The SEC charged St. Louis-based Stifel, Nicolaus and a former senior executive with defrauding five Wisconsin school districts by selling them unsuitably risky and complex investments funded largely with borrowed money.  The SEC's investigation continues.

According to the SEC's federal complaint, Stifel and SVP David Noack created a proprietary program to help the school districts fund retiree benefits.  The districts followed  the directives, establishing trusts that invested $200 million in notes linked to the performance of synthetic collateralized debt obligations (CDOs).  The investments were effected in 3 transactions from June to December 2006, and largely were paid for with borrowed funds ($163mn).

SEC Allegations Against Stifel.   Stifel and Noack are alleged to have misrepresented the risk of the investments, and they failed to disclose material facts to the school districts.  Eventually, the investments were a complete failure, but not for Stifel and Noack who earned significant fees.

• Alleged misrepresentations:  Stifel and Noack made sweeping assurances to the school districts, misrepresenting that:  (i) it would take “15 Enrons” - a catastrophic, overnight collapse - for the investments to fail;  (ii) 30 of the 105 companies in the portfolio would have to default and that 100 of the top 800 companies in the world would have to fail before the school districts would suffer a loss of their principal.
• Alleged failed disclosures:  Stifel and Noack failed to disclose these material facts:  (i) that the portfolio in transaction #1 was performing poorly from the outset;  (ii) credit rating agencies placed 10% of the portfolio on negative watch within 36 days of closing;  (iii) certain CDO providers expressed concerns about the risks of Stifel’s proprietary program and declined to participate in it.

The SEC added that the product was unsuitable for the school districts and didn't meet their investment needs.  The districts had no prior experience with CDOs and related instruments, and both Stifel and Noack knew the districts lacked the requisite sophistication and experience to independently evaluate the risks of the investment. The substantial leverage and the structure of the synthetic CDOs further exposed the districts to a heightened risk of catastrophic loss. 

The investments steadily declined in value in 2007 and 2008, and by 2010 the districts learned that investments # 2 and #3 were complete losses - leading the lender to seize all of trusts’ assets.  The districts suffered a complete loss of their investment and suffered credit rating downgrades for failing to provide additional funds to the trusts they established.

“Stifel and Noack abused their longstanding 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.”   -- Elaine Greenberg, Chief of the SEC Enforcement - Municipal Securities and Public Pensions Unit.

Alleged Violations.   Section 17(a) (Securities Act of 1933), Section 10(b) and Rule 10b-5 (Securities Exchange Act of 1934).  Stifel further violated, and Noack aided and abetted, violations of Section 15(c)(1)(A) of the '34 Act.

The SEC seeks disgorgement , prejudgment interest, and financial penalties.  The SEC’s investigation is continuing.

SEC Staff Credits.  Teams from Enforcement's Muni Securities and Public Pensions Unit, led by Elaine Greenberg and Mark Zehner;  Structured and New Products Unit, led by Kenneth Lench and Reid Muoio. Chicago Regional Office staff assisted.  Steven Seeger and Robert Moye of the CRO will lead the SEC’s litigation.

For further details, go to:   [SEC PR 11-165, 8/10/11]  and [Litigation Release 22064]