Rejection of Securities America Settlement Has Wide-Ranging Implications

State securities regulators hail judge’s decision as protecting investors’ interests, but trouble looms for BD

On Friday, March 18, in Dallas, after hearing oral arguments in the case, U.S. District Judge Royal Furgeson rejected a class action settlement under which independent broker-dealer Securities America would have paid $21 million to settle charges that it didn’t conduct the proper due diligence on investments sold by Securities America reps from Provident Royalties LLC and Medical Capital Holdings Inc.

Both companies have been charged with fraud by the SEC, and plaintiffs in the case allege they had lost $400 million.

The judge’s decision allows arbitration cases to proceed in separate states where securities regulators have brought action against Securities America and its management, including CEO Jim Nagengast (left).

“Investors and state securities regulators have won a significant legal victory,” said David Massey of NASAA, the association of state securities regulators, who writes regularly for AdvisorOne. “This case could have had a chilling effect on all state securities regulators seeking restitution on behalf of investors. The court’s decision means that defendants cannot use the federal courts to evade investors or state securities regulators.”

An official from one of those states that had filed suit against Securities America weighed in as well. “We are very pleased with the decision,” says Bryan Lantagne, director of the Massachusetts Securities Division. “It makes clear that the states have the authority that Congress intended them to have in these securities matters.” He said that in rejecting the settlement, the judge negated the issue that the states were concerned about, which was preemption of state securities laws.

NASAA, where Massey (left) serves as president, had filed a brief with the federal court arguing that the proposed class action settlement would have stopped Massachusetts and Montana investors from bringing separate arbitration claims against Securities America. In January, a FINRA arbitration panel awarded $1 million to a claimant who had accused Securities America and one of its reps with breach of fiduciary duty and financial elder abuse over the sale of promissory notes of Medical Capital.

At that time, Janine Wertheim, Securities America Inc.'s senior VP and chief marketing officer, told AdvisorOne's Joyce Hanson that  “The award was based on the specific facts of this investor's case, and we disagree with the outcome. Securities America does not believe it acted inappropriately in the sale of these investments.“ 

Securities America’s RevenueIn a statement released Monday, Wertheim said that “We are disappointed that the court in Texas did not approve the settlement on Friday, but remain committed to finding a solution to the Medical Capital and Provident Royalties matters for the company, its advisors and their clients."

The Associated Press had reported that attorneys for Securities America have said the broker-dealer would be forced to close if Friday’s agreement was not approved. Some plaintiffs’ attorneys agree, noting that the settlement is the only way for investors to recoup at least some of their losses. Others note that Securities America is well capitalized through its parent company Ameriprise Financial, and it is unlikely the Minneapolis-based Ameriprise would let its subsidiary fail.

In her statement released to AdvisorOne on March 21, Wertheim said “Ameriprise has reached out to us to determine whether it can help the parties to find a reasonable resolution for all constituents. We hope to develop a process in the coming days that

would facilitate exploration of such a resolution, and to have a good sense by the end of the week whether such a resolution is possible."

In Investment Advisor magazine’s annual directory of independent broker-dealers, in 2010, Securities America ranked 11th in number of reps among independent BDs—1,906 as of April 1, 2010—and fifth in revenue, with $412 million in gross revenue. Securities America ranked 17th in average annual production per rep—at $167,961 gross production—and had $14.4 billion in fee-based assets under management. Securities America also reported in Investment Advisor's annual directory that 17% of its reps had their own RIA.

Lessons for Other Broker-Dealers

Whatever the outcome of the lawsuits and arbitration cases, industry watchers say the ruling has larger implications for independent broker-dealers as a whole.

“All the independent broker-dealers must be following this with mixed emotions,” said Philip Palaveev in an interview with AdvisorOne on Monday. “I feel bad for the professionals and advisors at Securities America; they are one of the largest and most established firms and there’s tremendous talent on board,” said Palaveev, president of Fusion Advisor Network, and a regular contributor to AdvisorOne.

“Independent BDs all get involved with private placements; other BDs were participating in these deals,” Palaveev (left) pointed out.” Private placements are dangerous territory, and well-meaning firms and well-meaning advisors can step on a land mine. This goes to show how dangerous alternatives and hedge funds” can be. Because the broker-dealer is big itself and has an even bigger parent company,  “Securities America has the deepest pockets; highest payout potential” to plaintiffs, Palaveev said. “Ameriprise is the most appealing target.”

Could Securities America have done more due diligence on the products? “In retrospect,” says Palaveev, “every BD has to have a comprehensive a process as possible” when it comes to due diligence

The Recruiters Swoop In

Broker-dealer recruiters are less careful in their reactions.  “It’s going to change the broker-dealer industry dramatically,” says one recruiter for a small independent firm

who asked not to be identified. “Ameriprise has deep pockets, but we are talking about half a billion dollars to clean this up.”

Like Palaveev, this recruiter pointed out that Securities America is not the only firm that sold these investments, and suggested other broker-dealers may face serious repercussions if Friday’s ruling is upheld.

“If the ruling doesn’t get overturned and individual arbitrations can’t be bundled up into a single class action settlement by each broker-dealer, then the cost of claims, not to mention the cost of litigation, will crush every one of them,” he said.

The recruiter claims he received seven unsolicited calls from Securities America reps within hours of the ruling. One producer group took 17 minutes to fill out and fax back the affiliation agreement paperwork.

“You can kick out the right leg or the left leg, but either way it doesn’t look good for Securities America and many other firms,” according to the recruiter. “Even if they survive litigation, their E&O costs alone will have advisors looking elsewhere.”

Another recruiter who agreed to be quoted, Rick Peterson, based in Houston, said that “most recruiters recognize trends and would be calling advisors at Securities America to discuss the alternatives available to them.” Peterson think other independent broker-dealers will be looking at the firm as well:  “Securities America, and more broadly, other IBDs, are vulnerable right now as targets.”

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