The $750 million IBM Southeast Employees Federal Credit Unionwas taken to court by a member who is alleging it was negligent inchoosing a securities broker-dealer to recommend to itsmembers.
Claudia Schorrig, a member of the CU, alleged in her complaint thatWellstone Securities, the credit union's former brokerage firm thatsold her investments, was “nothing more than a bucket shop rifewith fraud.”
The suit also named IBM Southeast Employees CEO Lary McCants alongwith Christi-lyn Seay, Jay Jones and Barbara Leschander, all formerbroker-dealer agents with Wellstone.
Schorrig charged that she invested $60,000 with CornerstoneMinistries Investments through Wellstone Securities which shesubsequently lost. Both firms have since filed for bankruptcy undera cloud of fraud allegations.
“The credit union not only recommended Wellstone, which in turn,sold Cornerstone's worthless securities to unsuspecting investorslike Claudia,” the complaint alleged, “the credit union would gomuch, much farther into the miry clay with Wellstone. The creditunion would so descend by actively soliciting members to purchaseCornerstone securities through Wellstone.”
Schorrig, who is seeking class-action status on behalf of hundredsof credit union members in similar circumstances, charged that thecredit union was negligent in not revealing to members the problemsboth Wellstone and Cornerstone were experiencing. She also chargedthat McCants, as CEO, is liable for the credit union recommendingWellstone through his governance of the credit union's duediligence and other procedures.
For its part, the credit union characterized Schorrig's complaintas inaccurate.
“The lawsuit is entirely misdirected and is rife withinaccuracies,” IBM said through its law firm. “In our view, it isjust one more ripple in the growing tide of legal actions broughtby unfortunate victims of either fraud, their own bad judgment orour troubled economy, who now hope they might recover their lossesby imposing blame on the nearest deep pockets. The credit union andits CEO, Lary McCants, deny the allegations and intend tovigorously defend themselves in court.”
The credit union would not comment further on the case.
Legal sources familiar with issues similar to those raised in thesuit say a lot in the case may turn on whether the credit unionmade statements that recommended the securities firm and how manyand what sort were made. Additionally, it will hinge on how manydisclaimers the CU included about any investments.
“Even without looking at the law, I can tell you that if the caseis based merely on the physical presence of brokerage personnel, itis probably not going anywhere,” observed one lawyer who declinedto comment on the record without seeing the complaint. “Justbecause my law firm lets me have an office in its building doesn'tmean they necessarily endorse everything I do.”
The member's complaint cited a credit union newsletter from thesummer of 2003 where the CU alerted members that “independentfinancial service representatives” were in the building “speciallytrained to answer your questions with valuable information that canimprove your financial well-being.”
But the newsletter also carried disclaimers that said explicitlythat any investments with Wellstone were not insured or guaranteedby the credit union.
The complaint also noted that Cornerstone had been cited forfailures by securities regulators in different states and suggestedthat the credit union should have known this and disclosed it tomembers.
Schorrig's lawyer noted that the case had just been filed on June30 and that the process through which the extent of credit unionrecommendations of Wellstone and Cornerstone Ministries Investmentsmight be discovered has only just begun. Her lawyer also observedthat the credit union's implied endorsement of the broker-dealerswas not confined to the use of the offices, but that the creditunion blurred the line between the broker-dealers and employees byhaving them listed on its Web site and including them in its phonesystem.
Further, Jeffery Kaplan, one of Schorrig's lawyers and partner withthe Miami law firm of Dimond, Kaplan and Rothstein, suggested thatthe credit union had an additional interest in the broker-dealersbeing onsite through some sort of financial relationship withWellstone.
“We don't know precisely what it was, but we can assume that therewas some sort of financial understanding between the credit unionand the brokerage,” Kaplan noted. The complaint cited testimonyoffered by Cornerstone Board Member John Ottinger that the reportalleged implied the credit union made money on the sales but didnot allege what the relationship had been.
Ottinger offered his testimony as part of Cornerstone's bankruptcyproceedings.
While the NCUA does not allow federal credit unions to make aprofit directly from security sales, a 1993 NCUA Letter to CreditUnions (150) allows federal credit unions to be reimbursed forhaving broker-dealers in their offices.
“A federal credit union that contracts directly with third partiesto provide mutual funds and other nondeposit investment products toits members may receive an amount not to exceed the total of directand indirect costs to the federal credit union of anyadministrative functions performed on behalf of the third party,”the letter instructs.
“Thus, a federal credit union that contracts directly with a thirdparty to provide investment products may not make a profit from thesales of such products. However, a federal credit union may offerinvestment products through a CUSO, and the amount of reimbursementor compensation the CUSO may receive is not limited.”
Seay, one of the former broker-dealers who worked for Wellstone inthe IBM Southeast Employees offices named in the suit, said that asof July 6 she had not yet been served regarding the suit, and wasquick to counter some of Schorrig's claims in her complaint.
“There is no way anyone could fail to understand that we wereclearly part of a separate organization from the credit union orthat the investments were not insured or guaranteed by the creditunion,” Seay said. She maintained that while she worked in anoffice at IBM Southeast Employees, large signs on the doors made itclear that visitors were entering the offices of WellstoneSecurities and that clients had to sign “many, many” documents thatalso made that clear.
“None of our applications, for example, carried the name of thecredit union,” said Seay, who described her job at the time as thatof an “independent contractor” for Wellstone.
Because the case has just been filed, Schorrig's lawyers wouldn'tspeculate on what course it might take, but Seay said it might havebeen filed prematurely. Seay observed that the CornerstoneMinistries Investments bankruptcy proceedings were continuing andthat they indicated Schorrig might still make back some of hermoney.
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