Federal Deposit
Insurance Corporation

{{4-1-90 p.A-1236}}
   [¶5,113] FDIC Docket No. 87-61e, FDIC 87-62k (4-25-88).

   A bank's board chairman was assessed a civil money penalty and permanently removed from banking for willful and continuing disregard for the bank's safety and soundness and violations of law and regulations in allowing excessive overdrafts by a related firm. The bank president, a director, was suspended from participating in the affairs of a bank for three years for approving the overdrafts on the chairman's direction.

   [.1] Regulation O—Related Interests—Controlling Influence
   A firm in which a bank officer has controlling influence in managerial and financial decisions is considered a related interest of that officer.

   [.2] Regulation O—Lending Limitations
   Extensions of credit to an officer and his related interest in excess of the lending limits of the bank violates Reg. O.

   [.3] Regulation O—Lending Limitations—Preferential Terms
   Overdrafts of a related interest are considered insider credit on preferential terms in violation of Reg. O because the credits have lower effective interest rate, in larger amounts, for longer periods than credit extended to other borrowers, and involved above normal risk of repayment.

   [.4] Regulation O—Lending Limitations—Approval by Board of Directors
   Because the insider credit in the form of overdrafts exceeded 5% of the bank's unimpaired capital and surplus, prior approval from the bank's board of directors was required. Failure to get the required prior approval violates Reg. O.

   [.5] Civil Money Penalties—Amount of Penalty—Factors Determining
   The civil money assessment of $17,000 is appropriate and justified by these factors: three separate violations of Reg. O that existed for long periods and in substantial amounts, previous history of similar violations, unreasonable reliance on an earlier favorable FDIC letter, and the amount assessed is a very small fraction of the authorized maximum penalty.

   [.6] Prohibition, Removal, or Suspension—Factors Determining Liability— Violation of State Law
   Officers' violation of state law, by approving overdrafts that exceeded state lending limits, satisfies the first element for removal.

   [.7] Prohibition, Removal, or Suspension—Factors Determining Liability— Breach of Fiducicary Duty

   The officers, by approving the overdrafts of an insider, breached their fiduciary duty by taking actions that were in their own pecuniary interests in a situation which clearly involved a conflict of interest. This constitutes a wrongful conduct that meets the first element for removal. {{4-1-90 p.A-1237}}
   [.8] Prohibition, Removal, or Suspension—Factors Determining Liability— Disregard for Safety and Soundness
   The officers' practice of approving overdrafts of a financially unstable firm for almost a year in substantial amounts without proper documentation and on verbal assurances of repayment demonstrates their willful disregard for the bank's safety.

   [.9] Prohibition, Removal or Suspension—Permanent Order
   The permanent removal of a bank officer from banking is appropriate considering the multiple violations of law and regulation, breach of fiduciary duty, receipt of personal financial gain, and willful disregard for the bank's safety and soundness.

   [.10] Prohibition, Removal, or Suspension—Temporary Order
   A bank officer's culpability is mitigated by the fact that he approved overdrafts on instruction of a bank chairman who dominated him, had a lesser financial stake, and a lesser degree of involvement in the transaction.

In the Matter of *** and *** individually,
and as directors, officers, and persons
participating in the conduct of the affairs of
***,BANK


(Insured State Nonmember Bank)
DECISION AND ORDER
FDIC 87-61e
FDIC 87-62k

   I. INTRODUCTION

   This proceeding is a consolidated action brought by the Federal Deposit Insurance Corporation ("FDIC") against *** and *** ("Respondents"), individually and as directors and officers of *** Bank, *** ("Bank"), seeking civil money penalties for violation of section 22(h) of the Federal Reserve Act (12 U.S.C. 375b) and sections 215.4(a), (b), and (c) of Regulation O of the Board of Governors of the Federal Reserve System (12 C.F.R. Part 215.4(a), (b), and (c)) ("Reg. O")¹ and removal pursuant to section 8(e)(1) of the Federal Deposit Insurance Act ("FDI Act"), (12 U.S.C. §1818(e)(1)).

II. STATEMENT OF THE CASE

   A. DESCRIPTION OF THE CHARGES

   On April 1, 1987, the FDIC's Board of Review issued a Notice of Assessment of Civil Money Penalties, Findings of Fact and Conclusions of Law, Order to Pay and Notice of Hearing ("Notice of Assessment") against Respondents *** and *** for their alleged violations of sections 215.4(a), (b), and (c) of Reg. O. The Notice of Assessment alleged that Reg. O was violated due to the existence of overdrafts in the checking account of ***. Allegedly, *** was a related interest of Respondents, and Respondent ***, as chairman of the Bank's board, directed Respondent ***, as president of the Bank, to approve the payment of checks which resulted in substantial "overdrafts" of up to $160,000 in ***'s checking account for 332 days. FDIC enforcement counsel argued in its brief and at the administrative hearing that the "overdrafts" were actually extensions of credit, given their frequency and amounts, made on a preferential basis, without prior approval of the Bank's board of directors, and in excess of the lending limits to bank insiders. Pursuant to section 18(j)(3) of the FDI Act (12 U.S.C. §1828(j)(3)), Respondent *** was assessed a $17,000 civil money penalty and Respondent *** was assessed a $3,500 civil money penalty for their respective participation in the Reg. O violations.
   On April 14, 1987, the FDIC's Board of Directors ("Board") issued a Notice of Intention to Remove from Office and to Prohibit From Further Participation ("Notice of Intention") against Respondents *** and *** pursuant to section 8(e)(1) of the FDI Act (12 U.S.C. §1818(e)(1)). The Notice of Intention similarly alleged that Respondents violated Reg. O due to the existence of overdraft transactions involving ***. It further alleged that in addition to violating Reg. O, Respondents' conduct constituted an unsafe and unsound banking practice and a breach of their fiduciary duty as directors of the Bank. The allegation that Respondents engaged in an unsafe or un-

   Respondents, through counsel, jointly filed answers to each notice on April 29, 1987. A pre-hearing conference was held on May 26, 1987, in ***. At that time, counsel for Respondents proposed the entry of a protective order, and such an order was entered on June 2, 1987. A hearing before Administrative Law Judge ("ALJ") William Gershuny was commenced in ***, on July 6, 1987 and continued to July 15, 1987. As a preliminary matter, the FDIC filed and presented a Motion to Vacate the Protective Order ("Motion to Vacate") that had been entered on June 2, 1987; the ALJ deferred ruling on this matter until the issuance of his recommended decision.

   On December 28, 1987, ALJ Gershuny issued his Recommended Decision and Order ("Rec. Dec.") in the consolidated removal and civil money penalty actions. The ALJ found that each Respondent, in violation of section 8(e), engaged in unsafe and unsound banking practices, that the Bank suffered a substantial financial loss due to Respondents' actions, and that their activity demonstrated a continuing disregard for the safety and soundness of the Bank. Although FDIC's Notice of Intention alleged, and evidence was produced at the hearing, that each Respondent also violated Reg. O and the state lending limit, breached his fiduciary duty as a director and officer, received financial gain from the *** transactions, and demonstrated a willful disregard for the safety and soundness of the Bank, the ALJ declined to consider these issues as a matter of judicial restraint and economy. Having found the FDIC met its minimum burden under section 8(e)(1) (i.e., proved at least one factor from each of the three elements required for a section 8(e) violation²), the ALJ concluded that Respondent *** should be removed as a director and officer of the Bank and be prohibited from participating in the affairs of the Bank or any other FDIC-insured bank for a period of five years. The ALJ also concluded that Respondent *** should be removed as a director and officer of the Bank and be

   D. FDIC ENFORCEMENT COUNSEL'S
EXCEPTIONS TO THE ALJ'S RECOM-
MEND DECISION³

   On January 29, 1988, FDIC Enforcement Counsel filed Exceptions to the Recommended Decision of the ALJ. Those exceptions dealt with the following:
   1) The absence of specific findings of fact by the ALJ;
   2) The ALJ's denial of FDIC's motion to vacate the protective order;
   3) The ALJ's failure to consider all of the allegations against Respondents;
   4) The ALJ's proposed removal of Respondent *** for a period of only five years and of Respondent *** for a period of only six months (FDIC enforcement counsel sought permanent removal and a three year period, respectively);
   5) The ALJ's reduction of Respondent ***'s civil money penalty from $17,000 to $10,000; and
   6) The ALJ's failure to find that *** was a related interest of Respondent *** and the failure to impose a penalty upon him.

III. SUMMARY OF THE BOARD OF
DIRECTOR'S DECISION

   The Board has reviewed the record,⁴ the parties briefs,⁵ FDIC Enforcement Counsel's exceptions and the Recommended Decision of the ALJ. Although the Board's review of the ALJ's Recommended Decision unnecessarily was made more difficult by his failure to include complete findings of fact and conclusions of law and his lack of citation to the record, nevertheless, the Board[s] finds that the ALJ's statement of the facts and legal conclusions, except as to the appropriate remedies, are supported by the evidence in the record as a whole. Specifically, the Board agrees and finds that *** was a related interest of Respondent ***, but not of Respondent ***, that Respondent *** violated section 215.4(c) of Reg. O, and that both Respondents demonstrated a continuous disregard for the safety and soundness of the Bank and engaged in unsafe or unsound practices which resulted in a substantial financial loss to the Bank, in violation of section 8(e)(1) of the FDI Act.
   The Board, however, has also determined that the ALJ erred by not addressing all of the allegations in the Notice of Assessment and Notice of Intention and that he should have made findings of fact and conclusions of law as to each such allegation. The ALJ having failed to do so, however, the Board has undertaken an independent review of those issues that were alleged in the notices and the evidence presented at the hearing but not addressed by the ALJ. These issues are: first, whether Respondents violated sections 215.4(a) (preferential loans to insiders) and 215.4(b) (loans to insiders and their related interests without prior board approval) of Reg. O; and second, whether Respondents violated a rule, law, or regulation, breached their fiduciary duties as directors and officers, received financial gain from the *** transactions, and demonstrated a willful disregard for the safety and soundness of the Bank as set forth in section 8(e) of the FDI Act.

IV. DISCUSSION

   A. VIOLATION OF SECTIONS 215.4(a)
AND (b) OF REG. O

   [.1] The ALJ found and the Board agrees that *** was a related interest of Respondent ***⁶ due to his ability to exercise a controlling influence over managerial and financial decisions of the company as a result of his increased financial investment in it (TR. 575-6, 1094-5), and based on the numerous examples of his actual exercise of control of the day-to-day operations of ***⁷ (TR. 551, 554, 566-70, 573, 977, 984, 1006, 1011, 1048, 1051, 1054-5, 1059, 1061). The ALJ also found and the Board agrees that *** was not a related interest of Respondent *** because he did not and was unable to exert a controlling influence over the company as that term is defined in section 215.2(b).⁸ Indeed, Respondent *** was himself under the control of Respondent ***.⁹

   [.2] The ALJ found and the Board agrees that Respondent *** violated section 215.4(c) of Reg. O due to extensions of credit to him and to his related interests that were in excess of the lending limits of the Bank (FDIC Ex. 17). The ALJ, however, having found one violation of Reg. O (section 215.4(c)), determined it was unnecessary for him to address whether the overdrafts to *** also constituted preferential loans under section 215.4(a) or were made without prior board of directors' approval under section 215.4(b). This Board concludes that the ALJ erred in this respect, and that he should have decided these issues. Consequently, on the basis of the record, the Board must do so without the benefit of the ALJ's recommendation and make findings of fact and conclusions of law as to these alleged violations. We do so as set forth below.¹⁰

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   1. Violation of Section 215.4(a)

   [.3] The record establishes that extensions of credit to *** were also in violation of section 215.4(a) of Reg. O which prohibits extensions of credit to insiders or their related interests on preferential terms.¹¹ The extensions were preferential in that credit was extended at a lower effective rate of interest, in larger amounts and for longer periods of time than any similar credit extended to any other borrowers at the Bank (TR. 467); the credit to *** involved above normal levels of risk of repayment.
   The FDIC examiner assigned to review the overdraft activity at the October 30, 1985 examination of the Bank testified that the full value of all the assets as listed as the collateral equalled only $541,000 while ***'s indebtedness to the Bank and participating institutions was $815,000 resulting in a collateral deficiency of approximately $300,000 excluding the subject overdrafts (TR. 137, 454). There was a serious risk of non-repayment because of the technical insolvency of ***. The $11,000 of direct *** indebtedness to the Bank was in default and classified as a Loss (FDIC Ex. 1). As of October 31, 1985, *** had total assets of $627,000, total liabilities of $1,378,000, a negative net worth of $751,000 (TR. 121, FDIC Ex. 1 and 11) and negative net income of approximately $179,000, for the preceding eleven months (TR. 124). ***'s interest payments on its obligations had been delinquent for over two years (TR. 418). There had been no reductions in principal on any of ***'s direct extensions of credit or participations sold to other banks since their inception (TR. 114).
   Thus, due to the fact that the extensions of credit were at a lower effective rate of interest, in larger amounts and for longer periods of time than any credit extended to any other borrowers at the Bank, and involved more than the normal risk of repayment because of a lack of sufficient collateral and the insolvency of ***, Respondent *** violated section 215.4(a) of Reg. O.

   2. Violation of Section 215.4(b)

   [.4] The extensions of credit to *** also violated section 215.4(b) of Reg. O in that the extensions of credit in the form of overdrafts were made to a related interest of Respondent *** and did not receive the approval of a disinterested majority of the Bank's board of directors prior to their disbursement (TR. 381). Prior approval was required because the credit extended to Respondent *** exceeded 5% of the Bank's unimpaired capital and surplus (FDIC Ex. 17). Not only did the board not give its prior approval, on two occasions, on May 28, 1985 and July 26, 1985, the board resolved that no overdrafts were to be permitted in the account of *** (TR. 379, 1066, 1153 and FDIC Exs. 19 and 20). Thus, Respondent ***'s failure to obtain prior board approval violated section 215.4(b) of Reg. O.

   Having found that Respondent ***, while serving as an officer and director of the Bank, violated Reg. O, the Board concludes that a civil money penalty should be assessed.
   The ALJ concluded that, based on all the evidence presented, the civil money penalty should be reduced from $17,000 to $10,000. The ALJ determined that, while Respondent *** did violate Reg. O, he had justifiably relied on a 1981 letter from an FDIC regional counsel which stated that *** was not a related interest of Respondents.¹² The ALJ found Respondent ***'s reliance on the letter was an indication of

3. *** was charged $7.00 per overdraft (an effective rate of 3.4%) for a total of $1,400 in service charges (TR. 377-378).
4. *** should have been charged interest, which, using a 13.5% rate (the rate the Bank used for creditworthy customers with unsecured loans) would have cost it $8,419, approximately $7,000 more than it was charged (TR. 394-5).

   [.5] The Board finds that the assessment of the $17,000 civil money penalty originally proposed is justified and appropriate based on the entire record in this matter: Respondent *** violated three separate provisions of Reg. O—sections 215.4(a), (b) and (c); the violations were lengthy in duration and substantial in dollar amounts, and there is a history of previous violations of a similar nature. Respondent ***'s ability to pay is not an issue—he has a net worth of $6.6 million (Stip. Tr. pp. 161 and 910). Whatever good faith reliance there may have been by Respondent *** on the earlier FDIC letter indicating that *** was not a related interest, that reliance was unreasonable in this case in light of his training and experience as an attorney, accountant, and banker and his awareness of his increased influence and control over the operations of *** through his increasing personal investments in *** (FDIC Exs. 2(b), 5(b), and 6(b)), especially in the months between the July 18, 1984 and the October 25, 1985 examination. Furthermore, Respondent ***'s blatant disregard of the notice of the *** Commissioner of Banking that the transactions at issue in this proceeding were extensions of credit thereby resulting in violations of the *** lending limit statute, certainly calls into doubt his good faith with respect to these overdrafts (See FDIC Ex. 106(a))¹⁸. Another factor that the Board has

3. Financial Gain to Respondents

   Respondents obtained personal financial gain as a result of the extensions of credit to ***. The nature of the overdrafts, which resulted form payments of interest due on *** loan participations held at other banks, suggests that the Bank was providing interest-free funding for the continued operation of *** (Tr. 882). This continued operation of *** through the interest-free use of Bank funds, personally benefited Respondents as shareholders and creditors of ***.
   In addition, by keeping *** in business, the Respondents also gained financially by delaying the time when their personal guarantees of ***'s debt would have to be honored (TR. 896-897, 945). The fact that Respondent *** had sufficient personal financial resources to meet his obligation as guarantor does not overcome the fact that as long as *** was in business, he continued to have the use of the funds needed to clear the overdrafts and the income earned from those funds (Tr. 1121, 1043).
   Respondents argue that they did not intend to gain financially by their conduct and that any amount of interest payment saved was wholly insignificant compared to Respondent ***'s personal financial wealth. While the amount of interest expense saved may have been small when compared to his total wealth, it was not insignificant. The statute does not require either a finding of intent to gain or that the gain be substantial —merely evidence of financial gain. The evidence in this record supports such a conclusion.

4. Willful Disregard for the Safety and
Soundness of the Bank

   [.8] The ALJ determined and the Board agrees that Respondents' conduct demonstrated a continuing disregard for the safety and soundness of the Bank. The practice of approving *** overdrafts continued for almost a year in substantial amounts at a time when the solvency of *** was in doubt and with only verbal assurances of repayment from Respondent ***. These actions were intentional and posed a serious threat to the safety and soundness of the Bank.
   Based on the record, the Board concludes that Respondents' conduct also constituted a willful disregard for the safety and soundness of the Bank. Respondents' conduct was deliberate and occurred in the face of their full knowledge of all of the facts (Tr. 1003, 1039). Respondent *** approved the overdrafts knowing that the funds would be used as working capital for ***, a company he knew or should have known to be insolvent or in danger of insolvency. Respondent *** admitted directing Respondent *** to pay the *** overdrafts and that he was aware of the frequency in which they were occurring (Tr. 1003, 1092). Respondents
{{4-1-90 p.A-1245}}argued, however, that ***'s verbal assurances that the overdrafts would be repaid reflected their regard for the Bank's safety. However, no personal guaranty was ever executed (Tr. 1039, 1065), and verbal assurances are not legally binding. To extend inadequately secured credit as Respondents did here evidences a willful disregard for the safety of the Bank.
   Respondents' also argued that their reliance on the 1981 FDIC letter negates any showing of willfulness. Even if Respondents' were, in fact, reasonably entitled to rely on that letter in extending unsecured credit to *** as an unrelated party, the credit was still knowingly and repeatedly extended over a period of time to a financially risky business entity without adequate collateral and without properly documented and enforceable guarantees. No reasonable and prudent bank officer or director would knowingly engage in this type of lending practice. Such a practice is an obvious threat to the safety and soundness of a bank when it places at serious risk a substantial amount of bank funds. Thus, in the face of their knowledge of the factual circumstances of *** and their experience as bankers, Respondents' conduct can only be characterized as demonstrating a willful disregard for the safety and soundness of the Bank.

   D. THE APPROPRIATE REMEDY FOR
RESPONDENT ***'S SECTION 8(e)(1)
CONDUCT

   FDIC enforcement counsel sought to remove Respondent *** from his position as an officer and director of the Bank and to prohibit him from participating in the affairs of any other FDIC-insured institution. The ALJ, on the basis of the statute's grant of broad discretion to impose an appropriate remedy and on his perception that Respondent ***'s conduct was atypical and not likely to recur, recommended removal for a fixed five-year term.

   [.9] On the basis of the serious nature of Respondent ***'s conduct and this Board's conclusions that, in addition to the elements cited by the ALJ, Respondent *** violated additional elements of section 8(e) by violations of two additional subsections of Reg. O and the *** state lending limit, by breaching his fiduciary duty, by receiving personal financial gain, and by demonstrating a willful disregard for the safety and soundness of the Bank, the Board concludes that the ALJ's proposed remedy inadequately reflects the seriousness of Respondent ***'s actions and conduct. The Board, therefore, orders that Respondent *** be permanently removed from banking pursuant to the terms of section 8(e).

   E. THE APPROPRIATE REMEDY FOR
RESPONDENT ***'S SECTION 8(e)(1)
CONDUCT

   Section 8(e)(5) provides that an "agency may issue such orders of suspension or removal from office, or prohibition from participation in the conduct of the affairs of the bank as it may deem appropriate" (emphasis added). As suggested by the ALJ, this language grants the Board authority to fashion a remedy that is appropriate considering all of the circumstances. The legislative history of section 8(e) indicates that Congress desired to provide regulatory agencies with the mechanism to eradicate insider abuse and to protect the banking industry. Section 8(e) became an additional remedy to the already existing penalty of insurance termination to provide bank regulatory agencies the flexibility to take effective action against individuals that jeopardized the integrity of a bank without imposing the more disruptive and uncertain sanction of insurance termination. The Board has concluded that imposition of a fixed term suspension or removal is consistent with the legislative history, language, and purpose of section 8(e). Imposition of a term removal allows the agency to deal with insider abuse while fashioning a sanction that it deems appropriate considering the circumstances of each case.
   The Board finds that in this case the ALJ's proposed remedy²¹ for Respondent *** inadequately reflects the serious nature of his actions and the severity of the threat to the Bank. A six month suspension simply is not an appropriate remedy for the offenses involved. This Board, therefore, finds that removal of Respondent *** from the Bank and prohibition from participation in the conduct of the affairs of any other FDIC-insured institution for a period of three years is the appropriate remedy in this instance.

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   [.10] While the evidence establishes that Respondent ***'s involvement in the extensions of credit to *** aided in the violations of the state lending limit statute, breached his fiduciary duty, and represented a willful and a continuing disregard for the safety and soundness of the Bank which resulted in personal financial gain and thus warrants his removal under 8(e), Respondent ***'s conduct was different from that of Respondent ***. The record indicates that Respondent *** was dominated by Respondent ***, that he acted at ***'s command, that he had a lesser financial stake in *** and had a lesser degree of involvement in the *** transactions. Respondent ***'s lesser culpability leads us to conclude that a term removal of three years is just.

   F. THE PROTECTIVE ORDER IS
INVALID

   On June 2, 1987, the ALJ granted Respondents' motion for entry of a protective order. At the time, the FDIC made no objection and the protective order was entered and subsequently attached to third-party subpoenas. Respondents argue that they requested the protective order to ensure the privacy of the proceedings. However, the right to a private administrative proceeding is expressly granted by 12 U.S.C. §1818(h)(1) unless this Board makes a specific determination that an open proceeding is necessary to protect the public interest. No such determination was made in this matter.
   On July 6, 1987, the first day of the hearing, FDIC enforcement counsel moved to vacate the protective order. The ALJ directed the parties to brief this issue. In its brief, enforcement counsel argued that the protective order should be vacated on the grounds that Respondents have no constitutional right to be protected from disclosure, that disclosure is discretionary with the FDIC, that the protective order was overbroad, ambiguous, and too restrictive upon the FDIC, and that it infringed upon First Amendment Rights. Respondents, on the other hand, contended that the protective order gave no more than the statute allowed and it was in a form familiar to the FDIC. The ALJ attempted to resolve this issue in a footnote (Rec. Dec. at 2). The ALJ determined that the FDIC waived its right to raise the validity of the protective order because the FDIC failed to object to the protective order prior to the hearing and that, in any event, the protective order was appropriate to insure that third parties subpoenaed to testify at the hearing were aware of the confidentiality and privacy features contained in the FDIC Rules and Regulations.
   It is this Board's view that the protective order was unnecessary in view of section 8(h)(1). In fact, the propriety of a protective order in a proceeding such as this is highly questionable since both the ALJ and this Board lack the authority to both enforce compliance or to punish violations of such an order. At most, it appears that the protective order was an unenforceable moral obligation as to those persons who agreed to be bound by it. Even if the protective order was somehow enforceable, its binding effect would last no longer than the duration of the administrative proceeding. Moreover, this Board cannot and will not be bound by any such administrative order by an ALJ that attempts to restrict its authority to disclose matters that are left to its discretion by statute or regulation. Therefore, the protective order at issue here is unnecessary and void, and the issue is considered moot.

V. CONCLUSION

   The Board finds that Respondent *** violated Reg. O and that a $17,000 civil money penalty should be assessed against him; that an order under section 8(e)(1) should be issued as to Respondent *** removing him from the Bank and prohibiting him from participating in the conduct of the affairs of any other FDIC-insured institutions; and that an order under section 8(e)(1) should be issued as to Respondent *** removing him from the Bank and prohibiting him from participating in the conduct of the affairs of any other FDIC-insured institution for a period of three years.

ORDER TO PAY CIVIL MONEY
PENALTIES AND ORDER OF
REMOVAL AND PROHIBITION
FROM FURTHER PARTICIPATION

   For the reasons set forth in the above Decision, the Board of Directors of the Federal Deposit Insurance Corporation hereby ORDERS that:

1. A civil money penalty in the amount of $17,000 be, and is, assessed against Respondent ***, pursuant to section 18(j)(3) of the FDI Act, 12 U.S.C. 1828(j)(3);

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2. Pursuant to section 8(e)(1) of the FDI Act, 12 U.S.C. §1818(e)(1), Respondent *** is removed as a director and officer of *** Bank, *** and prohibited from participation in any manner in the conduct of the affairs of the Bank or any other FDIC-insured institution.
3. Pursuant to section 8(e)(1) of the FDI Act, 12 U.S.C. §1818(e)(1), Respondent *** is removed as a director and officer of *** Bank, ***, and prohibited from participation in any manner in the conduct of the affairs of the Bank or any other FDIC-insured institution for a period of three years from the effective date of this Order.

/s/ Robert E. Feldman
Hoyle L. Robinson

   Executive Secretary

RECOMMENDED DECISION AND
ORDER

FDIC 87-61e
FDIC 87-62k

   WILLIAM A. GERSHUNY, Administrative Law Judge: A consolidated hearing was conducted in ***, during the period July 6-15, 1987, on Notice of Intention to Remove from Office issued April 14, 1987, pursuant to Sec. 8(e)(1) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(e)(1), and a Notice of Assessment of Civil Money Penalties issued April 1, 1987, pursuant to Sec. 18(j)(3) of the Act, 12 U.S.C. 1828(j)(3), based on the existence of overdrafts in the account of a related interest for approximately 332 days during the period of July 1984 through August 1985, in the average amount of $68,000, with only the imposition of the customary $7.00 overdraft charge and without interest.
   Neither notice alleges personal dishonesty on the part of either Respondent and, at the hearing, counsel for the FDIC expressly stated that the FDIC makes no such contention (Tr. 76). Moreover, the record evidence discloses no basis for such a suggestion, finding of fact, or conclusion of law.
   For the reasons set forth below, I find and conclude (1) that each Respondent has demonstrated a willful and continuing disregard for the safety and soundness of the Bank by engaging and participating in an unsafe or unsound practice relating to the *** overdrafts which produced a substantial financial loss to the Bank; and (2) that Respondent *** violated Regulation O based on the *** overdraft transactions. Based on these findings and conclusions, I recommend (1) that, pursuant to Sec. 8(e)(1) of the Act, the FDIC, for a period of five years from the date of the final order in this case, remove Respondent *** as a director and officer of the Bank and prohibit him from participating in any manner in the conduct of the affairs of the Bank or any other FDIC-insured bank, and that, pursuant to Sec. 18(j)(3) of the Act, a civil money penalty of $10,000 be imposed on him, based on the Regulation O violation; and (2) that, pursuant to Sec. 8(e)(1) of the Act, the FDIC, for a period of six months from the date of the final order in this case, remove Respondent *** as a director and officer of the Bank and prohibit him from participating in any manner in the conduct of the affairs of the Bank or any other FDIC insured bank.
   Pursuant to Sec. 308.13(b) of the FDIC Rules and Regulations, and based on the entire record,^* I hereby make the following:

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Findings of Fact and Conclusions of Law

I. Jurisdiction

   The Notices allege, Respondents admit, and I find that Respondent ***, as Chairman of the Board of an insured State nonmember bank and a principal shareholder (39.6%), and Respondent ***, as President and as a director of the bank, are subject to the jurisdiction of the FDIC and its rules and regulations.

II. The Allegations and Contentions

   A. The Allegations of the Notices. The "removal" notice alleges that *** and *** are related interests of each Respondent within the meaning of Regulation O by reason of their ownership interests and their power to exercise a controlling influence over the management or policies of the companies; that, despite the deteriorating financial condition of *** Respondents caused and permitted the company to overdraw on its account, over a period of more than a year, in amounts averaging $68,000; that, because of the large amounts and lengthy period of time involved, these transactions amounted to unsecured credit extensions at preferential rates of interest, with more than the normal risk of repayment, without prior approval of the board of directors, and in excess of lending limit restrictions; and that such transactions also violated State lending limit restrictions. The notice also also alleges that these transactions constituted unsafe or unsound banking practices and that Respondents breached their fiduciary duty by acting with impermissible conflicts of interest as personal creditors of ***, as principals of *** in its capacity as borrower from the Bank, as lending officers of the Bank, as Bank officials contractually responsible for servicing *** loans on behalf of a participating bank, and as personal guarantors on loans made and participated out by the Bank. The notice also alleges a substantial loss to the Bank of approximately $7,000 by reason of its charging only a $7.00 overdraft charge rather than the current rate of interest for unsecured credit, and that Respondents received financial gain by reason of ***'s continued existence and their not being called upon to honor their personal guarantees to the participating bank. Finally, the removal notice alleges that the facts demonstrate a willful and continuing disregard for the safety and soundness of the Bank. The notice seeks the removal of Respondents, under Section 8(e)(1) of the Act, from their positions at the Bank or any other FDIC-insured bank; in its posthearing brief, however, the FDIC indicates that it seeks only to remove Respondent *** for a period of three years.
   The civil money penalty notice alleges the same overdraft transactions, and seeks to impose on Respondent *** a penalty of $17,000 and on Respondent *** a penalty of $3,500, based on the violations of Regulation O.
   B. The Contentions of Respondents. Respondents contend that *** is not a related interest because neither has the requisite stock ownership or the ability to exercise a controlling interest in the company, and that they were not afforded the statutory opportunity to rebut any presumption of control prior to initiation of an enforcement proceeding. They also contend that a formal January 23, 1981 legal opinion of then FDIC Regional Counsel *** expressly declaring *** not to be a related interest of Messrs. *** and ***, and *** loans not to be subject to Regulation O is determinative of that issue and that, in the alternative, the FDIC's recognition and acceptance of that opinion without question during a number of examinations from 1981 until the 1985 examination (on which these cases are based) completely negates the essential "scienter" element of the removal statute; that the *** overdrafts cannot be considered extensions of credit for purposes of Regulation O, because Sec. 215.4(d) of the Regulation, which specifically deals with prohibited overdrafts, does not by its terms encompass overdrafts of related interests and thus evidences a regulatory intent that overdrafts be tested for legality only under that provision. Respondents also contend that $7,000 of lost interest (even assuming

III. The *** Overdrafts

   Between July 19, 1985 and August 4, 1986, the *** checking account was overdrawn on 332 days, in amounts ranging from $122 to $160,597, for an average of approximately $68,000 per day. The overdrafts were created by the payment of checks drawn on the *** account and through direct debits by the Bank to the account. Acting at the express direction of Chairman *** and upon ***'s assurances that such payments were appropriate and that he, ***, would cover them personally, President *** approved these payments and debits. In this connection, the record evidence reveals, and my observation of each of the Respondents while testifying confirms, that ***, as a principal shareholder of the Bank, an attorney, and a certified public accountant with wide-ranging domestic and foreign business interests, exercised exclusive control over the *** transactions through domination and coercion of the unsophisticated ***.
   For each overdraft, *** was charged the customary $7 overdraft charge, for a total of $1,400 in service charges. The Bank, at the time, had no overdraft policy in effect which would govern overdrafts of this duration and amount. A number of these overdrafts were paid by the Bank despite Board of Director resolutions of May 28, 1985, and July 26, 1985 (passed at the request of the State Commissioner of Banking) which specifically prohibited further overdrafts in the *** account.
   At no time did the Bank enter into a preauthorized overdraft agreement with *** or prearrange a credit line for purpose of overdraft protection.
   At no time did either Respondent withhold from state or federal examiners any fact relating to these overdrafts and, as stated above, the FDIC does not allege or contend that either Respondent engaged in personal dishonesty relating to these transactions.
   These *** overdrafts, given their frequency and amounts, must for purposes of these cases be treated as unsecured extensions of credit. Overdrafts typically are in small amounts, at infrequent intervals, of short duration, and the result of inadvertence. They typically are approved for payment only after a determination that the customer has the ability to promptly repay the funds. The *** overdrafts have none of these characteristics, and it is quite clear on this record that the practice was utilized to avoid the higher interest costs which would be applied if the funds were borrowed.

IV. Section 8(e)(1) Removal

   A. The Essential Elements. Section 8(e)(1) of the Federal Deposit Insurance Act provides for the removal of officers and directors of an insured bank. Admittedly, each Respondent is subject to this provision. The provision establishes three separate and distinct categories of essential elements, each with a number of alternative grounds. The first category relates to the wrongful conduct that must be established to support a removal action: (1) "any violation of law, {{4-1-90 p.A-1250}}rule, or regulation or of a cease-and-desist order which has become final;" or (2) "any unsafe or unsound practice in connection with the bank;" or (3) "any act, omission, or practice which constitutes a breach of his fiduciary duty." The second category relates to the effect of the wrongful conduct: (1) "the bank has suffered or will probably suffer substantial financial loss or other damage;" or (2) "the interests of its depositors could be seriously prejudiced;" or (3) "the director or officer has received financial gain." The third category relates to the mental state of the director or officer, i.e. "scienter:" (1) "personal dishonesty" or (2) "a willful or continuing disregard for the safety or soundness of the bank."
   Here the FDIC relies on each of the alternative elements to support removal of Respondents *** and ***, except violation of a final cease-and-desist order, serious prejudice to the interests of the depositors, and personal dishonesty on the part of either Respondent. As noted above, I find and conclude (1) that both Respondents caused the Bank to engage in an unsafe or unsound banking practice; (2) that the Bank has suffered a substantial financial loss; and (3) that both Respondents have exhibited in this connection a willful and continuing disregard for the safety and soundness of the Bank. Having found that the FDIC has met its burden under Section 8(e)(1), I decline at this time to consider its alternative bases for removal. An important element of the doctrine of judicial restraint is that only those issues necessary to the decision be resolved.
   B. The *** Overdrafts as an Unsafe or Unsound Banking Practice. An unsafe or unsound banking 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 of loss or damage to an institution. 112 Cong. Rec. 126474; First National Bank of Eden v. Department of Treasury, 568 F.2d 610, 611 (8th Cir. 1978); First National Bank of LaMarque v. Smith, 610 F.2d 1258, 1265 (5th Cir. 1980). The opinion of Examiner ***, which I credit and adopt, is that by permitting the *** overdraft activity to continue to the extent it did between July 1984 and August 1985, Respondents caused the Bank to engage in such an unsafe or unsound banking practice. His opinion was shared by Assistant Regional Director ***, and Respondents offered no expert opinion to the contrary. These opinions rested on a set of virtually uncontroverted facts; that an overdraft situation existed for 332 days, in amounts ranging from $122 to $160,000, for an average of $68,000; that Respondent *** directed *** to honor the checks and assured him that he personally would cover them; that *** approved the overdrafts, despite express directions from the Board of Directors in the Spring and Summer of 1985 not to do so; that no interest was charged on any of the overdrafts despite the fact that such overdrafts were in the nature of loans and no attempt was made to compel *** to enter into an agreement to pay interest; that a number of the overdrafts resulted from the Bank's payment of ***'s interest obligations to a participating bank from its correspondent account and the debiting of ***'s account at the Bank; that ***'s financial statements covering the period reflected a loss history and a rapidly deteriorating condition that for all intents and purposes *** was insolvent; that ***'s interest payments on its direct obligations to the Bank were delinquent for a considerable period of time and there had been no principal reductions: that ***'s efforts to liquidate inventory had been unsuccessful; and that, apart from the overdrafts and without taking into account the guarantees of Respondents, the book value of collateral for the *** indebtedness to the Bank and the participating banks was inadequate by at least $300,000. ARD *** opined that under these circumstances "a prudent banker would have long since tried to shut them [the overdrafts] off or else try to protect themselves if they were relying on some kind of oral representation [of ***]." I can only conclude that the Bank, through Messrs. *** and ***, engaged in an unsafe or unsound banking practice in connection with the *** overdraft activity between July 1984 and August 1985.
   C. The Substantial Financial Loss to the Bank. Commissioned Examiner ***, whose testimony I credit, calculated the financial loss suffered by the Bank by reason of charging *** only with the $7 overdraft charge and not interest. Using a 13.5% rate (which the Bank used for creditworthy customers with unsecured loans), he calculated that the Bank would have earned $8,419 in interest on the overdrafts if they had been treated as loans. Offsetting this amount with the $1400 overdraft charges actually {{4-1-90 p.A-1251}}collected, the Bank's loss of interest is approximately $7,000. This amount represents 10-20% of the Bank's 1984 earnings. Moreover, the Bank incurred an expense or cost of funds when it advanced these overdrawn funds to ***. The Bank's 1984 cost of funds was 8.4%. And, finally, the Bank lost interest income through its correspondent accounts, when those accounts were debited to make ***'s interest payments to the participating banks. I conclude that these losses, however imprecise they may be (and certainly Respondents can derive no benefit from the fact that losses flowing from their violative conduct are incapable of a more precise calculation), are substantial within the meaning of Sec. 8(e)(1). Congressional intent is clear in this regard—whether the loss is "substantial" is not to be determined with respect to the size of the bank, for to "rule otherwise would inflate the degree of harm needed to be shown as the size of the bank increased." S. Rep. No. 323, 95th Cong., 1st Sess. 7 (1977). In this connection, I credit the opinion of Assistant Regional Director *** as to the substantiality of the loss compared with 1984 earnings of the Bank. More importantly, however, common experience dictates that a $7,000-plus loss be deemed to be a substantial one.
   D. The Willful or Continuing Disregard for the Safety or Soundness of the Bank. Although neither the statute nor its legislative history defines "willful or continuing disregard," the legislative history cited in the FDIC brief makes clear that Congress did not intend that removal be only for personal dishonesty, gross negligence, or a single breach of duty. This provision has been judicially construed by the Court of Appeals in Brickner v. FDIC, 747 F.2d 1198, 1202-3 (8th Cir. 1984):

   We agree...that "willful disregard" and "continuing disregard" present two distinct, alternative standards for removal. The use of the disjunctive "or" between the words "willful" and "continuing" in the statute reveals a clear intent to make either one an offense.
   [A]lthough "continuing disregard" may require some showing of knowledge of wrongdoing, it does not require proof of the same degree of intent as "willful disregard."

V. Section 18(j)(3) Civil Money Penalties

   A. Violations Subject to Penalties. Sec. 18(j)(3) of the Act authorizes the imposition of civil money penalties for statutory violations only. The commission of unsafe or unsound banking practices does not subject a bank or its officers and directors to such penalties, and thus the findings and conclusions above, while sufficient to support an order of removal or suspension under Sec. 8(e) of the Act, are irrelevant here. The only statutory violation alleged in the civil money penalty notice is that of Sec. 22(h)(3) of the Federal Reserve Act, implemented by Regulation O, 12 CFR 215.
   B. *** as a Related Interest of Respondents. Regulation O, promulgated by the Federal Reserve Board to implement Sec. 22(h)(3) of the Federal Reserve Act, 12 U.S.C. 375b, and made applicable to insured state nonmember banks by Sec. 337.3 of FDIC Rules and Regulations, is intended to curb the granting of preferential credit terms to bank "insiders," i.e. executive officers, directors, and principal shareholders, and to their "related interests." Sec. 215.2(k) defines "related interests" as "a company that is controlled by a person..." "Control of a company" is defined by Sec. 215.2(b)(1)(iii) as "the power to exercise a controlling influence over the management or policies of the company." Individuals like Respondents are rebuttably presumed under Sec. 215.2(b)(2) to have control where, as here, they are executive officers or directors of the company and have the power to vote more than 10 percent of the stock of the company. Both were executive officers and directors of ***, and each owned 20 percent of the stock.
   The conclusion to be drawn from the record evidence before me is inescapable— *** is a related interest of Respondent ***. Indeed, in responding to my questions at the hearing, Mr. *** conceded that, as ***'s sometime attorney and accountant, as its creditor and banker, as guarantor of its notes, and as an executive officer and director of the business, he had the power to exercise a controlling influence over the management and policies of *** (Tr. 1094-5). Wholly apart from Mr. ***'s conclusory admissions made during the hearing, the record evidence is replete with examples of the actual exercise of his control of the day- {{4-1-90 p.A-1253}}to-day operations of the company: he was an incorporator and sometimes attorney; he conceived and executed a plan for the absorption of *** by one of his companies; he conducted a detailed examination of the company's cash flow, cost of sales and other expenses, and prepared a document for use by the company's creditors; he directed the payment of accounts payable and the liquidation of major portions of the company's inventory; he interviewed and hired a controller for the company; he travelled on behalf of the company to floral trade shows to gain expertise in the business and to examine one of its properties in Florida for purposes of evaluating its usefulness; he received director's fees ranging from $500-$600 a month; he borrowed money for the use and benefit of the company; he personally funded the company's experimental "greens" process, and purchased approximately $400,000 of *** notes from a participating bank; and, admittedly, he was the only person with the financial capacity to keep the troubled *** afloat.
   The conclusion that ***, at all relevant times, was a related interest of Respondent *** is not affected by the 1981 legal opinion of then FDIC Regional Counsel *** to the contrary. At the hearing, counsel for the FDIC stated that the FDIC does not disavow that 1981 opinion, but takes the position here that it was based on misrepresentations of fact or, in the alternative, that the material facts have changed between 1981 and 1985. It is unnecessary to consider either of these assertions, for the reason that it is the responsibility of the fact-finder, based on the record evidence compiled in these proceedings, to decide the issue of related interest. It is wholly immaterial what opinion was expressed in 1981, what information was then available to the Regional Counsel, or whether the opinion was correct. The determination of related interest is to be made on the basis of evidence received in these cases bearing on the relationship between Respondent *** and *** during the relevant period of time. Whether the existence of that legal opinion and its recognition and acceptance by the FDIC for four years until the 1985 examination, with full access to all relevant facts, are relevant to other issues is considered below. Similarly, it is unnecessary to consider the contention that other statutory provisions, i.e. Sec. 23A of the Federal Reserve Act, contemplate an opportunity to rebut the presumption of control before initiation of an enforcement proceeding, for the reason that no such pre-enforcement element is included in the statute. Suffice it to say that, under Regulation O, a respondent specifically is afforded an opportunity to rebut the presumption, and in this case Respondents took full advantage of that opportunity and introduced a considerable amount of evidence. In addition, FDIC does not rely here solely on the basis of a rebuttable presumption; it has directly established control, without reliance on a presumption, under Sec. 215.2(b)(iii) of the Regulation.
   The record evidence, however, will not support a conclusion that *** is a related interest of Respondent ***, and it serves to rebut, beyond any doubt, the statutory presumption to the contrary. Like ***, Mr. *** was an officer (treasurer) and director of ***, was an original investor, received director's fees, and attended business meetings. But Sec. 215.2(b)(3) of Regulation O states that these elements alone are not to be considered "control." Whatever additional acts were performed by him clearly were the product of domination and economic coercion on the part of Mr. ***. As discussed above at pages 4-5, Mr. *** played a dominating role in the operation of the Bank by reason of his position as principal shareholder and as an attorney and accountant with wide-ranging domestic and foreign business interests. This was readily apparent not only from a review of the documents and the substance of their testimony. Mr. *** is a man used to being in control, a man of definite opinions about the most complex of financial matters. Mr. ***, on the other hand, is a passive man, comfortable and apparently quite able in his position as president of a small agricultural bank in a rural area. The former was in control of the complex business transactions of the Bank; the latter, the routine agricultural business. The former put together complex deals, including all *** transactions and its contemplated absorption by one of ***'s companies; the latter followed blindly, honestly understanding little of the nature and effect of the papers prepared by *** and given to him for signature, relying instead on the integrity and judgement of the former. To contend, as the {{4-1-90 p.A-1254}}FDIC does here, that Respondent *** had either the power to exercise control or did in fact exercise control in the affairs of *** is to ignore completely the testimony and, more important, the nature of the man. I am unable to find and conclude that Respondent ***, by reason of his nature or his investment position or his position with the Bank, either had or exercised such power. To the contrary, I find that, as to all dealings concerning ***, Respondent *** was dominated and controlled by ***.
   C. The Overdrafts Violated Lending Limit Provisions of Regulation O. Paragraph 4(c) of the Notice alleges that the *** credit extensions in the form of overdrafts violated the lending limit provisions of Regulation O, Sec. 215.4(c). That provision prohibits the extension of credit to any related interest of an executive officer or principal shareholder in an amount that, when aggregated with the amount of credit extended to that person and all related interests of that person, exceeds 15 percent of the Bank's unimpaired capital and surplus, in the case of loans that are not fully secured. An additional 10 percent of the Bank's unimpaired capital and surplus is allowed in the case of fully secured loans. The *** overdrafts have been held in Part IV-B above to be extensions of credit.
   Respondent *** does not dispute the calculations of lending limits as applied to him —during the relevant period, it ranged from $281,000 to $305,000. Similarly, he does not dispute the fact that the *** overdrafts exceeded these limits on 164 occasions by excessive amounts. I find and conclude that credit extensions to Respondent *** and his related interests during the relevant period violated the lending limit provisions of Sec. 215.4(c) of Regulation O.
   Having found one violation of Regulation O, I find it unnecessary to decide whether the overdrafts to *** also constituted preferential loans under Sec. 215.4(a) or were made without prior Board approval under Sec. 215.4(b). Nor is it necessary to consider whether, as contended by Respondents, overdrafts are not to be treated as credit extensions within the meaning of Sec. 215.4(a) and (b) of Regulation O, because they are specifically covered under Sec. 215.4(d). As concluded above, the *** overdrafts are overdrafts in name only; in substance, they are and were intended by Respondent *** to be interest-free credit extensions, not overdrafts. Moreover, they had none of the characteristics of overdrafts. And, finally, Regulation O specifically defines an extension of credit to include an "advance by means of an overdraft..." Sec. 215.3(a)(2). I have no authority to disregard an explicit definition in an implementing regulation promulgated by the Federal Reserve Board and the Federal Deposit Insurance Corporation. That argument properly is addressed, upon review, to the agency itself and to the appellate court.
   D. The Civil Money Penalty. Having found that Respondent *** violated Regulation O, I now consider the issue of the amount of the penalty which I recommend be assessed.
Section 18(j)(3) of the Act provides:

   In determining the amount of the penalty, the [FDIC] shall take into account the appropriateness of the penalty with respect to the size of the financial resources and good faith of the member bank or person charged, the gravity of the violation, the history of previous violations, and such other matters as justice may require.

   Pursuant to Sec. 308.13 of the FDIC Rules and Regulations, I recommend:
   (1) that, pursuant to Sec. 8(a)(1) of the Act, the FDIC, for a period of five years from the date of the final order in this case, remove Respondent *** as a director and officer of the *** BANK and prohibit him from participating in any manner in the conduct of the affairs of said BANK or any other FDIC-insured bank;
   (2) that, pursuant to Sec. 8(e)(1) of the Act, the FDIC, for a period of six months from the date of the final order in this case, remove Respondent *** as a director and officer of the *** BANK and prohibit him from participating in any manner in the conduct of the affairs of said Bank or any other FDIC-insured bank; and
   (3) that, pursuant to Sec. 18(j)(3) of the Act, the FDIC assess a civil money penalty of $10,000 against Respondent ***.
   Dated: December 28, 1987.

/s/ WILLIAM A. GERSHUNY
Administrative Law Judge