PNC Financial Services Group, Inc. has entered into settlement agreements with the Securities and Exchange Commission (SEC), the Federal Reserve Bank of Cleveland and the Office of the Comptroller of Currency. The settlements are the result of questionable accounting used with special purpose entities (SPE’s) that held marginal assets of the company.
In an announcement issued yesterday, PNC said it “consented to an SEC cease and desist order to settle the matter and neither admitted nor denied the SEC’s findings regarding disclosure, accounting and record keeping violations.” PNC said no fines or monetary penalties will be assessed, “and no further adjustments to any PNC financial statements are required in connection with any of these matters.”
The questionable accounting centers around SPE’s formed with American International Group, Inc. (AIG) in 2001. In January, when PNC announced the SEC inquiry, AIG issued a statement saying that it had already included the SPE’s in its consolidated balance sheet and would not be impacted by PNC actions.
The SEC’s findings said during 2001, PNC transferred $762 million in loans and venture capital assets — many of which were volatile, troubled or nonperforming — to 3 SPE’s sponsored by AIG in which PNC held a substantial interest. Each transaction involved the creation of two limited liability companies, one of which sold a substantial ownership interest to PNC and a minority ownership interest to AIG — whose management role was limited, at best. With funds received in exchange for its shares, each SPE purchased loans or venture capital assets from PNC.
PNC continued to service the loans and other assets transferred to the SPE’s.
The SEC findings went on to say that PNC treated the loans and other assets transferred to the SPE’s as if they were no longer assets of PNC as a consolidated bank holding company. PNC intended that, as a result of the transactions, its balance sheet would reflect a reduction in exposure to troubled loans and volatile assets, and its income statement would not reflect associated loan losses. PNC should have consolidated the assets of the SPE’s in its regulatory reports and financial statements.
In order for PNC to exclude the assets of the SPE’s from its consolidated balance sheet, AIG would have had to have participated more in the risk and reward process of the SPE’s. In addition, the SEC said that a prepaid one-year management fee to AIG effectively reduced its investment to less than the three percent required for nonconsolidation.
SPE’s are regularly used by large mortgage companies in loan securitizations.
According to the SEC, PNC publicly said the moves were part of “a strategy of turning its corporate focus away from commercial lending, and reducing its loan exposure.”
The agency noted that PNC violated the financial reporting, record keeping and antifraud provisions of the federal securities laws. The SEC said PNC’s materially false and misleading disclosures in SEC filings and press releases about its financial condition and performance, including a material overstatement of its 2001 earnings, created a materially inaccurate picture.
One specific example pointed out by the SEC was an October 18, 2001 press release where PNC reported $361 million in nonperforming loans and $374 million in total nonperforming assets. In fact, the figures did not include $207 million in nonperforming assets held in the SPE’s.
A January 17, 2002 press release presented a table setting forth PNC’s nonperforming assets by type, which included a total of $268 million in nonperforming assets as of December 31, 2001, the SEC said. That announcement went on to say that excluded “from the table and reflected below are . . . certain assets sold to subsidiaries of a third party financial institution. These assets will be included in nonperforming assets in PNC’s bank holding company regulatory filings.”
The January press release continued by disclosing that the amounts of nonperforming assets sold to the subsidiaries of the third party financial institution were $84 million as of June 30, 2001, $207 million as of September 30, 2001 and $172 million as of December 31, 2001, according to the commission findings . This was the first time that PNC publicly disclosed the amounts of the nonperforming assets among the assets it had transferred to the SPE’s, although it did not incorporate them into the table for nonperforming assets.
As of June 30, 2002, PNC reported nonperforming assets of $500 million.
PNC announced on January 29 of this year that it would revise its fourth quarter financial results and restate its second and third quarter 2001 financial statements to reflect the consolidation of the SPE’s. This was followed by amended 10-Q filings with the SEC in March.
“We’ve learned from it, and we’re moving forward in our effort to build a stronger company,” said PNC’s chairman, president and CEO James E. Rohr. “Working with the bank regulators, we have developed a detailed action plan over the past several months to address areas needing enhancement, and implementation of that plan is underway.”
PNC said that as a result of the bank regulatory actions, it will need prior regulatory approval to engage in certain new activities, add new directors or employ new senior executive officers.
