In a sweeping 581-page report (here), the examiner appointed in connection with the New Century Financial Corporation bankruptcy found that New Century “engaged in a number of significant improper and imprudent practices related to its loan originations” that “created a ticking time bomb that detonated in 2007.”
Bankruptcy examiner Michael J. Missal issued his report as part of the investigation he undertook at the request of New Century’s bankruptcy trustee to examine “any and all accounting and financial statement irregularities, errors and misstatements.” The report is dated February 29, 2008, but it was unsealed on March 26, 2008 at the request of former New Century Employees.
The examiner’s report concludes that New Century “had a brazen obsession with increasing loan originations, without due regard to the risks associate with that business strategy.” The report also concludes that New Century “engaged in at least seven wide-ranging accounting practices in 2005 and 2006” that “resulted in material misstatements of the Company’s financial statements.” The examiner did not find sufficient evidence to conclude that New Century engaged in earnings management or manipulation “although its accounting irregularities almost always resulted in increased earnings.”
The report also states that New Century’s outside accounting firm, KPMG, “contributed to certain of these accounting and financial reporting deficiencies by enabling them to persist and, in some instances, precipitating the Company’s departure from applicable accounting standards.”
The report states that as a result of New Century’s accounting failures New Century understated its repurchase reserve in the third quarter of 2006 by 100%, and reported a quarterly profit of $63.5 million when it should have reported a loss.” In addition, the accounting errors resulted in the payment of performance bonuses to key executives in 2005 “that were at least 300% more than they should have been.” New Century also made “a number of false and misleading statements in its public filings, press releases and other communications.”
Based on his investigation, the examiner believes that “several causes of action may be available to the estate.” First, the report concludes that the estate may be able to assert causes of action against KPMG for “professional negligence and negligent misrepresentations.” Second, the estate may be able to assert causes of action against former officers “to recover certain of the bonuses… that were tied, directly or indirectly, to the incorrect financial statements.” These causes of action, the report states, “could seek million of dollars of recoveries.”
The examiner also considered whether the company’s former officials breached their fiduciary duties, and whether the estate has possible claims against the officials. The report notes that any assertion of these claims would have “strong defenses to overcome, particularly the business judgment rule and statutory and other limitations.”
While the examiner’s conclusions may (and undoubtedly will) be the subject of substantial debate, the report’s analysis of the company’s loan origination practices and accounting shortcomings is remarkably detailed. The sheer sweep and magnitude of the report and the depth of its detail could make New Century the poster child for the excesses of the subprime lending boom, evoking inevitable comparisons with Enron as the byword for an entire era. Indeed, the report suggests a number of echoes from that earlier period, including in particular the accounting firm’s supposed complicity in the company’s alleged excesses.
The fallout from the subprime meltdown will continue to accumulate in the months and years to come, but the New Century bankruptcy examiner’s report may represent the first installment on the history of the era.
A March 26, 2008 Bloomberg.com article discussing the examiner’s report can be found here. A March 27, 2008 Wall Street Journal article discussing the report can be found here.