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January 28, 2013

SEC's Allegations of MBS Fraud Survive Summary Judgment

By Anne Sherry, J.D.

An SEC enforcement action alleging a fraudulent mortgaged-backed securitization scheme survived the defendant's summary judgment motion. The SEC alleged that Radius Capital Corp. securitized mortgage loans through the Ginnie Mae mortgage-backed securities program and sold them to investors on the false pretense that the loans were or would be FHA insured. FHA-insured. The SEC seeks injunctive relief, disgorgement, and a monetary penalty (SEC v. Radius Capital Corp., January 24, 2013, Steele, J.).

Basis for summary judgment motion. The founder and CEO of Radius, Robert DiGiorgio, moved for summary judgment on the grounds that the alleged conduct was not "in connection with" or "in the offer and sale of" a security, was not part of a fraudulent scheme, and did not involve scienter; the alleged false statements were not material; and DiGiorgio was not in control of Radius during the relevant time period.

"In connection with," scheme liability, and control. The court noted that whether an action occurred in connection with the purchase or sale of securities is a flexible standard and that the SEC need only show a fraudulent scheme in which the securities transactions coincide. The SEC argued that all of the conduct at issue was part of a fraudulent scheme; the private offering registration exemption did not apply, but even if it did, the Securities Act's antifraud provisions would still apply; DiGiorgio's arguments that the sales were to sophisticated investors have no significance; and the misstatements did not have to be communicated directly to investors for the defendant to be liable.

Responding to DiGiorgio's argument that the SEC failed to prove that he participated in a fraudulent scheme, the SEC argued that there is substantial evidence that the defendant controlled Radius and participated in a scheme to pool deficient loans and obtain a government guarantee under false pretenses. The SEC offered DiGiorgio's own deposition testimony and that of former Radius employees indicating that DiGiorgio controlled Radius and did not appoint anyone to take over his duties after his wife passed away.

Materiality and scienter. The court noted that the test for materiality is a reasonable-investor standard. In response to DiGiorgio's reliance on the declaration of a Wachovia Securities account representative who purchased a number of the securities on behalf of Wachovia, the SEC argued that one person's subjective belief is irrelevant to the objective standard for materiality. With respect to scienter, the SEC claimed that DiGiorgio's statements that the loans backing Radius mortgage-backed securities were eligible for FHA insurance were intentionally, recklessly, or negligently false; the SEC also pointed to deposition transcripts for evidence that DiGiorgio knew of Ginnie Mae's requirements.

Holding. With respect to each of the grounds for summary judgment, the SEC responded with factual and legal counterarguments. Drawing all possible inferences in favor of the SEC in each event, the court found that there were genuine issues of material fact as to all five of DiGiorgio's assertions. Accordingly, the court denied summary judgment. The case is No. 2:11-cv-116-FtM-29DNF.

Attorneys: H. Michael Semler for Securities and Exchange Commission. Robert A. DiGiorgio, pro se. Companies: Radius Capital Corp.

LitigationEnforcement: Enforcement FraudManipulation

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