U.S. Securities and Exchange Commission
Litigation Release No. 18905 / September 28, 2004
Accounting and Auditing Enforcement Release No. 2112 / September 28, 2004
SECURITIES AND EXCHANGE COMMISSION v. JEREMY R. LENT, JOHN V. HASHMAN, YINZI CAI, DOUGLAS WACHTEL and BRUCE RIGIONE, United States District Court for the Northern District of California, Civil Action No. C-04-4088 FMS
SEC BRINGS FRAUD AND INSIDER TRADING CHARGES AGAINST FORMER TOP EXECUTIVES OF NEXTCARD, INC.
On September 28, 2004, the Securities and Exchange Commission filed securities fraud charges against the former Chairman, Chief Executive Officer ("CEO") and three other senior officers of NextCard, Inc., a San Francisco, California-based credit card issuer. NextCard, which is now in bankruptcy, was the first major credit card issuer to offer cards exclusively over the Internet.
According to the Commission's complaint, beginning in at least November 2000, NextCard began to suffer higher than expected delinquencies and losses on its credit card loans-a reflection of customers paying their credit card bills late or not paying them at all. Instead of revealing these problems to investors, NextCard's senior officers made a series of undisclosed, after-the-quarter accounting adjustments on NextCard's books. The adjustments - which NextCard's then-CEO described in his own handwritten notes as "accounting gimmickry" - made it appear that NextCard's customers were paying their bills in a timely fashion, a key indicator of the financial health of a credit card issuer.
In fact, NextCard's business model of issuing credit cards over the Internet resulted in NextCard issuing cards to many customers with relatively poor credit who could not pay back their credit card loans in a timely fashion and, in many instances, not at all. Instead of accounting for these as bad loans and writing them off as uncollectible, as NextCard had done in previous quarters, NextCard simply reclassified many of these accounts as "fraudulent accounts," which were not separately reported to the public, and then failed to tell anyone. Thus, defendants led stock analysts and investors to believe falsely that NextCard was meeting its projections and that its late-paying and uncollectible loans were rising only moderately, when in fact they were escalating rapidly.
The Commission's complaint charges the following former NextCard officers with financial fraud: former Chairman Jeremy Lent of Holualoa, Hawaii; former CEO, John Hashman of Danville, Calif.; former President and Chief Operating Officer Yinzi Cai of Palo Alto, Calif.; former Controller, Douglas Wachtel of San Francisco, Calif.; and former Chief Financial Officer, Bruce Rigione of New Canaan, Conn. The complaint, which was filed in federal district court in San Francisco, also charges Lent, Hashman, Cai and Wachtel with insider trading, based on their sale of NextCard stock at inflated prices during the course of the fraud. Lent sold approximately $7 million worth of NextCard stock, Hashman sold $321,000, Cai sold $423,000 and Wachtel sold $105,000. Lent's stock sales were carried out through the Lent Family Trust, which is also named in the complaint as a relief defendant.
The complaint alleges that NextCard failed to disclose to investors reclassifications or changes in its accounting methodology for late paying and uncollectible loans in its earnings releases and periodic reports for the fourth quarter of the 2000 fiscal year and the first and second quarters of 2001. In addition, the complaint alleges that for the second quarter of 2001 NextCard changed its methodology for calculating reserves for its uncollectible loans. This change reduced the amount of reserves the company had to set aside to cover expected losses on its loans by 15% to 25%, and artificially inflated the company's reported net income for the second quarter of 2001.
According to the complaint, in October 2001 the Office of the Comptroller of the Currency ("OCC"), which regulated NextCard's subsidiary, NextBank, required NextCard to reverse the reclassifications and changes in accounting methodology. On October 31, 2001, NextCard issued a press release stating that it was changing its accounting for uncollectible loans and that the OCC considered NextBank to be significantly undercapitalized. NextCard's stock price fell 84% that day, and the company went into bankruptcy the following year.
The Commission's complaint charges the defendants with committing and aiding and abetting fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and Rule 10b-5 thereunder, as well as aiding and abetting NextCard's violations of the same statue. The complaint also charges Lent, Hashman, Rigione and Wachtel with aiding and abetting NextCard's violations of the reporting provisions of the Exchanges Act, Section 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. Further, Lent, Hashman, Cai and Wachtel are charged in the complaint for violations of Section 17(a) of the Securities Act of 1933 ("Securities Act") and for insider trading in violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The complaint also charges Lent, Hashman and Cai as control persons for NextCard's violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Hashman and Lent as control persons for NextCard's violations of Section 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
This is the second action brought by the Commission as a result of the financial fraud at NextCard. In September 2003, the Commission charged three former employees of NextCard's independent auditors, Ernst and Young ("E&Y"), for altering and destroying E&Y's working papers for the fiscal year 2000 audit of E&Y client NextCard, Inc.
The Commission acknowledges the assistance and cooperation of the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.