A Pennsylvania law firm said it has filed a prospective shareholders class action in federal court against mortgage insurer PMI Group, accusing the management of hiding its deteriorating financial picture.

The lawsuit against Walnut Creek, Calif.-based PMI–a major stakeholder in Financial Guaranty Insurance Company (FGIC)–alleged the company acted improperly from Nov. 2, 2006 until March 3, when it disclosed big losses.

In a complaint filed with U.S. District Court in San Francisco by the Schiffrin Barroway Topaz & Kessler law firm, PMI and its officers and directors were accused of actions that violated the 1934 Securities Exchange Act.

The law firm said in a statement that PMI management had failed to disclose FGIC had exposure to defaults on mortgage-backed securities and was materially impaired as a result, as well as that PMI failed to properly account for its investment in FGIC, and in doing so overstated its financial results.

A spokesperson for PMI said as per corporate policy the lawsuit could not be commented on.

The suit also charges that PMI engaged in improper underwriting practices in its book of business related to insurance, and had far greater exposure to defaults and losses in its insurance book than it disclosed.

Management was accused of hiding the fact that the company would have to stop writing insurance policies to borrowers, which would have a negative result on future business, and that PMI's financial statements were not prepared in accordance with Generally Accepted Accounting Principles.

According to the suit, the insurer lacked adequate internal and financial controls, and as a result its statements about financial well-being and future business prospects “were lacking in any reasonable basis when made.”

The suit said that beginning in July 2007 through this March, PMI began acknowledging its exposure to anticipated losses and defaults related to the housing and credit crisis.

According to PMI, those losses and defaults were caused by the company's failure to engage in proper underwriting practices. When PMI announced losses that were related to large increases in defaults and its investment in FGIC, ratings agencies such as Fitch downgraded the company's stock, it was noted.

By October 2007, Standard & Poor's announced that it placed PMI on negative CreditWatch with negative implications.

According to the complaint, all during this time, the company continued to make “denials and misrepresentations about the true nature of its finances and prospects, even as the artificially inflated price of its stock began a slow but steady decline.”

The law firm said that on March 3, PMI had “shocked investors” when it announced that its 2007 annual report would be filed late, and that the company's U.S. mortgage insurance operations had reported a net loss of $236 million in the fourth quarter.

The company's quarterly loss was the result of an increase in default inventory, higher claim rates and higher average claim sizes.

Additionally, the company reported that its federal guaranty segment would report a significant net loss for the fourth quarter and full-year 2007, driven by equity losses of FGIC.

FGIC losses resulted from unrealized mark-to-market losses and loss adjustment expenses at FGIC.

Plaintiffs seek to recover damages on behalf of class members, who can get more information and sign up to participate at www.sbtklaw.com.

PMI provides credit, capital and risk-transfer services. Through its wholly- and partially-owned subsidiaries, PMI offers residential mortgage insurance and credit enhancement products, financial guaranty insurance, and financial guaranty reinsurance.

One such entity that PMI has an equity stake in is FGIC, which is an insurance holding company whose wholly-owned subsidiary, Financial Guaranty Insurance Corp., provides credit enhancement on infrastructure finance and structured finance securities worldwide.

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PMI Hit With Stockholder Suit

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