by T. GormanPosted on Posted in SECActions

A frequently used remedy in Commission enforcement actions is the officer and director bar. A permanent bar has the very harsh effect of precluding the person from being an officer or director of any public company. That, of course, can end the career of an executive, counseling care in its application. One Court recently rejected the SEC’s request for a permanent officer and director bar calling the request “abusive.” SEC v. Nocella, Case No. 4:12-cv-1051 (S.D. Tx. Opinion August 11, 2014).

The complaint

Nocella is a financial fraud action against two former bank officers, CEO Anthony Nocella and CFO J. Russell McCann. The complaint centers on what was claimed to be 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.

Following discussions with an investment bank about a possible sale of the institution, 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 reclassified under the applicable GAAP provisions.

The third was the Great New program, another loan modification program. It involved 28 residential borrows who were severely delinquent. 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.

Collectively, the schemes concealed 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. 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 requested a permanent injunction, disgorgement, prejudgment interest, civil penalties, officer and director bars and repayment under SOX 304.

The ruling

The Court considered the question of remedies against Messrs. Nocell and McCann in ruling on a summary judgment motion. The Court found that under Fresh Start, Franklin sent letters to borrowers who were who were delinquent and modified their loan if the most recent payment was made. This was inconsistent with bank policy. For Strathmore the loans were modified without obtaining new appraisals. Effectively a year’s worth of interest was capitalized. The loans were then misclassified. Through Great News residential mortgages were also modified if the next payment was made. The modification deferred overdue interest to the maturity of the loan.

The Court then turned to the question of whether an officer or director bar should be imposed. Citing SEC v. Patel, 61, F. 3d 137, 141 (2nd Cir. 1995), six factors were identified for consideration: a) the egregiousness of the violation; b) recidivism; c) roles in the company during the fraud; d) degree of scienter; e) economic stake; and f) likelihood of future violations.

Here the violations were not egregious, the Court concluded. Franklin devised a plan to allow borrowers to remain in their homes with modified loans that were accounted for incorrectly. “Whatever Nocella and McCann’s role, their actions were not flagrant. They did not profit widely or enrich others with this program,” according to the Court. They were both first time offenders. While they were senior officers of the bank, many at the institution participated in the programs which were disclosed to the FDIC. While being the CEO and CFO makes them “abstractly accountable for the actions of the company . . . This does not mean . . . that they were individually responsible for incorrect accounting.”

Likewise, neither defendant acted with the intention to defraud the shareholders. When the FDIC disagreed with the Strathmore loan classifications, the pertinent corrections were made. Rather, the acts involved here appear to stem from “a good-faith attempt to manage a floundering bank during a recession. Finally, neither is in a position to violate the securities laws in the future. Mr. Nocella retired and Mr. McCann works for a private bank.

Based on these findings the Court declined to enter an officer and director bar as to either defendant concluding: “This court recognizes that it is wrong that Franklin Bank Corporation improperly accounted for modified mortgages under their management. It is abusive to seek a permanent bar against two executives who were working for a troubled company in a troubled time without adequate evidence that they were responsible for the improper accounting.”

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by T. GormanPosted on Posted in SECActions

The SEC brought an action against a reputed “app” manufacturer who sold shares in two different entities beginning first in Colorado and later from Georgia. From each location, and for each entity, the sales pitch was essentially the same. Indeed, investors were told that the second company was just the renamed first. In each instance the result was the same – friends and other investors lost; the defendants profited. SEC v. Gamer, Civil Action No. 1:14-cv-02650 (N.D. Ga. Filed August 15, 2014).

Defendant Heidi Ann Gamer was home from classes at Dartmouth College with her domestic partner in Colorado when she registered defendant Gamer Economic Systems, LLC or GES in that state. The idea was to market interactive software and technology, including applications for smartphones. A prospectus for GES was developed which identified the new technologies. It explained that initial capital would be raised from investors to be used for operations.

Coworker’s family members were the initial investors. They were told that that Ms. Gamer had connections to build apps for political campaigns and expected to sell licensing rights for upwards of $10 million. Cash flowed in for the operation, prompting a wider marketing campaign. Now investors were told about a product called “StoryMap.” This app supposedly permitted television viewers to look up the episodic history of a show and purchase items seen on the set.

Investors from Colorado, New Hampshire and Virginia wired funds to the GES bank account. Over a period of about one year, beginning in August 2011, 17 investors furnished GES and Ms. Gamer with over $400,000. Some received investor agreements which promised quarterly financial statements and 5% of any GES royalties once the firm began to show a profit.

In July 2012 Ms. Gamer and her partner relocated to Atlanta. The location was closer to several software developers. A new entity was formed, defendant Gamer Media Partners or GMP. Investors were not told that GMP was a new entity. Rather, they were told that GES had changed its name.

Again investors were solicited using StoryMap. Some investors were told that there was a $1 million contract to use the technology in the Indian film industry. Others were told that a partnership had been formed that would make available $2 million for the exclusive licensing of StoryMap. In some sales pitches potential investors were told of a $100,000 contract with Dartmouth College and a deal with the Atlanta Falcons. Between August 2012 and May 2013 Ms. Gamer sold interest to 27 investors, raising over $370,000 for interests in GMP.

The contracts did not exist. The funds were not used to develop the business as

represented. Rather, much of the money was diverted to personal use. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23071 (August 19, 2014).

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