RBC Capital Markets LLC of New York has agreed to pay $30.4 million to settle charges that it sold unsuitable, high-risk investments to five eastern Wisconsin school districts, as well as charges that it inadequately disclosed the risks.
The misconduct charges were brought by the Securities and Exchange Commission, or SEC, after RBC marketed and sold $200 million in credit-linked notes to trusts created by the districts.
The notes were tied to the performance of synthetic collateralized debt obligations, or CDOs, according to the SEC’s Sept. 27 Order Instituting Cease and Desist Proceedings. The CDOs held a portfolio of more than 100 credit default swaps linked to corporate bond obligations.
The school districts borrowed almost all of the money they used to purchase these CDO investments as a way to meet their unfunded retiree benefit obligations.
The other player in the deal, St. Louis-based brokerage firm Stifel, Nicolaus & Co., was charged by the SEC in August with defrauding the school districts in connection with the same transactions. David W. Noack, the firm’s former senior executive vice president, was also charged.
The Fraud Losses Millions For School Districts
This SEC action appears to be pending. The complaint states that the CDO investments did in fact fail, causing the school districts to lose tens of millions of dollars as a result of the fraud.
The settlement monies from RBC will be distributed to the school districts through a Fair Fund, the SEC’s cease and desist order said.
A U.S. broker-dealer affiliated with the Royal Bank of Canada Europe Limited, RBC marketed and sold the CDO investments to the school districts in three transactions between June and December 2006. They were sold despite concerns about their suitability for a municipal investor like a school district, the SEC order said.
The sale of these complex, high-risk investments was deemed negligence, resulting in charges against RBC per Section 17(a)(2) and Section 17(a)(3) of the federal Securities Act of 1933.
In addition, RBC’s marketing materials did not explain the risks associated with the CDO investments and the school districts were not the kind of knowledgeable and sophisticated buyer that could be expected to appreciate the nature of this convoluted investment.
RBC used models based on credit spread rather than quality, which served to understate the inherent default risk in the CDO investment, the SEC order explained. The investments were structured in such a way that there was only a 1 percent difference between receiving the expected return and complete failure.
In fact, only a 5 percent to 6 percent decline was needed to completely wipe out the CDO investments of these municipal entities, which were in no position to suffer such a catastrophic loss. The SEC order stated that RBC knew the school districts were risking their entire pension fund portfolio.
The deal was put together by both Stifel Nicolaus and RBC, according to the SEC order. Stifel Nicolaus designed the investment program for the school districts, and contacted RBC, which offered the products.
The SEC order also stated that, despite discussions regarding the riskiness of these CDO investments and RBC’s reluctance to sell them to their own municipal clients, it decided to rely on Stifel’s suitability analysis.
RBC also affixed its signature to a side letter that said Stifel was relying on the school districts to determine the suitability of the CDO investments for themselves, the SEC order said.
The action against Stifel Nicolaus appears to be ongoing, and the two financial companies have taken shots at each other in public statements.
On Sept. 27, on news of the RBC settlement, Stifel Nicolaus released a statement saying that RBC had misrepresented to both Stifel Nicolaus and the school districts the profits it had earned on such products, as well as the risks associated with them.
A Sept 28 report in The Edmonton Journal featured RBC taking the shot, however. The story said that RBC released a statement claiming it did not know Stifel Nicolaus was misrepresenting the riskiness of these products to the school districts, or it would not have participated in the transactions.
The school districts in question are in all in eastern Wisconsin. They are of West Allis-West Milwaukee, Kenosha School District No. 1, School District of Waukesha, Kimberly Area School District and the School District of Whitefish Bay, according to the SEC order.
The terms of the RBC settlement, as indicated in the SEC order, state that RBC neither admits nor denies the charges laid out in the cease and desist order beyond their use in the proceedings.
Guiliano Law Group
The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.
