Thornburg Mortgage executives charged with hiding financial condition

By Caroline Salls

Pittsburgh, March 13 - The Securities and Exchange Commission has charged the senior-most executives at the former Thornburg Mortgage Inc., now known as TMST, Inc., with hiding the company's deteriorating financial condition at the onset of the financial crisis, according to an SEC news release.

The SEC said the executives' plan backfired, and the company lost 90% of its value in two weeks.

The SEC alleged that Thornburg Mortgage chief executive officer Larry Goldstone, chief financial officer Clarence Simmons and chief accounting officer Jane Starrett schemed to fraudulently overstate the company's income by more than $400 million and falsely record a profit rather than an actual loss for the fourth quarter in its 2007 annual report.

Behind the scenes, the agency said Thornburg was facing a severe liquidity crisis and was unable to make on-time payments for substantial margin calls it received from its lenders in the weeks leading up to the filing of its annual report on Feb. 28, 2008.

According to the SEC's complaint filed in federal court in New Mexico, even though Thornburg was violating lending agreements by failing to make on-time payments, the executives were unwilling to disclose the severity of their liquidity crisis to investors and Thornburg's auditor.

For example, in an e-mail to Goldstone and Simmons, Starrett said, "We have purposefully not told [our auditor] about the margins calls."

The SEC said Goldstone, Simmons and Starrett scrambled to satisfy all outstanding margin calls and then timed the filing of the annual report to occur just hours later in order to precede additional margin calls and avoid full disclosure.

The SEC alleged that the executives' plan to never disclose the delayed margin call payments fell through when they were unable to raise cash quickly enough to meet more margin calls received soon after filing the annual report.

When Thornburg began to default on this new round of margin calls, the agency said it was forced to disclose its problems in 8-K filings with the SEC.

By the time the company filed an amended annual report on March 11, 2008, the SEC said its stock price had collapsed by more than 90%. Thornburg never fully recovered and filed for bankruptcy on May 1, 2009.

"The truest test of corporate executives' commitment to full and accurate shareholder disclosure comes not during times of soaring profits and double-digit growth, but when companies are under financial stress and shareholders have the greatest need for accurate information," SEC division of enforcement director Robert Khuzami said in the release.

"These Thornburg executives flunked that test by issuing a series of misleading statements and half-truths to conceal Thornburg's rapidly deteriorating situation."

The SEC said it has now filed financial crisis-related enforcement actions against 98 individuals and entities, including more than 50 chief executive officers, chief financial officers and other senior corporate officers.

ARM financing

According to the SEC's complaint against the Thornburg executives, Thornburg purchased and held adjustable-rate mortgage securities and also securitized ARM loans in addition to its lending business that focused on "jumbo" and "super-jumbo" ARMs.

In order to finance its mortgage business and investment-related activities, the SEC said Thornburg needed constant access to financing, which included money borrowed from various lenders under reverse repurchase agreements.

The repo agreements required Thornburg to maintain a degree of liquidity and subjected the company to margin calls if the value of its ARM securities serving as collateral for its loans fell below designated thresholds.

The SEC said Thornburg was generally required to pay cash to reduce its loan amount or pledge additional collateral to the lender either the same day or the day following a margin call.

In the weeks leading up to Thornburg's annual report filing, the agency said the company received more than $300 million in margin calls that severely drained its liquidity.

Thornburg was late in meeting the margin calls from at least three lenders and received a reservation of rights letter from one confirming that Thornburg was in violation of its lending agreement and could be declared in default at any time.

Unwilling to disclose these events and the extent of the liquidity crisis, the SEC said the Thornburg executives improperly determined that more than $400 million in market-value losses related to its ARM securities were temporary and therefore did not need to be recognized in the company's income statement.

Deception allegations

The SEC alleged that Goldstone, Simmons and Starrett engaged in a scheme to deceive Thornburg's auditor and investors into believing that Thornburg had successfully met all margin calls.

Keeping the extent of its margin call crisis quiet and relying on the cooperation and forbearance of its lenders, the SEC said Thornburg was able to make the final payment on its margin calls about 12 hours before filing its annual report.

Knowing that its reprieve from outstanding margin calls was only temporary and additional margin calls were likely in light of Feb. 27, 2008 news that a large European hedge fund holding substantial mortgage-backed securities like Thornburg's ARM securities was about to collapse, the agency said Thornburg filed its annual report at 4 a.m. local time on Feb. 28.

According to the SEC release, the executives' urgency to file the annual report before the negative impact of the hedge fund's collapse was evident in an e-mail that Simmons sent to Starrett saying that he gave Thornburg's SEC reporting manager "a 6 a.m. Thursday deadline to file the K. I do not want there to be any issues based on Thursday activity."

In its complaint, the SEC said Thornburg's financial condition and liquidity immediately continued to deteriorate after filing its annual report. By 6 a.m., Thornburg began to receive additional margin calls that exceeded its available liquidity by 7:30 a.m.

Nevertheless, even as Thornburg's stock price dropped in the hours and days following the annual report filing, the SEC said Goldstone and Simmons continued to publicly project the same false financial condition they had presented in the annual report, and they encouraged the company's investor relations group to do the same.

The SEC's complaint charges Goldstone, Simmons and Starrett with violations of the antifraud, deceit of auditors, reporting, record keeping and internal controls provisions of the federal securities laws. The complaint seeks officer and director bars, disgorgement and financial penalties.

Charges denied

In two separate releases, Starrett, Goldstone and Simmons denied the allegations contained in the SEC lawsuit.

"The allegations in the complaint filed against me are without merit," Starrett said in her release. "I intend to vigorously defend against this lawsuit."

Goldstone and Simmons also said they "believe the action is wholly without merit," and they have refused to settle the matter with the SEC.

"We are profoundly disappointed by the SEC's lawsuit, which is based on unfounded claims, e-mails taken out of context and inaccurate interpretations of management's actions surrounding the company's financial filings at the height of the financial crisis in February and March 2008," Goldstone and Simmons said in a joint release.

"The SEC's case singles out and punishes us for not having the clairvoyance to anticipate an unprecedented financial system crisis.

"It is worth noting that this same crisis was not foreseen by two Secretaries of the Treasury, two Chairmen of the Federal Reserve, the Chairman of the SEC, and the heads of major public and private financial institutions across the globe.

"Any fair and objective assessment of our actions during that time shows that the SEC's allegations against us have no merit.

"In its zealousness to find people to blame for the financial crisis, the SEC has brought a case based on hindsight that is not supported by the facts, unwinnable in court, and profoundly unfair."

Auditor review

Goldstone and Simmons said KPMG, the company's auditor, conducted a review of the circumstances surrounding TMST's financial statements at the time and stated that it had no concerns about management's integrity.

Goldstone and Simmons said the auditor had found no material weaknesses in the company's internal controls, and that the restatement of TMST's financials resulted from "an error in judgment" about the impact of rapidly changing and illiquid credit markets on the company's financial condition and not from fraud on the part of management.

TMST, formerly Thornburg Mortgage, is a Santa Fe, N.M., lender specializing in jumbo mortgages that filed for bankruptcy on May 1, 2009 in the U.S. Bankruptcy Court for the District of Maryland. Its Chapter 11 case number is 09-17787.

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