Report Details Lender's Collapse

New Century Called 'Brazen'

New Century Financial, the subprime lender that was one of the first casualties of the housing crisis, had a "brazen obsession" with risky home loans that spurred it to engage in "significant improper and imprudent" financial practices, according to a report released yesterday.

The long-awaited report examines what went awry at New Century, the second-largest subprime lender before it raced into Chapter 11 bankruptcy protection in April 2007, and says shareholders could recover a small fraction of the billions of dollars they lost in the process by suing companies and individuals who may have exacerbated the debacle.

Michael J. Missal, the lead investigator, acting at the behest of the Justice Department, pointed the finger at audit firm KPMG, which he said contributed to New Century's problems in "troubling and puzzling" ways. In some cases, KPMG may have recommended departures from accounting standards, overruled the judgments of in-house specialists and caved under pressure from corporate executives, the report says.

Missal, a Washington lawyer who played a similar role in investigating the causes of the 2002 WorldCom collapse, outlined a possible negligence case against KPMG for breaching professional standards and failing to ask skeptical questions in its audits and reviews of New Century.

Missal also concluded that New Century might have a case against former executives to recover millions of dollars in bonuses that were tied to inflated financial reports in 2005 and 2006.

The Securities and Exchange Commission and federal prosecutors in Los Angeles are investigating the circumstances of New Century's rapid decline, including whether stock trades by the Irvine, Calif., company's founders violated insider-trading laws. The New Century probe is among the most advanced of several investigations by the FBI and federal securities regulators into the subprime lending fiasco.

Kathleen Fitzgerald, a spokeswoman for KPMG, one of the nation's four largest accounting firms, said KPMG "strongly disagreed with the report's conclusions." She said that "an objective review of the facts and circumstances will affirm our position."

The report reads like an autopsy of New Century, detailing its "dangerous and ultimately fatal" lending practices as its senior managers "turned a blind eye" to the risks. The company employed at least seven improper accounting tricks, including under-calculating the financial reserves it maintained to cover bad loans and losses, Missal said.

The maneuvers carried significant consequences. New Century understated its reserves by as much as 1,000 percent in the third quarter of 2006 and reported a profit of $63.5 million during that period when it should have reported a loss, according to the report.

As a result, the company's founders, Robert K. Cole, Edward F. Gotschall and Brad A. Morrice, collected performance bonuses at least 300 percent higher than they should have been, Missal wrote.

Charles Sipkins, a spokesman for Cole and Gotschall, said they had not reviewed the report but that they "have cooperated and will continue to cooperate with the examiner and any inquiries." Morrice could not be reached for comment late yesterday.

The fortunes of New Century, founded in 1995, closely tracked the overheated housing market. During its first year, New Century wrote $357 million worth of loans. In 2006, the figure was $60 billion.

But the pressure to generate fees increasingly led brokers to approve "liar's loans," those that did not require borrowers to verify their incomes. Brokers made frequent exceptions when borrowers were not able to meet the company's meager guidelines, according to the report.

While New Century took on such risks, its marketing team prepared advertisements calling it a "New Shade of Blue Chip" and promoting its integrity.

The bankruptcy report was issued nearly six years after Congress passed corporate-accountability legislation spurred by fraud at Enron and WorldCom. The law, known as Sarbanes-Oxley, imposed tight oversight of the accounting industry and extended criminal penalties for executives who commit financial crimes.

Hugh Burns, a spokesman for New Century, said in a written statement: "The Company is pleased that the Examiner's report is finally completed and that we can take the next steps of confirming the plan of liquidation, therefore substantially concluding the bankruptcy process."