The court-appointed trustee overseeing the liquidation of Thornburg Mortgage Inc. is suing a group of the company's former top executives well as its outside law firm for engaging in a "multifaceted conspiracy" to secretly use the failed lender's employees and assets to launch a new company.

Joel I. Sher, the bankruptcy trustee overseeing the liquidation of Thornburg, once the nation's second-largest independent mortgage company, said in a lawsuit filed in U.S. Bankruptcy Court in Baltimore that Thornburg's former chief executive and chief financial officer paid themselves "unauthorized" bonuses and "excessive" salaries while launching a start-up company. Then with the help of partner at a big San Francisco law firm, he says, the two engaged in a "grand scheme to hide and cover up" their actions.

"Faced with an impending bankruptcy, two of [Thornburg's] senior officers, together with one of the [its] most trusted attorneys, embarked upon a multifaceted conspiracy in which they converted substantial amounts of the debtors' cash, proprietary and confidential information, and used the debtors' personnel and fixed assets to start up a secret new business venture," according to the suit filed Tuesday.

Sher, an attorney at Baltimore law firm Shapiro, Sher Guinot & Sandler, was named the Chapter 11 trustee of Thornburg, now named TMST Inc., last year after it was discovered that former managers had used the lender's employees and assets to launch a new company.

Named in the suit are former Thornburg CEO Larry A. Goldstone and former CFO Clarence G. Simmons III, as well as attorney Karen A. Dempsey, a partner in the San Francisco firm Orrick Herrington Sutcliffe, which is also a defendant.

Also named in the suit are two other former Thornburg insiders, Deborah J. Burns, a vice president of structured finance, and Amy Pell, director of investor relations, plus SAF Financial Inc., the company launched by Goldstone and Simmons.

Sher is seeking $12 million from the defendants for damages from their breach of their duty of loyalty to Thornburg. He's also seeking $10 million against Dempsey and Orrick for legal malpractice. A pre-trial conference is slated for April 21 in Baltimore.

Orrick's attorney Pamela Phillips, of the San Francisco firm Howard Rice, called Sher's suit "outrageous."

"Ms. Dempsey provided excellent legal services to the debtors that helped them greatly, both before and after they filed for bankruptcy," she said. "The lawsuit's claims against Ms. Dempsey are outrageous, and reflect a bankruptcy trustee's desire to find deep pockets without regard to the actual facts. Orrick will defend itself and Ms. Dempsey vigorously, and we are confident that we will prevail."

Burns, citing the advice of counsel, declined to comment. Goldstone, Simmons, and Pell didn't reply to messages seeking comment.

Among the allegations in the suit, Sher claims the defendants, fearing bankruptcy was imminent, amended a management agreement that transferred millions of dollars to an affiliate company. They used the cash to fund the new venture and "then lied to the board about the reason for the amendment."

Sher also claims the defendants "illegally paid themselves hundreds of thousands of dollars in unauthorized bonuses on the eve of bankruptcy," and as well as taking "excessive post petition salaries while they were primarily engaged in promoting their new venture."

Thornburg, a real estate investment trust that specialized in making jumbo mortgage loans, was founded in 1993. While it avoided the excesses subprime-mortgage market during the real-estate bubble, Thornburg eventually succumbed to Chapter 11 as the value of the mortgage-backed securities the company packaged and sold to investors plummeted in value as the housing crisis deepened.

The company tried to hang on, selling $21.9 billion in mortgage assets in 2007. But as prices for mortgage-backed securities continued to fall in 2008, Thornburg, with Goldstone and Simmons leading the effort, looked to buy a thrift to save the company's failing lending business. Ownership of a thrift would give Thornburg access to customer deposits, a cheaper funding source than credit from investment banks, which Thornburg's had traditionally relied on to fund its lending business.

But according to Sher's complaint, by March 2009 Goldstone and Simmons realized that Thornburg's wasn't going to get necessary approval from its banks to go forward with a restructuring using the thrift strategy. The two, while still at Thornburg, then "developed a secret plan" to win the necessary approvals and raise money for a "Goldstone/Simmons NEWCO" for their own economic gain.

Thornburg, based in Santa Fe, N.M., filed for Chapter 11 protection in May of last year listing assets of $24.4 billion and debts of $24.7 billion. The bulk of those assets — some $19.7 billion — were held in securitization trusts.

Sher is winding down the company and selling off its assets for the benefit of creditors. Last month, Select Portfolio Servicing Inc., a mortgage-servicing business owned by Credit Suisse Group, bought Thornburg's $11 billion mortgage-servicing portfolio for about $95 million.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.