SEC Announces $28 Million RMBS Settlement


On April 24, the U.S. Securities and Exchange Commission announced that it filed and simultaneously settled a suit alleging that an H&R Block subsidiary engaged in the fraudulent sale of subprime residential mortgage-backed securities (RMBS). The complaint alleges that during a short period at the beginning of 2007, Option One Mortgage, now known as Sand Canyon Corporation, sponsored over $4 billion of RMBS and represented to investors that it would repurchase or replace any pooled mortgage for which there was a breach of a representation or warranty. The SEC alleges that at the time it sponsored the RMBS at issue, Option One was experiencing financial difficulties related to the broader decline of the subprime mortgage market and faced substantial margin calls from its creditors. As such, Option One’s condition would have prevented the company from meeting its obligations to repurchase faulty loans. Further, according to the SEC, (i) Option One failed to disclosure that it was reliant on a line of credit from its parent, (ii) H&R Block was under no obligation to provide that funding, and (iii) Option One’s losses threatened H&R Block’s credit rating at a time when the parent was negotiating the sale of Option One.

The SEC did not immediately make the settlement available, but it announced that without admitting or denying the allegations Option One agreed to (i) disgorge over $14 million, (ii) pay prejudgment interest of nearly $4 million, and (iii) pay a $10 million penalty. The SEC touts this latest action as part of financial crisis-related enforcement efforts that collectively have obtained more than $1.98 billion in penalties, disgorgement, and other monetary relief. Though the investigation likely precedes the state-federal Residential Mortgage-Backed Securities Working Group and appears to have been conducted by the SEC alone, the SEC notes its role as co-chair of that group, which seeks to leverage resources to pursue alleged misconduct in the RMBS market.

This settlement, comments from the SEC, and the still developing efforts of the RMBS Working Group indicate that institutions should expect continued aggressive pursuit of alleged wrongdoing in the RMBS market. This was made clear by comments from Kenneth Lench, Chief of the SEC Division of Enforcement’s Structured and New Products Unit that the SEC intends to “take action against those who fail to disclose or downplay important facts that make an investment riskier, even if those risks do not materialize. We remain committed to uncovering misconduct involving complex financial instruments including RMBS.” Also of note, the SEC has shown a continued willingness to employ so-called “no-admit” settlements, notwithstanding a challenge to that long-standing practice issued last year by Judge Rakoff of the Southern District of New York. Last month, the U.S. Court of Appeals for the Second Circuit issued an interim decision staying Judge Rakoff’s order that denied a significant no-admit settlement and required the SEC to pursue its claims at trial. In doing so, the circuit court stated that it had a significant problem with the district court’s decision to dictate policy to an executive administrative agency. Instead, the Second Circuit stated, courts should defer to the agency’s judgment on discretionary policy. A final decision on the district court’s ruling is still pending with the Second Circuit.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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