Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 1 of 196 UNITED STATES DISTRICT COURT DISTRICT OF NEW MEXICO IN RE THORNBURG MORTGAGE, INC Case No. 07-815 JB/WDS SECURITIES LITIGATION CONSOLIDATED CLASS ACTION COMPLAINT Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 2 of 196 TABLE OF CONTENTS NATURE OF THE ACTION 1 I. The Exchange Act Action 2 II. The Securities Act Action 12 JURISDICTION AND VENUE 15 PARTIES 15 I. Plaintiffs 15 II. Defendants 16 A. The Company 16 B. The Individual Defendants 17 III. Control Person/Group Published Information Allegations 18 SUBSTANTIVE ALLEGATIONS 20 I. Background 20 II. The Company Generates Revenue Based Upon the Small Spread Between its Investments and the Cost of Borrowing 21 III. The Company Relied Extensively on and Touted the Benefits of Leveraging its Assets to Grow its Business 24 IV. TMI and the Mortgage Market Meltdown 26 A. The Implosion of Heavily Leveraged Subprime Backed Hedge Funds Due to Lender Margin Calls 28 B. High Risk Alt-A Loans Contribute to Mortgage Market Failures 28 C. Agency Ratings Begin To Lose Market Credibility In Early 2007 31 D. The Thornburg Defendants Repeatedly Tout the Invincibility of the Company’s MBS Asset Portfolio While at the Same Time Concealing That It Held Billions in Assets Backed by Risky Alt-A Loans 32 i Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 3 of 196 E. TMI’s Significant Involvement With Originated and Purchased Alt-A Loans 34 F. Unbeknownst to Shareholders, the ABCP Market Dries Up, Leaving TMI Forced Asset Sales as Only Viable Liquidity Option 38 G. TMI Commences an Undisclosed Discount Sale of Its Highest-Rated Assets While Informing the Market It Was Only “Exploring” Such Sales 39 H. TMI Fails to Disclose That It Still Holds Billions in Illiquid MBS Backed by Risky Alt-A Collateral 41 I. Asset Sales Do Not Fully Absolve the Company of Liquidity Issues 42 J. Adjustments to Loss Estimates Trigger SEC Inquiry 42 K. Effects of the Liquidity Crisis Continued to Plague TMI Throughout the Fall of 2007 and Into 2008 44 L. Company Touts 4Q07 Return to Profitability 45 M. February 2008 Announcement of Alt-A Portfolio and Margin Calls Stuns the Market 46 N. Company Faces Additional Margin Calls 48 O. KPMG Demands that TMI Restate its FY 2006 and 2007 Financial Statements 49 P. TMI Conceals the NYSE Investigation 51 Q. Company Finally Announces That It Must Restate 51 R. Lender Bailout Comes at Heavy Price 53 SUMMARY OF SCIENTER ALLEGATIONS 55 I. The Thornburg Defendants Knew and/or Recklessly Disregarded the Falsity of Their Class Period Statements and Omissions 55 II. Defendants Were Motivated to Commit Fraud 57 A. TMI’s “Manager” Is Paid To Grow the Company’s Balance Sheet Without Regard For Market Conditions 57 ii Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 4 of 196 B. The Thornburg Defendants were Motivated to Conceal the Entire Truth From Investors Due to the Imminent Threat of Bankruptcy 59 C. The Thornburg Defendants Were Motivated to Conceal the Truth to Raise Cash Through Public Offerings 60 D. The Thornburg Defendants were Motivated to Conceal the Truth to Complete Securitization Transactions to Fund Loan Originations When Borrowings Were Increasingly Difficult to Obtain 61 III. Additional Indicia Of Scienter 61 A. The Magnitude of the Funds Required to Meet Margin Calls Also Raises an Inference of Scienter 61 B. The Timing and Magnitude of the Company’s Restatement Raises a Strong Inference of Scienter 62 MATERIALLY FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD 62 I. April 2007 Misrepresentations and Omissions 62 A. The Thornburg Defendants Tout TMI’s Credit Quality and Asset Liquidity Due to TMI’s Purported Focus on “Prime” Mortgages, While Concealing Billions of Dollars in Alt-A Mortgage Backed Assets 62 II. May 2007 Misrepresentations and Omissions 64 A. Thornburg Defendants Disseminate Materially False and Misleading Offering Documents to Raise $121.7 Million in Capital and Fuel Liquidity 64 B. TMI’s First Quarter 2007 Form 10-Q 66 C. The Thornburg Defendants Misrepresent That TMI is Immune to the Risks Associated with the Alt-A Mortgage Market 69 III. June 2007 Misrepresentations and Omissions 70 A. The Thornburg Defendants Tout “Prime” Originations But Continue To Conceal Alt-A Origination Activity And Exposure 70 B. The Thornburg Defendants Disseminate Materially False and Misleading Offering Documents in Order to Raise $68.8 Million in Capital to Fuel Liquidity 71 iii Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 5 of 196 IV. July 2007 Misrepresentations and Omissions 74 A. The Thornburg Defendants Report 2Q EPS and that Dividend Will be Maintained, But Continue to Conceal Alt-A Holdings and Problems in the ABCP Market 74 V. August 2007 Misstatements and Omissions – The Thornburg Defendants Begin A Campaign of Selective Disclosure 77 A. TMI Files 2Q07 10-Q Concealing Asset Illiquidity and Billions in Alt-A Exposure 77 B. TMI Delays its Dividend Payment and Announces Asset Liquidation, But Conceals Billions of Dollars in Alt-A Backed Assets 81 C. Company Reveals Timing of Asset Sales, But Misrepresents Magnitude of Sales and Loss Incurred Therefrom 87 D. The Thornburg Defendants Disseminate Materially False and Misleading Offering Documents in Order to Raise $500 Million in Necessary Capital to Keep Company Afloat Following Liquidity Crisis 89 VI. September 2007 Misstatements 91 A. Mid-Quarter Update Conference Call 91 VII. October 2007 Misstatements 94 A. Press Release Announcing Adjustments to Loss Estimates 94 B. Press Release Announcing 3Q07 Financial Results and Conference Call to Discuss Results 95 VIII. November 2007 Misrepresentations and Omissions 98 A. Third Quarter Report on Form 10-Q 98 B. Freidman, Billings & Ramsey’s Investor Conference 100 IX. January 2008 Misrepresentations and Omissions 102 A. January 2008 Offering 102 X. February 2008 Misrepresentations and Omissions 103 iv Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 6 of 196 A. FY2007 Financial Results Press Release and Conference Call 103 B. The Undisclosed JP Morgan Default, Cross-Defaults, and First Disclosure of ARM Assets Backed by Alt-A Loans 109 XI. March 2008 Misstatements and Omissions 113 A. Thornburg Defendants Reveal Company’s Inability to Meet $270 Million in Margin Calls Would Have a “Material” Impact on its Borrowing Position 113 B. Thornburg Defendants Conceal KPMG Letter Withdrawing its 2/27/08 Audit Opinion, Requiring the Company to Restate its FY2006 and FY2007 Financial Results, and Issuing a Going Concern Warning 116 C. Thornburg Defendants Admit that the JP Morgan Default Triggered Cross-Default Provisions with All Other RPA Lenders 117 D. Thornburg Defendants Conceal NYSE Investigation 119 E. Thornburg Defendants Finally Reveal Existence of KPMG Letter and Requirement to Restate 119 F. Company Issues Restated Financial Results and Reports Greater Loss than Estimated Just Two Days Prior 120 G. Company Continues to Default on Repurchase Agreements 123 H. Company Announces Lender Bailout 123 POST CLASS-PERIOD DISCLOSURES/EVENTS 126 ALLEGATIONS OF GAAP VIOLATIONS 127 I. Subsequent Events 130 II. The Thornburg Defendants Failed to Disclose Adverse Facts and Events During the Class Period in Violation of GAAP and SEC Regulation S-K 132 III. Violations of SEC Regulation S-K 135 IV. The 2008 Restatement 135 LOSS CAUSATION/ECONOMIC LOSS 143 v Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 7 of 196 FRAUD-ON-THE-MARKET PRESUMPTION OF RELIANCE 149 NO SAFE HARBOR 150 CLASS ACTION ALLEGATIONS 150 FIRST CLAIM FOR RELIEF: For Violation of Section 10(b) of the Exchange Act and Rule 1 0b-5 Against the Thornburg Defendants 153 SECOND CLAIM FOR RELIEF: For Violation of Section 20(a) of the Exchange Act Against the Individual Defendants 157 ALLEGATIONS SPECIFIC TO THE SECURITIES ACT ACTION 158 I. Additional Securities Act Parties 159 A. The Underwriter Defendants 159 B. The Director Defendants 162 C. Duty to Conduct a Reasonable and Diligent Investigation 163 II. The Offerings 163 A. The May 2007 Offering 163 B. The June 2007 Offering 164 C. The September 2007 Offering 164 D. The January 2008 Offerings 165 III. The Revelation of Alt-A Exposure in the Company’s Portfolio and of Misstated FY2006 Financial Results 166 IV. Materially False Statements in the Offering Documents 168 A. The Shelf Registration Statement 168 B. The May 2007 Offering Documents Were Materially False or Misleading 168 C. The June 2007 Offering Documents Were Materially False or Misleading 170 vi Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 8 of 196 D. The September 2007 Offering Documents Were Materially False or Misleading 173 E. The January 2008 Offering Documents Were Materially False or Misleading 177 THIRD CLAIM FOR RELIEF: For Violation of Section 11 of the Securities Act Against the Thornburg Defendants, the Director Defendants, and the Underwriter Defendants 183 FOURTH CLAIM FOR RELIEF: For Violoation of Section 12(a)(2) of the Securities Act Agatins the Thornburg Defendants, the Director Defendants, and the Underwriter Defendants 185 FIFTH CLAIM FOR RELIEF: For Violation of Section 15 of the Securities Act Against the Individual Defendants 186 PRAYER FOR RELIEF 186 JURY DEMAND 187 vii Case 1:07-cv-00815-JB-WDS Document 68 Filed 05/27/2008 Page 9 of 196 CONSOLIDATED CLASS ACTION COMPLAINT Lead Plaintiffs, W. Allen Gage, individually and on behalf of J. David Wrather, Harry Rhodes, FFF Investments, LLC, Robert Ippolito, individually and as Trustee for the Family Limited Partnership Trust, and Nicholas F.