MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH (68581)
ALAN SCHULMAN (128661)
DARREN J. ROBBINS (168593)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
WOLF POPPER LLP
ROBERT C. FINKEL
845 Third Avenue
New York, NY 10022
Telephone: 212/759-4600
COHEN, MILSTEIN, HAUSFELD
& TOLL, P.L.L.C. BERNSTEIN LIEBHARD & LIFSHITZ
STEVEN J. TOLL SANDY A. LIEBHARD
999 Third Avenue, Suite 3600 274 Madison Avenue
Seattle, WA 98104 New York, NY 10016
Telephone: 206/521-0080 Telephone: 212/779-1414
Attorneys for Plaintiffs
SUPERIOR COURT OF THE STATE OF CALIFORNIA
COUNTY OF ORANGE
LEON RASACHACK and PHILIP A. ) Case No. 796083
ETTEDGUI, On Behalf of Themselves )
and All Others Similarly Situated, ) CLASS ACTION
)
Plaintiffs, ) COMPLAINT FOR DAMAGES BASED
) UPON VIOLATION OF
vs. ) CALIFORNIA CORPORATIONS
) CODE ¡ì¡ì25400 AND 25500
FIRST ALLIANCE CORPORATION, BRIAN ) [filed Jun. 25, 1998]
CHISICK, SARAH CHISICK and MARK K. )
MASON, )
)
Defendants. ) Plaintiffs Demand A
____________________________________) Trial By Jury
SUMMARY OF ACTION
1. This is a securities class action suit on behalf of all
purchasers of the Class A common stock of First Alliance
Corporation ("First Alliance" or the "Company") between 4/24/97 and
5/27/98 (the "Class Period"), seeking to remedy violations of
California law by the Company and certain of the Company's officers
and directors (the "defendants"). This action alleges that the
directors and officers of First Alliance and its subsidiaries,
pursued a scheme and conspiracy that operated as a fraud or deceit
on purchasers of First Alliance stock during the Class Period.
Defendants' scheme was designed to and did enable First Alliance's
controlling shareholders Brian Chisick and Sarah Chisick ("B.
Chisick" and "S. Chisick," respectively) to sell nearly 5.088
million shares1 in a secondary stock offering for proceeds
exceeding $90.2 million. These stock sales were successfully
accomplished in significant part because of the apparent growth in
First Alliance's earnings per share ("EPS"), and defendants'
statements about First Alliance achieving significant net income
and EPS growth in 1998 and 1999, resulting in its stock price
trading at a significantly higher price/earnings ratio than was the
case with First Alliance's competitors. However, just months after
the secondary offering, First Alliance was forced to reveal that it
would report lower than expected results in the second quarter of
1998, in part due to the fact that it would no longer rely upon the
improper assumptions it had previously used to calculate its
_____________________
1 Unless otherwise noted all share and per-share figures are
adjusted to give affect to First Alliance's 3-for-2 stock split in
October 1997.
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earnings. As a result, First Alliance's stock price declined from
its Class Period high of $24-1/8 per share in 10/97 to as low as $9
per share. The stock chart below shows this artificial inflation
of First Alliance's stock during the Class Period and its collapse
when the adverse facts concerning its business became known:
First Alliance Corp.
April 14, 1997 - June 11, 1998
Daily Stock Prices
- 2 -
INTRODUCTION AND OVERVIEW
2. First Alliance originates, purchases, sells and services
non-conventional mortgage loans, secured primarily by first
mortgages on single family residences through its subsidiary First
Alliance Mortgage Company. The Company originates loans through a
retail branch network composed of 31 offices in 17 states and in
the United Kingdom. First Alliance was founded in 1971 by B.
Chisick. For most of its history, First Alliance was a mortgage
broker that sold loans to private investors. However, in the early
1990's a market developed for the packaging and sale of subprime
loans which substantially increased First Alliance's ability to
sell large quantities of loans. In 1995, defendants sought to
benefit from the increasing interest in the subprime lending market
segment. Consequently, in late 1995 to early 1996 First Alliance
caused its financial and legal advisors to prepare the necessary
documentation for its initial public offering ("IPO") and in 1996,
First Alliance carried out its IPO raising some $63 million, from
the sale of 6,037,500 shares of Class A common stock. B. Chisick
and his wife, S. Chisick, continued to hold 16 million shares of
Class B common stock which provided them with 91% voting control of
the Company. After the IPO, which was carried out at, $11.33 per
share, First Alliance was a strong performer, trading at $18 to $20
per share. However, in early 1997, First Alliance's stock price
dropped to the $12-$13 range as First Alliance announced lackluster
fourth quarter 1996 results and several large subprime lenders
shocked the market with revelations of large write-offs and
accounting problems.
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3. This price decline greatly concerned the insiders as it
wiped out over $100 million of their holdings and derailed the
Chisicks' plan to dispose of a large amount of their shares. Thus,
in 4/97, defendants contrived the scheme complained of herein which
was designed to and did inflate the Company's stock price, as
defendants issued favorable but false statements about First
Alliance's finances, future prospects, expansion and new loan
programs.
4. Defendants' scheme was very successful. They drove First
Alliance stock to a Class Period high of $24-1/8 in late 10/97 and
maintained the stock at high and inflated levels thereafter
throughout the balance of the Class Period.
5. During the Class Period, the defendants were consistently
enthusiastic, optimistic and very reassuring about First Alliance's
financial results and prospects. For instance, First Alliance
consistently touted its "solid" financial results and growth, and
"conservative accounting," which would ensure First Alliance's
continued EPS growth in the future. First Alliance assured
investors that its favorable results were the result of "our proven
ability to generate origination fees" and that First Alliance's
shares were "an excellent value." First Alliance claimed it was
successfully expanding in the U.S. and United Kingdom which would
lead to increased EPS of $1.83-$1.87 in 1998. When higher
prepayment rates were noted by some competitors in mid-1997, First
Alliance assured the market that its assumptions regarding
prepayment rates were "conservative" which would lead to increased
revenues being recognized in the future.
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6. During 1997, First Alliance consistently reported record
earnings. When First Alliance reported its 2ndQ net income and EPS
of $7.9 million and $.35, respectively, it attributed these results
to increasing economies of scale leading to increasing margins.
7. On 9/17/97, First Alliance successfully carried out its
secondary offering wherein B. Chisick and S. Chisick were able to
sell some 5.1 million shares for $90.2 million.
8. During the winter of 1997-1998, First Alliance continued
to assure investors that it was experiencing solid growth and that
its prepayment assumptions were conservative and the charges
against their company were not significant, and that First Alliance
would have an EPS of $1.80-$1.87 in 1998.
9. As a result of First Alliance's false representations and
reassurances, forecasts and financial statements, First Alliance's
stock traded at artificially inflated levels throughout the Class
Period. In fact, throughout the Class Period, First Alliance's
actual earnings were materially lower than reported.
10. Ultimately, when a nationally recognized organization
joined in suits against the Company alleging improper lending
practices and when loan originations declined, First Alliance was
forced to admit its results in 1998 would be much worse than
defendants had previously represented due to "unexpected"
prepayment increases and possible writedowns of assets. Analysts
immediately cut estimates for 1998 EPS to $1.25-$1.28 from $1.80-
$1.87. First Alliance's stock prices dropped to below $9-1/2 per
share, a 60% decline from its Class Period high of $24-1/8, and 45%
lower than where defendants had dumped $90 million of their own
First Alliance shares.
- 5 -
11. First Alliance's 1995-1998 financial results are set
forth below:
First Alliance
(in thousands, except EPS)
Fiscal 1995
Year
Total Revenues $58,880
Net Income $30,542
EPS $ 1.91
Fiscal 1996
3/31 6/30 9/30 12/31 Year
Total Revenues $14,810 $17,024 $18,922 $20,115 $70,871
Net Income $ 7,742 $ 9,167 $ 8,633 $ 6,597 $32,139
EPS $ .49 $ .57 $ .43 $ .29 $ 1.72
Fiscal 1997
3/31 6/30 9/30 12/31 Year
Total Revenues $21,437 $23,244 $23,395 $27,573 $95,649
Net Income $ 7,684 $ 7,866 $ 8,188 $ 9,034 $32,772
EPS $ .35 $ .35 $ .37 $ .42 $ 1.30
Fiscal 1998
3/31
Total Revenues $25,350
Net Income $ 7,262
EPS $ .35
12. The positive statements made by defendants during the
Class Period were each false and misleading when made and also
failed to disclose the following material adverse conditions
adversely affecting First Alliance's business, set forth below:
(a) First Alliance's illicit practices of hiding its
unconscionably high origination fees from borrowers by increasing
the loan amounts to include origination fees was increasingly
having a negative effect on its ability to sign up new borrowers
and was causing the defection of employees;
(b) First Alliance was continuing to be adversely
affected by increasing restrictions in the United Kingdom which
would curtail the Company's success there;
(c) First Alliance was continuing to conceal the fact
that prepayments were increasing at an alarming rate which was
adversely affecting the Company's results as First Alliance was
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using out-of-date and unreasonable assumptions regarding prepayment
rates in the calculation of its gains;
(d) Many of the Company's borrowers were not less
creditworthy people willing to pay higher fees but were in fact
people with good credit who were tricked into paying unreasonable
and unconscionable origination fees by the Company's deceptive
sales practices, and as a result of these practices, the Company
would be facing increasing complaints, lawsuits and adverse
publicity in the future;
(e) First Alliance was artificially inflating its
reported revenues, net income and EPS by improperly recognizing
revenues and by engaging in the artifices and manipulations
detailed in ¶¶75-86 hereof; and
(f) As a result of the foregoing, the forecasts that
First Alliance would achieve 1998 EPS of $1.80-$1.87, respectively,
were known by the defendants to be false when made.
JURISDICTION AND VENUE
13. This Court has jurisdiction over the cause of action
asserted in this Complaint pursuant to the California Constitution,
Article VI, ¡ì10, because this case is a cause not given by statute
to other trial courts. The claims asserted herein arise under
¡ì¡ì25400 and 25500 of the Cal. Corp. Code.
14. During the Class Period, First Alliance had its principal
place of business in Irvine, California. Each of the individual
defendants resides in and is a citizen of the State of California.
Most of the false and misleading statements made by the defendants
were disseminated in or from California. The amount in controversy
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of plaintiffs' claims is less than $75,000 exclusive of interest
and costs. This action is not removable to federal court.
CLASS ACTION ALLEGATIONS
15. Plaintiffs bring this action as a class action pursuant
to California Code of Civil Procedure ¡ì382 on behalf of all persons
and entities who purchased or otherwise acquired First Alliance
stock during the Class Period (the "Class"). Excluded from the
Class are the defendants, members of their families and any entity
in which a defendant has an interest.
16. The Class is composed of numerous purchasers, the joinder
of whom is impracticable. The disposition of their claims in a
class action will provide substantial benefits to the parties and
the Court. During the Class Period, First Alliance had 11 million
shares of stock outstanding, owned by thousands of shareholders.
17. There is a well-defined community of interest in the
questions of law and fact involved in this case. The questions of
law and fact common to the members of the Class which predominate
over questions which may affect individual Class members include
the following:
(a) Whether Cal. Corp. Code ¡ì¡ì25400 and 25500 were
violated by defendants;
(b) Whether defendants omitted and/or misrepresented
material facts to or emanating from California which were
disseminated to the general public;
(c) Whether defendants failed to disclose, or conspired,
directly or indirectly, with one another in not disclosing,
material facts necessary to make the statements made not
misleading;
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(d) Whether defendants knew or recklessly disregarded
that their statements were false and misleading;
(e) Whether the price of First Alliance stock was
artificially inflated during the Class Period; and
(f) The extent of damage sustained by Class members and
the appropriate measure of damages.
18. Plaintiffs' claims are typical of those of the Class
because plaintiffs and the Class sustained damages from defendants'
wrongful conduct.
19. The prosecution of separate actions by individual Class
members would create a risk of inconsistent and varying
adjudications.
20. Plaintiffs will adequately protect the interests of the
Class. They have retained counsel who are experienced in class
action securities litigation. Plaintiffs have no interests which
conflict with those of the Class.
21. A class action is superior to other available methods for
the fair and efficient adjudication of this controversy.
THE PARTIES
22. (a) Plaintiff Leon Rasachack purchased 150 shares of
First Alliance common stock on 5/19/98 at $14 per share, 500 shares
on 5/15/98 at $13-1/2 per share and 500 shares on 5/19/98 at $14
per share, and was damaged thereby.
(b) Plaintiff Philip A. Ettedgui purchased 100 shares of
First Alliance common stock on 2/18/98 at $16-5/8 per share and 500
shares on 5/7/98 at $12-15/16 per share, and was damaged thereby.
- 9 -
23. First Alliance maintains its headquarters in Irvine,
California. During the Class Period, First Alliance's common stock
traded in an efficient market on the NASDAQ National Market System.
24. (a) Defendant Brian Chisick ("B. Chisick") is Chairman
of the Board, a member of the Stock Incentive Committee and
Compensation Committee and Chief Executive Officer of First
Alliance. Because of his positions with the Company, he had access
to the adverse non-public information about its business, finances,
products, 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 and connections with
other corporate officers and employees, attendance at management
and Board of Directors meetings and committees thereof and via
reports and other information provided to him in connection there-
with.
(b) Defendant Sarah Chisick ("S. Chisick") is a Director
and former executive officer of First Alliance and a member of the
Stock Incentive Committee. Because of her position with the
Company, she had access to the adverse non-public information about
its business, finances, products, 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 and
connections with corporate officers and employees, attendance at
Board of Directors meetings and committees thereof and via reports
and other information provided to her in connection therewith.
- 10 -
(c) B. Chisick and S. Chisick (collectively, the
"Chisicks") jointly sold 5,088,750 shares in a secondary offering
in 9/97 for net proceeds of $90.2 million. These sales constituted
31% of the Chisicks' joint holdings.
(d) Defendant Mark K. Mason ("Mason") was Executive Vice
President, Chief Financial Officer and a director of First
Alliance. Because of his position with the Company, he had access
to the adverse non-public information about its business, finances,
products, 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 opera-
tions compared thereto), conversations and connections with other
corporate officers and employees, attendance at management and
Board of Directors meetings and committees thereof and via reports
and other information provided to him in connection therewith.
During the Class Period, Mason sold 37,628 shares of First Alliance
stock for proceeds of $758,182. The sales constituted 45% of
Mason's stock holdings.
25. The individuals named as defendants in ¶24(a)-(b) and (d)
are referred to herein as the "Individual Defendants."
26. The Individual Defendants, by reason of their stock
ownership, management positions, and membership on First Alliance's
Board, were controlling persons of First Alliance and had the power
and influence, and exercised the same, to cause it to engage in the
illegal conduct complained of herein. Each defendant was provided
with copies of the Company's reports and press releases alleged
herein to be misleading prior to or shortly after their issuance
and had the ability and opportunity to prevent their issuance or
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cause them to be corrected. Because of their positions and access
to material non-public information available to them but not to the
public, each of these defendants knew or recklessly disregarded
that the adverse facts specified herein had not been disclosed to
and were being concealed from the public and that the positive
representations which were being made were then materially false
and misleading. The Individual Defendants are liable for the false
statements pleaded in First Alliance releases, reports and SEC
filings, as those statements were each "group-published"
information of First Alliance, the result of collective actions of
the Individual Defendants.
DEFENDANTS CONSPIRACY, AIDING AND ABETTING
AND WILLFUL PARTICIPATION IN THE FRAUDULENT SCHEME
27. First Alliance's dominant shareholders were the Chisicks,
who controlled about 91% of the voting power of its stock. As of
the IPO, the Chisicks held 97% of the Class B Common which held 4
votes for each of their 16 million shares. The 6.03 million shares
sold in the IPO held only one vote each. Even though the Chisicks
hold only 72% of the outstanding stock before the secondary
offering, they held 91% of the voting power. After the secondary
offering, the Chisicks held 53% of the outstanding stock of First
Alliance but had 80% of the voting power. Thus, the Chisicks had
control of the Company disproportionate to their ownership of its
stock. B. Chisick, S. Chisick and Mason were senior officers
and/or directors of First Alliance and therefore controlled and/or
prepared its public releases and SEC filings. Thus, the defendants
had the opportunity to falsify First Alliance's public
representations.
- 12 -
28. The Chisicks and Mason wanted to inflate the price of
First Alliance's stock so they could sell their shares at favorable
prices. The Chisicks and Mason sold 31% and 45% of their holdings,
respectively. The Chisicks' sales were extraordinary in timing and
amounts. Never at any time prior to the Class Period did
defendants dump such dramatic amounts of First Alliance stock.
Mason had an additional motivation to engage in the fraud alleged
herein as he was eligible for the Company's annual bonus program
which was linked to achieving growth in sales and improved
operating efficiencies. Thus, the better First Alliance's
financials appeared, the higher Mason's bonus. As a result of
First Alliance's perceived strong results, Mason received $650,000
in bonuses in 1997.
BACKGROUND TO THE CLASS PERIOD
29. First Alliance originates, purchases, sells and services
non-conventional mortgage loans, secured primarily by first
mortgages on single family residences. The Company originates
loans through a retail branch network composed of 31 offices in 17
states and in the United Kingdom. First Alliance was founded in
1971 by B. Chisick. For most of its history, First Alliance was a
mortgage broker that sold loans to private investors. However, in
the early 1990's a securities market for subprime loans developed
which increased First Alliance's ability to sell large quantities
of loans. In 1995, the subprime market segment became hot, causing
the defendants to want to benefit from this market situation. In
1996, First Alliance carried out an IPO raising some $63 million,
from the sale of 6,037,500 shares of Class A common stock. The
Chisicks received payments of $45 million on S distribution
- 13 -
dividends from the proceeds raised in the offering. After the IPO,
which was carried out at $11.33 per share, First Alliance was a
strong performer trading at $18 to $20 per share. However, in
early 1997, First Alliance's stock price dropped to the $12-$13
range as First Alliance announced lackluster fourth quarter 1996
results and several large finance companies shocked the market with
revelations of large write-offs and accounting problems.
30. This price decline greatly concerned the insiders as it
diminished the value of their holdings. The Chisicks, in
particular, wanted to dispose of a large amount of their shares,
but wanted to do so at much higher prices. Thus, in April 1997,
defendants embarked upon the scheme complained of herein which
revolved around defendants' favorable but false statements about
First Alliance's finances, future prospects, expansion and new loan
programs.
FALSE AND MISLEADING STATEMENTS
ISSUED DURING THE CLASS PERIOD
31. On 4/24/97, First Alliance announced its results for the
1stQ 97. The press release stated:
First Alliance Corp. today announced net income of $7.7
million, or .35 cents per share, for its first quarter
ended March 31, 1997.
Net income for the quarter increased 66% over pro
forma net income of $4.6 million, or 21 cents per share,
for the first quarter of 1996.
* * *
The increase in net income was primarily the result
of increased loan originations and purchases.
Additionally, in the first quarter the Company completed
its first sale of loans originated in the United Kingdom
of $3.6 million, and as a result, the Company's UK
operations contributed 1 cent per share to net income in
the quarter.
- 14 -
"Our financial performance was again solid, driven
by our proven ability to generate substantial origination
fees and our successful retail branch expansion, said
Brian Chisick, president and chief executive officer.
"Our relative profitability continues to improve as well.
In the first quarter, our centralized operations drove an
increase in pre-tax margin to 60% of revenues, up from
53% in the first quarter of 1996. We also continue to
differentiate ourselves as one of the few companies in
our sector to generate positive cash flow from
operations, which reduces the need for dilutive capital-
raising and dependence on credit facilities to fund
working capital and, we believe, gives First Alliance
excellent earnings quality."
32. Also on 4/24/97, in an effort to boost the price of the
Company's stock, First Alliance announced a share repurchase
program whereby the Company "will purchase up to 1,500,000 shares
of its Class A Common Stock." The release stated:
"We believe that shares of First Alliance currently
represent an excellent value, and present an opportunity
to significantly increase shareholder value through the
repurchase of our shares," said Brian Chisick, President
and Chief Executive Officer. "Because we generate
positive cash flow from operations, and have a strong
cash position today, we are uniquely positioned to seize
this opportunity. Most companies in our sector operate
on a negative cash flow basis and, as much, they are
generally unable to take advantage of this opportunity
for their shareholders."
33. Subsequent to the release of its 1stQ 97 results, First
Alliance spoke to securities analysts, money and portfolio
managers, institutional investors, brokers and stock traders to
discuss First Alliance's business and its prospects. During the
conversations, B. Chisick (the CEO) and Mason (the CFO) made
representations and answered questions. During the conversations,
they directly disseminated important information to the market by
stating:
* The outlook for First Alliance was solid and loan
origination growth was and would continue to be strong as
the Company continued to open new branches.
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* First Alliance would be repurchasing half of the 1.5
million shares authorized in the very near term because
the stock was undervalued and the repurchase would
improve EPS in the future.
* First Alliance was increasingly able to market its loans
to borrowers who did not mind paying its origination fees
which was leading to strong cash flows and earnings.
* As a result of the positive trends in its business, First
Alliance would enjoy EPS growth to $1.80+ in 1998.
34. On 4/25/97, Prudential Securities issued a report on
First Alliance written by J. Scutti. This report was written after
Scutti had extensive discussions with B. Chisick and Mason on or
about 4/24/97 and was based on and repeated information provided
Scutti by them. Subsequent to the release of this report, First
Alliance copied and distributed it, thus adopting it as its own.
The report forecast 1997 and 1998 EPS of $1.45 and $1.83,
respectively and the following F97/F98 quarterly results:
EPS/1997 EPS/1998
QTR.
1st: $ .34A $ .43
2nd: $ .33 $ .45
3rd: $ .37 $ .47
4th: $ .40 $ .48
Year: $1.45 $1.83
The report also stated:
First Alliance reported first-quarter earnings of
$0.35 per share, up 18.2% sequentially and nearly 68%
year-over-year. First Alliance reported first quarter
earnings of $0.35 per share, well ahead of our estimate
of $0.45, and substantially above last year's $0.21 per
share. Quarterly results continued to be driven by
substantial year-over-year loan originations growth, as
the company expands its retail branch network
geographically, while increasing penetration in existing
markets. During the quarter, First Alliance opened two
new retail offices in Edison, New Jersey and Boston,
Massachusetts to bring the total number of offices to 24,
including the United Kingdom. . . .
. . . First Alliance also announced that it has
received board approval for a share repurchase program,
whereby the company will purchase up to 1.5 million of
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its Class A Common Stock. Management anticipates it will
repurchase roughly half of the allocation in the very
near term, with the remainder of the repurchase
authorization to be absorbed over the next several
quarters. As a result, we believe earnings could be
positively impacted by the lower shares outstanding by
roughly 1%-2% in 1997 and approximately 3%-6% in 1998,
which is not reflected in our estimates. Given the
better-than-expected earnings, we have raised our 1997
and 1998 earnings estimates, to [$1.45] and [$1.83],
respectively, as loan origination volume should remain
robust through 1998 as the company continues to pursue a
geographic expansion strategy while increasing
penetration in existing markets. As a result, at current
levels we remain buyers of this stock given the upside
opportunity with a price target of $20 per share.
* * *
Overall, we believe that the outlook for First
Alliance remains solid as loan origination growth should
remain robust as the company opens new retail branches,
while maintaining positive cash flow. Despite recent
weakness, fundamentals remain intact at First Alliance.
As a result, we remain aggressive buyers of this stock
with a $20 price target.
35. On 5/2/97, First Alliance announced the opening of new
branch officers in Virginia and the United Kingdom. The press
release also stated:
"With these new branches, we will have opened 11
retail branch offices in the past 12 months. This
reflects our continuing strategy of aggressive, high-
quality growth primarily through expanding retail loan
originations," said Brian Chisick, president and, chief
executive officer.
"The U.K. market has been very successful for First
Alliance. We completed our first sale of loans
originated in the U.K. during the first quarter, and saw
our U.K. operations contribute to our profits as well.
The United Kingdom has an improving economy and a proud
heritage of home ownership, which make it an ideal market
for our product."
36. On 6/23/97, B. Chisick and Mason were interviewed by the
Wall Street Transcript. Both B. Chisick and Mason made several
bullish statements which were repeated to the market by The Wall
Street Transcript ("TWST"):
- 17 -
TWST: Is your company a potential takeover
target?
* * *
Mr. Chisick: You know, based on our projections, and
based on our realistic ability to
increase our franchise by opening
additional offices, the answer to your
question specifically, is probably not
for the immediate future. We're so
excited about the increase in our
business and in our franchise and our
earnings, and our ability to serve our
shareholders, that the answer is probably
no because any potential deal that came
to the table would be undervalued, based
on where the stocks generally in the sub-
prime sector, as well as the potential
that the company has. So probably not,
in answer to your question.
* * *
Mr. Chisick: Operations and management. First
Alliance is very blessed and very
fortunate to have some of the most
experienced managers in the industry.
And just to give you an idea, the head of
our loan service department has been with
the company 20 years. A lot of the
operational management team, I think
average 20 years in the industry, and a
high percentage of that 20 years is with
First Alliance Mortgage Company. So
we've been there, done that gone through
many economic cycles. There's nothing
out there that can really shock us.
* * *
"First Alliance's stock is trading in the
$21 range, and everyone believes, the
analysts believe that it will be in the
$30 range by the end of the year."
Chisick, First Alliance Corp.
* * *
Mr. Mason: Just to continue Brian's thought, since
we went public last year, he and I have
spent about, cumulatively, a month, on
the road, at different times, speaking
with analysts, media, such as yourself,
investors, both current and potential
- 18 -
investors, attempting to differentiate
First Alliance. I think that Brian and I
feel a little bad in that, with all of
that work, and all of those miles, it
doesn't seem like we've had the impact
that we had hoped, with respect to First
Alliance in particular.
I think that the record speaks for itself
in terms of the business decisions and
the strategy, and how well the company
has executed that strategy to date. I
think it's an excellent record. Many
companies today continue to dilute their
shareholders because of the business
plans that they have selected. First
Alliance, instead is buying back its own
stock. And I think that is the strongest,
statement that we can make today.
* * *
"We have an excellent franchise. We are
enjoying continuing growth and continued
profitability." -- Chisick, First
Alliance Corp.
* * *
TWST: What case would you make for your
company, versus the competition, and I
guess, what do you see are your distinct
competitive advantages, particularly when
there are Wall Street conduits and
mortgage brokerage houses that are
perhaps competitors in some sense.
* * *
Mr. Chisick: We feel that we don't have competition.
As we mentioned, the competition that we
do have is internal, and that is our
ability to hire and train people. And
just to explain that we don't fish out of
the same pond as everyone else in the
sector. Everyone else in the sector goes
and buys loans from brokers, whereas we
target market to borrower, using
technology that we've developed over the
years to locate the type of sub-prime
borrower that we want to do business
with. We have a very efficient delivery
system, in terms of when the borrower
calls us, within one or two days the
property has been appraised, and the
prospects are in our office. And because
of our very highly efficient overall
- 19 -
sales systems, we actually sign long
documents on about 60 percent of the
folks that come into the office.
So, we're not over-concerned with
competition. The industry should be
concerned with competition, the wholesale
industry in that they all derive their
loans from the same conduit, which is the
brokers. We don't do that. We actually
deal direct. We find and deal directly
with the borrowers, with all the results
and advantages, such as controlling the
paperwork. The LTVs are lower. The
origination fees are higher, and the
resultant performance of our pools is
infinitely better than most of the other
folks, relative to delinquencies and loan
losses, as we talked about. Our loan
losses are negligible.
* * *
TWST: Do you feel that the current market price
reflects what you see as the stable,
long-term value for your stock, when
compared to the stock market in general,
but relative, secondly, to your peer
group.
Mr. Chisick: I think, if you will, that stocks in this
sector have been on a real slide for the
last three, four months, as a result of a
couple of companies in the automobile
sector, which you're undoubtedly aware of
accounting issues with the automobile
sector, and also, as far as the wholesale
lenders if you will. A lot of them are
doing tremendous volume, booking
tremendous gain, and while their
delinquency number and loss number are
low, the investors, I think do not feel
very comfortable with them.
More recently, unfortunately, some of the
wholesalers have some published figures
that were not as good as anticipated; a
little higher on delinquencies, a little
higher on losses, and as such, I think
the perception of the investor is kind of
a herd instinct perception, and they've
abandoned the sector en masse. And with
that said, we feel kind of put upon. Our
business is more solid than ever in terms
of the income is greater, the expansion
- 20 -
plan is going per plan, the delinquencies
and the losses are lower, and
unfortunately, we're all painted with the
same brush. So, in answer to your
questions specifically, I feel the stock
value, based on our plans and our
reality, is extremely underpriced at this
point, and I think that some of the
analysts are looking for a $30 figure
towards the end of this year.
Mr. Mason: Just to put it in numeric perspective,
today, First Alliance is priced at about
ten times the estimate for 1997 earnings.
Those earnings estimates are based upon
growth in excess of 30 percent in
earnings. So today, you can buy 30
percent growth for a ten multiple. I'd
say that was underpriced.
37. On 6/26/97, First Alliance announced it had agreed to
acquire Standard Pacific Savings, F.A. ("Standard Pacific") a
federally chartered thrift based in Newport Beach, California. The
press release stated:
Total value of the transaction will be in the range
of $10 to $11 million in cash, with the final value to be
$575,000 in excess of the stockholders' equity of
Standard Pacific at the date of acquisition.
* * *
"This is an exciting opportunity for First
Alliance," said Brian Chisick, chairman and chief
executive officer. "The funding flexibility, cost
advantages and other product possibilities that come with
this institution give us a competitive edge in our
marketplace. We have developed a real estate secured
credit card product, and this acquisition will give the
company the opportunity to issue that product and
others."
38. On 7/3/97, First Alliance announced a collaborative
arrangement with Mego Mortgage Corporation whereby Mego Mortgage
would assist First Alliance in originating high Loan-to-Value
("LTV") loans through First Alliance's domestic retail channels.
The release stated:
- 21 -
Under the collaborative arrangement, First Alliance
will originate loan products, up to 125% LTV, according
to Mego Mortgage's underwriting guidelines. In pursuit
of these efforts, Mego Mortgage will provide
comprehensive training to First Alliance's respected sub-
prime retail origination channels. Loans originated
under this agreement will be sold, servicing release, to
Mego Mortgage.
Brian Chisick, President and Chief Executive Officer
of First Alliance, commented, "This arrangement with Mego
Mortgage creates an important new incremental business
opportunity for First Alliance. Through our targeted
marketing programs, we attract a number of high credit
quality customers who do not fit our LTV criteria. We
are therefore delighted to have Mego Mortgage as an
established partner to help us commence a High LTV loan
program."
39. The positive statements made by defendants between
4/24/97-7/3/97 were each false and misleading when made and also
failed to disclose the following material adverse conditions
adversely affecting First Alliance's business, set forth below:
(a) First Alliance's illicit practices of hiding its
unconscionable fees from borrowers by increasing the loan amounts
was having an increasingly negative effect on its ability to sign
up new borrowers and was causing the defection of large numbers of
employees;
(b) First Alliance was being adversely affected by
increasing restrictions in the United Kingdom which would curtail
the Company's success there;
(c) Prepayments were increasing at an alarming rate
which would adversely affect the Company's future results which
First Alliance was concealing by using out-of-date and unreasonable
assumptions regarding prepayments in the calculation of its gains;
- 22 -
(d) The Company was concerned about competition which
was one of the reasons prepayments were increasing which the
Company concealed from the market;
(e) Many of the Company's borrowers were not less
creditworthy people willing to pay higher fees but were in fact
people with good credit who were tricked into paying unreasonable
and unconscionable origination fees by the Company's deceptive
sales practices and as a result of these practices the Company
would be facing increasing complaints, lawsuits and adverse
publicity in the future; and
(f) As a result of the foregoing, the forecast that
First Alliance would achieve 1998 EPS of $1.83 and 30% growth
rates, were known by the defendants to be false when made.
40. On 7/22/97, First Alliance announced the opening of a new
retail branch office in Croydon, England. The press release
stated:
"The U.K. market has been an outstanding success for
First Alliance since we opened our first retail branch
there in August 1996," commented Brian Chisick, president
and chief executive officer of First Alliance. "First
Alliance has opened a total of four retail branch offices
in the U.K., with the three newest offices opening in the
last six months. This strategic expansion is driving our
penetration of the exciting U.K. marketplace."
41. On 7/24/97, First Alliance reported 2ndQ 97 results,
including net income of $7.9 million or $.35 per share. The press
release stated:
The increase in net income for the second quarter of
1997 was primarily the result of increased loan
originations and purchases, as well as higher net
interest income earned on the Company's loans hold for
sale and residual interests in securitizations.
"We are very pleased with our second quarter
results," said Brian Chisick, president and chief
- 23 -
executive officer. "Our profit margins continue to
improve as well. Increasing economies of scale and
centralized operations produced a pre-tax margin of 57%
of revenues, up from 55% in the second quarter of 1996."
"This profitability is further distinguished by our
cash flow. During the quarter we generated $5.8 million
of cash, which we used to fund loans held for sale and to
repurchase First Alliance stock. Our cash flow and
liquidity reduces the need for dilutive capital-raising
and dependence on credit facilities to fund working
capital. This gives First Alliance excellent earnings
quality."
* * *
Also in the second quarter First Alliance
Corporation and Mego Mortgage Corporation announced a
high loan-to-value ("LTV") alliance. Under this
arrangement, First Alliance will originate loan products
for purposes of debt consolidation and/or home
improvement at up to 125% LTV, according to Mego
Mortgage's underwriting guidelines. Loans originated
under this agreement will be sold, servicing released, to
Mego Mortgage.
Mr. Chisick commented, "This arrangement with Mego
Mortgage allows First Alliance to further capitalize on
its existing marketing. Our marketing programs attract
a number of high credit quality customers who do not fit
our low LTV criteria. We are therefore delighted to have
Mego Mortgage as an established partner to help us
commence a high LTV loan program."
42. Subsequent to the release of its 2ndQ 97 results, First
Alliance spoke to securities analysts, money and portfolio
managers, brokers and stock traders to discuss First Alliance's
business and its prospects. During the conversations, B. Chisick
(the CEO) and Mason (the CFO) made presentations and answered
questions. During the call -- and in follow-up conversations with
participants -- they directly disseminated important information to
the market by stating:
* First Alliance continued to enjoy solid growth and income
from gains on the sale of loans was becoming more
significant.
- 24 -
* First Alliance had began originating high LTV loans which
would greatly expand its pool of borrowers and potential
for growth.
* The United Kingdom market was being successfully
exploited and would lead to favorable results in the
future.
* First Alliance's origination of higher LTV loans would
not adversely affect the Company as it would sell loans
on a whole loan basis, diminishing the adverse affects on
its margins.
* The Company's growth was on target to achieve 1998 EPS of
$1.87+.
43. On 7/25/97, Prudential issued a report on First Alliance
written by Scutti, which was based on and repeated information
provided to Scutti in conversations with B. Chisick and Mason on or
about 7/24/97. The report forecast 1997 and 1998 EPS of $1.47 and
$1.87, respectively, and the following quarterly F98 EPS:
Q1 $ .43
Q2 $ .45
Q3 $ .48
Q4 $ .50
Year $1.87
The report also stated:
- Given the better-than-expected second-quarter earnings,
we are adjusting our full year estimate to $1.47 per
share to account for the upside surprise.
- We are also raising our 1998 estimate to $1.87 given
the potential for recent acquisition and new business
developments to add material growth.
- Total loan origination increased substantially, rising
9.1% sequentially and 43.1% year-over-year as retail
branch expansion broadened market presence.
- Operating margin expansion continued year-over-year as
the pretax and net margins rose to 56.9% and 34.1%
respectively.
- Credit-quality remained strong as delinquencies
declined to 4.1%, falling from 4.4% in the previous
quarter and 6.1% in the year-ago period.
- 25 -
- The acquisition of Standard Pacific Savings bank and
agreement to underwrite high LTV loans for Mego mortgage
offers additional growth opportunities.
- Given the revised earnings estimates and solid growth
opportunities, we have raised our price target to $25
from $22 per share.
* * *
Given the solid second-quarter earnings and the
potential for growth to remain strong through 1997 and
into 1998, we have raised our 1997 and 1998 earnings
estimates to [$1.47] and [$1.87], respectively, up from
$1.45 and [$1.83]. We have also raised our price target
on the stock to $25 from $22 owing to the revised
earnings estimates and the broader market performance,
which should support some additional estimates and the
broader market performance, which should support some
additional multiple expansion as we believe the stock
would be fairly valued at 12-13 times our 1998 estimates.
Furthermore, we believe that given the solid fundamental
outlook and the superior earnings quality, as the company
continues to be cash flow positive, earnings risk is low,
assuming the economy remains relatively strong. At
current valuation levels, we continue to believe upside
potential exists; we remain buyers of this stock.
* * *
Delinquency and charge-off rates continue to improve
from already low levels. Delinquency and charge-off
rates continued to fall both sequentially and year-over-
year. The total portfolio delinquency rate equaled 4.1%
for the quarter, down sequentially and year-over-year,
from 4.4% and 6.1%, respectively.
We continue to believe that delinquency levels at
First Alliance should remain low given the company's
stringent underwriting guidelines and collection efforts,
Furthermore, given the company's propensity to sell
higher risk loans servicing released, we anticipate that
First Alliance will continue to originate those loans
that fall outside the company's underwriting parameters,
but will sell them on a whole-loan basis, which will not
jeopardize credit quality.
We believe that the outlook for First Alliance
remains solid as loan growth remains robust as FACO opens
new retail branches, maintains positive cash flow, and
expands its product offerings. We believe that FACO is
positioned to continue to capitalize on demand for non-
conforming home equity loans both in the U.S and in the
U.K. As a result of its fundamental strength, retail
distribution, and conservative underwriting standards, we
- 26 -
believe the company can continue to grow earnings at a
25%-30% sustainable rate over the next few years. As a
result, we remain buyers of this stock with a $25 price
target.
44. On or about 7/28/97, Mason was interviewed by National
Mortgage News regarding new guidelines in the for lenders. Mason
stated the new guidelines were unlikely to diminish First Alliance's
prospects in the U.K. This was repeated to the market in an
article dated 7/28/97.
45. On 9/12/97, First Alliance filed a Prospectus and
Registration Statement with the SEC pursuant to a stock offering in
which the Brian and Sara Chisick Revocable Trust (of which B.
Chisick and S. Chisick are co-trustees) offered 4.425 million
shares plus 663,750 shares to cover over allotments. The
overallotments were exercised in full and the Chisicks received net
proceeds of $90.2 million from the sale of their shares. The
shares sold were Class B shares which immediately converted into
Class A shares upon their sale.
46. The Prospectus contained First Alliance's results for the
six months ended 6/30/97 including net income of $15.5 million or
$.70 per share. The Prospectus represented the following regarding
these results:
INTERIM UNAUDITED FINANCIAL INFORMATION -- In the
opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments
(consisting only of various normal accruals) necessary to
present fairly the Company's consolidated financial
condition, results of operations and cash flows. The
financial condition at June 30, 1997 is not necessarily
indicative of the financial condition to be expected at
December 31, 1997 and results of operations for the six
months ended June 30, 1997 are not necessarily indicative
of the results of operations to be expected for the year
December 31, 1997.
- 27 -
47. The Prospectus also represented the following:
HIGH LTV PROGRAM. In July 1997, the Company entered
into an agreement with Mego Mortgage Corporation ("Mego")
under which the Company will originate loan products
("High LTV Loans") according to Mego's underwriting
guidelines for purposes of debt consolidation and/or home
improvement at loan-to-value ratios ("LTVs") of up to
125%. The Company will sell such High LTV Loans on a
servicing released basis to Mego soon after funding. The
Company believes the origination and sale of High LTV
Loans, which would not otherwise satisfy the Company's
underwriting guidelines, will allow the Company to
realize additional revenues from leads already generated
by its marketing efforts.
* * *
LEGAL PROCEEDINGS
The Company is a party to various routine legal
proceedings arising out of the ordinary course of its
business. Management believes that none of these
actions, individually or in the aggregate, will have a
material adverse effect on the results of operations or
financial condition of the Company.
48. Subsequent to the secondary offering, First Alliance
spoke to M. Peckham of Bear Stearns regarding First Alliance's
business and its prospects. During the conversations, B. Chisick
(the CEO) and Mason (the CFO) made representations and answered
questions. They directly disseminated important information to the
market by stating:
* The maturation of the Company's new stores both in the
U.S. and U.K. would drive the Company's growth of 20%
over the next three years.
* Competition was not much of a factor as entry into the
retail market was difficult.
* The Company's credit card operations would be an
important area of growth going forward.
* The Company was on track to achieve EPS of $1.87 in 1998.
49. On 9/30/97, Bear Stearns issued a report on First
Alliance written by Peckham. This report was written after Peckham
- 28 -
had extensive discussions with B. Chisick and Mason and was based
on and repeated information provided Peckham by them. Subsequent
to the release of this report, First Alliance copied and
distributed it, thus adopting it as its own. The report forecast
1997 and 1998 EPS of $1.47 and $1.87, respectively, a 20% five-year
growth rate and the following 98 quarterly results:
EPS/1998
QTR.
1st: $ .42
2nd: $ .45
3rd: $ .48
4th: $ .52
Year: $1.87
The report also stated:
Given the higher profitability of retail originations
compared to the wholesale originations that predominate
among many of its pears and given the company's positive
cash flow compared to the negative cash flow of most of
its peers, it is not surprising that First Alliance
enjoys a premium valuation to the group. Indeed, among
its peers, only The Money Store, which is predominantly
retail and in addition has national name brand
recognition, has a higher P/E multiple than First
Alliance. At present, First Alliance is in only 16
states, four of them for less than one year. We believe
that the maturation of the company's existing branch
network, plus the addition of at least four offices per
year, should drive the company's earnings at an annual
compounded rate of at least 20% for the next three to
five years. Our EPS estimates are [1.47] for 1997 and
[$1.87] for 1998, an increase of 27%. We are
establishing a 6-month target price of $27, which implies.
a 1998 P/E multiple of 14.3, above that of its peers and
comparable to where The Money Store has typically traded.
Retail is more immune to competition than wholesale, so
we do not believe that First Alliance's earnings will be
subjected to the same sort of pressures as those of some
of its peers. In addition, with 3 retail offices still
ramping up and at least another 4 anticipated to open
within the next 12 months, we feel very comfortable with
our 1998 estimate. As First Alliance becomes better
known to investors and with the additional float from its
recent secondary offering of common stock, we believe
that First Alliance will even more firmly establish
itself near the top of its peer group.
* * *
- 29 -
[T]he company is in the process of rolling out a credit
card secured by home equity that, in effect, gives
existing customers a chance to increase their LTV. We
believe that this could be a very material source of
profit going forward. And . . . the company's marketing
efforts, though targeted, still turn up potential
borrowers who do not have enough equity to qualify for
one of First Alliance's core loan products. To take
advantage of such leads, the company has entered into an
agreement with Mego Mortgage, a company specializing in
high LTV loans, pursuant to which First Alliance
originates such loans to Mego Mortgage's specifications
and then sells the loans servicing-released to Mego
Mortgage. This generates both incremental profits and
incremental cash.
First Alliance's Accounting Is Conservative, In Our
View. Many of First Alliance's peers generate a very
significant portion of their earnings from non-cash gain-
on-sale revenue. Given First Alliance's unique retail
strategy, gain-on-sale represents only one-quarter of its
revenues, with origination fees accounting for one-half
and interest income and servicing fees making up the
remaining one-quarter. And as to the one-quarter that
comes from gain-on-sale, we believe that First Alliance
books the gains using assumptions that are more
conservative than average. The company uses "standard"
assumptions for losses and average life, but uses a
discount rate of 15%, above the average of about 12%.
50. The positive statements made by defendants between
7/22/97 and 9/30/97 were each false and misleading when made and
also failed to disclose the following material adverse conditions
adversely affecting First Alliance's business, set forth below:
(a) First Alliance's illicit practices of hiding its
unconscionable fees from borrowers by increasing the loan amounts
was having an increasingly negative effect on its ability to sign
up new borrowers and was causing the defection of large numbers of
employees;
(b) First Alliance was being adversely affected by
increasing restrictions in the United Kingdom which would curtail
the Company's success there;
- 30 -
(c) Prepayments were increasing at an alarming rate
which would adversely affect the Company's future results which
First Alliance was concealing by using out-of-date and unreasonable
assumptions regarding prepayments in the calculation of its gains;
(d) First Alliance was artificially inflating its
reported revenues, net income and EPS in the 2ndQ and the six
months ended 6/30/97 by improperly recognizing revenues and by
engaging in the artifices and manipulations detailed in ¶¶75-86
hereof;
(e) Many of the Company's borrowers were not less
creditworthy people willing to pay higher fees but were in fact
people with good credit who were tricked into paying unreasonable
and unconscionable origination fees by the Company's deceptive
sales practices and as a result of these practices the Company
would be facing increasing complaints, lawsuits and adverse
publicity in the future;
(f) The introduction of credit cards was not a
significant boost to First Alliance due to the high fees associated
with the cards which would impede their widespread acceptance;
(g) The introduction of higher LTV loans was subjecting
the Company to lower margins and increasing competition; and
(h) As a result of the foregoing, the forecast that
First Alliance would achieve 1998 EPS of $1.87 was known by the
defendants to be false when made.
51. On 10/22/97, First Alliance reported is 3rdQ 97 result
including net income of $8.2 million or $0.37 per share. The
release stated:
- 31 -
Net income for the quarter increased 40% over pro
forma not income of $5.8 million, or $0.26 per share, for
the third quarter of 1996.
* * *
The increase in net income for the third quarter of
1997 over the prior year was primarily the result of
increased loan originations and purchases, as well as
higher net interest income earned on the Company's loans
held for sale and residual interests in securitizations,
and a decrease in the Company's effective income tax
rate.
Commented Brian Chisick, president and chief
executive officer of First Alliance, "Our origination
growth from new retail branches continues to exceed our
expectations. During the quarter we opened now retail
branches to serve the metropolitan areas of Baltimore and
the southern portion of Greater London in the United
Kingdom. With these openings and our latest branch
opening in Minnesota, announced this morning, we have
opened nine new retail branches so far this year."
"We are also pleased with our progress during the
quarter in increasing the liquidity of First Alliance
shares," continued Chisick.
"The stock split, combined with the secondary
offering of 3.9 million shares of previously privately
held stock that was completed in September, significantly
increased shares available for trading. Additionally,
Bear, Stearns & Co. Inc. and Montgomery Securities, who
acted as co-managers of the secondary offering, have
initiated analyst coverage on the Company and have begun
making a market in the Company's Class A Common Stock."
Loan originations and purchases in the quarter
increased 86% to $147.2 million compared to $79.1 million
in the third quarter of 1996. Retail loan originations.
increased 37% to $101.5 million from $74.1 million in the
third quarter of 1996. For the first nine months,
originations and purchases increased 56% to $367.3
million and retail originations increased 35% to $283.1
million.
The increase in retail loan originations was
primarily the result of the Company's continuing retail
branch expansion.
The increase in wholesale purchases and sales is the
combined result of (i) increased premiums available in
the market which has allowed the company to increase its
purchase and resale of wholesale loans, and
(ii) initiation in the third quarter of a strategy to
- 32 -
purchase loan to value loans located near the Company's
retail branch offices for the purpose of marketing to
these homeowners for additional borrowing needs.
52. Subsequent to the release of its 3rdQ 97 results, First
Alliance spoke to securities analysts, money and portfolio
managers, brokers and stock traders to discuss First Alliance's
business and its prospects. B. Chisick (the CEO) and Mason (the
CFO) made representations and answered questions. In the
conversations they directly disseminated important information to
the market by stating:
* The Company's fundamentals were solid and the Company's
expansion and growth in offices would lead to continued
growth in revenues and earnings in 1998 and beyond.
* Delinquencies were up modestly but the introduction of
higher LTV products was succeeding.
* Operations in the U.K. were generating a very positive
response.
* The Company's stock was undervalued, and considering its
hidden earnings power due to First Alliance's accounting,
the company would have favorable results in the future.
* The Company was on track to earn $1.87 in 1998.
53. On 10/23/97, Prudential issued a report on First Alliance
written by Scutti. This report was written after Scutti had
extensive discussions with B. Chisick and Mason and was based on
and repeated information provided Scutti by them. Subsequent to
the release of this report First Alliance copied and distributed
it, thus adopting it as its own. The report forecast 1997 and 1998
EPS of $1.47 and $1.87, respectively and the following 1998
quarterly results:
- 33 -
QTR. EPS/1998
1st: $ .43
2nd: $ .45
3rd: $ .48
4th: $ .50
Year: $1.87
The report also stated:
First Alliance reported third quarter earnings of
$0.37 per share, slightly ahead of our estimate; up 4.1%
sequentially and 40.4% year over year. The better-than-
expected third quarter earnings were driven by continued
strength in loan origination volume, which increased
28.2% sequentially and 86.0% year over year, to $147.2
million. Retail originations continued to serve as the
primary driver of total origination growth during the
quarter, increasing 10.1% sequentially and 37% year over
year to $101.5 million, and accounting for approximately
69% of total volume. Wholesale production advanced
significantly during the quarter, rising over 100%
sequentially to $45.7 million. The growth in wholesale
production was the result of (1) increased premiums
available in the market, and (2) the initiation of a
strategy to purchase low loan-to-value loans located near
retail branch offices.
* * *
Year-to-date, First Alliance has opened nine new
retail branches, four of which are in the U.K. Given
that the loans originated in the U.K. are being
warehoused pending the company's U.K. securitization,
which is anticipated in the first half of 1998, First
Alliance has not recognized roughly $1.4 million in net
loan origination fees, which will only be recognized as
income upon the sale of the related loans. We believe
that this unrecognized fee income could represent roughly
$0.05-$0.06 per share.
Overall, given the continued strength in the
underlying fundamentals at First Alliance, we believe the
potential for growth should remain strong through 1997
and into 1998. We believe that given the company's
positive cash flow, the solid loan origination growth and
the manageable credit quality, the stock would be fairly
valued at 12-13 times our 1998 estimate. At current
levels, we believe additional upside opportunity exists.
* * *
We believe that the delinquency levels at First Alliance
should remain low given the company's stringent
underwriting guidelines and aggressive collection
- 34 -
efforts. Furthermore, given the company's propensity to
sell higher risk loans with servicing released, we
anticipate that First Alliance will continue to originate
those loans that fall outside the company's underwriting
parameters, which should further enhance loan origination
fee income, without incurring the additional risk
exposure.
Overall, we believe that the outlook for First
Alliance is solid as loan growth remains robust, branch
expansion continues, and additional products are added.
We believe that First Alliance is positioned to continue
to capitalize on the growing demand for non-conforming
home equity loans, both in the United States and the U.K.
In addition, we believe that movement into the high-LTV
market, along with the introduction of its secured home
equity card, will allow the company to continue to
capitalize on cross selling opportunities and increase
market penetration. As a result, we believe that First
Alliance will be able to grow earnings at a 25%-30%
sustainable rate over the next few years. We remain
buyers of this stock with a $25 price target.
54. On 10/31/97, Bear Stearns issued a report on First
Alliance written by D. George. This report was written after
George had extensive discussions with B. Chisick and Mason and was
based on repeated information provided George by them. Subsequent
to the release of this report, First Alliance copied and
distributed it, thus adopting it as its own. The report forecast
1997 and 1998 EPS of $1.47 and $1.87, respectively, a 20% five-year
growth rate and the following 1998 quarterly results:
QTR. EPS/1998
1st: $ .42
2nd: $ .45
3rd: $ .48
4th: $ .52
Year: $1.87
The report also stated:
First Alliance reported 3Q97 EPS of $0.37 beating
the consensus number of $0.36, with strong origination
growth and stable credit quality. The company's unique
retail origination strategy should, in our view, continue
to produce positive cash flow and EPS growth of 20%-plus,
with predictable losses and predictable average lives in
- 35 -
its loan securitizations. Based on these favorable
attributes, the company currently trades at a premium P/E
to all of its peer group except for The Money Store. As
investors differentiate more and more among subprime
mortgage lenders, we believe that First Alliance will
continue to rate highly. Our target price is $27.
No surprises here. First Alliances's in-line
results were characterized by continued strong growth in
originations (86% year-over-year and 28% sequentially)
and stable credit quality. Delinquencies were up
modestly to 4.3% of the portfolio from 4.1% in 2Q97,
while annualized net losses were 30 basis points, flat
with the previous two quarters. The percentage of loans
originated at wholesale was higher than usual at about
30% (the balance coming from retail) as the company began
purchasing low loan-to-value loans near existing FACO
branches for the purpose of marketing to these homeowners
for future borrowings. We think this strategy makes
sense, inasmuch as it captures large pools of borrowers
with untapped equity (because the current LTVs are low),
and highlights the highly entrepreneurial and
opportunistic management style that has worked so well
for CEO Brian Chisick since he founded the company in
1971.
Branch Expansion Continues Apace. During the
quarter, First Alliance opened two new retail branch
offices, one in Baltimore and another in London, its
fourth U.K. office. And concurrent with the 3Q97
earnings release, FACO opened a branch office in
Minneapolis, its ninth branch opening so far in 1997 and
its 32nd officer overall. As we wrote in our previous
First Call, we expect branch expansion to continue, both
here and abroad, at a pace of about one new office per
quarter, which pace the company has surpassed handily so
far in 1997.
Hidden Earnings Power. While the company's results
for the quarter were very solid, they could have been
even better. The company originated about $25 million
more loans than it sold during the quarter, which loans
had accompanying net loan origination fees of
approximately $1.4 million, or about $0.04 per share.
Those originations fees (points) will be recognized in
income upon eventual securitization.
We Think First Alliance is Undervalued. We continue
to like First Alliance's annual growth prospects, and
believe that it can sustain compound annual growth in EPS
of at least 20% over the next three to five years.
First, the company is in only 17 states at present, so
that geographic expansion should be significant. Second,
the company has four offices in the United Kingdom, a
market that is relatively underreserved and that
- 36 -
therefore offers exciting prospects. Third, we expect
new products to be major drivers of growth; real-estate-
secured credit cards and high-LTV lending are two such
initiatives. If those products kick in faster than we
anticipate, then our $1.87 EPS estimate for 1998 should
prove to be low. Even based on such estimate, FACO
shares are trading at a P/E of 11.8, which is well under
our projected growth rate for the company. While such
multiple represents a premium to all subprime mortgage
lenders other than The Money Store, we believe that First
Alliance's retail focus and positive cash flow justify
such a premium. We also believe that such attributes
justify a stock price of at least $27 within the next 6
months.
55. In early 12/97, shares of specialty finance companies
fell due to concerns over the use of an accounting technique that
some charge inflates earnings projections. In response to
inquiries from the Dow Jones News Service, Mason was interviewed.
Dow Jones reported that:
Mark Mason, First Alliance's chief financial
officer, said he feels comfortable with the assumptions
his company makes when using gain-on-sale. First
Alliance has been conservative when making its
assumptions and has good cushion against performance not
being what the company expected.
56. In early 1998, concerns arose regarding prepayment rate
increases in the subprime lending market. B. Chisick was quoted in
the American Banker responding to this issue. The article stated:
When a First Alliance borrower wants to refinance
with another company, First Alliance turns over the loan
to its portfolio protection division, Mr. Chisick said.
The division tries "to give our customer a better deal
than they are being offered."
First Alliance loans are especially vulnerable to
refinancing because more than three-quarters are at
adjustable rates and the company's loans are for less of
the home's value than most of its competitors allow.
"We're a prime target for all of our competitors,"
Mr. Chisick said, "but we're still within our prepayment
estimations."
- 37 -
57. In early 1998, B. Chisick was interviewed by Mark Veverka
of The Wall Street Journal. After interviewing B. Chisick and
analysts covering First Alliance, Veverka wrote an article entitled
"First Alliance Appeals to Analysts." The article stated the
following:
First Alliance is an originator and seller of
"nonconventional," or subprime loans. That means that
most of its business comes from providing home-equity
loans to borrowers who usually don't qualify for similar
loans from banks. The company makes money by receiving
fees from originating the loans, and then earns
additional income on the back end by bundling the notes
and selling them in the secondary market as securities.
The company, founded by Chairman and Chief Executive
Brian Chisick 25 years ago in Anaheim, began as a
mortgage broker that sold loans to private investors.
But that changed in the early 1990s with the advent of a
securities market for subprime loans.
Then two years ago, the subprime market caught fire.
Momentum investors -- those geared towards the short term
-- flocked to companies such as Los Angeles-based Aames
Financial, whose stock soared from a 52-week low of
around $11 to more than $40 in October 1996. However,
the industry suddenly came crashing down last year when
it became evident that some of these lenders had
projected higher profits on their books than the loans
would ultimately produce, according to Sutro's Mr.
Abrahams.
* * *
Yet these profit projections, according to analysts
and industry executives, have often gone awry. The
reason: some companies have been overly optimistic as to
how long loans will actually remain outstanding and, in
turn, how long they'll be able to generate certain
service fees from them.
So what makes First Alliance different?
For one thing, the company originates most of its
loans in-house through a network of 33 branch offices,
rather than relying heavily on independent brokers, as
many of its competitors do. The result is that First
Alliance tends to make more money on origination fees
than do its rivals.
- 38 -
In addition, the independent brokers often try to
"churn" new business for themselves by going back to
their customers and getting them to refinance their loans
with other companies. Because of its strong retail
network, First Alliance doesn't have this problem.
* * *
The upshot: With about 50% of its profits coming
from loan-origination fees and about 25% of its earnings
generated from interest income, First Alliance hasn't
been compelled to use unrealistic gain-on-sale
projections to prop up its earnings. In fact, First
Alliance says that only 20% of its earnings are dependent
on gain-on-sale assumptions.
* * *
For his part, Mr. Chisick has similar expectations.
"As long as we arrange conservative loans and stick to
our guns," he says, "we'll always do well."
58. On 1/16/98, Chisick was quoted in an article in the
American Banker questioning how First Alliance would respond to
competitive threats from Countrywide Credit Industries. The
article stated:
"Countrywide is mainly wholesale," he said. "They
do loans through brokers; we don't compete with them in
that sense."
Mr. Chisick said he is not worried about
Countrywide's retail initiatives, either. "They don't
have knowledge that we have," he said.
First Alliance targets potential borrowers through
direct mail and then presells loans by phone. "Will we
do less business?" he asked. "No, we'll do more. We'll
open more branches and do more direct mailings."
59. On 1/23/98, First Alliance reported its results for 4thQ
97 and year ended 12/31/97, including 4thQ net income of $9.0
million or $0.42 per share. The press release stated:
Commented Brian Chisick, president and chief
executive officer of First Alliance: "Our progress this
year has been very gratifying. In 1997, our
accomplishments included the following":
-- 10 new retail branch offices were opened in the
United States and the United Kingdom, increasing
the retail branch network by 43%.
- 39 -
-- Loan originations and purchases grew 63% to $528.5
million and retail originations increased 37% to
$398.4 Million.
-- Pretax income grew to 55% or revenues while the
Company made substantial investments in new
products and branch openings.
-- Loan delinquencies and losses remained low. Total
delinquencies decreased to 4.1% of the servicing
portfolio and loan losses decreased to 0.24% of the
average servicing portfolio for the year.
Additionally, real estate owned as a percent of the
ending servicing portfolio decreased to only 0.2%.
-- Positive cash flow allowed the Company to
repurchase $20.5 million of its outstanding shares.
-- A secondary offering of shares by shareholders
increased the total public ownership of the Company
to 49%.
"These achievements reflect the superior results
attainable from our retail strategy and the success of
our ongoing retail branch expansion. Additionally we are
pleased with the response by investors to the increase in
liquidity and market makers resulting from the secondary
offering."
60. On 1/27/98, four months after defendants sold $90 million
of their own shares, First Alliance announced an increase in its
share repurchase program. The release stated:
"We believe that shares of First Alliance currently
represent an excellent value, and present an opportunity
to significantly increase shareholder value through the
repurchase of our shares," said Brian Chisick, president
and chief executive officer.
61. Subsequent to the release of its 4thQ 97 results, First
Alliance spoke to securities analysts, money and portfolio
managers, brokers and stock traders to discuss First Alliance's
business and its prospects. During the conversations, B. Chisick
(the CEO) and Mason (the CFO) made representations and answered
questions, and directly disseminated important information to the
market by stating:
- 40 -
* First Alliance had written up the value of its interest-
only strips which was an indication of its conservative
accounting for calculating its gain on sales.
* First Alliance used very conservative assumptions for
prepayment rates in calculating its gains.
* The problems in the 4thQ 97 were temporary and did not
impact the Company's future prospects.
* First Alliance continued to anticipate 20% annual growth
in EPS over the next three to five years with 1998 EPS of
$1.80-$1.87.
62. On 1/26/98, Bear Stearns issued a report on First
Alliance written by Peckham. This report was written after Peckham
had extensive discussions with B. Chisick and Mason and was based
on repeated information provided Peckham by them. Subsequent to
the release of this report, First Alliance copied and distributed
it, thus adopting it as their own. The report forecast 1998 EPS of
$1.80, a 20% five-year growth rate and the following 1998 quarterly
results:
QTR. EPS/1998
1st: $ .35
2nd: $ .45
3rd: $ .48
4th: $ .52
Year: $1.80
The report also stated:
In a tough equity market environment for--all
specialty finance company stocks, First Alliance shares
were down more than $2 Friday after the company reported
audited 4Q97 EPS of $0.42, beating the consensus number
of $0.39. The decline was apparently caused by concerns
about the operating results for the quarter, inasmuch as
the company benefited from a write-up in the value of its
residual/IO strips during the quarter due to better-than-
expected loan performance that contributed $0.09 to EPS.
Such an increase in the fair value of this asset (based
on what we think are very conservative prepayment
assumptions) comes at a time of downward adjustments in
the value of residuals/IOs at some other specialty
finance companies due to faster-than-expected
refinancings. Indeed, Green Tree Financial's
- 41 -
announcement in November that it would take a $125-$150
million charge to cover such refinancings shocked
investors and has contributed to the recent decline in
specialty finance company stock prices, including First
Alliance's (giving management the opportunity to
repurchase $12.8 million in stock during the quarter).
In light of this, we think the write-up is a powerful
statements about the conservation of FACO's gain-on-sale
(GOS) assumptions relative to actual performance of the
company's loan portfolio. Moreover, we were pleasantly
surprised by the decline in reported loan losses: down to
9 basis points from 30 basis points in the September
quarter. Loss levels, though likely to increase from
here, now more accurately reflect the better quality of
loans originated at retail; the lion's share of credit
losses over the past several quarters related to bulk
loan purchases in 1993 and 1994 that had substantially
run off by the end of 4Q97.
Notwithstanding these positive developments, EPS
would have fallen short of the $0.39 consensus number
without the $0.09 benefit from the write-up. During the
quarter, the company saw premiums on loans it sells in
the wholesale market decline compared to previous
quarters, as demand for subprime mortgages in the
secondary markets appears to have eased modestly. A
second factor relates to the higher prepayment assumption
used by FACO in its 4Q97 securitization; because the
company hiked its CPR assumption on adjustable rate
mortgages to 40% from 35%, the gain on sale margin
decreased. And as a result of marketing initiatives, the
company's originations in the quarter carried slightly
lower coupons than usual. But while we were disappointed
with the operating results for the quarter, we see a
number of positives for First Alliance in 1998, not the
least of which is 20% growth in EPS. Furthermore, we
regard FACO shares as very undervalued at just 7.4x our
1998 EPS estimates of $1.80. First Alliance boasts
strong positive cash flow, solid credit quality, a strong
balance sheet, predictable (domestic and international)
growth prospects and a successful niche retail lending
strategy developed over its 26-year history.
* * *
A Growth Story. We continue to like First
Alliance's growth prospects, and believe that it can
sustain compound annual growth in EPS of at least 20%
over the next three to five years. First, the company is
in only 17 states at present, so that geographic
expansion should be significant (new offices on Long
Island and in New Jersey are scheduled to open this
quarter). Second, the company has four offices in the
United Kingdom, a market that is relatively underserved
and that therefore offers exciting prospects. Third, a
- 42 -
growing portfolio of recently acquired low LTV loans
should Provide additional growth as First Alliance
refinances these new customers to higher LTV loans.
63. On 1/26/98, Prudential issued a report on First Alliance
written by Scutti. This report was written after Scutti had
extensive discussions with B. Chisick and Mason and was based an
repeated information provided Scutti by them. Subsequent to the
release of this report, First Alliance copied and distributed it,
thus adopting it as its own. The report forecast 1998 EPS of $1.87
and the following 1998 quarterly results:
QTR. EPS/1998
1st: $ .35
2nd: $ .52
3rd: $ .45
4th: $ .55
Year: $1.87
The report also stated:
-- Ten new offices were opened in 1997 to bring the
retail franchise to 33 offices; two additional offices
are expected to open in the first quarter.
-- Given geographic expansion and new product growth,
we have maintained our 1998 earnings estimate of $1.87
and initiated a preliminary 1999 estimate of $2.20 per
share.
-- Given the solid fundamentals and the positive cash
flow, we remain buyers of this stock with a 6-9 month
price target of $25 per share and a long term 12-18 month
price target of $37.
First Alliance reported fourth quarter earnings of
$0.42 per share, slightly ahead of our estimate and up
12.5% sequentially and 43.2% year over year. The better-
than-expected fourth quarter earnings included $0.09 per
share related to the asset write-up recorded during the
quarter. The write-up, which equaled $3.1 million pretax
($1.9 million after-tax) related to the fair value of
residual assets, as cash collections were higher than
originally estimated given favorable interest rates and
low loan losses. Going forward we believe the company
will periodically record similar write-ups, however, we
believe the size of the write-up will be significantly
smaller. The write-up reported in the fourth quarter
- 43 -
reflected an accumulation over several quarters as the
company had not recorded gains, whereas we believe the
company will report future asset write-ups more
frequently.
* * *
Despite the lower earnings, we have maintained our
1998 estimate and initiated a preliminary 1999 estimate
of $2.20 per share. We believe that the U.K operation
should contribute meaningfully to earnings in 1998 and
beyond, while new domestic products, including the low-
LTV (loan-to-value) production, should enhance loan
origination volume. In addition, the company currently
has roughly $30 million in U.K. loans held-for-sale on
its balance sheet. In conjunction with these loans,
First Alliance also has roughly $4 million in deferred
fee income. The company intends to securitize these
loans, however, it is uncertain as to whether the loans
will be included in the regular quarterly securitization,
or will have to be securitized separately. Given the
geographic disparity, we believe the company will have to
securitize these loans separately and will do so on a
semiannual basis in the second and fourth quarters of
1998. Through these securitizations, First Alliance will
realize additional gain on sale revenue.
* * *
Overall, the outlook for First Alliance remains
solid on heavy loan growth given ongoing branch
expansion new products offering and international
exposure. Although we are somewhat concerned as to the
narrower gains recorded on securitized loans and whole
loan sales, we believe the additional production
anticipated from the new products and the gains to be
recorded from the U.K. loan sales should offset any
weakness. As a result, given the company's growing
portfolio, solid credit quality and cash flow positive
results, we remain buyers of this stock.
64. The positive statements made by defendants from 10/22/97-
1/26/98 were each false and misleading when made and also failed to
disclose the following material adverse conditions adversely
affecting First Alliance's business, set forth below:
(a) First Alliance's illicit practices of hiding its
unconscionable fees from borrowers by increasing the loan amounts
was having an increasingly negative effect on its ability to sign
- 44 -
up new borrowers and was causing the defection of large numbers of
employees;
(b) First Alliance was being adversely affected by
increasing restrictions in the United Kingdom which would curtail
the Company's Success there;
(c) Prepayments were increasing at an alarming rate
which would adversely affect the Company's future results which
First Alliance was concealing by using out-of-date and unreasonable
assumptions regarding prepayments in the calculation of its gains;
(d) First Alliance was artificially inflating its
reported revenues, net income and EPS by improperly recognizing
revenues and by engaging in the artifices and manipulations
detailed in ¶¶75-86 hereof;
(e) Many of the Company's borrowers were not less
creditworthy people willing to pay higher fees but were in fact
people with good credit who were tricked into paying unreasonable
and unconscionable origination fees by the Company's deceptive
sales practices and as a result of these practices the Company
would be facing increasing complaints, lawsuits and adverse
publicity in the future; and
(f) As a result of the foregoing, the forecast that
First Alliance would achieve a 20% growth rate over the next three
to five years and 1998 EPS of $1.80-$1.87, were known by the
defendants to be false when made.
65. On 4/24/98, First Alliance announced its 1stQ 98 results
including net income of $0.35 per share. The release stated:
"We are pleased with results of the quarter,"
commented Brian Chisick, president and chief executive
officer of First Alliance. "Despite a decline in our
- 45 -
pre-tax margin associated with the retention of our
United Kingdom loan production and costs related to the
development of our real estate secured credit card
program, earnings per share increased as a result of our
share repurchase program. Compared to the first quarter
of 1997, loan originations and purchases grew 42%, and
retail originations grew 35% without any contribution
from the two new branches opened in the quarter in San
Diego, California and Howell, New Jersey."
66. Subsequent to the release of its 1stQ 98 results, First
Alliance spoke to securities analysts, money and portfolio
managers, brokers and stock traders to discuss First Alliance's
business and its prospects. B. Chisick (the CEO) and Mason (the
CFO) told the analysts the following:
* Loan originations remained healthy and new branch
openings continued on track.
* First Alliance would be securitizing U.K. loans in the
2ndQ 98 which would cause the results for that quarter to
be favorable.
* Due to the growing retail base, First Alliance was
positioned for substantial growth in 1998 and on into
1999 with 1998 EPS of $1.80-$1.82.
67. On 4/27/98, Prudential issued a report on First Alliance
written by Scutti. This report was written after Scutti had
extensive discussions with B. Chisick and Mason and was based on
repeated information provided Scutti by them. The report forecast
1998 and 1999 EPS of $1.82 and $2.15, respectively, and the
following 1998 quarterly results:
QTR. EPS/1998
1st: $ .35A
2nd: $ .50
3rd: $ .44
4th: $ .53
Year: $1.82
- 46 -
The report also stated:
-- New product offerings gained momentum as First
Alliance completed the test marketing of its secured
credit card.
-- During the quarter, the company repurchased
approximately 600,000 shares, and is authorized to
purchase an additional 1.6 million.
-- Given the in-line results for the quarter, we have
maintained our 1998 and 1999 estimates of $1.82 and $2.15
respectively.
-- Based on the solid fundamental outlook and the
company's positive cash flow, we have maintained our Buy
rating and $25 price target on the stock.
First Alliance reported first quarter earnings of
$0.35 per share, in-line with our estimate. While on a
year over year basis, earnings were only up modestly,
earnings for the first quarter of 1997 included a $0.02
per share gain related to the completion of a U.K.
securitization. Excluding the gain, earnings were up
9.4% year over year. Loan origination volume increased
41.9% as compared to the year-ago period, to $149.5
million owing to growth with the company's retail branch
network to 34 offices, two of which were opened during
the quarter. Also supporting loan origination growth,
wholesale production accelerated as a result of the gains
within the company's low-LTV (loan-to-value) program.
During the quarter, First Alliance continued to develop
new product opportunities as test marketing was completed
on its secured credit card program. Alliance repurchased
approximately 600,000 shares of stock during the quarter,
and has authorization to complete additional purchases of
up to 1.6 million shares.
Given the in-line first quarter earnings, we have
maintained our 1998 and 1999 estimates of $1.82 and $2.15
respectively. Overall, based on the company's growing
retail franchise, manageable credit quality and positive
cash flow, we believe First Alliance is positioned for
sustainable growth through 1998 and into 1999. As a
result we remain buyers with a $25 price target. Loan
growth remained strong given heightened activity within
both the wholesale and retail channels. Total loan
production equaled $149.5 million in the first quarter,
falling 7.3% sequentially on typical seasonality, but
increasing 41.9% year over year. Retail originations
continued to dominate total production, contributing
80.8%, as geographic expansion has fueled loan
origination growth.
- 47 -
68. On 4/28/98, Bear Stearns issued a report on First
Alliance written by Peckham. This report was written after Peckham
had extensive discussions with B. Chisick and Mason and was based
on repeated information provided Peckham by them. The report
forecast 1998 and 1999 EPS of $1.80 and $2.20, respectively, a 20%
five-year growth rate and the following 1998 quarterly results:
QTR. EPS/1998
1st: $ .35A
2nd: $ .48
3rd: $ .40
4th: $ .57
Year: $1.80
The report also stated:
First Alliance reported 1Q98 EPS of $0.35, which was
also the consensus number. That compares to $0.34 in
1Q97, but the comparison needs to be adjusted to be
meaningful, in our view. The year-ago number contained
$0.02 per share for a U.K. loan sale; were First Alliance
to have securitized during 1Q98 the $38 million of U.K.
loans on its books at March 31, 1998, the 1Q98 EPS would
have been at least $0.47, up 38% from 1Q97. These U.K.
loans, along with other more recent U.K. originations,
are expected to be securitized in 2Q98.
69. In early May 1998, the American Association of Retired
Persons ("AARP") filed a motion to join a lawsuit against the
Company.
70. Immediately following AARP's motion, on 5/13/98, First
Alliance abruptly announced the resignation of Mason.
71. First Alliance, on 5/18/98, issued a press release which
stated:
"We are shocked to learn of this motion. We stand on our
record of 25 years of service to homeowners who need
access to mortgage lending. Our borrowers, in many
cases, cannot obtain funds through traditional lenders
and depend on us as valuable financing resource."
- 48 -
72. The positive statements made by defendants from 4/24/98
to 5/98 were each false and misleading when made and also failed to
disclose the following material adverse conditions adversely
affecting First Alliance's business, set forth below:
(a) First Alliance's illicit practices of hiding its
unconscionable fees from borrowers by increasing the loan amounts
was having an increasingly negative effect on its ability to sign
up new borrowers and was causing the defection of large numbers of
employees;
(b) First Alliance was being adversely affected by
increasing restrictions in the U.K. which would curtail the
Company's success there;
(c) Prepayments were increasing at an alarming rate
which would adversely affect the Company's future results which
First Alliance was concealing by using out-of-date and unreasonable
assumptions regarding prepayments in the calculation of its gains;
(d) First Alliance was artificially inflating its
reported revenues, net income and EPS by improperly recognizing
revenues and by engaging in the artifices and manipulations
detailed in ¶¶75-86 hereof;
(e) Many of the Company's borrowers were not less
creditworthy people willing to pay higher fees but were in fact
people with good credit who were tricked into paying unreasonable
and unconscionable origination fees by the Company's deceptive
sales practices and as a result of these practices the Company
would be facing increasing complaints, lawsuits and adverse
publicity in the future; and
- 49 -
(f) As a result of the foregoing, the forecast that
First Alliance would achieve 1998 EPS of $1.80-$1.82, were known by
he defendants to be false when made because First Alliance's
reported earnings were being 'created only through falsification of
its financial results, and its actual business conditions as
outlined above were such that it was losing millions and therefore
could not possibly achieve the kind of earnings growth forecast.
73. Finally, on 5/27/98 First Alliance announced that its
earnings for 2ndQ 98 would be less than analysts' current
estimates. The release stated:
"Our retail loan production during the first 45 days
of the quarter has not met our expectations," commented
Brian Chisick, president and chief executive officer of
First Alliance. "While our retail production is expected
to be 10% to 20% below the prior quarter's results, we do
not expect this drop in production to be permanent."
"In addition, over the last two months we have
experienced a significant and unexpected increase in our
level of prepayments," continued Mr. Chisick. "This will
reduce the value of our second quarter securitization
residual and could result in a reduction of the value of
our current outstanding residuals. We are not aware of
any change in the market or our practices that would
cause us to believe that the current level of prepayments
will continue. However, consistent with our conservative
accounting practices, we will value our residuals using
the most recent higher prepayment experience."
Because of the reduced levels of loan production,
the Company also announced that the planned
securitization of loans originated in the United Kingdom
has been deferred. "To achieve a better execution on our
United Kingdom securitization, we have decided to defer
the securitization until later in the year. This will
allow the Company to securitize a greater volume of loans
as well as provide our underwriters more time to achieve
the most favorable pricing," commented Mr. Chisick.
74. First Alliance (B. Chisick) told analysts that prepayment
rates would be increased for variable-rate loans from 40% to 45%
and for fixed-rate loans from 25% to 30%. They also indicated that
- 50 -
they would be reevaluating the Company's interest-only strips to
determine whether a writedown would be necessary and indicated that
this analysis could ultimately result in a writedown of the
residual assets. This was only six months after the Company had
actually increased the value of the residual interest in the 4thQ
97. Analysts immediately cut their estimates from $1.80-$1.82 for
F98 EPS to $1.25-$1.28. Thus, contrary to the 20% net growth the
defendants represented to the markets First Alliance would achieve
in annual EPS growth, the Company's 1998 EPS will now be 17% lower
than it was in 1997. First Alliance's stock price dropped to as
low as $9-1/8, 61% below its Class Period high of $24-1/8 and still
trades in the $8-$9 range.
FIRST ALLIANCE'S FALSE FINANCIAL
REPORTING DURING THE CLASS PERIOD
75. In order to inflate the price of First Alliance's stock,
defendants caused the Company to falsely report its results for the
2ndQ, 3rdQ and 4thQ 97 and 1stQ 98 through the use of unjustifiable
assumptions to calculate its gain recognition on excess servicing
rights, thereby materially overstating its revenue, net income and
EPS in at least the last three quarters of 97 and first quarter of
1998. Ultimately, First Alliance revealed that its results for the
2ndQ 98 would be adversely affected due to changes in the
assumptions of prepayment rates First Alliance used to calculate
gain and to possibly write down its residual interests.
76. First Alliance reported the following amounts during the
Class Period:
- 51 -
6/30/97 9/30/97 12/31/97 3/31/98
Revenue $23.2M $23.4M $27.6M $25.4M
Net Income $ 7.9M $ 8.2M $ 9.0M $7.3M
EPS $ 0.35 $ 0.37 $ 0.42 $0.35
77. These 2ndQ, 3rdQ and 4thQ 97 and 1stQ 98 results were
included in Form 10-Q's filed with the SEC. The Form 10-Q's, which
were signed by B. Chisick and Mason represented that the
accompanying financial statements included "all adjustments
(consisting only of various normal adjustments) necessary to
present fairly the Company's consolidated financial position,
results of operations and cash flows." The 1997 results were
incorporated in the Company's Form 10-K for the year ended
12/31/97, which also represented that the results were presented in
conformity with Generally Accepted Accounting Principles ("GAAP").
78. These representations were false and misleading when
made, as First Alliance's financial statements for the 2ndQ, 3rdQ
and 4thQ 97 and 1stQ 98 were not a fair presentation of First
Alliance's results and were presented in violation of GAAP and SEC
rules.
79. GAAP are those principles recognized by the accounting
profession as the conventions, rules and procedures necessary to
define accepted accounting practice at a particular time. SEC
Regulation S-X (17 C.F.R. ¡ì210.4-01(a)(1)) states that financial
statements filed with the SEC which are not prepared in compliance
with GAAP are presumed to be misleading and inaccurate, despite
footnote or other disclosure. Regulation S-X requires that interim
financial statements must also comply with GAAP, with the exception
that interim financial statements need not include disclosure which
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would be duplicative of disclosures accompanying annual financial
statements. 17 C.F.R. ¡ì210.10-01(a).
80. The Individual Defendants caused First Alliance to
falsify its reported financial results through its improper gain
recognition on loan securitizations by understating its prepayment
assumptions. In fact, during 1997, First Alliance's prepayment
experience was increasing dramatically on its loans which would
result in lower cash payments to First Alliance in the future.
Nevertheless, in order to show favorable earnings, First Alliance
based its calculation of gains on the sale of servicing rights on
the assumption that prepayment rates were the same as they had
historically been. First Alliance knew this was not a reasonable
or fair assumption as it was well known in the home equity lending
industry that prepayment rates were skyrocketing during 1997.
81. GAAP, as set forth in FASB Statement of Concepts
("Concepts") No. 5, provides the basic requirements for revenue to
be recognizable: (1) revenue must have been earned; and (2) revenue
must be realizable (collectible). See concepts No. 5, ¶83. "If
collectibility . . . is doubtful, revenues and gains may be
recognized-on the basis of cash received." Concepts No. 5, ¶84g.
82. During the Class Period, First Alliance utilized a
prepayment assumption (called the constant prepayment rate or
"CPR") of 35%-40% for adjustable-rate loans and 25% for fixed-rate
loans. While these rates may have more closely reflected reality
in prior years, during the Class Period, they did not. During
1997, due to low unemployment, low interest rates and a favorable
economic outlook, prepayments accelerated industry wide.
Nonetheless, First Alliance did not adjust its assumptions used to
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calculate loans. As a result, the Company was able to report
favorable earnings during the Class Period. In fact, its gain as
a percentage of loans sold increased from 3.2% in 1996 to 4.7% in
1997.
83. Unfortunately for investors, these results, and the
representations concerning them, were false. Absent the Company's
improper accounting for revenues, First Alliance would have
reported materially lower EPS (at least 10% lower in each quarter
during 1997) and its gain on sales of loans would have been below
4%.
84. Ultimately, on 5/27/98, First Alliance announced that it
anticipated 2ndQ 98 results to fall below analyst expectations in
part due to increases in the Company's prepayment assumptions (from
25% to 30% for fixed-rate loans and from 40% to 45% for adjustable-
rate loans) and that Company may need to write down its residual
assets.
85. Due to these accounting improprieties, the Company
presented its financial results and statements in a manner which
violated GAAP, including the following fundamental accounting
principles:
(a) The principle that interim financial reporting
should be based upon the same accounting principles and practices
used to prepare annual financial statements (APB No. 28, ¶10) ;
(b) The principle that financial reporting should
provide information that is useful to present and potential
investors and creditors and other users in making rational
investment, credit and similar decisions was violated (FASB
Statement of Concepts No. 1, ¶34);
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(c) The principle that financial reporting should
provide information about the economic resources of an enterprise,
the claims to those resources, and effects of transactions, events
and circumstances that change resources and claims to those
resources was violated (FASB Statement of Concepts No. 1, ¶40) ;
(d) The principle that financial reporting should
provide information about how management of an enterprise has
discharged its stewardship responsibility to owners (stockholders)
for the use of enterprise resources entrusted to it was violated.
To the extent that management offers securities of the enterprise
to the public, it voluntarily accepts wider responsibilities for
accountability to prospective investors and to the public in
general (FASB Statement of Concepts No. 1, ¶50);
(e) The principle that financial reporting should
provide information about an enterprise's financial performance
during a period was violated. Investors and creditors often use
information about the past to help in assessing the prospects of an
enterprise. Thus, although investment and credit decisions reflect
investors' expectations about future enterprise performance, those
expectations are commonly based at least partly on evaluations of
past enterprise performance (FASB Statement of Concepts No. 1,
¶42);
(f) The principle that financial reporting should be
reliable in that it represents what it purports to represent was
violated. That information should be reliable as well as relevant
is a notion that is central to accounting (FASB Statement of
Concepts No. 2, ¶¶58-59);
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(g) The principle of completeness, which means that
nothing is left out of the information that may be necessary to
insure that it validly represents underlying events and conditions
was violated (FASB Statement of Concepts No. 2, ¶79) ; and
(h) The principle that conservatism be used as a prudent
reaction to uncertainty to try to ensure that uncertainties and
risks inherent in business situations are adequately considered was
violated. The best way to avoid injury to investors is to try to
ensure that what is reported represents what it purports to
represent (FASB Statement of Concepts No. 2, ¶¶95, 97).
86. Further, the undisclosed adverse information concealed by
defendants during the Class Period is the type of information
which, because of SEC regulations, regulations of the national
stock exchanges and customary business practice, is expected by
investors and securities analysts to be disclosed and is known by
corporate officials and their legal and financial advisors to be
the type of information which is expected to be and must be
disclosed.
CAUSE OF ACTION
Violation Of ¡ì¡ì25400 And 25500 Of The
California Corporations Code
(Against All Defendants)
87. Plaintiffs incorporate ¶¶1-86.
88. Acting individually and pursuant to a scheme and
conspiracy or aiding or abetting each other, defendants, directly
and indirectly, induced the purchase of First Alliance stock by
plaintiffs and members of the Class by circulating or
disseminating, in or from California, false information regarding
the prospects of First Alliance in order to artificially inflate
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the price of First Alliance stock. Defendants' wrongdoing included
the making of and/or participation in the making of untrue
statements, which were intended to induce purchases of First
Alliance common stock by plaintiffs and the Class, and which were,
at the time and in light of the circumstances under which they were
made, false or misleading with respect to material facts, or
omitted to state material facts necessary in order to make the
statements made, in light of the circumstances under which they
were made, not misleading, and which defendants knew or had
reasonable grounds to believe were false and misleading.
89. Plaintiffs and the members of the Class purchased First
Alliance stock at prices which were affected by defendants,
fraudulent scheme and sustained substantial damages as a result of
defendants' acts because, in reliance on the integrity of the
market, they paid artificially inflated prices for First Alliance
stock. Plaintiffs and the members of the Class would not have
purchased First Alliance stock at the prices they paid, or at all,
if they had been aware that the market price had been artificially
and falsely inflated by defendants' misleading statements and
concealments. At the time of the purchases of First Alliance stock
by plaintiffs and the members of the Class, the fair market value
of said stock was substantially less than the prices paid by them.
90. By reason of the foregoing, defendants violated ¡ì25400 of
the Cal. Corp. Code, thereby entitling the members of the Class to
recover damages pursuant to ¡ì25500.
BASIS OF ALLEGATIONS
91. Plaintiffs have alleged the foregoing based upon the
investigation of their counsel, which investigation included a
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review of First Alliance's SEC filings, securities analysts,
reports and advisories about the Company, press releases issued by
the Company, and media reports about the Company and plaintiffs
believe that substantial evidentiary support will exist for the
allegations set forth herein after a reasonable opportunity for
discovery.
PRAYER FOR RELIEF
WHEREFORE, plaintiffs pray for judgment as follows:
1. Declaring this action to be a proper class action on
behalf of the Class defined herein;
2. Awarding plaintiffs and the members of the Class
compensatory damages;
3. Awarding plaintiffs and the members of the Class
pre-judgment and post-judgment interest, as well as reasonable
attorneys' fees, expert witness fees and other costs;
4. Awarding extraordinary, equitable and/or injunctive,
relief as permitted by law, equity and the appropriate state law
remedies; and
5. Awarding such other relief as this Court may deem just
and proper.
DATED: June 24, 1998
MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH
ALAN SCHULMAN
DARREN J. ROBBINS
/s/
________________________________
WILLIAM S. LERACH
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
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WOLF POPPER LLP
ROBERT C. FINKEL
845 Third Avenue
New York, NY 10022
Telephone: 212/759-4600
COHEN, MILSTEIN, HAUSFELD
& TOLL, P.L.L.C.
STEVEN J. TOLL
999 Third Avenue, Suite 3600
Seattle, WA 98104
Telephone: 206/521-0080
BERNSTEIN LIEBHARD & LIFSHITZ
SANDY A. LIEBHARD
274 Madison Avenue
New York, NY 10016
Telephone: 212/779-1414
Attorneys for Plaintiffs
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| Securities Class
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