On Tuesday, March 13, 2012, the SEC announced that it had filed claims against the CEO, CFO and Chief Accounting Officer of Thornburg Mortgage Inc., which used to be one of the nation’s largest mortgage companies, alleging that the three executives hid "the company’s deteriorating financial condition at the onset of the financial crisis" in the company’s Annual Report. According to the Commission, "[t]he plan backfired and the company lost 90 percent of its value in two weeks," and ultimately filed for bankruptcy. The case is the latest brought by the SEC relating to the market crisis.
In the suit filed in New Mexico, the Commission alleges that CEO Larry Goldstone, CFO Clarence Simmons, and Chief Accounting Officer Jane Starrett devised a plan to falsely overstate Thornburg Mortgage’s income by more than $400 million in the company’s 2007 Annual Report. The scheme also entailed recording a profit for the fourth quarter, rather than an actual loss. In the weeks leading up to that filing, Thornburg Mortgage received more than $300 million in margin calls. The three executives decided to conceal the company’s inability to make those payments by improperly determining that more than $400 million in market value losses related to its adjustable rate mortgage or "ARM" securities were temporary and, as a result, did not need to be recognized as income. The Commission also claimed that the three did not disclose the margin calls and pending crisis to their auditors.
As the SEC stated in its press release, the three executives "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." The SEC further detailed the events:
Keeping the extent of its margin call crisis quiet and relying on the cooperation and forbearance of its lenders, Thornburg [Mortgage] was able to make the final payment on its margin calls approximately 12 hours before filing its annual report. 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 [Mortgage] filed its annual report at 4 a.m. local time on February 28.
The plan backfired when, after the filing of the Annual Report on February 28, 2008, Thornburg Mortgage was unable to raise enough cash to meet post-Report margin calls. By 6 a.m., that day the company began to receive additional margin calls, which ended up exceeding its available liquidity in 90 minutes. Despite these events, Messrs. Goldstone and Simmons "continued to publicly project the same false financial condition they had presented in the annual report." Ultimately, the company was required to disclose the defaults in Form 8-K filings with the SEC. Finally, on March 11, 2008, Thornburg Mortgage filed an amended Annual Report and its stock price plummeted more than 90%.
The SEC’s 11-count complaint charges the three defendants with violations of the antifraud, deceit of auditors, reporting, record keeping, and internal controls provisions of the federal securities laws. The Commission seeks a permanent injunction against future remedies, a lifetime director and officer bar, disgorgement of all ill-gotten gains, together with pre-judgment interest, and civil penalties.
Robert Khuzami, Director of the SEC’s Division of Enforcement said "[t]he truest test of corporate executives’ commitment to full and accurate shareholder disclosure comes not during times of soaring profits and double-digit growth, but when companies are under financial stress and shareholders have the greatest need for accurate information." He pointed out that three defendants "flunked that test."
The SEC has sued 98 individuals and entities (including over 50 CEOs, CFOs and senior officers) in cases related to the financial crisis. Among the other market crisis cases brought by the SEC are proceedings against:
• RBC Capital Markets LLC who was named in a September 2011 settled administrative proceeding brought by the SEC for misconduct relating to the sale of unsuitable investments (credit-linked notes that were tied to the performance of synthetic collateralized debt obligations or "CDOs") to five Wisconsin school districts;
• Thomas Wu, the former CEO of United Commercial Bank, who was sued by the SEC for misleading investors regarding the financial state of the bank in 2008 financial crisis;
• six former executives of Fannie Mae and Freddie Mac, who were sued by the SEC for securities fraud, alleging that "they knew and approved of misleading statements claiming the companies had minimal holdings of higher-risk mortgage loans, including subprime loans"; and
• Citigroup Global Markets, Inc., who settled with the SEC for misleading investors about a $1 billion CDO tied to the housing market (a settlement which was rejected by Judge Jed Rakoff and the fate of which now is being considered by the Second Circuit Court of Appeals).