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FDIC Enforcement Decisions and Orders |
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A bank's board chairman was assessed a civil money penalty and permanently removed from banking for willful and continuing disregard for the bank's safety and soundness and violations of law and regulations in allowing excessive overdrafts by a related firm. The bank president, a director, was suspended from participating in the affairs of a bank for three years for approving the overdrafts on the chairman's direction.
[.1] Regulation ORelated InterestsControlling Influence
[.2] Regulation OLending Limitations
[.3] Regulation OLending LimitationsPreferential Terms
[.4] Regulation OLending LimitationsApproval by Board of Directors
[.5] Civil Money PenaltiesAmount of PenaltyFactors Determining
[.6] Prohibition, Removal, or SuspensionFactors Determining Liability Violation of State Law
[.7] Prohibition, Removal, or SuspensionFactors Determining Liability Breach of Fiducicary Duty
The officers, by approving the overdrafts of an insider, breached their fiduciary duty by taking actions that were in their own pecuniary interests in a situation which clearly involved a conflict of interest. This constitutes a wrongful conduct that meets the first element for removal.
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[.9] Prohibition, Removal or SuspensionPermanent Order
[.10] Prohibition, Removal, or SuspensionTemporary Order
In the Matter of *** and *** individually,
I. INTRODUCTION
This proceeding is a consolidated action brought by the Federal Deposit Insurance Corporation ("FDIC") against *** and *** ("Respondents"), individually and as directors and officers of *** Bank, *** ("Bank"), seeking civil money penalties for violation of section 22(h) of the Federal Reserve Act (12 U.S.C. 375b) and sections 215.4(a), (b), and (c) of Regulation O of the Board of Governors of the Federal Reserve System (12 C.F.R. Part 215.4(a), (b), and (c)) ("Reg. O")1 and removal pursuant to section 8(e)(1) of the Federal Deposit Insurance Act ("FDI Act"), (12 U.S.C. §1818(e)(1)).
II. STATEMENT OF THE CASE
A. DESCRIPTION OF THE CHARGES
On April 1, 1987, the FDIC's Board of Review issued a Notice of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of Law, Order to Pay and Notice of Hearing ("Notice of Assessment") against Respondents *** and *** for their alleged violations of sections 215.4(a), (b), and (c) of Reg. O. The Notice of Assessment alleged that Reg. O was violated due to the existence of overdrafts in the checking account of ***. Allegedly, *** was a related interest of Respondents, and Respondent ***, as chairman of the Bank's board, directed Respondent ***, as president of the Bank, to approve the payment of checks which resulted in substantial "overdrafts" of up to $160,000 in ***'s checking account for 332 days. FDIC enforcement counsel argued in its brief and at the administrative hearing that the "overdrafts" were actually extensions of credit, given their frequency and amounts, made on a preferential basis, without prior approval of the Bank's board of directors, and in excess of the lending limits to bank insiders. Pursuant to section 18(j)(3) of the FDI Act (12 U.S.C. §1828(j)(3)), Respondent *** was assessed a $17,000 civil money penalty and Respondent *** was assessed a $3,500 civil money penalty for their respective participation in the Reg. O violations.
Respondents, through counsel, jointly filed answers to each notice on April 29, 1987. A pre-hearing conference was held on May 26, 1987, in ***. At that time, counsel for Respondents proposed the entry of a protective order, and such an order was entered on June 2, 1987. A hearing before Administrative Law Judge ("ALJ") William Gershuny was commenced in ***, on July 6, 1987 and continued to July 15, 1987. As a preliminary matter, the FDIC filed and presented a Motion to Vacate the Protective Order ("Motion to Vacate") that had been entered on June 2, 1987; the ALJ deferred ruling on this matter until the issuance of his recommended decision.
On December 28, 1987, ALJ Gershuny issued his Recommended Decision and Order ("Rec. Dec.") in the consolidated removal and civil money penalty actions. The ALJ found that each Respondent, in violation of section 8(e), engaged in unsafe and unsound banking practices, that the Bank suffered a substantial financial loss due to Respondents' actions, and that their activity demonstrated a continuing disregard for the safety and soundness of the Bank. Although FDIC's Notice of Intention alleged, and evidence was produced at the hearing, that each Respondent also violated Reg. O and the state lending limit, breached his fiduciary duty as a director and officer, received financial gain from the *** transactions, and demonstrated a willful disregard for the safety and soundness of the Bank, the ALJ declined to consider these issues as a matter of judicial restraint and economy. Having found the FDIC met its minimum burden under section 8(e)(1) (i.e., proved at least one factor from each of the three elements required for a section 8(e) violation2), the ALJ concluded that Respondent *** should be removed as a director and officer of the Bank and be prohibited from participating in the affairs of the Bank or any other FDIC-insured bank for a period of five years. The ALJ also concluded that Respondent *** should be removed as a director and officer of the Bank and be
D. FDIC ENFORCEMENT COUNSEL'S
On January 29, 1988, FDIC Enforcement Counsel filed Exceptions to the Recommended Decision of the ALJ. Those exceptions dealt with the following:
III. SUMMARY OF THE BOARD OF
The Board has reviewed the record,4 the parties briefs,5 FDIC Enforcement Counsel's exceptions and the Recommended Decision of the ALJ. Although the Board's review of the ALJ's Recommended Decision unnecessarily was made more difficult by his failure to include complete findings of fact and conclusions of law and his lack of citation to the record, nevertheless, the Board[s] finds that the ALJ's statement of the facts and legal conclusions, except as to the appropriate remedies, are supported by the evidence in the record as a whole. Specifically, the Board agrees and finds that *** was a related interest of Respondent ***, but not of Respondent ***, that Respondent *** violated section 215.4(c) of Reg. O, and that both Respondents demonstrated a continuous disregard for the safety and soundness of the Bank and engaged in unsafe or unsound practices which resulted in a substantial financial loss to the Bank, in violation of section 8(e)(1) of the FDI Act.
IV. DISCUSSION
A. VIOLATION OF SECTIONS 215.4(a)
[.1] The ALJ found and the Board agrees that *** was a related interest of Respondent ***6 due to his ability to exercise a controlling influence over managerial and financial decisions of the company as a result of his increased financial investment in it (TR. 575-6, 1094-5), and based on the numerous examples of his actual exercise of control of the day-to-day operations of ***7 (TR. 551, 554, 566-70, 573, 977, 984, 1006, 1011, 1048, 1051, 1054-5, 1059, 1061). The ALJ also found and the Board agrees that *** was not a related interest of Respondent *** because he did not and was unable to exert a controlling influence over the company as that term is defined in section 215.2(b).8 Indeed, Respondent *** was himself under the control of Respondent ***.9
[.2] The ALJ found and the Board agrees that Respondent *** violated section 215.4(c) of Reg. O due to extensions of credit to him and to his related interests that were in excess of the lending limits of the Bank (FDIC Ex. 17). The ALJ, however, having found one violation of Reg. O (section 215.4(c)), determined it was unnecessary for him to address whether the overdrafts to *** also constituted preferential loans under section 215.4(a) or were made without prior board of directors' approval under section 215.4(b). This Board concludes that the ALJ erred in this respect, and that he should have decided these issues. Consequently, on the basis of the record, the Board must do so without the benefit of the ALJ's recommendation and make findings of fact and conclusions of law as to these alleged violations. We do so as set forth below.10
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[.3] The record establishes that extensions of credit to *** were also in violation of section 215.4(a) of Reg. O which prohibits extensions of credit to insiders or their related interests on preferential terms.11 The extensions were preferential in that credit was extended at a lower effective rate of interest, in larger amounts and for longer periods of time than any similar credit extended to any other borrowers at the Bank (TR. 467); the credit to *** involved above normal levels of risk of repayment.
2. Violation of Section 215.4(b)
[.4] The extensions of credit to *** also violated section 215.4(b) of Reg. O in that the extensions of credit in the form of overdrafts were made to a related interest of Respondent *** and did not receive the approval of a disinterested majority of the Bank's board of directors prior to their disbursement (TR. 381). Prior approval was required because the credit extended to Respondent *** exceeded 5% of the Bank's unimpaired capital and surplus (FDIC Ex. 17). Not only did the board not give its prior approval, on two occasions, on May 28, 1985 and July 26, 1985, the board resolved that no overdrafts were to be permitted in the account of *** (TR. 379, 1066, 1153 and FDIC Exs. 19 and 20). Thus, Respondent ***'s failure to obtain prior board approval violated section 215.4(b) of Reg. O.
Having found that Respondent ***, while serving as an officer and director of the Bank, violated Reg. O, the Board concludes that a civil money penalty should be assessed.
[.5] The Board finds that the assessment of the $17,000 civil money penalty originally proposed is justified and appropriate based on the entire record in this matter: Respondent *** violated three separate provisions of Reg. Osections 215.4(a), (b) and (c); the violations were lengthy in duration and substantial in dollar amounts, and there is a history of previous violations of a similar nature. Respondent ***'s ability to pay is not an issuehe has a net worth of $6.6 million (Stip. Tr. pp. 161 and 910). Whatever good faith reliance there may have been by Respondent *** on the earlier FDIC letter indicating that *** was not a related interest, that reliance was unreasonable in this case in light of his training and experience as an attorney, accountant, and banker and his awareness of his increased influence and control over the operations of *** through his increasing personal investments in *** (FDIC Exs. 2(b), 5(b), and 6(b)), especially in the months between the July 18, 1984 and the October 25, 1985 examination. Furthermore, Respondent ***'s blatant disregard of the notice of the *** Commissioner of Banking that the transactions at issue in this proceeding were extensions of credit thereby resulting in violations of the *** lending limit statute, certainly calls into doubt his good faith with respect to these overdrafts (See FDIC Ex. 106(a))18. Another factor that the Board has
C. REMOVAL UNDER SECTION 8(e)
The ALJ found and the Board agrees that, by virtue of the unsecured extensions of credit to ***, both Respondents engaged in an unsafe or unsound banking practice by permitting the extension of credit to persist for a period of 332 days, in amounts varying from $122 to $160,000 (Tr. 373, FDIC Ex. 7), without proper documentation to ensure repayment (Tr. 382, 1065), at a time when ***'s financial condition was deteriorating (Tr. 882, 391; FDIC Ex. 16), and despite express resolutions by the Bank's board not to do so (FDIC Ex. 19 and 20); that Respondents caused substantial financial loss to the Bank in the amount of approximately $7,000 (Tr. 931);19 and that Respondents evidenced a continuing disregard for the safety and soundness of the Bank by knowingly permitting the practices to continue for such a substantial length of time (Tr. 882).
1. Violation of Law, Rule, or Regulation
[.6] As set forth in Section A, supra, the violation of law criteria of section 8(e)(1) with respect to Respondent *** has been met by virtue of his violations of Reg. O. In addition, the record indicates that both Respondents, based on their participation in the overdrafts, caused violations of ***'s state lending limit statute.20 The state lending limit statute provides that no more than 20 percent of a bank's capital and surplus may be extended to any one entity. The purpose of the lending limit is to prevent the risk of critical loss posed by having too much of the banks resources tied in to the fortunes of a single borrower. On the date of the examination, the Bank's lending limit was $140,000. The Bank's records showed that extensions to *** had exceeded that amount on numerous occasion (Tr. 392-393, 882, 1175-6, FDIC Ex. 17). Thus, Respondents ***'s and ***'s unlawful conduct has satisfied the first element of section 8(e)(1).
2. Breach of Fiduciary Duty
[.7] Officers and directors occupy a position of trust and must safeguard the interest of their depositors and shareholders. They have the duty to act diligently, prudently, honestly, and carefully in carrying out their responsibilities and must ensure their bank's compliance with state and federal banking laws and regulations. Respondent *** testified correctly that his fiduciary duty in part was to abstain from participating in the decisions on any loan transaction where he had a personal interest (Tr. 1069). The record indicates, however, that Respondent *** directed Respondent *** to extend credit to *** by way of the overdrafts (Tr. 1164), i.e., *** participated in the decision to extend credit to a borrower, ***, an entity in which he had a personal financial interest, thereby breaching his fiduciary duty. Respondent ***, moreover, despite his own financial interest in ***, willingly carried out ***'s instructions and approved the overdrafts to ***. Thus, the record clearly indicates that both Respondents breached their fiduciary duties by taking actions that were in their own pecuniary interests in a situation which clearly involved a conflict of interest (Tr. 448, 892).
3. Financial Gain to Respondents
Respondents obtained personal financial gain as a result of the extensions of credit to ***. The nature of the overdrafts, which resulted form payments of interest due on *** loan participations held at other banks, suggests that the Bank was providing interest-free funding for the continued operation of *** (Tr. 882). This continued operation of *** through the interest-free use of Bank funds, personally benefited Respondents as shareholders and creditors of ***.
4. Willful Disregard for the Safety and
[.8] The ALJ determined and the Board agrees that Respondents' conduct demonstrated a continuing disregard for the safety and soundness of the Bank. The practice of approving *** overdrafts continued for almost a year in substantial amounts at a time when the solvency of *** was in doubt and with only verbal assurances of repayment from Respondent ***. These actions were intentional and posed a serious threat to the safety and soundness of the Bank.
D. THE APPROPRIATE REMEDY FOR
FDIC enforcement counsel sought to remove Respondent *** from his position as an officer and director of the Bank and to prohibit him from participating in the affairs of any other FDIC-insured institution. The ALJ, on the basis of the statute's grant of broad discretion to impose an appropriate remedy and on his perception that Respondent ***'s conduct was atypical and not likely to recur, recommended removal for a fixed five-year term.
[.9] On the basis of the serious nature of Respondent ***'s conduct and this Board's conclusions that, in addition to the elements cited by the ALJ, Respondent *** violated additional elements of section 8(e) by violations of two additional subsections of Reg. O and the *** state lending limit, by breaching his fiduciary duty, by receiving personal financial gain, and by demonstrating a willful disregard for the safety and soundness of the Bank, the Board concludes that the ALJ's proposed remedy inadequately reflects the seriousness of Respondent ***'s actions and conduct. The Board, therefore, orders that Respondent *** be permanently removed from banking pursuant to the terms of section 8(e).
E. THE APPROPRIATE REMEDY FOR
Section 8(e)(5) provides that an "agency may issue such orders of suspension or removal from office, or prohibition from participation in the conduct of the affairs of the bank as it may deem appropriate" (emphasis added). As suggested by the ALJ, this language grants the Board authority to fashion a remedy that is appropriate considering all of the circumstances. The legislative history of section 8(e) indicates that Congress desired to provide regulatory agencies with the mechanism to eradicate insider abuse and to protect the banking industry. Section 8(e) became an additional remedy to the already existing penalty of insurance termination to provide bank regulatory agencies the flexibility to take effective action against individuals that jeopardized the integrity of a bank without imposing the more disruptive and uncertain sanction of insurance termination. The Board has concluded that imposition of a fixed term suspension or removal is consistent with the legislative history, language, and purpose of section 8(e). Imposition of a term removal allows the agency to deal with insider abuse while fashioning a sanction that it deems appropriate considering the circumstances of each case.
[.10] While the evidence establishes that Respondent ***'s involvement in the extensions of credit to *** aided in the violations of the state lending limit statute, breached his fiduciary duty, and represented a willful and a continuing disregard for the safety and soundness of the Bank which resulted in personal financial gain and thus warrants his removal under 8(e), Respondent ***'s conduct was different from that of Respondent ***. The record indicates that Respondent *** was dominated by Respondent ***, that he acted at ***'s command, that he had a lesser financial stake in *** and had a lesser degree of involvement in the *** transactions. Respondent ***'s lesser culpability leads us to conclude that a term removal of three years is just.
F. THE PROTECTIVE ORDER IS
On June 2, 1987, the ALJ granted Respondents' motion for entry of a protective order. At the time, the FDIC made no objection and the protective order was entered and subsequently attached to third-party subpoenas. Respondents argue that they requested the protective order to ensure the privacy of the proceedings. However, the right to a private administrative proceeding is expressly granted by 12 U.S.C. §1818(h)(1) unless this Board makes a specific determination that an open proceeding is necessary to protect the public interest. No such determination was made in this matter.
V. CONCLUSION
The Board finds that Respondent *** violated Reg. O and that a $17,000 civil money penalty should be assessed against him; that an order under section 8(e)(1) should be issued as to Respondent *** removing him from the Bank and prohibiting him from participating in the conduct of the affairs of any other FDIC-insured institutions; and that an order under section 8(e)(1) should be issued as to Respondent *** removing him from the Bank and prohibiting him from participating in the conduct of the affairs of any other FDIC-insured institution for a period of three years.
ORDER TO PAY CIVIL MONEY
For the reasons set forth in the above Decision, the Board of Directors of the Federal Deposit Insurance Corporation hereby ORDERS that:
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/s/ Robert E. Feldman
Executive Secretary
RECOMMENDED DECISION AND
FDIC 87-61e
WILLIAM A. GERSHUNY, Administrative Law Judge: A consolidated hearing was conducted in ***, during the period July 6-15, 1987, on Notice of Intention to Remove from Office issued April 14, 1987, pursuant to Sec. 8(e)(1) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(e)(1), and a Notice of Assessment of Civil Money Penalties issued April 1, 1987, pursuant to Sec. 18(j)(3) of the Act, 12 U.S.C. 1828(j)(3), based on the existence of overdrafts in the account of a related interest for approximately 332 days during the period of July 1984 through August 1985, in the average amount of $68,000, with only the imposition of the customary $7.00 overdraft charge and without interest.
I. Jurisdiction
The Notices allege, Respondents admit, and I find that Respondent ***, as Chairman of the Board of an insured State nonmember bank and a principal shareholder (39.6%), and Respondent ***, as President and as a director of the bank, are subject to the jurisdiction of the FDIC and its rules and regulations.
II. The Allegations and Contentions
A. The Allegations of the Notices. The "removal" notice alleges that *** and *** are related interests of each Respondent within the meaning of Regulation O by reason of their ownership interests and their power to exercise a controlling influence over the management or policies of the companies; that, despite the deteriorating financial condition of *** Respondents caused and permitted the company to overdraw on its account, over a period of more than a year, in amounts averaging $68,000; that, because of the large amounts and lengthy period of time involved, these transactions amounted to unsecured credit extensions at preferential rates of interest, with more than the normal risk of repayment, without prior approval of the board of directors, and in excess of lending limit restrictions; and that such transactions also violated State lending limit restrictions. The notice also also alleges that these transactions constituted unsafe or unsound banking practices and that Respondents breached their fiduciary duty by acting with impermissible conflicts of interest as personal creditors of ***, as principals of *** in its capacity as borrower from the Bank, as lending officers of the Bank, as Bank officials contractually responsible for servicing *** loans on behalf of a participating bank, and as personal guarantors on loans made and participated out by the Bank. The notice also alleges a substantial loss to the Bank of approximately $7,000 by reason of its charging only a $7.00 overdraft charge rather than the current rate of interest for unsecured credit, and that Respondents received financial gain by reason of ***'s continued existence and their not being called upon to honor their personal guarantees to the participating bank. Finally, the removal notice alleges that the facts demonstrate a willful and continuing disregard for the safety and soundness of the Bank. The notice seeks the removal of Respondents, under Section 8(e)(1) of the Act, from their positions at the Bank or any other FDIC-insured bank; in its posthearing brief, however, the FDIC indicates that it seeks only to remove Respondent *** for a period of three years.
III. The *** Overdrafts
Between July 19, 1985 and August 4, 1986, the *** checking account was overdrawn on 332 days, in amounts ranging from $122 to $160,597, for an average of approximately $68,000 per day. The overdrafts were created by the payment of checks drawn on the *** account and through direct debits by the Bank to the account. Acting at the express direction of Chairman *** and upon ***'s assurances that such payments were appropriate and that he, ***, would cover them personally, President *** approved these payments and debits. In this connection, the record evidence reveals, and my observation of each of the Respondents while testifying confirms, that ***, as a principal shareholder of the Bank, an attorney, and a certified public accountant with wide-ranging domestic and foreign business interests, exercised exclusive control over the *** transactions through domination and coercion of the unsophisticated ***.
IV. Section 8(e)(1) Removal
A. The Essential Elements. Section 8(e)(1) of the Federal Deposit Insurance Act provides for the removal of officers and directors of an insured bank. Admittedly, each Respondent is subject to this provision. The provision establishes three separate and distinct categories of essential elements, each with a number of alternative grounds. The first category relates to the wrongful conduct that must be established to support a removal action: (1) "any violation of law,
{{4-1-90 p.A-1250}}rule, or regulation or of a cease-and-desist order which has become final;" or (2) "any unsafe or unsound practice in connection with the bank;" or (3) "any act, omission, or practice which constitutes a breach of his fiduciary duty." The second category relates to the effect of the wrongful conduct: (1) "the bank has suffered or will probably suffer substantial financial loss or other damage;" or (2) "the interests of its depositors could be seriously prejudiced;" or (3) "the director or officer has received financial gain." The third category relates to the mental state of the director or officer, i.e. "scienter:" (1) "personal dishonesty" or (2) "a willful or continuing disregard for the safety or soundness of the bank."
V. Section 18(j)(3) Civil Money Penalties
A. Violations Subject to Penalties. Sec. 18(j)(3) of the Act authorizes the imposition of civil money penalties for statutory violations only. The commission of unsafe or unsound banking practices does not subject a bank or its officers and directors to such penalties, and thus the findings and conclusions above, while sufficient to support an order of removal or suspension under Sec. 8(e) of the Act, are irrelevant here. The only statutory violation alleged in the civil money penalty notice is that of Sec. 22(h)(3) of the Federal Reserve Act, implemented by Regulation O, 12 CFR 215.
Pursuant to Sec. 308.13 of the FDIC Rules and Regulations, I recommend:
/s/ WILLIAM A. GERSHUNY |
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