SEC Charges Three Subprime Lenders with Fraud
by Jann Swanson on
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Three former mortgage executives were charged with fraud on Monday for activities growing out of their roles at the defunct New Century Mortgage
The charges were brought by the U.S. Securities and Exchange Commission (SEC) which accused the three of covering up the rapidly declining financial condition of their firm before it filed for bankruptcy in April, 2007.
The three are Brad Morrice, former Chief Executive; Patti Dodge the former CFO and former Controller David Kenneally. The SEC is seeking to permanently enjoin the defendants from future violations of the federal securities laws, disgorgement of funds with prejudgment interest and to bar them from acting as an officer or director. The suit, filed in federal court in the Central District of California also seeks unspecified civil penalties.
New Century was one of the largest of the independent providers in the subprime lending market, lending to persons with poor credit or high debt ratios.
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The government accused the officers of attempting to keep investors in the dark about the financial condition of New Century, assuring investors that the business was performing well while failing to disclose a growing incidence of loan defaults, mandatory loan repurchases and requests for repurchases.
The SEC also charges that Dodge and Kenneally fraudulently accounted for some of the expenses associated with repurchasing bad loans. Kenneally, with Dodge's knowledge, allegedly changed New Century's accounting method for loan repurchases. These changes violated generally accepted accounting standards and led to what the SEC said were materially overstatements of the company's financial prospects.
The executives are also charged with causing substantial investor losses. The company announced in February 2007 that it had to restate its 2006 financial statements at which point its stock plunged 36 percent to the high teens. It was trading at less than $1 when the company finally filed for bankruptcy.
Today's indictments come less than a month after U.S. Attorney General Eric Holder announced the creation of a new interagency fraud unit that will oversee investigations into the mortgage meltdown. The SEC is a participant in that fraud unit. At the time of that announcement Holder made it clear that investigations of subprime mortgage irregularities were already underway and that prosecutions would be forthcoming.
Judge upholds rule on foreclosure
Homeowners struggling to avoid foreclosure got some good news Tuesday.
U.S. District Judge Kent Dawson upheld a bankruptcy court ruling that makes it harder for lenders to foreclose on home mortgages.
The case, which was heard by a panel of federal judges in November, concerned whether Mortgage Electronic Registration Systems Inc., or MERS, could foreclose on residences on behalf of lenders. The electronic system records the ownership of residential mortgages for the mortgage banking industry.
Dawson said the company could not foreclose on a home because it did not provide evidence that it held the note on the residence and didn't show that it was an agent of the lender.
About half of all U.S. mortgages "whose loans have been securitized, sliced and diced are now held by (MERS)," according to a blog posted by securities analyst Barry Ritholtz.
The case started in bankruptcy court two years ago.
MERS asked bankruptcy Judge Linda Riegle for permission to start foreclosure proceedings against a property owned by Lisa Marie Chong. Bankruptcy trustee Lenard Schwartzer objected, saying the electronic system was not a "real party in interest" in the mortgage loan.
Like many mortgages, Chong's loan had been securitized, meaning it had been pooled or packaged into a security held by investors.
MERS was unable to show that it had possession of the note. The bankruptcy judge ruled in Schwartzer's favor. The decision was appealed to federal court.
In his decision Tuesday, Dawson said the registration system does not lose money when borrowers fail to make payments on home mortgages.
Dawson ruled that Mortgage Electronic Registration Systems must at least provide evidence that it was a representative of the mortgage loan holder, which it failed to do.
"Since MERS provided no evidence that it was the agent or nominee for the current owner of the beneficial interest in the note, it has failed to meet its burden of establishing that it is a real party in interest with standing," Dawson said, affirming the bankruptcy court ruling.
Real estate attorney Tisha Black-Chernine said the ruling is good news for struggling borrowers and home-owners.
"It will have a dramatic effect on lenders being able to foreclose," she said.
Because the decision makes it more difficult to foreclose, she hopes lenders will be more willing to negotiate with homeowners struggling to meet mortgage payments by approving short sales or making other concessions.
In a short sale, a lender agrees to let a homeowner sell his home for less than is owed. This is particularly helpful, because many homeowners owe far more than their homes are worth since home prices have fallen.
Houses sold in short sales typically go for 30 percent more than homes sold after foreclosure, Black-Chernine said.
Appraisers looking at the short sale price will use it in determining the market value. Thus, avoiding foreclosure results in higher market values for other houses, she said.
"It should help buoy home prices," Black-Chernine said.
Bill Uffelman, chief executive officer of the Nevada Bankers Association, a trade group, predicted that most foreclosures will be able to proceed because the real mortgage owners and notes will be able to be identified in most cases. However, he said many homeowners facing foreclosure may be able to stay in their homes longer because of the delay.
"In the end in 99.9 percent of the cases, ownership of the note will be proved," he said.
Although the decision is believed to be the first of its kind in Nevada, the Kansas Supreme Court made a similar finding in a similar case.
An attorney for the electronic system did not return a call for comment on whether it will appeal.
Contact reporter John G. Edwards at email@example.com or 702-383-0420.