The subprime lending industry was starting to buckle under the weight of bad loans in November 2006, when executives at Irvine-based New Century Financial Corp. held a conference call to release their latest earnings.
Loan volume was down and defaults were up, the earnings report showed, and in recent weeks at least five stock analysts had downgraded the company's shares. Moreover, four executives had sold nearly $20 million in stock in the last four months, six times as much as they had sold over the previous 12 months.
That led one analyst to ask whether there was anything investors should know.
"It's just part of their personal financial diversification plan," Chief Executive Brad A. Morrice said in response to the question during the Nov. 2 earnings call.
Those executive stock sales, however, have emerged as a central element in the Justice Department's criminal investigation of New Century, according to a person familiar with the inquiry who was not authorized to speak publicly.
No charges have been filed, and attorneys for the company's former top executives say that none of the executives sold stock based on information that had not been disclosed to the public and that the executives retained most of their shares when the company went under.
"Their stock sales were modest -- and entirely appropriate -- steps to diversify their assets," said John Spiegel, a Los Angeles attorney who represents five former New Century executives. "Any suggestion to the contrary simply flies in the face of the facts."
Justice Department officials declined to comment on their investigation of New Century, which collapsed into bankruptcy in early 2007 after a short-lived reign as the nation's biggest subprime lender.
The Times conducted its own review of the executive stock trades, analyzing Securities and Exchange Commission filings detailing 277 stock purchases and sales from 2003 to 2007 by six top executives.
Among other things, The Times looked at the executives' use of trading plans to sell stock, mostly after exercising options to buy at a low price and then sell at a much higher price. Federal regulators sanctioned use of such plans in 2000 as a way for executives to engage in regular sales of stock without being accused of making trades based on inside information.
To be an effective shield, however, the plans must be designed and executed carefully, securities experts say.
Although the trading plans themselves do not have to be disclosed publicly, executives routinely disclose when a sale is made under a plan. By reviewing these disclosures, as well as the plans for two of the executives, The Times found that:
* Company founders Robert K. Cole and Edward F. Gotschall adopted trading plans in June 2006 and then started new ones less than a year later, amid rising loan defaults. Between June and September 2006 alone, the rate of loans that were delinquent more than 60 days climbed nearly 30%.
* Cole adopted a trading plan on Sept. 15, 2006, and sold 25,000 shares under it the same day. Two other executives, Chief Financial Officer Patti M. Dodge and Executive Vice President Kevin Cloyd, sold stock within a week of setting up their plans in February 2005. Legal experts say making trades so quickly after a plan is adopted weakens the protection offered by a trading plan, because prosecutors or shareholder attorneys could argue that the plans were drafted to facilitate a quick dumping of shares.
* All six executives either enacted plans or made trades on the same dates as other executives, which legal experts say could raise questions about whether they were acting in concert on inside information.
* The trades do not appear to follow regular patterns. Over two years, for example, Morrice made only two sales under his trading plan -- and both were in July 2005, allowing him to sell $6.4 million worth of stock before the price fell about 40% later that summer.
Typically, trading plans call for executives to sell a set amount of shares each month or quarter, experts say, and executives usually stick to the same plan for at least a year.
"Any time there is a change in the trading plan, that raises a red flag," said Andrew Stoltmann, a Chicago securities attorney who advises firms on stock trading. "If you put on top of that a share price that's declining and a company that is soon to go into bankruptcy, prosecutors can have a field day with those sorts of facts."
New Century was founded in 1995 by Cole, Gotschall and Morrice, who had worked together at Plaza Home Mortgage in Santa Ana. Selling high-cost loans to high-risk borrowers, they built a subprime lending empire with more than 240 offices in 35 states and more than 7,000 employees, commanded from a high-rise in Irvine.
Fueled by the housing boom, the company's share price closed at an all-time high of $65.14 on Dec. 15, 2004. But it was downhill from there, as New Century and other subprime lenders suffered rising defaults and reduced demand.