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Option One Settles Allegations of Securities Fraud

The former subprime lending arm of H&R Block Inc. has agreed to a settlement over alleged deception in the sale of residential mortgage-backed securities. At issue was its commitment to repurchase bad loans even though it was incapable of meeting that commitment.

At the height of the subprime mortgage crisis, in December 2007, H&R Block made the decision to permanently shut down subsidiary Option One Mortgage Corp. The move resulted in the closing of three offices and 620 layoffs.

The closing was followed by the 2008 sale of Option One’s mortgage servicing operation to American Home Mortgage Servicing Inc.

But although Option One’s financial condition was rapidly deteriorating in 2007, it failed to advise RMBS investors about its dire situation, according to a complaint filed Tuesday in U.S. District Court for the Central District of California by the Securities and Exchange Commission.

According to the SEC, the formerly Irvine, Calif.-based company promised investors of $4.3 billion in RMBS issued in 2007 that it would repurchase loans that breached representations and warranties but neglected to tell those investors about its deteriorating condition or that it was incapable of meeting the repurchase obligations.

It had been previously profitable but started experiencing a revenue decline and significant losses in mid-2006, the securities regulator said. It was hit with hundreds of millions of dollars in margin calls from its creditors. While it was receiving financial support from H&R Block, the parent company was under not obligation to provide the funding — something the subprime lender allegedly failed to disclose to investors.

“The SEC further alleges that Block never guaranteed Option One’s loan repurchase obligations and that Option One’s mounting losses threatened Block’s credit rating at a time when Block was negotiating a sale of Option One,” according to the statement.

Option One, which now goes by the name Sand Canyon Corp., agreed to settle the SEC’s charges for $28.2 million. The settlement, which is subject to court approval, includes $14,250,558 in disgorgement, $3,982,027 in pre-judgment interest and a $10 million penalty. It also enjoins the company from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.

The SEC indicated that Option One originated $40 billion during its fiscal-year 2006, though H&R Block previously reported that the unit’s originations were $28.4 billion during the 12 months ended Jan. 31, 2007.

The SEC touted more than $1.98 billion in penalties in financial crisis-related enforcement actions. More than a hundred defendants — including 44 chief executive officers, chief financial officers and other senior corporate officers — have been charged by the SEC.

“We will take action against those who fail to disclose or downplay important facts that make an investment riskier, even if those risks do not materialize,” SEC Division of Enforcement Chief Kenneth Lench said in a news release. “We remain committed to uncovering misconduct involving complex financial instruments including RMBS.”

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