UNITED STATES DISTRICT COURT NASHVILLE DIVISION...
Transcript of UNITED STATES DISTRICT COURT NASHVILLE DIVISION...
UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF TENNESSEE
NASHVILLE DIVISION
CAROLYN LYNN, individually and on behalf of all others similarly situated,
Plaintiffs,
V.
ARTHUR F. HELF, H. LAMAR COX, MICHAEL R. SAPP, FRANK PEREZ and TENNESSEE COMMERCE BANCORP, INC.,
Defendants.
CaseNo. 3:12-CV-01137
CLASS ACTION
Judge Aleta A. Trauger
FIRST AMENDED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS
Lead Plaintiff Grand Slam Capital Master Fund, Ltd. and Plaintiff Carolyn Lynn
(collectively "Plaintiffs"), individually and on behalf of all others similarly situated (the "Class"
as defined herein), allege upon Plaintiffs' personal knowledge as to their own acts, the
investigation made by and through their counsel, which includes, inter al/a, a review of public
filings made by Tennessee Commerce Bancorp, Inc. ("TNCC" or the "Company") with the
Securities and Exchange Commission (the "SEC"), reports of the Federal Deposit Insurance
Corporation ("FDIC"), Office of Inspector General, as well as teleconferences, press releases,
news articles, analysts' reports, and media reports concerning the Company, and upon
information and belief as to all other matters, based upon the aforementioned investigation.
1. This is a class action, brought on behalf of all person, other than defendants, who
purchased TNCC common stock between April 18, 2008 through January 27, 2012, inclusive
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(the "Class Period"), to recover damages caused by defendants' violations of Sections 10(b) and
20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 74 etseq.
2. TNCC is operated as the bank holding company for Tennessee Commerce Bank
("TCB" or the "Bank"), which prior to being closed by the Tennessee Department of Financial
Institutions on January 27, 2012—offered various retail and commercial banking services to
small to medium-sized businesses, entrepreneurs, and professionals in the Nashville metropolitan
area, Tennessee. TNCC was founded in 2000 and is headquartered in Franklin, Tennessee.
SUMMARY OF THE ACTION
3. The collapse of TNCC did not come about all at once. It, instead, was the product
of years of mismanagement, fraud and greed. Post-2007, Defendants knew that their conduct
would likely lead to the Bank's failure. Nevertheless, Defendants continued their misconduct,
while covering-up the Bank's true financial state in order to preserve their exorbitant salaries,
perks and stock benefits. Despite repeated warnings from the FDIC, the Tennessee Department
of Financial Institutions ("TDFI"), as well their own employees and executives, Defendants
failed to put an end to the fraud and mismanagement, choosing to enrich themselves at the
expense of investors who—relying on Defendants' misrepresentations falsely believed TNCC
to be a standout in the commercial lending space.
4. Beginning in 2008, while more prudent banks were reigning in their lending to
adjust for the downturn in the economy, TNCC ramped up its commercial lending business,
acquiring, originating and/or underwriting over a billion dollars' worth of loans in the space of
just three years. Defendants held the Bank out as an exception to the economic downturn that
had decimated the banking industry. Defendants even went so far as to claim that TNCC would
benefit from the decreased competition that would result from the economic downturn. The
truth, however, was when the economy finally hit the transportation, warehousing, commercial
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real estate ("CRE") and other markets that TNCC was concentrated in, they were exponentially
affected.
5. Simultaneous with the rapid expansion in the Bank's assets, TNCC and the
Individual Defendants knowingly and continuously; (a) disregarded, failed to enforce or set aside
its loan underwriting policies and guidelines, (b) failed to objectively monitor and evaluate its
loan portfolio for degradation in loan quality and credit risk, and (c) ignored regulations and laws
governing the prudent recognition and mitigation of losses. This 'perfect storm' of bank
malfeasance and mismanagement led to unrestrained and imprudent lending to less-than-credit-
worthy borrowers, coupled with a failure to recognize, report or recoup losses when they
inevitably began to accumulate.
6. One of the most striking, knowing misstatements made by Defendants during the
Class Period was their understated allowance for loan and lease losses (the "ALLL") that the
Bank recognized for loans that were impaired or in danger of default. Generally accepted
accounting principles ("GAAP"), which are applicable to both annual reports and interim
financial statements such as quarterly reports, require that banks individually and collectively
evaluate loans for impairment and recognize a charge to earnings for the portion of those loans
that are expected to remain unpaid by the borrower. Throughout the Class Period, the FDIC and
TDFI pleaded with the Bank (to no avail) to raise their materially understated ALLL.' When the
Bank was closed in January of 2012, the FDIC estimated that the total losses in its loan portfolio
1 As discussed in more detail herein, the recognition of loan and lease losses is governed by various GAAP rules, including FAS 5, FAS 114 and SOP 03-3. FAS S governs the collective evaluation of an entity's loan portfolio for impairment. FAS 114 deals with the impairment of individual loans and SOP 03-3 deals with loans acquired with deteriorated credit quality. Working together, FAS 5, 114 and SOP 03-3 required the Bank to individually evaluate of its loans and then determine the risk of default for each loan and group of loans, recognizing the expected losses in the ALLL.
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were $4168 million or 42% of the Bank's $1.0 billion in assets. This revelation stood in stark
contrast to statements in the quarterly report that Defendants filed on August 12, 2011 the last
periodic financial statement filed by TNCC—that the Bank's ALLL was only "$28 [million], or
2.44% of total loans" which Defendants falsely represented was "adequate to cover losses
inherent in the loan portfolio. ,2 This gave investors the false impression that the Bank was far
less risky than it actually was and gave no indication whatsoever that it was on the verge of
collapse.
7. The driving factor behind the massive losses incurred by the Bank prior to its
closing was undisclosed lax, inoperative and unenforced underwriting and loan origination
controls. Despite repeated statements in each of its major SEC filings that the Bank had
sufficient and effective internal controls over underwriting and loan origination, those standards
and controls actually were, for all intents and purposes, eliminated at some point prior to 2008.
8. During the Class Period, the FDIC noted, during each of its examinations, major
deficiencies in the Bank's underwriting standards. The most serious violations included: (a) a
$15 million dollar loan to a unnamed Director of TNCC, $7 million of which was written off as a
complete loss; (b) a lending relationship with a single party, identified only as "Relationship A"
that resulted in a $65 million dollar loan, of which at least $30.2 million was a complete loss; and
(c) a significant portion of the Bank's loans were underwritten without regard to the loan-to-
value (LTV) and without obtaining any documentation, including credit reports or other financial
information. Simply stated, Defendants failed to disclose to investors that the Bank's
underwriting guidelines were completely abandoned during the Class Period.
2 Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 10 (Aug. 12, 2011).
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9. To exasperate the situation, Defendants failed to take affirmative steps to timely
recognize or mitigate losses. For example, much of the Bank's loan portfolio was connected to
the trucking and transportation industry. Accordingly, maintaining adequate collateral controls
protected the Bank against the risks of default. These controls, however, were non-effective, and
when employed, often violated applicable law. The most serious failure was a reported finding
by the FDIC that the Bank was routinely holding repossession in excess of the 6-month period
mandated under Tennessee law.'
10. Defendants were well-motivated to ensure that the public did not understand or
appreciate the level of mismanagement and deception. Throughout the Class Period, Defendants
were paid massive salaries and bonuses, received excessive perks and were granted considerable
stock options—all while driving the Bank towards its ultimate failure. For example, in 2007
Defendants unilaterally more than doubled their salaries, in violation of applicable rules
governing the award of compensation for executive officers. During the following three years,
Defendants were paid millions of dollars in additional compensation, as well as $1,000 per
month for Company cars, country club memberships and other perks. This was done in the face
of a stunning lack of oversight over the Bank's operations and while Defendants both concealed
and misrepresented the Bank's true financial position. In order to keep their benefits, Defendants
continued to conceal the true condition of the Bank, until they could no longer do so, in late
2011. Indeed, even when regulatory examiners from the FDIC and TDFI threatened to expose
the deception through appropriate enforcement actions, Defendants attempted to obfuscate and
See, FDIC, Office of Inspector General, Material Loss Review of Tennessee Commerce Bank, Franklin, Tennessee, Report No. AUD-12-014, at 1-14 ("FDIC Inspector General's Report", (Sept. 13, 2012). ("Examiners noted that a significant portion of the bank's repossessions were held in excess of the 6-month maximum period permitted under Tennessee law.")
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delay in order to preserve the artifice of the Bank's success, as well as their excessive
compensation and other valuable benefits.
11. When the true condition of the Bank came to light, Plaintiffs and other members
of the Class were dealt massive losses. For example, a shareholder who purchased TNCC
common stock in May of 2010, for around $10.00, and held that stock until the Bank announced,
on January 20, 2012, that its financial statements for previous years should not be relied upon,
would have lost approximately 98% of their investment.
12. By this action, Plaintiffs and the Class seek to recover damages against
Defendants for their violations of §§ 10(b) and 20(a) of the Exchange Act and SEC Rule lOb-S
promulgated thereunder by the SEC.
JURISDICTION AND VENUE
13. This Court has subject-matter jurisdiction pursuant to Section 27 of the Securities
Exchange Act of 1934, 15 U.S.C. § 78aa, and 28 U.S.C. §§ 1331 and 1337.
14. Venue is proper in this District pursuant to Section 27 of the Exchange Act, 15
U.S.C. § 78aa, and 28 U.S.C. § 1391(b). At all times relevant to this Complaint, TNCC's
maintained its principal place of business in Williamson County at 381 Mallory Station Road,
Suite 207, Franklin, Tennessee 37067-8264. In addition, many of the acts and practices
complained of herein, including the drafting and distribution of fraudulent information
concerning TNCC and its operations, occurred primarily in the Middle District of Tennessee.
15. In connection with the acts alleged in this Complaint, defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not
limited to, the mails, interstate telephone communications and the facilities of the national
securities markets.
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PARTIES
16. Lead Plaintiff Grand Slam Capital Master Fund, Ltd. purchased the common
stock of TNCC at artificially and fraudulently inflated prices during the Class Period and, as set
forth more fully in the annexed certification, thereby suffered substantial economic damages.
17. Plaintiff Carolyn Lynn purchased the common stock of TNCC at artificially and
fraudulently inflated prices during the Class Period and, as set forth more fully in the annexed
certification, thereby suffered economic damages.
18. Defendant Tennessee Commerce Bancorp, Inc. is a bank holding company for its
single asset, Tennessee Commerce Bank, located at 381 Mallory Station Road, Suite 207,
Franklin, Tennessee, 37067. On January 27, 2012, the Tennessee Department of Financial
Institutions closed Tennessee Commerce Bank, appointing the Federal Deposit Insurance
Company as receiver. Upon the closing of the Bank, the Bank's deposits were taken over by
Republic Bank & Trust Co. Prior to its closing, TCB operated as a nontraditional commercial
bank. Unlike many banks, the Bank did not conduct retail operations and did not have a network
of bank branches. Instead, TCB specialized in originating and underwriting many different types
of loans, mostly collateral-based, to small-to-medium sized businesses, entrepreneurs and
professionals within a 250 mile radius of Nashville, Tennessee.
19. Defendant Arthur F. Helf was a director of TNCC and the Bank from the date of
their inception in 2000 until the failure of the Bank in January of 2012. Defendant Helf also held
the office the Chairman of the TNCC Board and Chief Executive Officer ("CEO") of TNCC and
TCB from their founding in 2000 to his retirement on December 31, 2009. Following his
retirement as Chairman and CEO, Defendant Helf Continued to serve as a director of TNCC and
take part in the decision making processes at the Company. Prior to his retirement, Defendant
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Heif held the position of Chairperson of the Company's Executive Committee, which was
dissolved in 2009. Defendant Helf is a citizen of the State of Tennessee.
20. Defendant H. Lamar Cox was a director of TNCC and the Bank from the date of
their inception in 2000 until the failure of the Bank in January of 2012. Defendant Cox held the
position of Chief Operating Officer ("COO") of TNCC and the Bank from December 2009 to
January 27, 2012, the date the bank failed. Previously Defendant Cox held the positions of Chief
Administrative Officer ("CAO"), responsible for operations and support functions, from 2005 to
2009. Prior to that, Defendant Cox was Chief Financial Officer ("CFO") of TNCC and the Bank
from 2000 to 2005 and March 7, 2008 to August 18, 2008. As the proxy statement filed by
TNCC on April 19, 2011 states: "Mr. Cox's banking career brings in-depth knowledge of the
financial services industry and significant financial expertise to assist the board in overseeing the
management of the Corporation. He has over 35 years of banking experience in the areas of
finance, operations, retail banking, compliance and lending. Mr. Cox is a Certified Public
Accountant, licensed in Georgia and Tennessee and is a veteran of the United States Navy."
TNCC, Proxy Statement (Schedule 14A), at 11 (Apr. 19, 2011) (the "April 2011 Proxy"). As the
Company's COO, CAO and CFO, Defendant Cox held significant managerial influence over the
Company, the Bank and their operations, including those of day-to-day operations.
21. Defendant Michael R. Sapp was a director of TNCC and the Bank from the date
of their inception in 2000 until the failure of the Bank in January of 2012. Defendant Sapp
assumed the role of President and CEO of the Corporation and the Bank upon the resignation of
Defendant Helf on December 31, 2009, a role which he held until the failure of the bank in
January of 2012. According to the April 2011 Proxy; Defendant "Sapp br[ought] strong and
broad financial services experience to the board as well as a deep understanding of the
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Corporation's business and operations and the economic, social and regulatory environment in
which we operate. He has over 30 years of banking experience, with 25 years of such service in
Middle Tennessee. He was Division Manager/Senior Vice President, Equipment Finance
Division, at First American National Bank in Nashville for 13 years until 1997. Mr. Sapp began
his banking career in 1978 at BancOhio National Bank (now The PNC Financial Services
Group, Inc.) as a branch lending officer. He has been active in the Middle Tennessee Leadership
Council." April 2011 Proxy at 5.
22. Defendant Frank Perez held the position of Chief Financial Officer of TNCC and
the Bank from July 31, 2008 through the failure of the Bank in January of 2012. As the April
2011 Proxy states: "Perez previously served as Chief Financial Officer of Cumberland Bank &
Trust from 2005 to 2008. He also served as an internal audit manager of Crowell & Crowell,
PLLC and a senior accountant of AIG American General." April 2011 Proxy at 29.
23. Defendants Helf, Cox, Sapp and Perez are sometimes referred to herein as the
"Individual Defendants." Because of the Individual Defendants' positions as directors or senior
officers of the Company, each had access to the material adverse undisclosed information about
the Company's business, operations, operational trends, financial statements, markets and
present and future business prospects via access to internal corporate documents (including the
Company's operating plans, budgets and forecasts and reports of actual operations compared
thereto), conversations, communications and connections with other corporate officers and
employees, attendance at management and/or Board of Directors meetings and committees
thereof and via reports and other information provided to them in connection therewith.
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24. As relevant filings indicated, the TNCC "board of directors has the ultimate
oversight responsibility for the risk management process." See April 19, 2011 Proxy at 11.
Indeed, as TNCC's April 2011 Proxy—TNCC's last during the Class Period statesmore fully:
The board of directors is responsible for providing oversight of our risk management processes. The board oversees planning and responding to risks arising from changing business conditions. The board also is responsible for overseeing compliance with laws and regulations, responding to recommendations from supervisory authorities and overseeing management's conformance with internal policies and controls addressing the operations and risks of significant activities. Full board meetings regularly include reports on risk exposures as well as reporting on financial condition, credit risks, liquidity risks and other risk related matters inherent in our operation. Our senior risk officer and chief credit officer frequently provide reports at board meetings with respect to management's assessment of risk exposure and the controls in place to monitor those risks.
Id.
25. It is appropriate to treat the Individual Defendants as a group for pleading
purposes and to presume that the false, misleading and incomplete information conveyed in the
TNCC's public filings, press releases and other publications as alleged herein are the collective
actions of the narrowly defined group of defendants identified above. Each of them, by virtue of
their high-level positions with the Company and the Bank, directly participated in the
management of the Company and the Bank, was directly involved in the day-to-day operations
of the Company and the Bank at the highest levels and was privy to confidential proprietary
information concerning the Company and its business, operations, products, growth, financial
statements, and financial condition, as alleged herein. Each was involved in drafting, producing,
reviewing and/or disseminating the false and misleading statements and information alleged
herein, was aware, or recklessly disregarded, that the false and misleading statements were being
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issued regarding the Company, and approved or ratified these statements, in violation of the
federal securities laws.
26. As officers and controlling persons of a publicly held company whose common
stock was registered with the SEC pursuant to the Exchange Act, was traded on the NASDAQ
stock market, and was governed by the provisions of the federal securities laws, each defendant
had an affirmative duty to disseminate timely, accurate, and truthful information with respect to
the Company's financial condition and performance, growth, operations, financial statements,
business, products, markets, management, earnings, and present and future business prospects,
and to correct any previously issued statements that became materially misleading or untrue, so
that the market price of the TNCC's publicly-traded securities would be based upon truthful and
accurate information. The Individual Defendants' misrepresentations and omissions during the
Class Period violated these specific requirements and obligations.
27. The Individual Defendants participated in the drafting, preparation, or approval of
the various public and shareholder and investor reports and other communications complained of
herein and knew of, or recklessly disregarded, the misstatements contained therein and omissions
therefrom, and knew of (or recklessly disregarded) their materially false and misleading nature.
Because of their Board membership or executive and managerial positions with TNCC, each of
the Individual Defendants had access to the adverse undisclosed information about the
Company's business prospects and financial condition and performance as particularized herein
and knew (or recklessly disregarded) that these adverse facts rendered the positive
representations, made by or about TMI and its business, issued or adopted by the Company,
materially false and misleading.
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28. The Individual Defendants, because of their positions of control and authority as
officers or directors of TNCC and the Bank, were able to and did control the content of the
various SEC filings, press releases and other public statements pertaining to the Company during
the Class Period. Each Individual Defendant was provided with copies of the documents alleged
herein to be misleading prior to or shortly after their issuance or had the ability and/or
opportunity to prevent their issuance or cause them to be corrected.
29. Accordingly, each of the Individual Defendants is responsible for the accuracy of
the public reports and releases alleged herein and therefore primarily liable for the
representations contained therein.
30. Each of the defendants is also liable as a participant in a fraudulent scheme and
course of business that operated as a fraud or deceit on purchasers of TNCC securities by
disseminating materially false and misleading statements and/or concealing material adverse
facts. The scheme, among other things, was designed to (a) deceive the investing public
regarding TNCC's business, operations, and the intrinsic value of TNCC's publicly traded
securities and assets, and (b) cause Plaintiffs and other members of the Class to purchase
TNCC's publicly traded securities and to do so at artificially inflated prices.
PLAINTIFFS' CLASS ACTION ALLEGATIONS
31. Plaintiffs brings this action as a class action pursuant to Federal Rules of Civil
Procedure 23(a) and (b)(3) on behalf of all those persons who purchased TNCC common stock
between April 18, 2008 through January 27, 2012, inclusive and thereby suffered economic
damages (the "Class"). Fed. R. Civ. P. 23(a), (b)(3). Excluded from the Class are defendants,
the officers and directors of the Company, 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.
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32. The members of the Class are so numerous that joinder of all members is
impracticable. According to the Company's quarterly report filed on August 12, 2011, TNCC
had 12,196,900 shares of common stock outstanding. Tennessee Commerce Bancorp, Inc.,
Quarterly Report (Form 10-Q), at 3 (Aug. 12, 2011). While the exact number of Class members
is unknown to Plaintiffs at this time and can only be ascertained through appropriate discovery,
Plaintiffs believe that there are hundreds or thousands of members in the proposed Class. Record
owners and other members of the Class may be identified from records maintained by the
Company or its transfer agent and may be notified of the pendency of this action by mail, using
the form of notice similar to that customarily used in securities class actions.
33. Plaintiffs' claims are typical of the claims of the members of the Class as all
members of the Class are similarly affected by defendants' wrongful conduct in violation of
federal law that is complained of herein.
34. Lead Plaintiff will fairly and adequately protect the interests of the members of
the Class and has retained counsel competent and experienced in class and securities litigation.
35. 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 statements made by defendants to the investing public during the
Class Period misrepresented material facts about the business, operations, and financial condition
of the Company;
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(c) whether defendants acted knowingly or recklessly in making materially
false and misleading statements during the Class Period;
(d) whether the market prices of the Company's common stock were
artificially inflated or distorted during the Class Period because of defendants' conduct
complained of herein; and
(e) to what extent the members of the Class have sustained damages and the
proper measure of damages.
36. A class action is superior to all other available methods for the fair and efficient
adjudication of this controversy since joinder of all members is impracticable. Furthermore, as
the damages suffered by individual Class members may be relatively small, the expense and
burden of individual litigation make it impossible for members of the Class to individually
redress the wrongs done to them. There will be no difficulty in the management of this action as
a class action.
BACKGROUND SUPPORTING A STRONG INFERENCE OF SCIENTER
37. From its inception in 2000, TNCC operated as a holding company for a single
asset, Tennessee Commerce Bank. The Bank was set up as a non-traditional banking institution,
specializing in commercial and industrial ("C&I") loans, as well as real estate loans (consumer
and commercial) and credit card loans. Prior to closing, the Bank had no branch locations and
did not have consumer customers. The Bank, instead, operated three loan production offices—
besides its headquarters in Franklin—in Alabama, Minnesota and Georgia, catering primarily
small-to-medium sized business customers in the transportation and warehousing,
manufacturing, finance and insurance, construction, commercial real estate and healthcare
industries.
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38. As of 2010, TNCC's loan portfolio, which consisted primarily of loans that the
Bank had originated or underwritten, was valued at as much as $1.4 billion As of the Bank's
closure by the FDIC and the TDFI on January 27, 2012, and appointment of the FDIC as
receiver, total assets were valued at approximately $1.0 billion, approximately 42% of which
were determined to constitute a loss and not recoverable.
39. Following the failure of the Bank, the FDIC's Office of the Inspector General,
Office of Audits and Evaluations, commissioned KPMG LLP to prepare a report examining the
material losses at the Bank. Published in September of 2012, the Material Loss Review of
Tennessee Commerce Bank, Franklin, Tennessee, or the FDIC Inspector General's Report as it is
referred to herein, was published by the FDIC and detailed the extent of the fraud and
mismanagement within TNCC (the "FDIC Inspector General's Report"). FDIC Office of the
Inspector General, Material Loss Review of Tennessee Commerce Bank, Franklin, Tennessee,
Report No. AUD-12-014 (September 13, 2012).
40. Among other things, the FDIC Inspector General's Report concluded that Bank
management, including Defendants Helf, Sapp, Cox and Perez had failed enforce controls over
the financial reporting, credit and underwriting and loss mitigation at the Bank during the Class
Period. Much of the information included in this Complaint was derived, at least in part, from
the FDIC Inspector General's Report.
A. TNCC's History of Mismanagement, Self-Interest and Path to Failure
41. In 2007, the Bank's terminated CFO, George Fort, brought suit against
Defendants and the Bank, claiming, among other things, that Defendants Helf, Cox and Sapp had
encouraged Bank personnel to circumvent internal controls and violate approved policies and
procedures. See Fort v. Tennessee Commerce Bank, et al., Case No. 3-08-0668, at 3 (M.D.
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Tenn., filed July 9, 2008). Fort claimed that the lack of effective internal controls "materially
and adversely affected [his] certification responsibilities relative to the Company's Securities and
Exchange Commission periodic filings, including but not limited to its annual 10K filing[." Id.
at 2-3.
42. In June of 2007, Defendants Helf, Sapp and Cox made headlines when they took
unilateral action to double their salaries in violation of both NASDAQ rules and the Bank's
policies. The dramatic increase in salary is evinced by the following table from TNCC's 2008
proxy filing:
Tennessee Commerce Bancorp, Inc., Proxy Statement (Schedule 14A), at 19 (April 29, 2008).
43. Defendants also seized the opportunity to grant themselves $2.3 million in golden
parachute benefits in the event that they were terminated for any reason:
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- - - - -
Id. at 23. At the time when the raises were approved, TNCC was not in compliance with
NASDAQ Marketplace Rule 4350(c), which requires that a majority of the compensation
committee of the board granting such raises be composed of independent directors. See
NASDAQ Marketplace Rule 4350(c) ("Each issuer shall maintain a sufficient number of
independent directors on its board of directors to satisfy the audit committee requirement set
forth in Rule 4350(d)(2)."). Rule 4350 is intended to prevent the type of cash grab executed by
Defendants Sapp, Cox, and Helf in this instance. See Ed. at IM-4350-4 ("Independent director
oversight of executive officer compensation helps assure that appropriate incentives are in place,
consistent with the board's responsibility to maximize shareholder value. The rule is intended to
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provide flexibility for an issuer to choose an appropriate board structure and to reduce resource
burdens, while ensuring independent director control of compensation decisions.").
44. In reaction to the unauthorized increase in compensation to Defendants Helf, Sapp
and Cox, three members of the TNCC Board, Winston C. Hickman, Regg E. Swanson and
Fowler E. Low, resigned. Two of the three directors that resigned penned letters discussing the
reason for their resignation - their disgust at the unilateral pay raises. As Regg E. Swanson
wrote:
My decision is a direct result of my disagreement with the board's action and policy regarding executive compensation and the manner in which the vote was taken to approve this policy. I feel the direction the executive management has taken regarding their compensation is unethical. Their desire to attain compensation that I feel is excessive based on information that I have obtained independent of the board, and the subsequent vote process which granted the compensation has violated my trust in the management of the bank. Above all this has put me in a position where I do not feel I can act to uphold my fiduciary responsibilities as a member of the Board.
Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex. 99.2, at * 1 (July 19, 2007).
45. Similarly, Fowler H. Low wrote, in pertinent part:
The June 2007 adoption of a new "compensation policy" is the primary reason for my resignation. I can not, in good faith, continue to be a member of a board that accepts/approves such a "policy." It is a "policy" that, in my opinion, is not in the best interests of our stockholders, rather a policy crafted to provide excessive and retroactive compensation to "executive managers."
***
Notwithstanding the quantum leap in remuneration for the key executives, the clever (cunning) defining of "their" compensation that enabled the directors who are employees of the bank to vote for one another, up and down the organizational chart, is cause enough (for me) to resign. Perhaps I am more naive than most, but I must wonder if I was the only director and/or stockholder whose interpretation of this prohibition for executive officers that are also Compensation Committee members to discuss or vote on matters
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relating to "their" compensation allowed for the "I cover you and you cover me" votes, as was done in this instance.
It seems to me that the executive officers/directors have concluded that the board can be manipulated in whatever manner deemed desirable (by the executive officers). Indeed this compensation issue and the "vote" as counted reflect as much. I have to question whether we are a board of directors, -- or a board of directed. In this environment, I can not perform my fiduciary responsibilities as a director of the bank.
Id. at Ex. 99.3, at *1.ft2. Notably, following these dramatic increases in salary, the
mismanagement and breach of policy, rules and the law began to worsen.
46. With the onset of the recession in 2008 the economy significantly deteriorated,
but the Bank continued with business as usual, pushing hard to underwrite and originate massive
amounts of loans, primarily in the C&I space. Unrestrained growth during the Class Period,
coupled with high concentrations in industries particularly susceptible to an economic slowdown
posed significant risks to the Bank's liquidity. As the FDIC Inspector General's Report
concluded, the overconcentration of the Bank's loans in the C&I space, coupled with massive
growth, made the Bank extremely vulnerable to an extended downturn in the economy:
After opening in 2000, TCB embarked on a sustained high growth strategy centered in C&I loans. While many of TCB's C&I loans were made in its local market of middle Tennessee, a large amount were made in out-of-territory areas throughout the United States. The bank's assets, which totaled $97 million after two years of operations, grew by 1,343 percent to $1.4 billion by year-end 2010. Together with weak credit risk management practices (as described later), TCB's significant exposure to certain segments of the C&I industry made the bank vulnerable to a sustained economic downturn. Figure 2 illustrates the general composition of TCB's loan portfolio in the years preceding the institution's failure and highlights the high growth strategy that focused on C&I loans.
TCB's exposure to C&I loans presented elevated risk to the bank due to the sensitivity of C&I loans to the economy and the limited marketability of specialized collateral securing many of the bank's C&I loans.
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FDIC Inspector General's Report at 1-8. Nonetheless, these risks were not truthfully disclosed to
shareholders and such practices were not abated, even after the FDIC had expressed concerns
related to these issues. See Ed.
47. To compound matters, the Bank's loan policy and underwriting standards were
not followed during the Class Period. The FDIC consistently noted lax underwriting standards
and a complete breakdown in the Bank's internal controls relating to the origination and
underwriting of loans. See FDIC Inspector General's Report at I-li ("Ineffective credit
underwriting, administration, monitoring, and collection practices contributed to the asset quality
problems that developed at TCB when the economy and the bank's target lending markets
deteriorated."). The serious flaws in the Bank's underwriting and loan origination practices were
not disclosed to investors. Instead, TNCC actively promoted itself as a risk-averse lender
throughout the Class Period, attempting to differentiate and distance itself from the risky lending
like the type that had caused so much pain in the residential market. Tennessee Commerce
Bancorp, Inc., Qi 2009 Earnings Call, Bloomberg Transcript, at 4 (Apr. 29, 2009) ("We have
discussed on prior calls, Tennessee Commerce does not have any exposure to subprime loans.
We believe our diversified loan portfolio insulates us in part from the effects of any single
economic sector."). As the economy worsened and TNCC's liquidity problems became more
dire, the Bank's loan policy was routinely disregarded and internal underwriting and origination
controls failed to prevent the Bank from underwriting loans that were progressively more risky
and more expensive than the sub-prime and Alt-A loans that had upended the residential
mortgage market. FDIC Inspector General's Report at 1- 11 ("The April 2007 and April 2008
examination reports indicated that TCB's lending practices were generally satisfactory, although
the reports included some recommended improvements. However, subsequent examination
20 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 20 of 100 PageD #: 315
reports became increasingly critical of the bank's lending practices as the bank's financial
condition deteriorated and weak risk management practices became more apparent and
widespread.").
48. Beginning in 2008, while the Bank and the Individual Defendants were publically
stating that TNCC had an exceptional risk profile, the Company's actual risk profile was
degrading exponentially, which drew the attention of the FDIC. During regular yearly
examinations, the FDIC concluded that throughout the Class Period prudent underwriting
standards—including those in the Bank's own loan policy werenot being followed.
Nonetheless, in 2008 and each year after, the Bank continued to underwrite and originate
massive amounts of loans. Lax controls and an unrestrained explosion in the loan profile
eventually proved to hasten the demise of the Bank. For example, in 2009, the Bank's
outstanding loan balance grew unrestrained by over $310 million or 39% from the previous
year whileinternal controls over loan underwriting and originations went unsupervised and
unenforced, and unchanged. At the same time, as discussed herein, the Bank became more-and-
more illiquid, wildly originating loans, while failing to earn sufficient revenues or recoup losses
sufficient to support operations or bolster the Bank's cash-strapped balance sheet. FDIC
Inspector General's Report at 1-7 ("TCB's Board and management failed to appropriately adjust
to changes in economic conditions. For example, the Board and management continued to
expand the loan portfolio with loans of questionable repayment capacity despite a slowing
economy when their peers were restricting loan growth.").
49. As the Bank's liquidity situation worsened, the incentive to conceal the truth
about the Bank's lending practices, risk profile and lack of controls intensified. The financial
bellwether of these problems is known as the ALLL, the allowance for loan and lease losses. As
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the FDIC Inspector General's Report sets forth, the ALLL is perhaps the most important tool for
investors to measure the overall risk profile of a bank:
According to the Interagency Policy Statement on the Allowance for Loan and Lease Losses, the ALLL represents one of the most significant estimates in an institution's financial statements and regulatory reports. As a result, each institution is responsible for developing, maintaining, and documenting a comprehensive, systematic, and consistently applied process for determining the ALLL.
FDIC Inspector General's Report at 1-13.
50. As discussed in detail infra, throughout the Class Period the Bank understated its
ALLL, failing to sufficiently account for the risk of its assets in accordance with GAAP,
including FAS 5 and FAS 114, which govern the ALLL. As the FDIC Inspector General's
Report concluded:
TCB's loan grading system was not appropriately applied, resulting in numerous and large credit downgrades during examinations. The August 2010 and September 2011 examination reports noted that, in many cases, management was aware of the declining ability of borrowers to service their debt, but appeared reluctant to downgrade loans to an appropriate loan grade. This had the effect of delaying recognition of problem loans and not adequately providing for known credit losses via the ALLL.
Management failed to appropriately identify, measure, and provide for the level of deterioration in the loan portfolio in 2010 and 2011. Specifically, examiners noted during the August 2010 examination that an additional provision of at least $16.3 million to the ALLL was warranted to provide for the risk in the loan portfolio. The bank also needed to adopt a more robust Financial Accounting Standard (FAS) 5 and FAS 114 methodology and use a shorter time frame for calculating historical loan losses to reflect the risk in the loan portfolio and the environment in which the bank was operating.
Examiners noted at the September 2011 joint examination that the ALLL was severely deficient in relation to the level of risk in the loan portfolio and that an additional provision of $80.2 million was
22 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 22 of 100 PageD #: 317
warranted. In addition, the bank's FAS 114 impairment analyses were either inadequately supported, inadequately measured, or used invalid assumptions. Further, management failed to recognize credit losses in a timely manner, which resulted in an insufficient FAS 5 ALLL allocation since the calculation was based on historical losses. The bank's external auditors also noted in 2011 that controls over estimating the ALLL were not adequate. An underfunded ALLL can have the effect of delaying the recognition of deterioration in the credit quality of the loan portfolio.
FDIC Inspector General's Report at 1-13. Failure to accurately account for the ALLL denied
investors the ability to properly judge the quality of the Bank's portfolio, artificially inflating the
Bank's stock price for an extended period of time, before the truth slowly emerged.
51. To compound matters, the Bank's loss mitigation controls were extremely poor,
resulting in broken laws and losses that were not timely recognized. As the economy worsened,
the loans in the Bank's C&I portfolio began defaulting, but the bank did not have sufficient
controls to exercise its right to the collateral in a timely or efficient manner, further delaying the
recognition of losses and resulting in violations of the law. As the FDIC described:
TCB had no repossessed assets as of December 31, 2006. However, by the close of 2007, the bank had repossessed assets of about $7 million consisting primarily of trucks that were leased through the bank's indirect funding programs. Management attributed the high level of repossessions to increases in fuel costs and the resulting impact on the trucking industry. In addition, due to the structure of the leases through the brokers, the bank was not becoming aware of the problems until the leases were 90 to 120 days past due. Examiners noted that a significant portion of the bank's repossessions were held in excess of the 6-month maximum period permitted under Tennessee law. TCB subsequently formed a subsidiary called the Tennessee Commercial Asset Services, Inc., to hold repossessed assets beyond the 6-month period allowed by Tennessee law and assist the bank in selling and collecting proceeds from repossessed assets.
As of July 2010, repossessions totaled $28.3 million, of which $26.4 million consisted of trucks and over-the-road equipment. In addition, the bank had 381 loans secured primarily by tractor/trailers that were over 180 days past due and the collateral
23 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 23 of 100 PageD #: 318
had not yet been repossessed. A total of 153 of the 381 loans were over 300 days past due.
TCB did not have adequate loss mitigation policies and procedures to monitor the repossession and timely disposition of collateral. TCB often relied on various third-party dealers and brokers for payment collection and collateral repossession services. It does not appear that the bank adequately understood, assessed, or monitored the risk exposure related to these third-party relationships. For example, we observed an instance in which a single broker was servicing over 1,100 leases valued at over $58 million, yet the broker had only 4 employees performing collection services. This suggests an inadequate infrastructure that may have limited the broker's ability to support and service a labor intensive lease portfolio on behalf of TCB. To further illustrate management's inadequate monitoring of broker relationships, an examiner loan review of a broker relationship at the 2009 joint examination noted numerous deficiencies, including but not limited to, a lack of a physical on-site collateral inspection, a lack of a formalized agreement between TCB and the broker, and a potential conflict of interest involving used tractor/trailer sales and inventory.
FDIC Inspector General's Report at 1-14 to I-iS. The failure to ensure effective loss mitigation
further misled investors as to the credit quality of the Bank and gave a false impression of the
risks that the downturn in the economy were posing to the Bank.
52. At the same time, the Bank had become more reliant on risky and expensive non-
core, non-traditional deposits to fund the explosion in lending that they had embarked upon.
During the Class Period TNCC became highly dependent upon non-core, non-traditional forms
of funding. These non-core funding sources posed special risks which were never fully disclosed
to investors, primarily because the Bank structured deposit purchases to avoid having the
purchased deposits classified as such under banking industry conventions:
TCB relied heavily on non-core funding sources, particularly time deposits above the insurance limit, Internet deposits, and brokered deposits, to fund its loan growth and maintain liquidity. When properly managed, non-core funding sources offer a number of important benefits, such as ready access to funds in national markets when core deposit growth in local markets lags planned asset growth. However, non-core funding sources also present
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potential risks, such as increased volatility when interest rates change and difficulty accessing such funds when the financial condition of an institution deteriorates. In addition, institutions become subject to limitations on the use of brokered deposits and the interest rates they can offer on deposits when the institutions fall below Well Capitalized. Under distressed financial or economic conditions, institutions could be required to sell assets at a loss in order to fund deposit withdrawals and other liquidity needs. In March 2009, the FDIC issued FIL-13-2009, The Use of Volatile or Special Funding Sources by Financial Institutions That are in a Weakened Condition, which indicated that institutions with aggressive growth strategies or excessive reliance on volatile funding sources are subject to heightened supervisory monitoring and examination.
The bank's liquidity position began to weaken as asset quality issues in the loan portfolio became prevalent. At the August 2010 joint examination, examiners largely attributed a decrease in TCB's net non-core funding dependence ratio to a decrease in time deposits of $100,000 or more and an increase in Other Savings Deposits, which are classified as core deposits, through promotional rates that were three times higher than the bank's peer group average. Examiners noted that the potential volatility of the Other Savings Deposits was similar, or possibly even greater than, traditional noncore funding sources. By September 2011, examiners determined that TCB's liquidity was critically deficient and threatened the viability of the institution.
FDIC Inspector General's Report at 1-17 to 1-19.
53. In essence, TNCC's management failed to ensure that reasonable controls were in
place to administer the Bank in a prudent manner, while simultaneously concealing the truth
from regulators and investors alike. As time went on, the pressure to conceal the truth
intensified, with Defendants underreporting the risks that were posed by the Bank's loan profile
and operational footprint. As the FDIC Inspector General's Report on the failure of the bank
concluded, TNCC's management was solely and directly responsible for the failure of the Bank:
TCB's Board and executive management team did not provide effective oversight and management of the institution. As discussed more fully in subsequent sections of this report, the
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Board and management implemented an unconventional and risky Business Bank strategy that exposed TCB to significant operational and credit risk in the event of a sustained downturn in the economy. Specifically, TCB:
• emphasized high loan growth and specialized lending without adequate risk management practices;
• developed large and complex borrowing relationships that exposed the bank to significant risk and credit losses;
• engaged in unusual lending practices, such as life insurance premium financing, without appropriately analyzing the associated risks or properly documenting the deliberations of the Board or management's rationale for conducting such practices;
• did not maintain capital at levels that were commensurate with the bank's risk profile; and
• executed a funding strategy for sustaining loan growth and maintaining liquidity that involved heavy reliance on non-core funding sources, particularly Internet and brokered deposits.
FDIC Inspector General's Report at 1-6.
54. All of these factors contributed to the demise of TNCC in January of 2012.
However, the risks associated with them were not disclosed. Indeed, Defendants concealed the
true risk of the Bank's profile and the scope of the internal control deficiencies not only from
investors, but also from regulators. Strikingly, even when confronted with their false statements,
Defendants stubbornly refused to admit their mistakes, instead continuing the misstatements and
further pushing the Bank to the edge. See, Ed. at 1-7. As the FDIC described:
TCB's Board and management also failed to adequately address concerns identified during examinations of the bank. For example, the Board was reluctant to enter into a Memorandum of Understanding (MOU) with regulators to address risk management issues identified during the June 2009 examination and "strongly disagreed" with many of the findings in the August 2010 examination. The Board and management were also reluctant to accept the advice of external loan reviewers. Further, examination reports of TCB noted apparent violations of laws and contraventions of statements of policy pertaining to appraisals,
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legal lending limits, false and/or misleading statements, the Allowance for Loan and Lease Loss (ALLL) methodology, loans to a financial subsidiary, and the purchase of a large speculative asset. Such apparent violations and contraventions reflected negatively on TCB's Board and management.
Id.
55. The motive for Defendants deception and concealment of the Bank's true
condition are clear. Notwithstanding the extremely poor financial and operational condition of
Bank during the Class Period, Defendants were excessively compensated. This is particularly
evident when the non-performance and mismanagement of the Bank is laid bare. For instance,
during the Class Period, the Individual Defendants earned millions of dollars in salary and
bonuses, while they were driving the bank into receivership:
Tennessee Commerce Bancorp, Inc., Proxy Statement (Schedule 14A), at 34 (April 16, 2010).
56. Even as the Bank teetered on the verge of collapse, Defendants Sapp, Perez and
Cox were all paid over $500,000 in 2010, with Defendant Sapp earning over $700,000:
27 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 27 of 100 PageD #: 322
Tennessec Commercc Bancorp, Inc., Proxy Stalcincut (Schedule 14A), at 30 (April 19, 2011)
(the "April 2011 Proxy Statement").
57. Moreover, as detailed above, a significant portion of Defendants' compensation
throughout the Class Period was in the form of stock or options grants. See Ed. As such,
Defendants had a considerable incentive to take steps to see that the stock price remained high,
including concealing the true risk and control condition of the Bank. Indeed, it was only when
the Bank was no longer liquid and the truth could no longer be concealed that Defendants began
to reveal the truth of the dire situation. See infra.
58. In addition to their salaries, bonus and stock grants, Defendants were also paid for
various other perks, such as attending Board meetings and luxury automobiles. Again, in 2010,
as the bank was failing, shareholders paid approximately $1,000 per month for automobiles for
Defendants Cox, Sapp and Perez and nearly triple that as compensation for attendance at board
meetings. As the April 2011 Proxy Statement sets forth:
28 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 28 of 100 PageD #: 323
April 2011 Proxy Statement at 30. Additional compensation for attending Board meetings for
Defendants Helf and Sapp in 2010 are included in the following table:
All 0Th
F ...:;r- ... ..................
Id. This, of course, is in addition to compensation paid to Defendant Helf for his participation on
the Board in 2010, which amounted to over $250,000:
-H
L:::•:L:,;.: Li
Id. at 41.
59. Indeed, Defendants Helf, Sapp and Cox even had their country club membership
paid for by shareholders: "The Bank provides a car allowance to each of Messrs. Helf, Sapp and
Cox and pays each of their annual dues at a local country club, expenses related to their
respective use of such country club for matters related to our business and their respective
reasonable expenses for continuing education courses necessary to maintain any certifications or
licenses that each of them holds." Tennessee Commerce Bancorp, Inc., Proxy Statement
(Schedule 14A), at 22 (Apr. 20, 2009).
60. Their own compensation was such a high priority to Defendants that the FDIC
indicated that there was a basis for questioning whether Defendants were using Troubled Asset
29 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 29 of 100 PageD #: 324
Relief Program ("TARP") funds for compensation, in direct violation of pertinent regulations. In
December of 2008, TNCC received $30 million in TARP CPP funds. Defendants refused to
provide documentation to the FDIC describing how those funds were utilized. As the FDIC
Inspector General's Report describes:
The August 2010 joint examination report stated that examiners were unable to determine whether TCB fully complied with the CPP Agreement and the requirements of EESA based on limited information provided by the bank. According to RMS officials, examiners made multiple attempts to gain information from the CFO and other bank management officials, as well as by reviewing financial information and Board committee minutes. Examiners noted that the bank's Board minutes were silent regarding TCB's use of the $24 million in funds down streamed from Bancorp. Examiners also noted that the Board approved a new expenditure policy and revised several employment contracts and deferred compensation agreements to comply with Treasury requirements. However, the complete terms of the contracts and agreements were not disclosed to examiners. Examiners further noted that Compensation Committee minutes, which were only provided through May 2009, documented the bank's efforts to comply with EESA. We did not find evidence that examiners performed follow-up inquiries with TCB's management after the 2010 joint examination to obtain additional information regarding the bank's compliance with the CPP Agreement.
FDIC Inspector General's Report at 1-32 (emphasis added).
61. In the end, the deception carried on by the Bank throughout the Class Period
could no longer be concealed. On November 1, 2011, TNCC issued a Current Report (Form 8-
K) announcing that it was restating its financial results for the second quarter of fiscal year 2011
ended June 30, 2011. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2
(Nov. 1, 2011) (the "Initial Restatement"). As the November 1, 2011 Initial Restatement stated:
On October 27, 2011, management of the Corporation, and subsequently, its Audit Committee and Board of Directors, determined that its financial statements for the quarter ended June 30, 2011, as included in the Corporation's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011, should no longer be relied upon due to an expected approximately
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$83.0 million increase in the provision for loan losses and related allowance for loan losses as a result of an ongoing joint examination of Tennessee Commerce Bank (the "Bank"), a wholly-owned subsidiary of the Corporation, by the Federal Deposit Insurance Corporation (the "FDIC") and the Tennessee Department of Financial Institutions (the "TDFI"). Consequently, the Corporation intends to file an amendment to its Form 10-Q for the period ended June 30, 2011, as soon as reasonably practicable, to give effect to the expected increase in the provision and allowance for loan losses.
Id. (emphasis added).
62. Nonetheless, the November 1, 2011 Restatement left investors with the false
impression that TNCC's financial statements for other periods did not need to be restated. It was
not until January 20, 2012, that it was announced that additional periods would need to be
restated. This was a forced admission, due to the fact that KraftCPAs PLLC ("Kraft") had
notified the bank that it was withdrawing its audit opinion for all financial statements post-
December 31, 2010 and unspecified previous periods. See Tennessee Commerce Bancorp, Inc.,
Current Report (Form 8-K), at 2 (Jan. 20, 2012); see also Tennessee Commerce Bancorp, Inc.,
Current Report (Form 8-K), Ex. 99. 1, at *1 (Jan. 25, 2012) ("We have read the statements under
Item 4.02 of the Current Report on Form 8-K filed with the Securities and Exchange
Commission on January 20, 2012 regarding withdrawal of our audit report on the Corporation's
financial statements as of December 31, 2010 and for the year then ended and the possibility that
we may withdraw earlier audit reports pursuant to the results of a forensic review of the
Corporation's small ticket loan portfolio. We agree with these statements pertaining to our
firm.")
B. Knowingly False and Misleading Statements During the Class Period
63. Throughout the Class Period, the Individual Defendants routinely and
systematically made false and misleading statements concerning the strength and/or effectiveness
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of the internal controls, compliance with the law, adherence to financial accounting rules and the
efficacy of TNCC's underwriting and deposit policies. These statements were known to be false
when made, as evinced by, among other things, relevant SEC filings, insider statements and the
FDIC Inspector General's Report. Indeed, not only were the statements known to be false when
made, they were disseminated specifically to ensure that shareholders would continue to employ
the Individual Defendants and support their excessive salaries, bonuses, perks, stock grants,
insurance payment and other material benefits. Had the Individual Defendants revealed the true
internal operating conditions and prospects of the Bank, as they were legally required to do,
investors would have recoiled from the Bank and the Individual Defendants would have lost their
positions, as well as many millions of dollars in compensation.'
1. False Statements Concerning TNCC's 2007 Operations
64. As noted above, in late 2007, TNCC and the Bank's CFO, George Fort, was
terminated after blowing the whistle on a lack of internal controls, self-dealing and violations of
financial reporting standards and the law at the Company and Bank. As such, Defendants were
forced to admit in the Company's 2007 annual report that certain internal controls were lacking.
Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at F-2, et seq. (April 18, 2008)
(the "2007 Annual Report"). Nonetheless, the disclosures were incomplete and misleading to the
point of being meaningless and left investors with the false impression that Fort's complaints
were isolated incidents and had been sufficiently dealt with. Nothing could be further from the
truth.
65. The 2007 Annual Report was filed with the SEC on April 18, 2008 —the first day
of the Class Period - and was signed by Defendants Helf, Cox and Sapp. In addition,
However, in the end, the Bank may have survived under new and better leadership.
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Defendants Heif and Cox, both separately signed certifications required by the Sarbanes-Oxley
Act of 2002, Pub. L. No. 107-204, § 302, 116 Stat. 745, 777, codified at 15 U.S.C. § 7241
("SOX certification"). According to the Act, the chief executive and chief financial officers of a
corporation must certify in each annual or quarterly report that:
1. the signing officer has reviewed the report;
2. based on the officer's knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading;
3. based on such officer's knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the issuer as of and for, the periods presented in the report;
4. (the signing officers—
(a) are responsible for establishing and maintaining internal controls;
(b) have designed such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared;
(c) have evaluated the effectiveness of the issuer's internal controls as of a date within 90 days prior to the report; and
(d) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date;
(e) the signing officers have disclosed to the issuer's auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function)-- (f) all significant deficiencies in the design or operation of internal controls which could adversely affect the issuer's ability to record, process, summarize, and report financial data and have identified for the issuer's auditors any material weaknesses in internal controls; and
(g) any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer's internal controls; and
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(h) the signing officers have indicated in the report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
15 U.S.C. § 7241(a). Defendants Helf and Cox's certifications were knowingly false when
signed, because the Bank's internal controls were insufficient, ineffective, and/or ignored - aside
from the categories in which weaknesses were identified in the 2007 Annual Report - and the
report contained material misstatements of fact, as alleged herein.
66. The 2007 Annual Report falsely represented the effectiveness of TNCC's
financial and internal controls as they existed in fiscal year 2007 by stating:
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended) that is designed to produce reliable financial statements in conformity with accounting principles generally accepted in the United States. The Company's internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden, and misstatements resulting from error or fraud may occur and not be detected. Also, because of changes in conditions, internal control
34 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 34 of 100 PageD #: 329
effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
Management, with the participation of the Company's Chief Executive Officer and acting Chief Financial Officer, conducted an assessment of the effectiveness of the Company's system of internal control over financial reporting as of December 31, 2007, based on criteria for effective internal control over financial reporting described in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management identified the following material weaknesses in internal control over financial reporting as of December 31, 2007:
Employee Accounts - Certain transactions related to employee accounts were not appropriately processed, reviewed and approved in accordance with Company policy; and
Asset/Liability Management Committee - While the Company has an Asset/Liability Management Committee (the "ALCO") that provides information to the Company's Board of Directors, no meetings of the ALCO were held during 2007.
These control deficiencies had no known impact on the Company's financial reporting.
2007 Annual Report at F-2. Accordingly, the 2007 Annual Report identifies two discrete
categories in which TNCC's internal controls were not effective; (a) process and review of
employee accounts, and (b) meetings of the "Asset/Liability Management Committee."
67. The actual deficiencies in TNCC's controls, however, were far more significant
than the above analysis provides and, as such, Defendants Helf, Cox and Sapp knew those
statements to be false when made.
68. Specifically, the FDIC's examination of the Bank in 2007 revealed that controls
over the review and analysis of financial data were inadequate and that the Bank's loan policy
was "too general and brief" See FDIC Inspector General's Report at 1-12 ("FDIC and/or TDFI
examiners noted the following: Documented reviews and analysis of interim or annual financial
35 Case 3:12-cvM1137 Document 44 Filed 04/18/13 Page 35 of 100 PageD #: 330
data were not adequate (April 2007 examination) [and] Certain portions of the loan policy were
too general and brief and needed enhancement.").
a) Undisclosed Lack of Effective Underwriting and Loan Administration Controls
69. In April of 2007, bank examiners noted that there were significant warning flags
in the Bank's credit monitoring and loan underwriting procedures, leading to misleading
financial reporting of potential bad loans. As the FDIC Inspector General's Report stated, in
their 2007 examination of the Bank:
Examiners observed instances in which risk rating downgrades, inclusions on the watch list, and subsequent charge-offs occurred within a period of weeks, suggesting ineffective credit monitoring. Examiners noted that earlier recognition of potentially problem loans, particularly within the small indirect loan portfolio, could substantially reduce losses. The report also indicated that review and analysis of large borrowing relationships needed improvement and that the bank's loan policy, which addressed most major topics recommended by prevailing guidance, needed enhancement in some areas, including collection procedures.
FDIC Inspector General's Report at 1-24. The untimely recognition of losses, and the associated
adjustment to loan loss reserves or lack thereof, is one of the most important criteria for investors
seeking to purchase an equity position in a Bank. The misstatement of loan losses is
unquestionably material and Defendants Helf, Sapp and Cox were aware in 2007 that the Bank
was not recognizing expected losses in a timely manner, as required under GAAP rules.'
70. The 2007 Annual Report mentioned no such deficiencies in the Bank's financial
reporting controls. Instead, the 2007 Annual Report falsely and misleadingly reassured investors
As discussed infra, FAS 5, FAS 114 and SOP 03-3 all govern the recognition for loan losses. FAS 5 governs the collective evaluation of an entity's loan portfolio for impairment. FAS 114 deals with the impairment of individual loans and SOP 03-3 deals with loans acquired with deteriorated credit quality.
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by assuring them that the Bank's Board, management and auditor had all taken part in ensuring
the soundness of the Bank's investments.
Credit risk and exposure to loss are inherent parts of the banking business. Management seeks to manage and minimize these risks through its loan and investment policies and loan review procedures. Management establishes and continually reviews lending and investment criteria and approval procedures that it believes reflect the risk sensitive nature of the Bank. The loan review procedures are set to monitor adherence to the established criteria and to ensure that on a continuing basis such standards are enforced and maintained. Management's objective in establishing lending and investment standards is to manage the risk of loss and provide for income generation through pricing policies.
2007 Annual Report at 27 (emphasis added). Again, nothing could have been further from the
truth and these statements were materially false when made.
b) Defective Controls Over Loss Mitigation
71. In addition, as early as 2006, Defendants were aware that the Bank was routinely
and systematically violating Tennessee State law by failing to promptly dispose of repossessed
assets. Defendants were aware that the Bank's internal controls were insufficient to promptly
identify and report past due accounts in a timely manner. As a result, TNCC's financial
reporting was continuously inaccurate and misstated. As the FDIC Inspector General's Report
states:
TCB had no repossessed assets as of December 31, 2006. However, by the close of 2007, the bank had repossessed assets of about $7 million consisting primarily of trucks that were leased through the bank's indirect funding programs. Management attributed the high level of repossessions to increases in fuel costs and the resulting impact on the trucking industry. In addition, due to the structure of the leases through the brokers, the bank was not becoming aware of the problems until the leases were 90 to 120 days past due. Examiners noted that a significant portion of the bank's repossessions were held in excess of the 6-month maximum period permitted under Tennessee law. TCB subsequently formed a subsidiary called the Tennessee Commercial Asset Services, Inc.,
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to hold repossessed assets beyond the 6-month period allowed by Tennessee law and assist the bank in selling and collecting proceeds from repossessed assets.
FDIC Inspector General's Report at 1-14. These serious violations of the law and lapses in the
Bank's controls are not mentioned in TNCC's 2007 Annual Report.
C) Understatement of Risk and Character of Non-Core Deposits
72. In addition, the Defendants Helf, Cox and Sapp were fully aware that the amount
and risk of deposits being purchased by the Bank on the wholesale internet market were
materially understated. While the 2007 Annual Report acknowledges that the Bank did rely on
the volatile and risky wholesale deposit market for a portion of its loan funding, the Bank
systematically misrepresented the scope of the risk and exposure. The 2007 Annual Report
stated:
The Bank also obtains funding in the wholesale deposit market which is accessed by means of an electronic bulletin board. This electronic market links banks and sellers of deposits to deposit purchasers such as credit unions, school districts, labor unions, and other organizations with excess liquidity. Deposits may be raised in $99 or $100 increments in maturities from two weeks to five years. Management believes the utilization of the electronic bulletin board is highly efficient and the average rate has been generally less than rates paid in the local market. Participants in the electronic market pay a modest annual licensing fee and there are no transaction charges. Management has established policies and procedures to govern the acquisition of funding through the wholesale market. Wholesale deposits are categorized as "Purchased Time Deposits" on the detail of deposits shown in this Item 7. Management may also, from time to time, engage the services of a deposit broker to raise a block of funding at a specified maturity date.
Total average deposits in 2007 were $685,063, an increase of $233,828, or 51.82% over the total average deposits of $451,235 in 2006. Average non-interest bearing deposits increased by $2,922, or 15.95%, from $18,325 in 2006 to $21,247 in 2007. Average savings deposits decreased by $5,423 from $12,678 in 2006 to $7,255 in 2007. Average purchased deposits increased by $62,547, or 32.57%, from $192,064 in 2006 to $254,611 in 2007.
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The average rate paid on purchased deposits in 2007 was 5.28% compared to 4.82% in 2006. Purchased time deposit funding represented 37.27% of total funding in 2007 compared to 33.96% in 2006.
2007 Annual Report at 25 (emphasis added).
73. Nonetheless, TNCC's management manipulated these numbers in order to hide
the true amount of non-core deposits that the Bank was relying on to fuel its growth. As the
FDIC reported to Defendants in 2006 and 2007, the Bank's non-core funding dependence was
not fully reflected, due to the fact that the Bank was structuring its purchases to manipulate the
numbers and make the situation look less risky:
The April 2006 examination report noted that TCB's Internet deposits represented 52 percent of the bank's core deposits (which accounted for 67 percent of total deposits). TCB obtained its Internet deposits through an electronic bulletin board that linked banks and sellers of deposits to deposit purchasers, such as credit unions, school districts, labor unions, and other organizations with excess liquidity. TCB purchased its Internet deposits in increments of $99,000, which resulted in a net non-core funding dependence ratio that did not fully reflect the bank's reliance on potentially volatile funding sources. [Footnote] Net non-core funding dependence ratio is a measurement of noncore liabilities, less short-term investments divided by long-term assets. Internet deposits below $100,000 are classified as core deposits under the UBPR definition, therefore, while Internet deposits may exhibit the characteristics of non-core deposits, they are not reflected in the net non-core funding dependence ratio.
FDIC Inspector General's Report at 1-18.
2. False Statements Concerning TNCC's Operations in 2008
74. On March 16, 2009, TNCC filed its 2008 Annual Report on Form 10-K, which
falsely stated that there were no material deficiencies in the internal controls of the Bank,
including, but not limited to underwriting and investment recovery procedures. Tennessee
Commerce Bancorp, Inc., Annual Report (Form 10-K), at F-2 (March 16, 2009) (the "2008
Annual Report"). The Form 10-K also falsely underreported the Bank's reliance on non-core,
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"wholesale" or "purchased time deposits," which are extremely volatile and have a
disproportionate effect on the Bank's liquidity. Furthermore, the 2008 Annual Report failed to
inform investors that the Bank had not developed a capital plan, which would govern the high
asset growth - and simultaneous explosion in risk - that the bank was experiencing, due primarily
to the concentration of the Bank's lending in the C&I space. The 2008 Annual Report was
signed by Defendants Helf, Sapp, Perez and Cox. In addition, Defendants Helf and Perez each
signed false SOX Certifications representing that the 2008 Annual Report was free from
misstatement and TNCC's internal controls were sufficient and effective.
75. As the 2008 Annual Report stated in pertinent part:
Management, with the participation of the Corporation's Chief Executive Officer and Chief Financial Officer, conducted an assessment of the effectiveness of the Corporation's system of internal control over financial reporting as of December 31, 2008, based on criteria for effective internal control over financial reporting described in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that the Corporation maintained effective internal control over financial reporting as of December 31, 2008.
2008 Annual Report, at F-2.
a) Undisclosed Lack of Effective Controls Over Loss Mitigation
76. The 2008 Annual Report failed to inform investors that the Bank's controls
concerning asset recovery, i.e., the repossession and sale of seized assets, were essentially
nonexistent. Not only was the Bank routinely and systematically violating Tennessee law, the
failure to report or late reporting of—defaults and associated repossessions had a material
impact on the Bank's financial reporting and should have triggered increases in loan loss
reserves, see infra. As the FDIC Inspector General reported regarding the 2008 examination of
the Bank:
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Examiners noted an increase in repossessed assets primarily trucks that were leased through the bank's lease pool program. These repossessions resulted in an apparent violation of Tennessee law because a significant portion of the repossessions were held by the bank in excess of the 6-month maximum permitted by state statute.
FDIC Inspector General Report at 1-25. The failure to disclose such a serious and ongoing
breach of internal controls and the law left investors with a false impression of the Bank and its
operational controls, which were described as effective and conservative in the 2008 Annual
Report.
b) Failure to Fully Disclose Risks Associated with Increased Loan Concentration
77. Beginning in 2008, TNCC was admonished to begin closely evaluating and
reviewing its assets in order to comply with applicable GAAP rules, governing the recognition of
loan and lease losses. Of particular concern to the Bank's examiners was the extremely high
concentration of the Bank's assets in the C&I space. As the FDIC noted in its 2008 examination
of the bank, not only had the Bank failed to develop and implement a "capital plan" which would
help the bank deal with its overconcentration risk issues, the Bank had also failed to adjust its
loan loss reserves to account for an explosion in its C&I lending:
Specifically, the April 2008 examination report stated that: . . . The Board did not develop a capital plan as recommended in the prior-year examination report. . . . Strategic planning needed to be strengthened. Specifically, TCB's Board had not reviewed the bank's strategic plan on an annual basis and the plan had not been amended to reflect the changes in the bank's activities. . . . TCB's C&I concentration at year-end 2007 was 539 percent of total capital (which placed TCB in the 99th percentile of its peer group).
Examiners noted that the bank's sustained high asset growth, which ranked in the 96th percentile compared its peer group average at year-end 2007, continued to erode the bank's capital position. Examiners again recommended that the Board adopt a written capital plan.
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FDIC Inspector General's Report at 1-25. In other words, ranking in the 991h and 96th percentile
for C&I concentration and asset growth, it was knowingly reckless for the Board not to
effectively manage the Bank's risk by crafting, adopting and implementing a reasonable capital
plan. No such plan was implemented and the Bank's reckless growth and adoption of
unreasonable risk continued.
C) Failure to Fully Disclose the Amount and Risk Profile of Non-Core Deposits
78. In addition, the Defendants Helf, Cox, Perez and Sapp were fully aware that
amount and risk of deposits being purchased by the Bank on the wholesale internet market were
materially understated. While the 2008 Annual Report acknowledges that the Bank did rely on
the volatile and risky wholesale deposit market for a portion of its loan funding, the Bank
systematically misrepresented the scope of the risk and exposure. The 2008 Annual Report
stated:
The Bank also obtains funding in the wholesale deposit market which is accessed by means of an electronic bulletin board. This electronic market links banks and sellers of deposits to deposit purchasers such as credit unions, school districts, labor unions, and other organizations with excess liquidity. Deposits may be raised in $99 or $100 increments in maturities from two weeks to five years. Management believes the utilization of the electronic bulletin board is highly efficient and the average rate has been generally less than rates paid in the local market. Participants in the electronic market pay a modest annual licensing fee and there are no transaction charges. Management has established policies and procedures to govern the acquisition of funding through the wholesale market. Wholesale deposits are categorized as "Purchased Time Deposits" on the detail of deposits shown in this Item 7. Management may also, from time to time, engage the services of a deposit broker to raise a block of funding at a specified maturity date.
Total average deposits in 2008 were $949,005, an increase of $263,942, or 38.53% over the total average deposits of $685,063 in 2007. Average non-interest bearing deposits increased by $2,097, or 9.87%, from $21,247 in 2007 to $23,344 in 2008. Average
42 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 42 of 100 PageD #: 337
savings deposits decreased by $724 from $7,255 in 2007 to $6,531 in 2008. Average purchased deposits increased by $200,443, or 78.73%, from $254,611 in 2007 to $455,054 in 2008. The average rate paid on purchased deposits in 2008 was 4.50% compared to 5.28% in 2007. Purchased time deposit funding represented 47.95% of total funding in 2008 compared to 37.27% in 2007.
2007 Annual Report at 27 (emphasis added). The foregoing statement is false, in that it
underreported the amount of purchased deposits that the Bank held on its books. As the FDIC
Inspector General's Report concluded, the Bank was routinely purchasing internet deposits in
amounts under $100,000, which are classified as "core" deposits, although they exhibit the
characteristics of non-core assets. See FDIC Inspector General's Report at 1-18. Non-core
deposits are extremely risky, exhibiting "increased volatility when interest rates change and
difficulty accessing such funds when the financial condition of an institution deteriorates." Id. at
1-17.
79. Finally, the 2008 Annual Report failed to disclose continued violations of policy
and law that had plagued the Bank's Asset/Liability Committee. In the 2007 Annual Report, the
Bank had disclosed that internal controls were ineffective concerning the Asset/Liability
Committee, which had not met in 2007. In 2008 Defendants took their deception further,
apparently fabricating committee minutes in violation of Tennessee Law:
[T]he April 2008 examination report stated that: The bank's Asset/Liability Committee had not met on a regular basis since the prior regulatory examination. However, "minutes" of what were actually "very informal discussions" among the Committee members were inappropriately submitted to the Board. The examination report stated that the minutes "appear to be false and misleading statements provided in reports to the Board" and that they had the potential to mislead the directorate as well as examiners that review Board meeting documentation. The report cited TCB with an apparent violation of Tennessee Code Annotated Section 45-2-1706--Improper Maintenance of accounts—False or deceptive entries and statements.
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FDIC Inspector General's Report at 1-25.
3. False and Misleading Statements Concerning Operations in 2009
80. TNCC and the Bank continued to run off the rails in 2009. In 2009, the Bank's
outstanding loan balance grew unrestrained by over $310 million or 39% from the previous
year whileinternal controls over loan underwriting and originations went unsupervised and
unenforced. At the same time, the bank became ever more illiquid, originating massive amounts
of loans without adhering to responsible underwriting guidelines, while failing to earn sufficient
revenues or recoup losses sufficient to support operations or bolster the Bank's cash-strapped
balance sheet. This information, however, was not revealed in any truthful or meaningful way to
TNCC's investors.
81. The 2009 annual report was filed with the SEC on March 9, 2010, and similar to
previous years, contained numerous misstatement and omissions concerning the Bank's internal
controls, financial reporting and compliance with relevant underwriting policies and applicable
laws. See Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K) (Mar. 9, 20 10) (the
"2009 Annual Report").' Among other things, the 2009 Annual Report: (a) falsely represented
that the Bank's internal controls were sufficient, effective and enforced; (b) misrepresented the
quality and risk profile of the Bank's assets; and (c) falsely reported the Bank's financial results,
due to the knowing violation of GAAP rules.
82. The 2009 Annual Report was signed by Defendants Helf, Sapp, Cox and Perez.
In addition, Defendants Sapp and Perez each signed false SOX Certifications representing that
The 2009 Annual Report filed on March 9, 2010 was later amended. As the amended annual report states, it was filed in order to make three categories of minor corrections, none of which concern the allegations herein. See Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K/A), at 2 (May 27, 2010). All references to the "2009 Annual Report" are to the original report on Form 10-K filed on March 9, 2010.
44 Case 3:12-cvM1137 Document 44 Filed 04/18/13 Page 44 of 100 PageD #: 339
the 2008 Annual Report was free from misstatement and TNCC's internal controls were
sufficient, effective and enforced.
a) Undisclosed Lack of Effective Loan Underwriting and Administration Controls
83. In the 2009 Annual Report, Defendants knowingly misrepresented the almost
complete lack of internal controls at the bank in 2009 concerning both the origination and
financial accounting for loans theBank's only assets. Nonetheless, the Bank continued to
originate hundreds-of-millions of dollars' worth of new loans in 2009—originating over $90
million in new loans during the first quarter of 2009 alone—despite the fact that the economy
had slowed and the Bank's concentration of loans in the C&I space represented a growing risk to
liquidity. As the FDIC noted:
[In 2009] TCB's loan portfolio had grown by $310 million (or 39 percent) since the prior examination. Examiners suggested that the Board consider suspending or curtailing its growth strategy while evaluating the systemic risk to the institution. Examiners further suggested that management consider establishing concentration criteria relative to capital in order to manage the bank's significant industry exposure and concentration risk, as had been done by regulatory agencies related to CRE lending. While the bank demonstrated awareness of the concentrations as a percentage of capital, examiners noted that the financial condition of the bank was highly sensitive to economic conditions, and recommended that the Board and management carefully consider additional strategies to further mitigate concentration risk going forward.
FDIC Inspector General's Report at 1-27. Such an explosion in loan origination alone—
particularly at a time when the economy was contracting would pose additional material risk to
the Bank. However, the failure of the Bank to sufficiently monitor, verify and report the risk
quality of the loans being originated magnified the risk.
84. During its 2009 examination of the Bank, the FDIC discovered that the Bank had
been systematically originating loans without proper or sufficient documentation—in violation of
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the Bank's lending and underwriting guidelines. As the FDIC Inspector General's examination
of the Bank in 2009 observed:
Examiners noted that although the [Bank's written loan origination] policy was adequate, lax underwriting, administration, and monitoring practices were evident. For example, examiners noted instances in which credit reports were not obtained prior to loan origination, global cash flow analyses were not performed, LTVs were high, and financial information on borrowers was missing.
The June 2009 joint examination report suggested that refresher training be provided for all employees with loan authority or who had responsibility for credit documentation to reinforce the importance of strong credit practices in a declining economy. The report added that implementing a credit culture consistent with the then current economic environment that was evident through Tennessee and the nation, as well as reassessing the organization's risk appetite, would be a prudent plan of action.
FDIC Inspector General's Report at 1-27. In other words, the Individual Defendants were aware,
at least as early as 2009 that the Bank was originating the functional equivalent of commercial
sub-prime, stated income loans almost two years after the worst economic disaster in U. S.
economic history had been triggered by the very same types of loans on residential properties.
85. At the same time, the Individual Defendants described the Bank bothin the
2009 Annual Report and other contemporaneous statements—as well run and well capitalized,
with very little exposure to risk. For example, during the earnings call discussing financial
results for the first fiscal quarter of 2009, Defendant Perez, CFO of TNCC falsely stated:
[sic] We have discussed on prior calls, Tennessee Commerce does not have any exposure to subprime loans. We believe our diversified loan portfolio insulates us in part from the effects of any single economic sector.
Tennessee Commerce Bancorp, Inc., Qi 2009 Earnings Call, Bloomberg Transcript, at 4 (Apr.
29, 2009). Not only was this statement knowingly false on one level—i. e., the Bank was
46 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 46 of 100 PageD #: 341
originating subprime loans, but the loan portfolio was not sufficiently diversified, with extremely
high concentration risk in the C&I lending space. See FDIC Inspector General's Report at 1-27.
86. The effect on the Bank's capital position resulting from the Individual
Defendants' failure to maintain sufficient underwriting controls was immediately apparent to the
FDIC. As the Inspector General's Report states:
Examiners noted that adverse loan and lease classifications had quadrupled since year-end 2007, delinquent loans had increased nearly two-fold, and loans charged off had increased substantially.
Notably, six borrowing relationships (not including Relationship A) accounted for 44 percent of adversely classified loans. Examiners attributed a sizeable portion of adverse loan classifications, including small indirect loans, to slowing economic conditions in the trucking and tour bus industries. As a result of the bank's less-than satisfactory asset quality, earnings were insufficient to support operations or augment capital. Examiners also found that liquidity needed improvement, adding that liquidity contingency plans emphasizing potential asset-based sources of liquidity needed to be developed given the bank's financial condition.
FDIC Inspector General's Report at 1-26 to 27.
b) The Materially Misstated Allowance for Loan and Lease Losses and Related GAAP Rules
87. The 2009 Annual Report's most damaging false statements to investors concerned
the Bank's understated ALLL, which is perhaps the most valuable tool for evaluating the risk
profile of a banking investment. The ALLL is described by the Board of Governors of the
Federal Reserve System as follows:
The purpose of the ALLL is to reflect estimated credit losses within a bank's portfolio of loans and leases. Estimated credit losses are estimates of the current amount of loans that are probable that the bank will be unable to collect given the facts and circumstances since the evaluation date (generally the balance sheet date). That is, estimated credit losses represent net charge-offs that are likely to be realized for a loan or group of loans as of the evaluation date. The ALLL is presented on the balance sheet as
47 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 47 of 100 PageD #: 342
a contra-asset account that reduces the amount of the loan portfolio reported on the balance sheet.
Board of Governors of the Federal Reserve System, Supervisory Policy and Guidance Topics:
Allowance for Loan and Lease Losses (ALLL),
http://wwwfederalreservc.gov/bankinforcg/topics/alllhtrn . An increase in the ALL is
accompanied by a corresponding decrease in a bank's operating income, reflected on the income
statement. Department of the Treasury, Office of the Comptroller of the Currency, Allowance
for Loan and Lease Losses, at 1, Comptroller's Handbook (May 1998) "The [ALLL], which was
originally referred to as the 'reserve or bad debts,' is a valuation reserve established and
maintained by charges against the bank's operating income."). Accordingly, any increase in the
ALLL will be reflected in a bank's earnings, making such an adjustment immediately obvious to
investors and reflecting an increase in the risk profile of the bank's investments. See Ed.
("Bank's must establish an allowance for loan and lease losses because there is credit risk in their
loan and lease portfolios. The allowance, which is a valuation reserve, exists to cover the loan
losses that occur in the loan portfolio of every bank. As such, adequate management of the
allowance is an integral part of a bank's credit risk management process.") (emphasis in
original).
88. In 2009, according to the FDIC's examination, TNCC had adversely classified
assets of $95 million, which accounted for approximately 75% of the Bank's Tier 1 capital.
According to the FDIC's criteria, "adversely classified assets" are defined as:
Assets subject to criticism and/or comment in an examination report. Adversely classified assets are allocated on the basis of risk (lowest to highest) into three categories: Substandard, Doubtful, and Loss.
FDIC Inspector General's Report at 1-42. Under the GAAP rules governing the ALLL, the
probable losses on all of those adversely classified assets should have been accurately estimated
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and accrued as loan losses, including a charge to the income statement in the amount of the
expected losses. They were not.
89. Indeed, for the entire year of 2009, TNCC recognized only $19 million in accrued
losses. At the same time, net charge-offs for 2009 had increased by 400% (from $5.9 million to
$24.6 million), but the TNCC's allowance for loan and lease losses ("ALLL") only increased by
only 32% or approximately $6.5 million. The failure of TNCC to adjust the ALLL to adequately
account for the extraordinary inherent risk of the Bank's asset profile represented a knowing,
blatant and ongoing breach of applicable GAAP rules, including FAS 5, FAS 114 and SOP 03-3.
90. Working together, GAAP rules applicable to loan and lease losses provide a
cohesive methodology for adjusting the book value of such assets once losses are probable. The
primary GAAP rules which make up the ALLL are FAS 5 and FAS 114. FAS 114 governs
accounting for losses on individual loans which have been reviewed and it has been determined
that the creditor (here, the Bank) will be unable to collect all of the amounts which are due
according to the contractual terms of the loan agreement. See United States Department of the
Treasury, Comptroller of the Currency Administrator of National Banks, Comptroller's
Handbook: Allowance for Loan and Lease Losses, at 6 (May 17, 2012),
http://wwwocc. gov/publications/publications-by-type/cornptrollers-handbook/alllpdf Like
FAS 114, FAS 5 governs accounting for losses on a group of assets when losses are probable and
can be estimated; however, FAS 5 applies to a homogeneous group of loans which are classified
after a FAS 5 review of individual loans has been conducted. See United States Department of
the Treasury, Office of the Comptroller of the Currency, Interagency Policy Statement on the
Allowance for Loan and Lease Losses, SR 06-17, at 5 (Dec. 13, 2006),
http://wwwfederalreservc.gov/boarddocs/srletters/2006OSRO617a1 pdf
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91. FAS 5, which is part of the GAAP rules, requires that loss contingencies be
recognized by a charge to income if both of the following conditions are met:
(a) Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.
(b) The amount of loss can be reasonably estimated.
Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 5:
Accounting for Contingencies, Financial Accounting Foundation (March 1975).
92. FAS 114 deal specifically with the impairment of a particular loan and is also part
of the GAAP rules. According to FAS 115:
A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. As used in this Statement and in Statement 5, as amended, all amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. This Statement does not specify how a creditor should determine that it is probable that it will be unable to collect all amounts due according to the contractual terms of a loan. A creditor should apply its normal loan review procedures in making that judgment. An insignificant delay or insignificant shortfall in amount of payments does not require application of this Statement. A loan is not impaired during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Thus, a demand loan or other loan with no stated maturity is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding.
Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 114:
Accounting by Creditors for Impairment of a Loan, Financial Accounting Foundation (May
1993).
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93. Similarly, Statement of Position 03-3 ("SOP 03-3") relates to loans that are
acquires, as opposed to originated (which are covered by FAS 114), and requires that losses be
recognized in the following circumstances:
04 Loss accruals or valuation allowance. Valuation allowances should reflect only those losses incurred by the investor after acquisition that is, the present value of all cash flows expected at acquisition that ultimately are not to be received. For loans that are acquired by completion of a transfer, it is not appropriate, at acquisition, to establish a loss allowance. For loans acquired in a purchase business combination, the initial recognition of those loans should be the present value of amounts to be received.
American Institute of Certified Public Accountants, Inc., Statement of Position 03-3 Accounting
for Certain Loans or Debt Securities Acquired in a Transfer, Accounting for Certain Loans or
Debt Securities § 10,880 (December 12, 2003).
94. Working together FAS 5, 114 and SOP 03-3 provide a framework whereby
responsible bank managers may timely identify and recognize loan losses, before those loans are
actually charged off. This provides potential investors with a picture of a bank's risk profile at
any given time and, particularly in times of economic turmoil—such as were present in the US
economy in 2009—allows investors to identify banks with particular risk investments or classes
of investments.
95. Defendants knowingly violated the above rules by underestimating accrued loan
losses in order to: (1) falsely inflate their earnings during the Class Period, earnings which would
have been adversely affected by an increase in loan loss reserves; and (2) give the illusion of a
much lower risk profile than the bank had in reality, due to a lack of internal controls and
inadequate, unenforced and unmonitored underwriting guidelines. As noted above, the upshot of
this knowing deception was to ensure that the Individual Defendants would continue to receive
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the excessive and lavish compensation that they had granted themselves, while they were
simultaneously defrauding investors running the Bank into the ground.
96. Defendants intentionally and repeatedly failed to either implement or enforce
sufficient controls to effectively identify, evaluate and recognize loan losses in accordance with
the above-referenced GAAP rules. As the interagency Policy Statement on Allowance for Loan
and Lease Losses Methodologies and Documentation for Banks and Savings Institutions (the
"Policy Statement") states:
Boards of directors of banks and savings institutions are responsible for ensuring that their institutions have controls in place to consistently determine the allowance for loan and lease losses (ALLL) in accordance with the institutions' stated policies and procedures, generally accepted accounting principles (GAAP), and ALLL supervisory guidance. To fulfill this responsibility, boards of directors instruct management to develop and maintain an appropriate, systematic, and consistently applied process to determine the amounts of the ALLL and provisions for loan losses. Management should create and implement suitable policies and procedures to communicate the ALLL process internally to all applicable personnel. Regardless of who develops and implements these policies, procedures, and underlying controls, the board of directors should assure themselves that the policies specifically address the institution's unique goals, systems, risk profile, personnel, and other resources before approving them. Additionally, by creating an environment that encourages personnel to follow these policies and procedures, management improves procedural discipline and compliance.
Federal Financial Institutions Examination Council, Policy Statement on Allowance for Loan
and Lease Losses Methodologies and Documentation for Banks and Savings Institutions, at *5
(July 2, 2001). The Individual Defendants consistently failed to either develop or maintain
appropriate systems for the recognition of losses on a timely basis, resulting in materially
misstated financial statements, including an exaggerated Tier 1 Capital Ratio and a materially
understated ALLL.
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97. Following its June 2009 joint examination with the TDFI, the FDIC determined
that the Bank was in "troubled condition" and that 75% of the Bank's Tier 1 Capital—or $95
million worth of loans—qualified as adversely classified. Under FAS S and 114, it was
incumbent on the Bank to undertake a thorough examination of all of those adversely classified
assets in order to determine whether any of them were sufficiently impaired to require an
increase in the ALLL. However, "lax underwriting, administration, and monitoring" led to a
lack of oversight of the loan profile and an insufficient ALLL. FDIC Inspector General's Report
at 1-27. A lack of documentation compounded matters, because even if proper FAS 5 and 114
review of the loan profile taken place, "a lack of current financial information on borrowers"
would prevent an accurate assessment of the risk of the Bank's assets. See Ed.
98. Indeed, at the same time that the FDIC was warning the Bank that the risk profile
of the loan portfolio was increasing and monitoring by management was deficient, Defendants
actually decreased the ALLL, proclaiming their triumph over the perceived risk in the Bank's
portfolio: "Our provision for loan losses is down significantly from earlier this year due to
our aggressive stance on managing problem loans,' noted Mr. Sapp." Tennessee Commerce
Bancorp, Inc., Current Report (Form 8-K), Ex. 99. 1, at *2 (Oct. 20, 2009) (emphasis added).
99. Similarly, on January 19, 2010, TNCC issued a press release, trumpeting false and
misleading financial results and improved credit quality for the fourth quarter of fiscal year 2009.
Ex. 99.1. As the press release, which was filed with the SEC as an exhibit to a current report on
January 20, 2010, stated:
"Tennessee Commerce's fourth quarter results highlight the progress we made in growing our net interest income, expanding net interest margin and improving credit quality this year," stated Mike Sapp, President and Chief Executive Officer of Tennessee Commerce Bancorp. "Our earnings gained momentum in the fourth quarter and marked our highest level of net interest income,
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operating income and net income this year despite the continued weakness in the economy.
"We made substantial progress in improving our credit quality during the second half of 2009," continued Mr. Sapp. "Total nonperforming loans dropped 32.2% to $20.5 million compared with $30.2 million in the third quarter of this year and were at their lowest level in the past five quarters. The continued improvement in credit quality was reflected in our reporting the lowest level of net charge-offs this year. We believe our excellent results highlight our focus on the business banking market as well as the strength of our core market in Middle Tennessee."
Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex. 99. 1, at *1 (Jan. 20, 2010).
TNCC's "credit quality" had not improved in the second half of 2009 and the Bank's insufficient
controls over financial reporting and the evaluation of risk in the loan portfolio rendered
statements concerning "nonperforming loans," "charge-offs" and the Bank's ALLL wholly false
and misleading. See FDIC Inspector General's Report at 1-27. The Bank's financial condition
had not improved in the fourth quarter of 2001. In fact, the FDIC had previously informed
TNCC that its examination had revealed that the Bank had adversely classified assets of $95
million, which accounted for approximately 75% of the Bank's Tier 1 capital. See Ed. at I-iS.
Moreover, the FDIC had expressed serious concerns over the evaluation and documentation of
risk at the Bank, lax underwriting practices (in violations of the Bank's loan policies) and a
deterioration of the Bank's loan portfolio. See, e.g., FDIC Inspector General's Report at 1-27
("As a result of the bank's less-than-satisfactory asset quality, earnings were insufficient to
support operations or augment capital.").
C) Insufficient and Ineffective Controls Over Loss Mitigation
100. In addition, the 2009 Annual Report continued to misstate the efficacy of the
Bank's controls regarding loss mitigation and repossessions. The 2009 Annual Report falsely
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provided investors with the illusion of an orderly and strictly monitored and administered loss
mitigation process:
Other Real Estate and Repossessed Assets: Real estate acquired by foreclosure is carried at the lower of the recorded investment in the property or its fair value, less costs to sell, at the date of foreclosure, determined by appraisal. Declines in value indicated by reappraisals as well as losses resulting from disposition are charged to operations. Subsequent costs are expensed as they occur after any re-acquisitions. Other real estate owned is included in other assets on the balance sheet, with a carrying value of approximately $814,000 and $5,764,000 in 2009 and 2008, respectively. Repossessed assets acquired by foreclosure are carried at the lower of the recorded investment in the asset or its estimated fair value. Declines in value indicated by reappraisals as well as losses resulting from disposition are charged to operations. These repossessed assets are either disposed of by the Bank or sold to TCB. Subsequent costs are expensed as they occur after any re-acquisitions. Repossessions are included in other assets on the balance sheet, with a carrying value of approximately $27,169,000 and $10,694,000 in 2009 and 2008, respectively, if a repossession of the Bank is not resold within the six month holding period allowed by Tennessee law, it is purchased by TCB at fair market value. The sole purpose of TCB is the resale of assets repossessed by the Bank. At December 31, 2009 and 2008, TCB carried approximately $9,782,000 and $4,701,000, respectively, and nothing in prior years on its balance sheet. TCB carries these purchases as inventory.
2009 Annual Report at F- 10.
101. In reality, repossessions at the Bank continued to be conducted in violation of
Tennessee law and with virtually no oversight by executive management or the Board. As the
FDIC Inspector General's report states:
TCB did not have adequate loss mitigation policies and procedures to monitor the repossession and timely disposition of collateral. TCB often relied on various third-party dealers and brokers for payment collection and collateral repossession services. It does not appear that the bank adequately understood, assessed, or monitored the risk exposure related to these third-party relationships. For example, we observed an instance in which a single broker was servicing over 1,100 leases valued at over $58 million, yet the broker had only 4 employees performing collection services. This
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suggests an inadequate infrastructure that may have limited the broker's ability to support and service a labor intensive lease portfolio on behalf of TCB. To further illustrate management's inadequate monitoring of broker relationships, an examiner loan review of a broker relationship at the 2009 joint examination noted numerous deficiencies, including but not limited to, a lack of a physical on-site collateral inspection, a lack of a formalized agreement between TCB and the broker, and a potential conflict of interest involving used tractor/trailer sales and inventory.
FDIC Inspector General's Report at 1-14 to 1-15. The undisclosed loss mitigation deficiencies,
particularly when considered in conjunction with the increase in risk of the loan portfolio and lax
underwriting controls, represent a material misstatement, which would grow in importance as the
condition of the Bank worsened.
d) Undisclosed Regulatory Action
102. The 2009 Annual Report also failed to disclose actions that the FDIC had
undertaken following the conclusion of the June 2009 examination of the Bank. As noted above,
in a letter dated October 8, 2009, the FDIC informed the Bank that it was deemed to be in
"troubled condition" and instructed the Board and management of the Bank to "administer the
bank in such a way as to stabilize its risk profile and strengthen its financial condition." FDIC
Inspector General's Report at 1-27. Defendants did no such thing.
103. Further, the FDIC's letter of October 8, 2009 informed Defendants that, following
a join examination by the FDIC and the Tennessee Department of Financial Institutions
("TDFI") in June of 2009, not only was the Bank deemed to be in a "troubled condition," but that
"informal corrective action would be recommended to the RMS Regional Director." FDIC
Inspector General's Report at 1-27. The 2009 Annual Report does not mention the October 8,
2009 letter, nor does it mention the corrective measures that had been proposed by the FDIC.
Instead, the Annual Report includes only a misleading boilerplate acknowledgement that at some
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point in the future the bank might be subject to potential corrective actions by regulators at some
amorphous point in the future:
Our bank subsidiary is not currently under, nor does management expect it to be placed under, a formal enforcement action. Nonetheless, we can provide no assurance that we will not become subject to a regulatory action, possibly including a memorandum of understanding, cease and desist order, prompt corrective action and/or other regulatory enforcement action.
2009 Annual Report at 11.
4. False and Misleading Statements Concerning Fiscal Year 2010
104. In 2010, as the Bank's liquidity position was becoming more tenuous and the
quality of its poorly underwritten loan profile was deteriorating, it was even more incumbent on
Defendants to keep up the appearances of the Bank as a well-managed, well-capitalized,
financial institution - which Defendants did by continuing their false and misleading statements
to investors.
a) Undisclosed Regulatory Activity and Results of Regulatory Examinations
105. On October 8, 2009, the FDIC notified the TNCC Board that the Bank had been
deemed to be in "troubled condition" as a result of the joint examination performed by the FDIC
and TDFI in June of 2009. The letter went on to instruct the Bank's Board and Management to
"administer the bank in such a way as to stabilize its risk profile and strengthen its financial
condition." FDIC Inspector General's Report at 1-27. The October 8, 2009 letter also warned
that the FDIC would seek informal corrective action.
106. As eluded to in the FDIC's October 8, 2009 letter to the Board, the FDIC
transmitted a draft Memorandum of Understanding ("MOU") to the TNCC Board on January 21,
2010, seeking a number of remedial measures in order to stabilize the Bank's financial condition.
Among other things, the MOU proposed by the FDIC requested that:
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• submit a capital plan to achieve and maintain Leverage, Tier 1 Risk-Based, and Total Risk-Based capital ratios of 9 percent, 11 percent, and 13 percent, respectively;
• prohibit salary increases or bonus payments for top executive managers or loan officers without the prior written approval of the Regional Director and the TDFI Commissioner until the bank could achieve sustained profitability;
• formulate, adopt, and submit a written plan of action to address the bank's volatile liability dependence ratio;
• approve a revised internal credit grading system for internal loan review purposes;
• develop a written plan to reduce the level of nonperforming assets, repossessions, and assets classified adversely at the June 2009 joint examination;
• restrict additional advances to any borrower for whom the bank holds an uncollected charged-off asset or whose extension of credit is adversely classified; and
• restrict asset growth to 10 percent during any consecutive 6-month period without providing a growth plan to regulators.
FDIC Inspector General's Report at 1-20 to 1-2 1.
107. Nonetheless, Defendants rejected the MOU, knowingly and recklessly ignoring
the mismanagement objected to by the FDIC and TDFI and continuing on a path to the Bank's
ultimate failure. The primary reason for Defendants unwillingness to enter into the MOU
appears to be that it would have restricted the ability of the Bank to increase the salaries,
bonuses, benefits and perks enjoyed by Defendants Helf, Cox, Sapp and Perez. Defendants
never entered into an MOU with the FDIC and many, if not all, of the FDIC and TDFI's
concerns went entirely unaddressed .7
Instead the Bank attempted to mollify the FDIC by passing an insufficient and toothless Board resolution, which did not address and did not correct the serious violations of controls, policy and law addressed by the FDIC's proposed MOU. See FDIC Inspector General's Report at 1-21 ("TCB's Board never signed an MOU with the FDIC and TDFI, and many of the objectives and goals of the proposed MOU were not met.").
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108. Defendants concealed the FDIC and TDFI's conclusions from investors and, in
fact, made no mention whatsoever of the MOU or the FDIC's intention to bring an enforcement
action until November of 2010—more than a full year following the FDIC's October 9, 2009
letter. See supra. In fact, it was not until November of 2011, upon the issuance of TNCC's 10-Q
for the third fiscal quarter of 2010, that any impeding action by the FDIC against TNCC was
even mentioned. See Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 33
(Nov. 12, 2010). When the proposed FDIC/TDFI action was mentioned to investors, the full
gravity of the situation was not materially disclosed. For example, the quarterly report filed on
November 12, 2010 failed to inform shareholders that the FDIC had requested that the Bank
enter into an MOU at all, simply stating that: "no MOU has been entered into by the bank." Id.
Next, the November 12, 2010 Quarterly Report failed to set forth the reasons behind the FDIC's
request that the Bank enter into an MOU in the first instance. See Ed. Finally, and perhaps most
significantly, the November 12, 2010 Quarterly Report failed to inform shareholders of the
reasons why the Individual Defendants did not want to agree to the FDIC's proposed MOU-
namely, the fact that their own personal compensation would have been greatly curtailed. See Ed.
109. In April of 2010, the FDIC and TDFI performed a joint visitation, following up on
the recommendations that were made in the proposed butnever executed—MOU. While the
FDIC noted some modest improvements, the Bank's situation was still precarious and financial
reporting and loss mitigation controls were still insufficient:
The visitation noted some progress, but the overall condition of the bank remained less than satisfactory. Notably, the balance of repossessed assets had more than doubled, and earnings continued to suffer from high provision expenses. Examiners also found that the bank's credit grading, administration, and underwriting practices related to Relationship A were questionable and that additional information regarding the debt service ability, collateral
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valuation, and ownership of pledged collateral was needed to fully assess the risk associated with the relationship.
FDIC Inspector General's Report at 1-28. The Quarterly Report filed by TNCC on May 7, 2010
noted no weaknesses in the Bank's financial reporting, credit underwriting or loss mitigation
controls. See Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 23 (May 7,
2010) ("Management is responsible for ensuring that controls are in place to ensure the adequacy
of the loan loss reserve in accordance with GAAP, our stated policies and procedures, and
regulatory guidance.").
110. The 2010 Annual Report, filed on April 18, 2011, misleadingly attempted to
downplay the seriousness of the FDIC's examination and related informal enforcement action at
the end of 2009/2010, including the FDIC's request that TNCC enter into an MOU. Indeed,
many of the statements made in the 2010 Annual Report concerning the FDIC and its regulation
of the bank are misleading, while others are outright falsities. For instance, the 2010 Annual
Report states that "as of March 17, 2011, the Bank [had been] deemed to be in troubled
condition." Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at 7, 19 (April 18,
2011) (the "2010 Annual Report").' In reality, the FDIC had deemed the Bank to be in "troubled
condition" as of October 8, 2009, when the FDIC sent a letter to the Bank's Board advising them
of that fact.
The 2010 Annual Report was later amended on April 18, 2011, June 1, 2011 and June 2, 2011. The April 18, 2011 amendment was made to correct a typographical error. The June 1, 2011 amendment was made purportedly to disclose the consent order entered with the FDIC on May 25, 2011. Tennessee Commerce Bancorp, Inc., Amended Annual Report (Form 10-K/A), at *2 (June 1, 2011). Finally, the June 2, 2011 amendment was made to include a report of TNCC's accountant. Tennessee Commerce Bancorp, Inc., Amended Annual Report (Form 10-K/A), at *2 (June 2, 2011). With those exceptions, the 2010 Annual Report was not modified in any way and, unless otherwise noted, all citations to the 2010 Annual Report are to the initial report filed with the SEC on April 18, 2011. See Ed.
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b) The Materially Understated ALLL
111. In addition, Defendants attempted to characterize the FDIC's suggested $16
million increase in the ALLL at the end of 2009 as unreasonable. Defendants knowingly and
falsely stated that the $16 million increase in the ALLL was not necessary when they well-
knew it was. Indeed, a materially higher ALLL was necessary given the known deterioration in
the Bank's loan profile. As the 2010 Annual Report misleadingly states:
[T]he FDIC and TDFI have advised the Bank because of inadequacies in its allowance for loan and lease losses, and loan impairment methodologies, a restatement of the Bank's allowance for loan and lease losses in its periodic reports to the regulators for the quarters ended December 31, 2009, March 31, 2010 and June 30, 2010 should be restated. Although the FDIC and TDFI focused on these three reporting periods in the examination, we anticipate that any restatement could also include financial statements for the period ending September 30, 2010. Restatement of the Bank's regulatory periodic reports likely will result in the restatement of the Corporation's financial statements for the same periods and included in this annual report. We strongly disagree with many of the findings in the report of examination, especially the factors giving rise to the need to restate our prior financial statements, primarily due to differences in our loan and lease loss impairment analysis. However, the changes that may be made in the restatement may be material in the quarter made and may be material to the full year period in which the quarterly results are included. FDIC and TDFI have proposed an increase in our allowance for loan and lease losses of up to approximately $16 million, an amount not recognized in the financial statements to this annual report. We do not concur with this amount and our regulators have not provided us with their methodology. Accordingly, if ultimately required, the increase to our allowance for loan and lease losses may differ from the amount our regulators are requiring. In accordance with established procedures of the FDIC and TDFI we plan to vigorously appeal what we believe to be the various inaccuracies contained in the report of examination, including the required impairment charges. While we have 60-days to file an appeal after the receipt of a material supervisory determination, we cannot predict the timing of a final regulatory determination or whether we will prevail.
2010 Annual Report at 19.
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112. In reality, by the time that the 2010 Annual Report was issued in April of 2011,
the Bank's ALLL should have been much, much higher than an additional $16 million. Due to,
among other things, the FDIC's continued examination and attempts at enforcement, Defendants
well-knew that it would take much more than $16 million to adequately reflect the tremendous
risk that the Bank's loan portfolio was exhibiting at that time, rendering the statements regarding
the proposed ALLL increase in the 2010 Annual Report wholly false and misleading.
113. Strikingly, TNCC's loan loss reserve for 2010 was lower than the ALLL for 2009,
despite the fact that Defendants knew—due to the FDIC and TDFI's admonishments—that the
Bank's loan profile had deteriorated to the point of endangering the viability of the Bank. For
example, the press release announcing TNCC's fourth quarter 2010 financial earnings both
fraudulently described the Bank's ALLL and gave investors a false view of the financial health
of the Bank:
The increase in non-performing assets to $91.2 million at December 31, 2010 compared to $86.5 million at September 30, 2010 was mainly attributed to one relationship that totaled $3.5 million. Early stage delinquencies at December 31, 2010 improved $14.4 million from September 30, 2010 to 1.5% of total loans. Repossessed assets, consisting primarily of transportation assets, have decreased by 17% from $36.9 million at December 31, 2009 to $30.6 million at December 31, 2010. "While ATA truck tonnage index reports showed softening during the last half of the year, industry indicators point towards a positive rebound in 2011," stated Mike Sapp, President and Chief Executive Officer of Tennessee Commerce Bancorp, Inc.
The loan loss provision of $3.8 million for the fourth quarter of 2010 was the lowest provision expense recorded since the $3.3 million provision expense for the fourth quarter of 2008. Net charge-offs for the fourth quarter of 2010 amounted to $4.0 million, compared to $5.8 million for the third quarter of 2010. "We are pleased to return to profitability and to see the rebound in our net interest margin. Although non-performing loans increased during the fourth quarter, this was driven by specific larger loans rather than a decrease of overall credit quality. Additionally,
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we remain focused on enhancing our capital position and reducing the level of credit risk," stated Mike Sapp.
Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex. 99.1 at *2 (Jan. 21, 2011)
(emphasis added). Similarly, as the 2010 Annual Report falsely stated:
The provision for loan losses in 2010 was $20,011, a decrease of $11,028, or 35.53%, below the provision of $31,039 expensed in 2009. Of this provision, $1,550, or 7.75%, was attributable to loan growth recorded during 2010. The remainder of the loan loss provision in 2010 funded net charge-offs of $18,461. (in millions of dollars.)
2010 Annual Report at 39. The FDIC had alerted Defendants that these statements were false,
yet they were made notwithstanding that admonition. Among other things, the FDIC and TDFI's
joint August 2010 examination had specifically notified defendants that: (a) "the ALLL
calculation required a more robust FAS 114 and FAS S methodology"; (b) that "improved
monitoring of the C&I portfolio, which totaled 465 of Total Risk-Based Capital at the time of
examination" was required; (c) that an immediate minimum "$16.3 million provision to the
ALL was needed to provide for the inherent risk in the loan portfolio"; and that "Call
Reports for June 30, 2010, March 31, 2010, and December 31, 2009, needed to be amended to
reflect the true financial condition of the bank." FDIC Inspector General's Report at 1-28
(emphasis added).
114. A fraudulent decrease in the ALLL under circumstances where the Bank's
adversely classified assets had dramatically rose not only represented a violation of the FDIC's
warnings, but a blatant and ongoing breach of GAAP rules, namely FAS 5, FAS 114 and SOP
03-3. In addition, not only was the ALLL falsely stated, the total amount of charge-offs was
fraudulently understated due to "management's failure to recognize losses in a timely manner
and reflect those losses within the appropriate period result[ing] in inaccurate financial
reporting." FDIC Inspector General's Report at 1-28.
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C) The Undisclosed Lack of Internal Controls Over Loan Underwriting, Risky Deposits and Loss Mitigation
115. As in previous years, TNCC's annual report for fiscal year 2010 included a
number of false and misleading statements, including, but not limited to a statement that
management had implemented, maintained and reviewed effective internal controls during the
year. 2010 Annual Report, at F-2 et seq. As the 2010 Annual Report stated in pertinent part:
Management, with the participation of the Corporation's Chief Executive Officer and Chief Financial Officer, conducted an assessment of the effectiveness of the Corporation's system of internal control over financial reporting as of December 31, 2010, based on criteria for effective internal control over financial reporting described in "Internal Control—Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that the Corporation maintained effective internal control over financial reporting as of December 31, 2010.
Id. at F-2.
116. In reality, the Bank did not have effective internal controls over many areas of its
operations. Perhaps the most glaring and damaging lack of control was over the origination and
underwriting of loans. Despite the FDIC's repeated warnings, the Bank had continued to
originate and underwrite massive amounts of new loans, which—contrary to the false statements
in the 2010 annual report where known not to comply with the Bank's stated underwriting
guidelines or prudent lending requirements. As the FDIC Inspector General's Report stated:
The August 2010 joint examination report stated that TCB's Board and management had failed to provide appropriate oversight of the operation of the bank and its performance. As mentioned earlier, examiners noted concern regarding the lack of proper analysis by the bank before entering into new and unconventional lending practices involving insurance premium financing, as well as the lax lending practices related to credits extended to individuals involved with banking and on loans secured by other financial institutions' stock most notably Relationship A. Further, management's failure to recognize losses in a timely manner and
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reflect those losses within the appropriate period resulted in inaccurate financial reporting.
FDIC Inspector General's Report at 1-28. Despite this, the 2010 Annual Report, as with prior
years, falsely inform investors that the Bank was conservative in its lending practices and had
internal controls and underwriting guidelines in place to ensure the integrity of loans originated
and underwritten by the Bank.
117. The lack of effective—or indeed any real internal underwriting controls—is
illustrated by what the FDIC described as "Relationship A." As the FDIC Inspector General's
Report describes, just 6 of the Bank's borrowing relationships accounted for 44% of the $73.8
million in adversely classified loans in 2009. One of these was Relationship A, which had grown
in 2010 and would eventually result in at least $30 and as much as over $60 million in losses:
TCB started a lending relationship (referred to in this report as Relationship A) as early as 2007 with a local borrower that grew into an interconnected, complex set of at least 17 loans to various entities related to the borrower. Some of the loans were loan participations purchased by TCB from entities related to the borrower, and a majority of the loans was secured by stock of the various entities affiliated with the borrower. These related interests were first identified as such during the April 2010 joint visitation, which showed a total exposure for Relationship A of $47.5 million. During the September 2011 joint examination, examiners determined that TCB's exposure to Relationship A had grown to a total of $65 million, or 57 percent of the bank's capital, surplus, and undivided profits. As a result of poor credit decisions, weak underwriting, and inadequate monitoring, examiners concluded that the entire $65 million needed to be adversely classified. Of this amount, $30.2 million was loss. Relationship A accounted for 24 percent of the $273.8 million in total loans identified for classification (and 40 percent of the $76.3 million in loss classifications) at the September 2011 joint examination.
FDIC Inspector General's Report at 1-10. The fact that Relationship A was allowed to be
initiated evinces a lack of effective oversight and controls in itself; however, the fact that the
exposure of the Bank was allowed to grow from $47 million to over $65 million from 2010 to
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2011 is nothing short of reckless. Neither the 2010 Annual Report nor any other filing mentions
Relationship A or the fact that the Bank had almost $50 million worth of exposure due to just a
single client. As of the end of fiscal year 2010, Relationship A accounted for approximately
4.2% of the Bank's loan portfolio on its own.
118. The lack of underwriting controls is also illustrated by the Bank's reckless foray
into the underwriting of loans on life insurance policies. These loans were uncollectible from
their inception, due to legal precedent forbidding the practice. Nonetheless, the Bank originated
and underwrote approximately $5.2 million in loans, writing off that entire amount. See FDIC
Inspector General's Report at 1-10. As the FDIC Inspector General's Report described:
Between March 2009 and May 2010, TCB originated loans that represented 100 percent funding of premiums on large life insurance policies which were owned by irrevocable life insurance trusts established by the insured individuals. Court decisions indicated that neither TCB, nor any successor beneficiary, could collect on the death benefits associated with the policies, upholding the insurance companies' argument that they would not have sold the life insurance policies if they knew that TCB had financed the initial premiums for the insured parties. TCB charged off all $5.2 million of these loans.
Id. This boondoggle is not simply a bad business decision, but represents a complete lack of
oversight of the loan origination and underwriting process. These uncollectable loans never
should have been made in the first instance—they were void when made—and had the Bank
adhered to its loan underwriting policy they would not have been. Investors had no idea that the
Bank was undertaking such illogical and reckless risks.
119. In addition to these risks, and the underwriting and loan origination deficiencies
noted in previous years, the 2010 FDIC examiners also noted the following:
• High loan-to-value (LTV) positions for many loans resulted in thin collateral protection margins, and LTV limits were not established on loans secured by publicly traded or closely held stock (June 2009 and August 2010 examinations).
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• The bank's use of personal guarantees was inadequate or ineffective. For example, guarantors did not always provide guarantees or provided only partial guarantees (August 2010 examination).
• There was a lack of detail regarding any analysis of cash flows and/or repayment capacity in credit memoranda, and a lack of, or inadequate, global cash flow analyses (August 2010 and September 2011 examinations).
• Appraisals were either not obtained, obtained after loans were funded, or were outdated and prepared by the borrower (August 2010 examination).
• Loans extended to individuals involved in banking or secured by the stock of other financial institutions exhibited particularly poor underwriting and resulted in significant losses. A number of these loans contained little, if any, documented financial analysis before the loans were made (August 2010 examination).
• Additional credit was extended to borrowers after their lines had reached the maximum limit (August 2010 and September 2011 examinations).
FDIC Inspector General's Report at 1-12. Any one of the foregoing breaches in internal controls
would be a serious point of concern for any bank. The failure to disclose such serious breaches,
much less take steps to correct them, not only represents a knowing and material
misrepresentation, but also a conscious disregard for the preservation of the Bank's assets.
d) Insufficient Controls Over Loss Mitigation and Risks Posed by Non-Core Deposits
120. Finally, as with previous years, the 2010 Annual Report failed to alert investors to
continued violations of the law, applicable regulations and Bank policy, including, but not
limited to loss mitigation laws—none of which was disclosed to investors in the 2010 Annual
Report or any other filing. See FDIC Inspector General's Report at 1-28 ("Matters requiring the
Board's attention included, but were not limited to . . . apparent violations of laws, rules,
regulations, and contraventions of statements of policy were in need of immediate correction.").
In fact, as the FDIC Inspector General observed:
As of July 2010, repossessions totaled $28.3 million, of which $26.4 million consisted of trucks and over-the-road equipment. In
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addition, the bank had 381 loans secured primarily by tractor/trailers that were over 180 days past due and the collateral had not yet been repossessed. A total of 153 of the 381 loans were over 300 days past due.
TCB did not have adequate loss mitigation policies and procedures to monitor the repossession and timely disposition of collateral.
FDIC Inspector General's Report at 1-14.
121. Desperate to raise funds to cover the undisclosed losses that were mounting,
TNCC increased its reliance on risky, high interest rate non-core deposits. Nonetheless, TNCC
took steps to disguise the deposits as "Other Savings Deposits" by purchasing them in
denominations of less than $100,000. As such, investors were further misled as to the continued
viability of the Bank. As the FDIC Inspector General's Report stated:
The bank's liquidity position began to weaken as asset quality issues in the loan portfolio became prevalent. At the August 2010 joint examination, examiners largely attributed a decrease in TCB's net non-core funding dependence ratio to a decrease in time deposits of $100,000 or more and an increase in Other Savings Deposits, which are classified as core deposits, through promotional rates that were three times higher than the bank's peer group average. Examiners noted that the potential volatility of the Other Savings Deposits was similar, or possibly even greater than, traditional noncore funding sources. By September 2011, examiners determined that TCB's liquidity was critically deficient and threatened the viability of the institution.
FDIC Inspector General's Report at 1-19. When coupled with the concealment of degradation of
the Bank's loan portfolio, understatement of the ALLL, false statements concerning
underwriting, loss mitigation and other controls, the non-core deposit concealment presented an
impenetrable wall of deception, preventing any investor from discerning the true condition of the
Bank.
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5. Knowingly False and Misleading Statements Concerning Fiscal Year 2011
122. Desperate to retain their significant salaries, perks and other benefits, Defendants
made final, desperate attempts to mislead investors and prop up the failing Bank in 2011, despite
the fact that the Bank's portfolio and liquidity had deteriorated beyond repair due to
mismanagement and a lack of effective internal controls.
a) Undisclosed Lack of Loan Underwriting and Portfolio Monitoring Controls
123. As in previous years, the internal controls regarding many aspects of TNCC's
business—including, but not limited to underwriting of loans, financial reporting, loss mitigation
and accounting were absent, unenforced or ineffective. Because the Bank failed and was
closed by the FDIC and TDFI in January of 2012, no annual report for fiscal year 2011 was
issued by TNCC. Nonetheless, each of the two quarterly reports issued by TNCC in 201 1—one
in May and the other in August—contained knowingly false statements regarding the
effectiveness of TNCC's controls over disclosure and financial reporting.' For example, the
TNCC report for the fiscal quarter ended March 31, 2011 falsely stated:
We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information 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. We carried out an evaluation, under
As with annual reports, Regulation S-X requires that interim financial statements must also comply with GAAP, with the limited exception that interim financial statements need not include disclosure which would be duplicative of disclosures accompanying annual financial statements. 17 C.F.R. § 210.10-01(a).
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the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to allow timely decisions regarding disclosure in the reports that we file or submit to the Securities and Exchange Commission under the Exchange Act.
There were no changes in our internal control over financial reporting during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 33 (filed May 16, 2011)
("March 2011 Quarterly Report"). The June 2011 Quarterly Report contained the same false
disclosure. See Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 42 (filed
Aug. 12, 2011) ("June 2011 Quarterly Report").
124. Consistent with previous years, TNCC's loan origination and underwriting policy
guidelines appear to have been completely disregarded in 2011. For example, as noted above, in
2011 a single complex relationship—Relationship A, with a single borrower, represented $65
million in loss exposure for the bank (or approximately 5.6% of the Bank's stated loan
portfolio' as of June 30, 2011). In addition, internal underwriting controls had deteriorated to the
point where the Bank was making undisclosed bad loans to its own Directors and employees. As
the Nashville Post reported on February 1, 2012, TNCC had significant exposure, due to loans
made to its Directors:
'° As discussed infra, the true value of TNCC's loan portfolio as of June 30, 2011 cannot be accurately determined, due to the fact that the Company's financial statements contained material misstatements.
70 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 70 of 100 PageD #: 365
As Tennessee Commerce Bank was unraveling at the seams last week prior to finally being shut down, executives were likely busy tying up loose ends. One of them involved a $15 million loan to a director, against which they took a $7 million loss reserve. A spokeswoman for the bank said she could not find anyone Monday to get details about the loan or the director to whom it was made. But the writedown speaks to the underwriting shortcomings which were not confined to any single category of loans that bedeviled Tennessee Commerce.
Geert Dc Lombaerde, Tennessee Commerce Wrote Down $7M of Director's Loan, Nashville
Post (Feb. 1, 2012),
http://nashvillepost.corn/blogs/postbusiness/2012/2/1/tennessee commerce wrote clown 7m of'
directors loan; see also Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2
(Jan. 31, 2012) ("On January 24, 2012, director William W. McInnes submitted his resignation
from the Board of Directors of the Company and the Bank, effective January 27, 2012.").
125. In 2011, TNCC actually originated loans which purported to be secured by valid
and genuine assets, but, instead, were secured by assets that had already been repossessed (or
should have been repossessed) by the Bank:
We also noted instances during 2011 in which TCB disposed of repossessed collateral by originating a new loan to a new borrower secured by the repossessed collateral. This practice resulted in numerous loans secured by the same collateral. In many cases, a portion of the funds to finance the new loan were applied to the balance of the original defaulted loan secured by the collateral, leaving a residual balance on the original loan that the bank did not recognize as a loss in a timely manner. While it is possible that the bank may have continued to pursue deficiency judgments on the original borrower and collections from guarantors, a prudent banking practice would have been to recognize the loss when the collection was deemed unlikely and reporting any future collections as a recovery. The net impact of this practice resulted in at least $22 million in residual balances on loans that should have been recognized as losses.
FDIC Inspector General's Report at I-iS. In addition to these deficiencies and those noted in
earlier years, the FDIC noted additional deficiencies in 2011, such as:
71 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 71 of 100 PageD #: 366
• There was a lack of detail regarding any analysis of cash flows and/or repayment capacity in credit memoranda, and a lack of, or inadequate, global cash flow analyses (August 2010 and September 2011 examinations).
• Additional credit was extended to borrowers after their lines had reached the maximum limit (August 2010 and September 2011 examinations).
Id. at 1-12. Such a stunning lack of underwriting integrity was necessarily material and indicates
a startling lack of oversight over the Bank's internal controls. The sheer magnitude of these
loans, representing "at least $22 million" in unrecognized losses indicates that Defendants knew
of, and condoned or encouraged, the practice.
126. In addition, as in previous years, the FDIC noted that the Bank did not have
controls in place to properly identify, record and report loans that were in danger of default:
• Management was lax in placing loans on nonaccrual in line with the established loan policy (August 2010 examination).
• Several large loans had been restructured with concessions, resulting in reduced payments, and were not reported as a Troubled Debt Restructuring (TDR). Loans that qualify as TDRs are required to be evaluated for impairment. Failure to properly identify TDRs could result in misstatements to the bank's ALLL allocation (August 2010 examination).
• In general, loan officers did not appear to have an adequate working knowledge of their borrowers (August 2010 examination).
• Monitoring and valuation of collateral was inadequate (August 2010 and September 2011 examinations).
• Loan proceeds were used for purposes other than their stated purpose or management was unaware of what the loan proceeds were used for (September 2011 examination).
FDIC Inspector General's Report at 1-12. Coupled with the breaches of the loan underwriting
and origination policies and controls, the failure to accurately monitor loans which were in
danger of default magnified the material misstatements in the Bank's financial statements,
making it impossible for investors to accurately determine the credit risk of the Bank's loan
72 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 72 of 100 PageD #: 367
portfolio at any given time. The failure of controls that were intended to detect and remedy these
problems was not disclosed to investors prior to the Bank's failure in January of 2012.
b) Undisclosed Lack of Compliance with Regulator Consent Order
127. On February 11, 2011, the FDIC made good on its threat to pursue a formal
enforcement action and sent TNCC a consent order, outlining the remedial steps that Defendants
needed to undertake immediately (the "Consent Order"). See FDIC Inspector General's Report
at 1-29. Among other things, the Consent Order required the Bank to:
• submit a capital plan to achieve and maintain Leverage, Tier 1 Risk-Based, and Total Risk-Based capital ratios of 8.5 percent, 10 percent, and 11.5 percent, respectively;
• formulate and submit a plan for the reduction and collection of delinquent loans;
• review the loan policy and procedures for effectiveness and make all necessary revisions in order to strengthen the bank's lending procedures and abate additional supervisory guidance;
• develop and submit a written plan addressing liquidity, volatile liabilities, and asset/liability management;
• restrict additional advances to any borrower for whom the bank holds an uncollected charged-off asset or whose extension of credit is adversely classified;
• restrict increases in total assets to no more than 5 percent during any consecutive 12 month period and restrict any new line of business without the prior consent of the FDIC and TDFI; and
. eliminate and/or correct all apparent violations of laws and regulations.
FDIC Inspector General's Report at 1-22. Defendants refused to sign the consent order, only
stipulating to it when forced to on May 25, 2011. See Ed. In the interim, Defendants stalled,
focusing more on arguing the merits of particular and irrelevant, narrow classifications instead of
73 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 73 of 100 PageD #: 368
assessing, measuring, and adequately addressing the risk of its loan portfolio. Id. at 1-29.
Meanwhile, the condition of the Bank continued to deteriorate.
128. In March of 2011, the TDFI and FDIC visited the Bank to assess whether any of
the items covered in the unsigned consent order had been addressed. The FDIC concluded that
the Bank had failed to meaningfully comply with the serious concerns outlined in the proposed
Consent Order. Among other things, the ALLL remained seriously understated, underwriting
guidelines were not being followed and laws and regulations were still being violated. As the
FDIC noted:
While a reduction in the balances of previously classified loans was noted, the level of classifications, combined with management's previous and continued resistance to recognize problem loans, remained a concern to examiners. The ALLL remained significantly underfunded, and management appeared to have been focused more on arguing the merits of particular classifications instead of assessing, measuring, and adequately providing for the risks in the loan portfolio. However, the Board stipulated to the proposed Order effective May 25, 2011.
FDIC Inspector General's Report at 1-29. Even though the Bank stipulated to the Consent Order,
the September 2011 joint examination revealed that, among other things, the ALLL remained
materially understated and the other terms of the Consent Order had not been meaningfully
addressed. See Ed. at 29-3 1.
129. Indeed, throughout 2011, while Defendants knew that the Bank was on the verge
of collapse due to mismanagement and the ALLL was materially misstated in violation of both
the FDIC's warnings and applicable accounting conventions, Defendants continued to
disseminate these false statements regarding the effectiveness of internal controls (including loan
and underwriting policies), the financial risk of the loan portfolio and the Bank's loss mitigation
efforts.
74 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 74 of 100 PageD #: 369
C) The Materially Misstated ALLL
130. Defendants' false statements in 2011 were not confined to its typical SEC filings.
By the beginning of 2011, the Bank was quickly becoming illiquid and the only way for
Defendants to keep their fraudulent enterprise running was to raise enormous amounts of new
capital in order to cover the concealed losses in their loan profile. To this end, on May 9, 2011,
Defendants "made an investor presentation at the Gulf South 2011 Bank Conference in New
Orleans, Louisiana," presenting false information concerning the Bank's operations and
financials in an effort to lure unsuspecting investors into investing in the quickly failing Bank.
See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (May 12, 2011).
Among other things, the presentation given by Defendants at that conference falsely presented
the Bank's ALLL provision:
Id. at Ex. 99. 1, at 18. Moreover, Defendants made a point of showing off the Bank's misstated
Tier 1 Capital ratio" which, like the ALLL, falsely understated the risk of the Bank's assets. See
Ed. at 17 (falsely stating that the Bank's Tier 1 Capital ratio was "11.37%" as of December 31,
2010 and "10.93%" as of March 31, 2011). Additionally, the presentation gave investors the
false impression that the Bank was well managed and adhered to strict underwriting and loan
" A Bank's tier one capital ratio is calculated by dividing a bank's equity capital by its risk-weighted assets ("RWA"). See Basil Capital Accord, International Convergence of Capital Measurement and Capital Standards, Bank for International Settlements, at 14-15 (April 1998). RWA is calculated by multiplying the value of an asset by the risk that the entire loan balance will not be paid in full. As discussed herein, TNCC systematically understated the risk of its portfolio, skewing the denominator of the RWA calculation and making the Bank's loan portfolio appear far less risky than it truly was.
75 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 75 of 100 PageD #: 370
origination guidelines, which is most certainly did not. See Ed. at 9 ("No shared national credits
and sub-prime or alt-A loans"). Defendants Sapp, Cox and Perez are all listed as having taken
part in the presentation. See Ed. at 8.
131. Both of the quarterly reports issued by the Bank in 2012 included financial
statements and statements of internal control effectiveness that were known to be false at the
time that they were filed and disseminated. See March 2011 Quarterly Report, filed on May 16
2011. The March 2011 Quarterly Report also gave the false impression that the Bank's reserves
would decrease as the fiscal year progressed. Defendants well-knew they would not, considering
the fact that they were drastically understated at the time of the March 2011 Quarterly Report.
As the March 2011 Quarterly Report falsely stated:
Nonperforming assets, which includes non-accruing loans, troubled debt, loans 90+ days past due, repossessions and other real estate owned, increased to $94,424 at March 31, 2011 compared to $81,621 at March 31, 2010 and $91,151 at December 31, 2010. As a result of seasonal factors related to the transportation industry, our nonperforming assets typically increase during the first quarter and decrease throughout the remainder of the year. (in millions of dollars)
March 2011 Quarterly Report at 24. The March 2011 Quarterly Report also presented materially
false financial numbers concerning the Bank's ALLL for the three months ended March 31,
2011, recognizing only $26.1 million in its allowance:
TIyt m:I: ei&i .I.,r3 111
Id. at 10. The FDIC and TDFI had previously informed TNCC on numerous occasions that its
ALLL was severely deficient. Indeed, as of March of 2011, TNCC's ALLL was at least $100 to
76 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 76 of 100 PageD #: 371
$400 mifilon short of what it should have been under FAS 5, FAS 114 and other relevant bank
accounting conventions. See FDIC Inspector General's Report at * 1 (reporting that the Bank's
"total assets at closing were $1.0 billion and that the estimated loss . . . was $416.8 million").
Defendant Perez signed the March 2011 Quarterly Report on behalf of TNCC and the Bank.
132. In August, Defendants continued the charade of viability by continuing to present
a knowingly false picture of the Bank, which they knew to be on the verge of collapse.
Specifically, the June 2011 Quarterly Report, filed with the SEC on August 12, 2011, continued
to falsely present the ALLL, mischaracterizing the Bank's assets as much less risky than they
were known to be at the time. June 2011 Quarterly Report at 10. As the June 2011 Quarterly
Report stated in pertinent part:
The total allowance reflects managements' estimate of loan losses inherent in the loan portfolio at the balance sheet date. Management considers the allowance for loan losses ("ALLL") of $28.2 million adequate to cover losses inherent in the loan portfolio. The following table presents by loan category, the changes in ALLL and the recorded investment in loans for the six months ended June 30, 2011 and the twelve months ended December 31, 2010:
£rths flu: L -
S. .- I . .:..;:e.
June 2011 Quarterly Report at 10. The FDIC and TDFI had previously informed TNCC on
numerous occasions that its ALLL was severely deficient. Indeed, as of June 2011, TNCC's
ALLL was at least $100 million short of what it should have been under FAS 5, FAS 114 and
other relevant bank accounting conventions. In fact, less than a month later, the FDIC informed
Defendants that the ALLL needed to be increased by at least $80 million. See FDIC Inspector
77 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 77 of 100 PageD #: 372
General's Report at 1-30. Defendant Perez signed the June 2011 Quarterly Report on behalf of
TNCC.
133. The FDIC excoriated the presentation of the ALLL in the 2011 financial
statements, concluding that the Bank had no basis for publishing the numbers as it did:
Examiners noted at the September 2011 joint examination that the ALLL was severely deficient in relation to the level of risk in the loan portfolio and that an additional provision of $80.2 million was warranted. In addition, the bank's FAS 114 impairment analyses were either inadequately supported, inadequately measured, or used invalid assumptions. Further, management failed to recognize credit losses in a timely manner, which resulted in an insufficient FAS S ALLL allocation since the calculation was based historical losses. The bank's external auditors also noted in 2011 that controls over estimating the ALLL were not adequate. An underfunded ALLL can have the effect of delaying the recognition of deterioration in the credit quality of the loan portfolio.
FDIC Inspector General's Report at 1-13 (emphasis added).
134. In September of 2011, the FDIC and TDFI conducted their final joint examination
prior to the closing of the Bank in January of 2012. The report detailed many of the same
problems that had been consistently pointed out to Defendants as the result of previous
examinations. The difference was that this report was accompanied by a conclusion that the
"financial condition of the bank was critically deficient and that near-term failure was highly
probable ....FDIC Inspector General's Report at 1-30. The following deficiencies were noted
as part of the examination:
• Apparent violations, including an apparent legal lending limit violation and contravention of Statements of Policy (some of which were repeat criticisms).
• Management and the Board failed to appropriately adjust for changing economic conditions and identify risk in the loan portfolio. The bank continued to grow loans in an uncertain economic environment, while their peers were restricting loan growth. Examiners noted that several classified
78 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 78 of 100 PageD #: 373
loans were originated during a time of economic uncertainty, and without a full understanding or consideration of the level of risk-exposure to the bank.
• Poor credit administration practices and inadequate monitoring of the loan portfolio had resulted in an excessive level of adversely classified items (i.e., $298.9 million, or 21 percent of the bank's assets and 506 percent of Tier 1 Capital plus the ALLL). Adversely classified loans totaling $76.3 million were identified as loss, which included two large borrowing relationships of $47.8 million.
• The ALLL was severely deficient and an additional provision expense of $80.2 million was required to reflect examination-identified loan losses and to replenish the ALLL to an appropriate level.
• An independent loan review performed in June 2011 identified nine borrowers with loans totaling $65.9 million warranting downgrades from management's internal loan grades. Examiners identified $157.3 million in loan downgrades at the examination.
• Loans related to Relationship A were underwritten without adequate global cash flow analyses and without realistic in-depth analysis of the value of the collateral. In addition, there were no policies and procedures in place for the types of loans extended to the borrowers, which resulted in credit risk not being adequately assessed.
• Liquidity was critically deficient and threatened the viability of the bank. Examiners noted that access to secondary funding sources had ceased due to substantial deterioration in asset quality and capital.
Id. (emphasis added).
d) The Restatement of TNCC's Financial Results and the ALLL
135. Despite the results of the FDIC and TDFI's joint examination of the bank in
September of 2011, Defendants waited almost two months before they did anything. And even
when they did partially disclose the fraudulent nature of their financial statements, Defendants
falsely represented that only TNCC's June 2011 Quarterly Report needed to be restated, despite
their knowledge of the falsity of the Company's financial statements for the previous three years.
The Initial Restatement was made on November 1, 2011, when TNCC issued a Current Report
(Form 8-K) announcing that it was restating its financial results for the second quarter of fiscal
79
Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 79 of 100 PageD #: 374
year 2011 (the June 2011 Quarterly Report), ended June 30, 2011. As the Nov. 1, 2011 Initial
Restatement stated:
On October 27, 2011, management of the Corporation, and subsequently, its Audit Committee and Board of Directors, determined that its financial statements for the quarter ended June 30, 2011, as included in the Corporation's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011, should no longer be relied upon due to an expected approximately $83.0 million increase in the provision for loan losses and related allowance for loan losses as a result of an ongoing joint examination of Tennessee Commerce Bank (the "Bank"), a wholly-owned subsidiary of the Corporation, by the Federal Deposit Insurance Corporation (the "FDIC") and the Tennessee Department of Financial Institutions (the "TDFI"). Consequently, the Corporation intends to file an amendment to its Form 10-Q for the period ended June 30, 2011, as soon as reasonably practicable, to give effect to the expected increase in the provision and allowance for loan losses.
Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Nov. 1, 2011) (emphasis
added). The November 1, 2011 Restatement left investors with the false impression that
TNCC's financial statements for other periods did not need to be restated. See Ed.
136. It was not until January 20, 2012, nearly two and a half months after the Initial
Restatement, that Defendants announced that additional periods would need to be restated. In
reality, Defendants had no other choice, due to the fact that Kraft had notified the bank that it
was withdrawing its audit opinion for all financial statements post-December 31, 2010 and
unspecified previous periods. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-
K), at 2 (Jan. 20, 2012); see also Tennessee Commerce Bancorp, Inc., Current Report (Form 8-
K), Ex. sss99.1 (Jan. 23, 2012) ("We [Kraft] have read the statements under Item 4.02 of the
Current Report on Form 8-K filed with the Securities and Exchange Commission on January 20,
2012 regarding withdrawal of our audit report on the Corporation's financial statements as of
December 31, 2010 and for the year then ended and the possibility that we may withdraw earlier
80 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 80 of 100 PageD #: 375
audit reports pursuant to the results of a forensic review of the Corporation's small ticket loan
portfolio. We agree with these statements pertaining to our firm.").
137. The FDIC concurred with the conclusion that TNCC's financial statements were
materially misstated, with the Bank systematically failing to recognize losses in an accurate or
timely manner:
A third-party evaluation found that 14 percent of TCB's loan portfolio was nonperforming as of November 2011. TCB's final Call Report for December 31, 2011 reported that 26 percent of the C&I portfolio and 25 percent of the CRE portfolio was greater than 30 days past due or in non-accrual status. These classifications, in addition to an increase in past due loans, posed a significant risk to the institution and resulted in large loan losses. As reflected in Figure 3, loan charge-offs increased significantly in 2011, with a majority of the charge-offs pertaining to C&I loans, indicating a failure to recognize losses in a timely manner and reflect those losses within the appropriate reporting period.
Fkwn H rnidLeass, 2072011
r -: -. -.
FDIC Inspector General's Report at 1- 15.
138. Nonetheless, as late as August of 2011, TNCC knowingly and falsely stated in its
quarterly filing for the June 30, 2011 quarter that: "It is management's intent to maintain an
ALLL that is adequate to absorb current and estimated losses which are inherent in a loan
portfolio." June 2011 Quarterly Report at 33. An identical false statement was made in the
March 2011 Quarterly Report. See March 2011 Quarterly Report at 27 ("It is management's
81 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 81 of 100 PageD #: 376
intent to maintain an ALLL that is adequate to absorb current and estimated losses which are
inherent in a loan portfolio."). As discussed herein it was not management's intent to maintain
an adequate ALLL, as evinced by numerous, crystal clear, warnings from the FDIC, TDFI and
other parties, ignored by Defendants, that the Bank's ALLL was seriously and materially
understated. Indeed, Defendants were aware that the ALLL was materially deficient at least as
early as 2009, when the FDIC suggested that the ALLL needed to be increased for fiscal year
2009 by at least $16 million. See supra. In 2011, when these statements were made, the ALLL
was understated by at least $100 to $400 million dollars, based on the FDIC's conservative
estimates. See FDIC Inspector General's Report at *2 ("The FDIC notified the Office of
Inspector General (010) on March 13, 2012 that TCB's total assets at closing were $1.0 billion
and that the estimated loss to the DIF was $416.8 million (or 42 percent of TCB's total assets).
TCB's final Consolidated Reports of Condition and Income indicated that the bank lost more
than $165 million during 2011 and had negative equity capital.").
139. As one commentator noted following the failure of the Bank in January of 2012:
This was a whooper, showing a $116.1 million loss September 30, 2011 (the latest FDIC report available) after a $97.3 million charge off. It is the largest banking failure this year in a state that has not had a banking failure since Bank of Alamo in West Tennessee November 8, 2002.
The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $416.8 million.
Christopher Menkin, Stockholders Lose All in $116 MM Bank Loss in Tennessee,
SeekingAlpha.com , Jan. 30, 2012, http://seekinga1pha.corninstab1og/388783-cbristopher -
rnenkin/262442stockho1ders1osea1hin-i 16-1 -nun -bank -1ossin4ennessee.
LOSS CAUSATION
82 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 82 of 100 PageD #: 377
140. Class members were damaged as a result of TNCC and the Individual
Defendants' fraudulent conduct as set forth herein. During the Class Period, as detailed herein,
Defendants engaged in a scheme to deceive the market and a course of conduct that artificially
inflated TNCC's stock price and operated as a fraud or deceit on Class Period purchasers of
TNCC common stock by misrepresenting to and concealing material information from the public
about, inter al/a: (1) the Company's loan origination and loss mitigation practices; (2) the
existence and effectiveness of the Company's internal controls over operations and financial
reporting, and whether those controls were being enforced; and (3) the true risk of the Bank's
loan portfolio.
141. These material misstatements and omissions caused and maintained artificial
inflation in TNCC's stock price throughout the Class Period until the truth was fully, albeit
slowly, revealed to the market. As the price of TNCC's stock increased, Class members
unwittingly and in reliance on Defendants' false and misleading statements and/or omissions
purchased TNCC stock at artificially inflated prices. But for Defendants' material
misrepresentations and omissions, Plaintiffs and other Class members would not have purchased
TNCC stock, or would not have purchased it at the artificially inflated prices at which it traded
during the Class Period.
142. As Defendants' material misrepresentations and omissions were disclosed and
became apparent to the market in a piecemeal fashion throughout the Class Period, TNCC stock
fell dramatically as the prior artificial inflation bled from the Company's stock price. Due to
their purchases of TNCC stock during the Class Period, Plaintiffs and other members of the
Class suffered economic damages under the federal securities laws.
83 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 83 of 100 PageD #: 378
143. The following examples support a showing of loss causation pursuant to Rule 8(a)
of the Federal Rules of Civil Procedure in accordance with the United States Supreme Court's
decision inDuraPharnis. v. Broudo, 544 U.S. 336 (2005).
144. As detailed above, Defendants' false and misleading statements and omissions
caused TNCC stock to trade at artificially inflated levels throughout the Class Period, reaching as
high as $19.60 per share before the public disclosures began and took place as a series of limited
disclosures over an extended period of time. Until the Bank was closed in 2012, each of the
prior public disclosures was in itself materially insufficient because each contained material
misstatements and material omissions. Nevertheless, as each of these limited, truth-revealing
disclosures came to light, they caused the artificial inflation to slowly dissipate from TNCC's
stock price.
145. A modest increase in the ALLL (albeit insufficient) in April 2009 caused the
Bank's share price to drop almost 15%, from a price of $9.39 prior to the release of the earnings
announcement to under $8.00 per share on May 8, 2009. See Tennessee Commerce Bancorp,
Inc., Current Report (Form 8-K), Ex. 99. 1, at *1 (Apr. 7, 2009) ("Tennessee Commerce expects
to increase its reserve for loan losses to approximately 1.40% of total loans at the end of the first
quarter of 2009, a 10 basis point increase compared with the fourth quarter of 2008.").
146. A similar increase in the ALLL in November of 2009 caused a similar decrease in
share price, with TNCC's share price falling over 10%, from $5.50 on November 2, 2009 to
$4.95 on November 6, 2009. Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-
Q), at 17 (Nov. 6, 2009) ("Net income for the three months ended September 30, 2009 was
$1,161[,000], a decrease of $725 or 38.44% compared to net income of $1,886[,000] for the
three months ended September 30, 2008. The decrease is attributable to an increase in the
84 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 84 of 100 PageD #: 379
provision for loan losses of 183.78% from $1,850[,000] for the three months ended
September 30, 2008 to $5,250[,000] for the same period in 2009.").
147. When TNCC announced that it had, again, raised its ALLL—albeit by an entirely
inadequate amount and announced that the Federal Reserve had placed restrictions on the
Company's capital holdings, the Company's stock price plunged by over 30%, from $6.70 on
July 27, 2010, to $4.65 on August 3, 2010. See Tennessee Commerce Bancorp, Inc., Current
Report (Form 8-K), Ex. 99. 1, at 1 (July 27, 20 10) ("The loan loss provision of $4.5 million for
the second quarter of 2010 exceeded the net charge-offs of $4.2 million, resulting in a ratio of
loan loss provision to net charge-offs of 105.6%. The allowance for loan losses at June 30, 2010
was $20.3 million or 1.7% of total loans. The coverage ratio of allowance for loan losses to non-
performing loans at June 30, 2010 was 59.6%."); see also Tennessee Commerce Bancorp, Inc.,
Current Report (Form 8-K), at 2 (July 28, 20 10) ("Following a review of Tennessee Commerce
Bancorp, Inc. (the "Corporation") by the Federal Reserve Bank of Atlanta (the "Federal Reserve
Bank") at its inspection of the Corporation as of June 30, 2009, which was updated through
December 31, 2009, the Federal Reserve Bank instructed the Corporation's board of directors to
adopt, no later than August 7, 2010, a board resolution whereby the Corporation will agree to
obtain the written approval of the Federal Reserve Bank prior to (i) incurring additional
indebtedness at the parent level, including indebtedness associated with trust preferred securities,
(ii) taking any action that would cause a change in debt instruments relating to indebtedness
incurred at the parent level, (iii) declaring or paying dividends to common or preferred
shareholders, (iv) reducing the Corporation's capital position by purchasing or redeeming
treasury stock and (v) making any distributions of interest, principal or other sums on
subordinated debentures or trust preferred securities.").
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148. When, on April 18, 2011, TNCC belatedly announced that the FDIC and TDFI
had determined that the bank was in "troubled condition"12 and that formal enforcement
action was being sought, TNCC's share price fell by almost 14%, from $4.44 per share on
April 15th to $3.82 on April 18, 2011. Tennessee Commerce Bancorp, Inc., Annual Report
(Form 10-K), at 8 (Apr. 18, 2011) ("Moreover, as of March 17, 2011, the Bank has been
deemed to be in troubled condition.").
149. In addition, when TNCC announced that it had stipulated to the Consent Order
with the FDIC on July 28, 2011, and that the TDFI had ordered the Bank to charge off all non-
real estate repossessed assets that were held over the six-month period mandated under
Tennessee law, the Company's stock price dropped over 38%, from $2.44 per share on July 27th
to $1.50 on July 29, 2011. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K),
Ex. 99. 1, at *2 (July 28, 2011) ("As a result of the Bank entering into a written agreement with
the Federal Deposit Insurance Corporation (FDIC) during the second quarter, the Bank has to
achieve and maintain a tier 1 leverage capital ratio of 8.50%, a tier 1 risk based capital ratio of
10.00% and a total risk based capital ratio of 11.50% by no later than December 31, 2011.").
150. When TNCC announced, after the close of business on November 1, 2011, that it
was restating its financial results for the fiscal quarter ended June 30, 2011, due to a misstated
ALLL, TNCC's share price fell almost 86%, from $0.90 per share to $0.13 per share. Tennessee
Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Nov. 1, 2011) ("On October 27,
2011, management of the Corporation, and subsequently, its Audit Committee and Board of
Directors, determined that its financial statements for the quarter ended June 30, 2011, as
12 As discussed supra, the FDIC had informed TNCC that the bank had been deemed to be in "troubled condition" in a letter dated October 9, 2009. See FDIC Inspector General's Report at 1-27.
86 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 86 of 100 PageD #: 381
included in the Corporation's Quarterly Report on Form 10-Q for the fiscal quarter ended June
30, 2011, should no longer be relied upon due to an expected approximately $83.0 million
increase in the provision for loan losses and related allowance for loan losses ....).
151. A shareholder who purchased TNCC stock on May 3, 2010, for $10.64 (the
closing price of TNCC's stock on that day), for example, and held the stock until the Bank
announced that its financial statement for 2010 and previous years should not be relied upon,
would have lost approximately 98% of his investment (the closing price of TNCC stock on
January 20, 2012 was $0.17 per share). Consequently, with each partial (albeit incomplete)
disclosure, the price of TNCC stock fell like a cascading waterfall.
152. Table 1 below shows the various corrective statements, paired with the
corresponding decrease in TNCC's share price:
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Table 1.
cc
II
153. Conversely, the false statements outlined herein had the desired effect of
artificially inflating TNCC's share price. For example, the highest prices in the Class Period all
occurred around dates when TNCC announced its annual and fourth quarter results.
Table 2.
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$12
As alleged herein, each of those reports contained knowingly false and misleading
statements intended and engineered to artificially inflate the Company's share price. Those
reports were each widely disseminated to the securities markets, investment analysts and the
investing public at large. The false and misleading statements alleged herein artificially inflated
TNCC's share price and, when those statements were slowly revealed to be false, shareholders
were left with investments worth far less than they had believed.
FRAUD-ON-THE-MARKET PRESUMPTION OF RELIANCE
154. The market for TNCC's common stock was open, well-developed and efficient at
all relevant times. TNCC's stock met the requirements for listing, and was listed and actively
traded on the NASDAQ Stock Market ("NASDAQ"), a highly efficient and automated market.
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As a regulated issuer, TNCC filed periodic public reports with the SEC and NASDAQ.
Defendants regularly communicated with public investors via established market communication
mechanisms, including through regular disseminations of press releases on the national circuits
of major newswire services and through other wide-ranging public disclosures, such as
communications with the financial press and other similar reporting services. TNCC 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.
155. As alleged herein, the change in the price of TNCC's stock - compared to the
changes in the peer group and NASDAQ - in response to the release of unexpected material
positive and negative information about the Company, shows there was a cause and effect
relationship between the public release of the unexpected information about TNCC and the price
movement in the Company's stock. During the Class Period, TNCC's stock was traded millions
of times per week. Numerous analysts followed TNCC, called in to the Company's conference
calls and issued reports throughout the Class Period. The Company was eligible to - and did -
register securities on Form S-3 during the Class Period. There were numerous market makers for
TNCC's stock.
156. As a result of the foregoing, the market for TNCC's common stock promptly
digested current information regarding TNCC from all publicly available sources and reflected
such information in the Company's stock price. Under these circumstances, all purchasers of
TNCC common stock during the Class Period suffered similar injury through their purchase of
TNCC's common stock at artificially inflated prices and the subsequent revelations causing
material declines in price, and a presumption of reliance applies.
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NO SAFE HARBOR
157. The statutory safe harbor provided for forward-looking statements under certain
circumstances does not apply to any of the allegedly false statements pled in this Complaint.
Some of the specific statements pled herein were not "forward-looking statements" when made,
nor were they adequately identified as such. 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 pled herein, Defendants are liable for those false forward-looking
statements because at the time each of those forward-looking statements was made,
Defendants knew that the particular forward-looking statement was materially false
and/or misleading when made.
CONTROL PERSON ALLEGATIONS UNDER § 20(a) OF THE EXCHANGE ACT
158. Section 20(a) of the Exchange Act states in pertinent part:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a).
159. The Individual Defendants (Helf, Sapp, Cox and Perez) by virtue of their
positions exercised control and authority over TNCC's internal operations, as well as the
Company's dissemination of information to investors, the public and the financial markets. In
addition, each of the Individual Defendants exercised direct control over the accounting practices
91 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 91 of 100 PageD #: 386
and procedures employed by TNCC throughout the Class Period. Therefore, by virtue of their
authority, control and positions as officers and/or directors of TNCC, the Individual Defendants
directly controlled the content of the various SEC filings, press releases and other public
statements made by TNCC executives pertaining to the Company and the Bank during the Class
Period.
160. As alleged herein, the Individual Defendants are liable for violation of § 10(b) of
the Exchanges Act for fraudulent statements made to investors during the relevant Class Period.
This includes, inter al/a, disseminating the annual reports on form 10-K that were filed with the
SEC and signed by various or all of the Individual Defendants (the "Primary Violations"). At the
time of the Primary Violations, Defendants Helf, Sapp, Cox and/or Perez were employed by
TNCC and the Individual Defendants held executive positions of control and authority over the
Company's business and operations.' 3 Further, each of the Individual Defendants had the
opportunity and ability to influence the content of TNCC's public statements and SEC filings,
including statements made in conjunction with the Primary Violations.
161. Also, the Primary Violations arose out of an agency relationship with TNCC,
rendering those statements attributable to each of the Individual Defendants. Defendants'
statements were a reflection of TNCC's corporate position as to the state of affairs at TNCC at
the time that they were made. Each of the Individual Defendants whowere directly
responsible for shaping, approving and steering TNCC's public statements--were responsible for
the content of those statements. Conversely, each of the Individual Defendants had it within
their ability to either: (a) correct the false and misleading statements after they were made; or (b)
13 As noted above, Defendant Perez joined the company as Chief Financial Officer of TNCC and the Bank on July 31, 2008. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Aug. 5, 2008).
92 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 92 of 100 PageD #: 387
urge that the false and misleading statement not be disseminated to the investing public. The
Individual Defendants failure to exercise this power and discretion renders them culpable under
§ 20(a).
162. Because each of the Individual Defendants were control persons within the
meaning of 20(a) of the Exchange Act, they are liable for damages thereunder.
CLAIM ONE
Violation of Section 10(b) of The Exchange Act And Rule lOb-S Promulgated Thereunder Attinst All Defendants
163. Plaintiffs incorporate by reference each paragraph above as if set forth herein.
164. During the Class Period, Defendants carried out a plan, scheme and course of
conduct which was intended to and, throughout the Class Period, did: (i) deceive the investing
public, including Plaintiffs and other Class members, as alleged herein; and (ii) cause Plaintiffs
and other members of the Class to purchase TNCC securities at artificially inflated prices. In
furtherance of this unlawful scheme, plan and course of conduct, Defendants, and each of them,
took the actions set forth herein.
165. Defendants: (a) employed devices, schemes, and artifices to defraud; (b) made
untrue statements of material fact and/or omitted to state material facts necessary to make the
statements not misleading; and (c) engaged in acts, practices, and a course of business which
operated as a fraud and deceit upon the purchasers of the Company's securities in an effort to
maintain artificially high market prices for TNCC securities in violation of Section 10(b) of the
Exchange Act and Rule lOb-S promulgated thereunder.
166. Defendants, individually and in concert, directly and indirectly, by the use, means
or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a
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continuous course of conduct to conceal adverse material information about the business,
operations and future prospects of TNCC and the Bank as specified herein.
167. These Defendants employed devices, schemes and artifices to defraud, while in
possession of material adverse non-public information concerning the Bank, its operations and
risk profile. Defendants also engaged in acts, practices, and a course of conduct as alleged
herein in an effort to assure investors of TNCC's value and performance and continued
substantial growth, which included the making of, or the participation in the making of, untrue
statements of material fact and omitting to state material facts necessary to make the statements
made about TNCC and its business operations and future prospects, in the light of the
circumstances under which they were made, not misleading, as set forth more particularly herein,
and engaged in transactions, practices and a course of business which operated as a fraud and
deceit upon the purchasers of TNCC securities during the Class Period.
168. Each of the Individual Defendants' primary liability, and controlling person
liability, arises from the following facts: (i) the Individual Defendants were high-level executives
and/or directors at the Company during the Class Period and members of the Company and the
Bank's management team or had control thereof; (ii) each of these defendants, by virtue of their
responsibilities and activities as a senior officer and/or director of the Company and the Bank
was privy to and participated in the creation, development and reporting of the Company's
internal budgets, plans, projections and/or reports; (iii) each of these defendants enjoyed
significant personal contact and familiarity with the other defendants and was advised of and had
access to other members of the Company's management team, internal reports and other data and
information about the Company's finances, loan portfolio, operations, and internal controls at all
relevant times; and (iv) each of these defendants was aware of the Company's dissemination of
94 Case 3:12-cvM1137 Document 44 Filed 04/18/13 Page 94 of 100 PageD #: 389
information to the investing public which they knew or recklessly disregarded was materially
false and misleading.
169. The Defendants had actual knowledge of the misrepresentations and omissions of
material facts set forth herein, or acted with reckless disregard for the truth in that they failed to
ascertain and to disclose such facts, even though such facts were available to them. Such
Defendants' material misrepresentations and/or omissions were done knowingly or recklessly
and for the purpose and effect of concealing the Company's operating condition and future
business prospects from the investing public and supporting the artificially inflated price of its
securities. As demonstrated by Defendants' misstatements of the Company's business,
operations and earnings throughout the Class Period, Defendants, if they did not have actual
knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtain
such knowledge by deliberately refraining from taking those steps necessary to discover whether
those statements were false or misleading.
170. As a result of the dissemination of the materially false and misleading information
and failure to disclose material facts, as set forth above, the market price of TNCC securities was
artificially inflated during the Class Period. In ignorance of the fact that the market prices of
TNCC publicly-traded securities were artificially inflated, and relying directly or indirectly upon
the false and misleading statements made by Defendants, the integrity of the market in which the
securities traded, and/or on the absence of material adverse information that was known to or
recklessly disregarded by Defendants but not publicly disclosed by Defendants during the Class
Period, Plaintiffs and the other members of the Class acquired TNCC securities during the Class
Period at artificially high prices. When the truth was revealed and TNCC's share price
plummeted, Plaintiffs and other members of the Class were damaged thereby.
95 Case 3:12-cvM1137 Document 44 Filed 04/18/13 Page 95 of 100 PageD #: 390
171. At the time of said misrepresentations and omissions, Plaintiffs and other
members of the Class were ignorant of their falsity, and believed Defendants' statements to be
true. Had Plaintiffs and the other members of the Class and the marketplace known the truth
regarding the true financial position and operating conditions that TNCC was experiencing,
which were not disclosed by Defendants, Plaintiffs and other members of the Class would not
have purchased or otherwise acquired their TNCC securities, or, if they had acquired such
securities during the Class Period, they would not have done so at the artificially inflated prices
which they paid.
172. By virtue of the foregoing, Defendants have violated Section 10(b) of the
Exchange Act, and Rule lOb-S promulgated thereunder.
173. As a direct and proximate result of Defendants' wrongful conduct, Plaintiffs and
the other members of the Class suffered damages in connection with their respective purchases
and sales of the Company's securities during the Class Period.
CLAIM TWO
Violation of Section 20(a) of The Exchange Act Against Defendants Hell, Cox, Sapp and Perez
174. Plaintiffs incorporate by reference each paragraph above as if set forth herein.
175. Defendants Helf, Sapp, Cox and Perez acted as controlling persons of TNCC
within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their
high-level positions, and their ownership and contractual rights, participation in or awareness of
the Company's operations or intimate knowledge of the false financial statements filed by the
Company with the SEC and disseminated to the investing public, defendants Helf, Cox, Sapp
and Perez had the power to influence and control and did influence and control, directly or
96 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 96 of 100 PageD #: 391
indirectly, the decision-making of the Company, including the content and dissemination of the
various statements which Plaintiffs contend are false and misleading.
176. Defendants Helf, Cox, Sapp and Perez were provided with or had unlimited
access to copies of the Company's reports, press releases, public filings and other statements
alleged by Plaintiffs to be misleading prior to or shortly after these statements were issued and
had the ability to prevent the issuance of the statements or cause the statements to be corrected.
177. In particular, each of these defendants had direct and supervisory involvement in
the day-to-day operations of the Company and, therefore, is presumed to have had the power to
control or influence the particular transactions giving rise to the securities violations as alleged
herein, and exercised the same.
178. As set forth above, defendants TNCC, Helf, Cox, Sapp and Perez each violated
Section 10(b) and Rule lOb-5 by their acts and omissions as alleged in this Complaint. By virtue
of their positions as controlling persons, defendants Helf, Cox, Sapp and Perez are liable
pursuant to Section 20(a) of the Exchange Act.
179. As a direct and proximate result of Defendants' wrongful conduct, Plaintiffs and
other members of the Class suffered damages in connection with their purchases of the
Company's securities during the Class Period.
PRAYER FOR RELIEF
WHEREFORE, Plaintiffs pray for relief and judgment, as follows:
A. determining that this action is a proper class action and certifying Lead Plaintiff
as Class Representative under Rule 23 of the Federal Rules of Civil Procedure;
B. awarding compensatory damages in favor of Plaintiffs and the other Class
members against all Defendants, jointly and severally, for all damages sustained as a result of
97 Case 3:12cvM1137 Document 44 Filed 04/18/13 Page 97 of 100 PageD #: 392
defendants' wrongdoing, in an amount to be proven at trial, including interest thereon;
C. awarding Plaintiffs and the Class their reasonable costs and expenses incurred in
this action, including counsel fees and expert fees; and
D. such other and further relief as the Court may deem just and proper.
JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury of all issues so triable.
Dated: April 18, 2013 Respectfully Submitted by:
BARRETT JOHNSTON, LLC
Is/George E. Barrett George E. Barrett, Bar No. 2672 Douglas S. Johnston, Jr., Bar No. 5782 Timothy L. Miles, Bar No. 21605 217 Second Avenue North Nashville, TN 37201 Telephone: (615) 244-2202 Facsimile: (615) 252-3798
Local Counsel
WOLF HALDENSTEIN ADLER FREEMAN & HERZ LLP Gregory M. Nespole Patrick Moran Martin E. Restituyo 270 Madison Avenue New York, New York 10016 Telephone: (212) 545-4600 Facsimile: (212) 545-4653
Lead Counsel
The Rosen Law Finn, P.A. Laurence M. Rosen Phillip Kim 275 Madison Avenue, 34th Floor New York, NY 10016 Telephone: (212) 686-1060
Of Counsel
98 Case 3:12-cvM1137 Document 44 Filed 04/18/13 Page 98 of 100 PageD #: 393
CERTIFICATE OF SERVICE
I hereby certify that on this the 18th day of April, 2013, the foregoing First Amended Class Action Complaint For Violation Of The Federal Securities Laws was filed electronically with the Clerk of Court to be served by operation of the Court's electronic filing system upon the following:
Laurence M. Rosen Phillip Kim THE ROSEN LAW FIRM, P.A. 275 Madison Avenue 34th Floor New York, NY 10016 (212) 686-1060 1rosc11(ärosen1e gal. corn 12k1rn(ärosen1ega1corn
Paul Kent Bramlett Robert P. Bramlett BRAMLETT LAW OFFICES P0 Box 150734 Nashville, TN 37215 (615) 248-2828 Fax: (615)254-4116 pknash1a';to1 .com robert(a:brarnlettlawoffices.com
Counsel for Plaintiff Carolyn Lynn
Darren M. Welch Joseph L. Barloon SKADDEN, ARPS, SLATE, MEAGHER
& FLOM, LLP 1400 New York Avenue, NW Washington, DC 20005 (202) 371-7000 Fax: (202) 393-5760 darrenwelch(a:skaddencom josephbar1oonskadden.coin
99 Case 3:12-cvM1137 Document 44 Filed 04/18/13 Page 99 of 100 PageD #: 394
John R. Jacobson Milton S. McGee, III RILEY, WARNOCK & JACOBSON 1906 West End Avenue Nashville, TN 37203 (615) 320-3700 jjacobson(drwjp1ccom Im c gee(ärwjp1c Corn
Counsel for Defendants Tennessee Commerce Bancorp, Inc., Arthur F. Helf H. Lamar Cox, and Michael R. Sapp
L. Gino Marchetti TAYLOR, PIGUE, MARCHETTI & BLAIR, PLLC 2908 Poston Avenue Nashville, TN 37203-1312 Telephone: (615) 320-3225 gniarchettiätprnb1aw.com
Michael R. Smith Bethany M. Rezek KING & SPALDING, LLP 1180 Peachtree Street, N.E. Atlanta, GA 30309-3521 Telephone: (404) 572-4600 mrsrnith(d:kslawcom brczek(Zks1awcom
Counsel for Defendant Frank Perez
Is/George E. Barrett GEORGE E. BARRETT BARRETT JOHNSTON, LLC
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