27 March 2010

Canyon Crest: New Owners, Old Questions, Part 6

The last post discussed a class-action lawsuit filed by investors against Metropolitan Mortgage and Securities Company and Summit Securities, Inc., and fifteen officers and directors, including president and controlling stockholder C. Paul Sandifur, Jr., charging violations of federal securities law.  There was a subsequent court hearing that is of bearing and interest and which has to do with an amended complaint filed by the plaintiffs and four separate motions by the defendants to dismiss the case; not on matters of fact, but purely about procedure.

The order that was given by federal district judge Fred Van Sickle as a result of this hearing was dated 5 November 2007 and essentially ordered the plaintiffs to come back with another amended complaint to address deficiencies in the previous one.  There are some items of interest, however, aside from the complexity of what constitutes a judicially acceptable plaintiffs' complaint.

One is that the case, known as Cauvel, et. al. v. Metropolitan Investment Securities Company, Inc. was a consolidation of the Cauvel matter with that of another one, Hall v. Metropolitan Mortgage and Securities Company, Inc.  The melding of the two cases occurred in August 2004.

Consequently, there was a first amended complaint, the one discussed in the last post on this blog, filed that December.  The grounds for the complaint were based from sections of two 1930s securities acts passed by a Democratic Party-controlled Congress in the aftermath of the debacle of the 1929 crash of the stock market and the ensuing Great Depression (which is, actually, very relevant for us now in 2010, isn't it?)

In the complaint, the plaintiffs dropped a claim predicated on one of the 1930s securities acts and replaced it with a securities law from Washington state.  It also added new defendants to the case, including the accounting firm, Price Waterhouse Coopers, and Roth Capital Partners, underwriters to the Metro/Summit empire.  October 2006 brought a settlement allowing for the dismissal of some of the defendants and, as a result, the court allowed the defendants to file a second amended complaint, which was done that month.

There is some history worth bringing up again here.  First, as said previous, Metropolitan (founded in 1953) had been primarily in the residential mortgage and receivables areas (as well as insurance, like Old Standard, current owner of Canyon Crest) and Summit (created by Metro in 1990) dealt with commercial lending and property development.  As Metro, however, could not keep its earnings in line with its rapid growth, it turned, in 2000, toward those areas on which Summit focused.

From that point, 2000, Metro and Summit were "a single enterprise focused on commercial lending."  As such, the two wrote some $20-30 million in loans each month in 2001 and 2002, which happened to be a period of economic downturn.  The goal, however, was a whopping $100 million per month and to meet this target, the judge's order statement continued, "the companies engaged in increasingly risky ventures." 

As little return was realized from Metro/Summit's commercial real estate business, the companies were unable to pay the rate of return promised investors who purchased their securities.  To raise cash, the companies simply issued more securities and sold them to people who were not informed of the risk or the condition of the Metro/Summit conglomerate.  Moreover, financial reporting was "tailored" to make the companies seem more profitable (or losing less money) than was really the case.  As the judge's order expressed it, "the Met group thus became wholly dependant [sic] on cash acquired from the sale of securities."

As early as 1995, Washington state regulators noticed violations, poor business practice and blatant interest conflicts.  A memorandum of understanding (MOU) was signed between the state and Metro, but, within three years, the latter was disregarding the terms of that document.  The company then hit on a clever strategy: it listed its debentures and preferred stock as "covered securities" on the Pacific Stock Exchange to evade regulatory restrictions from the state of Washington.

This allowed Metro/Summit to sell risky securities to more "unsophisticated" investors, but in late 2002 and early 2003, the SEC denied the companies' request to issue new securities.  This, and only this, led the companies' auditor and underwriter to review their roles with the companies and the latter abandoned its approval of the pricing and yield determinations of Metro/Summit securities.  By summer 2003, the National Association of Securities Dealers fined Metro/Summit $500,000 and prohibited further securities sales.  In November, the companies suspended dividend payments to shareholder investors and faced a $10 million cash need with only $7 million in the coffers.

In late January 2004, the auditor, Ernst and Young, rescinded its approval of the 2001 and 2002 financial reports of Metro/Summit (where was the auditor in 2001 and 2002?) and this was followed within two weeks or so with a filing of bankruptcy.  The class action suit originally sought to make Ernst and Young (which started auditing the books in June 2001--starting with the 2001 report) and its predecessor, Price Waterhouse Coopers, defendants in the case.  This was also true with Roth Capital Partners, the underwriter, which had underwriter obligations, as defined by the 1930s federal securities statute, to verifying Metro/Summit's accuracy in stock registration statements and prospectuses.

Judge Van Sickel, in his order, noted that "although the SCAC [second amended complaint] is deficient in a number of respects, it would be inappropriate to dismiss an action of this complexity prior to granting the opportunity to correct the deficiencies. . . "  Consequently, Van Sickel allowed the plaintiffs to follow a third amended complaint, though he also dismissed Roth and Price Waterhouse Coopers as defendants and also dismissed the part of the complaint dealing with Washington state securities law because Metro/Summit was able to skirt its authority in getting an exemption by listing their securities on the Pacific Stock Exchange, which was subject to federal regulation.

Ernst and Young's lawyers argued that the plaintiff's complaint was deficient in a procedural sense because it did not meet the criteria of a "short and plain statement," which, given the 78-page length of the judge's order, much less the "legalese" that all judicial documents seem to have, seems like an oxymoron generally!  Still, the judge ruled that this was a legitimate argument because there was no need in the complaint for the plaintiffs to cite great detail as to the defendants' actions.  As Van Sickel stated, "the proper time for such revelation is discovery," at trial, rather than in the complaint.  The judge did commend the plaintiffs' attorneys for putting in a great deal of work and acknowledged that they were "blessed with the wealth of facts" available to them.  Ernst and Young and Roth both were able to persuade the judge that there was a lack of "particularity" in the plaintiff's assertions about misrepresentations in securities registration statements made by Metro/Summit.

The defense challenges to assertions by the plaintiffs in the complaint go on for mind-numbing page after page and hardly constitute a "short and plain" list of exceptions.  While the defendants secured some minor victories or, at the very least, persuaded the judge to make the plaintiffs go back and give more detail in the third complaint, most of the plaintiff's positions were held to be reasonable and admissible to trial.

Within two months, the plaintiffs filed their third amended complaint.  Naturally, the defendants filed more dismissal motions.  In March 2008, Van Sickel allowed dismissal of certain claims against an individual defendant.  More legal processes followed concerning certification of the plaintiffs' claims under federal securities law, which were granted, while claims under state law were denied.  Nothing then happened between January 2009 and February 2010, when the court received a "preliminary approving settlement between the class and defendant Roth Capital Partners, LLC." 

So, at the moment, it appears that case still continues against all defendants, excepting Roth, with some dismissal of charges against others.  At this point, from the time the first complaint was filed in 2003, the case has dragged along, as is so often the case, for seven years.

As will be seen from the next post, the painfully slow wheels of our judicial system, thanks for numerous exceptions and motions from defense attorneys particularly, can bring about a conclusion of the case that bodes better for the defendants than for the plaintiffs, especially when the latter were already elderly when the case was first filed.

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