By Ray Birch
OSHKOSH, Wis.—A credit union here that purchased an Illinois-based bank in 2019 has filed suit against the bank and three members of its former leadership team, alleging fraud in the presentation of the bank’s financials prior to the deal’s closing.
In what may be a first since credit unions began purchasing banks over the last decade, Verve, a Credit Union, has file suit against South Central Bank. In 2019, the $1.4-billion Verve acquired substantially all of the assets of the $300-million, Chicago-based South Central Bank, a subsidiary of First Business Bankcorp. But since the deal closed, the credit union is alleging wrongdoing by the bank’s management and is asking for more than $1 million in damages in its claim, citing common law fraud and civil conspiracy. It is also seeking punitive damages.
The lawsuit, filed in Cook County Circuit Court, names as defendants First Business Bancorp, the former South Central Bank; Marc Grayson, South Central’s former board chairman; Todd Grayson, the bank’s former president, and Charles Rudy, former COO/CFO.
The complaint alleges that following the sale’s closing, Verve discovered “significant accounting irregularities” that were “concealed or otherwise misrepresented by defendants.” It said it was induced to enter into a “Purchase and Assumption Agreement with FBBC and SCB under false pretenses to acquire substantially all of SCB’s assets.”
The suit further alleges that prior to the closing the defendants represented to Verve that SCB’s financial statements, books, accounts and records were prepared in accordance with generally accepted accounting principles (GAAP).
“GAAP allows for the capitalization of certain costs related to the development of internal use software or software upgrades and enhancements to internal use software that result in additional functionality. GAAP does not allow for the capitalization of costs related to IT support, routine maintenance and security or software development costs that are in a preliminary project stage,” the complaint reads. “SCB’s fixed assets schedule, which was maintained by defendants and provided to Verve prior to closing, including $1.7 million of capitalized costs related to services provided by RealNets, an IT support vendor utilized by SCB.”
RealNets Services
The suit states the net book value of the capitalized cost related to RealNets was approximately $965,000 as of the acquisition date. The types of services provided by RealNets for SCB included rebooting devices, changing passwords, reviewing spam/malware and filters/firewall and logs/fishing updates, reinstalling software and drivers, converting date to Excel format, and assisting users to connect to the network, Internet, printers and scanners.
“Defendants knowingly and intentionally capitalized the services performed by RealNets in violation of GAAP,” the lawsuit states. “Defendants knowingly and intentionally included the improperly capitalized RealNets services in SCB’s fixed assets schedule in order to misrepresent and artificially inflate SCB’s asset schedule and net equity by approximately $965,000.”
The complaint additionally alleges the defendants knowingly and intentionally “concealed their improper capitalization of RealNets services in SCB’s fixed assets schedule in an effort to deceive Verve and induce Verve to purchase substantially all of SCB’s assets without the agreed upon minimum equity price adjustment.”
Verve, a Credit Union is also alleging neither the improper capitalization nor the unpaid invoices were “reasonably discoverable” in due diligence prior to the closing of the sale. Following the closing, the suit states Verve discovered unpaid invoices totaling approximately $280,000 for goods and services provided to SCB prior to the closing date.
“The unpaid invoices constitute undisclosed liabilities per section 5.19 of the purchase agreement and should have been expensed by defendants prior to closing. Defendants knowingly and intentionally concealed the unpaid invoices in order to misrepresent and artificially inflate SCB’s balance sheet and net equity,” the complaint adds. “Defendants intentionally provided Verve with SCB’s asset schedule and balance sheet despite all defendants knowing that SCB’s assets schedule and balance sheet contained false statements of material fact and overstated SCB's assets and net equity.”
"No Strangers To Challenges'
Verve is being represented by Royal Oak, Mich.-based Howard & Howard, which represented the credit union during the acquisition.
Before it closed its doors,South Central Bank had been marginally profitable, making $591,000 in net income in 2017, $830,000 in 2018 and $189,000 in Q1 2019, according to FDIC data.
“We’ve grown more than a billion dollars in assets within the last six years and we’re no strangers to the challenges involved with mergers and acquisitions,” said Verve CEO Kevin Ralofsky, choosing not to comment on the lawsuit. “We know that in large‐scale deals, things aren’t going to be perfect. We are always looking out for what’s in the best interests of our team members and members, and this deal did just that. This is something we’d do again—we’re thrilled to be serving the Chicago market and for the strong team members we’ve gained.”