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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 1 of 84 PageID 286
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF TEXAS
DALLAS DIVISION
NORTH PORT FIREFIGHTERS’ PENSION – § LOCAL OPTION PLAN, Individually and on § Behalf of All Others Similarly Situated, §
§ Plaintiff, §
§ vs. §
§ TEMPLE-INLAND, INC., et al., §
§ Defendants. § §
Civil Action No. 3:11-cv-03119-B
CLASS ACTION
AMENDED CLASS ACTION COMPLAINT
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CERTIFICATE OF SERVICE
I hereby certify that on April 19, 2012, I caused the foregoing Amended Class Action
Complaint to be electronically filed with the Clerk of the Court using the CM/ECF system, which
will send notification of such public filing to all counsel registered to receive such notice.
/s/ Samuel H. Rudman SAMUEL H. RUDMAN
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NATURE OF THE ACTION
This is a federal securities class action on behalf of purchasers of the common stock
of Guaranty Financial Group Inc. (“Guaranty” or the “Company”) between December 12, 2007 and
August 24, 2009, inclusive (the “Class Period”), against Temple-Inland, Inc. (“Temple Inland”) and
certain of Temple Inland’s and Guaranty’s officers and/or directors (collectively, “Defendants,” as
further defined herein) for violations of the Securities Exchange Act of 1934 (the “Exchange Act”)
JURISDICTION AND VENUE
2. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) of the
Exchange Act [15 U.S.C. §§78j(b) and 78t(a)] and Rule 10b-5 promulgated thereunder [17 C.F.R.
§240.10b-5].
This Court has jurisdiction over the subject matter of this action pursuant to Section
27 of the Exchange Act [15 U.S.C. §78aa] and 28 U.S.C. §1331.
4. Venue is proper in this District pursuant to Section 27 of the Exchange Act and 28
U.S.C. §1391(b) and (c). The Company maintained its executive offices in this District and many of
the acts complained of herein, including the preparation and dissemination of materially false and
misleading information, occurred in substantial part in this District.
In connection with the acts and conduct complained of herein, Defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to,
the United States mail, interstate telephone communications, and the facilities of the New York
Stock Exchange (the “NYSE”), a national securities market.
PARTIES
6. Lead Plaintiff Bruce Owens (“Plaintiff”), as set forth in his certification previously
filed in this case and incorporated herein by reference, purchased the common stock of Guaranty
during the Class Period and has been damaged thereby.
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7. Defendant Temple Inland was a holding company that operated several businesses
through its various subsidiaries, including corrugated packaging, forest products, building products,
real estate and financial services businesses. On February 13, 2012, Temple Inland was acquired by
International Paper Company and is now its wholly-owned subsidiary.
8. Guaranty was a bank holding company that owned all the stock of Guaranty Bank
(the “Bank”). During December of 2007, Guaranty was spun off from Temple Inland and common
shares of Guaranty were distributed to Temple Inland shareholders (the “Spin-Off”) and began
trading on the NYSE. At all relevant times prior to the Spin-Off, Temple Inland dominated and
controlled Guaranty and its subsidiaries such that each was the alter-ego of Temple Inland. Temple
Inland used the Bank to support, create demand and generate profits for its core building products
business, rather than operating it as a traditional bank. On August 27, 2009, Guaranty and its
wholly-owned subsidiaries filed voluntary petitions under Chapter 11 of the Bankruptcy Code in the
United States Bankruptcy Court for the Northern District of Texas, Dallas Division. Accordingly,
Guaranty and the Bank are not named as Defendants in this lawsuit.
9. Defendant Kenneth M. Jastrow II (“Jastrow”) was Chief Executive Officer (“CEO”)
of Temple Inland and Chairman of its Board of Directors until December 28, 2007. Defendant
Jastrow simultaneously served as Chairman of the Board of Directors of Guaranty and the Bank until
he retired from such roles on August 26, 2008.
10. Defendant Kenneth R. Dubuque (“Dubuque”) served as the President, CEO and a
director of Guaranty and the Bank until his resignation from such positions on November 19, 2008.
Defendant Dubuque also served as the Company’s Chairman from August 26, 2008 through
November 19, 2008.
11. Defendant Ronald D. Murff (“Murff”) served as Senior Executive Vice President and
Chief Financial Officer (“CFO”) of Guaranty. On October 27, 2008, Defendant Murff also assumed
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the duties and responsibilities of Guaranty’s Principal Accounting Officer. On July 10, 2009,
Defendant Murff resigned from his positions as the Company’s Senior Executive Vice President,
CFO and Principal Accounting Officer.
12. Defendant Craig E. Gifford (“Gifford”) served as Guaranty’s Controller until
December 2007, when he became Guaranty’s Executive Vice President and Principal Accounting
Officer, until his resignation from such positions on October 27, 2008.
13. Defendants Temple Inland, Jastrow, Dubuque, Gifford and Murff are collectively
referred to herein as “Defendants,” and Defendants Jastrow, Dubuque, Gifford and Murff are
collectively referred to herein as the “Individual Defendants,” except as otherwise noted in this
paragraph and the Counts set forth below. Generally, the wrongful conduct alleged herein pertains
to the following Defendants during the period noted: (i) Defendant Temple Inland, as to its wrongful
conduct occurring through December 14, 2007; (ii) Defendant Jastrow, as to his wrongful conduct
occurring through August 26, 2008; (iii) Defendant Gifford, as to his wrongful conduct occurring
through October 27, 2008; and (iv) Defendants Dubuque and Murff, as to their wrongful conduct
occurring throughout the Class Period.
CLASS ACTION ALLEGATIONS
14. Plaintiff brings this action as a class action pursuant to Federal Rules of Civil
Procedure 23(a) and 23(b)(3) on behalf of himself and all persons who purchased the common stock
of Guaranty during the Class Period and were damaged thereby (the “Class”). Excluded from the
Class are Defendants, the officers and directors of the Company at all relevant times, members of
their immediate families and their legal representatives, heirs, successors or assigns and any entity in
which Defendants have or had a controlling interest.
15. The members of the Class are so numerous that joinder of all members is
impracticable. Guaranty had more than 35 million shares of stock outstanding during the Class
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Period, which were actively traded on the NYSE. While the exact number of Class members is
unknown to Plaintiff at this time and can only be ascertained through appropriate discovery, Plaintiff
believes that there are hundreds, if not thousands, of members in the proposed Class. Thus, the
disposition of their claims in a class action will provide substantial benefits to the parties and the
Court. Record owners and other members of the Class may be identified from records maintained by
Guaranty or its transfer agent. Notice can be provided to such record owners by a combination of
published notice and first-class mail, using techniques and a form of notice similar to those
customarily used in class actions arising under the federal securities laws.
16. Plaintiff will fairly and adequately represent and protect the interests of the members
of the Class. Plaintiff has retained competent counsel experienced in class action litigation under the
federal securities laws to further ensure such protection and intends to prosecute this action
vigorously.
17. Plaintiff’s claims are typical of the claims of the other members of the Class because
Plaintiff’s and all the Class members’ damages arise from and were caused by the same false and
misleading representations and omissions made by or chargeable to Defendants. Plaintiff does not
have any interests antagonistic to, or in conflict with, the Class.
18. A class action is superior to other available methods for the fair and efficient
adjudication of this controversy. Since the damages suffered by individual Class members may be
relatively small, the expense and burden of individual litigation make it virtually impossible for the
Class members to seek redress for the wrongful conduct alleged. Plaintiff knows of no difficulty that
will be encountered in the management of this litigation that would preclude its maintenance as a
class action.
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19. Common questions of law and fact exist as to all members of the Class and
predominate over any questions solely affecting individual members of the Class. Among the
questions of law and fact common to the Class are:
(a) whether the federal securities laws were violated by Defendants’ acts as
alleged herein;
(b) whether Defendants omitted and/or misrepresented material facts, including
those facts necessary to make the statements made, in light of the circumstances under which they
were made, not misleading;
(c)
false and misleading;
(d)
the Class Period; and
(e)
measure of damages.
whether Defendants knew or recklessly disregarded that their statements were
whether the price of Guaranty common stock was artificially inflated during
the extent of injuries sustained by members of the Class and the appropriate
BASIS OF PLAINTIFF’S ALLEGATIONS
20. Plaintiff’s allegations are based upon the investigation of Plaintiff’s counsel, which
included a review of United States Securities and Exchange Commission (“SEC”) filings by Temple
Inland and Guaranty; a review of the complaint filed by Kenneth L. Tepper, the Liquidation Trustee
for GFGI Liquidation Trust and Assignee of the Federal Deposit Insurance Corporation, (“FDIC”)
styled Kenneth L. Tepper v. Temple-Inland, Inc., et al ., No. 3:11-cv-02088 (N.D. Tex.) (the “Tepper
Complaint”); as well as an analysis of publicly available news articles and reports, public filings,
securities analysts’ reports and advisories about the Company, interviews of former Company
employees, interviews of people knowledgeable about the Company and its investments, press
releases, media reports, and other public statements issued by or about the Company. Plaintiff
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believes that substantial additional evidentiary support will exist for the allegations set forth herein
after a reasonable opportunity for discovery.
21. The allegations contained herein are supported by the detailed factual allegations set
forth in the Tepper Complaint, which was filed on August 22, 2011 by Kenneth L. Tepper in his
capacity as the Liquidation Trustee for the GFGI Liquidation Trust and Assignee of the FDIC. The
Tepper Complaint asserts claims for fraudulent transfer and breaches of fiduciary duty and alleges,
among other things, that at the time of Guaranty’s spin-off from Temple Inland, the Company was
insolvent. The Tepper Complaint names Temple Inland, TIN Inc., Forestar (USA) Real Estate
Group Inc., Jastrow, Dubuque, Randall D. Levy (“Levy”), Arthur Temple III and Larry E. Temple as
defendants. All defendants listed in the Tepper Complaint have answered the complaint and the case
is proceeding to discovery.
22. Moreover, the allegations made herein are further supported by the first-hand
knowledge of five (5) confidential witnesses (“CWs”). These witnesses are former senior-level
employees of Guaranty, each of whom was employed during the Class Period and provided facts
from various departments of the Company.
23. CW1 is a former Bank Senior Vice President of Investments employed with the Bank
from 1990 to late 2008. Among other things, CW1 was responsible for purchasing mortgage backed
securities (“MBS”) at the direction of Levy. CW1 was the Secretary of the Bank’s Asset Liability
Committee (“ALCO”) and regularly attended its meetings.
24. CW2 is a former Bank Director of Quantitative Analysis employed at the Bank from
2005 through 2009. Among other things, CW2 had responsibility for the valuation of the Bank’s
MBS portfolio and its asset/liability management.
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25. CW3 is a former Guaranty Senior Vice President of Marketing employed with the
Company from 2006 through late 2008. CW3 had responsibilities associated with Guaranty’s public
relations and marketing communications.
26. CW4 is a former Bank Executive Vice President employed with the Bank from 1998
to 2009
CW4 held a number of different positions with the Bank, including those with
responsibilities for the Bank’s residential real estate portfolio and its loan operations.
27. CW5 is a former Bank Senior Executive Vice President, Chief Lending Officer and
Chief Administrative Officer employed with the Bank from 1991 through the end of 2008. CW5
was responsible for overseeing the Bank’s lending activities, including real estate, commercial, and
mortgage wholesale lending.
SUBSTANTIVE ALLEGATIONS
Temple Inland Rids Itself of Guaranty, Leaving It Insolvent and Doomed to Fail
28. On November 29, 2007, Temple Inland announced that its Board of Directors had
formally approved the Spin-off. To implement the Spin-Off, Temple Inland distributed to its
stockholders one common share of Guaranty (and one related preferred stock purchase right) for
every three shares of Temple Inland common stock outstanding as of the close of business on
December 14, 2007, the record date of the distribution. At the time of the Spin-Off, Guaranty owned
100% of the stock of Guaranty Holdings Inc. I, which, in turn, wholly owned the Bank, a federally
chartered stock savings bank that began operations in 1988.
29. Temple Inland was party to debt obligations containing cross-default covenants,
which provided that if Guaranty or the Bank became insolvent or failed to make loan payments,
Temple Inland’s own debt obligations would default, resulting in severe financial ramifications, for
Temple Inland including bankruptcy. Accordingly, Temple Inland was compelled to provide capital
support to the Bank and Guaranty while they were its subsidiaries.
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30. Prior to the Class Period, Guaranty purchased investments in MBS, which are
securities created by pooling together residential mortgage loans with similar characteristics and
placing them in a trust. The trust then issues MBS, which pass through to investors a pro-rata share
of the interest and/or principal paid by borrowers on the underlying mortgages in the pool.
31. Guaranty’s portfolio of MBS consisted of: (1) U.S. Government and U.S.
Government Sponsored MBS, and (2) non-agency MBS. The MBS at issue in this case are
Guaranty’s non-agency MBS (hereinafter referred to as the “MBS portfolio”).
32. Non-agency MBS are issued by private institutions with their underlying collateral
generally consisting of mortgages which do not conform to the requirements (size, documentation,
loan-to-value ratios, etc.) for inclusion in MBS issued by agencies such as Ginnie Mae, Fannie Mae
or Freddie Mac.
33. During 2006 and 2007, the Bank had accumulated a large amount of MBS, such that
its MBS investments as a percentage of total assets substantially exceeded that of similarly situated
thrifts. At relevant times, Guaranty’s MBS portfolio accounted for no less than 22% of Guaranty’s
total assets.
34. A substantial portion of these MBS were concentrated in higher risk, toxic non-
agency MBS collateralized by risky Option ARMs. An “Option ARM” is typically a 30-year
adjustable rate mortgage that initially offers the borrower various payment options, including the
ability to select from fully amortizing payments, interest-only payments, and payments less than the
interest accrual rate, which can result in negative amortization thereby increasing the principal
amount of the loan.
35. Prior to the Spin-Off, Defendants knew that the Bank was significantly
undercapitalized. In fact, Temple Inland determined that the Bank’s MBS portfolio would contribute
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to sustained losses by the Bank, with adverse financial consequences to Temple Inland, and decided
to rid itself of these obligations. For example, prior to the Spin-Off:
(a) the Executive Committee of Temple Inland’s Board of Directors held a
meeting wherein Defendant Jastrow opined that the real estate markets in California were
deteriorating, partly due to adjustable rate mortgages being reset, coupled with mortgagor difficulties
in obtaining refinancing in a tight credit underwriting market. The deteriorating market conditions
during 2007 had a material adverse effect on the value of the Bank’s assets, especially because the
underlying mortgages with respect to the Bank’s MBS portfolio consisted of a high concentration of
California Option ARMs;
(b) Defendant Dubuque met with Temple Inland’s management and suggested
that the Bank needed as much as $200 million in additional capital;
(c) the minutes to the September 25, 2007 and October 20, 2007 Banks Board of
Directors meetings reflect that the Company’s directors, including those who sat on Temple Inland’s
Board, recognized that the Bank was in need of additional capital; and
(d) Defendants knew that the Bank was materially overvaluing its MBS portfolio
as it was employing flawed pricing models, as detailed herein.
36. CW4, a former Bank Executive Vice President of Risk Management, explained that
when plans for the Spin-Off were first announced in early 2007, he/she understood that the Bank
“expected” to receive an amount of capital from Temple Inland, which was based on an Office of
Thrift Supervision (“OTS”) assessment about the amount of capital that the Bank would need
without the financial support of Temple Inland. CW4 noted that Temple Inland did not provide the
Bank with the amount of capital that had been “expected” because it “recognized the losses”
building in the MBS and residential real estate portfolios and “did not want to throw good money
after bad.”
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37. Similarly, CW5, a former Bank Senior Executive Vice President, Chief Lending
Officer, and Chief Administrative Officer, explained that that the Bank’s capital shortage was
apparent at the time of the Spin-Off and that, as a result, after the Spin-Off, the Bank immediately
began trying to raise additional capital. CW5, who routinely attended the Bank’s Board of Directors
meetings, noted that the capital shortage was based on “a number of analyses and growth
projections,” which identified the need for additional capital.
38. CW5 also stated that he/she had informal discussions with Defendant Dubuque
wherein Defendant Dubuque expressed “frustrations” about the resources that the Bank received
from Temple Inland in the Spin-Off and expressed the need for $100 million in additional capital.
39. In addition CW3, a former Company Senior Vice President of Marketing, stated that
Bank executives had concerns about the Bank being “not adequately capitalized” at the time of the
Spin-Off, and indicated that the “mortgage-backed securities were the reason why the Bank was
having financial difficulty.” CW3 explained that he/she had discussions with Bank executives
between September and December 2007, wherein such executives voiced concerns about the Bank
being “not adequately capitalized.” CW3 commented that as the Bank’s finances deteriorated,
discussions about the Bank being under capitalized became more prevalent, and, further, that the
concern among Bank executives about the Bank’s capital position had increased to the point that in
the spring of 2008, Defendants Dubuque and Murff led a meeting attended by 50 to 60 officers
concerning the Bank’s capital position.
40. Defendants knew or recklessly ignored the fact that following the Spin-Off, in the
absence of substantial additional capital, Guaranty would be unable to satisfy its debt obligations as
they came due. Guaranty’s inadequate capitalization, and its inability to satisfy its maturing debt
obligations as they were scheduled to come due, were driven in large part by Defendants’ failure to
properly value the Bank’s risky and illiquid MBS portfolio, as detailed herein. Nonetheless,
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Defendants pressed on with the Spin-Off, despite the fact that Guaranty and the Bank were
undercapitalized and insolvent at that time.
Guaranty’s Materially False and Misleading Financial Statements
41. During the Class Period, Defendants engaged in improper financial practices that
were designed to, and did, artificially inflate the Bank’s regulatory capital, thereby masking the true
financial condition of the Company. Defendants improperly understated the Bank’s losses so that:
(1) the Company’s minimum regulatory capital requirements would not be breached; and (2) the
Company would be afforded the time necessary to procure much needed capital.
42. As a savings and loan company, the Bank was subject to regulations established by
the OTS and the FDIC, including those associated with the maintenance of certain capital
requirements.
43. OTS regulations establish four ratios for measuring the capital adequacy of a savings
and loan: (1) the “leverage” ratio, or the ratio of Tier 1 capital to adjusted tangible assets; (2) a “Tier
1 risk-based capital” ratio, or adjusted Tier 1 capital as a percentage of total risk-weighted assets; (3)
a “total risk-based capital” ratio, or the percentage of total risk-based capital to total risk-weighted
assets; and (4) a “tangible equity” ratio, or the ratio of tangible capital to total tangible assets.
44. Federal statutes and OTS regulations have also established five capital categories for
federal savings banks: well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. An institution is treated as well-capitalized when
its risk-based capital ratio is at least 10.00%, its Tier 1 risk-based capital ratio is at least 6.00%, its
leverage ratio is at least 5.00%, and it is not subject to any federal supervisory order or directive to
meet a specific capital level.
45. With respect to these measures, Guaranty’s financial statements prepared in
accordance with Generally Accepted Accounting Principles (“GAAP”) serve as the foundation for
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determining the sufficiency of the Bank’s regulatory capital. 1 Retained earnings, which are a
component of capital, are increased by the Company’s net income and reduced by net losses and
dividend payments. Accordingly, any losses recorded pursuant to GAAP, including “other than
temporary impairments” (“OTTI”) in the value of certain investments, result in a dollar-for-dollar
reduction in the amount of the Bank’s regulatory capital.
46. Significantly, pursuant to GAAP, unrealized losses on investment securities classified
as “available-for-sale” or “held-to-maturity” are not reported against net income, and, accordingly,
are not included in retained earnings and regulatory capital, until: (i) such losses become realized via
a sale; or (ii) they are deemed to be impaired due to an “other than temporary” decline in their value.
47. As detailed below, during the Class Period, Defendants, in violation of GAAP and
SEC rules and regulations, caused the Company to issue materially false and misleading financial
statements by masking hundreds of millions of dollars in OTTI losses on its MBS portfolio. In fact,
after it acquired “a significant degree of control” of the Bank, the OTS restated the Company’s
March 2009 Thrift Financial Report regulatory filing to reflect a $1.45 billon OTTI on the MBS
portfolio.
48. During the Class Period, Guaranty represented that the financial reports it issued were
presented in conformity with GAAP. In violation of GAAP and SEC rules and regulations,
Defendants:
(a) reported fair values and unrealized losses on the Company’s MBS portfolio
that the Defendants knew to be materially overstated and understated, respectively;
(b) failed to timely record an OTTI in the value of the Company’s MBS portfolio;
and
1 Applicable accounting standards in existence during the Class Period are referenced herein.
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(c) failed to disclose material events about the diminution in the value of the
MBS portfolio occurring subsequent to December 31, 2007 and prior to the filing of the 2007 Form
10-K.
49. GAAP consists of those principles recognized by the accounting profession as the
conventions, rules and procedures necessary to define accepted accounting practice at a particular
time. Regulation S-X [17 C.F.R. §210.4-01(a)(1)] states that financial statements filed with the SEC
that are not prepared in conformity with GAAP are presumed to be misleading and inaccurate.
The Overstated Value of Guaranty’s MBS Portfolio
50. As detailed below, Defendants materially overstated the reported fair value of
Guaranty’s MBS portfolio. Since the unrealized loss on the MBS portfolio is a function of its fair
value, any overstatement in the portfolio’s fair value will result in an understatement of unrealized
losses in a like amount.
51. As noted herein, prior to the beginning of the Class Period, the Bank accumulated a
high concentration of higher yielding, but highly risky, homebuilder-focused MBS. When valuing
this MBS portfolio for financial reporting purposes, Defendants caused Guaranty to utilize internal
processes, in-house valuation models and assumptions. Accordingly, during the Class Period,
Guaranty’s financial statements disclosed that “in the absence of quoted market prices, we estimate
the fair value of financial instruments.”
52. Defendants knew, or recklessly ignored, that the reported fair values and unrealized
losses on Guaranty’s MBS portfolio during the Class Period were materially false and misleading
because the Bank was utilizing improper pricing models to value its portfolio. As detailed below,
the Bank’s pricing model was flawed for the following reasons: (i) it mischaracterized nearly half of
the MBS portfolio as senior tranche securities, which resulted in materially misstated inputs being
recorded in Guaranty’s asset pricing models; (ii) the Bank did not model for loan credit risk until
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sometime in 2008; (iii) the asset pricing model incorporated outdated “parameters”; (iv) the cash
flow data used in valuing the MBS portfolio was assumed and not independently verified; (v)
liquidity factors were eliminated in valuing the MBS; (vi) the Bank did not model for loans in the
portfolio on an individual basis; and (vii) the MBS pricing model failed to account for the changes in
interest rate spreads on adjustable rate mortgages and only modeled the loan interest rate caps at the
time the securities were purchased.
53. During the Class Period, Defendants repeatedly and falsely highlighted the safety of
the MBS portfolio, in part because they represented that Guaranty’s MBS portfolio consisted solely
of “senior tranche” securities.
54. MBS are structured finance products where mortgages are pooled together into
several tranches of securities that are created and sold to investors. Typically, MBS are formed
when an issuer deposits mortgage loans into a trust. The issuer then provides the credit rating
agencies with information about the mortgages underlying the MBS so that they can assign ratings to
the series of bond tranches formed during the securitization.
55. The tranches have varying credit qualities ranging from AAA, AA (senior tranche), to
BB, B (subordinated) and to unrated (first loss). Any return of principal is allocated to the highest-
rated tranche first and then the lower-rated tranches, while any loss is assigned to the lowest-rated
tranche that is currently outstanding. Thus, the most senior tranches are expected to be insulated -
except in particularly adverse circumstances - from credit risk on the underlying mortgage pool,
since losses are first incurred by the more junior tranches of the securitization.
56. For each tranche, the so-called subordination level is defined as the proportion of
principal outstanding to other tranches with lower ratings, and is a key metric in determining how
much credit support senior tranches have from the subordinated tranches.
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57. During the Class Period, Defendants repeatedly claimed that the subordination levels
associated with the MBS portfolio insulated it from credit losses. Such representations were
materially false and misleading when made because nearly one-half of Guaranty’s MBS portfolio
during the Class Period were subordinated junior mezzanine tranche securities (hereinafter “Junior
MBS”). Defendants’ misrepresentations that Guaranty’s non-agency MBS were “senior tranche”
were important and highly material, as Guaranty’s Junior MBS securities were significantly
subordinated to senior tranche securities and, as such, were subject to greater exposure to loss than
Defendants represented.
58. Moreover, since Junior MBS have lower ratings and are more risky than senior
tranche MBS, they typically are assigned a higher “beta” factor in capital asset pricing models that
value such securities. Beta is typically viewed as the tendency of a security’s returns to respond to
swings in the market. A beta of 1.0 indicates that the security’s price will move with the market. A
beta of less than 1.0 means that the security will be less volatile than the market. A beta of greater
than 1.0 indicates that the security’s price will be more volatile than the market.
59. Given the rapidly declining market dynamics prior to and during the Class Period,
Defendants’ mischaracterization of nearly half of Guaranty’s MBS portfolio as senior tranche
securities resulted in materially misstated beta inputs being recorded in Guaranty’s asset pricing
models, which materially overstated the value of the MBS portfolio.
60. The material overstatement in the value of the MBS portfolio resulted in the
unrealized losses on such portfolio to be understated in a like amount, which created a materially
false and misleading impression about the sufficiency of the Bank’s capitalization and financial well-
being during the Class Period.
61. This misstatement was particularly material because the MBS portfolio accounted for
no less than 22% of Guaranty’s reported assets during the Class Period. The Company’s financial
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statements during the Class Period disclosed that at least 95% of the MBS portfolio was “internally-
valued” by Guaranty.
62. Defendants knew that their pre-Class Period and Class Period representations about
Guaranty’s MBS securities being composed of solely senior tranche securities, and their
representations about the valuations and unrealized losses on such securities, were materially false.
63. For example, CW1, a former Bank Senior Vice of Investments during the Class
Period who regularly attended the Bank’s Asset-Liability Committee (“ALCO”) meetings, noted that
the topic of whether the Bank purchased Junior MBS was discussed during at least one ALCO
meeting prior to the beginning of the Class Period, and that ALCO members were “comfortable”
with the risks associated with the MBS securities because, in part, they “did not want to give up the
yield” that would be lost by paying for increased credit enhancement.
64. Generally, an ALCO is a lending institution’s risk-management committee.
According to the Company’s 2008 Form 10-K, the ALCO was principally comprised of Guaranty’s
senior treasury and executive officers. CW1 and Defendants Dubuque and Murff were among the
ALCO’s twelve voting members.
65. Defendants knew, or recklessly ignored, that the reported fair values and unrealized
losses on Guaranty’s MBS portfolio during the Class Period were otherwise false, unsupportable and
not honestly believed when made.
66. CW1 explained that there were numerous deficiencies in the pricing model used to
value Guaranty’s MBS portfolio. CW1 noted that he/she put a number of Bank executives,
including Defendants Dubuque and Murff, on notice about such deficiencies on numerous occasions.
67. One such occasion occurred in January 2007 when CW1 sent an e-mail (the “January
Email”) to Defendants Dubuque and Murff and other Bank executives identifying a “laundry list” of
deficiencies in the pricing model used to value the MBS portfolio. The deficiencies identified in the
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January Email included using outdated “parameters” to value MBS and assess MBS losses and the
failure to independently verify the cash flows used in valuing the MBS.
68. In addition, CW1 stated that although liquidity factors were “a dominant variable” in
the valuation of MBS, the Bank eliminated such factors from the valuation analysis. CW1 also
noted that the Bank’s MBS pricing model failed to account for the changes in interest rate spreads on
adjustable rate mortgages. Instead, it only modeled the “interest rate caps on the loans” on a
“contemporaneous basis” at the time the securities were purchased.
69. In addition to the foregoing, CW1 noted that the values and unrealized losses on the
MBS portfolio were otherwise misstated because the Bank “never modeled for the credit risk of
loans” until sometime in 2008, and because the Bank could not “drill down to the loan level” to
assess loans in the portfolio on individual basis. Indeed, like any bond, the value of MBS is
determined by the underlying credit risk associated with them, which CW1 indicated was not
considered.
70. CW1 commented that, as a result of the foregoing, the analyses used to publicly
report the value of the MBS portfolio, and, as a consequence, unrealized losses thereon, were
inaccurate and without a reasonable basis until approximately summer 2008, when improvements in
the Bank’s modeling of the MBS portfolio were implemented.
71. CW1 noted that the improvements in the model at that time were akin to “closing the
barn door after the horse escaped” and that the Bank was “late to the party” with the implementation
of modeling improvements.
72. CW1 explained that he/she repeatedly and continually voiced the concerns he/she had
about the model the Bank used to value the MBS portfolio at ALCO meetings attended by
Defendants Dubuque and Murff and other members of the Bank’s management. Nonetheless,
Defendants displayed conscious indifference to the red flags voiced by the Bank’s Senior Vice
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President of Investments, CW1. In fact, when CW1 voiced such concerns, Defendant Dubuque and
others responded that the securities were “rated AAA” and said things like “let’s move on to another
topic.”
73. CW1 stated that he/she went as far as to forward weekly updates and “street” research
reports about the MBS market to senior members of Guaranty management so that the downward
trends and conditions in the MBS market would be evident to them. Nonetheless, CW1 stated that as
long as the MBS were rated AAA, senior management, including Defendant Dubuque, exhibited
little regard to these red flags. CW1 understood that senior Bank managers were more concerned
about the “spread earned” on the MBS portfolio than the risk of marking down the value of such
securities.
74. These representations by CW1 were echoed by other former Guaranty employees.
For example, a former Director of Quantitative Analysis at Bank during the Class Period, CW2,
issued an email on December 20, 2007 to the Guaranty’s and the Bank’s Treasurer, Michael Calcote
warning of impending losses in the MBS portfolio:
This graph kills me - do we need to start thinking about a plan B or plan C? Should we start reserving now for potential securities write-downs, or should we start quietly selling $50MM - $75MM a month of the MTAs or maybe do a little of both? I know economically it doesn’t make sense when we have positive spread and the loss on the bond is greater than the regulatory capital it frees up, but I’m concerned that this market’s going to snap and start trading at subprime-like prices - today’s loss of 5 points might look cheap to a 25 or 30 point hit in 2010 on a portfolio that is likely to have shrunk very little in the next 2 years.
75. CW2 stated that he/she was not the first to ring the MBS warning bell, as Stephen
Raffaele, who became Guaranty’s CFO in July 2009, issued a similar warning at an ALCO meeting
during the of summer 2007. Although he/she was not a voting ALCO member, CW2 regularly
attended the Bank’s ALCO meetings. CW2 commented that while certain ALCO members
repeatedly expressed concerns about the MBS portfolio, they were ignored, as no action was taken.
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76. With respect the valuation of the MBS portfolio, CW2 confirmed that the Bank’s
pricing model lacked a “credit perspective,” meaning the model “just assumed cash flows” would be
at a given level. Like CW1, CW2 commented that there was no independent verification of the cash
flows used in deriving the valuations of MBS securities.
77. CW2 also noted that prior to the Spin-Off, he/she performed certain analyses that
identified “pricing issues” in the MBS portfolio because the forecasted losses on the securities were
higher than what the Bank previously projected. CW2 explained that by December 2007, the Bank
knew there was going to be much more volatility in the MBS portfolio than had “previously been
expected,” based on certain tests CW2 performed two months earlier. While CW2 noted that he/she
desired to “improve” the model used to price the MBS portfolio, no improvements materialized until
sometime in 2008.
78. These facts demonstrate that Defendants knew or recklessly ignored that Guaranty’s
“internally valued” MBS portfolio, and the resulting unrealized losses thereon reported to investors
during the Class Period, were materially false, unsupportable and misleading.
79. Moreover, and as detailed below, while in possession of facts to the contrary,
Defendants repeatedly and falsely touted the safety of the MBS portfolio, claiming that it consisted
solely of “senior tranche” securities and that the subordination levels associated with the MBS
portfolio insulated Guaranty from credit losses.
The Failure to Record an OTTI in Guaranty’s Investment Securities
80. GAAP, in Statement of Financial Accounting Standards (“SFAS”) No. 115, provides
that investments in debt securities are to be classified in one of three categories: held-to-maturity,
trading, or available-for-sale.
81. During the Class Period, Guaranty classified its MBS portfolio as being either held-
to-maturity or available-for-sale.
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82. With respect to investment securities classified as either held-to-maturity or available-
for-sale, GAAP, in SFAS No. 115, provides that if it is “probable” that an owner of debt securities
will be unable to collect all amounts due in accordance with the contractual terms of the security, an
OTTI in the value of such securities is deemed to have occurred, stating, in part:
[A]n enterprise shall determine whether a decline in fair value below the amortized cost basis is other than temporary . . . . [I]f it is probable that the investor will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an other than temporary impairment shall be considered to have occurred. If the decline in fair value is judged to be other-than-temporary, the cost basis of the individual security shall be written down to fair value as a new cost basis and the amount of the write-down shall be included in earnings (that is, accounted for as a realized loss). [Emphasis added.]
83. Accordingly, pursuant to SFAS No. 115, Guaranty was required to recognize a charge
against its earnings when it was “probable” that it would be unable to collect “ all” amounts due on
its MBS portfolio in accordance with its contractual terms.
84. In addition to the guidance set forth in SFAS No. 115, the Staff of the Financial
Accounting Standards Board (“FASB”), in November 2005, issued its interpretation about the
meaning of “other than temporary” and its application associated with the impairment of certain
investments, like Guaranty’s MBS. Such interpretation, set forth in FASB Staff Position Nos. FAS
115-1 and FAS 124-1, provides that: 2
(1) An assessment of impairment is to occur during each interim period (i.e. , quarterly);
(2) Impairment shall be assessed at the individual security level ;
(3) An investment is impaired if its fair value is less than its cost;
(4) If the fair value of the investment is less than cost, the impairment is either temporary or other-than-temporary. Other-than-temporary does not mean permanent ; and
2 Like SFAS, during the Class Period, FASB staff positions were among the highest authority of GAAP. See SFAS No. 162.
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(5) An investor shall apply other GAAP guidance in determining whether an impairment is other-than-temporary, such as SFAS No. 115, Staff Accounting Bulletin (“SAB”) No. 59, Accounting Principles Board Opinion No. 18 and Emerging Issues Task Force (“EITF”) Issue No. 99-20. [Emphasis added].
85. Significantly, CW1, the Bank’s former Senior Vice President of Investments, stated
that during the Class Period, Guaranty did not assess MBS losses at the individual loan level. In
failing to do so, Guaranty violated the dictates of GAAP, which resulted in the failure to record a
material OTTI in the value of Guaranty’s MBS portfolio and consequently, a material overstatement
of its income and regulatory capital during the Class Period.
86. The staff of the SEC has long cautioned its registrants not to delay the recognition of
an OTTI in the value of investments. In fact, the SEC’s SAB No. 59 provides that “other than
temporary” does not mean “permanent” and that a write-down in available-for-sale and held-to-
maturity investments to fair value is required “unless evidence exists to support a realizable value
equal to or greater than the carrying value of the investment.”
87. Accordingly, existing, objectively verifiable evidence is necessary to overcome the
presumption that an OTTI occurred when the fair value of such securities are less than its cost.
Here, no such evidence was in existence, as Defendants knew or recklessly ignored.
88. In addition, pursuant to SAB No. 59, “the extent to which the market value has been
less than cost” is a factor to be considered in evaluating where an OTTI is to be recognized
89. As illustrated in the chart below, the reported and albeit understated, cumulative
unrealized loss on Guaranty’s MBS portfolio exploded during the Class Period, with the reported
value of Guaranty’s MBS portfolio totaling $2.2 billion at June 30, 2008, or an amount equal to
approximately just 60% of what Guaranty paid for such securities:
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in m illio ns
$1,500
$1,000
$500
Guaranty Financial Group Inc. Unrealized Losses On MBS Portfolio
$0 9/30/07 12/31/07 6/30/07
11/30/07 3/31/07
90. In addition, during the Class Period, the average delinquencies on Guaranty’s MBS
portfolio skyrocketed. In fact, as illustrated in the following chart, the average delinquency rate on
Guaranty’s MBS portfolio increased by approximately 250% in the nine month period ended June
30, 2008:
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91. A former Director of Financial Reporting at the Bank during the Class Period, CW3,
noted that, early in the Class Period the Bank’s management held “discussions” about the “sheer
volume of delinquencies on mortgages” and how the rising number of delinquencies were impacting
the MBS portfolio at the time.
92. The massive diminution in the value of, and the significant increase in the rate of
average delinquencies on, Guaranty’s MBS portfolio were red flags waving in the face of the
Defendants, indicating that Guaranty would not be able to collect all amounts due on its MBS
portfolio in accordance with their contractual terms, which rendered such investments impaired on
an other-than-temporary basis pursuant to GAAP.
93. Moreover, as illustrated in the following chart, by June 30, 2008, the following
securities in Guaranty’s MBS portfolio, with unrealized losses of nearly $500 million, had been
downgraded or placed on negative watch by rating agencies:
Securities on negative watch or downgraded
MALT 2005-38 A2 MALT 2005-51-3A1 MALT 2005-58 A3 MALT 2005-62-1A2 MALT 2005-76-1A2 CWALT-2006-0A2 A7 GPMF 2005-AR5 1A2 RALI 2005-005 A3 SAMI 2005-AR7 5A2 SAMI 2005-AR8 A5
As of June 30, 2008 $ in Millions Ratings Action
Amortized Unrealized Cost Fair Value Loss Date S&P Date Moodys
$73 $50 $23 led v..'E1tctI frcrri AAA
127 60 67 Neg Watch trom AAA
125 72 53 6/1 , 1 -11 8 Nieci Watch from AAA
119 79 40 6, -19.200::: Neg Watch tiol-ri A•.
129 64 65 Nieci '.A./Eltc:h frorri AAA
134 65 69 41g1!U Nieci Watch POni .A...A. 6192I:I08 Nieci Watch Poni AAA
56 35 21 72i200::: L:owi-iciradecl to Al
100 46 54 Neci V\(aLh Thorn AAA
41 19 22 111, Neg Watch PorriAAA
68 69 Nell Watch - orr-iAAA
1,041 558 483
94. The downgrading or placement of negative watch by ratings on the above noted
securities, coupled with the magnitude of their cumulative unrealized loss (more than 46%) and the
severe delinquency rates associated with such securities, signaled to the Defendants that it was not at
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all probable that Guaranty would collect all amounts due on such securities in accordance with their
contractual terms, thereby rendering such investments OTTI pursuant to GAAP.
95. This impropriety, as Defendants knew or recklessly ignored, overstated Guaranty’s
income, retained earnings and regulatory capital by at least $483 million by no later than June 30,
2008. The Guaranty Defendants knowingly or recklessly caused the Company not to record such
OTTI in the value of Guaranty’s MBS portfolio during the Class Period because, had they done so,
Guaranty would have been forced into conservatorship.
96. CW5, a former Bank Senior Executive Vice President, Chief Lending Officer, and
Chief Administrative Officer who routinely attended the Bank’s Board of Directors meetings,
explained that, prior to the beginning of the Class Period, Guaranty held ALCO meetings discussing
the rising number of defaults on the loans underlying the MBS and the “requirement to write down
the securities to market value due to impairments.” CW5 commented that beginning in the fourth
quarter 2007 and into 2008, “we talked about it [the potential for write-downs] a lot.” CW5 stated
that Defendant Dubuque and Murff attended the ALCO meetings where the potential MBS write-
downs were discussed.
97. CW4, a former Bank Executive Vice President of Risk Management, explained that
in the second quarter of 2008 the OTS voiced concerns that an OTTI existed in the MBS portfolio.
CW4 noted that while Bank executives tried to persuade the OTS that an OTTI did not exist because
the MBS were “performing satisfactorily” and their “cash flows” were steady, the OTS “did not care
that the cash flow was still the same” and noted that their “market value is going down” irrespective
of their cash flows. CW4 stated that eventually the rating agencies “weighed in” with downgrades
and that the Bank needed $2.2 billion in additional capital as a result of the deterioration in the MBS
portfolio.
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98. Nonetheless, Defendants ignored numerous red flags indicating that the Bank’s MBS
portfolio had suffered a nearly half a billion OTTI no later than June 30, 2008. To the contrary, as
detailed below, Defendants issued a series of materially false and misleading statements to support
the representation that the unrealized losses on such securities need not be charged against
Guaranty’s net income or included in the determination of its regulatory capital.
The Failure to Disclose Material Subsequent Events
99. Guaranty’s 2007 year end financial statements were also materially misstated because
they failed to disclose facts referred to as “subsequent events.” Such facts, which were required to
be disclosed pursuant to GAAP, were necessary to make the 2007 year end financial statements not
false and/or misleading.
100. GAAP, as articulated in Emerging Issues Task Force (“EITF”) Topic D-86, provides:
A registrant and its independent auditor have responsibilities with regard to post-balance-sheet-date subsequent events, as well as the application of authoritative literature applicable to such events.
101. Concerning subsequent events, EITF Topic D-86 makes reference to the American
Institute of Certified Public Accountant’s (“AICPA”) Statement on Auditing Standards No. 1,
Subsequent Events (or AU §560), which, states in pertinent part, as follows:
[E]vents or transactions sometimes occur subsequent to the balance-sheet date, but prior to the issuance of the financial statements that have a material effect on the financial statements and therefore require adjustment or disclosure in the statements. These occurrences hereinafter are referred to as “subsequent events.”
The first type [of subsequent event] consists of those events that provide additional evidence with respect to conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. . . .
*
The second type [of subsequent event] consists of those events that provide evidence with respect to conditions that did not exist at the date of the balance sheet being reported on but arose subsequent to that date. These events should not result in adjustment of the financial statements. Some of these events, however, may be of such a nature that disclosure of them is required to keep the financial statements from being misleading. . . .
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102. On February 29, 2008, Guaranty filed its 2007 Form 10-K with the SEC. The 2007
Form 10-K, which was signed by the Guaranty Defendants, represented that Guaranty’s 2007 year-
end financial statements, contained therein, were presented in conformity with GAAP. This
representation was materially false and misleading as Guaranty’s 2007 year-end financial statements
falsely disclosed that the combined unrealized loss on Guaranty’s MBS portfolio at December 31,
2007 totaled $274 million, when for the reasons set forth above, such amount was materially
understated.
103. Moreover, had the unrealized loss on Guaranty’s MBS portfolio at December 31,
2007 totaled $274 million, which it did not, the 2007 year end financial statements otherwise
violated GAAP because they failed to disclose that by the time Guaranty filed the Form 10-K with
the SEC on February 29, 2008, the unrealized loss on the MBS portfolio, as determined by Guaranty,
had increased by hundreds of millions of dollars since December 31, 2007.
104. This massive increase in the unrealized loss on the MBS portfolio was a material
subsequent event that GAAP required to be, but was not, disclosed in the 2007 year end financial
statements that Guaranty filed with the SEC on February 29, 2008.
105. As noted herein, Guaranty reported that 31 days later, on March 31, 2008, the
cumulative unrealized loss on its MBS portfolio totaled $1.070 billion , an amount approximating 4
times the loss Guaranty reported on such portfolio at December 31, 2007. When Guaranty disclosed
that the unrealized loss on its MBS portfolio totaled $1.070 billion , the price of its stock dropped
nearly 19%.
106. In addition to the violations of GAAP noted above, Defendants knowingly or
recklessly presented Guaranty’s financial results and statements in a manner that also violated at
least the following provisions of GAAP during the Class Period:
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(a) the principle that loan impairments be recognized when it is probable that a
creditor will be unable to collect all amounts due according to the contractual terms of the agreement
(SFAS No. 114);
(b) the principle that loan loss reserves recognize credit losses when it is probable
that a loss has been incurred and the amount can be reasonably estimated (SFAS No. 5);
(c) the principle that financial statements disclose loss contingencies when it is
reasonably likely that a loss has been incurred (SFAS No. 5);
(d) the principle that financial statements disclose certain significant risks and
uncertainties (Statement of Position No. 94-6);
(e) the principle that decreases in future cash flows expected to be collected on
certain loans or debt securities transfers be recognized as impairments (AICPA Statement of Position
03-3);
(f) the principle that interim financial reporting should be based upon the same
accounting principles and practices used to prepare annual financial statements (APB No. 28, ¶10);
(g) the concept that financial reporting should provide information that is useful
to present and potential investors and creditors and other users in making rational investment, credit
and similar decisions (Statement of Concepts (“Concepts Statement”) No. 1, ¶34);
(h) the concept that financial reporting should provide information about the
economic resources of an enterprise, the claims to those resources, and the effects of transactions,
events and circumstances that change resources and claims to those resources (Concepts Statement
No. 1, ¶40);
(i) the concept that financial reporting should provide information about how
management of an enterprise has discharged its stewardship responsibility to owners (stockholders)
for the use of enterprise resources entrusted to it. To the extent that management offers securities of
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the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to
prospective investors and to the public in general (Concepts Statement No. 1, ¶50);
(j) the concept that financial reporting should provide information about an
enterprise’s financial performance during a period. Investors and creditors often use information
about the past to help in assessing the prospects of an enterprise. Thus, although investment and
credit decisions reflect investors’ expectations about future enterprise performance, those
expectations are commonly based at least partly on evaluations of past enterprise performance
(Concepts Statement No. 1, ¶42);
(k) the concept of completeness, which means that nothing is left out of the
information that may be necessary to ensure that it validly represents underlying events and
conditions (Concepts Statement No. 2, ¶79); and
(l) the concept that conservatism be used as a prudent reaction to uncertainty to
try to ensure that uncertainties and risks inherent in business situations are adequately considered.
The best way to avoid injury to investors is to try to ensure that what is reported represents what it
purports to represent (Concepts Statement No. 2, ¶¶95, 97).
Pre-Class Period Materially False and Misleading Statements
107. On October 24, 2007, Temple Inland issued a press release announcing its financial
results for its 2007 third quarter, the period ended September 30, 2007. For the quarter, the
Company reported earnings of $36 million, or $0.33 per diluted common share. Following its 2007
third quarter earnings announcement, Temple Inland held a conference call with analysts and
investors, during which certain of Defendants made numerous positive statements about Guaranty.
108. For example, when asked if Guaranty “had problems with valuing [MBS] securities,”
Defendant Jastrow responded that such securities were AAA rated. The dialog stated, in pertinent
part, as follows:
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Chip Dillon - Citigroup – Analyst:
Okay, and I guess the next question is, I noticed from the S1, or I guess it’s a 1012B that you had increased. I guess in the last couple years, a lot of your private mortgaged backed securities, mentioned about $2.8 billion I guess have option arms in them. You mentioned senior tranches. Have you had problems with valuing those securities or receiving the pass through interest on them?
Defendant Jastrow:
Currently our securities are right at AAA, Chip, and I might note there are no sub prime loans as underlying collateral in those securities.
109. Similarly, when asked about Guaranty’s underwriting standings and the geographic
and non-agency composition of Guaranty’s MBS securities, Defendant Jastrow again responded by
stating that such securities were AAA rated. The following exchange took place:
Chip Dillon - Citigroup – Analyst:
Gotcha. And as you look to underwrite new business, have you changed any of [ ] the standards you’re using in terms of underwriting mortgages or changing some of the geographic balance you have?
Defendant Jastrow:
Thank you for the question. First of all, we have, for many years, and I’d say for many years, been a long-term portfolio lender. A portfolio of adjustable rate loans. Our focus has been on A paper not sub prime. As we said in the past we’re not an originator nor acquirer of sub prime loans. We, for a long time, had appropriate underwriting guidelines that over many years, many, many years, we’ve experienced good credit performance in our single family portfolio. So we continue to examine and analyze underwriting, but we continue to focus on the A paper and not down in the lower segments particularly related to sub prime.
Chip Dillon – Citigroup – Analyst:
Okay, and I guess the last question is, given kind of the, this obviously is more of a decision for Ken going forward, but I noticed back in ‘04 and ‘03 that almost 90% of the securities were always the government guaranteed ones and you only more recently shifted in the private mortgage bonds. Any thought in maybe going back to the position you were, or at least moving more toward owning you know, securities that are issued by the TSEs?
Defendant Jastrow:
Certainly Chip, we look at what’s available in the marketplace relative to meeting her with the right requirements. Once again, let me say that our securities are AAA rated.
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110. The statements referenced in the two preceding paragraphs were each materially false
and misleading because they failed to disclose:
(a) that while AAA rated, nearly one-half of the Company’s MBS portfolio was
comprised of subordinated Junior MBS that were subject to significant risk of loss;
(b) that the Bank employed flawed asset pricing models that materially overstated
the value of the MBS portfolio, which created a false impression about the financial solvency of the
Company; and
(c) based on the foregoing, Defendants lacked a reasonable basis for their positive
statements about the Company and its MBS portfolio.
111. On November 6, 2007, Temple Inland filed with the SEC its Form 10-Q for the
quarter ended September 30, 2007. The Form 10-Q contained materially false and misleading
financial statements with respect to the Bank’s assets for the period then ended (the “2007 Q3
Financial Statements”). For example, SFAS No. 115 required Temple Inland’s 2007 Q3 Financial
Statements to disclose the fair values and unrealized losses on the MBS that Temple Inland classified
as held-to-maturity and available-for-sale. In addition, Temple Inland’s 2007 Q3 Financial
Statements falsely represented that $3.7 billion of its non-agency MBS [ i.e. , the MBS portfolio]
(representing approximately 18% of Temple Inland’s assets at September 30, 2007), that had Option
ARMs as the underlying assets, were so-called senior tranches, when, as detailed herein, they were
not.
112. The statements referenced in the preceding paragraph remained alive and uncorrected
during the Class Period
Materially False and Misleading Statements Issued During the Class Period
113
The Class Period begins on December 12, 2007 when, on information and belief,
Guaranty’s common shares began trading on a “when issued” basis.
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114. On December 14, 2007, Guaranty filed a Form 8-K with the SEC that included an
Information Statement (the “Information Statement”) dated December 14, 2007, describing the
details of the Spin-Off and providing information about Guaranty. A prior version of the
Information Statement, which was subject to completion, was incorporated into the Form 10
registration statement associated with the Spin-Off.
115. Among other things, the Information Statement disclosed that the financial statements
included therein, and as a consequence, the financial disclosures upon which they were based, were
presented in accordance with GAAP. The Information Statement also disclosed that Guaranty’s
MBS portfolio was comprised of “senior tranches” issued by private issuers, stating, in relevant part:
The mortgage-backed securities we purchased in 2006 and 2005 and a portion of the securities we purchased in previous years have Option ARMs as the underlying assets. The outstanding principal balance of these securities at year-end 2006 was $3.4 billion. Of these securities, $581 million were issued by U.S. Government Sponsored Enterprises (FNMA, FHLMC) and the remaining $2.8 billion are senior tranches issued by private issuer institutions.
* * *
At September 30, 2007, all of the private issuer securities we own carried AAA ratings by two different nationally recognized securities rating organizations and none have been subsequently downgraded. We have no plans to sell any of the securities.
* * *
At September 30, 2007, the level of subordinated tranches held by third parties, available to absorb credit losses before any losses are attributable to the tranches we own, averaged 14.9% of the outstanding balances of the underlying loans while total delinquencies of the underlying loans averaged 8.1%.
* * *
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Carrying value and the estimated fair value of our financial instruments are:
September 30, Year-End 2007 2006
Carrying Fair Carrying Fair Value Value Value Value
(In millions) Financial assets
Loans receivable Mortgage-backed securities held-to-maturity:
U. S. Government and U.S. Government Sponsored Enterprises: Market quotes
Private Issuer: Internally valued Market quotes
Mortgage-backed securities available-for-sale: • S. Government and U.S. Government Sponsored Enterprises: Market quotes
Private Issuer: Internally valued Market quotes
* *
$ 9,561 $9,572 $ 9.617 $9,635
1.361 1,350 1,804 1.785
2.284 2.216 2.806 2.826
206 206 243 241
3.851 3,772 4,853 4,852
582 582 515 515
1.376 1.376
5 5 6 6
1,963 1,963 521 521
*
SFAS No. 157, Fair Value Measures - This new standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This guidance applies to fair value measurements already required or permitted and will be effective for our first quarter 2008. We are currently assessing the potential impact SFAS No. 157 will have on our financial statements, but anticipate it will only result in additional disclosure regarding estimates we make in determining fair value for some financial instruments.
116. The statements referenced in the preceding paragraph were each materially false and
misleading because they failed to disclose that:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
(b) the Bank employed flawed asset pricing models that materially overstated the
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial reporting misrepresented the true fair value of the
Bank’s MBS portfolio;
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(d) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(e) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices; and
(f) the Company’s financial statements were not fairly presented in conformity
with GAAP.
117. On December 31, 2007, Temple Inland issued a press release announcing the
completion of the Spin-Off as of the close of business on December 28, 2007. That same day,
Guaranty issued a press release announcing the commencement of its common shares trading on the
NYSE.
118. On February 6, 2008, Guaranty issued a press release announcing earnings of $6
million for the fourth quarter and $78 million year ended December 31, 2007, as compared to $33
million for the fourth quarter and $121 million year ended December 31, 2006. With respect to the
Company’s investment portfolio, the press release stated, in pertinent part, as follows:
The investment portfolio increased from $5.4 billion at December 31, 2006 to $5.5 billion at year end 2007. This portfolio consists of agency and non-subprime private issuer mortgage-backed securities, all of which are triple-A rated, with significant levels of subordination as credit enhancement. Guaranty has not purchased and does not hold any private issuer securities that rely on support from bond insurers.
119. Defendant Murff commented on the results, stating, in pertinent part as follows:
While market conditions certainly deteriorated in the latter half of 2007, we were relatively well-positioned prior to the sudden change in the housing and credit markets. For example, we sold our mortgage company and servicing assets in 2004 and 2005, and we completed the exit from this segment in early 2006. As a result, more than 96% of our single family mortgage portfolio was originated in 2005 and earlier. We did experience a significant increase in non-performing loans in the second half of 2007, principally out of our homebuilder portfolio. We have increased our allowance for loan losses from $65 million at the end of 2006 to $118 million at the end of 2007, which increased our allowance as a percentage of total loans from 0.68% to 1.17% during that same period. While we do not anticipate a recovery of the housing market in the near term, we feel that at this time we are appropriately reserved.
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120. That same day, Guaranty held a conference call with analysts and investors to discuss
the Company earnings and operations. During the conference call, Defendants Dubuque and Murff
made positive statements about the Company and its business prospects. Defendant Dubuque
explained that, at December 31, 2007, Guaranty’s MBS portfolio accounted for $5 billion, or
approximately 23% of the Bank’s total assets. With respect to the MBS portfolio, Defendant Murff
represented that such portfolio was backed by adjustable rate, single-family mortgages, which were
not part of subordinated tranches ( i.e. , senior securities) and, therefore, provided the portfolio with
extra credit protection and shielded it from losses. Defendant Murff stated, in pertinent part, as
follows:
On slide number 13, we’ve listed the amortized cost and fair values of our mortgage-backed securities as of December 31, 2007. The combined agency securities available for sale and held to maturity have an amortized cost totaling approximately $1.8 billion and their total fair value is the same. Of the private issue securities, those held available for sale have an amortized cost of approximately $1.37 billion and a carrying value of approximately $1.31 billion for a difference of approximately $55 million.
The private issue held to maturities securities have an amortized cost of approximately $2.41 billion and a fair value of approximately $2.2 billion for a difference of approximately $210 million. As [Defendant Dubuque] mentioned, each of these securities are adjustable rate and backed by single-family mortgages. Each of the private issuer securities were AAA rated at the time of purchase and continue to be AAA rated today. We have not invested in subprime securities, collateralized debt obligations or subordinated tranches. At December 31st, the average delinquency rate of the underlying loans for our private issue securities was 11%. The average current LTV on the underlying loans was approximately 78%. The average current credit score approximately 708. These securities do not have an insurance wrapper, rather, the AAA rating we feel remains on each of these securities primarily as a result of the underwriting criteria of the underlying loans and the high levels of subordination. We’ve shown on the slide that the subordination level at issue date for all of the private label securities was an average 10.7%. We have seen significant and growing subordination levels primarily as a result of prepayments that pay off our senior tranches first and the average subordination levels of these private securities have increased 14.5% as December 31, 2007. These sizable and growing subordination levels provide credit protection from credit losses because other investors absorb the losses first.
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121. Defendant Dubuque made similar observations about the Company’s MBS portfolio,
stating, in pertinent part, as follows:
Moving now to mortgage-backed securities. This is a fairly large portion of our portfolio. Each of these securities are backed by adjustable rate single-family mortgages. Approximately one-third of the securities are agency underwritten with a remaining two-thirds being private issuer. All of the private issue securities were rated AAA at the time of purchase and continue to be rated AAA today. We have not invested in subprime securities, collateralized debt obligations or subordinated tranches.
122. During the question and answer session, Defendants Dubuque and Murff made
additional statements about the Bank’s MBS portfolio. When questioned about the size of the
Bank’s MBS portfolio, Defendant Dubuque stated that it was “not a particularly good time to sell,”
tacitly admitting that the market for the Bank’s MBS securities was illiquid and lacked buyer
demand. The dialog stated, in pertinent part, as follows:
Terry McEvoy - Oppenheimer & Co. – Analyst:
I was wondering if you could give us a history and maybe the rationale behind having a relatively large securities portfolio like you guys do and you talked about runoff in the securities portfolio. Is there any thoughts of accelerating the pace of that runoff or are you just going to let nature take its course?
Defendant Dubuque:
In regard to the first question, the main reason why we built up that portfolio was because of the limits associated with the thrift charter. As you know, 70% of the assets held by a thrift have to be housing-related. So, in order to grow some of the other lucrative business lines like energy and middle market and small business, we needed to increase the size of the balance sheet so that was a relatively risk-free way of doing it. We also have liked the returns in that business as well. I don’t see any reason why we would accelerate the portfolio we have, getting out of it or shrinking it because we like the characteristics and it seems to be not a particularly good time to sell anyway. Ron, I don’t know if you want to add anything to that.
Defendant Murff:
The only thing I would add, Terry, is that we are continuing to see pay-downs in that portfolio on a monthly basis. It is probably pre-paying at a $70 million to $75 million per month number.
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123. When questioned about the valuations ascribed to the MBS portfolio, Defendant
Murff explained that Guaranty utilized internal models, the results of which were consistent with that
of third parties. The following exchange took place:
Matthew Barnett - Jet Capital – Analyst:
Hi. I just had a couple of questions. With respect to your ABS portfolio and the determination of fair value, can you discuss how you go about that?
Defendant Murff:
We gave some indication even in the Form 10 as we filed that back in December, but most of these securities, the agencies obviously you can tell would be ones that are priced just off the screen. Some of these securities, there are not easy ways to get pricing quotes so we do use internal models, with as current market-based data as we can get. We do use benchmark securities and then have interpolation based on characteristics of our securities from those benchmark securities to determine fair value.
We have used some external pricing services and third party consultants to look at our modeling and give us some idea of its consistency and validity and generally what we found from some of the third parties that we’ve had conversations with that our modeling capabilities would be materially consistent with theirs.
Matthew Barnett – Jet Capital – Analyst:
And for non agency ABS, if there is a market in there, is that what you use or do you use the model?
Defendant Murff:
For the most part, we would use the model off those private issue or mortgage-backed securities. That would be in almost all cases. And as I said, based upon what we have seen as we have talked with some third parties, the information that we have been using would be materially consistent with other parties.
124. In connection with the above noted conference call, Guaranty provided investors with
the following chart about Guaranty’s MBS portfolio at December 31, 2007:
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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 39 of 84 PageID 324
uamay
As of Dec. 31, 2007 ($ Billi ons)
AmortIzed Cost Fair
Available for Sale: Subordination Leve
Private Issue MSSIs
Agency $0.57 $057 15% 14.5%
Private $1.37 $1.31 10.7%
Held to Maturity: IOA
Agency $1.23 $1.23 5%
Private $2.41 $2.20 __________________________
Total: $5.58 $5.31 At Issue Dec-07
Significant, and growing Private Issue MBS nubordination iev&s
provide protection from • Adjustable rate credit losses
- AII AAA rated
- UnderIyng collateral delinquency rate: 11%
- Weighted average current LTV: 78% (current loan baIare/origiraI appraised value)
- Weighted average current credit score: 708 13
125. In response to these positive statements, shares of Guaranty common stock rose
16.5%, or $2.18 per share, to close at $15.33 per share on heavy trading volume.
126. The statements referenced above in paragraphs 132-136 were each materially false
and misleading for the following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(e) the Company’s internal and disclosure controls were materially deficient;
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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 40 of 84 PageID 325
(f) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices;
(g) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading; and
(h) based on the foregoing, Defendants lacked a reasonable basis for their positive
statements about the Company and its MBS portfolio.
127. On February 27, 2008, Defendant Dubuque and Steven Raffaele (“Raffaele”),
Guaranty’s Director of Corporate Strategy & Development, presented at the Keefe, Bruyette &
Woods, Inc.’s regional bank conference. During the conference, Defendant Dubuque explained that
Guaranty held a “disproportionate” amount of MBS in order to enable its prior parent company,
Temple Inland, to satisfy the qualified thrift lender (“QTL”) requirement that a certain amount of an
institution’s portfolio assets be qualified thrift investments, primarily residential mortgages and
related investments. Defendant Dubuque, stated, in pertinent part, as follows:
Why do we have a lot of mortgage-backed securities? Because -- or a disproportionate amount of mortgage-backed securities -- because it was the only way we could grow with a thrift charter. Our parent company couldn’t own a financial services company because it’s a manufacturing company. The only way to do it was to have a thrift charter.
With a thrift charter you have 70% you have got to invest in real estate assets. In order to do that and grow energy, grow C&I, grow small business, we had to grow the whole balance sheet. So we decided the safest way to do that, and get some decent earnings and leverage secondary capital, was to build mortgage-backed. So while we have a disproportionate share, we think they are pretty good asset quality. We can go get into that a little bit as well.
128. Raffaele followed up Defendant Dubuque’s comments by attempting to distinguish
Guaranty from other financial institutions holding MBS by minimizing the risks associated with
Guaranty’s MBS portfolio. Indeed, Defendants did so to facilitate an equity offering that Guaranty
was then contemplating to infuse it with necessary capital during the height of the U.S. sub-prime
mortgage and financial crisis. For example, Raffaele noted that the MBS portfolio “was not
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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 41 of 84 PageID 326
[composed of] highly structured securities,” or “involved in the subprime market” and were “senior
tranches, AAA rated” securities. Raffaele also represented that Guaranty’s MBS portfolio enabled
TIN to satisfy the QTL requirement by “scal[ing] not only our interest rate risk but also credit risk”
stating, in pertinent part, as follows:
On the mortgage-backed securities, and this is certainly an area where everyone is very focused now, particularly today. So, I think first of all to distinguish that, again, we were not involved with CDOs. We’re not involved in really any highly structured securities. We’re not involved in the subprime market. Just simply doing what we had done for a long time, which is investing in adjustable-rate securities.
Again, after we sold the mortgage company we needed to have an acceptable level of single-family mortgage assets. So the securities portfolio is a very efficient way to accomplish that and to scale not only our interest rate risk but also credit risk.
So all of the bonds that we bought were senior tranches, AAA rated. They continue to be AAA rated. The way we looked at that is toward subordination, toward getting bonds structured that we felt like would perform well under stress.
And certainly they have been. Subordination levels have been increasing with prepay rate. So at this point, that portfolio continues to perform. We have not announced any OTTI impairment.
129. When asked about the valuation of Guaranty’s MBS portfolio during the Q&A
section of the Keefe Conference, Defendant Dubuque, stated that Guaranty would be “more
transparent” with respect to its MBS portfolio, stating, in pertinent part, as follows:
Unidentified Audience Member:
How much of your securities portfolio has pay option ARMs underlying? Of that, what are the vintages and how are you currently valuing it?
Raffaele:
We are going to -- we plan to get our 10-K out here in the next few days, actually. As I mentioned, we’ve had a lot of questions on the securities portfolio. Our plan is to give a lot of detail in the K.
There – a significant portion of the portfolio, in answer to your question, is pay option ARM. Again, consistent with our investment in adjustable-rate not only securities but also loans.
So I’m going to refer you to the K because you’re going to get kind of a whole download from us here in I guess a couple of days.
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Page 42 of 84 PageID 327
Defendant Dubuque:
One of the difficulties we’ve had is being a subsidiary of a company, it hasn’t been as transparent as we would like. So we are going to probably – not probably, we will err on the side of being more transparent.
We think that is important. We have heard it from the investors. We have heard it from the analysts. We may give more detail than your typical bank, but it is what it is. So you will see it, we will see it. If we don’t do a good enough job of managing it, then you get a new manager.
130. The statements referenced in the three preceding paragraphs were each materially
false and misleading for the following reasons:
(a) nearly one-half of the Company’s MBS portfolio were subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS; and
(b) based on the foregoing, Defendants lacked a reasonable basis for their positive
statements about the Company and its MBS portfolio.
131. On February 29, 2008, Guaranty filed its 2007 Form 10-K with the SEC, which was
signed by the Individual Defendants, and included Guaranty’s 2007 year end financial statements
that were represented to have been presented in conformity with GAAP.
132. The 2007 Form 10-K falsely represented that its MBS portfolio did not consist of
subordinated tranches, but, rather, were senior tranches issued by private issuer institutions, stating,
in pertinent part, as follows:
All of the securities we own have single-family residential mortgage loans as the underlying assets. All of the private issuer securities we own involve tranches subordinate to our securities in the cash flow distribution from the underlying assets. As a result, those subordinated tranches absorb credit losses before any losses are attributable to our securities. The subordinated tranches for the securities we own do not include guarantees by third-party insurers. At year-end 2007, subordinated tranches averaged 14.5% of the outstanding balances of the loan pools underlying the securities we own, and 11.3% of those loans were delinquent on their payments. At year-end 2006, subordinated tranches averaged 13.4% of the loan pools underlying the securities we own and 4.3% of the loans were delinquent. None of the securities
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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 43 of 84 PageID 328
have sub-prime loans as underlying assets. Additionally, none of the securities are collateralized debt obligations or subordinated tranches.
* * *
The mortgage-backed securities we purchased in 2007, 2006, and 2005, and a portion of the securities we purchased in previous years have Option ARMs as the underlying assets. The amortized cost of Option ARM securities in our portfolio at year-end 2007 was $4.2 billion. Of these, $590 million were issued by U.S. Government Sponsored Enterprises (FNMA, FHLMC), and the remaining $3.6 billion are senior tranches issued by private issuer institutions.
133. The 2007 Form 10-K also included the following false and misleading representations
about the Company’s disclosure and internal controls:
Disclosure controls and procedures
Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing, and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal control over financial reporting
Management’s annual report on internal control over financial reporting is included in Item 8. Financial Statements.
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) in fourth quarter 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
134. Defendants Dubuque and Murff then certified these false and misleading
representations, stating, in pertinent part:
1. I have reviewed this Annual Report on Form 10-K of Guaranty Financial Group Inc.;
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2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors;
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 45 of 84 PageID 330
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
135. These representations about the Company’s internal and disclosure controls and
certifications thereon were repeated in all material respects in the Forms 10-Q that Guaranty filed
with the SEC during the remainder of the Class Period.
136. The statements referenced above in paragraphs 132-134 were each materially false
and misleading for the following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
(b) the Bank employed flawed asset pricing models that materially overstated the
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial statements failed to disclose subsequent events;
(e) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(f) the Company’s internal and disclosure controls, which were wrongfully
certified by Defendant Dubuque and Murff, were materially deficient;
(g) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices; and
(h) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading.
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137. On April 29, 2008, Guaranty issued a press release announcing its earnings for the
2008 first quarter, the period ended March 31, 2008, which stated, in pertinent part, as follows:
Guaranty Financial Group Inc. (NYSE: GFG) (“Guaranty”) today reported a net loss of $10 million or $0.28 loss per share for the first quarter 2008 compared to $27 million net income for the first quarter 2007. Results include $60 million higher provision for credit loss in first quarter 2008 compared to first quarter 2007.
*
The carrying value of the investment portfolio decreased from $5.5 billion at December 31, 2007 to $4.9 billion at March 31, 2008. Approximately $419 million of this decline was a result of unrealized losses within securities categorized as available-for-sale, and the remaining approximately $200 million decline was a result of principal reduction and payoffs. This portfolio consists of agency and non-agency mortgage-backed securities, none of which are secured by sub-prime collateral, all of which remain triple-A rated, with significant levels of subordination as credit enhancement. Guaranty has not purchased and does not hold any non-agency securities that rely on support from bond insurers. Securities market conditions weakened considerably in the first quarter, and the unrealized losses on the entire portfolio of securities increased to nearly $1.1 billion, none of which were considered other than temporary impairments or recognized in earnings.
Defendant Murff commented on the results, stating, in pertinent part, as follows:
Market conditions certainly continued to deteriorate in the first quarter 2008. We experienced continued increases in non-performing loans in the first quarter, principally out of our homebuilder portfolio. We have increased our allowance for loan losses from $71 million at March 31, 2007 to $172 million at March 31, 2008, which increased our allowance as a percentage of total loans from .74% to 1.67% during that same period. However, during that time frame of increasing reserves by more than $100 million, actual net charge-offs were only $7 million. While we do not anticipate a recovery of the housing market in the near term, we believe that at this time we are appropriately reserved.
138. That same day, Guaranty held a conference call with analysts and investors to discuss
the Company’s earnings and operations. With respect to the MBS portfolio, Defendant Dubuque
attempted to minimize the Company’s risk by noting that such securities were not subprime or part
of subordinated tranches, but were AAA rated securities with high subordination levels, stating, in
pertinent part, as follows:
As to mortgage-backed securities. With respect to the amortized cost basis of $5.3 billion in mortgage-backed securities this is a relatively large proportion of our assets. All the securities are collateralized by adjustable rate, single-family
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Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 47 of 84 PageID 332
mortgages none of which are sub-prime. Approximately one-third of the securities are agency underwritten with a remaining two-thirds being private issuers. All of the securities were rated AAA at the time of purchase and continue to be rated AAA today.
It is worth noting that the rating agencies began a wave of downgrades of Mortgage-backed securities several months ago, and have downgraded a very substantial number of securities, mostly secured by sub-prime collateral and many of them are even more complex collateralized debt obligations or CDOs. Today, all our securities are still AAA rated. This is consistent with the story we have been telling for many months now, the securities that we purchased have standard structures with very high subordination levels. Not only are we not invested in sub-prime securities, none of the securities are collateralized debt obligations or subordinated instruments. Of course, we cannot predict with certainty whether securities that we own will be downgraded by one or more of the rating agencies in the future, but we continue to monitor developments in this area, and are working diligently to ascertain the market value and intrinsic value of these securities, which Ron will discuss in greater detail. We still have the intent and ability to hold these mortgage-backed securities to maturity and based upon our current analysis, we do not expect any credit losses within these securities.
139. During the conference call, Defendant Murff noted that the large increase in the
unrealized loss on portions of the MBS portfolio designated as “available-for-sale,” resulted in a
significant decrease in the Company’s reported shareholder equity and per share book value, stating,
in pertinent part, as follows:
Accordingly the decrease in shareholder equity of a little over $200 million is instead a reflection of the increase in accumulated/other comprehensive loss from $35 million to $272 million during the first quarter which, is the effect of further unrealized losses in our available-for-sale securities net of tax benefits, which I will discuss in greater detail in a moment. These unrealized losses on mortgage-backed securities also impacted our book value per share as noted here.
* * *
[ ] the only other thing I would add to that is as you can see, the primary reason for the tangible capital being at the level that it was because of the unrealized losses on the available for sale mortgage backed securities that get included as Other/ Comprehensive income in our stockholders equity section and therefore serve to reduce our tangible capital levels. So, again, we view those as temporary, as we have talked about the securities valuations
140. Indeed, the increase in the unrealized loss on Guaranty’s MBS portfolio resulted in a
diminution in the Company’s shareholders’ equity and prompted Guaranty to suspend the payment
- 45 -
LflL':!ii
Non-agency MBS Vintage % to Total
75%
50%
25%
0% <=2004 2005 2006 2007
Year of Onghuition
Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 48 of 84 PageID 333
of dividends to preserve its dwindling equity. As Defendant Murff noted, “[o]ur Board of Directors
made the decision to not pay a dividend in the first quarter, a reflection of the board’s focus to ensure
that the bank remains well capitalized, and our loss for the quarter was only $10 million.”
141. Then, in conjunction with the following slides which were provided for the
conference call, Defendant Murff provided additional detail about Guaranty’s MBS portfolio. First,
Defendant Murff provided information about the composition of the MBS portfolio, stating, in part:
Non-agency MBS Product Type
Unpaid PrncipI Balance % of
($ In billions) Total Tradthonal Option Amis $3.0 82% Hybrid Option Arm D4 13% Hybrid Arm TOTAL $3.7 100%
Non-agency MBS by State
California 59% Florida 12% Arizona 3% Other 8% Not available TOTAL 100%
19
On slide 19, we have prepared in slide to give an understanding of the type of securities we own. You can see that approximately 83% are traditional, option ARMs. 13% are hybrid option ARMs and the remaining 5% are hybrid ARMs. With respect to vintage, we show our securities vintage. The percentage that is 2007 vintage is a reflection of the approximately $1.1 billion in non-agent securities that we purchased in late ‘07, after we saw market disruptions in the securities market drive returns to the level that we included were attractive at that time.
142. Then, Defendant Murff provided information about the unrealized losses on the MBS
portfolio, stating, in pertinent part, as follows:
The next slide is an update to the slide we’ve used previously showing the amortized cost and fair values of our mortgage-backed securities as of March 31, 2008. In
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round numbers, the combined agencies securities available for sale and held to maturity have an amortized cost totaling approximately $1.64 billion and their total fair value is the same. Of the non-agency securities, those held to maturity have an amortized cost of approximately $2.35 billion and a fair value of approximately $1.7 billion for a difference of approximately $650 million.
The non-agency securities held available for sale have an amortized cost of approximately $1.36 billion and a carrying value of approximately $0.94 billion for a difference of $420 million. Total difference between the amortized cost and the fair value of all these securities is $1.07 billion.
In particular, however the approximately $421 million unrealized loss in available for sale securities is recorded net of tax benefit as Accumulated/Other comprehensive income on our balance sheet and as mentioned before decreases our book equity by such amount, in our case $272 million.
As of March 31, 2008 ($ Billions)
Available for Sale: Agency Non-agency
Held to Maturity: Agency Non-agency
Total
Non-agency MBS • Adjustable rate • All AAA rated
Amorlized Co1 Fair Value
$0.55 $1.36 $0.94
$1.09
$1.09
$2.35
$1.70
$5.35
$4.26
• Underlying collateral delinquency rate: 158% • Weighted average current LTV: 79% (current loan balnceIoriinaI araised value) • Weighted average current credit score: 707
20
143. During the conference call, Defendant Murff attempted to allay investor concerns
about the unrealized losses on the MBS portfolio by stressing, among other things, that the securities
were AAA rated and that high subordination levels “will result in no credit losses in our [MBS]
securities,” stating, in part:
As Ken mentioned each of these securities are adjustable rate backed by single family mortgages. Each of the private-issued securities were AAA-rated at the time
- 47 -
mnty
Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 50 of 84 PageID 335
of purchase and continue to be so. We have not invested in sub-prime securities, collateralized debt obligations or subordinated traunches.
As of March 31, the average delinquency rate for our non-agency securities was 15.6%. We have also shown you the current LTVs and the average original credit scores for these securities. None of these securities have an insurance wrapper, rather the AAA-rating we feel remains on each of these securities primarily as a result of the underwriting criteria of the underlying loans in a high level of subordination.
On slide number 21, we have shown that the subordination levels at issue date for all of the private label securities was an average of 10.7%. We have seen significant and growing subordination levels primarily as a result of prepayments that pay off our senior traunches first and the average subordination level of these private securities has increased to 15.5% at March 31, 2008. These sizeable and growing subordination levels provide protection from credit losses because other investors absorb the losses first. As we look at our securities only, $199 million of our $3.7 billion of non-agency securities by unpaid principal balance have subordination levels below 10%. We continue to believe that our high subordination levels will result in no credit losses in our securities.
Subordination Levels Non-agency MBS
20%
15%
10%
5%
0%
At Issue Mar-08
Significant and growing subordination levels provide protection from credit losses
21
144. Defendant Murff then provided information about how Guaranty valued its MBS
portfolio. Unlike after the end of the prior quarter, when Defendants refused to update investors
about the value of Guaranty’s MBS portfolio that was in free fall, Defendant Murff highlighted that,
- 48 -
GuapaM
Net Unrealized Losses on MBS Smo
1,2W
I ,fl
500
2
Case 3:11-cv-03119-B Document 30 Filed 04/19/12 Page 51 of 84 PageID 336
after the end of the March 31, 2008 quarter, the value of the MBS portfolio had increased by
approximately 5%, stating, in part:
On the next slide, we have prepared a brief discussion of the valuation of these securities and particularly the source of the valuations. With respect to agencies, estimated values are provided by vendor sources. With respect to non-agencies, we obtained bids on benchmark bonds from several Wall Street dealers and market participants. We utilized the median bid for each benchmark security to determine the market yield for the segment and we utilized market yields and discount cash flow analysis on each of the remaining 37 securities to estimate their fair value. As also noted on this slide there have been four sales in the market that have contributed to a further decline in non-agency MBS market values during the quarter.
However since the end of the quarter, we have seen estimated fair values get somewhat better, up approximately five points which would reduce total unrealized losses to the neighborhood of $900 million. Notwithstanding these fluctuations, because we are a buy-and-hold investor with the intent and ability to hold these securities to maturity, and we expect to receive all principal and interest on all of them, none of the unrealized losses are considered other than temporary impairments which means that the unrealized losses do not run through our income statement.
Source of Fair Values
Agency MBS Fair values provided by vendor sources
Non-agency MBS > Obtain bids on eight benchmark bonds (out of
45 issuances) from several Wall Street dealers and market participants. Utilize median bid for each benchmark security to determine market yield for segment
" Utilize market yields in discounted cash flow analysis on each of the remaining 37 securities to estimate their fair value.
- Forced sales in the market (Thornburg, Carlyle, Peeton) contributed to a further decline in non-agency MBS market values during the first quarter.
Regent changes: Estimated fair values up approximately 5 points compared to quarter end. Total estimated unrealized losses at 4123108 are approximately $900 million. 22
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145. The statements referenced above were materially false and misleading for the
following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(e) the Company’s internal and disclosure controls were materially deficient;
(f) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices;
(g) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading; and
(h) based on the foregoing, Defendants lacked a reasonable basis for their positive
statements about the Company and its MBS portfolio.
146. That same day, April 29, 2008, Guaranty filed with the SEC its Form 10-Q for the
quarter ended March 31, 2008 (the “Q1 2008 Form 10-Q”), which was signed by Defendant Gifford
and included financial statements for the period then ended that were represented to have been
presented in conformity with GAAP.
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147. With respect to the MBS portfolio, the Q1 2008 Form 10-Q noted that the MBS
portfolio consisted of securities that were senior or senior-support tranches, stating, in pertinent part,
as follows:
The mortgage-backed securities we purchased in 2007, 2006, and 2005, and a portion of the securities we purchased in prior years, have Option ARMs as the underlying assets. None of the securities include sub-prime loans. The amortized cost at March 31, 2008 of securities in our portfolio with Option ARMs as the underlying assets was $4.1 billion. Of these, $568 million were issued by U.S. Government Sponsored Enterprises (FNMA, FHLMC) and the remaining $3.5 billion are senior or senior-support tranches issued by non-agency institutions.
* * *
Though determination of fair value is currently difficult because of limited trading activity of these types of securities, information we’ve gathered about market activity resulted in us concluding the fair value, as defined in SFAS No. 157, of the non-agency mortgage-backed securities was $1.1 billion less than our amortized cost at March 31, 2008. We have recorded $419 million of this unrealized loss in the carrying value of securities we classify as available-for-sale; the remainder relates to securities we classify as held-to-maturity and therefore we have not recorded those declines in the carrying value of the related securities.
148. The Q1 2008 Form 10-Q also revealed that the approximate $1.1 billion loss on the
MBS portfolio resulted almost entirely from “internally valued” non-agency MBS:
Information about our mortgage-backed securities portfolio at March 31, 2008 follows: Net TJiirealized Net Unrealized
Losses on Losses on Held Amortized Available-for- Carring to-Maturity
Cost Sale Securities Value Securities Fair Value (In millions)
U.S. Government and U. S. Government Sponsored Enterprises $ 1,639 $ $ 1,639 $ $ 1,639
Non-agency: InterInll\ valued 3,514 (419) 3,095 (648) 2,447 Market quotes 189 189 (3) 186
$ 5.32 $ (419) $ 4 , 923 $ (651) $ 4.272
149. The statements referenced in the two preceding paragraphs were each materially false
and misleading for the following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
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(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(e) the Company’s internal and disclosure controls, which were wrongfully
certified by Defendant Dubuque and Murff, were materially deficient;
(f) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices; and
(g) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading.
150. In response to these revelations, the price of Guaranty common stock plummeted
nearly 19% to $8.43 per common share, or less than half of its value when it began trading
approximately four months prior, as the market absorbed the adverse news about the Company and
its MBS portfolio. Defendants, however, continued to conceal the true financial condition of the
Company.
151. On May 1, 2008, Guaranty filed an S-1 Registration Statement (the “S-1”) with the
SEC proposing to raise $300 million via an offering of Guaranty common shares issuable upon the
exercise of subscription rights (the “Rights Offering”).
152. On May 27, 2008, Guaranty filed a Form 8-K with the SEC announcing that the
Company entered into an investment agreement pursuant to which an institutional investor agreed to
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purchase 7,423,333 shares of the Company’s common stock at a price of $5.17 per share for an
aggregate purchase price of $38.4 million.
153. On June 4, 2008, Guaranty issued a press release announcing the extension of record
date for the Rights Offering to allow the Company to continue its then existing negotiations on a
private placement. The press release noted that Guaranty expected to offer all or a portion of shares
not otherwise purchased in the Rights Offering in an underwritten offering.
154. On June 9, 2008, Guaranty filed a Form 8-K with the SEC announcing that the
Company entered into investment agreements with several institutional investors pursuant to which
the Company had agreed to sell 5.54 million shares of its Series B Mandatory Convertible Perpetual
Cumulative Preferred Stock (the “Series B Preferred Stock”) for aggregate consideration of
approximately $286.6 million. Additionally, the Company and the Bank entered into a purchase
agreement with institutional investors pursuant to which the Company and the Bank agreed to sell to
such investors subordinated notes of the Bank with an aggregate original principal amount of $275
million and 638,000 shares of Series B Preferred Stock for $275 million.
155. On July 22, 2008, Guaranty issued a press release announcing its previously disclosed
private placement transactions had closed, resulting in total gross proceeds to the Company of
approximately $600 million.
156. On July 31, 2008, Guaranty issued a press release announcing its earnings for the
2008 second quarter, the period ended June 30, 2008, which stated, in pertinent part, as follows:
Guaranty Financial Group Inc. (NYSE: GFG) (“Guaranty” or the “Company”) today reported a net loss of $85 million, or $2.24 per share, for the second quarter 2008, compared to a net loss of $10 million for the first quarter 2008, and $24 million in net income for the second quarter 2007. The two primary issues impacting results for the second quarter 2008 were a provision for credit losses of $99 million and a $46 million charge to income tax expense to establish a valuation allowance on deferred tax assets.
Guaranty raised $38.4 million in common equity in a private placement during the second quarter 2008 through the issuance of 7.4 million shares of common stock. At
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June 30, 2008, Guaranty Bank exceeded “well capitalized” regulatory standards. After June 30, 2008, Guaranty raised an additional $562 million, before offering costs, through the issuance of convertible preferred stock and subordinated debt in a private placement closed and funded on July 21, 2008, resulting in total proceeds raised of approximately $600 million, excluding offering costs, when added to the $38.4 million common stock issuance during the second quarter. Following the additional capital raise, Guaranty Bank’s pro forma regulatory capital ratios were tier 1 leverage ratio of 9.5%, tier 1 risk-based ratio of 11.6% and total risk-based ratio of 14.6%, all of which further exceeded the “well capitalized” standards of 5%, 6% and 10%, respectively.
* * *
The carrying value of the investment portfolio decreased from $4.9 billion at March 31, 2008 to $4.6 billion at June 30, 2008. Approximately $100 million of this decline was a result of additional unrealized losses within securities categorized as available-for-sale, and the remaining decrease was a result of principal reduction and payoffs. This portfolio consists of agency and non-agency mortgage-backed securities, none of which are collateralized debt obligations, none of which are secured by sub-prime collateral, and all of which have significant levels of subordination as a credit enhancement. All except one of the non-agency securities remain triple-A rated. Guaranty has not purchased and does not hold any non-agency securities that rely on support from bond insurers. Securities market conditions weakened considerably during first six months 2008, and the net unrealized losses on the entire portfolio of securities increased to approximately $1.4 billion, none of which were considered other than temporary impairments or recognized in earnings.
157. Defendant Dubuque commented on the results, stating, in pertinent part, as follows:
We are disappointed with our financial results for the quarter; however, following our successful capital raise, we have strengthened our capital position further beyond the ‘well capitalized’ regulatory standards. Last quarter we announced we were focused on near-term strategies related to credit, costs and capital, and we made significant progress on all three areas. We addressed credit challenges head-on, we were successful in cutting compensation and benefits expenses during the second quarter, and the infusion of $600 million in new capital since the end of the previous quarter strengthens our balance sheet and reinforces our strong liquidity position. Today excess borrowing capacity is in excess of $4.5 billion. In addition, core operating revenue remains strong, as evidenced by the greater than 5% increases in net interest income and noninterest income versus the same period one year ago.
158. Defendant Murff added, in pertinent part, as follows:
We experienced continued increases in non-performing loans in the second quarter, principally out of our homebuilder portfolio and single-family mortgage portfolio. We have further increased our allowance for loan losses from $172 million at March 31, 2008 to $250 million at June 30, 2008, which strengthened our allowance as a percentage of total loans from 1.67% to 2.44% during that same period. While we
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still do not anticipate a recovery of the housing market in the near term, we believe we are appropriately reserved at this time.
159. That same day, Guaranty held a conference call with analysts and investors to discuss
the Company’s earnings and operations. With respect to its MBS portfolio, Defendant Murff
represented that the unrealized losses had ballooned to more than $1.4 billion at June 30, 2008,
stating, in part:
The next slide shows the amortized cost in fair values of our mortgage-backed securities in June 30, 2008. In round numbers, the combined agency securities available for sale and held to maturity have an amortized cost totaling 1.48 billion and the total fair value is the same. This is a decrease of approximately $160 million as a result of pay off. Of the non-agency securities, those held to maturity, have an amortized cost of approximately $2.28 billion and a fair value of approximately $1.38 billion for a difference of approximately $900 million. The non-agency securities held available for sale have an amortized cost of approximately $1.35 billion and a fair value of approximately $830 million for a difference of approximately $520 million. The total difference between the amortized cost and the fair value of all of these securities is $1.42 billion, which is an additional unrealized loss of $350 million compared to the previous quarter. $100 million of the increased unrealized loss was for securities held available for sale.
The total unrealized loss unavailable for sale securities is now $513 million, which is recorded net of tax benefit as accumulated other comprehensive loss on our balance sheet and decreases our book equity by such amount, in our case a total of $334 million to date as of June 30, 2008.
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As of June 30, 2008 ($ Billions)
Amortized Cost Fair Value
Available for Sale:
Agency $0.52 $0.52
Non-agency $1.35 $0.83
Held to Maturity:
Agency $0.96 $0.96
Non-agency $2.28 $1.38
Total: $5.11 $3.69
Non-agency MBS
Adjustable rate
Net Unrealized Lomes on MRS (in millions)
1,411 • Held to NA atunty
D..viIle icr Sale
1,070
265 ii 0 41E
013
Der:C17 Mar-cI* jijri-cI:
• Underlying collateral total delinquency rate (including foreclosure and REO): 20.5%
• Weighted average current LTV: 80% (current loan balance/original appraised value)
• Weighted average current credit score: 707
19
160
During the conference call, Defendant Murff attempted to allay investor concerns
about the unrealized losses on the MBS portfolio by stressing, among other things, that the
securities’ AAA rating and high subordination levels would enable Guaranty to receive “every dollar
of principal and interest” on such securities, stating, in pertinent part, as follows:
Each of the securities are adjustable rate and backed by single-family mortgages. Each of the private issued securities were triple-A rated at the time of purchase and all but one continue to be triple-A rated today. We have not invested in subprime securities, collateralized debt obligations, or subordinates traunches. At June 30, the average total delinquency rate of the underlying collateral for our non-agency securities was 20.5%. The average current LTV on the underlying loans was 80% based on current loan balance as a percent of the original appraised value. The average original credit score was 707. These securities do not have an insurance wrapper. Rather, we feel that the securities maintain their high ratings as a result of the underlying criteria -- underwriting criteria of the underlying loans and high levels of subordination.
On slide number 20 we show that the subordination level on average for all of our non-agency mortgage-backed securities is a 15.7%. On this slide we previously explain how we come to the conclusion that our significant subordination level of each security provides protection from credit losses. In our quarterly credit review of each non-agency security, we project credit losses on underlying loans for each
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security overage remaining of life using appropriate assumptions for default rates and loss severity. We determine the extent to which each security subordination level is sufficient to absorb the projected losses on the underlying loans. Our conclusion at June 30, 2008, was that the subordination level for each non-agency security continues to be sufficient to protect our securities from credit loss. We continue to expect that we will receive every dollar of principal and interest that is contractually due and we have the intent and the ability to hold the securities to maturity.
Quarterly Credit Review of each Non-Agency MBS: • Project credit losses on underlying loans for each security over its
remaining life, using appropriate assumptions for default rates and loss severity.
• Determine extent to which each security's subordination level is sufficient to absorb the projected losses on the underlying loans. As of 6/30/08: 15.7% average subordination level on non-agency MBS.
June 30, 2008 Conclusion: The subordination level for each non-agency security continues to be sufficient to protect our securities from credit loss. We continue to expect that we will receive every dollar of principal and interest that is contractually due. We have the intent and the ability to hold the securities to maturity.
Significant subordination levels provide protection from credit losses
20
161. In response to these revelations, the price of Guaranty common stock plummeted
nearly 16% as the market absorbed the adverse news about the Company and its MBS portfolio.
Defendants, however, continued to conceal the true financial condition of the Company.
162. The statements referenced above were materially false and misleading for the
following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
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(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial results were artificially inflated due to the Bank’s
failure to timely record at least a $483 million OTTI in fair value of it MBS portfolio, which, in turn,
inflated its reported income, retained earnings and regulatory capital;
(e) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(f) the Company’s internal and disclosure controls were materially deficient;
(g) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices;
(h) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading; and
(i) based on the foregoing, Defendants lacked a reasonable basis for their positive
statements about the Company and its MBS portfolio.
163. On August 11, 2008, Guaranty filed with the SEC its Form 10-Q for the quarter
ended June 30, 2008 (the “Q2 2008 Form 10-Q”), which was signed by Defendant Gifford and
represented that Guaranty’s financial statements contained therein, for the periods then-ended, were
presented in conformity with GAAP.
164. With respect to the MBS portfolio, the Q2 2008 Form 10-Q noted that MBS portfolio
consisted of senior or senior-support tranches, stating, in part:
A significant amount of the mortgage-backed securities we own have Option ARMs as the underlying assets. None of the securities include sub-prime loans as
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underlying assets. The amortized cost at June 30, 2008 of securities in our portfolio with Option ARMs as the underlying assets was $4.0 billion. Of these, $540 million were issued by U.S. Government Sponsored Enterprises (FNMA, FHLMC) and the remaining $3.5 billion are senior or senior-support tranches issued by non-agency institutions.
165. The statements referenced above in paragraphs were materially false and misleading
for the following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial results were artificially inflated due to the Bank’s
failure to timely record at least a $483 million OTTI in fair value of it MBS portfolio, which, in turn,
inflated its reported income, retained earnings and regulatory capital;
(e) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(f) the Company’s internal and disclosure controls, which were wrongfully
certified by Defendants Dubuque and Murff, were materially deficient;
(g) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices; and
(h) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading
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166. On August 26, 2008, Guaranty issued a press release announcing retirement of
Defendant Jastrow as Guaranty’s Board Chairman and Defendant Dubuque’s election to replace him
in such capacity.
167. On October 6, 2008, the Company issued a press release announcing that Defendant
Gifford would resign from his position as Guaranty’s Principal Accounting Officer effective October
27, 2008 and that Defendant Murff would assume Defendant Gifford’s duties and responsibilities.
168. On November 5, 2008, Guaranty issued a press release announcing its earnings for
the 2008 third quarter, the period ended September 30, 2008. The Company also announced that it
had committed to a workforce reduction of approximately 4% of the Company’s employees in order
to reduce costs and maximize operational efficiency. The press release stated, in pertinent part, as
follows:
Guaranty Financial Group Inc. (NYSE: GFG) (“Guaranty” or the “Company”) today reported a net loss of $162 million for the third quarter 2008, compared to a net loss of $85 million for the second quarter 2008, and $21 million in net income for the third quarter 2007. Three primary non-cash charges impacting results for the third quarter 2008, which totaled $152 million, are an $85 million deferred income tax asset valuation charge, a $53 million other-than-temporary-impairment charge on a mortgage-backed security, and a $14 million impairment charge on goodwill and intangible assets related to the Company’s insurance agency. The results also include provision for credit losses of $78 million.
Guaranty raised $562 million in capital, before offering costs, through the issuance of subordinated debt and convertible preferred stock in a private placement closed and funded during the third quarter 2008. Total capital raised in the second and third quarters of 2008 is approximately $600 million, excluding offering costs, when added to the $38.4 million in capital raised during the last part of the second quarter 2008. The convertible preferred shares and accrued dividends were converted to approximately 63.5 million shares of common stock on October 1, 2008. With the new capital, Guaranty Bank’s regulatory capital ratios at September 30, 2008 were tier 1 leverage ratio of 9.0%, tier 1 risk-based ratio of 9.7% and total risk-based ratio of 12.6%, all of which exceeded the “well capitalized” standards of 5%, 6% and 10%, respectively.
*
Third quarter 2008 noninterest income included a $53 million charge for other-than- temporary impairment on one of the Company’s non-agency mortgage-backed
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securities and a $4 million loss on the sale of mortgage-backed securities, which resulted in overall noninterest income that was a loss of $19 million for third quarter 2008, compared to noninterest income of $41 million for the second quarter 2008.
* * *
The carrying value of the investment portfolio decreased from $4.6 billion at June 30, 2008 to $4.0 billion at September 30, 2008. Approximately $200 million of this decline was a result of principal reduction and payoffs. The Company also sold agency securities totaling approximately $400 million. This portfolio consists of agency and non-agency mortgage-backed securities, none of which are collateralized debt obligations, none of which are secured by sub-prime collateral, and all of which have significant levels of subordination as a credit enhancement. Guaranty has not purchased and does not hold any non-agency securities that rely on support from bond insurers.
169. Defendant Dubuque commented on the results, stating, in pertinent part, as follows:
We are pleased to have completed the private placement during the quarter that resulted in approximately $600 million of new capital since May 2008, which strengthened our balance sheet and liquidity position. We have also recently benefited from a net inflow of $1.8 billion in deposits in the month of October alone, which is an increase of approximately 20% since the end of the prior month. Today excess borrowing capacity is in excess of $5.7 billion. On the other hand, we are disappointed with our financial performance for the quarter, which included three non-cash charges totaling $152 million during the quarter.
170. That same day, Guaranty held a conference call with analysts and investors to discuss
the Company’s earnings and operations. With respect to its MBS portfolio, Defendant Murff
represented that Guaranty had sold approximately $400 million in agency securities and had
recorded a $53 million OTTI on one non-agency MBS security. With respect to its MBS securities
portfolio, Defendant Murff discussed the valuation of the MBS portfolio, stating, in pertinent part, as
follows:
First in valuing each non-agency security, we found that there are currently no observable transactions for our non-agency mortgage backed securities and little reliable observable evidence. Broker price estimates we received for these securities vary widely from broker to broker. The SEC advised the both recently addressed fair value measurements when there are few observable transactions for a financial instrument. As a result of the issuance of the SEC memorandum and the FASB staff position 157-3, we place somewhat less weight on non-binding indicative broker quotations for the non-agency securities than we have in previous periods.
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Beginning in third quarter 2008, in addition to considering dealer indicative value estimates, we incorporated the results of a multiple path valuation approach prepared for us by a third party as a significant input in our determination of the fair value of our internally valued non-agency securities. We believe the third party valuation approach incorporates market participant assumptions including required return.
VaI.ualion.Ø.each NUn•Aincy MBS: •
Currently no obseivalble lransaclioris for our rIDn-agency MS, and little reliable obserbIe evidence. *
Broker price estimates vary widely from broker-to-brcker. • The SEC and FASB both rec&tIy addressed lair value measurements there are tew abvab1e
transactions for a financial instrument. Asa result, we placed somewhat less weight on non-binding iicalive broker quotations for the non-agency Eecurties than in previous periods.
•
Beginning in third qtjarter 2008 in addition o wrisideringdealer indbinptive vqlueeshmtes, irrxred Ilie resuhs of a multiple-path valuation approach p-epared by 6 ihirdjrty as a significant input ii our rILrmination of fair value ofur internally vIued non-agency securities- The third party valuation approach incorporates market participant umptkns, including required rern
$tmbr 30,20H OTTI Analysis' OIine extentto which adi bcndS credit enIanCaM6nL(wF1ich is primly in tfcm of suwrdinalion) is sufficient to absb the pojeted oses on the unidadwnq 1ons. As ot913O/O: approximately 16% average subDrdInaton level on non-agency MES.
•
Other than the security for wIicl we recorded an other -than -tmpor-n1j irment to reduce the c3nylrig amount S53 million 1 $79 million:
- We consider tie unrealized losses on the secuirifies we own to be temporary-
We have the intent and w eivewe have the ability to hold them '.1ti1 rpymern, - We believe, based on our current estimates of cash flows on the securities, we 'MI I receive all stated
interest and principal. Each of the ni>n-ancy secuntis is credit-enhane1 pnmanly by subrdint lrannes rc(oied by us, which will absorb credit losses of the u riderlying bans Until those 1rnchs are depleted- We vLirrriIIy estimate the credit Loes on the undedyipig kiis will not exceed those subordinate tranzInesard QlI1rfrn1 oi ditenhnerjirt. Ther?ore. our seGUrl 'Mil not iincur credit
171. During the conference call, Defendant Murff then attempted to justify Guaranty’s
belated OTTI charge, stating,in part:
Then in doing our OTTI analysis, we determined the extent to which each bond’s credit enhancement primarily in the form of subordination is sufficient to absorb the projected losses on the underlying loans. Our conclusion at September 30, was that the subordination level for each non-agency security except one continues to be sufficient to protect our securities from credit loss.
Other than the security for which we recorded in other then temporary impairment to reduce the carrying amount, $43 million to $79 million, we consider the unrealized losses on the securities we own to be temporary. We have the intent and we believe we have the ability to hold them until repayment and we believe based on current estimates of cash flows on these securities we will receive all stated interest and principal.
Each of the non-agency securities is credit enhanced primarily by subordinated tranches not owned by us, which will absorb credit losses of the underlying loans
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until those tranches are depleted. We currently estimate the credit losses on the underlying loans will not exceed those subordinated tranches and therefore our securities will not incur credit loss. With respect to the one security for which we recorded in other then temporary impairment, although we reduced the carrying amount $53 million to $79 million it is very important to recognize that in our analysis the amount that we projected as our best estimate of actual credit loss on the security was only $2.5 million out of a security with an unpaid principal balance well over $100 million. Nonetheless the accounting rules require that we take an impairment charge of $53 million based on the valuation method discussed above. Moving now to efficiency on slide number 18, non-interest expense was $105 million for the quarter, an increase of 6% compared to the prior quarter. However, as we’ve mentioned earlier in this call, we expensed $14 million impairments related to our insurance agency. Outside of that charge, our non-interest expenses were down significantly from $96 million in the second quarter of this year, net of the severance cost during that quarter to $91 million this quarter, excluding the $14 million impairment charge
172. In response to these revelations, the price of Guaranty common stock declined 20% as
the market absorbed the adverse news about the Company. Defendants, however, continued to
conceal the true financial condition of the Company.
173. The statements referenced above were materially false and misleading for the
following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial results were artificially inflated due to the Bank’s
failure to timely record at least a $483 million OTTI in fair value of it MBS portfolio, which, in turn,
inflated its reported income, retained earnings and regulatory capital;
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(e) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(f) the Company’s internal and disclosure controls were materially deficient;
(g) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices;
(h) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading; and
(i) based on the foregoing, Defendants lacked a reasonable basis for their positive
statements about the Company and its MBS portfolio.
174. On November 11, 2008, Guaranty filed with the SEC its Form 10-Q for the quarter
ended June 30, 2008 (the “Q3 2008 Form 10-Q”), which was signed by Defendant Murff and
represented that Guaranty’s financial statements contained therein, for the periods then-ended, were
presented in conformity with GAAP. With respect to the MBS portfolio, the Q3 2008 Form 10-Q
noted that the MBS portfolio consisted of securities that were senior or senior-support tranches,
stating, in part:
A significant amount of the mortgage-backed securities we own have Option ARMs as the underlying assets. None of the securities include sub-prime loans as underlying assets. The amortized cost at September 30, 2008 of securities in our portfolio with Option ARMs as the underlying assets was $3.6 billion. Of these, $249 million were issued by U.S. Government Sponsored Enterprises (FNMA, FHLMC) and the remaining $3.3 billion are senior or senior-support tranches issued by non-agency institutions.
175. The statements referenced in the preceding paragraph were each materially false and
misleading for the following reasons:
(a) nearly one-half of the Company’s MBS portfolio was subordinated Junior
MBS that were subject to significantly greater risk of loss and possessed lower subordination levels
than senior tranche MBS;
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(b) the Bank employed flawed asset pricing models that materially overstated that
value of the MBS portfolio and created a false impression about the financial solvency of the
Company;
(c) the Company’s financial results were artificially inflated due to the Bank’s
failure to state the MBS portfolio at its true fair value;
(d) the Company’s financial results were artificially inflated due to the Bank’s
failure to timely record at least a $483 million OTTI in fair value of it MBS portfolio, which, in turn,
inflated its reported income, retained earnings and regulatory capital;
(e) the Company’s financial reporting misrepresented its true financial condition,
liquidity, capital and ability to satisfy its future debt obligations as they matured;
(f) the Company’s internal and disclosure controls, which were wrongfully
certified by Defendant Dubuque and Murff, were materially deficient;
(g) the Company, through the Bank, was engaged in unsafe and/or unsound
banking practices; and
(h) the Company’s financial statements were not fairly presented in conformity
with GAAP and were materially false and misleading
176. On November 19, 2008, the Company issued a press release announcing Defendant
Dubuque’s resignation from his position as Guaranty’s Chairman of the Board, President and CEO
effective November 18, 2008. The Company also announced the appointment of Kevin J. Hanigan
(“Hanigan”), former Senior Executive Vice President and Chief Banking Officer of the Company
and the Bank, to fill the role of President and Chief Operating Officer of the Company and the Bank.
177. On December 17, 2008, the Company issued a press release announcing its
commitment to reduce its workforce by approximately 10%, or approximately 250 employees.
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178. On January 2, 2009, Guaranty filed a Form 8-K with the SEC announcing that it sold
its wholly-owned subsidiary, Guaranty Insurance Services, Inc. for approximately $40 million,
effective December 31, 2008.
179. On March 17, 2009, the Company filed a Form NT 10-K with the SEC, disclosing
that it was unable to timely file its Form 10-K for the year ended December 31, 2008 due to an
ongoing “analysis and discussion” with its accountants concerning the appropriateness of the
valuation of its MBS portfolio and the extent to which such portfolio had incurred an OTTI. In
addition, Guaranty disclosed that it expected to report a loss of at least $444 million, or a loss of
$8.84 per diluted share, for the year ended December 31, 2008, stating, in pertinent part:
Guaranty Financial Group Inc. (the “Company”) is filing this Notification of Late Filing on Form 12b-25 with respect to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 (the “Form 10-K”). The Company is unable, without unreasonable effort and expense, to timely file the Form 10-K because the Company has not completed its financial statements for the fiscal year ended December 31, 2008. The Company is continuing to analyze and to discuss with its independent registered public accountants the appropriate valuation for balance sheet purposes of its mortgage-backed securities portfolio, including the extent of other than temporary impairment of this portfolio. The outcome of this analysis could affect, among other things, the adequacy of the Company’s capital and the extent to which additional capital will be appropriate. The Company is also discussing the extent, and potential terms and conditions, of required new capital with its board of directors and its principal stockholders, as well as with government authorities. The Company currently expects to file the Form 10-K no later than the fifteenth calendar day following the prescribed due date.
*
The Company expects to report a loss of $444 million, or a loss of $8.84 per diluted share, for the year ended December 31, 2008, compared to earnings of $78 million, or $2.20 per diluted share, for the year ended December 31, 2007. Depending on the outcome of the Company’s continuing review of the appropriate valuation for balance sheet purposes of its mortgage-backed securities portfolio, including the extent of other than temporary impairment of this portfolio, the loss actually reported by the Company could be higher.
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180. On March 31, 2009, Guaranty filed a Form 8-K with the SEC stating that on “a
preliminary unaudited basis,” the Bank had fallen below the capital ratios prescribed by the OTS,
stating, in pertinent part, as follows:
Guaranty Financial Group Inc. (the “Company”) is filing this Report on Form 8-K to disclose that it has not completed its financial statements for the fiscal year ended December 31, 2008, and that accordingly it has not filed its Annual Report on Form 10-K for that year on a timely basis. As previously disclosed, the Company continues to review with its independent registered public accountants the appropriate valuation for balance sheet purposes of its mortgage-backed securities portfolio, including the extent of other-than-temporary impairment of this portfolio. The outcome of this analysis could affect, among other things, the adequacy of the Company’s capital. This analysis could be affected by pending action by the Financial Accounting Standards Board with respect to the recognition and presentation of other-than-temporary impairment, as outlined in Proposed FASB Staff Position FAS 115-a, FAS 124-a, and EITF 99-20-b.
On June 8, 2008, the Company disclosed that Guaranty Bank’s board of directors adopted a resolution, at the request of the Office of Thrift Supervision (“OTS”), confirming, among other things, that Guaranty Bank will maintain Core and Risk-based capital ratios of at least 8% and 11%, respectively. On a preliminary unaudited basis, we believe that we have fallen below these prescribed capital ratios as of March 31, 2009. Our capital ratios could be impacted by the anticipated decision of the Financial Accounting Standards Board discussed above. These ratios are also impacted by regulatory requirements for capital treatment of our mortgage-backed securities portfolio. Guaranty Bank is discussing with OTS the capital treatment of our mortgage-backed securities, and additional enforcement action beyond the capital maintenance resolution.
Also, as previously disclosed, on a preliminary unaudited basis the Company anticipates that it will report that it incurred a loss of $444 million, or a loss of $8.84 per diluted share, for the year ended December 31, 2008, compared to earnings of $78 million, or $2.20 per diluted share, for the year ended December 31, 2007. Depending on the final determination of the appropriate valuation of the mortgage-backed securities portfolio, including the extent of other-than- temporary impairment of this portfolio, the loss actually reported by the Company could be higher.
The Company is in discussions with its board of directors and principal stockholders, as well as with government authorities, concerning raising substantial additional equity capital which, if completed, would result in significant dilution for the current common stockholders. No agreements have been reached with respect to this capital infusion.
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181. On March 31, 2009, the Company filed a second Form NT 10-K with the SEC (as
corrected), disclosing its continued inability to file its Form 10-K for the year ended December 31,
2008.
182. On April 8, 2009, Guaranty filed a Form 8-K with the SEC announcing that it, and
the Bank, had both consented to the issuance of a Cease and Desist Order (the “Order”) by the OTS,
requiring them to notify and/or obtain OTS approval before engaging in certain transactions and
maintain certain capital requirements. Guaranty also disclosed that if, by May 21, 2009, the Bank
does not meet the required capital ratios set forth in the Order, the Company and the Bank shall
adopt plans detailing the actions to be taken to merge with or be acquired by another federally
insured depository institution, or voluntarily liquidate by filing an appropriate application with the
OTS, stating, in part:
On April 6, 2009, Guaranty Financial Group Inc. (the “Company”) and its wholly-owned subsidiary, Guaranty Bank (the “Bank”) each consented to the issuance of an Order to Cease and Desist (the “Company Order” and the “Bank Order,” respectively, and together, the “Orders”) by the Office of Thrift Supervision (the “OTS”).
The Company Order requires that the Company notify, and in certain cases receive the permission of, the OTS prior to: (i) declaring, making or paying any dividends or other capital distributions on its capital stock; (ii) incurring, issuing, renewing, repurchasing or rolling over any debt, increasing any current lines of credit or guaranteeing the debt of any entity; (iii) making payments (including, without limitation, principal, interest or fees of any kind) on any existing debt; (iv) making certain changes to its directors or senior executive officers; (v) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; and (vi) making any golden parachute payments or prohibited indemnification payments.
The Bank Order requires that the Bank notify, or in certain cases receive the permission of, the OTS prior to (i) increasing its total assets in any quarter in excess of an amount equal to net interest credited on deposit liabilities during the quarter; (ii) rolling over or renewing any brokered deposits or accepting any new brokered deposits or soliciting any deposits by offering interests rates higher than those permissible for brokered deposits; (iii) making certain changes to its directors or senior executive officers; (iv) entering into, renewing, extending or revising any contractual arrangement related to compensation or benefits with any of its directors or senior executive officers; (v) making any golden parachute or prohibited
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indemnification payments; (vi) paying dividends or making other capital distributions on its capital stock; (vii) entering into certain transactions with affiliates; and (viii) entering into third-party contracts outside the normal course of business.
The Orders also require that the Bank meet and maintain both a core capital ratio equal to or greater than 8.0 percent and a total risk-based capital ratio equal to or greater than 11.0 percent. The Bank must also submit to the OTS within prescribed time periods a liquidity management and contingency plan, a revised Fair Value/OTTI Policy, a commercial real estate risk assessment plan, a risk management policy, a revised allowance for loan and lease loss policy, a strategic plan and policy for management and disposition of real estate owned, a loan modification plan, and a revised business plan.
Simultaneous to the effective date of the Orders, the Company and the Bank advised the OTS that management believes, based upon presently available unaudited financial information, that the Bank does not meet the required capital ratios set forth above. The Company is in discussions with its board of directors and principal stockholders, as well as with government authorities, concerning raising substantial additional equity capital which, if completed, would result in significant dilution for the current common stockholders. No agreements have been reached with respect to this capital infusion. If by May 21, 2009 the Bank does not meet the required capital ratios set forth above, either through a successful capital raise or otherwise, the Company and the Bank shall adopt plans detailing the actions to be taken to merge with or be acquired by another federally insured depository institution, or voluntarily liquidate by filing an appropriate application with the OTS. As previously disclosed, the Bank’s capital ratios are impacted by regulatory requirements for capital treatment of our mortgage-backed securities portfolio. The Bank is discussing with government authorities the capital treatment of its mortgage-backed securities. The results of these discussions may affect the Bank’s ability to comply with the minimum capital ratio requirements set forth in the Orders.
183. On May 14, 2009, the Company filed a Form NT 10-Q with the SEC, which disclosed
that Guaranty was unable to timely file its Form 10-Q for the quarter ended March 31, 2009 due to
the ongoing analyses and discussions with its accountants about the appropriateness of the valuation
of its MBS portfolio and the extent to which such portfolio had incurred an OTTI, stating, in
pertinent part, as follows:
Guaranty Financial Group Inc. (the “Company”) is filing this Notification of Late Filing on Form 12b-25 with respect to the Company’s Quarterly Report on Form 10- Q for the quarter ended March 31, 2009 (the “First Quarter 2009 Form 10-Q”). The Company is unable, without unreasonable effort and expense, to timely file the First Quarter 2009 Form 10-Q because the Company has not completed its financial statements for the fiscal year ended December 31, 2008 or the quarter ended March
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31, 2009. The Company is continuing to analyze and to discuss with its independent registered public accountants the appropriate valuation for balance sheet purposes of its mortgage-backed securities portfolio, including the extent of other-than-temporary impairment of this portfolio. The outcome of this analysis could affect, among other things, the adequacy of the Company’s capital and the extent to which additional capital will be appropriate. The Company is in discussions with its board of directors and principal stockholders, as well as with government authorities, concerning raising substantial additional equity capital which, if completed, would result in significant dilution for the current common stockholders. No agreements have been reached with respect to this capital infusion. As previously disclosed in the Current Report on Form 8-K filed by the Company on April 6, 2009 (the “Current Report”), the Company and its wholly-owned subsidiary, Guaranty Bank (the “Bank”) each consented to the issuance of an Order to Cease and Desist (the “Company Order” and the “Bank Order,” respectively, and together, the “Orders”) by the Office of Thrift Supervision (the “OTS”), which Order places material restrictions on the operations of the Bank and the Company, including the requirement that the Bank meet and maintain both a core capital ratio equal to or greater than 8.0 percent and a total risk-based capital ratio equal to or greater than 11.0 percent by May 21, 2009. Please see the Current Report for a more detailed description of the terms of the Orders. If by May 21, 2009 the Bank does not meet the required capital ratios set forth in the Orders, either through a successful capital raise or otherwise, the Company and the Bank shall adopt plans detailing the actions to be taken to merge with or be acquired by another federally insured depository institution, or voluntarily liquidate by filing an appropriate application with the OTS.
184. On June 29, 2009, the Company filed a Form 8-K disclosing that Guaranty’s Board of
Directors and management determined that the only remaining means by which the Company might
possibly raise sufficient capital to comply with the Order is through a plan for open bank assistance,
which would involve a significant equity capital infusion from private investors. The Company also
disclosed that if the FDIC did not approve such a plan: (a) it would no longer have the intent and
ability to hold its MBS portfolio; (b) it would be required to take material charges relating to the
impairment of assets; (c) substantial doubt about its ability to continue as a going concern would
exist; and (d) the preliminary financial information it provided for the periods ended December 31,
2008 and March 31, 2009, should not be relied upon.
185. On July 10, 2009, the Company filed a Form 8-K with the SEC announcing, among
other things, that Defendant Murff had resigned as the Company’s Senior Executive Vice President,
CFO and Chief Accounting Officer, and that Guaranty’s Board of Directors had appointed Raffaele
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to assume Defendant Murff’s duties and responsibilities on that date. The Company also announced
that Hanigan was elected to serve as Chairman of the Board of Directors and CEO in addition to his
role as President of Guaranty.
186. On July 23, 2009, the Company filed a Form 8-K with the SEC announcing that, at
the OTS’s direction, the Bank filed an amended TFR as of and for the three months ended March 31,
2009. The amended TFR reflected substantial Bank asset write downs, including a write down of
non-agency MBS resulting in an impairment charge in the amount of $1.45 billion and a goodwill
impairment in the amount of $106.6 million. The Company also announced its ability to continue as
a going concern was not probable and that a receiver or conservator of the Bank would be appointed,
stating, in part:
As previously disclosed in a Current Report on Form 8-K filed on June 29, 2009, Guaranty Financial Group Inc. (the “Company”) has been working on a plan to raise substantial capital for it and its wholly-owned subsidiary, Guaranty Bank (the “Bank”) through an open bank assistance transaction with the Federal Deposit Insurance Corporation (“FDIC”) and the Office of Thrift Supervision (“OTS”) and with private investors, including the Company’s current principal stockholders. On July 17, 2009, at the direction of OTS, the Bank filed an amended Thrift Financial Report (“TFR”) as of and for the three months ended March 31, 2009. This filing reflected substantial asset write downs as described below, which resulted in the Bank having negative capital reflected in the TFR as of that date.
The Company believes that these write downs foreclosed the possibility of applying for open bank assistance. Our primary stockholders have not affirmed their willingness to commit to a capital infusion in support of such an application. As a result, the Company no longer believes that it will be possible for the Company or the Bank to raise sufficient capital to comply with the Orders to Cease and Desist described in the Company’s Current Report on Form 8-K filed on April 8, 2009. In light of these developments, the Company believes that it is probable that it will not be able to continue as a going concern.
The Company continues to cooperate with the OTS and the FDIC as they pursue potential alternatives for the business of the Bank. Any such transaction would not be expected to result in the receipt of any proceeds by the stockholders of the Company.
In connection with this process, the OTS has directed that the Board of Directors of the Bank consent to the OTS exercising its statutory authority to appoint the FDIC as receiver or conservator for the Bank. If the FDIC is so appointed, the FDIC, rather
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than the Board, would control the operations of the Bank. The Board has complied with the OTS demand for such consent, but the appointment of a receiver or conservator has not yet occurred. In the meantime the Board continues to function, but the OTS is exercising a significant degree of control over what had heretofore been the functions of the Board.
The amended TFR as of and for the three months ended March 31, 2009 reflected the following adjustments:
• An adjustment to write down the non-agency mortgage-backed securities to estimated fair value (including the write off of the related deferred tax assets) resulting in an impairment charge in the amount of $1,450.3 million; and
• an adjustment to write off goodwill in the amount of $106.6 million.
Based on these adjustments, the Bank’s core capital ratio stood at negative 5.78% as of March 31, 2009. The Bank’s total risk based capital ratio as of March 31, 2009 stood at negative 5.52%. Both of these ratios result in the Bank being considered critically under-capitalized under regulatory prompt corrective action standards.
187. On August 17, 2009, the Company filed a Form NT 10-Q with the SEC, which
disclosed that Guaranty was unable to timely file its Form 10-Q for the quarter ended June 30, 2009.
188
On August 21, 2009, the OTS closed the Bank and appointed the FDIC as receiver.
189
On August 24, 2009, the Company filed a Form 8-K with the SEC disclosing that the
Bank was closed by the OTS and that the FDIC was appointed as receiver to the Bank. The
Company also disclosed that the NYSE had suspended trading in Guaranty’s common stock.
190. On August 27, 2009, Guaranty filed for bankruptcy protection pursuant to Chapter 11
of the Bankruptcy Code. Guaranty’s directors resigned immediately after the bankruptcy filing.
191. Thus, slightly more than 15 months after the Spin-Off, the financial institution that
Temple Inland had repeatedly trumpeted before the Spin-Off as being well capitalized, and had
repeatedly promised would be appropriately capitalized at the time of the Spin-Off, had negative
capital and was critically undercapitalized.
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Additional Scienter Allegations
192. As alleged herein, Defendants acted with scienter in that they knew, or recklessly
disregarded, that the public documents and statements they issued and disseminated to the investing
public in the name of the Company, or in their own name during the Class Period, were materially
false and misleading. Defendants knowingly and substantially participated or acquiesced in the
issuance or dissemination of such statements and documents as primary violations of the federal
securities laws. Defendants, by virtue of their receipt of information reflecting the true facts
regarding Guaranty, their control over, and/or receipt and/or modification of Guaranty’s allegedly
materially misleading misstatements, were active and culpable participants in the fraudulent scheme
alleged herein.
193. Defendants knew and/or recklessly disregarded the falsity and misleading nature of
the information which they caused to be disseminated to the investing public. The fraudulent
scheme described herein could not have been perpetrated during the Class Period without the
knowledge and complicity or, at least, the reckless disregard of the personnel at the highest levels of
the Company, including the Individual Defendants.
194. The Individual Defendants, because of their respective positions, controlled the
contents of the Company’s public statements during the Class Period. Each Defendant was provided
with or had access to copies of the documents alleged herein to be false and/or misleading prior to or
shortly after their issuance and had the ability and opportunity to prevent their issuance or cause
them to be corrected. Because of their positions and access to material non-public information, these
Defendants knew or recklessly disregarded that the adverse facts specified herein had not been
disclosed to and were being concealed from the public and that the positive representations that were
being made were false and misleading. As a result, each of these Defendants is responsible for the
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accuracy of Guaranty’s corporate statements and are therefore responsible and liable for the
representations contained therein.
195. Defendants engaged in deceptive and fraudulent conduct that was designed to, and
did, mask the financial infirmity of the Bank.
196. During the Class Period, Defendants repeatedly, and falsely, claimed that the MBS
portfolio was safe and insulated from credit risk because Guaranty’s MBS portfolio consisted solely
of senior tranche securities, when, in fact, nearly one-half of such securities were junior MBS.
Furthermore, Defendants discussed the Bank’s purchase of junior MBS at an ALCO meeting prior to
the beginning of the Class Period.
197. Defendants knew or recklessly ignored that their mischaracterization of nearly half of
the Guaranty MBS portfolio as senior tranche securities also resulted in a material overstatement in
the value of the MBS portfolio during the Class Period. In addition, prior to and during the Class
Period, Defendants chose to disregard repeated warnings about the numerous deficiencies existing
in the asset pricing model that the Bank utilized to “internally value” the MBS portfolio, as detailed
herein.
198. As a result of the foregoing, Defendants knew, or recklessly ignored, that the reported
fair values and unrealized losses on Guaranty’s MBS portfolio during the Class Period were
otherwise false, unsupportable and not honestly believed when made.
199. In addition, as detailed herein, during the Class Period, Defendants ignored numerous
red flags indicating that the Bank’s MBS portfolio had suffered a nearly half a billion OTTI no later
than June 30, 2008. Confronted with these red flags and the objections voiced by the OTS about the
existence of an OTTI in the MBS portfolio in the second quarter of 2008, Defendants displayed
conscious indifference to the dictates of GAAP and failed to record an OTTI in the value of the MBS
portfolio.
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200. The scienter of Defendants is also evidenced by the Sarbanes-Oxley mandated
certifications of Defendants Dubuque and Murff, who acknowledged their responsibility to investors
for establishing and maintaining controls to ensure that material information about Guaranty was
made known to them and that the Company’s disclosure related controls were operating effectively.
201. Defendants were motivated to engage in the fraudulent course of conduct alleged
herein in order to facilitate the Company’s ability to raise desperately needed capital. Indeed, the
fraud alleged herein enabled Guaranty to procure over $600 million in financing at a time when
capital raising in the marketplace had screeched to a halt. Those proceeds would have been
unobtainable but for Defendants’ fraudulent concealment of the fact that Guaranty was insolvent and
its loan portfolio was grossly overstated during the Class Period. Indeed, Guaranty Defendants
pushed forward with the Company’s capital raising efforts during the Class Period when they knew
that the Company was undercapitalized and insolvent and that its MBS portfolios were grossly
overstated.
Loss Causation/Economic Loss
202. During the Class Period, as detailed herein, Defendants engaged in a scheme to
deceive the market and a course of conduct that artificially inflated the prices of Guaranty common
stock and operated as a fraud or deceit on Class Period purchasers of Guaranty common stock. By
failing to disclose and misrepresenting the adverse facts associated with Guaranty’s MBS portfolio,
among other adverse facts detailed herein, Defendants presented a false and misleading picture of
Guaranty’s financial condition. Defendants’ false and misleading statements had the intended effect
of causing Guaranty common stock to trade at artificially inflated levels throughout the Class Period,
trading as high as $18.50 per share during the Class Period.
203. As Defendants’ prior misrepresentations and fraudulent conduct seeped into and were
absorbed by the marketplace, the price of Guaranty common stock declined as the prior artificial
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inflation came out. As a result of their purchase and/or acquisition of Guaranty common stock
during the Class Period, Plaintiff and the other Class members suffered economic loss, i.e. , damages,
under the federal securities laws.
204. The decline in Guaranty common stock during the Class Period was a direct result of
the nature and extent of Defendants’ fraud being absorbed and understood by investors and the
market through a series of partial disclosures. The timing and magnitude of the price decline in
Guaranty common stock negates any inference that the loss suffered by Plaintiff and the other Class
members was caused by changed market conditions, macroeconomic or industry factors or
Company-specific facts unrelated to Defendants’ fraudulent conduct. Accordingly, the economic
loss, i.e. , damages, suffered by Plaintiff and the other Class members was a direct result of
Defendants’ fraudulent scheme to artificially inflate the prices of Guaranty common stock and the
subsequent declines in the value of Guaranty common stock was the result of Defendants’ prior
misrepresentations and other fraudulent conduct being revealed to the marketplace.
Applicability of Presumption of Reliance: Fraud on the Market Doctrine
205. At all relevant times, the market for Guaranty common stock was an efficient market
for the following reasons, among others:
(a) Guaranty common stock met the requirements for listing, and was listed and
actively traded on the NYSE, a highly efficient and automated market;
(b) as a regulated issuer, Guaranty filed periodic public reports with the SEC,
NYSE and Federal Banking regulators;
(c) Guaranty regularly communicated with public investors via established
market communication mechanisms, including regular disseminations of press releases on the
national circuits of major newswire services and other wide-ranging public disclosures, such as
communications with the financial press and other similar reporting services; and
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(d) Guaranty was followed by several securities analysts employed by major
brokerage firms who wrote reports which were distributed to the sales force and certain customers of
their respective brokerage firms. Each of these reports was publicly available and entered the public
marketplace.
206. As a result of the foregoing, the market for Guaranty common stock promptly
digested current information regarding Guaranty from all publicly available sources and reflected
such information in the prices of the publicly traded securities. Under these circumstances, all
purchasers of Guaranty common stock during the Class Period suffered similar injury through their
purchase of Guaranty common stock at artificially inflated prices and a presumption of reliance
applies.
No Safe Harbor
207. The statutory safe harbor provided for forward-looking statements under certain
circumstances does not apply to any of the allegedly false statements pleaded herein. Many of the
specific statements pleaded herein were not identified as “forward-looking statements” when made.
To the extent there were any forward-looking statements, there were no meaningful cautionary
statements identifying important factors that could cause actual results to differ materially from those
in the purportedly forward-looking statements. Alternatively, to the extent that the statutory safe
harbor does apply to any forward-looking statements pleaded herein, Defendants are liable for those
false forward-looking statements because at the time each of those forward-looking statements were
made, the particular speaker knew that the particular forward-looking statement was false, and/or the
forward-looking statement was authorized and/or approved by an executive officer of Guaranty who
knew that those statements were false when made.
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COUNT I
Violation of Section 10(b) of the Exchange Act and Rule 10b-5
Promulgated Thereunder Against All Defendants
208. Plaintiff repeats and realleges each and every allegation set forth above as if fully set
forth herein.
209. This Count pertains to the following Defendants with respect to their wrongful
conduct during the period noted: (i) Defendant Temple Inland, as to its wrongful conduct occurring
through December 14, 2007; (ii) Defendant Jastrow, as to his wrongful conduct occurring through
August 26, 2008; (iii) Defendant Gifford, as to his wrongful conduct occurring through October 27,
2008; and (iv) Defendants Dubuque and Murff, as to their wrongful conduct occurring throughout
the Class Period.
210. During the Class Period, Defendants disseminated or approved the false statements
specified above, which they knew or recklessly disregarded were misleading in that they contained
misrepresentations and failed to disclose material facts necessary in order to make the statements
made, in light of the circumstances under which they were made, not misleading.
211. Defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 in that they:
(a) employed devices, schemes, and artifices to defraud;
(b) made untrue statements of material facts and/or omitted to state material facts
necessary in order to make the statements made, in light of the circumstances under which they were
made, not misleading; and
(c) engaged in acts, practices, and a course of business that operated as a fraud or
deceit upon Plaintiff and others similarly situated in connection with their purchases of Guaranty
common stock during the Class Period.
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212. Plaintiff and the Class have suffered damages in that, in reliance on the integrity of
the market, they paid artificially inflated prices for Guaranty common stock. Plaintiff and the Class
would not have purchased Guaranty common stock at the prices they paid, or at all, if they had been
aware that the market prices had been artificially and falsely inflated by Defendants’ misleading
statements.
213. As a direct and proximate result of these Defendants’ wrongful conduct, Plaintiff and
the other members of the Class suffered damages in connection with their purchase of Guaranty
common stock during the Class Period. Plaintiff and other members of the Class suffered economic
loss, i.e. , damages, under the federal securities laws when the above-described revelations were
absorbed by the market and the artificial inflation in the price of Guaranty common shares was
removed.
214. Plaintiff could not have learned of the extent of Defendants’ intentional conduct until
the Tepper Complaint was filed in August 2011.
COUNT II
Violation of Section 20(a) of the Exchange Act Against the Individual Defendants
215
Plaintiff repeats and realleges each and every allegation contained above as if fully set
forth herein.
216
This Count pertains to the following Defendants with respect to their wrongful
conduct during the period noted: (i) Defendant Jastrow, as to his wrongful conduct occurring through
August 26, 2008; (ii) Defendant Gifford, as to his wrongful conduct occurring through October 27,
2008; and (iii) Defendants Dubuque and Murff, as to their wrongful conduct occurring throughout
the Class Period.
217. The Individual Defendants acted as controlling persons of Guaranty within the
meaning of Section 20(a) of the Exchange Act as alleged herein. By reason of their position as
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officers and/or directors of Temple Inland and Guaranty, and their ownership of Guaranty common
stock, the Individual Defendants had the power and authority to cause Guaranty to engage in the
wrongful conduct complained of herein. By reason of such conduct, the Individual Defendants are
liable pursuant to Section 20(a) of the Exchange Act.
PRAYER FOR RELIEF
WHEREFORE, Plaintiff, on behalf of himself and the Class, prays for judgment as follows:
A. Determining that this action is a proper class action, certifying Plaintiff as Class
representative and designating Lead Counsel as Class Counsel under Rules 23(a), (b)(3) and (g) of
the Federal Rules of Civil Procedure;
B. Awarding compensatory damages in favor of Plaintiff and the other Class members
against all Defendants, jointly and severally, for all damages sustained as a result of Defendants’
wrongdoing, in an amount to be proven at trial, including interest thereon;
C. Awarding Plaintiff and the Class their reasonable costs and expenses incurred in this
action, including attorneys’ fees, accountants’ fees and experts’ fees and other costs and
disbursements; and
D. Awarding Plaintiff and the Class such other and further relief as the Court may deem
just and proper under the circumstances.
JURY TRIAL DEMANDED
Plaintiff hereby demands a trial by jury.
DATED: April 19, 2012 ROBBINS GELLER RUDMAN & DOWD LLP
SAMUEL H. RUDMAN MARIO ALBA JR.
/s/ Samuel H. Rudman SAMUEL H. RUDMAN
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58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax) [email protected] [email protected]
ROBBINS GELLER RUDMAN & DOWD LLP
X. JAY ALVAREZ MATTHEW I. ALPERT 655 West Broadway, Suite 1900 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)
Lead Counsel For Plaintiff
KENDALL LAW GROUP, LLP JOE KENDALL (State Bar No. 11260700) JAMIE J. McKEY (State Bar No. 24045262) 3232 McKinney, Suite 700 Dallas, TX 75204 Telephone: 214/74-3000 214/744-3015 (fax)
Liaison Counsel
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CERTIFICATE OF SERVICE
I hereby certify that on April 19, 2012, I caused the foregoing Amended Class Action
Complaint to be electronically filed with the Clerk of the Court using the CM/ECF system, which
will send notification of such public filing to all counsel registered to receive such notice.
/s/ Samuel H. Rudman SAMUEL H. RUDMAN