The SEC has repeatedly discussed the dozens of investigations it has underway regarding the market crisis. Reportedly, a significant amount of Commission resources are being invested in these inquiries, as indicated by the remarks of Commissioner Walter, discussed here, and others. Despite what has been billed as a major effort, few cases have been brought. One is SEC v. Mozilo, involving former senior officials of former number one subprime lender Countrywide. That case, discussed here, centers on a “disclosure fraud” – that is, the defendants did not disclose what the SEC said was the deteriorating financial condition of the company as the market crisis unfolded.

The SEC filed another market crisis case against the senior officers of a one-time high-flying subprime lender. This action involves the once number three subprime lender, New Century Financial Corporation. SEC v. Morrice, Case No SAC09-01426 (C.D. Cal. Filed Dec. 7, 2009). The defendants are former CEO and co-founder Brad Morrice, CFO Patti Dodge and Controller David Kenneally.

Like the case against the Countrywide executives, Morrice begins with disclosure fraud. The complaint adds allegations charging accounting fraud and ties those to investor losses from offerings of securities. Unlike Mozilo, there are no allegations of insider trading, although the individual defendants are alleged to have obtained ill-gotten gains through compensation.

The disclosure fraud is predicated on what the company, primarily Mr. Morrice and Ms. Dodge, failed to tell investors about the loan portfolio of the one time giant lender. According to the complaint, New Century, which was a REIT, originated and purchased loans through two divisions. The company focused on subprime lending, according to its periodic filings. In those filings the company repeatedly played down the risks associated with this type of lending program.

During the second and third quarters of 2006 as the market deteriorated, New Century experienced a liquidity crisis. Mr. Morrice and Ms. Dodge were receiving reports titled “Storm Warning” which detailed the impact of the crisis on the company during the period. Yet, each executive failed to ensure the disclosure of this information, leaving investors with false information about the financial condition of the company.

A second facet of the fraud involved accounting manipulations, according to the complaint. Specifically, Ms. Dodge and Mr. Kenneally are alleged to have improperly made significant reductions in the reserves during the second and third quarters of 2006. This action was taken in the face of dramatically increasing loan repurchases and repurchase requests. As a result, the repurchase reserves were understated and the financial results were overstated for the second quarter of 2006 by 165%. For the third quarter pre-tax earnings were reported as $90 rather than $18 million.

These actions artificially inflated the share price, injuring shareholders. In the second half of 2006, the company raised $142.5 million by selling stock to new investors. When the company announced on February 7, 2007 that it would restate its financial results for the first three quarters of 2006 to correct errors for its allowance for loan repurchase losses and that it had a material weakness in internal controls, the share price fell nearly 40% from just over $30 to about $19. By early April, the company filed for bankruptcy. The Commission’s complaint, which alleges violations of the antifraud and reporting provisions as well as a claim for failure to reimburse under SOX Section 304, is in litigation. See also Litig. Rel. 21327 (Dec. 7, 2009).

The SEC has now brought cases against executives of the former number one and number three subprime lenders. The former number one company has, of course, been acquired. The former number three has been in bankruptcy for two years after announcing a restatement that furnished at least a partial road map to its difficulties. A handful of other market crisis cases have been brought. When others will be brought is unclear.