Securities firm Stifel Nicolaus balks at fraud charge

Secretary of State Todd Rokita’s high-profile securities-fraud case against St. Louis-based Stifel Nicolaus &
Co. has thrown the spotlight on a question hanging over the entire securities industry:

Should firms and their
financial advisers have anticipated the potential collapse of the market for an obscure form of bonds known as auction-rate
securities?

Rokita, a Republican, filed an administrative complaint against Stifel Oct. 1, charging the firm and
its financial advisers failed to disclose the risks of the securities to 142 Hoosiers who invested $55 million.

The
case ensnares a Carmel-based advisory team led by Dave Knall and Jeff Cohen, which oversees billions of dollars on behalf
of many of the state’s wealthiest businesspeople.

They and other Stifel advisers aren’t personally
on the line in the case, which targets only the firm. Transactions cited in the complaint involved advisers scattered across
Stifel’s seven Indiana offices, though two-thirds were Cohen’s clients. Those clients accounted for 80 percent
of the money.

Auction-rate securities are bonds whose interest rates are meant to be reset regularly at daily,
weekly or monthly auctions. Many financial firms marketed them as safe, liquid and cash-like investments. But when credit
markets seized up as the recession deepened last year, auctions began to fail, freezing the $200 billion market and leaving
investors unable to access their money.

Because only a handful of previous auctions ever had failed, many investors
considered the securities a safe form of temporary financing—essentially a better-yielding alternative to money market
accounts.

Stifel CEO Ronald Kruszewski said his firm did nothing wrong.

“Hindsight’s always
20/20,” he said. “No one anticipated a complete market collapse. It’s just that simple. And to say you committed
fraud by not disclosing an unknown risk can only be true with the benefit of hindsight.”

To provide liquidity
to its clients, Stifel earlier this year offered to buy back all their auction-rate securities at face value over three years—a
deal Kruszewski said was accepted by 100 percent of Hoosier clients.

That seemed to be a fair resolution,
said Mark Maddox, an Indianapolis securities attorney who advised his clients to accept the offer.

“I thought it was a good and reasonable solution to a problem that was really much bigger
than Stifel,” Maddox said. “In a situation where the investors have been given that kind
of buyback plan, I’m not sure what the regulatory concern is from the state of Indiana.”

But Rokita told IBJ he believes he’s fully justified in pressing forward.

He said complaints from Stifel customers spurred the investigation. His complaint threatens penalties
as harsh as permanently barring Stifel from the securities industry in Indiana.

“It’s like every one
of our cases. It’s driven by the evidence,” he said. “And there’s strong evidence here there was no
training and lack of supervision by Stifel.”

Some of Cohen’s clients say Rokita is overreaching.

“They haven’t stolen the funds. They haven’t misrepresented the funds. We’ve hit
a little bump in the road in the investment market. And anybody that’s an investor is going to be subject to risks,”
said retired real estate developer Tom Rush. “That’s our system, and something we should all be aware of.”

Other Stifel clients pointed out their auction-rate holdings were a tiny slice of much larger portfolios, and said
they were well aware of their risks.

“I made an investment decision. It’s nobody’s fault but
my own,” said Gene Zink, a former Duke Realty Corp. executive who now is CEO of Strategic Capital Partners LLC. “And
I think Jeff and Dave worked tirelessly to find a solution.”

Some of Cohen’s clients said they suspect
Rokita, 39, is playing tough in part to improve his political prospects. His second term as secretary of state ends next year,
and by law he can’t run again.

The job is a traditional stepping stone to higher office. Rokita hasn’t
declared himself in any race and said he doesn’t know if he’ll run next for “dogcatcher or governor.”
Even so, he’s raising campaign contributions and recently held a golf outing to that end.

None of that has
anything to do with his case against Stifel, Rokita said.

“[Stifel’s auction-rate buyback agreement]
still doesn’t address the lack of supervision, the lack of training and selling unsuitable securities,” he said.
“That’s not the standard of care. That’s not the duty houses have to their clients, that when caught they
make them whole.”

According to the complaint, Stifel held weekly phone calls with institutional clients that
included a discussion of the risks of auction-rate securities. But the state charges procedures and training were lax for
the advisers working with retail customers.

“None of this is a surprise to Stifel or really anyone in their
industry,” Rokita said, pointing out he issued his complaint the same day Colorado released its own over Stifel’s
auction-rate procedures.

“There’s been national discussion and settlement among other companies,”
he said. “They’ve been charged with this civilly in other states.”

Some firms have gone further
than Stifel and agreed to repurchase all auction-rate securities immediately. But most of those are heavyweights on Wall Street,
such as Merrill Lynch and Morgan Stanley, that received big cash infusions under the Troubled Asset Relief Program, or TARP.
Stifel, a comparatively small firm with $90 billion in client assets, did not seek TARP funding.

The investment
firms and their clients weren’t alone in getting stung when the auction-rate market collapsed. The state of Indiana
was forced to pay higher interest costs after auction-rate securities issued for construction of Lucas Oil Stadium froze up.
Local hospital systems also saw costs rise.

Indiana University business professor Charles Trzcinka doesn’t
buy that the meltdown was entirely unforeseeable.

“People look at history and say the past predicts the future.
It does sometimes, but sometimes it doesn’t. The turkey walks around well fed and thinks the world is wonderful until
Thanksgiving and something changes,” he said.

“This is a turkey-at-Thanksgiving problem. The world
was inferring from the past these were wonderful securities that had all this future, safe and easy, and they weren’t
looking at the contract itself and what can happen.”•