If you're either a current or prospective shareholder of Chimera Investment Corporation (CIM 1.80%), you need to be aware of the fact that it remains embroiled in an accounting quagmire that's attracted the attention of both the Securities and Exchange Commission and the New York Stock Exchange.

The magnitude of the alleged accounting errors were disclosed in a recent restatement of earnings covering the time period from November 2007 (the company's inception) through September 30, 2011. The cumulative impacts were as follows:

  • decrease in interest income of $306.7 million from $1.8 billion to $1.5 billion
  • increase in other-than-temporary impairment losses of $449.3 million from $67.5 million to $516.8 million
  • decrease in realized losses on sales of residential mortgage-backed securities of $22.6 million from $28.2 million to $5.6 million
  • increase in net gains (losses) on interest only RMBS of $42.1 million from an unrealized loss of $34.8 million to an unrealized gain of $7.3 million
  • decrease in realized losses on principal writedowns on non-agency RMBS of $49.2 million from $49.2 million to $0.0
  • increase in the provision for loan losses of $4.4 million from $8.9 million to $13.3 million
  • decrease in net income of $646.7 million from $1.1 billion to $434.7 million
  • increase in accumulated other comprehensive income of $636.0 million from $30.0 million to $666.0 million
  • increase in accumulated deficit of $640.4 million from $289.2 million to $929.6 million, and a decrease in total stockholders' equity of $4.4 million to $3.3 billion

Suffice it to say, we're not talking about an inconsequential oversight, as these changes go to the very heart of Chimera's operations. But even more disturbing than the errors themselves, as accounting is admittedly an imprecise science, is how they likely came about. That is, were they the result of intentional misconduct or where they, rather, the byproduct of incompetence?

Let me be clear: There is no direct evidence of intentional misconduct. However, this is not to say that it didn't happen. For instance, there are at least two reasons to infer culpability in this situation. First, the error, while balance sheet neutral, resulted in a dramatic overstatement of net income. According to an earlier filing by the company, its restated net income for the period declined by approximately $695 million, or 65.5%, from approximately $1.06 billion to $367 million.

And, second, this wouldn't be the first time that Chimera's leaders had engaged in illicit conduct. As I've discussed previously, in 1994, the founder of Chimera's external manager, Annaly Capital Management (NLY -0.72%), "was censured by the NASD, fined $150,000, suspended "30 days from associating with any member of the NASD," and had his securities license revoked. The charges? Among other things, 'filing inaccurate [regulatory] reports,' 'filing [an] incomplete and inaccurate annual audit,' and keeping 'inaccurate books and records.'"

But let's assume for the moment that it wasn't the result of an intentional act on the part of Chimera leadership. This still doesn't excuse it from responsibility for one simple reason. Namely, the person who was presumably in charge of accounting and other financial matters at Chimera -- that is, the chief financial officer -- appears to have been hired not because of her accounting and financial acumen but rather because she was the sister of Annaly's now-CEO.

Why didn't Chimera's chief executive officer step in and fix the situation? My guess is that he didn't want to rock the proverbial boat, as he too appears to have been hired thanks to familial ties -- his father is a member of Annaly's board of directors. The point being, if you've ever wondered why nepotism is generally frowned upon, this is it.

The takeaway for investors, in turn, is that even if Chimera eventually emerges from under the current cloud of suspicion, I would encourage you to ask yourselves whether these are the type of people to whom you feel comfortable entrusting your hard-earned money. I, for one, do not.