MANHATTAN (CN) - A federal judge has certified a securities fraud class action against Sallie Mae, the top student loan provider in the United States.
Lead plaintiff SLM Ventures accused SLM Corp., Sallie Mae's corporate name, of telling investors it used strict underwriting standards for its loans, while weakening those standards by approving risky loans to students at for-profit schools.
U.S. District Judge William H. Pauley III laid out the allegations in a 19-page ruling.
"In 2006, Sallie Mae's management decided to expand the company's PEL [Private Education Loan] business. Between June 2006 and December 2007, Sallie Mae's PEL portfolio more than doubled, growing from $7 billion to $15.8 billion. At the time, Sallie Mae publicly stated that it had applied strict underwriting standards to all PEL borrowers. However, SLM Ventures alleges that Sallie Mae actually relaxed its underwriting standards and loaned billions of dollars to borrowers with low credit scores and other high risk borrowers who attended part-time, correspondence, or for-profit schools." (Citations omitted.)
Sallie Mae then moved as many problem loans as possible into forbearance to hide the true number of private loans that were delinquent or in default, in violation of Generally Accepted Accounting Principles and Securities and Exchange Commission regulations, the investors said.
They accuse Sallie Mae's chairman of fudging the numbers to profit on a merger.
"In April 2007, Sallie Mae and its then-Chairman of the Board, Albert L. Lord ('Lord'), negotiated to sell the company to a group of private equity investors (the 'Flowers Transaction'). The strike price was set at $60 per share, and was contingent on Sallie Mae's financial performance and outlook. If the proposed merger closed, Lord would receive a cash payment totaling $225 million representing the value of his stock options.
"While the Flowers Transaction was pending, Sallie Mae faced billions of dollars of redemption obligations for outstanding equity forward contracts. Under those contracts, Sallie Mae raised cash by selling common stock and agreeing to buy the stock back at the higher strike price. However, if the Flowers Transaction was not consummated, Sallie Mae would be required to pay approximately $2 billion to settle the equity forward contracts. On October 8, 2007, citing the recent passage of the College Cost Reduction and Access Act of 2007 ('CCRAA') as a material adverse effect on Sallie Mae's financial performance and outlook, the private equity group backed out of the Flowers Transaction. On December 12, 2007, Sallie Mae abandoned the deal," Judge Pauley wrote. (Citations omitted.)
Investors claim that Sallie Mae finally made the disclosures after the deal began to unravel.
"During an investor call, Lord revealed that Sallie Mae was increasing its PEL loss reserves but refused to answer questions about the credit worthiness of Sallie Mae's loan portfolio. According to media reports, Lord was 'agitated' and 'profane' during the call. Following the call, Sallie Mae's stock dropped by twenty-one percent," the order states.
The stock plummeted another 13 percent on Jan. 3, 2008, and Sally Mae announced a 50 percent decline in its net income on Jan. 23, 2008.
Investors representing SLM Ventures, which claims to have lost $2.9 million due to fraud, became lead plaintiff in a lawsuit against the company on April 1, 2009.
Pauley certified the investors as a class last week.
"During the class period, defendants publicly characterized the company's PEL business as 'essential,' 'our economic engine on the loan side of the business,' and 'now obviously our principal business.' Although PELs accounted for only 16 percent of Sallie Mae's total managed loan portfolio in 2006, they generated 23 percent of the company's core earnings. Sallie Mae's PEL portfolio more than doubled between June 2006 and December 2007 and defendants later disclosed that, by the end of 2007, 15 percent of Sallie Mae's PEL portfolio consisted of loans to students who were 'poor credit risks' attending the 'wrong schools.' Analysts reported on the profitability, projected growth, and potential credit risks of Sallie Mae's PEL business in dozens of reports and news articles following each class period earnings announcement.
"Other courts have concluded that the types of misrepresentations and omissions SLM Ventures alleges - about the company's core business revenue and improper accounting practices, as well as underwriting practices, loan loss reserves and internal risk controls - are material to a reasonable investor," the order states. (Citations omitted.)
The class includes "all persons or entities who bought or otherwise acquired SLM Corporation common shares between January 18, 2007, and January 23, 2008, and who possessed any of those shares over one or more of the dates of December 19, 2007, January 3, 2008, and January 23, 2008."
Read the Top 8
Sign up for the Top 8, a roundup of the day's top stories delivered directly to your inbox Monday through Friday.