Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, March 22, 2011

SEC BRINGS FRAUD CHARGES IN SILICON VALLEY REAL ESTATE INVESTMENT SCHEME

The SEC charged Calif.-based JSW Financial Inc. and five officers for defrauding investors in two real estate funds, alleging that the firm used investor funds to prop up the officers’ own failing real estate development projects while concealing the loss of $17 million of investors’ money.  The SEC alleges that from 2002 to 2008, JSW and its predecessor, Jim Ward & Associates (JWA), created two real estate investment funds – Blue Chip Realty Fund and Shoreline Investment Fund – and told investors that their money would be used to make loans secured by residential real estate. In reality, according to the SEC, the firms’ officers used most of the money to make unsecured and undocumented loans to entities that the officers themselves controlled, which were suffering mounting losses and protracted delays on Silicon Valley real estate development projects. Meanwhile, as the enterprise collapsed, investors continued receiving monthly statements showing steady growth in the value of their portfolios.

The SEC’s complaint seeks injunctive relief and disgorgement of ill-gotten gains against JSW, Ward, Lee, Locker, Tipton and Lin, as well as monetary penalties against the five officers. The complaint also seeks disgorgement of ill-gotten gains and appointment of a receiver over Blue Chip and Shoreline as relief defendants.

March 22, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Spyglass Equity Systems Reps with Boiler Room Operations

The SEC charged three firms and four individuals involved in a boiler room scheme operating out of Los Angeles that defrauded investors who they persuaded to buy purportedly profitable trading systems.  According to the SEC, representatives of Spyglass Equity Systems Inc. cold-called investors and made false and misleading statements to help raise more than $2.15 million from nearly 200 investors nationwide for two related investment companies – Flatiron Capital Partners LLC (FCP) and Flatiron Systems LLC (FS). However, only a little more than half of that money was actually used for the advertised trading purposes, and much of the trading that did occur failed to use the purported trading systems. FCP and FS wound up losing about $1 million in investor funds. The managing member of the two firms – David E. Howard II – misused almost $500,000 of investor money for unauthorized business expenses as well as personal expenses including travel, entertainment, and gifts for his girlfriend.

Along with Howard, FCP and FS, Spyglass and its owners – Richard L. Carter, Preston L. Sjoblom and Tyson D. Elliott – also are charged with fraud in connection with the unregistered securities offerings.

The SEC seeks permanent injunctions, disgorgement plus prejudgment and post-judgment interest, and financial penalties.

March 22, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FiNRA Fines Southwest Securities and Expels its Correspondent Firm for Improper Short Sales

FINRA announced today that it fined Southwest Securities, Inc., of Dallas, $650,000 for deficiencies in due diligence, risk assessment and written supervisory procedures that permitted one of its correspondent firms, Cutler Securities, to lose over $6 million in one day through improper short sales. FINRA also required Southwest to designate a risk management officer to identify and manage the risks associated with its correspondent clearing services business. In addition, FINRA expelled Cutler Securities and barred its President, Glenn Cutler, for Cutler Securities' violative short selling.

On August 6, 2009, its second day of clearing through Southwest, Cutler Securities bought over 17.8 million shares of a stock while selling over 20.3 million shares of the same stock. Despite receiving alerts regarding this trading during the day, Southwest allowed Cutler to establish a 2.5 million share short position. Cutler Securities was unable to meet its obligation on the position, requiring Southwest to close the position, leaving it with an unsecured debit balance of approximately $6.3 million.

Among the deficiencies in Southwest's supervisory practices were failures to establish written due diligence policies, written criteria to determine the acceptability of potential correspondents, awareness of the proper procedure for terminating correspondent firms on an intra-day basis, appropriate trading alert parameters for many of its correspondent firms, and procedures recognizing that it had clearing and settlement responsibility for all correspondent firms that had the ability to execute trades away from Southwest.Cutler Securities also had significant regulatory and supervisory deficiencies relating to its short sales, including a history of failing to comply with Regulation SHO by obtaining locates and properly marking order tickets, and a failure to comply with SEC Emergency Orders.

In settling this matter, Southwest and Cutler neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

March 22, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Supreme Court Unanimously Rules No Bright-Line Rule of Statistical Significance in Matrixx

The U.S. Supreme Court unanimously decided, in Matrixx Initiatives, Inc. v. Siracusano (No. 09-1156) (Mar. 22, 2011)( Download Matrixx opinion) that plaintiffs can state a case for securities fraud under Rule 10b-5 based on a pharmaceutical company's failure to disclose reports of adverse events associated with a product even though the reports do not disclose a statistically significant number of adverse events.  Although this outcome was widely predicted, it is something of a surprise that no Justice even felt the need to write a concurring opinion.  Justice Sotomayor wrote the Court's opinion and emphasized that the Northway/Basic definition of materiality cannot be reduced to a bright-line test.  "As in Basic, Matrixx's categorical rule would 'artificially exclud[e]' information that 'would otherwise be considered significant to the trading decision of a reasonable investor.'...Matrixx's argument rests on the premise that statistical significance is the only reliable indication of causation.  This premise is flawed."  Although in many instances reasonable investors would not consider reports of adverse events to be material information, plaintiffs have alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports a material.

In addition, plaintiffs have also alleged facts "giving rise to a strong inference" that Matrixx acted with scienter.  "Matrixx's proposed bright-line rule requiring an allegation of statistical significance to establish a strong inference of scienter is just as flawed as its approach to materiality."  The Supreme Court once again found it unnecessary to consider whether scienter includes reckless conduct.  

March 22, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, March 21, 2011

Oxley Works on Behalf of FINRA for Adviser SRO

Investment News reports that FINRA has hired Michael Oxley (of Sarbanes-Oxley) as a lobbyist to advocate its position for a SRO (presumably FINRA) for investment advisers.  Finra hires big gun to lobby for advisor biz SRO

March 21, 2011 in News Stories, Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Judge Refuses to Approve Securities America Settlement

Securities America (as readers of this blog know) faces class actions and arbitrations brought by customers who suffered losses from private placement sold by its brokers.  SA and plaintiffs' attorneys in one class action negotiated a $21 million settlement and previously obtained a temporary stay of arbitrations that SA said would otherwise deplete its assets.  SA said that unless the settlement was approved, it would be out of business.  On March 18, however, a federal district court judge refused to approve the settlement and refused to continue the stay of the arbitrations.  See Judge rejects Securities America class settlement.)  Observers have wondered whether SA's parent, Ameriprise Financial, would bail it out.  Reuters reported earlier today that Ameriprise refused to commit itself, but Investment News reports that it has announced it would be willing to contribute cash to its subsidiary.  Details were not provided. 

March 21, 2011 in News Stories, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Saturday, March 19, 2011

Sale on Judges As Gatekeepers

Judges Who Settle, by Hillary A. Sale, Washington University School of Law in St. Louis, was recently posted on SSRN.  Here is the abstract:

This Article develops a construct of judges as gatekeepers in corporate and securities litigation, focusing on the last-period, or settlement stage of the cases. Many accounts of corporate scandals have focused on gatekeepers and the roles they played or, in some cases, abdicated. Corporate gatekeepers, like investment bankers, accountants, and lawyers, function as enablers and monitors. They facilitate transactions and enable corporate actors to access the financial and securities markets. Without them the transactions would not happen. In class actions and derivative litigation, judges are the monitors and enablers. They are required to oversee the litigation arising from bad transactions and corporate scandals. Unlike other types of private law litigation, where the parties settle and have the case dismissed, judges must approve settlements of class actions and derivative litigation. They are actually charged with fiduciary responsibilities and control the exit stage, or settlement, of the litigation. As a result, the judges’ job is to be a gatekeeper.

The judges are not, however, doing their jobs. “Doing their jobs” requires actual scrutiny of the role of defense counsel and insurers, both of whom amplify agency costs. It also requires scrutiny of the settlement collusion between defendants and plaintiffs. Yet, traditionally both academics and the courts have failed to analyze those issues in the context of the costs of aggregate and derivative litigation. This Article provides a real cut at those issues. It then develops and explores principles for gate keeping judges, which, if implemented, will decrease the agency costs of this type of litigation and ensure that the judges are actually functioning as the fiduciaries they are required to be.

March 19, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bai on Deterring Manipulation in Financial Crisis

Deterring 'Double-Play' Manipulation in Financial Crisis: Increasing Transaction Cost as a Regulatory Tool, by Lynn Bai, University of Cincinnati - College of Law, was recently posted on SSRN.  Here is the abstract:

The sub-prime mortgage crisis that originated in the United States has triggered a global credit crunch, threatening the solvency of emerging markets that have relied heavily on foreign debt, and resulting in the devaluation of their currencies. Currency market interventions by the central banks in countries with a currency board system lead to higher short-term interest rates and further declinations in the local stock market. This economic setting invites the double-play manipulation strategy that simultaneously attacks both the local currency and the stock market. History has shown that a central bank’s stock market intervention is costly and that sustaining the intervention over a meaningful period of time is a major challenge. In this paper, we examine the effect of a pan-market increase in transaction cost on double-play manipulators’ trading strategies when government intervention is limited to revenues generated by the transaction levy. We show that this regulatory change not only helps sustain equity market intervention but also reduces the short pressure in both the currency and the equity market.

March 19, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

FDIC Sues Washington Mutual Execs for Recklessness

Earlier this week the FDIC sued Kerry K. Killinger, former CEO of failed savings bank Washington Mutual, and two of the bank's executives, Stephen J. Rotella and David C. Schneider.  In the suit, which is seeking $900 million in damages, the FDIC charges that the executives recklessly pursued short-term gains to increase their own compensation, in disregard of the bank's safety and soundness.  This is the FDIC's first suit against executives at a major bank.

Killinger called the claims "baseless and unworthy of the government."

NYTimes, F.D.I.C. Sues Ex-Chief of Big Bank That Failed  (Mar. 17, 2011)

March 19, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Raj Rajaratnam Trial: Second Week

The second week of the Raj Rajaratnam trial was mostly devoted to the testimony (both direct and cross) of Anil Kumar, the former McKinsey executive, who previously pleaded guilty to securities fraud charges.  In addition, the prosecutors played more  of those many taped phone conversations between RR and other individuals discussing various acquisitions.  The most interesting tape may have been the conversation between RR and Rajat Gupta, the former Goldman director, involving Goldman board discussions about possible deals.  (The SEC has sued Gupta in an administrative proceeding; Gupta, in turn, has sued the SEC in federal court.)

Kumar testified that he gave "super confidential information" about McKinsey client AMD and other companies to RR in exchange for $2 million, some of which was paid through an offshore account set up in the name of his housekeeper.  RR's defense attorney aggressively cross-examined Kumar, accusing him of a "monstrous lie" in setting up the phony account and fraud on the IRS.  RR's attorney also argued that the money paid by RR was for legitimate advice and that the information was not material nonpublic information.

After Kumar's testimony concluded, the prosecutor played still more taped conversations, this time RR's calls with former Intel employee Rajiv Goel (who also has pleaded guilty and is expected to testify).  In one of them RR said he had received information about PeopleSupport "because one of our guys is on the board."

 

March 19, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Seeks Comments on Debt Research Reports Concept Release

FINRA recently requested comment on a Concept Proposal to Identify and Manage Conflicts Involving the Preparation and Distribution of Debt Research Reports.  According to the Executive Summary:

FINRA seeks comment on a concept proposal to apply objectivity safeguards
and disclosure requirements to the publication and distribution of debt
research reports. The proposal has a tiered approach that generally would
provide retail debt research recipients with most of the same protections
provided to recipients of equity research, while exempting debt research
provided solely to institutional investors from many of those provisions.

The comment period expires April 25, 2011.

March 19, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

IBM TO PAY $10 MILLION IN SETTLED FCPA ENFORCEMENT ACTION

The SEC settled charges with International Business Machines Corporation (“IBM”) that it violated the books and records and internal control provisions of the Foreign Corrupt Practices Act of 1977 (“FCPA”) as a result of the provision of improper cash payments, gifts, and travel and entertainment to government officials in South Korea and China.

As alleged in the SEC’s Complaint, from 1998 to 2003, employees of IBM Korea, Inc., an IBM subsidiary, and LG IBM PC Co., Ltd., a joint venture in which IBM held a majority interest, paid cash bribes and provided improper gifts and payments of travel and entertainment expenses to various government officials in South Korea in order to secure the sale of IBM products.

It was further alleged that, from at least 2004 to early 2009, employees of IBM (China) Investment Company Limited and IBM Global Services (China) Co., Ltd., both wholly-owned IBM subsidiaries, engaged in a widespread practice of providing overseas trips, entertainment, and improper gifts to Chinese government officials.

Without admitting or denying the SEC’s allegations, IBM consented to the entry of a final judgment that permanently enjoins the company from violating the books and records and internal control provisions of the FCPA, codified as Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934. IBM also agreed to pay disgorgement of $5,300,000, $2,700,000 in prejudgment interest, and a $2,000,000 civil penalty.

March 19, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Gupta Sues SEC

The SEC created a stir a few weeks ago when it brought an administrative enforcement action against Rajat Gupta, the former P&G and Goldman director, for tipping confidential inside information to Raj Rajaratnam. Many questioned why the SEC chose to exercise its new authority in Dodd-Frank to bring an administrative proceeding against Gupta and did not bring an action in federal district court and why the DOJ had not brought a criminal proceeding against Gupta.  (The prosecutor in his opening statement at Rajaratnam's trial referred to the alleged tips from Gupta to Rajaratnam, and this week  at the trial audio tapes were played of conversations between the two.)

Now Gupta has brought an action against the SEC, asserting that the SEC rushed to bring the administrative action against him and that his constitutional right to a trial by a jury has been violated.  The law also questions whether the SEC can assert the Dodd-Frank provisions to conduct that allegedly took place before enactment of the statute.

NYTimes, Ex-Goldman Director Sues S.E.C. Over Galleon Case

March 19, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Friday, March 18, 2011

SEC Proposes Rule to Readopt Beneficial Ownership Reporting Requirements on Security-Based Swaps

The SEC proposed for public comment a rule on BENEFICIAL OWNERSHIP REPORTING REQUIREMENTS AND SECURITY BASED SWAPS.  According to its summary, the rule is intended:

To preserve the application of our existing beneficial ownership rules to persons who purchase or sell security-based swaps after the effective date of new Section 13(o) of the Securities Exchange Act of 1934, we are proposing to readopt without change the relevant portions of Rules 13d-3 and 16a-1. The proposals are intended to clarify that following the July 16, 2011 statutory effective date of Section 13(o), which was added by Section 766 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), persons who purchase or sell security-based swaps will remain within the scope of these rules to the same extent as they are now.

Comments should be received on or before April 15, 2011.

March 18, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Steel Technologies Officers with Insider Trading in Advance of Merger Announcement

The SEC charged four executives at Steel Technologies, a Louisville-based steel processing company, and four of their family and friends with illegal insider trading in advance of the company’s acquisition.  The SEC alleges that Patrick Carroll, William “Tad” Carroll, David Mark Calcutt and David Stitt – who are vice presidents of sales at Steel Technologies – traded based on confidential information about their company’s acquisition by Mitsui & Co. (USA) Inc. Three of the four executives illegally tipped family members or friends. The ring of eight traders together purchased $578,000 of Steel Technologies stock in the month prior to the public announcement of the acquisition and made $320,000 in illegal profits.

According to the SEC’s complaint filed in U.S. District Court for the Western District of Kentucky, Patrick and Tad Carroll are brothers of Michael Carroll, who is the president and chief operating officer of Steel Technologies. Patrick traded after Michael introduced him to Mitsui representatives who were touring the Steel Technologies facility where Patrick worked. Patrick tipped his son James, who then purchased his own Steel Technologies stock shortly before the acquisition was publicly announced. Tad bought more than $84,000 of Steel Technologies stock approximately one week before the public announcement following his own communications with Michael.

The SEC alleges that before getting inside information about the forthcoming acquisition, Calcutt liquidated nearly all of his company stock. However after he went on a hunting trip with Michael Carroll, Calcutt soon started aggressively buying Steel Technologies stock at higher prices. He also tipped his brother Christopher Calcutt, who then sold all of his shares in another company for a loss and used that money to buy Steel Technologies stock on margin to increase his illicit gains.

According to the SEC’s complaint, Stitt, Monroe and Somers have known each other since childhood. Stitt learned about the forthcoming acquisition on the Friday before the public announcement and immediately purchased Steel Technologies stock that same day. Over the weekend, Stitt told Monroe about the forthcoming acquisition. On Monday, Monroe passed the inside information to Somers. That same day, Monroe told his broker to immediately open a new account so he could buy Steel Technologies stock. Somers also immediately traded based on the inside information. During the SEC’s investigation, Stitt and Monroe contradicted each other’s testimony about their communications and advance knowledge of the acquisition.

The SEC’s complaint charges the eight defendants with securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Commission seeks permanent injunctive relief, disgorgement of illicit profits with prejudgment interest, and the imposition of monetary penalties against all defendants.

March 18, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Law Firm's Study Finds It Can Pay to Fight the Regulators

Sutherland Asbill & Brennan LLP recently announced the results of its 2011 Sutherland SEC/FINRA Litigation Study – an annual review of the litigated cases brought by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) against broker-dealers and associated persons.  The study finds that at least in some cases it paid to fight SEC and FINRA charges, particularly in cases involving fraud. 

Highlights from the study include:

• Of the 237 charges that were litigated by the SEC and FINRA and resulted in SEC Administrative Law Judge (ALJ) or FINRA Hearing Panel decisions during FY 2009 and FY 2010, respondents succeeded in getting approximately 13% of the charges dismissed.
• FINRA respondents with counsel are significantly more successful than pro se respondents.
• SEC staff failed to prove fraud charges approximately 57% of the time in FY 2009-2010.
• When SEC and FINRA respondents were found to have been liable for one or more charges, 33% of the time the ALJ or the Hearing Panel imposed monetary sanctions that were lower than the staff sought at the trial.
• When cases were appealed from SEC ALJs to the full Commission, 33% of SEC respondents were successful in getting reduced sanctions

The study is available at the firm's website.

March 18, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Republican Law Makers Want to Put the Brakes on Fiduciary Duty Obligation

Republicans on the House Financial Services Committee call on SEC Chair Schapiro to slow down on considering any rule to extend the investment adviser's fiduciary duty to broker-dealers.  They call for more rigorous analysis and a cost-benefit analysis to justify any proposed rule.  This was essentially the position taken by the two dissenting (Republican) Commissioners in the SEC's fiduciary duty study, released earlier this year.  Bloomberg, Republicans Want More Study Before SEC Sets U.S. Fiduciary Rule

March 18, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, March 16, 2011

PCAOB Issues Report on Chinese Reverse Mergers

The Public Company Accounting Oversight Board (PCAOB) recently issued its first public Research Note which provides new data on the  growth of reverse merger transactions involving companies from the China region.

The Research Note, entitled, "Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region (January 1, 2007 through March 31, 2010)," was prepared by the PCAOB Office of Research and Analysis (ORA) to provide further context to the issues discussed in Staff Audit Practice Alert No. 6 issued on July 12, 2010.  That Alert was based on observations from the PCAOB inspection process that some U.S. registered accounting firms may not be conducting audits of companies with operations outside of the U.S. in accordance with PCAOB standards.

In the period from January 2007 to March 31, 2010, ORA staff found that out of the 603 reported reverse merger transactions, 159 of those involved companies from the China region; the remaining 444 transactions involved primarily U.S. companies. Overall, reported reverse merger transactions involving companies from the China region during that time represented 26 percent of all reverse merger transactions reported during that time period.

The number of reverse merger transactions in the study involving companies from the China region was almost triple the number of initial public offerings (IPOs) conducted in the U.S. by companies from the PRC during that time. There were 56 IPOs from such companies, representing 13 percent of the IPOs completed in the United States.

Additionally, following the reverse merger transaction, two-thirds of the Chinese reverse merger companies in the study had market capitalization below $75 million as of March 31, 2010, while more than three-quarters of the companies from the PRC that conducted IPOs had market capitalization above $75 million as of March 31, 2010.

As of March 31, 2010, the market capitalization of the 159 Chinese reverse merger companies identified by ORA staff was $12.8 billion, less than half the $27.2 billion market capitalization of the 56 companies from the PRC that conducted IPOs during the same period. As of that date, 59 percent of Chinese reverse merger companies reported less than $50 million in revenues or assets as of their most recent fiscal year.

PCAOB-registered accounting firms based in the United States audited 74 percent of the Chinese reverse merger companies, while China-based registered firms audited 24 percent. Due to the position taken by authorities in the PRC, the PCAOB is currently prevented from conducting inspections of the U.S.-related audit work of PCAOB-registered firms in the PRC and, to the extent their audit clients have operations in the PRC, PCAOB-registered firms in Hong Kong SAR.

March 16, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Execs at Ohio Finance Company with Bilking Elderly Investors

The SEC today charged three senior executives at Akron, Ohio-based Fair Finance Company with orchestrating a $230 million fraudulent scheme involving at least 5,200 investors – many of them elderly.  The SEC alleges that after purchasing Fair Finance Company, chief executive officer Timothy S. Durham, chairman James F. Cochran, and chief financial officer Rick D. Snow deceived investors while selling them interest-bearing certificates. Fair Finance had previously operated for decades as a privately-held consumer finance company. But under the guise of loans, Durham and Cochran schemed to divert investor proceeds to themselves and others as well as struggling and unprofitable entities that they controlled. Durham and Cochran further misused investor funds to buy classic cars and other luxury items to enhance their own lavish lifestyles.

In a parallel criminal proceeding, the U.S. Department of Justice today unsealed criminal charges against Durham, Cochran and Snow for the same alleged misconduct.

The SEC’s complaint seeks permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, penalties and officer and director bars against each of the defendants.

March 16, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former Supervisor at Colonial Bank for Role in Securities Fraud Scheme

The SEC today charged Teresa A. Kelly, the former operations supervisor of Colonial Bank’s mortgage warehouse lending division (MWLD), with participating in a $1.5 billion securities fraud scheme.  According to the SEC, Kelly enabled the sale of fictitious and impaired mortgage loans and securities from the MWLD’s largest customer – Taylor, Bean & Whitaker Mortgage Corp. (TBW) – to Colonial Bank. She caused these securities to be falsely reported to the investing public as high-quality, liquid assets.

The SEC previously charged former TBW chairman and majority owner Lee B. Farkas in June 2010, charged TBW’s former treasurer Desiree E. Brown in February 2011, and charged the head of Colonial Bank’s MWLD Catherine L. Kissick earlier this month.  According to the SEC’s complaint filed in U.S. District Court for the Eastern District of Virginia, Kelly along with Farkas, Kissick and Brown perpetrated the fraudulent scheme from March 2002 to August 2009, when Colonial Bank was seized by regulators and Colonial BancGroup and TBW each filed for bankruptcy. Because TBW generally did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing arrangements primarily through Colonial Bank’s mortgage warehouse lending division to fund such mortgage loans.

The SEC alleges that TBW began to experience liquidity problems and overdrew its then-limited warehouse line of credit with Colonial Bank by approximately $15 million each day. Kelly, Farkas, Kissick and Brown concealed the overdraws through a pattern of “kiting” in which certain debits were not entered until after credits due for the following day were entered. In order to conceal this initial fraudulent conduct, Kelly, Farkas, Kissick and Brown created and submitted fictitious loan information to Colonial Bank and created fictitious mortgage-backed securities assembled from the fraudulent loans. By the end of 2007, the scheme consisted of approximately $500 million in fake residential mortgage loans and approximately $1 billion in severely impaired residential mortgage loans and securities. These fictitious and impaired loans were misrepresented as high-quality assets on Colonial BancGroup’s financial statements.

The SEC’s complaint charges Kelly with violations of the antifraud, reporting, books and records and internal controls provisions of the federal securities laws.

March 16, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)