Securities Law Blog

Less than two months after GunnAllen Financial was shut down, another independent-contractor broker-dealer has closed its doors. AFA Financial Group LLC, with about 100 advisers on staff, made the decision to cease its operation based in Calabasas, California on April 30, 2010.

The firm’s president, Morrie Reiff, said, “Our reps were not producing what they needed to produce to keep the doors open.”

According to Mr. Reiff, the firm took a devastating hit by the downturn of the stock market in 2008 and 2009, and was not able to continue making its errors-and-omission-insurance payments.

In its seven years of operation, AFA had only seen one arbitration claim filed against it until the dramatic increase it suffered in 2010. In 2010 investors have sued the firm seven times, mostly over the sale of Provident Royalties LLC private placements, which was charged with being part of a massive Ponzi scheme in 2009 by the Securities and Exchange Commission (SEC).

On Thursday April 29, 2010 the Financial Industry Regulatory Authority (FINRA) permanently barred Tom Bretton from the securities industry for his alleged involvement in a $1.3 million fraud. The former Chief Compliance Officer and Head Trader in the Garden City, NY office of Prestige Financial, Inc. was accused of running a fraudulent trading scheme that imposed improper charges on his clients’ trades, according to the FINRA report.

Allegedly from September 2006 through June 2009, Bretton placed large customer orders, typically of 1,000 shares or more, through a firm proprietary account instead of effecting the trades through the customers’ accounts. For securities being purchased, Bretton allegedly increased the price per share by $.02 to $.05 before allocating the shares to the customers’ accounts. For securities being sold, Bretton allegedly decreased the price by $.02 to $.05 before allocating proceeds to customer accounts. FINRA found that these findings were never authorized by or disclosed to the customers.

According to FINRA, Bretton allegedly concealed his fraud by entering false information on the corresponding order tickets regarding the share price and the time the customer order ticket was received, entered and executed.

The scheme generated $1.3 million in profits for the proprietary accounts, of which Bretton received 33% interest, equaling a payday of $429,000.

On April 27, 2010 the Financial Industry Regulatory Authority (FINRA) fined five broker-dealers for the illegal sale of more than 8 billion shares of penny stocks on behalf of their customers. Fagenson & Co., Inc., RBC Capital Markets Corp., Equity Station, Inc., Olympus Securities, LLC and Alpine Securities Corp. have been fined a combined total of $385,000.

The majority of the illegal sales involved Universal Express Inc. More than 7.5 billion shares of the company’s unregistered stock were sold by the five firms, generating proceeds of roughly $8.4 million.

Regulators allege that despite indications that the sale of the stock was potentially illegal, the firms failed to take appropriates measures to determine whether the sale of the securities followed federal registration requirements.

In 2004 the Securities and Exchange Commission (SEC) filed a complaint alleging that Universal had issued more than 500 million shares of unregistered stock for distribution to the public. In 2007, a federal court ordered Universal to pay an estimated $22 million in fines and disgorgement. Despite the actions taken against Universal, the five firms carried out most of the illegal sales after the SEC’s complaint or after its enforcement action.

All of the firms, except Equity Station Inc., were found to have failed to establish and enforce a reasonable supervisory system to prevent the sale of unregistered stock.

“Brokerage firms are the first line of defense when it comes to preventing the illegal distribution of unregistered securities into the public markets. The failure to detect and prevent these sales creates serious risks to the unsuspecting customers who purchased these unregistered securities,” said James Shorris, FINRA Executive Vice President and Executive Director of Enforcement.

FINRA found that each of the five firms allowed their customers to deposit large blocks of thinly traded securities in certificate form and then immediately liquidate those positions.

According to the FINRA report, Fagenson reported earning $44,000 in commissions and was fined $165,000; RBC earned $68,000 in commissions and was fined $135,000; Alpine earned $47,000 and was fined $40,000; Equity earned $13,575 and was fined $25,000; and Olympus earned $5,200 and was fined $20,000.

On April 21, 2010, Bruce Karatz, former chief executive of one of the nation’s most successful home builders, was convicted on four felony counts of fraud related to his alleged manipulation of executive stock options. The former KB Home executive was found guilty by a jury in Los Angeles, California of two counts of mail fraud, making false statements in a regulatory filing and lying to company accountants.

Back in 2006 KB Home hired an outside law firm to investigate its options policies in response to the Securities and Exchange Commission’s (SEC) and Justice Department’s increased scrutiny of stock option grants at the time. Following the investigation Karatz retired after being with the company for two decades and settled a lawsuit with the SEC for $7 million in fines and restitution to KB Home.

In March 2009, a federal grand jury indicted Karatz on 20 felony charges. The charges claimed that from 1999 until 2006 Karatz backdated his own stock options and those of other executives. The jury acquitted Karatz of 16 of the charges stating that there was no evidence of intent to defraud investors, but that he did lie about backdating to KB Home accountants in a 2006 quarterly report, according to court documents.

According to prosecutors, the alleged scheme enabled Karatz to make more than $6 million in “secret pay.”

Following the conviction, Karatz’s lawyers attested that Karatz never thought he was committing a crime, and they are looking to appeal.

On April 23, 2010 the Denver District Court issued a temporary restraining order, freezing the assets of Sean Michael Mueller and his companies, Mueller Capital Management LLC and Mueller Over Under Fund LP. The Greenwood Village, Colorado hedge fund manager has been under investigation by the Colorado State Securities Division for the past month for his alleged involvement in a multi-million dollar Ponzi scheme.

The court order to freeze Mueller’s assets came after Colorado State Securities Commissioner Fred Joseph filed for the order following the receipt of a complaint from an anonymous investor, and learned of Mueller’s failed suicide attempt on April 22, 2010. According to the state securities division, the anonymous investor also “expressed concern that Mueller was effectively operating the fund as a Ponzi scheme, representing that he has never lost money in any monthly period and providing investors with inflated expectations of returns.”

According to court documents, before attempting to jump off of a 19 story building, Mueller sent an email to investors stating, “I don’t know where to begin, so I will start with, I’m sorry. The stress of life has overwhelmed everything else. Please realize that I didn’t set out to end this way, I always thought I could pull it out in the end but events sped up to end that dream.”

According to Joseph, Mueller claimed to have a complicated investment strategy to make it sound like investors could make a lot of money. In a memorandum for the Fund filed in 2002, Mueller allegedly asked for a minimum investment of $500,000 into the Over Under Fund, claiming the fund would attempt to raise $100 million. He allegedly stated that the Fund would engage in short-term trading of stocks and would borrow money in order to leverage investors’ funds, according to court documents.