NEW YORK -- The Securities and Exchange Commission has accused a brokerage firm of duping five Wisconsin school districts into placing highly risky bets with public money -- bets that resulted in fat fees for the broker and devastating losses for the public.
The case exemplifies the kind of behavior that worsened the fallout from the most punishing financial crisis in generations: A firm peddles an opaque product to investors without fully describing how risky the product actually is, leading to the investors' ruin.
But the SEC is late to the game. The school districts themselves filed a lawsuit in 2009, leveling essentially the same accusation. Now, more than two years later, the federal government is filing a complaint, seeking injunctions and penalties.
With the economy still wounded from the financial crisis, experts say the SEC needs more firepower to root out the bad financial actors and ensure a meltdown doesn't happen again. The financial industry became more complicated than ever before in the years leading to the crisis, and SEC officials say they're still learning how to police it.
"Enforcement needs greater coordination," said Joseph S. Fichera, chief executive of New York-based financial advisory firm Saber Partners and a former expert adviser to the SEC. "The federal government could do that, but Congress needs to be supportive of it. It's like medicine: An ounce of prevention would be better than a pound of cure."
The SEC contends that in this case, the nature of the investments that went bad for the school districts necessitated a particularly deliberative process of investigation.
"These are complex products," said Elaine C. Greenberg, who heads the SEC's Municipal Securities and Public Pensions Unit. "We had to make sure we understood what the transaction was about."
Nearly three years have passed since the financial crisis, and many experts have said the federal government's approach to law enforcement has been lacking. None of the major actors has been convicted of wrongdoing, and the most significant fine levied by the SEC -- a $550 million settlement with Goldman Sachs last year -- amounted to less than a week's worth of revenue for the firm.
The SEC's challenges are compounded by other arms of government. As its workload has increased, members of Congress have insisted on starving it of funds -- despite repeated insistence from lawmakers and regulators that the agency needs more money and more staff to carry out its operations.
But with lawmakers intent on trimming the federal budget, the SEC has come under fire. A House panel approved a measure in June to keep funding for the agency flat next year at $1.2 billion. The Obama Administration has asked to raise the agency's budget by about $200 million for 2012.
To an extent, delays in SEC enforcement are inevitable. Unless it's taking emergency action, the agency generally conducts full investigations before filing a suit. That contrasts with the procedure in private lawsuits, in which lawyers can gather evidence after the case has been brought.
But there's another reason this suit took so long: The SEC units in charge of it didn't even exist until last year.
As part of an effort to stay as sophisticated as the industry it polices, the SEC created specialized units last year, including the Municipal Securities and Public Pensions Unit and the Structured and New Products Unit, which together brought this Wisconsin school district case.
In January 2010, the SEC installed chiefs for those units, which then grew over the coming months. The municipal unit and the structured products unit did not have full-fledged staffs until the spring, their respective chiefs said in interviews.
"I do think in these areas we're getting smarter," said Kenneth R. Lench, who heads the structured products unit.
"In the old days," he said, "there was no specialization. It was just whatever came in the door, whoever had time."
In this case, filed on Wednesday, the SEC has accused the St. Louis-based brokerage Stifel, Nicolaus & Co. and one of its former executives of misrepresenting particularly arcane investments known as synthetic collateralized debt obligations. The school districts that bought notes tied to the products were effectively guaranteeing a portfolio of corporate bonds against default without fully understanding the risks they were taking on, the agency said.
The school districts invested funds for employee benefits and borrowed more money in an attempt to magnify their returns. The former Stifel executive named in the suit, David Noack, was a trusted adviser to these school districts.
"Stifel and Noack induced the School Districts to invest in complex financial instruments through a series of falsehoods and misrepresentations," the SEC said in the complaint. "Stifel and Noack knew that the School Districts were risk-averse, and they knew that the preservation of capital was of paramount importance."
The brokerage told the school districts that it would take "15 Enrons" for these investments to fail, according to the SEC complaint and the original lawsuit filed by the districts. In fact, it took far less than that.
The school districts weren't told that the portfolio of corporate bonds in one of the deals was performing badly from the beginning, and that a portion of the credits was subsequently downgraded, the SEC said.
By 2010, the school districts' $200 million investment had been totally wiped out. More than four-fifths of that investment was funded by borrowed money, which made the losses far worse.
Stifel pushed back against the SEC's allegations in a statement, saying it would "vigorously defend" itself and laying blame on another firm involved in the deals.
"Based on what we knew in 2006, the investments were suitable," Stifel said in the statement.
Such complicated deals are a rarity for municipal investors, said Matt Fabian, managing director of the Concord, Mass.-based Municipal Market Advisors.
"This is a different kind of thing than anybody else in the muni world at least has seen," Fabian said. "In general, the SEC has become more activist in the municipal space."