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FDIC Enforcement Decisions and Orders
Respondent is prohibited from participating in the conduct of affairs of, or exercising voting rights in, any insured institution without the prior written approval of the FDIC.
In the Matter of
STATEMENT OF THE CASE
John J. Schmalzer ("Schmalzer"), through his letters, first
on June 15, 2004 ("the June 15 Application"), and then
supplemented by his letter of July 6, 2004 ("the July 6
Supplement"), both addressed to the Regional Director of the Dallas
Region of the Federal Deposit Insurance Corporation ("FDIC"),
made application to the FDIC for termination
of the Order of Prohibition from Further Participation ("Order of Prohibition") issued against him by the FDIC on December 21, 2000. Respondent seeks termination of the Order of Prohibition so that he may apply his education, training, and experience in unspecified positions for unspecified financial institutions or organizations enumerated in section 8(e)(7)(A) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. §1818(e)(7)(A). This application arises under section 8(e)(7)(B) of the Act, 12 U.S.C. §1818(e)(7)(B) and section 8(j) of the Act, 12 U.S.C. §1818(J).
John J. Schmalzer became employed with BestBank, Boulder, Colorado ("BestBank") in 1996 as a Vice President and BestBank's Risk Manager officer.
Prior to his employment with BestBank, Schmalzer was employed with the FDIC for twelve years, of which nine years consisted of his being a commissioned FDIC examiner. As a commissioned examiner in the FDIC's Dallas Region with an extensive accounting background and as licensed Certified Public Accountant, Schmalzer was the FDIC's designated Accounting Specialist in the Dallas Region.
Prior to his employment with the FDIC, Schmalzer obtained a formal B.S. degree in Accounting from the University of Illinois - Chicago, Chicago, Illinois.
BestBank became an insured depository institution on October 25, 1984. As the result of massive fraud and large losses associated with BestBank's subprime credit card portfolio, BestBank was closed by the Commissioner of the Colorado Division of Banking on July 23, 1998. At the time of closing, BestBank had total assets of $314 million and total deposits of approximately $284.5 million in about 5,500 accounts. Approximately $59.2 million in deposits in about 1,800 accounts were uninsured.
As of June 30, 2004, the FDIC's Division of Finance estimated that the FDIC incurred losses totaling nearly $221 million because of the failure of BestBank.
1. Schmalzer's Role in the Failure of BestBank
Schmalzer's position as BestBank's Risk Manager officer included his direct involvement in numerous internal risk management and compliance operations of BestBank, including direct responsibility for monitoring BestBank's credit card portfolios for quality, performance, delinquencies and providing accurate financial information concerning the operations of such credit card portfolios to BestBank's board of directors and the FDIC and the Colorado Division of Banking.
In the March 1996 Risk Assessment Report to BestBank's board of directors, Schmalzer identified numerous weaknesses within BestBank's credit card portfolio managed by third-party Century Financial Group, Inc., ("CFG"). A concentration in the All Around Travel Club ("AATC") subprime credit card receivables threatened BestBank's viability. Despite his knowledge of CFG's improper reaging of delinquent accounts, Schmalzer minimized the risk to BestBank resulting from this concentration in his report to the board of directors. Schmalzer conducted two audits reflecting CFG's substantial reaging of the portfolio; however, he again failed to report his findings to BestBank's board. As such, he knowingly participated in the funding of poor quality credit card receivables, a large number of which were determined to be uncollectible during the June 1998 joint FDIC and State examination of BestBank. BestBank's losses resulting from these receivables extinguished BestBank's capital and allowance for Loan Losses.
In April 1998, Schmalzer internally reviewed CFG's audited December 31, 1997, financial statement and affirmatively reported to BestBank's board of directors that CFG possessed the financial wherewithal to meet its contractual indemnification responsibilities. Schmalzer again failed to disclose any of CFG's improper activities in his written report to the Bank's board. Additionally, during 1998, Schmalzer failed to inform the FDIC or the State in meetings or during the examination of BestBank that CFG was engaged in improper reaging of the AATC credit card portfolio.
2. Prior Applications
On October 14, 2003, Schmalzer began employment with Key Equipment
Finance, Inc., Superior, Colorado ("KEF"), a division of Key
Corporate Capital, Inc. which is a wholly-owned subsidiary of KeyBank,
N.A., Cleveland, Ohio ("KeyBank"), a national
bank owned by KeyCorp, Cleveland, Ohio ("KeyCorp").
On December 10, 2003, Schmalzer filed a written request with the FDIC for a modification to the Order of Prohibition to allow him to be employed by KEF. KEF officials informed the FDIC that Schmalzer would not be employed at KEF, currently or in the future. On January 20, 2004, Schmalzer withdrew his request to modify the Order of Prohibition.
C. The Present Application
In the June 15, 2004 Application, Schmalzer requests that the FDIC terminate its Order of Prohibition against him so that he can apply his education, training, and experience in unspecified positions for unspecified financial institutions or organizations and their affiliates subject to section 8(e)(7)(A) of the Act. On June 30, 2004, the FDIC requested additional information from Schmalzer, including all information with supporting documentation detailing pending employment positions for which Respondent had applied; employment positions Respondent had held since issuance of the Order of Prohibition; and all employment activities that demonstrated Respondent's rehabilitation. Respondent proposes no limitations with respect to any prospective employment and does not disclose any institutions where he would seek employment or positions for which he would apply in either the June 15 Application or the July 6 Supplement.
D. Findings of Fact
In his June 15 Application, Schmalzer sets forth several grounds for requesting that the Order of Prohibition be terminated.
First, Respondent asserts that the possibility of his gainful employment, particularly as related to his education, training, and experience, has been diminished by the affiliation of companies with financial institutions.
Second, Schmalzer asserts that since issuance of the Order of Prohibition, he has "demonstrated extreme cooperation" with both the FDIC and the U.S. Attorney's office with respect to the civil litigation cases and Federal criminal prosecution case that have resulted from the failure of BestBank.
Third, Schmalzer asserts that over the past three and one-half years of cooperative efforts with the U.S. Attorney, he has demonstrated his knowledge, understanding of, respect for, and agreement with safe and sound banking practices.
Fourth, Schmalzer asserts, with respect to his conduct at BestBank, that he recognizes where he could have improved his research of issues and reported his findings, that he was not involved in any criminal activity, and that he did not receive "any inordinate gain."
Fifth, Schmalzer asserts he has demonstrated personal ethics since issuance of the Order of Prohibition.
Sixth, Respondent sets forth certain employment-related activities which he asserts demonstrate his rehabilitation since issuance of the Order of Prohibition. These activities allegedly have involved assessment of risk, reporting financial information, and disclosure of weaknesses and irregularities to his employers.
The FDIC finds that Respondent has failed to disclose any position he would seek or any institution subject to section 8(e) to which he would apply for prospective employment and that Respondent has failed to provide any documentation demonstrating his rehabilitation after issuance of the Order of Prohibition. Given these facts, the FDIC cannot use its predictive judgment to protect the public and fulfill its statutory obligation to assess Respondent's fitness to participate in the conduct of the affairs of an insured depository institution, the risk to safety and soundness posed by Respondent's participation, and the effect of Respondent's participation on public confidence in any particular financial institution.
DECISION AND ORDER
Section 8(e)(7)(B) of the Act states in pertinent part:
(7) INDUSTRYWIDE PROHIBITION.
(B) EXCEPTION IF AGENCY PROVIDES WRITTEN CONSENT.
If, on or after the date an order is issued under this subsection which removes or suspends from office any institution-affiliated party or prohibits such party from participating in the conduct of the affairs of an insured depository institution, such party receives the written consent of-
(i) the agency that issued such order, and
(ii) the appropriate Federal financial institutions regulatory agency of the institution
described in any clause of subparagraph (A) with respect to which such party proposes to become an institution-affiliated party.
subparagraph (A) shall, to the extent of such consent, cease to apply to such party with respect to the institution described in each written consent.
12 U.S.C. §1818(e)(7)(B).
In applications to modify or terminate orders of prohibition, an applicant has a strong burden of proof to justify the modification he seeks. In the Matter of Richard M. Wright, FDIC Enf. Dec. & Ord. (Transfer Binder), ¶ 5264, at A-3178, 2000 WL 1742018, at *3 (Oct. 2, 2000). The applicant must demonstrate: (1) his fitness to participate directly or indirectly in the conduct of the affairs of an insured depository institution; (2) that his participation would not pose a risk to the institution's safety and soundness; and (3) that his participation would not erode public confidence in the institution. Id. See also In the Matter of Michael D. McCormick, 2 FDIC Enf. Dec. & Ord. (Bound), ¶ 5212, at A-2411, 1994 WL 226623, at *3 (Apr. 5, 1994); In the Matter of Charles E. Floyd, 2 FDIC Enf. Dec. & Ord. (Bound), ¶ 5177, 1992 WL 812871 (Apr. 16, 1992); In the Matter of Frederick M. Pfeiffer, 2 FDIC Enf. Dec. & Ord. (Bound), ¶ 5163A, at A-1656 (Feb. 28, 1991); In the Matter of *** Bank, Docket No. FDIC-83-153e, 1 FDIC Enf. Dec. & Ord. (Bound), ¶ 5117, at A-1305 (Aug. 9, 1988). By his June 15 application and July 6 Supplement, Schmalzer seeks to have the Order of Prohibition terminated, which would permit him to participate in the affairs of any financial institution or organization enumerated in section 8(e)(7)(A) of the Act, 12 U.S.C. §1818(e)(7)(A).
Upon review of the record as a whole, the FDIC finds that Schmalzer has not presented sufficient evidence or persuasive argument which meets the burden of proof necessary to obtain termination, or even modification of the Order of Prohibition that the FDIC issued against him. See In the Matter of Stephen F. Redman, FDIC Enf. Dec. & Ord. (Transfer Binder), ¶ 5257, at A-3084, 1999 WL 557243, at *3 (June 25, 1999) (Respondent failed to provide specific, concrete evidence demonstrating how he had been rehabilitated or how his work duties evidenced rehabilitation; therefore, Respondent's request for modification was denied); Wright, supra (Respondent failed to provide evidence to demonstrate that he had been sufficiently rehabilitated to provide legal services to insured depository institutions involving disclosures on securities matters; therefore, Respondent's request for modification was denied); Floyd, supra, at A-1978, 1992 WL 812871, at *3 (In his request for reconsideration, Respondent never presented any evidence of rehabilitation showing he had occupied positions of trust since the Order of Prohibition was issued against him. The FDIC found there had been no demonstration that warranted Respondent's return to banking).
In reviewing applications to modify orders of removal and prohibition
under section 8(e) of the Act, the FDIC is required to use its
predictive judgment to protect the public. Sletteland v.
FDIC. 924 F.2d 350, 353 (D.C. Cir. 1991); Wright,
supra, at A-3178, 2000 WL 1742018, at *3. See also Redman,
supra, (Respondent proposed to be employed in certain bank holding
company subsidiaries and other financial institutions in nonexecutive
positions claiming such positions would provide adequate supervision;
with no specific situation to evaluate with respect to Respondent's
contention, the FDIC found no evidence presented to adequately reduce
risk to the safety and soundness of an institution, and denied the
application). Orders of removal and prohibition under section 8(e) of
the Act are remedial and are issued not to punish, but rather to
protect the public, further underscoring the importance of the FDIC's
predictive judgment. See Hudson v. United States, 522 U.S.
93, 103 (1997) (noting Congress intended debarment sanctions against
bankers to be civil in nature); United States v. Stoller, 78
F.3d 710 (1st Cir. 1996). Schmalzer has provided no evidence of his
rehabilitation and no circumstances against which to assess: his
fitness, the effect his participation would have on the risk to safety
and soundness of any financial institution, and the effect his
participation would have on the public confidence in the financial
institution. Therefore, the FDIC cannot employ its "predictive
judgment" as contemplated by section 8(e)(7)(B) of the Act, 12
U.s.C. §1818(e)(7)(B), and the holding by the D.C. Circuit in
Sletteland and followed in Redman, and
Wright, supra. Consequently, Schmalzer's application must
Accordingly, the FDIC finds that Respondent's request for Termination of the Order of Prohibition is denied.
Pursuant to delegated authority.
Dated at Washington, D.C. this 21st day of October, 2004.
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