This SEC Case relates to misrepresentations made by former bank executives to hide the bank's worsening loan portfolio.  This case also relates to our other case reported today, involving KPMG Auditors.  KPMG was the auditor for the bank in this case, and they allegedly failed to conduct adequate audit procedures that may have detected or prevented the misrepresentations supposedly made by the bank executives in this case.  

For further details on the SEC's KPMG case, go to:   ["Financial Crisis Charges Against KPMG Auditors"].

[ by Howard Haykin ]

The SEC on Wednesday charged 3 former executives of Commonwealth Bankshares, a Norfolk, VA-based institution, with the alleged crime of understating millions of dollars in losses on the bank subsidiary's books so as to mask the true weakened health of the bank’s loan portfolio at the height of the financial crisis.  The banking subsidiary was Bank of the Commonwealth.
 

Profiles of Defendants.   Edward Woodard, Jr., 69, a resident of Norfolk, VA, served as Director Chairman, and CEO of Commonwealth for most of the period, from 1987 through December 2010.  In April 2010, Commonwealth's Board replaced Woodard as Chairman of the Board, though Woodard continued to serve as a director until 12/31/10.  On that date, Woodward retired and stepped down from all his positions with Commonwealth. 

In 2008, Woodward;s total compensation from Commonwealth amounted to $699K - that including salary and contributions to Woodward's pension and deferred comp plans.  In 2010, when he retired, his remuneration totaled $1.45 million and consisted of similar though large components.

The SEC notes that Woodard invoked his Fifth Amendment right against self-incrimination during testimony in the Commission's investigation.

Cynthia Sabol, age 49, a resident of Virginia Beach, VA, from February 2004 through 9/23/11 served as Commonwealth EVP, CFO, Secretary and principal accounting officer.  Her employment with the bank sub ended when Bank of the Commonwealth closed its doors in 2008,  In 2008, Sabol received compensation totaling $263K, which included salary and contributions to her pension and deferred compensation plans.  In 2010, Sabol's compensation totaled $338K, and included similar components as in 2008.  Sabol is a CPA licensed to practice in Virginia, and her license still is active. Sabol, like Woodard, invoked her Fifth Amendment right against self-incrimination during testimony in the Commission's investigation.

Stephen Fields,  49, a resident of Chesapeake, VA, was employed with Commonwealth from December 2003 through December 2010.  From 2003 through 2004, Fields served as SVP and Commercial Loan Officer of Commonwealth.  From 2005 until his termination in December 2009, Fields served as EVP and Commercial Loan Officer.   Prior to joining Commonwealth, Fields had been employed as a bank examiner with the Federal Reserve Bank of Richmond.  Fields also invoked his Fifth Amendment right against self-incrimination during testimony in the Commission's investigation.
 

SEC Findings and Allegations.   The SEC alleges that all three executives were responsible for misrepresentations to investors by the bank’s parent company Commonwealth Bankshares.  The consistent message in Commonwealth’s public statements and SEC filings was that its portfolio of loans - which made up about 94% of the company’s total assets in 2008 - was conservatively managed according to strict underwriting standards aimed at keeping the bank’s reserved losses low during a time of unprecedented economic turmoil.

In reality, Woodard allegedly knew the true state of Commonwealth’s rapidly-deteriorating loan portfolio, and he supposedly worked to hide the problems and to engineer the misleading public statements - particularly those made in earnings releases. Both Sabol and Fields apparently cooperated throught their respective roles with the company. 

• For example, Sabol knew of the activity to mask the problems with the company’s loan portfolio and the corresponding effect these masking practices had on the bank’s financial statements and disclosures, yet she signed the disclosures and certified to the investing public that they were accurate.

• Fields oversaw the bank’s largest portfolio of construction and development loans and so he too was aware and went along with the masking practices.

The misrepresentations and misstated balances allegedly pertained to the allowance for loan and lease losses (known as ALLL),  which the executives continually understated by 17% to 25% for the inclusive period, November 2008 to August 2010.  This had the effect of understate the bank's reported loss before income taxes by about 64% for fiscal year 2008. 

Commonwealth also understated its losses on real estate repossessed by the bank - known as OREO - in 2 fiscal quarters, causing the bank to understate reported loss before income.  For 8 consecutive fiscal quarters, Commonwealth underreported its total non-performing loans.

The SEC further alleges that Commonwealth obtained an appraisal for its largest collateral-dependent loan that falsely inflated the value of the collateral. The bank executed hundreds of “change-in-terms agreements” at the end of the quarter to remove tens of millions of dollars of loans from its reported non-performing loans. Woodard, Sabol, and Fields helped enable the bank to artificially bring otherwise-delinquent loans current by permitting checking accounts associated with the guarantors of the delinquent loans to be overdrawn. The bank also disbursed loan proceeds without inspecting the property to confirm that the work requiring the disbursement had actually been performed.

Such actions would violate antifraud, reporting, recordkeeping, internal controls, deceit of auditors, and Sarbanes-Oxley certification provisions of the federal securities laws.  The SEC’s investigation continues. 

SEC Staff Credits.   Investigation by Laura Josephs, Thomas Silverstein, David Karp, Lucas Moskowitz, and David Estabrook.  SEC litigation will be led by Richard Hong.

For further details, go to:   [SEC PR 13-4, 1/9/13 ] and [SEC Complaint].