Risk Management

Mi Casa Es Su Casa? Maybe Not

Puerto Rican residential mortgage company R&G Financial settles SEC charges that it improperly accounted for housing loans it sold to other financi...
Stephen TaubFebruary 13, 2008

Puerto Rico’s second-largest mortgage loan originator for single-family residences has settled civil financial fraud charges for allegedly overstating earnings by about $180 million. The alleged fraud involved improper accounting for billions of dollars worth of mortgage-related transactions from 2002 through 2004.

According to the Securities and Exchange Commission, the accounting irregularities enabled R&G Financial to report an apparent 12-quarter streak of “record earnings.”

Since the accounting and disclosure problems began surfacing in early 2005, R&G’s stock price has plunged 75 percent, cutting its market value by about $900 million.

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R&G improperly accounted for the sale of non-conforming mortgage loans to other Puerto Rican financial institutions in two different ways, according to the commission’s complaint. First, R&G improperly recognized gain on sales of mortgages; these transactions were not true sales under generally accepted accounting principles because of full recourse provisions in the written contracts. In addition, R&G “significantly overvalued” interest-only strips retained by the company in its purported mortgage loan sale transactions.

The SEC also alleged that R&G managed earnings through a series of mortgage loan swap transactions with other Puerto Rican financial institutions.

According to the complaint, R&G’s former CEO, CFO, and other senior managers knew, or were reckless in not knowing, that the company was improperly accounting for mortgage-related transactions as sales.

During the 2003 audit, R&G’s former CEO sought to obtain a legal opinion from outside counsel to support true-sale accounting treatment of certain mortgage-related transactions under SFAS 140, according to the SEC. After legal research and analysis, this first outside legal counsel informed the former CFO that the requested opinion could not be provided because the legal counsel did not believe that the transactions qualified as true sales, it added.

This attorney also told the former CFO that he believed there would be a significant adverse impact on the company’s financial statements should the transactions be re-characterized as secured borrowings, the commission alleged.

“Outside counsel subsequently informed R&G Financial’s former CEO in a brief conversation that he had been asked to provide a true sale opinion but could not and that he was concerned that the company had a problem,” the complaint further stated. This outside legal counsel’s concerns were never addressed because the former CFO was able to obtain true sale opinions from a second outside law firm after the filing of the company’s 2004 annual report, the Complaint asserted.

Without admitting or denying the Commission’s allegations, R&G has consented to the entry of a court order enjoining it from violating those antifraud, reporting, books and records and internal control provisions of the federal securities laws.