Stockbroker Charged With Fraud by SEC : Securities: Investigation focuses on dealers who allegedly duped municipal investors into high-risk derivatives.
The Securities and Exchange Commission has filed civil fraud charges against a stockbroker in connection with an investigation focusing on Houston securities dealers who allegedly duped municipal agencies into making high-risk investments.
While unrelated to the SEC’s investigation of possible wrongdoing in Orange County’s bankruptcy, the case underscores the agency’s broad concern about unscrupulous securities dealers who may be preying on municipal finance customers.
Named in the complaint filed this week by the Chicago office of the SEC is Kenneth J. Schulte, a stockbroker who formerly worked in Houston for Hart Securities and Murchison Investment Bankers. He currently works in Boca Raton, Fla., for Comprehensive Capital Corp.
The complaint focuses on allegedly improper sales practices by Schulte involving 14 client municipalities and school districts in Ohio.
“There were investments that were totally inappropriate for municipalities that were being recommended by a broker who knew that they were inappropriate and who then lied about what the investments are,” said Mary E. Keefe, regional director of the SEC in Chicago.
For example, Keefe said, Schulte led municipal officials to believe in some cases that they were putting their money into low-risk U.S. government-backed securities when, in fact, they were buying high-risk derivative investments. In other cases, Schulte allegedly misled investors about the risk of the sophisticated investments they were buying, she said.
In its complaint, the SEC said Schulte traded in mortgage-backed derivative investments known as interest-only securities, or IOs, inverse IOs and inverse floaters. These are complex securities designed to pay out more in interest as rates fall--and, conversely, less if rates rise, as they did throughout 1994. In fact, Orange County sustained heavy losses by investing in inverse floaters.
SEC officials said their investigation is continuing into “various individuals and entities,” which are believed to include the three brokerage firms for whom Schulte has worked since the spring of 1990.
Schulte, reached at his home in Delray Beach, Fla., declined to comment other than to say he did no business with municipalities in California. He referred questions to Paul S. Francis, a Houston lawyer representing his former employer, Hart Securities.
Francis said an internal probe of Schulte’s activities while working for Hart from June to December, 1991, turned up no wrongdoing. During Schulte’s stint with Hart, Francis added, Schulte sold IOs but not the other types of investments cited in the SEC complaint.
“Based on our investigation, we believe he did adequately disclose the characteristics of the IOs, including their risks, and faithfully executed the purchases and sales requested by the customers,” Francis said.
He said the SEC subpoenaed records involving Schulte’s transactions in mid-1994. Francis said Hart also has received “inquiries” from the National Assn. of Securities Dealers and securities regulators in Texas and Missouri about related matters.
SEC officials said the total losses suffered by the Ohio agencies has not been determined. The agency, however, said it traced $7.5 million in investments that four of the municipal investors made through Schulte, and that $3.4 million--roughly 45%--was lost.
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