SEC Files Settled Action Tied To Restatement

The SEC filed another action centered on a restatement resulting from improper accounting and internal controls. In this instance the firm lacked procedures for dealing with related party transactions despite contrary disclosures and failed to properly value its most significant asset. In the Matter of Home Loan Servicing Solutions, Ltd., File No. 3-16882 (October 5, 2015).

Respondent Home Loan is a Cayman Islands corporation whose primary asset is Rights to mortgage servicing rights. The firm is an outgrowth of another business run by its Chairman, Ocwen Financial Corp. Ocwen services mortgages that have been securitized and which are owned by trusts. One of its obligations is to advance funds to the trusts to cover payments missed by borrowers. Ocwen’s Executive Chairman, which owned about 13% of its NYSE listed shares, created Home Loan whose shares are traded on NASDAQ, to purchase Ocwen’s mortgage servicing rights. Under the arrangement Home Loan retained Ocwen to subservice all mortgages underlying the Rights purchased. Certain executives at Ocwen took positions with Home Loan.

Home Loan disclosed that it had adopted policies and procedures to avoid potential conflicts with respect to related party transactions. In fact the firm did not have any written procedures specifying when an officer or director with a conflict was required to recuse himself or herself. Thus, when the firm entered into transactions with Ocwen, sometimes the Chairman recused himself and sometimes he did not.

When Home Loan purchased Rights from Ocwen the price was set by a third party appraisal. Other terms of the transactions varied however. The transactions were submitted to the Home Loan Credit Committee for review and approval. The Chairman was a member of that committee. In 2012 Home Loan entered into five transactions with Ocwen totaling about $67.5 billion. The Chairman did not participate in the negotiations regarding the transactions but approved them as a member of the Credit Committee. In 2013 there were four additional transactions. The Chairman recused himself from one. He also typically reviewed and approved the transactions on the Ocwen side.

In 2014 Ocwen and Home Loan entered into a transaction with Ocwen to acquire early buy-out loans . These are delinquent loans eligible for purchase by the mortgage servicer. Home Loan purchased $672 million that represented the most delinquent portion of the portfolio of early buy-out loans. The Chairman approved the transaction in an email on the condition that it did not trigger a loss by Home Loan.

The Rights acquired from Ocwen were the primary asset of Home Loan. Since they were illiquid, valuation was difficult. The valuation of the Rights was listed by the firm as a Critical Accounting Policy.

To value the Rights, Home Loan retained a third party. Since the value of the Rights was generally stable, a point emphasized in the disclosure, the firm developed a methodology it used which was the equivalent of their carrying value rather than the best estimate of fair value,. That estimate was used as long as the price reflected in the carrying value was within 5% of the price reflected in the fair value estimate provided by the third party. The Chairman told senior management this approach could create difficulties. Nevertheless, neither management nor the Audit Committee evaluated the issue to determine if the method used complied with GAAP.

In August 2014 Home Loan restated its Forms 10-K for the years 2012 and 2013 and Form 10-Q for the first quarter of 2014. The restatement was the result of a review conducted with the external auditors and management in early 2014 of the value used for the Rights. That review determined that while the carrying value was within 5%, it did not reflect fair value under GAAP. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B).

To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, it will pay a penalty of $1.5 million.

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