Federal Deposit
Insurance Corporation

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   [¶5061] FDIC Docket No. FDIC-84-23b, FDIC-84-67k (2-19-86).

   FDIC issued a cease and desist order against a bank for extending credit without the normal complement of documentation, operating with inadequate loan loss reserves, engaging in hazardous lending and lax collection practices, operating with an inadequate level of capital, operating with inadequate liquidity, and violating laws and regulations. The FDIC also assessed civil money penalties against some of the bank's directors for receiving credit from the bank in excess of the legal lending limit even though the bank had not suffered any actual losses.

   [.1] Examiners—Loan Classification—Review by ALJ
   As the fact finder, the ALJ is entitled to review the factual predicates for loan classifications. Once it is shown that the facts support adverse classifications, the ALJ should defer to the training, experience, and expertise of the bank examiners.

   [.2] Lending and Collection Policy and Procedures—Inadequate Documentation
   Documentation of loans is important to safe and sound banking because it guarantees that a complete credit analysis will be performed prior to approval of the loan. Documentation also ensures that a bank's board of directors will have sufficient information to fulfill its fiduciary duties to supervise and monitor the lending activities of the bank.

   [.3] Examiners—Bias
   A highly discretionary governmental activity such as the conducting of a bank examination, will not be overturned due to bias of a government agent unless it is shown that the bias is directed specifically at the person who alleges the harm by the activity.

   [.4] Examiners—Bias
   Prior involvement in bank examinations, which increases an examiner's expertise, does not create a legal bias. The experience and the resulting increased awareness actually leads to more thorough examinations and sounder conclusions.

   [.5] Assets—Unsafe or Unsound Practices
   21.5% of a loan portfolio subject to adverse classification is an excessive and disproportionate quantity of low quality assets when the average for a comparable bank is only 10%.

   [.6] Capital—Adequacy—Unsafe or Unsound Practices
   A bank whose adversely classified assets are approximately two times that of unimpaired capital and reserves is engaged in an unsafe or unsound banking practice because its capital provision is inadequate.

   [.7] Definitions—Covered Transaction
   A covered transaction means "the acceptance of securities issued by the affiliate as collateral security for a loan or extension of credit to any person or company."

   [.8] Federal Reserve Act §23A—Transactions with Affilliates—Affilliates Stock as Collateral
   The use of stock of an affiliate to collateralize a loan clearly is one type of transaction limited by the Federal Reserve Act to prevent a bank from risking too large an amount in an affiliated enterprise and to assure that extensions of credit to affiliates will be repaid.

   [.9] Federal Reserve Act §23A—Covered Persons—Control
   A covered person is presumed to have control of a company if the person is an executive officer or director of the company and has power to vote more than 10% of any class of voting securities.

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   [.10] Regulation O—General Prohibitions—Approval by Board of Directors
   All extensions of credit to executive officers, directors, principal shareholders, and their related interests must receive prior approval by a disinterested majority of the board of directors.

   [.11] Cease and Desist Orders—FDIC Authority to Issue
   When a bank has engaged in unsafe or unsound practices and has committed numerous violations of laws and regulations, the FDIC has broad discretion to exercise its expertise in fashioning an appropriate remedy to stop the practices and violations, to prevent future such abuses, and to correct the effects of the practices or violations.

   [.12] Deposits—Brokered—Reports to FDIC
   Requiring a bank to give written notice to the FDIC when its brokered deposits fund equals 5% or more of the bank's total deposits is a method of off-site monitoring of a bank designed to gain regulatory attention in the event the bank does turn extensively to brokered deposits, and is appropriate.

   [.13] Cease and Desist Orders—Affirmative Remedies—Lending Authority Restricted
   When a bank director had primary responsibility for 22 loans subject to adverse classification and when a board of directors failed to supervise the director's lending activities, the FDIC may remove the director's lending and investment authority and require the bank to retain a qualified chief loan officer who understands the importance of loan portfolio diversity and who will devote full time and attention to the responsibilities of that position.

   [.14] Civil Money Penalties—Amount of Penalty—Statutory Standard
   In determining the amount of a civil money penalty, the FDIC must consider the financial resources and good faith of the bank or person, the gravity of the violations, the history of previous violations, and such other matters as justice requires.

In the Matter of * * * BANK and * * *,
individually.
In the Matter of * * * individually and in
their capacities as executive officers,
directors or principal shareholders of * * *
BANK, (INSURED STATE
NONMEMBER BANK)


FDIC-84-23b
FDIC-84-67k
(Consolidated Action)
DECISION

I. INTRODUCTION

   This proceeding is a consolidation of two separate actions brought by the Federal Deposit Insurance Corporation ("FDIC"), a cease and desist action against * * * Bank, * * * ("Bank"), and its principal shareholder and president, * * *, pursuant to section 8(b)(1) ("section 8(b)") of the Federal Deposit Insurance Act ("FDI Act"), 12 U.S.C. § 1818(b)(1), and a civil money penalty proceeding against the directors of the Bank (the Bank, the directors, and Mr. * * * are collectively referred to as "Respondents"), pursuant to section 18(j) of the FDI Act, 12 U.S.C. § 1828(j), for violations of section 22(h) ("section 22(h)") or "Reg. O"¹) and section 23A ("section 23A") of the Federal Reserve Act, 12 U.S.C. §§ 375(b)(1) and 371c, and pursuant to section 106(b)(2) ("section 106") of the Bank Holding Company Act of 1956 as amended ("BHCA") (12 U.S.C. § 1972(2)). The FDIC alleged that the Respondents had engaged in certain unsafe or unsound banking practices and had violated the aforementioned statutes and regulation. The FDIC sought a cease and desist order designed to terminate and correct the adverse effects of the unsafe or unsound practices and violations of law. The FDIC also proposed that civil money penalties ranging from $1,000 to $100,000 be assessed against the Bank's directors.
   The Board of Directors ("Board") has reviewed the record, the parties' briefs, and the Recommended Decision and Order of the Administrative Law Judge ("ALJ"). With certain exceptions that are discussed herein, infra, including his discussion and conclusions with regard to the propriety of

Finally, the Board declines to exercise its discretion under section 308.17 of the FDIC's Rules and Regulations and denies Respondents' request for oral argument.

II. STATEMENT OF THE CASE

   On August 22, 1983, the FDIC commenced an examination of * * *.² The August 22, 1983 examination found that the Bank's condition had seriously deteriorated since the prior FDIC examination. Adversely classified assets totaled $7.6 million, of which $6.9 million consisted of loans. Approximately $6.7 million of the loans were adversely classified as "Substandard" and $200,000 as "Loss". This was a dramatic increase from the 1981 examination.³ The ratio of adversely classified loans to total loans increased from 3.59 percent in 1981 to 28.72 percent in 1983 and the Bank's delinquency ratio⁴ had increased from 3.2 percent to 9.7 percent. The $6.9 million in loans were adversely classified in large part because: (1) the loans had been extended (or renewed) without the normal complement of documentation, such as the borrowers' financial statements or structured repayment plans, and (2) the loans were primarily made either to the Bank's majority shareholder, * * *, Sr., and his family and business interests (* * * line") or to Mr. * * * business associate, * * *, and his family and business interests (* * * line"). In addition to the large volume of loans subject to adverse classifications, the Report of Examination expressed concern over the Bank's capital position and about the inadequacy of the Bank's loan valuation reserve ("loan loss reserve") in relation to the quantity of its poor quality assets, the lack of substantive, detailed lending, collection or investment policies, poor liquidity management and inadequate supervision by the board of directors over the affairs of the Bank. The Bank was also cited for various violations of law, including loans in excess of the lending limits prescribed by section 23A of the Federal Reserve Act and Reg. O. As a result, the Bank was assigned a composite CAMEL rating of "four". On February 8, 1984, the FDIC issued a Notice of Charges and of Hearing ("First Notice") to * * * pursuant to section 8(b)(1) of the FDI Act, 12 U.S.C. § 1818(b)(1). Mr. * * *, in addition to being the principal shareholder of the Bank,⁵ is the President and a member of the Bank's board of directors. As President, he functions as the chief lending officer and is primarily responsible for many of

III. THE ALJ'S RECOMMENDED
DECISION
   Although the ALJ rejected some of the adverse loan classifications assigned by the FDIC, he concluded that the Bank had engaged in the following unsafe or unsound banking practices: hazardous lending and lax collection practices, disproportionate quantity of poor quality loans, inadequate capital and reserves, inadequate supervision of lending activities by the Bank's board of directors, and inadequate liquidity. He determined, however, that the Bank's loan loss reserve was adequate, finding that the FDIC's evidence on the issue was not persuasive. Although he did not uphold the FDIC on all alleged violations of law, he did find that the Bank had extended credit in violation of the lending limits of section 23A and Reg. O and the safety and soundness requirements of section 106.
   As a result of his findings, the ALJ recommended that a cease and desist order be imposed upon * * *. He adopted most of the FDIC's proposed order, including the provisions that the Bank reduce loans classified "Substandard" to $2.0 million within 18 months, maintain a capital ratio of 7.5 percent, establish an independent audit committee composed of outside directors, provide prior board approval on all loans exceeding $50,000 and inform the FDIC of brokered deposit activity when such deposits exceed five percent of total deposits. He rejected the FDIC's request that all lending authority be removed from Mr. * * * on the ground that such a provision is tantamount to a removal under section 8(e) of the FDI Act, 12 U.S.C. § 1818(e). He reasoned that section 8(e) is the exclusive means by which the FDIC can seek to limit conduct of a bank officer and that the FDIC had not offered sufficient proof to justify

IV. THE PARTIES' EXCEPTIONS

   The FDIC excepted to the ALJ's refusal to find several of the Bank's extensions of credit to be violative of section 23A, Reg. O and section 106. The FDIC also strongly objected to the recommendation that Mr. * * *'s lending authority not be restricted and to the two-thirds reductions in civil money penalties. The Respondents argued that the ALJ erred in failing to scrutinize more closely the August 1983 Report of Examination. They argued that the State of * * * March 1984 Report of Examination, in which a substantially lower volume of loans was subject to adverse classification, more accurately pictured the condition of the Bank and that, therefore, the Bank had not engaged in unsafe or unsound banking practices. They excepted to most of the ALJ's conclusions regarding section 23A violations on the ground that the FDIC had not proven that an alleged affiliate of the Bank was, in fact, an affiliate within the meaning of the statute. They objected to the brokered deposit provision, the provision requiring prior board approval for loans exceeding $50,000 and the requirement of outside directors. They also objected to the assessment of civil money penalties on the grounds that many of the alleged violations of law were not, in fact, violations and that those which did occur were inadvertent. The Respondents have also requested, pursuant to section 308.17 of the FDIC's Rules and Regulations, 12 C.F.R. § 308.17, that the FDIC's Board of Directors hear oral argument on the case prior to rendering a final decision in this matter.⁹

V. OPINION

   The divergent views of each party on the facts at issue in this action and the conclusions to be drawn therefrom led to extended hearings and a lengthy Recommended Decision and Order by the ALJ. For ease of analysis, we have divided this section into four parts. In Part A, infra, we discuss and analyze the ALJ's findings concerning the allegations of unsafe or unsound banking practices by * * *, the parties' exceptions and our conclusions with regard to these issues. In Part B, infra, we discuss and analyze the alleged violations of law. Part C, infra, discusses the ALJ's Recommended Order to Cease and Desist. Finally, in Part D, infra, we discuss and analyze the ALJ's Order to Pay Civil Money Penalties and our conclusions with respect thereto.

A. Unsafe and Unsound Banking Practices

   1. The Parties' Positions

   The FDIC's allegations that the Bank had engaged in six categories of unsafe or unsound banking practices were hotly contested by the Respondents in this proceeding. The bases for these allegations are thirty-three extensions or renewals of credit, totaling over $5.9 million, which had been made without at least one type of documentation considered essential to prudent banking:

   (1) Loan files on thirty of thirty-three loans did not contain current or suffi-

ciently detailed financial information about the borrowers (PFF¹⁰ 10–40);
   (2) Eighteen of the thirty-three loans were not collateralized with adequate security when made (PFF 42–60);
   (3) Twenty-five of the thirty-three loans lacked an adequate repayment program, including determinations as to the source of repayment (PFF 62–87); and
   (4) Eighteen of the thirty-three loans were made with either no or erroneous documentation as to their purposes (PFF 89–109).

   2. The ALJ's Decision

   a. Findings of Fact

   The FDIC's evidence concerning lack of loan documentation, except in a few instances, was uncontested. The ALJ, therefore, adopted the FDIC's PFF 10–40, 42–46, 48–57, 59–60, 62–87 and 89–109. (R.D. App. A, Table II). He rejected PFF 47 (inadequate collateral documentation for a $50,000 loan to * * * and PFF 58 (inadequate collateral documentation for a $370,000 loan to * * *)¹⁴ because he felt the security for these loans was sufficient. (R.D. 32; App. A, Table II; App. B., n.8.). From these findings of fact, the ALJ concluded that incomplete loan documentation justifies an assignment of adverse classifications. He, therefore, held that twenty-six of the thirty-three loans, totaling $5.0 million, should be subject to adverse classification because they were extended without two or more essential categories of documentation. (R.D. 31-2; App. A, Table I) The ALJ did accept the Respondents' argument that an occasional lapse in prudent banking procedures does not support an adverse classification and on that basis rejected classification of the remaining seven loans, totaling $1.0 million, which were shown to lack only a single category of documentation—adequate financial information about the borrowers or specific repayment plans. Id. He also rejected a finding of adverse classification on $900,000 of other loans because the FDIC had offered no proof supporting this action beyond the August 1983 Report of Examination. (R.D. 33; App. B, n.2.)
   The ALJ did not address in detail the Respondent's allegations concerning bias and prejudice of the FDIC examiners or the weight to be accorded the State's examination of March 1984.¹⁵ He merely stated that the State's determination that only $1.9 million, rather than $5.0 million, of loans should be subject to adverse classifications "fail[ed] to overcome the conclusion that the overwhelming preponderance of loan classification contained in the report of the August 1983 FDIC examination were accurate." (R.D. 6) He did not, however, provide any citations to the record to support this conclusion. While the ALJ disagreed with certain adverse classifications, he felt this, by itself, did not discredit either the EIC of the August 1983 examination or the Report of Examination. A showing that one examiner is more critical than another "is no justification for escaping the conclusions of that more critical examiner and is no invitation to ignore the results of duly performed bank examination." (R.D. 7)
   The Board has reviewed the findings cataloged by the ALJ in Table II and the corresponding citations contained in the FDIC's proposed findings and agrees with the ALJ that the record contains substantial evidence concerning the lack of proper documentation for the thirty-three loans at issue. The Board, therefore, adopts and incorporates herein by reference the findings presented in the ALJ's Table II.¹⁶ and the citations to the record contained in the FDIC's

   [.1] Upon finding that the thirty-three loans lacked proper documentation, the ALJ examined the validity of assigning adverse loan classification. (R.D. App. A, Table I)¹⁸ As the fact finder, the ALJ is properly entitled to review the factual predicates for the loan classifications. In this case, determination of the existence or nonexistence of loan documentation does not require expertise in either banking or bank examination practices. It is the view of this Board, however, that the decision to classify a loan is one which requires the specialized training, experience and expertise possessed by a bank examiner. Once it is shown that the facts support adverse classifications, the ALJ should defer to the training, experience and expertise of the examiners and the exercise of their judgment regarding the classification of individual loans. Therefore, we find that classifications assigned by the FDIC examiners are to be accorded deference unless it is shown they are without factual basis or are unreasonable in light of the factual basis.
   The ALJ found, and we concur, that the thirty-three loans in question had been extended without the normal complement of documentation. In other words, sufficient facts were proven to support the assignment of adverse classifications to these loans. Since the FDIC examiner's conclusions concerning the loan classifications are supported by verifiable facts, they should be overruled only if they are shown to be unreasonable in light of those facts.

   [.2] The Respondents present two arguments in support of their contention that the examiners' actions were unreasonable. The Board finds that neither argument is persuasive or sufficient to overturn the loan classifications of the August 1983 Report of Examination. First, the Respondents argue that incomplete loan file documentation is not unusual and bank examiners should rely upon unrecorded information known to the Bank's loan officers. From this argument, Respondents would have this Board conclude that the August 1983 loan classifications were unreasonable because the examiners failed to take into account this off-the-record knowledge. While there is some evidence in the record to support the Respondents' argument when incomplete loan files are isolated occurrences, the evidence also strongly supports the conclusion that "a pattern of credit extensions attended by few, if any, of the routine and normally expected safeguards" existed at the Bank. (R.D. 31) It would appear, therefore, that the failure to document loans was a pervasive practice at * * *. Documentation of loans is important to safe and sound banking because it guarantees that a complete credit analyses will be performed prior to approval of the loan. (Tr. Vol III, 69–73) If specific information is relied upon by loan officers in evaluating loans, prudent banking practice requires that the information be recorded in the loan file. (Tr. Vol. III, 71) Such a procedure will also ensure that banks' boards of directors will have sufficient information to fulfill their fiduciary duties to supervise and monitor the lending activities of the bank. Finally, written documentation is of critical importance for examination of the quality of a loan. (Tr. Vol. III, 67-8) Undocumented information possessed by a lending officer is a factor that may be considered before classifying a loan. (Tr. Vol. III, 88-9) On the other hand, the Board concludes that the existence of unrecorded information will not mitigate the threat posed to a bank by the lack of accepted and conventional banking practices where, as here, the absence of documentation is so pervasive. (Tr. Vol. V-A, 80).

   [.3,.4] The Respondents' second argument is that the EIC's prior experience with the Penn Square investigation so prejudiced her view concerning concentration of credit that she was unable to perform an objective examination of * * *. Even assuming arguendo that the EIC was improperly influenced by the Penn Square experience, the lack of loan file documentation still provides a sufficient objective, factual basis for the adverse loan classifications. Moreover, we find that the record supports the ALJ's conclusion that the examination should not be discounted on the ground of prejudice or bias because the Respondents did not provide any evidence that the alleged bias was directed specifically at * * * , Mr. * * * or any of its other shareholders, directors or officers. The courts have held, and this Board agrees, that a highly discretionary governmental activity, e.g., the conduct of

   b. Conclusions of Law

   Upon finding that loans totaling $5.0 million, out of $24.3 million in total loans, had been extended without proper documentation and were subject to adverse classifications, the ALJ concluded that the Bank's lending and collection practices were unsafe or unsound banking practices. (R.D. 31-2) Although the Recommended Decision does not identify specific facts from the record supporting this conclusion of law, it appears that the ALJ implicitly accepted the FDIC's PFF 7–9, 41, 61 and 88 as the underlying factual basis for this holding.²⁰

   [.5,.6] The ALJ also held that, with 21.5 percent ($5.0 million out of $24.3 million) of a loan portfolio subject to adverse classification, the Bank had maintained an excessive and disproportionate quantity of low quality assets because the average for a comparable bank was only ten percent. (R.D. 33-4) As he did with his conclusion concerning the bank's lending practices, the ALJ failed to provide any citations to the record in support of his conclusion on this issue, but appears implicitly to have adopted PFF 109. (R.D. 27) He also held that the Bank's capital provision was inadequate,

   B. Violations of Law

   1. The Violations Alleged

   a. Section 23A of the Federal Reserve Act

   The FDIC alleged that thirty-six loans by the Bank violated various statutes and regulations. Twenty-eight loans were charged with being violations of section 23A(a)(1) of the Federal Reserve Act, which restricts the extent to which banks can engage in "covered transactions" with an affiliate. The FDIC argued that these loans involve a "covered transaction"²² in that they were secured by stock of * * *, an affiliate of the Bank and that the aggregate value of the loans exceed the lending limits of section 23A. The Respondents countered with two alternative arguments: (1) that * * * was not an "affiliate" of the Bank as that term is defined by the statute, and (2), alternatively, that even if * * * was an affiliate for purposes of section 23A, the loans in question were not "extensions of credit" within the meaning of statute because they were renewals of loans originating prior to the effective date of the applicable provision.

   b. Section 106 of the BHCA

   Eight loans made to persons associated with the Bank's correspondent bank, * * * Bank * * *, or to business interests of those persons, were alleged to be in violation of section 106(b) of the BHCA. This statutory provision prohibits loans to executive officers or directors of * * * or the directors' interests unless they are on substantially the same terms as those prevailing at the time for comparable transactions and do not involve more than the normal risk of repayment or present other unfavorable features. The Respondents argued that five of the loans were made to persons or companies which do not fall within the meaning of "executive officers" or "related interests" of executive officers as defined in section 106(b) and that the remaining three are on the same terms as comparable transactions and do not present any unusual risk of nonrepayment.

   c. Reg. O

   The FDIC contended that the eight loans which allegedly violated section 106(b) also violated the lending limits of section 215.4(a) of Reg. O, 12 C.F.R. § 215.4(a). which prohibits loans to the Bank's executive officers, directors, principal shareholders or their related interests unless they are on substantially the same terms as those prevailing at the time for comparable transactions, do not involve more than the normal risk of repayment, or present other unfavorable features. Under Reg. O, a loan to a third party is treated as a loan to a covered person if the proceeds are used for the tangible benefit of, or are transferred to, a covered person. The FDIC alleged that the loans to persons associated with * * * were, in effect, made to Mr. * * * because, during the period of time the eight loans were outstanding, Mr. * * * and his related interests had preferential loans from * * * of approximately $1.9 million. The Respondents again denied that the loans were of poor quality or that Mr. * * * line of credit at * * * was a quid pro quo for the favorable terms allegedly given by the Bank on the loans to * * * executive officers.
   Twenty of the twenty-eight loans that allegedly violated section 23A had been made to * * *, a director of the Bank, and to * * *, a related interest of * * *, a director of the Bank. These, in addition to the eight loans discussed in reference to section 106, allegedly violated section 215.4(b) of Reg. O, 12 C.F.R. § 215.4(b), which prohibits extensions of credit to executive officers, directors, principal shareholders or their related interests in excess of a specified limit.²³ unless approved in advance by a disinterested majority of a bank's board of directors. The Respondents did not contest that a disinterested majority of the Bank's board

   2. The ALJ's Decision

   a. Background

   As a preliminary matter the Board notes that the FDIC and the Respondents stipulated to the following:
   [1] * * *...and * * * are and have been at all relevant time "related interests" of * * * within the meaning of section 22(h) of the Federal Reserve Act, 12 U.S.C. § 375b, and Regulation O, 12 C.F.R. Part 215, thereunder and [* * * is an] "affiliate" of * * * within the meaning of section 23A of the Federal Reserve Act, 12 U.S.C. § 371c, by virtue of * * * ownership, control, or voting power. At all relevant times * * * exercised a controlling influence over * * *. * * * and * * * are and have been at all relevant times related interests of * * *.
   [2] At all relevant times * * * has maintained a "correspondent account" at * * * Bank within the meaning of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). At all relevant times * * * and * * * were "executive officers" of * * * within the meaning of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)) and at all such times * * * and * * * were also "directors" of * * * within the meaning of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)).
   [3] (a) As of August 22, 1983, * * * had extended and still carried on its books extensions of credit secured by stock in * * * to the following obligors:

   (b) Of these extensions of credit, at least $600,000 was transferred to * * * to purchase stock.
   (c) Of these extensions of credit, $200,000 in the name of * * *, $100,000 in the name of * * *, and $100,000 in the name of * * * was outstanding prior to October 19, 1982. This was in excess of ten percent of the capital stock and surplus of * * *. The extensions of credit referenced in paragraph [3](c) were made in violation of section 23A.

(Tr. Vol. II, Exh. 10)
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   [d] That 10 of the extensions noted in [3](a) were approved after the fact by * * * board of directors.
   (Tr. Vol. I, Att. c)

   b. Section 23A of the Federal Reserve Act

   Despite Stipulation [1] above, much time during the hearings, large portions of the parties' briefs, and the ALJ's Recommended Decision were spent on the issue of whether or not * * * is an "affiliate" of the Bank within the meaning of section 23A. The Board finds that the stipulation of the parties set forth above is conclusive and dispositive as to the fact that * * * is an affiliate of * * * for purposes of section 23A. The Board, therefore, concurs with the ALJ's conclusion to that effect, but concludes that his analysis apart from the stipulation was not necessary.
   The ALJ then held that twenty-four of the twenty-eight loans at issue violated section 23A because the * * * stock used to collateralize the loans had been purchased with proceeds from those loans. He did not view the remaining four loans as violations of section 23A, although secured by stock of * * * because he concluded that the stock had not been purchased with the proceeds from the loans. The basis for the ALJ's decision was his interpretation of section 23(A)(a)(2)²⁵, from which he concluded that "a suspect transaction would seemingly require a factual predicate linking the "issuance" of the securities directly to the `loan...to any person.'" (R.D. App. B, n.25) Thus, he reasoned that "absent an indicia of a purchase money security interest taken in connection with the same transaction," no benefit is derived by the affiliate from the loan.

   [.7,.8] We note that portions of proceeds of three of the loans²⁶ the ALJ deemed not to violate section 23A were, in fact, used to purchase stock in * * * , which, in turn, collateralized the loans. (Tr. Vol. II. Exh. 10). The Board finds, however, that the ALJ erred in his interpretation of section 23A(a)(2). Section 23A is quite clear that a covered transaction means "the acceptance of securities issued by the affiliate as collateral security for a loan or extension of credit to any person or company." 12 U.S.C. § 371c(b)(7)(D). The statute does not limit this type of covered transaction only to loans whose proceeds are used to purchase the offending collateral. Moreover, the ALJ's emphasis on what he viewed to be the underlying purpose of section 23A is misplaced. (R.D., App. B, n.25) Section 23A(a)(2) applies to those situations which facially do not appear to be covered transactions, but which the statute deems to be within the purview of section 23A. Paragraph (a)(2), therefore, permits bank regulatory agencies to look beyond the form to the substance of transactions in order to reach all extensions of credit which are effectively transactions between banks and their affiliates. Since the transactions alleged here to violate section 23A fall within the literal definition of "covered transactions", the provision cited by the ALJ in support of his contrary conclusion is not applicable. The purpose of section 23A is to "prevent a bank from risking too large an amount in affiliated enterprise and to assure that extensions of credit to affiliates will be repaid." 12 C.F.R. § 250.240. The use of stock of an affiliate to collateralize a loan clearly is one type of transaction section 23A is designed to limit, regardless of when or how the borrower obtained funds to purchase the collateral.
   The Board, therefore, adopts PFF 114 and finds that the twenty-eight extensions of credit listed therein, secured by stock of * * * , are in violation of the lending limits of section 23A.

   c. Section 106(b) of the BHCA

   The ALJ upheld the FDIC's position on two of the eight extensions of credit alleged to be in violation of section 106(b) of the BHCA, rejected it on five loans and made conflicting statements with regard to the final loan.²⁷ As set forth below, the Board

   [.10] Section 215.4(b) of Reg. O establishes minimum lending limits, above which all extensions of credit to executive officers, directors, principal shareholders, and their related interests must receive prior approval by a disinterested majority of the board of directors. Twenty loans which are alleged to violate this requirement were extended to * * * , a director of the Bank, and * * * , a related interest of Mr. * * *. The record contains substantial evidence supporting the ALJ's conclusions that these loans were made to covered persons, that their aggregate amount exceeded the minimum, and that the Bank's board failed to give approval prior to the disbursement of the proceeds. (Tr. Vol. I, Att. C; Vol. VII, 94-6) Similarly, the record supports the ALJ's conclusion that the eight loans extended to officers of * * * and their related interests did not violate section 215.4(b) because the evidence does not establish that a benefit inured to a "covered party."
   The ALJ found that the $600,000 the Bank had extended to purchase stock in * * * inured to the benefit of Mr. * * * because Mr. * * * related interest benefited by the infusion of capital. Since the aggregate amount is in excess of the lending limits set forth in section 215.4(c), he found that these loans violated that provision of Reg. O. The Respondents argued that it was the purchasers of stock that received the benefit from the transaction. This argument, however, does not refute the fact that the issuer of the stock also derived a benefit. Moreover, loans do not violate section 215.4(c) only when the benefit which inures to covered persons is an intended one. Nothing in section 215.4(c) requires that the loans be part of a scheme designed to benefit covered persons. As long as covered persons benefit from a loan, it is subject to the lending limits of section 215.4(c). The Board, therefore, agrees with the ALJ's conclusion that the borrowers used the proceeds of the loans in question for the benefit of a related interest of Mr. * * * in violation of the lending limits of section 215.4(c) of Reg. O.

   C. Order to Cease and Desist

   1. The ALJ's Recommended Order and
the Parties' Exceptions
   The ALJ recommended that an Order to Cease and Desist be issued (hereinafter referred to as "Recommended Order"). The Recommended Order, with a few exceptions discussed below, adopted the provisions proposed by the FDIC.²⁹ The Respondents did not contest the ALJ's conclusion that an order should be imposed on the Bank. However, the Respondents took exception to numerous parts of the ALJ's Recommended Order, including the following provisions:³⁰

   1. ¶2 (requiring additions to loan loss reserves to cover assets classified loss and maintenance of an adequate reserve, R.D. 55) because the ALJ found the Bank's loan valuation reserve to be adequate.
   2. ¶5 (requiring correction of all violations of sections 22(h) and 23A and Reg. O, R.D. 59) because there had been no violations of sections 22(h) and 23A of the Federal Reserve Act.
   3. ¶7 (requiring prior approval by the Bank's board for all loans over $50,000, R.D. 59) because the $50,000 floor on prior approval represents a substantial portion of the Bank's loans.
   4. ¶8 (requiring a majority of outside directors, R.D. 59) because no law requires such a provision and there was no

showing that an insider directorship is an unsafe or unsound banking practice.
   5. ¶12 (requiring notice to FDIC when brokered deposits exceed five percent of total deposits, R.D. 60) because there was no showing that use of brokered deposits are an unsafe or unsound banking practice or that the Bank had or was about to use them.

   2. Analysis

   [.11] The Board notes at the outset that where, as here, it has found that a bank had engaged in unsafe or unsound practices and has committed numerous violations of laws and regulations, it has, under established court precedent, broad discretion to exercise its expertise in fashioning an appropriate remedy to stop the practices and violations, to prevent future such abuses and to correct the effects of the practices or violations. First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 680 (5th Cir. 1983); del Junco v. Conover, 682 F.2d 1338, 1340 (9th Cir. 1982), cert. denied, 459 U.S. 1146 (1983); Gross National Bank v. Comptroller of the Currency, 573 F.2d 889, 897 (5th Cir. 1978). In view of our findings of fact and conclusions set forth above, the Board agrees with the ALJ that the issuance of a cease and desist order to the Bank is both appropriate and necessary. There only remains a determination of whether the ALJ's Recommended Order is an appropriate remedy. In general, we find that the provisions adopted by the ALJ are a proper response to the unsafe or unsound practices and violations found in this proceeding. Therefore, the Board adopts paragraphs 1 through 14 of the ALJ's Recommended Order.
   The Board's conclusion that the Bank and Mr. * * * have committed numerous violations of sections 22(h) and 23A and Reg. O is more than adequate justification for a requirement that Respondents correct those violations. Similarly, the findings that the Bank has engaged in unsafe or unsound practices justifies a provision requiring the Respondents not to engage in such practices in the future.³¹ Despite the Respondents' objections, the Board concludes that there is ample evidence in the record to support a view that any corrective efforts by the Respondents are a direct result of the initiation of the enforcement action by the FDIC. Thus, this type of injunctive relief is clearly warranted to ensure not only that the Respondents carry through with proper corrective action, but that such abuses do not occur in the future.
   The Respondents objected to the ALJ's recommendation that all credit extensions in excess of $50,000 receive prior approval of the Bank's board of directors on the ground that the Bank's current policy which requires prior approval on loans greater than $100,000 is satisfactory to the FDIC. The record in this proceeding does not show that the FDIC has approved the Bank's current loan policy and, in fact, shows that only the State of * * * has approved the policy. (Tr. Vol. V, 84, 86-7; VIII, 62) Indeed, the record establishes a total lack of supervision over the lending activity of the Bank's officers, especially Mr. * * * , by the Bank's board of directors. This evidence justifies stringent measures, including requiring prior approval by the Bank's board of all loans over $50,000.
   The Respondent also took exception to paragraph 8 of the Recommended Order, arguing that a board of directors comprised of insiders is not necessarily an unsafe or unsound banking practice and that outside directors are not required by federal law or regulation. Wholly apart from the Respondents' argument that an inside board is not a per se unsafe or unsound practice, the record is replete with testimony that the current board of the Bank exercised little if any judgment independent from that of Mr. * * * and did not fulfill its duties and responsibilities. Therefore, requiring a majority of outside directors and an independent audit committee for the Bank are, in this Board's view, both justified and necessary to ensure that the board of directors of the

   [.12] Experience over the past several years has indicated that brokered deposits are utilized more frequently and more extensively by banks with financial problems than banks in sound condition. The Bank has been found to be in a weakened financial condition resulting from unsafe or unsound practices. Should its condition continue to deteriorate, there is the potential danger that it would turn to highly volatile brokered deposits to overcome liquidity difficulties. Thus, past history and present intentions are not particularly useful guides. The reporting requirement is in actuality a method of off-site monitoring of the Bank designed to gain regulatory attention in the event the Bank does turn extensively to brokered deposits. If, as Respondents appear to imply, the Bank continues its present course and does not utilize brokered deposits, the reporting requirement does not create any burden on the Bank.
   Furthermore, while Respondents' statement that section 8(b) requires proof of unsafe or unsound practices (or violations of laws, rules, regulations or outstanding orders) as a predicate for issuance of a cease and desist order is correct, the Board does not agree with the narrow interpretation of the statute that Respondents' argument implies—that each provision of a cease and desist order must be directly related to a specific unsafe or unsound practice. As the courts have held, once unsafe or unsound practices have been established, the bank regulatory agencies have broad discretion to fashion proper remedies not only to halt and correct current or former practices but also to prevent future abuses that could result in further deterioration of a bank's financial condition. Even assuming arguendo that Respondents' argument has some merit (an assumption with which the Board disagrees), the ALJ's finding, with which the Board agrees, that the Bank had inadequate liquidity (an unsafe or unsound practice) justifies the requirement. The use of brokered deposits could in the Board's view seriously aggravate the Bank's asset/liability matching problems, creating even greater liquidity problems. Therefore, the Board concludes that there is more than sufficient justification for the inclusion of paragraph 12.
   The ALJ declined to adopt a provision requiring the Bank to remove Mr. * * * lending and investment authority and to retain a new qualified chief lending and investment officer. The ALJ concluded that such a restriction was unnecessary because other provisions of the Recommended Order—mandating reduction of adversely classified loans, restoring and maintaining a 7.5 percent capital ratio, requiring outside directors and an audit committee comprised only of outside directors, adopting written loan, investment, and liquidity policies and submitting compliance reports to the FDIC—would check the "pervasive influence" of Mr. * * * eliminating the need for what he characterized as "Draconian" relief. (R.D. 52) He also determined that the proposed provision "is tantamount" to removal from office, "a result not authorized in this proceeding [i.e., one brought under section 8(b) of the FDI Act] but only in an appropriate case [under section 8(e) of the FDI Act]." (R.D. 52) The ALJ reasoned that "there is precious little left to do for the controlling shareholder and principal operating official of this Bank if he is not to participate in credit extensions and investment decisions." (R.D. 52).

   [.13] The Board agrees that other provisions in the Recommended Order may accomplish much to prevent continuance of
{{4-1-90 p.A-722}}the unsafe or unsound practices and violations of law and to correct their effects. This, however, does not address the question of the appropriateness of a provision which limits Mr. * * *'s role in the lending and investment activities of * * *. The Respondents have stipulated that Mr. * * * had primary responsibility for twenty-two of the loans subject to adverse classifications. (Tr. Vol. I, Att. C; Vol. II, Exh. 10) The Board found that many of those loans for which Mr. * * * had primary responsibility resulted in violations of sections 23A and 106 and Reg. O. We have also found the Bank's board of directors failed to supervise Mr. * * *'s lending activities to the point where the board exercised no prior approval on any loans. This failure permitted a large portion of the Bank's loan portfolio to be concentrated in loans to Mr. * * * , his family and related interests and to Mr. * * * , his family and related interests. These facts led the Board to the inevitable conclusion that the Bank's directors failed to live up to their responsibilities. Lastly, the record contains substantial evidence to support the ALJ's observation that the outside "entrepreneurial activity on the part of * * *...distract[ed] from his responsibilities concerning the Bank...." (R.D. 50) Thus, removing Mr. * * *'s lending and investment authority and requiring the Bank to retain a qualified chief loan officer who understands the importance of loan portfolio diversity and who will devote full time and attention to the responsibilities of that position are methods to deal with the Bank's excessive number of classified loans and to prevent a future recurrence of such problems. This Board believes that such a remedy is clearly "reasonably related" to the unsafe or unsound banking practices and violations of law in this case. Therefore, the Board finds that the cease and desist order in this proceeding should include these requirements.
   The Board also finds that the ALJ was incorrect in concluding that removal of Mr. * * *'s lending and investment authority is "tantamount" to a section 8(e) removal. The restriction is more limited than that imposed under section 8(e). In a section 8(e) removal, an officer or director is prohibited from participating in any manner in the conduct of the bank with which he is currently associated and from participating in any manner in the conduct of any other FDIC insured bank. 12 U.S.C. § 1818(e)(1), (j)(2). As such, a section 8(e) removal would not only eliminate Mr. * * *'s lending authority, but would also remove him as an officer and member of the board, and prevent him from exercising his controlling interest in the Bank and any other FDIC insured bank. Therefore, it is clear that the ALJ was incorrect in equating FDIC's proposed relief with that afforded under section 8(e) of the FDI Act.
   The order will have no effect on Mr. * * *'s other duties as president—bank operations, public relations, employment, personnel management, etc. More importantly, Mr. * * * will be permitted to continue to serve on the Bank's board of directors and to exercise his right to be heard on and to vote on all matters before the Bank's board. Mr. * * * will be an active participant in the development, implementation and monitoring of the loan, loan collection, capital, investment and liquidity policies required by the order. Contrary to the ALJ's assertion, this limitation does not deny Mr. * * * "meaningful participation in restoring the Bank to an appropriate level of regulatory confidence." Furthermore, this provision will not be a particular hardship on Mr. * * * in view of his other banking interests, as well as his "many" outside business interests. (R.D. 52) For the foregoing reasons, we adopt the FDIC's proposed provision to limit Mr. * * *'s lending and investment authority.

   D. Order to Pay Civil Money Penalties

   The FDIC seeks assessments of civil money penalties of $75,000 against Mr. * * * , $10,000 against his son, * * *, and $1,000 against each of the remaining individual Respondents. The Respondents argue that the assessments should be $1,000, $100, and $100 each, respectively, on the ground that substantially fewer violations of law occurred than, in fact, have been established by the record.
   The ALJ noted that, although the violations of law were not the result of "deliberate overreaching" (R.D. 63), they were, nonetheless, not "inadvertent." (R.D. 64) On the other hand, he observed that the multiple statutory violations arose from the same set of loans, several violations were not, in his view, proven and the Bank had not suffered any actual loss from the offending loans. (R.D. 64) Moreover, he stated that no "yardstick" had been provided against which to measure the FDIC's re- {{4-1-90 p.A-723}}quested relief in order to produce "a result consistent with precedent, if any, or with prevailing legislative and regulatory sentiment." (R.D. 63) In the end, the ALJ reduced the FDIC's proposed penalties by two-thirds, thereby recommending that Mr. * * * be assessed a civil money penalty of $25,000, his son be assessed a $3,333 penalty and each of the remaining individual Respondents be assessed a $333 penalty. The method by which the ALJ arrived at the reduction, however, is not at all clear. Indeed, the ALJ may have been influenced by the modest size of prior penalties paid. The Board does not find prior assessments to be a particularly useful guide against which to judge the penalties in this case without a thorough review of the facts and violations upon which the prior penalties were predicated.

   [.14] The Board has undertaken an independent review of the civil money penalties in light of the discrepancy between the penalties assessed by the FDIC in the Notice of Assessment and those recommended by the ALJ. In determining whether to assess civil money penalties and the amount of such penalties, the Board is guided by the statutes, 12 U.S.C. §§ 1828(j) and 1972(2)(F), the Regulations, 12 C.F.R. § 308.64-.72, and the September 30, 1980 Interagency Policy Statement Regarding the Assessment of Civil Money Penalties by the Federal Financial Institutions Regulatory Agencies ("Policy Statement"). The statutes and regulations require the FDIC to consider the financial resources and good faith of the Respondents, the gravity of the violations, the history of previous violations and other such matters as justice requires in assessing civil money penalties. The Policy Statement lists thirteen factors the federal banking agencies have deemed relevant in determining whether the violations are of sufficient gravity to assess penalties. These factors are:
   1. Evidence that the violation or pattern of violations was intentional or committed with a disregard of the law or the consequences to the institution;
   2. The frequency or recurrence of violations and the length of time the violation has been outstanding.
   3. Continuation of the violation after the respondent becomes aware of it, or its immediate cessation and correction;
   4. Failure to cooperate with the agency in effecting early resolution of the problem;
   5. Existence of concealment of the violation, or its voluntary disclosure;
   6. Any threat of or actual loss or other harm to the institution, including harm to public confidence in the institution, and the degree of any such harm;
   7. Evidence that participants or their associates received financial gain or other gain or benefit or preferential treatment as a result of or from the violation;
   8. Existence of any restitution by the participants in the violation;
   9. History of prior violations, particularly where similarities exist between those and the violations under consideration;
   10. Previous criticism of the institution for similar violations;
   11. Presence or absence of a compliance program and its effectiveness;
   12. Tendency to create unsafe or unsound banking practices or breach of fiduciary duty; and
   13. The existence of agreements, commitments or orders intended to prevent the subject violation.

   45 Fed. Reg. 59,423 (1980).

   Although it does not appear from the record in this case that the violations of law were deliberate or intentional, we concur with the ALJ's assessment that they were not inadvertent. (Factor 1) The FDIC has proven that thirty-two extensions of credit made between October 1982 and August 1983 resulted in at least fifty-two separate violations of applicable statutes and regulations.³² (Factor 2) The Respondents claimed that the section 23A violations were corrected once they become aware of them, but the evidence is not persuasive that this, in fact, did occur or that they took any steps to correct the section 106 or Reg. O violations. (Factor 3) While the Bank had not suffered any losses from the violations as of the date of the hearings, there is a threat of future loss since many of the offending loans are adversely classified. For the loans collateralized by stock of * * *

IV. CONCLUSION

   For the reason set forth in footnote 9, the Board adopts and issues the accompanying Order Denying Request for Oral Argument.
   The Board, having found that the Bank and * * * , Sr. engaged in unsafe or unsound practices as set forth herein at pages 14–26 and violations of sections 23A and 106 and Reg. O as set forth herein at pages 30–39, adopts and issues, pursuant to section 8(b) of the FDI Act, 12 U.S.C. § 1818(b), the accompanying Order to Cease and Desist. Furthermore, for the reasons set forth herein at pages 48–55, the Board also adopts and issues the accompanying Order to Pay Civil Money Penalties.
   By direction of the Board of Directors.
   Dated at Washington, D.C., this 19th day of February 1986.
   /s/ Hoyle L. Robinson
   Executive Secretary

I. SUMMARY OF PROCEEDINGS

   A hearing in these consolidated cases was held in * * * , on December 10–19, 1984 and January 24, 1985. The record consists of a transcript¹ and 137 exhibits, numbered 1 through 32, 34 through 77, and 79 through 106 for the FDIC, lettered B, D, E, J, and L through MM for the respondents, and Judge's Ex. 1.

II. PROPOSED FINDINGS OF FACT

A. Introduction

   The parties in this proceeding have entered into a Stipulation of certain matters of fact and law attached to volume I of the transcript of this proceedings as Attachment C ("Stipulation"). These proposed findings specifically refer to the Stipulation in logical sequence. The FDIC also requests that the court make the additional findings of fact set forth below in detail.

B. History and Background

   1. See Stipulation ¶1.
   2. See Stipulation ¶2. * * * has been a related interest of * * * at all relevant times. (Tr. II 62–63 - * * * , Sr.; Tr. II 27–30 - * * *).
   3. See Stipulation ¶3.
   4. See Stipulation ¶4.
   5. See Stipulation ¶5. Exs. 3–9. The * * * Bank (* * * "Bank") promised to establish a regulatory compliance committee. (Ex. 6, at 2.) The Bank's promise was not kept; the committee never functioned. (Tr. VII 61- * * *) The letter containing this promise was false in stating that Respondent * * * had no relationship with the principal stockholders of the Bank. (Ex. 6, at 2; Tr. VII 62 - * * *.) The letter (Ex. 6) was signed by * * *, Sr. Although the minutes of the Bank's board of directors reflect consideration of communications from * * * , Commissioner of Banking, no such consid-

   6. See Stipulation ¶6.

c. Lending Practices

   i. Extending credit without adequate financial information

   7. Bank credit files normally contain current and historical financial statements of the borrower; credit comments stating the purpose, amount, terms, conditions, collateral, and the source and schedule of repayment of the loan; borrowing resolutions; security agreement or mortgage; title opinion; appraisals; and financing statements. (Tr. I 82–84 - * * * , Tr. III 69–72 - * * *.) Banks ask for both profit and loss statements and balance sheets. (Tr. I 116 -* * *.) Normally, such financial information is obtained before the credit is extended. (Tr. I 116 - * * *) To evaluate credit- worthiness of prospective borrowers, banks analyze profit and loss statements and balance sheets. (Tr. I 114-15 - * * *.)
   8. In reviewing a guarantor's financial statement, the value of the investment in the firm whose debt is guaranteed is deducted from the assets (and therefore from the net worth) of the guarantor. (Tr. III 71 -* * *; Tr. V A 67 - * * *.)
   9. It is an unsafe or unsound banking practice to extend credit (unless the credit is secured by readily marketable collateral) without first obtaining adequate financial information on all obligors. Without such information it is not possible to evaluate the obligor's financial capability. (Tr. III 69–73 - * * *.) The extensions of credit in ¶¶10–39, infra involved this unsafe or unsound banking practice. (Tr. III 73 - * * *.)
   10. * * * ($160,000). Of the total line at the Bank, $70,000 was added subsequent to the previous examination (Ex. 7). The most recent financial information was dated May 31, 1981. (Tr. III 73 - * * *.)
   11. * * * ($115,000). * * * financial statement omitted assets he reportedly owned. (Tr. III 74 - * * *.)
   12. * * * ($300,000). The financial statement on file at the bank dated February 28, 1983, was not detailed, i.e., $345,000 was carried in accounts receivable and notes receivable and $45,000 was carried as accrued interest, but the obligors were not identified. Terms relating to escrow funds of $37,900 were not described. There was no income statement and only an incomplete cash flow statement. Notes payable of $500,000 were not detailed. (Tr. III 74 -* * *)
   13. * * * ($125,000). The financial statement dated September 11, 1980, on which the borrowing was predicated, was not in sufficient detail. The statement carried accounts receivable of $310,000, but did not identify the obligor. The values listed as investments in * * * Corporation ($100,000) and * * * ($100,000) were not supported. * * * and partnership office building values of $150,000 and $100,000 respectively, did not describe how the values were determined. (Tr. III 74–75 -* * *.)
   14. * * * ($225,000). The financial statement dated September 30, 1982, was not detailed. Real estate and personal property were valued at $478,000 without stating how the values were determined. * * * stock was valued at $1,401,700, but the bid price obtained during the examination of $2.00 per share resulted in a value of only $350,000. At the previous examination, the value was $2.50 per share. There was no support for the determination of * * * value. The statement showed $337,000 in listed (NYSE) stocks, but did not identify the stocks. A bank loan did not identify the lender. There was no detailed description of the sources of income. There was no evidence of verification of the assets or of a credit check. The statement did not address the possibility of contingent liabilities. (Tr. III 76–78 - * * *; see also Tr. V B 160–61, 163 - * * *)
   15. * * * ($125,000). The value listed for the * * *s residence and condominium ($1,500,000) was not supported. The value listed for * * * Company ($7,357,700) was not supported by a fully completed financial statement of * * * Company. There was no evidence that the Bank verified * * * borrowing or credit ratings at other institutions. (Tr. III 78 - * * *.)
   16. * * * ($214,000). No financial information was available for the borrower (Mrs. * * *). (Tr. III 78–79 - * * *.)
   17. * * * ($135,000). The financial statement listed accounts receivable at $14,000, but did not provide detail. The value (at February 28, 1983) placed on real estate ($836,000) was not supported by the appraised value dated April 5, 1982, of $810,000 by * * *. The mortgage payable {{4-1-90 p.A-727}}was not further detailed. There was no income statement. The cash flow statement was incomplete. (Tr. III 79 - * * *.)
   18. * * * ($233,000). The financial statements were not sufficiently detailed. The income information was not of the same date as the balance sheet. (Tr. III 79 -* * *.)
   19. * * * ($50,000). The financial information was not detailed. The balance sheet dated February 27, 1983 did not itemize accounts receivable, notes receivable, "future benefit of retained employees," accounts payable, checks outstanding, and current and long term notes payable. There was no income statement to coincide with the February 27, 1983 balance sheet. (Tr. III 79–80 - * * *.)
   20. * * * ($270,000). The financial statement dated December 31, 1982, was not sufficiently detailed. The * * * stock was valued at $9.35 per share ($2,836,400) although its bid price had been $2.00 per share (or $606,700) for an extended period of time. See the discussion of the * * * credit, supra Proposed Findings of Fact ("PFF") ¶14. The * * * stock listed as an asset on the balance sheet was not owned by the corporation. * * * partnership, * * *, and * * *, were all closely held investments and had no supporting documentation for those values. The values of real estate holdings ($1,420,000) were also not supported. Bank loans were not itemized. There was no evidence in the files that the Bank's management verified liabilities or checked the obligor's credit rating at other institutions. (Tr. III 80–81 - * * *.)
   21. * * * ($218,000). * * * September 6, 1980, financial statement listed net worth at $124,000. The most recent December 31, 1982, statement was signed by * * * personally, rather than in his corporate capacity. This statement (Ex. 71) did not accurately reflect the company's liabilities. The statement listed total liabilities of $164,200 on December 31, 1982, when the company had borrowings of at least $217,900. No income statement was provided and the cash flow statement was incomplete. (Tr. III 81–82 - * * *.)
   22. * * * ($324,000). No income statements or cash flow statements were available. The April 30, 1983, financial statement (Ex. 75) was signed by * * * personally and not in a representative capacity. The total liabilities ($500,000) omitted at least $47,000 in liabilities. (Exs. 73–75; Tr. III 82 - * * *.)
   23. * * * ($184,000). No income or cash flow statements were available. The balance sheet did not itemize accounts receivable ($275,000), which included a receivable from * * * in the amount of $251,500 (Tr. II 65–66 - * * *, Sr.; Ex. 77), or have supporting documentation for real estate values on the October 30, 1982, statement. Notes payable were not itemized. There was no statement pertaining to contingent liabilities. The August 30, 1983 financial statement (Ex. 57) received during the examination omitted $110,000 in liabilities to * * *. (Tr. II 145 - * * *, Sr.) These liabilities were guaranteed by * * *, whose financial statements (Exs. 41–43) were also false in that they omitted guaranties in the amount of as much as $1,282,984 (as of July 29, 1983, * * *: $110,000 for * * * and $250,000 for * * *: $257,984 for * * * and $665,000 for * * *) and overstated the value of stock held in * * * (Exs. 40–43, 53–55, 61, 62; Tr. II 140-45 - * * *, Sr.; and Tr. III 82–83 - * * *.)
   24. * * * Jr. ($329,000). The borrower's August 19, 1982, statement reflected a $175,000 investment in * * * * * *, whose loans had been assumed by * * *, because of an inability to repay. There was no support for the $175,000 investment. There was no income information on the August 19, 1982, and August 31, 1983 (Ex. 19) statements. The borrower omitted a liability for a promissory note dated December 20, 1980, ($85,000) payable to * * *. There was no statement pertaining to contingent liabilities on the August 19, 1982, statement. (Tr. III 83 - * * *.)
   25. * * * ($36,000). Financial statements dated August 30, 1982 (Ex. 33), and August 31, 1983 (Ex. 34), were not sufficiently itemized with respect to accounts receivable or notes receivable, * * *, Contract 3, and * * *. There were no income or cash flow statements. (Tr. III 84 - * * *.) The financial statement dated August 31, 1983 (Ex. 34) omitted liabilities of at least $35,600. (Tr. II 131-34 - * * *) This financial statement was signed in a representative capacity by * * *. (Ex. 34.)
   26. * * * ($237,000). Financial statements dated July 27, 1982, and August 31, 1983 (Ex. 68), were not sufficiently detailed {{4-1-90 p.A-728}}as to notes receivable, which included a receivable from * * * in the amount of $50,000; stocks and bonds; investment in partnership; and notes payable. There was no income information. (Tr. II 63–64, 146 -* * *.; Tr. III 84 - * * *.)
   27. * * * ($299,000). There was no personal financial information. (Tr. III 84 -* * *.)
   28. * * * ($6,000). There was no current financial information. (Tr. III 87 - * * *.)
   29. * * * ($3,000). The note was dated January 12, 1985, the last financial information on file was dated April 1, 1981. (Tr. III 87 - * * *.)
   30. * * * ($40,000). The loan was made on May 14, 1982, with no current financial information on file. (Tr. III 87 - * * *.)
   31. * * * ($130,000). There was no current financial information including income and cash flow statements. (Tr. III 87 -* * *.)
   32. * * * ($195,000). There was no financial information available on the company. (Tr. III 87 - * * *.)
   33. * * * ($370,000). No current financial information was available for guarantor * * *. Guarantor statements overvalued the * * * investment based on that company's financial statement. (Tr. III 87 - * * *.)
   34. * * * & * * *, d/b/a * * * ($75,000). No financial information had been obtained on the business or individuals prior to the examination. (Tr. III 87–88 -* * *).
   35. * * * and * * * ($105,000). The Bank extended additional credit in March and September of 1982 without obtaining current financial information. (Tr. III 88 -* * *.)
   36. * * * and * * * ($28,000). The bank did not have current financial information on the borrowers when $28,000 was extended on April 16, 1982. Management was aware of the problems of * * *, a company in which * * * was a principal. (Tr. III 88 - * * *.)
   37. * * * ($267,000). The most current statement on file when the loan dated September 24, 1982, was made was dated March 31, 1980, and reflected negative net worth of $16,200. (Tr. III 88 - * * *.)
   38. * * * and * * * ($152,000). The bank extended additional credit in 1982 and 1983 without obtaining current financial information. The latest information on file was dated November 23, 1979. (Tr. III 88–89 - * * *.)
   39. * * * and * * * ($136,000). When bank management extended $89,000 on May 20, 1983 and $1,900 on May 20, 1983, the borrowers' most current statement was dated May 28, 1982. Bank management did not obtain sufficient financial information to verify the borrowers' ability to service this debt. (Tr. III 89 - * * *.)
   40. The total of the loans listed in ¶¶10–39, supra, as lacking financial information was $5,086,000. (Tr. III 194 - * * *) This represented 73.7 percent of the Bank's total adversely classified loans of $6,903,000.

   ii. Extending credit without adequate security

   41. If a bank has received and analyzed adequate financial information, performed a credit check, and established a favorable credit history, it may be prudent to extend unsecured credit. (Tr. III 89 - * * *.) In other cases, the extension of credit without adequate security is an unsafe or unsound practice. (Tr. IV 90 - * * *; Tr. IX 28 -* * *.) The extensions of credit in ¶¶42–59, infra, involved this unsafe or unsound banking practice. (Tr. III 90 - * * *.)
   42. * * * ($115,000). The loan was unsecured. The obligor's financial statement, which listed total assets of $278,100; total liabilities of $37,000; and net worth of $241,100 on August 1, 1980, did not support unsecured credit of $130,000. Major assets consisted of real estate and personal property of $205,200 and $45,000 investment in closely held * * *. (Tr. III 90–91 -* * *.) See also PFF ¶11, supra.
   43. * * * ($125,000). The loan was unsecured. The obligor's financial statement was not detailed. There was no evidence of a credit check or verification of assets, and there was no income information. Total unsecured debt of $300,000 was excessive in comparison to $984,800 listed net worth. (Tr. III 91 - * * *.) See also PFF ¶13, supra.
   44. * * * ($225,000). The loan was unsecured. The obligor's financial statement lacked detail, and the * * * investment was significantly overstated. See discussion of * * * financial statement supra, PFF ¶14. With the * * * investment adjusted to $2.00 per share, the obligor's net worth would be $1,214,300, rather than $2,266,100. (Tr. III 91 - * * *.)
   45. * * * ($214,000). This extension of credit was secured only by restricted * * *
{{4-1-90 p.A-729}}stock. (Tr. III 92 - * * *.) See also PFF ¶16, supra, and ¶115, infra.
   46. * * * ($135,000). The security was a junior lien on a shopping center in * * *. There was no final title search, recorded mortgage, or insurance. The appraisal was performed, not by an independent party, but rather by * * *. A letter in the file dated February 5, 1982, from a first mortgagor to * * *, in care of * * * indicated a possible first lien balance of $575,000 * * *. Appraised value was stated to be $810,000 and the loan was $135,000. An assignment of rents was taken but without corresponding loan terms or provisions concerning the receipt of rents. Funds were disbursed December 3, 1981 but a mortgage security agreement was not taken until March 16, 1983. (Ex. 10, at 34; Tr. III 93 -* * *.) See also PFF ¶17, supra.
   47. * * * ($50,000). The financial statement (total liabilities of $6,682,800, net worth of $2,006,700 with fixed assets of $6,443,400) did not support unsecured borrowings. (Tr. III 93 - * * *.) See also PFF ¶19, supra.
   48. * * * ($270,000). The loan was unsecured. The obligor's financial capacity did not support unsecured borrowings. Some assets listed on this corporation's statement were not owned by the company. (Tr. III 93–94 - * * *.) See also PFF ¶20, supra.
   49. * * * ($218,000). The loan was unsecured. The obligor's financial statement did not support the unsecured credit. (Tr. III 94 - * * *.) See also PFF ¶21, supra.
   50. * * * ($300,000). The loan was unsecured. When the bank advanced $500,000 on January 28, 1982, the corporation's latest financial statements dated September 30, 1980, listed total assets of $2,399,000, total liabilities of $2,229,000, and net worth of $170,000. The obligor's net loss for the year of 1982 was $752,000. Net loss for 1981 was $402,000. (Tr. III 94 - * * *.)
   51. * * * ($324,000). Five hundred thousand dollars of the line was secured by a vendee's interest in a contract deed on a commercial building in * * *. There was no final title search. A November 9, 1983, letter from * * * reflected a first lien in the amount of $469,000. An appraisal dated April 8, 1982, by * * * valued the property at $1,400,000. Approximately $40,000 was unsecured. (Tr. 94–95 - * * *.) See also PFF ¶22, supra.
   52. * * * ($184,000). The loan was unsecured. The obligor's financial statement adjusted for * * * debt would show total liabilities of $901,000 and net worth of $356,000 rather than total liabilities of $791,000 and net worth of $565,000. The financial statement did not support unsecured credit. (Tr. III 95 - * * *.) See also PFF ¶23, supra.
   53. * * *, Jr. ($329,000). This loan was secured by 72,727 shares of restricted * * * stock owned by * * *, Sr. and a 1983 automobile. (Tr. III 95 - * * *.) The borrower's financial statement (Ex. 19) was false in that the stock was owned by his father. (Exs. 41 and 42.) See also PFF ¶24, supra, and ¶115, infra.
   54. * * * ($36,000). This loan was secured only by 20,000 shares of restricted * * * stock. (Tr. III 95 - * * *.) See also PFF ¶25, supra, and ¶115, infra.
   55. * * * ($237,000). This amount of the obligor's liabilities to the Bank was unsecured. Her financial statement (Ex. 68) was questionable and did not support unsecured credit. (Tr. III 95–96 - * * *.) See also PFF ¶26, supra.
   56. * * * ($299,000). This credit was secured by 10,000 shares of * * *, closely held by the * * * family. The financial information obtained on this company was not sufficiently detailed. (Tr. III 96 - * * *.) See also PFF ¶27, supra.
   57. * * * ($40,000). The obligor's equity in his home did not provide for sufficient security. Its appraised value was only $47,500. A lien of approximately $20,000 was prior to the Bank's. (Tr. III 96 - * * *.) See also PFF ¶30, supra.
   58. * * * ($370,000). The loan was unsecured. Financial statement dated February 28, 1983 listed the company's total assets at $783,400, total liabilities $743,800, and net worth of $39,600, with a year end net loss before taxes of $180,500. This information did not support unsecured borrowings of $585,000 on June 28, 1983. (Tr. III 97 -* * *.) See also PFF ¶33, supra.
   59. * * * and * * * ($136,000). The line had an insufficient collateral margin. (Tr. III 97 - * * *.) See also PFF ¶36, supra.
   60. The total of the loans listed in ¶¶42–59, supra, as lacking adequate security was {{4-1-90 p.A-730}}$3,607,000. (Tr. III 194 - * * *.) This represented 52.3 percent of the Bank's total adversely classified loans of $6,903,000. In each case the inadequate security was accompanied by inadequate financial information.

   iii. Failing to establish and enforce realistic programs for repayment or to determine the source of repayment.

   61. Most banks determine the source of repayment of loans before extending credit and then establish a program for the loans' repayment. (Tr. I 84–85 - * * *; Tr. III 100 - * * *.) Determining the source of repayment is important to determine how the loan will be repaid. (Tr. I 85 - * * *; Tr. III 101-02 - * * *.) Extending credit without determining the source of repayment and without establishing plans for repayment involves unsafe or unsound banking practices. (Tr. III 100–102 - * * *, Tr. V A 79–80 - * * *.) The extensions of credit in ¶¶62–86, infra, involved this unsafe or unsound banking practice. (Tr. III 102 -* * *.)
   62. * * * (115,000). There was no specific repayment program and all payments to the date of the examination had been made by individuals other than * * *. When the loan was renewed on March 18, 1983, interest was paid from a * * * and * * * money market deposit account. Proceeds of the loan had paid * * *, debts of $30,000, $30,000, and $70,000 on September 18, 1980. A $15,000 principal repayment had been made by * * * d/b/a * * * on September 20, 1982. (Tr. III 102 - * * *.)
   63. * * * ($300,000). No definite repayment program existed for this line of credit. The December 10, 1981, credit file comments state that amortization of the note would begin as the business dictated. On March 29, 1983, interest of $35,000 was paid from a * * * and * * * money market deposit account. (Tr. III 103 - * * *.)
   64. * * * ($125,000). No definite amortization program existed. Proceeds of the loan paid * * *'s loans at * * *. Payments were made by * * * d/b/a * * * and by a * * * and * * * money market deposit account. (Tr. III 103 - * * *.)
   65. * * * ($225,000). Proceeds of the $225,000 credit originating on October 26, 1982, were for the benefit of * * *. As of the examination date, no principal payments had been made. President * * * told the examiners the loan would be paid out the week of September 19, 1983. It was not. On February 3, 1984 the loan was paid by * * * d/b/a * * *. The borrower never made any payments. (Tr. III 103-04 -* * *.)
   66. * * * ($125,000). Since June 29, 1981, there had been no repayment program for this credit. Interest payments of $20,300 were made from the proceeds of * * * loan PFF ¶50, supra. (Tr. III 104 -* * *.)
   67. * * * ($214,000). No repayment program existed for this line. (Tr. III 104 -* * *.)
   68. * * * ($135,000). No repayment program had been in effect since the loan's inception on December 3, 1981, when the borrower's demand account was credited to cover an overdraft created by a check payable to * * * for $107,000. (Tr. III 104-05 -* * *.)
   69. * * * ($233,000). Notes for $100,000 and $30,000 had no specific repayment schedule. The $100,000 note originated on November 19, 1982, to cover partially an overdraft in * * *'s demand account. A principal and interest payment of $107,800 was made on September 18, 1982, by * * * d/b/a * * *. (Tr. III 105 - * * *.)
   70. * * * ($50,000). This line had been stagnant since 1979. (Tr. III 105 - * * *.)
   71. * * * ($270,000). This line had been stagnant since November 26, 1980. (Tr. III 105 - * * *.)
   72. * * * ($218,000). This line originated November 19, 1982, to cover an overdraft in * * * demand account. No repayment program was in effect. (Tr. III 105-06 -* * *.)
   73. * * * ($300,000). No repayment program was in effect. The proceeds primarily went to individuals or businesses other than the borrower (PFF ¶66, supra), and were not for real estate improvements, contrary to statements in a letter from * * * dated January 17, 1982. (Tr. III 106 - * * *.)
   74. * * * ($324,000). Bank management had not requested any amortization for one and one-half to two years. Proceeds of the loan were not used to upgrade the real estate as stated in the credit file. Instead, * * * loans at the * * *, * * *, * * * (" * * *") and * * * Bank, * * *, * * *, (" * * * Bank ") were paid, * * *, debt ($63,940.32 to * * * Bank) was paid, and $23,200 was placed in a money order {{4-1-90 p.A-731}}and endorsed over to * * *. (Judge's Ex. 1, at 6; Tr. III 106 - * * *.)
   75. * * * ($184,000). A portion of this line had been extended since February, November, or December of 1982 and no scheduled repayment program was in effect. (Tr. III 107 - * * *.)
   76. * * * ($329,000). Proceeds from the various loans benefited * * *, * * *, and * * *. Notes originating in May of 1981, June 1982, August 1982, and October 1982 had no definite repayment plan. Under an agreement dated December 23, 1981, * * *, agreed to pay all interest on business and student loans of * * *, until December 31, 1983. (Tr. III 107 - * * *.)
   77. * * * ($237,000). Portions of the line originated June 19, 1980, and in 1982, for which no repayment program had been instituted. Of the proceeds, $128,600 went to * * * and $96,400 went to * * *. A June 1983 interest payment on the $225,000 loan was made by * * * d/b/a * * * and by * * *. Of the $38,000 loan, $13,000 benefited * * *. No payments had been made by the borrower. (Tr. III 107-08 - * * *.)
   78. * * * ($299,0000). No scheduled repayment program had been instituted for this line, which commenced in 1974. All proceeds benefited * * *. Interest payments have been made by * * *. (Tr. III 108 - * * *.)
   79. * * * ($40,000). On May 14, 1982, this note was extended on a demand basis with no scheduled repayment program. (Tr. III 108 - * * *.)
   80. * * * ($130,000). This note was dated December 13, 1982, due on demand. No definite repayment plan was specified although credit file notes indicated that monies would be applied to the loan as lot in the developments were sold. The Bank requested a $22,000 principal reduction on December 13, 1981, but extended payment to December 13, 1982, and even then did not get full principal payment. (Tr. III 108-09 - * * *.)
   81. * * * ($370,000). The Bank's credit files indicated that only interest was requested to be paid on the $585,000 note dated June 28, 1983 due February 28, 1984. No other terms for principal repayment were specified. (Tr. III 109 - * * *.)
   82. * * * and * * * ($339,000). No repayment program was specified for this cash crop farming and logging line of credit, consisting of three demand notes that date back to December 1982. (Tr. III 109 -* * *.)
   83. * * * and * * * ($105,000). All four loans, totaling $102,500, were on a demand basis. The remaining balance consisted of an * * * check (drawing account) and an overdraft. One loan for $50,000 dated to February 4, 1981. (Tr. III 111 - * * *.)
   84. * * * ($204,000). This line was adversely classified at the 1981 examination, when the notes were on a demand basis. The line increased approximately $20,000 between examinations with all notes remaining on a demand basis. Although a 30 per cent dairy assignment was received, it was not sufficient to reduce principal. (Tr. III 111 - * * *.)
   85. * * * ($136,000). Although the Bank renewed the loans at a 10 per cent interest rate, the borrowers as of the examination date were three months delinquent on $89,000. Even at the reduced interest rate, the repayment program may be unrealistic. (Tr. III 111-12 - * * *.)
   86. * * * ($152,000). Most of the borrowers' notes were on a demand basis rather than being amortized on a specific program. (Tr. III 112 - * * *.)
   87. The total of the loans listed in ¶¶62–86, supra, as lacking adequate repayment plans was $5,159,000. (Tr. III 194 - * * *.) This represented 74.8 percent of the Bank's total adversely classified loans of $6,903,000.

   iv. Extending credit without determining its purpose

   88. Banks normally determine the purpose of a loan before extending credit. (Tr. I 84 - * * *; Tr. III 118 - * * *.) The failure to do so is an unsafe or unsound practice because without such information the lending officer cannot evaluate the risk of the loan or its compliance with loan policy. (Tr. III 119 - * * *.) The extensions of credit in ¶¶89–106, infra, involved this unsafe or unsound banking practice. (Ex. 84; Tr. III 124 - * * *.)
   89. * * * ($115,000). * * *'s loan paid * * * debt of $130,000 on September 18, 1980. (Tr. III 124-26, 164 - * * *.) The ultimate purpose was to "correct" a reported violation of Regulation O. (Ex. 4, at 4–5; Ex. 84; Ex. 85, at 2.)
{{4-1-90 p.A-732}}
   90. * * * ($300,000). Approximately $200,000 of the $300,000 loan paid * * *'s (* * *'s related interest) debt at the Bank. (Ex. 84; Tr. III 126, 164 - * * *.)
   91. * * * ($125,000). The $300,000 loan was at the Bank due to Mr. * * *'s purchase of * * * units. Proceeds paid * * *'s debt at * * *. (Tr. III 127 - * * *.) The credit file lacked information concerning the purpose of the credit. (Ex. 84; ;Tr. III 126-27, 164 - * * *.)
   92. * * * ($225,000). The Bank's credit files lacked purpose statements. (Tr. III 173 - * * *.) President * * * contacted the borrower during the examination as to the use of the $225,000. The $225,000 had been wired to the account of * * * (wholly-owned by * * *) and the $200,000 was used to pay * * *'s debt (wholly-owned by * * *) at * * *, (`* * *'). (Tr. III 168 -* * *.)
   93. * * * ($125,000). The Bank's credit file lacked a purpose statement. (Tr. III 164 - * * *.)
   94. * * * ($214,000). The Bank's credit file lacked a purpose statement. (Tr. III 164 - * * *.) President * * * had only a separate memorandum (not in the file) indicating that Mrs. * * * purchased $100,000 of * * * stock on June 1, 1982. On May 6 and 7, 1980, $160,000 was disbursed. Proceeds were disbursed by a $100,000 bank money order #91991 to * * * and $60,000 made two $30,000 principal payments on an unidentified loan. (Tr. III 143-45 - * * *.)
   95. * * * ($135,000). The Bank's credit file lacked a purpose statement. The $135,000 covered an overdraft in the borrower's demand account due to a check drawn on the account payable to * * * (Tr. III 143, 164 - * * *.)
   96. * * * ($233,000). The Bank's credit file lacked purpose comments. Of the total, $100,000 was used to cover part of an overdraft in * * *'s demand account arising from a check drawn on that account payable to * * * for $332,345.89. (Ex. 84; Tr. III 142-43, 164 - * * *.)
   97. * * * ($50,000). The Bank's credit file lacked purpose comments. (Ex. 84; Tr III 164 - * * *.)
   98. * * * ($270,000). The Bank's credit file lacked purpose comments. President * * *, admitted to examiners that he was not certain of the purpose of the extension. (Ex. 84; Tr. III 138-39, 164 - * * *.)
   99. * * * ($218,000). The Bank's credit file lacked purpose comments. Proceeds of the loan were used to cover an overdraft in * * *'s demand account arising from a check drawn on the account and made payable to * * *. (Ex. 84; Tr. III 140, 164 -* * *.)
   100. * * * ($300,000). Notes in the Bank's credit files stated that proceeds were for construction financing of roads, sewer, and water in the * * * outlet (* * *) and preliminary planning of drainage, sewer, and water in the 7th Addition in * * *. (Ex. 10, at 36.) A trace of the proceeds indicated a different use of the funds. Of the $500,000 note, $13,100 was used to pay interest on * * * of * * * notes; $500 was used to make an interest payment on * * *; $20,300 was used to make a payment on * * *'s $225,000 note; $56,800 was wired to * * * to pay * * * interest; $4,600 went to affiliated * * * for * * *; $11,300 went to * * *, with notation "interest as of December 31, 1981;" $210,000 was deposited in * * *'s account #135-829; $47,600 was made payable to * * *, $100,000 was credited to the Bank's account for the account of * * *; $4,200 was wired to * * * Bank, * * *, * * * ("* * *") for * * * and $31,800 was wired to * * * for the account of * * * with the notation " * * *, * * *." The $100,000 note was used to pay * * *'s debt ($96,000) at * * *. The remaining funds were placed in a money order for * * *. (Ex. 84; Tr. III 127-33, 164 - * * *.)
   101. * * * ($324,000). Notes in the Bank's credit file indicated $500,000 was used for leasehold improvements and expansion of the parking area and loading docks of the present building. A memorandum found in the file from Assistant Cashier * * * to * * * indicated that the $500,000 was used for a transfer of ownership (* * *), and to pay * * * $117,800 (of which $63,900 paid debts at * * * Bank). Of the remaining $129,900, $23,200 was used for a money order payable to * * *, and subsequently endorsed over to * * *. (Ex. 84; Tr. III 139, 164 - * * *.)
   102. * * * ($184,000). The Bank's credit File lacked purpose statements. (Ex. 84; Tr. III 150, 164 - * * *.)
   103. * * * ($36,000). The Bank's credit file lacked purpose statements. (Ex. 84; Tr. III 150, 164 - * * *.)
{{4-1-90 p.A-733}}
   104. * * * ($299,000). The Bank's credit file lacked purpose statements. The funds went to * * *. (Ex. 84; Tr. III 147-48, 164 -* * *.)
   105. * * * ($329,000). The Bank's credit file lacked purpose statements. A separate memorandum maintained by President * * * indicated that * * * purchased $100,000 of * * * stock on June 1, 1982. Of an original $150,000 in proceeds, $72,000 was deposited into * * * * * * demand account and $78,000 was wired to * * * Bank, for * * *. (Ex. 84; Tr. III 145-46, 164 - * * *.)
   106. * * * ($237,000). The Bank's credit file lacked purpose statements. Of the total, $225,000 was used to pay debts of * * *, and * * *, $13,000 of the original $38,000 was used to pay a * * * (* * * related interest) loan and $49,000 was used for a transaction between Merrill Lynch * * * and * * *. (Tr. III 148-50, 164 - * * *.)
   107. The total of the loans listed in ¶¶89–106, supra, as lacking statement of purpose was $3,179,000. (Tr. III 195 - * * *.) This represented 46.2 percent of this Bank's total adversely classified loans of $6,903,000.
   108. See Stipulation ¶8.

D. Condition Resulting From Unsafe or Unsound Lending Practices

   109. A substandard asset is one that is inadequately protected by current sound worth or the paying capacity of the obligor. (Tr. III 63 - * * *.) Such credit weaknesses may jeopardize the liquidation of the loan and cause the Bank to sustain loss. (Tr. VA 35 - * * *.) Loans adversely classified as of August 22, 1983, were $6,721,000 "substandard," and $182,000 "loss." (Ex. 10, at 8, -6; Tr. VA 37 - * * *) A loan may be classified because it is undersecured, there is insufficient cash flow, or there is not a normal amortization program, among other things. (Tr. I 109 - * * *.) A condition resulting from the * * * hazardous lending and lax collection practices was an excessive and disproportionately large volume of poor quality loans in relation to * * * total loans. (Tr. III 192 - * * *.) The Bank's adversely classified loans represented 28.7 percent of its total loans. (Ex. 10, at 8; Tr. III 186-87 - * * *.) An average bank of the same size would have not more than ten percent of its loans adversely classified. (Tr. VB 142 - * * *.) As of October 31, 1983, the Bank had ceased accruing interest on $988,000 of its loans. (Ex. E, at 3.)

E. Accounting Practice

   110. * * * had engaged in an unsafe or unsound banking practice in that it failed to make adequate provisions for its reserve for possible loans losses ("loan valuation reserve"). The Bank has waited until assets are almost uncollectible before charging them off. (Tr. VB 148 - * * *.) As of August 22, 1983, the loan valuation reserve of * * * totaled $308,000, while the total of all loans subject to adverse classification was $6,903,000. (Ex. 10, at 8–9; Tr. III 196 -* * *.) An adequate reserve would have been $690,000 or more. (Tr. III 196-97 -* * *.) See also Part IV B ii-iii of this Brief, infra, at 50–53. As a result, the financial statements prepared by * * * have overstated its earnings and equity capital. (Tr. III 199–200 - * * *.)

   F. Liquidity Practice

   111. * * * has engaged in an unsafe or unsound banking practice in that it has operated with inadequate liquidity. (Tr. III 200-12 - * * *.) During a period beginning on January 1, 1983, and ending on August 22, 1983, * * * had borrowed for 70 days at an average borrowing of $419,000 and a maximum borrowing of $925,000. (Tr. III 207 - * * *.) This is substantially more than normal. (Tr. III 210 - * * *.) As of August 22, 1983, only $65,000 of * * * investment portfolio of $10,777,000 was scheduled to mature within one year. (Tr. III 204 - * * *.)

G. Capital Practice

   112. * * * has engaged in unsafe or unsound banking practice in that it has operated with an inadequate level of capital for the kind and quality of assets it held. (Tr. III 212-15 - * * *.) As of August 22, 1983, the total of $7,407,000 in adversely classified assets not considered in computing * * * adjusted capital and reserves was 271 percent of * * * adjusted equity capital and reserves.² (Tr. III 214 - * * *.)

{{4-1-90 p.A-734}}
H. Supervision by Directors

   113. * * * board of directors has failed to provide adequate supervision over * * * and other active officers of * * *. (Tr. III 215 - * * *; Tr. VII 48–63 - * * *.) Abusive practices regarding loans to insiders and associates of insiders of * * * have been of concern to the FDIC for about five years. These concerns have been expressed to the board of directors of * * * repeatedly by letters and in reports of examination, as more fully set forth in PFF ¶5, supra.

I. Violations

   114. See Stipulation ¶13.
   115. * * * was and is a highly speculative stock. (Ex. 1, at 2; Tr. III 20 - * * *.) The company had not been profitable at the time the loans were made and had not become profitable even a year later. (Ex. 1, at 5, 25; Tr. III 20 - * * *.) The company was financially strapped even a year following the cash infusion represented by the loans. (Ex. 1, at 10; Tr. III 23 - * * *.) The stock continued to be risky even up to the time of the hearing. (Tr. III 32 - * * *.) In addition, the stock was restricted stock, making it not readily marketable. See the Securities and Exchange Commission's Rule 144, 17 C.F.R. § 230.144. See also, Lehr, Some Securities Law Issues in Lending on Pledged Stock, 38 Bus. Law. 91 (1982).
   116. The $100,000 extension of credit in the name of * * * reflected in paragraph 13(a) of the Stipulation was actually an undisclosed accommodation loan to * * * to buy stock in * * *. (Ex. 1, at 18, 32, 38; Exs. 41–42, 79–80, 88–106; Tr. II 87–95 -* * *, Sr.; Tr. III 66 - * * *.) In connection with this transaction, * * *, falsely warranted that he owned the stock. (Tr. II 197 - * * *; Ex. 83; Ex. II, at 4.) Other loans purportedly made to * * * actually benefited his father or * * *. (Tr. III 145-46 - * * *.)
   117. See Stipulation ¶14.
   118. See Stipulation ¶15. The Bank generally charged interest rates of 12 percent or more on its loans. (Tr. III 220 - * * *; Ex. 67; Tr. IV 10–11 - * * *.) See also Stipulation ¶5(d).
   119. See Stipulation ¶16(a).
   120. The extension of credit was made without first obtaining current written financial information about * * *. Repayment of the extension of credit was dependent upon the income received from * * *, whose credit was of more than normal risk. (Tr. III 182-84 - * * *.)
   121. See Stipulation ¶17(a).
   122. The extension of credit was unsecured. The company was having financial difficulty and had written off some inventory and receivables. (Tr. III 174-76 - * * *.) * * * had operated at a loss in its most recent fiscal year. (Ex. 10, at 42.) There was only a limited guaranty (Tr. III 177 -* * *.)
   123. See Stipulation ¶17(c).
   124. By virtue of the transactions set forth in ¶117 supra, the extensions of credit described in ¶¶118-23 presented a conflict of interest of * * *.
   125. See Stipulation ¶18.

   Its adjusted gross assets provides an indication of the amount of protection which a bank's capital accounts provide for its depositors. This ratio also reflects the extent to which asset loss or depreciation can be absorbed by the bank's capital accounts before its depositors' funds are impaired. In this regard, capital consists of equity capital (defined to include common stock, perpetual preferred stock, capital surplus, undivided profits, contingency reserves, other capital reserves, mandatory convertible instruments, and reserves for loan losses) less assets classified loss and one-half of assets classified doubtful. FDIC Statement of Policy on Capital Adequacy, 46 Fed. Reg. 62,694 (1981).
   This statement of policy has been superseded by the FDIC's regulation, Capital Maintenance, 50 Fed. Reg. 11,128 (1985) (to be codified at 12 C.F.R. Part 325) and by the FDIC's Statement of Policy on Capital, 50 Fed. Reg. 11,138 (1985).
{{4-1-90 p.A-735}}
   To the extent any requested finding of fact may be deemed a conclusion of law, or vice versa, the FDIC requests that it be so regarded.

III. PROPOSED CONCLUSIONS OF
LAW

   The parties in this proceeding have entered into a Stipulation of certain matters of fact and law attached to volume I of the transcript of this proceeding as Attachment C ("Stipulation"). The FDIC requests that the court make the additional conclusions of law set forth below.

A. Jurisdiction

   1. The FDIC has jurisdiction over the Bank and the subject matter of this proceeding. See Stipulation ¶1.
B. Unsafe or Unsound Practices

   2. The Bank and * * * have engaged in the following unsafe or unsound banking practices within the meaning of section 8(b) of the Federal Deposit Insurance Act:
   (a) The Bank extended credit without first obtaining adequate financial information on all obligors. PFF ¶¶7–40.
   (b) The Bank extended credit without adequate security. PFF ¶¶41–60.
   (c) The Bank failed to establish and enforce realistic programs for repayment or failed to determine the source of repayment. PFF ¶¶61–87.
   (d) The Bank extended credit without determining the purpose of the credit. PFF ¶¶:88–107.
   (e) The Bank operated with an inadequate reserve for loan losses. PFF ¶110.
   (f) The Bank operated with inadequate liquidity. PFF ¶111.
   (g) The Bank operated with inadequate capital. PFF ¶112.
   (h) The Bank operated with inadequate supervision by its board of directors. PFF ¶¶5, 113.

C. Violations

   3. As of August 22, 1983, the Bank had granted extensions of credit in the amount of at least $600,000 secured by stock of * * *, an "affiliate" of the Bank within the meaning of section 23A of the Federal Reserve Act (12 U.S.C. § 371c), in violation of the lending limit and security restrictions of such section. PFF ¶114.
   4. The extensions of credit in paragraph 3 inured to the tangible benefit of, or were transferred to * * *, a related interest of * * *. They were made in amounts in excess of the lending limit of section 215.2(f) of Regulation O (12 C.F.R. § 215.2(f)), in violation of section 215.4(c) of Regulation O (12 C.F.R. §215.4(c)) and section 22(h)(1) of the Federal Reserve Act (12 U.S.C. § 375b(1)). PFF ¶114.
   5. On or about February 10, 1983, * * * extended credit in the amount of $5,000 to * * *. This extension of credit was not made on substantially the same terms as those prevailing at the time for comparable transactions with other persons. This extension of credit presented other unfavorable features by virtue of a conflict of interest of * * *, arising from his controlling influence over * * * and his seeking funds for himself and his related interests from * * *, in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). PFF ¶118; Answer ¶6.
   6. On or about February 14, 1983, * * * extended credit in the amount of $45,000 to * * *. This extension of credit was not made on substantially the same terms as those prevailing at the time for comparable transactions with other persons. This extension of credit presented other unfavorable features by virtue of a conflict of interest of * * *, arising from his controlling influence over * * * and his seeking funds for himself and his related interests from * * *, in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). Further, * * * was * * *'s lending officer with respect to extensions of credit to * * *. PFF ¶118; Answer ¶7.
   7. On or about February 11, 1983, * * * extended credit in the amount of $3,000 to * * *. This extension of credit was not made on substantially the same terms as those prevailing at the time for comparable transactions with other persons. This extension of credit presented other unfavorable features by virtue of a conflict of interest of * * *, arising from his controlling influence over * * * and his seeking funds for himself and his related interests from * * *, in violation of section 106(b)(2) of the Bank Holding Company Act Amend- {{4-1-90 p.A-736}}ments of 1970 (12 U.S.C. § 1972(2)). PFF ¶118; Answer ¶8.
   8. On or about April 11, 1983, * * * extended credit in the amount of $5,000 to * * *. This extension of credit was not made on substantially the same terms as those prevailing at the time for comparable transactions with other persons. This extension of credit presented other unfavorable features by virtue of a conflict of interest of * * *, arising from his controlling influence over * * * and his seeking funds for himself and his related interests from * * *, in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). PFF ¶11; Answer ¶9.
   9. On or about May 12, 1983, * * * extended credit in the amount of $30,000 to * * *. This extension of credit was not made on substantially the same terms as those prevailing at the time for comparable transactions with other persons. This extension of credit presented other unfavorable features by virtue of a conflict of interest of * * * arising from his controlling influence over * * * and his seeking funds for himself and his related interests from * * *, in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). PFF ¶118; Answer ¶10.
   10. On or about June 13, 1983, * * * extended credit in the amount of $200,000 to * * * and to his related interest, * * * by extending credit in the amount of $400,000 and at the same time selling a participation in the amount of $200,000 to * * *. This extension of credit was made in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)) in that it involved more than the normal risk of repayment or presented one or more of the following unfavorable features:
   (a) The extension of credit was made without first obtaining current written financial information about * * *;
   (b) The extension of credit presented a conflict of interest of * * *; and
   (c) Repayment of the extension of credit was dependent upon the income received from * * *, whose credit was of more than normal risk within the meaning of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). PFF ¶¶119-20, 124; Answer ¶11.
   11. On or about June 28, 1983, * * * extended credit in the amount of $585,000 to * * * and to his related interest, * * *. This extension of credit was made in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)) in that it involved more than the normal risk of repayment or presented one or more of the following unfavorable features:
   (a) * * * had operated at a loss in its most recent fiscal year;
   (b) The extension of credit presented a conflict of interest of * * *; and
   (c) The extension of credit was not fully secured. PFF ¶¶121-24; Answer ¶13.
   12. On or about July 15, 1983, * * * extended credit in the amount of $48,513.93 to * * *. This extension of credit was not made on substantially the same terms as those prevailing at the time for comparable transactions with other persons. This extension of credit presented other unfavorable features in the form of a conflict of interest of * * *, arising from his controlling influence over * * * and his seeking funds for himself and his related interests from * * *, in violation of section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). PFF ¶121-24; Answer ¶13.
   13. The extensions of credit described in paragraphs 5 through 12 of the Proposed Conclusions of Law ("PCL"), supra, inured as well to the tangible economic benefit of * * *, and his related interests within the meaning of section 215.3(f) of Regulation O (12 C.F.R. § 215.3(f)). As a result, each of the extensions of credit described in paragraphs 5 through 12 was also made in violation of section 22(h)(3) of the Federal Reserve Act (12 U.S.C. § 375b(3)) and section 215.4(a) of Regulation O (12 C.F.R. § 215.4(a)). PFF ¶114.
   14. On or about October 19, 1982, * * * extended credit in the amount of $105,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶17.
{{4-1-90 p.A-737}}
   15. On or about November 5, 1982, * * * extended credit in the amount of $2,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. §371c(a)(1)(A)). PFF ¶114; Answer ¶18.
   16. On or about November 19, 1982, * * * extended credit in the amount of $1,500 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. §371c(a)(1)(A)). PFF ¶114; Answer ¶19.
   17. On or about December 1, 1982, * * * extended credit in the amount of $100,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶20.
   18. On or about December 1, 1982, * * * extended credit in the amount of $100,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶21.
   19. On or about February 2, 1983, * * * extended credit in the amount of $400,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶22.
   20. On or about February 8, 1983, * * * extended credit in the amount of $114,219.87 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. §371c(a)(1)(A)). PFF ¶114; Answer ¶24.
   21. On or about February 11, 1983, * * * extended credit in the amount of $72,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶25.
   22. On or about February 18, 1983, * * * extended credit in the amount of $2,500 to * * *, secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶26.
   23. On or about March 9, 1983, * * * extended credit in the amount of $110,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶27.
   24. On or about March 18, 1983, * * * extended credit in the amount of $7,000 to * * * secured by stock in * * * at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶29.
   25. On or about March 22, 1983, * * * extended credit in the amount of $4,600 to * * * secured by stock in * * * at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Fed- {{4-1-90 p.A-738}}eral Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶30.
   26. On or about March 23, 1983, * * * extended credit in the amount of $2,500 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶31.
   27. On or about April 4, 1983, * * * extended credit in the amount of $19,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶32.
   28. On or about April 18, 1983, * * * extended credit in the amount of $105,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶33.
   29. On or about May 19, 1983, * * * extended credit in the amount of $1,500 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶35.
   30. On or about May 20, 1983, * * * extended credit in the amount of $9,250 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶36.
   31. On or about May 28, 1983, * * * extended credit in the amount of $200,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶37.
   32. On or about June 1, 1983, * * * extended credit in the amount of $5,500 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶38.
   33. On or about July 28, 1983, * * * extended credit in the amount of $5,600 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶40.
   34. On or about August 3, 1983, * * * extended credit in the amount of $1,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶42.
   35. On or about August 5, 1983, * * * extended credit in the amount of $1,200 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶43.
   36. On or about August 10, 1983, * * * extended credit in the amount of $5,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶44.
   37. On or about August 31, 1983, * * * extended credit in the amount of $2,500 to {{4-1-90 p.A-739}}* * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶46.
   38. On or about September 8, 1983, * * * extended credit in the amount of $1,500 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. § 371c(a)(1)(A)). PFF ¶114; Answer ¶47.
   39. On or about September 28, 1983, * * * extended credit in the amount of $80,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. §371c(a)(1)(A)). PFF ¶114; Answer ¶48.
   40. On or about November 28, 1983, * * * extended credit in the amount of $200,000 to * * * secured by stock in * * *, at a time when, taken together with the amount of credit then outstanding on its books secured by such stock, the amount extended exceeded ten percent of capital and surplus, in violation of section 23A(a)(1)(A) of the Federal Reserve Act (12 U.S.C. §371c(a)(1)(A)). PFF ¶114; Answer ¶52.
   41. Each of the extensions of credit described in PCL ¶¶5–12, 13–16, 18, 21, 24–30, and 32–39, supra, was made without the prior approval required by section 337.3(b) of the FDIC's Rules and Regulations, 12 C.F.R. § 337.3(b), section 215.4(b) of Regulation O, 12 C.F.R. §215.4(b), and section 22(h)(2) of the Federal Reserve Act, 12 U.S.C. §375b(2), in violation of such sections.
   42. Each of the respondents has violated sections 22(h) and 23A of the Federal Reserve Act (12 U.S.C. §§ 375b and 371c), Regulation O (12 C.F.R. Part 215) promulgated under section 22(h) of the Federal Reserve Act, and section 106(b)(2) of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. § 1972(2)). PFF ¶114; Answer ¶¶29–32, 38, 40, 44, 46, and 47.
{{4-1-90 p.A-740}}

{{4-1-90 p.A-741}}
KEY TO TABLE II (Ed. note: Table II precedes Table I in official material.)

   1(a) Extending credit without obtaining adequate financial information.
   1(b) Extending credit without obtaining adequate security.
   1(c) Failure to establish and enforce a realistic program for repayment or to determine the source of repayment.
   1(d) Extending credit without determining its purpose.

   (a) Operating with an inadequate reserve for loan losses;
   (b) Engaging in hazardous lending and lax collection practices;
   (c) Operating with an inadequate level of capital;
   (d) Operating with inadequate liquidity; and
   (e) Violating sections 22(h) and 23A of the Federal Reserve Act (12 U.S.C. §§ 375b and 371c) and Regulation O (12 C.F.R. Part 215), promulgated under section 22(h) of the Federal Reserve Act.

   (a) A limit on loans as a percentage of assets;
   (b) Limits on the Bank's reliance on a particular liability category (e.g. large out-of-area certificates of deposit); and
   (c) Limits on the rate-sensitivity position of the Bank's assets and liabilities.

   Its adjusted gross assets provides an indication of the amount of protection which a bank's capital accounts provide for its depositors. This ratio also reflects the extent to which asset loss or depreciation can be absorbed by the bank's capital accounts before its depositors' funds are impaired. In this regard, capital consists of equity capital (defined to include common stock, perpetual preferred stock, capital surplus, undivided profits, contingency reserves, other capital reserves, mandatory convertible instruments, and reserves for loan losses) less assets classified loss and one-half of assets classified doubtful. FDIC Statement of Policy on Capital Adequacy, 46 Fed Reg. 62,694 (1981) (FDIC Proposed Finding of Fact 112).
[There was no rebuttal by respondents on this issue.]
   6. Did the Bank's board of directors fail to adequately supervise * * *, et al.?
   FDIC's legal theory and proposed facts in support of a finding that unsafe or unsound banking practice occurred regarding (6):
   * * *'s board of directors has failed to provide adequate supervision over * * * and other active officers of * * * (Tr. Vol. III 215; VII 48–63). Abusive practices regarding loans to insiders and associates of insiders of * * * have been of concern to the FDIC for about five years. These concerns have been expressed to the board of directors of * * * repeatedly by letters and in reports of examination, as more fully set forth supra.
The respondents offered the following rebuttal:
   Ms. * * *'s definition of "insider" for purposes of both her concentrations of credit and lending limit violations is substantially broader than anything which has been legally recognized.... Although there is some margin for subjective judgment even {{4-1-90 p.A-761}}in this definition, it was intended to be a relatively narrow one by Congress and to afford individuals and companies potentially impacted by the Regulation's [Regulation O] restrictions some notice of the standard of responsibility and performance they would be held to. There is no room in this statute for aggregation on the basis of personal relationships, common business interests per se, association, or even the recognized relationships of husband and wife or father and son per se. Yet all of these previously mentioned relationships were used by Ms. * * * to draw connections between individuals and companies for the purpose not only of determining concentrations of credit but also, apparently, for classifying those credit extensions.
Resp. Br. at 15–16.
   c. Unsafe or Unsound Banking Practices: Findings and Conclusions
   The term "unsafe or unsound banking practice" lacks statutory definition, although its meaning has been recognized in banking parlance and by bank regulators, and interpretations have been adopted by the courts.⁷ The following quotation, taken from a memorandum prepared for congressional hearings on amendment to Section 8 of the Act, by then Chairman of the Federal Home Loan Bank Board John E. Horne, has been cited frequently for the "definition" of an unsafe or unsound banking practice:

   Generally speaking, an "unsafe or unsound practice" embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.

   ...transactions which are the subject of a binding written contract or commitment entered into on or before July 28, 1982, and except that any renewal of a participation in a loan to such an affiliate as a result of the enactment of this statute, or any participation in a loan to such an affiliate emanating from the renewal of a binding written contract or communication outstanding on July 28, 1982, shall not be subject to the collateral requirements of this Act.

   The bill accomplishes three major objectives. First, it liberalizes certain unduly restrictive provisions in the existing statute while still protecting a bank from adverse transactions with affiliates. Second, several potentially dangerous loop- holes are closed. Finally, it reorganizes and clarifies the statute to facilitate compliance and enforcement.

   "(ii) such company or shareholder controls in any manner the election of a majority of the directors...of the other company, or (iii) [if] such company or shareholder, directly or indirectly, exercises a controlling influence over the management or policies of the other company..."

   Corporate control is an inexact concept. [*] Certainly it carries with it power {{4-1-90 p.A-767}}to direct corporate policy and considerable patronage. [*] According to a noted corporate scholar, "`control' may be defined as the capacity to choose directors. As a corollary, it carries capacity to influence the board of directors and possibly to dominate it." Berle, "Control" in Corporate Law, 58 Colum. L. Rev. 1212 (1958).
   Power to control through the election of directors may exist where a large block of shares, even though a minority, is owned by one group and the remaining shares are widely scattered. This is called practical or working control.

   (a) Operating with an inadequate reserve for loan losses;
   (b) Engaging in hazardous lending and lax collection practices;
   (c) Operating with an inadequate level of capital;
   (d) Operating with inadequate liquidity; and
   (e) Violating Sections 22(h) and 23A of the Federal Reserve Act (12 USC §§ 375b and 371c) and Regulation O (12 CFR Part 215), promulgated under Section 22(h) of the Federal Reserve Act.

   (b) Within eighteen months from the effective date of this ORDER, the Bank shall reduce the total of loans classified "Substandard" as of August 22, 1983, to not more than $2,000,000. As used in this paragraph, "reduce" means (i) to sell without recourse or to collect, (ii) to charge off, or (iii) to improve the quality of adversely classified assets sufficiently to warrant removing any adverse classification by the FDIC in succeeding examinations.

   (b) In Reports of Condition and Income requested by the FDIC or the Commissioner of Banking for the State of * * * ("Commissioner") and filed by the Bank prior to the effective date of this ORDER and subsequent to August 22, 1983, the Bank shall reflect a provision for loan losses which is adequate in light of the condition of the Bank's loan portfolio and which, at a minimum, equals the adjustments required by paragraph 2(a) of this ORDER. If necessary to comply with this ORDER, the Bank shall file amended Reports of Condition and Income.
   (c) Prior to submission or publication of any Report of Income or Report of Condition requested by the FDIC or the Commissioner after the effective date of this ORDER, the board of directors of the Bank shall review the adequacy of the Bank's reserve for loan losses and make any provision necessary to maintain the adequacy thereof. The minutes of the meeting of the board of directors of the Bank and of its audit committee at which {{4-1-90 p.A-774}}such reviews are undertaken shall indicate the results of the review, the amount of increase in the reserve recommended, if any, and the basis for determination of the amount of reserve provided.

   (b) Areas to be addressed in the Bank's lending policy shall include without limitation the following:
   (i) General files of lending in which the Bank will engage and the kinds or types of loans within each general field.
   (ii) The lending authority of each loan officer.
   (iii) Responsibility of the board of directors in reviewing, ratifying, or approving loans.
   (iv) Guidelines under which unsecured credit will be granted.
   (v) Guidelines for rates of interest and the term of repayment for secured and unsecured credit.
   (vi) Limitations on the amount advanced in relation to the value of the collateral securing the credit and the documentation required by the Bank for each type of secured credit.
   (vii) The maintenance and review of complete and current credit files on each obligor.
   (viii) The collection procedures of the Bank including without limitation what actions are to be taken against borrowers who fail to make timely payments.
   (ix) Limitations on the extension of credit through overdrafts.

   (b) The formal semiannual capital ratio analysis in June and December of each year provided for in paragraph 6(a) shall not be construed to negate the responsibility of the Bank and its board of directors to maintain, throughout the
{{4-1-90 p.A-775}}year, an adequate level of capital protection for the kind, quality, and degree of market depreciation of assets held by the Bank.
   (c) Any increase in equity capital and reserves necessary to meet the requirements of paragraph 6(a) may be accomplished by the following:

   (d) If all or part of the increase in total equity capital and reserves necessary to meet the requirements of paragraph 6(a) of this ORDER is accomplished by the sale of new securities, the board of directors of the Bank shall forthwith take all steps necessary to adopt and implement a plan for the sale of such additional securities, including soliciting proxies and voting any shares or proxies owned or controlled by them in favor of the plan. Should the implementation of the plan involve a public distribution of the Bank's securities (including a distribution limited only to the Bank's existing shareholders), the Bank shall prepare offering materials fully describing the securities being offered, including an accurate description of the financial condition of the Bank and the circumstances giving rise to the offering, and any other material disclosures necessary to comply with the Federal securities laws. Prior to the sale of the securities and, in any event, not less than thirty days prior to the dissemination of such materials, the plan and any materials used in the sale of the securities shall be submitted to the FDIC at Washington, D.C. for its review. Any changes requested to be made in the plan or materials by the FDIC shall be made prior to their dissemination. If the increase in equity is provided by the sale of preferred stock or subordinated debt, then all terms and conditions relative to interest rate and any convertibility factor, shall be presented to the Regional Director for prior approval.
   (e) In complying with the provisions of this paragraph 6, the Bank shall, during the distribution, provide to any subscriber or purchaser of the Bank's securities, written notice of any planned or existing development or other change which is materially different from the information reflected in any offering material used in connection with the sale of the Bank's securities. The written notice required by this paragraph 6(e) shall be furnished within the ten days from the date such material development or change was planned or occurred, whichever is earlier, and shall be furnished to every purchaser or subscriber who received or was tendered the information contained in the Bank's original offering materials.

   (b) Within three months from the effective date of this ORDER, the Bank shall establish an audit committee composed solely of outside directors.
   (c) "Outside director" means an individual (i) not in the employee of the Bank, and (ii) whose total outstanding direct and indirect indebtedness to the Bank, including the indebtedness of any
{{4-1-90 p.A-776}}related interest of the individual, does not exceed $100,000.

   (a) A limit on loans as a percentage of assets;
   (b) Limits on the Bank's reliance on a particular liability category (e.g. large out-of-area certificates of deposits); and
   (c) Limits on the rate-sensitivity position of the Bank's assets and liabilities.

   S = Substandard
   D = Doubtful
   L = Loss

   (Determinations, Section II-C-1: Hazardous Lending and Lax Collection Practices)
   S = Substandard
   D = Doubtful
   L = Loss

KEY TO VIOLATIONS
(1) 12 CFR $337.3(b)
(2) 12 USC $371c (a) (1) (A), (B) (23A)
(3) 12 USC $375b (1), (2), (3) (Section 22(h) FRA)
(4) 12 USC $1972 (2) (Section 106(b) BHCA)
(5) 12 CFR $215.4(a), (b), (c) (Regulation O)
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