Securities Law Blog

Two lawsuits have been filed in Palm Beach County Circuit Court against HighTower Advisors, LLC and broker Curtis Lyman. According to court documents, two clients of Mr. Lyman filed the suits over the sale of promissory notes with Banyon 1030-32 LLC. The sale of the notes turned out to be a feeder fund for the $1.4 billion Ponzi scheme controlled by disbarred Florida attorney Scott Rothstein.

Collectively, the two investors invested and lost more than $4.6 million. The lawsuit against HighTower and Mr. Lyman alleges investment fraud, the sale of unregistered securities, breach of fiduciary duty and negligence.

The notes with Banyon went into default in November 2009 when Rothstein’s Ponzi scheme was exposed. According to court documents, Mr. Lyman’s clients were investing in Banyon notes up until October 2009.

In a June 2009 email to a client, Mr. Lyman wrote “I remain comfortable on the Banyon program. Business has remained strong and they have not ‘oversubscribed’ their demand, which is the biggest business risk I think they have. We are monitoring that closely, but, at the moment, they are working to raise over 300 million dollars in order to retire more expensive hedge funds lines. My recommendation is to renew the notes.”

The Banyon fund was controlled by George G. Levin. According to the lawsuits, Mr. Lyman told his clients that “he normally did not do ‘private deals’ as he was very leery and cautious of them” but that he had known Mr. Levin for a long time and that he personally guaranteed the notes. Mr. Lyman allegedly told investors that their investments with Mr. Levin would serve as capital for structured legal settlements, and would produce a guaranteed rate of return through the notes.

Spokeswoman for HighTower, Jennifer Connelly, indicated that the Banyon fund predated Mr. Lyman joining HighTower, and that these “legacy investments” were at no time on the HighTower platform.

HighTower CEO Elliot Weissbluth said that Mr. Lyman has his “unreserved” support.
“We are aggressively pursuing all available remedies because Curt Lyman is as much a victim as the other Ponzi scheme victims. We are defending any allegations of HighTower wrongdoing,” Weissbluth said.

According to HighTower, the significant amount of personal capital invested in the Ponzi scheme by Mr. Lyman shows that he had no intent to harm his clients.

The Securities and Exchange Commission (SEC) has put a halt on any new or pending exemptive requests by exchange-traded funds (ETFs) that are seeking to make “significant investments” in derivatives. The purpose of this decision is to allow the SEC time to review the use of financial derivatives by mutual funds, ETFs, and other investments, in order to determine whether new protections are needed for investors. The action will have no affect on already existing ETFs or other funds.

According to SEC Chairman Mary Schapiro, “It’s appropriate to engage in a more thorough review of the use of derivatives by ETFs and mutual funds given the questions surrounding the risks associated with the derivative instruments underlying many funds.”

The SEC’s review will seek to evaluate whether the current use of derivatives is compliant with provisions of the Investment Company Act in relation to leverage, concentration and diversification. They will look at whether there is adequate risk management implemented and maintained, as well as rules in place for the “proper procedure for a fund’s pricing and liquidity determinations regarding its derivatives holdings.”

Furthermore, the SEC will explore whether appropriate oversight of the use of derivatives is being provided by fund boards of directors. As well as if the risks created by derivatives are being adequately disclosed and if there should be special reporting requirements for funds’ derivative activity.
Derivatives are being faulted for playing a role in the financial crisis, and have since come under increased scrutiny in the U.S. and Europe. Greater federal regulation for derivatives is included in pending legislation, and would grant the SEC more policing authority.

GunnAllen Financial Inc. has been shut down by the Financial Industry Regulation Authority (FINRA) for failing to meet its mandatory net capital requirements. On Friday March 19, 2010 FINRA warned the Tampa, Florida based broker/dealer that it had fallen below its capital requirement, and was subsequently unable to open for business the following Monday.

The closing has left 400 reps and advisers to look for new firms. One of the largest branch offices at GunnAllen, RG Michals Holdings Inc., will be moving roughly 70 brokers to Aegis Capital Corp. According to Investment News, “One of the biggest problems facing the 400 or so reps and advisers who remain at the company is finding an independent broker-dealer that uses its clearing firm.”

Upon closing, GunnAllen’s clearing firm, Ridge Clearing & Outsourcing Solutions, Inc. took over client accounts. J.P. Turner & Co. LLC, Aegis Capital and Lombard Securities Inc., are among the few firms that have access to Ridge.

There are several factors that are believed to have lead to the firm’s closing. The broker/dealer has been caught in a swarm of client lawsuits, some seeking as much as $50 million in damages. Many of the claims stem from disgraced broker Frank Bluestein’s alleged activities related to a Ponzi scheme that fell apart in 2007. The SEC charged Bluestein with fraud for soliciting roughly 800 investors who invested $74 million in an alleged Ponzi scheme. Other client lawsuits have been filed against GunnAllen over the sale of Provident Royalties LLC private placements. According to GunnAllen executives, legal costs mounting to about $500,000 per month were devastating the firm.

Some speculate that despite the firm’s investment in compliance systems and hiring compliance personnel, the presence of ethically challenged brokers was a major contributing factor to GunnAllen’s ruin. According to the firm’s former general counsel, David Jarvis, GunnAllen “let the inmates run the asylum, and that’s where the firm failed.”

In its first action as part of its initiative of active examinations and investigations, the Financial Industry Regulation Authority (FINRA) expelled Provident Asset Management, LLC from the securities industry on March 18, 2010. The regulator said it expelled the Dallas-based broker/dealer for selling allegedly fraudulent private placements offered by its affiliate, Provident Royalties, LLC in a “massive Ponzi scheme.”

FINRA claims that Provident Asset Management misrepresented the sale of private placement offerings. The broker/dealer allegedly told investors that funds raised through the offerings would be used to purchase interests in the oil and gas business. They would include funding exploration activity and the acquisition of real estate, oil and gas leases and mineral rights. In memoranda issued by Provident Royalties, investors were promised returns of up to 18 percent per year produced by revenues generated primarily from the sale of oil and gas assets. Instead investor funds were allegedly pooled together in order to make dividend and principal payments to earlier investors, in classic Ponzi style.

From September 2006 to January 2009, Provident Royalties raised more than $480 million from thousands of investors, by allegedly marketing and selling preferred stock and limited partnership interests in a series of 23 private placements.

Provident neither admitted nor denied FINRA’s allegations, but consented to their findings and are no longer allowed to sell securities. The lawyer representing two Provident executives, Brendan Coughlin and Henry Harrison, said they “vigorously deny any claim of wrongdoing.”

FINRA began its initiative in response to an increase in investor complaints regarding private placements and following the Securities and Exchange Commission’s (SEC) actions surrounding the sale of certain private placement offerings.

According to FINRA, they will continue to dig deeper in their investigation into the broker-dealers that sold Provident and other questionable private placements. Their attentions will be focused on firms’ compliance with suitability, supervision and advertising rules, as well as the possibility of fraud.

In Manhattan, an investor lawsuit was dismissed against Canadian Imperial Bank of Commerce (CIBC) and four of its executives on March 17, 2010. Filed by Plumbers & Steamfitters Local 773 Pension Fund, the lawsuit was seeking class actions status on behalf of all the investors who bought CIBC shares in the U.S. between May 31, 2007 and May 29, 2008. The claimants alleged that CIBC committed securities fraud and misled investors about its mortgage-backed holdings.

U.S. District Judge William H. Pauley III threw out the case stating that the investors failed to adequately allege that the bank intended to defraud them. According to Judge Pauley, at no point did the plaintiff’s complaint make any reference to specific CIBC documents to discredit CIBC, nor did they demonstrate that CIBC possessed information that was contrary to their public statements. The Judge further asserted that given that the executives suffered large losses in their common stock holdings and compensation, it would be “nonsensical to impute dishonest motives” to them.

In his ruling, Judge Pauley wrote, “Knowledge of a general economic trend does not equate to harboring a mental state to deceive, manipulate, or defraud. CIBC, like so many other institutions, could not have been expected to anticipate the crisis with the accuracy the plaintiff enjoys in hindsight.”