The SEC said it has charged Capital One Financial Corp. and twosenior executives for understating millions of dollars in auto loanlosses incurred during the months leading into the financialcrisis.

According to an SEC investigation, the agency found that infinancial reporting for the second and third quarters of 2007,Capital One failed to properly account for losses in its autofinance business when they became higher than originallyforecasted.

Capital One agreed to pay $3.5 million to settle the SEC'scharges, the agency said.

The two executives – former Chief Risk Officer Peter A. Schnalland former Divisional Credit Officer David A. LaGassa – also agreedto settle the charges against them.

Schnall agreed to pay an $85,000 penalty and LaGassa agreed topay a $50,000 penalty to settle the SEC's charges, according to theagency.

The profitability of Capital One's auto loan business wasprimarily derived from extending credit to subprime consumers, theSEC said Wednesday.

As credit markets began to deteriorate, Capital One's internalloss forecasting tool found that the declining credit environmenthad a significant impact on its loan loss expense, the SECsaid.

However, Capital One failed to properly incorporate theseinternal assessments into its financial reporting and thusunderstated its loan loss expense by approximately 18% in thesecond quarter and 9% in the third quarter in 2007, the agencysaid.

“Accurate financial reporting is a fundamental obligation forany public company, particularly a bank's accounting for itsprovision for loan losses during a time of severe financialdistress,” said George Canellos, co-director of the SEC Division ofEnforcement.

From October 2006 through the third quarter of 2007, Capital OneAuto Finance experienced significantly higher charge-offs anddelinquencies for its auto loans than it had originally forecasted, the SEC'sinvestigation discovered.

The elevated losses occurred within every type of loan in eachof COAF's lines of business, the SEC said. Its internal lossforecasting tool assessed that its escalating loss variances wereattributable to an increase in a forecasting factor it called the“exogenous,” which measured the impact on credit losses fromconditions external to the business such as macroeconomicconditions.

A change in this exogenous factor generally had a significantimpact on COAF's loan loss expense, and it was closely monitored bythe company through its loss forecasting tool, according to theSEC.

Capital One determined that incorporating the full exogenouslevels into its loss forecast would have resulted in a secondquarter allowance build of $72 million by year-end. The SEC saidsince no such expense was incorporated for the second quarter, itwould have resulted in a third quarter allowance build of $85million by year-end.

Capital One and the two executives neither admitted nor deniedthe findings in consenting to the SEC's order requiring them tocease and desist from committing or causing any violations offederal securities laws, the SEC said.