What happens when you sue your broker--but the broker goes bust?
Forbes Magazine
Tough Luck
By Seth Lubove
The case of Miller & Schroeder is a cautionary tale about how you shouldn't leave everything up to a financial adviser, no matter how smart he is, no matter how well he's delivered for you in the past. Follow the old adage: "If your mother tells you she loves you, check it out."
Miller & Schroeder, a Minneapolis-headquartered investment firm, specialized in helping investors pull in dependable interest payments from bonds. The clients, many of them elderly, had done just fine for a long time on a diet of reliable corporate and municipal paper that the firm fed them. Then from 1996 to 1999 Miller & Schroeder peddled municipal bonds to allow an outfit called Heritage Healthcare to build a dozen nursing homes focused on Alzheimer's care.
The pitch resonated with clients getting on in years. They weren't even spooked by the fact that the series of debt issues was nonrated. Few bothered to browse through the eye-glazing prospectuses. "Who reads those?" sighs John Rohner, 73, a retired furniture retailer living in Rancho Bernardo, Calif. "They're a volume thick, and they tell you in every one that you're taking a risk."
"When I talked to these people, they didn't have a clue what they bought," says Brian Barry, a Los Angeles lawyer who's trying to get class status for a lawsuit he brought against Miller & Schroeder on behalf of several Heritage investors. "They were completely misled. They were told, ‘It's a muni bond, it's safe, they're going to help old people like you.'"
Rohner, who had six years of satisfaction buying bonds through Miller & Schroeder broker Mark Augusta, says he bought $200,000 of the Heritage securities, whose alluring 8.8% yield was double that of AAA-rated munis at the time. For a top-bracket taxpayer, that was equivalent to as much as 12% on a corporate bond. "I had complete trust in him," says Rohner of broker Augusta. Rohner claims that Augusta told him Medicare would cover the patients' bills, so it was as if the government guaranteed the bonds.
Alas, the entire $144 million series of Heritage bonds defaulted beginning in 2000. Heritage blamed low patient reimbursement.
Whatever the reason, lawsuits and arbitration complaints were hurled at Miller & Schroeder for underwriting and flogging the bonds. The main sales push came from brokers in the Solana Beach, Calif. office. Miller & Schroeder also acted as the market maker for the thinly traded issues. "The Heritage bond product was created by Miller & Schroeder from inception through sale," says Bradd Milove, a lawyer who recently won an $833,000 arbitration case against Augusta and the firm, or what's left of it.
As an indication of the clientele Miller & Schroeder was after, Milove unearthed a 1997 letter from the firm's Solana Beach office seeking the donor list from the local Alzheimer's Association. The letter promised that the donors would "only be solicited" to invest in Heritage's Fort Worth Alzheimer's care facility.
Getting any sizable restitution, however, is problematic. After selling off various pieces of the firm, Miller & Schroeder filed for Chapter 7 bankruptcy in January. It has said the bondholders were sophisticated types who should have been aware of the risks. "There's nothing more I can do," sighs John Behnke, 82, who hopes to get back some of the $85,000 he says he invested through the firm.
Who can the investors go after now? Maybe the companies that bought pieces of Miller & Schroeder prior to the firm's bankruptcy. But that's not so easy.
For instance, former Irwin Jacobs associate Dennis Mathisen bought much of Miller & Schroeder and its thriving Indian casino financing business last September for $1.6 million and the assumption of $13 million debt, and then simply changed the name to Marshall Miller & Schroeder, keeping many of the same employees and offices. Smelling a shell game--and a deeper pocket--some of the lawsuits named the successor firm as a defendant.
Nice try. Arguing that it never assumed the liabilities of Miller & Schroeder and that whatever wrongdoing happened was before its acquisition, the Marshall Miller firm has already convinced a judge to remove it from at least one of the arbitration cases (out of ten in which it's named). Brian Leonard, the bankruptcy trustee overseeing the case in Minneapolis, says merely that he hasn't "reached any conclusions one way or another" regarding the allegations of fraudulent conveyance, and that it may be a "few months" before he takes any action.
Some larger investors, including three Heartland funds that were forced into liquidation last year after losing $4.8 million, have sued U.S. Trust, the unit of Charles Schwab that was supposed to be overseeing the bonds. U.S. Trust says it had no duty to vet the bonds. Other investors are going after Robert Kasirer, the Beverly Hills promoter behind Heritage, who says he was in the dark about the Heritage deal's flaws.
What about targeting individual brokers, such as Augusta? Doubtful, due to their lack of assets. "Going after brokers is generally an exercise in futility," says Arthur Leider, a San Diego arbitration specialist who represents five elderly Heritage investors.
Augusta, cited as a top Heritage bond seller, claims in a court filing that he, too, was duped. Now working for U.S. Bancorp's Piper Jaffray unit, he contends that the bonds were "fraudulently misrepresented" to him by the firm's research department and that Miller & Schroeder's lawyers left him "twisting slowly in the wind" when it came time to defend his role in the scandal. "It's like suing the salesman on the floor for selling a bad car from General Motors," complains Augusta's San Diego attorney, Steven Green.
That argument apparently persuaded a San Diego Superior Court judge, who vacated at least one arbitration award against Augusta, citing the "extrinsic fraud" that Miller & Schroeder committed against him by bungling his legal representation.
This despite a separate arbitration complaint from the son of late Augusta client James Fleshman, who charges that, even though his nonagenarian father was declared physically and mentally incapable of managing his financial affairs, Augusta sold him a series of bum Heritage and corporate junk bonds, resulting in losses of $229,000. Augusta's lawyer won't comment on this particular case.
Cardinal rule of banking: Know your customer. Cardinal rule of investing: Know your broker. |
