SEC Goes After Capital One for Understating Auto Loan Losses
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UPDATED: May 2, 2013
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Capital One Financial Corporation has agreed to pay $3.5 million to the Securities and Exchange Commission (SEC) in response to claims that the company understated millions of dollars in auto loan losses.
Specifically, the SEC order claimed that Capital One understated auto loan losses from its auto finance business, Capital One Auto Finance (COAF), sustained during the second and third quarters of 2007. The discrepancies amounted to as much as $72 million in the second quarter and $51 million in the third quarter.
In a statement, George Canellos, Co-Director of the SEC’s Division of Enforcement, said that Capital One had broken one of its obligations to the public by failing to accurately report its auto loan losses.
“Capital One failed in this responsibility by underreporting expenses relating to its loan losses even as its own internal forecasting tool had signaled an increase in incurred losses due to the impending financial crisis,” Canellos said.
To calculate auto loan losses, COAF utilized a Look Ahead model that divided loan loss into four categories: losses caused by the maturation of an account, losses due to credit quality based on when a loan was booked, losses due to seasonal patterns and losses caused by exogenous factors, such as macroeconomic trends.
The 2007 recession, as well as the number of subprime auto loans COAF granted, increased the impact of exogenous factors in the company’s auto loan losses. Capital One, as well as two of COAF’s chief executives, failed to include any of these losses in its quarterly reports.
The SEC also found two of the company’s executives—former Chief Risk Officer Peter A. Schnall and former Divisional Credit Officer David A. LaGassa—specifically at fault for the misrepresentation of data. The two caused the understatements of loan loss by deviating from standard procedures and failing to employ proper internal controls to estimate the cost of written off and defaulted auto loans.
Schnall agreed to pay a penalty of $85,000 and LaGassa will pay a penalty of $50,000.
Some may argue that Capital One’s punishment is too lenient. For a company of Capital One’s size, $3.5 million is a small sum. Additionally, under the agreement with the SEC, the company does not have to admit any wrongdoing or restate its losses for the quarters in question.
Understating losses, however, is not a new trend. Several banks have been charged with understating losses during the height of the recession. Earlier this year, three former executives of a Norfolk, Virginia-based Bank of the Commonwealth were charged with hiding millions in losses. In September of 2012 the SEC charged three former bank executives from Nebraska with attempting to understate millions in losses and misrepresent the bank’s health.
In a statement on the Capital One case, Gerald W. Hodgkins, Associate Director of the Division of Enforcement, said the SEC would continue to take these cases seriously.
“The SEC will not tolerate deficient controls surrounding an issuer’s financial reporting obligations, including quarterly reporting obligations,” Hodkins said.