THE COMMISSION’S LATEST MARKET CRISIS CASE

The SEC brought another market crisis case centered on the failure of senior corporate officials to disclose the disintegrating financial condition of their company as the market crisis unfolded. Thornburg Mortgage, Inc. was then the nation’s second largest independent mortgage company after Countrywide Financial Corporation. Like the officers of Countrywide and those of other mortgage giants, Thornburg’s senior officers concealed the true condition of the institution even as it tumbled to default and ruin, according to the complaint. SEC v. Goldstone, Case No. 12-257 (D.N.M. Filed March 13, 2012)

Named as defendants are Larry Goldstone, the former CEO and president of the lender, Clarence Simmons, former CFO and senior executive v.p. and Jane Starrett, former chief accounting officer. Thornburg was a publicly traded, single family mortgage lender. 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.

In the fourth quarter of 2007 the company experienced about $360 million in margin calls. This followed a period in which Thornburg paid about $2 billion in margin calls and had to liquidate about $22 billion in mortgage backed securities at an estimated loss of $1.1 billion.

As the company prepared to file its 2007 10-K its financial condition continued to plummet. 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 violated its lending agreements with at least three lenders. If the firm was declared in default its financial condition would sink further. That default would trigger another under the cross-default clauses with its other lenders which would lead to the seizure of its ARM securities that were the collateral for its 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 by defendants Goldstone, Simmons and Starrett. It was certified by Messrs. Glodstone 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 complaint alleges 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). The case is in litigation.