happened to hedge funds like Citigroup’s ASTA/MAT hedge funds. In using a municipal arbitrage strategy, the funds ultimately were forced to sell their positions at fire-sale prices, causing significant losses to investors. The dismal performance of hedge funds has continued into 2009. One of the most recent hedge funds to shutter is the Highland CDO Opportunity Fund, which encountered massive losses from its holdings of high-risk collateralized debt obligations (CDOs). In October, similar circumstances forced Highland to close two other hedge funds: the Crusader Fund and the Credit Strategies Fund.

The shocking upheaval in the hedge fund industry is casting new light on the largely unregulated world of hedge funds. Registration with the Securities and Exchange Commission (SEC) is done on a voluntary basis only. At the same time, investments in hedge funds have grown astronomically. At their peak, approximately 10,000 hedge funds managed nearly $2 trillion in assets. Today, the figure is closer to $1 trillion.

According to Senators Chuck Grassley and Carl Levin a new bill introduced to the Senate has been designated to improve the carelessness and transparency of the hedge fund industry. Introduced on January 29, 2009 the Hedge Fund Transparency Act of 2009 (S. 344) would make it mandatory for hedge fund managers to register with the SEC and open up their books to government examiners. Following their original statement Senators Grassley and Carl Levin also described the bill as an “attempt to address securities law loopholes that enable hedge funds to operate under a cloak of secrecy.”

State Street Charged by SEC with Misleading Investors

Boston, Massachusetts-based financial firm State Street Bank and Trust Company was charged by the Securities and Exchange Commission (SEC) last week with misleading investors about subprime investment exposure. Further, State Street was charged with selectively disclosing a more complete set of facts to certain investors.

State Street, who has already agreed to settle these charges against it, will pay more than $300 million to investors who lost money during the subprime market collapse in 2007. Robert Khuzami, the new Director of the SEC’s Division of Enforcement, had this to say on the matter: "State Street led investors to believe that their investments were more diversified than a typical money market portfolio, when instead they were invested almost entirely in subprime investments that ultimately caused hundreds of millions of dollars in losses.” The actual investments in question stem from State Street’s Limited Duration Bond Fund, among others.

The Limited Duration Bond Fund was marketed beginning in 2002 as an alternative to a money market fund, labeling it an “enhanced cash” investment strategy. Regardless of how it was marketed, the way it performed in 2007 after being loaded with subprime residential mortgage-backed securities and derivatives was disastrous.

Prior to the collapse, State Street informed their internal advisory group of the precarious situation of the fund and this select group of investors recommended that their clients redeem their investments from all related funds. In the ensuing selloff, State Street sold most of the funds’ liquid assets to pay off the redemption demands of the select group of better informed investors. This depletion of liquid assets magnified the loss that other investors felt when they too eventually tried to pull their assets out of the Limited Duration Bond Fund and other funds.

Of the announced settlement, $255 million will go towards compensating investors who lost money in State Street funds. This amount is in addition to the $350 million State Street has already paid or agreed to pay to certain investors through private settlements and lawsuits.

State Regulators vs. The Securities and Exchange Commission - Who Best Regulates Your Assets?

There is an ongoing debate regarding the role of state regulators in financial product oversight as Congress mulls over a proposal to expand the range of state oversight. Currently, financial advisors with under $25 million in assets are regulated by state regulators, with anything over that amount being regulated by the Securities and Exchange Commission (SEC). Congress is considering increasing state oversight to include firms with up to $100 million in assets, effectively stripping the SEC of some oversight.

The timing of this change is directly related to the apparent failure of the regulation system in the United States following an explosion of long operating fraudulent schemes being uncovered over the past year. There has been finger pointing, calls for greater reform, and an apparent lack of consensus on the issue. The answer which no one seems to be able to answer is, how do we best split regulation between state and federal departments?

Texas Securities Commissioner Denise Voigt Crawford has been a vocal advocate of giving more power to state regulators. State regulators were stripped of many powers under the National Securities Markets Improvement Act of 1996, powers which Ms. Crawford believes should be reinstated. “The naivete behind the view that markets are always self-correcting now seems apparent,” she said. “But clearly, reliance by the investing public on federal securities regulators, self-regulatory organizations (SRO) and `gatekeepers' in the years preceding the crisis and in its midst to detect and prevent even the most egregious of frauds and deceit was equally naive.” This sentiment is not shared by many, however, who see the idea of giving state regulators more power as potentially damning to investors and the U.S. financial market as a whole.

Joseph Borg, director of the Alabama Securities Commission, recently spoke on the matter at the Financial Services Institute's OneVoice 2010 Broker-Dealer Conference in New Orleans. When asked if states would be able to handle the increased work load, Borg stated, “Some yes, some no.” He offered a solution by which states would be allocated more resources and interstate cooperation would increase.

It remains to be seen if Congress will increase the threshold on state regulation, but the good news for investors is that meaningful discussion on the topic is happening, and hopefully, good law making will follow.

FINRA Fines Two Financial Firms for Inadequate Anti-Money Laundering Programs

The Financial Industry Regulatory Authority (FINRA) has fined two financial firms for insufficiencies in their anti-money laundering (AML) programs. Penson Financial Services of Dallas, Texas and Pinnacle Capital Markets of Raleigh, North Carolina were fined $450,000 and $300,000, respectively. These two fines follow a similar action in October 2009 involving deficiencies in the AML program at Scottrade.

Penson Financial Services was fined for failing to operate a functional AML compliance program. The specific failure involved insufficient personal resources allotted to review AML exception reports. In addition to this, FINRA found that penny stock deposits and liquidations were insufficiently reviewed, thus allowing the possibility for fraud and money laundering. Also, written AML procedures were inadequate, and the firm failed to maintain accurate records regarding unsecured deficits in the accounts of its correspondent firms, among other things. Despite enhancements to its AML program in 2007, deficiencies remained endemic to the Penson AML program.

Pinnacle Capital Markets, whose principal business relates to providing online access of U.S. securities markets to foreign customers, including many foreign financial institutions, was fined for deficiencies found regarding detection and reporting of suspicious activity as well as failure to guarantee the identity of account holders. The firm used a manual system of daily reviewing its trade blotter and in doing so failed to detect suspicious trading activity. One such failure involved a pump and dump scheme targeted in a Securities and Exchange Commission (SEC) enforcement action. In a specific failure based on their precise business model, Pinnacle failed to verify the identity of sub-account holders whose accounts were created under the main accounts of foreign financial institutions.

In typical fashion, the firms neither affirmed nor denied the charges against them. To read the official FINRA press release, click here.

Inland American Non-Traded REITs Prove Disastrous for Investors

Inland American REITs have proven to be disastrous for many investors. These non-traded REITs, which were sold to investors as a conservative investment with little risk, have turned out to be anything but conservative. Even before losing a great deal of value, these products, by their very nature, were costly for investors. Many such products had a built in commission of up to 15%.

Another drawback for this product type is the fact that such securities are not traded. Unlike traded REITs, whose value is determined by trading markets on a daily basis, non-traded REITs often times have their values determined by the very company offering them. Further, investors who wish to get out of non-traded REITs are subject to the issuer’s redemption program. Many companies suspended such programs as their holdings lost value.

Holders of non-traded REITs like Inland American may be able to get out of their investment and recoup their investment loss through FINRA arbitration.