(CN) - The SEC claims in court that three former executive of bankrupt mortgage lender Thornburg Mortgage hid the company's deteriorating financial condition from auditors and investors as the financial crisis began, and 90 percent of the company's equity vanished in a two-week span.
"Thornburg's executives schemed to drop a disingenuous annual report into the public realm at the most opportune moment possible while knowing it was merely the calm before the next storm," the SEC said in a statement announcing its lawsuit in Albuquerque Federal Court.
The SEC accuses former CEO Larry Goldstone, CFO Clarence Simmons III and Chief Accounting Officer Jane Starrett of overstating the company's income by more than $400 million and falsely recording a profit for the fourth quarter of 2007, despite facing a "severe liquidity crisis" that made it unable to meet more than $300 million in margin calls in the before the filing of its annual report in February 2008.
At the time, "Thornburg was a publicly-traded single-family mortgage lender and the nation's second-largest independent mortgage company after Countrywide Financial Corporation," the SEC says in its 41-page complaint.
"Even though Thornburg was violating lending agreements by failing to make on-time payments, the executives were unwilling to disclose the severity of their liquidity crisis to investors and Thornburg's auditor," the SEC's regional director Donal Hoerl in Denver said in a statement.
"For example, in a February 25 e-mail from Starrett to Goldstone and Simmons, she said, 'We have purposefully not told [our auditor] about the margins calls.' Goldstone, Simmons, and Starrett scrambled to satisfy all outstanding margin calls and then timed the filing of the annual report to occur just hours later in order to precede additional margin calls and avoid full disclosure. As Goldstone had earlier stated to Simmons and Starrett in an e-mail, 'We don't want to disclose our current circumstance until it is resolved.' The intention was 'to keep the current situation quiet while we deal with it,'" according to Hoerl's statement.
The SEC said Thornburg was late in meeting margin calls from at least three lenders and received a reservation of rights letter from one, stating that it had violated its lending agreement and could be declared in default at any time.
"Unwilling to disclose these events and the extent of the liquidity crisis, Thornburg executives improperly determined that more than $400 million in market value losses related to its ARM securities were temporary and therefore did not need to be recognized in the company's income statement," Hoerl said.
The plan backfired when executives were unable to raise cash quickly enough to meet more margin calls after the annual report was released, the SEC said. Only when the company defaulted on the new margin calls did it disclose its problems in 8-K filings with the SEC. By the time an amended annual report was filed on March 11, the stock price had plummeted by more than 90 percent and never recovered. The company filed to bankruptcy protection in May 2009.
The defendants also accused of scheming to make Thornburg's auditor and investors believe it had successfully met all margin calls.
"Knowing that its reprieve from outstanding margin calls was only temporary and additional margin calls were likely in light of February 27 news that a large European hedge fund holding substantial mortgage-backed securities like Thornburg's ARM securities was about to collapse, Thornburg filed its annual report at 4 a.m. local time on February 28," according to the SEC statement. "The executives' urgency to file the annual report before the negative impact of the hedge fund's collapse was evident in an e-mail that Simmons sent to Starrett saying that he gave Thornburg's SEC reporting manager 'a 6:00 AM Thursday deadline to file the K. I do not want there to be any issues based on Thursday activity.'"
Despite the stock price's plummeting after release of the annual report, Goldstone and Simmons continued to publicly project the same false financial condition they had presented in the annual report, and encouraged the company's investor relations group to do the same, according to the complaint.
"Privately, reflecting on the company's stock price drop, Simmons commented in an e-mail to Goldstone soon after the annual report was filed, 'I guess the recent development section did not go over well. If they only knew,'" the SEC said in its statement.
Based in Santa Fe, N.M., Thornburg focused on "jumbo" and "super-jumbo" adjustable rate mortgages, and bought ARM securities and securitized ARM loans. The company needed constant access to financing, including money borrowed under reverse repurchase agreements that required Thornburg to maintain a certain degree of liquidity and subjected it to margin calls if the value of its ARM securities that served as collateral for loans fell below certain threshholds.
The SEC accuses the three executives of fraud, deceit of auditors, reporting, record keeping violations, and other securities violations. It seeks disgorgement, financial penalties, and wants the defendants barred from being officers in publicly traded corporations.
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