The Securities and Exchange Commission charged three former top officers of New Century Financial Corporation with securities fraud for misleading investors as New Century’s subprime mortgage business was collapsing in 2006. At the time of the fraud, New Century was one of the largest subprime lenders in the nation.
In its complaint, the SEC alleges that New Century disclosures generally sought to assure investors that its business was not at risk and was performing better than its peers. However, New Century failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. The complaint also alleges that Dodge and Kenneally fraudulently accounted for expenses related to bad loans that it had to repurchase.
The SEC’s complaint names as defendants:
- Former CEO and co-founder Brad A. Morrice
- Former CFO Patti M. Dodge
- Former Controller David N. Kenneally
It was interesting to see the SEC bring this case after the Department of Justice lost a similar case against two former Bear Stearns hedge fund managers. In both cases, there were some public statements about how they would weather the subprime crisis. In the Bear Stearns case, it was a private fund. In this New Century it was a public company. The argument is both cases is that the principals were hiding their knowledge of the underlying losses.
The SEC is charging the New Century trio with accounting fraud as part of their scheme to hide the losses from the subprime loans going bad. Part of the downfall may have been its conversion in 2004 to become a mortgage REIT. While this structure reduces the amount of taxes it needs to pay, it also requires the company to distribute at least 90% of its annual taxable income. That means New Century would have trouble accumulating capital for operations and keeping reserves for future losses.
The complaint is a fun read because it takes you through the greed of the subprime marketplace as New Century introduces new products that, in hindsight, are increasingly riskier. As the losses accumulated, the disclosure got murkier and murkier. The SEC sees the disclosure as “false and misleading.”
New Century’s trademarked byline was “A new shade of blue chip.” It seems like red (as in the ink) would have been a better color choice.