The co-founders of the now-defunct subprime auto lender Honor Finance have been accused by the Securities and Exchange Commission (SEC) of defrauding investors by artificially propping up loan performance in its only asset-backed securitization issuance.
The SEC complaint, filed Thursday in the U.S. District Court for the Northern District of Illinois, accuses defendants James Robert Collins and Robert Frank DiMeo, both 51, of deceptively packaging “several thousand” auto loans as collateral for its $100 million securitization in 2016.
Honor, at Collins’ and DiMeo’s direction, allegedly disguised the poorly performing and delinquent underlying loans by applying false borrower payments to make it look as if borrowers were making payments when they were not. They also extended the payment due dates of thousands of loans that would otherwise be delinquent, allowing Honor to avoid treating the loans as charge-offs, according to the complaint.
In fact, materials presented to investors stated payment extensions would be granted to consumers periodically, and no more than every three months. But Honor provided loan modifications more frequently — about 24,000 times to 5,600 unique loans, or 38% of the loan pool. Honor also failed to disclose a practice of delaying marking a vehicle for repossession until after the lender took possession of the car, waiting in some cases until the car had been sold.
“Defendants’ fraudulent actions set up [the securitization] as a house of cards which was doomed to fail, and it predictably collapsed when their scheme unraveled,” reads the complaint.
If convicted, the men would be barred from leading any public company and forced to pay back any gains derived from improper conduct, according to the SEC. They may also face additional civil money penalties and action related to preventing them from “directly or indirectly violating” the laws and rules outlined in the complaint.
Honor Finance fallout
The complaint is the latest chapter in a three-year saga that began when Honor Finance’s first and only securitization began to collapse due to ballooning losses in June 2018. By July of that year, the issuer had stopped originating loans, received downgrades from both Kroll Bond Rating Agency and S&P Global Ratings, and lost most of its executive team, including Collins and DiMeo.
Then, in August 2018, Westlake Financial was tapped to service the downgraded portfolio by Wells Fargo Bank, the latter of which served as a trustee of Honor’s securitization. Westlake exercised its right nearly a year later to redeem the notes. At the time, the average cumulative net loss rate was around 30%.
Private equity firm CIVC Partners, which owned 99% of Honor, sued in the summer of 2019 to recoup the $25 million equity investment it had made in the lender. The Department of Justice then hit Collins, DiMeo and Michael Walsh, an accountant, with a fraud indictment in May 2020. A trial has been set for August 2022.
A cautionary tale
The case underscores the SEC’s authority to hold individual executives personally liable for misleading investors, Ken Rojc, managing partner of the Auto Finance Group at Nisen & Elliott, told Auto Finance News. “If you’re a principal or CFO, you’re going to be held individually accountable if you’re adopting loan modification procedures that are implemented in such a way to defraud investors,” he said. “If you’re recklessly extending loans or making false borrower payments, then I think what the SEC is saying is that crossed the line.”
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