Securities and Exchange Commission v. Nocella et al
Filing
42
OPINION on Partial Summary Judgment terminating 36 . (Signed by Judge Lynn N. Hughes) Parties notified. (ghassan, 4)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF TEXAS
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Plaintiff,
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'Versus
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Anthony J Nocella andJ Russell McCann, §
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Defendants.
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Securities and Exchange Commission,
Civil Action H- 12.-105 I
Opinion on Partial Summary Judgment
I.
Introduction.
The Securities and Exchange Commission sued a bank for violating its regulations.
Here, it seeks to bar two of the bank's executives from working as officers or directors of a
publicly traded company. The two officers moved for partial judgment. They will prevail
because they are fit to serve as officers or directors.
2.
Background.
Franklin Bank Corporation financed real estate and originated single-family, residential
mortgages. Anthony J Nocella was its chief-executive officer, and J Russell McCann was its
chief-financial officer.
In
2007,
home prices fell, and many mortgages were delinquent. In response to the
distress, Franklin modified loans using three programs: (a) Fresh Start; (b ) Strathmore; and (c)
Great News.
Under Fresh Start, Franklin sent letters to borrowers who were four or more payments
past due. If a borrower made his next payment, Franklin would consider the loan current and
any residual balance was to be due at maturity of the loan. The modified loans were not listed
as impaired and were removed from Franklin's disclosures.
This was inconsistent with Franklin's policies on non-performing assets. When a loan
became four payments past due, it was to remain as non-accruing until the loan was current and
the borrower demonstrated an ability to repay. Generally accepted accounting principles require
a loan to be considered impaired when it is likely that a creditor can not collect all amounts that
are due.
Nocella and McCann concede that some of the modified loans were accounted for
incorrectly in the third quarter, but they say that they did not know about it at the time.
Franklin modified millions of dollars of loans through Fresh Start. The Federal Deposit
Insurance Corporation did not criticize Fresh Start.
Franklin also had four loans with Strathmore, a residential construction company.
Strathmore asked for a modification when it realized it could not repay the loans. Without
performing new appraisals, Franklin's credit committee modified the loans with an interest
reserve for the next 12 months. Franklin would, in effect, capitalize the year's interest.
After the modifications, McCann classified the loans as performing. The misclassification caused Franklin to understate its non-performing loans and overstate its reported
earnings for the third quarter. When the FDIC disagreed with that classification, Franklin
reclassified them as "non-performing troubled debt restructurings."
Through Great News, Franklin incorrectly accounted for non-performing loans. Its
executive vice president, Dan Cooper, sent the "Great News letters" in the fourth quarter to 28
single-family borrowers without receiving a payment. Although severely past due, the letters
said that the loans would be considered current for the third-quarter if the borrower made his
next payment. This modification also deferred overdue interest payments to the maturity of the
loan.
The commission says that Nocella approved the letters and directed Cooper to reduce
the third-quarter, non-performing loans without an immediate payment. Nocella and McCann
say that they did not discuss the modifications with Cooper or authorize the backdating.
3.
Officer-and-Director Bar.
A court may bar a person from serving as an officer or director of a public company if
he (a) violates Section 10(b) of the Securities Exchange Act of 1934 and (b) "demonstrates
unfitness to serve as an officer or director.'" The court is afforded discretion and may consider
the defendants' (a) egregiousness of the violation; (b) recidivism; (c) roles in the company
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during the fraud; (d) degree of scienter; (c) economic stake; and (D likelihood of future
violations. 2
4.
Nocella and McCann.
First, the violations were not egregious. Franklin devised a plan to allow borrowers to
remain in their homes with modified loans that were accounted for incorrectly. Whatever
Nocella and McCann's role, their actions were not flagrant. They did not profit widely or enrich
others with this program.
Second, Nocella and McCann are both first-time offenders. The commission concedes
that they have not been ever charged with a securities-law violation.
Third, they each held prominent positions in the bank. Other Franklin officials,
however, reviewed the letters and the proposed modifications; Nocella and McCann did not
create or implement the programs on their own. They were also disclosed to the FDIC. As CEO
and CFO, they are abstractly accountable for the actions of the company and cannot claim they
were oblivious. This does not mean, however, that they were individually responsible for
incorrect accounting.
Fourth, the defendants acted with no intent to defraud Franklin's shareholders and with
no extreme departure from business judgment. When the FDIC disagreed with the Strathmore
loan classifications, Nocella and McCann corrected Franklin's books to reflect its criticisms.
Fifth, their financial gain was minimal. As Franklin employees and shareholders, they
wanted the bank to succeed. They did not, however, sell stock or exercise options during this
time. However misguided, the modifications were not a get-rich scheme for management. They
appear to be a good-faith attempt to manage a floundering bank during a recession.
Sixth, neither is in a position to violate securities laws in the future. Nocella retired, and
McCann works for a private bank that does not file public-securities reports. It is unlikely that
the misconduct will recur.
5.
Conclusion.
Anthony]. Nocella and]. Russell McCann will not be barred from serving as officers
or directors of a publicly traded company. This court recognizes that it is wrong that Franklin
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Bank Corporation improperly accounted for modified mortgages under their management. It
is abusive to seek a permanent bar against two executives who were working for a troubled
company in a troubled time without adequate evidence that they were responsible for the
improper accounting.
Signed on August
lL,
2.0I4,
at Houston, Texas.
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Lynn N. Hughes
United States DistrictJudge
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