Lender inflated its profit, report says
Driven by a “brazen obsession” with generating sub-prime mortgages, Irvine’s New Century Financial Corp. engaged in improper accounting that overstated its profit and allowed top executives to reap millions of dollars in inflated or undeserved bonuses, a U.S. Bankruptcy Court examiner said in a report released Wednesday.
Michael J. Missal’s report said senior managers “turned a blind eye” to the “ticking time bomb” created by the high-risk lending in 2005 and 2006. At the same time, Missal said, New Century’s auditor, KPMG, contributed to the problems by failing to exercise due care in reviewing its books, leading to material misstatements in New Century’s financial reports.
A spokesman for two of the company’s former senior executives said they have not had time to study the 581-page report but were cooperating with the examiner and other investigators. In a statement, the company said it was pleased that the report had been completed, enabling its plan for liquidation to continue.
KPMG, meanwhile, said it “strongly disagreed” with the report’s findings, though it offered no detailed rebuttal to the allegations.
New Century, once the nation’s largest independent sub-prime home lender, was one of the earliest firms to collapse because of mortgage defaults. Bombarded by demands that it buy back soured loans, it said in February 2007 that it would restate its financial reports.
It stopped taking loan applications that March and filed for bankruptcy in April 2007 in U.S. Bankruptcy Court in Delaware. Creditors have filed claims seeking $35.1 billion from the company.
Missal was appointed by U.S. Bankruptcy Judge Kevin Carey last June to examine New Century’s accounting practices. His report concluded that investors and others may have legal grounds to sue New Century, its top executives and KPMG for damages.
Because bonuses to top executives were tied to reported financial results, five senior managers could be compelled to return $2.9 million in excess bonus awards for 2005, Missal said. Also, he said, $2 million more paid in 2006 to the top three officials was “undeserved altogether when accurate financial statements are taken into account.”
These and certain other bonus payments to executives may be recovered “under unjust enrichment and bankruptcy law theories,” he said.
Missal said certain officers and directors might also be exposed to various other claims for certain actions or their failure to act, but he added that they also had significant legal defenses.
A spokesman for Robert Cole and Edward Gottschall, two of New Century’s founders, issued a statement on their behalf saying: “While we have not yet had a chance to review the report, Mr. Gottschall and Mr. Cole have cooperated and will continue to cooperate with the examiner and any other inquiries.”
Missal said KPMG might be found to have committed accounting malpractice and thus be forced to return about $5 million in accounting and auditing fees it earned from New Century in 2005 and 2006.
It might also be possible for creditors to recover millions of dollars in additional damages from the accounting firm for a wide range of expenses that New Century incurred as a result of having inflated financial results, Missal said. They include costs related to investigations of its relationship with KPMG that have been conducted by Missal, the Securities and Exchange Commission and the U.S. Justice Department, he said.
The company said last week that under its liquidation plan, most unsecured creditors would recover less than 25 cents on the dollar, and some as little as 1 cent on the dollar, Reuters reported.
In its statement, KPMG suggested that Missal may have skewed his findings to find a “deep pockets” target for recovering damages in the case.
“We strongly disagree with the report’s conclusions concerning KPMG, and we believe that an objective review of the facts and circumstances will affirm our position,” the accounting firm said.
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