The SEC has taken action that should send shivers up the spines of many of Wall Street investment banks. The SEC recently charged 10 brokers associated with the now-defunct Brookstreet Securities Corp. (out of Irvine, California) with fraud for falsely marketing investments in complex derivative securities backed by mortgages as safe and suitable for retirees and as appropriate for those with conservative investment goals. In particular, the defendants portrayed risky collateralized mortgage obligations as safe investments to more than 750 customers. The customers subsequently incurred over $35 million in losses investing in these “low risk” investments. Seven of the ten brokers were based in West Palm Beach, Florida, and the others were based in Hawaii, Oregon, and Montana. FINRA, the Financial Industry Regulatory Authority, has brought a similar complaint alleging fraud against six other former Brookstreet brokers.
According to the SEC’s complaint, the brokers disguised the risks of investing in the derivatives of mortgage-backed securities and pushed their customers into risky investments through blatant misrepresentations. The customers were told that the funds would only use limited amounts of margin, yet the brokers heavily margined these accounts. The defendants also stated these securities were suitable investments for those with conservative investment objectives.
Brookstreet’s practice was indicative of what was an unfortunate trend in the financial industry between 2004 and 2007. Several class action lawsuits and many arbitrations have been filed against brokerage firms such as Citigroup, Morgan Keegan and Charles Schwab (among others) for similar practices. It will be interesting to see if the SEC sticks to its guns and prosecutes some of the major brokerage firms that sold similar high risk, complex structured finance securities under guise of being safe, low risk investments.
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