FOR IMMEDIATE RELEASE
December 8, 2009
Andrew G. Petillon
Associate Regional Director, Enforcement
SEC Los Angeles Regional Office
Senior Trial Counsel
SEC Los Angeles Regional Office
SEC Charges California Firm and CEO With Defrauding Customers
in Sales of Risky Mortgage-Backed Securities
The Securities and Exchange Commission today charged Irvine, Calif.-based Brookstreet Securities Corp. and its President and CEO Stanley C. Brooks with fraud for systematically selling risky mortgage-backed securities to customers with conservative investment goals. The fraud cost many Brookstreet investors their savings, homes, or retirement cushions, and eventually caused the firm to collapse.
The SEC alleges that Brookstreet and Brooks developed an internal program through which the firm's registered representatives sold particularly risky and illiquid types of Collateralized Mortgage Obligations (CMOs) to more than 1,000 seniors, retirees, and others for whom they were unsuitable. The SEC further alleges that Brookstreet continued to promote and sell risky CMOs to retail investors even after Brooks received numerous indications and personal warnings that these were "dangerous" investments that could become worthless overnight. One trader even called Brookstreet's program a "scam." Finally, in a last-ditch effort to save Brookstreet from failing during the financial crisis, Brooks allegedly directed the unauthorized sale of CMOs from Brookstreet customers' cash-only accounts, causing substantial investor losses.
"These were complex mortgage derivative securities with byzantine pricing, valuation and trading characteristics," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Selling them to retirees and conservative investors was profoundly and egregiously wrong."
"Brooks sanctioned and supported an ill-conceived program that misled retail customers to invest in risky derivatives of mortgage-backed securities," said Rosalind R. Tyson, Director of the SEC's Los Angeles Regional Office.
According to the SEC's complaint, filed in federal district court in Santa Ana, Calif., Brookstreet customers invested approximately $300 million through the firm's CMO program between 2004 and 2007. The SEC alleges that Brooks knew, or was reckless in not knowing, that Brookstreet and its registered representatives were selling unsuitable CMOs to retail customers. Among the warnings he received:
- In 2005, Brooks received from Brookstreet's compliance department a copy of FINRA Notice 93-73, which described CMOs as suitable only for sophisticated investors with a high-risk profile.
- In 2005, Brooks received information that the CMO program was trading risky CMOs that could become worthless overnight and was further informed that there was an inherent risk in distributing odd lot positions of program CMOs to customers.
- In 2006, three of Brookstreet's institutional bond traders met with Brooks and told him that program CMOs were very dangerous, illiquid, inappropriate for any retail investor, and had unreliable pricing. They called the CMO program a "scam" because it is not possible to have such high returns using CMOs without substantially increasing the risk. One of the institutional bond traders followed up with a letter reiterating these points and asking "from a moral standpoint" that Brooks not let the CMO program continue.
- In 2006, Brooks received numerous e-mails from registered representatives stating that program CMOs were illiquid and that the CMO Bond Group would not execute sell requests. Brooks also was told that the CMO Bond Group was purchasing volatile CMOs that were depreciating rapidly.
The SEC's complaint specifically alleges that the defendants violated the antifraud provisions of Section 17(a) of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 thereunder. The Commission seeks permanent injunctive relief against both defendants, and disgorgement of ill-gotten gains with prejudgment interest, and financial penalties against Brooks.
The SEC previously charged 10 Brookstreet registered representatives with making misrepresentations to investors related to the sale of risky CMOs.