In December 2009, the United States Securities and Exchange Commission (“SEC”) charged a Houston-based broker with unauthorized and unsuitable trading on behalf of two Florida municipalities. According to the SEC, the trading put the municipalities at risk of losing millions of dollars while the broker reaped commissions of more than $14 million.
The SEC’s complaint alleges that Harold H. Jaschke, while associated with the brokerage firm First Allied Securities, Inc., churned the accounts of the City of Kissimmee, Fla., and the Tohopekaliga Water Authority and lied to both customers about his trading practices. Churning is a fraudulent practice that occurs when a broker makes excessive trades in order to generate commissions and other revenue without regard for the customer’s investment objectives.
The SEC’s complaint further 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 percent, the value of a 30-year bond could drop by 25 percent.
According to the SEC, Jaschke’s risky trading strategy involved buying and selling the same bond within a matter of days, and sometimes within the same day. Jaschke exposed the municipalities to even greater risks when he leveraged their accounts using repurchase agreements to finance the bond purchases that the municipalities 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.
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 capital. Jaschke also knew that the municipalities’ ordinances prohibited the use of repurchase agreements for investments. 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 seeks a permanent injunction and disgorgement of commissions with prejudgment interest and a financial penalty.
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.