As the House of Representatives passed the market crisis bill on Friday, the Commission filed what may be the first of a series of actions arising out of its sub-prime mortgage investigations. At the same time, a jury in Northern California found the former General Counsel of McAfee, Inc. not guilty on fraud charges based on option an option backdating scheme at that company.

Subprime investigations

SEC v. Ainsworth, Case No. EDCV 08-1350 (C.D. Cal. Oct. 3, 2008) is a case in which the claims are based on what is alleged to be unscrupulous subprime mortgage lending. The complaint is based on a scheme in which defendants fraudulently sold unsuitable securities to home owners which were paid for with cash obtained from refinancing the investor’s home with a subprime negative amortization mortgage. The transactions generated fees for defendants at each step.

The complaint names four individuals as defendants. The individual defendants were employed by a group of companies that acted as a broker dealer, mortgage company and life insurance company. The Commission’s complaint details a series of transactions in which individual home owners were defrauded. Typically, the individual home owners identified in the complaint had no prior investment experience, limited education, some worked multiple jobs and they did not have the cash for the unsuitable investments defendants induced them to make.

Each investor had a home with a fixed rate mortgage that defendants tapped to generate cash to make the investments and generate fees for themselves. Typically, Defendants would convince the investor to make an investment with one of the affiliated companies, such as mutual fund shares or variable annuity. The investment would be paid for with the equity from the home and by refinancing the investor’s fixed rate to get lower payments. This transaction, which generated more cash for the investments, was done with a variable rate subprime mortgage that had negative amortization. According to the complaint, the investments defendants convinced the investors to make were not suitable for these first time investors. In convincing the investors to enter into these transactions, defendants did not disclose the fees and insurance charges associated with the deals.

The Commission’s complaint requests an injunction prohibiting future violations of Sections 17(a) and 10(b), disgorgement and prejudgment interest and civil penalties. The case is in litigation.

Option backdating

Kent H. Roberts was acquitted of two counts of securities fraud in his option backdating trial on Friday. The jury was unable to decide a third count based on falsifying records. U.S. v. Roberts, Case No. 070100 (N.D. Cal. Feb. 27, 2008). The SEC filed similar claims against Mr. Roberts last year. That case is still pending. SEC v. Roberts, Case No. 1:07 cv 00407 (N.D. Cal. Feb. 28, 2007).