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Mortgage losses slam Irvine broker

NASD has told Brookstreet Securities to close customer accounts. Sources say it has begun shutting down its operations.

June 22, 2007|E. Scott Reckard | Times Staff Writer

Losses on mortgage-backed securities have forced an Irvine brokerage firm to begin shutting down its operations, people close to the company said Thursday.

At least some of the losses were said to be incurred by clients of the brokerage, Brookstreet Securities.

Because of the losses, brokerage regulator NASD told Brookstreet this week to limit its activities to liquidating customer accounts, said Scott Brooks, an executive vice president at the firm. NASD officials declined to comment.

"Unfortunately, we are on 'SELL ONLY,' " Stanley C. Brooks, Scott's father and the firm's founder, said in an e-mail sent Wednesday through the company's nationwide network of 600 brokers, many of whom work from their homes. In the e-mail, Brooks said the 17-year-old firm's net worth had fallen from $11 million at the end of May to a negative $2.1 million.

Scott Brooks referred requests for additional comment to his sister, Julie Mains, an attorney at Brookstreet, who he said was trying to work out a deal to save the firm. Repeated efforts to reach Mains were unsuccessful.

The Brookstreet case is another illustration of how weakness in the housing market, which has led to a wave of defaults on loans to high-risk sub-prime borrowers, is spreading financial pain beyond sub-prime lenders and distressed homeowners.

Several major investment operations, including two hedge funds managed by Bear Stearns Cos., have been struggling to avoid being forced to shut down in the wake of losses on mortgage-backed investments.

All of the buyers of the riskiest mortgage-backed investments were believed to be sophisticated financial firms such as hedge funds, said Richard Eckert, a sub-prime mortgage analyst at Roth Capital in Newport Beach.

As much as $75 billion could be lost on mortgage securities because of the sub-prime meltdown, Eckert added. Most of the holders, however, would be able to withstand the losses or have purchased additional securities or insurance to offset a downturn in the mortgage bond market, he said.

However, the losses at Brookstreet extended to individual investors, said Samuel Edwards of Shepherd, Smith & Edwards, a Houston law firm that specializes in investor claims against brokerages.

Edwards said his firm had fielded similar complaints from at least half a dozen Brookstreet investors "from Hawaii to New York to Florida" who said they thought they owned safe investments but saw the value of their accounts drop sharply before they were liquidated.

One Brookstreet broker, who declined to be identified because only Mains was authorized to speak for the firm, attributed Brookstreet's troubles to a bond division at the firm that had set up a special website for wealthy investors.

The broker said the site allowed investors to purchase collateralized mortgage obligations -- bonds backed by various flows of payments on pools of mortgages -- with as little as 10% down and the other 90% borrowed, rather than the 50% down that is typically required on such margin accounts.

A combination of rising longer-term interest rates and defaults on sub-prime mortgages caused the mortgage bonds to lose value -- losses that were greatly magnified because of the heavy borrowing that funded the purchases, the broker said.

In some cases this would more than wipe out an investor's entire position overnight, putting the burden on Brookstreet to make up any amounts owed to the National Financial unit of Fidelity Investments, which held the accounts.

In the end, National Financial began selling the assets of investors as their accounts declined, leaving them, like Brookstreet itself, with huge losses, the broker said.

"Disaster, the firm may be forced to close," Stanley Brooks said in his e-mail to brokers Wednesday. "Today, the pricing system used by National Financial has reduced values in all collateralized mortgage obligations. Many of those accounts were on margin and have suffered horrendous markdowns."

Adam Banker, a Fidelity Investments spokesman, said Fidelity wasn't responsible for the losses. The firm was simply exercising its rights under its contracts, Banker said, adding that it used highly reputable third parties to place values on mortgage securities.

Brookstreet's website says the firm offers clients "virtually unlimited investment choices" to grow and protect their savings. It says it employs "a careful, conservative approach to business and to investing," assuring investors that they are protected by Securities Investor Protection Corp. and Boston-based Fidelity.

However, the website warns: "Coverage does not protect against a decline in the market value of securities."

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