A December 22, 2015 decision of the U.S. District Court of the Southern District of Florida in In re Ocwen Financial Corporation Securities Litigation illustrates the impact that an investigation and order of the Securities Exchange Commission (“SEC”) may have on a plaintiff’s ability to allege actionable false statements by an issuer regarding its internal controls.
The Executive Chairman of Ocwen Financial Corp. ("Ocwen") also acted as Chairman for Home Loan Servicing Solutions ("HLSS"). Prior to the SEC publicly announcing the settlement of charges relating to Ocwen and HLSS, on September 4, 2015, the Court granted the Ocwen defendants’ motion to dismiss in its entirety the Consolidated Amended Complaint (“CAC”) filed against Ocwen. The CAC alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The class plaintiffs, consisting of those who purchased Ocwen securities between May 2, 2013 and December 19, 2014, alleged that Ocwen made false statements claiming that its Executive Chairman recused himself from all transactions in which he has a conflict of interest and false statements claiming that Ocwen had internal controls in place to prevent its Executive Chairman from participating in the approval of related-party transactions. For example, in Ocwen’s Form 10-K for 2012 and 2013 it claimed to have “robust" policies in place to prevent conflicts of interest in the approval of related party transactions. The class plaintiffs alleged that these were material misstatements because, due to Ocwen’s allegedly inadequate internal controls, the Executive Chairman did not properly recuse himself from transactions in which he had a conflict of interest. However, the Court held that the CAC failed to allege material falsity or a strong inference of scienter, in part because it did not allege that he personally approved any related-party transactions.
One month later on October 5, 2015, the SEC issued a Cease-and-Desist Order (“HLSS Order”) and settled charges against HLSS. The SEC found that HLSS stated in its Form 10-K and 10-KA that it “adopted policies, procedures and practices to avoid potential conflicts” present in related-party transactions, and that its Chairman “recuses himself from decisions pertaining to related transactions.” Although HLSS did not admit the truth of the allegations in paying a $1.5 million penalty, it agreed to settle charges that it had violated of Section 13(b)(2)(B) because “HLSS had no written policies or procedures concerning recusals for related party transactions” and its Chairman approved many related-party transactions between HLSS and Ocwen. The SEC alleged that its Chairman approved certain of HLSS’s 2012 transactions with Ocwen totaling approximately $67.5 billion and part of its 2013 transactions with Ocwen totaling approximately $120 billion. Even when the Chairman recused himself from such transactions and negotiations, the SEC alleged that he still received pertinent committee memoranda on the subject.
Following this SEC order, the class plaintiffs filed a Third Amended Consolidated Complaint (“TAC”) incorporating the SEC’s allegations in the HLSS Order concerning the Chairman's approval of related-party transactions. In ruling on the defendants’ motion to dismiss, the Court held that “the SEC Release allegations support the material falsity of the statements about [the Chairman's] recusal from related-party transactions.” The Court further held that the TAC adequately pleaded scienter in that the allegations of his active approval of transactions demonstrated his knowledge of them. This scienter was imputed to Ocwen since Erbey had substantial control over its activities. Thus, the Court held that the class plaintiffs pleaded actionable misstatements.
Since this partial denial of the defendants’ motion to dismiss, the SEC has issued another order (“Ocwen Order”) supporting the Court’s decision regarding the scienter allegations. On January 20, 2016, although not admitting any of the allegations, Ocwen settled charges for $2 million. The Ocwen Order alleged that Ocwen disclosed that it had controls in place requiring that the Chairman recuse himself from transactions with companies in which he had a conflict of interest. Despite this disclosure, the SEC alleged that no such controls existed and the Chairman's practice of recusal was both inconsistent and ad hoc, repeatedly approving related-party transactions, including a $75 million deal.