FDIC: 1996 - Docket No. FDIC-85-50k


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{{4-1-90 p.A-828}}
[¶5064] FDIC Docket No. FDIC-85-50k (5-5-86).

Civil money penalties assessed against former bank directors for extending to bank insiders credit involving more than the normal risk of repayment, exceeding the lending limit, and at preferential interest rates.

[.1] Regulation O—General Prohibition—Approval by Board of Directors
A lending limit violation occurs whenever certain amounts of credit extensions to insiders are surpassed. Good faith and reasonableness may be considered in assessing liability for the violations, but not in determining whether a violation has, in fact, occurred.

[.2] Director—Civil Money Penalties—Lending Limit Violations
Executive officers and principal shareholders of a bank should not be permitted to obtain loans from their bank on terms that are not available to the public.

[.3] Loans—Collateral—First Mortgage
If there is already a first mortgage on property used to secure a loan, an extension of credit has unfavorable features which creates a greater than normal risk or repayment.

[.4] Directors—Duties and Responsibilities—Reliance on Other Directors
A director's reliance on another director's misrepresentation that no liens exist on his house in no way relieves the first director of liability.

[.5] Civil Money Penalties—Amount of Penalty—Good Faith
The statute that authorizes the FDIC to assess civil money penalties permits consideration of good faith and other matters as justice may require. A good faith reasonable belief on the part of bank directors that the unimpaired capital of the bank was increased by $750,000, when, in fact, the unimpaired capital was not increased by that amount, mitigates the liability of the directors.

[.6] Directors—Experience in Banking—Lack
A person cannot enter the banking business and purchase control of a bank, becoming its chief executive officer, without knowledge of banking law. The director of a bank owes a fiduciary duty to the bank's depositors, and to the public that relies on the safety and soundness of the bank.

In the Matter of * * * AND AS
PRINCIPAL SHAREHOLDER, AND AS A PERSON PARTICIPATING IN THE
AFFAIRS OF THE BANK, AND * * *
INDIVIDUALLY AND AS OFFICERS
AND/OR DIRECTORS * * * BANK

(INSURED STATE NONMEMBER BANK)
DECISION AND ORDER TO PAY
FDIC-85-50k

STATEMENT OF THE CASE
   These proceedings arise under section 18(j)(3) of the Federal Deposit Insurance Act (the "Act"), 12 U.S.C. § 1828(j)(3). On March 20, 1985, the Board of Review of the Federal Deposit Insurance Corporation (the "FDIC"), pursuant to delegated authority, issued a written Notice of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of Law, and Order to Pay ("Notice") against * * * ("Respondent * * *"), former executive officer, director and principal shareholder of the * * * Bank (the "Bank"), and * * * former members of the board of directors of the Bank (the "directors"), pursuant to section 18(j)(3) of the Act. The Notice charged Respondent * * * and the directors with violations of section 22(h) of the Federal Reserve Act, as amended, 12 U.S.C. § 375b, and Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. Part 215 ("Reg. O"), promulgated thereunder, and made to apply to insured State nonmember banks by section 18(j)(2) of the Act, 12 U.S.C. § 1828(j)(2), and section 337.3(b) of the FDIC's Rules and Regulations, 12 C.F.R § 337.3(b). The Notice sought civil money penalties against Respondent * * * and the directors in the following amounts: $90,000 against Respondent * * *, $5,000 against Mr. * * *, and $2,500 each against Mr. * * *, Mr. * * *, and Mr. * * *.
   The violations of Reg. O arose from five transactions, four of which did not receive prior approval by the Bank's board of direc- {{4-1-90 p.A-829}}tors, and each of which exceeded the limit for such extensions of credit and involved more than the normal risk of repayment. As a result of the violations, the Bank lost approximately $25,000 in imputed interest, and the Bank's funds were put at risk for periods of as long as seventy days.
   Each Respondent requested a hearing pursuant to section 308.69 of the FDIC's Rules of Practice and Procedures, 12 C.F. R. § 308.69, and a formal hearing was held on October 1-3, 1985, before Administrative Law Judge Alan W. Heifetz (the "ALJ"). Only the FDIC submitted a posthearing brief. The ALJ submitted a recommended Decision and Order on January 21, 1986, which recommended a penalty of $90,000 against Respondent * * * but which reduced the size of the penalties against each of the other directors by one-half. Neither party submitted exceptions to the Decision and Order.

OPINION
The Board of Directors of the FDIC (the "Board") finds the ALJ's recommended Findings of Fact to be supported by the evidence in the record. We therefore adopt and incorporate herein by reference the Findings of Fact on pages 2 through 10 of the recommended Decision. The Board also agrees with the analysis of the law set forth in the ALJ's recommended Decision. We find that analysis to be supported both by statute and established precedent. The Board therefore adopts and incorporates herein by reference the ALJ's Decision of law on pages 10 through 19 of the recommended Decision.¹
Having found that Respondent * * * and the Directors engaged in violations of Reg. O as set forth in the ALJ's recommended Decision, the Board finds the ALJ's recommended ORDER TO PAY is appropriate as a penalty and as a deterrent for future abuses. Therefore, the Board adopts herein that ORDER, as set forth below as its final ORDER TO PAY CIVIL MONEY PENALTIES in this proceeding.

ORDER TO PAY
   After taking into account the appropriateness of the penalty with respect to the financial resources and the good faith of each Respondent, the gravity of these violations, the history of previous violations, and all of the circumstances, it is ORDERED, that by reason of the violations found herein, a penalty of $90,000 be, and hereby is, assessed against Respondent * * *; a penalty of $2,500 be, and hereby is, assessed against Respondent * * *; and a penalty of $1,250 be and hereby is, assessed against each of Respondents * * *, * * *, and * * *, pursuant to section 18(j)(3) of the Act (12 U.S.C. § 1828(j)(3)).
   FURTHER ORDERED, that the penalty assessed hereby shall be payable and collected not later than 20 days from the date this Order becomes final and unappealable.
   By the direction of the Board of Directors.
   Dated at Washington, D.C. this 5th day of May, 1986.
   /s/ Margaret M. Olsen (for)
   Hoyle L. Robinson
   Executive Secretary

RECOMMENDED DECISION

FDIC-85-50k

* * * , Esquire
For * * *
* * *, Esquire
For * * *,
pro se
* * *
For the Federal Deposit
Insurance Corporation
Before: ALAN W. HEIFETZ
Administrative Law Judge

DECISION AND ORDER
Statement of the Case
This administrative action was initiated by the Board of Directors of the Federal Deposit Insurance Corporation ("FDIC") on March 20, 1985, when it issued a Notice of Assessment of Civil Money Penalties ("Notice") and an Order to Pay ("Order") against * * *, majority shareholder and former Chairman of the Board of Directors

¹ The Board does note that whereas the ALJ stated that neither party had introduced evidence regarding the financial resources of the Respondents, the FDIC had indeed introduced the net worths of each Respondent in its Examination Report, p. 133. This information was considered by the Board in determining the appropriateness of the penalties.
{{4-1-90 p.A-830}}of the * * * Bank ("the Bank"), and * * * and * * * Directors of the Bank, pursuant to the provisions of Section 18(j)(3) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1828(j)(3), and the FDIC's Rules of Practice and Procedures, 12 C.F.R. Part 308.¹ The Notice charged * * * and the Directors with violations of Section 22(h) of the Federal Reserve Act, as amended, 12 U.S.C. § 375b, and Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. Part 215 ("Regulation O") promulgated thereunder, made to apply to insured State nonmember banks by Section 18(j)(2) of the Act, 12 U.S.C. § 1828(j)(2), and Section 337.3(b) of the FDIC Rules and Regulations, 12 C.F.R. § 337.3(b). Penalties were assessed against Respondents in the following amounts: $90,000 against Respondent * * *; $5,000 against Respondent * * *; and $2,500 each against Respondents * * *.
   Each Respondent requested a hearing pursuant to Section 308.69 of the FDIC's Rules and Practice and Procedures, 12 C.F.R. § 308.69, and by letter dated May 14, 1985, the matter was referred to me for hearing and the issuance of a Final Decision. A formal hearing was held on October 1-3, 1985, in * * *. Only the FDIC submitted a post-hearing brief. Upon the entire record, including my observation of witnesses, I make the following findings of fact and conclusions of law:
Findings of Fact
   The Bank is a corporation existing and doing business under the laws of the State of * * * , having its principal place of business in * * *. At all times pertinent to this proceeding, the Bank was an insured State nonmember bank subject to the Act, 12 U.S.C. §§ 1811-1831d, and the FDIC's Rules and Regulations, 12 C.F.R. Chapter III. The FDIC has jurisdiction over the Bank and the subject matter of this proceeding.
   * * * was a principal shareholder of the Bank within the meaning of Section 215.2(j) of Regulation O at all times pertinent to this administrative proceeding. He also participated in the conduct of the affairs of the Bank and was a director and executive officer, within the meaning of Sections 215.2(c) and (d) of Regulation O, from June 11 until September 10, 1984, when he resigned from the Board of Directors. At all times pertinent to this administrative proceeding, the Directors were included within the meaning of directors contained in Section 215.2(c) of Regulation O.
   Pursuant to Section 8(b) of the Act, 12 U.S.C. § 1818(b), the Board of Directors of the Bank, including Respondent * * *, entered into a Stipulation and Consent to the issuance of an Order to Cease and Desist dated July 12, 1983. The Order required the Bank, its directors, officers, employees, agents, successors and assigns, and other persons participating in the conduct of the affairs of the Bank, to "adopt procedures which will ensure future compliance with all applicable laws, rules and Regulations." G. Ex. 1 at 6.
   In late March 1984, on recommendation of * * * , a brokerage firm on the West Coast where he had been doing business, went to London to see their independent agent, * * * , in an effort to locate a source of inexpensive loan funds. * * * , in turn, introduced him to * * * , managing director of the * * * Bank. During the course of being wined and dined by * * * , * * * indicated his interest in acquiring a * * * bank and * * * readily offered to finance the acquisition. Within a week, * * * had drawn up an agreement in letter form. Tr. 589-93, 649-52.
   The agreement called for the deposit of $1.2 million "with the * * * Bank * * * at the account of the * * * Bank * * * in consideration of an advance of $250,000 to finance the purchase of 80 percent of the shares of the Bank in addition to an advance of $750,000 to infuse new capital into the Bank. * * * was also to arrange for the Bank to appoint * * * as its principal correspondent Bank. * * * Bank * * * would pay * * * 5% interest on the deposit maintained by the Bank at * * * , and * * * would have the rights of offset against the Bank's deposit for any loss which * * * might incur in its loan to * * *. According to the agreement, * * * would consider the Bank's deposit at * * * a "blocked account for the term of the loan" to * * * "and shall not release the deposit back to the [Bank] unless and until the loan is repaid in full. On the other hand, in the event of a partial repayment of the loan during term, the [Bank] will be allowed

¹ For purposes of this decision, Respondents * * * will be collectively referred to as "the Directors," and Respondent * * * will be referred to individually.
{{4-1-90 p.A-831}}to withdraw an equivalent portion of its deposit." G. Ex. 24.
On April 5, 1984, prior to departing from London on a return flight to the United States, * * * went to * * *'s office to sign the letter agreement. Tr. 593-94. According to * * *, "in my haste to reach an agreement; get a loan, get on that airplane, I signed it without reading it carefully enough." Tr. 661. He then left for the airport, intending to "study" the document on the trip home. After rereading it, * * * realized he could not honor the terms of the agreement and told this to * * * when he returned home. * * * offered * * * the Bank's stock along with a mortgage on a $1.1 million warehouse in * * * as collateral for the loan. According to * * *, * * * accepted this, and * * * assumed "he was loaning me the million dollars." No closing ever took place which would place a mortgage on the warehouse property. Tr. 596-97.

A. The Transfer of Funds to The * * *
Bank
   On April 9, 1984, * * * offered to purchase not less than 80% of the Bank's outstanding stock at a price of $2.20 per share, and thereafter to cause not less than $750,000 to be infused as additional equity capital. * * *'s application for change of control of the Bank was approved by the * * * Department of Financial Institutions, and was not disapproved by the FDIC, pursuant to mandatory investigations which failed to reveal any information unfavorable to the applicant or his financial condition.
   * * * was represented by reputable legal counsel in connection with his acquisition of stock and the preparation and filing of his application for change of control. Prior to the conclusion of the deal, the Directors received from * * * a personal financial statement which reflected a net worth of $6,746,000, with liquidity in the amount of $600,000. They also received a statement of personal history which reflected stability and expertise in areas vital to rural banking. The Directors made no independent effort to determine the truth of the matters contained in those statements.
   On June 15, 1984, * * * presented a $250,000 cashier's check drawn on * * * to the Bank to purchase over 80% of the * * * for collection.
   * * * thereafter made a recommendation to the Directors that the Bank open a correspondent depository account at * * *. According to * * *, he made the recommendation since "that was a requirement of * * * in order to make me that [$1.2 million] loan. I assumed at that time. . . that he must own a piece" of * * * and wanted another correspondent account of that bank. Tr. 701. * * * told the Directors that the benefits the Bank could receive for opening this interest bearing account was the possibility that the Bank could become involved in the Universal automatic teller machine business, and that * * * would participate in loans originated by the Bank. Tr. 758-60. The Directors agreed to open the account, and wired $305,000 to * * * on June 18, 1984, with the wire transfer instructions specifically stating that the funds represented thereby were to be credited to the account of the Bank. That same day, * * * called the president of * * * to introduce himself and request that an interest bearing account be opened in the Bank's name. Tr. 739-40.
   For some unexplained reason, the $305,000 was credited to the account of * * * Bank instead of the Bank. Those funds were then transferred to the * * * account at * * * on June 19, 1984, and $250,000 of that amount was transferred to the * * * account at the Bank. * * * had signatory authority over the * * * account. He used that money to purchase stock from the Bank's stockholders during the week of June 20-27, 1984. G. Ex. 9. There was no evidence presented to indicate that any of the Respondents knew the source of the $250,000 was not * * *, but rather was the funds intended for the Bank's depository account.
   The wire transfer was not credited to the Bank's account at * * * until July 27, 1984, despite repeated and expeditious efforts by the Directors to recover the Bank's funds. The Bank's account was credited within a day after * * * partially repaid $253,000 on his loan to * * *. Interest that would have accrued on $305,000 during the period of June 18 to July 27, 1984, would have amounted to less than $5,000.

B. The Infusion of Additional Capital and
Issuance of Stock
   On June 28, 1984, in compliance with his April 9 offer, Respondent * * * gave to the {{4-1-90 p.A-832}}Bank a cashier's check in the amount of $750,000 from * * *. The check was issued on April 18, 1984, the same date as the $250,000 cashier's check discussed in Part A, the name * * * as the remitter. The Bank notified * * * on June 28 of the receipt of the cashier's check, and was assured that the check would be honored upon presentment. Never before had the Bank experienced the failure or refusal of another financial institution to honor its own check.
   On June 29, 1984, in reliance on the advice of the Regional Office of the FDIC and * * *, a C.P.A. firm specializing in bank accounting, the Bank deposited the cashier's check. Thereafter, the Bank issued 1,798,455 shares of common stock to * * * and increased its equity capital accounts by $750,000. G. Ex. 30, 31. Neither * * * nor the FDIC advised the Bank that the cashier's check should not continue to be reflected in the Bank's equity capital account after a reasonable time for its collection had expired, and the subject was not discussed. The check was sent to * * * for collection, to the same address where the $250,000 cashier's check discussed in Part A was sent. G. Ex. 29. As far as the Directors could determine, the $250,000 check took only five days to collect, since the Bank received those funds, through the wire transfer of $250,000 from the * * * account at * * * to the * * * account at the Bank, on June 20, 1984.
   The $750,000 cashier's check was not honored in the ordinary course of business. After ten days had passed from the time the check was sent to * * *, * * * attempted to contact * * *, Managing Director of * * *, on July 12 but received no reply. He called again on July 13 and was told by * * * that because the check was for such a large amount, it had to be sent to the * * * branch of * * * for collection rather than * * *. After another ten working days had passed, which * * * considered to be the usual time required for an overseas check to clear, he again called * * * on July 25. * * * told * * * that handling problems had occurred at * * * Bank in * * *, but that the check would be honored within the immediate future. No further communication between the two men occurred until August 20 or 21, when * * * called * * *, but received no reply. Tr. 724-27.
   * * * also spoke with * * * when he realized the $750,000 check was not clearing. He did not believe * * *'s representations that the check was sent to the wrong branch office. When he pressed * * * for the truth, * * * told him that he was obtaining the funds from somewhere else. Tr. 663-66. * * * had an ongoing dialogue with * * * until he realized that * * * was not going to deliver the funds. He reported his conversations with * * * at times to all the Directors, but he discussed these matters with * * * at "regular intervals." Tr. 666-67.
   During the latter part of July, * * * was called by * * *, Chairman of * * *, who asked * * * to come to * * * for a business meeting.² * * * told * * * during the meeting that * * * was not going to cover the loan. * * * was not going to honor his commitment. Tr. 606. * * * told * * * that three different banks were each going to lend him $250,000. On the following day, * * * and his wife executed a note for a $750,000 loan, pledging the Bank's stock as collateral.³ * * * never received the $750,000 from * * *, even though * * * held the Bank's stock for approximately ten days. Tr. 608-09.
   * * * also applied for a $1 million loan from * * * Bank on June 28 or 29, 1984. * * * testified that the purpose of this loan was to pay off * * *, if he had honored his commitment. When he did not do so, * * * decided to use the loan proceeds as replacement capital for the Bank. Tr. 609-10. * * * knew sometime in July that * * * was trying to obtain replacement capital from * * * and from * * *. Tr. 733-34. * * * had difficulty in obtaining the loan from * * * because of problems in getting a $1 million life insurance policy on * * * approved and forwarded to * * *. Tr. 727-30. This transaction finally settled on September 6, 1984. Approximately 70 days after the issuance of the Bank stock, * * * pledged it as collateral for the $1 million loan from * * * and used $750,000 of the proceeds as replacement capital for the * * * cashier's check.

² * * * told * * * during this conversation that the Bank's correspondent account at * * * was finally credited for $305,000. Tr. 604. See Part A for a discussion of this transaction.

³ * * * also executed an indemnification agreement with * * * as Chairman of the board of the Bank. This agreement stated that the Bank would indemnify and hold harmless * * * for the misappropriation of funds from the Bank's correspondent account to the account of * * *, discussed in Part A. Joint Ex. 1 at 107-08.
{{4-1-90 p.A-833}}
   At no time did the Bank commence civil litigation in an effort to collect the funds represented by the cashier's check. According to * * *, the common stock certificates issued in exchange for the cashier's check were not cancelled by the Bank because they were required as partial collateral for the loans that * * * was trying to obtain from * * * and * * *. Tr. 738-39.
   The Bank did not charge any interest to Respondent * * * pending its collection of the * * * cashier's check, but it did receive $150,000 from him in exchange for an asset which it had previously acquired for $100,000. See Part E, supra. Any claim the Bank could have asserted for unpaid interest on the infusion of capital transaction would have amounted to less than $20,000.
   The FDIC conducted a visitation of the Bank at the close of business on June 29, 1984, as a follow-up to an Order of Correction dated March 26, 1984. In responding to a visitation questionnaire which asked whether the immediate credit given to * * * for the uncollected $750,000 cashier's check constituted a Regulation O violation, * * * responded that he believed no extension of credit had occurred. Joint Ex. 1 at 6. The FDIC examiner recommended a reexamination of the compliance with the Order of Correction "at the earliest opportunity." Id. at 8.
   This reexamination occurred at the close of business on July 20, 1984, and continued through early September, when an exit conference was held with the Directors. During the course of the examination and at the exit conference, the potential violations of Regulation O were discussed informally with * * *, * * * and * * *, and formally at a Board of Directors meeting. Tr. 176-77.

C. The Extension of Credit to Respondent
* * * and His Wife
   On July 9, 1984, * * * presented an application for a $200,000 loan for him and his wife to the Directors. * * * told the Directors that the loan would be secured by a first mortgage on the * * * residence. The appraised value of the house as of July 31, 1984, was $420,000. G. Ex. 36, 37. A separate and subsequent appraisal of the same property yielded a value of $455,000. R. Ex. 9. Based upon the representation that this would be a first mortgage on the property, the appraised value of the property, and the extent of the Directors' knowledge of the financial condition of * * *, as discussed in Part A, infra, the loan application was unanimously approved by the Board, with * * * abstaining.
   On July 17, 1984, the Bank made an extension of credit to * * * and his wife in the amount of $204,332.90, which included a commitment fee of $4,000 and miscellaneous expenses of $332.90, and which was evidenced by a promissory note bearing interest at the Bank's base or prime rate, plus 2%.
   The Directors belatedly discovered the existence of a first mortgage on the * * *' residence, which * * * had forgotten about. The indebtedness secured by that prior lien was approximately $263,000 as of July 17, 1984, and the prior lien was further secured by additional collateral sufficient in value to discharge entirely all obligations to the prior lienholder. R. Ex. 7, 8. Nevertheless, on August 13, 1984, the Directors voted to accept an offer from * * * to substitute as collateral for the loan a first mortgage on 20 residential subdivision lots in the * * * development, discussed in Part E, subject to prior proof of value as determined by an appraisal in standard form.
   On August 31, 1984, * * * conveyed 30 unencumbered residential subdivision lots in trust for the purpose of securing the * * *' loan. The lots had a cumulative wholesale value of $300,000 and a cumulative appraised value of $405,000.

D. The Extension of Credit to * * *
On July 24, 1984, the Bank made an extension of credit to * * * in the amount of $50,500, which included a commitment fee of $500, and which was evidenced by a promissory note bearing interest at the Bank's base or prime rate, plus 2%. * * * was a limited partnership which maintained an office in * * *, a city within 30 miles of * * *. The purpose of the loan was the development of resort real estate in the mid- * * * area. * * * recommended that the general partner of * * * create a financial relationship with the Bank, of which the loan was part. Tr. 757-58. Prior to obtaining the loan, * * * presented financial statements of all its partners to the Bank, indicating net worths in the several million dollar range. Guarantees from all of the partners, both general and limited, were also received. Tr. 747-49. There was no evidence {{4-1-90 p.A-834}} in the Bank's files that a credit analysis of these financial statements was undertaken by the Bank. Tr. 477-78.
* * * paid * * * $10,000 from its loan proceeds as a retainer fee to begin work on site development for an * * * project. Tr. 672-73.⁴ The Directors were informed of this payment during the week of September 3, 1984. On September 10, after determining that he had received a portion of the loan proceeds, * * *, in response to a suggestion from Respondent * * *, issued and delivered to the Bank his personal check in the amount of $10,000, which was applied in partial satisfaction of the * * * indebtedness to the Bank.

E. The Extension of Credit to * * *
   On July 20, 1984, the Bank invested $100,000 in mortgage funds through * * *. The investment was made on the advice of * * *, who assured the Directors that the Bank would not incur any loss by virtue of their reliance upon his advice.
   In its report of examination, the FDIC determined that the * * * investment was a worthless asset subject to being charged off in its entirety. Due to this adverse classification, Respondent * * * asked * * * to reimburse the Bank for the loss attributable to the * * * investment.
   On September 11, 1984, the Bank made an extension of credit to * * * in the amount of $153,288.70, which included a commitment fee of $3,000 and miscellaneous expenses of $288.70, and which was evidenced by a promissory note bearing interest at the Bank's base or prime rate, plus 2%. * * *, president, director and 100% owner of * * *, had known * * * for approximately 4 years and had worked with * * * as a contractor and purchaser of residential property lots which * * * developed. * * * had no other relationship with * * *. Tr. 369-71. As of September 11, 1984, * * * had a net worth in excess of $3.1 million. Tr. 382.
   * * * used the proceeds of the Bank loan to purchase property from * * * in the * * * subdivision. * * * gave a deed of trust on 20 of those lots to the Bank to secure the loan. Each lot had an appraised value of $13,500. R. Ex. 3. * * * purchased the lots from * * * at their contract price of $10,000 each.
   The net proceeds of the extension of credit in the amount of $150,000 were endorsed and deposited into the account of * * * on September 11, 1984. Immediately thereafter, the proceeds were paid in their entirety to the Bank as indemnification for the loss resulting from the * * * investment. Contemporaneously therewith, the Bank assigned to * * * all of its right, title and interest in and to the * * * mortgage contract.
Discussion
   Congress added Section 22(h) to the Federal Reserve Act, 12 U.S.C. § 375b, in 1978 to combat perceived abuses of insider bank transactions. Finding that "[p]roblem banks and insider abuses have been virtually synonymous," Congress attempted to "place insiders on the same level with the banking public [so] they would no longer be saved preferential spots in line before the loan windows." H.R. Rep. No. 1383, 95th Cong., 2d Sess. 10, 12, reprinted in 1978 U.S. Code Cong. & Ad. News 9273, 9282, 9284. Section 22(h) places limits on the amount of extensions of credit which may be made by a member bank to its executive officers or principal shareholders, with or without approval of the board of directors, and prohibits preferential lending to those individuals. Section 18(j) of the Federal Deposit Insurance Act makes the provisions of the Federal Reserve Act applicable to nonmember insured banks and their officers, directors, employees, agents and others participating in the conduct of the affairs of such nonmember insured banks. 12 U.S.C. § 1828(j).
   Regulation O implements Section 22(h) of the Federal Reserve Act. The term "extension of credit" is defined at Section 215.3 of Regulation O:
   (a) An extension of credit is a making or renewal of any loan, a granting of a line of credit, or an extending of credit in any manner whatsoever, and includes:

* * *
(2) An advance by means of an overdraft, cash item, or otherwise;

⁴ No evidence was presented that Respondents * * * * * * had any knowledge of the * * * payment to * * * prior to the week of September 3, 1984. Respondent * * * would have had knowledge of the payment only if the $10,000 check to * * * from * * * was a non-sufficient funds check, as the FDIC had alleged. Based on the evidence presented, the $10,000 check from * * * to * * * was presented for payment only once, on July 26. Tr. 459-66, 749-52; G. Ex. 40, 41. It was therefore not proved that Respondent * * * had knowledge of the payment of the * * * loan proceeds to * * * until the week of September 3.
{{4-1-90 p.A-835}}

* * *
(8) Any other transaction as a result of which a person becomes obligated to pay money (or its equivalent) to a bank, whether the obligation arises directly or indirectly, or because of an endorsement on an obligation or otherwise, or by any means whatsoever.
(b) An extension of credit does not include:

* * *
(2) A receipt by a bank of a check deposited in or delivered to the bank in the usual course of business unless it results in the carrying of a cash item for or the granting of an overdraft.

* * *
   (f) An extension of credit is considered made to a person covered by this part to the extent that the proceeds of the extension of credit are used for the tangible economic benefit of, or are transferred to, such a person.
   A "cash item" is a check or other item in process of collection payable in cash upon presentation to a bank. Tr. 103-04. As long as the $750,000 cashier's check remained uncollected, it was a cash item. The $750,000 infusion of capital transaction therefore was an extension of credit to * * * since it was an advance by means of a cash item. 12 C.F.R. § 215.3(a)(2). * * * was given immediate credit for the $750,000 cashier's check even though the Bank did not receive the funds for approximately 70 days. He was thereby obligated to pay money to the Bank because the Bank issued stock certificates to him, further bringing the transaction within Regulation O. 12 C.F.R. § 215.3(a)(8).
   The $204,000 loan to * * * and his wife was obviously an extension of credit since it involved a making of a loan to them. 12 C.F.R. § 215.3(a). Each of the other transactions in question in this case was an extension of credit since the proceeds of the transaction were used for the tangible economic benefit of * * * or were transferred to him. 12 C.F.R. § 215.3(f). The * * *'s loan proceeds were transferred to * * *, as was $10,000 of the * * * loan proceeds. The $305,000 wire transfer was used for the tangible economic benefit of * * * to the extent that $250,000 of those funds were used to finance the purchase of 80% of the outstanding stock of the Bank.
A. Lending Limit Violations.
   The limitation on extension of credit in Section 22(h)(1) of the Federal Reserve Act as implemented by Regulation O is as follows:

The prior approval requirement of Section 22(h)(2) of the Federal Reserve Act as implemented by Regulation O is as follows:

Since * * * did not honor its $750,000 cashier's check in the ordinary course of business, the aggregate lending limit applicable to executive officers and principal shareholders of the Bank under Section 215.4(c) of Regulation O from June 30 to {{4-1-90 p.A-836}} September 30, 1984, was $20,000 for fully secured extensions of credit and $12,000 for unsecured loans. If the check had been honored, the Bank's unimpared capital would have increased by $750,000, raising these limits to $124,500 for unsecured extensions of credit and $207,500 for secured extensions of credit. For the same period, the lending limits of the Bank to executive officers or principal shareholders without prior approval of the Board of Directors was $25,000, pursuant to Section 215.4(b) of Regulation O.
The $750,000 infusion of capital transaction was a technical violation of the Regulation O lending limits because it involved an extension of credit to an executive officer and principal shareholder which exceeded $12,000, the Bank's limit on unsecured loans to insiders. Board approval was not given for this extension of credit, thus the $25,000 limit of Section 215.4(b) of Regulation O was also violated.

   [.1] Arguments were presented by the Respondents concerning the reasonableness of their actions in assuming that a financial institution would honor its own check. Respondents also claimed good faith reliance on the advice of the FDIC and their accounts in booking the cashier's check on its capital account. Regulation O, on the other hand, is clearly written to provide no defenses for reasonableness or good faith. A lending limit violation occurs whenever certain amounts of extensions of credit to insiders are surpassed. Good faith and reasonableness may be considered in assessing liability for the Regulation O violations, but not in determining whether a violation has in fact occurred.
   All of the remaining extensions of credit to * * *, when aggregated with the $750,000 extension of credit, exceeded the lending limit of Regulation O, Section 215.4(c). With regard to the limit in Section 215.4(b), only the $204,000 loan to * * * and his wife received approval from the Directors, with * * * abstaining from the vote. That loan therefore does not come within the ambit of Section 215.4(b). All of the other transactions are subject to the $25,000 limit in that Section, and when the amounts of those extensions of credit are aggregated, they exceed that limit, in violation of Regulation O.
B. Preferential Loan Violations
   Section 22(h) (3) of the Federal Reserve Act, 12 U.S.C. § 375b(3), prohibits extensions of credit to bank insiders on terms that are not creditworthy or are preferential. That section is implemented by Regulation O, Section 215.4(a), which provides:

Both the use of $250,000 of the Bank's funds transferred to * * * and the $750,000 infusion of capital transaction were Regulation O violations because they were preferential extensions of credit. * * * was not charged interest on the use of the Bank's funds in either transaction, and no collateral was offered. Respondents claimed that * * * more than paid for any interest that could have been charged to him on these transactions by purchasing the * * * mortgage commitments for $150,000 -$50,000 more than the Bank paid for them. This after the fact rationalization in no way alleviates the preferential nature of the extension of credit at the time when the credit was outstanding.

[.2] Regulation O was promulgated to enforce the Congressional mandate that insider transactions in banks should be sharply curtailed. Executive officers and principal shareholders of a bank should not be permitted to obtain loans from their bank on terms that are not available to the public. No bank would permit a member of the public to obtain a loan without a clear understanding as to what interest rate will be charged, when interest payments will be due, and what collateral or guarantee will be offered. No such understandings were reached in these two transactions. Even after it became clear to the Directors that * * * was being enriched by the use of Bank funds, no interest payments were demanded of him. At the time of the * * * mortgage transaction, there was no under- {{4-1-90 p.A-837}}standing between the parties that the additional $50,000 * * * paid for that asset was being offered as reimbursement for interest which would have accrued on these extensions of credit. * * * himself testified that he considered the $50,000 to be a contribution to capital of the Bank, and not an interest payment. Tr. 677. By extending credit to * * * in these two situations without a loan agreement providing for a sum certain in interest payments, Respondents violated Section 215.4(a) of Regulation O.

[.3] The $204,000 loan to * * * and his wife was preferential since insufficient collateral was pledged. Had the Bank received a first mortgage on the * * *'s residence, as the Directors had believed, there would have been no Regulation O violation. However, since a first mortgage on the property already existed, the extension of credit had unfavorable features which created a greater than normal risk of repayment. This is true even if the prior lien was secured by additional collateral sufficient in value to discharge entirely the obligations to the prior lienholder, since the Bank would still be faced with the unfavorable feature of being subordinate in priority of repayment.

   [.4] The Directors' reliance on * * *'s misrepresentation that no liens existed on his house in no way relieves them of liability. Such reliance in fact exacerbates the preferential nature of this loan. A member of the public who wishes to obtain an extension of credit for an amount of this size would be required to provide a title search of the property being used as collateral. * * * was not required to do this. The Directors' reliance was as much a cause for this regulation O violation as was * * * misrepresentation.
   The extension of credit to * * * and * * * did not violate Section 215.4(a) of Regulation O. Both of these loans carried an interest rate of the prime rate, plus 2%. The * * * loan was guaranteed by all of the * * * partners, both general and limited, who had net worths in the several million dollar range. * * * was owned and directed by * * *, who had dealt with both * * * and * * * extensively prior to obtaining this loan. The * * * loan was secured by a deed of trust on readily marketable property valued at $270,000. There was no evidence presented to illustrate any other features of these extensions of credit which would create a greater than normal risk of repayment or a violation of Regulation O, Section 215.4(a).
   C. Penalties
   The FDIC is empowered to impose civil penalties against any person participating in the conduct of the affairs of an insured nonmember bank who violates Section 22(h) of the Federal Reserve Act or any lawful regulation, such as Regulation O, promulgated thereunder. Section 18(j)(3) of the Federal Deposit Insurance Act provides:

The FDIC did not introduce any evidence concerning the size of the financial resources of the Respondents, but at the same time the Respondents did not produce evidence indicating the penalties would exceed their financial resources. Respondents cannot deny the gravity of credit extensions totaling $1,360,000, which was more than ten times the size of the Bank's then existing equity capital and reserves. The Bank had a history of previous Regulation O violations, and at the time the present violations occurred, it was subject to a cease and desist Order directing it to adopt procedures to ensure future compliance with all applicable laws and regulations. Even if compliance procedures were adopted by the {{4-1-90 p.A-838}}Bank, of which no indication was given, they were not effective in preventing the present violations. The laxity in approach to this previous Order was illustrated by * * *'s testimony, in which he stated that he knew the Order existed, but he "really didn't know what it meant" and he never "looked at [it] very carefully." Tr. 598-99. As Chairman of the Board of the Bank, * * * was never given an instruction session on Regulation O or his responsibilities as a bank director. Tr. 599. In fact, * * * stated, "Regulation O means that I have a problem, and I really don't know why." Tr. 682. This lack of understanding and sensitivity to the duties and obligations of bank directors is a serious consideration in determining the appropriateness of the penalty.

[.5] On the other hand, the statute permits consideration of good faith and "other matters as justice may require." The Federal Financial Institutions Examination Council developed a supervisory policy specifying the factors that should be taken into consideration in deciding whether, and in what amount, civil money penalties should be imposed for violations of certain statutes regulating banking activity, including Section 22(h) of the Federal Reserve Act. Interagency Policy Regarding the Assessment of Civil Money Penalties by the Federal Financial Institutions Regulatory Agencies, 45 Fed. Reg. 59,423 (1980). In addition to some of the factors set forth in Section 18 (j)(3)(B) of the Federal Deposit Insurance Act, the interagency policy lists the following factors relevant to the present proceeding:

* * *

Id.

   A review of the violations illustrates the lack of evidence of intentional violations on the part of the Directors, or of violations committed with a disregard for the law. The Directors also attempted to correct many of the violations as soon as they became aware of them, in the shortest period of time possible.
   No evidence was presented that the Directors had any knowledge of the written agreement between * * * and * * *. Nor did the Directors know, or have any reason to believe, that part of the Bank's $305,000 wire transfer to * * * was being used as a source of funds to purchase the Bank's stock. The Directors were told of benefits the Bank could receive from opening a correspondent account at * * *. Although the decision to do so could be faulted as poor judgment, considering the Bank's earnings problems, a lack of business acumen does not create a Regulation O violation. With no knowledge of the misappropriation of funds, the Directors cannot be responsible for the Regulation O violations of this transaction.
   The $750,000 cashier's check which the Bank received from * * * was a cash item from the item of its presentation since the Bank gave immediate credit to it by issuing additional stock to * * *. The Directors should have known that a technical Regulation O violation was occurring. However, they relied in good faith on the advice of the Regional Office of the FDIC and a reputable accounting firm and deposited the check, reflecting the amount in the Bank's equity capital account. Given the nature of the transaction and the relative knowledge of international banking practices of all parties involved, it was reasonable for the Directors to rely on that advice and believe that the Bank's unimpaired capital, and the Regulation O lending limits which are based on it, was increased by $750,000. This good faith reasonable belief mitigates their liability for the initial extension of credit to * * *.
   After a reasonable period of time for collection of the check had passed, the Directors could no longer rely in good faith on the initial advice given to them. At some point in mid-July 1984, the Directors should have realized that * * * had received a $750,000 extension of credit in violation of Regulation O. * * * should have been aware of this prior to the other directors since he was in the Bank from day to day and in close contact with * * * and * * *. All directors should have known of the violations at that point in time - not just because a reasonable time for the collection of the check had passed, but also because {{4-1-90 p.A-839}} the FDIC raised the possibility of Regulation O violations in its visitations to the Bank. Immediate steps should have been taken at that time either to collect the funds from * * *, by court action or otherwise, or to cancel the stock issued to him. The Respondents' argument that the stock issued to * * * could not be cancelled since it was needed as collateral for alternative loans to provide replacement capital for the $750,000 check, while reinforcing the fact that the Directors knew the cashier's check was not going to be honored, does not relieve them of responsibility for the Regulation O violations at that point. * * * did not need stock in hand to obtain a loan for replacement capital. He could have pledged the stock which would be reissued by the Bank upon receipt of the loan proceeds. Strong actions were required by the Directors once they knew the $750,000 check would not be honored. No actions were in fact taken. The Directors are responsible for violating the lending limits and preferential loan limitations of Regulation O from mid-July 1984, until September 6, 1984, when * * * finally forwarded $750,000 to the Bank.
   The $204,000 extension of credit to * * * and his wife occurred prior to the time the Directors should have known that * * * would not honor its cashier's check. At the time of this loan, the Directors had no reason to believe that this extension of credit would exceed the lending limits in Regulation O. Their lack of knowledge mitigates the violations caused by this extension of credit.⁵ While the extension of credit to * * * occurred after the Directors should have known that the lending limitations in Regulation O would not permit additional extensions of credit to * * *, no evidence was presented to show that the Directors had any knowledge that proceeds from that loan would be paid to * * *. Therefore, there are mitigating circumstances to be taken into account with respect to the Regulation O violations which occurred in the * * * loan. Finally, the Directors did know that the extension of credit to * * * would be used to purchase property from * * *. Since that loan occurred after the Directors should have known of the Bank's lending limitations, they bear full responsibility for the violations of Regulation O caused by this transaction.
   During the course of his examination as witness in this case, the FDIC examiner who recommended the issuance of the Notice of Assessment, after reviewing all of the testimony regarding the transactions, admitted that he would have to reconsider "very seriously" his recommendations of assessment against the Directors. Tr. 559-60. I conclude that the Directors failed diligently to perform the duty of due care required of bank directors and that their failure resulted in Regulation O violations which caused financial harm to the Bank. However, after considering the good faith of the Directors, their attempts to remedy many of the violations when they became apparent, and the lack of a finding of willful, intentional or knowing conduct concerning more than half of the violations originally charged, I conclude that the penalties assessed against Respondents * * *, * * *, * * *, and * * * should be reduced by one-half.
   A similar conclusion cannot be made for Respondent * * *. He was principally responsible for the violations which occurred and the harm caused to the Bank and the Directors. It was * * * who recommended that the Bank open a correspondent account at * * *, knowing that his agreement with * * * would result in a block against the use of those funds by the Bank. * * * claimed that he repudiated that agreement, yet he still expected to receive funds from * * *. He knew or should have known the reason the $305,000 was not credited to the Bank's account, but he did nothing for 42 days to remedy the situation.
   * * * also knew or should have known that * * * would not honor its $750,000 cashier's check, since there was no reason for * * * to honor the agreement. * * * had received nothing in return for $750,000. Additional proof that * * * did not believe the check would be honored is found in the fact that on the very day he presented the check to the Bank, he applied for a $1 million loan from * * * as replacement capital. This is a curious fact, considering that his rationale for using * * * as a source of funds in the first place was the allegedly inexpensive loan funds that could be obtained from foreign banks.

⁵ This finding in no way excuses the preferential nature of this loan.
{{4-1-90 p.A-840}}
Since * * * knew that the cashier's check would not be honored, he was fully aware that he received an extension of credit from the Bank. He should have known that this extension of credit violated Regulation O by being preferential and in excess of the Bank's lending limits. These violations occurred over a 70-day period, despite warnings from the FDIC and, in the end, the Directors. There was no attempt on the part of * * * to reimburse the Bank for the interest it lost on this transaction. The payment of $50,000 as contribution to capital in return for an asset which he subsequently sold for value cannot be used as an after the fact rationalization concerning the failure to pay interest on a preferential loan. * * * bears full responsibility for all Regulation O violations caused by this transaction.
All subsequent extensions of credit to * * * prior to the repayment of $750,000 would similarly violate Regulation O. * * * should have known this, and yet he requested these additional loans. It was * * * who misrepresented the status of liens on his personal residence, creating a preferential loan. * * * recommended both the * * * and * * * relationships to the Directors. In both situations, * * * knew that he would receive part of the proceeds of those loans, in further violation of Regulation O. All of the violations initially charged against * * * have been clearly proved.

[.6] * * * argues that he did not even realize that he was breaking the law. Concerning his entire dealings with the Bank, * * * said, "I stand to lose a million dollars, and everybody looks at me like I've done something [wrong]. And if I have, I'm too dumb to know it." Tr. 692. Calling himself a "wheeler-dealer," * * * stated that he was "not a banker-type guy that sets behind a desk and asks questions." Tr. 695. "I'm a real estate developer. I had gone into this bank as an investment, not to be a banker, not to run a bank." Tr. 694. A clear message must be conveyed that a person cannot enter the banking business and purchase control of a bank, becoming its chief executive officer, without knowledge of banking law. The director of a bank owes a fiduciary duty to the bank's depositors and to the public which relies on the safety and soundness of the bank. * * * egregiously violated that duty. He violated Regulation O to such an extent that the very financial stability of the Bank was threatened. As a result of previous proceedings, * * * has been permanently removed from banking. He now must be severely penalized for his actions. The total penalty assessed against * * * is proper.
Accordingly, I recommend that the Board of Directors of the FDIC issue the following:

ORDER TO PAY
   After taking into account the appropriateness of the penalty with respect to the financial resources and the good faith of each Respondent, the gravity of these violations, the history of previous violations, and all of the circumstances, it is
   ORDERED, that by reason of the violations found herein, a penalty of $90,000 be, and hereby is, assessed against Respondent * * *; a penalty of $2,500 be, and hereby is, assessed against Respondent * * *; and a penalty of $1,250 be and hereby is, assessed against each of Respondents * * *, and * * *, pursuant to section 18(j)(3) of the Act (12 U.S.C. § 1828(j)(3)).
   FURTHER ORDERED, that the penalty assessed hereby shall be payable and collected not later than 20 days from the date this Order becomes final and unappealable.
   /s/ Alan W. Heifetz
   Chief Administrative Law Judge
   U.S. Department of Housing and Urban Development
   451 7th Street, S.W., #2156
   Washington, D.C. 20410
   Dated: January 21, 1986

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