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[¶5181] In the Matter of Ronald J. Grubb, Bank of Hydro, Hydro, Oklahoma, Docket Nos. FDIC-88-282k and FDIC-89-111e (8-25-92).
In a consolidated action, the FDIC Board finds that repeated extensions of credit to respondent and his related interests warrant his removal from banking and assessment of a $50,000 civil money penalty. This decision affirms the administrative law judge's recommendation regarding the civil money penalty, but rejects his recommendation as to removal and prohibition.
[.1] Practice and Procedure—Recommended Decision—Exceptions—Oral Argument
The grant of a request for oral argument is within the discretion of the Board. Where the factual and legal arguments are fully set forth in the parties' submissions and the lack of oral argument will not prejudice the respondent, the Board denies the request.
[.2] Regulation O—Related Interests
An entity in which respondent has a one third interest is an affiliate for purposes of Regulation O. Letters of credit and loan to it are not exempt as indebtedness to the bank for the purpose of protecting the bank against loss.
[.3] Regulation O—Lending Limitations—Collateral
It is a violation of the requirement that insider loans be secured for respondent to treat his unsecured guaranty as collateral for extension of credit to his business interests.
[.4] Regulation O—Lending Limitations—Security Interest
A judgment as to which appeal rights have not expired and which is not a perfected security interest cannot qualify as collateral with an ascertainable market value for purposes of FDI Act Section 23A.
[.5] Regulation O—Overdrafts—Offsets
The right of offset, created by the text of the bank's checking account signature card, does not constitute collateral for purposes of Section 23A.
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[.6] Cease and Desist Order—Violation—Civil Money Penalty
Failure to document reasons for purchasing loan participation and for extensions of credit to borrowers with classified loans, as required by cease and desist order, are violations of the order whether or not losses to the bank result.
[.7] Civil Money Penalty—Factors Determining—Good Faith
An attitude of treating the bank's resources as if they were his own funds to enjoy without restraint does not reflect well on respondent's good faith for purposes of determining a civil money penalty.
[.8] Civil Money Penalty—Factors Determining—Gravity of Violation
For purposes of quantifying the gravity of violation, loans which have been charged off can be considered even if they are later repaid. Also counted, in addition to direct losses to the bank, are unpaid interest and the benefit to respondent of below-market interest and prohibited overdrafts.
[.9] Civil Money Penalty—Factors Determining—Other Matters
Improvement in the bank's financial condition is not a matter required by justice to be considered in determining the amount of a civil money penalty.
[.10] Removal—Factors Determining Liability—Fiduciary Duty
Respondent breached his fiduciary duty to the bank by failing to see that it operated in compliance with law and regulations, and by ignoring conflicts created by transaction which he devised for his own benefit.
[.11] Removal—Factors Determining Liability—Unsafe and Unsound Practices
Loans in violation of Regulation O, without collateral or with unperfected security interests, to borrowers with negative net worth or with outstanding classified loans are abusive insider transactions constituting unsafe or unsound banking practices.
[.12] Removal—Factors Determining Liability—Losses to Bank
Determination whether a bank has suffered, or probably would suffer, a substantial loss is to be made as of the time of issuance of the removal notice; subsequent redemptive acts are irrelevant to a removal action.
[.13] Removal—Factors Determining Liability—Prejudice to Depositors
Repeated violations, breaches of fiduciary duty and unsafe or unsound practices, with their resulting losses to the bank, subjected depositors to the risk of serious prejudice.
[.14] Removal—Factors Determining Liability—Disregard for Safety and Soundness
Continuing or repetitive violations constitute willful disregard for the safety and soundness of the bank.
[.15] Neither respondent's banking skills and experience nor his conduct at other banks he owns should be considered mitigating factors in a removal and prohibition action.
In the Matter of
RONALD J. GRUBB,
individually and as a director and/or person
participating in the conduct
of the affairs of
BANK OF HYDRO
HYDRO, OKLAHOMA
(Insured State Nonmember Bank)
DECISION AND ORDERS
FDIC-88-282k and
FDIC-89-111e
INTRODUCTION
This proceeding is a consolidated action brought by the Federal Deposit Insurance
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Corporation ("FDIC" or "Petitioner") against Ronald J. Grubb ("Respondent"), individually and as a director and/or person participating in the conduct of the affairs of Bank of Hydro, Hydro, Oklahoma ("Bank"), seeking civil money penalties pursuant to former sections 18(j)(3) and 18(j)(4) of the Federal Deposit Insurance Act ("FDI Act"), 12 U.S.C. §§ 1828(j)(3) and 1828(j)(4), and the FDIC Rules of Practice and Procedure, 12 C.F.R. Part 308; and also seeking removal pursuant to former section 8(e)(1) of the FDI Act, 12 U.S.C. § 1818(e)(1) and the FDIC Rules of Practice and Procedure, 12 C.F.R. Part 308.1 Respondent is charged with violations of section 23A of the Federal Reserve Act ("Act"), 12 U.S.C. § 371c, as made applicable to insured State nonmember banks by section 18(j)(1) of the FDI Act; section 22(h) of the Act, 12 U.S.C. § 375b, and sections 215.4(a), (b), and (c) of Regulation O of the Board of Governors of the Federal Reserve System ("Regulation O"), 12 C.F.R. Part 215, as promulgated thereunder and made applicable to insured State nonmember banks by section 18(j)(2) of the FDI Act, 12 U.S.C. § 1828(j)(2), and section 337.3(a) of the FDIC Rules and Regulations, 12 C.F.R. § 337.3(a); and a Cease-and-Desist Order issued by Petitioner.
The Decision of the Board of Directors ("Board") of the FDIC finds that the repeated extensions of credit to Respondent and his related interests which are alleged in the Notice of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of law, Order to Pay and Notice of Hearing ("Assessment Notice") and Notice of Intention to Remove and/or Prohibit From Further Participation ("Removal Notice") involved over forty violations of section 23A of the Act and Regulation O, resulted in substantial financial loss to the Bank totalling $606,033, of which Respondent subsequently repaid $484,607; that these transactions constituted breaches of Respondent's fiduciary duty of the Bank, involved unsafe or unsound practices, and resulted in economic benefit to Respondent; and that such violations, practices, and breaches demonstrate Respondent's willful or continuing disregard for the safety or soundness of the Bank.
As Administrative Law Judge Steven M. Charno ("ALJ") found, Respondent continually used the Bank as his own "personal purse that he might employ without regard to regulatory constraints." R.D. at 18.2 Furthermore, the violations and prohibited loans continued even after similar violations cited in the 1986 Report of Examination were discussed with Respondent.
The Board orders Respondent to pay a civil money penalty of $50,000 and further orders that Respondent is removed as a director of the Bank and prohibited from serving or acting as an institution-affiliated party and/or from participating in any manner in the conduct of the affairs of any insured depository institutions.
REQUEST FOR ORAL ARGUMENT
Respondent's Exceptions include a request for oral argument before the Board. Respondent argues that this case presents some unique characteristics because of the "Grubb Lawsuit" discussed at page 22 below, and that the FDIC Dallas Regional Office has exhibited a prejudicial attitude toward him; hence, Respondent's briefs cannot adequately present Respondent's position, and Respondent will be prejudiced if the Board fails to grant oral argument.
[.1] The grant of a Request for Oral Argument is an extraordinary matter within the discretion of the Board. 12 C.F.R. § 308.17. The Board has previously discussed those circumstances in which it would grant such a request. See In the Matter of Harold Hoffman, 2 P-H FDIC Enf. Dec. ¶5140; FDIC Docket No. FDIC-85-42b, 1 P-H FDIC Enf. Dec. ¶5062. After considering Respondent's request, the Board finds none of those circumstances in the instant case. The factual and legal arguments are fully set forth in the parties' submissions. As to the assertions of prejudice against Respondent by the
1 Because the charges specified in the Notice of Intention to Remove and/or Prohibit From Further Participation occurred prior to the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 101 Stat. 183 (August 9, 1989) ("FIRREA"), Respondent's conduct will be measured by the substantive provisions of sections 8(e)(1), 8(i)(2)(i), and 8(j)(4) of the FDI Act, 12 U.S.C. § 1818(e)(1), as they existed prior to amendment. The scope and effect of any removal order by the Board, however, is determined by post-FIRREA section 8(e)(6) and 8(e)(7) of the FDI Act, 12 U.S.C. §§ 1818(e)(6) and 1818(e)(7)(1989).
2 Citation in this Decision shall be as follows:
Recommended Decision—"R.D. at ____."
Transcript—"Tr. at ____."
Exhibits—"FDIC Ex. ____" or "Resp. Ex. ____" or "Resp. Late-Filed Ex. ____."
{{11-30-92 p.A-2009}}FDIC Regional Office, Respondent offers no supportive evidence. In any event, such prejudice, if true, would be irrelevant to the disposition of this proceeding, which will be decided on whether the allegations in the Assessment Notice and Removal Notice are supported by the preponderance of evidence in the record as a whole, including the testimony of the parties' witnesses, the Exhibits, and the Joint Stipulation of Facts. Thus, oral argument will not aid the Board in this matter, and Respondent will not be prejudiced by the lack or oral argument. Accordingly, the Board denies Respondent's Request for Oral Argument.
I. STATEMENT OF THE CASE
A. DESCRIPTION OF THE CHARGES
On December 22, 1988, the FDIC issued the Assessment Notice against Respondent3 for the alleged violations of section 23A of the Act and of Regulation O cited above. The Assessment Notice, as amended, alleged (1) violations of the lending limits of section 23A(a)(1)(A) of the Act, the collateral security requirements of section 23A(c)(1) of the Act, and the creditworthy requirements and lending limits of sections 215.4(a)(2) and 215.4(c), respectively, of Regulation O, with respect to the issuance and subsequent renewals of a letter of credit on behalf of MGM Production Company ("MGM"), an alleged "affiliate" of the Bank and "related interest" of Respondent, as those terms are defined in section 23A(b)(1) of the Act and section 215.2(k) of Regulation O, respectively; (2) violations of the creditworthy requirements of section 215.4(a)(2) of Regulation O, the lending limits of section 215.4(c) of Regulation O, and the prior approval requirements of section 215.4(b) of Regulation O, with respect to overdrafts on checking accounts maintained at the Bank on behalf of Respondent and certain of his "related interests," namely MGM, Falcon Management Company ("Falcon Management"), and Ron Grubb Investments ("RGI"); (3) violations of the overdraft prohibition of section 215.4(d) of Regulation O with respect to overdrafts on Respondent's personal account; (4) violations of the collateral requirements of section 23A(c)(1) of the Act with respect to the overdrafts of MGM and Falcon Management; (5) violations of the creditworthy requirements of section 215.4(a)(2) of Regulation O with respect to the issuance and renewal of a loan to Falcon Production Company ("Falcon Production"), an alleged "related interest" of Respondent, and violation of the lending limits of section 215.4(c) of Regulation O with respect to the renewal of that loan; (6) violations of sections 215.4(a)(2) and 215.4(c) of Regulation O with respect to certain payments to Respondent in connection with the so-called Falcon Production ORE transaction; (7) violations of sections 215.4(c) and 215.4(a)(2) of Regulation O with respect to four extensions of credit made to Respondent during 1986 and 1987; (8) violations of the November 29, 1985 Cease-and-Desist Order issued by the FDIC to the Bank by (a) capitalizing uncollected interest on two occasions, (b) twice failing to document the reasons for extensions of credit to classified borrowers, (c) failing to document the reasons for purchasing a loan participation, and (d) failing to amend the loan policy to reflect changes required by the FDIC Pursuant to former section 18(j)(4) of the FDI Act, 12 U.S.C. § 1828(j)(4), Respondent was assessed a $50,000 civil money penalty for participation in the alleged violations of the Act, Regulation O, and the Cease-and-Desist Order.
On July 13, 1989, Petitioner issued the Removal Notice to Respondent pursuant to section 8(e)(1) of the FDI Act, 12 U.S.C. § 1818(e)(1).4 The Removal Notice realleged that Respondent violated section 23A of the Act and various provisions of Regulation O as described above. It further alleged that Respondent's illegal conduct resulted in Respondent's engaging or participating in unsafe or unsound banking practices and breaches of his fiduciary duty to the Bank, and demonstrated his willful or continuing disregard for the safety or soundness of the Bank; and that as a result of Respondent's acts, omissions and/or practices, the Bank has suffered or will probably suffer substantial financial loss or other damage in the amount of approximately $606,033, and resulted in Respondent's receiving financial
3 The Assessment Notice named four additional individuals as Respondents in this proceeding. All four were dismissed from the action as a result of negotiated settlements with the FDIC.
4 The Removal Notice named two additional individuals as Respondents. Both were dismissed from the action as a result of negotiated settlements with the FDIC.
{{11-30-92 p.A-2010}}gain amounting to $887,560. The Removal Notice seeks to permanently prohibit Respondent from further participation in the conduct of the affairs at the Bank or any other FDIC-insured institution. In December 1989, the civil money penalty and removal actions were consolidated for hearing and decision.
B. SUMMARY OF PROCEEDINGS
Following prehearing conferences on October 3, 1989, December 28, 1989, and April 10–11, 1990, and the submission by the parties of a Joint Stipulation of Facts and prehearing briefs together with proposed findings of fact and conclusions of law, a four-day evidentiary hearing was held in the matter before the ALJ on December 3–6, 1990 in Oklahoma City, Oklahoma. The parties submitted initial post-hearing briefs, together with proposed findings of fact and conclusions of law, on June 24, 1991, and simultaneous reply briefs on July 12, 1991. In December 1991, the ALJ allowed Respondent to file three late-filed exhibits and proposed supplemental findings of fact and conclusions of law based thereon. Petitioner filed a brief opposing receipt of the exhibits. The ALJ received the late-filed exhibits in evidence, R.D. at 2.
C. SUMMARY OF THE TRANSACTIONS
ON WHICH THE PARTIES BASE
THEIR CHARGES AND DEFENSES
The alleged violations set forth in the Assessment Notice and the Removal Notice occurred from December 1985 through February 1988. Transactions both previous and subsequent to this period are relied on by Respondent in defense. Because of the number and complexity of transactions involved in this proceeding, they are summarized below.5
1. General Background.
(a) The Bank had total assets of $27.7 million and total capital of $2.328 million as of the April 27, 1990, Examination. FDIC Ex. 335 at 2.
(b) Respondent Ronald J. Grubb owns 94 percent of the Bank through his control of Hydro Bancshares, Inc., and is a director and person participating in the affairs of the Bank. He bought his first bank in 1974 and has owned controlling interests in 17 banks in Oklahoma and Texas. He purchased an interest in the Bank in 1977, Tr. at 580-83, and obtained control of the Bank in 1981, FDIC Ex. 3. In 1985, respondent owned more than 50 percent of nine banks, and 35 percent of another, FDIC Ex. 1. At of 1990, he owned controlling interests in 6 banks, FDIC Ex. 335.
(c) The 1985 Report of Examination of the Bank stated that the Bank's condition reflected a serious deterioration from the last examination; that loan classifications had doubled; that 53 percent of all classified loans were originated by Respondent; that it was recommended that Respondent refrain from further lending and completely divorce himself for the loan area. Consequently, Respondent resigned as chairman of the board of the Bank, but continued to serve as a director. The president of the Bank also resigned, although he also continued to serve as a director.
(d) Fred Schamburg, who graduated from college in 1981 and immediately went to work for the Bank as a trainee, was promoted to president of the Bank during the 1985 Examination, Tr. at 917. He served in that position at least until November 1991, Resp. Late-filed Ex. 330.
(e) On November 29, 1985, an FDIC Cease-and-Desist Order became effective against the Bank, based on the results of the 1985 Examination.6
(f) During the period 1985 through 1988, the Bank had but one outside director, who
5 This summary is based upon facts which are stipulated by the parties or otherwise are part of the record and uncontroverted. If there is no record reference, the facts are derived from the Joint Stipulation of Facts.
6 In summary, the Cease-and-Desist Order required the Bank to (1) obtain independent, outside directors, 92) retain management acceptable to the FDIC, 93) maintain adjusted primary capital equal to or greater than 8.0 percent of adjusted total assets, (4) reduce adversely classified assets, (5) establish an adequate allowance for loan losses, (6) refrain from extending additional credit to any borrower whose loan has been classified "Doubtful" or "Loss" and is still uncollected, or whose loan has been classified "Substandard" and is uncollected unless the board of directors has signed a written statement giving reasons why failure to extend such credit would be detrimental to the best interests of the Bank, and refrain from purchasing participations in loans unless the board of directors documents the reasons for the purchase prior to their purchase, (7) adhere to loan policies and procedures, and review and modify its current written loan policies and procedures and present same to the FDIC for approval, (8) refrain from declaring or paying any cash dividend in excess of 50 percent of the earnings and profits for the year under consideration, (9) refrain from purchasing or repurchasing loan participations if the loan has been adversely classified or exhibits other unfavorable characteristics, (10) eliminate concentrations of credit, and 911) eliminate technical exceptions to loan documentation.
{{11-30-92 p.A-2011}}was elected in March 1987 and resigned in May 1988. FDIC Ex. 1–4.
2. Bank Examinations during the Relevant Period.
(a) Petitioner's Exhibits 1–4 consist of Reports of Examination on the Bank dated May 10, 1985, July 18, 1986, December 31, 1987, and January 23, 1989 (the last three Examinations having been conducted jointly with the Oklahoma State Banking Department).
(b) The 1985 Report of Examination classified "Substandard" three loans outstanding to Respondent totalling $330,000, stating, "It is apparent that the debtor does not warrant unsecured debt. The credit is classified Substandard due to its unsecured status and the deteriorating financial condition of the borrower."
At the conclusion of each examination, Respondent and other Bank directors met with the examiners regarding the results of the examination, and Respondent and other Bank directors received copies of each Report of Examination. After the 1986 Examination, both the FDIC and the Oklahoma State Banking Department sent Respondent and other Bank directors letters regarding alleged violations of law and alleged violations of the FDIC's Cease-and-Desist Order discovered in the 1986 Examination and recited in the 1986 Report of Examination. After the 1987 and 1989 Examinations, the FDIC sent letters to Respondent and other Bank directors regarding alleged violations of law and alleged violations of the FDIC's Cease-and-Desist order discovered at the 1987 and 1989 Examinations and cited in the 1987 and 1989 Reports of Examination.
3. Transactions Involving Alleged Violations.
(a) MGM Letters of Credit. MGM was an oil and gas production company, one-third owned by Respondent (see page 20, below). On February 14, 1986, the Bank issued a standby, irrevocable letter of credit, effective March 10, 1986, for $265,000, to secure a bond issued by Travelers Insurance Company ("Travelers") in that amount to bond off mechanic's liens for MGM's benefit in the lawsuit (see page 21, below). The letter of credit was guaranteed by Respondent, who signed a "blank" promissory note and a "blank" guaranty agreement but was not secured by a pledge of collateral.
When the letter of credit was issued, MGM had lost the lawsuit (increasing the risk that the letter of credit would be called) but was appealing it. Also at that time, the Bank had loans outstanding to Respondent which had been adversely classified "Substandard" during the 1985 Examination.7 When issued, the letter of credit exceeded 10 percent of the Bank's capital and surplus by $37,700 and, when aggregated with the Bank's $110,000 loan to Falcon Production, another related interest of Respondent (see page 14, below) exceeded 15 percent of the Bank's capital and surplus by $34,050.
The 1986 Examination Report cited the letter of credit as a violation of section 23A of the Act.
On March 9, 1987, and again on March 9, 1988, the Bank issued replacement, standby, irrevocable letters of credit for $265,000, again guaranteed by Respondent but without perfected security interests in any pledged collateral. On the dates of issuance, the Bank had outstanding loans to Respondent and Falcon Production which had been adversely classified "Substandard" at the 1986 Examination and "Doubtful" at the 1987 Examination. The 1987 letter of credit was classified "Doubtful" at the 1987 Examination.8
On April 14, 1988, the lawsuit having been lost by MGM on appeal, the Bank disbursed $235,801 on MGM's behalf, pursuant to the letter of credit,9 and treated the payments as a loan to MGM. The loan was
7 Shortly thereafter, the loans were repaid with the proceeds of a Certificate of Deposit which had served as collateral for a previous letter of credit for MGM at another bank controlled by Respondent, Tr. at 847, 848.
8 "...President Schamburg also indicated that there is a reasonable expectation that the letter of credit may have to be funded, as the appeal situation indicates that MGM lost the initial lawsuit, and accordingly, could also lose the appeal. Bank Director Ronald J. Grubb has executed a blank, signed note and guaranty form to support the letter of credit in event of funding. No collateral has been pledged to secure this contingent liability. No financial information is available on MGM to determine repayment capacity, and with guarantor Grubb's weak financial condition as detailed on page 2-a-2, coupled with the letter of credit's unsecured status, a Doubtful classification is accorded." December 31, 1987 Report of Examination, FDIC Ex. 3 at 2-a-9.
9 The parties so stipulated. However, the payments were not made to Travelers pursuant to the bond, but directly to a lien holder and to MGM's attorney for legal fees. The latter payment appears to be beyond the obligation of the Bank under the letter of credit and hence a new extension of credit to MGM.
{{11-30-92 p.A-2012}}guaranteed by Respondent, but the Bank did not have a perfected security interest in any pledged collateral. At the time the loan was funded, the Bank's aggregate extensions of credit to Respondent, MGM, and Falcon Production exceeded 15 percent of the Bank's capital and surplus by $192,025.
The MGM loan was charged off by the Bank as a loss in late 1988, Tr. at 960. The principal of the loan was repaid by Respondent on November 14, 1991, Resp. Late-filed Ex. 330.
(b) Overdrafts. During 1986 and 1987, the Bank maintained checking accounts on behalf of MGM, Falcon Management, a corporation wholly owned by Respondent, and RGI, Respondent's sole proprietorship, and Respondent. All of these accounts were overdrawn at various times between July 1, 1986, and November 30, 1987.
(c) Dealings With Falcon Production. Respondent was one of the original incorporators of Falcon Production and served as its President and one of its directors. For several years, it was an inactive company without assets. In 1985. Respondent sold the corporation to his son, Shawn J. Grubb, Tr. at 629; but Respondent had the authority to borrow on the account of Falcon Production from the Bank and had been granted power of attorney by his son for purposes of conducting the business of Falcon Production.
On December 31, 1985, the Bank made a one year, single payment loan to Falcon Production in the amount of $110,000 for the purpose of purchasing a mineral lease from Respondent. Respondent signed the promissory note and security agreement, and personally guaranteed the Bank from any loss by signing a guaranty agreement. At that time, the Bank had an outstanding loan to Respondent that was adversely classified "Substandard" at the 1985 Examination. The Falcon Production loan was secured with collateral represented by a mineral mortgage. The proceeds of the loan were used as payment on Respondent's personal loans at the Bank which had been classified "Substandard" in the 1985 Examination Report. The 1986 Report of Examination classified the Falcon Production loan "Substandard".10
On February 12, 1987, the Bank renewed the loan to Falcon Production on the same terms, again with the note and security agreement signed by Respondent and personally guaranteed by him. In addition to the mineral mortgage, Falcon Production posted as collateral a second mortgage on a 479 acre farm in Harmon County, Oklahoma. At that time, the Bank had an outstanding loan to Respondent that was adversely classified "Substandard" at the 1986 Examination; and the Bank's extensions of credit to MGM, Respondent, and Falcon Production exceeded 15 percent of the Bank's unimpaired capital and unimpaired surplus.
On February 2, 1988, Falcon Production failed to make the principal and interest payments due on the loan. The first mortgage was also past due, Tr. at 971. On February 22, 1988, the Bank accepted a deed from Falcon Production to the Harmon County farm in lieu of foreclosure, and paid off the outstanding superior lien held by the Equitable Life Assurance Society of the United States in the amount of $134,447. The Bank accounted for the real estate acquired by crediting the Falcon Production loan in the amount of $124,311, for the past due principal and accrued interest, and listing the acquired property as Other Real Estate ("ORE") in the amount of $342,000, representing 90 percent of the appraised value of $380,000, according to an appraisal of the property dated January 15, 1988. Resp. Ex. 36.
On February 17, 1988, the Bank had disbursed funds to Falcon Production in the amount of $48,553 by depositing that amount into Falcon Production's account at the Bank, which was used to pay an insufficient funds item drawn by Respondent on the account to make payment on Respondent's personal loan at the Bank's affiliate, First State Bank of
10 "Collateral for this loan is supposed to consist of a mortgage of mineral rights on 110 acres in Blaine County, Oklahoma; however, the mortgage document reflects the mortgagor as Falcon Production Company, even though Ronald J. Grubb is the reported owner of the property. . . . There were no title investigation reports or appraisals on these mineral rights in the credit file. An informal memorandum in the credit file prepared by Mr. Grubb indicated that he had purchased the mineral rights in 1982 for $110,000 and has since leased the rights on two occasions at $1,000 per acre. Unaudited financial information for Falcon Production Company dated 12-31-85 disclosed. . .deficit NW (15.4M). President Schamburg indicated that repayment of this debt was to come from income generated by the company from the purchase and sale of oil and gas leases, but no income information was available on the company, and President Schamburg indicated that sales of oil and gas leases were very slow at present due to the overall depressed state of the oil industry." July 18,1986, Report of Examination, FDIC Ex. 2 at 2-a-2.
{{11-30-92 p.A-2013}}Mooreland, Mooreland, Oklahoma. On February 22, 1988, the Bank disbursed an additional $34,688 to Falcon Production, of which $34,000 was transferred to the account of RGI at the Bank. These two payments, totalling $83,241, purportedly represented Falcon Production's "equity" in the transferred real estate, the difference between 90 percent of appraised value and the amounts paid and credited by the Bank in satisfaction of the first mortgage loan and the Bank's loan to Falcon Production.
On February 22, 1988, the Bank's extensions of credit to MGM and Respondent exceeded 15 percent of the Bank's unimpaired capital and unimpaired surplus.
(d) Respondent's Personal Loans. During the 1985 Examination of the Bank, Respondent's personal loans in the amount of $330,000 were classified "Substandard" because they were unsecured and because his financial net worth had been steadily declining. All of these loans had been paid off by April 1986, with the proceeds of the Falcon Production loan and of Respondent's certificate of deposit at BankCentral which had previously been securing the letter of credit issued by that bank on behalf of MGM.
The Bank made four extensions of credit to Respondent during 1986 and 1987: a $75,000 loan on April 25, 1986; a $150,000 loan on June 5, 1986, which was used to renew the principal and unpaid interest of the April 25th loan and to provide $73,884 in new funds; a $100,000 loan on October 29, 1986, approximately $39,000 of which was used to pay Respondent's overdrafts on another account with the Bank; and a $250,000 loan on April 14, 1987, which consolidated the June and October 1986 loans and provided a three year term with monthly payments of $1,922 and a final balloon payment of $243,815.
During the July 1986 Examination, and prior to the October 1986 loan, Respondent was informed by the FDIC that the June 1986 loan was a violation of Regulation O and also had been adversely classified "Substandard". He thereupon executed the 1986 Assignment of the "Grubb Judgment" (see page 23, below). A few months later, the Bank loaned Respondent an additional $100,000 in October 1986. When the April 1987 loan was made to Respondent, the Falcon Production loan and the June 1986 loan to Respondent had been classified "Substandard" at the 1986 Examination. Respondent purportedly granted the Bank additional collateral security at the time of the April 1987 loan. The April 1987 loan was classified "Doubtful" at the 1987 Examination.11
When loans were made to Respondent in 1986 and 1987, the Bank's extensions of credit to Respondent, MGM, and Falcon Production exceeded 15 percent of the Bank's unimpaired capital and unimpaired surplus.
In August 1988, Respondent ceased making payments on the April 1987 loan. In December 1988, the Bank charged off as loss the accrued but uncollected interest in the amount of $10,895, Tr. at 469. The January 23, 1989 Report of Examination classified the loan as "Loss".12 Shortly thereafter, Respondent executed the 1989 Assignment, perfected on February 15, 1989, as security for the loan up to $250,000. In June
11 "Collateral consists of Mtges on a service station in Clinton, Oklahoma and a condominium in Pagosa Springs, Colorado. Both of these Mtges are signed only by Mr. Grubb and his wife has refused to sign. The bank does not have title information on these two properties; therefore, the ownership and lien positions are uncertain. President Schamburg estimates the service station to be work 210M. Mrs. Grubb reportedly refused to signed [sic] the Mtges due to domestic issues. . .
"A review of Grubb's financial statements indicates that he is highly leveraged and his financial condition has been deteriorating. His NW has declined from 8,891M in 1984 to 7,490M in 1985, and in 1986 to 2,985M...
. . ."Grubb has also won a favorable judgment which is now in appeal and its outcome still unknown. All of these factors indicate that Mr. Grubb's financial condition and income is in a state of significant and uncertain change. A classification of Doubtful is assigned to the credit due to the deteriorating financial condition of the borrower, uncertainty associated with collateral lien position, if any, and the long term amortization period." December 31, 1987 Report of Examination, FDIC Ex. 3 at 2-a-2, 2-a-3.
12 "Payments of 1,922 were being made until August, 1988 when curtailment ceased entirely. Chairman Grubb stated that the reason he could no longer meet his payment schedule was due to his acquisition of the assets of MGM Production Company, Inc.... The bank has taken an assignment on the [Grubb] judgement, but has not properly perfected its lien. The judgement has been pledged to other creditors and a list provided by Chairman Grubb's accountant during the examination reflects that this bank is to receive the above principal only, but no interest.... Chairman Grubb and his wife are presently involved in divorce litigation and the bank will apparently lose its lien [on the service station] if she is awarded the property in a settlement. This property was appraised on 12-23-88 at 136M. The bank also holds a deed of trust on a condominium in Colorado, but no title opinion reflecting the lien position has been obtained.... This property was appraised at 70M on 7-2-88. A joint PS of Ronald J. and Cleta L. Grubb dated 12-31-87 reflects...a NW of 1,099.3M with contingent liabilities of (Continued)
{{11-30-92 p.A-2014}}of 1989, the Bank charged off as loss $248,806 representing the unpaid principal balance on the loan.
By letter dated April 20, 1990, the Oklahoma State Banking Commissioner (at the request of Respondent's counsel, acting on behalf of the Bank) indicated no objection to the rebooking of the loan, based upon the second jury verdict and the supersedeas bond in the Grubb Lawsuit (page 22, below); provided it remain in nonaccrual status, and with the further requirement that the Bank obtain a subordination agreement from the F&M Bank regarding its assignment of the judgment. FDIC Ex. 342. This requirement was fulfilled by the November 30, 1990 Subordination Agreement with F&M Bank, Resp. Ex. 320. The principal of the April 1987 loan was repaid by Respondent on November 14, 1991, Resp. Late-filed Ex. 330.
4. Transactions Relied on by Respondent in Defense.
(a) MGM Production company Formation. In September 1982, the Bank made a one-year loan of $500,000 to Doyle Matthews and Joey May, of which $300,000 was participated out to another bank controlled by Respondent. No payments were due on the loan until maturity, Tr. at 829. The borrowers' financial statements indicated a combined net worth of $7.8 million. Collateral consisted of accounts receivable, oil and gas drilling and production equipment, and an assignment of mortgage on numerous oil well and related leases owned by Tulsa Petroleum Resources, Inc. ("TPR"). Tr. at 824–833; Resp. Ex. 288.
On November 12, 1982, mechanic's and materialman's liens were filed by third parties against the TPR assets and revenues generated thereby, Tr. at 825. In October and December 1982, May and Matthews made payments on their loan, Tr. 828–833; Resp. Ex. 288.
In November 1982, Respondent, May, and Matthews formed MGM. respondent was a one-third owner. On November 23, 1982, MGM executed an agreement to purchase the assets of TPR, Tr. at 825. In December 1982, MGM borrowed $450,000 from Citizens National Bank & Trust Co., Oklahoma City, Oklahoma, Oklahoma City, Oklahoma, for the purpose of purchasing the assets of TPR, Tr. at 1190-94. The proceeds were used to pay off the Matthews and May loan from the Bank, Tr. at 614–616. The loan, totalling $180,305.15 in principal and $7,257.30 in interest, was paid off on March 23, 1983, Resp. Ex. 288.
Also in March 1983, bonds for up to $265,000 were posted by Travelers, backed by a standby, irrevocable letter of credit from BancCentral, Amarillo, Texas, a bank controlled by Respondent, to bond off the liens. Suit was commenced on one or more of the liens in March or April, 1983. The lawsuit was lost by MGM in state district court after trial in March 1984 but was appealed, Tr. at 661–680. The bond and the BancCentral letter of credit were renewed in 1985, at which time Respondent posted a CD in the amount of $265,000 to secure the letter of credit.
In early 1986, Respondent sold his interest in BancCentral. When the letter of credit was replaced by one issued by the Bank, Respondent's CD at BancCentral was used to pay off his loans at the Bank which had been classified "Substandard" at the 1985 Examination, Tr. at 848–849; FDIC Ex. 153.
(b) The "Grubb Judgment" and Its Assignment.
(i) Background. In February 1983, Respondent and a partner purchased Security State Bank, Weatherford, Oklahoma ("Security State") from The First National Bank and Trust Company of Oklahoma City, Oklahoma City, Oklahoma ("First National"), which had foreclosed on the stock under a pledge agreement. As part of the transaction, First National restructured some debt and advanced approximately $5 million in the form of a loan to Respondent and his partner to recapitalize Security State. Thereafter, in September 1983, Respondent caused Hydro Bancshares, Inc. (the Bank's holding company) to contribute $1.5 million to the capital of Security State. In February 1984, Respondent paid First National $222,629.88 in interest on the loans in order to obtain renewals of the loans. In March 1984, Respondent made a $1 million capital contribution to Security State. Security State was closed on September 21, 1984.
(ii) The Lawsuit and Judgments. On August 31, 1984, Respondent filed suit in United States District Court for the Western
12 Continued: 15,726.5M. Major assets include 3,734.9M in bank stock and 2,750M for the above judgement receivable. A loss of the above law suit would leave the borrower insolvent. Chairman Grubb expressed only slight disagreement with the severity of the classification, but offered no real supporting information." January 23, 1989 Report of Examination, FDIC Ex. 4 at 2-a-2.
{{11-30-92 p.A-2015}}District of Oklahoma for damages against First National, alleging that First National violated federal and state securities laws in the sale of the Security State stock, and asking for rescission of the notes to First National in connection with the transaction ("Grubb Lawsuit"). First National counterclaimed for payment on the notes. Sometime in 1985,13 Respondent was awarded a jury verdict of $2,722,629.88 plus attorney fees and post-judgment interest, and the counterclaim of First national on the notes was dismissed ("1985 Grubb Judgment"). First National appealed to the U.S. Court of Appeals for the 10th Circuit, and was required to post a supersedeas bond backed by U.S. Treasure obligations. While the appeal was pending, First National was declared insolvent by the Comptroller of the Currency on July 14, 1986 and the FDIC was appointed Receiver.
After being made a party to the suit, the FDIC as Receiver moved to exonerate the supersedeas bonds posted by First National under 28 U.S.C. § 2408, asserting, inter alia, that a judgment creditor is entitled only to a pro rate share of the failed bank's estate. The motion was denied in Grubb v. FDIC, 833 F. 2d 222 (10th Cir. 1988).
On the substantive appeal, in a decision dated February 16, 1989, the U.S. Court of Appeals for the 10th Circuit upheld the judgments below on liability and dismissal of First National's counterclaims, but remanded for a new trial on damages unless Respondent accepted a remittitur reducing the award to $222,629.88. Grubb v. FDIC, 868 F. 2d 1151 (10th Cir. 1989).
In July 1989, Respondent rejected the remittitur and thereafter the damages claim was retried. In December 1989, a jury awarded Respondent approximately $2.7 million. On October 26, 1990, the Court entered judgment in the principal amount of $2,725,157.65 ("1990 Grubb Judgment"). Respondent was also awarded prejudgment interest in the amount of $1,606,660, and attorneys fees of $467,000. The FDIC as Receiver paid the judgment for attorneys fees in December 1990, and appealed the other judgments. By agreement dated November 13, 1991, Respondent and the FDIC as Receiver settled the appeal for $3,250,000, which was paid to Respondent from the supersedeas bond, Resp. Late-filed Ex. 329.
(iii) Assignments of the Judgments. On July 23, 1986, Respondent executed a Security Agreement with the Bank, granting a security interest in "Judgment Bond posted by First National Bank" in the Grubb suit, in the amount of $3,355,000, Resp. Ex. 310 ("1986 Assignment"). This assignment was never perfected by the Bank.
On February 9, 1989, Respondent executed an Assignment of Judgment granting the Bank a security interest in the "Judgment Bond" with respect to the principal of Respondent's April 14, 1987 loan in the amount of $250,000. The 1989 Assignment was perfected by the Bank on February 15, 1989, by filing with the Clerk of Court, FDIC Ex. 352, the day before the damages portion of the 1985 Judgment was remanded for new trial or acceptance of the remittitur.
On November 30, 1990, Respondent executed an Assignment of Judgment as Collateral, assigning to the Bank part of his rights, title, and interest in and to the judgments, proceeds and supersedeas bonds in the Grubb suit, pursuant to a Supplemental Security Agreement of the same date ("1990 Assignment"). Also on November 30, 1990, the Bank and Respondent executed a Subordination Agreement with The F & M Bank and Trust Company, Tulsa, Oklahoma ("F&M"), which recognized the first lien position of F&M and provided that the Bank would be paid the first $484,606 of cash proceeds from the security in exchange for an assignment to F&M of all rights of the Bank in and to the indebtedness of Respondent and the collateral. The 1990 assignment was perfected by filing the Clerk of Court on December 4, 1990. See Resp. Ex. 320–322.
D. SUMMARY OF THE ALJ'S
RECOMMENDED DECISION, PROPOSED
FINDINGS, CONCLUSIONS & ORDER
ALJ Charno issued a 51-page Recommended Decision, Findings of Fact and Order ("R.D.") dated March 25, 1992, summarized below, in which he found many violations of section 23A and Regulation O, and concluded that the imposition of a civil money penalty in the amount of $50,000 is reasonable and appropriate, but that the Removal Notice should be dismissed.
13 The Judgment on Jury Verdict is dated October 31, 1985, Resp. Ex. 319.
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1. Alleged Violations.
(a) MGM Letters of Credit. The ALJ concluded that the letters of credit issued on February 14, 1986 and March 9, 1987, each in the amount of $265,000, violated the lending limit of section 23A(a)(1)(A) of the Act; that the letters of credit issued February 14, 1986, March 9, 1987, and March 9, 1988, as well as the funding of the last letter of credit on April 14, 1988 in the amount of $235,801, violated the collateral requirements of section 23A(c)(1) of the Act; that the first two letters of credit and the funding of the last letter of credit violated the lending limits of section 215.4(c) of Regulation O; and that all three letters of credit violated the creditworthy requirements of section 215.4(a)(2) of Regulation O because the adverse classification of loans to Respondent on the dates of these extensions of credit to MGM, the guarantor of the MGM extensions of credit, constituted "unfavorable features" thereunder. In so concluding, the ALJ rejected Respondent's arguments that MGM is not an "affiliate" of the Bank; that his personal guaranty constitutes sufficient collateral under section 23A(c)(1) of the Act; and that the transactions are exempt from Regulation O. Finally, the ALJ rejected as "moot" the Petitioner's requested findings that the issuance of each letter of credit violated the creditworthy requirements of section 215.4(a)(2) for additional reasons ("blank" promissory notes and guaranty agreements, no collateral, no financial information on MGM, and marked deterioration of Respondent's financial condition).
(b) Overdrafts. The ALJ concluded that the MGM and Falcon Management overdrafts were not secured by acceptable collateral in violation of section 23A of the Act; that the overdrafts of Respondent, MGM, Falcon Management, and RGI violated the lending limits of section 215.4(c) of Regulation O and the prior Board approval requirements of section 215.4(b) of Regulation O and the creditworthy requirements of section 215.4(a)(2) of Regulation O; and that the overdrafts on Respondent's personal account violated section 215.4(d) of Regulation O. In so doing, the ALJ rejected Respondent's arguments that the lending limits of Regulation O and the collateral requirements of section 23A were not violated because all overdrafts were subject to rights of offset created by the text of the Bank's checking account signature cards and therefore were secured by segregated deposits which constituted collateral; that overdrafts were properly approved by the Bank's directors; and that the overdrafts on his personal account were covered by the exceptions contained within section 215.4(d) of Regulation O because a written agreement with the Bank provided for repayment and pledged his other accounts to repay any particular overdraft.
(c) Falcon Production Transactions.
(i) Loans. The ALJ concluded that Falcon Production was a related interest of Respondent; that the loan of $110,000 to Falcon Production on December 31, 1985, and its subsequent renewal violated the creditworthy requirements of Regulation O because when made and renewed Respondent, the guarantor, had outstanding loans from the Bank which had previously been classified "Substandard"; and that the renewal of the loan to Falcon Production on February 12, 1987, violated the lending limits of section 215.4(c) of Regulation O.
(ii) Other Real Estate Transaction. The ALJ found that Respondent arranged the ORE transaction in order to allow the Bank to hold the real estate until he could reacquire it and to obtain additional funds during a period when any further loan to him by the Bank was proscribed by the lending limits of Regulation O. The ALJ concluded that the payments to Falcon Production representing "equity" in the real estate collateral were extensions of credit to Respondent under section 215.3(a)(8) of Regulation O because he was obligated to repay these amounts to the Bank since they were received in violation of Section 414B of the Oklahoma Banking Code, 6 Okla. Stat. Ann. § 414B and also received as a result of unsafe or unsound banking practices; and that both extensions of credit violated the creditworthy requirements of section 215.4(a)(2) of Regulation O and the lending limits of section 215.4(c) of Regulation O. In so concluding, the ALJ rejected Respondent's arguments that the equity payments were "loan acquisition costs" and therefore permitted under section 414B of the Oklahoma Banking Code; and that the equity payments did not constitute unsafe or unsound banking practices.
(d) Respondent's Personal Loans. The ALJ concluded that the four loans by the Bank to Respondent in 1986 and 1987 violated the lending limit restrictions of section 215.4(c) of Regulation O; and violated the creditwor-
{{11-30-92 p.A-2017}}thy requirements of section 215.4(a)(2) of Regulation O because extensions of credit to Respondent by a bank in which he held a controlling interest, in violation of the lending limits of Regulation O, was a conflict of interest and hence an "unfavorable feature" under section 215.4(a)(2) of Regulation O (citing Docket No FDIC-84-23b, 1 P-H FDIC Enf. Dec. ¶5061 (1986)). The ALJ rejected Respondent's argument that the loans were adequately secured with collateral and that in any event Respondent's financial condition was adequate to support these extensions of credit.
(e) Order to Cease and Desist. The ALJ concluded that the alleged violations of the Cease-and-Desist Order occurred and that Respondent, as a member of the Bank's board of directors, had an affirmative obligation to monitor and insure the Bank's compliance with the provisions of that order, citing Docket No. FDIC-85-303k, 1 P-H FDIC Enf. Dec. ¶5089 (1987), and Docket No. FDIC-80-34k, 1 P-H FDIC Enf. Dec. ¶5004 (1981). In so concluding, he rejected Respondent's defenses that these violations were mere technical failures properly to document board discussions and decisions in the minutes, and that the President of the Bank, Fred Schamburg, had assumed responsibility for these lapses.
2. Civil Money Penalty. The ALJ ruled that Respondent's violations of section 23A, Regulation O, and state law render him liable for a civil money penalty, and that the size of the penalty must be determined by taking into account the size of the financial resources and good faith of Respondent, the gravity of the violation, the history of previous violations, and such other matters as justice may require, in accordance with former 12 U.S.C. § 1828(j)(3). The ALJ also cited the Interagency Policy Regarding the Assessment of Civil Money Penalties by the Federal Financial Institutions Regulatory Agencies ("Interagency Policy"), stating that the elements listed therein would be considered as relevant in the context of the five statutorily mandated factors.
(a) Financial Resources. The ALJ, noting that the parties stipulated Respondent's total income as of December 31, 1989, exceeded $450,000, including annual salaries from various banks which total more than $200,000, and that Respondent conceded he could pay a $50,000 penalty over a three-year period, found that, as long as Respondent continues to receive the stipulated remuneration for his activities as a banker, he will have sufficient financial resources to allow him to pay a $50,000 civil money penalty.
(b) Good Faith. The ALJ found that no prohibited overdrafts or violations of paragraphs 6(c), 6(d) or 7(b) of the Cease-and-Desist Order took place after the 1987 examination of the Bank, and therefore Respondent made a successful effort, albeit belatedly, to "correct" these types of violations; that the principal balances of the Bank's loans to Respondent and MGM were ultimately repaid on November 14, 1991, thereby at least partially "correcting" the violations caused by these loans; that, "I am not inclined to make much of Respondent's failure to repay these loans at an earlier date," because "the record is clear that Respondent was without the financial resources to retire these debts until his lawsuit against the FDIC came to fruition;" that Respondent repaid the principal balances of his personal loan and the MGM loan the day after receipt of $3,250,000 in settlement of his lawsuit against the FDIC, and his delay in repayment was not demonstrative of bad faith; that Respondent's attitude with respect to the Falcon Production ORE transaction is representative of his general attitude toward the Bank:
While he does not appeal ever to have engaged in a transaction with the intention of securing a profit which would cause a loss to the Bank, he has often treated the Bank's resources as if they were his personal purse which he might employ without regard to regulatory constraints.
R.D. at 18.
The ALJ also found that Respondent's personal honesty had not been called into question, that he did not attempt to conceal his activities or otherwise deceive either regulators or the Bank's management, and that he cooperated with the inquiries of Petitioner and the Oklahoma State Banking Department. He concluded that, while the degree of good faith demonstrated by Respondent would tend to preclude the imposition of a penalty in excess of $50,000, a penalty in that amount is reasonable.
(c) Gravity of the Violation. The Recommended Decision states that the gravity of Respondent's violations may be measured by (1) their effect upon the Bank and (2) the
{{11-30-92 p.A-2018}}extent to which Respondent benefited from the violations. As to the first measure, the ALJ found that the Bank's aggregate extensions of credit to Respondent and his related interests between February 1986 and December 1990 were at all times in excess of regulatory lending limits, but the weight to be accorded this lengthy duration is lessened by Respondent's financial inability to make restitution prior to November 1991. As to the second measure, the Recommended Decision notes the FDIC has measured benefit to the violator by the amount of actual loss suffered by a bank as a result of the violation; and finds that neither the prohibited overdrafts nor the violations of the Cease-and-Desist Order, nor the principal balances of the MGM loan or the personal loans to Respondent, nor the principal balance of the extension of credit to Falcon Production, nor the Falcon Production ORE transaction, results in "actual loss"; but that Respondent failed to pay accrued interest of $10,895 on his personal loan and $12,979 on the extension of credit to MGM, resulting in significant actual losses to the Bank. The ALJ concluded that the minimum civil money penalty which can be imposed in this proceeding is $23,874, and the penalty actually imposed should substantially exceed that minimum.
(d) History of Previous Violations. The ALJ found that Respondent was informed of his alleged violations at the conclusion of bank examinations in 1986, 1987, and 1989.
(e) Matters Required by Justice. The ALJ notes that Respondent made restitution to the Bank of more than $484,000, and that his violations "were not shown to have created an unsafe or unsound condition at the Bank. Indeed, probative evidence of record establishes that significant improvements in the Banks' financial condition took place under Respondent's management between 1985 and 1991." On the deterrent factor, the ALJ found that in the ORE transaction, "[r]espondent misused his position to obtain additional credit denied him by law while retaining the power to reassert control over the real estate he conveyed to the Bank. This breach of fiduciary duty justifies a penalty approximately twice as great as the economic benefit which Respondent received as a result of his violations."
The ALJ concluded that the imposition of a $50,000 civil money penalty is supported by substantial evidence of record.
3. Removal. The Recommended Decision states that Respondent has been shown to have engaged in violations of law and regulation which have economically benefited him and hence, under section 8(e)(1) of the FDI Act, the FDIC is entitled to an order removing him from banking if the violations demonstrate Respondent's willful or continuing disregard for the safety and soundness of the Bank, noting that the Petitioner made no allegations that the violations involved Respondent's personal dishonesty. The Recommended Decision contains no findings or conclusions concerning the alternative statutory criteria for removal, that is, whether Respondent's activities also constituted (1) breaches of his fiduciary duty or (2) unsafe or unsound banking practices, or whether Respondent's conduct (1) caused substantial loss or damage to the Bank or (2) seriously prejudiced the interests of the Bank's depositors, stating Petitioner's contentions in that regard are "moot."
The Recommended Decision notes that "willful" disregard has been defined by the FDIC as "conduct which is practiced deliberately in contemplation of the results," while "continuing" disregard has been held to be "that conduct which is voluntarily engaged in over a period of time with heedless indifference to the prospective consequences," citing Docket No. FDIC-85-215e, 1 P-H FDIC Enf. Dec. ¶5069 (1986). The Recommended Decision frames the question for determination to be whether Respondent's repetitive violations of law and regulations were shown to have been made either (1) deliberately with intended consequences or (2) voluntarily and without regard to consequences.
The ALJ found that the repetitive nature of the violations of lending limits "came into being when the Bank renewed extensions of credit which Respondent had become financially unable to repay," and held that becoming financially unable to repay a loan cannot constitute "deliberate" or even "voluntary" conduct and does not demonstrate a lack of regard for the Bank's safety of soundness. The ALJ stated that, "[i]ndeed, the record establishes that Respondent willingly pledged collateral which proved sufficient to insure the ultimate repayment of the principal balances of all of the extensions of credit challenged in the Proceeding," R.D. at 22. He concluded that these hypothecations demonstrate that Respondent, "though unable to prevent the continu-
{{11-30-92 p.A-2019}}ing lending limit violations found herein, took positive action to insure the Bank's safety and soundness in connection with those loans. . .," R.D. at 22, 23. The ALJ concluded that a "similar pattern" emerges with respect to Respondent's other violations. He stated:
After receiving the report of the July 18, 1986 examination, Respondent and his related interests committed the following new violations: (1) overdrawing accounts on eight occasions, each of which was "corrected" by voluntary repayment within one week of the overdraft and none of which was shown to have exposed the Bank to a possibility of "abnormal risk or loss," (2) failing by virtue of inaction to insure the Bank's compliance with the Cease and Desist Order on five occasions, none of which was alleged to have exposed the Bank to a possibility of "abnormal risk or loss," and (3) the Falcon Production ORE transaction. (Footnotes omitted.)
While noting that the latter transaction involved three new violations and created an abnormal, "albeit ultimately unrealized," risk to the Bank, the ALJ found there is no evidence that Respondent's imposition of such a risk on the Bank was deliberate or was one of a series of voluntary acts over time.
The ALJ also found it "significant" that neither Respondent nor his related interests was alleged to have committed "any type of new violation after November of 1987," and concluded that Respondent was not shown to have demonstrated a willful or continuing disregard for the safety or soundness of the Bank.
Finally, noting that the issuance of a removal order is a discretionary act on the part of the FDIC, the ALJ stated that two additional facts merit consideration:
First, the violations engendered in significant part by the deterioration in Respondent's financial condition were not duplicated at the five other banks which he controlled. Second, Respondent brings to banking an unquestioned array of aptitudes, skills and experience which the industry can ill-afford to lose at this juncture.
The ALJ concluded that the Removal Notice should be dismissed.
E. EXCEPTIONS TO THE ALJ'S RECOMMENDED DECISION
Respondent's Exceptions total 45 pages, and refer to and incorporate many proposed findings and conclusions as well as arguments set forth in Respondent's earlier briefs. Petitioner's Exceptions total 65 pages plus a 5-page appendix. Those exceptions of the parties which, after careful review, the Board considers to merit discussion are discussed in the text of the Decision.
II. SUMMARY OF THE BOARD OF
DIRECTORS' DECISION
The Board has carefully reviewed the record, the parties' briefs, exceptions, and other pleadings on the merits and the Recommended Decision. The Board's review of the Recommended Decision was unnecessarily made more difficult by the ALJ's failure to include complete findings of fact and conclusions of law.14 Nevertheless, the Board finds that the ALJ's statement of the facts and legal conclusions, except as to the appropriate remedies, are supported by the evidence in the record as a whole with certain exceptions which will be noted later. Specifically, the Board agrees with and adopts the statutory and regulatory violations set forth in the Summary of the Recommended Decision, supra.
The Board also agrees that the imposition of a civil money penalty is appropriate in this proceeding, although it disagrees with certain of the findings and conclusions of the ALJ in his analysis.
The Board has determined that the ALJ erred by not addressing all of the allegations in the Assessment Notice and Removal Notice and that he should have made findings of fact and conclusions of law as to each such allegation. The ALJ having failed to do so, the Board has undertaken an independent review of those issues that were alleged in the notices and the evidence presented at the hearing but not addressed by the ALJ. These issues are whether the transactions complained of (1) constituted breaches of Respondent's fiduciary duty to the Bank; (2) constituted unsafe or unsound practices; (3) caused substantial loss or damage to the Bank; or (4) could cause serious prejudice to the interests of the Bank's depositors. The Board's Findings of Fact and Conclusions
14 See Docket No. FDIC-87-61e, FDIC-87-62k, 2 P-H FDIC Enf. Dec. ¶5113 (1988).
{{11-30-92 p.A-2020}}of Law on these issues are set forth in the Appendix to this Decision.
The Board does not agree that the Removal Notice should be dismissed. For the reasons set forth below, the Board finds, in addition to the numerous statutory and regulatory violations, that Respondent engaged in unsafe or unsound practices and breached his fiduciary duty, resulting in substantial financial loss to the Bank, possible serious prejudice to the interests of the Bank's depositors, and financial gain or other benefit to Respondent; and that such violations, practices, and breaches demonstrate a willful or continuing disregard by Respondent for the safety or soundness of the Bank, in violation of section 8(e)(1) of the FDI Act. Considering all relevant facts of record, the Board in its discretion concludes it is appropriate to remove Respondent as officer and/or director of the Bank and to prohibit Respondent from participation in any manner in the conduct of the affairs of the Bank or any other FDIC-insured institution.
III. DISCUSSION
A. VIOLATIONS OF LAW, REGULATION, AND THE CEASE-AND-DESIST ORDER
The Board agrees with and adopts the ALJ's Findings of Fact Nos. 1–27, R.D. at 24–26, and Conclusions of Law Nos. 1–17, R.D. at 41, 42.
1. MGM Letters of Credit. The Board agrees with and adopts the ALJ's findings of fact, conclusions of law and discussion of these transactions, R.D. at 2–6; Findings of Fact Nos. 28–50, and Finding of Fact No. 51 after substituting the figure $250,000 for the figure $484,606; and Conclusions of Law Nos. 18–20, 25, 28, 31, 33, and 37; and adopts Conclusions of Law Nos. 26, 27, 29, 30, 32, 34, 36, and 38 after substituting the words "continued to violate" for the word "violated" in each such Conclusion, R.D. at 41–43.
[.2] Respondent takes a number of exceptions.15 First, Respondent argues that MGM is not an "affiliate" of the Bank, despite his one-third ownership. He claims he acquired his interest in MGM in order to save the Bank from a loss on the 1982 loan to May and Matthews, and that the Bank agreed, in consideration of the pay-off of the May and Matthews loan in early 1983, to issue a stand-by letter of credit to secure the bonding off of the liens in the materialman's suit. Hence, claims Respondent, MGM is a company ". . . where control results from the exercise of rights arising out of a bona fide debt previously contracted..." and therefore excluded from the definition of "affiliate" in section 23A(b)(2)(E) of the Act. For much the same reasons Respondent argues that the letters of credit and loan to MGM are exempt from Regulation O because they represent "indebtedness to a bank for the purpose of protecting the bank against loss ..." under 12 C.F.R. § 215.3(b)(4) and hence are not extensions of credit for purposes of Regulation O.16
The Board agrees with the ALJ that Respondent's argument with respect to section 23A(b)(2)(E) of the Act is "without logical or factual support," R.D. at 4. The Board has previously held that statutory exceptions to limitations on extensions of credit to related interests must be strictly construed. Docket No. FDIC—85-82e, 2 P-H FDIC Enf. Dec. § 5137 (1989). Logically, "control" for purposes of section 23A(b)(2)(E) must be control by the bank.17 Factually, Respondent's assertions as to his motives in forming MGM and purchasing the assets of TPR, and the existence of an agreement by the Bank to issue a letter of credit if and when needed in exchange for payment of the May and Matthews loan, are unsupported by any evidence except his own testimony.18 The
15 While taking numerous exceptions to the Recommended Decision, Respondent requests that, "the ALJ's recommended decision be adopted insofar as it is consistent with the issuance of a $50,000.00 civil money penalty," provided removal not be ordered. Respondent's Exceptions at 41. Nevertheless, we will address most of Respondent's exceptions on the merits.
16 If the MGM letters of credit and loan do not constitute extensions of credit under Regulation O, many of the lending limit violations alleged in the Assessment Notice and the Removal Notice would be eliminated.
17 The argument that an insider can gain control of a company by exercising rights arising out of a bona fide debt to the bank, and thus avoid insider status for future transactions between the company and the bank, a indicative of Respondent's failure to distinguish between his own financial interests and those of the Bank which he controls.
18 Respondent's interpretation of events of 1982 and 1983 was challenged by the testimony of Mr. Wayne Allen Nichols, a loan officer at Citizens National Bank & Trust, Oklahoma City, Oklahoma. He testified with respect in his discussions with Respondent and Matthews and May in December 1982, in connection with MGM's application to that bank for a loan in the amount of $1.3 million to purchase the assets of TPR. In December 1982,
(Continued)
{{11-30-92 p.A-2021}}alleged agreement by the Bank was never reduced to writing in any form, nor is there evidence that any officer or director of the Bank except Respondent was aware of the obligation.19 The Bank's pre-existing obligation was not discussed at the February 21, 1986, special meeting of the Loan and Discount Committee at which the issuance of the letter of credit was approved. FDIC Ex. 153. The Board must conclude that the obligation was either nonexistent or "authorized" only by Respondent, not the Bank.
Moreover, Respondent's assertion that the Matthews and May loan was a loss in 1982 is unsupported by any evidence other than Respondent's testimony. Indeed, the evidence of record belies Respondent's assertion. In November 1982, when MGM was formed, the May and Matthews loan was 10 months from maturity, the borrowers had a combined net worth of $7.8 million, and the loan was secured by collateral in addition to that to which the materialmen's liens attached on November 12, 1982, Tr. at 824–833; Resp. Ex. 288.20
Finally, the Board finds that in the many discussions between the FDIC and directors of the Bank concerning the serious violations of section 23A and Regulation O related to the MGM transactions, from July 1986 onward, Respondent never mentioned the Bank's 1982 undertaking to issue a letter of credit to MGM, nor claimed that MGM was not an affiliate of the Bank, until after the issuance of the Assessment Notice in December 1988. For example, the joint letter from directors of the Bank dated December 1, 1986, responding to the 1986 Report of Examination and the FDIC's letter dated November 21, 1986, discussing the violations, never mentions the MGM transactions. FDIC Ex. 14. Nor does Respondent's letter to the FDIC dated March 25, 1988, responding to the FDIC's letter dated March 4, 1988 "concerning the violations of certain regulations in Bank of Hydro's examination dated December 31, 1987," assert that MGM is not an affiliate. Rather, the letter states that:
To correct the MGM Production Company violation, we intend to obtain individual loans from the 3 individuals involved in MGM, including myself, to back up the Letter of Credit. The 3 individuals will be responsible for their own debt and separate collateral to secure the debt. These individuals will service the debt out of their own funds and not MGM Production Company's revenue.
Respondent testified, in response to a question by the ALJ, that the first time he mentioned to the FDIC or to any bank examiner for the State his explanation concerning the 1982 loan that resulted in MGM was "when it became apparent to me they were serious in pursuing this action." Tr. at 820.
Based on the record as a whole, the Board must conclude that the alleged nexus between the 1982 May and Matthews loan and the 1986 letter of credit on behalf of MGM while admittedly imaginative was conceived after the fact. The assertions are more instructive as to Respondent's attitude that he and the Bank are one economic entity than as to the true history of the MGM transactions.
For the same reasons, the Board rejects Respondent's argument that the MGM transactions did not constitute extensions of credit under section 215.3(b)(4)(i) of Regulation O.
Respondent next argues that the MGM transactions did not violate the collateral requirements of section 23A(c)(1) of the Act because Respondent's personal guarantee was adequate collateral, citing Black's Law Dictionary 238 (5th ed. 1979); Connelly v. Wells, 142 Conn. 529, 115 A. 2d 444, 447 (1955); and United States v. Bland, 159 F. Supp. 295, 403 (D. Md. 1958). The Board does not dispute that "collateral security" is sometimes defined to include the obligation of a third person. For example, the statutory definition of collateral security under the Maryland Retail Installment Sales Act, which
18 Continued: that bank loaned MGM $450,000 on an unsecured basis but with a negative pledge not to encumber the assets being purchased. The existing collateralized loan to the Bank was never mentioned. The purport of his testimony is that MGM applied for a loan to purchase assets that were considered by the borrowers to be a good business deal, not a bail-out of a loss situation.
19 President Schamburg testified that he first learned about the "May and Matthews scenario" in the spring of 1986 before the letter of credit was issued, Tr. at 1001, 1002.
20 Apparently, Respondent fails to see the inconsistencies inherent in his arguing that the May and Matthews loan was a loss to the Bank in November 1982, on the one hand, and that his personal loans and the MGM loan should not have been considered losses to the Bank in 1988 and 1989, on the other.
{{11-30-92 p.A-2022}}was at issue in United States v. Bland, specifically included "the undertaking of any surety or guarantor for the buyer." In contrast, section 23A(c)(1) of the Act, in specifying the items which are acceptable collateral, does not mention a guaranty. It does require that acceptable collateral have ascertainable market values. A guaranty might be considered an "other debt instrument" under section 23A(c)(1)(C), in which event it would be required to have a market value equal to 120 percent of the amount of the extension of credit. A guaranty could be considered to have an ascertainable market value only if it in turn were secured by collateral with an ascertainable market value.21 Here, the guaranty was not for 120 percent of the credit extended, and was not secured with collateral. Hence, it could not have met the requirements of section 23A of the Act.
[.3] Finally, the very purpose of the statutory provision would be nullified by the interpretation urged by Respondent. This was an extension of credit to a closely-held corporation controlled by Respondent. The Bank had no financial statement or other information on the corporation or on the other two owners, who failed to respond to the Bank's request for financial statements and failed to sign the notes and guarantees proffered to them, Tr. at 943-54. In other words the Bank, quite properly, considered the MGM letters of credit and loan as extensions of credit to Respondent. For Respondent to be allowed to treat his unsecured guaranty as "collateral" for extensions of credit made for all practical purposes to himself would defeat the very purpose of the statute. For similar reasons, section 23A(c)(4) provides that securities issued by an affiliate of a bank are not acceptable collateral for a loan or credit to any affiliate of that bank.
[.4] Respondent next argues that in July 1986, the Grubb Judgment was pledged as collateral for Respondent's personal guaranty. The Board is of the view that a judgment as to which appeal rights have not expired cannot quality as collateral with an ascertainable market value for purposes of section 23A of the Act. Moreover, as stated by the ALJ, the security interest in collateral required by section 23A must be perfected in order to protect depositors from the dangers of inadequately secured insider transactions. Fitzpatrick v. FDIC, 765 F. 2d 569 (6th Cir. 1985). There was never a perfected security interest in the Grubb judgment with respect to the MGM letters of credit. The principal only of the April 1988 loan to MGM, charged off as a loss in December 1988, was covered by the 1990 Assignment of the second Grubb judgment, which was perfected on December 4, 1990. Clearly, the collateral requirements of section 23A of the Act were not met for the MGM extensions of credit by the Grubb Judgment.22
2. Overdrafts. The Board adopts the findings of fact, conclusions of law, and analysis of the ALJ with respect to overdrafts of Respondent and his related interests, R.D. 7–9; Findings of Fact Nos. 52–73, 74 as corrected by changing the account number to 0-659-014, and 75–92, R.D. at 28–31; Conclusions of Law Nos. 39, 41–42, 44–46, 48–51, 53–57, and 59–60; and adopted Conclusions of Law Nos. 40, 43, 47, 52, and 58 after substituting the words "continued to violate" for the word "violated," R.D. at 44–46.
[.5] Respondent argues that the collateral requirements of section 23A were not violated because all of the overdrafts were secured by segregated deposits within the Bank, in accordance with 12 U.S.C. § 84(c)(6). The Board agrees with the ALJ that the right of offset arguably created by the text of the Bank's checking account signature cards does not constitute secured collateral for purposes of section 23A or for purposes of the exemption from Regulation O. See section 32.6(f)(2) & (3) of the Office of the Comptroller of the Currency ("OCC") Rules and Regulations, 12 C.F.R. § 32.6(f)(2) & (3), which the OCC has stated clarifies the fact that a bank may not merely rely on the right of set-off against the deposit in the event of non-payment. 48 Fed. Reg. 15844 (April 12, 1983). The Board has recognized the necessity for an express assignment to the bank where cash collateral is involved. Docket No. FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, 1 P-H FDIC Enf. Dec. ¶5049 at A-537 (1985).
Respondent also argues that the prior approval requirements of section 215.4(b) were
21 The board rejects Respondent's apparent argument that a market value for the guaranty can be calculated from the market values of the items of property listed on the guarantor's personal financial statement.
22 Moreover, the posting of collateral in July 1986 for an extension of credit made in February 1986 would not eliminate the previous section 23A(c) violations. The same is true with respect to the 1990 Assignment and the 1987 and 1988 letters of credit and the April 1988 loan.
{{11-30-92 p.A-2023}}met because a majority of the Bank's board of directors approved the overdrafts "on an individual and daily basis." The Board agrees with the ALJ that, because the Bank's records show that such overdrafts were approved after the disbursement of funds, the burden shifts to Respondent to demonstrate that the challenged overdrafts were approved by a disinterested majority of directors prior to disbursement of funds. The very general testimony of the Bank's President, Fred Schamburg, does not meet this burden, Tr. at 988, 989. Respondent himself admitted that overdrafts may have been approved by a single disinterested director that happened to be at the Bank, Tr. at 901.
Respondent next argues that the overdrafts on his personal account fall within the exceptions of section 215.4(d) of Regulation O.23 The Board agrees with the ALJ that there is no evidence of a written plan providing for the payment of interest, as required by the first exception; and that the second exception requires an actual transfer of funds between accounts upon the occurrence of an overdraft.
3. Falcon Production Transactions. The Board agrees with and adopts the ALJ's analysis of these transactions, R.D. at 9–13 and Findings and Fact Nos. 93–131, R.D. at 31–34; rejects Findings of Fact Nos. 132–135, R.D. at 34, 35; adopts Conclusions of Law Nos. 61–65 and 67–78; and adopts Conclusions of Law Nos. 66 and 79 after substituting the words "continued to violate" for the word "violated," R.D. at 46–47.
Respondent does not contest the violations found with respect to the extension and renewal of the $110,000 loan to Falcon Production in December 1985 and February 1987.
With respect to the "Other Real Estate" transaction in February 1988, Enforcement Counsel argues that Respondent, as a fiduciary of the Bank, is obligated to repay to the Bank the "equity payments" to Falcon Production totalling $83,241 because (1) Respondent allegedly received the funds in violation of state law and (2) he allegedly received them as a result of an unsafe or unsound banking practice; hence, the disbursement of the "equity" to Respondent were "extensions of credit" for purposes of section 214.3(a)(8) of Regulation O.
(a) Violation of State Law. The state law in question is section 414B of the Oklahoma Banking Code, 6 Okla. Stat. Ann. 414B, which allows a bank to acquire real estate in satisfaction of a previously contracted debt and requires that the acquired real estate be booked at the lower of fair market value or the bank's "recorded investment." The section further provides that "recorded investment" shall, as relevant, consist of unpaid principal of the debt satisfied, unpaid accrued interest, and "loan acquisition costs." Respondent argues that "loan acquisition costs" is a broad enough term to include payments representing equity made in the course of a loan work-out. FDIC Enforcement Counsel argues that Respondent's interpretation would defeat the very mandate of the statute—to book the real estate at the lower of fair market value or the bank's "recorded investment" —because the debtor's "equity" in the property is the difference between those two figures. The Board agrees with the ALJ that the statutory provisions cited by Respondent as analogous fail to support Respondent's interpretation because they lack the very accounting requirements at issue here; and that the statutory interpretation urged by FDIC Enforcement Counsel is logical and supportive of the basic statutory intent to prohibit risky real estate transactions on the part of banks.24
(b) Unsafe or Unsound Banking Practices. Respondent argues that, far from being an unsafe or unsound banking practice, the ORE transaction was a good deal for the Bank. It allowed the Bank to "pay off" the $110,000 loan in default and to obtain a "valuable income producing property" with an "uncontested and substantial value," Resp. Reply Brief at 5.25 FDIC Enforcement Counsel argues that making substan-
23That section provides:
No member bank may pay an overdraft of an executive officer or director of the bank, unless the payment of funds is made in accordance with (1) a written, pre-authorized, interest-bearing extension of credit plan that specifies a method of repayment or (2) a written, pre-authorized, transfer of funds from another account of the account holder at the bank.
24 The Bank Commissioner for the State of Oklahoma ("Bank Commissioner") testified that the payments violated section 414B. Tr. at 490.
25 Respondent's assertions as to the estimated and actual revenues to the Bank from the Harmon County farm were contradicted by Bank Examiner Melton, who conducted the 1990 Examination which classified the Falcon (Continued)
{{11-30-92 p.A-2024}}tial cash "equity" payments to a debtor when collateral security is acquired in lieu of fore-closure upon default is inherently risky and abnormal banking practice, despite the existence of an appraised value in excess of the funds paid out.
The ALJ found that the practice was neither usual nor prudent, and that it transferred the risk of further decline in property value to the Bank. He concluded that the transaction was an unsafe or unsound banking practice and therefore Respondent was not entitled to receive the funds disbursed during the ORE transaction. The Board agrees. Bank Commissioner Wayne H. Osborn testified that in his experience as an expert in banking affairs in the state of Oklahoma, he had never seen an ORE transaction handled this way, and that he would not have allowed it for the simply reason that the Bank could possible suffer some future loss, Tr. at 493.26
The Board concludes that the "equity" payments to Falcon Production, for the benefit of Respondent, violated state law and were unsafe or unsound banking practices, and Respondent is obligated to repay the Bank because these payments were made in violation of his fiduciary duty to the Bank.
As a consequence, the payments constituted extensions of credit under Regulation O, which defines an "extension of credit" to include:
(8) Any other transaction as a result of which a person becomes obligated to pay money (or its equivalent) to a bank, whether the obligation arises directly or indirectly or because of an endorsement on an obligation or otherwise, or by any other means whatsoever.
12 C.F.R. § 215.3(a)(8). The Board recently held that any debtor-creditor relationships is, by definition, an extension of credit at the time the obligation arises, unless specifically excepted by the regulation. In the Matter of Ira lee Brannan, David Brannan, and Stephen L. Brannan, Freedom Bank, DeLeon, Texas, Docket No. FDIC-91-37k, 2 P-H FDIC Enf. Dec. ¶5176, at A-1963 (1992). The "equity payments" violated the lending limits of section 215.4(c) of Regulation O; and, because made without provisions for interest and repayment, violated the comparable terms requirements of section 215.4(a)(1) of Regulation O; and, because the extensions were undocumented and made to a borrower with other loans adversely classified, violated the creditworthy requirements of section 215.4(a)(2) of Regulation O.
4. Respondent's Personal Loans. The Board adopts the ALJ's Findings of Fact Nos. 136–153, R.D. at 35, 36; and Conclusions of Law Nos. 80–82, 84–86, 88–90, and 92–94; and adopts Conclusions of Law Nos. 83, 87, 89, 91 and 95, after substituting the words "continued to violate" for the word "violated," R.D. at 47, 48.
The ALJ found that each of the four loans made to Respondent during 1986 and 1987 violated the lending limits of section 215.4(c) of Regulation O.27 He also concluded that because Respondent on each of the four occasions sought to borrow money from a bank which he controlled in violation of the lending limits of Regulation O, each of the loans had an "unfavorable feature" violative of section 215.4(a)(2) of Regulation O, citing Docket No. FDIC-84-23b, 1 P-H Enf. Dec. ¶5061 (1986). The Board concurs.
At the administrative hearing, Respondent challenged each of the Reports of Examination for adversely classifying loans made to or guaranteed by Respondent. Respondent appears to argue that the adverse classification of his loans in the 1985 Report of Examination was erroneous, and therefore the credits made to him or with his personal guaranty in late 1985 (Falcon Production) and 1986 (MGM Letter of credit, personal loans to Respondent) cannot be said to contain unfavorable features. First, as we have stated above, the 1986 loans to Re-
25 Continued: Production ORE "Substandard." He testified that he could substantiate Bank revenues from the farm of $14,000 in 1988, $12,400 in 1989, and $18,000 in 1990, resulting in yields on the Bank's investment in the property ($342,000) of 4.09% in 1988 and 3.5% in 1989.
26 President Schamburg testified that he was unaware of any similar transaction during his six year tenure with the Bank, although "I have talked with legal counsel that knows of two instances in Oklahoma that that's been done," Tr. at 1029. However, the Bank's own expert witness could recall only two similar instances in his career as a bank examiner with the OCC and the Federal Reserve Board, and both involved banks with severe regulatory problems which eventually failed, Tr. at 1141, 1142. Respondent introduced no evidence concerning similar transactions.
27 The October 29, 1986, loan to Respondent in the amount of $100,000 exceeded the lending limits of section 215.4(c) of Regulation O even if the MGM extension of credit were not taken into account. See Findings of Fact Nos. 145–148, R.D. at 35, 36.
{{11-30-92 p.A-2025}}spondent had "unfavorable features" which are unrelated to the adverse classification of Respondent's previous loans. Second, the Board has frequently held that classifications of loans and other assets made by FDIC bank examiners are entitled to deference by the Board and should not be overturned unless shown to be arbitrary or capricious, without factual basis, or outside a zone of reasonableness. See Docket Nos. FDIC-83-252b&c, FDIC-84-49b, FDIC-84-50e, 1 P-H FDIC Enf. Dec. ¶5049 (1985), aff'd., Sunshine State Bank v. FDIC, 783 F. 2d 1580 (11th Cir. 1986). "Unless shown to be arbitrary or capricious or outside a zone of reasonableness, the ALJ, the Board and the courts must give significant deference to [FDIC bank examiners]," id., at 1584. After careful review of the testimony of Examiner Dennis Kanter, Tr. at 145–168, the 1985 Report of Examination, FDIC Ex. 1, and the statement of financial position of Respondent and his wife as of December 31, 1983, and December 31, 1984, FDIC Ex. 284, the Board finds that the adverse classifications of Respondent's loans in the 1985 Report of Examination were reasonable and appropriate.
Respondent also argues that his personal loans were secured with collateral in the form of the Grubb Judgment and hence did not violate the creditworthy requirements of section 215.4(a)(2) of Regulation O. As noted earlier, the assignment to the Bank was not perfected until February 1989, and it was known to the Bank that at least one and possibly more other banks had prior liens on the judgment. Within days after perfection of the assignment, the value of the 1985 judgment was substantially diminished by the decision in Grubb v. FDIC, 868 F. 2d 1151 (10th Cir. 1989). When Respondent rejected the remittitur of some $220,000 in July 1989, the judgment had essentially no direct recovery value. The next assignment of the Grubb Judgment to the Bank did not occur until November 1990, after Respondent's personal loans had been written off by the Bank, and that assignment was not perfected until December 1990.
Without deciding whether a judgment as to which appeal rights have not expired can ever be considered appropriate collateral for purposes of section 215.4(a)(2) of Regulation O, the Board finds that the facts here— the delay in assigning the judgment, the delay in perfecting the assignment, and the value of the judgment when assignment was perfected—preclude a determination that assignment of the Grubb Judgment with respect to Respondent's personal loans satisfied the creditworthy requirements of section 215.4(a)(2) of the Regulation O.
5. Cease-and-Desist Order. The ALJ found that all alleged violations of the Cease-and-Desist Order did in fact occur. Respondent contests the allegation that the Bank's loan policy was not amended to incorporate changes required by the FDIC. The Board agrees with the ALJ that the weight of the evidence shows that the required changes were not incorporated by the Bank. Respondent does not contest the two violations involving capitalizations of interest. As to the violations relating to failure to document reasons for extensions of credit to classified borrowers and for purchasing a loan participation, Respondent argues that the failure was the responsibility of Bank President Schamburg. The Board agrees with the ALJ that Respondent, as a member of the Bank's board of directors, had an affirmative obligation to monitor and insure the Bank's compliance with the provisions of the Cease-and-Desist Order. See Docket No. FDIC-85-303k, 1 P-H Enf. Dec. p 5089 at 7090 (1987). This is particularly true with respect to Respondent, who was severely criticized for his lending policies and practices in the 1985 Report of Examination which engendered the Cease-and-Desist Order, who agreed to remove himself from lending activities at the Bank during the 1985 Examination, FDIC Ex. 1, and who proposed the transactions as to which the Board failed to document its reasons for approval, Jt. Stip. 184–188.
[.6] The ALJ found that "none of the foregoing violations resulted in a loss to the Bank." The Board declines to adopt this finding. The only evidence in the record on this point indicates that there might well have losses associated with some of the transactions involved in these violations.28 If troublesome transactions are properly discussed and documented in the minutes, they will
28 The Duke extension of credit at issue, in the amount of $10,000, was adversely classified as "Substandard" in the 1989 Report of Examination, FDIC Ex. 4 at 2-a-1. The 1990 Report of Examination notes that of the Duke loans totalling $350,00 in 1989, $56,000 has been taken into ORE or Other Assets, $83,000 paid in cash, and
(Continued)
{{11-30-92 p.A-2026}}likely not obtain approval without strong supporting reasons, which of course is the purpose of the Cease-and-Desist Order provision in question.
The Board adopts Findings of Fact Nos. 154–157, 159–161, 163–168, and 170; adopts Findings of Fact Nos. 158 and 162 after adding at the end of each the sentence, "Respondent was responsible for the loan transaction and it was conducted at his request;" and rejects Finding the Fact No. 169, R.D. at 36–38; and adopts Conclusions of law Nos. 96–100, R.D. at 48, 49.
B. CIVIL MONEY PENALTY
The five statutory factors the Board is required to consider are: the size of the financial resources and good faith of the person charged, the gravity of the violations, the history of previous violations, and such other factors as justice may require. 12 U.S.C. § 1818(i)(2)(G), formerly 12 U.S.C. § 1828(J) (3)(B).29
In assessing civil money penalties, the Board seeks to deprive the violators of any financial benefit derived as a result of the violation, provide a sufficient degree of punishment, and an adequate deterrent to the Respondent and others from future violations of banking laws and regulations. See, generally, In the Matter of *** Bank, Docket No. FDIC-85-2k, 1 P-H FDIC Enf. Dec. ¶5063 (1986); In the Matter of Ira Lee Brannan, David Brannan, and Stephen L. Brannan, Freedom Bank, DeLeon, Texas, supra.
First, the Board agrees that Respondent has committed violations of laws and regulations which render him liable for the payment of a civil money penalty. The Board disagrees with certain of the findings of fact, observations, and conclusions of law of the ALJ on this subject, as discussed below.
Each of the five statutory requirements is discussed below.
1. Financial Resources. The Board adopts all of the ALJ's findings on financial resources, R.D. at 16, except for his final finding that, as long as Respondent continues to receive the stipulated remuneration for his activities as a banker, he will have sufficient financial resources to allow him to pay a $50,000 civil money penalty. The substantial evidence of record is that Respondent's financial resources will allow him to pay a much larger penalty, whether or not be continues to receive banking income.30 Respondent's December 31, 1987, joint financial statement, FDIC Ex. 287, showed a net worth of $1,099,000. While assets included the $2,750,000 Grubb Judgment, Respondent has in fact been paid $3,717,000 as a result of that lawsuit, thereby significantly improving his asset position and reducing interest expenses. The Board finds the record supports a conclusion that Respondent has the financial resources to pay a substantial civil money penalty, even after full repayment to the Bank of the losses suffered on the transactions at issue here.
2. Good Faith. The Board disagrees with several of the ALJ's conclusions concerning Respondent's good faith. First, the Board disagrees that the fact that no prohibited overdrafts or violations of the Cease-and-Desist Order occurred after November 1987 demonstrates that Respondent made a successful effort to "correct" these types of violations. More to the point is the fact that numerous prohibited overdrafts occurred after the 1986 Report of Examination set forth numerous violations of law and regulations related to overdrafts of Respondent and his related interests, and the bank examiners had discussed them with Respondent.31 These over-
28 Continued: $49,000 charged against loss reserves, and $54,000 adversely classified as "Substandard" (over the Bank's strong disagreement). FDIC Ex. 335 at 2-a-3. The Stickler loan participation of $197,000 was adversely classified "Substandard" in the 1990 Report of Examination, FDIC Ex. 335 at 2-a-10.
29 Pursuant to former section 18(j)(4)(A) of the Act, 12 U.S.C. § 1828(j)(4)(A), the FDIC is entitled to assets civil money penalties of up to $1,000 per day for each day the violation continues. Thus, as of the date of the hearing, the FDIC was authorized to asses penalties of over $1,500,000 for the gross period of time that credit attributable to Respondent were in an overline position, counting the overline as only one violation of Regulation O.
30 The Board disagrees with the ALJ's statement that the only evidence in the record concerning Respondent's "actual income" is that relating to his various salaries as a banker and hence there is no evidence to support a finding that he would have the financial ability to pay a civil money penalty if he is removed from banking, R.D. at 16, n. 39. Joint Stipulation of Fact No. 200 states that as of December 31, 1989, Respondent's total income was $450,117.08. Joint Stipulations of Fact Nos. 201–205 state that Respondent's annual salaries from banks total $204,000. Respondent testified that he could pay a $50,000 civil money penalty over three years if the Grubb Judgment were paid. Tr. at 1099.
31 The overdrafts occurring after the July 1986 Examination are not minor violations. Respondent's joint account with his wife was overdrawn from 8-26-86 to 9-1-86 by over $11,000; the RGI account was overdrawn for two days in August 1986 by $4,000, from September 10–27, 1986 by amounts ranging from $12,000 to $45,000, (Continued)
{{11-30-92 p.A-2027}}drafts did not cease until the Bank Commissioner issued further written warnings to the Bank in October and December, 1987, FDIC Ex. 337 and 339, more than one year later. Finally, the Falcon Production ORE payment of $48,663 to Falcon Production on February 17, 1988, was made to cover an insufficient funds item which the Bank was holding, which had been drawn by Respondent in order to pay Respondent's personal loan at the Bank's affiliate, First State Bank of Mooreland, Mooreland, Oklahoma. Tr. at 400, FDIC Ex. 335 at 6-a-1.
Second, the Board rejects the ALJ's conclusion that Respondent's failure to repay the loans in question at an earlier date, causing repeated violations because the Bank renewed the prohibited loans, is excused by Respondent's inability to repay the loans at an earlier date. There may be situations in which a respondent's financial inability to correct a violation would be a mitigating factor in determining the respondent's good faith. In this proceeding, however, it clearly is not. Respondent's ability to repay was in question at the time the improper extensions of credit at issue here were first made in 1985, 1986, 1987, and 1988, as evidenced by the fact that loans to Respondent were classified in the 1985, 1986, and 1987 Reports of Examination.32 Moreover, Respondent could have attempted to liquidate certain of his property which he argues was collateral security for his defaulted loans—such as his silver bars and valuable art work, Tr. at 652, and the real estate which was purportedly mortgaged to secure Respondent's personal loans in April 1987—in order to pay off or reduce one or more of the loans, but he did not do so. In the same manner, if Respondent was entitled to "equity payments" in connection with the Falcon ORE transaction in 1988, as he argues, why was the so-called equity not at least credited to Respondent's obligations at the Bank, rather than paid to him in cash?
The Board finds that, taking into account only the real property pledged or attempted to be pledged with respect to the Falcon Production loan and Respondent's personal loans, Respondent could have corrected many of the violations involved in this case had he caused those properties to be liquidated and the proceeds applied to the reduction of outstanding loans.
The Board also rejects the ALJ's finding that there is no evidence that Respondent failed to cooperate with Petitioner or the State with respect to any matter cited in the Assessment Notice or Removal Notice. The Board finds that all of the violations of law and regulations occurring after the July 1986 Examination are evidence of Respondent's failure to cooperate with the FDIC and the State with respect to prohibited transactions— the overdrafts and the October 1986 loan of $100,000 to Respondent, which were the same types of transactions of which Respondent had been warned in July 1986, and the Falcon Production ORE transaction.
[.7] The Board agrees with the ALJ that Respondent's attitude with respect to the Falcon Production ORE transaction is representative of his general attitude toward the Bank, that is, he has often treated the Bank's resources as if they were his personal purse which he might employ without regard to regulatory restraints, R.D. at 18. This attitude, and the transactions which demonstrate it, do not reflect well on Respondent's good faith for purposes of a civil money penalty.
3. Gravity of the Violations. The R.D. states that the gravity of Respondent's violations may be measured by (1) the effect of those violations upon the Bank and (2) the extent to which Respondent benefited from the violations. As to the first measure, the ALJ found that the Bank's aggregate extensions of credit to Respondent and his related interests were continuously in excess of regulatory limits between February 1986 and December 1990, but concluded that the "weight" of this lengthy duration is less-
31 Continued: on October 26, 1986 by $40,993, and on various occasions in April, May, June, August, September, and November, 1987, by amounts ranging from $308 to $13,452; the MGM account was overdrawn for a week in September 1986 by amounts ranging up to $712, and by over $6,000 on January 6 and 7, 1987; and Falcon Management was overdrawn by $1,610 on October 27 and 28, 1987. The largest of these overdrafts, on the RGI account, were caused by an $80,000 check signed by Respondent and a check for $60,099.58 signed by Respondent 1987 Report of Examination, FDIC Ex. 3 at 6-a-2 and 6-a-3.
32 The ALJ based his finding that Respondent was unable to pay on Respondent's "uncontroverted testimony" and the expert testimony of FDIC bank examiner Adams that "as early as 1986, Respondent was unable to meet his outstanding debts except by further borrowing...," R.D. at 17, footnote 50. Examiner Adams' testimony supports the Board's conclusion rather than that reached by the ALJ.
{{11-30-92 p.A-2028}}ened by Respondent's financial inability to make restitution prior to November 1991. Again, the Board rejects this conclusion because it was apparent at the time the prohibited extensions of credit were first made to him or guaranteed by him that Respondent was a credit risk, and because he did not use the resources which he testified were available to the Bank to curtail the prohibited transactions.33 The Board finds that the number, size, and the lengthy duration of the prohibited extensions of credit to Respondent and his related interests all reflect the serious gravity of the violations.
With respect to the economic benefit received by Respondent, the Recommended Decision notes that this Board has concluded as a matter of law that any receipt of credit which should not have been received is an indirect economic benefit to the recipient, citing In re R. Wayne Lowe, Docket No. FDIC-89-21k, 2 P-H FDIC Enf. Dec. ¶5153 (1990). However, the Recommended Decision then states that the correct method of quantifying the benefit in this case is by the amount of "actual loss" to the Bank, citing Docket No. FDIC-85-87k, 2 P-H FDIC Enf. Dec. ¶5119 (1988). The ALJ holds that loans to Respondent and his related interests which were written off as "loss" but subsequently "voluntarily returned to the Bank" cannot be considered in calculating the amount of benefit to the violator. The ALJ then finds that the Bank suffered "significant actual losses" because of unpaid accrued interest of $10,895 on Respondent's personal loan and $12,979 on the extension of credit to MGM, R.D. at 20; and concludes that the "minimum civil money penalty which can be imposed in this proceeding is $23,874," and that the penalty actually imposed should substantially exceed that minimum.
[.8] The Board rejects the "gravity" calculations made by the ALJ in several respects. The purpose of civil money penalties is to reduce risk to financial institutions by discouraging the types of insider transactions which experience has shown to be the major cause of bank failure. To hold that prohibited transactions "don't count" for civil money penalty purposes if the insider repays them, would eliminate the major deterrent purpose of civil money penalties. As the Board held in Docket Nos. FDIC-85-82e, FDIC-85-83k, 2 P-H FDIC Enf. Dec. ¶5137 at A-1463-64 (1989), the fact that charged off portions of a prohibited loan are ultimately recovered does not eliminate or excuse the existence of the violation of Regulation O. Likewise, loans which have been classified "Loss" and written off can be considered losses for purposes of quantifying the gravity of violations, even if later repaid.34 Repayment may be taken into account as a mitigating factor, "as justice may require." The Board also rejects the ALJ's conclusion that unpaid interest on the Falcon Production loan and the equity payments in the ORE transaction, although required by the Bank Commissioner to be written off as "Loss," should not be included in calculating loss to the Bank because the Bank "would not necessarily suffer a loss," R.D. at 20, footnotes 59 and 60, apparently because the value of the ORE will cover them. There are few transactions which demonstrate greater "gravity of violation" than the Falcon Production ORE transaction equity payments of Respondent. Those amounts, as well as the unpaid interest on the underlying loan, have been written off as losses to the Bank. The fact that such amounts may ultimately be recouped by the Bank does not detract from the gravity of the violations involved or the risk to the Bank at the time the transaction was consummated. Moreover, the loss to the Bank from the Falcon Production transactions appears to be greater than the sum of the unpaid interest and equity payments written off. The low revenue received on the ORE, as set forth in the April 27, 1990 Report of Examination, means that the Bank has suffered and continues to suffer lost opportunity on the significant funds it has invested in this transaction.
The Board concludes that the Bank incurred the following direct losses with respect to the extensions of credit to Respondent and his related interests which are the subject of this proceeding:
| MGM loan |
$248,780 |
| Falcon Production loan |
14,311 |
| Falcon Production ORE funds |
83,241 |
| Respondent's personal loans |
259,701 |
| Total |
$606,033 |
33 See Respondent's testimony at Tr. 652, 653.
34 The case cited by the ALJ for the "actual loss" proposition, Docket No. FDIC-85-87k, 2 P-H FDIC Enf. Dec. ¶5110 (1988), involved loans which, as here, had been classified "Loss" by bank examiners and therefore written off.
{{11-30-92 p.A-2029}}
These amounts are in addition to the losses of opportunity resulting from the Bank's inability to utilize funds tied up in ORE and in charged off loans.
Finally, the Board is of the view that in this case the benefit to Respondent substantially exceeded the loss to the Bank. In addition to the loans charged off as "Loss", Respondent received the benefit of $281,527 in prohibited overdrafts. While these were all repaid, Respondent had the use of funds which were obviously needed for some purpose. Moreover, all of the loans and overdrafts gave Respondent access to funds which he could not have obtained elsewhere, at least not on the same terms, on an arm'slength basis. The Board also notes that Respondent was never charged interest on the Falcon Production ORE payments he received in February 1988 or interest on the other extensions of credit at issue here after they were charged off by the Bank in 1988 and 1989. While difficult to quantify, the Board finds that the benefit to Respondent of unpaid interest on the Falcon Production ORE payments and the charge-off loans to Respondent and to MGM amounted to at least $150,000,35 and that the total benefits to Respondent resulting from the prohibited transactions amounted to at least $200,000 in addition to the losses of $121,426 which have not been repaid.
4. History of Previous Violations. The ALJ found that the 1986, 1987, and 1989 Examination Reports contain specific criticisms and discussions of numerous alleged violations of Regulation O, section 23A and the Act and the FDIC's Cease-and-Desist Order. The Board agrees.
[.9] 5. Matters Required by Justice. The Board declines to adopt the ALJ's finding that significant improvements in the Bank's financial condition took place under Respondent's management between 1985 and 1991. The evidence in the record is at best mixed. The condition of the Bank did improve between 1985 and 1991, moving from the CAMEL rating of 4 to a rating of 3. However, the 1985 Report of Examination noted that the Bank's condition reflected a serious deterioration from the previous examination; that loan classifications had doubled; that 53 percent of all classified loans were originated by Respondent; and recommended that Respondent completely divorce himself from the loan area. At the conclusion of the 1985 Examination. Respondent resigned as chairman of the board and removed himself from the lending area. Moreover, the November 29, 1985 Ceaseand-Desist Order, promulgated as a result of the 1985 Examination, was a very significant factor in the improvement in the Bank's condition.
Finally, the Board is of the view that rarely if ever would improvement in a bank's financial condition be a matter required by justice to be considered in determining the amount of a civil money penalty. The purpose of civil money penalties is to deter abusive insider conduct which has traditionally been a major cause of bank failures. That purpose would be substantially defeated if only those instances of conduct which ultimately result in damage to the affected bank's condition could be punished.
The Board does agree with the ALJ's conclusion that in the Falcon Production ORE transaction the Respondent misused his position to obtain additional credit denied him by law while retaining the power to reassert control over the real estate he conveyed to the Bank, in breach of his fiduciary duty to the Bank, R.D. at 21.
The Board also notes that the repayment made by Respondent in November 1991 of
35 The ORE payments totalling $83,241 were made in February 1988. No interest has ever been charged on this extension of credit.
The MGM loan of $235,801 was made in April 1988. Principal and accrued interest totalling $248,780 were charged off in December 1988. No interest has accrued since that date. Respondent repaid the principal only in November 1991.
The terms of Respondent's April 1987 loan of $250,000 were clearly more favorable than terms being offered other customers of the Bank. Respondent defaulted on the loan in August 1988. The Bank charged off accrued but uncollected interest of $10,895 in December 1988, and the unpaid principal of $248,806 in June 1989. No interest was charged after December 1988. Respondent repaid the principal only in November 1991.
Without compounding interest and without including the below-market interest charged on Respondent's loan from April 1987 to December 1988, a rough but conservative calculation of interest not charged follows:
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