The U.S. Securities and Exchange Commission filed a federal civil lawsuit today against brokerage firm Stifel, Nicolaus & Co. and a former Stifel executive alleging fraud relating to investments sold to several Wisconsin school districts.

The SEC suit, filed in the U.S. District Court, Eastern District of Wisconsin, this morning against St. Louis-based Stifel and a former Stifel senior vice president, David Noack, is the latest SEC case targeting brokerage firms' sales of complex investments in the run-up to the financial crisis. Last year Goldman Sachs paid $550 million to settle similar charges.

The SEC suit alleges Stifel and Noack defrauded five Wisconsin school districts in 2006 by "selling them unsuitably risky and complex investments funded largely with borrowed money," according to the SEC complaint.

The fraud charges involve collateralized debt obligations, or CDOs. Five Wisconsin school districts and benefit trusts filed a civil lawsuit in Wisconsin in September 2008 alleging fraud and negligence by Stifel, relating to the placement of $200 million in investments that the school districts claimed they were assured were safe.

Elaine Greenberg, chief of the SEC's division of Enforcement's Municipal Securities and Public Pensions Unit, said today's filing is the first fraud charge the SEC has made relating to CDOs sold to school districts.

As a result of its investigation, Greenberg said the SEC found that Stifel and Noack misrepresented the risk of these investments, they failed to disclose material facts to the school districts and they recommended to the school districts that the school districts invest in these products despite the fact that they were unsuitable for the school districts.

The SEC complaint alleges that Stifel and Noack made sweeping assurances to the school districts, contending that it would take "15 Enrons" -- a catastrophic, overnight collapse referring to Enron Corp., the Houston, Texas-based energy company that went bankrupt in late 2001 -- for the investments to fail. The SEC said the firm also misrepresented that 30 of the 105 companies in the portfolio would have to default and that 100 of the top 800 companies in the world would have to fail before the school districts would suffer a loss of their principal.

The SEC also alleges that Stifel and Noack failed to disclose that the portfolio in the first transaction performing poorly from the outset, credit rating agencies placing 10 percent of the portfolio on negative watch within 36 days of closing, and certain CDO providers expressed concerns about the risks of Stifel's proprietary program and declined to participate in it.

According to the SEC's complaint, Stifel and Noack sold the school districts an unsuitable product that did not meet their investment needs and that the school districts had no prior experience with investing in CDOs and related instruments.

Stifel and Noack knew that the school districts lacked the requisite sophistication and experience to independently evaluate the risks of the investment, and knew that the school districts relied on Stifel and Noack's recommendations, the SEC contends. The school districts contributed $37.3 million toward the $200 million investment and borrowed the remaining $162.7 million.

The SEC alleges that the heavy use of leverage and the structure of the synthetic CDOs exposed the school districts to a heightened risk of catastrophic loss. The investments steadily declined in value in 2007 and 2008 as the CDO portfolios suffered a series of downgrades.

By 2010, the school districts learned that the second and third investments were a complete loss and that the lender had seized all of the trusts' assets. The school districts suffered a complete loss of their investment and suffered credit rating downgrades for failing to provide additional funds to the trusts they established.

SEC officials said their investigation is continuing.

- Jim McConville