Blunk recommended that customers participate in a
Stock-to-Cash program
under which customers would pledge stock to obtain loans to
purchase other products.
Customers obtained non-recourse loans, totaling approximately $1.8
million, from a
non-broker-dealer company and pledged stock to that entity as
collateral for the loans;
the pledged stock would be transferred to the loaning entity’s
securities account, which
was maintained at a clearing firm.
The loans were in amounts
up to 90 percent of the value of the pledged stock and were
typically for a short period of
time, usually three years, with no payments required during the
term of the loan; instead,
customers were required to pay the full principal and interest due
at the end of the loan
term. Customers used some of the loan proceeds to purchase
insurance products through
Blunk.
Documentation used by the
loaning entity made it
appear that the entity was retaining the securities customers
pledged and might use
those securities to enter into hedging transactions, but the
customers actually conveyed
full ownership of their stock to the entity conducting the
program, which routinely sold
the securities upon receipt and often moved the money into its own
bank account.
When the entity became unable to make
complete payments to
customers with profitable portfolios, it used the proceeds from
the sale of securities new
customers pledged to pay off its obligations to existing customers
and diverted money to
pay for expenses not related to its operation. Blunk did not undertake adequate efforts to find
out what happened to
the stock that was conveyed to the lender; he relied on
information the persons marketing
the program provided and assumed that the lender was a
broker-dealer holding the stock
for his customers in custodial accounts. Blunk did not undertake
any steps to verify this
mistaken assumption.
The intermediaries with
whom Blunk dealt
refused to provide more information when he tried to obtain information
about the lender
and nevertheless, continued to entrust his clients’ securities to
the lender.