Four Arkansans face lawsuit over failed mortgage company: investors pumped in more than $10 million before Colorado Venture went bankrupt.

In late 2003, Florian Homm thought he could turn around UCAP Inc., a publicly traded mortgage company in Denver run by four Arkansas businessmen.

"Please treat my money as if it were your own," Homm said in an e-mail to UCAP's president and CEO, Dan Moudy of Benton, and board member William McCord of Hot Springs on Nov. 19, 2003, after he agreed to pump $5.1 million into UCAP. "Everybody--please make sure we do not satisfy those creditors who make the most noise but ... those that accept a large hair cut."

Within a few months, Homm's money was spent. By July 2005, the Securities & Exchange Commission had delisted UCAP.

Homm of Majorca, Spain, was one of three investors who now say they were duped into pouring more than $10 million into UCAP.

Homm, Joseph McAdams of Hot Springs and Richard Smyth of Amelia Island, Fla., are suing Moudy; McCord; Lynn Bradley of El Dorado, UCAP's chief financial officer; and David Colwell, UCAP's chief operating officer. The investors also have named the Little Rock accounting firm Moore Stephens Frost in their lawsuit filed in U.S. District Court in Hot Springs.

The investors are seeking more than $30 million in damages for alleged fraud, violations of sate and federal securities laws, breach of contract, and breach of fiduciary duty.

"The defendants used false and misleading financial reports that hid more than $30 million in losses and glorified financial forecasts to induce further investment including investments by Homm and McAdams," according to the lawsuit filed in May by the investors. "(Moore Stephens Frost) was an active participant in the scheme to defraud, recklessly issuing false financial statements which it knew would be used to raise money from plaintiffs."

Moudy and McCord deny the allegations. Bradley and Colwell haven't filed their answers yet and couldn't be reached for comment.

Moore Stephens Frost vehemently has denied that it did anything wrong and has asked that the case be thrown out of court.

"The complaint does not plead a single fact--a single document, memorandum, e-mail, meeting, etc.--that even arguably raises any (much less a strong) inference that MSF made or issued a false statement knowing that it was false or that MSF had any improper motive to engage in fraudulent conduct," MSF said in its court documents.

MSF also said the statute of limitations has run on the allegations.

McCord and Moudy said they too lost millions in UCAP, which had operations in Arkansas through its main subsidiary, United Capital Mortgage Corp. of Aurora, Colo.

McCord and Moudy have filed their own lawsuit against UCAP seeking a judgment for any amount that they have to pay related to UCAP.

McCord is seeking more than $3.5 million that he has lost as result of being a creditor and investor of UCAP.

Moudy said in his court papers that there was never any "fraudulent scheme" by anyone to encourage the plaintiffs to invest in UCAP or loan the company money.

The four Arkansas businessmen blame the demise of UCAP on the investors, who Moudy said were trying to control UCAP, a once profitable company co-founded by McCord in 1986.

But the investors said that from November 2001 until April 2004, the four Arkansans controlled UCAP and its subsidiary, and they ruined the business.

"The control exercised by the Arkansas Four allowed them to keep the true financial condition of UCAP hidden from plaintiffs, outside directors, investors and the SEC," the investors said in the lawsuit.

The motive for keeping the true financial picture murky, the investors alleged, "was to enable UCAP to continue its lending arrangement with its primary lender, (GMAC Residential Mortgage Funding Corp.) ... (The lender) required UCAP to meet certain financial covenants, such as tangible net worth, shareholder's equity, leverage ratios and net income."

McCord personally guaranteed the mortgage funding's line of credit and was "highly motivated" to make UCAP's financial statements avoid recognition of losses or any facts that would cause the lender any concern about the financial viability of UCAP, the investors said.

"During the period from January 2000 until April 2004, defendants intentionally manipulated the UCAP income statements and balance sheet to enable UCAP to meet the financial covenants of the (Residential Mortgage Funding) loan," the investors said.

David Wells, a Little Rock attorney who is representing McCord and Moudy, said, "We don't believe the case has merit, and we think the details provided in the pleadings clearly establishes that."

Beginnings

UCAP was a multistate provider of mortgage lending and brokerage services that also had real estate investments.

UCAP's business was handled through its wholly owned subsidiary, United Capital Mortgage Corp., which was a full-service residential mortgage lender. It had about 200 employees and generated "substantial" revenue for UCAP.

UCAP had operated under the name of Lahaina Acquisitions Inc. of Denver. (The name wasn't changed to UCAP until July 2002.)

In October 2001, Lahaina appointed Homm, an award-winning fund manager, entrepreneur and capital markets expert, to its board of directors.

"Lahaina is a direct beneficiary of lower interest rates and the associated U.S. re-financing boom," Homm said in a 2001 news release. "The company is an investment paradox. The shares are at all time lows while the balance sheet, management, earnings quality and outlook have never been better."

Trouble Develops

Trouble started to emerge in UCAP's fiscal year 2002.

When UCAP's 2002 fiscal year report was released in January 2003, the company announced it had lost $3.28 million in 2002 after earning $3.1 million in 2001. Its revenue had fallen 19.1 percent from $24.65 million in 2001 to $19.93 million in 2002.

But executives tried to put the best spin on the numbers by focusing on UCAP's loan originations, which increased 93.7 percent to $928 million in its fiscal year 2002, up from $479 million in 2001.

"I am extraordinarily pleased with our results for this year," Moudy said in a news release on Jan. 15, 2003. "Notwithstanding the serious contraction in our national economy, our growth continues unabated as we continue to demonstrate the inherent strength and stability of this remarkably powerful mortgage banking organization."

Also in the statement, Colwell, the company's COO, said, "Our objectives, quite simply, are growth, earnings and increasing shareholder value."

In March 2003, UCAP at McAdams' request hired James Farmer as the new CEO to cut costs and revive the struggling company.

Farmer had served as the president of Worthen Bank & Trust in Little Rock before it was sold to Boatmen's Bancshares of St. Louis.

But "UCMC revenue during Mr. Farmer's short tenure declined substantially," Moudy said in his court papers. Moudy said that relationships with the largest income producers were damaged.

One of Farmer's first projects was trying to determine the true financial health of UCAP. The accounting firm of Moore Stephens Frost handled UCAP's annual reports and quarterly reports from 2001 through March 31, 2003.

Farmer hired another accounting firm, Richey May of Denver, to look at the books. Richey May found "numerous material misstatements and omissions in UCAP's financial statements and public filings," according to the investors.

At a specially called board of directors meeting via telephone at the end of August 2003, Farmer said UCAP's financial statements for 2001 through June 30, 2003, were wrong and needed to be restated, the investors said.

Then Farmer dropped another bomb: Instead of UCAP being a solvent company, it needed $1.5 million in cash immediately to keep going.

Moudy and McCord told McAdams that Farmer was wrong and was "simply trying to take control of UCAP," the investors said. McAdams resigned from the board of directors in protest on Sept. 11, 2003.

In October 2003, Farmer was fired as CEO because of a disagreement over whether UCAP needed to file amended forms with the SEC, the investors said. But Moudy said Farmer was fired because he refused to provide McAdams with financial information.

As the company was about to hemorrhage, UCAP's executives asked Homm for more cash. On Nov. 24, 2003, Homm invested another $5.1 million, which brought his total investment in the company to $6.18 million.

Up to that point, McAdams had invested more than $3 million. (UCAP had repaid McAdams about $800,000, leaving a balance of $2.33 million.)

Smyth had settled a lawsuit with UCAP involving a number of issues and received $650,000 in cash and 3 million shares of UCAP, which he thought was worth $2 million. Smyth said he never would have settled the lawsuit if he had been aware of UCAP's true financial picture, the investors said in the lawsuit.

The investors also said that UCAP executives didn't tell Homm about the concerns accounting firm Rickey May had about the company.

Moudy said Homm had full knowledge of the financial risk and voluntarily handed over the money in exchange for the ultimate ownership of the company.

Within 90 days after receiving Homm's money, the defendants had spent it.

On April 13, 2004, Homm sent another message to Moudy seeking a complete restructuring.

"After injecting more than $5 million, liabilities and operating inefficiencies are still strangling UCAP and UCMC," Homm wrote. "Clearly operating losses have been abhorrent. Layoffs and salary cuts are a must."

But it is unclear if UCAP started restructuring.

Less than 10 days after Homm sent his memo, on April, 22, 2004, UCAP filed forms with the SEC that for the first time disclosed to the plaintiffs and investing public the magnitude and materiality of the misstatements and omissions in the financial information UCAP filed with the SEC for 2001 through March 31, 2003.

But UCAP said it didn't have the money to pay someone to complete the restatement or the audit work.

"(UCAP) has suffered significant and ongoing losses in its principal operating subsidiary and has no current means to pay off its debts as they mature," the filing said.

The investors blamed Moore Stephens Frost and Don Cole, who was a MSF partner at the time but no longer works for the company. Cole wasn't named in the lawsuit.

Moore Stephens Frost "actively participated in the fraud perpetrated by the Arkansas Four while MSF was engaged as UCAP's auditor," the investors said. "During the time Cole and MSF was engaged as UCAP's auditor, they failed to follow generally accepted accounting principals in preparing financial statements and related financial documents that they knew would be publicly filed with the SEC."

The lawsuit said both Cole and Moore Stephens Frost either knowingly or recklessly allowed the executives of UCAP to "'cook the books' by avoiding any number of accounting red flags in order to avoid recognition of massive operating losses, accurate reporting of insider transactions regarding the issuance of stock, and hidden transfers of real estate."

In November 2004, United Capital Mortgage Corp. filed for Chapter 11 bankruptcy protection in Colorado and listed between $1 million and $10 million in debt and the same amount for its assets.

The bankruptcy case was closed in December 2004.

By Mark Friedman

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