(Update II: Quotes added from defendants attorneys.)
The Securities and Exchange Commission today charged three former executives of failed Irvine-based subprime lender New Century Financial with fraud for allegedly misleading investors as the business was “collapsing” in 2006.
Robert Khuzami, the agency’s director of enforcement, said, “New Century shareholders took a double-hit: The company’s mortgage assets and business performance became increasingly impaired, and management manipulated its numbers and concealed its deteriorating performance.”
The SEC is charging former chief executive and co-founder Brad Morrice of Laguna Beach; former chief financial officer Patti Dodge of Irvine; and former controller David Kenneally of Rossmoor. The complaint, filed in federal court in the Central District of California, seeks civil penalties and from Morrice and Dodge reimbursement of bonuses and other incentive or equity-based compensation.
In addition, the SEC is seeking a severe personal penalty against the three: a bar against ever again serving as officers or directors of a publicly traded company.
Josh Epstein, a spokesman for Proskauer, the law firm representing Morrice, called the SEC’s charges against the former executive “flatly false.”
“Brad did all he could to save the company and to accurately report the company’s numerous challenges to its shareholders,” Epstein said. “While his efforts failed, there was no fraud.”
Morrice remained a large shareholder until the end, losing millions of dollars when New Century filed for bankruptcy in April 2007, Epstein said.
“Brad was among the biggest victims of the company’s collapse,” he said.
Terry Bird, an attorney for Dodge, said, “We believe the evidence will show that Ms. Dodge fully and completely fulfilled all her fiduciary and corporate obligations to New Century and its shareholders.”
“She looks forward to responding to these allegations and clearing her good name,” Bird said.
John Vandevelde, an attorney for Kenneally, said the former executive was never a “top officer” but a new accountant who lost “every penny he ever invested in the company he believed in.”
Kenneally never signed any financial statements and relied on the outside auditors for accounting treatment now under question by the SEC, his lawyer said.
“Mr. Kenneally will defend any allegation that he engaged in anything approaching securities fraud,” his lawyer said.
New Century was once the top publicly traded subprime lender in the country, making $60 billion in home loans in a single year. It failed in dramatic fashion in spring 2007 as investors began shying away from securities backed by mortgages to people with spotty credit records.
The SEC charged that New Century misrepresented the growing risks of its subprime loan portfolio. It withheld information about defaults, which forced it to buy back at a loss loans it had sold earlier to Wall Street.
In addition, the SEC alleged, the company understated the loan-to-value ratio of its loans. Beginning in early 2005, about a third of New Century’s loans were so-called “80/20″ loans in which borrowers took out two simultaneous loans worth 80 percent and 20 percent of a home’s value.
New Century made it look like the 80/20 borrowers had equity, the SEC alleged. They did that by calculating that the 80 percent loan had a loan-to-value of 64 percent (80 percent of the home’s value times the 80 percent). That created imaginary equity to cover the second 20 percent loan.
When home values began to decline in 2006, many holders of these 80/20 loans started defaulting.
Indeed, New Century borrowers defaulted in growing numbers in 2006. During the last three months of the year, 2.4 percent of the company’s loans defaulted the first month payment was due. Nearly 15 percent defaulted in the first few months of the loans — early enough to trigger demands for repayment by the investors who had bought the mortgages from New Century.
The SEC did not charge co-founder Robert Cole who stepped down as chief executive in 2006, though he stayed on the board of directors. And co-founder Edward Gotschall, who died in January of natural causes, also was not named in the complaint. Gotschall was generally considered the head numbers guy at the company, but he stepped back in 2006, remaining on the board but not active in day-to-day management.
Read the complaint HERE.
Ronald Campbell contributed to this report.
