Liberty Mortgage Funding filed for Chapter 7 bankruptcy in 2008 after experiencing serious financial troubles. Its chief operating officer admitted to keeping the company afloat by misappropriating lenders' funds, creating fake loans. An investigation found one employee, the COO, had too much unchecked power over finances. An insurance company agreed to pay $1.15 million to partially cover lenders' losses from Liberty Mortgage's collapse as a lesson about proper financial oversight.

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From the Louisville Business First
:http://www.bizjournals.com/louisville/print­edition/2012/07/27/liberty­
mortgages­downfall­provides.html
Liberty Mortgage’s downfall provides
lessons for businesses
SUBSCRIBER CONTENT: Jul 27, 2012, 6:00am EDT Updated: Jul 30, 2012, 10:31am EDT
Kevin Eigelbach
Reporter­ Louisville Business First
Email | Twitter
When Louisville­based Liberty Mortgage Funding was granted preliminary approval for
$480,000 in state tax incentives in 2006, it looked like things were going great for the
mortgage banker.
At that time, it announced plans to boost employment from 40 to 150 in the next two years.
But in reality, the company already was in serious financial trouble, and two years later it would
file for Chapter 7 liquidation.
And its chief operating officer admitted that she kept the company solvent at first by using her
own money and then by misappropriating lenders’ money.
The case is one example of the type of business practices that occurred prior to the near
collapse of the mortgage industry at the outset of the recent recession.
It illustrates the bad things that can happen to a business when one employee has too much
unchecked power over finances.
And it shows what can happen when lenders don’t watch their money closely enough.
Insurance company to pay $1.15 million to victims
In this case, an insurance company has agreed to cover part of lenders’ losses.
According to U.S. Bankruptcy Court records, New Jersey­based Admiral Insurance Co.
agreed to pay $1.15 million to settle a proceeding brought in the bankruptcy case.
Admiral provided officer­ and manager­liability insurance for Liberty Mortgage.

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Bankruptcy court judge Thomas Fulton approved the settlement on May 2.
John Wilson, the court­appointed bankruptcy trustee for Liberty Mortgage, filed the proceeding
on behalf of Liberty Mortgage in March 2009, asserting claims against Admiral; against Liberty’s
founder and president, Robert Vaughn Lloyd; and against Bounmy Phouthavong, Liberty’s
former vice president.
Phouthavong, a native of Laos, was sentenced on Sept. 28, 2010, to pay $5 million in
restitution and to serve 51 months in prison in connection with defrauding Liberty lender
Dallas­based Texas Capital Bank NA and the former mortgage company Taylor, Bean &
Whitaker Mortgage Corp.
According to the Federal Bureau of Prisons, Phouthavong is serving her sentence at a federal
corrections institution in Marianna, Fla., and is scheduled for release July 15, 2014.
Admiral agreed to pay the $1.15 million to trustee Wilson, who would deduct administrative
fees and disperse the balance to two of Liberty Mortgage’s creditors, Texas Capital and the
now­defunct First Collateral Services Inc., formerly of Concord, Calif.
The settlement helps the creditors of Liberty Mortgage, Wilson said, “but it doesn’t make them
whole.”
Liberty Mortgage reported having $10.4 million in liabilities and $1.2 million in assets when it
filed for liquidation.
“We never really got to the bottom of what happened — how they incurred such a huge debt,”
Wilson said. “There were some questionable mortgages made, and they had tremendous
expenses. The scheme (Phouthavong) had was probably the straw that brought them down.”
Liberty had plans to expand to 150 employees
In the early 2000s, Liberty Mortgage was a successful mortgage broker that employed 40.
Founded in Evansville in 2001, the company opened its Louisville office in 2002.
Phouthavong joined the company that year after she and Lloyd became romantically involved,
according to an autobiography she wrote that was made part of the court record.
She had been a successful software consultant before she joined Liberty Mortgage.
Phouthavong testified in a deposition in the bankruptcy case that Lloyd concerned himself with
the sales side of the business, and she focused on the operations side. Financial information
was not shared with anyone else in the company, she testified.
In September 2006, the Kentucky Economic Development Finance Authority gave the
company preliminary approval for $480,000 in state tax incentives, contingent on it creating 24
new jobs.
Business First reported at the time that the company planned to increase employment to 150
during the next two years.

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The company closed before it could qualify for the incentives, said Mandy Lambert, executive
director of the Office of Research and Public Affairs for the Kentucky Cabinet for Economic
Development.
According to Phouthavong’s autobiography, the company began having financial trouble as
early as 2003 as it made the transition from mortgage broker to mortgage banker so it could
maximize revenue on each loan it closed.
As a mortgage broker, the company served as a middle man between borrowers and lenders,
and it got paid immediately when a lender funded a loan.
As a mortgage banker, however, the company kept the loans until it sold them to an investor,
which could take 30 to 45 days.
The changed timing of cash flows and a big slowdown in business at the end of 2003 prompted
company president Lloyd to give the company cash infusions from his own funds, Phouthavong
wrote.
The stress from the business resulted in serious health problems for Lloyd in April 2004, after
which he spent three days in University Hospital, she wrote.
Unwilling to tell Lloyd the truth about the company’s cash­flow problems in the wake of his
health problems, Phouthavong used personal funds and borrowed $53,000 from her personal
line of credit to pay the company’s expenses, according to court records.
Diverting money came next
As the company’s money troubles continued, Phouthavong accidentally discovered a way to
divert lender money to pay company expenses, she wrote in her autobiography.
Liberty Mortgage’s business model typically worked this way:
• Liberty Mortgage would find someone who wanted to borrow money and would arrange to
grant them a mortgage.
• Liberty Mortgage would send the borrower’s information to a lender such as First Collateral. If
First Collateral approved the loan, it would send money to a title company, which would
disperse it to Liberty Mortgage when a loan was consummated.
• Liberty Mortgage would sell the mortgage to an investor such as Deutsche Bank or Taylor,
Bean & Whitaker. The investor then would pay off First Collateral and send the remaining funds
to Liberty Mortgage.
But in 2005, one of Liberty Mortgage’s borrowers backed out and decided not to sign a
mortgage.
First Collateral already had advanced the money to the title company, however, and the title
company asked Phouthavong what to do with it.
She should have had the title company wire the money back to First Collateral, she wrote, but

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instead she had the company wire it to Liberty Mortgage to cover payroll coming due.
“I was able to pay the funds back pretty quickly, but then I realized that this was a way for me
to get funds whenever I was feeling desperate,” she wrote. “At that time, I think I was
rationalizing to myself and considered it borrowing since I was paying interest on it and then
paying it back when I could.”
Audited via fax or e­mail
Initially, she kept track of funds she took and paid back. But then Liberty Mortgage started
closing fewer loans, and Phouthavong found herself having to “borrow” more and more money.
“After a while, I just discarded the tracking since it was now way beyond my control,” she
wrote, and so the company eventually owed more than it could pay back.
Rather than waiting for real loans to fall through, she created fictitious loans using real names
and information from Liberty Mortgage customers. When the title company stopped
cooperating, she created her own title company, Venture Title Group, and had lenders send
money to it.
According to her deposition, during the years Phouthavong was creating these fictitious loans,
Liberty Mortgage was audited annually by an outside accounting firm. The audit was a
requirement for the company to keep its status as a Federal Housing Administration­approved
lender.
In her deposition, Phouthavong testified that she chose as auditor a company that did not
conduct on­site audits, but instead had Liberty e­mail or fax its monthly statements. “They had
the easiest requirements,” she testified.
If the firm had done a more thorough audit, she testified, it might have discovered the fictitious
loans.
It was a difficult fraud for the banks to detect because Phouthavong used true information
from customers to make fictitious loans, said Mike Wilson, who practices law with his father,
bankruptcy trustee John Wilson.
“It was clever in the sense that when you have this kind of financing, it’s kind of complicated
and can disguise a lot of fictitious transactions,” said Mike Wilson, who worked on the
bankruptcy case with his father.
In retrospect, the banks could have done more to verify that the loans actually closed and the
mortgages were recorded, he said.
Liberty Mortgage's fiscal problems compounded as the subprime mortgage crisis went into full
swing and borrowers began defaulting on loans. Companies such as the former Countrywide
Home Loans Inc. and Deutsche Bank, to which Liberty Mortgage had sold loans, began
pressuring Liberty Mortgage to buy them back, according to the autobiography.
Title companies and lenders became stricter with their credit policies, so Liberty Mortgage
found it harder to find more borrowers to keep the flow of money coming, Phouthavong wrote

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in her autobiography.
Using online payment system to divert funds
At the end of 2007, First Collateral announced that it planned to shut down and wanted all
accounts cleared by March 2008. Phouthavong found another lender, Texas Capital, and began
using advances from Texas Capital to pay down what Liberty Mortgage owed to First Collateral.
She also found a way to use Taylor Bean & Whitaker’s online payment system to have money
that should have gone to Texas Capital sent directly to Liberty Mortgage. She testified that this
was as simple as changing an address in the company’s online payments system.
According to her plea to bank fraud and wire fraud, during 2008 Phouthavong defrauded Texas
Capital of $3.4 million by obtaining 12 false loans using stolen identities. She also defrauded
Taylor Bean & Whitaker of $1.8 million during that time, according to her plea.
Her scheme came to light after First Collateral conducted an audit, and in August 2008 First
Collateral sued Liberty Mortgage, asserting breach of contract and fraud. Liberty Mortgage
owed First Collateral $2.2 million at that point, according to the lawsuit.
That’s when, according to her autobiography, she told Lloyd what she had done, and he fired
her.
They continued to live together, she wrote in her autobiography, although they barely spoke
for months after her revelation to him.
She testified in her deposition that Lloyd had not seen the company’s financial statements or
bank statements since early 2003.
“He asked, but I didn’t provide,” she testified.
In a memo to the court written for Phouthavong’s sentencing, her attorney, Michael Mazzoli,
noted that she “did not act for personal gain. She began stealing only after she had poured all
of her own resources into her boyfriend’s failing business. When events produced a surplus in
Liberty’s accounts, (she) did not take personal advantage of the situation; rather, she used the
money to pay the victim banks.”
No checks and balances
Attempts to reach Lloyd through his attorney, Michael S. Jackson of Boehl, Stopher & Graves
LLP, were not successful.
In his own deposition for the bankruptcy case, Lloyd testified that he was Phouthavong’s sole
supervisor, but he could not give any example of checks or balances he had set up to monitor
her activities.
She did show him Excel spreadsheets that purported to show the company’s financial
information on them, he said, but he never followed up to ensure the information was
accurate.

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“I had no reason to believe that it wasn’t accurate,” he testified.
The players
The following companies were involved in the recent settlement of an adversary proceeding in
the bankruptcy case of Liberty Mortgage Funding:
• Prajna Group Inc., which did business as Liberty Mortgage Funding, an Illinois corporation
formerly based at 9300 Shelbyville Road but now defunct;
• First Collateral Services Inc., of Concord, Calif., which provided lines of credit to finance
mortgages for mortgage brokers throughout United States, including Liberty Mortgage;
• Texas Capital Bank NA, of Dallas, which provided lines of credit to mortgage brokers,
including Liberty Mortgage;
• Admiral Insurance Co., Cherry Hill, N.J., which insured Liberty Mortgage for management
liability.
Kevin Eigelbach covers these beats: Financial services, residential real estate,
property and casualty insurance, construction, unions, engineers, architects,
agriculture, South End, Southwest County, Bullitt County.