The SEC has charged another former mortgage executive with fraud in a scheme intended to scam at least $1.5 billion from private investors and the U.S. Treasury's Troubled Asset Relief Program (TARP).

According to the SEC complaint, Lee Farkas, former chief executive officer and chairman of Taylor, Bean & Whitaker (TBW) Mortgage Corporation, "engaged in a pattern of fraudulent conduct" for the purpose of selling at least $1.5 billion of fictitious and impaired residential mortgage loans to Colonial Bank. Those loans were then falsely reported by Colonial to the investing public as high-quality, liquid assets, which allowed Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds. Upon announcing it had obtained approval receive $550 million in TARP funds, Colonial BancGroup saw its stock price jump 54 percent, representing the its largest one-day price increase since 1983.

TBW was principally in the business of servicing mortgages for Freddie Mac and eventually became the largest non-despository mortgage lender in the country. The company began to experience financial difficulties in 2002 and Farkas attempted to raise money from Colonial BancGroup and other sources, ultimately running up "tens of millions" of dollars in overdrafts at the bank's subsidiaries.  He then tried to sell fakes mortgages to the bank, as well as impaired assets, and loans that were already owned by others. Finally, as the housing crisis worsened, Farkas and the unnamed co-conspirators tried to obtain control of Colonial BancGroup which had access to some $500 million in TARP money.  The indictment said their various schemes had resulted in losses of $1 billion or more, none of which was obtained from TARP funds.

Here are some comments from the SEC press release:

TBW began to experience liquidity problems and overdrew its then-limited warehouse line of credit with Colonial Bank by approximately $15 million each day. The SEC alleges that Farkas pressured an officer at Colonial Bank to assist in concealing TBW's overdraws through a pattern of "kiting" whereby certain debits to TBW's warehouse line of credit were not entered until after credits due to the warehouse line of credit for the following day were entered. As this kiting activity increased in scope, TBW was overdrawing its accounts with Colonial Bank by approximately $150 million per day.

The SEC alleges that in order to conceal this initial fraudulent conduct, Farkas devised a plan for TBW to create and submit fictitious loan information to Colonial Bank. Farkas also directed the creation of fictitious mortgage-backed securities assembled from the fraudulent loans. By the end of 2007, the scheme consisted of approximately $500 million in fake residential mortgage loans and approximately $1 billion in severely impaired residential mortgage loans and securities. As a direct result of Farkas's misconduct, these fictitious and impaired loans were misrepresented as high-quality assets on Colonial BancGroup's financial statements.

The SEC alleges that in addition to causing Colonial BancGroup to misrepresent its assets, Farkas caused BancGroup to misstate to investors and TARP officials that it had obtained commitments for a $300 million capital infusion, which would qualify Colonial Bank for TARP funding. Farkas falsely told BancGroup that a foreign-held investment bank had committed to financing TBW's equity investment in Colonial Bank. Contrary to his representations to BancGroup and the investing public, Farkas never secured financing or sufficient investors to fund the capital infusion. When BancGroup and TBW later mutually announced the termination of their stock purchase agreement, essentially signaling the end of Colonial Bank's pursuit of TARP funds, BancGroup's stock declined 20 percent.

Both TBW and Colonial BancGroup filed for bankruptcy and shut down lending operations in August 2009.

This is the latest in a series of actions taken against lenders for alleged abuses that occurred during the early part of the decade.  In November 2009, Attorney General Eric Holder announced that the administration had created an interagency group to crack down on financial fraud.  The task force, named the Financial Fraud Enforcement Task Force, is made up of representatives of the Department of Justice, Securities and Exchange Commission, and the Department of Housing and Urban Development. READ MORE