SEC Charges Reg Cap Violations


America’s second largest bank has been charged with violating federal securities laws based on alleged overstatement of regulatory capital. The Securities and Exchange Commission (SEC) filed the charges in connection with the bank’s 2009 acquisition of a major brokerage house. They include allegations that inherited notes were permissibly misstated. The misstatements in regulatory filings reached into billions of dollars.

Reg Cap

Regulatory capital refers to the amount of capital that a bank must hold pursuant to SEC and other applicable rules, and it is intended to serve as a buffer against adverse market conditions. In the course of acquiring the brokerage firm, the bank assumed a large portfolio of structured notes and other financial instruments. The bank recorded the assumed notes at “discount to par,” yet it redeemed the notes “at par.” Accordingly, it was required to realize losses on the notes as they matured and to deduct these on its reporting of regulatory capital as the losses occurred.

Internal Controls

The SEC charged the bank with violating provisions relating to internal controls and record keeping. As of March 31, 2014, 90 percent of the notes had matured, but the bank had not deducted any of the realized losses from its regulatory capital. As more and more notes matured, each subsequent fiscal quarter and fiscal year from 2009 resulted in overstatement of regulatory capital by greater and greater amounts in the regulatory filings. Eventually, the overstatement reached into the billions of dollars. However, by April 2014, internal controls — which had failed the bank in this area for five years — in fact discovered the problem, and upon further analysis, the bank reported the overstatements in a Form 8-K filing on April 28, 2014.

Mitigated Penalties

The bank agreed to pay a $7.65 million penalty. In addition to correcting its report of regulatory capital, the bank cooperated with SEC staff during the investigation and voluntarily took steps to remediate its internal controls that caused the reporting deficiencies. According to Andrew J. Ceresney, director of the SEC’s Division of Enforcement, the self-reporting, quick remediation and overall cooperation were factors in determining the penalty:

“[The bank] self-reported its regulatory capital overstatements, remediated the issues quickly, and cooperated in our investigation. This penalty reflects credit for that cooperation, which allowed us to conduct our investigation efficiently and effectively.”

Accuracy of Records

The necessity of maintaining the integrity of records and filings was restated by Michael J. Osnato, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit:

“The federal securities laws require all public companies to maintain accurate books and records as well as a system of internal accounting controls sufficient to assure transactions are recorded as necessary.”