The SEC brought another significant market crisis case, this time against the senior officers of a failed financial institution. The complaint centers on repeated efforts by the CEO, COO and manager of credit risk to conceal the rapidly devolving financial condition of the institution from the auditors and the public as key large loans and collateral deteriorated in the wake of the evolving financial crisis in 2008 and 2009. Ultimately their efforts failed and the bank was closed by California authorities at a huge loss to the FDIC. SEC v. Wu, Case No. CV-11-4988 (N.D. Cal. Filed Oct. 11, 2011).

The Commission’s action names as defendants: Thomas Wu, then the Chief Executive Officer of United Commercial Bank and UCBH Holdings, Inc.; Ehrahim Shabudin, COO of the bank and its holding company and for part of the period chief credit officer; Thomas Yu, First Vice President, Manager of Credit Risk and Portfolio Management; and Craig On, CFO of the holding company. Each defendant invoked his Fifth Amendment rights during the underlying investigation. The complaint alleges violations of Securities Act 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and the related rules.

United Commercial Bank was a rapidly growing San Francisco based financial institution. Over a period of ten years the bank doubled its size while making a number of acquisitions. Those included a bank in the People’s Republic of China, the first by a U.S. bank. It was lead by its CEO Thomas Wu who became a prominent figure in the banking industry.

In 2008 as the economic crisis unfolded and the real estate market declined, the value of loans and collateral held in the bank’s portfolio of commercial and construction loans declined. Delinquencies increased. Seven large loans in particular deteriorated and had a significant impact on the bank.

Mr. Wu monitored large and troubled loans in the bank’s portfolio as the crisis unfolded in 2008. The bank set up a Special Assets Group which he led with the assistance of Mr. Shabudin and others. By December 2008, and continuing through first quarter of the next year, the committee met weekly to examine the largest problem loans. The committee examined updated appraisals and other new information revealing the true status of the loans. Much of this information was withheld from the auditors. Messrs. Wu and Shabusdin discussed ways to delay any negative financial impact from the deteriorating loans.

Messrs. Wu and Shabudin worked with Mr. Yu, to minimize the impact of the declining loans and collateral on the financial statements, according to the complaint. Mr. Yu was responsible for managing the bank’s problem loans under their supervision. He also had a lead role in the bank’s efforts to sell troubled loans and concealed information from the auditors. Since subordinates were instructed to delay incorporating updated negative information regarding problem loans and collateral, losses and reserves were not properly recorded. Thus the bank’s reserve package, including a section which focused on troubled loans, was materially incorrect. It was furnished to the auditors.

During this period the bank had at least seven large loans which were carried at inflated values or with understated reserves. Individually, and collectively these loans had a material impact on the financial statements. If restated in accord with GAAP these loans would have increased the reported losses by about 50% from a net loss of $134 million to a net loss of $200 million.

Mr. Shabudin, as the bank’s Chief Credit Officer, coordinated the information made available to the outside auditors. Key facts updating the condition of large loans and showing their deterioration were withheld from the auditors. The auditors were however furnished with inaccurate memoranda along with the materially false loan loss package.

Mr. On certified the accuracy of the 2008 Form 10-K as the CFO of UCBH. He also executed internal loan loss calculations and made representations to the auditors. “Given the concerted efforts of other senior executives to hide and delay loan losses, and given what he knew about at last a portion of the mounting losses, On should have known . . .” that the financial statements were not accurate according to the complaint. That Form 10-K was filed with the Commission on May 20, 2009 following an earlier earnings call which reported results.

On November 6, 2009 the California Department of Financial Institutions closed the bank and appointed the FDIC as receiver. UCB was the ninth largest bank to fail during the financial crisis of 2008 and 2009. That failure cost the FDIC $2.5 billion.

Only Mr. On settled with the Commission. He consented to the entry of a permanent injunction prohibiting violations of Securities Act Sections 17(a)(2) & (3) along with reporting, recordkeeping and internal control provisions. He also agreed to pay a civil penalty of $150,000 and consented to an entry in a related administrative proceeding of an order suspending him from appearing or practicing before the SEC as an accountant with a right to reapply after five years. The other defendants are litigating the action.

Program: The Impact of the Supreme Court’s Decision in Morrison v. National Bank of Australia on securities litigation and SEC enforcement actions. Presented by Celequ Legal Education in conjunction with West Thomson. Webcast on October 12, 2011 from 12:00 to 1:00 EST. For furtrher information please click here