Tucson-based First Magnus Financial Corporation wasn’t a victim of the credit crisis in 2007 — it was a signficant cause of it.

And maybe if more people had been paying attention to the kinds of things the officers and directors of the company were doing, clues would have surfaced of the impending economic crisis that has since hit the nation — and the world.

That’s the gist of a $1 billion lawsuit filed Feb. 26 in U.S. Bankruptcy Court by Larry Lattig, trustee appointed by the court to advocate for creditors of First Magnus, including, through his attorneys at Lackey Hershman in Dallas: Jamie Welton and Deborah Deitsch-Perez.

The suit argues the former directors and officers stripped millions of dollars from First Magnus that was supposed to be kept in reserve for repurchase and indemnity obligations owed to the commercial banks that financed the loans and the Wall Street firms that purchased them. Among the 40 named defendants are Gurpreet Jaggi, Thomas Sullivan Sr., Thomas Sullivan Jr., Bill Gaylord, Gary Malis, Dominick Marchetti and Karl Young.

Lead attorney Welton said “the complaint details how the directors and officers originated bad loans, in the worst markets, paid themselves hundreds of millions in stock redemptions, bonuses, and distributions when they sold the loans to Wall Street, and then said ‘sorry Charlie, we’re broke’ when Wall Street asked for their money back. Now the taxpayers are holding the bag. It’s not right. It’s why the economy is in the mess it’s in. We will make certain that the creditors of First Magnus, including the thousands of employees left unpaid, recover every last penny they are owed from these defendants.”

The lawsuit says more than 70 percent of the loans originated by First Magnus from January 2005 through Aug. 21, 2007, when it filed for bankruptcy protection, were purchased by Lehman Brothers and Countrywide Financial. Lehman filed for bankruptcy in September 2008 and was subsequently liquidated. Countrywide was acquired by Bank of American in July 2008. 

The purchases by Lehman and Countrywide from First Magnus contained financial covenants and provisions which, if triggered, would have required First Magnus to repurchase the loans. The triggers included such as things as a home-owner missing the first or second month’s partments or if a loan were paid off within the first 90 days. But First Magnus kept only $400,000 for repurchases on about $2 billion in loans.

During bankruptcy proceedings, Lehman Brothers said First Magnus owed it more than $395 million and Countrywide said it was owed more $100 million in obligations for loan repurchases.

Despite what First Magnus officials publicly maintained, the lawsuit claims the company was a big player in selling riskier mortgages. Leading up to its bankruptcy filing, at least half of all the mortgages handled by First Magnus were either Alt-A — riskier than prime but not as risky as subprime — or below. The company was the eighth largest originator of Alt-A mortgages, representing almost 2.4 percent of all such loans sold in the United States.

“As defaults and foreclosures skyrocketed in First Magnus’ primary markets, so did the repurchase and indemnification claims made by the [mortgage purchasers],” according to the lawsuit. “When First Magnus failed to honor its repurchase and indemnity obligations, the Wall Street firms and commercial banks that did business with First Magnus had to write-down the collateral they held, pay the heightened premiums for CDS (credit default swap) contracts, and honor the CDS contracts they sold, and horde cash reserves to account for losses. The ‘credit crisis’ resulted and spiraled into an unprecedented global financial crisis.”

Jaggi, Young and other former First Magnus executives issued a statement denying the allegations in the lawsuit saying they’re “absurd” and “libelous.” It was well-known First Magnus collapsed because of “market conditions far beyond its influence or control,” they said.

“The credit market collapse was unprecedented in the nation’s history, and had nothing to do with any actions of First Magnus or its officers,” the statement said.

Contact reporter Joe Pangburn at jpangburn@azbiz.com or at (520) 295-4259.