Brendan McDermid/ReutersA Capital One banking center in New York. Federal regulators said the company understates its losses on auto loans in filings.Federal regulators on Wednesday accused Capital One and two of its executives of understating millions of dollars in auto loan losses suffered during the financial crisis.
The case, which the Securities and Exchange Commission agreed to settle with Capital One and the executives, illustrated a common financial misdeed during the crisis. As losses mounted in 2007 and 2008, some Wall Street firms covered up the woes from the public, prompting a wave of federal actions against Countrywide Financial and other lending giants.
In the case of Capital One’s auto-lending business, according to the S.E.C., the bank “materially understated” its loan loss expenses and “failed to maintain effective internal controls.” The S.E.C. contended that Peter A. Schnall, who was Capital One’s chief risk officer at the time, and David A. LaGassa, a lower-level executive, failed to prevent the improper statements.
“Accurate financial reporting is a fundamental obligation for any public company, particularly a bank’s accounting for its provision for loan losses during a time of severe financial distress,” George Canellos, the co-chief of the S.E.C.’s enforcement unit, said in a statement. “Capital One failed in this responsibility.”
But the S.E.C. could face questions over whether its penalties fit the crime. Capital One, one of the nation’s biggest banks, paid $3.5 million to settle the case, a minuscule amount for a company of its size. And like most banks accused of wrongdoing during the 2008 crisis, Capital One was not required to admit or deny wrongdoing.
“The settlement does not require a restatement of Capital One’s financial results,” said a bank spokeswoman, Tatiana Stead. She added that the deal “will not affect any current or future business activities by Capital One.”
The two executives also emerged relatively unscathed. Mr. Schnall agreed to pay an $85,000 penalty, and Mr. LaGassa settled for $50,000. Neither is barred from the securities industry. They are still employed by Capital One, though in different roles.
“The company continues to have confidence in Mr. Schnall and Mr. LaGassa and we believe that they can perform in their current roles with the company,” Ms. Stead said.
Lawyers for both men did not respond to requests for comment.
The S.E.C.’s case stems from early 2007, when the subprime lending market was beginning to collapse. At Capital One’s subprime auto-lending arm, the losses outpaced the bank’s initial forecast.
The bank scrambled to react. Mr. LaGassa organized a “swat team” to diagnose the losses and provided almost daily e-mail updates to Capital One’s senior executives. In an e-mail cited by the S.E.C., Mr. LaGassa warned he was “not optimistic that we are going to suddenly see a slowing in losses.”
Ultimately, an internal “loss forecasting tool” traced the mounting problems to “exogenous” factors — external problems like the souring economy.
But the bank, according to the S.E.C., looked the other way. For example, according to the S.E.C., Capital One failed to include any “exogenous-driven losses” in its assessment of the second quarter in 2007.
Capital One, the S.E.C. said in the order, “gave insufficient weight to the evidence available at the time.”
The bank’s actions, the S.E.C. said, caused the company to “materially” understate its loan loss expense in public filings. In the second quarter alone, Capital One understated the expense by up to $72 million, or about 18 percent.
“Financial institutions, especially those engaged in subprime lending practices, must have rigorous controls surrounding their process for estimating loan losses to prevent material misstatements of those expenses,” Gerald W. Hodgkins, a senior S.E.C. enforcement official, said. “The S.E.C. will not tolerate deficient controls surrounding an issuer’s financial reporting obligations, including quarterly reporting obligations.”
Ultimately, an internal “loss forecasting tool” traced the mounting problems to “exogenous” factors — external problems like the souring economy.
But the bank, according to the S.E.C., looked the other way. For example, according to the S.E.C., Capital One failed to include any “exogenous-driven losses” in its assessment of the second quarter in 2007.
Capital One, the S.E.C. said in the order, “gave insufficient weight to the evidence available at the time.”
Capital One’s actions, the S.E.C. said, caused the company to “materially”
understate its loan loss expense in public filings. In the second quarter alone, Capital One low-balled the expense by up to $72 million, or about 18 percent.
“Financial institutions, especially those engaged in subprime lending practices, must have rigorous controls surrounding their process for estimating loan losses to prevent material misstatements of those expenses,” Gerald W. Hodgkins, a senior S.E.C. enforcement official said. “The S.E.C. will not tolerate deficient controls surrounding an issuer’s financial reporting obligations, including quarterly reporting obligations.”