[ by Larry Goldfarb ]

The SEC announced that sentences were handed down to 2 senior officers of a commercial lending subsidiary of Sterling Financial Corp. a publicly traded bank holding company based in Lancaster, PA.  Joseph Braas and Michael Schlager were sentenced in a criminal action for orchestrating a sophisticated financial fraud that lasted over 5 years. Brass got a 15-year federal prison while Schlager got 20 years.  Each stretch is followed by 5 years of supervised release.  

Braas and Schlager also were each ordered to pay $53 million in restitution. The pair had previously pleaded guilty to one count of conspiracy to commit mail fraud, and 2 counts of mail fraud, all affecting a financial institution.

SEC Findings and Allegations.   The SEC filed a civil action against the pair on 1/6/11, based based on the same conduct alleged in the criminal case.  Without admitting or denying the Commission’s allegations, Braas and Schlager agreed to settle the matter, and Final Judgments were entered as to each.  It's alleged that, from at least February 2002 until April 2007, Braas, the lender's VP and COO, and Schlager, the lender's EVP, orchestrated a pervasive and wide-ranging scheme using fraudulent underwriting and reporting practices to hide mounting losses and defaults within EFI’s commercial loan portfolio from Sterling’s senior management and auditors.

They further are alleged to have been able to subvert virtually every aspect of the company's loan process and internal controls, which enabled them to:

• create fictitious loans for the purpose of making monthly payments on delinquent loans,
• alter loan documents to hide delinquent and fictitious loans,
• grant excessive deferrals and resets of delinquent loans to make them appear current,
• reassign loan payments to unrelated accounts to fund payments on delinquent loans, and,
• use aliases for borrowers to circumvent EFI’s maximum lending limitations.
• The pair also deceived Sterling’s internal and independent auditors through fraudulent accounting entries, false collateral descriptions and appraisals,fabricated UCC filings, and by recruiting vendors to assist in the circumvention of loan confirmation procedures.

By allegedly reporting false false financial information to Sterling, the bank holding company's quarterly and annual reports contained materially false and misleading financial statements for the subsidiary. 

Sterling ultimately charged off $281 million of EFI finance receivables - representign a large majority of EFI’s loan portfolio, and approximately 13% of Sterling’s total loan portfolio during the period of the fraud.

Additional information is in Litigation Release No. 21797 (January 6, 2011).

For further details, go to:   [SEC Litigation Release 22480, 9/13/12].