Jury Deadlocks on Key SEC Claims

A jury was unable to reach a verdict on half of the claims asserted by the SEC against two senior executives of Thornburg Mortgage, Inc., the second largest independent mortgage company in the country. The charges centered on a market crisis era scheme in which the Commission alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A, 13(b)(2)(B) and 13(b)(5) as well as control person liability under section 20(a). Last week the jury, after several days of deliberation, was unable to reach a verdict on charges of fraud and lying to the auditors while finding in favor of former CEO Larry Goldstone and CFO Clarence Simmons on other charges. SEC v. Goldstone, Case No. 12-257 (D.N.M. Filed March 13, 2012).

The SEC claimed that shortly before the filing of the 2007 Form 10-K on February 28, 2008 the institution was suffering from a liquidity crisis. The cash for the long term lender came from the short term capital markets through repurchase or repo agreements. Those agreements required Thornburg to make margin calls if the value of the securities collateralizing them fell below certain thresholds. The company had paid about $2 billion in margin calls and liquidated about $22 billion in mortgage backed securities.

As the mortgage company prepared to file its 2007 10-K its financial condition continued to deteriorate. Adjustable rate mortgage or ARM securities it held dropped in value, although the firm did not take a write down. By late February 2008 the company could not meet the more than $300 million in margin calls it had recently received. At the same time, paying late meant that Thornburg would violate its agreements with at least three lenders. If the firm was declared in default its financial condition would sink further. That default would trigger the cross-default clauses with other lenders which would lead to the seizure of the ARM securities that were the collateral for the loans. Disclosure of these facts would undermine plans to raise additional cash. It would also result in questions by the auditors about the valuation of its ARM securities which could lead to a $400 million write-off.

The auditors were not told about the violation of the lending agreements or that that Thornburg sold some of its ARM securities to make margin calls. Just hours before filing the Form 10-K the company made the final payment on its margin calls. The Form 10-K was approved and certified by defendants Goldstone and Simmons. The filing represented that Thornburg had successfully met its margin calls without being required to sell assets. It also stated that the firm had the ability to hold its ARM securities until they recovered their market value.

Within two hours of filing the Form 10-K the company received more margin calls. Thornburg did not have the capital to meet the calls. Two business days after the filing the mortgage company filed a Form 8-K acknowledging this fact and stating that it had received a notice of default. Five days later on March 7, 2008 Thornburg filed a second Form 8-K announcing that it would restate its days old Form 10-K. When that restatement was filed on March 11 it reflected a loss of $428 million from the write down of its ARM securities. It also reported a loss in the fourth quarter, erasing the previously claimed gain for the period, and acknowledged that the company might not continue as a going concern. Eventually the Thornburg filed for bankruptcy.

The jury was unable to reach a verdict on the key fraud and lying to the auditors charges. It did return a verdict in favor of the defense on charges relating to books and records and certifications.

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