WASHINGTON — A report released Thursday by the Treasury Department's Office of the Inspector General details how the Office of Thrift Supervision allowed thrifts to backdate capital infusions, and criticizes senior agency officials for taking no action when they discovered other thrifts had engaged in backdating — even, in one instance, when the OTS had expressly told the thrift not to do so.
"We consider these matters very serious and find it alarming that such high level OTS officials were not only aware of the backdating at two thrifts, but either directed or authorized the thrifts to backdate the capital contribution," the IG wrote. "Approving or directing the thrifts to backdate these contributions is inappropriate as the accounting treatment is not in accordance with generally accepted accounting principles and allows for misleading financial reporting by the thrifts."
Observers said the report further damages the OTS' credibility, which has already been undermined by the failure of multiple large thrifts, including Washington Mutual Inc. and IndyMac Bancorp. The OTS is increasingly likely to be eliminated in any move to restructure the regulatory agencies.
"They are on everyone's hit list," said Cornelius Hurley of the Graduate Program in Banking and Financial Law and its related Morin Center for Banking and Financial Law at Boston University School of Law. "It looks like their only hope is if Congress gets stymied and does nothing."
The report said the backdating occurred at six thrifts but it names only one, the failed IndyMac. But sources have identified one other, Florida-based BankUnited, which failed Thursday.
The report found that OTS officials had expressly permitted a capital infusion to be backdated for two thrifts. IndyMac was allowed to book a capital infusion received on May 9, 2008, for its first quarter, while "Thrift No. 2" — believed to be BankUnited — was allowed to count an Aug. 5 capital infusion toward its second quarter. The report said that on a conference call held Aug. 4, 2008, Scott Polakoff, then the agency's deputy director, told OTS regional officials to backdate a capital infusion at Thrift No. 2 so it would be recognized as of June 30. Polakoff, who was promoted to acting director of the agency earlier this year after the departure of John Reich, was suspended in March pending further investigation into the matter. Polakoff declined to comment.
It is unclear if Reich was aware of the backdating, and a spokesman for the IG said the agency did not interview the former director. In an e-mail sent late Thursday, Reich said the report was "old news" and accused the Treasury IG of having "too much time on his hands." Reich said the issue had been blown out of proportion and that only a very few thrifts were affected. He also defended Polakoff, calling his suspension a "travesty of justice."
In its report, the IG said a thrift in the Southeast asked permission to backdate, was denied by the agency, and then proceeded to do so anyway. After the OTS discovered the thrift had engaged in backdating, it did not take any enforcement action, according to the IG report.
The OTS also uncovered evidence of backdating at thrifts in its West and Northeast regions but did not take corrective action at either institution, the IG said.
The agency did require a Southeast thrift to restate its financial reports after it uncovered backdating there, the IG said.
"With the exception of the thrift that OTS directed to reverse the transaction and the thrift complied, OTS did not take appropriate action to address the other instances of backdating once the examiners became aware of such transactions," the IG said.
The OTS defended its actions, arguing that it had not misled investors or the public.
"The contributions increased capital at the thrift level but had no impact on the equity reported by the holding companies in their consolidated public financial statements," the OTS' acting director, John Bowman, wrote in a letter to the IG.
Bill Ruberry, an OTS spokesman, said the agency has already taken action to remedy the situation. In all six cases, the thrifts backdated a capital infusion from their holding company. Ruberry said that thrifts may recognize regulatory capital from a holding company if a note is received before the end of a reporting period.
"The OTS' error in this was not making sure a valid note receivable existed," he said. "Each of these transactions would have been acceptable if such a note would have been recorded. We are talking about pieces of paper in a file. That's what these cases amount to. Providing capital to banks and thrifts that need it is a good thing and positive for the continued health of the institutions. The post- period capital positions had nothing but a positive impact on the health of the institutions involved."
Kip Weissman, a partner at Luse Gorman, also defended the agency's actions, to a point.
"It's important to keep it in perspective," he said. "I think the OTS officials were working with the banks to increase their capital. The goal was to increase their capital. There was no conclusion to evade regulatory responsibilities or allow the banks to have lower regulatory capital. Even though at the end of the day this was the wrong way to go about doing it."
But Ellen Seidman, a former director of the OTS, said the backdating appeared inappropriate.
"If we are going to have call reports both for the use of the regulators and the use of the public, the rules of the game need to be clear and followed," she said. "We have here not only a situation where they were not followed but in a couple cases action that was contrary to the rules."
She dismissed arguments that it was a simple paperwork mistake.
"We are probably dealing with institutions about what their capital level was and its not just a matter that they are well capitalized, it matters how well capitalized they are," said Seidman, who is now the director of the Financial Services and Education Project at the New America Foundation. "It's time to not be defensive and to make sure the problem is fixed."
James Barth, the Lowder Eminent Scholar in Finance at Auburn University, agreed.
"There was shoddy regulatory oversight provided by OTS, which is regulatory breakdown at a time regulators should be maintaining confidence in our financial systems," he said. "It's hard to have confidence when the regulatory authorities which are supposed to provide oversight fail to do so. It undermines financial confidence in financial statements reported by our financial institutions."
He said the report was "additional icing on the cake" for those who want eliminate the OTS.
The report was sparked after IG officials discovered evidence of backdating at IndyMac while investigating the thrift's failure.
Darrel Dochow, the agency's former Western region director, was suspended and eventually left the agency after the backdating was uncovered.
The IG noted that the OTS has issued guidance on accounting standards for capital injections, but said additional guidance is needed to outline steps for OTS examiners to identify and address backdating of capital contributions if and when they occur. The IG also recommended the OTS determine if there have been any other cases of backdating capital contributions.
