united states district court middle district of...

UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF TENNESSEE

NASHVILLE DIVISION

CAROLYN LYNN, individually and on behalf of all others similarly situated,

Plaintiffs,

v.

ARTHUR F. HELF, H. LAMAR COX, MICHAEL R. SAPP, FRANK PEREZ,TENNESSEE COMMERCE BANCORP, INC. and KraftCPAs PLLC,

Case No. 3:12-CV-01137

Judge Aleta A. Trauger

Defendants.

SECOND AMENDED CLASS ACTION COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS

Case 3:12-cv-01137 Document 59 Filed 09/30/13 of 164 PageID #: 1365

TABLE OF CONTENTS

I. INTRODUCTION................................................................................................................. 4 II. SUMMARY OF THE ACTION ...........................................................................................5 III. JURISDICTION AND VENUE.......................................................................................... 12 IV. PARTIES............................................................................................................................. 12

A. Plaintiffs ...........................................................................................................................12 B. Defendants........................................................................................................................ 13 C. Control Person and Group Published Information Allegations........................................16 1. Additional Section 20(a) Allegations Concerning Defendant Sapp..............................20

2. Additional Section 20(a) Allegations Concerning Defendant Perez.............................25

3. Additional § 20(a) Allegations Concerning Defendant Helf......................................... 29

4. Additional Section 20(a) Allegations Concerning Defendant Cox............................... 32

V. PLAINTIFFS’ CLASS ACTION ALLEGATIONS ...........................................................35 VI. BACKGROUND SUPPORTING A STRONG INFERENCE OF SCIENTER.................37

A. TNCC’s History of Mismanagement, Self-Interest and Path to Failur............................38 B. Knowingly False And Misleading Statements During The Class Period ........................56

1. False Statements Concerning TNCC’s Operations In 2007.......................................... 56

a. Undisclosed Lack of Effective Underwriting and Loan Administration Controls. 60

b. Defective Controls Over Loss Mitigation............................................................... 62

c. Understatement of Risk and Character of Non-Core Deposits...............................62

2. False Statements Concerning TNCC’s Operations in 2008.......................................... 64

a. Undisclosed Lack of Effective Controls Over Loss Mitigation..............................65

b. Failure to Fully Disclose Risks Associated with Increased Loan Concentration ... 66

c. Failure to Fully Disclose the Amount and Risk Profile of Non-Core Deposits......67

3. False and Misleading Statements Concerning Operations in 2009............................... 68

a. Undisclosed Lack of Effective Loan Underwriting and Administration Controls. 70

b. The Materially Misstated Allowance for Loan and Lease Losses and Related

GAAPRules............................................................................................................ 73 c. Insufficient and Ineffective Controls Over Loss Mitigation...................................80

d. Undisclosed Regulatory Action..............................................................................81

4. False and Misleading Statements Concerning Fiscal Year 2010..................................82

a. Undisclosed Regulatory Activity and Results of Regulatory

Examinations........................................................................................................... 83 b. The Materially Understated ALLL ......................................................................... 87

c. The Undisclosed Lack of Internal Controls Over Loan Underwriting, Risky

Deposits and Loss Mitigation............................................................................................91 d. Insufficient Controls over Loss Mitigation and Risks Posed by Non-Core Deposits

................................................................................................................................. 95 5. Knowingly False and Misleading Statements Concerning Fiscal Year 2011 ...............96

a. Undisclosed Lack of Loan Underwriting and Portfolio Monitoring Controls........96

b. Undisclosed Lack of Compliance with Regulator Consent Order........................101

c. The Materially Misstated ALLL........................................................................... 103

d. The Restatement of TNCC’s Financial Results and the ALLL............................108

VII. KRAFT’S ROLE IN THE FRAUDULENT MISREPRESENTATION OF THE BANK’S FINANCIAL CONDITION ..............................................................................................111

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A. Overview of Applicable Accounting Standards............................................................. 113 B. Kraft’s Reckless Disregard of Red Flags .......................................................................114 1. Lack of Effective Loan Underwriting Standards ........................................................117 2. Failure to Recognize Credit Losses in Accord with GAAP........................................125 3. The Recklessly Unrestrained Growth in TNCC’s Loan Portfolio ..............................131 4. Lack of Effective Executive Oversight Over Credit Risk and Loss Mitigation..........135 5. Warnings by the FDIC and TDFI................................................................................ 141

VIII. LOSS CAUSATION.........................................................................................................146 IX. FRAUD-ON-THE-MARKET PRESUMPTION OF RELIANCE ...................................152 X. NO SAFE HARBOR......................................................................................................... 154 XI. CONTROL PERSON ALLEGATIONS UNDER § 20(a) OF THE EXCHANGE ACT 154 XII. CLAIMS............................................................................................................................ 156 XIII. PRAYER FOR RELIEF.................................................................................................... 161

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Lead Plaintiff Grand Slam Capital Master Fund, Ltd. and Plaintiff Carolyn Lynn

(collectively “Plaintiffs”), individually and on behalf of all others similarly situated (the “Class”

as defined herein), allege upon Plaintiffs’ personal knowledge as to their own acts, the

investigation made by and through their counsel, which includes, inter alia, a review of public

filings made by Tennessee Commerce Bancorp, Inc. (“TNCC” or the “Company”) with the

Securities and Exchange Commission (the “SEC”), reports of the Federal Deposit Insurance

Corporation (“FDIC”), Office of Inspector General, as well as teleconferences, press releases,

news articles, analysts’ reports, and media reports concerning the Company, and upon

information and belief as to all other matters, based upon the aforementioned investigation.

I. INTRODUCTION

1. This is a class action, brought on behalf of all investors, other than defendants,

who purchased TNCC common stock between April 18, 2008 through January 27, 2012,

inclusive (the “Class Period”), to recover damages caused by defendants’ violations of Sections

10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. § 78a,

et seq.

2. TNCC is operated as the bank holding company for Tennessee Commerce Bank

(“TCB” or the “Bank”), which—prior to being closed by the Tennessee Department of Financial

Institutions on January 27, 2012—offered various retail and commercial banking services to

small to medium-sized businesses, entrepreneurs, and professionals in the Nashville metropolitan

area, Tennessee. TNCC was founded in 2000 and is headquartered in Franklin, Tennessee.

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II. SUMMARY OF THE ACTION

The collapse of TNCC did not come about all at once. Instead, the failure of the

Company was the product of years of gross mismanagement, fraud and greed. Post-2007, the

Individual Defendants 1 knew that their conduct would lead to the Bank’s failure. Nevertheless,

the Individual Defendants continued their misconduct, fraudulently portraying the Bank as a

responsible and profitable lender and covering-up the overstatement of earnings (caused by the

understatement of loan losses), lack of internal controls, underwriting guidelines and credit

monitoring that was quickly leading TNCC to financial ruin. Had Plaintiffs and other investors

known of TNCC’s deteriorating financial and internal control condition, due in large part to the

reckless origination of over four hundred million dollars ($400.000,000) in often undocumented,

under-secured and recklessly risky loans during the Class Period, investors would have quickly

held the Individual Defendants and management to account. Therefore, in order to preserve their

exorbitant salaries, bonuses, perks and stock benefits, the Individual Defendants fraudulently

covered up, among other things; (a) the true state of the Bank’s loan portfolio and

understatement of loan losses, (b) the lack of effective internal controls at TNCC, (c) lack of

adherence to prudent underwriting guidelines, (d) violations of law, (e) millions of dollars in

loans to insiders and members of TNCC’s Board of Directors (“Board”), and (f) complete

absence of credit risk planning at the Bank.

1 Defendants Helf, Cox, Sapp and Perez are collectively referred to herein as the “Individual Defendants”. As described in greater detail infra, each of the Individual Defendants held a position of executive responsibility over the operations, financial reporting, internal controls and preparation and/or review of TNCC’s filings with the SEC and statements to the investing public.


4. When the truth could no longer be concealed from investors, and no further

restatement of TNCC’s fraudulent financial results could placate regulators, such as the FDIC

and the Tennessee Department of Financial Institutions (“TDFI”), the Bank was closed and it

was revealed that over $416 million or 47% of TNCC’s loan portfolio was completely

uncollectable .2 This stands in stark contrast to the public front that the Individual Defendants,

primarily Defendants Sapp and Perez who were the public voice of TNCC, portrayed to investors

as late as just a few months before the collapse of TNCC. Indeed, until the restatement of

TNCC’s financial results in November of 2011, investors were regularly assured by Defendants

Sapp and Perez that TNCC was a standout in the commercial lending space, immune to the type

of credit problems that had ruined other residential mortgage lenders in 2008 like Countrywide.

As late as just a few months prior to the restatement and the failure of the Bank, Defendant Sapp

was falsely reassuring investors that: “First and foremost, your management team is committed

to operating the bank in a safe and sound manner.” 3 Nothing could have been further from the

truth.

Beginning in 2008, Individual Defendants held the Bank out as an exception to

the economic downturn that had decimated the banking industry. The Individual Defendants

even claimed that TNCC would benefit from the decreased competition that would result from

the crisis. Thus, while more prudent banks were reigning in their lending, TNCC irresponsibly

2 As discussed herein, the Bank and Individual Defendants were joined in their fraudulent activities by its auditors KraftCPAs PLLC, which disregarded a number of serious and ongoing indications of persistent fraudulent activity in the conduct of TNCC, eventually leading to a withdrawal of Kraft’s 2010 audit report and a suggestion that previous reports would be withdrawn as well. Accordingly, Kraft is named herein as a primary violator of Section 10(b) of the Exchange Act

Tennessee Commerce Bancorp, Inc., Q1 2011 Earnings Call, Bloomberg Transcript (Apr. 29, 2011)

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ramped up its commercial lending business, acquiring, originating and/or underwriting over a

billion dollars’ worth of loans in the space of just three years. The truth, however, was when the

economic downturn finally hit TNCC’s business space—the transportation, warehousing,

commercial real estate (“CRE”) sectors—TNCC substantially suffered.

6. Even though the Bank was rapidly increasing its loan portfolio, TNCC and the

Individual Defendants knowingly and continuously failed to alert investors to material

deficiencies in the Bank’s internal controls and financial reporting. The serious indications of

ongoing and persistent fraud at TNCC included:

a. beginning in 2007 and continuing throughout the Class Period, TNCC’s

loan underwriting policies and guidelines were systematically disregarded,

not enforced or entirely set aside, resulting in $416.8 million or 42% of the

Bank’s outstanding loans in 2012 being wholly uncollectable,

b. internal controls were insufficient to either objectively or sufficiently

monitor and evaluate the Bank’s loan portfolio for degradation in loan

quality and credit risk, and

c. regulations and laws governing the prudent recognition and mitigation of

losses were routinely and systematically ignored and disregarded.

This ‘perfect storm’ of bank malfeasance and mismanagement led to unrestrained and imprudent

lending to less-than-credit-worthy borrowers, coupled with a failure to recognize, report or

recoup losses when they inevitably began to accumulate.

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7. None of these factors were ever fully or fairly disclosed to investors, who, instead,

were fraudulently told that the Bank’s creditworthiness was actually improving until late in 2011,

just prior to the FDIC closing the Bank.

8. Nonetheless, as late as April 29, 2011—months before the failure of the Bank ,

the Individual Defendants, such as Defendant Sapp, were reassuring investors that TNCC put

“financial soundness first” and that the Bank was committed to “ maintaining sounds

underwriting and portfolio management .” Tennessee Commerce Bancorp, Inc., Q1 2011

Earnings Call, Bloomberg Transcript (Apr. 29, 2011). These statements were blatantly and

knowingly false when made.

9. One of the most striking, knowing misstatements made and approved by the

Individual Defendants during the Class Period was their understated allowance for loan and lease

losses (the “ALLL”) that the Bank recognized for loans that were impaired or in danger of

default. Generally accepted accounting principles (“GAAP”), which are applicable to both

annual reports and interim financial statements such as quarterly reports, require that banks

evaluate loans, individually and collectively, for possible loss and recognize an accrued charge to

income for the dollar amount of probable contingent loss 4. For at least the last three (3) years of

the Bank’s operation (2009 to 2012), the ALLL was continuously and materially understated by

anywhere from $16 million to $416.8 million. Specifically, it is documented that, when the

4 As discussed in more detail herein, the recognition of loan and lease losses is governed by various GAAP rules, including FAS 5 and FAS 114. FAS 5 governs the collective evaluation of an entity’s loan portfolio for impairment. FAS 114 deals with the impairment of individual loans. Working together, FAS 5 and 114 required the Bank to individually evaluate of its loans and then determine the risk of default for each loan and group of loans, recognizing the expected losses in the ALLL.


Bank failed in January of 2012, approximately 42% or $416.8 million of the Bank’s $1.0 billion

in outstanding loans were estimated to be uncollectable by the FDIC. Inasmuch as the ALLL

represents an ‘estimate’ or ‘opinion’ on the quality of a bank’s assets, 5 neither the Bank, the

Individual Defendants, nor TNCC had any reasonable basis whatsoever for their ‘opinion’ that

the ALLL was sufficiently stated in 2009, 2010 or 2011 to alert investors to the fact that as much

as 42% of the Bank’s outstanding loans were uncollectible. Indeed, in August 12, 2011—the last

periodic financial statement filed with the SEC by TNCC before the Bank’s failure—the ALL

was a mere “$28 [million], or 2.44% of total loans.” 6 That ‘estimate’ is about $388.8 million or

39.46% short of the actual mark ,7 an unreasonable and unsupportable ‘opinion’ by any

reasonable or objective benchmark.

10. The driving factor behind the massive losses incurred by the Bank prior to its

closing was undisclosed lax, inoperative and unenforced underwriting and loan origination

controls. Despite repeated statements in each of its major SEC filings that the Bank had

sufficient and effective policies and internal controls over underwriting and loan origination,

those standards and controls actually were, for all intents and purposes, eliminated at some point

prior to 2008. Loans were made on ‘stated income’, without credit checks or appraisal of

collateral sufficient to adequately ascertain the risks posed by those loans.

5 In reality, as discussed herein the ALLL has an objective basis, reflecting losses that are both probable and reasonably estimable on loan and lease assets. See Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 5 (March 1975). 6 Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 10 (Aug. 12, 2011). 7 Even when forced to restate the ALLL, Defendants missed the mark by over $320 million; the restatement raised the horribly insufficient all from $28 million to just $83 million in November of 2011. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Nov. 1, 2011).

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11. In fact, during the Class Period, the FDIC noted during each of its examinations

that there were major deficiencies in the Bank’s underwriting standards. The most serious

violations included: (a) a $15 million dollar loan to a unnamed Director of TNCC, $7 million of

which was written off as a complete loss; (b) a lending relationship with a single party, identified

only as “Relationship A” that resulted in a $65 million dollar loan, of which at least $30.2

million was a complete loss; and (c) a significant portion of the Bank’s loans were underwritten

without regard to the loan-to-value (LTV) and without obtaining any documentation, including

credit reports or other financial information. Simply stated, Defendants failed to disclose to

investors that the Bank’s underwriting guidelines were completely abandoned during the Class

Period.

12. To exasperate the situation, the Individual Defendants failed to take affirmative

steps to timely recognize or mitigate losses. For example, much of the Bank’s loan portfolio was

heavily concentrated in the trucking and transportation industry. Accordingly, maintaining

adequate collateral controls would have protected the Bank against the risks of default. These

controls, however, were non-effective, and when haphazardly employed, often were untimely

and/or violated applicable law. The most serious failure was a reported finding by the FDIC that

the Bank was routinely holding repossession in excess of the 6-month period mandated by

Tennessee statute 8 .

8 See, FDIC, Office of Inspector General, Material Loss Review of Tennessee Commerce Bank, Franklin, Tennessee, Report No. AUD-12-014, at I-14 (Sept. 13, 2012) (“FDIC Inspector General’s Report”). (“Examiners noted that a significant portion of the bank’s repossessions were held in excess of the 6-month maximum period permitted under Tennessee law.”)

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13. The Individual Defendants were well-motivated to ensure that the public did not

understand or appreciate the level of mismanagement and deception. Throughout the Class

Period, the Individual Defendants were paid massive salaries and bonuses, received excessive

perks and were granted considerable stock options—all while driving the Bank towards its

ultimate failure. For example, in 2007 the Individual Defendants unilaterally more than doubled

their salaries, in violation of applicable rules governing the award of compensation for executive

officers. During the following three years, the Individual Defendants were paid millions of

dollars in additional compensation, as well as $1,000 per month for Company cars, country club

memberships and other perks. This was done in the face of a stunning lack of oversight over the

Bank’s operations and while the Individual Defendants both concealed and misrepresented the

Bank’s true financial position. In order to keep their benefits, the Individual Defendants

continued to completely conceal the true condition of the Bank, until they could no longer do so,

in late 2011. Indeed, even when regulatory examiners from the FDIC and TDFI threatened to

expose the deception through appropriate enforcement actions, Defendants attempted to

obfuscate and delay in order to preserve the artifice of the Bank’s success, as well as their

excessive compensation and other valuable benefits.

14. When the true condition of the Bank came to light, Plaintiffs and other members

of the Class were dealt massive losses. For example, a shareholder who purchased TNCC

common stock in May of 2010, for around $10.00, and held that stock until the Bank announced,

on January 20, 2012, that its financial statements for previous years should not be relied upon,

would have lost approximately 98% of their investment.

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15. By this action, Plaintiffs and the Class seek to recover damages against

Defendants for their violations of Sections 10(b) and 20(a) of the Exchange Act and SEC Rule

10b-5 promulgated thereunder by the SEC.

III. JURISDICTION AND VENUE

16. This Court has subject-matter jurisdiction pursuant to Section 27 of the Securities

Exchange Act of 1934, 15 U.S.C. § 78aa, and 28 U.S.C. §§ 1331 and 1337.

17. Venue is proper in this District pursuant to Section 27 of the Exchange Act, 15

U.S.C. § 78aa, and 28 U.S.C. § 1391(b). At all times relevant to this Complaint, TNCC’s

maintained its principal place of business in Williamson County at 381 Mallory Station Road,

Suite 207, Franklin, Tennessee 37067-8264. In addition, many of the acts and practices

complained of herein, including the drafting and distribution of fraudulent information

concerning TNCC and its operations, occurred primarily in the Middle District of Tennessee.

18. In connection with the acts alleged in this Complaint, defendants, directly or

indirectly, used the means and instrumentalities of interstate commerce, including, but not

limited to, the mails, interstate telephone communications and the facilities of the national

securities markets.

IV. PARTIES

A. PLAINTIFFS

19. Lead Plaintiff Grand Slam Capital Master Fund, Ltd. purchased the common

stock of TNCC at artificially and fraudulently inflated prices during the Class Period and, as set

forth more fully in the annexed certification, thereby suffered substantial economic damages.

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20. Plaintiff Carolyn Lynn purchased the common stock of TNCC at artificially and

fraudulently inflated prices during the Class Period and, as set forth more fully in the annexed

certification, thereby suffered economic damages.

B. DEFENDANTS

21. Defendant Tennessee Commerce Bancorp, Inc. is a bank holding company for its

single asset, Tennessee Commerce Bank, located at 381 Mallory Station Road, Suite 207,

Franklin, Tennessee, 37067. On January 27, 2012, the Tennessee Department of Financial

Institutions closed Tennessee Commerce Bank, appointing the Federal Deposit Insurance

Company as receiver. Upon the closing of the Bank, the Bank’s deposits were taken over by

Republic Bank & Trust Co. Prior to its closing, TCB operated as a nontraditional commercial

bank. Unlike many banks, the Bank did not conduct retail operations and did not have a network

of bank branches. Instead, TCB specialized in originating and underwriting many different types

of loans, mostly collateral-based, to small-to-medium sized businesses, entrepreneurs and

professionals within a 250 mile radius of Nashville, Tennessee.

22. KraftCPAs PLLC is a Tennessee public accounting and consulting firm, with its

principle place of business located at 555 Great Circle Road, Nashville, TN 37228. Kraft has

additional offices in Columbia and Lebanon, Tennessee and was founded in 1958. Kraft served

as the outside auditor for TNCC throughout the Class Period, rendering its first audit report for

the Company in 2006 and each year thereafter until the collapse of the bank in 2012.

23. Defendant Arthur F. Helf was a director of TNCC and the Bank from the date of

their inception in 2000 until the failure of the Bank in January of 2012. Defendant Helf also held

the office the Chairman of the TNCC Board and Chief Executive Officer (“CEO”) of TNCC and

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TCB from their founding in 2000 to his retirement on December 31, 2009. Following his

retirement as Chairman and CEO, Defendant Helf Continued to serve as a director of TNCC and

take part in the decision making processes at the Company. Prior to his retirement, Defendant

Helf held the position of Chairperson of the Company’s Executive Committee, which was

dissolved in 2009. Defendant Helf is a citizen of the State of Tennessee.

24. Defendant H. Lamar Cox was a director of TNCC and the Bank from the date of

their inception in 2000 until the failure of the Bank in January of 2012. Defendant Cox held the

position of Chief Operating Officer (“COO”) of TNCC and the Bank from December 2009 to

January 27, 2012, the date the bank failed. Previously Defendant Cox held the positions of Chief

Administrative Officer (“CAO”), responsible for operations and support functions, from 2005 to

2009. Prior to that, Defendant Cox was Chief Financial Officer (“CFO”) of TNCC and the Bank

from 2000 to 2005 and March 7, 2008 to August 18, 2008. As the proxy statement filed by

TNCC on April 19, 2011 states: “Mr. Cox's banking career brings in-depth knowledge of the

financial services industry and significant financial expertise to assist the board in overseeing the

management of the Corporation. He has over 35 years of banking experience in the areas of

finance, operations, retail banking, compliance and lending. Mr. Cox is a Certified Public

Accountant, licensed in Georgia and Tennessee and is a veteran of the United States Navy.”

TNCC, Proxy Statement (Schedule 14A), at 11 (Apr. 19, 2011) (the “April 2011 Proxy”). As the

Company’s COO, CAO and CFO, Defendant Cox held significant managerial influence over the

Company, the Bank and their operations, including those of day-to-day operations.

25. Defendant Michael R. Sapp was a director of TNCC and the Bank from the date

of their inception in 2000 until the failure of the Bank in January of 2012. Defendant Sapp

assumed the role of President and CEO of the Corporation and the Bank upon the resignation of

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Defendant Helf on December 31, 2009, a role which he held until the failure of the bank in

January of 2012. According to the April 2011 Proxy; Defendant “Sapp br[ought] strong and

broad financial services experience to the board as well as a deep understanding of the

Corporation's business and operations and the economic, social and regulatory environment in

which we operate. He has over 30 years of banking experience, with 25 years of such service in

Middle Tennessee. He was Division Manager/Senior Vice President, Equipment Finance

Division, at First American National Bank in Nashville for 13 years until 1997. Mr. Sapp began

his banking career in 1978 at BancOhio National Bank (now The PNC Financial Services Group,

Inc.) as a branch lending officer. He has been active in the Middle Tennessee Leadership

Council.” April 2011 Proxy at 5.

26. Defendant Frank Perez held the position of Chief Financial Officer of TNCC and

the Bank from July 31, 2008 through the failure of the Bank in January of 2012. As the April

2011 Proxy states: “Perez previously served as Chief Financial Officer of Cumberland Bank &

Trust from 2005 to 2008. He also served as an internal audit manager of Crowell & Crowell,

PLLC and a senior accountant of AIG American General.” April 2011 Proxy at 29.

27. Defendants Helf, Cox, Sapp and Perez are sometimes referred to herein as the

“Individual Defendants.” Because of the Individual Defendants’ positions as directors or senior

officers of the Company, each had access to the material adverse undisclosed information about

the Company’s business, operations, operational trends, financial statements, 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, communications and connections with other corporate officers and

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employees, attendance at management and/or Board of Directors meetings and committees

thereof and via reports and other information provided to them in connection therewith.

C. CONTROL PERSON AND GROUP PUBLISHED INFORMATION ALLEGATIONS

28. Section 20(a) of the Exchange Act states in pertinent part:

Every person who, directly or indirectly, controls any person liable under any provision of this title [15 USCS §§ 78a et seq.] or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable (including to the Commission in any action brought under paragraph (1) or (3) of section 21(d) [15 USCS § 78u(d)]), unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.

15 U.S.C. § 78t(a).

29. As alleged herein, the Individual Defendants are primarily liable for violations of

§ 10(b) of the Exchange Act for fraudulent statement made to investors concerning the lack of

effective internal controls and misstatement of the financial condition of TNCC during the Class

Period. Further, each of the Individual Defendants had the opportunity and/or ability to induce,

change, rescind or otherwise influence the public statements of TNCC and its employees.

30. At all times relevant to this complaint, Defendants Helf, Sapp and Cox were

members of the TNCC Board of Directors. As relevant filings indicated, the TNCC “board of

directors has the ultimate oversight responsibility for the risk management process.” See April

2011 Proxy at 11. Indeed, as TNCC’s April 2011 Proxy—TNCC’s last during the Class

Period—states more fully:

The board of directors is responsible for providing oversight of our risk management processes. The board oversees planning and

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responding to risks arising from changing business conditions. The board also is responsible for overseeing compliance with laws and regulations, responding to recommendations from supervisory authorities and overseeing management's conformance with internal policies and controls addressing the operations and risks of significant activities. Full board meetings regularly include reports on risk exposures as well as reporting on financial condition, credit risks, liquidity risks and other risk related matters inherent in our operation. Our senior risk officer and chief credit officer frequently provide reports at board meetings with respect to management's assessment of risk exposure and the controls in place to monitor those risks.

Id. As such, Defendants Helf, Sapp and Cox had the opportunity and ability to influence the

content of TNCC’s public statements and SEC filings, including the fraudulent statements

alleged herein. For instance, Defendants Helf, Sapp and Cox personally signed the annual

reports for fiscal years 2007, 2008, 2009 and 2010, each of which included fraudulent statements

concerning the internal controls and financial condition of TNCC. See Tennessee Commerce

Bancorp, Inc., Amendment No. 3 to Annual Report (Form 10-K/A), at 66 (June 1, 2011);

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at 44 (Mar. 9, 2010);


Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at F-29 (Apr. 18, 2008).

31. Similarly, since being appointed in August of 2008, Defendant Perez has held the

executive position of Chief Financial Officer at TNCC, with direct managerial responsibility

over the financial operations of the Company, which serve as the basis for this action. Defendant

Perez also personally signed each of the fraudulent annual reports for years 2009 and 2010, as

well as numerous other fraudulent SEC filings, including, but not limited to the fraudulent

Quarterly Report filed by TNCC on August 12, 2011. See Tennessee Commerce Bancorp, Inc.,

Amendment No. 3 to Annual Report (Form 10-K/A), at 66 (June 1, 2011); Tennessee Commerce

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Bancorp, Inc., Annual Report (Form 10-K), at 44 (Mar. 9, 2010); see also Tennessee Commerce

Bancorp, Inc., Quarterly Report (Form 10-Q), at 44 (Aug. 12, 2011).

32. It is appropriate to treat the Individual Defendants as a group for pleading

purposes and to presume that the false, misleading and incomplete information conveyed in the

TNCC’s public filings, press releases and other publications as alleged herein are the collective

actions of the narrowly defined group of defendants identified above. Each of them, by virtue of

their high-level executive positions with the Company and the Bank, directly participated in the

management of the Company and the Bank, was directly involved in the day-to-day operations

of the Company and the Bank at the highest levels and was privy to confidential proprietary

information concerning the Company and its business, operations, products, growth, financial

statements, and financial condition, as alleged herein. Each was involved in drafting, producing,

reviewing and/or disseminating the false and misleading statements and information alleged

herein, was aware, or recklessly disregarded, that the false and misleading statements were being

issued regarding the Company, and approved or ratified these statements, in violation of the

federal securities laws.

33. As officers, directors and/or controlling persons of a publicly held company

whose common stock was registered with the SEC pursuant to the Exchange Act, was traded on

the NASDAQ stock market, and was governed by the provisions of the federal securities laws,

each defendant had an affirmative duty to disseminate timely, accurate, and truthful information

with respect to the Company’s financial condition and performance, growth, operations, financial

statements, business, products, markets, management, earnings, and present and future business

prospects, and to correct any previously issued statements that became materially misleading or

untrue, so that the market price of the TNCC’s publicly-traded securities would be based upon

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truthful and accurate information. The Individual Defendants’ misrepresentations and omissions

during the Class Period violated these specific requirements and obligations.

34. The Individual Defendants participated in the drafting, preparation, or approval of

the various public and shareholder and investor reports and other communications complained of

herein and knew of, or recklessly disregarded, the misstatements contained therein and omissions

therefrom, and knew of (or recklessly disregarded) their materially false and misleading nature.

Because of their Board membership or executive and managerial positions with TNCC, each of

the Individual Defendants had access to the adverse undisclosed information about the

Company’s business prospects and financial condition and performance as particularized herein

and knew (or recklessly disregarded) that these adverse facts rendered the positive

representations, made by or about TMI and its business, issued or adopted by the Company,

materially false and misleading.

35. The Individual Defendants, because of their positions of control and authority as

officers or directors of TNCC and the Bank, were able to and did control the content of the

various SEC filings, press releases and other public statements pertaining to the Company during

the Class Period. Each Individual Defendant was provided with copies of the documents alleged

herein to be misleading prior to or shortly after their issuance or had the ability and/or

opportunity to prevent their issuance or cause them to be corrected.

36. Accordingly, each of the Individual Defendants is responsible for the accuracy of

the public reports and releases alleged herein and therefore primarily liable for the

representations contained therein.

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37. Each of the defendants is also liable as a participant in a fraudulent scheme and

course of business that operated as a fraud or deceit on purchasers of TNCC securities by

disseminating materially false and misleading statements and/or concealing material adverse

facts. The scheme, among other things, was designed to (a) deceive the investing public

regarding TNCC’s business, operations, and the intrinsic value of TNCC’s publicly traded

securities and assets, and (b) cause Plaintiffs and other members of the Class to purchase

TNCC’s publicly traded securities and to do so at artificially inflated prices.

38. Because each of the Individual Defendants are control persons within the meaning

of § 20(a) of the Exchange Act, they are liability for damages thereunder.

1. Additional Section 20(a) Allegations Concerning Defendant Sapp

39. Throughout the Class Period, Defendant Sapp, as a founding Director, Chairman,

CEO, President and/or Chief Lending Officer, exerted day-to-day control over the entirety of the

operations of TNCC and the Bank.

40. As TNCC’s last proxy statement describes, Defendant Sapp was “a founding

director” of TNCC and “served as Chairman, Chief Executive Officer and President” of TNCC

and the Bank since December 31, 2009. April 2011 Proxy at 5. “Prior to that, [Defendant Sapp]

served as President and Chief Lending Officer [of TNCC] from 2001 through 2009.” Id. The

April 2011 Proxy goes on to state that: “Mr. Sapp brings strong and broad financial services

experience to the board as well as a deep understanding of the Corporation’s business and

operations and the economic, social and regulatory environment in which [the Bank] operate[s].”

Id.

20


41. As stated above, Defendant Sapp personally signed each of the fraudulent annual

reports that were filed with the SEC during the Class Period. See Tennessee Commerce

Bancorp, Inc., Amendment No. 3 to Annual Report (Form 10-K/A), at 66 (June 1, 2011);




42. Further, Defendant Sapp signed multiple Sarbanes-Oxley § 302 declarations,

fraudulently certifying that, among other things, TNCC’s financial information disclosure

controls and procedures were designed “to provide reasonable assurance regarding the reliability

of financial reporting and the preparation of financial statements for external purposes in

accordance with generally accepted accounting principles.” Tennessee Commerce Bancorp, Inc.,

Amendment No. 3 to Annual Report (Form 10-K/A), at Ex. 31.1 (June 2, 2011), see also

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at Ex. 31.1 (Mar. 9, 2010).

Defendant Sapp also signed multiple Sarbanes-Oxley § 901 certifications, falsely attesting to the

fact that “[t]he information contained in the [fiscal year 2010 Annual] Report fairly present[ed],

in all material respects, the financial condition and results of operations of the Corporation.”

Tennessee Commerce Bancorp, Inc., Amendment No. 3 to Annual Report (Form 10-K/A), at Ex.

32.1 (June 2, 2011); see also Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K),

at Ex. 32.1 (Mar. 9, 2010).

43. Defendant Sapp held himself out to investors and the press as the public face of

TNCC, with control over the Company’s operations and finances. Defendant Sapp appeared at

each and every earnings conference call that took place during the Class Period. During those

calls, Defendant Sapp purported to be an expert on every aspect of TNCC’s business, particularly

21


its loan portfolio and risk management activities. See, e.g. , Tennessee Commerce Bancorp, Inc.,

Q1 Earnings Call, Bloomberg Transcript (Apr. 29, 2011) (“First and foremost, your management

team is committed to operating the bank in a safe and sound manner . . . . We believe in strong

underwriting and vigilant portfolio management.”).

44. Defendant Sapp was continuously identified as “key personnel” that TNCC and

the Bank were “dependent” upon as “instrumental to [TNCC’s] operations.” As TNCC’s last

annual report states in pertinent part:

We rely on the services of key personnel.

We depend substantially on the strategies and management services of certain of our officers—Michael R. Sapp, Chairman, Chief Executive Officer and President; Frank Perez, Chief Financial Officer; and H. Lamar Cox, Chief Operating Officer. The loss of the services of any of these officers could have a material adverse effect on our business, results of operations and financial condition. We are also dependent on certain other key officers who have important customer relationships or are instrumental to our operations. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations. Management believes that our future results will also depend in part upon our attracting and retaining highly skilled and qualified management, as well as sales and marketing personnel. We compete with a large number of other financial institutions in the Nashville MSA for such personnel, and we cannot assure you that we will be successful in attracting or retaining such personnel.

Our ability to continue to engage in and grow our national market funding programs depends on stable business relationships.

Our ability to continue to grow the national market funding portion of our portfolio is dependent upon our retaining those members of our senior management and those loan officers who have experience and relationships with those equipment vendors and financial services companies who originate the underlying lease transactions. In the event that any of these members of senior management, particularly President Mike Sapp, were to terminate

22


his or her employment with us, or in the event that our relationships with any of these vendor/brokers were to be discontinued, our ability to continue to increase our national market funding portfolio could be adversely affected.

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K/A), at 23 (June 1, 2011) (some

emphasis added).

45. TNCC itself states that all of the Bank’s lending activities are under the “direct

supervision and control” of Defendants Helf, Sapp and Cox:

All lending activities of the Bank are under the direct supervision and control of the Officers Loan Committee, the Executive Committee of the Board and, in some cases, the full Board of Directors. The Officers Loan Committee consists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox, and approves loans up to $1,000. The Executive Committee consists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox and two outside directors, and approves loans up to 15% of Tier I Capital. The full Board of Directors approves all loans above those limits. The full Board of Directors also approves loan authorizations, if any, for any executive officer. The Bank’s established maximum loan volume to deposits is 100%. The Executive Committee of the Board makes a monthly review of loans that are 90 days or more past due and the full Board of Directors makes a quarterly review of loans that are 90 days or more past due.

Tennessee Commerce Bancorp, Inc., Annual Report (Form 8-K), at 28 (Mar. 16, 2009); see also

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K/A), at 43 (June 1, 2011) (“All

lending activities of the Bank are under the direct supervision and control of the Direct Loan

Committee, the Indirect Loan Committee, the President’s Committee and, in some cases, the full

Board of Directors of the Bank. The Direct and Indirect Loan Committees are chaired by senior

lenders John Burton and Doug Rogers, respectively. The Chief Credit Officer and the Chief

Operating Officer serve as permanent members of both committees. These two committees

23


approve any new loans in an amount up to 15% of Tier I Capital. Any new loan in an amount

equal to or above $5,000 is sent for approval to the President’s Loan Committee, which is

chaired by Chairman/CEO/President Mike Sapp and consists of the members of the Direct or

Indirect Loan Committees and the Senior Vice President of Risk Management. The Bank’s

Board of Directors must ratify all proposed extensions of credit made by management that are in

excess of $10,000. In addition, the full Board must approve all extensions of credit to the Bank’s

directors, executive officers and their related parties.”).

46. Similarly, Defendant Sapp is a member of the Bank’s “Asset Liability and

Investment Committee”, which was charged with oversight of the Bank’s credit monitoring and

liquidity:

The Bank’s Asset Liability and Investment Committee, which consists of the Corporation’s non-independent board members and executive officers and certain other bank officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Cox and Frank Perez, is charged with monitoring the liquidity and funds position of the Bank. The committee regularly reviews (a) the rate sensitivity position on a three-month, six-month and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of liabilities.

Tennessee Commerce Bancorp, Inc., Amendment No. 3 to Annual Report (Form 10-K/A), at 50

(2011). Nearly all of the allegations of fraud in this Complaint concern the liability and

investments of TNCC via the Bank during the Class period. Accordingly, Defendant Sapp had

direct responsibility for all of the matters alleged herein.

47. In his position at TNCC, Defendant Sapp also exerted his control as an

administrator of TNCC’s compensation plan, making recommendations to the Compensation

Committee of the Board on which executives and employees of the Company and Bank were

entitled to or deserving of bonuses and raises in pay. As TNCC’s April 2011 Proxy states:

24


Under the 2007 Equity Plan, Messrs. Sapp and Cox, acting as the committee administrators of the plan, determine the terms of each grant to eligible participants and make their recommendations to the Compensation Committee. The Committee also receives advice and recommendations from MCCA related to executive equity grants, especially during our TARP period and the permitted forms and amounts of equity compensation. The 2007 Equity Plan authorizes equity grants in the form of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted performance stock, performance units and unrestricted shares of our common stock. The exercise price of options granted under the 2007 Equity Plan may not be less than the fair market value of the shares of our common stock on the date of grant.

April 2011 Proxy at 22.

48. In addition to being liable for primary violations of § 10(b) as described

elsewhere herein, Defendant Sapp is also liable as a control person by virtue of his ability and

opportunity to exert control over the statements of TNCC and its employees.

2. Additional Section 20(a) Allegations Concerning Defendant Perez

49. From the date of his appointment as Chief Financial Officer of TNCC until the

closing of the Bank in 2012, Defendant Perez exerted plenary control over TNCC’s finances,

internal controls and reporting.

50. As CFO Defendant Perez signed each of the false and misstated annual report

filed during his tenure at TNCC. See Tennessee Commerce Bancorp, Inc., Amendment No. 3 to

Annual Report (Form 10-K/A), at 66 (June 1, 2011); Tennessee Commerce Bancorp, Inc.,

Annual Report (Form 10-K), at 44 (Mar. 9, 2010); Tennessee Commerce Bancorp, Inc., Annual

Report (Form 10-K), at 46 (Mar. 16, 2009). In conjunction with the filing of those reports,

Defendant Perez also signed multiple Sarbanes-Oxley § 302 declarations, fraudulently certifying

that, among other things, TNCC’s financial information disclosure controls and procedures were

25


designed “to provide reasonable assurance regarding the reliability of financial reporting and the

preparation of financial statements for external purposes in accordance with generally accepted

accounting principles.” Tennessee Commerce Bancorp, Inc., Amendment No. 3 to Annual

Report (Form 10-K/A), at Ex. 31.2 (June 2, 2011), see also Tennessee Commerce Bancorp, Inc.,

Annual Report (Form 10-K), at Ex. 31.2 (Mar. 9, 2010); Tennessee Commerce Bancorp, Inc.,

Annual Report (Form 10-K), at Ex. 31.2 (Mar. 16, 2009). Defendant also signed multiple

Sarbanes-Oxley § 901 certifications, falsely attesting to the fact that “[t]he information contained

in the [fiscal year 2010 Annual] Report fairly present[ed], in all material respects, the financial

condition and results of operations of the Corporation.” Tennessee Commerce Bancorp, Inc.,

Amendment No. 3 to Annual Report (Form 10-K/A), at Ex. 32.2 (June 2, 2011); see also

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at Ex. 32.2 (Mar. 9, 2010);

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at Ex. 32.2 (Mar. 16, 2009).

51. Along with Defendant Sapp, Defendant Perez also held himself out to investors

and the public alike as the public face of TNCC, with control over its operations and finances.

For example, Defendant Perez often made presentations to investors, trumpeting the false and

misleading ALLL number and the efficiency of TNCC’s non-existent risk management controls

and emphasizing their attractiveness to investors. See Tennessee Commerce Bancorp, Inc.,

Current Report (Form 8-K), Ex. 99.1 (Feb. 16, 2011) (falsely describing TNCC as having a

“Small but highly liquid and conservative investment portfolio”) (emphasis added); Tennessee

Commerce Bancorp, Inc., Current Report (Form 8-K), at Ex. 99.1 (May 12, 2011) (“Reserves

increased from the fourth quarter [of 2010] to $26.1 million, representing 2.16% of total loans”).

52. Similarly, like Defendant Sapp, Defendant Perez was present and communicated

with investors at each earnings conference that took place during his tenure with the bank—from

26


the third quarter of fiscal year 2008 through the close of the bank. As Chief Financial Officer, it

was Defendant Perez’s job to describe in detail the ALLL number and why it was sufficient to

protect investors against future write-downs of bad loans. See, e.g. , Tennessee Commerce

Bancorp, Inc., Q4 2010 Earnings Call, Bloomberg Transcript (Jan. 21, 2011) (“Let me now turn

to credit metrics. First of all, the provision for loan losses of $3.8 million provided 93% coverage

of the $4.1 million in charge-offs for the quarter. We noted in the earnings release earlier that the

provision expense for the fourth quarter of 2010 represented the [lowest] loss provision expense

since the fourth quarter of 2008 when we recorded a $3.3 million provision. It is also worth

noting that while the provision is still elevated for the 12 months ended December 31, 2010, it

has decreased $11 million from the same period in 2009.”).

53. Similarly, Defendant Perez is a member of the Bank’s “Asset Liability and

Investment Committee”, which was charged with oversight of the Bank’s credit monitoring and

liquidity:

The Bank’s Asset Liability and Investment Committee, which consists of the Corporation’s non-independent board members and executive officers and certain other bank officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Cox and Frank Perez, is charged with monitoring the liquidity and funds position of the Bank. The committee regularly reviews (a) the rate sensitivity position on a three-month, six-month and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of liabilities.


(2011). Nearly all of the allegations of fraud in this complaint concern the liability and

investments of TNCC via the Bank during the Class period. Accordingly, Defendant Perez had

direct responsibility for all of the matters alleged herein.

27


54. Defendant Perez was continuously identified as “key personnel” that TNCC and

the Bank were “dependent” upon as “instrumental to [TNCC’s] operations.” As TNCC’s last

annual report states in pertinent part:



Our ability to continue to engage in and grow our national market funding programs depends on stable business relationships.

Our ability to continue to grow the national market funding portion of our portfolio is dependent upon our retaining those members of our senior management and those loan officers who have experience and relationships with those equipment vendors and financial services companies who originate the underlying lease transactions. In the event that any of these members of senior management, particularly President Mike Sapp, were to terminate his or her employment with us, or in the event that our relationships with any of these vendor/brokers were to be discontinued, our ability to continue to increase our national market funding portfolio could be adversely affected.

28



(June 2, 2011) (some emphasis added).


elsewhere herein, Defendant Perez is also liable as a control person by virtue of his ability and

opportunity to exert control over the statements of TNCC and its employees.

3. Additional § 20(a) Allegations Concerning Defendant Helf

56. Throughout the Class Period Defendant Helf, as founder and a member of the

TNCC Board of Directors, exerted significant control over the operations of the Company and

had the ability to influence the operations, financial reporting and public statements of TNCC’s

employees. Defendant Helf held the positions of Chairman of the Board of Directors and Chief

Executive Officer of TNCC and the Bank from the time of their founding in 2000 until his

retirement effective December 31, 2009. Following is retirement, Defendant Helf continued in

his role as founder of TNCC and Director, as well as an influential advisor to the Company and

Bank.

57. During the class period, Defendant Helf personally signed all of the fraudulent

annual reports filed with the SEC on behalf of TNCC. See Tennessee Commerce Bancorp, Inc.,

Amendment No. 3 to Annual Report (Form 10-K/A), at 66 (June 1, 2011); Tennessee Commerce

Bancorp, Inc., Annual Report (Form 10-K), at 44 (Mar. 9, 2010); Tennessee Commerce Bancorp,

Inc., Annual Report (Form 10-K), at 46 (Mar. 16, 2009); Tennessee Commerce Bancorp, Inc.,

Annual Report (Form 10-K), at F-29 (Apr. 18, 2008).

58. Defendant Helf also signed various Sarbanes-Oxley certifications while he

occupied the position of Chairman and Chief Executive officer of TNCC and the Bank,

29


certifying that, among other things, TNCC’s financial information disclosure controls and

procedures were designed “to provide reasonable assurance regarding the reliability of financial

reporting and the preparation of financial statements for external purposes in accordance with

generally accepted accounting principles.” Tennessee Commerce Bancorp, Inc., Annual Report

(Form 10-K), at Ex. 31.1 (Mar. 16, 2009); Tennessee Commerce Bancorp, Inc., Annual Report

(Form 10-K), at Ex. 31.1 (Apr. 18, 2008). Defendant also signed multiple Sarbanes-Oxley § 901

certifications, falsely attesting to the fact that “[t]he information contained in the [fiscal year

2010 Annual] Report fairly present[ed], in all material respects, the financial condition and

results of operations of the Corporation.” Tennessee Commerce Bancorp, Inc., Annual Report

(Form 10-K), at Ex. 32.1 (Mar. 16, 2009); Tennessee Commerce Bancorp, Inc., Annual Report

(Form 10-K), at Ex. 32.1 (Apr. 18, 2008).

59. During his tenure as Chairman and Chief Executive Officer, Defendant Helf

exercised significant control over the bank and its operations, representing the final decision

maker in the organization. Defendant Helf led both the “Officers Loan Committee” and the

“Executive Committee” which oversaw the lending decisions made by the Bank, giving him

plenary control over the Bank’s loan portfolio. As the Fiscal Year 2008 Annual Report

described:

All lending activities of the Bank are under the direct supervision and control of the Officers Loan Committee, the Executive Committee of the Board and, in some cases, the full Board of Directors. The Officers Loan Committee consists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox, and approves loans up to $1,000. The Executive Committee consists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox and two outside directors, and approves loans up to 15% of Tier I Capital. The full Board of Directors approves all loans above those limits. The full Board of Directors also approves loan authorizations, if any, for any executive officer. The Bank’s established maximum loan volume

30


to deposits is 100%. The Executive Committee of the Board makes a monthly review of loans that are 90 days or more past due and the full Board of Directors makes a quarterly review of loans that are 90 days or more past due.

Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at 28 (Mar. 16, 2009).

60. Defendant Helf continued on as a director following his retirement as Chairman

and Chief Executive Officer at the end of 2009 and continued to have a hand in the day-to-day

operations of the Bank. In addition to remaining a Board member, with “providing oversight of

[the Company’s] risk management processes,” April 2011 Proxy at 1, Defendant Helf remained

an influential part of the Bank’s Asset Liability and Investment Committee, with authority over

the Bank’s loan portfolio, policies and risk management:

The Bank’s Asset Liability and Investment Committee, which consists of the Corporation’s non-independent board members and executive officers and certain other bank officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Cox and Frank Perez, is charged with monitoring the liquidity and funds position of the Bank. The committee regularly reviews (a) the rate sensitivity position on a three-month, six-month and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of liabilities. The Bank operates an asset/liability management model. At December 31, 2010, the Bank had a positive cumulative re- pricing gap between four and 12 months of approximately $6,716 or 0.46% of total year-end assets. See Item 7A of this Annual Report on Form 10-K for additional information.



61. Just after his retirement, Defendant Sapp reassured investors that Defendant Helf

would continue to play an important role at TNCC at an earnings conference call held just after

his retirement:

31


Art Helf retired as Chairman effective December 31. Art and I started Tennessee Commerce in 2000 with the unique vision to create a different kind of bank that could respond to the growing needs of businesses and customers with a service-first approach. He had been instrumental to our success and will remain involved in representing us in the community as a member of our Board and in an advisory capacity.

Tennessee Commerce Bancorp, Inc., Q4 2009 Earnings Call, Bloomberg Transcript (Jan. 20,

2010).

62. As the June 2011 Proxy described: “As our previous Chairman and Chief

Executive Officer, Mr. Helf brings deep institutional knowledge and perspective to the board

regarding our strengths, challenges and opportunities.” June 2011 Proxy at 5.


elsewhere herein, Defendant Helf, as founder, Chairman, CEO and persistent member of the

TNCC Board, is also liable as a control person by virtue of his ability and opportunity to exert

control over the statements of TNCC and its employees.

4. Additional Section 20(a) Allegations Concerning Defendant Cox

64. Throughout the Class Period, first as Chief Administrative Officer and later as

Chief Operating Officer, Defendant Cox exerted significant control and influence over the

operations and financial reporting of TNCC. Defendant Cox held the position of Chief

Administrative officer from 2005 through 2009 and was appointed Chief Administrative Officer

in December of 2009, a position which he held until the closing of the Bank. As the April 2001

Proxy states: “Prior to that, he served as Chief Financial Officer of the Corporation and the Bank

from 2000 to 2005 and acting Chief Financial Officer from March 7, 2008 until August 18, 2008.

Mr. Cox's banking career brings in-depth knowledge of the financial services industry and

32


significant financial expertise to assist the board in overseeing the management of the

Corporation. He has over 35 years of banking experience in the areas of finance, operations,

retail banking, compliance and lending.” April 2011 Proxy at 6.

65. Defendant Cox personally signed each of the fraudulent annual reports which, in

large part, for the basis of this Complaint. See Tennessee Commerce Bancorp, Inc., Amendment

No. 3 to Annual Report (Form 10-K/A), at 66 (June 1, 2011); Tennessee Commerce Bancorp,

Inc., Annual Report (Form 10-K), at 44 (Mar. 9, 2010); Tennessee Commerce Bancorp, Inc.,

Annual Report (Form 10-K), at 46 (Mar. 16, 2009); Tennessee Commerce Bancorp, Inc., Annual

Report (Form 10-K), at F-29 (Apr. 18, 2008).

66. Defendant Cox’s role was so important to TNCC and the Bank that he was

continuously identified as a key member of management. As TNCC’s last annual report states:



33



(June 2, 2011).

67. In his position at TNCC, Defendant Cox also exerted his control as an

administrator of TNCC’s compensation plan, making recommendations to the Compensation

Committee of the Board on which executives and employees of the Company and Bank were

entitled to or deserving of bonuses and raises in pay. As TNCC’s April 2011 Proxy states:

Under the 2007 Equity Plan, Messrs. Sapp and Cox, acting as the committee administrators of the plan, determine the terms of each grant to eligible participants and make their recommendations to the Compensation Committee. The Committee also receives advice and recommendations from MCCA related to executive equity grants, especially during our TARP period and the permitted forms and amounts of equity compensation. The 2007 Equity Plan authorizes equity grants in the form of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted performance stock, performance units and unrestricted shares of our common stock. The exercise price of options granted under the 2007 Equity Plan may not be less than the fair market value of the shares of our common stock on the date of grant.


68. Defendant Cox also exerted control over the internal controls and financial

reporting of TNCC through his participation in the Bank’s Asset Liability and Investment

Committee, exercising authority over the Bank’s loan portfolio, policies and risk management:

The Bank’s Asset Liability and Investment Committee, which consists of the Corporation’s non-independent board members and executive officers and certain other bank officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Cox and Frank Perez, is charged with monitoring the liquidity and funds position of the Bank. The committee regularly reviews (a) the rate sensitivity position on a three-month, six-month and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of

34


liabilities. The Bank operates an asset/liability management model. At December 31, 2010, the Bank had a positive cumulative re- pricing gap between four and 12 months of approximately $6,716 or 0.46% of total year-end assets. See Item 7A of this Annual Report on Form 10-K for additional information.




elsewhere herein, Defendant Cox, as head of the Bank’s operations, is also liable as a control

person by virtue of his ability and opportunity to exert control over the statements of TNCC and

its employees.

V. PLAINTIFFS’ CLASS ACTION ALLEGATIONS

70. Plaintiffs brings this action as a class action pursuant to Federal Rules of Civil

Procedure 23(a) and (b)(3) on behalf of all those persons who purchased TNCC common stock

between April 18, 2008 through January 27, 2012, inclusive and thereby suffered economic

damages (the “Class”). Fed. R. Civ. P. 23(a), (b)(3). Excluded from the Class are defendants,

the officers and directors of the Company, members of their immediate families and their legal

representatives, heirs, successors, or assigns, and any entity in which defendants have or had a

controlling interest.

71. The members of the Class are so numerous that joinder of all members is

impracticable. According to the Company’s quarterly report filed on August 12, 2011, TNCC

had 12,196,900 shares of common stock outstanding. Tennessee Commerce Bancorp, Inc.,

Quarterly Report (Form 10-Q), at 3 (Aug. 12, 2011). While the exact number of Class members

is unknown to Plaintiffs at this time and can only be ascertained through appropriate discovery,

35


Plaintiffs believe that there are hundreds or thousands of members in the proposed Class. Record

owners and other members of the Class may be identified from records maintained by the

Company or its transfer agent and may be notified of the pendency of this action by mail, using

the form of notice similar to that customarily used in securities class actions.

72. Plaintiffs’ claims are typical of the claims of the members of the Class as all

members of the Class are similarly affected by defendants’ wrongful conduct in violation of

federal law that is complained of herein.

73. Lead Plaintiff will fairly and adequately protect the interests of the members of

the Class and has retained counsel competent and experienced in class and securities litigation.

74. Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class. Among the

questions of law and fact common to the Class are:

a. whether the federal securities laws were violated by defendants’ acts as

alleged herein;

b. whether statements made by defendants to the investing public during the

Class Period misrepresented material facts about the business, operations,

and financial condition of the Company;

c. whether defendants acted knowingly or recklessly in making materially

false and misleading statements during the Class Period;

36


d. whether the market prices of the Company’s common stock were

artificially inflated or distorted during the Class Period because of

defendants’ conduct complained of herein; and

e. to what extent the members of the Class have sustained damages and the

proper measure of damages.

75. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable. Furthermore, as

the damages suffered by individual Class members may be relatively small, the expense and

burden of individual litigation make it impossible for members of the Class to individually

redress the wrongs done to them. There will be no difficulty in the management of this action as

a class action.

VI. BACKGROUND SUPPORTING A STRONG INFERENCE OF SCIENTER

76. From its inception in 2000, TNCC operated as a holding company for a single

asset, Tennessee Commerce Bank. The Bank was set up as a non-traditional banking institution,

specializing in commercial and industrial (“C&I”) loans, as well as real estate loans (consumer

and commercial) and credit card loans. Prior to closing, the Bank had no branch locations and

did not have consumer customers. The Bank, instead, operated three loan production offices—

besides its headquarters in Franklin—in Alabama, Minnesota and Georgia, catering primarily

small-to-medium sized business customers in the transportation and warehousing,

manufacturing, finance and insurance, construction, commercial real estate and healthcare

industries.

37


77. As of 2010, TNCC’s loan portfolio, which consisted primarily of loans that the

Bank had originated or underwritten, was valued at as much as $1.4 billion As of the Bank’s

closure by the FDIC and the TDFI on January 27, 2012, and appointment of the FDIC as

receiver, total assets were valued at approximately $1.0 billion, approximately 42% of which

were determined to constitute a loss and not recoverable.

78. Following the failure of the Bank, the FDIC’s Office of the Inspector General,

Office of Audits and Evaluations, commissioned KPMG LLP to prepare a report examining the

material losses at the Bank. Published in September of 2012, the Material Loss Review of

Tennessee Commerce Bank, Franklin, Tennessee, or the FDIC Inspector General’s Report as it is

referred to herein, was published by the FDIC and detailed the extent of the fraud and

mismanagement within TNCC (the “FDIC Inspector General’s Report”). FDIC Office of the

Inspector General, Material Loss Review of Tennessee Commerce Bank, Franklin, Tennessee,

Report No. AUD-12-014 (September 13, 2012).

79. Among other things, the FDIC Inspector General’s Report concluded that Bank

management, including Defendants Helf, Sapp, Cox and Perez had failed enforce effective

internal controls over the financial reporting, credit and underwriting and loss mitigation at the

Bank during the Class Period. Much of the information included in this Complaint was derived,

at least in part, from the FDIC Inspector General’s Report.

A. TNCC’S HISTORY OF MISMANAGEMENT, SELF-INTEREST AND PATH TO FAILURE

80. In 2007, the Bank’s terminated CFO, George Fort, brought suit against

Defendants and the Bank, claiming, among other things, that Defendants Helf, Cox and Sapp had

encouraged Bank personnel to circumvent internal controls and violate approved policies and

38


procedures. See Fort v. Tennessee Commerce Bank, et al., Case No. 3-08-0668, at 3 (M.D.

Tenn., filed July 9, 2008). Fort claimed that the lack of effective internal controls “materially

and adversely affected [his] certification responsibilities relative to the Company’s Securities and

Exchange Commission periodic filings, including but not limited to its annual 10K filing[.]” Id.

at 2-3.

81. In June of 2007, Defendants Helf, Sapp and Cox made headlines when they took

unilateral action to double their salaries in violation of both NASDAQ rules and the Bank’s

policies. The dramatic increase in salary is evinced by the following table from TNCC’s 2008

proxy filing:

Std cpNmMPrnpa1Pmt Ya41 Sth A2 A,tjrnF.He1f

$37.500 Offr 3W F. t ddl R- S.Pp 2007

Pr CfJig Okr j icci 1ao.c

C1a-

V.1. and Nouqualifd

No-Eqmt Dfrnd IthP1a cop—at.. — 4flOthr

Co—t3 Cpmt4-14 Total $414 $.414

1po,ox - 23.37B 445.37

1::. -30.939 M,439 -

22.640 403640 - 43.2i - 2.410 3.410

Tennessee Commerce Bancorp, Inc., Proxy Statement (Schedule 14A), at 19 (April 29, 2008).

82. Defendants also seized the opportunity to grant themselves $2.3 million in golden

parachute benefits in the event that they were terminated for any reason:

39


EtiEonefitu and P outs upon Ternunation

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Id. at 23. At the time when the raises were approved, TNCC was not in compliance with

NASDAQ Marketplace Rule 4350(c), which requires that a majority of the compensation

committee of the board granting such raises be composed of independent directors. See

NASDAQ Marketplace Rule 4350(c) (“Each issuer shall maintain a sufficient number of

independent directors on its board of directors to satisfy the audit committee requirement set

forth in Rule 4350(d)(2).”). Rule 4350 is intended to prevent the type of cash grab executed by

Defendants Sapp, Cox, and Helf in this instance. See id . at IM-4350-4 (“Independent director

oversight of executive officer compensation helps assure that appropriate incentives are in place,

40


consistent with the board’s responsibility to maximize shareholder value. The rule is intended to

provide flexibility for an issuer to choose an appropriate board structure and to reduce resource

burdens, while ensuring independent director control of compensation decisions.”).

83. In reaction to the unauthorized increase in compensation to Defendants Helf, Sapp

and Cox, three members of the TNCC Board, Winston C. Hickman, Regg E. Swanson and

Fowler E. Low, resigned. Two of the three directors that resigned penned letters discussing the

reason for their resignation - their disgust at the unilateral pay raises. As Regg E. Swanson

wrote:

My decision is a direct result of my disagreement with the board’s action and policy regarding executive compensation and the manner in which the vote was taken to approve this policy. I feel the direction the executive management has taken regarding their compensation is unethical. Their desire to attain compensation that I feel is excessive based on information that I have obtained independent of the board, and the subsequent vote process which granted the compensation has violated my trust in the management of the bank. Above all this has put me in a position where I do not feel I can act to uphold my fiduciary responsibilities as a member of the Board.

Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex. 99.2, at *1 (July 19, 2007).

84. Similarly, Fowler H. Low wrote, in pertinent part:

The June 2007 adoption of a new “compensation policy” is the primary reason for my resignation. I can not, in good faith, continue to be a member of a board that accepts/approves such a “policy.” It is a “policy” that, in my opinion, is not in the best interests of our stockholders, rather a policy crafted to provide excessive and retroactive compensation to “executive managers.”

* * *

Notwithstanding the quantum leap in remuneration for the key executives, the clever (cunning) defining of “their” compensation that enabled the directors who are employees of the bank to vote for one another, up and down the organizational chart, is cause

41


enough (for me) to resign. Perhaps I am more naive than most, but I must wonder if I was the only director and/or stockholder whose interpretation of this prohibition for executive officers that are also Compensation Committee members to discuss or vote on matters relating to “their” compensation allowed for the “I cover you and you cover me” votes, as was done in this instance.

It seems to me that the executive officers/directors have concluded that the board can be manipulated in whatever manner deemed desirable (by the executive officers). Indeed this compensation issue and the “vote” as counted reflect as much. I have to question whether we are a board of directors, -- or a board of directed. In this environment, I can not perform my fiduciary responsibilities as a director of the bank.

Id. at Ex. 99.3, at *1-*2. Notably, following these dramatic increases in salary, the

mismanagement and breach of policy, rules and the law began to worsen.

85. With the onset of the recession in 2008 the economy significantly deteriorated,

but the Bank continued with business as usual, pushing hard to underwrite and originate massive

amounts of loans, primarily in the C&I space. Unrestrained growth during the Class Period,

coupled with high concentrations in industries particularly susceptible to an economic slowdown

posed significant risks to the Bank’s liquidity. As the FDIC Inspector General’s Report

concluded, the overconcentration of the Bank’s loans in the C&I space, coupled with massive

growth, made the Bank extremely vulnerable to an extended downturn in the economy:

After opening in 2000, TCB embarked on a sustained high growth strategy centered in C&I loans. While many of TCB’s C&I loans were made in its local market of middle Tennessee, a large amount were made in out-of-territory areas throughout the United States. The bank’s assets, which totaled $97 million after two years of operations, grew by 1,343 percent to $1.4 billion by year-end 2010. Together with weak credit risk management practices (as described later), TCB’s significant exposure to certain segments of the C&I industry made the bank vulnerable to a sustained economic downturn. Figure 2 illustrates the general composition of TCB’s loan portfolio in the years preceding the institution’s failure and highlights the high growth strategy that focused on C&I loans.

42


* * *

TCB’s exposure to C&I loans presented elevated risk to the bank due to the sensitivity of C&I loans to the economy and the limited marketability of specialized collateral securing many of the bank’s C&I loans.

FDIC Inspector General’s Report at I-8. Nonetheless, these risks were not truthfully disclosed to

shareholders and such practices were not abated, even after the FDIC had expressed concerns

related to these issues. See id .

86. To compound matters, the Bank’s loan policy and underwriting standards were

not followed during the Class Period. The FDIC consistently noted lax underwriting standards

and a complete breakdown in the Bank’s internal controls relating to the origination and

underwriting of loans. See FDIC Inspector General’s Report at I-11 (“Ineffective credit

underwriting, administration, monitoring, and collection practices contributed to the asset quality

problems that developed at TCB when the economy and the bank’s target lending markets

deteriorated.”). The serious flaws in the Bank’s underwriting and loan origination practices were

not disclosed to investors. Instead, TNCC actively promoted itself as a risk-averse lender

throughout the Class Period, attempting to differentiate and distance itself from the risky lending

like the type that had caused so much pain in the residential market. Tennessee Commerce

Bancorp, Inc., Q1 2009 Earnings Call, Bloomberg Transcript, at 4 (Apr. 29, 2009) (“We have

discussed on prior calls, Tennessee Commerce does not have any exposure to subprime loans.

We believe our diversified loan portfolio insulates us in part from the effects of any single

economic sector.”). As the economy worsened and TNCC’s liquidity problems became more

dire, the Bank’s loan policy was routinely disregarded and internal underwriting and origination

controls failed to prevent the Bank from underwriting loans that were progressively more risky—

and more expensive—than the sub-prime and Alt-A loans that had upended the residential

43


mortgage market. FDIC Inspector General’s Report at I-11 (“The April 2007 and April 2008

examination reports indicated that TCB’s lending practices were generally satisfactory, although

the reports included some recommended improvements. However, subsequent examination

reports became increasingly critical of the bank’s lending practices as the bank’s financial

condition deteriorated and weak risk management practices became more apparent and

widespread.”).

87. Beginning in 2008, while the Bank and the Individual Defendants were publically

stating that TNCC had an exceptional risk profile, the Company’s actual risk profile was

degrading exponentially, which drew the attention of the FDIC. During regular yearly

examinations, the FDIC concluded that throughout the Class Period prudent underwriting

standards—including those in the Bank’s own loan policy—were not being followed.

Nonetheless, in 2008 and each year after, the Bank continued to underwrite and originate

massive amounts of loans. Lax controls and an unrestrained explosion in the loan profile

eventually proved to hasten the demise of the Bank. For example, in 2009, the Bank’s

outstanding loan balance grew unrestrained—by over $310 million or 39% from the previous

year—while internal controls over loan underwriting and originations went unsupervised and

unenforced, and unchanged. At the same time, as discussed herein, the Bank became more-and-

more illiquid, wildly originating loans, while failing to earn sufficient revenues or recoup losses

sufficient to support operations or bolster the Bank’s cash-strapped balance sheet. FDIC

Inspector General’s Report at I-7 (“TCB’s Board and management failed to appropriately adjust

to changes in economic conditions. For example, the Board and management continued to

expand the loan portfolio with loans of questionable repayment capacity despite a slowing

economy when their peers were restricting loan growth.”).

44


88. As the Bank’s liquidity situation worsened, the incentive to conceal the truth

about the Bank’s lending practices, risk profile and lack of controls intensified. The financial

bellwether of these problems is known as the ALLL, the allowance for loan and lease losses. As

the FDIC Inspector General’s Report sets forth, the ALLL is perhaps the most important tool for

investors to measure the overall risk profile of a bank:

According to the Interagency Policy Statement on the Allowance for Loan and Lease Losses , the ALLL represents one of the most significant estimates in an institution’s financial statements and regulatory reports. As a result, each institution is responsible for developing, maintaining, and documenting a comprehensive, systematic, and consistently applied process for determining the ALLL.

FDIC Inspector General’s Report at I-13.

89. As one of the most significant estimates of credit risk for a banking institution, it

is incumbent on a bank’s board of directors to ensure that cohesive policies are in place for the

consistent and accurate calculation of the ALLL:

Boards of directors of banks and savings institutions are responsible for ensuring that their institutions have controls in place to consistently determine the allowance for loan and lease losses (ALLL) in accordance with the institutions' stated policies and procedures, generally accepted accounting principles (GAAP), and ALLL supervisory guidance. To fulfill this responsibility, boards of directors instruct management to develop and maintain an appropriate, systematic, and consistently applied process to determine the amounts of the ALLL and provisions for loan losses. Management should create and implement suitable policies and procedures to communicate the ALLL process internally to all applicable personnel. Regardless of who develops and implements these policies, procedures, and underlying controls, the board of directors should assure themselves that the policies specifically address the institution's unique goals, systems, risk profile, personnel, and other resources before approving them. Additionally, by creating an environment that encourages personnel to follow these policies and procedures, management improves procedural discipline and compliance.

45


The determination of the amounts of the ALLL and provisions for loan and lease losses should be based on management's current judgments about the credit quality of the loan portfolio, and should consider all known relevant internal and external factors that affect loan collectibility as of the reporting date. The amounts reported each period for the provision for loan and lease losses and the ALLL should be reviewed and approved by the board of directors. To ensure the methodology remains appropriate for the institution, the board of directors should have the methodology periodically validated and, if appropriate, revised. Further, the audit committee2 should oversee and monitor the internal controls over the ALLL determination process.

* * *

For financial reporting purposes, including regulatory reporting, the provision for loan and lease losses and the ALLL must be determined in accordance with GAAP. GAAP requires that allowances be well documented, with clear explanations of the supporting analyses and rationale.6 This Policy Statement describes but does not increase the documentation requirements already existing within GAAP. Failure to maintain, analyze, or support an adequate ALLL in accordance with GAAP and supervisory guidance is generally an unsafe and unsound banking practice.

FDIC, 5000 – Statements of Policy (July 2, 2001),

http://www.fdic.gov/regulations/laws/rules/5000-4650.html . As such, the ALLL is not simply a

haphazard guess at what a bank’s estimable and probable loan and lease losses are on a quarterly

and yearly basis, subject to cohesive and consistent policies and procedure, managed directly by

a bank’s board of directors and audit committee.

90. As discussed in detail infra, throughout the Class Period the Bank understated its

ALLL, failing to sufficiently account for the risk of its assets in accordance with GAAP,

including FAS 5 and FAS 114, which govern the ALLL. As the FDIC Inspector General’s

Report concluded:

TCB’s loan grading system was not appropriately applied, resulting in numerous and large credit downgrades during

46


examinations. The August 2010 and September 2011 examination reports noted that, in many cases, management was aware of the declining ability of borrowers to service their debt, but appeared reluctant to downgrade loans to an appropriate loan grade. This had the effect of delaying recognition of problem loans and not adequately providing for known credit losses via the ALLL.

* * *

Management failed to appropriately identify, measure, and provide for the level of deterioration in the loan portfolio in 2010 and 2011. Specifically, examiners noted during the August 2010 examination that an additional provision of at least $16.3 million to the ALLL was warranted to provide for the risk in the loan portfolio. The bank also needed to adopt a more robust Financial Accounting Standard (FAS) 5 and FAS 114 methodology and use a shorter time frame for calculating historical loan losses to reflect the risk in the loan portfolio and the environment in which the bank was operating.

Examiners noted at the September 2011 joint examination that the ALLL was severely deficient in relation to the level of risk in the loan portfolio and that an additional provision of $80.2 million was warranted. In addition, the bank’s FAS 114 impairment analyses were either inadequately supported, inadequately measured, or used invalid assumptions. Further, management failed to recognize credit losses in a timely manner, which resulted in an insufficient FAS 5 ALLL allocation since the calculation was based on historical losses. The bank’s external auditors also noted in 2011 that controls over estimating the ALLL were not adequate. An underfunded ALLL can have the effect of delaying the recognition of deterioration in the credit quality of the loan portfolio.

FDIC Inspector General’s Report at I-13. Failure to accurately account for the ALLL denied

investors the ability to properly judge the quality of the Bank’s portfolio, artificially inflating the

Bank’s stock price for an extended period of time, before the truth slowly emerged.

91. To compound matters, the Bank’s loss mitigation controls were extremely poor,

resulting in broken laws and losses that were not timely recognized. As the economy worsened,

the loans in the Bank’s C&I portfolio began defaulting, but the bank did not have sufficient

47


controls to exercise its right to the collateral in a timely or efficient manner, further delaying the

recognition of losses and resulting in violations of the law. As the FDIC described:

TCB had no repossessed assets as of December 31, 2006. However, by the close of 2007, the bank had repossessed assets of about $7 million consisting primarily of trucks that were leased through the bank’s indirect funding programs. Management attributed the high level of repossessions to increases in fuel costs and the resulting impact on the trucking industry. In addition, due to the structure of the leases through the brokers, the bank was not becoming aware of the problems until the leases were 90 to 120 days past due. Examiners noted that a significant portion of the bank’s repossessions were held in excess of the 6-month maximum period permitted under Tennessee law. TCB subsequently formed a subsidiary called the Tennessee Commercial Asset Services, Inc., to hold repossessed assets beyond the 6-month period allowed by Tennessee law and assist the bank in selling and collecting proceeds from repossessed assets.

As of July 2010, repossessions totaled $28.3 million, of which $26.4 million consisted of trucks and over-the-road equipment. In addition, the bank had 381 loans secured primarily by tractor/trailers that were over 180 days past due and the collateral had not yet been repossessed. A total of 153 of the 381 loans were over 300 days past due.

TCB did not have adequate loss mitigation policies and procedures to monitor the repossession and timely disposition of collateral. TCB often relied on various third-party dealers and brokers for payment collection and collateral repossession services. It does not appear that the bank adequately understood, assessed, or monitored the risk exposure related to these third-party relationships. For example, we observed an instance in which a single broker was servicing over 1,100 leases valued at over $58 million, yet the broker had only 4 employees performing collection services. This suggests an inadequate infrastructure that may have limited the broker’s ability to support and service a labor intensive lease portfolio on behalf of TCB. To further illustrate management’s inadequate monitoring of broker relationships, an examiner loan review of a broker relationship at the 2009 joint examination noted numerous deficiencies, including but not limited to, a lack of a physical on-site collateral inspection, a lack of a formalized agreement between TCB and the broker, and a potential conflict of interest involving used tractor/trailer sales and inventory.

48


FDIC Inspector General’s Report at I-14 to I-15. The failure to ensure effective loss mitigation

further misled investors as to the credit quality of the Bank and gave a false impression of the

risks that the downturn in the economy were posing to the Bank.

92. At the same time, the Bank had become more reliant on risky and expensive non-

core, non-traditional deposits to fund the explosion in lending that they had embarked upon.

During the Class Period TNCC became highly dependent upon non-core, non-traditional forms

of funding. These non-core funding sources posed special risks which were never fully disclosed

to investors, primarily because the Bank structured deposit purchases to avoid having the

purchased deposits classified as such under banking industry conventions:

TCB relied heavily on non-core funding sources, particularly time deposits above the insurance limit, Internet deposits, and brokered deposits, to fund its loan growth and maintain liquidity. When properly managed, non-core funding sources offer a number of important benefits, such as ready access to funds in national markets when core deposit growth in local markets lags planned asset growth. However, non-core funding sources also present potential risks, such as increased volatility when interest rates change and difficulty accessing such funds when the financial condition of an institution deteriorates. In addition, institutions become subject to limitations on the use of brokered deposits and the interest rates they can offer on deposits when the institutions fall below Well Capitalized. Under distressed financial or economic conditions, institutions could be required to sell assets at a loss in order to fund deposit withdrawals and other liquidity needs. In March 2009, the FDIC issued FIL-13-2009, The Use of Volatile or Special Funding Sources by Financial Institutions That are in a Weakened Condition, which indicated that institutions with aggressive growth strategies or excessive reliance on volatile funding sources are subject to heightened supervisory monitoring and examination.

* * *

The bank’s liquidity position began to weaken as asset quality issues in the loan portfolio became prevalent. At the August 2010 joint examination, examiners largely attributed a decrease in TCB’s net non-core funding dependence ratio to a decrease in time

49


deposits of $100,000 or more and an increase in Other Savings Deposits, which are classified as core deposits, through promotional rates that were three times higher than the bank’s peer group average. Examiners noted that the potential volatility of the Other Savings Deposits was similar, or possibly even greater than, traditional noncore funding sources. By September 2011, examiners determined that TCB’s liquidity was critically deficient and threatened the viability of the institution.

FDIC Inspector General’s Report at I-17 to I-19.

93. In essence, TNCC’s management failed to ensure that reasonable controls were in

place to administer the Bank in a prudent manner, while simultaneously concealing the truth

from regulators and investors alike. As time went on, the pressure to conceal the truth

intensified, with Defendants underreporting the risks that were posed by the Bank’s loan profile

and operational footprint. As the FDIC Inspector General’s Report on the failure of the bank

concluded, TNCC’s management was solely and directly responsible for the failure of the Bank:

TCB’s Board and executive management team did not provide effective oversight and management of the institution. As discussed more fully in subsequent sections of this report, the Board and management implemented an unconventional and risky Business Bank strategy that exposed TCB to significant operational and credit risk in the event of a sustained downturn in the economy. Specifically, TCB:

emphasized high loan growth and specialized lending without adequate risk management practices;

developed large and complex borrowing relationships that exposed the bank to significant risk and credit losses;

engaged in unusual lending practices, such as life insurance premium financing, without appropriately analyzing the associated risks or properly documenting the deliberations of the Board or management’s rationale for conducting such practices;

did not maintain capital at levels that were commensurate with the bank’s risk profile; and

50


executed a funding strategy for sustaining loan growth and maintaining liquidity that involved heavy reliance on non-core funding sources, particularly Internet and brokered deposits.


94. All of these factors contributed to the demise of TNCC in January of 2012.

However, the risks associated with them were not disclosed. Indeed, Defendants concealed the

true risk of the Bank’s profile and the scope of the internal control deficiencies not only from

investors, but also from regulators. Strikingly, even when confronted with their false statements,

Defendants stubbornly refused to admit their mistakes, instead continuing the misstatements and

further pushing the Bank to the edge. See id. at I-7. As the FDIC described:

TCB’s Board and management also failed to adequately address concerns identified during examinations of the bank. For example, the Board was reluctant to enter into a Memorandum of Understanding (MOU) with regulators to address risk management issues identified during the June 2009 examination and “strongly disagreed” with many of the findings in the August 2010 examination. The Board and management were also reluctant to accept the advice of external loan reviewers. Further, examination reports of TCB noted apparent violations of laws and contraventions of statements of policy pertaining to appraisals, legal lending limits, false and/or misleading statements, the Allowance for Loan and Lease Loss (ALLL) methodology, loans to a financial subsidiary, and the purchase of a large speculative asset. Such apparent violations and contraventions reflected negatively on TCB’s Board and management.

Id.

95. The motive for Defendants deception and concealment of the Bank’s true

condition are clear. Notwithstanding the extremely poor financial and operational condition of

Bank during the Class Period, Defendants were excessively compensated. This is particularly

evident when the non-performance and mismanagement of the Bank is laid bare. For instance,

51


during the Class Period, the Individual Defendants earned millions of dollars in salary and

bonuses, while they were driving the bank into receivership:

Na aaPriapa1Piüu hfid1 R

H Lcd

4,thrnF. He1 -

Cia

Ya1u ad Nnuaaitd

on-Eqmt frrd

smrk Opt- li—tinKm Cmpm tatin 4flOthr - \ear Salan Ronu .tnrd l LI Awardi 2 ' Compniaton 1 ' Eaniiagi 4 ' Conpaiafiu Total

200., 400.CCO - 15.CC . - - $ 5242 . 45$5 $521227 2002 400.ODD - - - 35,939 1.01.439 2c•: - - 40D.OM - 1.11.4J IOD 1.1 - - - - - -

2OW 350cc.: - 15.0 - - 25$45 447.201 2c 350.' - 4~,750 - 315.O - 49.2 5 763.OD6

350. - - 275 - 43.)36 1.3.756 4.co: - - - - 1.52 476.52 400cO: - - 222_5 3 6040 - 54$15 1037,413 4M.OD D - 414 1.15.414

96. Tennessee Commerce Bancorp, Inc., Proxy Statement (Schedule 14A), at 34

(April 16, 2010).

97. Even as the Bank teetered on the verge of collapse, Defendants Sapp, Perez and

Cox were all paid over $500,000 in 2010, with Defendant Sapp earning over $700,000:

Nan adPdFitoa hrdlRSpp

Fri:Prsz

}LLrCrn CfOph.g Ok' .:1ale;E, Ro; .I

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Chap V1u d

Noqualifid No-Eqmt 1frrd

Stool- Cptrn hruth Plaa

Ceprnarn All Oher Yer Salart' Bni Aw & Awrds n Earnano CnrftpenIatrrn Total 2010 - 1T%4 -., g - - . :3.24c1 49.491 717.70 100 4x.c.:.D - 13.000 - - 0.242 45.!;i 521.227 20C!; 4CC.X( - - 221_500 30,0) - 3V39 1.019.43 :1: S - S - S - - 1425

15l - - - - - 515 - - - - 3 ,-.jo 121.513

1010 4C.CCC - 1 141.784 - - . 44.48 61.756 4g.48 2COP 350.000 - 15.0 - - 245 59.25 447.201 ia 35c.c - 4L750 - 313,0M - 49.25

:10 S - S - S - S - c.x .414.09

010 350. - 117.7 - - - - 215.5c

98. Moreover, as detailed above, a significant portion of Defendants’ compensation

throughout the Class Period was in the form of stock or options grants. See id . As such,

Defendants had a considerable incentive to take steps to see that the stock price remained high,

including concealing the true risk and control condition of the Bank. Indeed, it was only when

52


the Bank was no longer liquid and the truth could no longer be concealed that Defendants began

to reveal the truth of the dire situation. See infra .

99. In addition to their salaries, bonus and stock grants, Defendants were also paid for

various other perks, such as attending Board meetings and luxury automobiles. Again, in 2010,

as the bank was failing, shareholders paid approximately $1,000 per month for automobiles for

Defendants Cox, Sapp and Perez and nearly triple that as compensation for attendance at board

meetings. As the April 2011 Proxy Statement sets forth:

Lrn-Trm

Liftftrnrrn. AutonlDbfle Ftnbr Senre Carebiuranct ReincaUDu Name ?r.rniunii Aflwnr. aInctDr ?r.rninnii R.imburI.m€nt hdlRpp 53 12.X 33.5CO 3.41 -

- -

12.55: 13-ON 55.50c 3A6 -

- - - -

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(b)KIr P~ md Mr L~ ~ —bu—d ~ 2010 f3f ~M ~b~d m t~ iml~ftm to theo, of hdqut

April 2011 Proxy Statement at 30. Additional compensation for attending Board meetings for

Defendants Helf and Sapp in 2010 are included in the following table:

• Cha

qualified HruM No-Eqit frrd orPaid 5t± Opt e?la Cnmmtu 4flOtkr

Nan mCaiJi Aivardi Awards Cmpmaatnn Earniagi Cnmpeniathrn Total MdtF:sp 33.50c - - - - -

IiLC 55j00 - - - - -

E.Liv -::r wJ.o di:L: tze Lia i' .LLrd t.L .:L fx ::iLt F: irJti:. d. 1ow mdL1d

Id. This, of course, is in addition to compensation paid to Defendant Helf for his participation on

the Board in 2010, which amounted to over $250,000:

53


Name

Paul W. Lherksefl Dennis L. Grim.aud Wiihan W. M1±Ine nmus R. Nlfln Darrel E. Reifschneider Paul A. Thom Arthur F. Hell

Fen E arid or Paid Stock in Cash ard"

1&i4MP S 17,S4S 1:lM) - 3S,IMMP - 40: 34H0 17:4 401j4:M:P - 1:CL:I:: - 1SiMP 17S4S

Ch3ap La Pengan

value and NoqaaJifd

Nam-Equity Ifernd Cqrham Intav Plan Conpaialioa J1 Other

Awarth ciiianra P ariii S - - 1SHX S -

— l.S : L:i:L: -

1S43 - - -

1S4S - - -

1.848 - 6.i:1:L -

— — 1:4HX

Total i2.34S

ii,S4S

iS34S 41:S4S

2i1,34S

Id. at 41.

100. Indeed, Defendants Helf, Sapp and Cox even had their country club membership

paid for by shareholders: “The Bank provides a car allowance to each of Messrs. Helf, Sapp and

Cox and pays each of their annual dues at a local country club, expenses related to their

respective use of such country club for matters related to our business and their respective

reasonable expenses for continuing education courses necessary to maintain any certifications or

licenses that each of them holds.” Tennessee Commerce Bancorp, Inc., Proxy Statement

(Schedule 14A), at 22 (Apr. 20, 2009).

101. Their own compensation was such a high priority to Defendants that the FDIC

indicated that there was a basis for questioning whether Defendants were using Troubled Asset

Relief Program (“TARP”) funds for compensation, in direct violation of pertinent regulations. In

December of 2008, TNCC received $30 million in TARP CPP funds. Defendants refused to

provide documentation to the FDIC describing how those funds were utilized. As the FDIC

Inspector General’s Report describes:

The August 2010 joint examination report stated that examiners were unable to determine whether TCB fully complied with the CPP Agreement and the requirements of EESA based on limited information provided by the bank. According to RMS officials, examiners made multiple attempts to gain information from the CFO and other bank management officials, as well as by reviewing

54


financial information and Board committee minutes. Examiners noted that the bank’s Board minutes were silent regarding TCB’s use of the $24 million in funds down streamed from Bancorp. Examiners also noted that the Board approved a new expenditure policy and revised several employment contracts and deferred compensation agreements to comply with Treasury requirements. However, the complete terms of the contracts and agreements were not disclosed to examiners. Examiners further noted that Compensation Committee minutes, which were only provided through May 2009, documented the bank’s efforts to comply with EESA. We did not find evidence that examiners performed follow-up inquiries with TCB’s management after the 2010 joint examination to obtain additional information regarding the bank’s compliance with the CPP Agreement.

FDIC Inspector General’s Report at I-32 (emphasis added).

102. In the end, the deception carried on by the Bank throughout the Class Period

could no longer be concealed. On November 1, 2011, TNCC issued a Current Report (Form 8-

K) announcing that it was restating its financial results for the second quarter of fiscal year 2011

ended June 30, 2011. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2

(Nov. 1, 2011) (the “Restatement”). As the November 1, 2011 Restatement stated:

On October 27, 2011, management of the Corporation, and subsequently, its Audit Committee and Board of Directors, determined that its financial statements for the quarter ended June 30, 2011, as included in the Corporation’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011, should no longer be relied upon due to an expected approximately $83.0 million increase in the provision for loan losses and related allowance for loan losses as a result of an ongoing joint examination of Tennessee Commerce Bank (the “Bank”), a wholly-owned subsidiary of the Corporation, by the Federal Deposit Insurance Corporation (the “FDIC”) and the Tennessee Department of Financial Institutions (the “TDFI”). Consequently, the Corporation intends to file an amendment to its Form 10-Q for the period ended June 30, 2011, as soon as reasonably practicable, to give effect to the expected increase in the provision and allowance for loan losses.

Id. (emphasis added).

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103. Nonetheless, the November 1, 2011 Restatement left investors with the false

impression that TNCC’s financial statements for other periods did not need to be restated. It was

not until January 20, 2012, that it was announced that additional periods would need to be

restated. This was a forced admission, due to the fact that KraftCPAs PLLC had notified the

bank that it was withdrawing its audit report for all financial statements post-December 31, 2010

and unspecified previous periods. See Tennessee Commerce Bancorp, Inc., Current Report

(Form 8-K), at 2 (Jan. 20, 2012); see also Tennessee Commerce Bancorp, Inc., Current Report

(Form 8-K), Ex. 99.1, at *1 (Jan. 25, 2012) (“We have read the statements under Item 4.02 of the

Current Report on Form 8-K filed with the Securities and Exchange Commission on January 20,

2012 regarding withdrawal of our audit report on the Corporation’s financial statements as of

December 31, 2010 and for the year then ended and the possibility that we may withdraw earlier

audit reports pursuant to the results of a forensic review of the Corporation’s small ticket loan

portfolio. We agree with these statements pertaining to our firm.”)

B. KNOWINGLY FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD

1. False Statements Concerning TNCC’s Operations In 2007

104. The Class Period commenced on April 18, 2008, when the Company filed its

2007 Annual Report on Form 10-K with the SEC (the “2007 Annual Report”). As noted above,

in late 2007, TNCC and the Bank’s CFO, George Fort, was terminated after blowing the whistle

on a lack of internal controls, self-dealing and violations of financial reporting standards and the

law at the Company and Bank. As such, the Individual Defendants were forced to admit in the

Company’s 2007 annual report that certain internal controls were lacking. Tennessee Commerce

Bancorp, Inc., Annual Report (Form 10-K), at F-2, et seq. (April 18, 2008). The statements,

however, were incomplete and misleading to the point of being meaningless because they left

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investors with the false impression that Fort’s complaints were isolated incidents and had been

addressed. Nothing could be further from the truth.

105. The 2007 Annual Report was filed with the SEC on April 18, 2008 – the first day

of the Class Period – and was signed by Defendants Helf, Cox and Sapp. In addition,

Defendants Helf and Cox, both separately signed certifications required by the Sarbanes-Oxley

Act of 2002, Pub. L. No. 107-204, § 302, 116 Stat. 745, 777, codified at 15 U.S.C. § 7241

(“SOX certification”). According to the Act, the chief executive and chief financial officers of a

corporation must certify in each annual or quarterly report that:

the signing officer has reviewed the report;

2. based on the officer's knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading;

3. based on such officer's knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the issuer as of, and for, the periods presented in the report;

4. (the signing officers—

(a) are responsible for establishing and maintaining internal controls;

(b) have designed such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared;

(c) have evaluated the effectiveness of the issuer's internal controls as of a date within 90 days prior to the report; and

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(d) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date;

(e) the signing officers have disclosed to the issuer's auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function)--

(f) all significant deficiencies in the design or operation of internal controls which could adversely affect the issuer's ability to record, process, summarize, and report financial data and have identified for the issuer's auditors any material weaknesses in internal controls; and

(g) any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer's internal controls; and

(h) the signing officers have indicated in the report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

15 U.S.C. § 7241(a). Defendants Helf and Cox’s certifications were knowingly false when

signed, because the Bank’s internal controls were insufficient, ineffective, and/or ignored - aside

from the categories in which weaknesses were identified in the 2007 Annual Report - and the

report contained material misstatements of fact, as alleged herein.

106. The 2007 Annual Report falsely represented the effectiveness of TNCC’s

financial and internal controls as they existed in fiscal year 2007 by stating:

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended) that is designed to produce reliable financial statements in conformity with accounting principles generally accepted in the United States. The Company’s

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internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden, and misstatements resulting from error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

Management, with the participation of the Company’s Chief Executive Officer and acting Chief Financial Officer, conducted an assessment of the effectiveness of the Company’s system of internal control over financial reporting as of December 31, 2007, based on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management identified the following material weaknesses in internal control over financial reporting as of December 31, 2007:

Employee Accounts – Certain transactions related to employee accounts were not appropriately processed, reviewed and approved in accordance with Company policy; and

Asset/Liability Management Committee – While the Company has an Asset/Liability Management Committee (the “ALCO”) that provides information to the Company’s Board of Directors, no meetings of the ALCO were held during 2007.

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These control deficiencies had no known impact on the Company’s financial reporting.

2007 Annual Report at F-2. Accordingly, the 2007 Annual Report identifies two discrete

categories in which TNCC’s internal controls were not effective; (a) process and review of

employee accounts, and (b) meetings of the “Asset/Liability Management Committee”

(“ALCO”).

107. The actual deficiencies in TNCC’s controls, however, were far more significant

than the above analysis provides and, as such, Defendants Helf, Cox and Sapp knew those

statements to be false when made.

108. Specifically, the FDIC’s examination of the Bank in 2007 revealed that controls

over the review and analysis of financial data were inadequate and that the Bank’s loan policy

was “too general and brief.” See FDIC Inspector General’s Report at I-12 (“FDIC and/or TDFI

examiners noted the following: Documented reviews and analysis of interim or annual financial

data were not adequate (April 2007 examination) [and] Certain portions of the loan policy were

too general and brief and needed enhancement.”)

a. Undisclosed Lack of Effective Underwriting and Loan Administration Controls

109. In April of 2007, the FDIC noted that there were significant warning flags in the

Bank’s credit monitoring and loan underwriting procedures, resulting in misleading financial

reporting of potential bad loans. As the FDIC Inspector General’s Report stated, in their 2007

examination of the Bank:

Examiners observed instances in which risk rating downgrades, inclusions on the watch list, and subsequent charge-offs occurred within a period of weeks, suggesting ineffective credit monitoring. Examiners noted that earlier recognition of potentially problem

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loans, particularly within the small indirect loan portfolio, could substantially reduce losses. The report also indicated that review and analysis of large borrowing relationships needed improvement and that the bank’s loan policy, which addressed most major topics recommended by prevailing guidance, needed enhancement in some areas, including collection procedures.

FDIC Inspector General’s Report at I-24. The untimely recognition of losses, and the associated

adjustment to loan loss reserves or lack thereof, is one of the most important criteria for investors

seeking to purchase an equity position in a Bank. The misstatement of loan losses is

unquestionably material and Defendants Helf, Sapp and Cox were aware in 2007 that the Bank

was not recognizing expected losses in a timely manner, as required under GAAP rules 9 .

110. The 2007 Annual Report failed to disclose the deficiencies in the Bank’s financial

reporting controls. Instead, the 2007 Annual Report falsely stating that the Bank’s Board,

management and auditor had all taken part in ensuring the soundness of the Bank’s investments.

Credit risk and exposure to loss are inherent parts of the banking business. Management seeks to manage and minimize these risks through its loan and investment policies and loan review procedures. Management establishes and continually reviews lending and investment criteria and approval procedures that it believes reflect the risk sensitive nature of the Bank . The loan review procedures are set to monitor adherence to the established criteria and to ensure that on a continuing basis such standards are enforced and maintained. Management’s objective in establishing lending and investment standards is to manage the risk of loss and provide for income generation through pricing policies.

2007 Annual Report at 27 (emphasis added). Again, nothing could have been further from the

truth and these statements were materially false when made.

9 As discussed infra, FAS 5 and FAS 114 govern the recognition for loan losses. FAS 5 governs the collective evaluation of an entity’s loan portfolio for impairment. FAS 114 deals with the impairment of individual loans.

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b. Defective Controls Over Loss Mitigation

111. In addition, as early as 2006, Defendants knew that the Bank was routinely and

systematically violating Tennessee State law by failing to promptly dispose of repossessed

assets. Defendants were aware that the Bank’s internal controls were insufficient to promptly

identify and report past due accounts in a timely manner. As a result, TNCC’s financial

reporting was continuously inaccurate and misstated. As the FDIC Inspector General’s Report

states:

TCB had no repossessed assets as of December 31, 2006. However, by the close of 2007, the bank had repossessed assets of about $7 million consisting primarily of trucks that were leased through the bank’s indirect funding programs. Management attributed the high level of repossessions to increases in fuel costs and the resulting impact on the trucking industry. In addition, due to the structure of the leases through the brokers, the bank was not becoming aware of the problems until the leases were 90 to 120 days past due. Examiners noted that a significant portion of the bank’s repossessions were held in excess of the 6-month maximum period permitted under Tennessee law. TCB subsequently formed a subsidiary called the Tennessee Commercial Asset Services, Inc., to hold repossessed assets beyond the 6-month period allowed by Tennessee law and assist the bank in selling and collecting proceeds from repossessed assets.

FDIC Inspector General’s Report at I-14. These serious violations of the law and lapses in the

Bank’s controls are not mentioned in TNCC’s 2007 Annual Report.

c. Understatement of Risk and Character of Non-Core Deposits

112. In addition, the Defendants Helf, Cox and Sapp also knew that the Bank was

materially understating the amount of deposits it was purchasing on the wholesale internet

market and the associated risks. While the 2007 Annual Report acknowledges that the Bank did

rely on the volatile and risky wholesale deposit market for a portion of its loan funding, the Bank

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systematically misrepresented the scope of the risk and exposure. The 2007 Annual Report

stated:

The Bank also obtains funding in the wholesale deposit market which is accessed by means of an electronic bulletin board. This electronic market links banks and sellers of deposits to deposit purchasers such as credit unions, school districts, labor unions, and other organizations with excess liquidity. Deposits may be raised in $99 or $100 increments in maturities from two weeks to five years. Management believes the utilization of the electronic bulletin board is highly efficient and the average rate has been generally less than rates paid in the local market. Participants in the electronic market pay a modest annual licensing fee and there are no transaction charges. Management has established policies and procedures to govern the acquisition of funding through the wholesale market. Wholesale deposits are categorized as “Purchased Time Deposits” on the detail of deposits shown in this Item 7. Management may also, from time to time, engage the services of a deposit broker to raise a block of funding at a specified maturity date.

Total average deposits in 2007 were $685,063, an increase of $233,828, or 51.82% over the total average deposits of $451,235 in 2006. Average non-interest bearing deposits increased by $2,922, or 15.95%, from $18,325 in 2006 to $21,247 in 2007. Average savings deposits decreased by $5,423 from $12,678 in 2006 to $7,255 in 2007. Average purchased deposits increased by $62,547, or 32.57%, from $192,064 in 2006 to $254,611 in 2007. The average rate paid on purchased deposits in 2007 was 5.28% compared to 4.82% in 2006. Purchased time deposit funding represented 37.27% of total funding in 2007 compared to 33.96% in 2006.

2007 Annual Report at 25 (emphasis added).

113. Nonetheless, TNCC’s management manipulated these numbers in order to hide

the true amount of non-core deposits that the Bank was relying on to fuel its growth. As the

FDIC reported to Defendants in 2006 and 2007, the Bank’s non-core funding dependence was

not fully reflected, due to the fact that the Bank was structuring its purchases to manipulate the

numbers and make the situation look less risky:

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The April 2006 examination report noted that TCB’s Internet deposits represented 52 percent of the bank’s core deposits (which accounted for 67 percent of total deposits). TCB obtained its Internet deposits through an electronic bulletin board that linked banks and sellers of deposits to deposit purchasers, such as credit unions, school districts, labor unions, and other organizations with excess liquidity. TCB purchased its Internet deposits in increments of $99,000, which resulted in a net non-core funding dependence ratio that did not fully reflect the bank’s reliance on potentially volatile funding sources. [Footnote] Net non-core funding dependence ratio is a measurement of noncore liabilities, less short-term investments divided by long-term assets. Internet deposits below $100,000 are classified as core deposits under the UBPR definition, therefore, while Internet deposits may exhibit the characteristics of non-core deposits, they are not reflected in the net non-core funding dependence ratio.


2. False Statements Concerning TNCC’s Operations in 2008

114. On March 16, 2009, TNCC filed its 2008 Annual Report on Form 10-K, which

falsely stated that there were no material deficiencies in the internal controls of the Bank,

including, but not limited to underwriting and investment recovery procedures. Tennessee

Commerce Bancorp, Inc., Annual Report (Form 10-K), at F-2 (March 16, 2009) (the “2008

Annual Report”). The 2008 Annual Report also falsely underreported the Bank’s reliance on

non-core, “wholesale” or “purchased time deposits,” which are extremely volatile and have a

disproportionate effect on the Bank’s liquidity. Furthermore, the 2008 Annual Report failed to

inform investors that the Bank had not developed a capital plan, which would govern the high

asset growth - and simultaneous explosion in risk - that the bank was experiencing, due primarily

to the concentration of the Bank’s lending in the C&I space. The 2008 Annual Report was

signed by Defendants Helf, Sapp, Perez and Cox. In addition, Defendants Helf and Perez each

signed false SOX Certifications representing that the 2008 Annual Report was free from

misstatement and TNCC’s internal controls were sufficient and effective.

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115. As the 2008 Annual Report falsely stated in pertinent part:

Management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, conducted an assessment of the effectiveness of the Corporation’s system of internal control over financial reporting as of December 31, 2008, based on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that the Corporation maintained effective internal control over financial reporting as of December 31, 2008.

2008 Annual Report, at F-2. For the reasons set forth below, TNCC’s internal control were not

effective or maintained in a reasonable manner during fiscal year 2008, therefore, these

statements were knowingly false when made.

a. Undisclosed Lack of Effective Controls Over Loss Mitigation

116. The 2008 Annual Report failed to inform investors that the Bank’s controls

concerning asset recovery, i.e. , the repossession and sale of seized assets, were essentially

nonexistent. Not only was the Bank routinely and systematically violating Tennessee law, the

failure to report—or late reporting of—defaults and associated repossessions had a material

impact on the Bank’s financial reporting and should have triggered increases in loan loss

reserves, see infra. As the FDIC Inspector General reported regarding the 2008 examination of

the Bank:

Examiners noted an increase in repossessed assets—primarily trucks that were leased through the bank’s lease pool program. These repossessions resulted in an apparent violation of Tennessee law because a significant portion of the repossessions were held by the bank in excess of the 6-month maximum permitted by state statute.

FDIC Inspector General Report at I-25. The failure to disclose such a serious and ongoing

breach of internal controls and the law left investors with a false impression of the Bank and its

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operational controls, which were described as effective and conservative in the 2008 Annual

Report.

b. Failure to Fully Disclose Risks Associated with Increased Loan Concentration

117. As the FDIC Inspector General’s Report sets forth, beginning in 2008, TNCC was

admonished by the FDIC to begin closely evaluating and reviewing its assets in order to comply

with applicable GAAP rules, governing the recognition of loan and lease losses. Of particular

concern to the Bank’s examiners was the extremely high concentration of the Bank’s assets in

the C&I space. The FDIC noted that not only had the Bank failed to develop and implement a

“capital plan” which would help the bank deal with its overconcentration risk issues, the Bank

had also failed to adjust its loan loss reserves to account for an explosion in its C&I lending:

Specifically, the April 2008 examination report stated that: . . . The Board did not develop a capital plan as recommended in the prior-year examination report. . . . Strategic planning needed to be strengthened. Specifically, TCB’s Board had not reviewed the bank’s strategic plan on an annual basis and the plan had not been amended to reflect the changes in the bank’s activities. . . . TCB’s C&I concentration at year-end 2007 was 539 percent of total capital (which placed TCB in the 99th percentile of its peer group). . . . Examiners noted that the bank’s sustained high asset growth, which ranked in the 96th percentile compared its peer group average at year-end 2007, continued to erode the bank’s capital position. Examiners again recommended that the Board adopt a written capital plan.

FDIC Inspector General’s Report at I-25. In other words, ranking in the 99th and 96th percentile

for C&I concentration and asset growth, it was knowingly reckless for the Board not to

effectively manage the Bank’s risk by crafting, adopting and implementing a reasonable capital

plan. No such plan was implemented and the Bank’s reckless growth and adoption of

unreasonable risk continued. None of this information was disclosed to investors.

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c. Failure to Fully Disclose the Amount and Risk Profile of Non-Core Deposits

118. In addition, the Defendants Helf, Cox, Perez and Sapp were fully aware that

amount and risk of deposits being purchased by the Bank on the wholesale internet market were

materially understated. While the 2008 Annual Report acknowledges that the Bank did rely on

the volatile and risky wholesale deposit market for a portion of its loan funding, the Bank

systematically misrepresented the scope of the risk and exposure. The 2008 Annual Report

stated:

The Bank also obtains funding in the wholesale deposit market which is accessed by means of an electronic bulletin board. This electronic market links banks and sellers of deposits to deposit purchasers such as credit unions, school districts, labor unions, and other organizations with excess liquidity. Deposits may be raised in $99 or $100 increments in maturities from two weeks to five years. Management believes the utilization of the electronic bulletin board is highly efficient and the average rate has been generally less than rates paid in the local market. Participants in the electronic market pay a modest annual licensing fee and there are no transaction charges. Management has established policies and procedures to govern the acquisition of funding through the wholesale market. Wholesale deposits are categorized as “Purchased Time Deposits” on the detail of deposits shown in this Item 7. Management may also, from time to time, engage the services of a deposit broker to raise a block of funding at a specified maturity date.

Total average deposits in 2008 were $949,005, an increase of $263,942, or 38.53% over the total average deposits of $685,063 in 2007. Average non-interest bearing deposits increased by $2,097, or 9.87%, from $21,247 in 2007 to $23,344 in 2008. Average savings deposits decreased by $724 from $7,255 in 2007 to $6,531 in 2008. Average purchased deposits increased by $200,443, or 78.73%, from $254,611 in 2007 to $455,054 in 2008. The average rate paid on purchased deposits in 2008 was 4.50% compared to 5.28% in 2007. Purchased time deposit funding represented 47.95% of total funding in 2008 compared to 37.27% in 2007.

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2007 Annual Report at 27 (emphasis added). The foregoing statement is false, in that it

underreported the amount of purchased deposits that the Bank held on its books. As the FDIC

Inspector General’s Report concluded, the Bank was routinely purchasing internet deposits in

amounts under $100,000, which are classified as “core” deposits, although they exhibit the

characteristics of non-core assets. See FDIC Inspector General’s Report at I-18. Non-core

deposits are extremely risky, exhibiting “increased volatility when interest rates change and

difficulty accessing such funds when the financial condition of an institution deteriorates.” Id. at

I-17.

119. Finally, the 2008 Annual Report failed to disclose continued violations of policy

and law that had plagued the Bank’s ALCO. In the 2007 Annual Report, the Bank had disclosed

that internal controls were ineffective concerning the ALCO, which had not met in 2007. In

2008 Defendants took their deception further, apparently fabricating committee minutes in

violation of Tennessee Law:

[T]he April 2008 examination report stated that: The bank’s Asset/Liability Committee had not met on a regular basis since the prior regulatory examination. However, “minutes” of what were actually “very informal discussions” among the Committee members were inappropriately submitted to the Board. The examination report stated that the minutes “appear to be false and misleading statements provided in reports to the Board” and that they had the potential to mislead the directorate as well as examiners that review Board meeting documentation. The report cited TCB with an apparent violation of Tennessee Code Annotated Section 45-2-1706—Improper Maintenance of accounts—False or deceptive entries and statements.


3. False and Misleading Statements Concerning Operations in 2009

120. TNCC and the Bank continued to run off the rails in 2009. In 2009, the Bank’s

outstanding loan balance grew unrestrained—by over $310 million or 39% from the previous

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year—while internal controls over loan underwriting and originations went unsupervised and

unenforced. At the same time, the bank became ever more illiquid, originating massive amounts

of loans without adhering to responsible underwriting guidelines, while failing to earn sufficient

revenues or recoup losses sufficient to support operations or bolster the Bank’s cash-strapped

balance sheet. This information, however, was not revealed in any truthful or meaningful way to

TNCC’s investors.

121. The 2009 annual report was filed with the SEC on March 9, 2010, and similar to

previous years, contained numerous misstatement and omissions concerning the Bank’s internal

controls, financial reporting and compliance with relevant underwriting policies and applicable

laws. See Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K) (Mar. 9, 2010) (the

“2009 Annual Report”). 10 Among other things, the 2009 Annual Report: (a) falsely represented

that the Bank’s internal controls were sufficient, effective and enforced; (b) misrepresented the

quality and risk profile of the Bank’s assets; and (c) falsely reported the Bank’s financial results,

due to the knowing violation of GAAP rules.

122. The 2009 Annual Report was signed by Defendants Helf, Sapp, Cox and Perez.

In addition, Defendants Sapp and Perez each signed false SOX Certifications representing that

the 2008 Annual Report was free from misstatement and TNCC’s internal controls were

sufficient, effective and enforced.

10 The 2009 Annual Report filed on March 9, 2010 was later amended. As the amended annual report states, it was filed in order to make three categories of minor corrections, none of which concern the allegations herein. See Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K/A), at 2 (May 27, 2010). All references to the “2009 Annual Report” are to the original report on Form 10-K filed on March 9, 2010.

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123. As in previous years, TNCC’s annual report contained a false and fraudulent

statement certifying that TNCC maintained and administered effective internal controls over

financial reporting during that year. Tennessee Commerce Bancorp, Inc., Annual Report (Form

10-K), at F-2 (Mar. 9, 2010) (“Management, with the participation of the Corporation’s Chief

Executive Officer and Chief Financial Officer, conducted an assessment of the effectiveness of

the Corporation’s system of internal control over financial reporting as of December 31, 2010,

based on criteria for effective internal control over financial reporting described in ‘Internal

Control—Integrated Framework,’ issued by the Committee of Sponsoring Organizations of the

Treadway Commission. Based on this assessment, management believes that the Corporation

maintained effective internal control over financial reporting as of December 31, 2010.”).

a. Undisclosed Lack of Effective Loan Underwriting and Administration Controls

124. In the 2009 Annual Report, Defendants knowingly misrepresented the almost

complete lack of internal controls at the bank in 2009 concerning both the origination and

financial accounting for loans—the Bank’s only assets. Nonetheless, the Bank continued to

originate hundreds-of-millions of dollars’ worth of new loans in 2009—originating over $90

million in new loans during the first quarter of 2009 alone—despite the fact that the economy

had slowed and the Bank’s concentration of loans in the C&I space represented a growing risk to

liquidity. As the FDIC noted:

[In 2009] TCB’s loan portfolio had grown by $310 million (or 39 percent) since the prior examination. Examiners suggested that the Board consider suspending or curtailing its growth strategy while evaluating the systemic risk to the institution. Examiners further suggested that management consider establishing concentration criteria relative to capital in order to manage the bank’s significant industry exposure and concentration risk, as had been done by regulatory agencies related to CRE lending. While the bank

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demonstrated awareness of the concentrations as a percentage of capital, examiners noted that the financial condition of the bank was highly sensitive to economic conditions, and recommended that the Board and management carefully consider additional strategies to further mitigate concentration risk going forward.

FDIC Inspector General’s Report at I-27. Such an explosion in loan origination alone—

particularly at a time when the economy was contracting—would pose additional material risk to

the Bank. However, the failure of the Bank to sufficiently monitor, verify and report the risk

quality of the loans being originated magnified the risk.

125. During its 2009 examination of the Bank, the FDIC discovered that the Bank had

been systematically originating loans without proper or sufficient documentation—in violation of

the Bank’s lending and underwriting guidelines. As the FDIC Inspector General’s examination

of the Bank in 2009 observed:

Examiners noted that although the [Bank’s written loan origination] policy was adequate, lax underwriting, administration, and monitoring practices were evident. For example, examiners noted instances in which credit reports were not obtained prior to loan origination, global cash flow analyses were not performed, LTVs were high, and financial information on borrowers was missing.

* * *

The June 2009 joint examination report suggested that refresher training be provided for all employees with loan authority or who had responsibility for credit documentation to reinforce the importance of strong credit practices in a declining economy. The report added that implementing a credit culture consistent with the then current economic environment that was evident through Tennessee and the nation, as well as reassessing the organization’s risk appetite, would be a prudent plan of action.

FDIC Inspector General’s Report at I-27. In other words, the Individual Defendants were aware,

at least as early as 2009 that the Bank was originating the functional equivalent of commercial

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sub-prime, stated income loans almost two years after the worst economic disaster in U.S.

economic history had been triggered by the very same types of loans on residential properties.

126. At the same time, the Individual Defendants described the Bank—both in the

2009 Annual Report and other contemporaneous statements—as well run and well capitalized,

with very little exposure to risk. For example, during the earnings call discussing financial

results for the first fiscal quarter of 2009, Defendant Perez, CFO of TNCC falsely stated:

[sic] We have discussed on prior calls, Tennessee Commerce does not have any exposure to subprime loans. We believe our diversified loan portfolio insulates us in part from the effects of any single economic sector.

Tennessee Commerce Bancorp, Inc., Q1 2009 Earnings Call, Bloomberg Transcript, at 4 (Apr.

29, 2009). Not only was this statement knowingly false on one level— i.e. , the Bank was

originating subprime loans, but the loan portfolio was not sufficiently diversified, with extremely

high concentration risk in the C&I lending space. See FDIC Inspector General’s Report at I-27.

127. The effect on the Bank’s capital position resulting from the Individual

Defendants’ failure to maintain sufficient underwriting controls was immediately apparent to the

FDIC. As the Inspector General’s Report states:

Examiners noted that adverse loan and lease classifications had quadrupled since year-end 2007, delinquent loans had increased nearly two-fold, and loans charged off had increased substantially.

Notably, six borrowing relationships (not including Relationship A) accounted for 44 percent of adversely classified loans. Examiners attributed a sizeable portion of adverse loan classifications, including small indirect loans, to slowing economic conditions in the trucking and tour bus industries. As a result of the bank’s less-than satisfactory asset quality, earnings were insufficient to support operations or augment capital. Examiners also found that liquidity needed improvement, adding that liquidity contingency plans emphasizing potential asset-based sources of

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liquidity needed to be developed given the bank’s financial condition.

FDIC Inspector General’s Report at I-26 to 27.

b. The Materially Misstated Allowance for Loan and Lease Losses and Related GAAP Rules

128. The 2009 Annual Report’s most damaging false statements to investors concerned

the Bank’s understated ALLL, which is perhaps the most valuable tool for evaluating the risk

profile of a banking investment. The ALLL is described by the Board of Governors of the

Federal Reserve System as follows:

The purpose of the ALLL is to reflect estimated credit losses within a bank’s portfolio of loans and leases. Estimated credit losses are estimates of the current amount of loans that are probable that the bank will be unable to collect given the facts and circumstances since the evaluation date (generally the balance sheet date). That is, estimated credit losses represent net charge- offs that are likely to be realized for a loan or group of loans as of the evaluation date. The ALLL is presented on the balance sheet as a contra-asset account that reduces the amount of the loan portfolio reported on the balance sheet.

Board of Governors of the Federal Reserve System, Supervisory Policy and Guidance Topics:

Allowance for Loan and Lease Losses (ALLL),

http://www.federalreserve.gov/bankinforeg/topics/alll.htm . An increase in the ALL is

accompanied by a corresponding decrease in a bank’s operating income, reflected on the income

statement. Department of the Treasury, Office of the Comptroller of the Currency, Allowance

for Loan and Lease Losses, at 1, Comptroller’s Handbook (May 1998) (“The [ALLL], which

was originally referred to as the ‘reserve or bad debts,’ is a valuation reserve established and

maintained by charges against the bank’s operating income.”). Accordingly, any increase in the

ALLL will be reflected in a bank’s earnings, making such an adjustment immediately obvious to

investors and reflecting an increase in the risk profile of the bank’s investments. See id .

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(“Bank’s must establish an allowance for loan and lease losses because there is credit risk in their

loan and lease portfolios. The allowance, which is a valuation reserve, exists to cover the loan

losses that occur in the loan portfolio of every bank. As such, adequate management of the

allowance is an integral part of a bank’s credit risk management process. ”) (emphasis in

original).

129. In 2009, according to the FDIC’s examination, TNCC had adversely classified

assets of $95 million, which accounted for approximately 75% of the Bank’s Tier 1 capital.

According to the FDIC’s criteria, “adversely classified assets” are defined as:

Assets subject to criticism and/or comment in an examination report. Adversely classified assets are allocated on the basis of risk (lowest to highest) into three categories: Substandard, Doubtful, and Loss.

FDIC Inspector General’s Report at I-42. Under the GAAP rules governing the ALLL, the

probable losses on all of those adversely classified assets should have been accurately estimated

and accrued as loan losses, including a charge to the income statement in the amount of the

expected losses. They were not.

130. Indeed, for the entire year of 2009, TNCC recognized only $19 million in accrued

losses. At the same time, net charge-offs for 2009 had increased by 400% (from $5.9 million to

$24.6 million), but the TNCC’s allowance for loan and lease losses only increased by only 32%

or approximately $6.5 million. The failure of TNCC to adjust the ALLL to adequately account

for the extraordinary inherent risk of the Bank’s asset profile represented a knowing, blatant and

ongoing breach of applicable GAAP rules, including FAS 5 and FAS 114.

131. Working together, GAAP rules applicable to loan and lease losses provide a

cohesive methodology for adjusting the book value of such assets once losses are probable. The

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primary GAAP rules which make up the ALLL are FAS 5 and FAS 114. FAS 114 governs

accounting for losses on individual loans which have been reviewed and it has been determined

that the creditor (here, the Bank) will be unable to collect all of the amounts which are due

according to the contractual terms of the loan agreement. See United States Department of the

Treasury, Comptroller of the Currency Administrator of National Banks, Comptroller’s

Handbook: Allowance for Loan and Lease Losses, at 6 (May 17, 2012),

http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/alll.pdf . Like

FAS 114, FAS 5 governs accounting for losses on a group of assets when losses are probable and

can be estimated; however, FAS 5 applies to a homogeneous group of loans which are classified

after a FAS 5 review of individual loans has been conducted. See United States Department of

the Treasury, Office of the Comptroller of the Currency, Interagency Policy Statement on the

Allowance for Loan and Lease Losses, SR 06-17, at 5 (Dec. 13, 2006),

http://www.federalreserve.gov/boarddocs/srletters/20060SR0617a1.pdf.

132. FAS 5, which is part of the GAAP rules, requires that loss contingencies be

recognized by a charge to income if both of the following conditions are met:

(a) Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.

(b) The amount of loss can be reasonably estimated.

Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 5:

Accounting for Contingencies, Financial Accounting Foundation (March 1975).

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133. FAS 114 deal specifically with the impairment of a particular loan and is also part

of the GAAP rules. According to FAS 115:

A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. As used in this Statement and in Statement 5, as amended, all amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. This Statement does not specify how a creditor should determine that it is probable that it will be unable to collect all amounts due according to the contractual terms of a loan. A creditor should apply its normal loan review procedures in making that judgment. An insignificant delay or insignificant shortfall in amount of payments does not require application of this Statement. A loan is not impaired during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Thus, a demand loan or other loan with no stated maturity is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding.

Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 114:

Accounting by Creditors for Impairment of a Loan, Financial Accounting Foundation (May

1993).

134. Working together FAS 5 and 114 provide a framework whereby responsible bank

managers may timely identify and recognize loan losses, before those loans are actually charged

off. This provides potential investors with a picture of a bank’s risk profile at any given time and,

particularly in times of economic turmoil—such as were present in the US economy in 2009—

allows investors to identify banks with particular risk investments or classes of investments.

135. Defendants knowingly violated the above rules by underestimating accrued loan

losses in order to: (1) falsely inflate their earnings during the Class Period, earnings which would

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have been adversely affected by an increase in loan loss reserves; and (2) give the illusion of a

much lower risk profile than the bank had in reality, due to a lack of internal controls and

inadequate, unenforced and unmonitored underwriting guidelines. As noted above, the upshot of

this knowing deception was to ensure that the Individual Defendants would continue to receive

the excessive and lavish compensation that they had granted themselves, while they were

simultaneously defrauding investors running the Bank into the ground.

136. Defendants intentionally and repeatedly failed to either implement or enforce

sufficient controls to effectively identify, evaluate and recognize loan losses in accordance with

the above-referenced GAAP rules. As the interagency Policy Statement on Allowance for Loan

and Lease Losses Methodologies and Documentation for Banks and Savings Institutions (the

“Policy Statement”) states:

Boards of directors of banks and savings institutions are responsible for ensuring that their institutions have controls in place to consistently determine the allowance for loan and lease losses (ALLL) in accordance with the institutions’ stated policies and procedures, generally accepted accounting principles (GAAP), and ALLL supervisory guidance. To fulfill this responsibility, boards of directors instruct management to develop and maintain an appropriate, systematic, and consistently applied process to determine the amounts of the ALLL and provisions for loan losses. Management should create and implement suitable policies and procedures to communicate the ALLL process internally to all applicable personnel. Regardless of who develops and implements these policies, procedures, and underlying controls, the board of directors should assure themselves that the policies specifically address the institution’s unique goals, systems, risk profile, personnel, and other resources before approving them. Additionally, by creating an environment that encourages personnel to follow these policies and procedures, management improves procedural discipline and compliance.

Federal Financial Institutions Examination Council, Policy Statement on Allowance for Loan

and Lease Losses Methodologies and Documentation for Banks and Savings Institutions, at *5

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(July 2, 2001). The Individual Defendants consistently failed to either develop or maintain

appropriate systems for the recognition of losses on a timely basis, resulting in materially

misstated financial statements, including an exaggerated Tier 1 Capital Ratio and a materially

understated ALLL.

137. Following its June 2009 joint examination with the TDFI, the FDIC determined

that the Bank was in “troubled condition” and that 75% of the Bank’s Tier 1 Capital—or $95

million worth of loans—qualified as adversely classified. Under FAS 5 and 114, it was

incumbent on the Bank to undertake a thorough examination of all of those adversely classified

assets in order to determine whether any of them were sufficiently impaired to require an

increase in the ALLL. However, “lax underwriting, administration, and monitoring” led to a

lack of oversight of the loan profile and an insufficient ALLL. FDIC Inspector General’s Report

at I-27. A lack of documentation compounded matters, because even if proper FAS 5 and 114

review of the loan profile taken place, “a lack of current financial information on borrowers”

would prevent an accurate assessment of the risk of the Bank’s assets. See id .

138. Indeed, at the same time that the FDIC was warning the Bank that the risk profile

of the loan portfolio was increasing and monitoring by management was deficient, Defendants

actually decreased the ALLL, proclaiming their triumph over the perceived risk in the Bank’s

portfolio: “’Our provision for loan losses is down significantly from earlier this year due to our

aggressive stance on managing problem loans,’ noted Mr. Sapp.” Tennessee Commerce

Bancorp, Inc., Current Report (Form 8-K), Ex. 99.1, at *2 (Oct. 20, 2009) (emphasis added).

139. Similarly, on January 19, 2010, TNCC issued a press release, trumpeting false and

misleading financial results and improved credit quality for the fourth quarter of fiscal year 2009.

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Ex. 99.1. As the press release, which was filed with the SEC as an exhibit to a current report on

January 20, 2010, stated:

“Tennessee Commerce’s fourth quarter results highlight the progress we made in growing our net interest income, expanding net interest margin and improving credit quality this year,” stated Mike Sapp, President and Chief Executive Officer of Tennessee Commerce Bancorp. “Our earnings gained momentum in the fourth quarter and marked our highest level of net interest income, operating income and net income this year despite the continued weakness in the economy.

“We made substantial progress in improving our credit quality during the second half of 2009,” continued Mr. Sapp. “Total nonperforming loans dropped 32.2% to $20.5 million compared with $30.2 million in the third quarter of this year and were at their lowest level in the past five quarters. The continued improvement in credit quality was reflected in our reporting the lowest level of net charge-offs this year. We believe our excellent results highlight our focus on the business banking market as well as the strength of our core market in Middle Tennessee.”

Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex. 99.1, at *1 (Jan. 20, 2010).

TNCC’s “credit quality” had not improved in the second half of 2009 and the Bank’s insufficient

controls over financial reporting and the evaluation of risk in the loan portfolio rendered

statements concerning “nonperforming loans,” “charge-offs” and the Bank’s ALLL wholly false

and misleading. See FDIC Inspector General’s Report at I-27. The Bank’s financial condition

had not improved in the fourth quarter of 2001. In fact, the FDIC had previously informed

TNCC that its examination had revealed that the Bank had adversely classified assets of $95

million, which accounted for approximately 75% of the Bank’s Tier 1 capital. See id . at I-15.

Moreover, the FDIC had expressed serious concerns over the evaluation and documentation of

risk at the Bank, lax underwriting practices (in violations of the Bank’s loan policies) and a

deterioration of the Bank’s loan portfolio. See, e.g. , FDIC Inspector General’s Report at I-27

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(“As a result of the bank’s less-than-satisfactory asset quality, earnings were insufficient to

support operations or augment capital.”).

c. Insufficient and Ineffective Controls Over Loss Mitigation

140. In addition, the 2009 Annual Report continued to misstate the efficacy of the

Bank’s controls regarding loss mitigation and repossessions. The 2009 Annual Report falsely

provided investors with the illusion of an orderly and strictly monitored and administered loss

mitigation process:

Other Real Estate and Repossessed Assets: Real estate acquired by foreclosure is carried at the lower of the recorded investment in the property or its fair value, less costs to sell, at the date of foreclosure, determined by appraisal. Declines in value indicated by reappraisals as well as losses resulting from disposition are charged to operations. Subsequent costs are expensed as they occur after any re-acquisitions. Other real estate owned is included in other assets on the balance sheet, with a carrying value of approximately $814,000 and $5,764,000 in 2009 and 2008, respectively. Repossessed assets acquired by foreclosure are carried at the lower of the recorded investment in the asset or its estimated fair value. Declines in value indicated by reappraisals as well as losses resulting from disposition are charged to operations. These repossessed assets are either disposed of by the Bank or sold to TCB. Subsequent costs are expensed as they occur after any re-acquisitions. Repossessions are included in other assets on the balance sheet, with a carrying value of approximately $27,169,000 and $10,694,000 in 2009 and 2008, respectively. If a repossession of the Bank is not resold within the six month holding period allowed by Tennessee law, it is purchased by TCB at fair market value. The sole purpose of TCB is the resale of assets repossessed by the Bank. At December 31, 2009 and 2008, TCB carried approximately $9,782,000 and $4,701,000, respectively, and nothing in prior years on its balance sheet. TCB carries these purchases as inventory.

2009 Annual Report at F-10.

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141. In reality, repossessions at the Bank continued to be conducted in violation of

Tennessee law and with virtually no oversight by executive management or the Board. As the

FDIC Inspector General’s report states:

TCB did not have adequate loss mitigation policies and procedures to monitor the repossession and timely disposition of collateral. TCB often relied on various third-party dealers and brokers for payment collection and collateral repossession services. It does not appear that the bank adequately understood, assessed, or monitored the risk exposure related to these third-party relationships. For example, we observed an instance in which a single broker was servicing over 1,100 leases valued at over $58 million, yet the broker had only 4 employees performing collection services. This suggests an inadequate infrastructure that may have limited the broker’s ability to support and service a labor intensive lease portfolio on behalf of TCB. To further illustrate management’s inadequate monitoring of broker relationships, an examiner loan review of a broker relationship at the 2009 joint examination noted numerous deficiencies, including but not limited to, a lack of a physical on-site collateral inspection, a lack of a formalized agreement between TCB and the broker, and a potential conflict of interest involving used tractor/trailer sales and inventory.

FDIC Inspector General’s Report at I-14 to I-15. The undisclosed loss mitigation deficiencies,

particularly when considered in conjunction with the increase in risk of the loan portfolio and lax

underwriting controls, represent a material misstatement, which would grow in importance as the

condition of the Bank worsened.

d. Undisclosed Regulatory Action

142. The 2009 Annual Report also failed to disclose actions that the FDIC had

undertaken following the conclusion of the June 2009 examination of the Bank. As noted above,

in a letter dated October 8, 2009, the FDIC informed the Bank that it was deemed to be in

“troubled condition” and instructed the Board and management of the Bank to “administer the

bank in such a way as to stabilize its risk profile and strengthen its financial condition.” FDIC

Inspector General’s Report at I-27. Defendants did no such thing.

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143. Further, the FDIC’s letter of October 8, 2009 informed Defendants that, following

a join examination by the FDIC and the Tennessee Department of Financial Institutions

(“TDFI”) in June of 2009, not only was the Bank deemed to be in a “troubled condition,” but that

“informal corrective action would be recommended to the RMS Regional Director.” FDIC

Inspector General’s Report at I-27. The 2009 Annual Report does not mention the October 8,

2009 letter, nor does it mention the corrective measures that had been proposed by the FDIC.

Instead, the Annual Report includes only a misleading boilerplate acknowledgement that at some

point in the future the bank might be subject to potential corrective actions by regulators at some

amorphous point in the future:

Our bank subsidiary is not currently under, nor does management expect it to be placed under, a formal enforcement action. Nonetheless, we can provide no assurance that we will not become subject to a regulatory action, possibly including a memorandum of understanding, cease and desist order, prompt corrective action and/or other regulatory enforcement action.

2009 Annual Report at 11.

4. False and Misleading Statements Concerning Fiscal Year 2010

144. In 2010, as the Bank’s liquidity position was becoming more tenuous and the

quality of its poorly underwritten loan profile was deteriorating, it was even more incumbent on

Defendants to keep up the appearances of the Bank as a well-managed, well-capitalized,

financial institution - which Defendants did by continuing their false and misleading statements

to investors.

145. As in previous years, TNCC’s annual report contained a false and fraudulent

statement certifying that TNCC maintained and administered effective internal controls over

financial reporting during that year. Tennessee Commerce Bancorp, Inc., Amendment No. 3 to

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Annual Report (Form 10-K/A), at F-2 (June 2, 2011) (“Management, with the participation of

the Corporation’s Chief Executive Officer and Chief Financial Officer, conducted an assessment

of the effectiveness of the Corporation’s system of internal control over financial reporting as of

December 31, 2010, based on criteria for effective internal control over financial reporting

described in ‘Internal Control—Integrated Framework,’ issued by the Committee of Sponsoring

Organizations of the Treadway Commission. Based on this assessment, management believes

that the Corporation maintained effective internal control over financial reporting as of

December 31, 2010.”)

a. Undisclosed Regulatory Activity and Results of Regulatory Examinations

146. On October 8, 2009, the FDIC notified the TNCC Board that the Bank had been

deemed to be in “troubled condition” as a result of the joint examination performed by the FDIC

and TDFI in June of 2009. The letter went on to instruct the Bank’s Board and Management to

“administer the bank in such a way as to stabilize its risk profile and strengthen its financial

condition.” FDIC Inspector General’s Report at I-27. The October 8, 2009 letter also warned

that the FDIC would seek informal corrective action.

147. As eluded to in the FDIC’s October 8, 2009 letter to the Board, the FDIC

transmitted a draft Memorandum of Understanding (“MOU”) to the TNCC Board on January 21,

2010, seeking a number of remedial measures in order to stabilize the Bank’s financial condition.

Among other things, the MOU proposed by the FDIC requested that:

submit a capital plan to achieve and maintain Leverage, Tier 1 Risk-Based, and Total Risk-Based capital ratios of 9 percent, 11 percent, and 13 percent, respectively;

prohibit salary increases or bonus payments for top executive managers or loan officers without the prior written

83


approval of the Regional Director and the TDFI Commissioner until the bank could achieve sustained profitability;

• formulate, adopt, and submit a written plan of action to address the bank’s volatile liability dependence ratio;

• approve a revised internal credit grading system for internal loan review purposes;

• develop a written plan to reduce the level of nonperforming assets, repossessions, and assets classified adversely at the June 2009 joint examination;

• restrict additional advances to any borrower for whom the bank holds an uncollected charged-off asset or whose extension of credit is adversely classified; and

• restrict asset growth to 10 percent during any consecutive 6- month period without providing a growth plan to regulators.

FDIC Inspector General’s Report at I-20 to I-21.

148. Nonetheless, Defendants rejected the MOU, knowingly and recklessly ignoring

the mismanagement objected to by the FDIC and TDFI and continuing on a path to the Bank’s

ultimate failure. The primary reason for Defendants unwillingness to enter into the MOU

appears to be that it would have restricted the ability of the Bank to increase the salaries,

bonuses, benefits and perks enjoyed by Defendants Helf, Cox, Sapp and Perez. Defendants

never entered into an MOU with the FDIC and many, if not all, of the FDIC and TDFI’s

concerns went entirely unaddressed. 11

11 Instead the Bank attempted to mollify the FDIC by passing an insufficient and toothless Board resolution, which did not address and did not correct the serious violations of controls, policy and law addressed by the FDIC’s proposed MOU. See FDIC Inspector General’s Report at I-21 (“TCB’s Board never signed an MOU with the FDIC and TDFI, and many of the objectives and goals of the proposed MOU were not met.”).

84


149. Defendants concealed the FDIC and TDFI’s conclusions from investors and, in

fact, made no mention whatsoever of the MOU or the FDIC’s intention to bring an enforcement

action until November of 2010—more than a full year following the FDIC’s October 9, 2009

letter. See supra. In fact, it was not until November of 2011, upon the issuance of TNCC’s 10-Q

for the third fiscal quarter of 2010, that any impeding action by the FDIC against TNCC was

even mentioned. See Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 33

(Nov. 12, 2010). When the proposed FDIC/TDFI action was mentioned to investors, the full

gravity of the situation was not materially disclosed. For example, the quarterly report filed on

November 12, 2010 failed to inform shareholders that the FDIC had requested that the Bank

enter into an MOU at all, simply stating that: “no MOU has been entered into by the bank.” Id.

Next, the November 12, 2010 Quarterly Report failed to set forth the reasons behind the FDIC’s

request that the Bank enter into an MOU in the first instance. See id . Finally, and perhaps most

significantly, the November 12, 2010 Quarterly Report failed to inform shareholders of the

reasons why the Individual Defendants did not want to agree to the FDIC’s proposed MOU—

namely, the fact that their own personal compensation would have been greatly curtailed. See id .

150. In April of 2010, the FDIC and TDFI performed a joint visitation, following up on

the recommendations that were made in the proposed—but never executed—MOU. While the

FDIC noted some modest improvements, the Bank’s situation was still precarious and financial

reporting and loss mitigation controls were still insufficient:

The visitation noted some progress, but the overall condition of the bank remained less than satisfactory. Notably, the balance of repossessed assets had more than doubled, and earnings continued to suffer from high provision expenses. Examiners also found that the bank’s credit grading, administration, and underwriting practices related to Relationship A were questionable and that additional information regarding the debt service ability, collateral

85


valuation, and ownership of pledged collateral was needed to fully assess the risk associated with the relationship.

FDIC Inspector General’s Report at I-28. The Quarterly Report filed by TNCC on May 7, 2010

noted no weaknesses in the Bank’s financial reporting, credit underwriting or loss mitigation

controls. See Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 23 (May 7,

2010) (“Management is responsible for ensuring that controls are in place to ensure the adequacy

of the loan loss reserve in accordance with GAAP, our stated policies and procedures, and

regulatory guidance.”)

151. The 2010 Annual Report, filed on April 18, 2011, misleadingly attempted to

downplay the seriousness of the FDIC’s examination and related informal enforcement action at

the end of 2009/2010, including the FDIC’s request that TNCC enter into an MOU. Indeed,

many of the statements made in the 2010 Annual Report concerning the FDIC and its regulation

of the bank are misleading, while others are outright falsities. For instance, the 2010 Annual

Report states that “as of March 17, 2011, the Bank [had been] deemed to be in troubled

condition.” Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at 7, 19 (April 18,

2011) (the “2010 Annual Report"). 12 In reality, the FDIC had deemed the Bank to be in

“troubled condition” as of October 8, 2009, when the FDIC sent a letter to the Bank’s Board

advising them of that fact.

12 The 2010 Annual Report was later amended on April 18, 2011, June 1, 2011 and June 2, 2011. The April 18, 2011 amendment was made to correct a typographical error. The June 1, 2011 amendment was made purportedly to disclose the consent order entered with the FDIC on May 25, 2011. Tennessee Commerce Bancorp, Inc., Amended Annual Report (Form 10-K/A), at *2 (June 1, 2011). Finally, the June 2, 2011 amendment was made to include a report of TNCC’s accountant. Tennessee Commerce Bancorp, Inc., Amended Annual Report (Form 10-K/A), at *2 (June 2, 2011). With those exceptions, the 2010 Annual Report was not modified in any way and, unless otherwise noted, all citations to the 2010 Annual Report are to the initial report filed with the SEC on April 18, 2011. See id .

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b. The Materially Understated ALLL

152. In addition, Defendants attempted to characterize the FDIC’s suggested $16

million increase in the ALLL at the end of 2009 as unreasonable. Defendants knowingly and

falsely stated that the $16 million increase in the ALLL was not necessary—when they well-

knew it was. Indeed, a materially higher ALLL was necessary given the known deterioration in

the Bank’s loan profile. As the 2010 Annual Report misleadingly states:

[T]he FDIC and TDFI have advised the Bank because of inadequacies in its allowance for loan and lease losses, and loan impairment methodologies, a restatement of the Bank's allowance for loan and lease losses in its periodic reports to the regulators for the quarters ended December 31, 2009, March 31, 2010 and June 30, 2010 should be restated. Although the FDIC and TDFI focused on these three reporting periods in the examination, we anticipate that any restatement could also include financial statements for the period ending September 30, 2010. Restatement of the Bank's regulatory periodic reports likely will result in the restatement of the Corporation's financial statements for the same periods and included in this annual report. We strongly disagree with many of the findings in the report of examination, especially the factors giving rise to the need to restate our prior financial statements, primarily due to differences in our loan and lease loss impairment analysis. However, the changes that may be made in the restatement may be material in the quarter made and may be material to the full year period in which the quarterly results are included. FDIC and TDFI have proposed an increase in our allowance for loan and lease losses of up to approximately $16 million, an amount not recognized in the financial statements to this annual report. We do not concur with this amount and our regulators have not provided us with their methodology. Accordingly, if ultimately required, the increase to our allowance for loan and lease losses may differ from the amount our regulators are requiring. In accordance with established procedures of the FDIC and TDFI we plan to vigorously appeal what we believe to be the various inaccuracies contained in the report of examination, including the required impairment charges. While we have 60-days to file an appeal after the receipt of a material supervisory determination, we cannot predict the timing of a final regulatory determination or whether we will prevail.

2010 Annual Report at 19.

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153. In reality, by the time that the 2010 Annual Report was issued in April of 2011,

the Bank’s ALLL should have been much, much higher than an additional $16 million. Due to,

among other things, the FDIC’s continued examination and attempts at enforcement, Defendants

well-knew that it would take much more than $16 million to adequately reflect the tremendous

risk that the Bank’s loan portfolio was exhibiting at that time, rendering the statements regarding

the proposed ALLL increase in the 2010 Annual Report wholly false and misleading.

154. Strikingly, TNCC’s loan loss reserve for 2010 was lower than the ALLL for 2009,

despite the fact that Defendants knew—due to the FDIC and TDFI’s admonishments—that the

Bank’s loan profile had deteriorated to the point of endangering the viability of the Bank. For

example, the press release announcing TNCC’s fourth quarter 2010 financial earnings both

fraudulently described the Bank’s ALLL and gave investors a false view of the financial health

of the Bank:

The increase in non-performing assets to $91.2 million at December 31, 2010 compared to $86.5 million at September 30, 2010 was mainly attributed to one relationship that totaled $3.5 million. Early stage delinquencies at December 31, 2010 improved $14.4 million from September 30, 2010 to 1.5% of total loans. Repossessed assets, consisting primarily of transportation assets, have decreased by 17% from $36.9 million at December 31, 2009 to $30.6 million at December 31, 2010. “While ATA truck tonnage index reports showed softening during the last half of the year, industry indicators point towards a positive rebound in 2011,” stated Mike Sapp, President and Chief Executive Officer of Tennessee Commerce Bancorp, Inc.

The loan loss provision of $3.8 million for the fourth quarter of 2010 was the lowest provision expense recorded since the $3.3 million provision expense for the fourth quarter of 2008. Net charge-offs for the fourth quarter of 2010 amounted to $4.0 million, compared to $5.8 million for the third quarter of 2010. “We are pleased to return to profitability and to see the rebound in our net interest margin. Although non-performing loans increased during the fourth quarter, this was driven by specific larger loans

88


rather than a decrease of overall credit quality. Additionally, we remain focused on enhancing our capital position and reducing the level of credit risk,” stated Mike Sapp.

Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex. 99.1 at *2 (Jan. 21, 2011)

(emphasis added). Similarly, as the 2010 Annual Report falsely stated:

The provision for loan losses in 2010 was $20,011, a decrease of $11,028, or 35.53%, below the provision of $31,039 expensed in 2009. Of this provision, $1,550, or 7.75%, was attributable to loan growth recorded during 2010. The remainder of the loan loss provision in 2010 funded net charge-offs of $18,461. (in millions of dollars.)

2010 Annual Report at 39. The FDIC had alerted Defendants that these statements were false,

yet they were made notwithstanding that admonition. Among other things, the FDIC and TDFI’s

joint August 2010 examination had specifically notified defendants that: (a) “the ALLL

calculation required a more robust FAS 114 and FAS 5 methodology”; (b) that “improved

monitoring of the C&I portfolio, which totaled 465 of Total Risk-Based Capital at the time of

examination” was required; (c) that an immediate minimum “$16.3 million provision to the

ALL was needed to provide for the inherent risk in the loan portfolio ”; and that “Call

Reports for June 30, 2010, March 31, 2010, and December 31, 2009, needed to be amended to

reflect the true financial condition of the bank.” FDIC Inspector General’s Report at I-28

(emphasis added).

155. A fraudulent decrease in the ALLL under circumstances where the Bank’s

adversely classified assets had dramatically rose not only represented a violation of the FDIC’s

warnings, but a blatant and ongoing breach of GAAP rules, namely FAS 5 and FAS 114. In

addition, not only was the ALLL falsely stated, the total amount of charge-offs was fraudulently

understated due to “management’s failure to recognize losses in a timely manner and reflect

89


those losses within the appropriate period result[ing] in inaccurate financial reporting .” FDIC

Inspector General’s Report at I-28 (emphasis added).

156. Nonetheless, the fraudulently understated ALLL and non-existent credit

monitoring at the Bank was cited throughout fiscal year 2010 as an affirmative sign that TNCC

was a well-managed, risk controlled bank that—rather than facing increasing pressure from a

deteriorating loan portfolio—was poised to flourish. As discussed herein, nothing was further

from the truth and the Bank would soon face closure by the FDIC and TDFI. See Tennessee

Commerce Bancorp, Inc., Q2 2010 Earnings Call, Bloomberg Transcript (July 27, 2010) (As

Defendant Sapp stated: “Our provision for the quarter was $4.5 million which exceeded our net

charge-offs of $4.2 million, with our allowance to gross loans remaining at 1.7%. Credit quality

was stable and improving with non-performing loans plus loans over 90 days past due decreasing

1 million from the prior quarter and non-performing assets decreasing to 37.8 million compared

to 41.5 million at March 31.”); Tennessee Commerce Bancorp, Inc., Q2 2010 Earnings Call,

Bloomberg Transcript (July 27, 2010) (As Defendant Perez stated: “The allowance for loan

losses to gross loans of 1.70 remained the same from the linked first quarter.”); Tennessee

Commerce Bancorp, Inc., Q3 2010 Earnings Call, Bloomberg (Oct. 29, 2010) (As Defendant

Perez stated: “The allowance for loan losses as a percentage of loans has increased from 1.70 to

75. This was mainly driven by a quantitative change in our analysis of the pool of non-

performing loans that are not individually reserved for.”); Tennessee Commerce Bancorp, Inc.,

Q4 2010 Earnings Call, Bloomberg Transcript (Jan. 21, 2011) (As Defendant Sapp stated: “We

expect our provision to be slightly higher than our charge-offs, resulting in a slight increase in

our allowance.”); Tennessee Commerce Bancorp, Inc., Q4 2010 Earnings Call, Bloomberg

Transcript (Jan. 21, 2011) (As Defendant Perez stated: “Let me now turn to credit metrics. First

90


of all, the provision for loan losses of $3.8 million provided 93% coverage of the $4.1 million in

charge-offs for the quarter. . . . It is also worth noting that while the provision is still elevated for

the 12 months ended December 31, 2010, it has decreased $11 million from the same period in

2009.”); Tennessee Commerce Bancorp, Inc., Q1 2010 Earnings Call, Bloomberg Transcript

(Apr. 21, 2010) (As Defendant Sapp stated: “Our provision for the quarter was 4.6 million,

which exceed our net charge-offs of 4.4 million with our allowance to gross loans remaining

1.7%.”); Tennessee Commerce Bancorp, Inc., Q1 2010 Earnings Call, Bloomberg Transcript

(Apr. 21, 2010) (As Defendant Perez stated: “[O]ur expenses – including provision expenses –

remain controlled. We continue to provide an excess of net charge-offs and expect quarterly

provision expense over the remainder of the year to be in line with the first quarter.”).

c. The Undisclosed Lack of Internal Controls Over Loan Underwriting, Risky Deposits and Loss Mitigation

157. As in previous years, TNCC’s annual report for fiscal year 2010 included a

number of false and misleading statements, including, but not limited to a statement that

management had implemented, maintained and reviewed effective internal controls during the

year. 2010 Annual Report, at F-2 et seq. As the 2010 Annual Report stated in pertinent part:

Management, with the participation of the Corporation's Chief Executive Officer and Chief Financial Officer, conducted an assessment of the effectiveness of the Corporation's system of internal control over financial reporting as of December 31, 2010, based on criteria for effective internal control over financial reporting described in "Internal Control—Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that the Corporation maintained effective internal control over financial reporting as of December 31, 2010.

Id. at F-2.

91


158. In reality, the Bank did not have effective internal controls over many areas of its

operations. Perhaps the most glaring and damaging lack of control was over the origination and

underwriting of loans. Despite the FDIC’s repeated warnings, the Bank had continued to

originate and underwrite massive amounts of new loans, which—contrary to the false statements

in the 2010 annual report—where known not to comply with the Bank’s stated underwriting

guidelines or prudent lending requirements. As the FDIC Inspector General’s Report stated:

The August 2010 joint examination report stated that TCB’s Board and management had failed to provide appropriate oversight of the operation of the bank and its performance. As mentioned earlier, examiners noted concern regarding the lack of proper analysis by the bank before entering into new and unconventional lending practices involving insurance premium financing, as well as the lax lending practices related to credits extended to individuals involved with banking and on loans secured by other financial institutions’ stock—most notably Relationship A. Further, management’s failure to recognize losses in a timely manner and reflect those losses within the appropriate period resulted in inaccurate financial reporting.

FDIC Inspector General’s Report at I-28. Despite this, the 2010 Annual Report, as with prior

years, falsely inform investors that the Bank was conservative in its lending practices and had

internal controls and underwriting guidelines in place to ensure the integrity of loans originated

and underwritten by the Bank.

159. The lack of effective—or indeed any real internal underwriting controls—is

illustrated by what the FDIC described as “Relationship A.” As the FDIC Inspector General’s

Report describes, just 6 of the Bank’s borrowing relationships accounted for 44% of the $73.8

million in adversely classified loans in 2009. One of these was Relationship A, which had grown

in 2010 and would eventually result in at least $30 and as much as over $60 million in losses:

TCB started a lending relationship (referred to in this report as Relationship A) as early as 2007 with a local borrower that grew

92


into an interconnected, complex set of at least 17 loans to various entities related to the borrower. Some of the loans were loan participations purchased by TCB from entities related to the borrower, and a majority of the loans was secured by stock of the various entities affiliated with the borrower. These related interests were first identified as such during the April 2010 joint visitation, which showed a total exposure for Relationship A of $47.5 million. During the September 2011 joint examination, examiners determined that TCB’s exposure to Relationship A had grown to a total of $65 million, or 57 percent of the bank’s capital, surplus, and undivided profits. As a result of poor credit decisions, weak underwriting, and inadequate monitoring, examiners concluded that the entire $65 million needed to be adversely classified. Of this amount, $30.2 million was loss. Relationship A accounted for 24 percent of the $273.8 million in total loans identified for classification (and 40 percent of the $76.3 million in loss classifications) at the September 2011 joint examination.

FDIC Inspector General’s Report at I-10. The fact that Relationship A was allowed to be

initiated evinces a lack of effective oversight and controls in itself; however, the fact that the

exposure of the Bank was allowed to grow from $47 million to over $65 million from 2010 to

2011 is nothing short of reckless. Neither the 2010 Annual Report nor any other filing mentions

Relationship A or the fact that the Bank had almost $50 million worth of exposure due to just a

single client. As of the end of fiscal year 2010, Relationship A accounted for approximately

4.2% of the Bank’s loan portfolio on its own.

160. The lack of underwriting controls is also illustrated by the Bank’s reckless foray

into the underwriting of loans on life insurance policies. These loans were uncollectible from

their inception, due to legal precedent forbidding the practice. Nonetheless, the Bank originated

and underwrote approximately $5.2 million in loans, writing off that entire amount. See FDIC

Inspector General’s Report at I-10. As the FDIC Inspector General’s Report described:

Between March 2009 and May 2010, TCB originated loans that represented 100 percent funding of premiums on large life insurance policies which were owned by irrevocable life insurance trusts established by the insured individuals. Court decisions

93


indicated that neither TCB, nor any successor beneficiary, could collect on the death benefits associated with the policies, upholding the insurance companies’ argument that they would not have sold the life insurance policies if they knew that TCB had financed the initial premiums for the insured parties. TCB charged off all $5.2 million of these loans.

Id. This boondoggle is not simply a bad business decision, but represents a complete lack of

oversight of the loan origination and underwriting process. These uncollectable loans never

should have been made in the first instance—they were void when made—and had the Bank

adhered to its loan underwriting policy they would not have been. Investors had no idea that the

Bank was undertaking such illogical and reckless risks.

161. In addition to these risks, and the underwriting and loan origination deficiencies

noted in previous years, the 2010 FDIC examiners also noted the following:

• High loan-to-value (LTV) positions for many loans resulted in thin collateral protection margins, and LTV limits were not established on loans secured by publicly traded or closely held stock (June 2009 and August 2010 examinations).

• The bank’s use of personal guarantees was inadequate or ineffective. For example, guarantors did not always provide guarantees or provided only partial guarantees (August 2010 examination).

• There was a lack of detail regarding any analysis of cash flows and/or repayment capacity in credit memoranda, and a lack of, or inadequate, global cash flow analyses (August 2010 and September 2011 examinations).

• Appraisals were either not obtained, obtained after loans were funded, or were outdated and prepared by the borrower (August 2010 examination).

• Loans extended to individuals involved in banking or secured by the stock of other financial institutions exhibited particularly poor underwriting and resulted in significant losses. A number of these loans contained little, if any, documented financial analysis before the loans were made (August 2010 examination).

94


• Additional credit was extended to borrowers after their lines had reached the maximum limit (August 2010 and September 2011 examinations).

FDIC Inspector General’s Report at I-12. Any one of the foregoing breaches in internal controls

would be a serious point of concern for any bank. The failure to disclose such serious breaches,

much less take steps to correct them, not only represents a knowing and material

misrepresentation, but also a conscious disregard for the preservation of the Bank’s assets.

d. Insufficient Controls over Loss Mitigation and Risks Posed by Non-Core Deposits

162. Finally, as with previous years, the 2010 Annual Report failed to alert investors to

continued violations of the law, applicable regulations and Bank policy, including, but not

limited to loss mitigation laws—none of which was disclosed to investors in the 2010 Annual

Report or any other filing. See FDIC Inspector General’s Report at I-28 (“Matters requiring the

Board’s attention included, but were not limited to . . . apparent violations of laws, rules,

regulations, and contraventions of statements of policy were in need of immediate correction.”).

In fact, as the FDIC Inspector General observed:

As of July 2010, repossessions totaled $28.3 million, of which $26.4 million consisted of trucks and over-the-road equipment. In addition, the bank had 381 loans secured primarily by tractor/trailers that were over 180 days past due and the collateral had not yet been repossessed. A total of 153 of the 381 loans were over 300 days past due.

TCB did not have adequate loss mitigation policies and procedures to monitor the repossession and timely disposition of collateral.


163. Desperate to raise funds to cover the undisclosed losses that were mounting,

TNCC increased its reliance on risky, high interest rate non-core deposits. Nonetheless, TNCC

95


took steps to disguise the deposits as “Other Savings Deposits” by purchasing them in

denominations of less than $100,000. As such, investors were further misled as to the continued

viability of the Bank. As the FDIC Inspector General’s Report stated:

The bank’s liquidity position began to weaken as asset quality issues in the loan portfolio became prevalent. At the August 2010 joint examination, examiners largely attributed a decrease in TCB’s net non-core funding dependence ratio to a decrease in time deposits of $100,000 or more and an increase in Other Savings Deposits, which are classified as core deposits, through promotional rates that were three times higher than the bank’s peer group average. Examiners noted that the potential volatility of the Other Savings Deposits was similar, or possibly even greater than, traditional noncore funding sources. By September 2011, examiners determined that TCB’s liquidity was critically deficient and threatened the viability of the institution.

FDIC Inspector General’s Report at I-19. When coupled with the concealment of degradation of

the Bank’s loan portfolio, understatement of the ALLL, false statements concerning

underwriting, loss mitigation and other controls, the non-core deposit concealment presented an

impenetrable wall of deception, preventing any investor from discerning the true condition of the

Bank.

5. Knowingly False and Misleading Statements Concerning Fiscal Year 2011

164. Desperate to retain their significant salaries, perks and other benefits, Defendants

made final, desperate attempts to mislead investors and prop up the failing Bank in 2011, despite

the fact that the Bank’s portfolio and liquidity had deteriorated beyond repair due to

mismanagement and a lack of effective internal controls.

a. Undisclosed Lack of Loan Underwriting and Portfolio Monitoring Controls

165. As in previous years, the internal controls regarding many aspects of TNCC’s

business—including, but not limited to underwriting of loans, financial reporting, loss mitigation

96


and accounting—were absent, unenforced or ineffective. Because the Bank failed and was

closed by the FDIC and TDFI in January of 2012, no annual report for fiscal year 2011 was

issued by TNCC. Nonetheless, each of the two quarterly reports issued by TNCC in 2011—one

in May and the other in August—contained knowingly false statements regarding the

effectiveness of TNCC’s controls over disclosure and financial reporting. 13 For example, the

TNCC report for the fiscal quarter ended March 31, 2011 falsely stated:

We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to allow timely decisions regarding disclosure in the reports that we file or submit to the Securities and Exchange Commission under the Exchange Act.

* * *

There were no changes in our internal control over financial reporting during the quarter ended March 31, 2011 that have

13 As with annual reports, Regulation S-X requires that interim financial statements must also comply with GAAP, with the limited exception that interim financial statements need not include disclosure which would be duplicative of disclosures accompanying annual financial statements. 17 C.F.R. § 210.10-01(a).

97


materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 33 (filed May 16, 2011)

(“March 2011 Quarterly Report”). The June 2011 Quarterly Report contained the same false

disclosure. See Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-Q), at 42 (filed

Aug. 12, 2011) (“June 2011 Quarterly Report”).

166. Consistent with previous years, TNCC’s loan origination and underwriting policy

guidelines appear to have been completely disregarded in 2011. For example, as noted above, in

2011 a single complex relationship—Relationship A, with a single borrower, represented $65

million in loss exposure for the bank (or approximately 5.6% of the Bank’s stated loan

portfolio 14 as of June 30, 2011). In addition, internal underwriting controls had deteriorated to

the point where the Bank was making undisclosed bad loans to its own Directors and employees.

As the Nashville Post reported on February 1, 2012, TNCC had significant exposure, due to

loans made to its Directors:

As Tennessee Commerce Bank was unraveling at the seams last week prior to finally being shut down, executives were likely busy tying up loose ends. One of them involved a $15 million loan to a director, against which they took a $7 million loss reserve. A spokeswoman for the bank said she could not find anyone Monday to get details about the loan or the director to whom it was made. But the writedown speaks to the underwriting shortcomings — which were not confined to any single category of loans — that bedeviled Tennessee Commerce.

14 As discussed infra, the true value of TNCC’s loan portfolio as of June 30, 2011 cannot be accurately determined, due to the fact that the Company’s financial statements contained material misstatements.

98


Geert De Lombaerde, Tennessee Commerce Wrote Down $7M of Director’s Loan, Nashville

Post (Feb. 1, 2012) (emphasis added),

http://nashvillepost.com/blogs/postbusiness/2012/2/1/tennessee_commerce_wrote_down_7m_of

_directors_loan; see also Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2

(Jan. 31, 2012) (“On January 24, 2012, director William W. McInnes submitted his resignation

from the Board of Directors of the Company and the Bank, effective January 27, 2012.”).

167. In 2011, TNCC actually originated loans which purported to be secured by valid

and genuine assets, but, instead, were secured by assets that had already been repossessed (or

should have been repossessed) by the Bank:

We also noted instances during 2011 in which TCB disposed of repossessed collateral by originating a new loan to a new borrower secured by the repossessed collateral. This practice resulted in numerous loans secured by the same collateral. In many cases, a portion of the funds to finance the new loan were applied to the balance of the original defaulted loan secured by the collateral, leaving a residual balance on the original loan that the bank did not recognize as a loss in a timely manner. While it is possible that the bank may have continued to pursue deficiency judgments on the original borrower and collections from guarantors, a prudent banking practice would have been to recognize the loss when the collection was deemed unlikely and reporting any future collections as a recovery. The net impact of this practice resulted in at least $22 million in residual balances on loans that should have been recognized as losses.

FDIC Inspector General’s Report at I-15 (emphasis added). In addition to these deficiencies and

those noted in earlier years, the FDIC noted additional deficiencies in 2011, such as:

There was a lack of detail regarding any analysis of cash flows and/or repayment capacity in credit memoranda, and a lack of, or inadequate, global cash flow analyses (August 2010 and September 2011 examinations).

Additional credit was extended to borrowers after their lines had reached the maximum limit (August 2010 and September 2011 examinations).

99


Id. at I-12. Such a stunning lack of underwriting integrity was necessarily material and indicates

a startling lack of oversight over the Bank’s internal controls. The sheer magnitude of these

loans, representing “at least $22 million” in unrecognized losses indicates that Defendants knew

of, and condoned or encouraged, the practice.

168. In addition, as in previous years, the FDIC noted that the Bank did not have

controls in place to properly identify, record and report loans that were in danger of default:

Management was lax in placing loans on nonaccrual in line with the established loan policy (August 2010 examination).

Several large loans had been restructured with concessions, resulting in reduced payments, and were not reported as a Troubled Debt Restructuring (TDR). Loans that qualify as TDRs are required to be evaluated for impairment. Failure to properly identify TDRs could result in misstatements to the bank’s ALLL allocation (August 2010 examination).

In general, loan officers did not appear to have an adequate working knowledge of their borrowers (August 2010 examination).

Monitoring and valuation of collateral was inadequate (August 2010 and September 2011 examinations).

Loan proceeds were used for purposes other than their stated purpose or management was unaware of what the loan proceeds were used for (September 2011 examination).

FDIC Inspector General’s Report at I-12. Coupled with the breaches of the loan underwriting

and origination policies and controls, the failure to accurately monitor loans which were in

danger of default magnified the material misstatements in the Bank’s financial statements,

making it impossible for investors to accurately determine the credit risk of the Bank’s loan

portfolio at any given time. The failure of controls that were intended to detect and remedy these

problems was not disclosed to investors prior to the Bank’s failure in January of 2012.

100


169. The explosion of lending throughout the Class Period, as well as the falsely

understated credit risk at TNCC were actually acknowledged to be “red flags” by TNCC

executive management. As Defendant Sapp stated just six months before the Restatement during

the first quarter 2011 earnings conference call, while he falsely tried to distance himself from the

reality of the untenably and unreasonably high credit risk at the Bank:

One unfortunate byproduct of the model is that it has several red flags for regulators given the current credit cycle. We focus on technology to drive an convenient deposit model for our customers. These results [sic] in a perception as deposit volatility, compared to brick and mortar branches. We have had an above average growth rate over the past several years and we became used to being able to raise capital when it was needed to support that growth. The current environment is different and we will make appropriate changes in strategy in response.

Tennessee Commerce Bancorp, Inc., Q1 2011 Earnings Call, Bloomberg Transcript (Apr. 29,

2011) (emphasis added).

b. Undisclosed Lack of Compliance with Regulator Consent Order

170. On February 11, 2011, the FDIC made good on its threat to pursue a formal

enforcement action and sent TNCC a consent order, outlining the remedial steps that Defendants

needed to undertake immediately (the “Consent Order”). See FDIC Inspector General’s Report

at I-29. Among other things, the Consent Order required the Bank to:

submit a capital plan to achieve and maintain Leverage, Tier 1 Risk-Based, and Total Risk-Based capital ratios of 8.5 percent, 10 percent, and 11.5 percent, respectively;

formulate and submit a plan for the reduction and collection of delinquent loans;

review the loan policy and procedures for effectiveness and make all necessary revisions in order to strengthen the

101


bank’s lending procedures and abate additional supervisory guidance;

• develop and submit a written plan addressing liquidity, volatile liabilities, and asset/liability management;

• restrict additional advances to any borrower for whom the bank holds an uncollected charged-off asset or whose extension of credit is adversely classified;

• restrict increases in total assets to no more than 5 percent during any consecutive 12 month period and restrict any new line of business without the prior consent of the FDIC and TDFI; and

• eliminate and/or correct all apparent violations of laws and regulations.

FDIC Inspector General’s Report at I-22. Defendants refused to sign the consent order, only

stipulating to it when forced to on May 25, 2011. See id . In the interim, Defendants stalled,

focusing more on arguing the merits of particular and irrelevant, narrow classifications instead of

assessing, measuring, and adequately addressing the risk of its loan portfolio. Id. at I-29.

Meanwhile, the condition of the Bank continued to deteriorate.

171. In March of 2011, the TDFI and FDIC visited the Bank to assess whether any of

the items covered in the unsigned consent order had been addressed. The FDIC concluded that

the Bank had failed to meaningfully comply with the serious concerns outlined in the proposed

Consent Order. Among other things, the ALLL remained seriously understated, underwriting

guidelines were not being followed and laws and regulations were still being violated. As the

FDIC noted:

While a reduction in the balances of previously classified loans was noted, the level of classifications, combined with management’s previous and continued resistance to recognize problem loans, remained a concern to examiners. The ALLL remained significantly underfunded, and management appeared to have been focused more on arguing the merits of particular

102


classifications instead of assessing, measuring, and adequately providing for the risks in the loan portfolio. However, the Board stipulated to the proposed Order effective May 25, 2011.

FDIC Inspector General’s Report at I-29. Even though the Bank stipulated to the Consent Order,

the September 2011 joint examination revealed that, among other things, the ALLL remained

materially understated and the other terms of the Consent Order had not been meaningfully

addressed. See id . at 29-31.

172. Indeed, throughout 2011, while Defendants knew that the Bank was on the verge

of collapse due to mismanagement and the ALLL was materially misstated in violation of both

the FDIC’s warnings and applicable accounting conventions, Defendants continued to

disseminate these false statements regarding the effectiveness of internal controls (including loan

and underwriting policies), the financial risk of the loan portfolio and the Bank’s loss mitigation

efforts.

c. The Materially Misstated ALLL

173. Defendants’ false statements in 2011 were not confined to its typical SEC filings.

By the beginning of 2011, the Bank was quickly becoming illiquid and the only way for

Defendants to keep their fraudulent enterprise running was to raise enormous amounts of new

capital in order to cover the concealed losses in their loan profile. To this end, on May 9, 2011,

Defendants “made an investor presentation at the Gulf South 2011 Bank Conference in New

Orleans, Louisiana,” presenting false information concerning the Bank’s operations and

financials in an effort to lure unsuspecting investors into investing in the quickly failing Bank.

See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (May 12, 2011).

Among other things, the presentation given by Defendants at that conference falsely presented

the Bank’s ALLL provision:

103


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4J 513W 9.111 WM 2U.ml 4QQ elm

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Id. at Ex. 99.1, at 18. Moreover, Defendants made a point of showing off the Bank’s misstated

Tier 1 Capital ratio 15 which, like the ALLL, falsely understated the risk of the Bank’s assets.

See id . at 17 (falsely stating that the Bank’s Tier 1 Capital ratio was “11.37%” as of December

31, 2010 and “10.93%” as of March 31, 2011). Additionally, the presentation gave investors the

false impression that the Bank was well managed and adhered to strict underwriting and loan

origination guidelines, which is most certainly did not. See id. at 9 (“No shared national credits

and sub-prime or alt-A loans”). Defendants Sapp, Cox and Perez are all listed as having taken

part in the presentation. See id . at 8.

174. Both of the quarterly reports issued by the Bank in 2012 included financial

statements and statements of internal control effectiveness that were known to be false at the

time that they were filed and disseminated. See March 2011 Quarterly Report, filed on May 16

2011. The March 2011 Quarterly Report also gave the false impression that the Bank’s reserves

would decrease as the fiscal year progressed. Defendants well-knew they would not, considering

the fact that they were drastically understated at the time of the March 2011 Quarterly Report.

As the March 2011 Quarterly Report falsely stated:

15 A Bank’s tier one capital ratio is calculated by dividing a bank’s equity capital by its risk- weighted assets (“RWA”). See Basil Capital Accord, International Convergence of Capital Measurement and Capital Standards, Bank for International Settlements, at 14-15 (April 1998). RWA is calculated by multiplying the value of an asset by the risk that the entire loan balance will not be paid in full. As discussed herein, TNCC systematically understated the risk of its portfolio, skewing the denominator of the RWA calculation and making the Bank’s loan portfolio appear far less risky than it truly was.

104


Nonperforming assets, which includes non-accruing loans, troubled debt, loans 90+ days past due, repossessions and other real estate owned, increased to $94,424 at March 31, 2011 compared to $81,621 at March 31, 2010 and $91,151 at December 31, 2010. As a result of seasonal factors related to the transportation industry, our nonperforming assets typically increase during the first quarter and decrease throughout the remainder of the year. (in millions of dollars)

March 2011 Quarterly Report at 24. The March 2011 Quarterly Report also presented materially

false financial numbers concerning the Bank’s ALLL for the three months ended March 31,

2011, recognizing only $26.1 million in its allowance:

Fr Three udd1larih31.2011

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CGastLIEica residential and i,1dILEriaL Ccnumr Ti lea ses ThtaI 304 2 04 S 1.414 S 15 S 1.321 S 21.43

i4 j - i (41) - i4 2 - 42

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Id. at 10. The FDIC and TDFI had previously informed TNCC on numerous occasions that its

ALLL was severely deficient. Indeed, as of March of 2011, TNCC’s ALLL was at least $100 to

$400 million short of what it should have been under FAS 5, FAS 114 and other relevant bank

accounting conventions. See FDIC Inspector General’s Report at *1 (reporting that the Bank’s

“total assets at closing were $1.0 billion and that the estimated loss . . . was $416.8 million”)

Defendant Perez signed the March 2011 Quarterly Report on behalf of TNCC and the Bank.

175. In August, Defendants continued the charade of viability by continuing to present

a knowingly false picture of the Bank, which they knew to be on the verge of collapse.

Specifically, the June 2011 Quarterly Report, filed with the SEC on August 12, 2011, continued

to falsely present the ALLL, mischaracterizing the Bank’s assets as much less risky than they

were known to be at the time. June 2011 Quarterly Report at 10. As the June 2011 Quarterly

Report stated in pertinent part:

105


The total allowance reflects managements’ estimate of loan losses inherent in the loan portfolio at the balance sheet date. Management considers the allowance for loan losses (“ALLL”) of $28.2 million adequate to cover losses inherent in the loan portfolio. The following table presents by loan category, the changes in ALLL and the recorded investment in loans for the six months ended June 30, 2011 and the twelve months ended December 31, 2010:

lThllm A.11ownce for loan loist:

Provtton Fmdir

For the Ril tat -

R1tte- 14fanith R1tte- Coini&d1 Couitracfiin riidtt1 Other id iidui1 Conuni& Tz lei Tot al

I :

I 10.414 1 15 - HAS (1.754) :2.43 -

M006) (12.2N)

-

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12,520 a 309 : •:i4;. 11.5:

June 2011 Quarterly Report at 10. The FDIC and TDFI had previously informed TNCC on

numerous occasions that its ALLL was severely deficient. Indeed, as of June 2011, TNCC’s

ALLL was at least $100 million short of what it should have been under FAS 5, FAS 114 and

other relevant bank accounting conventions. In fact, less than a month later, the FDIC informed

Defendants that the ALLL needed to be increased by at least $80 million. See FDIC Inspector

General’s Report at I-30. Defendant Perez signed the June 2011 Quarterly Report on behalf of

TNCC.

176. The FDIC excoriated the presentation of the ALLL in the 2011 financial

statements, concluding that the Bank had no basis for publishing the numbers as it did:

Examiners noted at the September 2011 joint examination that the ALLL was severely deficient in relation to the level of risk in the loan portfolio and that an additional provision of $80.2 million was warranted. In addition, the bank’s FAS 114 impairment analyses were either inadequately supported, inadequately measured, or used invalid assumptions. Further, management failed to recognize credit losses in a timely manner, which resulted in an insufficient FAS 5 ALLL allocation since the calculation was based historical losses. The bank’s external auditors also noted in 2011 that controls over estimating the ALLL were not adequate. An underfunded ALLL can have the effect of delaying the

106


recognition of deterioration in the credit quality of the loan portfolio.

FDIC Inspector General’s Report at I-13 (emphasis added).

177. In September of 2011, the FDIC and TDFI conducted their final joint examination

prior to the closing of the Bank in January of 2012. The report detailed many of the same

problems that had been consistently pointed out to Defendants as the result of previous

examinations. The difference was that this report was accompanied by a conclusion that the

“financial condition of the bank was critically deficient and that near-term failure was highly

probable . . . .” FDIC Inspector General’s Report at I-30. The following deficiencies were noted

as part of the examination:

Apparent violations, including an apparent legal lending limit violation and contravention of Statements of Policy (some of which were repeat criticisms).

Management and the Board failed to appropriately adjust for changing economic conditions and identify risk in the loan portfolio. The bank continued to grow loans in an uncertain economic environment, while their peers were restricting loan growth. Examiners noted that several classified loans were originated during a time of economic uncertainty, and without a full understanding or consideration of the level of risk-exposure to the bank.

Poor credit administration practices and inadequate monitoring of the loan portfolio had resulted in an excessive level of adversely classified items (i.e., $298.9 million, or 21 percent of the bank’s assets and 506 percent of Tier 1 Capital plus the ALLL). Adversely classified loans totaling $76.3 million were identified as loss, which included two large borrowing relationships of $47.8 million.

The ALLL was severely deficient and an additional provision expense of $80.2 million was required to reflect examination-identified loan losses and to replenish the ALLL to an appropriate level.

107


An independent loan review performed in June 2011 identified nine borrowers with loans totaling $65.9 million warranting downgrades from management’s internal loan grades. Examiners identified $157.3 million in loan downgrades at the examination.

Loans related to Relationship A were underwritten without adequate global cash flow analyses and without realistic in-depth analysis of the value of the collateral. In addition, there were no policies and procedures in place for the types of loans extended to the borrowers, which resulted in credit risk not being adequately assessed.

Liquidity was critically deficient and threatened the viability of the bank. Examiners noted that access to secondary funding sources had ceased due to substantial deterioration in asset quality and capital.

Id. (emphasis added).

d. The Restatement of TNCC’s Financial Results and the ALLL

178. Despite the results of the FDIC and TDFI’s joint examination of the bank in

September of 2011, Defendants waited almost two months before they did anything. And even

when they did partially disclose the fraudulent nature of their financial statements, Defendants

falsely represented that only TNCC’s June 2011 Quarterly Report needed to be restated, despite

their knowledge of the falsity of the Company’s financial statements for the previous three years.

The Restatement was made on November 1, 2011, when TNCC issued a Current Report (Form

8-K) announcing that it was restating its financial results for the second quarter of fiscal year

2011 (the June 2011 Quarterly Report), ended June 30, 2011. As the Nov. 1, 2011 Restatement

stated:

On October 27, 2011, management of the Corporation, and subsequently, its Audit Committee and Board of Directors, determined that its financial statements for the quarter ended June 30, 2011, as included in the Corporation’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2011, should no longer be relied upon due to an expected approximately

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$83.0 million increase in the provision for loan losses and related allowance for loan losses as a result of an ongoing joint examination of Tennessee Commerce Bank (the “Bank”), a wholly-owned subsidiary of the Corporation, by the Federal Deposit Insurance Corporation (the “FDIC”) and the Tennessee Department of Financial Institutions (the “TDFI”). Consequently, the Corporation intends to file an amendment to its Form 10-Q for the period ended June 30, 2011, as soon as reasonably practicable, to give effect to the expected increase in the provision and allowance for loan losses.

Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Nov. 1, 2011) (emphasis

added). The November 1, 2011 Restatement left investors with the false impression that

TNCC’s financial statements for other periods did not need to be restated. See id .

179. It was not until January 20, 2012, nearly two and a half months after the

Restatement, that Defendants announced that additional periods would need to be restated. In

reality, Defendants had no other choice, due to the fact that Kraft had notified the bank that it

was withdrawing its audit report for all financial statements post-December 31, 2010 and

unspecified previous periods. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-

K), at 2 (Jan. 20, 2012); see also Tennessee Commerce Bancorp, Inc., Current Report (Form 8-

K), Ex. 99.1 (Jan. 23, 2012) (“We [Kraft] have read the statements under Item 4.02 of the

Current Report on Form 8-K filed with the Securities and Exchange Commission on January 20,

2012 regarding withdrawal of our audit report on the Corporation’s financial statements as of

December 31, 2010 and for the year then ended and the possibility that we may withdraw earlier

audit reports pursuant to the results of a forensic review of the Corporation’s small ticket loan

portfolio. We agree with these statements pertaining to our firm.”)

180. The FDIC concurred with the conclusion that TNCC’s financial statements were

materially misstated, with the Bank systematically failing to recognize losses in an accurate or

timely manner:

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A third-party evaluation found that 14 percent of TCB’s loan portfolio was nonperforming as of November 2011. TCB’s final Call Report for December 31, 2011 reported that 26 percent of the C&I portfolio and 25 percent of the CRE portfolio was greater than 30 days past due or in non-accrual status. These classifications, in addition to an increase in past due loans, posed a significant risk to the institution and resulted in large loan losses. As reflected in Figure 3, loan charge-offs increased significantly in 2011, with a majority of the charge-offs pertaining to C&I loans, indicating a failure to recognize losses in a timely manner and reflect those losses within the appropriate reporting period.

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181. Nonetheless, as late as August of 2011, TNCC knowingly and falsely stated in its

quarterly filing for the June 30, 2011 quarter that: “It is management’s intent to maintain an

ALLL that is adequate to absorb current and estimated losses which are inherent in a loan

portfolio.” June 2011 Quarterly Report at 33. An identical false statement was made in the

March 2011 Quarterly Report. See March 2011 Quarterly Report at 27 (“It is management’s

intent to maintain an ALLL that is adequate to absorb current and estimated losses which are

inherent in a loan portfolio.”). As discussed herein it was not management’s intent to maintain

an adequate ALLL, as evinced by numerous, crystal clear, warnings from the FDIC, TDFI and

other parties, ignored by Defendants, that the Bank’s ALLL was seriously and materially

understated. Indeed, Defendants were aware that the ALLL was materially deficient at least as

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early as 2009, when the FDIC suggested that the ALLL needed to be increased for fiscal year

2009 by at least $16 million. See supra. In 2011, when these statements were made, the ALLL

was understated by at least $100 to $400 million dollars, based on the FDIC’s conservative

estimates. See FDIC Inspector General’s Report at *2 (“The FDIC notified the Office of

Inspector General (OIG) on March 13, 2012 that TCB’s total assets at closing were $1.0 billion

and that the estimated loss to the DIF was $416.8 million (or 42 percent of TCB’s total assets). . .

. TCB’s final Consolidated Reports of Condition and Income indicated that the bank lost more

than $165 million during 2011 and had negative equity capital.”)

182. As one commentator noted following the failure of the Bank in January of 2012:

This was a whooper, showing a $116.1 million loss September 30, 2011 (the latest FDIC report available) after a $97.3 million charge off. It is the largest banking failure this year in a state that has not had a banking failure since Bank of Alamo in West Tennessee November 8, 2002.

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $416.8 million.

Christopher Menkin, Stockholders Lose All in $116 MM Bank Loss in Tennessee,

SeekingAlpha.com, Jan. 30, 2012, http://seekingalpha.com/instablog/388783-christopher -

menkin/262442-stockholders-lose-all-in-116-1-mm-bank-loss-in-tennessee.

VII. KRAFT’S ROLE IN THE FRAUDULENT MISREPRESENTATION OF THE BANK’S FINANCIAL CONDITION

183. During the Class Period, Kraft violated Generally Accepted Auditing Standards

(“GAAS”) and acted recklessly in conducting its audits of TNCC’s financial statements and

issuing unqualified audit reports over the financial statements. Kraft served as the external

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auditor for TNCC throughout the Class Period, rendering its first audit report for the Company in

2006 and for each fiscal year through 2010.16 TNCC’s financial statements for 2007, 2008,

2009 and 2010 violated GAAP because they misrepresented and failed to disclose that TNCC

had materially understated its ALLL. Through its audit procedures, Kraft should have uncovered

evidence of the Company’s failures to comply with GAAP. Kraft’s failure to do so constituted

an extreme departure from GAAS. Absent recklessness, Kraft could not have issued the

unqualified audit reports given the magnitude of TNCC’s violations of GAAP.

184. Kraft was required to be familiar with the risk factors that affected depository

institutions, generally, and TNCC, in particular, in the proper presentation of their financial

statements. Risk factors identify areas of an audit that have an increased risk and, therefore, may

require additional testing by the auditors.

185. Red flags are fraud risk factors that indicate a high risk of material misstatement.

Red flags come to the attention of the auditor through its audit procedures required under GAAS,

and place a reasonable auditor on notice that the audited company could potentially be engaged

in wrongdoing. During the Class Period, numerous red flags should have been apparent to Kraft,

but, as alleged below, Kraft either failed to properly inquire further into such red flags or ignored

them outright. Either way, Kraft violated GAAS and allowed TNCC to overstate its earnings for

the fiscal years 2007, 2008, 2009 and 2010.

16 Kraft was engaged by TNCC to serve as the external auditor for the Company November of 2005, succeeding Crowe Chizek and Company, LLC, which had served as the Company’s auditor since its formation in 2000. Kraft remained TNCC’s auditor until the time of the Bank’s closure by the FDIC in January of 2012; however, no audit report was issued after December 31, 2010.

112


A. OVERVIEW OF APPLICABLE ACCOUNTING STANDARDS

186. The Public Company Accounting Oversight Board ("PCAOB"), established by

the Sarbanes-Oxley Act of 2002 (“SOX”), is tasked with the responsibility to develop auditing

and related professional practice standards to be followed by registered public accounting firms.

On April 16, 2003, the PCAOB adopted as interim standards, the generally accepted auditing

standards, described in the American Institute of Certified Public Accountants' ("AICPA")

Auditing Standards Board's (“ASB”) Statement on Auditing Standards No. 95, “Generally

Accepted Auditing Standards,” in existence on that date. An auditor's reference to "the standards

of the Public Company Accounting Oversight Board (United States)" refers to GAAS in

existence as of April 16, 2003 and subsequent auditing standards issued by the PCAOB. For

clarity, all references to GAAS herein include the standards of the PCAOB in existence during

the Class Period.

187. GAAS is comprised of ten basic standards that establish the quality of an auditor's

performance and the overall objectives to be achieved in a financial statement audit. Auditors are

required to follow these standards in each and every audit they conduct. GAAS includes

Statements on Auditing Standards ("SAS") issued by the ASB of the AICPA, which are codified

in AICPA Professional Standards under the prefix “AU,” and the auditing standards issued by

the PCAOB under the prefix “AS.”

188. The AICPA Audit & Accounting Guide ("AAG") for depository and lending

institutions are primarily designed to provide guidance for independent accountants on the

application of the standards of fieldwork. Specifically, it provides guidance on the risk

assessment process and the design of audit procedures, as well as general audit considerations

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unique to depository and lending institutions like TNCC. The AAG is considered authoritative

GAAS.

189. The AICPA also issues Audit Risk Alerts ("ARAs"). The ARAs are issued for

various industries, including financial institutions such as TNCC. The ARAs provide auditors

with an overview of recent economic, industry, regulatory, and professional development and, in

particular, those that may affect audit engagements. The ARAs are considered industry guidance

for auditors to use in performing their audit procedures. These ARAs should have focused the

Kraft audit team on those specific aspects of TNCC's financial statements where an increased

level of risk of material misstatement was present and additional considerations were warranted.

B. KRAFT’S RECKLESS DISREGARD OF RED FLAGS

190. Kraft was required to plan, conduct, and report on the results of its audit of TNCC

in accordance with GAAS. Kraft knew that investors, when making an investment decision,

would rely on its reports as an independent auditor with respect to the Company's financial

statements and on its assessment of the effectiveness of the Company's internal controls over

financial reporting.

191. For purposes of its audits of TNCC for 2007, 2008, 2009 and 2010, Kraft had a

professional obligation in accordance with GAAS to perform the following procedures, among

others, to:

a. Understand TNCC’s business, AU Section 311, “Planning and Supervision”, which includes the following:

i. AU Section 311 required Kraft to adequately plan the work and properly supervise its assistants. In accordance with AU Section 311, Kraft is required to perform specific audit procedures to obtain an

114


understanding of TNCC and its environment, including internal controls, and assess the risks of material misstatement in the financial statements. AU § 311.06 - .09.

ii. GAAS required Kraft’s understanding of TNCC’s business to be developed through (1) its experience with TNCC and its industry, (2) inquiries with TNCC personnel, and (3) review of AICPA AAGs and other materials such as ARA. See AU § 311.07- 08. Ultimately, Kraft auditors should have had specific knowledge as to TNCC’s risk management strategies, organizational structure, product lines and services, strategies for lending and investing and other characteristics. AAG, Chapter 5;

b. Assess internal controls processes where transactions originated and through to their inclusion in the financial statements, AU Section 319 (“Consideration of Internal Control in a Financial Statement Audit”), including the following:

i. Kraft should have tested the operating effectiveness of controls for loans including the inspection of “loan documents to determine whether the institution's lending policies and procedures are being followed", AAG, Chapter 8;

c. Perform analytical procedures, AU Section 329 (“Analytical Procedures”), to substantiate that the financial statements produced by TNCC were free of material misstatement.

i. Kraft should have performed analytical review procedures to identify risks of material misstatements and applied particular scrutiny to accounts that were vulnerable as a result of TNCC’s relaxation of lending standards and acceptance of increased credit risk, AU §§ 329.06 - 329.07.

d. Apply auditing procedures to accounts with a high risk of misstatement such as the accounting estimates related to ALLL, AU Section 342 (“Auditing Accounting Estimates”), as well as increase the nature, timing, and extent of auditing procedures applied when a high risk of fraud or error was present, AU Section 316 (“Consideration of Fraud in a Financial Statement Audit”),

115


i. In accordance with AU Section 342, assessing TNCC’s calculation of ALLL, GAAS required concentration on "key factors and assumptions that [we]re (a) significant to the accounting estimate, (b) sensitive to variations, (c) deviations from historical patterns, [and] (d) subjective and susceptible to misstatement and bias." See AU § 342.09. Also Kraft needed to perform tests to establish the reliability of management’s representations. AU § 333 (“Management Representation”)

192. GAAS sets forth factors that present a high degree to risk of material

misstatement and of which auditors such as Kraft are required to be aware. For example, GAAS

states that there is a high degree of risk related to accounting estimates. AU § 316.54. This risk

would apply, for example, to TNCC’s estimate of ALLL.

193. Further, at every step of the audit, Kraft was required to exercise professional

skepticism. GAAS requires that an auditor exercise professional skepticism, AU Section 230

(“Due Professional Care in the Performance of Work”), when performing its audits. Professional

skepticism is an attitude that includes a questioning mind and a critical assessment of the

evidence. See AU § 230.07.

194. As described herein, there were a number of red flags and serious indications of

fraud suggesting fraud at TNCC that were recklessly disregarded by Kraft. Among other things,

the broad categories of red flags—each with numerous facets--included:

a. TNCC’s lack of effective loan underwriting standards;

b. Failure to recognize credit losses in a timely and accurate manner in accordance

with GAAP, i.e. , FAS 5 and 114,

c. The dramatic expansion in TNCC’s loan portfolio without adequate risk

management practices,

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d. A lack of management or board oversight and ineffective or non-existent internal

controls over credit risk monitoring and loss mitigation, and

e. Warnings and alerts from regulators, such as the FDIC and TDFI.

1. Lack of Effective Loan Underwriting Standards

195. Perhaps no other factor suggested the risk of financial fraud at TNCC more than

the lack of effective loan underwriting, origination, and/or renewal policies at the Bank. It was

the origination of hundreds of millions of dollars in high-risk, low or undocumented loans that

precipitated the financial fraud at TNCC, i.e. , the overstatement of earnings caused by the

understatement of the ALLL.

196. As early as 2007, FDIC examinations of TNCC alerted the Board, management,

and Kraft to weaknesses in loan underwriting and credit administration. As the FDIC’s 2007

examination of the Bank noted:

[E]xaminers observed instances in which risk rating downgrades, inclusions on the watch list, and subsequent charge-offs occurred within a period of weeks, suggesting ineffective credit monitoring.

FDIC Inspector General’s Report at I-24. As time went on, the weaknesses in loan underwriting

and credit administration only intensified which, when combined with unenforced origination

policies and the disregard of credit monitoring, led to further material misstatements of the

ALLL and other credit statistics. The FDIC and TDFI continually noted problems with credit

administration, including loan underwriting and renewal, at TNCC throughout the Class Period.

As the FDIC Inspector General’s Report states in summary:

High loan-to-value (LTV) positions for many loans resulted in thin collateral protection margins, and LTV limits were not established on loans secured by publically traded or closely held stock (June 2009 and August 2010 examinations).

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There was a lack of perfection of security interests in collateral and/or an ability to substantiate collateral values for indirect small loans (June 2009 examination).

The bank’s use of personal guarantees was inadequate or ineffective. For example, grantors did not always provide guarantees or provided only partial guarantees (August 2010 examination).

There was a lack of detail regarding any analysis of cash flows and/or repayment capacity in credit memoranda, and a lack of, or inadequate, global cash flow analyses (August 2010 and September 2011 examinations).

Appraisals were either not obtained, obtained after loans were funded, or were outdated and prepared by the borrower (August 2010 examination).

Additional credit was extended to borrowers after their lines had reached the maximum limit (August 2010 and September 2011 examinations).

* * * Documented reviews and analysis of interim or annual financial data were not adequate (April 2007 examination).

Certain portions of the loan policy were too general and brief and needed enhancement. Of particular note were policies pertaining to collection procedures (April 2007 examination).

Management was lax in placing loans on nonaccrual in line with the established loan policy (August 2010 examination).

Several large loans had been restructured with concessions, resulting in reduced payments, and were not reported as a Troubled Debt Restructuring (TDR). Loans that qualify as TDRs are required to be evaluated for impairment. Failure to properly identify TDRs could result in misstatement to the bank’s ALLL allocation (August 2010 examination).

In general, loan officers did not appear to have an adequate working knowledge of their borrowers (August 2010 examination).

Monitoring and valuation of collateral was inadequate (August 2010 and September 2011 examinations).

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Loan proceeds were used for purposes other than their stated purpose or management was unaware of what the loan proceeds were used for (September 2011 examination).

FDIC Inspector General’s Report at I-12, I-13. Any one of these very serious flaws in the

Bank’s underwriting policies and guidelines should have served as a red flag to auditors, but

together the failure to heed such serious indications of fraud over multiple years illustrates

recklessness on the part of Kraft. For example, the lack of documentation on loans and high loan-

to-value loans in violation of loan procedures represents a specific red flag identified by relevant

auditing guidance. See AICPA, AAG: Depository and Lending Institutions, Exhibit 5-1: Fraud

Risk Factors, AAG-DEP 5.218, pp. 118-119 (June 1, 2010) (stating that audit risk factors

include: “Lack of an appropriate system of authorization and approval of transactions in areas

such as lending and investment, in which the policies and procedures for the authorization of

transactions are not established at the appropriate level; and inadequate controls over transaction

recording, including the setup of loans on systems.”).

197. One tangible example of the lack of internal control over loan origination and

underwriting standards at the Bank is “Relationship A”, an “interconnected, complex set of at

least 17 loans” with a single local borrower. Id. at I-10. In the end, Relationship A grew to “$65

million, or 57 percent of the bank’s capital, surplus, and undivided profits.” Ibid. “As a result of

poor credit decisions, weak underwriting, and inadequate monitoring, examiners concluded that

the entire $65 million needed to be adversely classified. Of this amount, $30.2 million was a

loss.” Ibid. The extension of loans beyond credit limits, increased concentration of the loan

portfolio in a single borrower, and relaxation of credit standards all represent risk factors for

financial fraud for an auditor. See AICPA, AAG: Depositor and Lending Institutions, Exhibit 5-

1: Fraud Risk Factors, AAG-DEP 5.218, at pp. 110-111 (“There is excessive pressure on

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management or operating personnel to meet financial targets set up by those charged with

governance management, including incentive goals: a. Unrealistically aggressive loan goals and

lucrative incentive programs for loan originations, shown by, for example: . . . Relaxation of

credit standards . . . Excessive extension of credit standards with approved deviation from policy

. . . Excessive concentration of lending . . . .”).

198. Another example of the reckless origination of loans at TNCC is the revelation

that TNCC had made a $15 million loan to an unnamed member of the Board, $7 million of

which was uncollectible. Geert De Lombaerde, Tennessee Commerce Wrote Down $7M of

Director’s Loan, Nashville Post (Feb. 1, 2012) (“As Tennessee Commerce Bank was unraveling

at the seams last week prior to finally being shut down, executives were likely busy tying up

loose ends. One of them involved a $15 million loan to a director, against which they took a $7

million loss reserve. A spokeswoman for the bank said she could not find anyone Monday to get

details about the loan or the director to whom it was made. But the writedown speaks to the

underwriting shortcomings — which were not confined to any single category of loans — that

bedeviled Tennessee Commerce.”). A reckless and conflicted loan of this nature, to a member of

TNCC’s Board of Directors, represents a clear indication of fraud under relevant auditing

considerations. See AICPA, AICPA, Audit & Accounting Guide: Depositor and Lending

Institutions, Exhibit 5-1: Fraud Risk Factors, AAG-DEP 5.218, at pp. 112 (stating that fraud risk

factors include: “Significant related entity transactions not in the ordinary course of business or

with related entities not audited or audited by another firm, such as the following . . . Loans and

other transactions with directors, officers, significant shareholders, affiliates, and other

related parties, particularly those involving favorable terms.” ) (emphasis added).

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199. Further, during the Class Period, the Bank engaged in exotic and reckless lending

schemes that were also overlooked by its auditors. As the FDIC noted:

[The Bank] also engaged in unusual lending practices, such as insurance premium financing, and made a number of particularly risky loans to individuals in the banking sector that were secured by the stock of other banks in the year before its failure.

* * *

Between March 2009 and May 2010, TCB originated loans that represented 100 percent funding of premiums on large life insurance policies which were owned by irrevocable life insurance trusts established by the insured individuals. Court decisions indicated that neither TCB, nor any successor beneficiary, could collect on the death benefits associated with the policies, upholding the insurance companies’ argument that they would not have sold the life insurance policies if they knew that TCB had financed the initial premiums for the insured parties. TCB charged off all $5.2 million of these loans.

FDIC Inspector General’s Report at I-5, I-10. Like lending to directors and officers, engaging in

the exotic—and extremely risky—types of lending that TNCC was engaged in represented a

significant standalone risk factor for fraud. See AICPA, AICPA, Audit & Accounting Guide:

Depositor and Lending Institutions, Exhibit 5-1: Fraud Risk Factors, AAG-DEP 5.218, at pp.

110-111 (“There is excessive pressure on management or operating personnel to meet financial

targets set up by those charged with governance management, including incentive goals: a.

Unrealistically aggressive loan goals and lucrative incentive programs for loan originations,

shown by, for example: . . . Excessive lending in new products ”) (emphasis added).

200. To compound matters, the loans that TNCC was originating and underwriting

were primarily loans in an extremely narrow and risky sector of the commercial lending market.

As the FDIC Inspector General noted in its review:

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[The Bank] failed primarily because its board of directors (Board) and management did not effectively manage the risks associated with the bank’s sustained high growth in C&I lending. Notably, [the Bank] had a significant concentration in an economically sensitive and specialized segment of the C&I market pertaining to the transportation industry. [The Bank]’s lending in this area included loans to leasing companies and lease brokers for the financing of trucks, buses, and other commercial use vehicles. However, [the Bank]’s underwriting, administration, monitoring, and collection procedures for these and other C&I loans was not adequate. Contributing to the bank’s credit risk exposure were large and complex borrowing relationships that were not effectively managed.

* * *

[The Bank] also engaged in unusual lending practices, such as insurance premium financing, and made a number of particularly risky loans to individuals in the banking sector that were secured by the stock of other banks in the year before its failure.

FDIC Inspector General’s Report at I-5. Excessive concentration of lending in a particular

market represents an additional risk factor for financial fraud. See AICPA, AAG: Depositor and

Lending Institutions, Exhibit 5-1: Fraud Risk Factors, AAG-DEP 5.218, at pp. 110-111

(“Excessive concentration of lending (particularly new lending”).

201. As applicable auditing standards reflect, the lack of effective internal controls—

particularly an area that directly affects the company’s earnings—is a significant risk factor for

fraud in financial reporting and should have led Kraft to gather more evidence to support its

conclusion that TNCC’s financial statements were free of material misstatement. See AU §

316.85 (“The following are examples of risk factors relating to misstatements arising from

fraudulent financial reporting . . . Incentives/Pressures . . . 1. Financial stability or profitability is

threatened by economic, industry, or entity operating conditions such as (or indicated by) . . .

Recurring negative cash flows from operations or an inability to generate cash flows from

operations while reporting earnings and earnings growth”); AU § 316.85 (“The following are

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examples of risk factors relating to misstatements arising from fraudulent financial reporting. . . .

There is ineffective monitoring of management as a result of the following: . . . Ineffective board

of directors or audit committee oversight over the financial reporting process and internal

control.”); AU § 325 (“A material weakness is a deficiency, or a combination of deficiencies, in

internal control over financial reporting, such that there is a reasonable possibility that a material

misstatement of the company's annual or interim financial statements will not be prevented or

detected on a timely basis.”).

202. Indeed, as AU Section 330 sets forth, the greater the level of assessed risk, the

more assurance the auditor needs to gather in order to come to a conclusion about the relevant

financial statements:

The greater the combined assessed level of inherent and control risk, the greater the assurance that the auditor needs from substantive tests related to a financial statement assertion. Consequently, as the combined assessed level of inherent and control risk increases, the auditor designs substantive tests to obtain more or different evidence about a financial statement assertion. In these situations, the auditor might use confirmation procedures rather than or in conjunction with tests directed toward documents or parties within the entity.

AU § 330.07. Given the extraordinary risks posed by TNCC’s lack of internal controls and

oversight over loan origination and underwriting, Kraft recklessly failed to design or implement

sufficient tests to support its conclusion that TNCC’s internal controls over financial reporting

were sufficient and/or that the financial statements were not misstated, when in fact they were.

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203. Even in the years that Kraft performed a financial statement audit only, 17 2009

and 2010, it still had a duty to identify and report deficiencies in TNCC’s internal controls to

management and the audit committee. As AU Section 325 provides:

The auditor must communicate in writing to management and the audit committee all significant deficiencies and material weaknesses identified during the audit. The written communication should be made prior to the issuance of the auditor's report on the financial statements. The auditor's communication should distinguish clearly between those matters considered significant deficiencies and those considered material weaknesses, as defined in paragraphs 2 and 3.

If oversight of the company's external financial reporting and internal control over financial reporting by the company's audit committee is ineffective, that circumstance should be regarded as an indicator that a material weakness in internal control over financial reporting exists. Although there is not an explicit requirement to evaluate the effectiveness of the audit committee's oversight in an audit of only the financial statements, if the auditor becomes aware that the oversight of the company's external financial reporting and internal control over financial reporting by the company's audit committee is ineffective, the auditor must communicate that information in writing to the board of directors.

These written communications should include:

a. The definitions of significant deficiencies and material weaknesses and should clearly distinguish to which category the deficiencies being communicated relate.

b. A statement that the objective of the audit was to report on the financial statements and not to provide assurance on internal control.

c. A statement that the communication is intended solely for the information and use of the board of directors, audit committee, management, and others within the organization.

17 In fiscal years 2009 and 2010 TNCC represented that it did not qualify as an “accelerated filer” and therefore was not required to submit to an audit of internal controls over financial reporting. See 15 U.S.C. § 7201 et seq .

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When there are requirements established by governmental authorities to furnish such written communications, specific reference to such regulatory authorities may be made.

AU §§ 325.04-325.06.

204. TNCC’s annual reports for fiscal years 2009 and 2010 each include a section

entitled “Management’s Report on Internal Controls Over Financial Reporting”, which include a

statement attesting to the Company’s maintenance of “effective internal control[s] over financial

reporting.” Tennessee Commerce Bancorp, Inc., Amendment No. 3 to Annual Report (Form 10-

K/A), at F-2 (June 2, 2011); Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at

F-2 (Mar. 9, 2010). Accordingly, from the available evidence, there is no indication that Kraft

either identified or reported any of the serious internal control deficiencies identified herein—

such as, for example, the failure of TNCC to recognize the residual balances of refinanced loans

as a loss, resulting in a $22 discrepancy or the seriously and persistently understated ALLL

caused by a lack of adherence to loan origination standards, see FDIC Inspector General’s

Report at I-13 to I-16—during fiscal years 2009 and 2010, in violation of AU Section 325.

205. The lack of effective underwriting standards and controls throughout the Class

Period represented a serious fraud risk factor for Kraft. Had Kraft heeded such a persistent and

blatant red flag—and its many incarnations as illustrated above—it would have necessarily

discovered the understated ALLL and corresponding overstated earnings of the Bank in fiscal

years 2007 throughout 2010.

2. Failure to Recognize Credit Losses in Accord with GAAP

206. One of the most significant and ongoing red flags of fraud at TNCC during the

Class Period, that was either ignored or recklessly disregarded by Kraft, is the failure of TNCC

to recognize losses in a timely or accurate manner in accordance with FAS 5 and 114, resulting

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in the material understatement of the ALLL. As discussed throughout this Complaint, FAS 5

and 114 are the building blocks for establishing the ALLL, probably the single most important

financial bellwether for a Bank. See, e.g. , FDIC, FDIC Law, Regulations, Related Acts § 5000 –

Statements of Policy, Federal Deposit Insurance Corporation (Feb. 28, 2013) (“The ALLL

represents one of the most significant estimates in an institution's financial statements and

regulatory reports.”), available at http://www.fdic.gov/regulations/laws/rules/5000-4700.html;

Tyler Craft, Learning from Acquisitions: An ALLL Perspective, The Risk Management

Association Journal (October 2012) (“The allowance for loan and lease losses (ALLL) is one of

the most important calculations in the banking industry.”).

207. As described at length herein, TNCC had insufficient internal controls over the

assessment and documentation of credit risk throughout the Class Period. This includes a

reckless or intentional lack of controls over the identification of non-performing loans. For

instance, TNCC failed to conform to GAAP by evaluating both individual loans and pools of

loans for impairment, under FAS 114 and FAS 5. See, e.g. , FDIC Inspector General’s Report at

I-13 (“Management failed to appropriately identify, measure, and provide for the level of

deterioration in the loan portfolio in 2010 and 2011. Specifically, examiners noted during the

August 2010 examination that an additional provision of at least $16.3 million to the ALLL was

warranted to provide for the risk in the loan portfolio. The bank also needed to adopt a more

robust FAS 5 and FAS 114 methodology and use a shorter time frame for calculating historical

loan losses to reflect the risk in the loan portfolio and the environment in which the bank was

operating.”). As a result, adjustments to the value of the loan portfolio were delayed or simply

not disclosed. Due to this, the ALLL was understated throughout the Class Period. TNCC also

failed to attempt to mitigate losses once loans did become impaired, holding collateral beyond

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the statutory time limit and compounding the losses to the Bank and investors. See id. at I-14

(“TCB did not have adequate loss mitigation policies and procedures to monitor the repossession

and timely disposition of collateral.”).

208. The reckless manner with which TNCC applied FAS 5 and 114 is illustrated by a

comparison of the reported ALLL to the growth of the loan portfolio year-over-year. As the

table below illustrates, recognition of losses varied wildly, without regard to the growth of the

loan portfolio, which should have alerted a reasonable auditor to the risk of misstatement. In

many periods, the loan portfolio grew precipitously, while the ALLL was decreased:

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Table 1.

TCB Loans vs Allowance for Loan Loss

(In Thousands)

Fiscal

2007; 1

2007; 2

2007; 3 2007; 4 2008; 1

2008; 2

2008; 3

2008; 4 2009; 1

2009; 2

2009; 3 2009; 4 2010; 1

2010; 2

2010; 3 2010; 4 2011; 1

2011; 2

Restatement FDIC Loss Est.

% Increase in Loan Allowance for Loan Loans % Increase in ALLL

Portfolio Loss

$591,245 8.38% $7,758.00 11.34%

$652,520 10.36% $8,619.00 11.10%

$739,155 13.28% $9,250.00 7.32%

$794,322 7.46% $10,321.00 11.58%

$864,948 8.89% $11,034.00 6.91%

$938,636 8.52% $11,520.00 4.40%

$997,839 6.31% $12,191.00 5.82%

$1,036,725 3.90% $13,454.00 10.36%

$1,103,942 6.48% $15,424.00 14.64%

$1,147,119 3.91% $18,938.00 22.78%

$1,159,705 1.10% $19,690.00 3.97%

$1,171,301 1.00% $19,913.00 1.13%

$1,186,171 1.27% $20,110.00 0.99%

$1,197,059 0.92% $20,346.00 1.17%

$1,241,669 3.73% $21,742.00 6.86%

$1,229,811 -0.96% $21,463.00 ‐ 1.28%

$1,208,610 -1.72% $26,114.00 21.67%

$1,156,808 -4.29% $28,205.00 8.01%

$1,156,808 0.00% $111,205.00 294.27%

$1,000,000 ‐13.56% $416,800.00 274.80%

% of ALL to Loans

1.31%

1.32%

1.25%

1.30%

1.28%

1.23%

1.22%

1.30%

1.40%

1.65%

1.70%

1.70%

1.70%

1.70%

1.75%

1.75%

2.16%

2.44%

9.61%

41.68%

The failure of TNCC to adjust the ALLL commensurate with the growth of the loan portfolio

should have served as a red flag to Kraft that financial fraud may be occurring at TNCC. See

AICPA, Audit & Accounting Guide: Depositor and Lending Institutions, Exhibit 5-1: Fraud Risk

Factors, AAG-DEP 5.218, at pp. 110 (fraud risk factors for a depository and lending institution

include: “Rapid growth or unusual profitability, especially compared to that of other peer

financial institutions; for example, unusually large growth in the loan portfolio without a

commensurate increase in the size of the allowance for loan and lease losses ”) (emphasis

added).

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209. By 2010, TNCC’s loan portfolio had deteriorated to the extent that the lack of a

reasonable ALLL could no longer be ignored, with the FDIC calling for the immediate increase

of the ALLL to reflect the deteriorating credit quality of the Bank’s loan portfolio. See FDIC

Inspector General’s Report at I-28. While the FDIC called for only a modest increase in the

ALLL (an amount of $16.3 million) the Individual Defendants knew the situation to be far more

dire. Nonetheless, the Individual Defendants and TNCC management refused to adjust the

ALLL, refused to adopt a more robust FAS 114 and FAS 5 methodology, and continued down

the path to insolvency without alerting investors in any way to the failing nature of the Bank’s

finances.

210. Throughout the Class Period, and even when TNCC’s lies about its credit risk had

become untenable in 2011, Kraft refused to issue either a modified or adverse report on TNCC’s

financial statements. Had Kraft undertaken the type of testing associated with high fraud risk

accounts, such as the ALLL, it would have necessarily discovered the understated nature of the

ALLL. As applicable auditing standards provide, Kraft had the responsibility of accumulating

relevant, sufficient, and reliable data in order to test management’s compliance with FAS 5 and

FAS 114, and the relevant financial inputs for the ALLL estimate:

Review and test management's process. In many situations, the auditor assesses the reasonableness of an accounting estimate by performing procedures to test the process used by management to make the estimate. The following are procedures the auditor may consider performing when using this approach:

f. Identify whether there are controls over the preparation of accounting estimates and supporting data that may be useful in the evaluation.

g. Identify the sources of data and factors that management used in forming the assumptions, and consider whether such data and factors are relevant,

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reliable, and sufficient for the purpose based on information gathered in other audit tests.

h. Consider whether there are additional key factors or alternative assumptions about the factors.

i. Evaluate whether the assumptions are consistent with each other, the supporting data, relevant historical data, and industry data.

j. Analyze historical data used in developing the assumptions to assess whether the data is comparable and consistent with data of the period under audit, and consider whether such data is sufficiently reliable for the purpose.

k. Consider whether changes in the business or industry may cause other factors to become significant to the assumptions.

l. Review available documentation of the assumptions used in developing the accounting estimates and inquire about any other plans, goals, and objectives of the entity, as well as consider their relationship to the assumptions.

m. Consider using the work of a specialist regarding certain assumptions (section 336,Using the Work of a Specialist).

n. Test the calculations used by management to translate the assumptions and key factors into the accounting estimate.

AU § 342.05. Had Kraft employed these procedures in order to determine the accuracy of the

ALLL, it would have discovered that the ALLL was materially misstated. For instance, if Kraft

had sufficiently considered the “sources of data” making up the ALLL, i.e. , the consideration of

individual loans and pooled loans under FAS 114 and FAS 5, it would have discovered that

TNCC was not sufficiently or timely recognizing problem loans.

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211. In fact, where internal controls over the inputs to an estimate are non-functional or

absent—as they were at TNCC during the Class Period, particularly with respect to credit

monitoring and conformity with GAAP—there is a heightened responsibility to pay special

attention to such estimates. See AU § 342.05 (“An entity’s internal control may reduce the

likelihood of material misstatement.”); see also AU § 342.10 (“In evaluating reasonableness, the

auditor should obtain an understanding of how management developed the estimate. Based on

that understanding, the auditor should use one or a combination of the following approaches: a.

Review and test the process used by management to develop the estimate. b. Develop an

independent expectation of the estimate to corroborate the reasonableness of management's

estimate.”); AU § 329.02 (“Analytical procedures are an important part of the audit process and

consist of evaluations of financial information made by a study of plausible relationships among

both financial and nonfinancial data. Analytical procedures range from simple comparisons to

the use of complex models involving many relationships and elements of data. A basic premise

underlying the application of analytical procedures is that plausible relationships among data

may reasonably be expected to exist and continue in the absence of known conditions to the

contrary. Particular conditions that can cause variations in these relationships include, for

example, specific unusual transactions or events, accounting changes, business changes, random

fluctuations, or misstatements.”)

3. The Recklessly Unrestrained Growth in TNCC’s Loan Portfolio

212. TNCC’s unrestrained lending during the Class Period should have also

represented a significant fraud risk factor for Kraft, particularly given the lack of effective

underwriting standards discussed supra.

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213. During fiscal years 2008 and 2009, most small to mid-sized banks were reining in

their lending and bracing for perhaps the worst economic expansion in 80 years. See, e.g.,

AICPA, ARA Depository and Lending Institution Industry Developments-2008, AAM § 8050

(“AAM Section 8050”) (“Approximately 85 percent of domestic banks reported having tightened

lending standards on commercial and industrial (C&I) loans to large and middle market firms

since July 2008. Approximately 75 percent noted having tightened lending standards on C&I

loans to small firms during the same 3 month period.”).

Table 2.

Fiscal Year Quarter Loans % of Loan Increase

2007 4 794,322 45.6088% 2008 4 1,036,725 30.5170%

2009 4 1,171,301 12.9809% 2010 1 4 1,229,811 4.9953%

Chart 2.

Loan Portfolio Growth

1,400,000

1,200,000

1,

800,000

600,000

41:11:1,

200,000

II

1.1111111 45.0000% 40.0000% 35.0000% 311.1111111 25.0000%

15.0000% 10. 0000%

0.0000% 2007 2008 21:11:19 21:110

Loans -6 of Loan Increase

214. Nonetheless, TNCC was doing exactly the opposite, originating and/or

underwriting over $400,000,000 in loans during the Class Period. For example, from 2009 until

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the collapse of the Bank in January of 2012, TNCC recklessly originated or refinanced over $400

million in loans. See FDIC Inspector General’s Report at I-5 (“The credit quality of TCB’s loan

portfolio continued to decline in 2008 and accelerated as the economy deteriorated. However,

TCB continued its high growth strategy, reporting that it originated over $90 million in new

loans during the first quarter of 20009. In total, TCB originated or renewed about $400 million

in loans from 2009 until its failure.”). Indeed, in the period of just one year, from 2008 to 2009,

TNCC’s loan portfolio exploded in size, growing by over $310 million or 39% in the space of

approximately 14 months. Id. at I-27. Such a massive increase in the loan portfolio—

particularly when considered in conjunction with the noted lack of loan origination and

underwriting internal controls—should have served as a red flag for financial fraud to Kraft that

the risk of material misstatement was growing exponentially. See AICPA, AICPA, Audit &

Accounting Guide: Depositor and Lending Institutions, Exhibit 5-1: Fraud Risk Factors, AAG-

DEP 5.218, at pp. 110 (fraud risk factors for depository and lending institutions include: “Rapid

growth or unusual profitability, especially compared to that of other peer financial institutions;

for example, unusually large growth in the loan portfolio without a commensurate increase

in the size of the allowance for loan and lease losses ”) (emphasis added).

215. Moreover, TNCC was originating and underwriting loans in an extremely narrow

and risky sector of the commercial lending market, C&I, adding to the Bank’s exposure to risk.

As the FDIC Inspector General noted in its review:

[The Bank] failed primarily because its board of directors (Board) and management did not effectively manage the risks associated with the bank’s sustained high growth in C&I lending. Notably, [the Bank] had a significant concentration in an economically sensitive and specialized segment of the C&I market pertaining to the transportation industry. [The Bank]’s lending in this area included loans to leasing companies and lease brokers for the

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financing of trucks, buses, and other commercial use vehicles. However, [the Bank]’s underwriting, administration, monitoring, and collection procedures for these and other C&I loans was not adequate. Contributing to the bank’s credit risk exposure were large and complex borrowing relationships that were not effectively managed.


216. The result of such a dramatic increase in the loan portfolio—particularly in the

C&I sector—was to put TNCC in danger of not being able to maintain capital levels

commensurate with the Bank’s risk profile. While related to the red flags associated with the

explosion of lending at TNCC, the risk such lending put the Bank in should have represented a

separate and distinct red flag to Kraft of the risk of financial fraud. See AICPA, Audit &

Accounting Guide: Depositor and Lending Institutions, Exhibit 5-1: Fraud Risk Factors (giving

as an example of a fraud risk fact a “[t]hreat of failing to meet minimum capital adequacy

requirements that could cause adverse regulatory actions”).

217. Strikingly, the irresponsible explosion of lending at TNCC throughout the Class

Period, as well as credit risk at TNCC, was specifically acknowledged to be “red flags” by

TNCC executive management. As Defendant Sapp stated just six months before the Restatement

during the first quarter 2011 earnings conference call, while he falsely tried to distance himself

from the reality of the untenably and unreasonably high credit risk at the Bank:

One unfortunate byproduct of the model is that it has several red flags for regulators given the current credit cycle. We focus on technology to drive an convenient deposit model for our customers. These results [sic] in a perception as deposit volatility, compared to brick and mortar branches. We have had an above average growth rate over the past several years and we became used to being able to raise capital when it was needed to support that growth. The current environment is different and we will make appropriate changes in strategy in response .

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Tennessee Commerce Bancorp, Inc., Q1 2011 Earnings Call, Bloomberg Transcript (Apr. 29,

2011) (emphasis added).

218. The explosion the loan portfolio at TNCC during the Class Period, as well as

extremely poor underwriting and credit risk procedures, represented a blatant red flag that fraud

may be afoot at TNCC that year-upon-year Kraft recklessly failed to heed. See, e.g. , AU §

316.85 (giving as an example of “risk factors relating to misstatements arising from fraudulent

financial reporting,” “Rapid growth or unusual profitability, especially compared to that of other

companies in the same industry”). This is particularly true when the unrestrained growth of the

loan portfolio is considered in conjunction with the other red flags identified herein.

4. Lack of Effective Executive Oversight Over Credit Risk and Loss Mitigation

219. Similarly, Kraft recklessly overlooked the lack of reasonable Board and/or

management oversight over the critical operations of the bank, including credit risk monitoring

and loss mitigation.

220. One example of TNCC’s lack of credit risk monitoring procedures is illustrated

by the difficulties with the Bank’s ALCO. As part of its 2007 report on internal controls over

financial reporting, Kraft noted that:

The following material weaknesses have been identified and included in management’s assessment. (1) The Company’s policy prohibiting employees from initiating transactions affecting their own accounts without appropriate review was violated. Numerous transactions processed on employee accounts were not appropriately reviewed and approved. (2) Formal meetings of the Asset/Liability Management Committee did not occur during 2007. Furthermore, items discussed during informal meetings between members of the Asset/Liability Management Committee were presented to the Board of Directors in the form of formal minutes.

135



221. As TNCC’s SEC filings reflect, the ALCO Management Committee is “charged

with monitoring the liquidity and funds position of the Bank.” Tennessee Commerce Bancorp,

Inc., Annual Report (Form 10-K), at 35 (Mar. 16, 2009). In essence, the Committee had plenary

responsibility for overseeing the credit risk and liquidity position of the Bank:

The Bank’s Asset Liability and Investment Committee, which consists of the Corporation’s executive officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Cox and Frank Perez, is charged with monitoring the liquidity and funds position of the Bank. The committee regularly reviews (a) the rate sensitivity position on a three-month, six-month and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of liabilities. The Bank operates an asset/liability management model. At December 31, 2008, the Bank had a negative cumulative re-pricing gap within one year of approximately $(138,952) or approximately 11.84% of total year-end earning assets.

* * *

Like all financial institutions, the Corporation is subject to market risk from changes in interest rates. Interest rate risk is inherent in the balance sheet because of the mismatch between the maturities of rate sensitive assets and rate sensitive liabilities. If rates are rising, and the level of rate sensitive liabilities exceed the level of rate sensitive assets, the net interest margin will be negatively impacted. Conversely, if rates are falling, and the level of rate sensitive liabilities is greater than the level of rate sensitive assets, the impact on the net interest margin will be favorable. Managing interest rate risk is further complicated by the fact that all rates do not change at the same pace; in other words, short-term rates may be rising while longer term rates remain stable. In addition, different types of rate sensitive assets and rate sensitive liabilities react differently to changes in rates.

To manage interest rate risk, the Corporation must take a position on the expected future trend of interest rates. Rates may rise, fall or remain the same. The Asset-Liability Committee of the Bank

136


develops its view of future rate trends by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of the Corporation’s balance sheet. The Corporation’s annual budget reflects the anticipated rate environment for the next 12 months. The Asset-Liability Committee conducts a quarterly analysis of the rate sensitivity position. The results of the analysis are reported to the Board.

Id. at 33, 40.

222. The fact that the ALCO, a committee which is so vital to the responsible

operation of the Bank, did not meet in 2007, should have put Kraft on notice that the Bank was

not being managed in a reasonable manner so as to ensure the reliability of financial information

and that credit risk and associated policies were not being monitored or enforced to the extent

necessary for management to provide an reasonable estimate of credit risk, such as the ALLL.

223. In the following year, fiscal year 2008, Kraft issued an unqualified report on

internal controls over financial reporting failing to note any material weakness in internal

controls. However, the FDIC did identify weaknesses, for example, the FDIC’s April 2008

examination of the Bank which noted that that—despite Kraft’s identification of a material

weakness concerning the ALCO in its 2007 report—the Bank’s ALCO again did not hold regular

meetings and TNCC officials appeared to have fabricated minutes in order to mislead the board

of directors and/or regulators. See FDIC Inspector General’s Report at I-25 (“The bank’s

Asset/Liability Committee had not met on a regular basis since the prior regulatory examination.

However, “minutes” of what were actually “very informal discussions” among the Committee

members were inappropriately submitted to the Board. The examination report stated that the

minutes ‘appear to be false and misleading statements provided in reports to the Board’ and that

they had the potential to mislead the directorate as well as examiners that review Board meeting

documentation. The report cited TCB with an apparent violation of Tennessee Code Annotated

137


Section 45-2-1706—Improper Maintenance of accounts—False or deceptive entries and

statements.”). Kraft’s failure to report on the failure of the ALCO to hold formal meetings in

2008—particularly in light of the failure in the previous year, represents its reckless disregard of

auditing standards. See Auditing Standard No. 5 (“The auditor [of internal controls over

financial reporting] should properly plan the audit of internal control over financial reporting and

properly supervise the engagement team members. When planning an integrated audit, the

auditor should evaluate whether the following matters are important to the company's financial

statements and internal control over financial reporting and, if so, how they will affect the

auditor's procedures... Control deficiencies previously communicated to the audit committee or

management.”) (emphasis added).

224. In addition, the FDIC noted a number of violations of the law which were

ongoing at TNCC during the Class Period. These included the holding of collateral beyond the

period prescribed by Tennessee law, in violation of Tennessee Code Ann. § 45-2-607(b)(1). An

auditor has specific duties when presented with breaches of the law which may have a material

effect on the financial statements states, such as the illegal acts at TNCC, which are outlined in

AU Section 317. As AU Section 317 sets forth:

When the auditor becomes aware of information concerning a possible illegal act, the auditor should obtain an understanding of the nature of the act, the circumstances in which it occurred, and sufficient other information to evaluate the effect on the financial statements. In doing so, the auditor should inquire of management at a level above those involved, if possible. If management does not provide satisfactory information that there has been no illegal act, the auditor should—

a. Consult with the client's legal counsel or other specialists about the application of relevant laws and regulations to the circumstances and the possible effects on the financial

138


statements. Arrangements for such consultation with client's legal counsel should be made by the client.

b. Apply additional procedures, if necessary, to obtain further understanding of the nature of the acts.

AU § 317.10. Once the nature of the illegal acts is ascertained, and it is concluded that an illegal

act would have a material effect on the financial statements, it is the auditor’s duty to prepare a

qualified or adverse audit report:

If the auditor concludes that an illegal act has a material effect on the financial statements, and the act has not been properly accounted for or disclosed, the auditor should express a qualified opinion or an adverse opinion on the financial statements taken as a whole, depending on the materiality of the effect on the financial statements.

AU § 317.18. Exercising due care in conformance with AU Section 230.01, Kraft should have

discovered the illegal acts ongoing at TNCC during the Class Period. Once those acts were

discovered, and determined to have a material impact on the financial statements, Kraft had a

duty to disclose those acts in a qualified or adverse audit report. See id .

225. In the years that Kraft issued an report on the sufficiency of TNCC’s internal

controls over financial reporting, fiscal years 2007 and 2008, Kraft recklessly failed to

acknowledge various serious breaches of the law, company policy, and internal controls that

were ongoing at TNCC. Auditing Standard 5 requires, among other things, that an auditor

adequately determine the risk of the audit and use a top-down approach to identify possible

internal control deficiencies, including performing “walkthough[s]” to determine where controls

might be deficient:

Risk assessment underlies the entire audit process described by this standard, including the determination of significant accounts and

139


disclosures and relevant assertions, the selection of controls to test, and the determination of the evidence necessary for a given control.

* * *

The auditor should use a top-down approach to the audit of internal control over financial reporting to select the controls to test. A top-down approach begins at the financial statement level and with the auditor's understanding of the overall risks to internal control over financial reporting. The auditor then focuses on entity-level controls and works down to significant accounts and disclosures and their relevant assertions. This approach directs the auditor's attention to accounts, disclosures, and assertions that present a reasonable possibility of material misstatement to the financial statements and related disclosures. The auditor then verifies his or her understanding of the risks in the company's processes and selects for testing those controls that sufficiently address the assessed risk of misstatement to each relevant assertion.

* * *

In performing a walkthrough, at the points at which important processing procedures occur, the auditor questions the company's personnel about their understanding of what is required by the company's prescribed procedures and controls. These probing questions, combined with the other walkthrough procedures, allow the auditor to gain a sufficient understanding of the process and to be able to identify important points at which a necessary control is missing or not designed effectively. Additionally, probing questions that go beyond a narrow focus on the single transaction used as the basis for the walkthrough allow the auditor to gain an understanding of the different types of significant transactions handled by the process.

Auditing Standards No. 5, ¶¶ 10, 38. GAAS requires that particular attention should be paid to

certain accounts, such as the ALLL, which involves “Valuation or allocation” because of the

possibility that a misstatement in those accounts would cause the financial statements to be

misstated. See id . at ¶ 28.

140


226. Pursuant to Auditing Standard No. 5, Kraft recklessly failed to perform, or

recklessly performed, walkthroughs of Kraft’s loss mitigation and strategic planning functions.

Had Kraft performed a the prescribed walkthroughs, it would have discovered, among other

things, (1) the illegal fabrication of minutes of the ALCO noted by the FDIC in 2008, in

violation of Tenn. Code Ann. § 45-2-1706, see FDIC Inspector General’s Report at I-25, just as

Kraft had done in 2007, when it issued an adverse report on internal controls over financial

reporting based on the failure of the ALCO to meet and the violation of the Company’s policy

prohibiting employees from initiating transaction on their own accounts, see Tennessee

Commerce Bancorp, Inc., Annual Report (Form 10-K), at F-6 (Apr. 18, 2008); (2) the failure of

TNCC to adhere to Tennessee law with respect to repossessed assets in 2007 and 2008, in

violation of Tennessee Code Ann. § 45-2-607(b)(1), see FDIC Inspector General’s Report at I-

25; (3) indications of risk rating downgrades, watch list inclusion and charge-offs occurring

within a short period of time “suggesting ineffective credit monitoring,” see FDIC Inspector

General’s Report at I-24; (4) the failure of the Bank to develop and/or adopt a capital plan in

order to set parameters on the liquidity and credit risk, ibid; and (5) others identified herein.

5. Warnings by the FDIC and TDFI

227. Finally, Kraft recklessly disregarded the repeated warnings by the FDIC and

TDFI indicating an extremely high risk of financial fraud at TNCC, particularly with regard to

the fraudulently understated ALLL.

228. As discussed at length herein, the FDIC and TDFI made many examinations of

TNCC during the class period. The FDIC alone made seven separate examinations and/or

visitations of the Bank during the Class Period, with the TDFI making six (five of these were

joint visitations/examinations). It was the responsibility of Kraft to request from management,

141


read, and carefully consider the FDIC examination reports in order to reasonably plan and assess

the risk of the audit. See AS No. 5 (“The auditor should properly plan the audit of internal

control over financial reporting and properly supervise any assistants. When planning an

integrated audit, the auditor should evaluate whether the following matters are important to the

company's financial statements and internal control over financial reporting and, if so, how they

will affect the auditor's procedures - . . . Matters affecting the industry in which the company

operates, such as financial reporting practices, economic conditions, laws and regulations, and

technological changes . . . Matters relating to the company's business, including its organization,

operating characteristics, and capital structure . . . Legal or regulatory matters of which the

company is aware”).

229. The relevant examination reports from the FDIC and TDFI reveal that those

agencies were well aware of the seriousness of the lack of Board/management oversight and

effective internal controls at TNCC, as well as the impact that that lack of controls had on

financial reporting, such as the failure of the Bank to comply with FAS 5 and 114, the lack of

effective credit risk management, and the inability to implement sufficient loss mitigation

procedures. Time and again, yet to no avail, those agencies attempted to warn the Bank of the

consequences of continuing to operate in such a reckless manner, citing specific failings in the

Bank’s operations framework. Had Kraft reasonably considered these communicated risks, it

necessarily would have altered its audit plan to detect the financial fraud involving the

understated ALLL. See Auditing Standard No. 5 (the auditor “should achieve the following

objectives:...Understand the flow of transactions related to the relevant assertions, including how

these transactions are initiated, authorized, processed, and recorded; Verify that the auditor has

identified the points within the company's processes at which a misstatement - including a

142


misstatement due to fraud - could arise that, individually or in combination with other

misstatements, would be material; identify the controls that management has implemented to

address these potential misstatements; and identify the controls that management has

implemented over the prevention or timely detection of unauthorized acquisition, use, or

disposition of the company's assets that could result in a material misstatement of the financial

statements.”). The failure of Kraft to discover the financial fraud at TNCC, which was outlined

by the FDIC examination reports issued from 2007 to 2010, reflects a reckless lack of planning,

risk assessment, and insufficient testing during the conduct of the audits.

230. Perhaps the clearest illustration of Kraft’s failure to heed the warnings of the

FDIC is Kraft’s reckless disregard of the FDIC’s challenge of the Company’s ALLL presentation

in fiscal year 2010. In fiscal year 2010, Kraft initially issued a qualified report, giving it an

opportunity to alert investors to the materially understated ALLL. See infra , discussion of red

flags. Kraft’s initial audit report was qualified, pending an investigation into the FDIC’s

examination which suggested that the ALLL was deficient:

Due to an unresolved report of examination from the Federal Deposit Insurance Corporation and Tennessee Department of Financial Institutions that could require adjustments to the allowance for loan losses as discussed in Note 12, we were unable to satisfy ourselves about the valuation of the Company's allowance for loan losses as of December 31, 2010.

In our opinion, except for the effects of such adjustments, if any, as might be determined necessary based on the outcome of the regulatory examination discussed in Note 12, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tennessee Commerce Bancorp, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

143



231. Nonetheless, as discussed infra, instead of taking the opportunity to conduct

further testing and alert investors to the seriously understated ALLL, Kraft amended the qualified

report to an unqualified report on June 1, 2011. The amendment of the qualified report left

investors with the severely mistaken belief that the ALLL was sufficiently stated and that the

FDIC was incorrect in seeking an adjustment. As set forth herein, TNCC did enter into a consent

decree with the FDIC, but flatly refused to adjust the ALLL, standing by their fraudulent

presentation of the ALLL. As such, the consent order did nothing to correct TNCC’s

fraudulently stated ALLL. However, Kraft’s subsequent unqualified report mistakenly leads

investors to believe that the FDIC had approved the fraudulent ALLL number. As Kraft’s

amended report stated:

In our report dated April 15, 2011, we expressed an opinion that, except for an uncertainty related to the adequacy of the Company’s allowance for loan losses resulting from an unfinished regulatory examination, the 2010 consolidated financial statements presented fairly, in all material respects, the Company’s financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. As described in Note 12 to the financial statements, the Company has agreed to a formal Consent Order (the “Order”) with the Federal Deposit Insurance Corporation that eliminates uncertainties related to potential adjustments to the Company’s allowance for loan losses. Accordingly, our present opinion on the 2010 financial statements, as presented herein, is different from that expressed in our previous report.

In our opinion, the consolidated financial statements referred to above, as restated by amendment of Note 12 to the financial statements, present fairly, in all material respects, the financial position of Tennessee Commerce Bancorp, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.

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Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at F-3 (June 1, 2011).

232. Just a few months after Kraft issued its amended audit report for fiscal year

2010—withdrawing its qualified report as to the presentation of the ALLL in TNCC’s financial

statement—TNCC was forced to restate its financials. As noted above, on November 2, 2011,

TNCC issued a Current Report alerting investors that it was restating the ALLL as presented in

its quarterly report for the second fiscal quarter of 2011. The second quarter 2011 report, as with

TNCC’s previous quarterly reports, included a materially understated ALLL calculation. The

ALLL number that was originally reported was just $28,205,000. As part of the Restatement on

November 1, 2011 TNCC proposed an increase of $83 million, bringing the revised figure to

$111,205,000, a 394% increase.

233. This 394% increase in the ALLL, while striking, was inadequate. Moreover, the

restatement of the ALLL for only a single period was still inadequate, as reflected by Kraft’s

later guidance, filed with the SEC on January 25, 2012, stating that the firm was considering

withdrawing its audit report for fiscal years prior to 2010:

We have read the statements under Item 4.02 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on January 20, 2012 regarding withdrawal of our audit report on the Corporation’s financial statements as of December 31, 2010 and for the year then ended and the possibility that we may withdraw earlier audit reports pursuant to the results of a forensic review of the Corporation’s small ticket loan portfolio. We agree with these statements pertaining to our firm.

Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), Ex 99.1 (Jan. 25, 2012). Two

days later, on January 27, 2012, TNCC was closed by the FDIC and TDFI.

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234. Had Kraft reasonably investigated the indications of fraud highlighted by the

FDIC in 2007, 2008, 2009 and 2010, the Restatement and later the withdrawal of the 2010 audit

report would have been wholly unnecessary. Kraft was provided many, many opportunities to

fulfill its duties as auditor and ensure that it had “reasonable assurance about whether the

financial statement [were] free of material misstatement,” but year-after-year failed to do so. AU

§ 316.01. Such a failure was not only contrary to applicable auditing standards, but was

necessarily reckless. Ibid.

VIII. LOSS CAUSATION

235. Class members were damaged as a result of TNCC and the Individual

Defendants’ fraudulent conduct as set forth herein. During the Class Period, as detailed herein,

Defendants engaged in a scheme to deceive the market and a course of conduct that artificially

inflated TNCC’s stock price and operated as a fraud or deceit on Class Period purchasers of

TNCC common stock by misrepresenting to and concealing material information from the public

about, inter alia: (1) the Company’s loan origination and loss mitigation practices; (2) the

existence and effectiveness of the Company’s internal controls over operations and financial

reporting, and whether those controls were being enforced; and (3) the true risk of the Bank’s

loan portfolio.

236. These material misstatements and omissions caused and maintained artificial

inflation in TNCC’s stock price throughout the Class Period until the truth was fully, albeit

slowly, revealed to the market. As the price of TNCC’s stock increased, Class members

unwittingly and in reliance on Defendants’ false and misleading statements and/or omissions

purchased TNCC stock at artificially inflated prices. But for Defendants’ material

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misrepresentations and omissions, Plaintiffs and other Class members would not have purchased

TNCC stock, or would not have purchased it at the artificially inflated prices at which it traded

during the Class Period.

237. As Defendants’ material misrepresentations and omissions were disclosed and

became apparent to the market in a piecemeal fashion throughout the Class Period, TNCC stock

fell dramatically as the prior artificial inflation bled from the Company’s stock price. Due to

their purchases of TNCC stock during the Class Period, Plaintiffs and other members of the

Class suffered economic damages under the federal securities laws.

238. The following examples support a showing of loss causation pursuant to Rule 8(a)

of the Federal Rules of Civil Procedure in accordance with the United States Supreme Court’s

decision in Dura Pharms. v. Broudo, 544 U.S. 336 (2005).

239. As detailed above, Defendants’ false and misleading statements and omissions

caused TNCC stock to trade at artificially inflated levels throughout the Class Period, reaching as

high as $19.60 per share before the public disclosures began and took place as a series of limited

disclosures over an extended period of time. Until the Bank was closed in 2012, each of the

prior public disclosures was in itself materially insufficient because each contained material

misstatements and material omissions. Nevertheless, as each of these limited, truth-revealing

disclosures came to light, they caused the artificial inflation to slowly dissipate from TNCC’s

stock price.

240. A modest increase in the ALLL (albeit insufficient) in April 2009 caused the

Bank’s share price to drop almost 15%, from a price of $9.39 prior to the release of the earnings

announcement to under $8.00 per share on May 8, 2009. See Tennessee Commerce Bancorp,

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Inc., Current Report (Form 8-K), Ex. 99.1, at *1 (Apr. 7, 2009) (“Tennessee Commerce expects

to increase its reserve for loan losses to approximately 1.40% of total loans at the end of the first

quarter of 2009, a 10 basis point increase compared with the fourth quarter of 2008.”).

241. A similar increase in the ALLL in November of 2009 caused a similar decrease in

share price, with TNCC’s share price falling over 10%, from $5.50 on November 2, 2009 to

$4.95 on November 6, 2009. Tennessee Commerce Bancorp, Inc., Quarterly Report (Form 10-

Q), at 17 (Nov. 6, 2009) (“Net income for the three months ended September 30, 2009 was

$1,161[,000], a decrease of $725 or 38.44% compared to net income of $1,886[,000] for the

three months ended September 30, 2008. The decrease is attributable to an increase in the

provision for loan losses of 183.78% from $1,850[,000] for the three months ended September

30, 2008 to $5,250[,000] for the same period in 2009.”)

242. When TNCC announced that it had, again, raised its ALLL—albeit by an entirely

inadequate amount—and announced that the Federal Reserve had placed restrictions on the

Company’s capital holdings, the Company’s stock price plunged by over 30%, from $6.70 on

July 27, 2010, to $4.65 on August 3, 2010. See Tennessee Commerce Bancorp, Inc., Current

Report (Form 8-K), Ex. 99.1, at 1 (July 27, 2010) (“The loan loss provision of $4.5 million for

the second quarter of 2010 exceeded the net charge-offs of $4.2 million, resulting in a ratio of

loan loss provision to net charge-offs of 105.6%. The allowance for loan losses at June 30, 2010

was $20.3 million or 1.7% of total loans. The coverage ratio of allowance for loan losses to non-

performing loans at June 30, 2010 was 59.6%.”); see also Tennessee Commerce Bancorp, Inc.,

Current Report (Form 8-K), at 2 (July 28, 2010) (“Following a review of Tennessee Commerce

Bancorp, Inc. (the “Corporation”) by the Federal Reserve Bank of Atlanta (the “Federal Reserve

Bank”) at its inspection of the Corporation as of June 30, 2009, which was updated through

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December 31, 2009, the Federal Reserve Bank instructed the Corporation’s board of directors to

adopt, no later than August 7, 2010, a board resolution whereby the Corporation will agree to

obtain the written approval of the Federal Reserve Bank prior to (i) incurring additional

indebtedness at the parent level, including indebtedness associated with trust preferred securities,

(ii) taking any action that would cause a change in debt instruments relating to indebtedness

incurred at the parent level, (iii) declaring or paying dividends to common or preferred

shareholders, (iv) reducing the Corporation’s capital position by purchasing or redeeming

treasury stock and (v) making any distributions of interest, principal or other sums on

subordinated debentures or trust preferred securities.”).

243. When, on April 18, 2011, TNCC belatedly announced that the FDIC and TDFI

had determined that the bank was in “troubled condition” 18 and that formal enforcement action

was being sought, TNCC’s share price fell by almost 14%, from $4.44 per share on April 15th to

$3.82 on April 18, 2011. Tennessee Commerce Bancorp, Inc., Annual Report (Form 10-K), at 8

(Apr. 18, 2011) (“Moreover, as of March 17, 2011, the Bank has been deemed to be in troubled

condition.”).

244. In addition, when TNCC announced that it had stipulated to the Consent Order

with the FDIC on July 28, 2011, and that the TDFI had ordered the Bank to charge off all non-

real estate repossessed assets that were held over the six-month period mandated under

Tennessee law, the Company’s stock price dropped over 38%, from $2.44 per share on July 27th

to $1.50 on July 29, 2011. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K),

18 As discussed supra, the FDIC had informed TNCC that the bank had been deemed to be in “troubled condition” in a letter dated October 9, 2009. See FDIC Inspector General’s Report at I-27.

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Ex. 99.1, at *2 (July 28, 2011) (“As a result of the Bank entering into a written agreement with

the Federal Deposit Insurance Corporation (FDIC) during the second quarter, the Bank has to

achieve and maintain a tier 1 leverage capital ratio of 8.50%, a tier 1 risk based capital ratio of

10.00% and a total risk based capital ratio of 11.50% by no later than December 31, 2011.”)

245. When TNCC announced, after the close of business on November 1, 2011, that it

was restating its financial results for the fiscal quarter ended June 30, 2011, due to a misstated

ALLL, TNCC’s share price fell almost 86%, from $0.90 per share to $0.13 per share. Tennessee

Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Nov. 1, 2011) (“On October 27,

2011, management of the Corporation, and subsequently, its Audit Committee and Board of

Directors, determined that its financial statements for the quarter ended June 30, 2011, as

included in the Corporation’s Quarterly Report on Form 10-Q for the fiscal quarter ended June

30, 2011, should no longer be relied upon due to an expected approximately $83.0 million

increase in the provision for loan losses and related allowance for loan losses . . . .”).

246. A shareholder who purchased TNCC stock on May 3, 2010, for $10.64 (the

closing price of TNCC’s stock on that day), for example, and held the stock until the Bank

announced that its financial statement for 2010 and previous years should not be relied upon,

would have lost approximately 98% of his investment (the closing price of TNCC stock on

January 20, 2012 was $0.17 per share). Consequently, with each partial (albeit incomplete)

disclosure, the price of TNCC stock fell like a cascading waterfall.

247. Table 1 below shows the various corrective statements, paired with the

corresponding decrease in TNCC’s share price:

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Table 1 .

TNCC Share Price

$20.00

$15.00

614.00

$10.00

MOO

$4.00

248. Conversely, the false statements outlined herein had the desired effect of

artificially inflating TNCC’s share price. For example, the highest prices in the Class Period all

occurred around dates when TNCC announced its annual and fourth quarter results.

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Table 2 .

TNCC Share Price

$20.00

$16.00

$14.00

$12.00 FY 2008 Annual

FY 2009 Annual I

$10.00

$800

$6.00

$400

$2.00

$0.00

FY 2010 Annual Report

As alleged herein, each of those reports contained knowingly false and misleading statements

intended and engineered to artificially inflate the Company’s share price. Those reports were

each widely disseminated to the securities markets, investment analysts and the investing public

at large. The false and misleading statements alleged herein artificially inflated TNCC’s share

price and, when those statements were slowly revealed to be false, shareholders were left with

investments worth far less than they had believed.

IX. FRAUD-ON-THE-MARKET PRESUMPTION OF RELIANCE

249. The market for TNCC’s common stock was open, well-developed and efficient at

all relevant times. TNCC’s stock met the requirements for listing, and was listed and actively

traded on the NASDAQ Stock Market (“NASDAQ”), a highly efficient and automated market.

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As a regulated issuer, TNCC filed periodic public reports with the SEC and NASDAQ.

Defendants regularly communicated with public investors via established market communication

mechanisms, including through regular disseminations of press releases on the national circuits

of major newswire services and through other wide-ranging public disclosures, such as

communications with the financial press and other similar reporting services. TNCC was

followed by several securities analysts employed by major brokerage firms who wrote reports

which were distributed to the sales force and certain customers of their respective brokerage

firms. Each of these reports was publicly available and entered the public marketplace.

250. As alleged herein, the change in the price of TNCC’s stock – compared to the

changes in the peer group and NASDAQ – in response to the release of unexpected material

positive and negative information about the Company, shows there was a cause and effect

relationship between the public release of the unexpected information about TNCC and the price

movement in the Company’s stock. During the Class Period, TNCC’s stock was traded millions

of times per week. Numerous analysts followed TNCC, called in to the Company’s conference

calls and issued reports throughout the Class Period. The Company was eligible to – and did –

register securities on Form S-3 during the Class Period. There were numerous market makers for

TNCC’s stock.

251. As a result of the foregoing, the market for TNCC’s common stock promptly

digested current information regarding TNCC from all publicly available sources and reflected

such information in the Company’s stock price. Under these circumstances, all purchasers of

TNCC common stock during the Class Period suffered similar injury through their purchase of

TNCC’s common stock at artificially inflated prices and the subsequent revelations causing

material declines in price, and a presumption of reliance applies.

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X. NO SAFE HARBOR

252. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to any of the allegedly false statements pled in this Complaint.

Some of the specific statements pled herein were not “forward-looking statements” when made,

nor were they adequately identified as such. To the extent there were any forward-looking

statements, there were no meaningful cautionary statements identifying important factors that

could cause actual results to differ materially from those in the purportedly forward-looking

statements. Alternatively, to the extent that the statutory safe harbor does apply to any forward-

looking statements pled herein, Defendants are liable for those false forward-looking statements

because at the time each of those forward-looking statements was made, Defendants knew that

the particular forward-looking statement was materially false and/or misleading when made.

XI. CONTROL PERSON ALLEGATIONS UNDER § 20(a) OF THE EXCHANGE ACT

253. Section 20(a) of the Exchange Act states in pertinent part:

Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.

15 U.S.C. § 78t(a).

254. The Individual Defendants (ITelf, Sapp, Cox and Perez) by virtue of their

positions exercised control and authority over TNCC's internal operations, as well as the

Company’s dissemination of information to investors, the public and the financial markets. In

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addition, each of the Individual Defendants exercised direct control over the accounting practices

and procedures employed by TNCC throughout the Class Period. Therefore, by virtue of their

authority, control and positions as officers and/or directors of TNCC, the Individual Defendants

directly controlled the content of the various SEC filings, press releases and other public

statements made by TNCC executives pertaining to the Company and the Bank during the Class

Period.

255. As alleged herein, the Individual Defendants are liable for violation of § 10(b) of

the Exchanges Act for fraudulent statements made to investors during the relevant Class Period.

This includes, inter alia, disseminating the annual reports on form 10-K that were filed with the

SEC and signed by various or all of the Individual Defendants (the "Primary Violations"). At the

time of the Primary Violations, Defendants Helf, Sapp, Cox and/or Perez were employed by

TNCC and the Individual Defendants held executive positions of control and authority over the

Company's business and operations. 19 Further, each of the Individual Defendants had the

opportunity and ability to influence the content of TNCC's public statements and SEC filings,

including statements made in conjunction with the Primary Violations.

256. Also, the Primary Violations arose out of an agency relationship with TNCC,

rendering those statements attributable to each of the Individual Defendants. Defendants’

statements were a reflection of TNCC's corporate position as to the state of affairs at TNCC at

the time that they were made. Each of the Individual Defendants—who were directly

19 As noted above, Defendant Perez joined the company as Chief Financial Officer of TNCC and the Bank on July 31, 2008. See Tennessee Commerce Bancorp, Inc., Current Report (Form 8-K), at 2 (Aug. 5, 2008).

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responsible for shaping, approving and steering TNCC's public statements--were responsible for

the content of those statements. Conversely, each of the Individual Defendants had it within

their ability to either: (a) correct the false and misleading statements after they were made; or (b)

urge that the false and misleading statement not be disseminated to the investing public. The

Individual Defendants failure to exercise this power and discretion renders them culpable under

§ 20(a).

257. Because each of the Individual Defendants were control persons within the

meaning of 20(a) of the Exchange Act, they are liable for damages thereunder.

XII. CLAIMS

CLAIM ONE

Violation of Section 10(b) of The Exchange Act And Rule 10b-5 (Against All Defendants)

258. Plaintiffs incorporate by reference each paragraph above as if set forth herein.

259. During the Class Period, Defendants carried out a plan, scheme and course of

conduct which was intended to and, throughout the Class Period, did: (i) deceive the investing

public, including Plaintiffs and other Class members, as alleged herein; and (ii) cause Plaintiffs

and other members of the Class to purchase TNCC securities at artificially inflated prices. In

furtherance of this unlawful scheme, plan and course of conduct, Defendants, and each of them,

took the actions set forth herein.

260. Defendants: (a) employed devices, schemes, and artifices to defraud; (b) made

untrue statements of material fact and/or omitted to state material facts necessary to make the

statements not misleading; and (c) engaged in acts, practices, and a course of business which

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operated as a fraud and deceit upon the purchasers of the Company’s securities in an effort to

maintain artificially high market prices for TNCC securities in violation of Section 10(b) of the

Exchange Act and Rule 10b-5 promulgated thereunder.

261. Defendants, individually and in concert, directly and indirectly, by the use, means

or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a

continuous course of conduct to conceal adverse material information about the business,

operations and future prospects of TNCC and the Bank as specified herein.

262. These Defendants employed devices, schemes and artifices to defraud, while in

possession of material adverse non-public information concerning the Bank, its operations and

risk profile. Defendants also engaged in acts, practices, and a course of conduct as alleged

herein in an effort to assure investors of TNCC’s value and performance and continued

substantial growth, which included the making of, or the participation in the making of, untrue

statements of material fact and omitting to state material facts necessary to make the statements

made about TNCC and its business operations and future prospects, in the light of the

circumstances under which they were made, not misleading, as set forth more particularly herein,

and engaged in transactions, practices and a course of business which operated as a fraud and

deceit upon the purchasers of TNCC securities during the Class Period.

263. Each of the Individual Defendants’ primary liability, and controlling person

liability, arises from the following facts: (i) the Individual Defendants were high-level executives

and/or directors at the Company during the Class Period and members of the Company and the

Bank’s management team or had control thereof; (ii) each of these defendants, by virtue of their

responsibilities and activities as a senior officer and/or director of the Company and the Bank

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was privy to and participated in the creation, development and reporting of the Company’s

internal budgets, plans, projections and/or reports; (iii) each of these defendants enjoyed

significant personal contact and familiarity with the other defendants and was advised of and had

access to other members of the Company’s management team, internal reports and other data and

information about the Company’s finances, loan portfolio, operations, and internal controls at all

relevant times; and (iv) each of these defendants was aware of the Company’s dissemination of

information to the investing public which they knew or recklessly disregarded was materially

false and misleading.

264. The Defendants had actual knowledge of the misrepresentations and omissions of

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to

ascertain and to disclose such facts, even though such facts were available to them. Such

Defendants’ material misrepresentations and/or omissions were done knowingly or recklessly

and for the purpose and effect of concealing the Company’s operating condition and future

business prospects from the investing public and supporting the artificially inflated price of its

securities. As demonstrated by Defendants’ misstatements of the Company’s business,

operations and earnings throughout the Class Period, Defendants, if they did not have actual

knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtain

such knowledge by deliberately refraining from taking those steps necessary to discover whether

those statements were false or misleading.

265. As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of TNCC securities was

artificially inflated during the Class Period. In ignorance of the fact that the market prices of

TNCC publicly-traded securities were artificially inflated, and relying directly or indirectly upon

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the false and misleading statements made by Defendants, the integrity of the market in which the

securities traded, and/or on the absence of material adverse information that was known to or

recklessly disregarded by Defendants but not publicly disclosed by Defendants during the Class

Period, Plaintiffs and the other members of the Class acquired TNCC securities during the Class

Period at artificially high prices. When the truth was revealed and TNCC’s share price

plummeted, Plaintiffs and other members of the Class were damaged thereby.

266. At the time of said misrepresentations and omissions, Plaintiffs and other

members of the Class were ignorant of their falsity, and believed Defendants’ statements to be

true. Had Plaintiffs and the other members of the Class and the marketplace known the truth

regarding the true financial position and operating conditions that TNCC was experiencing,

which were not disclosed by Defendants, Plaintiffs and other members of the Class would not

have purchased or otherwise acquired their TNCC securities, or, if they had acquired such

securities during the Class Period, they would not have done so at the artificially inflated prices

which they paid.

267. By virtue of the foregoing, Defendants have violated Section 10(b) of the

Exchange Act, and Rule 10b-5 promulgated thereunder.

268. As a direct and proximate result of Defendants’ wrongful conduct, Plaintiffs and

the other members of the Class suffered damages in connection with their respective purchases

and sales of the Company’s securities during the Class Period.

CLAIM TWO

Violation of Section 20(a) of The Exchange Act (Against Defendants Helf, Cox, Sapp and Perez)

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269. Plaintiffs incorporate by reference each paragraph above as if set forth herein.

270. Defendants Helf, Sapp, Cox and Perez acted as controlling persons of TNCC

within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their

high-level positions, and their ownership and contractual rights, participation in or awareness of

the Company’s operations or intimate knowledge of the false financial statements filed by the

Company with the SEC and disseminated to the investing public, defendants Helf, Cox, Sapp

and Perez had the power to influence and control and did influence and control, directly or

indirectly, the decision-making of the Company, including the content and dissemination of the

various statements which Plaintiffs contend are false and misleading.

271. Defendants Helf, Cox, Sapp and Perez were provided with or had unlimited

access to copies of the Company’s reports, press releases, public filings and other statements

alleged by Plaintiffs to be misleading prior to or shortly after these statements were issued and

had the ability to prevent the issuance of the statements or cause the statements to be corrected.

272. In particular, each of these defendants had direct and supervisory involvement in

the day-to-day operations of the Company and, therefore, is presumed to have had the power to

control or influence the particular transactions giving rise to the securities violations as alleged

herein, and exercised the same.

273. As set forth above, defendants TNCC, Helf, Cox, Sapp and Perez each violated

Section 10(b) and Rule 10b-5 by their acts and omissions as alleged in this Complaint. By virtue

of their positions as controlling persons, defendants Helf, Cox, Sapp and Perez are liable

pursuant to Section 20(a) of the Exchange Act.

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274. As a direct and proximate result of Defendants’ wrongful conduct, Plaintiffs and

other members of the Class suffered damages in connection with their purchases of the

Company’s securities during the Class Period.

XIII. PRAYER FOR RELIEF

WHEREFORE, Plaintiffs pray for relief and judgment, as follows:

A. determining that this action is a proper class action and certifying Lead Plaintiff as Class

Representative under Rule 23 of the Federal Rules of Civil Procedure;

B. awarding compensatory damages in favor of Plaintiffs and the other Class members

against all Defendants, jointly and severally, for all damages sustained as a result of defendants’

wrongdoing, in an amount to be proven at trial, including interest thereon;

C. awarding Plaintiffs and the Class their reasonable costs and expenses incurred in this

action, including counsel fees and expert fees; and

D. such other and further relief as the Court may deem just and proper.

JURY TRIAL DEMANDED

Plaintiffs hereby demand a trial by jury of all issues so triable.

Dated: September 30, 2013 Respectfully Submitted by:

BARRETT JOHNSTON, LLC

/s/ George E. Barrett, Esq. George E. Barrett, Esq. Douglas S. Johnston, Jr., Esq. 217 Second Avenue North Nashville, TN 37201

Local Counsel

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WOLF HALDENSTEIN ADLER FREEMAN & HERZ LLP Gregory M. Nespole Robert B. Weintraub Patrick Moran Martin E. Restituyo 270 Madison Avenue New York, New York 10016 Telephone: (212) 545-4600 Facsimile: (212) 545-4653

Lead Counsel

The Rosen Law Firm, P.A. Laurence M. Rosen Phillip Kim 275 Madison Avenue, 34th Floor New York, NY 10016 Telephone: (212) 686-1060

Of Counsel

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CERTIFICATE OF SERVICE

I hereby certify that on September 30, 2013, a copy of the foregoing Second Amended Complaint Class Action Complaint for Violation of the Federal Securities Laws was filed electronically with the Clerk of the Court using the CM/ECF system, which will send notice of electronic filing to the counsel of record listed below.

Laurence M. Rosen Phillip Kim THE ROSEN LAW FIRM, P.A. 275 Madison Avenue 34th Floor New York, NY 10016 (212) 686-1060 [email protected] [email protected]

Paul Kent Bramlett Robert P. Bramlett BRAMLETT LAW OFFICES P O Box 150734 Nashville, TN 37215 (615) 248-2828 Fax: (615) 254-4116 [email protected] [email protected]

Counsel for Plaintiff Carolyn Lynn

Darren M. Welch Joseph L. Barloon SKADDEN, ARPS, SLATE, MEAGHER

& FLOM, LLP 1400 New York Avenue, NW Washington, DC 20005 (202) 371-7000 Fax: (202) 393-5760 [email protected] [email protected]

John R. Jacobson Milton S. McGee , III RILEY, WARNOCK & JACOBSON 1906 West End Avenue Nashville, TN 37203

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(615) 320-3700 [email protected] [email protected]

Counsel for Defendants Tennessee Commerce Bancorp, Inc., Arthur F. Helf, H. Lamar Cox, and Michael R. Sapp

L. Gino Marchetti TAYLOR, PIGUE, MARCHETTI & BLAIR, PLLC 2908 Poston Avenue Nashville, TN 37203-1312 Telephone: (615) 320-3225 [email protected]

Michael R. Smith Bethany M. Rezek KING & SPALDING, LLP 1180 Peachtree Street, N.E. Atlanta, GA 30309-3521 Telephone: (404) 572-4600 [email protected] [email protected]

Counsel for Defendant Frank Perez /s/George E. Barrett GEORGE E. BARRETT, #2672

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