PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 425 Lexington Avenue, 30th Floor New York, New York 10017
September 25, 2023
MEMORANDUM
TO: Howard Quinn, Partner
FROM: Victoria Chambers, Partner
CC: Jasmine Thornton, Lead Associate; Liam Donahue, Working Associate
RE: Initial Assessment — SEC Division of Enforcement Voluntary Request Letter, File No. HO-14287; Belmont Ridge Bank National Association
MATTER NO.: SC-MAT-2023-4172
THIS MEMORANDUM IS A PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION AND ATTORNEY WORK PRODUCT. IT IS PREPARED IN ANTICIPATION OF LITIGATION AND FOR THE PURPOSE OF PROVIDING LEGAL ADVICE TO BELMONT RIDGE BANK NATIONAL ASSOCIATION. IT SHOULD NOT BE DISCLOSED TO ANY PERSON OTHER THAN THOSE PERSONS WHO NEED TO KNOW ITS CONTENTS FOR THE PURPOSE OF OBTAINING OR PROVIDING LEGAL ADVICE IN CONNECTION WITH THE MATTERS DISCUSSED HEREIN.
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I. EXECUTIVE SUMMARY
Calderwood & Harkness LLP ("C&H" or the "Firm") was engaged on September 20, 2023, by Belmont Ridge Bank National Association ("BRB" or the "Bank"), a Nasdaq-listed (ticker: BRDG) national banking association (OCC Charter No. 24891) headquartered at 200 Park Avenue South, 38th Floor, New York, New York 10003, in connection with an inquiry by the Division of Enforcement of the United States Securities and Exchange Commission (the "SEC" or the "Commission"). The engagement is governed by the terms of the engagement letter executed between C&H and BRB, dated September 20, 2023.
On September 18, 2023, BRB received a voluntary request letter (the "Voluntary Request Letter" or the "VRL") from the SEC Division of Enforcement, Home Office (Washington, D.C.), assigned File No. HO-14287. The VRL was initially directed to BRB's regular outside securities counsel, Caldwell Pratt & Stein LLP ("CPS"), with lead partner Martin Caldwell receiving the letter at CPS's offices at 51 West 52nd Street, 24th Floor, New York, New York 10019. Upon receipt, Mr. Caldwell promptly notified BRB General Counsel and Chief Legal Officer Derek Sung, who in turn contacted C&H regarding potential retention for investigation defense purposes.
The Voluntary Request Letter focuses on BRB's public disclosures regarding its allowance for credit losses ("ACL") related to its digital consumer lending platform, "BridgeFin." Specifically, the SEC Staff's inquiry appears to center on whether BRB's fiscal year 2022 Annual Report on Form 10-K (filed with the Commission on February 28, 2023) and its Quarterly Reports on Forms 10-Q for the first quarter of 2023 (filed May 10, 2023) and the second quarter of 2023 (filed August 9, 2023) materially understated expected credit losses in the BridgeFin consumer fintech loan portfolio, thereby rendering BRB's periodic filings materially inaccurate or misleading.
The VRL identifies Senior Staff Attorney Andrea Felton and Staff Attorney Christopher Yuen as the primary SEC contacts for the matter. Staff Accountant Diane Milosevic is also listed as assigned to the inquiry. The matter is supervised by Branch Chief Renata Moss and Assistant Director Gregory Bonham of the Division of Enforcement's Financial Fraud Unit. The assignment of this matter to the Financial Fraud Unit is noteworthy, as discussed in greater detail in Section III.C below, and signals the potential seriousness with which the Staff is approaching the inquiry.
This memorandum is prepared for the purpose of providing an initial assessment of the SEC's inquiry and to outline a recommended course of action. The memorandum sets forth: (a) background on BRB and BridgeFin; (b) an analysis of the Voluntary Request Letter's scope and demands; (c) potential enforcement theories the Staff may be considering; (d) key factual and accounting issues that will likely form the substantive core of the investigation; (e) materiality considerations relevant to both the potential liability exposure and the defense posture; and (f) a preliminary defense strategy and recommended immediate next steps to protect BRB's interests and position the Bank favorably as the investigation progresses.
As discussed in detail herein, our preliminary assessment is that the SEC's inquiry presents a significant but manageable regulatory risk. The core issue — the treatment of re-aged and modified loans within BRB's Current Expected Credit Loss ("CECL") model — involves a judgment-based accounting estimate where reasonable disagreement among preparers, auditors, and regulators is not uncommon. BRB's institutional posture, including the unqualified audit opinion issued by Whitfield Keane LLP, the Bank's satisfactory OCC examination rating, and its established CECL governance framework, provides a solid foundation for a vigorous defense. Nonetheless, the matter requires prompt and careful attention to cooperation, privilege preservation, internal fact-gathering, and strategic engagement with the SEC Staff.
II. BACKGROUND ON BELMONT RIDGE BANK NA AND BRIDGEFIN
A. BRB Corporate Overview
Belmont Ridge Bank National Association is a national banking association organized and existing under the laws of the United States, chartered by the Office of the Comptroller of the Currency ("OCC") under Charter No. 24891. The Bank's principal executive offices are located at 200 Park Avenue South, 38th Floor, New York, New York 10003. BRB's common stock is publicly traded on the Nasdaq Stock Market under the ticker symbol "BRDG." As of September 2023, the Bank's market capitalization is approximately $4.7 billion, making it a mid-cap publicly traded financial institution subject to the full panoply of SEC reporting requirements applicable to issuers with securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
BRB's senior management team includes the following key officers who are relevant to this inquiry:
• Chief Executive Officer: Marcus R. Ellingham
• Chief Financial Officer: Patricia "Trish" Navarrete
• General Counsel and Chief Legal Officer: Derek Sung
• Chief Risk Officer: Annette Kowalski
• Chief Accounting Officer: Raymond Hu
• Audit Committee Chair (Independent Director): Gwendolyn Prescott
BRB adopted the Current Expected Credit Loss standard (Accounting Standards Codification Topic 326, "ASC 326" or "CECL") effective January 1, 2020, in accordance with the transition guidance provided by the Financial Accounting Standards Board ("FASB") and applicable regulatory directives from the OCC and federal banking regulators. The Bank's adoption of CECL represented a significant shift from the prior "incurred loss" model to a forward-looking "expected credit loss" model, requiring management to estimate the lifetime expected credit losses on financial assets measured at amortized cost at each reporting date.
BRB's key financial highlights for fiscal year 2022, as reported in the Bank's Form 10-K filed February 28, 2023, are as follows:
BRB's most recent OCC examination rating, as of September 2023, is Satisfactory, with a composite CAMELS rating of 2. This is a significant data point for the defense, as it indicates that the Bank's primary federal banking regulator has not identified safety and soundness concerns that would be consistent with a fundamentally flawed credit loss estimation methodology.
The Bank's transfer agent is Pinnacle Trust Company NA, located at 6201 15th Avenue, Brooklyn, New York 11219. BRB's independent registered public accounting firm is Whitfield Keane LLP ("WK"), PCAOB Registration No. 2847, with its engagement partner being Lorraine Dupont. Whitfield Keane's offices are located at 600 Third Avenue, 22nd Floor, New York, New York 10016. WK audited BRB's consolidated financial statements for fiscal years 2021 and 2022 and issued unqualified opinions on the financial statements for both years, including an unqualified opinion on the effectiveness of internal control over financial reporting as of December 31, 2022. WK's concurrence with BRB's ACL methodology and estimates will be an important element of the Bank's defense posture, as discussed further below.
B. BridgeFin Division
BridgeFin is not a separate legal entity. Rather, it operates as an internal division of BRB, housed within the Bank's broader consumer and small-business lending operations. BridgeFin is headed by Naveen Chakravarti, who holds the title of Senior Vice President and Division Head. Mr. Chakravarti reports to BRB's Chief Risk Officer, Annette Kowalski, with a dotted-line reporting relationship to the Chief Financial Officer, Patricia Navarrete, on matters relating to financial reporting and loss reserving for the BridgeFin portfolio.
BridgeFin was launched in the third quarter of 2020, at a time when demand for digital lending solutions was accelerating due to the broader shift toward online financial services precipitated, in part, by the COVID-19 pandemic. The division originates two principal categories of credit products:
1. Unsecured Personal Loans: Consumer installment loans originated through BridgeFin's mobile application and web platform, with an average loan size of approximately $18,400. These loans are typically extended to borrowers with near-prime to prime credit profiles, with stated terms generally ranging from 24 to 60 months.
2. Small-Business Microloans: Working capital and small-business purpose loans originated to sole proprietors and small businesses, with an average loan size of approximately $42,000. These microloans are generally underwritten using a combination of traditional financial statement analysis and BridgeFin's proprietary AI-driven underwriting model, with terms generally ranging from 12 to 36 months.
BridgeFin's principal competitive differentiator is its proprietary artificial intelligence-driven underwriting model, which utilizes machine learning algorithms trained on both traditional credit bureau data and alternative data sources to evaluate borrower creditworthiness and assign risk scores. The novelty and relative opacity of this AI-driven model is a factor that may increase the SEC Staff's scrutiny, given heightened regulatory and investor interest in the accuracy and reliability of AI-based financial decision-making systems.
For fiscal year 2022, BridgeFin reported the following key origination and portfolio metrics:
The BridgeFin portfolio thus represented approximately 10.7% of BRB's total assets as of December 31, 2022, and the division had experienced rapid growth since its launch — approximately $4.1 billion in outstanding loans accumulated over roughly two and a half years of operation. This rapid growth trajectory, combined with the use of novel AI-driven underwriting technology, are factors that likely attracted the Staff's attention and will require careful analysis throughout the investigation.
C. Prior Securities Counsel Involvement
The Forms 10-K and 10-Q at issue in the SEC's inquiry were prepared and reviewed by Caldwell Pratt & Stein LLP, BRB's regular outside securities reporting counsel. The CPS engagement has been led by Martin Caldwell, a partner at the firm, whose offices are located at 51 West 52nd Street, 24th Floor, New York, New York 10019. CPS has served as BRB's primary securities reporting counsel for approximately six years, during which time the firm has been responsible for advising on the preparation, review, and filing of BRB's periodic reports with the Commission, including the Forms 10-K and 10-Q that are the subject of the current inquiry.
As noted above, CPS initially received the SEC's Voluntary Request Letter before Calderwood & Harkness was retained for the investigation defense. It was CPS that communicated the receipt of the VRL to BRB General Counsel Derek Sung, and it was at that point that the decision was made to retain separate counsel for the investigation defense.
The involvement of CPS in the preparation and review of the disclosures now under scrutiny raises several important considerations. First, there is a potential need to assess CPS's involvement in the disclosures, including any advice rendered regarding ACL-related disclosures and the language used in the Management's Discussion and Analysis ("MD&A") sections of the periodic reports. The MD&A discussion of BridgeFin credit quality trends and ACL methodology will be a focal point of the Staff's review, and understanding what advice CPS provided — and what information was available to CPS at the time the disclosures were prepared — will be essential to constructing a complete factual record.
Second, we must be mindful of privilege and potential conflicts in our assessment of CPS's role. CPS's advice to BRB regarding the disclosures is protected by the attorney-client privilege, and that privilege belongs to BRB. However, to the extent that CPS's advice or involvement becomes a relevant issue in the investigation, careful management of the privilege will be required. We recommend that the delineation of roles between CPS (as securities reporting counsel) and C&H (as investigation defense counsel) be clearly established and communicated to all relevant parties, including BRB's management and board, to avoid any confusion or inadvertent waiver of privilege.
Third, the potential for conflicts of interest must be monitored. If the Staff were to focus on whether CPS's advice regarding the ACL disclosures was adequate, the interests of CPS and BRB could potentially diverge. At this stage, we do not believe such a conflict exists, but the issue should be revisited as the investigation progresses and additional facts come to light.
III. ANALYSIS OF THE VOLUNTARY REQUEST LETTER
A. Scope and Specific Document Requests
The Voluntary Request Letter sets forth approximately fifteen (15) categories of documents and information that the SEC Staff has requested from BRB. These categories are broad in scope and collectively encompass the full spectrum of documentation that would be relevant to an evaluation of BRB's ACL methodology, the accuracy of its credit loss estimates, and the adequacy of its public disclosures regarding the BridgeFin loan portfolio. The principal categories of requested documents include the following:
1. CECL Model Documentation: All documentation relating to BRB's CECL model for the BridgeFin loan portfolio, including the model's design specifications, assumptions, inputs, and outputs, as well as all model validation reports and model risk management assessments conducted during the relevant period.
2. ACL Calculation Workpapers: All workpapers, spreadsheets, memoranda, and supporting documentation relating to the calculation of BRB's allowance for credit losses for the BridgeFin portfolio for fiscal year 2022 and the first and second quarters of fiscal year 2023, including all quantitative analyses, qualitative factor assessments, and management overlay adjustments.
3. BridgeFin Loan-Level Data: Comprehensive loan-level data for the BridgeFin portfolio, including vintage cohort performance data, delinquency aging schedules, modification histories, re-aging records, and information regarding BRB's policies and procedures for the modification and re-aging of delinquent loans within the BridgeFin portfolio.
4. Internal Credit Risk Committee Materials: All minutes, agendas, presentations, reports, and supporting materials from meetings of BRB's internal credit risk committee (or any similarly constituted body with oversight responsibility for credit risk in the BridgeFin portfolio) during the relevant period.
5. Communications with Auditor Regarding ACL: All communications — whether oral or written — between BRB management and Whitfield Keane LLP regarding the Bank's ACL estimates, CECL methodology, credit loss assumptions, and related accounting judgments for the BridgeFin portfolio during the relevant period, including but not limited to management representation letters, audit inquiry response letters, and any communications regarding disagreements or proposed adjustments.
6. Board and Audit Committee Materials: All board of directors and Audit Committee minutes, agendas, presentations, and reports relating to credit risk, credit quality trends, and the allowance for credit losses for the BridgeFin portfolio during the relevant period.
7. SOX Certification Packages: All sub-certification packages and supporting documentation prepared in connection with the Sarbanes-Oxley Act Section 302 and Section 906 certifications executed by BRB's CEO and CFO for the FY 2022 Form 10-K and the Q1 and Q2 2023 Forms 10-Q, including any questionnaires, checklists, and disclosure committee materials.
8. OCC Communications: All communications with the Office of the Comptroller of the Currency regarding BridgeFin credit quality, the BridgeFin loan portfolio, or BRB's allowance for credit losses for BridgeFin during the relevant period, including OCC examination reports, matters requiring attention ("MRAs"), and related correspondence.
The remaining categories encompass additional supporting documentation, including organizational charts for relevant functions, policies and procedures manuals, internal audit reports, and communications among senior management regarding BridgeFin credit performance trends. The breadth of these requests is consistent with a thorough preliminary inquiry into the adequacy of BRB's ACL disclosures and the reliability of the underlying accounting estimates.
The time period covered by the Voluntary Request Letter extends from January 1, 2021 through August 31, 2023 — a period of approximately thirty-two months. This time frame captures the full period during which the BridgeFin portfolio experienced its most significant growth and, presumably, the period during which the credit quality trends that have attracted the Staff's attention first emerged.
Based on the scope of the document requests and the custodians implicitly targeted by the categories of requested materials, the key individuals whose files and communications are likely to be most responsive to the VRL include:
• Patricia "Trish" Navarrete, Chief Financial Officer
• Raymond Hu, Chief Accounting Officer
• Annette Kowalski, Chief Risk Officer
• Naveen Chakravarti, Senior Vice President & BridgeFin Division Head
• Personnel within BRB's credit risk management function
• Personnel within BRB's model risk management function
• Personnel within BRB's financial reporting and SEC reporting functions
In addition, documents from BRB's internal audit function, its disclosure committee, and the Audit Committee of the Board of Directors will be responsive to several categories of the VRL.
B. Voluntary vs. Compulsory Process
It is important to note at the outset that the Voluntary Request Letter is precisely what its name implies — a voluntary request for information. It is not a subpoena. BRB is not legally compelled to produce any documents or information in response to the VRL, and the Bank's failure to respond would not, in itself, constitute a violation of law or give rise to any legal liability.
However, the practical consequences of non-cooperation or partial cooperation at the voluntary stage are well understood in SEC enforcement practice. A decision not to cooperate with a voluntary request would almost certainly lead the Staff to seek authorization from the Commission for a Formal Order of Investigation under Section 21(a) of the Exchange Act, which would empower the Staff to issue compulsory subpoenas for documents and testimony. Importantly, the Voluntary Request Letter itself explicitly preserves the Staff's right to seek a formal order of investigation and to issue compulsory process if circumstances warrant.
Moreover, a company's cooperation posture at the voluntary stage often shapes the Staff's perception of the company and its management, and can have a significant influence on the ultimate outcome of the investigation. Companies that cooperate fully and promptly at the voluntary stage are more likely to receive favorable treatment in the Staff's exercise of its prosecutorial discretion, including the possibility that the Staff may ultimately close the investigation without recommending an enforcement action. Conversely, a refusal to cooperate or perceived obstruction can harden the Staff's position and increase the likelihood of a formal investigation and, ultimately, an enforcement action.
For these reasons, our recommendation is that BRB cooperate fully with the Staff's voluntary request while preserving all applicable privileges. Full cooperation does not mean waiver of privilege. BRB is entitled to withhold privileged documents from production, and we will establish a comprehensive privilege review protocol to ensure that attorney-client privileged communications and attorney work product are identified and protected throughout the document production process.
C. Significance of Assignment to the Financial Fraud Unit
The Voluntary Request Letter indicates that the investigation is being supervised by Branch Chief Renata Moss and Assistant Director Gregory Bonham, both of the Division of Enforcement's Financial Fraud Unit ("FFU"). The FFU is one of the Division's specialized units and is responsible for investigating potential fraud and disclosure violations by issuers, including financial reporting fraud, accounting manipulation, and material misstatements in periodic filings.
The involvement of the FFU is a significant procedural signal. It suggests that the Staff is evaluating potential accounting-fraud theories or, at a minimum, is taking the matter seriously enough to assign it to a unit with expertise in complex financial reporting investigations. It is important to note, however, that the Voluntary Request Letter itself does not allege fraud and references only the reporting provisions of the securities laws. The VRL's language is neutral and consistent with a preliminary inquiry, not an accusation of intentional misconduct.
It is also the case that assignment of financial institution disclosure matters to the FFU may be routine, particularly where the subject matter involves complex accounting estimates such as credit loss reserves. The FFU has the institutional expertise to evaluate CECL-related issues, and its involvement does not necessarily indicate that the Staff has reached any preliminary conclusions about the existence of fraudulent intent.
Nonetheless, the FFU assignment warrants careful monitoring. Throughout the investigation, we should be attentive to any indications that the Staff's theory is evolving from a strict-liability reporting case toward a scienter-based fraud theory, and we should adjust our defense strategy accordingly.
IV. POTENTIAL ENFORCEMENT THEORIES
Based on our analysis of the Voluntary Request Letter and the scope of the Staff's inquiry, the following are the principal enforcement theories that the SEC Staff may be evaluating. We address each in turn, including an assessment of the elements of each potential claim and the likely factual predicates the Staff would need to establish.
A. Section 13(a) of the Securities Exchange Act of 1934 — Periodic Reporting
Section 13(a) of the Exchange Act, 15 U.S.C. § 78m(a), requires every issuer of a security registered pursuant to Section 12 of the Exchange Act to file with the Commission such periodic reports as the Commission shall prescribe by rule. BRB's common stock is registered under Section 12(b) of the Exchange Act by virtue of its listing on the Nasdaq Stock Market, and BRB is therefore subject to the periodic reporting requirements of Section 13(a).
Rule 13a-1 under the Exchange Act, 17 C.F.R. § 240.13a-1, requires issuers to file annual reports on Form 10-K. Rule 13a-13, 17 C.F.R. § 240.13a-13, requires issuers to file quarterly reports on Form 10-Q. The filings potentially at issue in this investigation include:
• BRB's Annual Report on Form 10-K for fiscal year ended December 31, 2022, filed with the Commission on February 28, 2023;
• BRB's Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, filed with the Commission on May 10, 2023; and
• BRB's Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, filed with the Commission on August 9, 2023.
In addition, Rule 12b-20 under the Exchange Act, 17 C.F.R. § 240.12b-20, requires that, in addition to the information expressly required to be included in a statement or report, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.
The Staff's theory under Section 13(a) and Rules 13a-1, 13a-13, and 12b-20 would be that BRB's periodic filings contained materially inaccurate financial statements — specifically, that BRB's reported ACL of $143.5 million (representing a 3.50% coverage ratio on the $4.1 billion BridgeFin outstanding loan portfolio) materially understated expected credit losses, thereby rendering the consolidated financial statements included in the periodic filings materially inaccurate. The Staff may also contend that the MD&A discussion of BridgeFin credit quality trends and the ACL methodology did not provide investors with adequate information to understand the risks associated with the portfolio.
Critically, Section 13(a) and Rule 13a-1 are strict-liability provisions. The Commission need not prove that BRB or any of its officers acted with scienter — i.e., with knowledge of or reckless disregard for the falsity of the filings. The sole question is whether the periodic reports were materially inaccurate or misleading. This significantly lowers the evidentiary burden the Staff must meet to recommend an enforcement action under these provisions, and it is the most likely theory under which the Staff would proceed if it determines that the ACL was materially understated.
The strict-liability nature of Section 13(a), however, also affects the range of potential remedies and sanctions. A cease-and-desist order under Section 21C of the Exchange Act based solely on a Section 13(a) violation — without an accompanying fraud charge — represents a less severe outcome than a fraud-based action and is more commonly resolved through administrative settlement. This distinction is relevant to our defense strategy and settlement posture.
B. Section 13(b)(2)(A) — Books and Records
Section 13(b)(2)(A) of the Exchange Act, 15 U.S.C. § 78m(b)(2)(A), requires every issuer with securities registered pursuant to Section 12 to "make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer."
The Staff could contend that BRB's internal ACL calculations and supporting workpapers — the "books, records, and accounts" maintained by the Bank — did not accurately and fairly reflect the credit losses expected in the BridgeFin portfolio. In particular, the Staff's theory would likely focus on the treatment of the 12,847 re-aged or modified BridgeFin loans within BRB's ACL calculation workpapers. The Staff may argue that by treating these loans as "current" after modification and resetting their delinquency clocks for loss-rate estimation purposes, BRB's internal records did not accurately reflect the true credit risk profile of the portfolio.
Like Section 13(a), Section 13(b)(2)(A) is a strict-liability provision that does not require proof of scienter. The question is simply whether BRB's books and records were maintained in a manner that "in reasonable detail, accurately and fairly reflect[s]" the relevant transactions and asset dispositions. The "in reasonable detail" qualifier is significant — it provides some flexibility and acknowledges that absolute precision is not required. However, the Staff may argue that the gap between BRB's reported ACL and a properly calculated ACL was sufficiently large to exceed the bounds of reasonable detail.
A Section 13(b)(2)(A) charge is frequently paired with a Section 13(a) reporting charge in SEC enforcement actions involving financial reporting deficiencies, and we should anticipate that the Staff may pursue both theories in tandem.
C. Potential (but Less Likely) Scienter-Based Theories
The most serious potential theories the Staff could pursue would be antifraud charges under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5, or Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a). These provisions prohibit the making of material misstatements or omissions in connection with the purchase or sale of securities and require proof of scienter — that is, an intent to deceive, manipulate, or defraud, or, at a minimum, conduct that constitutes a severe departure from the standards of ordinary care (i.e., recklessness).
Based on our review of the Voluntary Request Letter and our preliminary discussions with BRB General Counsel Derek Sung, there is no current indication that the Staff is pursuing a fraud-based theory. The VRL does not allege fraud, does not reference the antifraud provisions of the securities laws, and does not contain the type of inflammatory or accusatory language that sometimes appears in requests associated with fraud investigations. Moreover, the VRL is a voluntary request rather than a subpoena issued pursuant to a formal order of investigation, which further suggests that the inquiry is at a preliminary stage and has not yet crystallized into a fraud investigation.
However, the Financial Fraud Unit assignment means that the possibility of a scienter-based theory cannot be ruled out. If the Staff were to uncover evidence suggesting that BRB officers were aware that the ACL was understated and deliberately chose not to correct it — or that they disregarded clear red flags indicating the inadequacy of the reserve — the Staff could escalate the matter to an antifraud theory. Such a theory would expose BRB and potentially its individual officers to significantly greater liability, including potential monetary penalties, officer-and-director bars, and disgorgement.
The key question for assessing the likelihood of a scienter-based theory is whether there is any evidence that BRB officers possessed contemporaneous knowledge that the ACL was materially understated and made a conscious decision not to adjust it. Based on our preliminary assessment, drawn from initial discussions with Mr. Sung, there is no indication of deliberate misconduct. BRB management appears to have relied in good faith on the Bank's CECL model, the judgment of its accounting professionals (including CAO Raymond Hu and his financial reporting team), and the concurrence of its independent auditor, Whitfield Keane LLP, which audited the BridgeFin ACL and issued an unqualified opinion on BRB's FY 2022 financial statements.
This preliminary assessment will need to be validated through the internal fact-gathering process described in Section VII.D below, including Upjohn-warned interviews of key personnel and a thorough review of internal communications. Any communications suggesting awareness of credit quality deterioration that was not reflected in the ACL, or disagreements among management regarding the adequacy of the reserve, would be critically important to our assessment of scienter risk.
V. KEY FACTUAL AND ACCOUNTING ISSUES
A. The ACL Dispute — BRB's Reported Figures vs. SEC Staff's Likely Concerns
The substantive core of the SEC's inquiry is the adequacy of BRB's allowance for credit losses for the BridgeFin loan portfolio. As reported in BRB's FY 2022 Form 10-K, the key credit quality and loss reserve metrics for BridgeFin were as follows:
We anticipate that the SEC Staff will scrutinize whether these figures adequately incorporated deteriorating credit quality metrics that were observable during the relevant period. In particular, the Staff is likely to focus on the following:
Rising Delinquency Rates in Later Vintages. Loan vintages originated after Q2 2021 appear to have experienced elevated delinquency rates relative to earlier BridgeFin vintages. To the extent that this deterioration in vintage performance was observable during the period in which the FY 2022 ACL was being estimated (i.e., during Q4 2022), the Staff may argue that BRB's CECL model failed to adequately incorporate this information into its loss projections.
Increased Charge-Offs. Similarly, if the charge-off experience on later-vintage BridgeFin loans was trending upward during the relevant period, the Staff may contend that BRB's reported net charge-off rate of 2.14% did not fully capture the portfolio's evolving loss profile.
Adequacy of Qualitative Factors and Management Overlays. Under CECL, management is expected to consider qualitative factors — including changes in lending policies, changes in economic conditions, and other relevant factors — in addition to the quantitative output of the loss estimation model. The Staff may examine whether BRB's qualitative factor assessments and any management overlays were sufficient to address the credit quality trends described above.
Based on preliminary internal analysis conducted at our direction, a plausible Staff position regarding the "correct" ACL for the BridgeFin portfolio could be approximately $180.8 million, representing a coverage ratio of approximately 4.41% on the $4.1 billion outstanding portfolio. This would imply a potential understatement of approximately $37.3 million (the difference between $180.8 million and the reported $143.5 million). This figure is preliminary and subject to revision as our forensic accounting analysis progresses, but it provides a useful working assumption for purposes of assessing materiality and potential liability exposure.
B. The Re-Aging / Loan Modification Issue
We believe that the central factual dispute in this investigation will be BRB's treatment of re-aged and modified BridgeFin loans within its CECL model. This issue goes to the heart of the ACL calculation and is likely the primary driver of the gap between BRB's reported ACL and the higher figure the Staff may assert.
Specifically, BRB's CECL model treated 12,847 re-aged or modified BridgeFin loans with an aggregate outstanding balance of $236.4 million as "current" after modification, effectively resetting the delinquency clocks on these loans for purposes of vintage cohort loss-rate estimation. Under this treatment, a loan that was 60 or 90 days past due prior to modification would, upon modification, be reclassified as a current loan and assigned to a new vintage for loss estimation purposes. This treatment resulted in the re-aged loans being attributed a lower estimated loss rate than they would have received had they remained in their original vintage delinquency buckets.
The impact of this treatment on BRB's reported credit quality metrics is significant. If the 12,847 re-aged or modified loans were instead kept in their original vintage delinquency buckets for loss-rate estimation purposes — i.e., if the pre-modification delinquency status were preserved rather than reset — the effect on key portfolio metrics would be as follows:
These adjusted figures represent a materially different picture of the BridgeFin portfolio's credit quality, and they form the basis for the higher ACL estimate that the Staff is likely to assert.
The question of whether BRB's re-aging treatment was appropriate is a complex one that involves the intersection of accounting standards (ASC 326), regulatory guidance (including OCC Handbook guidance on the treatment of troubled-debt restructurings and loan modifications), and industry practice. Under CECL, the standard does not prescribe a single methodology for estimating expected credit losses, and preparers are afforded significant judgment in selecting their loss estimation approach. However, any methodology must produce a reasonable and supportable estimate of lifetime expected credit losses, and the treatment of modified loans must be consistent with the economic substance of the modifications.
We recommend a detailed analysis of this issue by forensic accounting consultants, and specifically recommend engaging Brindoval Analytic Partners LLC for this purpose, as discussed in Section VII.C below. The key deliverables from Brindoval should include:
(i) An independent analysis of the re-aging treatment's impact on BRB's ACL estimates;
(ii) A comparison of BRB's re-aging practices to those of peer institutions with comparable digital lending portfolios;
(iii) An assessment of the consistency of BRB's treatment with applicable accounting standards and OCC regulatory guidance; and
(iv) An evaluation of whether BRB's disclosed policies and procedures regarding loan modifications and re-aging were followed consistently during the relevant period.
C. BRB's CECL Model Governance
Understanding the governance framework surrounding BRB's CECL model will be critical to the defense. As noted above, BRB adopted CECL effective January 1, 2020. The Bank's CECL model for the BridgeFin portfolio employs a vintage-cohort approach with qualitative overlays, which is a widely accepted methodology among financial institutions for estimating lifetime expected credit losses on consumer and small-business loan portfolios.
Under this approach, loans are grouped by vintage (i.e., by the quarter or year of origination), and historical loss experience for each vintage is used to project lifetime expected losses. Qualitative overlays are then applied to adjust the quantitative output for factors that the model may not fully capture, such as changes in economic conditions, changes in underwriting standards, or portfolio-specific risk factors.
Several aspects of BRB's CECL model governance will be particularly important to the investigation:
Model Validation History. We need to obtain and review all model validation reports for the BridgeFin CECL model conducted during the relevant period. Model validation is a critical control in the model risk management framework, and the findings of any model validation exercises — including any identified weaknesses, limitations, or recommendations for enhancement — will be closely scrutinized by the SEC Staff.
Internal Audit Findings. Any internal audit reports that address the BridgeFin ACL methodology, the re-aging treatment, or the adequacy of credit loss reserves will be responsive to the VRL and will be reviewed by the Staff. Favorable internal audit findings would support the defense; unfavorable findings could be used by the Staff to demonstrate that BRB was aware of potential issues with its methodology.
Model Risk Management Exceptions or Overrides. We need to determine whether any model risk management exceptions, overrides, or compensating controls were applied in connection with the BridgeFin CECL model during the relevant period. The existence of exceptions or overrides — or the absence thereof in circumstances where they might have been warranted — could be a significant issue.
Documentation of Management Judgments. CECL is an inherently judgment-based standard, and management's judgments in setting qualitative factors and overlays must be documented and supportable. We need to assess the quality and completeness of BRB's documentation of these judgments, particularly for the FY 2022 year-end ACL estimate and the Q1 and Q2 2023 interim estimates.
Communications among CFO Navarrete, CAO Hu, CRO Kowalski, and BridgeFin Division Head Chakravarti regarding credit deterioration trends in BridgeFin vintages will be especially critical. Any communications in which these individuals discussed concerns about rising delinquencies, the adequacy of the ACL, or the treatment of re-aged loans will be high-priority documents for both the Staff's review and our defense preparation. We should identify and review these communications at the earliest opportunity in the internal fact-gathering process.
D. Auditor's Role
Whitfield Keane LLP served as BRB's independent registered public accounting firm and audited BRB's FY 2022 consolidated financial statements, including the ACL for the BridgeFin portfolio. The engagement was led by partner Lorraine Dupont (WK PCAOB Registration No. 2847). WK issued an unqualified opinion on BRB's financial statements for FY 2022, indicating that, in WK's professional judgment, the financial statements presented fairly, in all material respects, the financial position of BRB in conformity with U.S. generally accepted accounting principles.
The fact that WK concurred with BRB's ACL methodology and estimates and issued an unqualified opinion is an important element of the defense. It demonstrates that an independent professional accounting firm, subject to PCAOB oversight and professional standards, reviewed BRB's CECL methodology and concluded that the resulting ACL was reasonable. While the SEC is not bound by an auditor's concurrence — and the Commission has pursued enforcement actions against issuers whose financial statements received unqualified audit opinions — the auditor's concurrence is a relevant consideration in assessing the reasonableness of BRB's estimates and the good faith of its management.
WK's audit workpapers regarding its evaluation of BRB's ACL methodology and the reasonableness of the BridgeFin reserve will be important background for our analysis. These workpapers would reveal, among other things, the extent to which WK independently evaluated the re-aging treatment, the assumptions underlying the vintage-cohort model, and the qualitative factors applied by management. However, WK's workpapers are subject to WK's own cooperation considerations and, potentially, its own privilege concerns, particularly if WK itself becomes a subject of regulatory scrutiny (e.g., a PCAOB inspection or investigation).
Whitfield Keane is separately represented by Hargrove & Millstein LLP (lead partner Samuel Hargrove), with offices at 1700 K Street NW, Suite 900, Washington, D.C. 20006. We should establish appropriate channels of communication with WK and H&M, to the extent permissible, to coordinate on matters of mutual interest while maintaining BRB's separate privilege and ensuring that BRB's defense is not compromised by any divergence of interests between BRB and its auditor.
It is worth noting that the SEC Staff may independently request WK's audit workpapers, either through a voluntary request to WK or through compulsory process. Under Section 106 of the Sarbanes-Oxley Act and PCAOB Rule 4006, the Commission has broad authority to access audit workpapers. WK's workpapers may therefore become part of the investigative record regardless of BRB's own production.
VI. MATERIALITY ANALYSIS
Materiality is the threshold question for any SEC enforcement action based on alleged misstatements in periodic filings. Under the Supreme Court's articulation in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), and Basic Inc. v. Levinson, 485 U.S. 224 (1988), a fact is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision. The SEC Staff has further elaborated on the application of materiality principles to financial statement misstatements in Staff Accounting Bulletin No. 99 ("SAB 99"), which provides that a registrant should evaluate both quantitative and qualitative factors in assessing whether a misstatement is material, and that a registrant may not rely exclusively on a numerical threshold to conclude that a misstatement is immaterial.
BRB's Internal Materiality Threshold. BRB has established an internal materiality threshold of 5% of pre-tax income for purposes of evaluating the significance of accounting misstatements and adjustments. This threshold is commonly used in the financial services industry and is consistent with long-standing auditing conventions, though as SAB 99 makes clear, it is not dispositive.
Quantitative Analysis. Applying the 5% threshold to BRB's FY 2022 financial results:
If the Staff's view of the ACL understatement is approximately $37.3 million, this figure exceeds BRB's internal materiality threshold by approximately $6.7 million, or roughly 6.1% of pre-tax income. On a purely quantitative basis, this suggests that the alleged understatement could be considered material under BRB's own internal framework.
However, materiality is a mixed question of law and fact, and the quantitative analysis must be considered in context. The $37.3 million figure, while exceeding the 5% of pre-tax income benchmark, represents a relatively modest percentage of other key financial metrics:
• As a percentage of shareholders' equity: $37.3 million / $4.03 billion = 0.91%
• As a percentage of total assets: $37.3 million / $38.2 billion = 0.10%
• As a percentage of pre-tax income: $37.3 million / $612 million = approximately 6.1%
The quantitative excess over the 5% threshold is relatively modest at $6.7 million, and the understatement's impact on BRB's balance sheet metrics (shareholders' equity and total assets) is negligible. This provides a basis for arguing that, on a purely quantitative basis, the alleged understatement falls within a zone where reasonable minds can differ as to its materiality.
Qualitative Materiality Factors. Under SAB 99, the analysis does not end with the quantitative assessment. Qualitative factors that could cause an otherwise numerically small misstatement to be considered material include, among others: (i) whether the misstatement masks a change in earnings or other trends; (ii) whether the misstatement hides a failure to meet analysts' consensus expectations; (iii) whether the misstatement involves an area of heightened investor sensitivity; and (iv) whether the misstatement concerns a segment or business unit that has been identified as playing a significant role in the issuer's operations or profitability.
Several qualitative factors weigh in favor of a finding of materiality in this case:
• BridgeFin as a New, High-Growth Business Line. BridgeFin is a relatively new division that has experienced rapid growth since its launch in Q3 2020. Investors and analysts have identified BridgeFin as a key driver of BRB's future growth, and any disclosure deficiency relating to this division may be viewed as qualitatively significant because it involves an area of heightened investor interest and attention.
• Fintech Lending as an Area of Market Sensitivity. The fintech lending space has attracted significant scrutiny from regulators, investors, and the media in recent years, particularly with respect to credit quality and underwriting standards. An alleged misstatement involving a fintech lending portfolio may be viewed as qualitatively material because of the broader market sensitivity to credit risk in this sector.
• AI-Driven Underwriting as a Novel Methodology. BridgeFin's use of AI-driven underwriting technology adds an element of novelty and potential opacity that may heighten investor concern about the reliability of credit loss estimates. To the extent that the alleged understatement relates to a model that investors cannot independently evaluate, the qualitative significance of the misstatement may be enhanced.
• Potential to Mask Credit Quality Deterioration. If the re-aging treatment had the effect of masking deteriorating credit quality trends in the BridgeFin portfolio — particularly rising delinquencies in later-originated vintages — the Staff may argue that the understatement was qualitatively material because it concealed a negative trend that would have been important to investors.
Defense Arguments on Materiality. Notwithstanding the foregoing, BRB has strong arguments on the materiality question. The core defense argument is that reasonable minds can differ on CECL estimates, and the difference between a 3.50% coverage ratio and a 4.41% coverage ratio represents a judgment-based range within which reasonable accounting professionals might arrive at different conclusions — not a clear accounting error or intentional manipulation.
Furthermore, the fact that Whitfield Keane LLP — an independent registered public accounting firm subject to PCAOB oversight — reviewed BRB's ACL methodology and concurred with the resulting estimate in issuing its unqualified audit opinion strongly supports the position that BRB's estimate was within the range of reasonable estimates. If the Bank's ACL were so clearly deficient as to be material, one would expect the auditor to have identified the issue and either required an adjustment or issued a qualified opinion.
Finally, the quantitative excess over the materiality threshold is relatively modest, and the impact on balance-sheet metrics is negligible. While qualitative factors may push toward a finding of materiality, the overall assessment is not clear-cut, and there is a reasonable basis for arguing that the alleged understatement, even if one accepts the Staff's higher ACL figure, does not rise to the level of a material misstatement.
VII. PRELIMINARY DEFENSE STRATEGY
A. Cooperation Posture
As discussed in Section III.B above, we recommend that BRB adopt a posture of full and proactive cooperation with the SEC Staff throughout this investigation. This recommendation is consistent with BRB's obligations as a publicly traded national bank, its institutional interest in maintaining a constructive relationship with its securities regulators, and the well-established principle that cooperation at the voluntary stage can significantly influence the ultimate outcome of an enforcement inquiry.
As an immediate step, we recommend that Calderwood & Harkness enter its appearance as counsel for BRB in this matter promptly. We will submit a formal appearance letter to Senior Staff Attorney Andrea Felton and Staff Attorney Christopher Yuen identifying C&H as BRB's investigation defense counsel and providing contact information for the undersigned and the C&H team assigned to the matter.
In connection with the appearance, we will request a meet-and-confer with the Staff to discuss the scope and timing expectations for BRB's response to the Voluntary Request Letter, the Staff's preferred production format (including any specifications for electronic document production), and any prioritization among the fifteen document categories. An early meet-and-confer serves multiple purposes: it demonstrates BRB's cooperative posture, it allows us to gain a better understanding of the Staff's focus areas and theories, and it provides an opportunity to begin building a constructive professional relationship with the assigned Staff attorneys.
Our target date for the initial response letter to the SEC is September 29, 2023. The initial response letter will acknowledge receipt of the VRL, confirm BRB's intent to cooperate, enter C&H's appearance, and propose a schedule for document production and the meet-and-confer.
B. Privilege Protection
The protection of BRB's legal privileges is paramount throughout this investigation. We recommend the following immediate actions:
Litigation Hold. We will prepare and issue a comprehensive litigation hold notice to be distributed to all BRB custodians whose documents may be responsive to the SEC's inquiry. The litigation hold will direct custodians to preserve all potentially relevant documents, whether in paper or electronic form, and to suspend any routine document destruction or retention schedule that might result in the loss of relevant materials. The litigation hold memorandum will be transmitted to BRB General Counsel Derek Sung for distribution to the identified custodians, and we will follow up to confirm receipt and compliance.
Privilege Protocol. We will develop a detailed privilege review protocol to be applied during the document collection and review process. The protocol will address the following categories of privilege:
• Attorney-Client Privilege: Communications between BRB and its counsel (both CPS and C&H) that are made for the purpose of seeking or providing legal advice are protected by the attorney-client privilege. These communications must be identified and withheld from production.
• Attorney Work Product: Documents and materials prepared by or at the direction of counsel in anticipation of litigation or regulatory proceedings are protected by the work product doctrine. This includes, among other things, memoranda, analyses, and communications prepared by C&H and, potentially, materials prepared at C&H's direction by forensic consultants.
• Bank-Examination Privilege: Communications between BRB and the OCC relating to OCC supervisory and examination activities may be protected by the bank-examination privilege. This privilege, while not absolute and subject to varying treatment across jurisdictions, should be asserted to the extent applicable to protect confidential supervisory information from disclosure to the SEC.
FRE 502(d) Protection. If the matter progresses toward formal proceedings, we recommend seeking a protective order under Federal Rule of Evidence 502(d), which provides that a federal court may order that any disclosure of privileged communications or work product does not constitute a waiver in the pending or any other federal or state proceeding. While a Rule 502(d) order is not available at the voluntary request stage, we should be prepared to seek such an order if the investigation transitions to formal proceedings.
C. Forensic Accounting Engagement
We strongly recommend retaining Brindoval Analytic Partners LLC to provide independent forensic accounting analysis in support of BRB's defense. Brindoval is a nationally recognized forensic accounting and financial advisory firm with deep expertise in banking, credit risk, and CECL-related matters. The firm is led by Dr. Franklin Osei, CPA, CFF, a former PCAOB inspection team member and recognized authority on credit loss estimation methodologies. Brindoval's offices are located at 350 South Grand Avenue, Suite 2100, Los Angeles, California 90071.
The Brindoval engagement should be structured as an engagement at the direction of Calderwood & Harkness LLP for the purpose of providing expert consulting assistance in connection with the SEC investigation. This structure is designed to preserve the work-product protection applicable to Brindoval's analyses and work product under the Kovel doctrine, which extends the attorney-client privilege to communications between counsel's agents (including consulting experts) and counsel's client when such communications are made for the purpose of facilitating the provision of legal advice. See United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).
The key deliverables we anticipate from the Brindoval engagement include:
(i) An independent analysis of BRB's CECL model for the BridgeFin portfolio, including an evaluation of the model's design, assumptions, inputs, and outputs;
(ii) A detailed analysis of the re-aging treatment of the 12,847 modified BridgeFin loans and the impact of that treatment on the reported ACL, delinquency rates, and net charge-off rates;
(iii) A comparison of BRB's re-aging practices and ACL methodology to peer institution practices and applicable regulatory expectations, including OCC Handbook guidance on troubled-debt restructurings and loan modifications;
(iv) An independent estimate of the ACL that would have resulted from alternative treatments of the re-aged loans, providing a quantitative basis for assessing the magnitude of any potential understatement;
(v) An assessment of the reasonableness of BRB's qualitative factor assessments and management overlays in the context of the credit quality trends observable during the relevant period; and
(vi) A report or memorandum summarizing Brindoval's findings and conclusions, suitable for use in discussions with the SEC Staff (if strategically appropriate) or as a foundation for expert testimony if the matter were to proceed to litigation.
We estimate that the Brindoval engagement will carry fees in the range of $500,000 to $750,000, depending on the scope and complexity of the analysis required. These fees should be recoverable as defense costs under BRB's D&O insurance policy, subject to the entity retention discussed in Section VII.E below.
D. Internal Fact-Gathering
Parallel to the document collection and production process, we will conduct an internal fact-gathering program designed to develop a comprehensive understanding of the facts underlying the SEC's inquiry. This program will consist of two principal components: (i) Upjohn-warned interviews of key BRB personnel, and (ii) a targeted review of internal documents.
Upjohn-Warned Interviews. We will conduct interviews of the following key BRB personnel, among others:
• Patricia "Trish" Navarrete, Chief Financial Officer
• Raymond Hu, Chief Accounting Officer
• Annette Kowalski, Chief Risk Officer
• Naveen Chakravarti, Senior Vice President & BridgeFin Division Head
• Relevant members of BRB's credit risk management function
• Relevant members of BRB's model risk management function
• Relevant members of BRB's financial reporting and SEC reporting teams
Each interview will be preceded by an Upjohn advisory, consistent with the requirements of Upjohn Co. v. United States, 449 U.S. 383 (1981), and its progeny. The Upjohn advisory will clearly inform each interviewee of the following:
(a) Calderwood & Harkness represents Belmont Ridge Bank National Association, the entity, and not any individual officer, director, or employee of the Bank;
(b) The purpose of the interview is to gather facts to enable C&H to provide legal advice to the Bank;
(c) The attorney-client privilege applicable to the interview belongs to the Bank, not to the individual, and the Bank may choose to waive the privilege at any time;
(d) The individual should keep the substance of the interview confidential and should not discuss it with other employees, except as directed by counsel; and
(e) While the individual is not required to have personal counsel present, the individual has the right to retain personal counsel at his or her own expense.
We will prepare a formal Upjohn/Corporate Representation Advisory Memorandum for this purpose and will finalize and transmit it on September 26, 2023.
Internal Document Review. In addition to the interviews, we will conduct a targeted review of the following categories of internal documents, which overlap with but are not coextensive with the categories requested in the VRL:
• CECL model documentation for the BridgeFin portfolio
• ACL calculation workpapers for FY 2022 and Q1–Q2 2023
• Audit Committee presentations and materials relating to BridgeFin credit risk and the ACL