SEC Says Broker Churned Municipal Accounts

The Securities and Exchange Commission has charged a Houston-based broker with engaging in “unauthorized and unsuitable” trading on behalf of two Florida municipalities.

The SEC’s complaint alleges that Harold H. Jaschke, while associated with the brokerage firm First Allied Securities, Inc., churned(1)  the accounts of the City of Kissimmee, Florida, and the Tohopekaliga Water Authority and lied to both customers about his trading practices on their behalf, “putting them at risk of losing millions of dollars while he reaped commissions of more than $14 million for himself,” according to a press release .      

“Jaschke was unscrupulous with the municipalities’ funds and ignored their interests for his own personal gain,” said Rosalind Tyson, Director of the SEC’s Los Angeles Regional Office. “He lied to his customers, took advantage of their trust, and risked their financial well-being.”      

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‘High-Risk, Short-Term Strategy’    

The SEC’s complaint, filed in federal court in Orlando, Florida, alleges that Jaschke engaged in a high-risk, short-term trading strategy involving zero-coupon U.S. Treasury bonds that were very sensitive to interest rate changes. For example, if interest rates were to increase by only 1%, the value of a 30-year bond could drop by 25%, according to the SEC.  The complaint says that Jaschke’s trading strategy involved buying and selling the same bond within a matter of days, and sometimes within the same dayexposing the municipalities to greater risks when he leveraged their accounts using repurchase agreements to finance the bond purchases that they otherwise would not have been able to afford. “This strategy dramatically increased the risks as Jaschke caused the municipalities to borrow large sums of money to hold larger bond positions,” according to the SEC.

Additionally, the SEC alleges that Jaschke knew the municipalities’ ordinances prohibited his trading strategy and required that their funds be invested with the paramount consideration to be safety of capitaland that he also knew that the municipalities’ ordinances prohibited the use of repurchase agreements for investment. According to the SEC’s complaint, had the bond market not swung sharply in Jaschke’s favor allowing the municipalities to close their accounts with a modest profit, they could have lost approximately $60 million over a two-year period as a result of his misconduct.

The SEC’s complaint alleges that Jaschke violated the antifraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and aided and abetted violations of the broker/dealer books and records provisions, Section 17(a) of the Exchange Act and Rule 17a-4(b)(4) thereunder. The SEC’s complaint seeks a permanent injunction and disgorgement with prejudgment interest and a financial penalty.

Related Enforcement Action      

In a related enforcement action, the SEC charged Jeffrey C. Young, First Allied’s former vice president of supervision, for failing to reasonably supervise Jaschke, failing to respond adequately to red flags relating to Jaschke, and failing to take reasonable steps to ensure that First Allied’s procedures regarding suitability were followed. Young agreed to settle the SEC’s enforcement action without admitting or denying the findings.       

The SEC’s order instituting settled administrative proceedings against Young suspends him from acting in a supervisory capacity for nine months and orders him to pay a $25,000 penalty.


      

 (1) Churning is a fraudulent practice that occurs when a broker engages in excessive trading in order to generate commissions and other revenue without regard for the customer’s investment objectives.

Indexes Bounce Back in 2009

As 2009 nears its end, it looks like it will be a good year for many equity indexes.

The Russell 3000 index, which measures approximately 98% of the investable U.S. equity universe, reflects what its sponsoring firm terms a “remarkable turnaround” for stocks in 2009, including an especially strong surge for growth stocks relative to value stocks.  According to a press release, amid the across-the-board positive returns for Russell’s family of U.S. equity benchmarks, the growth/value disparity particularly among midcaps stands out as perhaps the headline of the year.      

Rough Start

At the start of the year, the Russell 2000 index reflected the worst January for the small-cap segment since inception of the index, and it would only get worse until the entire U.S. equity market, as reflected in the Russell indexes, reached its lowest point year-to-date on Monday, March 9, 2009 and total returns began to grow.  March was the first month in 2009 to post positive total returns for the Russell 3000, Russell 1000 and Russell 2000 indexes, although Q109 returns would still end negative, according to Russell.      

By April, the small-cap Russell 2000 index illustrated an increase of 15.5%, and hit the second-largest monthly gain in 30 years of available data. In fact, every segment of the U.S. equity market measured by Russell indexes added value for the month of April, ranging from 10.5% for the Russell 3000 index to 10.1% for the Russell 1000 index, according to a press release.     

However, even with large gains in April, the U.S. equity market (as mirrored by the Russell indexes) were still far from recovered.  At the Russell indexes annual reconstitution on Friday, June 26, the total market capitalization of the Russell 3000 index reflected a 35.8% decline for the U.S. broad market for the past year, dropping from $16.5 trillion at reconstitution in 2008 to $10.6 trillion at reconstitution in 2009.  This was 42.7% below the 2007 high of $18.5 trillion, and it marked the first time since 1997 that the newly reconstituted index reflected less than $11 trillion.

After reconstitution, the Russell 3000 index continued to indicate positive growth throughout all cap-tiers of the market, turning out positive total returns for the third quarter, even after a dip into negative territory for all three major indexes in October 2009.  By November 2009 the broad market Russell 3000 index and large-cap Russell 1000 index continued to climb and broke their 52-week high, just over one year after the close of Lehman Brothers.

Below are the daily total returns for the major Russell U.S. indexes, in percentages based on the U.S. dollar, through market close December 28, 2009.   The final year-end total returns for the entire family of Russell indexes will be posted online the evening of December 31, 2009 here.

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 Russell U.S. Indexes YTD 2009 YTD 2008
 Broad-market Russell 3000 Index
 29.8% -37.3%
 Large-cap Russell 1000 Index
 29.9% -37.6%
 Small-cap Russell 2000 Index
 28.8% -33.8%
 Russell Midcap Index
 42.0% -41.5%
 Broad-market Russell 3000 Growth Index  
 38.5% -38.4%
 Broad-market Russell 3000 Value Index
 21.2% -36.3%

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