Lawsuit Highlights Importance of Keeping Clear Investment Boundaries

The $750 million IBM Southeast Employees Federal Credit Union was taken to court by a member who is alleging it was negligent in choosing a securities broker-dealer to recommend to its members. Claudia Schorrig, a member of the CU, alleged in her complaint that Wellstone Securities, the credit union’s former brokerage firm that sold her investments, was “nothing more than a bucket shop rife with fraud.” The suit also named IBM Southeast Employees CEO Lary McCants along with Christi-lyn Seay, Jay Jones and Barbara Leschander, all former broker-dealer agents with Wellstone. Schorrig charged that she invested $60,000 with Cornerstone Ministries Investments through Wellstone Securities which she subsequently lost. Both firms have since filed for bankruptcy under a cloud of fraud allegations. “The credit union not only recommended Wellstone, which in turn, sold Cornerstone’s worthless securities to unsuspecting investors like Claudia,” the complaint alleged, “the credit union would go much, much farther into the miry clay with Wellstone. The credit union would so descend by actively soliciting members to purchase Cornerstone securities through Wellstone.” Schorrig, who is seeking class-action status on behalf of hundreds of credit union members in similar circumstances, charged that the credit union was negligent in not revealing to members the problems both Wellstone and Cornerstone were experiencing. She also charged that McCants, as CEO, is liable for the credit union recommending Wellstone through his governance of the credit union’s due diligence and other procedures. For its part, the credit union characterized Schorrig’s complaint as inaccurate. “The lawsuit is entirely misdirected and is rife with inaccuracies,” IBM said through its law firm. “In our view, it is just one more ripple in the growing tide of legal actions brought by unfortunate victims of either fraud, their own bad judgment or our troubled economy, who now hope they might recover their losses by imposing blame on the nearest deep pockets. The credit union and its CEO, Lary McCants, deny the allegations and intend to vigorously defend themselves in court.” The credit union would not comment further on the case. Legal sources familiar with issues similar to those raised in the suit say a lot in the case may turn on whether the credit union made statements that recommended the securities firm and how many and what sort were made. Additionally, it will hinge on how many disclaimers the CU included about any investments. “Even without looking at the law, I can tell you that if the case is based merely on the physical presence of brokerage personnel, it is probably not going anywhere,” observed one lawyer who declined to comment on the record without seeing the complaint. “Just because my law firm lets me have an office in its building doesn’t mean they necessarily endorse everything I do.” The member’s complaint cited a credit union newsletter from the summer of 2003 where the CU alerted members that “independent financial service representatives” were in the building “specially trained to answer your questions with valuable information that can improve your financial well-being.” But the newsletter also carried disclaimers that said explicitly that any investments with Wellstone were not insured or guaranteed by the credit union. The complaint also noted that Cornerstone had been cited for failures by securities regulators in different states and suggested that the credit union should have known this and disclosed it to members. Schorrig’s lawyer noted that the case had just been filed on June 30 and that the process through which the extent of credit union recommendations of Wellstone and Cornerstone Ministries Investments might be discovered has only just begun. Her lawyer also observed that the credit union’s implied endorsement of the broker-dealers was not confined to the use of the offices, but that the credit union blurred the line between the broker-dealers and employees by having them listed on its Web site and including them in its phone system. Further, Jeffery Kaplan, one of Schorrig’s lawyers and partner with the Miami law firm of Dimond, Kaplan and Rothstein, suggested that the credit union had an additional interest in the broker-dealers being onsite through some sort of financial relationship with Wellstone. “We don’t know precisely what it was, but we can assume that there was some sort of financial understanding between the credit union and the brokerage,” Kaplan noted. The complaint cited testimony offered by Cornerstone Board Member John Ottinger that the report alleged implied the credit union made money on the sales but did not allege what the relationship had been. Ottinger offered his testimony as part of Cornerstone’s bankruptcy proceedings. While the NCUA does not allow federal credit unions to make a profit directly from security sales, a 1993 NCUA Letter to Credit Unions (150) allows federal credit unions to be reimbursed for having broker-dealers in their offices. “A federal credit union that contracts directly with third parties to provide mutual funds and other nondeposit investment products to its members may receive an amount not to exceed the total of direct and indirect costs to the federal credit union of any administrative functions performed on behalf of the third party,” the letter instructs. “Thus, a federal credit union that contracts directly with a third party to provide investment products may not make a profit from the sales of such products. However, a federal credit union may offer investment products through a CUSO, and the amount of reimbursement or compensation the CUSO may receive is not limited.” Seay, one of the former broker-dealers who worked for Wellstone in the IBM Southeast Employees offices named in the suit, said that as of July 6 she had not yet been served regarding the suit, and was quick to counter some of Schorrig’s claims in her complaint. “There is no way anyone could fail to understand that we were clearly part of a separate organization from the credit union or that the investments were not insured or guaranteed by the credit union,” Seay said. She maintained that while she worked in an office at IBM Southeast Employees, large signs on the doors made it clear that visitors were entering the offices of Wellstone Securities and that clients had to sign “many, many” documents that also made that clear. “None of our applications, for example, carried the name of the credit union,” said Seay, who described her job at the time as that of an “independent contractor” for Wellstone. Because the case has just been filed, Schorrig’s lawyers wouldn’t speculate on what course it might take, but Seay said it might have been filed prematurely. Seay observed that the Cornerstone Ministries Investments bankruptcy proceedings were continuing and that they indicated Schorrig might still make back some of her money. –[email protected]