by T. GormanPosted on Posted in SECActions

A financial fraud action was brought against former bank holding company CEO Anthony Nocella and CFO J. Russell McCann by the SEC. The action centers on the efforts of the two officers to conceal the true financial condition of Franklin Bank Corp. as the market crisis unfolded and its portfolio of real estate holdings unraveled. SEC v. Nocella, Case No. 4:12-cv-1051 (S.D. Tx. Filed April 6, 2012).

This is not the first action the Commission has filed against the officers of a financial institution who tried to conceal the deteriorating financial condition of their institution as the market crisis unfolded and took its toll. Prior actions include those brought against the officers of Countrywide Financial and UCBH. This may be the first however where the CEO and CFO tried to conceal the downward spiral of the institution’s loan portfolio and its finances by modifying the underlying loans to make them appear current when in fact they were not. As with prior schemes it failed.

The action centers on the efforts of Messrs. Nocella and McCann to prop-up Franklin Bank Corp., a Texas based savings and loan holding company. By the second quarter of 2007 the loan portfolio of the financial institution began to deteriorate as the financial crisis unraveled. During the summer of 2007 the two officers received reports that depicted a 24% increase in delinquencies in the loan portfolio compared to the prior three month period.

Despite its deteriorating financial condition, the two defendants were reviewing strategic alternatives which could include a sale of the bank. In August 2007 the two officers met with representatives of RBC Capital Markets. They were told that the institution needed to demonstrate positive earnings momentum to facilitate such alternatives.

Subsequently, Messrs. Nocella and McCann crafted three plans to improve the appearance of the loan portfolio and thus the operating results of the bank: Fresh Start, Strathmore Modifications and Great News. The first focused on bringing certain residential mortgages which were severely delinquent current by notifying the borrowers that if they made one payment, and agreed to certain other modifications, their loans would be considered current. Ultimately millions of dollars in loans were modified through this program to classify them current.

The second centered on the Strathmore Modifications. ThIS involved about $13.5 million involving four troubled loans to Strathmore Finance Company and its subsidiaries for construction projects in the Detroit area. By the summer of 2007 Strathmore could not repay the loans and requested a modification. The two defendants secured credit committee approval for a modification of the loans. In October 2007 the FDIC concluded after an examination that the loans should have been classified as “nonaccrual and evaluation for impairment” under the applicable GAAP provisions.

The third was the Great New program. It also involved the modification of residential real estate loans. This program involved 28 borrows who were severely delinquent, that is between 119 and 545 days past due. Under the program the borrowers only had to make the next payment to become current. Overall the loan modifications were not in accord with disclosed bank policies and GAAP.

The defendants’ schemes concealed from shareholders over $11 million in delinquent and non-performing single family residential loans and $13.5 million in non-performing residential construction loans, according to the complaint. Indeed, investors were falsely lead to believe that Franklin was outperforming other banks when in fact its financial condition was deteriorating. The programs did not save the institution. The bank ended in receivership and the holding company in bankruptcy in 2008.

The complaint alleges violations of Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). It seeks a permanent injunction, disgorgement, prejudgment interest, civil penalties, officer and director bars and repayment under SOX 304. The case is in litigation.

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by T. GormanPosted on Posted in SECActions

One of the hallmarks of SEC Enforcement in recent years has been aggressive insider trading actions. While the DOJ’s criminal cases often grab the headlines, the Commission’s market abuse unit has been hard at work, creating new investigative approaches which are often in the background of those headlines.

As last week drew to a close, the Commission filed another aggressive insider trading action. The case is based on little more than the trading of the seven defendants. SEC v. Yang, Case No. 12-cv-02473 (N.D. Ill. Filed April 4, 2012).

The action centers on the March 27, 2012 announcement by Xianfu Zhu, Chairman and CEO of Zhongpin Inc. that he had submitted a non-binding proposal to take the company private by purchasing all the outstanding shares. The price would be $13.50 per share, a 46% increase over the closing price the prior day. The company is a Delaware Corporation with headquarters in Changge City, Henan Province China. It is in the meat and food processing business.

Eight days after that announcement the Commission filed its insider trading complaint naming seven defendants:

  • Siming Yang, a New York City resident with a brokerage account at Wang Investment Associates and who, until recently, worked for a New York City investment adviser;
  • Prestige Trade Investment Ltd., a company created in January 2012 by defendant Yang which claims to be based in the PRC;
  • Caiyin Fan, a PRC citizen and resident who had a joint brokerage account with defendant Yang at Wang Investments in New York City;
  • Shui Chong (Eric) Chang, a resident of Hong Kong formerly employed at Deutsche Bank Securities, New York City who has a brokerage account at E*Trade;
  • Biao Cang, a PRC citizen resident in Hong Kong with two brokerage accounts at Interactive Brokers;
  • Jia Wu, a PRC citizen and resident with two brokerage accounts with Interactive Brokers; and
  • Ming Ni, a PRC citizen resident in Hong Kong with a brokerage account at Interactive Brokers.

The core of the complaint is the trading of each defendant in the period shortly before the potential deal announcement. During that time period:

  • Defendants Yang and Fan purchased 2,571 call options and 58,000 shares of Zhongpin stock for a total of $688,962. After the announcement they had unrealized profits of $733,000.
  • Prestige purchased over 3 million shares of stock. Between March 15, and 21 Defendant Yang transferred $29.8 million to it from overseas account at China Construction Bank. After the announcement the account had unrealized profits of $7.6 million.
  • Defendant Chang purchased 4,035 call options and 32,500 shares of stock for a total of $446,895 yielding unrealized profits of $828,188 after the deal announcement.
  • Defendant Cang bought 306 call options for a total purchase price of $17,135 which yielded realized profits of $39,745.
  • Defendant Wu bought 257 call options for a total of $15,568 which yielded realized profits of $34,288.
  • Defendant Ni purchased 4,300 shares of stock and 169 call options for a total purchase price of $68,980. The purchases yielded realized profits of $57,108.

Generally, the purchases represented a significant portion of the earnings and net worth of each defendant, at least based on the information in the account opening documents. That information may, however, be suspect in some instances since, for example, it appears that Defendant Yang failed to accurately disclose his employment.

The complaint also alleges that there may have been coordinated activity. Defendants Yang and Chang are alleged to have used a computer with the same IP address to access brokerage accounts. Yet Defendant Yang is alleged to reside in New York City while Defendant Chang resides in Hong Kong. Similarly, Defendants Cang, Wu and Ni each are alleged to have accessed their brokerage accounts using networks with the same IP address and hardware with identical Media Access Control addresses. Defendants Cang and Ni are alleged to reside in Hong Kong but Defendant Wu resides in the PRC.

The complaint calls the trading “suspicious.” No source of inside information is alleged other than “information and belief.” The allegations were however sufficient to secure a temporary freeze order. The case is in litigation.

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