Banks have been reclassifying their losses to avoid taking steep write-downs that could affect their ability to stay in business, helping them avoid the high-profile banking failures seen in recent weeks.
After the collapse of Silicon Valley Bank and Signature Bank this month, investors have been questioning the books of banks and finding that some of them reclassified their assets last year from "available for sale" to "held to maturity." Given the stock market losses seen last year as interest rates steadily rose, that allowed them to avoid the steep markdowns that led to the failure of Silicon Valley Bank as the bank had to sell off its Treasury bonds at a lower market value than it had paid. Among the leading banks reclassifying a combined hundreds of billions of dollars in assets last year were Charles Schwab, PNC Financial Services, JPMorgan Chase, Truist Financial, Wells Fargo and US Bancorp, according to the
Banks are facing other kinds of risks, however, and the Securities and Exchange Commission has begun to investigate the problems that emerged at SVB, Signature and other financial institutions. Among the questions that have emerged are about the stock sales by some of SVB's top executives only weeks before the bank collapsed, and the role of auditors who gave clean audit opinions only weeks before the demise of both SVB and Signature. SVB CEO Greg Becker sold $3.6 billion in shares only about two weeks before the bank collapsed. The trades were
"There's a couple things that the SEC might investigate," said Albany Law School professor Christine Chung, a former lawyer in the SEC's Enforcement Division. "One of them is stock sales by insiders shortly before the bank failed. The timeline on it is interesting. The CEO, for example, put in place a 10b5-1 plan in January of this year. A 10b5-1 plan basically says, 'I'm going to be selling stock on a declared schedule.' The idea is you put that plan in place for insiders because in theory they always have some type of inside information, so what you're trying to do is signal to the market that you're going to be selling this much over this time on this schedule, and then the decision on any individual transaction is out of the hands of the seller. It's a way of basically allowing people to make planned changes to their portfolio holdings in a way that the decision is out of their individual hands."
She noted that the SVB executives put in place a 10b5-1 plan in January and then sold the stock. "There's a 30-day cooling off period," she added. "They sold the stock 31 days later, and that ended up being about two weeks before the collapse of the bank. I think the SEC will be looking at the circumstances of the adoption of the plan, what the insiders knew at the time the plan was being adopted, respecting the bank's financial conditions and its risks, and then what they knew when they were in that period when they adopted the plan, and when they're selling, and two weeks later, something happens. So the SEC is going to look at all facts regarding the adoption of that plan, and specifically, what they knew when they were out there trying to raise money to shore up the bank's financials. It's one thing to have a plan in place saying I'm going to be doing this going forward. But this was the first sale under the plan two weeks before the failure of the bank."
Risks like the rapid rise in interest rates over the past year also led to accounting problems and perhaps ultimately to the bank failure at SVB. Worried investors began pulling their money out of SVB in response to reports from short sellers who had pointed to the potential accounting issues.
"There was essentially a mismatch of duration," said Chung. "They had a bunch of depositors who basically could withdraw money on demand. They had invested in a bunch of long-duration securities where you couldn't just immediately liquidate them. You have this situation where more people are requesting their money than you can give, based upon what you currently have and your ability to exit other positions. If you've got a bunch of money tied up in long-duration assets, and someone says, 'Give me all my money today,' you're going to run short, and that's what happened."
She believes the SEC will be looking at what was the state of understanding regarding this duration mismatch issue.
"Before the bank collapsed, the CEO was out in the market trying to raise a round of capital to shore up the bank's balance sheet," said Chung. "I think with respect to the sale, they're going to be asking what did you know about this duration mismatch and how tenuous things were when you were out there raising money? There's a risk management issue, and then there are going to be questions about whether there were proper disclosures and the like."
Besides the risk management issues, another question will be around whether the bank made proper disclosures and complied with the banking and securities laws.
"I'll note in that regard, we know now that the chief risk officer actually left her post in April of last year, and her departure was not disclosed," said Chung. "It's disclosed now in the preliminary proxy that came out earlier this month. It doesn't seem to have been disclosed, for example, via a Form 8-K at the time. Arguably, the departure of an executive with that title should have triggered an 8-K filing. They're going to be looking to see if there was technical compliance with disclosure requirements and with rules having to do with banking requirements, but then they're also going to be saying, what did you know about this durational mismatch and its risk to the bank and what did you say? And did you sell stock while you knew that there was a problem, and that problem hadn't been fully disclosed?"
The chief risk officer at Signature Bank had formerly been an auditor at KPMG for the bank, but left the firm in 2021 to work at Signature. The Big Four firm also audited SVB and gave both firms clean audit opinions only weeks before they collapsed (
"I think it's less about KPMG or any particular firm where somebody may have gone," said Chung. "I think it's more about are there conflicts of interest? Was there disclosure? Were the right people keeping an eye on risk, and if not, why not?"
She noted that with SVB, the charter of the risk management committee changed over time even as it grew to become a systemically important bank in the view of regulators. "You have a situation where the bank is becoming subject to more robust regulation, because it's now a category four SIB, and you don't have a chief risk officer, and the board seems to have been taking a look at its charter during this time to see what are their responsibilities and there's some wordsmithing that I think the SEC will be interested in."
She wonders why SVB lacked a chief risk officer at a time when its regulatory burden was increasing and the stock sales were occurring.
"Obviously, we're at the very beginning stages, and the SEC may investigate and conclude that there isn't anything actionable here," said Chung. "It's way too early to say that anyone violated rules, but I think these are areas that the SEC will be interested in looking at."
In addition to the trading issues, she predicted there will be an inquiry into SVB's financials.
"One thing that I noticed in looking at the 10-K annual report and the proxy is that loans to officers, directors and principal shareholders and their related interests tripled in the final quarter of 2022," said Chung. "That's really interesting to me. We don't know a ton about these loans. The proxy says that they were made on basically market terms, but we're talking about loans to insiders and affiliates of insiders, for example, potentially a hedge fund or a VC firm that is controlled by a director of the company. I'm interested in why loans to insiders and their affiliates tripled right before the bank failed. I think the SEC may be taking a look at that as well, in addition to the trading issues."
