H&R Block’s former mortgage subsidiary Option One has agreed to pay $28.2 million to settle charges from the Securities and Exchange Commission over its subprime mortgage investments.

Block sold off Option One in 2008 and it was renamed Sand Canyon. According to a recent Block earnings call transcript for Q2 2012, Sand Canyon is now a separate legal entity, although the SEC complaint treats it as still a subsidiary of Block in its complaint. The SEC charged Option One Mortgage Corporation with misleading investors in several offerings of subprime residential mortgage-backed securities by failing to disclose that its financial condition was significantly deteriorating. Option One, now known as Sand Canyon, agreed to pay $28.2 million to settle the SEC’s charges.

The SEC alleges that Option One promised investors in more than $4 billion worth of RMBS offerings that it sponsored in early 2007 that it would repurchase or replace mortgages that breached representations and warranties.  But Option One did not tell investors about its deteriorating financial condition and that it could not meet its repurchase obligations on its own.

“Option One’s financial condition deteriorated significantly as its large subprime mortgage lending business suffered from the collapse of the U.S. housing market,” said Robert Khuzami, director of the SEC’s Division of Enforcement, in a statement.  “The company nonetheless concealed from investors that its perilous finances created risk that it would not be able to fulfill its duties to repurchase or replace faulty mortgages in its RMBS portfolios.”

According to the SEC’s complaint filed in U.S. District Court for the Central District of California, Option One was one of the nation’s largest subprime mortgage lenders with originations of $40 billion in its 2006 fiscal year. Option One originated subprime loans and sold them in the secondary market through RMBS securitizations or whole loan pool sales.   

According to the SEC’s complaint, Option One was generally profitable prior to its 2007 fiscal year. However, when the subprime mortgage market started to decline in the summer of 2006, Option One experienced a decline in revenues and significant losses, and faced hundreds of millions of dollars in margin calls from its creditors. 

At the time Option One offered and sold the RMBS, it needed H&R Block, through a subsidiary, to provide it with financing under a line of credit in order to meet its margin calls and repurchase obligations.  But Block was under no obligation to provide that funding.  Option One did not disclose this information to investors. The SEC further alleges that Block never guaranteed Option One’s loan repurchase obligations and that Option One’s mounting losses threatened Block’s credit rating at a time when Block was negotiating a sale of Option One.

Without admitting or denying the SEC’s allegations, Option One consented to the entry of an order permanently enjoining it from violating the securities laws and requiring it to pay disgorgement of $14,250,558, prejudgment interest of $3,982,027, and a penalty of $10 million. The proposed settlement is subject to court approval.

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