The SEC has settled fraud charges against Doral Financial Corporation, which was once Puerto Rico’s leading residential mortgage lender. Doral, which is traded on the New York Stock Exchange and has offices in New York City, agreed to pay a $25 million civil penalty for illegal accounting practices.

In its case, the Commission charged that Doral’s misleading accounting helped the firm falsely claim 28-quarter streak of record earnings. In total, the firm overstated its income by approximately $921 million, or 100%, on a pre-tax, cumulative basis between 2000 and 2004. The overstatements also led to material misrepresentations in the company’s offering documents and press releases.

Since the firm’s phony disclosures came to light in early 2005, the market price of Doral’s common stock plummeted from almost $50 to under $10, reducing its equity market value by over $4 billion.

In addition to the penalty Doral agreed, without admitting or denying guilt, to an injunction against future violations of federal securities laws.

The Commission commended Doral for its “significant cooperation” with the investigation, and acknowledged the company’s steps to set matters right. Since learning of the accounting problems, Doral’s Board of Directors hired a new management team, restated the company's financials, and entered into consent orders with the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation.

But the SEC nonetheless made it clear that Doral’s overstatements were fraudulent and would not be tolerated.

“The scheme engaged in by Doral senior management involved improper valuation of corporate assets, sales lacking economic substance and round-trip transactions. Today’s action should emphasize that these types of accounting tricks will not be tolerated,” said Peter H. Bresnan, a Deputy Director in the Division of Enforcement.

Some in the Commission were alarmed to see this kind of accounting irregularity considering recent federal legislation and intensified regulation. “The accounting fraud at Doral is particularly troubling because it occurred after the reforms of the Sarbanes-Oxley Act,” said Linda Chatman Thomsen, Director of the Division of Enforcement.

When Sarbanes-Oxley was passed in 2002 in response to a number of major accounting scandals, including those at Enron and Tyco, it established new and enhanced standards for all U.S. company boards, management, and public accounting firms. Some consider Sarbanes-Oxley the most significant change to federal securities laws since the spate of new securities laws passed in the 1930s.

According to the Commission’s complaint, the troubles at Doral began when the company improperly accounted for the amount it received from selling bulk packages of mortgage loans it originated for other Puerto Rican financial institutions.

At first glance, Doral’s accounting policy seemed sound. The company obtained two valuations from third parties and compared them to its own, recording the lowest of the three in their consolidated financial statement. But the Commission found several problems with the way Doral put this policy into practice. Doral’s former treasurer and director emeritus allegedly influenced the third party valuations to obtain results higher or similar to its internal figure by feeding them misleading information.

Doral also improperly recognized a gain on sales of approximately $3.9 billion in mortgages to FirstBank Puerto Rico alone. These were not true sales under generally accepted accounting standards because of oral agreements or understandings between Doral’s former treasurer, its former director emeritus and FirstBank’s senior management.

Finally, the Commission alleged that Doral managed earnings through a series of contemporaneous purchase and sale transactions to and from other Puerto Rican financial institutions totaling approximately $847 million.

Doral completed a financial restatement in February 2006. According to that account, between 2000 and 2004 the company overstated its gains by between 24% and 65%.

The SEC, whose investigation of Doral is ongoing, acknowledged the assistance of the U.S. Attorney's Office, the Federal Bureau of Investigation, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Company.

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