ANOTHER MARKET CRISIS CASE
The SEC brought its second enforcement action this week stemming from its much discussed market crisis investigations. This case is against a broker dealer and its former CEO Stanley Brooks. It focused on the sale of risky mortgage-backed securities through what was called a “CMO Program” to retail customers looking conservative investments. SEC v. Brookstreet Securities Corp., Case No. SACV 09-01431 (C.D. Cal. Filed Dec. 8, 2009). Previously, the Commission brought an action based on the same conduct against ten registered representatives formerly with the firm, discussed here.
Brookstreet has been defunct since 2007. The market crisis case filed earlier this week was against former executives of subprime lender New Century which has been in bankruptcy since 2007. Each of these actions was cited by the Enforcement Director in his congressional testimony yesterday under the caption “Accomplishments and Initiatives.”
The action against Brookstreet alleges that the firm implemented a CMO Program to market collateralized mortgage obligations to retail customers. Specifically, over a three year period beginning in 2004 Mr. Brooks helped create a program under which the broker dealer and its registered representatives sold CMOs to retail customers. Although the investments were risky, they were marketed to customers with conservative investment goals including retirement accounts.
As part of the program, the firm maintained a spreadsheet which listed key characteristics regarding the accounts that purchased CMOs under the program. That spreadsheet shows the following: about 23% of the investors were IRA accounts; approximately 17% listed the preservation of capital as the investment objective; and about 43% of the account owners had incomes under $100,000. Nevertheless, about 90% of the CMOs traded in the program were high risk investments such as inverse floating rate CMOs which FINRA cautioned in 1993 were only suitable for sophisticated investors with a high risk profile.
The CMOs were marketed by the firm’s representatives using a number of misrepresentations. These included claims that the securities were: guaranteed by the government; presented low or no risk to principal; easily sold; and safe. These alleged misrepresentations are the basis for the enforcement action brought against the registered representatives last spring.
In early 2007, CMO prices dropped precipitously. This caused significant losses in the accounts at of the CMO Program customers as well as margin calls. Many customers did not have sufficient equity. To secure equity for these accounts and avoid a net capital problem the firm liquidated the CMO Program accounts, including those which were fully paid. This action caused a number of accounts to suffer significant losses. Many customers lost their savings, their homes and their ability to retire.
By June 2007, the firm failed to meet its net capital requirements. Brookstreet ceased operations. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(s). The case is in litigation. See also Litig. Rel. 21328 (Dec. 8, 2009).