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   [5086] FDIC Docket No. FDIC-86-92k (3-17-87)

   Civil money penalties assessed against bank directors in connection with the bank's extensions of credit to the directors and their related interests at preferential interest rates and involving more than the normal risk of repayment.

   [.1] Practice and Procedure—Exceptions to Recommended Decision—Time for Filing
   If a party does not file exceptions to the ALJ's Recommended Decision within 20 days after service, the party has waived the right to object to the Recommended Decision.

   [.2] Regulation O—Civil Money Penalties Assessed for Violation
   Preferential interest rates were found when loans were made to directors and their related interests at prime plus one percent, regardless of the credit quality of a particular loan, when prime plus one percent was not extended to any other borrower, and when extensions of credit to all other borrowers were at rates one to 4.5 percentage points higher than prime plus one percent.

   [.3] Civil Money Penalties—Amount of Penalty—Statutory Standard
   In determining whether civil money penalties are appropriate, the following factors are considered and balanced: the admission of ability to pay; the modest amount of the penalty when the maximum penalty could have been in excess of $150,000; the number, repetition, and serious nature of the violations, and the number of warnings by the FDIC; and the good faith of the directors exhibited by their payment to the bank of the difference in interest between the preferential rates and the rates paid by other comparable borrowers.

   [.4] Regulation O—Loans to Insiders—Preferential Terms
   Loans to directors and related interests must be made on substantially the same terms as those prevailing at the time for comparable transactions by the bank with other persons.

   [.5] Regulation O—Loans To Insiders—Degree of Risk
   Insider loans cannot involve more than the normal risk of repayment or present other unfavorable features.

   [.6] Definitions—Substandard Loan
   A substandard loan is one that involves more than a normal degree of risk, with the possibility that a loss may occur in the future.

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   [.7] Practice and Procedure—Evidence—Expert Opinion
   In the absence of a showing that the opinion of a bank examiner is based on an erroneous perception of the facts, the opinion is entitled to great deference by an administrative law judge.

   [.8] Civil Money Penalties—Amount of Penalty—Statutory Standard
   In determining the amount of a civil money penalty, a number of factors are to be considered: the appropriateness of the penalty with respect to the financial resources of the person charged, i.e. his ability to pay; his good faith; the gravity of the violations; the history of previous violations; and such other matters as justice may require.

In the Matter of * * * and * * *
individually and as directors of BANK OF
* * * (INSURED STATE
NONMEMBER BANK)


DECISION AND ORDER TO PAY
CIVIL MONEY PENALTIES

FDIC-86-92k

   This proceeding seeks a civil money penalty in the amount of $2,500 against * * * and a civil money penalty in the amount of $5,300 against * * * ("Respondents"),1 individually and as directors of the Bank of * * *, * * * ("Bank"), for violations of section 22(h) of the Federal Reserve Act (12 U.S.C. § 375b) and Regulation O of the Board of Governors of the Federal Reserve System ("Reg. O") (12 C.F.R. Part 215), promulgated thereunder.2 These violations occurred in connection with the Bank's extensions of credit to directors and their related interests at preferential interest rates and involving more than normal risk of repayment. Respondent * * * or his related interests received seven totaling $77,600. Respondent * * * received no loans, but as a member of the board of directors of the Bank approved the preferential loans to Respondent * * * and other directors.

   [.1] This matter was referred to Administrative Law Judge William A. Gershuny ("ALJ") and a formal hearing was held on September 11-12, 1986. The parties filed proposed findings of fact, proposed conclusions of law and briefs. FDIC enforcement counsel filed a reply brief. The ALJ issued his Recommended Decision3 on December 5, 1986, recommending entry of an order assessing civil money penalties against the Respondents in the amounts set forth in the Notice. No party filed exceptions to the Recommended Decision within twenty days after service and thus, pursuant to section 308.14 of the FDIC Rules, each party has waived the right to object to the Recommended Decision.
   Respondents admit all factual allegations concerning the loans at issue including the allegations of their direct participation in these transactions as directors of the Bank (R.D. at 2). Each Respondent further admits his ability to pay the assessed fine (R.D. at 5). Thus, the issues for determination were simply whether the admitted facts constituted violations of Reg. O and whether, and in what amount, civil money penalties should be assessed.

   [.2] The ALJ found that 1) during the relevant period loans were made to directors and their related interests at prime plus 1 percent, regardless of the credit quality of a particular loan; 2) prime plus 1 percent was not extended to any other borrower; and 3) extensions of credit to all other borrowers were at rates 1 to 4.5 percentage points higher than prime plus 1 percent. The record indicated three loans were made by the Bank to comparable borrowers. Each of these was made at considerably higher, negotiated interest rates and was secured by stock. The rate of interest on loans to Respondent * * * was uniform and not negotiated and the loans were unsecured. (R.D. at 3). Accordingly, the ALJ concluded that the director and related interest loans at issue were made on preferential terms in violation of section 215.4(a)(1) of Reg. O.


1 The Notice of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of Law, Order to Pay, and Notice of Hearing ("Notice") issued by the Federal Deposit Insurance Corporation ("FDIC") sought penalties against five additional directors or executive officers of the Bank of * * *. * * *, * * *, * * *, * * * , and * * * entered into a settlement agreement with the FDIC which was adopted by the Board of Review on August 27, 1986. Only Respondents * * * and * * * contested the FDIC's allegations and proposed relief at the hearing.

2 Reg. O is made to apply to insured State nonmember banks by section 18(j)(2) of the Federal Deposit Insurance Act ("Act") (12 U.S.C. § 1828(j)(2)) and section 337.3 of the FDIC Rules of Practice and Procedures ("FDIC Rules") (12 C.F.R. § 337.3).

3 Citations to the Recommended Decision shall be "R.D. at ________."
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   The ALJ further found that the loans to Respondent * * * or his related interest were classified by the FDIC because the loans were made with inadequate financial documentation and such documentation as there was showed Respondent's limited and decreasing net worth, as well as the absence of security for the loans. He concluded that the loans to Respondent * * * and his related interest involved more than the normal risk of repayment in violation of section 215.4(a)(2) of Reg. O.

   [.3] Finally, the ALJ concluded that in light of all the circumstances the penalties assessed were appropriate. In reaching this conclusion the ALJ specifically considered and balanced various factors including 1) the admission of ability to pay; 2) the modest amount of these penalties where the maximum penalty could have been well in excess of $150,000; 3) the number, repetition and serious nature of the violations in spite of the evidence of numerous warnings by the Commissioner of Banks and Trust Companies and the FDIC; and 4) the "good faith" of the directors exhibited by their payment to the Bank of the difference in interest between the preferential rates and the rates paid by other comparable borrowers.
   The Board of Directors ("Board") finds that the ALJ's Recommended Decision (appended hereto) is thorough, well reasoned and fully supported by the evidence in the record. We therefore adopt the ALJ's Recommended Decision and incorporate it herein by reference.

Order to Pay Civil Money Penalties

   On the basis of the record in this proceeding, including the ALJ's Recommended Decision dated December 5, 1986, and after taking into consideration the appropriateness of the penalties with respect to the financial resources and good faith of Respondents * * * and * * *, the gravity of the violations, the history of previous violations, and such other matters as justice may require, the Board adopts the Recommended Decision, incorporates it herein by reference and finds that * * * and * * *, individually and as directors of the Bank have violated section 22(h) of the Federal Reserve Act (12 U.S.C. § 375b) and section 215.4(a)(1) and (2) of Reg. O (12 C.F.R. § 215.4(a)(1) and (2)).
   ACCORDINGLY, IT IS HEREBY ORDERED, that a civil money penalty in the amount of $2,500 be, and hereby is, assessed against Respondent * * * and a civil money penalty in the amount of $5,300 be, and hereby is, assessed against Respondent * * * pursuant to section 18(j)(3) of the Act (12 U.S.C. § 1828(j)(3));
   IT IS FURTHER ORDERED, that the penalties hereby ordered shall not be paid directly or indirectly by the Bank of * * *, * * *, but shall be paid by the above named Respondents.
   This ORDER shall be effective and the penalties ordered shall be final and payable twenty (20) days from the date of this issuance and shall remain effective and enforceable except to the extent that, and until such time as, any provision of this ORDER shall have been modified, terminated, suspended or set aside by the FDIC.
   By direction of the Board of Directors.
   Dated at Washington, D.C. this 17th day of March, 1987.
/s/ Hoyle L. Robinson
Executive Secretary

FDIC-86-92k

RECOMMENDED DECISION AND
ORDER

   WILLIAM A. GERSHUNY, Administrative Law Judge: A hearing was conducted in * * * on September 11-12, 1986, at the request of Respondents * * * and * * *, on Notice of Assessment of Civil Money Penalties issued on April 30, 1986, pursuant to Section 18(j)(3) of the Federal Deposit Insurance Act. 12 U.S.C. 1828(j)(3). Penalties of $2,500 and $5,300 respectively were imposed in the Notice. The last posthearing briefs were filed on December 4, 1986.
   Upon the entire record,* including my observation of witness demeanor, I hereby make the following:

Findings of Fact and Conclusions of Law

I. Jurisdiction

   The Notice alleges, Respondents * * * and * * * admit, and I find that both the


* Respondent * * *' post-hearing request that his letter to the Board of Directors dated August 27, 1981, be received as Respondents' Exhibit 4, is granted.
{{4-1-90 p.A-1064}}Bank of * * *, an insured state nonmember bank, and Respondents * * * and * * * as directors of the bank, are subject to the Federal Deposit Insurance Act, 12 U.S.C. 1811–1831, and to the jurisdiction of the FDIC.

II. The Alleged Violations

   The Notice alleges a number of violations of Regulation O, based on loans to directors and their related interests, granted at preferential interest rates and involving more than the normal risk of repayment. Respondents here admit all factual allegations concerning the loans, including the allegations of "related interest" and their direct participation in these transactions as directors of the Bank.
   Thus, the issues remaining in this proceedings are narrow: whether those admitted facts, under the surrounding circumstances, constitute violations of Regulation O, and whether, and in what amount, civil penalties should be assessed.
   For reasons set forth below, I find and conclude that the loans were in violation of Regulation O, as preferential and involving more than the normal risk of repayment, and that, considering the circumstances, civil penalties in the amounts of $2,500 and $5,300 should be assessed against Respondents * * * and * * * respectively.

A. The Loans.

   Between 1981 and 1985, the Bank extended or renewed credit to Directors and their related interests at a rate of prime plus 1 percent. These transactions are summarized as follows:

Director No. of Loans Total
* * * 2 $35,000
* * * 2 85,000
* * * 7 77,600
* * * 5 27,458
* * * 2 29,633

B. Preferential Interest Rates.

   [.4] Section 215.4(a)(1) of Regulation O, made applicable to insured state nonmember banks by Sec. 337.3 of FDIC Rules and Regulations, provides that loans to directors and related interests must be made "on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions by the bank with other persons that are not covered by this Part and who are not employed by the bank." In assessing comparability, a number of factors generally are considered: the time of the loan; the net worth of the borrower; the collateral pledged; the liquidity of the collateral; and the overall credit quality of the loan.
   The record in this case clearly establishes that, during the relevant period, the interest rate applied to all director and related interest loans was prime plus 1 percent, or 11.5 percent, regardless of the overall credit quality of a particular loan; that prime plus 1 percent was not extended to any other borrower; and that loans to all other borrowers were at rates 1 to 4.5 percentage points higher than prime plus 1 percent.
   Based on the testimony and opinions of the two FDIC examiners, which I credit and to which I give great deference, Sunshine State Bank v. FDIC, 783 F.2d 1580 (11th Cir. 1986), I find that three loans were made by the Bank to comparable borrowers. The first was to one * * * in the amount of $20,000, and at an interest rate of 16 percent. This borrower had a net worth at the time of $1.4 million. The second was made to one * * * in the amount of $50,000, at a rate of prime plus 3 percent, or 13.5 percent. This borrower had a net of $1.5 million and the loan was secured by stock in a bank holding company. The third was made to one * * * in the amount of $87,000 at a rate of prime plus 2 percent, or 12.5 percent. This borrower had annual income of $70,000 and a net worth of $216,000, and the loan was secured by bank holding company stock. In the opinions of the examiners, there was nothing in the financial condition of these borrowers or their customer status to justify the difference in rates.
   The Bank president testified that the rates charged other borrowers were the product of negotiation. Yet directors did not negotiate for rates, but were uniformly afforded the lower rate of prime plus 1 percent. Respondent * * *, with several adversely classified loans, received the same rate as another director with high net worth and annual income.
   In the face of what appears to be clear evidence of preferential rates on director and related interest loans, Respondents contend that no violations occurred because it was the FDIC itself, in 1981, which advised the Bank "that use of a floating rate of {{4-1-90 p.A-1065}}interest at prime plus one percent was an acceptable means of maintaining parity within the bank with other comparable bank customers." (Respondents' Proposed Finding No. 1).
   This contention, however, finds no support in the record. The FDIC representatives who allegedly gave such an assurance were not called to testify. Moreover, Respondent * * * 1981 letter to the Board, which purports to summarize representations made to him by FDIC representatives during an August 1981 meeting in * * * (director loans "if renewed at the current rate of 1% over the discount rate will be acceptable"), is hardly material, for the record reflects that, in 1981, the rate of prime plus 1 percent was being afforded to borrowers other than directors. That practice stopped in 1982, which is the beginning of the time frame relevant to the loans here in question. And, finally, a contention that uniformity in rates applied to insider loans will satisfy Regulation O, ignores the essential feature of Section 215.4(a)(1), which is that insider loans must be at rates substantially the same as those offered other comparable borrowers. Uniformity of director rates has absolutely nothing to do with the concept of preference, which by necessity requires a determination of comparability.
   For these reasons, I find and conclude that the director and related interest loans described above were made on preferential terms, in violation of Sec. 215.4(a) of Regulation O.

C. Risk of Repayment

   [.5] Section 215.4(a)(2) of Regulation O requires that insider loans "not involve more than the normal risk of repayment or present other unfavorable features." The Notice alleges violations of this provision in connection with the loans to Respondent * * * and his related interest.

   [.6] Each of the loans was classified by the FDIC as substandard, i.e. involving more than a normal degree of risk, with the possibility that a loss may occur in the future. The classification was made by Examiner * * * on the basis of state financial statements which showed a decreasing net worth and an annual income for * * * of $40,000, the absence of security, and no principal reductions. Similarly, with respect to * * * related interest, there was only stale financial data which reflected net annual losses and assets which barely exceeded liabilities. Moreover, the loans to the related interest were unsecured and were personally guaranteed by * * * himself.

   [.7] Both * * * and Examiner * * * opined that a classification of substandard was proper. In the absence of a showing by Respondents that their opinion was based on erroneous perception of the facts, their opinion is entitled to great deference by an administrative law judge. Sunshine State Bank, supra.
   Based on the opinions of the FDIC examiners, I find and conclude that the loans to Respondent * * * and his related interest involve more than normal risk of repayment and, therefore, are violative of Section 215.4(a)(2) of Regulation O.

III. Civil Money Penalty

   Section 18(j)(3)(A) of the Federal Deposit Insurance Act authorizes the imposition of a civil money penalty of not more than $1,000 per day upon "any officer, director, employee, agent, or other person participating in the conduct of the affairs..." of a nonmember insured bank who violates Regulation O. Having found and concluded above that Respondents * * * and * * *, while serving as directors of the Bank, engaged and participated in multiple violations of Regulation O, I must conclude that they are liable for a civil penalty.

   [.8] In the determination of the amount of the penalty, Section 18(j)(3)(B) sets forth a number of factors to be considered: the appropriateness of the penalty with respect to the financial resources of the person charged, i.e. his ability to pay; his good faith; the gravity of the violations; the history of previous violations; and such other matters as justice may require. Here, it should be noted that both Respondents have admitted an ability to pay. Accordingly, there is no need to discuss this factor in determining the amount of the penalty.
   While the FDIC in its Notice assessed penalties of $2,500 and $5,300 respectively against Respondents * * * and * * * it is my responsibility under FDIC Rules and Regulations to make an independent recommendation as to the amount of the penalty, based on the record evidence. In this connection, I note that counsel for the FDIC at the hearing represented that the {{4-1-90 p.A-1066}}FDIC does not seek or recommend a penalty in excess of the amounts originally assessed in the Notice, and I defer to their judgment, despite the fact that the maximum penalties authorized by law could greatly exceed the penalties initially assessed by the FDIC.
   The "good faith" factor must be considered together with the history of previous violations. The record here is replete with prior warnings, commencing in 1981, from the State Commissioner of Banking and the FDIC concerning apparent violations of Regulation O, based on the preferential treatment of insiders. Yet the Board of Directors, chaired by Respondent * * *, an attorney, continued on the same course as before as to insider transactions, without consulting experienced bank counsel. That the directors reimbursed the Bank with the difference in interest between the preferential rates and the rates other comparable borrowers paid is admirable, but does not overcome their initial unlawful participation in such transactions. Fitzpatrick v. FDIC, 765 F.2d 569 (6th Cir. 1985).
   Moreover, the violations were many, were repetitive, and were serious. The loans to Respondent * * * and his related interest were classified substandard, i.e. involved a possibility of loss to the Bank. I take note, on the other hand, that there is no evidence or suggestion that these insider transactions threatened the continued existence of the Bank.
   Taking into consideration the foregoing findings of fact, conclusions of law, the entire record, and the factors prescribed under Section 18(j)(3) of the Federal Deposit Insurance Act, I find and conclude that civil money penalties of $2,500 and $5,300 are appropriate and should be assessed against Respondents * * * and * * * respectively. Accordingly, I issue the following:

RECOMMENDED ORDER TO PAY*

   After taking into account the appropriateness of the penalty with respect to the financial resources of Respondents * * * and * * *, their good faith, the gravity of the violations, the history of previous violations, and such other matters as justice may require, it is
   ORDERED that, by reason of the transactions and violations of law and regulation evidenced by the record in this case, a civil money penalty in the amount of $2,500 be, and the same hereby is, assessed against Respondent * * *; and a civil money penalty in the amount of $5,300 be, and the same hereby is, assessed against Respondent * * * pursuant to Section 18(j)(3) of the Act; and it is
   FURTHER ORDERED that this order shall be effective upon service on said * * * and * * * and that the penalties ordered shall be payable after 20 days from the date of such service.
   Dated at Washington, D.C. this 5th of December, 1986.
/s/ WILLIAM A. GERSHUNY
Administrative Law Judge
National Labor Relations Board
Washington, D.C. 20570

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