FINRA today announced charges against six brokers formerly associated with Brookstreet Securities Corporation, a now-defunct nationwide brokerage firm based in Irvine, CA, including fraud and making unsuitable recommendations to retail customers in the sale of collateralized mortgage obligations (CMOs).
FINRA's complaint alleges that from June 2004 through May 2007, the brokers sold CMOs to retail customers when the brokers themselves lacked a basic understanding of these complex and illiquid securities. The complaint alleges that the brokers failed to adequately investigate the CMO investments prior to selling the products and misrepresented or failed to disclose important information about the risks associated with an investment in CMOs. As a result, many customers were unaware of the speculative nature of the CMOs and suffered considerable losses. The complaint alleges that these brokers led their customers to believe that the CMOs were safe, government-backed securities. Customers were also told that they could achieve consistently high annual returns, in some cases up to 15 percent, regardless of market conditions. In fact, the complaint alleges that the CMOs purchased for the respondents' customers were generally not guaranteed by the government and were subject to uncertain cash flows and maturities, based on changes in interest rates.
According to the complaint, the customers generally acquired small "odd-lot" positions that could not be easily sold in the marketplace unless sold at a substantial discount or combined with other positions as part of a larger block. Moreover, the complaint charges that the respondents recommended the CMOs to their customers, many of whom were retired and/or unsophisticated, without carefully assessing whether these were suitable investments in light of the customers' investment objectives, financial situation and other factors. Many of the respondents' customers were seeking a safe, secure investment, including those who used retirement funds to invest in the CMOs. Instead, many suffered substantial losses to their retirement savings.
In a parallel action, the SEC today charged ten additional Brookstreet brokers with similar fraud. According to the Commission’s complaint, the defendants told their customers that the CMOs in which they would invest were safe, secure, liquid investments that were suitable for retirees and investors with conservative investment goals. The complaint alleges that contrary to these representations, the defendants invested in risky types of CMOs that: (1) were not all guaranteed by the United States government; (2) jeopardized customers’ yield and principal; (3) were largely illiquid; and (4) were only suitable for sophisticated investors with a high-risk investment profile. The complaint alleges that the defendants received $18 million in commissions and salaries related to CMO investments.
The complaint also alleges that some defendants told customers that they would use margin, or the ability to borrow money to purchase CMOs, only sparingly, when in fact they heavily margined customers’ accounts, resulting in losses of over $36 million.
The Commission’s complaint specifically alleges that the defendants violated the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The Commission seeks permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, and civil monetary penalties.