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FDIC Enforcement Decisions and Orders

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{{3-31-92 p.A-642}}
   [5050] FDIC Docket No. FDIC-84-100b (9-16-85).

   FDIC ordered a bank to cease and desist from unsafe or unsound banking practices, and to take affirmative action to correct such practices. The unsafe or unsound banking practices included operating with inadequate documentation; operating with ineffective loan collection practices; refinancing credits to borrowers in weak financial positions without improving collateral margins or establishing structured repayment programs; renewing or extending the due dates of loans without collection of interest due or obtaining adequate additional collateral to secure credit advanced for the purpose of paying interest; operating with an excessive volume of poor quality loans; failing to provide an adequate reserve for loan losses; failing to reflect accurately the bank's condition in published statements and other reports; operating without adequate liquidity and proper regard for funds management. (This order was terminated by order of the FDIC dated 1-30-92 see ¶ 9006.)

   [.1] Examination of Banks "—" Purpose
   The purpose of a bank examination is to determine the safety and soundness of the bank, to assess the financial condition of the bank, and its compliance with applicable law and regulations.

   [.2] Examiners — Weight Given to Opinion
   Whether a particular banking practice is unsafe or unsound may be established as a matter of fact through the testimony of a bank examiner.

   [.3] Unsafe or Unsound Practices — Statutory Standard
   An unsafe or unsound banking practice may be viewed as conduct contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder.

   [.1] Examiners — Weight Given to Opinion
   One relevant factor to consider in determining an adequate reserve is the opinion of a federal bank examiner.

   [.5] Directors — Duties and Responsibilities "—" Delegation to Officers
   The responsibility imposed on bank directors cannot be delegated to others, and it is negligent for directors to leave the management of a corporation entirely up to others.

   [.6] Cease and Desist Orders — Defenses — Cessation of Violation
   Unless a bank can make an initial showing that complete future compliance is guaranteed, practices of the bank occurring after the close of the pertinent reports of bank examinations are irrelevant to the issuance of a cease and desist order, and the remedy contained therein, and should be excluded.

   [.7] Cease and Desist Orders — Affirmative Remedies — Unsafe or Unsound Practice
   A cease and desist order may be issued against any bank if the FDIC finds that any violation or unsafe or unsound practice specified in the notice of charges has been established.

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   [.8] Cease and Desist Orders — FDIC Authority to Issue
   The issuance of a cease and desist order is a discretionary matter that depends on the individual facts of each case, and such an order will not be overturned unless found to be arbitrary and capricious, or a clear abuse of discretion.

In the Matter of * * * BANK * * *
(INSURED STATE NONMEMBER
BANK)


DECISION AND ORDER TO CEASE
AND DESIST
FDIC-84-100b
STATEMENT OF THE CASE
   These proceedings arise under Section 8(b) of the Federal Deposit Insurance Act (the "Act") (12 U.S.C. § 1818(b)). On June 6, 1984, the Board of Review of the Federal Deposit Insurance Corporation (the "FDIC"), pursuant to authority delegated by the Board of Directors (the "Board") of the FDIC, issued a written Notice of Charges and of Hearing against * * * Bank * * * (the "Bank" or "Respondent"), pursuant to Section 8(b) of the Act and Part 308 of the FDIC's Rules and Regulations (12 C.F.R. Part 308). The Notice of Charges and of Hearing (the "Notice") charged the Bank with having engaged in unsafe or unsound banking practices. The Notice specifically alleged that the Bank engaged in the following unsafe or unsound practices: (1) extending credit on inadequate security, (2) operating without an adequate loan loss reserve, (3) engaging in hazardous investment practices resulting in the acquisition of a long-term, illiquid securities portfolio, (4) operating with inadequate liquidity, (5) extending credit without establishing and enforcing repayment programs, (6) extending credit without obtaining current and complete credit information, (7) following imprudent credit administration in the renewal and/or extension of loans, (8) operating with an excessive level of adversely classified assets and with an excessive level of overdue and nonaccrual loans, (9) operating with management whose practices and policies are detrimental to the Bank, and (10) operating with a board of directors which was remiss in its supervision over the Bank's officers. The Notice sought an order under Section 8(b)(1) of the Act, requiring the Bank to cease and desist from the unsafe or unsound practices and requiring the Bank to remedy the conditions resulting from those practices.
   A formal hearing was held before Administrative Law Judge H. Maxwell Darks (the "ALJ"). Proposed Findings of Fact, Conclusions of Law, and Briefs were submitted by both parties, and the FDIC filed a Reply to Respondent's Suggested Findings of Fact and Conclusions of Law. The ALJ submitted a Recommended Decision and Proposed Order on June 10, 1985. Neither party submitted Exceptions to the Recommended Decision, Findings of Fact, and Conclusions of Law. The Bank, however, did file two unsuccessful motions to reopen the hearing for the purpose of receiving evidence subsequent to the February 3, 1984 Report of Examination.
   In his Recommended Decision, Findings of Fact, and Conclusions of Law, the ALJ made the following salient Findings of Fact: (1) the Bank had extended credit that is inadequately secured; (2) the Bank extended and renewed credit to borrowers without current and complete credit information; (3) the Bank had failed to establish and enforce programs for the repayment of loans and had refinanced credits without improving collateral margins; (4) the Bank renewed and/or extended loans without the collection in cash of interest due; (5) the Bank, as a consequence of hazardous lending and lax collection practices, had operated with an excessive level of adversely classified assets and with an excessive volume of overdue and nonaccrual loans; (6) the Bank had operated without an adequate loan loss reserve, causing earnings to be overstated and Consolidated Reports of Condition and Reports of Income to be inaccurate; (7) the Bank had engaged in hazardous investment practices, resulting in the Bank's acquiring a long term, illiquid securities portfolio with significant market depreciation; (8) the Bank had operated with inadequate liquidity and with poor funds management; (9) the Bank's directors were remiss in their supervision; and (10) the Bank operated with management whose practices and policies were detrimental to the Bank and the safety of its deposits.
   On the basis of these Findings of Fact, the ALJ found that the Bank's practices, as
{{4-1-90 p.A-644}}enumerated in the Findings of Fact, constituted unsafe or unsound banking practices within the meaning of Section 8(b) of the Act (12 U.S.C. § 1818(b)).
OPINION
   The Board finds the ALJ's recommended Findings of Fact to be supported by substantial evidence in the record. We, therefore, adopt and incorporate herein by reference Findings of Fact Number 1 through 35, on pages 3 through 9 of the Recommended Decision. The Board also agrees with the analysis of the law set forth in the ALJ's Recommended Decision. We find that analysis to be supported both by statute and established precedent. Therefore, the Board hereby adopts and incorporates herein by reference the ALJ's discussion and Conclusions of Law Numbers 1 through 6, on pages 9 through 18 of the Recommended Decision.
   Having found that Respondent has engaged in unsafe or unsound banking practices as set forth in the ALJ's Recommended Decision, the Board finds the ALJ's PROPOSED ORDER TO CEASE AND DESIST is appropriate both as a remedial measure and to prevent future abuses for the reasons set forth at pages 18 through 22 of the Recommended Decision. Therefore, the Board adopts herein that ORDER, as set forth below, as its final CEASE-AND-DESIST ORDER in this proceeding.
ORDER TO CEASE AND DESIST
   Having found and concluded that Respondent has engaged in unsafe or unsound banking practices within the meaning of Section 8(b) of the Act, the Board of the FDIC now issues a Cease-and-Desist Order ("ORDER") to * * * Bank, * * *, providing:
   IT IS HEREBY ORDERED, that * * * Bank * * *, its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank, CEASE AND DESIST from the following unsafe or unsound banking practices:

       (a) Operating with inadequate capital;
       (b) Extending credit which is inadequately secured and without adequate and appropriate supporting documentation;
       (c) Operating with ineffective loan collection practices;
       (d) Refinancing credits to borrowers in weak financial positions without improving collateral margins or establishing structure repayment programs;
       (e) Renewing or extending the due dates of loans without collection in cash of interest due or obtaining adequate additional collateral to secure credit advanced for the purpose of paying interest;
       (f) Engaging in hazardous investment practices;
       (g) Operating the Bank with an excessive volume of poor quality loans, loan related assets, and securities;
       (h) Failing to provide an adequate reserve for loan losses;
       (i) Failing to reflect accurately the condition of the Bank in published statements and Consolidated Reports of Condition and Income; and
       (j) Operating without adequate liquidity and proper regard for funds management.
   IT IS FURTHER ORDERED, that * * * Bank, * * *, its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank, take AFFIRMATIVE ACTION as follows:
   1. Within 120 days of the effective date of this ORDER, the Bank shall provide, and thereafter retain, management acceptable to the Regional Director of the FDIC's * * * Regional Office ("Regional Director"). Such management shall include a qualified chief executive officer who shall be given stated authority in writing by the board of directors of the Bank, including the responsibility for implementing and maintaining lending and investment policies in accordance with sound banking practices.
   2. While this ORDER is in effect, the Bank shall maintain at all times equity capital and reserves equal to or greater than 7.5 percent of its average daily total assets for the months of March, June, September, and December of each year. If such ratio is less than 7.5 percent, the Bank shall, within 30 days from receipt of a written notice of a capital deficiency from the Regional Director, present to the Regional Director a plan to increase the equity capital of the Bank or to take other measures to bring the ratio to 7.5 percent. Within 60 days after the plan is reviewed and no exception is taken thereto by the Regional Director, the Bank shall
{{4-1-90 p.A-645}}increase its equity capital and loan valuation reserves by an amount sufficient to bring the ratio to 7.5 percent.
   3. (a) As of the effective date of this ORDER, the Bank shall eliminate from its books, by charge off or collection, all assets or portions of assets classified "Loss" and one-half of the loans classified "Doubtful", as of February 3, 1984, that have not been previously collected or charged off. Reductions of these assets through proceeds of loans made by the Bank are not considered collection for the purpose of this paragraph.
   (b) While this ORDER is in effect, the Bank shall eliminate from its books, by charge off or collection, all assets or portions of assets classified "Loss" as determined at any FDIC or State of * * * examination or visitation.
   4. (a) Effective with the date of this ORDER, and after charge off of the loans required in Paragraph 3(a) of this Order, the Bank shall establish and thereafter maintain an adequate reserve for loan losses through charges to current operating income. In complying with the provisions of this paragraph, the board of directors of the Bank shall review the adequacy of the Bank's reserve for loan losses prior to the end of each calendar quarter. The reviews shall consider, at a minimum, the Bank's loan loss experience, an estimate of potential loss exposure in the portfolio, trends of delinquent and nonaccrual loans, and prevailing and prospective economic conditions. The minutes of the board meeting at which such review is undertaken shall include complete details of the reviews and the recommended increases in the reserve for loan losses.
   (b) Within 60 days from the effective date of this ORDER, the Bank shall review Consolidated Reports of Condition and Reports of Income ("Reports") filed with the FDIC since June 30, 1983 to determine if the Reports accurately depict the condition of the Bank. If necessary and appropriate, said Reports will be amended. Such amended Reports shall properly reflect the financial condition of the Bank as of the respective date and in particular shall contain a loan valuation reserve and provision for loan losses sufficient to support the quality and volume of the loan portfolio. Reports filed after the effective date of this ORDER shall also accurately reflect the financial condition of the Bank as of the reporting date.
   5. As of the effective date of this ORDER, the board of directors of the Bank shall require that the officers of the Bank adhere to its duly adopted policies governing lending and collection of loans which were adopted January 12, 1984.
   6. (a) As of the effective date of this ORDER, the Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower whose loan or other credit has been classified, in whole or in part, "Doubtful" and/or "Loss" and is uncollected. The requirements of this Paragraph do not prohibit the Bank from renewing (after full collection in cash of interest due from the borrower) credit already extended to the borrower.
   (b) As of the effective date of this ORDER, the Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower obligated in any manner to the Bank on any extensions of credit (including any portion thereof) that has been charged off the books of the Bank so long as such credit remains uncollected.
   (c) As of the effective date of this ORDER, the Bank shall not extend directly or indirectly any additional credit to or for the benefit of any borrower whose loan or other credit has been classified "Substandard", unless the Bank's board of directors has signed a detailed written statement giving reasons why failure to extend such credit would be detrimental to the best interests of the Bank. The statement shall be placed in the appropriate loan file and included in the minutes of the applicable board of directors' meeting.
   7. Within 30 days of the effective date of this ORDER, the Bank will review and amend, if necessary, its duly adopted investment policy. This policy shall include, but not be limited to, provisions for consideration of credit quality, diversification, maturity distribution, marketability, and income of potential investments. The results of this review shall be reduced to writing and included in the minutes of the applicable meeting of the board of directors. Thereafter, the Bank will take all steps necessary to assure compliance with its investment policy.
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   8. (a) Effective with the date of this ORDER, the Bank will, to the best of its ability and in keeping with sound and prudent practices, require Bank officers to comply with the provisions of its duly adopted policies governing liquidity and funds management.
   (b) Within 60 days of the date of this ORDER, a plan will be submitted to the Regional Director to achieve an acceptable rate sensitivity balance between investments and funding sources and to lessen the reliance on short-term, potentially volatile liabilities for funding longer term assets. The plan shall include, at a minimum, goals and strategies for the end of each calendar quarter beginning with the quarter following submission of the plan.
   9. Effective with the date of this ORDER, the Bank shall not declare or pay either directly or indirectly any cash dividend, without the prior written consent of the Regional Director.
   10. Within 30 days from the effective date of this ORDER, the Bank will submit a plan acceptable to the Regional Director to reduce the concentration of credit in * * *, as reflected in the February 3, 1984 Report of Examination, to 25 percent of total equity capital and reserves or less.
   11. While this ORDER is in effect, the Bank shall give written notice to the Regional Director at such time as the Bank intends to make use of brokered deposits. The notification should indicate how the brokered deposits are to be utilized with specific reference to credit quality of investments/loans and the effect on the Bank's funds position and asset/liability matching. The Regional Director shall have the right to reject the Bank's plans for utilizing brokered deposits. For purposes of this ORDER, brokered deposits are defined to include any deposits funded by third party agents or nominees for depositors, including deposits managed by a trustee or custodian when each individual beneficial interest is entitled to or asserts a right to Federal deposit insurance.
   12. Within 60 days of the effective date of this ORDER, and every 60 days thereafter, the Bank shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. All progress reports and other written responses to this ORDER shall be reviewed by the board of directors of the Bank and made a part of the minutes of the board meeting.
   13. Following the effective date of this ORDER, the Bank shall send to its shareholders or otherwise furnish a description of this ORDER (1), in conjunction with the Bank's next shareholder communication and also (2), in conjunction with its notice or proxy statement preceding the Bank's next shareholder meeting. The description and any accompanying communication, statement or notice shall be sent to the FDIC at Washington, D.C., for review at least 15 days prior to dissemination to shareholders. Any changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice, or statement.
   14. The effective date of this ORDER shall be thirty (30) days from the date of its service upon the Bank. The provisions of this ORDER shall be binding upon * * * Bank, * * *, its directors, officers, employees, agents, successors, assigns and other persons participating in the affairs of such Bank.
   The provisions of this ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provisions of this ORDER shall have been modified, terminated, suspended or set aside in writing by the FDIC.
   By direction of the Board of Directors, this 16th day of September, 1985.
/s/ Hoyle L. Robinson
Executive Secretary
DATE ISSUED: June 10, 1985
FDIC-84-100b
APPEARANCES:
* * *, General Counsel
* * *, Assistant General Counsel
* * *, Regional Counsel
Federal Deposit Insurance Corporation
550 17th St., N.W.
Washington, D.C. 20249
Counsel for Proponent
* * *, Esquire
Counsel for Respondent
BEFORE: H. Maxwell Darks
Administrative Law Judge
RECOMMENDED DECISION
   On June 6, 1984, the Federal Deposit Insurance Corporation (hereinafter FDIC) issued a NOTICE OF CHARGES AND OF
{{4-1-90 p.A-647}}HEARING against respondent, * * * Bank * * *, pursuant to Section 8(b) of the Federal Deposit Insurance Act, 12 U.S.C. Section 1818(b). The Notice charged that respondent had engaged in unsafe or unsound banking practices within the meaning of Section 8(b)(1) of the Act in conducting the business of the Bank. Specifically, the notice charged the respondent was engaged in unsafe or unsound banking practices in that 1) the respondent has engaged in hazardous lending and lax collection practices resulting in an excessive volume of poor quality loans and an excessive volume of overdue and nonaccrual loans; 2) respondent has failed to provide adequate reserve for loan losses; 3) respondent has engaged in hazardous investment practices resulting in the acquisition of a long-term, illiquid securities portfolio and has been and is being operated without adequate liquidity and without proper regard for funds management; 4) respondent operated with management whose practices are detrimental to the Bank and jeopardized the safety of its deposits; and 5) respondent's Board of Directors has failed to provide adequate supervision and direction over the officers of the Bank to prevent unsafe or unsound banking practices. The Notice also called for a hearing to take evidence in order to determine whether an appropriate order should be issued under the Act requiring respondent 1) to cease and desist from the unsafe or unsound banking practices and/or 2) to take affirmative action to correct the conditions resulting from such practices.
   Enclosed with its Notice of Charges and of Hearing ("Notice"), FDIC included a Stipulation and Consent to the Issuance of an Order to Cease and Desist ("Consent Agreement") advising respondent that consent to such an order would obviate the need for an administrative hearing. The Consent agreement recites that the Order is issued before commencement of any hearing or adjudication and that the consent of the Bank to the issuance of the Order would not constitute an admission of any nature. The Board of Directors of the Bank did not enter into an agreement with the FDIC at this time.
   Counsel for the Bank filed an answer to the Notice which was received by FDIC on July 9, 1984, admitting certain allegations contained in the Notice and denying others.
   A formal hearing was held in this matter in * * *, before Administrative Law Judge H. Maxwell Darks, beginning on September 4, 1984 and concluding on September 12, 1984. The hearing record consists of a transcript in seven volumes consisting of approximately 1161 pages. The FDIC introduced 25 exhibits designated FDIC-1 through 25 and the Bank introduced 14 exhibits designated * * * -1 through 14.
   By these proceedings, the FDIC has proposed and is seeking a cease and desist order to, in part, bar the respondent from continuing the alleged unsafe or unsound banking practices and violations of law, rules and regulations, and require the Bank to take affirmative action to correct conditions resulting from any such violation of practice. Also pertinent to this controversy, the FDIC seeks in its proposed order to retain management in the Bank acceptable to the Regional Director of the FDIC's * * * Regional Office and require the respondent to maintain total equity and control reserves at not less than 7.5 percent of its average daily total assets for the months of March, June, September and December of each year. The proposed order also seeks to eliminate from the respondent Bank all assets classified "loss" and one-half loans classified as "doubtful"; require the respondent to maintain adequate reserves for loan losses; respondent Bank to develop a plan to achieve an acceptable rate sensitivity balance between investment and funding sources; respondent Bank to develop an acceptable plan to reduce concentration of credit in * * *, (hereinafter referred to as * * *); requires respondent Bank to give written notice to the Regional Director of FDIC at such times as respondent intends to make use of brokered deposits, with the Regional Director retaining the right to reject respondent's plan and effective with the date of the Order, no cash dividends (directly or indirectly) shall be granted without the prior written consent of the Regional Director, FDIC.
ISSUES
   The issues to be decided in this case are essentially as follows:
   Whether unsafe or unsound banking practices have occurred and, if so, whether a cease and desist order should be issued requiring the Bank to cease such practices
{{4-1-90 p.A-648}}as charged and to take affirmative action to correct conditions resulting from any such practice as specified in the proposed order.
Germane to the issues is whether post-examination evidence (after February 3, 1984) may be introduced and considered in the cease and desist proceedings.
FINDINGS OF FACTS
   I find the following facts based upon the entire record including the hearing proceedings, pleadings, evidence and the proposed findings of fact and conclusions submitted by the parties.
   1. The * * * Bank, a corporation existing and doing business under the laws of the State of * * * and having its principal place of business in * * *, is and has been, at all times pertinent to this proceeding, an insured state nonmember bank. The Bank is subject to the Federal Deposit Insurance Act (12 U.S.C., Section 1811 through 1831d), the Rules and Regulations of the FDIC (12 C.F.R. Chapter III), and the laws of the State of * * *. The FDIC has jurisdiction over the Bank and the subject matter of this proceeding.

   [.1] 2. The purpose of an examination of a bank by the FDIC is to determine the safety and soundness of the institution, to assess the financial condition of the bank, and its compliance with applicable law and regulations.
   3. The Bank was examined by the FDIC as of the close of business on November 13, 1981, June 10, 1983, and February 3, 1984, and written reports were issued.
   4. The examination of the Bank as of February 3, 1984, was conducted in accordance with outstanding examination instructions, guidelines, standards, and criteria.
   5. As of February 3, 1984:
   (a) The Bank's total equity capital and reserves equaled $6,444,000.
   (b) The Bank's adjusted equity capital and reserves equaled $3,460,000.
   (c) The Bank's adjusted total assets equaled $67,283,000.
   (d) The Bank's total deposits equaled $63,109,000.
   (e) The Bank's total loans net of unearned income equaled $36,397,000.
   6. During the FDIC examination of the Bank conducted as of the close of business of February 3, 1984, certain assets of the Bank were analyzed for quality and were either passed (a loan which has been reviewed and not classified) or were specially mentioned or were assigned adverse classifications of "Substandard", "Doubtful" or "Loss" depending on the degree of risk to the Bank of each loan so analyzed.
   7. The FDIC's assignment of an adverse classification is an expression of the degree of the risk to the Bank that a certain loan will not be fully paid by a borrower in accordance with its stated terms.
   8. As of February 3, 1984, the following individuals were employed by the Bank:
   * * *, Chairman of the Board, elected to the Board June 10, 1965.
   * * *, President and Chief Executive Officer, hired on or about November 10, 1983.
   * * *, Executive Vice President, hired on or about June 9, 1983.
   * * * was President and Chief Executive Officer of the Bank from on or about October 1974 until January 1984. He joined the Bank in 1968.
   In passing, the Administrative Law Judge wishes to state that the selection of * * * as President and Chief Executive Officer and * * * as Executive Vice President was a step in the right direction in improving the quality of the management staff of the Bank.
   9. The Bank has engaged in unsafe or unsound banking practices in that the Bank has engaged in hazardous lending and lax collection practices, as evidenced by the following:
   (a) The Bank has extended credit to borrowers that was not adequately secured. The loans to * * *, and * * *, $382,178 and $4,000 respectively, were not adequately secured because the collateral held by the Bank was not adequate to cover the amount of the debt. * * * is in bankruptcy; and therefore, future earnings would not be a source of repayment. Other loans include * * * $186,123; * * * $119,906; * * *, $138,907; * * * $103,000; * * * $149,000; and * * * $497,000.
   (b) The Bank has extended credit or renewed loans to borrowers without complete and current financial information, as shown by the table with the heading "Assets Listed For Technical Exceptions". Some of the loans which are classified as "Substandard", "Doubtful", or "Loss" elsewhere
{{4-1-90 p.A-649}}in the report are also instances where the Bank has extended credit to borrowers without complete and current financial information. This includes loans to * * *, $497,000; * * * $72,000; and * * * $69,000 and $32,000.
   (c) The Bank has failed to establish and enforce programs for the repayment of loans, and has refinanced credits to borrowers without improving collateral margins. This practice exposes the Bank to a greater than normal risk. If the Bank is not aware of the borrower's financial situation, the Bank could be making a loan that cannot be repaid. The loans made to * * * and * * *, $209,088 and $18,522 respectively, consisted of four notes, three of which were renewals of prior notes. The same situation occurred in the handling of the * * * notes, $138,907. One note had been extended four times and another note with a balance of $94,000 had been renewed with interest added and extended four times without reduction. Other loans included the loan to * * *, $497,000; * * * $72,000; * * * $69,000 and $32,000.
   (d) The Bank renewed and/or extended the due dates of loans without collection in cash of interest due. As part of the Officers' Questionnaire provided by the Bank at the time of the examination and included in the report, the Bank was required to furnish a list of extensions of credit which when they were renewed or extended added the then due interest to principal. The Bank did furnish such a list showing 12 loans, totaling $427,000. This practice is generally considered unsafe and unsound because of inability to pay interest when due may be a sign of financial difficulty on the part of the borrower. Examples of the problems which can occur when loans are renewed with the payment of interest are evident among the classified loans including the loans to * * * and * * *.
   10. As a result of hazardous lending and lax collection practices, as shown in the Report of Examination as of February 3, 1984, the Bank had an extensive and disproportionately large volume of poor quality loans in relation to the Bank's total loans. Adversely classified loans as of February 3, 1984, consisted of $3,855,000 "Substandard", $352,000 "Doubtful", and $616,000 "Loss". This totals $4,823,000 and represented 13.3 percent of total loans and 74.8 percent of total equity capital and reserves.
   11. The percent of classified loans to total equity capital and reserves has increased from 35 percent as shown in the Report of Examination as of November 13, 1981, to 53 percent as of June 10, 1983, to 74.8 percent as of February 3, 1984.
   12. The Bank has an extensive volume of loans that are overdue or are on nonaccrual.1 As of February 3, 1984, there were 123 overdue loans totaling $2,403,000 or 6.31 percent of total loans, and 102 loans on nonaccrual totaling $2,666,000. Loans in these categories equaled 13.3 percent of gross loans of $38,089,000. The Report of Examination dated as of February 3, 1984 incorrectly states that overdue and nonaccrual loans are 13.9 percent of the Bank's gross loans.
   13. The Bank has engaged in unsafe and unsound banking practices in that the Bank has failed to provide an adequate reserve for loan losses. As of February 3, 1984, the balance of the loan valuation reserve account was $256,000. As of the same date, loans classified "Loss" totaled $616,000, more than two times the amount in the reserve account. Loans classified "Doubtful" totaled $352,000 and loans classified "Substandard" totaled $3,855,000 and no provision was made in the reserve for losses which may have to be realized in this portion of the portfolio.
   14. As a result of the Bank's failure to reflect on their earnings statement an adequate loan valuation reserve, earnings were overstated. Another result of a bank's failure to adequately provide for potential losses is that inaccurate Consolidated Reports of Condition and Reports of Income may be filed.
   15. As of February 3, 1984, the total assets of the Bank consisting primarily of loans, cash and securities were $70,011,000 and the adjusted total assets were $67,283,000.
   16. As of February 3, 1984, adversely classified assets equaled 194 percent of total equity capital and reserves.
   17. As of February 3, 1984, the Bank had invested the sum of $6,738,000 in * * * in

1 Overdue loans are loans where interest is past due 30 days or more. Loans on nonaccrual are loans not accruing interest because full payment of interest in not expected.
{{4-1-90 p.A-650}}25 bonds. The Bank purchased three bonds in 1977, two additional bonds totaling $750,000 in 1979, and in 1980, the Bank purchased 20 bonds totaling $4,197,000 between January and June of that year. The maturities on these bonds ranged from July 1, 1999 to July 1, 2012.
   18. As of February 3, 1984, the current market value of the * * * was $3,264,000.
   19. The bond ratings on * * * were suspended by Standard and Poor's Corporation in May 1983 and by Moody's Investor Service in June 1983.
   20. Instructions issued by the FDIC Division of Bank Supervision and contained in a memorandum dated August 23, 1983, and a credit review dated August 11, 1983, provided that * * * issued for Projects 1, 2 and 3 were considered of subinvestment quality; and therefore, the market depreciation was to be classified "Doubtful" and the remaining book value was to be classified "Substandard".
   21. The * * * are classified primarily because of the legal uncertainties surrounding the issuer, * * *.
   22. As of February 3, 1984, and based upon instructions from * * * purchased by the Bank totaling $6,738,000 were classified "Substandard" in the amount of $3,264,000 and "Doubtful" in the amount of $3,474,000. The total of these adversely classified securities equaled 104.6 percent of total equity capital and reserves. Market depreciation of $3,474,000 in the * * * equaled 53.9 percent of total equity capital and reserves.
   23. The investment in * * * of $6,738,000 and equal to 104.6 percent of equity capital and reserves is a concentration of credit, defined as an obligation which represents 25 percent or more of the Bank's total equity capital and reserves, and poses undue risk to the Bank and in contravention of the basic principle of risk diversification.
   24. The investment in * * * is unsafe or unsound because of its size, and the significant market depreciation inhibits the Bank's liquidity. The * * * cannot easily be sold; and therefore, the Bank is presently locked into keeping these low interest rate, extended maturity, * * *.
   25. The Bank has engaged in hazardous investment practices which have resulted in the Bank acquiring a long term, illiquid securities portfolio. Without regard to the Bank's investment in * * *, only one percent of the Bank's securities portfolio matures in one year or less, and 31 percent of the portfolio matures in ten years or more. If the Bank's investment in * * * were included at book value, then only .77 percent of the Bank's securities portfolio would mature in one year or less and 49.08 percent of the portfolio would mature in ten years or more.
   26. The result of the Bank's heavy reliance on long-term assets, in the form of long-term, illiquid securities, is that the bank is unable to make adjustments for rises in interest rates it may have to pay in order to keep or attract depositors; and therefore, in years when rates are high the Bank's earnings will be impaired.
   27. The Bank has engaged in unsafe and unsound banking practices in that it has operated without adequate liquidity2 and without proper regard for funds management as evidenced by the following:
As of February 3, 1984:
   (a) Net cash, short-term and marketable securities of $11,855,000 (exclusive of the * * *) equaled only 21.69 percent of net deposits and short-term liabilities of $54,665,000. This percent is the liquidity ratio of the Bank.
   (b) If the * * * were included in the above computation of liquidity at their book value (and assuming that the bonds could be sold at book value), then the liquidity ratio would be 27.66 percent.
   (c) The liquidity ratio for the Bank is inadequate.
   28. As of February 3, 1984, the Bank had four depositors with accounts that totaled collectively $7,755,000, a sum equal to 12.3 percent of all deposits.
   29. As of February 3, 1984, the dependency ratio of the Bank, that is, the percentage of long-term assets funded by rate sensitive and potentially volatile liabilities was 39.0 percent. This ratio is not adequate, and maintenance of a dependency ratio of 39.0 percent is an unsafe or unsound banking practice.
2 Liquidity describes the relationship of short-term, marketable assets to short-term liabilities. It is the relative ability of the bank to meet the demand of depositors.
 {{4-1-90 p.A-651}}
   30. Assets subject to interest rate adjustment within a six-months time period beginning February 3, 1984, equaled only 44.8 percent of liabilities subject to interest rate adjustment within the same six-months time period. The same ratio computed on a twelve-month basis equaled only 51.0 percent.
   31. There has been a deterioration in earnings in the Bank in the last three years. In 1981, the bank suffered losses; in 1982, the Bank's net income was somewhat improved at $902,000. In 1983, the Bank reported net income after dividends of $225,000; however, as of February 3, 1984, the Bank reported $616,000 in losses, which if recognized at the end of 1983 would have been well in excess of the net income of the Bank.
   32. The Bank overstated its earnings as of December 31, 1983, by failing to take into account the actual condition of the loan portfolio before determining earnings and dividends.
   33. The capital of the Bank has deteriorated in the past three years. As of February 3, 1984, total equity capital and reserves less adjustments for assets classified "Loss" and 50 percent of assets classified "Doubtful" and including the FDIC classification of * * * was 5.14 percent of adjusted total assets. The adjusted capital ratio (adjusted for loans classified "Doubtful" and "Loss") without consideration of * * * is 7.8 percent.
   34. During a period of several years, the Board of Directors of the Bank had failed to adequately supervise and direct the active officers of the Bank. It is the responsibility of the Board to establish policies and procedures pursuant to which management will operate the Bank and to insure that management is carrying out these policies. The Board of Directors failed in this responsibility.
   35. As of February 3, 1984, the Bank had been operated with management whose policies and practices were detrimental to the Bank and jeopardized the safety of the Bank's deposit. The President and Vice President have done the best they could with the condition created in the bank prior to their employment.

CONCLUSIONS OF LAW

       Whether unsafe or unsound banking practices have occurred and, if so, whether a cease and desist order should be issued requiring the bank to cease such practices as charged and to take affirmative action to correct conditions resulting from any such practices as specified in the proposed FDIC order.
   This case arises in the regulatory scheme under the Financial Institutions Supervisor Act of 1966, Public Law No. 89–695, 80 Stat. 1028, as amended. Under that act, codifying the supervision and regulation of the several systems of banks, i.e., national banks, state member banks, and state non-member banks, the FDIC retains its mandate to supervise and regulate state non-member banks. Section 202 of the Financial Institutions Supervisory Act amended Section 8 of the Federal Deposit Insurance Act by adding, among other things, subsection (b), under which these proceedings are brought.
       1. This Bank is subject to the Federal Deposit Insurance Act (12 U.S.C. Section 1811 through 1831d) the rules and regulations of the FDIC (12 CFR Chapter III); therefore the FDIC has jurisdiction over the Bank and the subject matter of this proceeding and authority to issue an order to cease and desist against the Bank under Section 8(b)(1) of the Act.
Unsafe or unsound banking practices
   It is provided in Section 8(b)(1) of the Federal Deposit Insurance Act (Title XII, U.S.C. Section 1818(b)(1)), in pertinent part:
       (b)(1) If, in the opinion of the appropriate federal banking agency, any insured bank, bank which has insured deposits, or any director, officer, employee, agent, or other person participating in the conduct of the affairs of such a bank is engaging or has engaged, ... in an unsafe or unsound practice in conducting the business of such bank, or in violating or has violated,...a law, rule, or regulation, or any condition imposed in writing by the agency ... the agency may issue and serve upon the bank or such director, officer, employee, agency, or other person a notice of charges in respect thereof. The notice shall contain a statement of the facts constituting the alleged viola- {{4-1-90 p.A-652}}
    tion or violations or the unsafe or unsound practice or practices, and shall fix a time and place at which a hearing will be held to determine whether an order to cease and desist therefrom should issue against the bank or the director, officer, employee, agent, or other person participating in the conduct of the affairs of such bank.

   [.2] While the Act refers to "unsafe or unsound" banking practices, it does not define that phrase or enumerate specific acts and conduct which constitute such practices. As pointed out by the FDIC in its original brief, as to whether a particular practice is unsafe or unsound may be established as a matter of fact through the testimony of a bank examiner. First National Bank of Eden v. Department of the Treasury, 568 F2d 610 (8th Cir. 1978). In Eden the court approved the definition of "unsafe or unsound" by the Comptroller of the Currency, stating:

   [.3] Also as noted by the FDIC, the courts have accepted the comptroller of the Treasury's definition of the phrase "unsafe and unsound".

       Congress did not define unsafe and unsound banking practices in Section 1818(b). However, the Comptroller [of the Currency] suggests that these terms encompass what may be generally viewed as conduct deemed contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder.1
Id. at 611 n.2. Accord, First National bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 685 (5th Cir. 1983).
   The Eden court also deferred to the expertise of the Comptroller of the Currency in defining what constitutes an unsafe or unsound practice, stating that the courts could only overturn an agency's determination based on a showing of arbitrary and capricious judgment. If substantial evidence supported the agency, its determination would stand. 568 F.2d at 611. See also, In re Franklin National Bank Securities Litigations, 478 F. Supp. 210 (E.D.N.Y. 1979).
   The trend of judicial review of bank regulatory action under Section 8(b) of the Act has been to defer to the expertise of the bank regulatory agencies in defining what constitutes an unsafe or unsound practice and limiting review to a determination of whether the action taken by the regulatory agency was arbitrary, capricious, or otherwise unsupported by substantial evidence. The Fifth Circuit in Groos National Bank v. Comptroller of the Currency, 573 F.2d 889, 897 (5th Cir. 1978), noted:
       The phrase "unsafe of unsound banking practice" is widely used in the regulatory statutes and in case law, and one of the purposes of the banking acts is clearly to commit the progressive definition and eradication of such practices to the expertise of the appropriate agencies.
   The District of Columbia Circuit in Independent Bankers Association of American v. Heimann, 613 F.2d 1164 (D.C. Cir. 1979) considered whether the Comptroller could statutorily define a particular "unsound or unsafe" practice. The Comptroller's challenged regulations prevented national bank insiders from receiving commissions for credit life insurance sold to the bank's borrowers.2 In upholding the regulation, the court stated that the agencies' discretionary authority to define and eliminate unsafe or unsound practice is to be "liberally construed". Id. at 1169.
   In First National Bank of La Marque v. Smith, 610 F.2d 1258 (5th Cir. 1980), the court affirmed the Comptroller's definition of "unsafe or unsound" practices reported in Eden. The Fifth Circuit held that payment of credit life insurance commissions to bank insiders constituted an unsafe or unsound banking practice. Id. at 1265.
   As my findings of fact detail, * * * Bank * * * engaged in practices of extending credit under questionable circumstances. The Bank has also engaged in hazardous lending and lax collection practices.
   The Bank has engaged in the following unsafe or unsound practices within the meaning of Section 8(b)(1) of the Act:
       (a) by extending credit to borrowers which were inadequately secured;
1 The practices must be analyzed in light of all relevant factors: [W]hat may be an acceptable practice for an institution with a strong reserve position, such as concentration in higher risk lending, may well be unsafe or unsound for a marginal operation.
   Financial Institutions Supervisory and Insurance Act of 1966; Hearings on S. 3158 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess., 49–50 (1966).
2 This practice is permitted in state non-member banks in * * * and * * * even though insiders in national banks in the same state are not permitted to receive such commissions.
 {{4-1-90 p.A-653}}
       (b) by extending credit or renewing loans to borrowers without complete and current financial information;
       (c) by failing to establish and enforce programs for the repayment of loans and by refinancing credits to borrowers without improving collateral margins;
       (d) by renewing or extending the due dates on loans without the collection in cash of interest due;
       (e) by operating with an excessive level of adversely classified assets in relation to the total equity capital and reserves of the Bank;
       (f) by operating with an excessive volume of overdue and non-accrual loans.
   In re: First State Bank of Wayne County, Monticello, Kentucky, FDIC-83-132(b) (FDIC decision dated June 19, 1984), appeal docketed, No. 84-3562 (6th Cir. July 18, 1984) held that failing to establish and enforce realistic programs for repayment of loans, extending credit that is inadequately secured and extending credit without complete and current credit information were unsafe or unsound practices.3 The facts clearly support the conclusion that the hazardous lending and lax collection practices of this bank were unsafe or unsound as construed under Section 8(b) of the Act.
   2. I therefore conclude that the Bank has engaged in unsafe or unsound practices within the meaning of Section 8(b)(1) of the Act.
   (a) by extending credit to borrowers which is inadequately secured;
   (b) by extending credit or renewing loans to borrowers without complete and current financial information;
   (c) by failing to establish and enforce programs for the repayment of loans, and by refinancing credits to borrowers without improving collateral margins;
   (d) by renewing or extending the due dates on loans without the collection in cash of interest due;
   (e) by operating with an excessive level of adversely classified assets in relation to the total equity capital and reserves of the Bank;
   (f) by operating with an excessive volume of overdue and nonaccrual loans.
   * * * Bank has engaged in an unsafe or unsound banking practice within the meaning of Section 8(b)(1) of the Act by failing to make provision for an adequate reserve for loan losses of the Bank, which has had the effect of misrepresenting and misstating the actual earnings and income of the Bank.
   As my findings detail, as of February 3, 1984 the balance of the loan valuation reserve account was $250,000. As of the same date, loans classified "loss" total $616,000, more than 2 times the amount in the reserve account. Loans classified "doubtful" totaled $352,000, and loans classified "substandard" totaled $3,855,000, and no provision was made in the reserve for losses which may have to be realized in this portion of the portfolio. As a result of the Bank's failure to reflect on their earnings statement and adequate loan evaluation reserve, earnings were overstated. As noted by the FDIC brief, the legislative history of Section 8(b) of the Act [12 U.S.C. Section 1818(b)] indicates that the "failure to make adequate transfers to reserves for absorbing losses" is an unsafe or unsound practice. Financial Institutions Supervisory and Insurance Act of 1966: Hearings on S. 3158 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess. 49–50 (1966). Although the federal banking agencies normally treat this practice as an unsafe or unsound banking practice rather than a violation of reporting requirements [e.g. Section 7(a)(1) of the Act (12 U.S.C. Sec-
3 Investment in loans on the basis of overappraisal of the security property; ... disregard of a borrower's incapacity and inability to repay his loan; and lack of any systematic collection program; failing to provide for liquidity; and ... failure to make adequate transfers to reserves for absorbing losses" were specifically mentioned on Chairman Horne's memorandum. Financial Institutions Supervisory and Insurance Act of 1966: Hearings on S. 3158 Before the House Comm. on Banking and Currency, 89th Cong., 2d Sess., 49–50 (1966).
   The loan portfolio is typically one of the most important categories of assets of a financial institution, both in terms of value and risk of loss. Because of the singular importance to financial institutions of the allowance for possible loan losses, the understatement of the allowance will cause quarterly financial results to be inaccurate, frequently to a material degree. In order to insure that their quarterly financial statements accurately state results of operations and financial condition, publicly-held, financial institutions have a duty to monitor the sufficiency of the allowance for possible loan losses on at least a quarterly basis. This duty can only be satisfied if management bases the amount of the allowance upon a consideration of all relevant factors, including but not limited to the historical experience of the institution, the collectibility of individual loans comprising the portfolio (including their current status and performance) and the impact of the current economic environment on the portfolio.
 {{4-1-90 p.A-654}}tion 1817(a)(1))] the considerations are the same as those governing registered financial companies under the securities laws:

   [.4] As noted, In re Utica Bankshares Corp., Exchange Act Release No. 20,702, Fed. Sec. L. Rep (CCH) Para. 73,424, at 63,098 (Feb. 29, 1984). One obviously relevant factor to consider in determining an adequate reserve is the opinion of federal bank examiners.
   Midland Bank and Trust Company v. Fidelity and Deposit Company of Maryland. 442 F. Supp. 960 (D.N.J. 1977) demonstrates that the lack of a repayment program can conceal deficiencies in credit quality:
   When loans would become past due, * * * and/or * * * would bring them up to date with renewal loans. Certain loans were repeatedly renewed without any payments being forthcoming. The fact that the Bank was not making any money on these loans and that all of these notes were delinquent was concealed by * * * , who in his monthly operating reports to the board listed renewal notes as new loans.
   As argued by FDIC, although classification is a judgmental exercise, there is ample evidence that it is a meaningful one. Thus, of $719,000 in "adversely classified" loans and $2,205,000 in "especially noted" loans in the Midland Bank and Trust Company case in which the FDIC did not seriously doubt ultimate collectibility (442 F. Supp. at 967), that bank ultimately lost more than $2,600,000.
   The purpose of the loan valuation reserve is to reveal the actual condition of the loan portfolio of the bank. Rules and regulations of the Internal Revenue Service with regard to permissible reserves for losses for bad debts (26 U.S.C., Section 585) are not germane to the disclosure issues addressed by the FDIC (or the Securities Exchange Commission), when it requires that adequate reserves be maintained. The primary issue is disclosure. Since transfers to the loan valuation reserve are usually made from current earnings, excess transfers to the reserve do not affect the taxes that a bank may pay because excess transfers are deductions from earnings. In the event that the reserve is understated, the effect is to overstate earnings and this can only result in increased taxes. I find that the transfers it would require to the reserves would not be in excess of the reserves that this Bank would need based upon its loan loss experience in the past 3 years. The facts clearly indicate that * * * Bank has engaged in unsafe and unsound banking practices by failing to maintain an adequate reserve for possible loan losses.
   3. I therefore conclude that the Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) by failing to make provisions for an adequate reserve for loan losses of the Bank which has had the effect of misrepresenting and misstating the actual earnings and income of the Bank.
   * * * Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by hazardous investment practices which consist of the purchase of * * * in an amount equal to more than 100 percent of the equity capital and reserves of the Bank and the acquisition of a long-term, illiquid securities portfolio.
   My findings further conclude that the total investment of $6,738,000 is equal to 104.6 percent of equity capital and reserve and represent a concentration of credit, defined as an obligation which represent 25 percent or more of the Bank's total equity capital and reserves, and poses undue risk to the Bank in contravention of the basic principle of risk. Market depreciation of * * * equaled 53.9 percent of total equity capital and reserves. My findings further expand the fact that without regard to the Bank's investment in * * *, only one percent of the Bank's securities portfolio matured in one year or less and 31 percent of the portfolio futures in 10 years or more. If the Bank's investment in * * * were included at book value, then only .77 percent of the Bank's securities portfolio would mature in one year or less and only 49.08 percent of the portfolio would mature in 10 years or more. The results of the Bank's heavy reliance on long-term assets, in the form of long-term, illiquid securities, is that the bank is unable to make adjustments for rises in interest rates it may have to pay in order to keep or attract depositors; and therefor, in years when rates are high the Bank's earnings will be impaired. As the above facts detail, the size of * * * investment and the significant market depreciation inhibits the Bank's liquidity as the securities cannot be easily sold; therefore the Bank is presently locked into keeping these low interest rate, extended maturity, Securities. For the above reason as stated, I {{4-1-90 p.A-655}}
conclude that the cease and desist order requiring that the Bank provide management acceptable to the Regional Director of the FDIC's Regional Office which should include a qualified chief executive officer who shall be given stated authority in writing by the board of directors of the Bank, which includes the responsibility for implementing and maintaining lending and investment policies in accordance with sound banking practices should be enforced. The order also requires the Bank to submit a plan acceptable to the Regional Director to reduce the concentration of credit in * * * reflected in the report of examination as of February 3, 1984 to 25 percent of total equity capital and reserves of the Bank or less.
   4. I therefore conclude that the Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by engaging in hazardous investment practices which consist of the purchase of * * * in an amount equal to more than 100 percent of the equity capital and reserves of the Bank and the acquisition of a long-term illiquid securities portfolio.
   * * * Bank has also engaged in an unsafe or unsound practice by failing to maintain adequate liquidity for the bank, and without proper regard for funds management. As of February 3, 1984, net cash, short-term and marketable securities of $11,855,000 (exclusive of the * * * equaled only 21.69 percent of net deposits and short-term liabilities of $54,665,000. This percent is the liquidity ratio of the bank which describes the relationship of short-term, marketable assets to short-term liability. This percentage means the Bank's relative ability to meet the demands of the depositors is unsound; thus the liquidity ratio for the bank is inadequate.
   5. I therefore conclude that the Bank has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by failing to maintain adequate liquidity for the Bank, and without proper regard for funds management.
   * * * Bank, through its Board of Directors, has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by failing to provide adequate or effective supervision over and direction of the active officers and management of the bank to prevent or abate the unsafe or unsound practices as have been previously described above. As noted in the brief by FDIC, representatives had been concerned with the financial condition of the Bank for a number of years. The report of examination dated as of November 13, 1981, disclosed that the Bank was experiencing serious deterioration in its liquidity position, earnings and asset quality. Of some concern was the fact that in 1979 and 1980 the Bank had purchased $6,691,000 of securities issued by the * * *. As noted in the report of examination, the securities were adversely affecting the liquidity of the bank, its capital and earnings due to depreciation and the long term maturities. After the examination, the board of directors of the Bank was asked to enter into a memorandum of understanding with the FDIC to address some of the problems which were evident. The board refused to enter into a memorandum of understanding. The next complete examination of the Bank was as of June 10, 1983. The Bank at this time was still experiencing liquidity problems and a deterioration of capital and earnings. There was also further deterioration in the Bank's loan portfolio and the loan valuation reserve was not adequate to reflect the actual condition of the Bank. A major contributor to the liquidity problem of the Bank was believed to be the * * *. Management was also considered unwilling or unable to make needed improvements. The board was asked to enter into a memorandum of understanding with the FDIC and they refused. The Bank was next examined as of February 3, 1984. As a result of this examination, the report indicated that the condition of the Bank had deteriorated to a point where positive and decisive action was mandatory. Further deterioration was noted in the Bank's capital, earnings and liquidity position. A third memorandum of understanding addressing problems revealed by this examination was presented to the board shortly after conclusion of the examination. The board did not enter into an agreement with the FDIC at this time. As noted by the FDIC brief, despite repeated comments from FDIC examiners that the condition of the Bank was deteriorating and that loan problems were increasing due to liberal lending and weak loan administration, the board of directors did very little to actively manage and control the Bank. Bank directors have a duty to direct the affairs of {{4-1-90 p.A-656}}
the Bank. The standard of care of directors of banks was set forth by the Supreme Court in Briggs v. Spaulding, 141 U.S. 132, 165-66 (1891):

       [W]e hold that directors must exercise ordinary care and prudence in the administration of the affairs of a bank, and that this includes something more than officiating as figure-heads. They are entitled under the law to commit the banking business, as defined to their duly authorized officers, but this does not absolve them from the duty of reasonable supervision, nor ought they to be permitted to be shielded from liability because of want of knowledge of wrong-doing, if that ignorance is the result of gross inattention. ...

   [.5] The responsibility imposed on directors cannot be delegated to others, and it is negligent for directors to leave the management of a corporation entirely to others. Heit v. Bixby, 276 F. Supp. 217, 231 (E.D. Mo. 1967). Directors of a bank may not escape liability based upon the fact that they had appointed as managing officer a person of good reputation. Gibbons v. Anderson, 80 F. 345 (W.D. Mich. 1897). Further, although a bank director may need only ordinary attention to the affairs of the institution in ordinary circumstances, if a director knows or by the exercise of ordinary care should have known any facts regarding the condition of the bank which would have put him on notice of the deteriorating condition, then the director must exercise the degree of care commensurate to the evil to be avoided. Rankin v. Cooper, 129 F. 1010 (W.D. Ark. 1907). See also Speer v. Dighton Grain, Inc., 624 P. 2d 952 (Kan. 1981).
   Although there is no allegation that the board of directors of the Bank has violated laws, rules or regulations with regard to the operation of the Bank, responsibility for the deteriorated condition of the Bank rests with the board of directors and it cannot be avoided by the declaration that the President of the Bank who had been President of the Bank for approximately ten years was "less than forthright and honest" in his dealings with the board.
   As noted in my comments with respect to the Bank's large investment of * * * affecting the liquidity of the Bank, I concluded that the cease and desist order should require the Bank to provide management acceptable to the Regional Director of FDIC, including a qualified chief executive office who shall be given stated authority in writing by the Board of Directors of the Bank which includes the responsibility for implementing and maintaining lending and investment policies in accordance with some banking practices. This would also require the Bank to submit a plan acceptable to the Regional Director, FDIC, to reduce the concentration of credit in * * * to 25 percent or less of total equity capital and reserves of the Bank.
   6. I therefore conclude that the Bank, through its board of directors has engaged in an unsafe or unsound practice within the meaning of Section 8(b)(1) of the Act by failing to provide adequate or effective supervision over and direction of the active officers and management of the Bank to prevent or abate the unsafe or unsound banking practices as described above.
       Whether practices which occurred after the conclusion of the examination upon which cease and desist proceedings are heard should be introduced and considered in determining if such order should be issued.

   [.6] * * * Bank has taken the position that the findings of the Court determine the condition of the bank as of March 15, 1985 rather than February 3, 1984. The FDIC argued during the hearing and in it's brief that any evidence of the condition of the Bank since February 3, 1984 is irrelevant and immaterial. On the other hand, it is the Bank's position that the evidence of matters occurring after February 3, 1984 must be taken into account by the hearing officer and ultimately the FDIC in deciding whether or not this has bearing upon the primary issue and deciding whether or not a cease and desist order is appropriate and should issue. While the bank filed a lengthy brief, their argument relies mainly on their belief that the acts of * * * , former President who was removed from office, was responsible for any wrongful acts of the Bank and that any evidence received thereafter would absolve the Bank from any wrongful act, however, the Bank has provided no evidence to support their conclusions. The only evidence the Bank introduced since February 3, 1984 was contained in one exhibit entitled daily statement of condition issued September 11, 1984. This document does not show the adequacy of the reserves, the liquidity or the business practices of the {{4-1-90 p.A-657}}
Bank. It does show that the equity capital and reserves of the bank had decreased 14.3 percent since the report of examination as of February 3, 1984. Historical events leading up to and prior to the issuance of notice of charges and of hearing by the FDIC clearly indicate that the condition of the bank has deteriorated quickly and without notice. The report of examination on November 13, 1981, again on June 10, 1983, and February 3, 1984, were presented to the Bank and on each occasion the examination showed a weakening and deteriorated condition. As stated by the FDIC brief, there is clearly room for doubt that the Bank will never again engage in the same or similar practices alleged by the FDIC in the present proceeding. Unless the Bank can make an initial showing that complete future compliance is guaranteed, practices of the Bank occurring after the close of the pertinent reports are irrelevant to the issuance of a cease and desist order and the remedy contained therein and should be excluded. Exclusion of such practices is essential where, as here, by relying on subsequent corrective actions the Bank will be free to repeatedly violate the law and engage in future harmful conduct with impunity.
   I therefore find that transactions and events occurring after February 3, 1984, should be excluded. Accordingly, I conclude that for purposes of proving and defending the allegations of unsafe or unsound practices and violations of law in the cease and desist actions, the relevant time period is prior to and including February 3, 1984.

Whether a cease and desist order should be issued.

   [.7] Since the evidence clearly demonstrates that * * * Bank engaged in unsafe or unsound bank practices, it must next be decided whether the issuance of a cease and desist order is appropriate. Section 8(b)(1) of the Federal Deposit Insurance Act, 12 U.S.C. Section 1818(b)(1978), provides in pertinent part that a cease and desist order may be issued against any bank:

       [i]f upon the record made at any ... hearing, the agency shall find that any violation or unsafe or unsound practice specified in the notice of charges has been established ... Such order may ... require the bank ... to cease and desist from the same, and, further, to take affirmative action to correct the conditions resulting from any such violation of practice.
   The Bank argues that a cease and desist order should not be issued since the charged practices prior to January, 1984 were when * * * , was associated with the Bank; that he engaged in some unsafe and unsound banking practices on behalf of the Bank; he engaged in hazardous lending and lax collection practices but that from and since September 19, 1983 when * * * was no longer associated with the Bank and * * * was employed as executive vice president of the Bank, the Bank has not engaged in such unsafe or unsound banking practices by such hazardous lending or lax collection practices. Further that since * * * became President of the Bank on November 1, 1983, the Bank had adopted and followed sound lending and collection policies and the Bank was not engaged in hazardous lending or lax collection practices from and since that date. The Bank argued that as a result of * * * hazardous lending and lax collection practices, the bank does have, at this time, an excessive volume of overdue and non-accrual loans but the Bank is acting responsibly and appropriately for the collection of such loans and the resolution of the problems such loans present. The Bank also argues that they have not engaged in unsafe and unsound banking practices by failing to provide an adequate reserve for loan losses inasmuch as no Bank can reasonably anticipate the financial consequences of the dishonesty of it's chief lending officer and President. The Bank also argues that the reserve for loans losses provided by the Bank were reasonable and adequate under ordinary circumstances and the directors of the Bank were unable to foresee and provide for the dishonesty of * * * in the reserve for the losses. However, the plain language of the above regulation indicates that the violation need not be ongoing and the case law is in accord. Section 8(b) of the Act provides, in applicable part, that a cease and desist order may be issued against any bank director or officer who is engaging or has engaged in an unsafe or unsound practice. Section 8(b) encompasses unsafe or unsound practices which are ongoing at the time of the issuance of the order and those that have already occurred. The plain language of the above {{4-1-90 p.A-658}}
regulations and case law indicates that the violations need not be ongoing at the moment of issuance of a cease and desist order by FDIC. The FDIC brief citing certain cases indicate administrative and judicial interpretation of the cease and desist powers of the national labor relation board and the federal telecommunications is in accord.
   In Lakeland Bus Lines, Inc. v. NLRB, 278 F.2d 888 (3rd Cir. 1960), the NLRB had issued a cease and desist order against Lakeland Bus Lines, Inc. Lakeland argued that it had discontinued its unfair labor practices and that there was no longer a basis for the issuance of an order. In dismissing Lakeland's argument, the 3rd Circuit stated:
       "Authority thoroughly establishes that compliance itself is not sufficient to deprive the board of its right to secure enforcement to make sure that repetition of the unfair labor practices does not occur in the future."
   In. NLRB v. Globe-Wernicke Systems Company, 336 F.2d 589 (6th Cir. 1964), Globe-Wernicke argued that a cease and desist order should not be enforced because the company had complied with the order. The Court disagreed, noting:
       "It is well settled that compliance with an order of the board is no defense to an entry of an order of enforcement. Abandonment of an unfair labor practice does not cause the controversy to become moot."
   Cases interpreting the power of the FTC are similar in result to the NRLB cases. In J. M. Sanders Jewelry Company 85 FTC 250(1975), the FTC adopted as a final order the initial decision of an Administrative Law Judge holding the defense of discontinuance to be without merit because:
       "Even assuming, arguendo, that respondent is now complying with all the requirements of the Truth in Lending Act, the evidence clearly establishes his "compliance" ... would have been subsequent to being contacted ... by representatives of the Federal Trade Commission."
85 F.T.C. at 265. Se also, Montgomery Ward & Co., Inc. v. F.T.C., 379 F.2d 666, 672 (7th Cir. 1967)
   In Zale Corporation and Corrigan-Republic, Inc. v. F.T.C., 473 F.2d 1317 (5th Cir. 1973), the Court reviewed a cease and desist order issued against a retail jewelry concern to prohibit the store from selling on consumer credit without properly disclosing finance charges as required by the Truth in Lending Act. Zale contended that after completion of the FTC examination that uncovered the violations, the company has remedied all such violations, thereby extinguishing the need for the cease-and-desist order. The Court applied an "abuse of discretion" test and remanded Zale's petition for review of the order, stating:
       Whether or not such practices have actually been abandoned can only be determined through subsequent enforcement procedures. Hence, while respecting the good corporate name of the Zale Enterprise, there is no valid assurance that if Zale were free of the Commission's restraint, it would not continue its former course."
   In Beneficial Corporation v. F.T.C., 542 F.2nd 611 (3rd Cir. 1976), cert. denied, 430 U.S. 983 (1977), the Court affirmed the power of the FTC to impose a cease-and-desist order notwithstanding discontinuance even prior to FTC action:
       "It (petitioner) contends, however, that because the early text was soon abandoned with no prompting from the Commission, the finding cannot support a cease and desist order. But this and other courts have held that at least where a discontinued deceptive trade practice could be resumed, the prior practice may be the subject of a cease and desist order." 542 F.2d at 617.

   [.8] At noted, these cases tend to establish that issuance of such an order is a discretionary matter which depends on the individual facts of each case, and that such an order will not be overturned unless found to be arbitrary and capricious or a clear abuse of discretion.
   The facts of this case support the issuance of a cease and desist order based on the foregoing case law and the expressed statutory language of Section 8(b) of the Act. It is clear that the FDIC may issue a cease and desist order based on practices as of a given date even if the practices have been modified. Even if the Bank could establish that the unsafe or unsound practices cited in the notice had ceased, the FDIC would still be justified in issuing a cease and desist order based on unsafe or unsound practices that existed at the time of the examination. Such {{4-1-90 p.A-659}}
an order is an appropriate instrument to deter and prevent future abuses, to correct conditions which have resulted from the unsafe or unsound banking practices and violations, and to protect the shareholders of the Bank and insure their security in the future. The numerous unsafe and unsound banking practices alone justify the issuance of an order to insure their non-occurrence in the future. Moreover, several conditions caused by the unsafe or unsound banking practices are still plaguing the Bank, such as adversely classified loans on the Bank's books, ineffective loan collection practices and refinancing credit to borrowers in weak financial positions and an appropriate order should correct such condition. An appropriate order with appropriate provisions should remedy inadequate reserve for loan losses, hazardous investment practices, maintain adequate liquidity and provide for effective bank supervision and management. It is also significant to recognize that this is not a case where the Bank voluntarily ceased the complained of practices; rather, the cessation of the activities was directly related to the last examination undertaken by the FDIC and that agency's actions.
   The Bank argues against a cease and desist order on the grounds that the Bank has not engaged and is not now (March 15, 1985) engaging in any unsafe or unsound practices in conducting the business of the Bank nor is it in an unsafe or unsound condition to continue operation as an insured Bank with respect to liquidity. The Bank argues that it has been and is now able to meet the liquidity demands upon it.
   In conclusion, the facts of this case justify the issuance of a cease and desist order directed toward unsafe or unsound banking practices that have occurred in the past and requiring the Bank to take affirmative action to correct conditions resulting from such practice which affects the Bank's financial soundness.
       Whether the * * * Bank should be required to maintain total equity capital reserve at not less than 7.5 percent of adjusted total assets during the time required in the proposed cease and desist order.
   In it's proposed cease and desist order, the FDIC provides that the Bank shall take all steps necessary to maintain total equity capital and reserves at not less than 7.5 percent of adjusted total assets. The FDIC purpose of this requirement is to correct alleged unsafe or unsound banking practices. The Bank did not specifically address this portion of the proposed cease and desist order but argues that the Bank did not engage in unsafe or unsound practices in it's investment practices, did not fail to provide for adequate reserve for loan losses, and that the reserve for loan losses provided by the Bank have been and are reasonable and adequate; that the FDIC acted arbitrarily in classifying as substandard and doubtful those securities issued by * * * as these securities are not in default or is there any reasonable basis for believing that the * * * , an agency of the United States, will default upon it's obligations to the * * * which underlies such securities and that the Bank has not and is not engaging in unsafe or unsound practices with respect to liquidity and the Bank has been and is now able to meet the liquidity demands upon it.
   My aforesaid findings in place of my previous findings found that the Bank had engaged in unsafe and unsound banking practices with respect to lending practices, and as a result of hazardous lending and lax collection practices, the bank had an excessive and disproportionate volume of poor quality loans in relation to the Bank's total loans. Findings also showed the percent of classified loans to total equity capital and reserves has increased from 35 percent as shown in the report of examination as of November 13, 1981 to 53 percent as of June 10, 1983 to 74.8 percent as of February 3, 1984. I have also further found that the Bank has engaged in unsafe or unsound banking practices in that the Bank had failed to provide an adequate reserve for loan losses. As a result of the Bank's failure to reflect on their earnings statement an adequate loan valuation reserve, earnings were overstated. I also found that the Bank had engaged in hazardous investment practices which have resulted in the Bank acquiring a long-term, illiquid securities portfolio. The result of the Bank's heavy reliance on long-term assets in the form of long-term, illiquid securities is that the Bank is unable to make adjustments in rises in interest rates they may have to pay in order to keep or attract depositors. I further found that the bank had engaged in unsafe or unsound banking practices in that they {{4-1-90 p.A-660}}operated without adequate liquidity and without proper regard for funds management.
   Since numerous unsafe or unsound practices have been found, a requirement of maintained equity capital and reserves at not less than 7.5 percent of adjusted total assets is reasonable and not arbitrary and capricious in light of the facts in this case. Section 908(a)(1) and (2) of the Act essentially provide that each appropriate federal banking agency shall establish minimal levels of capital for banking institutions and that the agency shall cause such institutions to achieve and maintain such capital levels. Subsections (b)(1) and (2)(A) go on to provide that the failure of a banking institution to maintain minimum capital levels may be deemed by an agency to constitute an unsafe or unsound practice and such agency may issue an enforceable directive to the institution requiring it to achieve its required capital level.
   The ratio of a bank's adjusted capital and reserves to its adjusted gross assets provides an indication of the amount of protection which a bank's capital accounts provide for its depositors. This ratio also reflects the extent to which asset loss or depreciation can be absorbed by the bank's capital accounts before its depositors' funds are impaired.
   The * * * Bank ratio of adjusted equity capital to adjusted total assets are in excess of safe and sound banking practices. In view of the foregoing evidence, I find the FDIC's requirement that * * * Bank maintain a ratio of total equity capital and reserves to adjusted total assets of not less than 7.5 percent is not unreasonable and should be included in the proposed cease and desist order.

PROPOSED ORDER TO CEASE AND DESIST

   IT IS HEREBY ORDERED, that * * * Bank, * * * , its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank, CEASE AND DESIST from the following unsafe or unsound banking practices:

       (a) Operating with inadequate capital;
       (b) Extending credit which is inadequately secured and without adequate and appropriate supporting documentation;
       (c) Operating with ineffective loan collection practices;
       (d) Refinancing credits to borrowers in weak financial positions without improving collateral margins or establishing structured repayment programs;
       (e) Renewing or extending the due dates of loans without collection in cash of interest due or obtaining adequate additional collateral to secure credit advanced for the purpose of paying interest;
       (f) Engaging in hazardous investment practices;
       (g) Operating the Bank with an excessive volume of poor quality loans, loan related assets and securities;
       (h) Failing to provide an adequate reserve for loan losses;
       (i) Failing to accurately reflect the condition of the Bank in published statements and Consolidated Reports of Condition and Income; and
       (j) Operating without adequate liquidity and proper regard for funds management.
   IT IS FURTHER ORDERED, that * * * Bank, its directors, officers, employees, agents, successors, assigns, and other persons participating in the conduct of the affairs of the Bank, take AFFIRMATIVE ACTION as follows:
   1. Within 120 days of the effective date of this ORDER, the Bank shall provide, and thereafter retain, management acceptable to the Regional Director of the FDIC's * * * Regional Office ("Regional Director"). Such management shall include a qualified chief executive officer who shall be given stated authority in writing by the board of directors of the Bank, including the responsibility for implementing and maintaining lending and investment policies in accordance with sound banking practices.
   2. While this ORDER is in effect, the Bank shall maintain equity capital and reserves equal to or greater than 7.5 percent of its average daily total assets for the months of March, June, September and December of each year. If such ratio is less than 7.5 percent, the Bank shall within 30 days from receipt of a written notice of a capital deficiency from the Regional Director present to the Regional Director a plan to increase the equity capital of the Bank or to take other measures to bring the ratio to 7.5 percent. Within 60 days after the plan is {{4-1-90 p.A-661}}
reviewed and no exception is taken by the Regional Director, the Bank shall increase its equity capital and loan valuation reserves by an amount sufficient to bring the ratio to 7.5 percent.
   3. (a) As of the effective date of this ORDER, the Bank shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "Loss" and one-half of the loans classified "Doubtful" as of February 3, 1984, that have not been previously collected or charged off. Reductions of these assets through proceeds of loans made by the Bank are not considered collection for the purpose of this paragraph.
   (b) While this ORDER is in effect, the Bank shall eliminate from its books, by charge-off or collection, all assets or portions of assets classified "Loss" as determined at any FDIC or State of * * * examination or visitation.
   4. (a) Effective with the date of this ORDER, and after charge-off of the loans required in Paragraph 3(a) of this Order, the Bank shall establish and thereafter maintain an adequate reserve for loan losses through charges to current operating income. In complying with the provisions of this paragraph, the board of directors of the Bank shall review the adequacy of the Bank's reserve for loan losses prior to the end of each calendar quarter. The reviews shall consider, at a minimum, the Bank's loan loss experience, an estimate of potential loss exposure in the portfolio, trends of delinquent and nonaccrual loans, and prevailing and prospective economic conditions. The minutes of the board meeting at which such review is undertaken shall include complete details of the reviews and the recommended increases in the reserve for loan losses.
   (b) Within 60 days from the effective date of this ORDER, the Bank shall review Consolidated Reports of Condition and Reports of Income ("Reports") filed with the FDIC since June 30, 1983 to determine if the Reports accurately depict the condition of the Bank. If necessary and appropriate, said Reports will be amended. Such amended Reports shall properly reflect the financial condition of the Bank as of the respective date and in particular shall contain a loan valuation reserve and provision for loan losses sufficient to support the quality and volume of the loan portfolio. Reports filed after the effective date of this ORDER shall also accurately reflect the financial condition of the Bank as of the reporting date.
   5. As of the effective date of this ORDER, the board of directors of the Bank shall require that the officers of the Bank adhere to its duly adopted policies governing lending and collection of loans which were adopted January 12, 1984.
   6. (a) As of the effective date of this ORDER, the Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower who has a loan or other extension of credit with the Bank that has been classified, in whole or in part, "Doubtful" and/or "Loss" and is uncollected. The requirements of this Paragraph do not prohibit the Bank from renewing (after full collection in cash of interest due from the borrower) credit already extended to the borrower.
   (b) As of the effective date of this ORDER, the Bank shall not extend, directly or indirectly, any additional credit to or for the benefit of any borrower obligated in any manner to the Bank on any extensions of credit (including any portion thereof) that has been charged-off the books of the Bank so long as such credit remains uncollected.
   (c) As of the effective date of this ORDER, the Bank shall not extend directly or indirectly any additional credit to or for the benefit of any borrower whose loan or other credit has been classified "Substandard" unless the Bank's board of directors has signed a detailed written statement giving reasons why failure to extend such credit would be detrimental to the best interests of the bank. The statement shall be placed in the appropriate loan file and included in the minutes of the applicable board of directors' meeting.
   7. Within 30 days of the effective date of this ORDER, the Bank will review and amend, if necessary, its duly adopted investment policy. This policy shall include, but not be limited to, provisions for consideration of credit quality, diversification, maturity distribution, marketability, and income of potential investments. The results of this review shall be reduced to writing and included in the minutes of the applicable meeting of the board of directors. Thereafter, the Bank will take all steps necessary to assure compliance with its investment policy.
{{4-1-90 p.A-662}}
   8. (a) Effective with the date of this ORDER, the bank will to the best of its ability and in keeping with sound and prudent practices, require Bank officers to comply with the provisions of its duly adopted policies governing liquidity and funds management.
   (b) Within 60 days of the date of this ORDER, a plan will be submitted to the Regional Director to achieve an acceptable rate sensitivity balance between investments and funding sources and to lessen the reliance on short-term, potentially volatile liabilities for funding longer term assets. The plan shall include, at a minimum, goals and strategies for the end of each calendar quarter beginning with the quarter following submission of the plan.
   9. Effective with the date of this ORDER, the Bank shall not declare or pay either directly or indirectly any cash dividend, without the prior written consent of the Regional Director.
   10. Within 30 days from the effective date of this ORDER, the Bank will submit a plan acceptable to the Regional Director to reduce the concentration of credit in * * * reflected in the report of examination as of February 3, 1984 to 25 percent of total equity capital and reserves or less.
   11. While this ORDER is in effect, the Bank shall give written notice to the Regional Director at such time as the Bank intends to make use of brokered deposits. The notification should indicate how the brokered deposits are to be utilized with specific reference to credit quality of investments/loans and the effect on the Bank's funds position and asset/liability matching. The Regional Director shall have the right to reject the Bank's plans for utilizing brokered deposits. For purposes of this ORDER, brokered deposits are defined to include any deposits funded by third party agents or nominees for depositors, including deposits managed by a trustee or custodian when each individual beneficial interest is entitled to or asserts a right to Federal deposit insurance.
   12. Within 60 days of the effective date of this ORDER, and every 60 days thereafter, the Bank shall furnish written progress reports to the Regional Director detailing the form and manner of any actions taken to secure compliance with this ORDER and the results thereof. All progress reports and other written responses to this ORDER shall be reviewed by the board of directors of the Bank and made a part of the minutes of the board meeting.
   13. Following the effective date of this ORDER, the Bank shall send to its shareholders or otherwise furnish a description of this ORDER (1), in conjunction with the Bank's next shareholder communication and also (2), in conjunction with its notice or proxy statement preceding the Bank's next shareholder meeting. The description shall fully describe the ORDER in all material respects. The description and any accompanying communication, statement or notice shall be sent to the FDIC at Washington, D. C., for review at least 15 days prior to dissemination to shareholders. Any changes requested to be made by the FDIC shall be made prior to dissemination of the description, communication, notice or statement.
   14. The effective date of this ORDER shall be ten (10) days from the date of its service upon the Bank. The provisions of this ORDER shall be binding upon * * * , its directors, officers, employees, agents, successors, assigns and other persons participating in the affairs of such Bank.
   The provisions of this ORDER shall remain effective and enforceable except to the extent that, and until such time as, any provisions of this ORDER shall have been modified, terminated, suspended or set aside by the FDIC.
   Pursuant to delegated authority.
   Date of Issuance: June 10, 1985
   /s/ H. Maxwell Darks
   Administrative Law Judge

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