U.S. attorney, S.C. attorney general investigating Horry County State Bank’s securities deals

Federal and state authorities have launched investigations into Horry County State Bank following allegations that the Loris-based financial institution violated securities laws.

The investigations were noted in the financially struggling bank’s third-quarter report filed last week with the U.S. Securities and Exchange Commission. Horry County State Bank said in the report that the U.S. Attorney’s office served a subpoena on Oct. 4 seeking documents related to the bank’s sale of subordinated debt notes to investors. The S.C. Attorney General’s office served a subpoena on Nov. 7 seeking a wide range of documents including those related to the subordinated debt notes as well as the offering and sale of company stock.

The state Attorney General also wants the bank to turn over minutes of meetings of the bank’s shareholders and board of directors plus documents related to board members, officers, shareholders and employees of Horry County State Bank.

The bank said in the report that it is working closely with federal and state authorities to provide them with the requested documents.

Jimmy Clarkson, the bank’s chief executive officer, told The Sun News he cannot comment on the investigations or any pending legal matters.

“It is our policy not to discuss ongoing litigations of any nature,” Clarkson said. “We are cooperating fully with the appropriate authorities, and we are confident that their investigations will prove no wrongdoing on our part.”

Separately, the U.S. Treasury Department has sent a representative to monitor the bank’s monthly board meetings because the bank has failed to start repaying nearly $12.9 million it received in 2009 under the Troubled Asset Relief Program, or TARP. The Treasury Department’s representative attended the bank’s June and July meetings, according to the quarterly report. The Treasury Department has the option to appoint two members to the bank’s board of directors for the coming year, but the agency has not yet told the bank whether it intends to do that, the report stated.

Mark Powell, spokesman for the S.C. Attorney General’s office, confirmed that agency’s investigation, saying the probe focuses on “activities involving securities issues at the bank.” Powell said further comment would be inappropriate since the investigation is ongoing.

Beth Drake, spokeswoman for the U.S. Attorney’s office in Columbia, said the agency does not comment on pending investigations.

Pending lawsuits outline accusations

The investigations appear to be related to a trio of civil lawsuits filed against the bank this year. Two of those lawsuits involve the bank’s sale of subordinated debt notes in 2010 while the third – a proposed class-action lawsuit – involves the bank’s sale of company stock.

All three of the lawsuits allege that Horry County State Bank did not properly disclose its financial problems to potential investors, as required by state and federal law. The subordinated debt notes were sold just months before the Federal Deposit Insurance Corp. ordered the bank to raise capital or face a possible shutdown. The bank remains under that consent order and has not been able to raise sufficient capital to meet the FDIC’s requirements.

According to the first two lawsuits, Horry County State Bank recruited wealthy investors to purchase subordinated debt notes – an investment that has a lower priority for repayment than other debts the bank owed, including the TARP funds – to help raise $15 million in capital. Horry County State Bank promised investors that if they purchased $1 million worth of notes, the bank would lend 90 percent of the money back to them. The notes were to pay 9 percent interest semi-annually while money the bank loaned back to investors carried a 6 percent annual interest rate.

Vaughn Stanaland, developer of the Devaun Park real estate project in Calabash, N.C., said in his lawsuit that he was recruited to invest in the notes during a meeting the bank arranged at the Surf Golf & Beach Club in North Myrtle Beach. Stanaland – who already had loans from the bank totaling $6.2 million for the Devaun Park project – agreed to invest $1 million in the notes because he relied on the bank’s promise to loan most of the money back to him, according to the lawsuit.

As the $6.2 million in loans were about to mature in 2011, Stanaland asked the bank for his 90 percent loan, court documents show. The bank refused to give him the money, offering a $250,000 loan instead. Stanaland claims the bank’s failure to give him the 90 percent loan as previously agreed left him without enough money to repay or renew his existing loans. The bank has since filed a foreclosure lawsuit on the Devaun Park property.

Richard Lovelace, Stanaland’s lawyer, said he cannot comment on the pending lawsuit.

A similar lawsuit was filed by Samuel and Pamela Thomas, who claim they invested $2 million in the notes based on the bank’s promise to lend 90 percent of the money back to them. The Thomases say they were misled into investing because the bank failed to follow through on its promise. That lawsuit is now in arbitration.

David Gundling, the lawyer representing the Thomases, could not be reached for comment.

A third lawsuit, filed by Robert Shelley, alleges that bank employees solicited Shelley and others to purchase company stock without disclosing the bank’s true financial condition. Shelley is seeking class-action status for anyone who purchased bank stock between July 1, 2009 and Dec. 31, 2011. That lawsuit is pending and a class has not yet been certified.

Gene Connell, the lawyer who filed the class-action lawsuit, said bank officers called customers such as Shelley to ask them if they were interested in purchasing bank stock.

“They would ask them to buy stock and tell them that everything was going great at the bank,” Connell said, adding that the bank did not provide a prospectus or any other financial documentation to the customers.

When customers agreed to the sales pitch, the money used to purchase the stock was debited from their bank accounts, according to the lawsuit. The bank’s stock – which is traded on the over-the-counter bulletin board – sold for about $9 per share before the FDIC’s consent order was issued in February 2011. The stock was trading at 31 cents per share on Friday.

Connell said he believes the civil lawsuits “might be a part of the catalyst” for the investigations by federal and state authorities.

TARP payment deferrals

Horry County State Bank said in its third-quarter filing that it “has engaged legal counsel for the litigation and intends to vigorously defend itself.”

The outcome of the lawsuits and investigations, however, could further damage the bank’s financial condition.

“Given the company’s current troubled financial condition, any expenses incurred by the company for defense costs, governmental sanctions or settlement or other litigation awards could have a material adverse effect on the company’s financial condition,” the bank stated in its quarterly report.

Horry County State Bank has recorded losses totaling $32.4 million since the FDIC issued its consent order. That amount includes a nearly $3.7 million loss recorded during the third quarter of this year, which ended Sept. 30. The bank is considered “significantly undercapitalized” by FDIC standards and Clarkson has said the bank must raise at least $13.2 million to become “adequately capitalized,” as required by the consent order.

The FDIC classifies banks according to their capital ratios, which is the percentage of a bank’s capital to its risks. Adequately capitalized banks have a ratio of 8 percent or higher. Horry County State Bank’s ratio was 4.4 percent at the end of Sept. 30.

The bank had hoped to raise capital through a stock offering this year, but investors were not interested in purchasing any shares.

“We have not had any success to date in raising this capital, and there are no assurances that we will be able to raise this capital on a timely basis, or at all,” Clarkson said in the report filed with the SEC.

The amount of non-performing loans declined during the first nine months of this year to $52.5 million – or about 10.2 percent of assets – compared with $60.4 million for the same period a year ago. However, the percentage of loans classified as being on a watch list or worse increased to 34.5 percent of all loans by Sept. 30 compared to 32 percent at the end of last year.

Another consent order the bank signed last year with the Federal Reserve Bank of Richmond prohibits Horry County State Bank from repaying any TARP money until its capital levels improve.

Under the TARP program, the government essentially bought equity in the bank, receiving 12,895 shares of preferred stock in exchange for the nearly $12.9 million capital infusion. Horry County State Bank is supposed to pay the government a quarterly dividend on the stock of 5 percent for the first five years and 9 percent thereafter. That means the bank’s dividend payment amounts will almost double in 2014.

Horry County State Bank so far has deferred seven TARP payments totaling more than $1.1 million.

In addition to the stock offering, the bank has been looking for a merger partner as a possible way to raise capital. Clarkson, however, does not hold out much hope for that option.

“Given the lack of a market for bank mergers, particularly in the Southeast, as a result of the current economic and regulatory climate, and the lack of success the company has had to date in attempting to raise capital, there can be no assurances the company will either raise additional capital or find a merger partner,” he said in the third-quarter report.