Thursday, September 29, 2016

Court reverses judgment for SEC on disclosure, accounting fraud claims

By Lene Powell, J.D.

A federal district court erred in awarding partial summary judgment for the SEC in an enforcement action against a bank and its CEO for alleged disclosure and accounting fraud, the Eleventh Circuit ruled. The district court wrongly decided as a matter of law that the CEO made false statements and failed to establish an affirmative defense that he relied on an accounting firm’s professional advice, when these issues involved questions of fact that should have been submitted to a jury. The Eleventh Circuit vacated the district court’s judgment and remanded for a new trial (SEC v. BankAtlantic Bancorp, Inc., September 28, 2016, Wilson, C.).

Alleged fraud. In the first half of 2007 during the run-up to the Great Recession, the market for Florida real estate softened, threatening BankAtlantic Bancorp’s portfolio of commercial residential loans. Alan Levan, the bank’s chairman and CEO, acknowledged the risk in a March 14 email to the bank’s Major Loan Committee, saying it was “pretty obvious that the music has stopped” and he believed the bank was in for a “long sustained problem in this sector.” Despite the gloom in this and other internal emails, Levan presented an optimistic front in a July 25, 2007 earnings call with shareholders about credit risk posed by the deteriorating real estate loans. He allowed that there were significant challenges in the builder land bank (BLB) loan category, but said they were not concerned about any other asset class and the portfolio as a whole was performing “extremely well.”

Meanwhile, Levan engaged an investment bank to advise on the possible sale of some loans in the troubled portfolio. The bank’s CFO warned Levan that accepting bids for the sale of the loans would require a change in their accounting classification from “held-for-investment” to “held-for-sale,” which under GAAP valuation standards would lower the value significantly. Upon advice from PwC that classification depended on whether management intended to sell the loans, the bank continued to categorize the loans as held-for-investment, allowing it to report the loan values at the higher original purchase price.

Fraud verdict. The SEC alleged that Levan’s statements during the earnings call were false or misleading in violation of Section 10(b) of the Exchange Act, and that it was improper for BankAtlantic to classify the loans marketed through the investment bank as held-for-investment. The district court agreed with the SEC and granted partial summary judgment that the statements constituted misrepresentations as a matter of law. The district court also determined as a matter of law that Levan and BankAtlantic failed to establish an affirmative defense that they relied on PwC’s advice regarding classification of the loans.

After a six-week trial, a jury found the defendants liable for making material misrepresentations and filing materially false financial statements by improperly classifying the loans. The court ordered civil monetary penalties of $4.5 million and $1.3 million against BankAtlantic and Levan, respectively, and enjoined Levan from serving as a director or officer of a public company for two years. The defendants appealed.

Disclosure claim. Reviewing the grant of partial summary judgment de novo, the circuit court found that testimony of Levan and the CFO and other record evidence contradicting the district court’s findings was sufficient to create a genuine issue of material fact as to whether Levan’s statements were false or misleading under Rule 10b-5.

Although courts will not accept self-serving testimony offered in a wholly conclusory manner, Levan and the CFO provided specificity and supporting facts for their testimony that they believed the earning call statements to be true. Levan testified that the loans the bank was concerned about were spread over multiple portfolios, not confined to any non-BLB asset class, and record evidence demonstrated that non-BLB loans generally were performing. Further, the defendants presented evidence that loan extensions and downgrades did not necessarily mean that the loans were in trouble. Accordingly, the circuit court held that the district court improperly weighed evidence at the summary judgment stage and should have credited information that contradicted its key factual conclusions.

Accounting claim. The district court also improperly decided as a matter of law that the defendants failed to establish a reliance-on-professional-advice affirmative defense. The defendants provided evidence that PwC received all the information necessary to render accounting advice, creating a genuine issue of material fact as to whether the defendants provided all relevant facts to PwC. By brushing aside this evidence in order to reach its conclusion, the district court inappropriately weighed the evidence at the summary judgment stage, the circuit court said.

Other rulings. Because it vacated and remanded the district court’s grant of partial summary judgment, the circuit court did not reach the issue of the two-year officer and director bar. The circuit court affirmed the district court’s rejection of judgment as a matter of law regarding the accounting fraud and pre-trial evidentiary rulings regarding testimony of the SEC’s expert and PwC’s 2012 look back report, finding no abuse of discretion or substantial prejudice in those rulings.

The case is No. 15-14629.

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