And another broker-dealer bites the dust

The swath of destruction cut by allegedly fraudulent private placements created by Provident Royalties LLC and Medical Capital Holdings Inc. is practically unprecedented in the securities industry. Small broker-dealers are petrified of raising money for investment-banking deals, limiting companies' ability to expand and potentially hire more workers, attorneys said. Meanwhile, insurance carriers that underwrite errors-and-omissions policies for broker-dealers aren't insuring new products, further stifling firms' ability to raise money by selling private placements of new business ventures. “I haven't ever seen it as bad as it is today, the inability of these little companies to raise money. There hasn't been any capital business done in the previous 12 months, and small business is the lifeblood of the economy,” said Rick Nummi, managing partner of Nummi & Associates PA, who used to work at the Securities and Exchange Commission. “Investment-banking conferences for small firms looking to raise money are like ghost towns,” he said, adding that small broker-dealers want more guidance from their self-regulator, the Financial Industry Regulatory Authority Inc., when it comes to selling private, high-risk deals. “The broker-dealers want from Finra a laundry list of due-diligence guidelines” so they can sell private placements, he said. Although some broker-dealers are working to settle various lawsuits stemming from Provident's failure, almost 40% of the independent broker-dealers that sold failed oil and gas private placements of that company are no longer in business.

STOP THE MUSIC

Indeed, the music has stopped for Boogie Investment Group Inc., yet another small broker-dealer felled — in part — by the cost of litigation resulting from the sale of failed private placements for Provident Royalties. Although similarities exist with the fallout from the technology stock bubble or, more recently, from auction-rate securities, the level of damage triggered by the allegedly fraudulent private placements is unique, said Bill Singer, a securities attorney. “The private placements were both a ticking time bomb and a toxic product,” he said. “They blew up on the firms and the investors.” Melbourne, Fla.-based Boogie, which filed its broker-dealer withdrawal request with Finra last month, is the 20th firm that sold Provident private placements to have exited or stated its intentions to exit the brokerage business. According to the website of the bankruptcy receiver for Provident, a total of 52 broker-dealers sold the shares, which promised high monthly yields of 1.25% to 1.5%. And 2011 has proved to be a particularly punishing year for broker-dealers that sold Provident private placements, with 11 — or more than 20% — shutting down so far. Two other Provident broker-dealers, including Securities America Inc., have changed hands. Alan Wolper, a law partner at Locke Lord LLP who represents Boogie Investment Group, said that the fallout from Provident was a concern, but the much larger hurdle was keeping up with the cost of regulation for a small, one-man firm. “Finra is difficult to deal with. The Boca [Raton, Fla.] office is particularly aggressive and intrusive,” Mr. Wolper said. “It's hard for a one-man shop,” he said. Boogie's chief executive and owner, Daniel Deighan, is “chief cook and bottle washer” at the firm, Mr. Wolper said. “He has to bring in new business and answer to Finra.” With no final Finra action involving Boogie, Finra spokeswoman Nancy Condon declined to comment about Mr. Wolper's assessment of the reasons why the firm is closing down.

PROVIDENT FACES CHARGES

The Securities and Exchange Commission charged Provident with fraud in 2009. Provident raised $485 million from 7,700 investors between 2006 and 2009. Joseph Blimline, one of Provident's owners, pleaded guilty to fraud in August in U.S. District Court in Dallas. The SEC action is continuing. Boogie wasn't a major dealer in Provident notes, selling just $410,000 in such offerings, according to documents filed in U.S. Bankruptcy Court in Dallas. It isn't clear exactly how many broker-dealers have shut down in direct response to the cost of litigation from investors' suing over private placements. Most of the 20 exiting firms, however, were weighed down by an array of legal costs, including payments to lawyers and settlements with investors in arbitration complaints, as well as fines levied by regulators. Boogie had revenue of $422,000 for the fiscal year ended in June, down from $1.2 million in 2008, according to the SEC filing.

BOOGIE FACES OTHER ACTIONS

Along with a class action from the Provident trustee, Boogie faced one other complaint from individual investors who bought Provident's Shale Royalties offerings. It also faced three other, non-Provident-related arbitrations. Not all broker-dealers that sold Provident private placements are in the same dire condition as Boogie and others. Some are settling with the Provident trustee, Milo Segner. For example, Investors Capital Corp., which sold $3.4 million of the private placements, this month reached a confidential settlement in the matter. The firm's general counsel, Melissa Tarentino, declined to comment about the settlement terms. Email Bruce Kelly at bkelly@investmentnews.com