Brooke Insurance Franchise Executives Settle SEC Fraud Charges

May 4, 2011

Five executives of the failed Kansas-based insurance agency franchise firm Brooke Corp. have agreed to settle charges of financial fraud brought against them by the Securities and Exchange Commission.

Charges against a sixth Brooke executive have not been settled.

The SEC charged the six with hiding critical information from investors and conducting a financial fraud.

The SEC alleges that senior executives at Brooke Corp. and two subsidiaries – whose line of business was insurance agency franchising and providing loans to franchisees – misrepresented their deteriorating financial condition in filings to investors and other public statements in 2007 and 2008. Meanwhile, behind the scenes they engaged in various undisclosed schemes to meet almost weekly liquidity crises, and falsified reports and made accounting maneuvers to conceal the rapid deterioration of the loan portfolio.

SEC v. Brooke

The Brooke companies are no longer in business.

“The unscrupulous senior corporate executives at Brooke Corp. orchestrated a massive scheme to conceal the company’s deteriorating financial condition through virtually any means necessary, including reporting inflated asset values, double-pledging collateral, and diverting funds for improper uses,” said Robert Khuzami, director of the SEC’s Division of Enforcement. “The fallout from their fraud had a devastating impact on the livelihood of hundreds of insurance franchisees that depended on Brooke and on the balance sheets of regional banks and other lenders, all of whom mistakenly relied on the good faith and honesty of these executives.”

The SEC’s complaint filed in federal court in Kansas charged two brothers and four other leading executives at Brooke Corp. and its two publicly-traded subsidiaries – Brooke Capital Corp. (insurance agency franchisor) and Aleritas Capital Corp. (lender to insurance agency franchises and other businesses):

  • Robert D. Orr – founder and former chairman of the board of Brooke Corp., former CEO and chairman of the board of Brooke Capital, former CFO of Aleritas.
  • Leland G. Orr – former CEO, CFO, and vice chairman of the board of Brooke Corp., and former CFO of Brooke Capital.
  • Kyle L. Garst – former CEO, president, and member of the board of Brooke Capital.
  • Michael S. Hess – former CEO and member of the board of Aleritas.
  • Michael S. Lowry – former CEO and member of the board of Aleritas.
  • Travis W. Vrbas – former CFO of Brooke Corp. and Brooke Capital.

According to the SEC’s complaint, Brooke Capital’s former management inflated the number of franchise locations by including failed and abandoned locations in company totals. They concealed that the financial assistance to franchisees was so burdensome that Robert and Leland Orr secretly borrowed funds received from Brooke insurance customers to pay company operating expenses. That money was supposed to be held in trust for payment of insurance premiums. They also hid Brooke Capital’s inability to timely pay funds owed to profitable franchisees and creditors. Aleritas’s former management hid the company’s inability to repurchase millions of dollars of short-term loans sold to its network of regional lenders. They sold or pledged the same loans as collateral to multiple lenders, and improperly diverted payments from borrowers for the company’s operating expenses. Aleritas’s former management concealed the deterioration of the company’s loan portfolio by falsifying loan performance reports to lenders, understating loan loss reserves, and failing to write-down its residual interests in securitization and credit facility assets.

In October 2008, Brooke Corp. declared Chapter 11 bankruptcy and suspended most of their operations. The companies were unable to reorganize in bankruptcy. The rapid collapse of the Brooke Companies had a “devastating regional impact as hundreds of its franchisees failed,” the SEC said. As a result of losses suffered on Aleritas loans, several regional banks also failed.

The SEC’s complaint charges violations of, among other things, the antifraud, reporting, record-keeping, and internal controls provisions of the federal securities laws. The complaint seeks permanent injunctions, officer and director bars, and monetary remedies against the Brooke executives.

Robert Orr, Leland Orr, Hess, Lowry, and Vrbas agreed to settle the charges against them without admitting or denying the SEC’s allegations. The settlements are subject to the approval of the U.S. District Court for the District of Kansas. The executives each consented to orders of permanent injunction and permanent officer and director bars. Lowry agreed to pay a disgorgement of $214,500, prejudgment interest of $24,004, and a $175,000 penalty. Hess agreed to pay a $250,000 penalty, and Vrbas agreed to pay a $130,000 penalty. Robert Orr and Leland Orr agreed to pay penalties and disgorgement in amounts to be determined by the court.

The SEC’s case against Garst continues in litigation.

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