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News Release: 01-04
GRAY DAVIS, Governor
Date: 02/01/01
WILLIAM KENEFICK, Acting Commissioner
Securities Broker-Dealer Sanctioned in "Failure to Supervise" Case
Agent was Simi Valley Investment Adviser Who Lost $6 Million in Y2K Bet
Los Angeles, February 1, 2001 — The California Department of Corporations announced today that the Los Angeles Superior Court has issued a final judgment in a lawsuit filed by the department against Schoff & Baxter, Inc., an Iowa-based securities broker-dealer with offices in Century City, Long Beach and Pasadena. The lawsuit alleged that Schoff & Baxter failed to supervise a Simi Valley investment adviser who lost $6 million in customer funds in a disastrous bet that Y2K would disrupt the stock market last year.
The judgment permanently enjoins Schoff & Baxter and its principals from violating provisions of the state securities law relating to compliance procedures and proper supervision of agents. In addition, it provides for the appointment of an Independent Consultant to review the firm’s compliance procedures and make reports to the department, requires the firm to hire a new Compliance Officer and orders the firm to pay costs and penalties of over $150,000. The firm stipulated to the judgment, which was issued by the court on January 11, 2001.
The failure to supervise charges evolve from the activities of Eric Vonn Schultz, a Simi Valley investment adviser doing business as Schultz Investment Advisory. Schultz, who was also an agent of Schoff & Baxter, used the firm to execute high risk equity and index option investments for his clients in late 1999 in a disastrous bet that the Y2K conversion would have a dramatic downward impact on the stock market. When the market didn’t fall, Schultz lost nearly $6 million in customer funds.
Schultz had about 240 customers that entrusted approximately $9 million to him under investment advisory agreements giving him custody of funds and securities, and full discretionary power of attorney for all client transactions. Schultz commingled customer funds with the general operating funds of the investment firm creating, in effect, an illegal mutual fund. Between November 30, 1999, and December 31, 1999, the value of the fund decreased from approximately $8.9 million to $3.6 million. At this time, the department took over the fund and had a receiver appointed.
The department noted that one of the most important duties of securities broker-dealers is the supervision of the activities of their agents. In this case, Schoff & Baxter approved Schultz’s trading account, failed to inspect Schultz’s off-site work location, and failed to detect the operation of an unregistered mutual fund by Schultz and his use of excessively risky trading strategies for investors who were unable to absorb the large financial losses. In addition, the lawsuit charged that the Long Beach branch of the firm was never inspected by Schoff & Baxter supervisors as required by law, despite the fact that at least five agents were serving clients from off-site locations.
Department officials commented that, "Schoff & Baxter knew or should have known its agent was risking client funds in a dangerous trading strategy of investing in high risk derivative investment products and in volatile high tech stocks. The investing public has a right to expect that securities broker-dealers will exercise proper supervision over the agents who advise them on investments and handle their money. There is no higher fiduciary duty for a securities firm than maintaining a culture of rigorous compliance and supervision."
The Department of Corporations is California's Financing and Investment Authority, reporting to the Business, Transportation and Housing Agency and the Governor. The Department is responsible for the regulation, enforcement and licensing of securities, franchises, off-exchange commodities, investment and financial services, independent escrows, consumer and commercial finance lending and residential mortgage lending. For further information or to obtain a complaint form, see the Department's Web site at www.corp.ca.gov.
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