The Securities & Exchange Commission (SEC) has charged H&R Block subsidiary Option One Mortgage Corporation with misleading investors in several offerings of sub-prime residential mortgage-backed securities (RMBS) by failing to disclose that its financial condition was significantly deteriorating. Option One, now known as Sand Canyon Corporation, agreed to pay $28.2 million to settle the SEC’s charges. The SEC alleges that Option One promised investors in more than $4 billion worth of RMBS offerings that it sponsored in early 2007 that it would repurchase or replace mortgages that breached representations and warranties. But Option One did not tell investors about its deteriorating financial condition and that it could not meet its repurchase obligations on its own.
“Option One’s financial condition deteriorated significantly as its large sub-prime mortgage lending business suffered from the collapse of the U.S. housing market,” said Robert Khuzami, director of the SEC’s Division of Enforcement. “The company nonetheless concealed from investors that its perilous finances created risk that it would not be able to fulfill its duties to repurchase or replace faulty mortgages in its RMBS portfolios.”
According to the SEC’s complaint filed in U.S. District Court for the Central District of California, Option One was one of the nation’s largest sub-prime mortgage lenders with originations of $40 billion in its 2006 fiscal year. Option One originated sub-prime loans and sold them in the secondary market through RMBS securitizations or whole loan pool sales. Option One was generally profitable prior to its 2007 fiscal year. However, when the sub-prime mortgage market began its decline in the summer of 2006, Option One experienced a decline in revenues and significant losses, and faced hundreds of millions of dollars in margin calls from its creditors. At the time Option One offered and sold the RMBS, it needed H&R Block, through a subsidiary, to provide it with financing under a line of credit in order to meet its margin calls and repurchase obligations. But Block was under no obligation to provide that funding. Option One did not disclose this information 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.
“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," said Kenneth Lench, Chief of the SEC Division of Enforcement’s Structured and New Products Unit. "We remain committed to uncovering misconduct involving complex financial instruments including RMBS.”
Without admitting or denying the SEC’s allegations, Option One consented to the entry of an order permanently enjoining it from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and requiring it to pay disgorgement of $14,250,558, prejudgment interest of $3,982,027, and a penalty of $10 million. The proposed settlement is subject to court approval. The SEC has now charged 102 individuals and entities in financial crisis-related enforcement actions, including 55 CEOs, CFOs, and other senior corporate officers. These enforcement actions have resulted in more than $1.98 billion in penalties, disgorgement, and other monetary relief for investors.
The SEC also is a co-chair of the Residential Mortgage-Backed Securities Working Group formed under the Financial Fraud Enforcement Task Force in January 2012. The Working Group is marshaling parallel efforts on the state and federal levels to collaborate on current and future investigations, pooling resources and streamlining processes to investigate in a comprehensive way those responsible for misconduct in the RMBS market. In addition to the SEC, other co-chairs of the Working Group include representatives from the Civil and Criminal Divisions of the U.S. Department of Justice, the Attorney General of the State of New York, and the United States Attorney’s Office.