A legal inferno has erupted around several Pittsburgh mortgage bankers, and the SEC is trying to keep their hands off the firehose by seeking to win a contempt of court citation on top of an earlier injunction.
The Securities and Exchange Commission has accused the mortgage bankers of stretching the truth about their investment products. In doing so, the agency hopes to send a message to other banks and financial institutions that advertising false or misleading information on investment products could earn them a hot seat in the cooler.
The SEC alleges the lenders offered collaterized mortgage obligations and other similar products with false or misleading product information in April.
The commission is also seeking contempt of court charges against them for continuing to offer the products after the courts had prohibited them from doing so.
The U.S. District Court for Western Pennsylvania issued a temporary restraining order Sept. 8 against further sales by 1st American Corp. (not affiliated with First American Bankshares Inc., of Washington, or any of its subsidiaries), G. Woods Mortgages, John Robert Woods and Approved Mortgage Corp. All are of Pittsburgh.
The action followed additional Securities and Exchange Commission charges of recurring fraud violations. The court delayed ruling on the contempt charges pending the review of finding of fact and conclusion of law testimony that was due Sept. 22.
John Robert Woods, president of 1st American Corp., declined to comment when contacted about the charges Sept. 22.
The restraining order follows a two-day contempt proceeding based on an SEC claim that 1st American violated a May 25 preliminary injunction order by continuing to sell a CMO the SEC says defrauded investors through false and misleading statements and material omissions.
In its complaint, the SEC contends that 1st American released an advertisement, cover letter and marketing brochure that characterized its product as a "highly rated product with all the safeguards and protection of a traditional CMO." In the advertisement, the SEC alleges, 1st American failed to make certain disclosures:
* Each 1st American investor only acquires an unperfected interest in a single mortgage instead of a pool of mortgages.
* By guaranteeing a 10% return for the life of their investment, 1st American increased the risk that all investors would not get the return promised.
The CMOs were unrated, contrary to the advertisement that said each had "an implied AAA rating."
* No independent trustee safeguards the mortgages.
The original SEC complaint filed against 1st American April 9 alleged the 1st American CMO was vastly different from traditional CMOs and bore none of the safeguards typically associated with them. It sought to enjoin the defendants permanently for violating Section 17 (a) of the Securities Act of 1933 and Section 10 (b) and Rule 10b-5 of the Securities Exchange Act.
Action was initially taken against 1st American April 12 when a court order temporarily froze all mortgages owned by 1st American, GWM and AMC. Another court order made May 25 enjoined the defendants from repeating the violations while continuing to freeze a portion of the mortgages owned by them, thus creating a fund to repay investors should restitution be ordered.
SEC, which has amended its complaint, now alleges that on May 15, during a three-week recess in the preliminary injunction hearing, 1st American and Woods began offering their 14 original CMO investors an opportunity to convert their purported CMOs into a mortgage-backed certificate.
That offering constituted "both a continuation of the original CMO fraud, as well as a distinct new fraud," said the commission in its litigation statement. 1st American and Woods tried to retain investor funds without curing the initial misrepresentations and omissions made in the first CMO offering, the SEC statement said. The statement also said 1st American failed to disclose the overall risks associated with the MBC product, to disclose that the court froze the underlying collateral, and to provide financial statements regarding 1st American.
A third fraudulent offering was made July 19 - a violation which prompted the commission to seek a contempt of court ruling - when 1st American and Woods offered a mortgage-backed investment note certificate at a 9% interest rate.
The investment note was offered through a 1st American's CMO newspaper advertisement in which the commission alleges that:
* The note was characterized as guaranteed when it wasn't;
* The degree of risk was mischaracterized by comparing investment note certificates to certificates of deposit, although the INCs bear a significantly greater degree of risk than CDs;
* It failed to adequately explain how 1st American will generate a 9% return;
* It failed to explain that the underlying collateral is subject to attachment by 1st American creditors; and
* It failed to provide any financial information about 1st American from which investors can adequately evaluate the risks of investing with them.