Accusations over how life insurers allocate death benefits have resulted in a formal investigation by Rep. Edolphus Towns into Prudential Financial. Towns opened the investigation following allegations that Prudential didn’t automatically deliver a lump-sum check to families of deceased soldiers, but instead deposited that money into its own general fund.

The investigation comes on the heels of a similar life insurer fraud investigation launched in late July by New York Attorney General Andrew Cuomo. As part of that probe, Cuomo issued subpoenas to Prudential, MetLife Inc. and six other insurers for information concerning payouts to policy beneficiaries.

Towns, who is chairman of the House Oversight and Government Reform Committee, says his panel will investigate the insurance benefits for U.S. soldiers provided by Prudential Financial and the Department of Veterans Affairs.

Both the Towns and Cuomo investigations are focusing on how some life insurance companies place clients’ death benefits in an interest-bearing account, with the bulk of the interest benefiting the insurer, not the policy holders. The practice has been in existence since the 1990s.

Bloomberg Markets magazine reported on July 28 that Prudential holds payments owed to the families of fallen soldiers in its general corporate account and sends survivors “checkbooks” that aren’t insured by the Federal Deposit Insurance Corp. Meanwhile, Prudential earns a profit on the money held and pays the beneficiaries minimal interest.

As reported Aug. 11 by the Wall Street Journal, Prudential is the sole provider of life insurance for active duty members and veterans of the U.S. armed forces, under the Servicemembers Group Life Insurance Program and the Veterans’ Group Life Insurance program.

Under the advice of JPMorgan Chase, high-risk interest-rate swaps have produced a mountain of debt for the Denver Public School system. The intent of the deal was for Denver schools to raise $750 million to refinance old debt and fully fund its pension system. That didn’t happen.

As reported back in March 2010 by The Cherry Creek News, it was former Denver Public School Superintendent Michael Bennet who first convinced the Denver school board to buy into the deal with JP Morgan. The strategy involved using variable-rate debt with interest rates of about 5%. The bank then attached an interest-rate swap to the arrangement, which essentially bet taxpayer money that interest rates would remain high.

When interest rates fell to historic lows, the deal earned the banks millions of dollars in fees, while Denver schools lost big.

Denver now wants to get out of the deal. But it will pay a hefty price to do so. The schools would have to pay the banks $81 million in termination fees, or about 19% of the system’s $420 million payroll.

As for the former superintendent at the center of the debacle, Bennet is now Democratic Senator Bennet – and desperately trying to stave off the bad press surrounding his role in the Denver school deal. On Tuesday night, Bennet beat out Andrew Romanoff – 54.2% to 45.7% – in Colorado’s Senate primary.

Interest-rate swaps have become synonymous with toxic investments for a growing number of states, cities and towns across America. States and local governments initially turned to the exotic financial instruments as a way to boost their budgets. Instead, many have found themselves pushed to the brink financially and forced to cut basic services like public transportation and sanitation.

An interest-rate swap is a contract between a bond issuer such as a school district or a state or city government and an investment bank. Both parties involved in an interest-rate swap transaction essentially “bet” on the movement of interest rates. Whichever party guesses wrong ends up paying. How much is paid or lost depends on several factors, including the size of the debt and current economic conditions.

When the housing industry started to crumble in 2007, followed by the downturn in the financial markets, interest-rate swap deals quickly began to sour for many state and local governments. Case in point: the Denver school system.

Denver schools turned to interest-rate swaps in 2008 on the advice of JPMorgan Chase and the Royal Bank of Canada. The deal was supposed to eliminate a $400 million pension fund gap for the school system. Instead, it caused a financial drain on Denver’s already-strapped budget. So far, Denver schools have paid $115 million in interest and other fees – an amount that’s at least $25 million more than what was initially envisioned.

Escaping an interest-rate swap is not easy or cheap. As reported Aug. 6 by the New York Times, Denver schools must pay the banks $81 million in termination fees, or about 19% of the system’s $420 million payroll.

Wisconsin is in a similar boat. Several years ago, s group of five school districts invested in derivatives as a way to boost returns to a joint pension fund. They now face losses of nearly $200 million, with the retirement system close to bankruptcy. A lawsuit has since been filed against the financial institutions behind the deal, Stifel Nicolaus & Co. and the Royal Bank of Canada (RBC).

Perhaps the most publicized case involving interest-rate swaps is that of Jefferson County, Alabama. As in the Denver school system, JP Morgan was the bank that arranged the Jefferson County deal, which entailed refinancing the Jefferson County sewer system in 2002 and 2003 with $5 billion in interest-rate swaps. Far from the money-saving investment proposed by the bankers, the deal nearly bankrupted Jefferson County.

If you have a story to tell involving interest-rate swaps, please contact a member of the securities fraud team at Maddox, Hargett & Caruso.

Investigations into retained asset accounts are heating up from regulators and New York Attorney General Andrew M. Cuomo. At issue is how insurance carriers report and maintain the death-benefit proceeds held in the accounts. According to an Aug. 4 story by Investment News, regulators are discussing the possibility of requiring carriers to break out details on the retained-asset accounts on the financial statements that insurers file with state regulators.

“We’re paying close attention to how these accounts are reported through the financial filing process and looking to see if more can be done with their oversight,” said Susan Voss, insurance commissioner of Iowa and president-elect of the National Association of Insurance Commissioners, in the Investment News story.

Insurers use retained asset accounts to keep cash when beneficiaries of the policies do not elect a lump-sum payout of death benefits. However, the accounts themselves aren’t backed by the Federal Deposit Insurance Corp. and may pay uncompetitive interest rates.

“These accounts were invented not to help consumers, but to help insurance companies,” said Bob Hunter, director of insurance for the Consumer Federation of America in Washington, in the Aug. 4 Investment News article. “I can’t think of any reason why you wouldn’t want a lump-sum payout.”

When survivors don’t opt for a lump-sum payment, insurers place the cash belonging to the beneficiaries in the insurers’ corporate accounts. The cash then earns upwards of 4.8% for the insurance companies. Beneficiaries, however, do not exact the same benefits. The insurers pay families as little as 0.5% interest, less than half the rate available at some FDIC-insured banks.

As reported by Aug. 6 by Bloomberg, beneficiaries need to give careful consideration to the interest rates being offered on retained asset accounts and whether that rate is high enough to take on the risk of forgoing FDIC insurance.

Currently, no state keeps track of how much money insurers are holding in retained assets.

Retained asset accounts translate into significant profits for insurance carriers. The accounts allow more than 100 carriers to earn investment income on $28 billion owed to life insurance beneficiaries, according to Bloomberg. At the same time, insurers typically market retained asset accounts as a “service” designed to give beneficiaries the appropriate amount of time to decide what they will eventually do with the funds.

Carriers make money by investing the funds in bonds and pocketing the difference between returns and the interest credited to the accounts.

According to Bloomberg, some 40% of retained asset accounts at insurance companies still have money in them a year later. Some insurance companies issue a “checkbook” to beneficiaries. Because the checks generally mimic actual bank checks, beneficiaries are likely to assume that their money is in bank-insured accounts when in reality it isn’t.

“There needs to be improved disclosure requirements,” said Jane Cline, president of the National Association of Insurance Commissioners, in the Aug. 6 Bloomberg article.

On July 29, New York Attorney General Andrew M. Cuomo launched a fraud investigation into the life insurance industry over practices that he says misled military families and others into putting benefits into insurer-controlled, low yield, potentially risky accounts that reaped millions of secret profits for the insurers.

Embattled broker/dealer Securities America has a new leader at the helm: Jim Nagengast. One of his first assignments as the new CEO: Dealing with the problems that Securities America brokers created when they unloaded Medical Capital private placements on investors from 2003 to 2008.

In January, Massachusetts Secretary of State William Galvin filed a lawsuit against Securities America, accusing the firm of misleading investors who bought the investments. According to the complaint, 400 Securities America representatives and advisers sold almost $700 million private placements issued by Medical Capital Holdings.

In July 2009, the Securities and Exchange Commission filed fraud charges against Medical Capital.

The Massachusetts lawsuit alleges that Securities America failed to tell investors key information about the private placements and, specifically, the financial condition of Medical Capital itself. In total, Medical Capital issued $2.2. billion in notes; about half are in default. Many broker/dealers sold the notes, but Securities America, which has more than 1,900 representatives and advisers, is the largest broker/dealer to have sold them.

As reported July 26 by Investment News, an administrative hearing at the Massachusetts Securities Division is set for Aug. 30. According to the story, Nagengast believes Securities America performed its due diligence in selling Medical Capital notes to investors.

There may be evidence to the contrary, however. The Massachusetts lawsuit cites several e-mails from Nagengast in 2005 stating that the firm should stop selling the product until it received audited financials from Medical Capital.

According to the complaint, Nagengast wrote the following in one e-mail:

“We simply have to tell [Medical Capital] that if they don’t have financials by [a specified] date, we will stop distributing the product on that date. Then they can decide if it’s worth spending $50,000 to have [the audit] done. If they won’t spend the money, that should give us concern.”

If you have a story to tell involving Securities America and/or Medical Capital Notes, please contact a member of the securities fraud team at Maddox, Hargett & Caruso.

Martin Wegener, a former financial representative for New England Securities, is accused of fleecing investors out of millions of dollars through an elaborate investment scam. The Securities and Exchange Commission (SEC) filed fraud charges against Wegener on June 14, 2010, accusing the one-time broker of scamming investors out of at least $6.5 million.

From December 1998 to May 2010, Wegener worked as a registered representative for New England Securities. According to the SEC, it’s during his employment at New England Securities that the investment scam allegedly occurred undetected.

In the SEC’s complaint, Wegener is accused of encouraging investors to withdraw funds from their New England Securities brokerage accounts so that he could, in turn, invest their money in certain publicly traded securities, publicly traded mutual funds, and other investment vehicles such as certificates of deposit or private businesses. In reality, however, Wegener deposited the money into bank accounts in the name of Wealth Resources.

As it turns out, the sole owner of Wealth Resources was Wegener.

In order to maintain the appearance of legitimate investing, Wegener provided customers with purported “brokerage account” statements from Wealth Resources, which falsely showed that Wegener had placed their money in a variety of investments.

The SEC says that never happened. Instead, Wegener used investors’ money for his personal gain.

Wegener reportedly operated his scam from at least 2007 through March 2010.

New England Securities is the licensed broker/dealer of New England Financial. Whether New England Securities could face regulatory sanctions in the future for failing to properly supervise Wegener remains to be seen. If that happens, however, it would not be the first time that New England Securities has been called on the carpet for supervisory violations.

According to the Financial Industry Regulatory Authority’s BrokerCheck, New England Securities paid a $500,000 fine in connection to that very issue in March 2009. Earlier that same year, the company was fined $1.2 million by FINRA for, among other things, failing to “establish, implement and enforce a supervisory system designed to monitor compliance with regard to participation of associated persons in outside business activities and private securities transactions.”

On March 24, 2010, New England Securities submitted an offer of settlement with the Massachusetts Securities Division over alleged supervisory violations of former representatives and sales of promissory notes.

Investors who purchased preferred shares of Fannie Mae and Freddie Mac stock continue to lament their decision. In 2007 and 2008, investment firms like UBS, Morgan Stanley, Citigroup, Merrill Lynch and others sold billions of dollars in various series of preferred stock issued by the two mortgage giants. According to investors, however, the brokerages never revealed key information about the preferred shares and the ticking time bomb they represented.

Specifically, investors allege they never knew about the rapidly deteriorating financial health of Freddie Mac and Fannie Mae – a decline that was largely fueled by the two companies’ voracious appetite for risky lending, excessive leverage and investments in toxic derivative products.

By the time Fannie Mae and Freddie Mac issued select series of preferred stock in 2007 and 2008, the damage had been done. Both companies were fading fast financially and desperately needed an immediate infusion of capital. Enter the idea to issue noncumulative preferred stock to investors. Investors were eager to jump on board. After all, the stock came with attractive dividends of about 8%. As for the toxic nature of Fannie and Freddie’s mortgage portfolio, that was something investors now say they were never told.

The brokerage firms that continued to sell preferred securities in Fannie Mae and Freddie Mac even in the face of the companies’ plummeting financial condition may have had good reason to keep such information under wraps. Why? Because of the profits they made in underwriting fees. As reported in a July 7 article in Forbes titled How Fannie and Freddie Unloaded Their Trash, brokerages took in more than one-third of a billion dollars total in fees between November 2007 and June 2008.

As for investors holding preferred shares in Fannie Mae and Freddie Mac, they saw their investments become essentially worthless with the deepening of the U.S. housing crisis. Finally, in 2008, the federal government took over Fannie Mae and Freddie after the two companies suffered huge loan losses.

A number of investors have since filed arbitration claims against the brokerages that allegedly misrepresented the various series of preferred stock in Fannie Mae and Freddie Mac. If you are an institutional investor or retail investor and were misled about your investments in Fannie Mae or Freddie Mac preferred shares, we want to hear your story. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA). Leave a message in the Comment Box below or via the Contact Us form.

The admission of guilt came on July 15 as Goldman Sachs settled civil fraud charges with the Securities and Exchange Commission (SEC) over its marketing of a collateralized debt obligations (CDO) package known as Abacus 2007-ACI.

In settling the matter, Goldman agreed to pay a $550 million fine. It is biggest fine ever levied by the SEC on a U.S. financial institution. Goldman also acknowledged that its marketing materials for Abacus contained incomplete information.

“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” says Robert Khuzami, Director of SEC Enforcement.

Goldman’s troubles began back in April, when the SEC accused the investment bank of failing to disclose that one of its clients, Paulson & Co, had helped select the securities contained in the Abacus mortgage portfolio and which was later sold to investors.

According to the SEC, Goldman did not reveal that Paulson, one of the world’s largest hedge funds, had, in fact, bet that the value of the securities would fall.

Following the collapse of the housing market, the securities in that mortgage portfolio – i.e. Abacus – lost more than $1 billion.

Despite the settlement with the SEC, Goldman is far from being out of legal hot water. One of the investors in Abacus was the Royal Bank of Scotland PLC (RBS), which lost $841 million as a result of the deal. Of Goldman’s $550 million settlement with the SEC, approximately $100 million will be paid to RBS. However, the RBS may be considering a civil suit against Goldman Sachs Group to recoup additional financial losses it sustained in Abacus, according to a July 16 article in the Wall Street Journal.

Meanwhile, Fabrice Tourre, who is the only Goldman Sachs executive named as a defendant in the SEC’s fraud lawsuit, has yet to settle with the regulator.

Tourre, the creator of Abacus, has repeatedly denied the SEC’s charges that he misled investors. A number of potentially damaging emails seem to refute Tourre’s claims, however. In one email, Tourre comments on the state of the housing market and the inevitable demise of Abacus:

“More and more leverage in the system. The whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implication of those monstrosities!!!”

The alleged stock broker fraud case involving Martin Wegener offers insight into what investors can do to avoid becoming victims of investment scams. On June 14, the Securities and Exchange Commission (SEC) charged Wegener and his companies – Wealth Resources, Inc. and Wealth Resources, LLC – with defrauding investors out of at least $6.5 million.

According to the SEC, Wegener was not a registered broker or investment adviser yet told his clients he would invest their money through Wealth Resources. He would then provide investors with purported “brokerage account” statements from Wealth Resources – statements that falsely represented a variety of investments courtesy of Wegener’s “financial acumen.”

Wegener never used his customers’ money for those investments, however. Instead, the SEC says he took clients’ money for his personal use, paid business expenses and made investments on his own behalf in entities where he had an ownership interest. Those companies included WU Ventures, LLC, Secura Technology, LLC, and Trailblazer Learning, Inc., as well as Wealth Resources. Investors’ funds also were transferred to Wegener’s former wife, Kristin Wegener.

The SEC further says that during the course of the alleged scam, Wegener used money from investors to make Ponzi-like payments to clients who wanted a portion or all of their investment returned.

The Wegener case offers several lessons for investors. First, before investing money with any financial professional, take time to verify that the person is a registered stock broker or financial advisor. Is the individual a member of the Financial Industry Regulatory Authority (FINRA)? Does the person have any customer complaints, disciplinary actions, fines, suspensions or other sanctions by FINRA, the SEC or other federal or state regulatory agencies listed on FINRA’s BrokerCheck Web site?

In addition, be leery of sales pitches that make exaggerated claims about the expected profitability of an investment, such as it will double in value in six months. The bottom line, if it sounds too good to be true, it usually is.

The admission of guilt came on July 15 as Goldman Sachs settled civil fraud charges with the Securities and Exchange Commission (SEC) over its marketing of a collateralized debt obligations (CDO) package known as Abacus 2007-ACI.

In settling the matter, Goldman agreed to pay a $550 million fine. It is biggest fine ever levied by the SEC on a U.S. financial institution. Goldman also acknowledged that its marketing materials for Abacus contained incomplete information.

“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” says Robert Khuzami, Director of SEC Enforcement.

Goldman’s troubles began back in April, when the SEC accused the investment bank of failing to disclose that one of its clients, Paulson & Co, had helped select the securities contained in the Abacus mortgage portfolio and which was later sold to investors.

According to the SEC, Goldman did not reveal that Paulson, one of the world’s largest hedge funds, had, in fact, bet that the value of the securities would fall.

Following the collapse of the housing market, the securities in that mortgage portfolio – i.e. Abacus – lost more than $1 billion.

Despite the settlement with the SEC, Goldman is far from being out of legal hot water. One of the investors in Abacus was the Royal Bank of Scotland PLC (RBS), which lost $841 million as a result of the deal. Of Goldman’s $550 million settlement with the SEC, approximately $100 million will be paid to RBS. However, the RBS may be considering a civil suit against Goldman Sachs Group to recoup additional financial losses it sustained in Abacus, according to a July 16 article in the Wall Street Journal.

Meanwhile, Fabrice Tourre, who is the only Goldman Sachs executive named as a defendant in the SEC’s fraud lawsuit, has yet to settle with the regulator.

Tourre, the creator of Abacus, has repeatedly denied the SEC’s charges that he misled investors. A number of potentially damaging emails seem to refute Tourre’s claims, however. In one email, Tourre comments on the state of the housing market and the inevitable demise of Abacus:

“More and more leverage in the system. The whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implication of those monstrosities!!!”