The Securities and Exchange Commission has charged a Virginia Beach-based bank holding company and its former chief financial officer with violating the federal securities laws by improperly accounting for a deferred tax asset that was not fully realizable due to the company’s deteriorating loan portfolio and financial condition.
Hampton Roads Bankshares, which is the holding company for the Bank of Hampton Roads and Shore Bank, agreed to pay a $200,000 penalty to settle the SEC’s charges. Former CFO Neal Petrovich, a CPA, agreed to pay $25,000 to settle the charges against him.
A deferred tax asset is an asset on a company’s balance sheet representing a right to offset a future tax obligation. According to the SEC’s orders instituting settled administrative proceedings, Hampton Roads improperly recorded the entire amount of its DTA in late 2009 and early 2010 without recording a valuation allowance, which represents the portion of the DTA for which it is more likely than not that a tax benefit will not be realized.
The SEC found that Hampton Roads and Petrovich decided not to record a valuation allowance against its DTA by unreasonably relying on financial projections that were inconsistent with internal company reports, which indicated that loan losses were likely to continue. As a result of the inflated DTA, Hampton Roads materially understated its losses on its income statement for fiscal year 2009 and the first quarter of 2010.
“Accounting determinations must be based on reasonable and supportable information, even in areas that require subjective judgment,” said Scott Friestad, associate director of the SEC’s Division of Enforcement, in a statement. “Hampton Roads and Petrovich failed in this responsibility.”
According to the SEC’s orders, the DTA reported by Hampton Roads was $56.4 million as of Dec. 31, 2009, and $70.3 million as of March 31, 2010. The vast majority of the DTA during this time period related to the company’s loan loss reserves. In March 2010, Petrovich and others under his direction prepared an internal memorandum analyzing whether a valuation allowance was required against the DTA as of year-end 2009. They determined that no valuation allowance was necessary because they improperly concluded that Hampton Roads was likely to become profitable again in 2011 and thus would utilize its DTA within the applicable time period. Therefore, the bank’s annual report for 2009 and its first quarterly report for 2010 included financial statements recording its DTA without a valuation allowance.
The SEC’s orders find that internal reports at Hampton Roads in late 2009 and the first half of 2010 indicated that the bank’s loan portfolio—including non-performing assets, delinquent loans, and non-accruing loans—was continuing to deteriorate, indicating that the loan losses were likely to continue.
Hampton Roads eventually restated its filings in August 2010 to record a valuation allowance against its entire DTA, which affected the capitalization level that the company was required to report quarterly to bank regulators and that investors consider material information. Prior to its restatement, Hampton Roads reported that it was “adequately capitalized” as of Dec. 31, 2009, and “undercapitalized” as of March 31, 2010. Following the restatement, Hampton Roads updated its reports to say it was “undercapitalized” as of Dec. 31, 2009, and “significantly undercapitalized” as of March 31, 2010.
“A valuation allowance is required for a deferred tax asset when it is more likely than not that the recorded tax benefit will not be realized,” said Michael Maloney, chief accountant in the SEC’s Division of Enforcement. “Based on the information contained in internal reports, it was unreasonable for Hampton Roads and Petrovich to conclude that the DTA would be fully realized.”
The SEC’s orders found that Hampton Roads violated the federal securities laws, and Petrovich was a cause of the violations. Hampton Roads and Petrovich consented to the orders without admitting or denying the findings. The orders require them to cease and desist from committing or causing any future violations of these provisions of the securities laws.
The SEC’s investigation was conducted by David Becker and David Estabrook, and the case was supervised by Laura Josephs.
