Category Archives: Investor Beware

Marcus Schrenker was Indiana’s own version of Bernie Madoff. Before his arrest in January, Schrenker had built a successful investment advisory business off of the money and trust of family and friends. Behind the scenes, however was a different story, with Schrenker selling nonexistent foreign currency funds, creating false account information, and using clients’ money to fund a lavish lifestyle that included a private plane and a luxurious lakeside estate. On Aug. 19, during federal sentencing in Pensacola, Fla., Schrenker was given 51 months in prison for charges stemming to the Jan. 11 plane crash in which Schrenker tried to fake his own death near Florida.

Schrenker’s legal issues are far from over, however. He still faces 11 felony counts related to his investment businesses in Indiana.

Schrenker’s victims include his aunt, Rita Schilling, who transferred more than $200,000 to one of Schrenker’s investment companies in August 2008. Another victim is a long-time friend, Charles Black. In 2004, Schrenker moved $100,000 out of Black’s account without his consent, according to a probable cause affidavit.

As in the case of Bernie Madoff, Schrenker’s roster of clients never became suspicious of the Indiana money manager because they knew him personally or had been introduced to him by people they trusted. Also like Madoff, Schrenker’s facade of investing prowess was aided by personal images of wealth and success.

The devil is in the details. This is especially true for leveraged and inverse exchanged traded funds, or ETFs. These aggressive and complicated financial products have evolved from straightforward instruments to funds that use baskets of derivatives and risky credit swaps to provide inverse, leveraged, leveraged-inverse, and commodity-linked returns. Unlike traditional ETFs, inverse and leverage ETFs have “leverage” inherently embodied into their product design. Translation: Increased risks for investors.

Leveraged ETFs use credit swaps or derivatives to amplify daily index returns, while inverse ETFs are designed to profit from a decline in the value of the underlying assets that the fund mirrors. This could be a stock index, currency, commodity or specific industry sector like real estate. If the underlying index declines by 1%, the inverse ETF should, in theory, increase 1% on that same trading day.

Investing in leveraged and inverse ETFs can be tricky, not to mention potentially dangerous for the average investor. These types of ETFs are meant to reflect the underlying asset moves on a daily basis. When held longer for a day, the end result can spell financial disaster.

Leveraged and inverse ETFs are big business for investment firms and financial advisers. Assets in leveraged and inverse funds increased 51% this year, reaching $32.8 billion. This explosive growth prompted the Financial Industry Regulatory Authority (FINRA) to issue a warning to brokers in June that leveraged and inverse ETFs may not be an appropriate investment for long-term investors because returns can deviate from underlying indexes if held for longer than a day.

Since then, several investment firms have halted their sales of leveraged ETFs. Among them: UBS, Edward Jones and Ameriprise Financial.

Yesterday, a class-action lawsuit was filed against ProShares – one of the top sellers of inverse and leveraged ETFs – over one of its inverse leveraged exchange traded funds. According to the complaint, the ProShares UltraShort Real Estate fund did not disclose a series of risks associated with the fund, including a “spectacular tracking error.” The lawsuit also says the company markets its leveraged funds as “simple directional plays.”

The ProShares UltraShort Real Estate fund was designed to deliver amplified returns against an index, which in its case was the Dow Jones Real Estate Index. The returns were supposed to be twice the opposite of that index. In 2008, however, the index fell 39%, yet the fund fell 48%.

New York-based Prime Capital Services (PCS) and several of its brokers – Eric J. Brown, Matthew J. Collins, Kevin J. Walsh and Mark W. Wells – face enforcement action by the Securities and Exchange Commission (SEC) for allegedly luring senior citizens and retirees to buy unsuitable variable annuities.

According to the SEC complaint, Prime Capital Services and its parent company, Gilman Ciocia of Poughkeepsie, New York, recruited the majority of clients by offering free-lunch seminars in Florida, encouraging elderly investors to schedule private appointments with PCS representatives. What the meetings reportedly failed to reveal, however, was key information relating to the variable annuities, including their high costs and lock-in periods.

The SEC contends Prime Capital Services and its brokers earned millions of dollars in sales commissions and that many of the variable annuities sold were unsuitable investments for customers due to their age, liquidity, and investment objectives.

In addition, the SEC says representatives from Prime Capital Services told customers that the annuities were “guaranteed” not to lose money, while failing to disclose the fact that the guarantee only occurs upon the death of the person holding the annuity. Prior to that, the value of a variable annuity can fluctuate widely depending on the performance of a portfolio’s securities.

The SEC also named Prime Capital Services’ President Michael P. Ryan in its complaint, along with PCS employees Rose M. Rudden and Christie A. Andersen.

In 2005, Prime Capital Services faced similar allegations and settled with the Financial Industry Regulatory Authority (FINRA). Without admitting any wrongdoing, the company paid a $200,000 fine, replaced the firm’s compliance officer and reportedly enhanced its compliance policies.

On March 23, 2009, a St. Louis, Missouri, FINRA arbitration panel awarded investor Philip Rein $220,944 plus interest on his claims of fraud, breach of fiduciary duty and negligence against Stifel, Nicolaus & Company. 

According to award documents (FINRA # 07-01495), the claimant alleged that St. Louis-based Stifel Nicolaus failed to heed his stated investing objectives, which were focused on generating money for retirement income. Instead, Stifel created a retirement portfolio for Rein by investing a portion of his assets in a Pacific Life Variable Annuity and another portion of assets in three aggressive, all equity, money-management funds.

Ultimately, because of the Stifel’s selected investments, the investor said he lost the majority of his principal.

A group for attorneys representing individual and institutional investors in securities arbitration disputes has formally petitioned the Securities and Exchange Commission (SEC) to remove a requirement that allows representatives from the securities industry to serve as arbitrators on Financial Industry Regulatory Association (FINRA) panels. 

The Public Investors Arbitration Bar Association, or PIABA, filed its petition with the SEC on June 11. 

Currently, FINRA rules mandate that any investor case involving $100,000 or more in damages must be heard by a three-person FINRA arbitration panel, with one of the panelists affiliated with the securities industry. PIABA wants investors to have the right to strike industry representatives from hearing their cases. 

“Requiring customers who believe they have been wronged by the securities industry to have claims decided by panels that must include a representative of that securities industry creates at the least the appearance of bias, if not outright bias,” said PIABA in its petition to the SEC.

As reported June 21 by Investment News, PIABA essentially is asking FINRA to expand a two-year pilot program that it launched in October 2008. The program entails 11 major brokerage firms that agreed to allow up to 276 investor plaintiffs a year choose all-public arbitration panels. 

Year-to-date through May 2009, 3,163 arbitration cases have been filed with FINRA. That is up 85% from the same period last year.

If you are an individual or institutional investor and have concerns about your investments, contact Maddox Hargett & Caruso at 800-505.5515. We can evaluate your situation to determine if you have a claim.

It’s official. The Financial Accounting Standards Board (FASB) has approved relaxing fair value, or mark to market, accounting rules, a move that gives banks leeway to assign a value to investments based on their own internal model of what the assets might sell for in the future rather than in current market conditions.

Revising the accounting standard will be a boost to banks, which stand to see a 20% or more gain in their quarterly operating profits. 

The FASB voted on easing the mark to market rule on April 2. 

Critics of the rule change say it will lessen the transparency of a company’s fiscal health and may encourage some institutions to inappropriately raise the value of certain assets to give the appearance of rosier balance sheets.

As for investors, without the early warning signs created by mark to market accounting, they could very well find themselves left in the dark when it comes to detecting potential problems of a particular financial market. If problems do arise, it may be too late for them to do anything about it. 

Proposed revisions to the fair value accounting standard known as FAS 157 have garnered harsh criticism from those who say the changes are ambiguous and undefined, lack substance and will create further inconsistencies as banks assign value to some assets. 

Under current FAS 157 rules, three different valuation levels exist for banks to price their mark-to-market holdings. Level 1 assets have readily observable prices and trade in active markets. Level 2 assets do not trade actively nor do they have easily obtainable prices. Level 3 assets include the most problematic holdings, such as collateralized debt obligations (CDOs), collateralized mortgage obligations (CMOs) and other exotic derivatives created by prime and subprime mortgages.  

Level 3 holdings are considered illiquid, with market prices so scarce that companies use internal models to gauge their value. In other words, placing a value on these assets is subjective and largely depends on assumptions or opinions. For this reason, Level 3 valuation is often referred to as “mark-to-myth” or “mark-to-imagination.” 

The new proposals for FAS 157 assume that “inactive” markets are the same as “distressed” markets. Moreover, the revisions essentially would allow banks to move more hard-to-value assets into Level 3. This means a company will be able to “handpick” the most appealing value for its assets, while casting aside any that might cause them financial turmoil. 

The bottom line: The proposed amendments to FAS 157 appear to squash the intended purpose of fair value accounting altogether. 

The Financial Accounting Standards Board plans to vote on the revisions to FAS 157 on April 2.

Dozens of retirees from Xerox Corp. and Eastman Kodak will soon share in a welcome pay-out after the Financial Industry Regulatory Authority (FINRA) ruled investment firm Morgan Stanley must pay $7.2 million to settle charges that two of its brokers wrongly persuaded 90 Rochester, New York, employees to take early retirement. Ultimately, the false promises of big profits and unsuitable investing strategies cost many of the investors their life savings. 

FINRA’s ruling breaks down to $3 million in fines and $4.2 million in restitution to the retirees. In addition, former Morgan Stanley broker Michael Kazacos is permanently barred from the securities industry. The second former Morgan Stanley broker, David Isabella, was charged with misconduct. His case must still go before a three-person FINRA hearing panel. Ira Miller, who managed both Kazacos and Isabella, has been suspended from acting as a supervisor for one year and fined $50,000. 

According to a March 25 statement issued by FINRA, from the years of 1998 to 2003, Kazacos allegedly solicited potential clients from Kodak and Xerox by promising them at least 10% annual returns on their investments with Morgan Stanley. He also reportedly told clients they would be able to keep up their current lifestyles by withdrawing 10% every year and not touch their principal.  

FINRA has charged Isabella with similar misconduct. As reported March 26 by 13WHAM-TV in Rochester, New York, Gerald Miller is one of the individuals who followed Isabella’s advice. Miller, who worked for Xerox, was told by the former Morgan Stanley broker that he would “make him a millionaire in 10 years.” Instead, three years after investing with Isabella, Miller learned that he and his wife needed to drop their 10 percent draw and that they were “going to run out of money in five years.” 

The Millers were later told by Isabella that they might need to sell the lakefront home they previously purchased for their retirement years, according to 13WHAM-TV. 

Other retirees are in the same predicament as the Millers. Some have financial issues, while others are headed toward bankruptcy because they retired too early. 

Morgan Stanley’s settlement with FINRA comes out to approximately $45,000 a person, far below the amount of money many retirees actually lost in the early retirement investment promotion.

Former high-profile executives with Merrill Lynch, including two CEOs, invested in hedge funds that lost huge amounts of money to disgraced money manager Bernard Madoff and his $50 billion Ponzi scheme. According to a March 5 report from Reuters, one-time chief executive officers Daniel Tully and David Komansky, along with former investment-banking chief Barry Friedberg, personally invested millions in the hedge funds, which were set up by former Merrill Lynch brokerage chief John “Launny” Steffens.

Steffens’ connection to Madoff was tied to Ezra Merkin, who, along with Steffens, is a partner in Spring Mountain Capital LP. Spring Mountain managed nine of Steffens’ hedge funds, and invested in three Merkin-led funds. Steffen reportedly was aware of their heavy Madoff exposure in at least one.

Shortly after Madoff’s arrest on Dec. 11, Steffens announced plans to shut down the Spring Mountain funds of hedge funds. It is unclear exactly how much money the Merrill Lynch executives lost.

Daniel Tully served as president and chief operating officer at Merrill Lynch from 1985 to 1996, and was named chairman in 1993. Succeeding Tully was David Komansky, who held the top spots from 1997 to 2003. John Steffens spent nearly four decades at Merrill Lynch, ultimately rising to vice chairman in charge of overseeing the company’s global assets division. He retired in 2001 to launch Spring Mountain Capital.

Revelations that several former top Merrill Lynch executives personally invested with Madoff and his alleged $50 billion Ponzi scheme are unsettling on several fronts. At one time, these men were CEOs and senior-level management, responsible for managing and overseeing billions of dollars of investors’ money during their tenure at Merrill Lynch. If they can put due diligence on the backburner when it comes to investing their own personal wealth – i.e. fail to perform the legwork necessary to fully understand exactly how Madoff and those associated with him made money – what does it say about the job they did in protecting the investments of Merrill Lynch’s own clients?

Missouri Secretary of State Robin Carnahan had harsh words for the brokerage firm Stifel, Nicolaus & Company and its plan to give investors holding auction-rate securities only $25,000, or 10%, or their frozen savings. 

On Feb. 11, Carnahan told Stifel it needed to immediately come up with an alternative solution that will buy back all frozen auction-rate securities from clients, many of whom have had their savings frozen since the collapse of the auction-rate market in February 2008.

Last August, a class-action lawsuit was filed against Stifel, Nicolaus & Company and its parent company, Stifel Financial Corp., by investors who claimed the companies deceived them about the investment risks of auction-rate securities and the auction market in which the securities were traded. Specifically, the lawsuit said that Stifel Financial and Stifel Nicolaus sold and represented auction-rate securities as “cash equivalents or better than money market funds.” 

Following the break-down of the auction-rate market one year ago, a number of Wall Street investment firms and banks agreed to buy back auction-rate securities for the prices their clients had paid for them. The buy-back settlements, which totaled more than $50 billion, put to rest state and federal charges that investment firms had improperly marketed and sold auction-rate securities to investors.

Stifel, the third-largest brokerage based in St. Louis, wasn’t part of the settlements, however. Until recently, the firm refused to buy back auction-rate securities from clients, claiming it did nothing wrong. Other regional brokerages, including Raymond James Financial, also have resisted ARS buy-back programs.

Those decisions have had a devastating effect on ARS investors like Glenn Linke, 80, and his wife, Norma, 73. As reported Jan. 11 in the St. Louis Dispatch, the elderly couple had decided to add a first-story bedroom to their house because they were no longer able to easily climb stairs. When the construction bills came due, they called their broker at Stifel Nicolaus, instructing him to sell some of their weekly CDs.

That’s when the Linkes’ were hit with news no investor wants to hear: Their money was frozen. The weekly CDs actually were auction-rate securities. 

The Linke’s story is typical of many investors stuck in auction-rate securities. Today, at least 33 formal complaints have been filed by Stifel’s auction-rate customers with the Missouri Secretary of State’s office. All report that they were promised auction-rate securities would be the “same as cash.”

On Feb. 11, after hearing Stifel’s plan for its auction-rate customers, one investor called Missouri’s Secretary of State to express his frustration. “Ten percent is nothing but an insult,” said the 60-year-old. “If it wasn’t for Stifel’s misleading sales tactics, I would have all of my savings right now.”

In a press statement released in response to Stifel’s auction-rate plan, Secretary of State Carnahan said the following:

 “After nearly a year, Stifel is finally beginning to address this issue but it is too little, too late for those who desperately need their frozen savings. It is time for Stifel to follow the lead of other major investment banks and give their customers the access to their money that was promised. In these uncertain economic times, my office will continue taking the necessary steps to help these investors get their savings back.”