WASHINGTON -- A civil suit filed yesterday by the SEC charges a securities dealer with violating the antifraud provisions of securities laws for allegedly failing to inform more than a dozen Ohio municipalities and school districts of the risks involved with derivative transactions that ultimately caused them to lose millions of dollars.
In the suit, filed in the U.S. District Court for the Northern District of Ohio, the Securities and Exchange Commission is seeking a permanent injunction barring the dealer, Kenneth Schulte, from conducting fraudulent securities transactions. In addition, the commission wants Schulte to turn over his profits from the transactions, the total of which the commission is still trying to calculate.
The suit also seeks a preliminary injunction against Schulte, who is employed as a registered representative for Comprehensive Capital Corp. in Boca Raton, Fla., the commission said.
In its complaint, the SEC said that from spring 1990 to April 1994 Schulte offered and sold millions of dollars of mortgage-backed security derivatives in the form of interest-only securities, inverse floaters, and inverse interest-only securities to at least 14 Ohio municipalities and school districts. The alleged violations occurred while Schulte was working for Comprehensive, as well as two Houston brokerdealers, Murchison Investment Bankers and Hart Securities Inc.
The commission alleged that, in soliciting the investments, Schulte "assured investors that investments in derivatives were safe and secure prior to their investing."
In dealing with the municipalities, Schulte was given a copy of their investment policies, which restrict them to short-term securities guaranteed by the U.S. government or its agencies, and which require them to make sure principal is preserved, the SEC said.
Even so, Schulte told the investors that the derivatives they were being sold "were consistent with the objectives listed in their investment policies" or Ohio's investment code, the SEC said.
In addition, Schulte "did not provide prospectuses or any other written materials to investors which fully described the nature or the risks of derivative securities," according to the commission.
Schulte also "failed to fully describe the nature or risks of derivative securities to investors prior to their investing," the SEC charged. "In some instances, Schulte told investors the derivatives were guaranteed by the U.S. Government," and he "assured investors their investment principal was not at risk."
The 14 Ohio municipalities and school districts that invested in the derivatives generally lost money from their investments, according to the SEC. The commission said it did not have an estimate for total losses, but said they are probably "in the excess of multimillions of dollars." Four of the municipalities together lost more than $3.4 million, the commission said.