Table Of ContentUNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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: Master Docket No. 1:05-md-01706-RO
In re DORAL FINANCIAL CORP. : (Civil Action No. 1:05-cv-04014-RO)
SECURITIES LITIGATION :
: ELECTRONICALLY FILED
:
CLASS ACTION
This document Relates To: :
:
CONSOLIDATED AMENDED
ALL ACTIONS. :
COMPLAINT FOR VIOLATION OF THE
:
FEDERAL SECURITIES LAWS
:
:
DEMAND FOR JURY TRIAL
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TABLE OF CONTENTS
Page
I. NATURE OF THE ACTION..............................................................................................1
II. JURISDICTION AND VENUE..........................................................................................9
III. PARTIES.............................................................................................................................9
IV. CLASS ACTION ALLEGATIONS..................................................................................13
V. SUBSTANTIVE ALLEGATIONS...................................................................................14
A. The Company and Its Business..............................................................................14
B. Doral “Sells” Its Pool of Mortgage Loans and Books a Gain on the “Sale”
of the Loans Generating Hundreds of Millions of Dollars of Phantom
Income....................................................................................................................15
1. Doral Falsely Represents that It Sold Its Mortgage Loans........................15
2. Doral Artificially Inflates the Value of Its IO Strips by
Manipulating Key Accounting Assumptions and Third Party
Valuations..................................................................................................19
C. The Restatement.....................................................................................................24
VI. MATERIALLY FALSE AND MISLEADING STATEMENTS ISSUED
DURING THE CLASS PERIOD......................................................................................26
A. Fiscal Year 2000....................................................................................................26
B. Fiscal Year 2001....................................................................................................36
C. Fiscal Year 2002....................................................................................................48
D. Fiscal Year 2003....................................................................................................60
E. Fiscal Year 2004....................................................................................................72
VII. ADDITIONAL SCIENTER ALLEGATIONS................................................................101
VIII. DORAL’S FINANCIAL REPORTING DURING THE CLASS PERIOD WAS
MATERIALLY FALSE AND MISLEADING AND VIOLATED GAAP....................106
A. Doral’s Admission that Its Financial Misstatements During the Class
Period Were Material...........................................................................................110
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Page
B. Doral’s Violations of GAAP................................................................................111
1. Misstated Mortgage Loan Transfers........................................................112
2. Misstated IO Strip Valuations..................................................................114
3. Misstated Derivative Instruments............................................................116
4. Misstated Investments..............................................................................116
5. Misstated Servicing Assets......................................................................116
6. Other Financial Misstatements................................................................118
7. Doral’s False and Misleading Reporting and Certifications of
Disclosure and Internal Controls.............................................................120
IX. PWC’S PARTICIPATION IN THE FRAUD.................................................................126
A. PwC’s Materially False and Misleading Statements During the Class
Period...................................................................................................................127
B. PwC Knew or Recklessly Disregarded that Doral’s Class Period Financial
Statements Were Materially Misstated................................................................132
C. PwC Knew or Recklessly Disregarded that Its “Audit” Report on Doral’s
2004 System of Internal Control over Financial Reporting Was Materially
Misstated..............................................................................................................134
D. PwC Knew or Recklessly Disregarded that Its “Audit” of Doral’s Class
Period Financial Statements Were Not Conducted in Accordance with
GAAS...................................................................................................................145
E. PwC’s Additional Scienter Allegations...............................................................152
X. LOSS CAUSATION/ECONOMIC LOSS......................................................................155
XI. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-
MARKET DOCTRINE...................................................................................................159
XII. NO SAFE HARBOR.......................................................................................................160
COUNT I.........................................................................................................................161
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Page
For Violation of §10(b) of the Exchange Act and Rule 10b-
5 Against All Defendants.....................................................................................161
COUNT II........................................................................................................................162
For Violation of §20(a) of the 1934 Act
Against All Defendants........................................................................................162
XIII. PRAYER FOR RELIEF..................................................................................................162
XIV. JURY DEMAND.............................................................................................................162
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Lead Plaintiff West Virginia Investment Management Board (“Lead Plaintiff”) and Plaintiffs
Angel A. Burckhart and Administracion De Compensaciones Por Accidentes De Automoviles
(collectively with the Lead Plaintiff referred to herein as “Plaintiffs”) assert the following
allegations, except as to allegations specifically pertaining to Plaintiffs and Plaintiffs’ counsel, based
upon the investigation undertaken by Plaintiffs’ counsel, which included analysis of publicly
available news articles and reports, public filings, securities analysts’ reports and advisories about
Doral Financial Corporation (“Doral” or the “Company”), press releases and other public statements
issued by the Company, interviews with former employees of the Company and media reports about
the Company. Plaintiffs believe that substantial additional evidentiary support will exist for the
allegations set forth herein after a reasonable opportunity for discovery.
I. NATURE OF THE ACTION
1. This is a federal securities class action brought on behalf of purchasers of Doral
securities between March 15, 2000, to October 25, 2005, inclusive (the “Class Period”), seeking to
pursue remedies under the Securities Exchange Act of 1934 (the “Exchange Act”).
2. Defendant Doral is a diversified financial services company engaged in mortgage
banking, commercial banking, institutional broker-dealer activities and insurance agency activities.
The Company’s financial activities are principally conducted in Puerto Rico and the New York City
Metropolitan area.
3. This case concerns a massive accounting fraud perpetrated by Doral and the other
Defendants.1 As detailed herein, during the Class Period, Doral issued materially false and
misleading financial statements that violated the federal securities laws and Generally Accepted
1 The term “Defendants” does not refer to defendant PWC, unless otherwise indicated.
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Accounting Principles (“GAAP”) in order to overstate the Company’s pre-tax income by more than
$920.8 million and understate its debt by more than $3,3 billion. During the Class Period, Doral
purportedly sold more than $4 billion of fixed rate non-conforming mortgages to First BanCorp and
others. In connection with the “sales,” Doral retained a portion of the interest to be paid on the
mortgages – known as an interest-only strip (“IO Strips”) – and booked a gain on the sale of the
mortgages. Doral then valued its growing pool of IO Strips utilizing certain assumptions that it
represented were “sound” and based on an “independent” analysis. As a result of these purported
“sales,” during the Class Period, Doral’s reported income grew considerably and its pool of IO Strips
rose as well. Contrary to Defendants’ representations, however, Doral did not truly “sell” the
mortgages but instead was simply borrowing money which was collateralized by the mortgages.
Indeed, through side deals and oral agreements, Doral provided the “purchaser” with full recourse
rights that were far beyond the scope of the limited recourse rights provided for in the written
contracts between the parties, thereby rendering the transactions as loans. Furthermore, the
assumptions utilized by Doral to value its IO Strips were not “sound” or “independent” but rather
were manufactured by Defendants to conceal losses in the Company’s portfolio of IO Strips.
4. Doral has now admitted that its reported financial results for the past five years were
materially false and misleading when issued and has restated its financial statements for the five year
period ended December 31, 2004 (the “Restatement”). Furthermore, as detailed herein, Doral has
conducted a so-called independent investigation, which was performed by the Company’s outside
counsel, Latham & Watkins, LLP (the “Independent Investigation”), into its accounting issues. The
Independent Investigation’s publicly reported findings state that Doral’s senior management,
including Defendants S. Levis, M. Levis, Melendez and D. Levis, Sr. (as defined below) “took
inappropriate actions that resulted in transactions or accounts not being properly recorded in the
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Company’s financial statements for the years ended December 31, 2004, 2003 and 2002 and for each
of the quarters of 2004 and 2003.” In addition, the Independent Investigation found, among other
things that:
• Defendants D. Levis and Melendez participated in a scheme that succeeded
in concealing IO Strip losses of $400 million to $600 million by
manipulating key valuation factors used to determine such losses;
• Defendants S. Levis and Melendez were informed of material errors in IO
impairment valuations prepared for the fourth quarter 2004 prior to the
publication of Doral’s financial results for that period, but took no action to
investigate or correct the errors;
• Defendants M. Levis and D. Levis provided false information concerning
Doral’s mortgage loans and sales to certain third-parties who used the
information to prepare “ independent” IO valuations” that formed a basis
for Doral’s published financial statements;
• Defendants M. Levis and D. Levis entered into oral agreements with
respect to certain mortgage loan sales that provided for recourse beyond that
established in the associated written sales contracts resulting in Doral’s
reversal of more than $595 million in previously reported “gain on sale
income” and the failure to report more than $3.3 billion in additional
recourse liabilities and debt as of December 31, 2004; and
• Defendant M. Levis entered into side letters guaranteeing the yield on
certain assets “sales” resulting in the further material misstatement of Doral’s
earnings and equity.
5. Defendants’ fraudulent scheme started to come to light in January 2005. On January
18, 2005, Doral reported its financial results for the fourth quarter of 2004. Among other things, the
Company noted that it had taken an “impairment charge” of $97.5 million related to the valuation of
its IO Strips and that these losses had, in effect, been offset with a “windfall” tax benefit. Given
these circumstances, analysts started to raise questions about the timing of the charges and the value
of the Company’s IO Strips. On the next trading day, January 19, 2005, the price of Doral common
stock declined 11% to close at $42.02 per share (split adjusted) on volume of 9.5 million shares and
continued to decline over the next four trading sessions closing at $38.96 per share (split adjusted)
on January 25, 2005. In an analyst report issued at that time, analyst Jim Shanahan at Wachovia
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Capital Markets, LLC (“Wachovia”), noted that the market continues to be concerned about an
“impairment of IO securities, a full week after the Company reported Q4 results.”
6. Then, on March 15, 2005, the market’s concerns about the quality of Doral’s reported
earnings were confirmed when Doral filed its Form 10-K for the year ended December 31, 2004,
with the Securities and Exchange Commission (“SEC”). The Form 10-K purported to disclose the
assumptions used by Defendants to value Doral’s IO Strips during the fourth quarter of 2004. The
market immediately perceived a “disconnect” between the assumptions used by Defendants in
comparison to then existing market conditions. For example, that same day, Wachovia analyst J.
Shanahan, issued a report noting the “overly aggressive [IO valuation] assumptions” used by Doral
and downgrading Wachovia’s investment rating for Doral common stock to “Under-perform” and
lowering earnings estimates for 2005.
7. On March 16, 2005, in response to the disclosures in the Form 10-K, the price of
Doral common stock lost 20% of its value, closing at a split-adjusted price of $29.32 per share on
trading volume of 7.5 million shares. The stock continued to fall, declining to a split-adjusted price
of $20.62 per share on March 18, 2005 in extremely heavy volume of more than ten times the daily
average.
8. Defendants attempted to stem the decline in the price of Doral common stock. On
March 17, 2005, Defendants held a conference call with analysts and investors to discuss the issues
raised concerning the valuation of Doral’s IO Strips, among other issues. During that call,
Defendant M. Levis falsely represented that the Company’s IO Strip valuation assumptions were
“sound” and based on the performance characteristics of the underlying loan portfolios. Similarly,
on March 18, 2005, Doral issued a press release entitled “Doral Financial Corporation Addresses
Unusual Market Activity.” The press release stated in pertinent part as follows:
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Mr. Salomon Levis, Chairman of the Board and Chief Executive Officer of Doral
Financial Corporation, a diversified financial services company, announced today
that the Company knows of no relevant events or material information causing the
unusual activity in the Company’s common stock on the New York Exchange other
than the recent downgrade of its common stock by certain analysts. Sandard [sic] &
Poor’s had also changed the Company’s credit outlook to negative from stable when
it reaffirmed the Company’s investment grade credit rating.
The Chairman noted that the Company held an investor call yesterday during which
management reiterated that the fundamentals of the Company such as loan
originations and fee income remained strong and that the Company was anticipating
record mortgage production, record commercial loans and record insurance fee
income for the first quarter of 2005. He encouraged investors that had not
participated in the call to hear the recorded version.
9. Despite Defendants’ efforts to conceal the full scope of their fraud, the market was
starting to appreciate the magnitude of Doral’s accounting machinations. On April 14, 2006, Merrill
Lynch & Co. analyst Kenneth Bruce downgraded Doral common stock to “Sell” from “Neutral” and
noted that if Doral were to value its IO securities more conservatively, it might write down its
portfolio by as much as $600 million, or $4 per share. The report also noted “the potential for an
accounting restatement, further [IO] impairment and the corresponding impact that either would
have on the company’s earnings model.” In response to this report, on April 14-15, the price of
Doral common stock continued to decline closing at a split-adjusted share price of $16.28.
10. On April 19, 2005, Doral issued a press release announcing that it would “correct” the
valuation methodology used to calculate the value of its IO Strips and that the Company’s estimate
was that this would result in a decrease in fair value of between $400 million to $600 million. The
Company also reported that its published financial statements for the past years “should no longer be
relied upon” and it would be restating its financial statements for the periods from January 1, 2000
through December 31, 2004.
11. That same day, the SEC informed Doral that it was initiating an inquiry into Doral’s
accounting and disclosure practices concerning its restatement announcement. The SEC
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investigation became a “formal” investigation in October 2005 and, as of this filing, the SEC
continues to actively investigated Doral.
12. Over the next several days, the price of Doral common stock declined to a split-
adjusted trading price below $15.00 per share, closing at $14.94 per share on or about April 25,
2005.
13. Following the announcement of the restatement, Doral’s management initiated an
internal review of the Company’s books, records and accounting practices, under the oversight of the
Audit Committee and with the assistance of outside consultants. According to Doral’s public filings,
this internal review “extended beyond issues surrounding the valuation of Doral Financial’s portfolio
of floating rate IOs.”
14. During this time, in addition to Doral’s internal review, the Independent Investigation
by Doral’s outside counsel was initiated and the accounting firm of Ernst & Young LLP was
engaged to assist with the investigation. On or about August 17, 2005, Doral’s Board of Directors
met to review the results of the Independent Investigation “to-date,” and immediately thereafter
asked for the resignations of defendants S. Levis, M. Levis, D. Levis, and Meléndez. When
Meléndez refused to tender his resignation, he was terminated from his position at Doral.
15. On August 24, 2005, the U.S. Attorney’s Office for the Southern District of New
York served Doral with a grand jury subpoena seeking the production of certain documents relating
to issues arising from the restatement, including corporate, auditing and accounting records, as well
as financial statements, prepared during the period January 1, 2000, to the date of the subpoena.
According to the Doral’s recent public filings, the Company has produced some documents and
information in response to the subpoena.
16. On the last day of the Class Period, October 25, 2005, Doral issued a press release
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Description:On March 16, 2005, in response to the disclosures in the Form 10-K, the price of. Doral common .. Vicente and the Company's outside auditors also.
