Court Filings Reveal Existence Of Undisclosed Second Alleged BofI Whistleblower

| About: BofI Holding, (BOFI)


Publicly available court filings from February-April 2016 show that BOFI took specific legal steps to conceal details regarding a second "whistleblower" from the public court system.

According to filings, BOFI anticipated that the individual, a former Assistant Vice President with significant experience, was going to use BOFI information to "assist in government investigations".

This revelation shatters BOFI's prior intimations that its whistleblower activity was confined to only one "rogue" and "junior" employee.

BOFI actively petitioned the court to move the case into private arbitration because it was concerned that if the case went public it would cause "irreparable harm" to BOFI.

The undisclosed second whistleblower casts significant doubt on both the Audit Committee and Dentons investigations, neither of which ever addressed this second whistleblower.

During last night's BofI Holding (NASDAQ:BOFI) earnings call, we were highly entertained by the discussion surrounding "investigations" and what the definition of an "investigation" is. In fact, when we asked Bloomberg to provide us with a transcript of the call, we got this odd video response:

Source: YouTube

We will let Brad Berning handle the philosophical question of what the definition of an "investigation" is. In the meantime, on to far more salient news...

...And then there were two...

We found a case in a San Diego court called BofI Federal Bank v. Golub, that shows that BOFI has been aware for quite some time of the existence of yet another "alleged whistleblower" and yet the company has not made any disclosure regarding this matter to investors. Needless to say, we think this finding is a BIG deal and is arguably the most "material" development related to the company since the first whistleblower case from October 2015. How can any reasonable investor not think that the existence of a second "alleged whistleblower" is not a significantly material revelation. We fondly remember Bob Ramsey speaking bullishly about BOFI stock months ago after he wrote that "no second whistleblower" had emerged. Hmm... will Bob be issuing a revision to his note in response to this article?

Will there be more whistleblowers? Are there already more? Is this the reason that the CEO provided a "Presidential-caliber" evasive response on the topic of "investigations"?

Author note: In this article, we use the term "second whistleblower" or "whistleblower" to refer to the employee in question in the Golub matter. Based on our review of BOFI court filings, the employee in question alleged that she was wrongfully terminated due to whistleblowing activities. It is important to note that from the filings, BOFI appears to dispute the former employee's whistleblower status (just as it disputes Erhart's whistleblower status). Nonetheless, BOFI's own court filings indicate that the woman filed a whistleblower claim with OSHA in October 2015, so we therefore believe it is appropriate to refer to the employee as a "whistleblower" both due to her OSHA complaint and for overall writing simplicity. Investors deserve to know that a second former employee has been involved in whistleblower activity, and absent this article, we doubt BOFI would have ever included this piece of litigation in its disclosures given it does not even include the Erhart matter in its legal disclosures.

We were wondering if the Golub matter would be disclosed on last night's call, but it was not. The existence of what appears to be a second whistleblower has implications from a government investigation perspective, internal controls perspective, and litigation perspective. Given that the stock fell ~30%+ on the revelation of the first whistleblower, we find it hard to see how management deemed information regarding an incremental whistleblower as immaterial from a disclosure perspective. This fact pattern calls into question the CEO's claims from last night that its ongoing dialogue with government agencies is not worthy of 8-K disclosure.

If the company felt comfortable enough to omit disclosure regarding a second alleged whistleblower, one has to wonder how the company defines its "materiality threshold" to disclose government "investigations".

Before getting into the guts of it, we think it is important to get this disclaimer out of the way right now. All of our research ever conducted on this stock has relied on only publicly available information.

The court document that we dug up in this article that serves as the basis for the entire article was filed by an individual named Polly Towill. Her name shows up on the top left of almost every piece of litigation that was filed in the past several years, suggesting that she is one of the company's chief external litigators.

Therefore, if BOFI management takes issue with the information provided in this article, we suggest they raise their concerns directly with their own lawyer because she is the one who filed these motions...

Given last night's discussion around whether an "investigation" is something that is material enough to warrant 8-K disclosure, we think this article also provides interesting insight into the types of things that BOFI management views as "material enough" to disclose (or in this case, NOT disclose) to investors...

How we came across the second whistleblower in court filings:

It took us reading through volumes of litigation relating to BOFI to actually dig up the lawsuit referenced later in this piece. To give you a sense for the amount of litigation we read through, our review spanned dozens of foreclosure filings all the way to a lawsuit from a former employee about an ergonomic complaint. Most of the litigation was immaterial from a securities perspective. For example, in Rowe vs. BOFI Federal Bank, the plaintiff sued the bank for wrongful termination after claiming she was dismissed because she complained about the lack of ergonomic support in the workplace. It obviously does not take a securities lawyer to see that this type of litigation is clearly not material to investors.

However, as usual, our dumpster dive on BOFI eventually resulted in what we view as yet another glaring example of the most egregious disclosure practices that we have ever seen from a public company.

The Friendly Bear feels almost foolish for having missed this key piece of litigation in past searches. The litigation in question was classified as an "arbitration dispute" making it seem fairly innocuous and uninteresting on face value. However, the most innocuous pieces of litigation often lead to the most interesting revelations (Hello Philidor!). BOFI's CEO presumably already loosely alluded to this litigation in very cryptic terms back in a January earnings call in which he talked about the potential for new lawsuits, but the Friendly Bear mistakenly assumed that the CEO's reference was related to the Houston securities fraud lawsuit. Oops. Our mistake, because the real lawsuit being referenced is far, far more damning!

Before continuing, we suggest that readers recreate our work and go get a copy of the docket relating to the case of "BOFI Federal Bank v. Golub" that was filed in a San Diego County court back in February 2016. The docket number is 37-2016-00004902. This website will allow you to download a copy yourself. The docket includes a number of documents filed by BOFI that demonstrate how BOFI was actively trying to move a former employee's lawsuit out of the court system and into the arbitration system (BOFI ultimately succeeded in April 2016).

Despite the volumes of litigation BOFI has filed in the past few months, never ONCE has BOFI mentioned the former employee from the aforementioned case in any of its federal pleadings (to our knowledge). The securities fraud lawsuit also did not mention this individual. Unsurprisingly, the individual has also never been named in any of BOFI's public filings or conference calls.

So we FELL OUT OF OUR CHAIRS when we got into the details of the Golub docket, particularly in the motion titled "BofI Federal Bank's Memorandum of Points and Authorities in Support of Motion for Preliminary Injunction". The motion makes it quite clear that both BOFI AND its lawyers at Shepard Mullin have been aware for quite some time that there was another employee at the bank who claims to have been whistleblowing.

A brief description of the employee in question is found in the declaration below:

Source: Declaration of Traci Holley, 37-2016-00004902

In its motion, BOFI itself said that it anticipated that the individual in question may have taken information from the bank with the intention of using it to "assist in a government investigation":

Source: BofI Federal Bank's Memorandum of Points and Authorities in Support of Motion for Preliminary Injunction; 37-2016-00004902

In other words, BOFI itself alleges that this individual - someone who appears to have a strong background in the banking industry (See Exhibit A) - took the rather extreme step of "wrongfully" taking information from BOFI with the intention of "assisting with a government investigation". This was despite the individual likely being well aware of the retribution faced by Erhart on a very public and now infamous conference call from October 14, 2015. It is highly unusual for a working professional to lose her mind on a whim and decide to walk out of a company with confidential information. Why in the world would someone with solid career experience take bold risks when faced with such a troubling fact pattern?

BOFI furthermore draws parallels between the second whistleblowerand Erhart in its own motion, noting that the employee in question is represented by the same lawyer as Erhart and was also "allegedly engaging in whistleblowing":

Source: BofI Federal Bank's Memorandum of Points and Authorities in Support of Motion for Preliminary Injunction; 37-2016-00004902

It is obviously no surprise that BOFI would be concerned about the potential for a second former employee's whistleblower allegations to be aired publicly, so we do not find it odd or nefarious that the company moved to force the case into private arbitration. Its Petition to Compel Arbitration (that was successful) is a fairly routine tactic employed by companies dealing with litigation from former employees.

However, in our view, any reasonable investor in BOFI stock would have likely viewed the arbitration case involving a second whistleblower as highly material to their decision of whether or not to invest in the stock. How could this piece of information NOT be considered material to investors given how the stock reacted to the prior lawsuit? This is a question of "total mix" of information and it seems clear to us that this information does in fact alter the mix.

What is most unbelievable about this situation is that BOFI appears to have been aware of the employee's "whistleblowing activities" as early as October 21, 2015 (although potentially even earlier given that the case claims she was terminated in May 2015).

Source: BofI Federal Bank's Memorandum of Points and Authorities in Support of Motion for Preliminary Injunction; 37-2016-00004902

Despite this fact, on October 29th 2015 (8 days after the second whistleblower OSHA complaint was filed), the company's CEO did not even mention anything about this individual on the earnings call, exclusively focusing attention on two other former employees and attributing all legal issues to a single "disgruntled" employee:

Source: October 29th, 2015 Call

There is only one instance in which the company's CEO even loosely alluded to the potential for more wrongful termination litigation. This was during a January 2016 earnings call (and in hindsight, we incorrectly attributed his commentary to a Houston securities fraud lawsuit filed in April 2016, rather than to this action that was opened in the San Diego court system in February 2016):

Source: January 28th, 2016 BOFI call

Given that all we have done is review one single public court filing related to this matter, we have no idea where this case has gone or what the underlying allegations were. The docket suggests that the case was ultimately sent to private arbitration in April 2016, and the only thing we know about arbitration is that it is a technique that companies often use in order to "maintain a low profile regarding the existence of a dispute":


BOFI's legal action to move the case into arbitration was first filed by BOFI on February 16, 2016.

We therefore find it very suspect that BOFI was able to convince DA Davidson, FBR, and KBW to underwrite a bond offering on February 25, 2016, only days after it moved the court to shift its dispute with the second whistleblower into private (i.e. secret) arbitration.

If you purchased bonds in that offering, we suggest that you reach out to the underwriters and ask about what they knew regarding this purported second whistleblower. Were these underwriters knowledgeable about what was happening in the San Diego court? Would this bond offering have been possible if potential investors were aware of the second whistleblower's existence?

Source: Bloomberg

We also find it particularly notable that Dentons, a law firm hired by BOFI to conduct an "independent" investigation into whistleblower claims - and a law firm that the CEO claimed on a recent earnings call "cleared management of any wrongdoing" - does not appear (based on BOFI public disclosures) to have even investigated anything relating to this second whistleblower despite concluding its investigation in March 2016.

By March 2016, assuming the Audit Committee was functioning in an appropriate manner, Dentons undoubtedly should have been informed of this second whistleblower and looked into it:

Source: BOFI 8-K dated March 14, 2016

So to summarize, here is what we can gather from this single public court filing:

  • There is clear evidence that BOFI was aware of a second employee alleging that she was involved in whistleblowing activities (BOFI would dispute her whistleblower status, but nonetheless, it is clear that this employee was engaged in some sort of whistleblower activities with at least OSHA).
  • The employee in question appears to have filed some sort of wrongful termination complaint against the bank in relation to her alleged whistleblowing activities (unclear where this complaint ultimately went, but we suspect it moved directly to secret arbitration at some point in April 2016 based on our review of the docket)
  • Based on the court filings, the employee in question claims that she was wrongfully terminated around May 2015 as a result of her "alleged" whistleblowing activities
  • In our view, the employee has strong credentials (pretty hard to argue about JPMorgan being a real banking institution), yet in spite of this, the employee took the risky and drastic step of taking BOFI information with her after leaving the company, which BOFI anticipated she did in order to "assist in government investigations"
  • The second whistleblower worked in single family mortgage audit (BOFI's questionable and wide-spread single family mortgages have been referenced in the past in the New York Times as well as in various blog posts, including a December 2014 Seeking Alpha blog post that first provided detail on BOFI's lending practices)
  • We think this entire fact pattern calls into question all of the public claims BOFI has made about the company facing whistleblower allegations from only one "junior" and "rogue" former auditor
  • BOFI has never disclosed this second whistleblower to the market, other than the CEO making a cryptic comment about the potential for more wrongful termination lawsuits (there is a BIG difference between the vague potential for new wrongful termination lawsuits - such as the one filed by Ms. Rowe relating to ergonomics - and BOFI's concern in the Golub docket that a former employee had wrongfully taken information with the purpose of assisting in a government investigation)
  • While actively petitioning the court to move its second whistleblower litigation into secret arbitration, BOFI sold bonds to the public with FBR, DA Davidson, and KBW all complicit in selling bonds that - in our view - contained highly misleading disclosures given the lack of mention of this second whistleblower
  • Dentons (a law firm tied to BOFI) ran a supposedly "independent investigation" into Erhart's claims, but the validity of that entire investigation is now called into question given that there was no mention of Dentons looking into allegations coming from a second whistleblower in the BOFI 8-K filed in March 2016
  • The Dentons review has been touted as a key piece of BOFI's defense in the Houston securities fraud matter, calling into question BOFI's defense claims in the Houston matter as well as with potential government inquiries that appear to be ongoing based on the CEO's commentary last night
  • The market is now going to naturally wonder if there are any other secret whistleblowers that BOFI is hiding from the public?
  • Closing thought: Following the Diamond Resorts (NYSE:DRII) fiasco, will BDO find this fact pattern material enough to force the company to disclose these allegations in the upcoming 10-K?

We leave readers with this somber parting thought. BOFI is not just any run of the mill company.

It is not in the business of selling couture clothes to wealthy New York socialites. This is a regulated bank. A company that is entrusted with people's hard earned life savings. While the company is no doubt tired of its public critics, this article serves a fundamental purpose as it is not only a topic of interest for shareholders, but also for the general public and for tax payers who fund institutions such as the FDIC.

We close this note by bringing back the painful memories of Madoff. We all need to remember that if more people had listened to Harry Markopolos when he first raised red flags, a $50B fraud could have been prevented and life savings could have been saved.

Source: Hornsby Law

Exhibit A: Selected Excerpts of Career History for Purported Second Whistleblower (LinkedIn Grab)

Source: Linkedin

Disclosure: I am/we are short BOFI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am/we are short BOFI. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. Additional disclosure: This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.

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