The aggressive use of loan modifications by two senior executives of a Texas thrift enabled the financial institution to hide bad loans and artificially inflate earnings. But the bank failed, and the two executives now must defend their actions in court.
Franklin Bank, S.S.B., was expected to cost the Deposit Insurance Fund approximately $1.5 billion when it failed in November 2008.
The failure was a black eye for Franklin Bank Corp.’s chairman at the time, Lewis S. Ranieri, who gained notoriety for his role as the “godfather” of mortgage-backed securities while at Salomon Brothers in the late 1970’s. Ranieri briefly stepped in as chief executive officer of Franklin Bank when the Houston-based company’s founder, Anthony J. Nocella, was ousted following the disclosure of bad mortgage accounting.
Ranieri has since moved on and is now affiliated with portfolio lender New Penn Financial LLC.
But Nocella, 70, is still tangled up in Franklin’s failure.
On Thursday, the Securities and Exchange Commission filed a federal lawsuit in Houston against Nocella and former Franklin chief financial officer J. Russell McCann.
According to the complaint, internal reports at the bank indicated that loan delinquency increased 24 percent between June and August 2007.
But the SEC alleges that the pair used aggressive loan modification techniques in the second half of 2007 to hide the true amount of non-performing loans and inflate earnings. The modification programs were operated under names like “Fresh Start” and “Great News” and made Franklin appear to be out-performing its rivals.
The modifications, however, allegedly violated accounting rules, the bank’s publicly stated policies on non-performing loans and federal securities laws.
More than $11 million in non-performing single-family loans and $13.5 million in non-performing residential construction loans were allegedly concealed.
The scheme enabled Franklin to report 30 cents a share in third-quarter 2007 earnings — 23 cents more per share than would have been reported without the loan modifications, according to the SEC.
“Nocella and McCann used the loan modification scheme like a magic wand to change non-performing loans into performing assets,” Robert Khuzami, who is director of the SEC’s division of enforcement, said in a statement. “Their disclosure and accounting tricks misled investors into believing that Franklin was outperforming other banks during the height of the financial crisis.”
The SEC seeks financial penalties and a clawback of bonuses as allowed under Section 304 of the Sarbanes Oxley Act of 2002. It also seeks to bar the two from serving as officers or directors of publicly traded companies and permanent injunctive relief to enjoin them from future violations of the federal securities laws.
Securities and Exchange Commission, Plaintiff, v. Anthony J. Nocella, and J. Russell McCann, Defendants.
Case No. 4:12-cv-01051, April 5, 2012 (U.S. District Court for the Southern District of Texas).
