SEC Drops Market Crisis Case When Faced With Retrial

The Commission dropped an action against two senior executives of Thornburg Mortgage, Inc. rather than retry the market crisis era case. In the initial trial a jury found in favor of the two executives on a number of counts but deadlocked on charges of fraud and lying to the auditors. SEC v. Goldstone, Case No. 12-257 (D.N.M. Filed March 13, 2012).

Thornburg Mortgage was the second largest independent mortgage company in the country. The SEC claimed that shortly before the filing of the firm’s 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. The company had paid about $2 billion in margin calls and liquidated about $22 billion in mortgage backed securities.

As the mortgage company prepared to file its 2007 10-K, its financial condition continued to deteriorate. The 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 would violate its agreements with at least three lenders. If the firm was declared in default its financial condition would sink further. That default would trigger the cross-default clauses with other lenders which would lead to the seizure of the ARM securities that were the collateral for the loans. Disclosure of these facts would undermine plans to raise additional cash. Disclosure 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 and certified by defendants Goldstone 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 Thornburg filed for bankruptcy. The complaint alleged 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 retrial was scheduled to begin on February 21, 2017.