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   [5088] FDIC Docket No. FDIC-86-139k (4-14-87)

   A bank director who made preferential loans for the benefit of affiliates and who authorized overdrafts in the checking accounts of those affiliates was assessed a civil money penalty for unsafe and unsound banking practices.

   [.1] Civil Money Penalties—Amount of Penalty—Statutory Standard
   In the determination of 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.

   [.2] Civil Money Penalties—Amount of Penalty—Statutory Standard
   A civil money penalty of $10,000 is appropriate against a bank director whose salary is $82,280 with additional earnings of $10-12,000 and who had a net worth of $356,000.

   [.3] Civil Money Penalties—Factors Determining Liability—Violation of Lending Limitations
   Even though a bank director did not derive any personal benefit or gain from a transaction, he may still be assessed a civil money penalty since he "literally thumbed his nose" at bank regulators and sound banking principles, and jeopardized the very existence of the bank which was organized to serve the community.

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In the Matter of * * *, individually and
as a former executive officer and director
* * * BANK


(INSURED STATE NONMEMBER
BANK)

DECISION AND ORDERFDIC-86-139k

DECISION

   The Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC") has reviewed the record and finds that the Administrative Law Judge's ("ALJ's") Recommended Decision (appended hereto) is in all material respects fully supported by the law and the evidence. The ALJ's Recommended Decision and Order is therefore adopted and incorporated herein by reference.
   The Board adopts the following Order as an appropriate penalty against Respondent * * *, individually and as a former executive officer and director of * * * Bank, * * *, for having violated Sections 22(h) and 23A of the Federal Reserve Act, 12 U.S.C. §§ 375b and 371c, Regulation O, 12 C.F.R. Part 215, and Section 337.3(b) of the FDIC's Rules and Regulations, 12 C.F.R. § 337.3(b). The Order requires * * * to pay a penalty of $10,000 within twenty (20) days.

ORDER

   After taking into account the appropriateness of the penalty with respect to the financial resources of Respondent * * *, his good faith, the gravity of the violations, the history of previous violations, and such other matters as justice may require, it is:
   HEREBY 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 $10,000 be, and the same hereby is, assessed against Respondent * * * pursuant to Section 18(j)(3) of the Federal Deposit Insurance Act; and it is
   FURTHER ORDERED, that the penalty shall be payable by Respondent * * *, twenty (20) days from the date of service of this Decision and Order.
   Dated at Washington, D.C., this 14th day of April 1987.
/s/ Hoyle L. Robinson
Executive Secretary

RECOMMENDED DECISION AND
ORDER

   WILLIAM A. GERSHUNY, Administrative Law Judge: A hearing was held in * * *, on September 17-18, 1986 at the request of Respondent * * *, on Notice of Assessment of Civil Money Penalties issued June 25, 1986, pursuant to Sec. 18(j)(3) of the Federal Deposit Insurance Act. 12 U.S.C. 1828(j)(3). The last post-hearing briefs were received on December 15, 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, Respondent * * * admits, and I find that both the * * * Bank (hereafter "Bank"), an insured state nonmember bank, and Respondent * * *, then its Chief Executive Officer and Chairman of the Board, 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 the following violations:
   (a) loans to or for the benefit of affiliates and related interests during 1983-85, granted at preferential interest rates, involving more than the normal risk of repayment, advanced without prior approval of the Board of Directors, in excess of lawful lending limits, on terms not consistent with safe and sound banking practices, and not secured in accordance with statutory collateral requirements, in violation of Section 23A of the Federal Reserve Act and Regulation O;
   (b) overdrafts in the checking accounts of those affiliates and related interests during substantially the same period, on terms not consistent with safe and sound banking practices and not secured in accordance with statutory collateral requirements, in violation of Sec. 23A; and
   (c) a 1984 loan to a director other than Respondent * * *, which involved more than the normal risk of repayment, in violation of Regulation O.


* The unopposed FDIC Motion to Correct Record is granted.
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   By Stipulation dated September 17, 1986, Respondent * * *, in lieu of filing an Answer to the Notice, admitted that the loans and overdrafts were made, as alleged; that * * * Corporation (hereafter "Holding Company") was an "affiliate" of the Bank within the meaning of Sec. 23A and was its principal shareholder within the meaning of Regulation O; that the entities involved in those loans and overdrafts were "affiliates" of the Bank within the meaning of Section 23A and "related interests" of the Holding Company within the meaning of Regulation O; and that the loans, as alleged, exceeded the lending limit requirements of Section 23A.
   Thus, the principal issues remaining in this proceeding are narrow: whether those uncontroverted facts, under the surrounding circumstances, constitute violations of Section 23A, Regulation O, and Sec. 337.3(b) of FDIC Rules and Regulations, and whether, and in what amount, a civil penalty should be assessed against Respondent * * *.
   For reasons set forth below, I find and conclude that the loans and overdrafts were in violation of those provisions, as alleged, and that, considering the circumstances, a civil penalty in the amount of $10,000 should be assessed against Respondent * * *.

A. Background.

   The Bank was organized in 1977 by community leaders to provide banking services in a riot-torn area of * * * no longer served by any other bank, to rekindle economic activity, and to finance the rehabilitation of existing, deteriorating slum housing.
   * * * (hereafter * * *), a wholly-owned, non-bank subsidiary of Holding Company, joined with other interests in eight (8) limited partnerships to rehabilitate, own, and operate such properties. They were not expected to generate profits. Virtually all of the loans and overdrafts which are the subject of this proceeding involve these limited partnerships.
   Respondent * * *, an attorney and realtor, was at all relevant times President and Chief Executive Officer of the Holding Company; Chairman of the Board and Chief Executive Officer of the Bank; and President of * * *. In late 1985, at the request of the FDIC, he resigned his positions with the Bank.
   The Notice does not allege, counsel for FDIC does not contend, and the evidence does not establish or suggest that Respondent * * * personally benefited in any way from any of the transactions involved in this proceeding.
   Rehabilitation of the slum housing by the limited partnerships was performed under the Federal Housing Act. The Department of Housing and Urban Development (HUD) makes monthly housing assistance payments to developers such as the limited partnerships, representing the difference between the fair rental levels established by HUD and the rental payments actually made by the tenants. This Housing Assistance Program also provides for the discretionary adjustment of monthly housing assistance payments to reflect increased operating expenses.
   Beginning in 1981–82, the limited partnerships began to experience unforeseen increases in operating expenses, principally for utilities. They applied to HUD for increases in the levels of monthly assistance payments, but found it necessary to borrow funds from the Bank to cover such increased expenditures pending HUD action on their applications. Eventually, in November 1985, HUD approved the applications and increased the monthly housing assistance payments to the limited partnerships, retroactive to late 1984.

B. The Loans.

   Between 1983 and 1985, thirty-eight (38) loans were made to * * * and the eight limited partnerships in an amount in excess of $3.4 million, and one letter of credit was issued to one of the limited partnerships in the amount of $168,000. These credit extensions are summarized as follows:

Borrower No. Total
* * * 3 180,000
* * * 3 60,000
* * * 2 390,519
Restoration Investors I 4 411,000
Restoration Investors II 5 156,000
Restoration Investors III 7 1,281,500
Restoration Investors IV 5 337,900
Restoration Investors V 8 486,900
* * * 2 322,000

   In 1984, the Bank renewed a loan to * * * in the amount of $80,000, for the benefit of * * *. The loans were secured by an $80,000 note receivable given to * * * by one of the limited partnerships in lieu of {{4-1-90 p.A-1071}}payment for construction work. Interest payments were made by * * *.
   In 1984, the Bank renewed a loan of $60,000, and advanced additional credit of $12,367 to Director * * *. Included was capitalized interest of $8,946. As of the end of 1984, the loan was past due.

C. The Overdrafts.

   As described more fully in the Notice and as stipulated by the parties, the accounts of * * * and the limited partnerships in 1984-5 were overdrawn on almost 400 days in amounts ranging from $2 to $514,681. Many of the overdrafts were paid with proceeds of loans credited to the accounts as late as seventeen days after the date of the note.

D. Lending Limits.

   Section 23A(a)(1) imposes two lending limitation requirements on transactions with affiliates. The first prohibits transactions which when aggregated for any one affiliate exceed ten percent of the bank's capital stock and surplus. The other prohibits transactions which when aggregated for all affiliates exceed twenty percent.
   Respondent * * * admits the allegations of the Notice that, as to certain of the loans and certain of the affiliates, both the ten and twenty percent limitations were exceeded. He contends, however, that Sec. 23A(a)(1) was not violated for the reason that the loans fell within the exemption provisions of Sec. 23A(d)(4), in that each was "fully secured by...obligations of the United States or its agencies...[or]...obligations fully guaranteed by the United States or its agencies...." Stated another way, Respondent contends that the loans were secured by HUD's monthly assistance payments.
   This contention is wholly without merit. First, the monthly assistance payments were not made by HUD to the Bank, but to the bank accounts of the limited partnerships. Second, the Bank had no control of the deposited funds. While it is true that under each of the notes it had authority to "appropriate and apply toward the payment of this Note, whether due or not, any moneys or credits...in the possession or under the control of the Bank...to...deposits [and] accounts...," the Bank never did so. Nor did it subject the accounts to "holds" or other effective controls to insure that requisite balances were maintained. And third, the limited partnerships did not assign the housing assistance payments to the Bank, as it could have sought to do under the HUD contracts by obtaining the written approval of HUD. That approval was neither sought nor obtained.
   I find and conclude that, as to the loans more fully identified in the Notice, the lending limit provisions of Sec. 23A were violated.

E. Collateral.

   Section 23A(c)(1) requires collateral of a market value equal to a minimum percentage of the amount of the loan for all affiliate loans. Where real and personal property is pledged as collateral, its market value must be 130 percent of the loan.
   Respondent * * * does not contest the alleged violations of Section 23A(c)(1). Reply Brief, p.1. Nevertheless, it is essential to discuss the circumstances surrounding these violations, as they have a direct bearing on the amount of the penalty to be imposed.
   The Notice alleges collateral violations as to each of the affiliate loans, based on inadequate security or no security at all. As pointed out above, the loans were not secured by the housing assistance payments. They were not assigned and the approval of HUD was neither sought nor obtained. Nor could the affiliates' demand accounts satisfy the collateral requirements of Sec. 23A(c)(1). Again, as pointed out above, there were no controls whatever on the accounts to insure that minimum balances were maintained. The Bank's right of setoff, of course, is not a security interest, as is clearly noted in the comments to Article 9 of the Uniform Commercial Code, and, in any event, since the housing assistance payments deposited to the accounts each month flowed out in matching amounts that same month in the form of operating expense payments, these accounts never had sufficient balances, and indeed were never intended, to secure the loans. And, finally, even as to those loans which were collateralized by real estate, the requirements of Sec. 23A(c)(1) were not satisfied. There were no current independent appraisals to support the requisite 130 percent market value floor and, on certain properties, taxes were delinquent.
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   As to the overdrafts, many were paid with proceeds of bank loans. While the notes were dated as of the first day of the overdraft, the proceeds were not credited until as many as seventeen days later. The deposit tickets, on the other hand, are dated as of the date of the account entry. Respondent * * * testified that the discrepancies arose because of the time needed to feed the loan data into the Bank's data processing system. This testimony strains credulity and I reject it. The record in this case is highly suggestive of a practice of back-dating affiliate notes in order to avoid the appearance of overdrawn accounts. The fact remains that the overdrafts represent uncollateralized extensions of credit to affiliates.
   For these reasons, I find and conclude that the collateral provisions of Sec. 23A(c)(1) have been violated as alleged.

F. Safe and Sound Banking Practices.

   Included within the concepts of unsound and unsafe banking practices are the concentrations of credit represented by these loans and overdrafts, the Bank's weak collateral position and its capitalization of interest. The above discussions of these practices will not be repeated here, and I find and conclude that these practices violate Sec. 23A(a)(4), which requires that such transactions "shall be on terms and conditions that are consistent with safe and sound banking practices."

G. Preferential Interest Rates.

   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 insiders and their 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." Respondent * * * admits that each of the limited partnerships was a related interest within the meaning of Regulation O.
   According to the testimony of Examiner * * * , a number of factors generally are considered in assessing comparability: 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 June 8, 1985, examination of the Bank revealed that twenty-seven loans to seven of the limited partnerships were made at prime plus ½ percent. Each loan was unsecured, and accompanying financial statements did not reflect an ability to service the loans. Repayment depended on the agreement of HUD to grant increases in the monthly housing assistance payments.
   During the same period, other comparable borrowers were obtaining variable rate loans from the Bank at prime plus 1 percent or prime plus 2 percent. Only one other loan was made a prime plus ½ percent, and that, by contrast, was made to * * * with a net worth of $2.4 million and was secured by an assignment of real estate improved with a 420-unit motel and parking facility. Moreover, the * * * loan was not adversely classified, whereas the related interest loans were classified by the FDIC as "substandard."
   At the hearing, Respondent * * * testified that loans were made to other real estate developers at comparable rates, but he was unable to state the rate of interest or whether the loans were collateralized. By post-hearing stipulations, evidence was received as to a $300,000 loan to one * * * at prime plus 1 percent. This loan was secured by the assignment of a 1.25 percent interest in developed real estate, and the borrower had a net worth of almost $5 million. This latter loan clearly is not comparable to the credit extensions involving the limited partnerships here, and Respondent * * *'s vague, unsupported testimony of "other" loans will not support a finding that the loans in question were comparable to those made to other borrowers.
   I therefore find and conclude that the loans to the limited partnerships were made on preferential terms, in violation of Sec. 215.4(a) of Regulation O.

H. Risk of Repayment.

   Section 215.4(a)(2) of the 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 loans to Director * * * and to seven of the limited partnerships.
   The * * * July 1984 loan of $72,367 was a renewal of an earlier $60,000 loan and included almost $9,000 of capitalized interest. As of the date of the * * * 1985 exami- {{4-1-90 p.A-1073}}nation, the loan had been past due for six months and was adversely classified. Deficiencies included a stale financial statement, previous cash flow problems of the borrower, the absence of a title policy as to pledged real estate, and a questionable appraisal of the property which presumed completion of an as-yet uncompleted project. The more than a normal risk of repayment is evidenced by these deficiencies and the delinquent status of the loan.
   Similarly, the loans to seven of the limited partnerships involved more than normal risk of repayment. The already weak financial condition of each, according to their accountants, was conditioned upon HUD's exercise of discretion in granting increases in the monthly housing assistance payments.
   I find and conclude, based on the opinion of the FDIC Examiner, which I credit and to which I give great deference, Sunshine State Bank v. FDIC, 783 F.2d 1580 (11th Cir. 1986), that these loans involve more than the normal risk of repayment and, therefore, are violative of Section 215.4(a)(2) of Regulation O.

I. Prior Approval.

   More than 25 of the loans to related interests (in excess of $25,000 or 5% of the Bank's capital and unimpaired surplus) had no prior approval of the Board of Directors or were given subsequent approval, in apparent violations of Section 215.4(b) of Regulation O. Respondent * * * testified that a written policy of polling Directors by telephone had been in place since 1979–80, and that he was informed by the Vice President - Loans that the policy was followed when approval at Directors' meetings was not obtained, that the Directors would be orally apprised of the results of the polling, and that he had no knowledge of whether polling records were kept. Respondent offered no other evidence of the existence or use of such a practice and did not call the officer purportedly in charge of polling. Examiner * * * credibly testified that no one at the bank mentioned such a practice, that he saw no evidence of polling, and that the written loan policy contained no provision for polling.
   I find and conclude that telephone polling of Directors for loan approval did not occur, that more than 25 loans to related interests had no prior approval, and that Section 215.4(b) of Regulation O and Section 337.3(b) of FDIC Rules and Regulations were violated.

III. Civil Money Penalty

   Section 18(j)(3)(A) of the Federal Deposit Insurance Act authorizes the imposition of a civil 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 Section 23A or Regulation O. Having found and concluded above that Respondent * * * , while serving as an officer and director of the Bank, engaged in multiple violations of these provisions, I must conclude also that he is liable for a civil penalty.

   [.1] 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.
   While the FDIC in its Notice assessed a penalty of $10,000 against Respondent * * * , it is my responsibility under the 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 FDIC does not seek or recommend a penalty in excess of $10,000, and I defer to their judgment, despite the fact that the maximum penalty authorized by law could exceed several million dollars.

   [.2] Turning initially to Respondent * * * ability to pay, the record reflects that he earned a salary of $82,280 from his positions with the Holding Company, the Bank and * * * and had additional earnings of $10-12,000 as a consultant. He is a licensed attorney and realtor, and had a net worth in May, 1985, of $356,000. Although he apparently does not have $10,000 in cash, Respondent * * * has sufficient assets for sale or as security for a loan to satisfy any penalty which might be imposed here. His ability to pay, therefore, is not a negative factor.

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   [.3] The "good faith" factor must be considered together with the history of previous violations. The record here is replete with prior warnings from the State, the Federal Reserve Board and the FDIC concerning apparent violations of Section 23A and Regulation O, based on the Bank's preferential treatment of the affiliates. Yet Respondent * * * , an attorney, continued on the same course as before as to these affiliate transactions, without consulting experienced bank counsel and without making any effort whatever to perfect the assignment of the HUD housing assistance payments to the Bank. It is difficult, if not impossible, to glean from this record any suggestion of a good faith effort on his part to comply with banking regulations. Respondent * * * admittedly was motivated to provide housing to the commmunity's needy. There is no evidence or suggestion that he derived any personal benefit or gain from the transactions in question. This, of course, is a factor to be considered in determining the amount of the penalty. But, at the same time, it must be said that, in the process of performing that social good, Respondent * * * literally thumbed his nose at bank regulators and sound banking principles, and jeopardized the very existence of the bank which was organized to serve this depressed community.
   Moreover, the violations were many, were repetitive, and were serious. Affiliate loans were not given prior Board approval, interest rates on these loans were preferential, more than normal risks of repayment were involved, and collateral was inadequate or non-existent. The adversely classified affiliate loans equaled 87% of the Bank's total capital and assets. Examiner * * * opined that these affiliate loans "threatened the existence of the Bank."
   Upon the foregoing findings of fact, conclusions of law, and the entire record, and pursuant to Section 18(j)(3) of the Federal Deposit Insurance Act, I find and conclude that a civil money penalty of $10,000 is appropriate and should be assessed against Respondent * * *. 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 Respondent * * * , his 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 $10,000 be, and the same hereby is, assessed against Respondent * * * pursuant to Section 18(j)(3) of the Federal Deposit Insurance Act; and it is
   FURTHER ORDERED that this Order shall be effective upon service on * * * and that the penalty ordered shall be payable after 20 days from the date of such service.
   Dated at Washington, D.C. this 22nd day of December, 1986.
/s/ WILLIAM A. GERSHUNY
Administrative Law Judge
National Labor Relations Board
Washington, D.C. 20570

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