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   [5090] FDIC Docket No. FDIC-86-117k (5-28-87)

   A Notice of Assessment of Civil Money Penalties against bank directors was dismissed because it wasn't shown that loans made to bank insiders were extended on preferential terms. Loans with an 11% interest rate are not preferential when made to bank insiders if other loans to non-insiders are extended at the same or lower interest rates and the loans are made in consideration of the creditworthiness of the borrowers, even though the bulk of loans extended by the bank during the same time period are in the 13–14% interest rate range.

   [.1] Regulation O—Civil Money Penalties Assessed for Violation
   Regulation O [¶2501] is intended to curb the granting of preferential credit terms to bank insiders to the detriment of shareholders and depositors.

   [.2] Regulation O—Loans to Insiders—Preferential Terms
   If non-insiders receive the same credit terms as bank insiders, the insider transaction doesn't violate Regulation O [¶2501]. If the term is extended only to the insider, a further analysis of the credit terms may be required to determine compliance.

In the Matter of * * * and * * * ,
individually, and as executive officers and
directors, and * * * individually, and as a
director of BANK OF * * * (INSURED

Decision and Order of Dismissal


   The Board of Directors has reviewed the record in this matter, including the Administrative Law Judge's Recommended Decision and Order (appended hereto). We have also examined the record in light of all the Federal Deposit Insurance Corporation's exceptions, and find that none require a modification of the Recommended Decision and Order. Based upon the record as a whole, we conclude that the Recommended Decision and Order are fully supported by the evidence. Therefore, we affirm the Recommended Decision and Order.


   IT IS ORDERED, that the Notice of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of Law, Order to Pay and Notice of Hearing be, and the same hereby is, dismissed.
   By direction of the Board of Directors.
   Dated at Washington, D.C., this 28th day of May, 1987.

/s/ Hoyle L. Robinson
Executive Secretary


   WILLIAM A. GERSHUNY, Administrative Law Judge: A hearing was conducted in * * * , on December 22–24, 1986, at the request of Respondents, on Notice of Assessment of Civil Money Penalties issued on June 11, 1986, pursuant to Section 18(j)(3) of the Federal Deposit Insurance Act. 12 U.S.C. 1828(j)(3). Penalties of $4500, $1000 and $4500 respectively were imposed in the Notice. At my suggestion, counsel for the parties presented closing arguments in lieu of post-hearing briefs, and were afforded the opportunity to file letter-briefs citing supplemental authorities, if any. None was submitted by any party.
   Upon the entire record, I hereby make the following:
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Findings of Fact and Conclusions of Law

I. Jurisdiction

   The Notice alleges, Respondents admit, and I find that both the Bank of * * * , an insured state nonmember bank, and Respondents, as executive officers and/or 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 three credit extensions in violation of Section 215.4(a)(1) of Regulation O: two loans with a preferential interest rate of 11%, the other, a participation in a real estate loan, with a preferential interest rate of 11% and a 30-year term. Respondents deny any violation of Regulation O, contending that the same or substantially the same terms were offered non-insider borrowers during the relevant period of time. In the alternative, they argue that the penalties proposed by the FDIC are excessive.
   The principal issue presented —the interpretation of Section 215.4(a)(1) of Regulation O —is, according to counsel, one of first impression in judicial or administrative proceedings.
   The relevant facts, consisting mainly of the examination procedures used in this case and loan transactions by the Bank, are simple and not in dispute.
   Two 11% loans, one to * * * , an executive officer and director of the Bank, the other to Director * * * , were made on October 31, 1983. Both were unsecured, but were supported by particularly strong financial statements. Again, as to these two loans, only the interest rate is alleged by the FDIC to be preferential.
   The third loan, made on February 13, 1984, to Director * * * by another bank and participated in by the Bank of * * * , was a 30-year, 11% real estate loan, secured by a Deed of Trust. Alleged to be preferential are both the 11% rate and the 30-year term.
   To determine whether the three loans might be preferential, the examiner-in-charge of the March 25, 1985 examination, * * * , selected a period of time one month on either side of the two October 1983 loans and approximately two months on either side of the February 1984 real estate loan. His survey of the first period did not consider installment loans, and looked only to the rate of interest charged a borrower. He considered neither the credit-worthiness of the borrower nor the comparability of the transaction. This survey revealed that thirteen of the seventeen loans found were made at 14% or higher, two at 13%, one at 12%, and one at 11%. * * *'s survey of the second period, which bracketed the * * * real estate loan, similarly excluded installment loans and did not take into account the comparability of loan transactions. This survey revealed that eight of the eleven loans found were at 14% or higher and the remaining three were in the 12.5–13.5% range. None were identified at or near 11%.
   Bank loan records offered by Respondents and covering a somewhat broader period of time surrounding the three loans in question, during which the prime rate fixed by a corresponding bank in the area remained level at 11%, revealed four loans at 10.5% to 11% to non-insider, credit-worthy borrowers in comparable transactions, three in the 12% range, and two in the higher 13–14% range. Two other loans, one at 10.5%, the other at 8.5% are not considered, as they were for the benefit of another director. Sec. 215.3(f). All loans at the lower rates were unsecured, and the FDIC conceded that each transaction was comparable to the two unsecured credit extensions involved here (Tr. 474–485).
   To simplify the proof in this case, the parties stipulated that, if all non-installment loans during the broader period were taken into account, the distribution would be similar, i.e. the greater number would bear interest rates in the 13–14% range and a lesser number would bear rates in the 10.5–11% range.
   Examiner * * * concluded that any insider loan made during the period he selected at less than 14% was preferential, and, accordingly, he scheduled the three 11% loans in question as apparent violations of Regulation O. He also calculated, for purposes of restitution by the three Respondents, the difference in interest between 11% and 14% for the periods during which the loans remained outstanding: $2638.91 for the * * * loan; $4402.32 for the * * * loan; and $802.82 for the * * * loan. Each Respondent thereafter made restitution un- {{4-1-90 p.A-1114}}der protest, in the amounts calculated by * * *
   As to the third credit extension, the participation in the 30-year real estate loan to * * *, * * *'s survey of the 120-day period revealed no secured loan for a term longer than 25 years: eighty-six were for 10 years; twenty-four for 15 years; seven for 20 years; and one for 25 years. Again, he did not take into account the comparability of those credit extensions. The Bank's written loan policy did not prohibit 30-year terms for residential real estate loans. Rather it provided that the "maximum term will be 10 years. A documented exception up to 20 years can be made." The policy also provided for Board of Director consideration of specific changes, i.e. deviations, which, in the opinion of the loan officer, are warranted. Finally, the policy stated that its provisions are "guide setting loan parameters in all areas of lending that should be followed as a general rule." Where the loan officer "feels broader terms should prevail," the policy provided that his "descretion" (sic) should be documented. In approving a deviation from the general rule for purposes of participating in this 30-year, 11% loan to * * * , the Board took into account a number of factors: that the residence to be constructed was located in * * * , a community more urbanized than rural * * *; that the residence was architectually designed, unlike the modest farm homes situated in remote areas around * * *; and that * * * homes were highly marketable, due to the real estate turnover of this area located near a military post.

* * *

   [.1]Regulation O, promulgated by the Federal Reserve Board to implement Sec. 22(h)(3) of the Federal Reserve Act, 12 U.S.C. 375b, and made applicable to insured state nonmember banks by Sec. 337.3 of FDIC Rules and Regulations, is intended to curb the granting of preferential credit terms to bank "insiders" to the detriment of shareholders and depositors. Section 215.4(a)(1), at issue here, tracks the statutory language and, in relevant part, provides:

       Terms and Creditworthiness. No member bank may extend credit to any of its executive officers, directors, or principal shareholders or to any related interest of that person unless the extension of credit: (1) is 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. . . .
   The parties have focused their attention principally on two elements of the regulation, "at the time" and "prevailing."
   In applying the first, "at the time," Examiner * * * testified that his selection of the two different time frames for an examination of the Bank's credit extensions (30 days on either side of the first two loans and 60 days on either side of the participation) was not based on any written criteria or instructions established by the FDIC or any other banking agency, but represented arbitrary periods of time which, in his opinion, would fairly reveal the credit terms being offered by the Bank. He agreed that any period of time selected should be one in which economic conditions remained stable. That standard was met in his selection of the first time period —the prime rate remained flat at 11% for the entire period. The second survey period, however, did not meet his standard for economic stability — the prime rate moved upward dramatically during that time, from 11% to 11.5%, and then to 12%. In addition, the FDIC conceded (Tr. 471) that the first survey period selected by the Examiner should be enlarged, in fairness to Respondents, to include an otherwise comparable 11% credit extension made by the Bank just several days before the onset of that period.
   Respondents, on the other hand, seek an interpretation of the term "at the time" which, on the basis of the record here, would encompass a broader period of time on either side of the loan dates and reflect economic conditions in which the prime rate remained at 10.5–11% for approximately a 14-month period, from January 1983 to March 1984. Using that period, the record would reflect, as indicated above, a number of comparable loans at 10.5% and 11% to non-insider borrowers.
   Given, however, the stipulation of the parties that, whatever survey period is used, the rate of interest on a vast majority of loans made by the Bank would fall in the 13–14% range, with a smaller number carrying interest rates of 10.5% or 11%, it is unnecessary to construe the term "at the time."
   This case turns, initially at least, on the meaning of the term "prevailing," and it is here that the parties are poles apart in their {{4-1-90 p.A-1115}}contentions. Examiner * * * testified that, as in the case of the term "at the time," he is guided by no written criteria or instructions. With actual experience in only a dozen or so examinations involving an application of Regulation O, he opined that "prevailing" means the "bulk" or the "majority" of the rates extended to borrowers in comparable transactions. His opinion as to the meaning of this statutory term, which the FDIC concedes (Tr. 469-70) is not entitled to the great deference required by Sunshine State Bank v. FDIC, 783 F.2d 1580 (11th Cir. 1986), finds support in the common dictionary definition of the term ("most frequent; in general or wide circulation or use or what exists generally; predominant or widespread beyond others of its kind or class").
   The position of the FDIC as to the proper construction of the term "prevailing" was clarified, however, during closing argument (Tr. 489, 493-4). The FDIC, counsel stated, is not contending that banks must fix credit terms for insider loans on the basis of a mechanical formula to determine what rates are applied in a majority of comparable, non-insider transactions; banks may give the same favorable rates to insiders as it gives to other comparable borrowers and need not bend over backwards in their effort to comply with Regulation O by imposing the least favorable credit terms on insiders. Yet this is precisely what Examiner * * * did when he concluded that any rate of interest afforded insiders during that period at less than 14% would be preferential.
   Respondents make no effort to ascribe a quantitative definition to the term. Rather they urge one that is consistent with common sense and the realities of the banking industry, i.e. that business loans are most often made on negotiated terms and that those credit terms will, in any given time period, vary within a wide range. The record in this case supports their position — interest rates on unsecured, non-installment loans varied from 9.5% to 14.4% at a time when the prime rate remained flat at 11%. Respondents contend that insider loans are not violative of Regulation O if made on the same or substantially the same terms as those extended to any other borrower in a comparable transaction.
   There appears to be no published interpretation of "prevailing" by any of the Federal banking agencies. A published Federal Reserve Board staff opinion of December 13, 1979, relating to standards for assessing credit worthiness and repayment risk, sheds some light on the question. It states that insider loans "should be made according to the same criteria. . .as are used by the bank for other borrowers" and that credit terms "shall be assigned without special consideration given to the borrower's position." FED. RES. BD. REGULATORY SERVICE, Sec. 3-1105. No useful guidance is to be derived from the many federal and state court decisions interpreting labor laws requiring payment of "prevailing wage rates." Under those laws, unlike here, the labor department determines wage rates prospectively for inclusion in certain government contracts and preferentiality is not a consideration. See e.g. Building and Construction Trades Dept. v. Donovan, 712 F.2d 611, 616-7 (D.C. Cir. 1983) cert. denied 464 U.S. 1069, and Commissioner v. Worcester Housing Authority, 393 N.E.2d 944, 949. Nor is there any clear legislative history to aid in the interpretation of the term. In commenting to the Congress on the proposed legislation, the FDIC referred to the problem of preferential credit terms as "interest rates below that charged other customers of the Bank" and, in a summary of the legislation, the pertinent provision is described as one which "would place insiders on the same level with the banking public and they would no longer be saved preferential spots in the line before the loan window. . . .The bill also requires all insider loans. . . .to be non-preferential. . . ." H.R.REP. NO. 95–1383, 95th Cong., 2d Sess. 10 et seq.

   [.2]The fact that Congress—as well as the framers of the regulation—found it necessary to couch this important proscription in the most general terms is clear evidence that it deemed the problem of insider credit abuse too complex and filled with too many variables to be amendable to a mechanical solution. More elastic terms than "substantially the same," "prevailing," "at the time," and "comparable," are hardly to be found in the English language. The conclusion thus seems inescapable: it is the spirit of the regulation —the elimination of credit preferences —rather than its phraseology that was intended to serve as the focus of enforcement. With this approach, the initial {{4-1-90 p.A-1116}}test of compliance thus becomes both simple to understand and simple to enforce: is the specific credit term extended to the insider more favorable than that offered during the relevant period to other bank customers in comparable transactions? If other borrowers receive the same term, the insider transaction is not violative of Regulation O. If the term is extended only to the insider, as in the case of the * * * loan, discussed below, a further analysis of the credit terms may be required to determine compliance.
   Here, the bulk of the loans made by the Bank in otherwise comparable transactions were in the 13–14% range. A number were made at 10.5% and 11%, and several at 12%. The 11% rate extended to Respondents is the same extended to other customers of the Bank and substantially similar to the 12% rate extended to others. It is more favorable than the rate given to the bulk of the Bank's commercial customers during that period, but, at the same time, it is less favorable than the 10.5% loans. Given such a range of interest rates during the relevant period, it cannot be said that the 11% rate given these three Respondents was preferential, in violation of Regulation O. To hold otherwise is to turn this important regulation on its head —insiders would be required to borrow at less favorable terms, and non-insiders would receive preferential treatment.
   The * * * loan in which the Bank participated is alleged to be preferential for yet another reason —its 30-year term. The survey conducted by the Examiner reveals that no other loan made by the Bank during the relevant period with a term longer than 25 years. Virtually all other loans, with the exception of the one 25-year loan and seven which carried a 20-year term, were made for 10–15 years. Thus, as to this specific credit term, the * * * credit extension was unique. However, the fact that no other borrower received a 30-year real estate loan does not end the matter. A second issue must be considered —whether the * * * loan was made on "substantially the same" terms as those offered other borrowers.
   For a number of reasons, I find and conclude that the FDIC failed in its burden to prove that the loan was not made on "substantially the same" terms as those offered non-insiders of the Bank.
   First, the statute, and the regulation which, in this respect, tracks it, requires only that insider loans be on terms "substantially the same" as those prevailing for other comparable transactions. The "same" terms are not required. The choice of a relative term, with highly elastic characteristics, as opposed to one more precise, is clear evidence of a Congressional recognition that, to a large extent, real estate and other commercial loans are priced on the basis of the risk of repayment as perceived by the bank and the negotiating ability of the borrower. Preferentiality can often be determined only by examining and comparing credit terms, i.e. principal, interest, collateral, and term, as a package, rather than individually.
   Second, to determine whether that package of credit terms extended to an insider is "substantially the same" as another requires some analysis other than a mechanical comparison of the individual components of the credit package. The FDIC recognizes that such an approach is essential for a proper Regulation O analysis (Tr. 475). Only in this way can a judgment be made as to whether, for example, a 10.5%, partially secured, 30-year loan for $100,000 carries terms substantially the same as an 11%, fully secured, 20-year loan for the same amount. The examiner admittedly made no such analysis in this case. Rather, he simply looked for other 30-year loans and, finding none, scheduled an apparent violation. Here, he might have considered the collateral to be of unusually high quality, given the uncontroverted fact that the residence was architectually designed, was located in an urban area near a large military post, and was readily marketable. Had he considered the quality of the collateral, together with the fact that the rate of interest given * * * was higher than that offered several other borrowers, the examiner might have concluded that the credit package extended to * * * was substantially the same as that offered other borrowers in comparable transactions. Or he might have considered that there is no substantial difference between a 25- and 30-year term, given the nature and purpose of real estate loans.
   Third, the legislation and the regulation was designed principally to curb uncontrolled borrowing by bank insiders, with no collateral or inadequate collateral and at below-market rates of interest. The * * * {{4-1-90 p.A-1117}}loan has none of these characteristics —it is within lending limits, it carries a rate of interest offered other borrowers, and it is more than adequately secured.
   Accordingly, I issue the following:


   IT IS ORDERED that the Notice of Assessment of Civil Money Penalties be, and the same hereby is, DISMISSED.
   Dated at Washington, D.C. this 30th day of January, 1987.

Administrative Law Judge
National Labor Relations Board
Washington, D.C. 20570

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