Home > Regulation & Examinations > Bank Examinations > FDIC Enforcement Decisions and Orders |
|||
FDIC Enforcement Decisions and Orders |
|
Bank ordered to cease and desist from numerous unsafe and unsound practices. Board declined to use its discretion to delay publication of the cease and desist order because the Bank had not shown "exceptional circumstances" under which publication would threaten its safety or soundness. (This order was terminated by order of the FDIC dated 2-25-93; see ¶
{{5-31-91 p.A-1657}}
[.2] Cease and Desist Orders Defenses Improved Condition
[.3] Directors and Officers Unauthorized Compensation Fiduciary Duty
[.4] Cease and Desist Orders Publication Exceptional Circumstances
[.5] Evidence Arising after Issuance of Notice
[.6] Cease and Desist Orders Termination
In the Matter of
This proceeding is brought pursuant to section 8(b)(1) of the Federal Deposit Insurance Act ("FDI ACT"), 12 U.S.C. § 1818(b)(1), for an order requiring Bank of Salem, Salem, Arkansas ("Insured Institution" or Respondent"), and its board of directors to cease and desist from certain unsafe and unsound banking practices and to correct the conditions resulting therefrom. After an examination of the Insured Institution by the Federal Deposit Insurance Corporation ("FDIC") as of May 26, 1989, the FDIC concluded that the Insured Institution is operating: 1) with inadequate capital and reserves; 2) with an excessive volume of poor quality assets and inadequate provisions for liquidity; 3) with management whose policies and practices are detrimental to the Insured Institution and jeopardize the safety of its deposits; and 4) in violation of certain laws and regulations.
II. STATEMENT OF THE CASE
On May 23, 1989, the FDIC's Memphis Regional Office ("Regional Office") began an examination of Bank of Salem and found that the Insured Institution's condition had seriously deteriorated since the prior FDIC examination of November 1, 1985.4 Adversely classified assets totaled $7,913,000, of which $7,379,000 were loans. Approximately $6,939,000 of the loans were classified as "Substandard," $236,000 as "Doubtful," and $204,000 as "Loss." This was a dramatic increase from the 1985 examination.5 The ratio of adversely classified loans increased from 9.3 percent to 22.2 percent. The change in adversely classified loans consisted of $3,838,000 in newly extended credits and $2,359,000 in loans not previously classified. In addition to the large volume of loans adversely classified, the Report of Examination expressed concern as to the Insured Institution's capital position, the adequacy of its loan loss reserve, its excessive concentration of credit, its poor liquidity management and the inadequate supervision of its officers. The Insured Institution was cited for violations of section 22(h) of the Federal Reserve Act and sections 215.4 and 215.7 of Regulation O.
III. THE ALJ'S RECOMMENDED
The ALJ concluded that all of the adverse loan classifications made by the FDIC examiner were supported by the facts in evidence and further concluded that the Insured Institution had engaged in the following unsafe and unsound banking practices: hazardous lending and lax collection practices, disproportionate quantity of poor quality loans, inadequate capital and reserves, inadequate loan loss reserves, inadequate supervision of lending activities by the Insured Institution's board of directors, and inadequate liquidity. The ALJ also found that the chairman of the board of directors, Richard T. Smith, breached his fiduciary duties by conditioning the approval of loans or extensions of credit on his receipt of a part of the proceeds.
IV. DISCUSSION
The Board has carefully reviewed the entire record of this proceeding, including the Recommended Decision, the briefs of the parties, and the exceptions. The Board concludes that most of the Insured Institution's exceptions reargue matters previously raised before the ALJ and which were adequately addressed by the ALJ. For the reasons set forth below, the Board finds the Insured Institution's other exceptions unpersuasive. The Board therefore adopts the ALJ's Recommended Decision except as modified herein.
The low capital-to-asset ratio and high level of classified assets are indicative of the Insured Institution's deteriorated condition. Since the 1985 examination, the volume of
{{5-31-91 p.A-1660}}assets subject to classification, primarily lending related, had increased significantly. This large percentage of adversely classified loans7 served as the factual basis for the charges of hazardous lending and lax collection practices, a disproportionate quantity of poor quality loans in relation to total loans (16.2 percent), inadequate unimpaired capital, inadequate loan loss reserves and negligent supervision by the board of directors, resulting in the poor condition of the Insured Institution.
[.1] Based upon the 1989 examination, FDIC Enforcement Counsel alleged that twenty-three loans were subject to adverse classifications based upon the following credit weaknesses:
[.2] It is clear that the Insured Institution's condition need not deteriorate to the point that it is on the verge of insolvency before it may be found to have engaged in unsafe or unsound banking practices. The Insured Institution, on the other hand, alleges that there has been substantial improvement in its financial condition since the 1989 examination and offered some evidence showing that adversely classified loans had improved. This alleged improvement is, however, unsubstantiated. For example, even giving the Insured Institution the benefit of the doubt as to that evidence which it presented on classified assets as they substantiate the improvements in the institution's capital position, it is at best a limited view as to the current condition of the Insured Institution. It does not provide an objective view of the current condition of the Insured Institution's remaining assets. Often, a bank focuses its energy entirely upon correcting problem assets and it fails to give adequate attention to preserving its remaining assets, which suffer as a result. The Board has heard this argument numerous times in the past in enforcement proceedings. The Board finds it equally unpersuasive in this case. Generally, such evidence goes to a bank's compliance with a corrective order, not the need for such an order. The same is true hereif improvement has occurred and it is substantiated in an objective manner by FDIC supervisory personnel, it could lead to modification of the Cease and Desist Order by the Regional Office or even to a sooner termination of the Order. Therefore, the Board declines to adopt the ALJ's finding (R.D. at
(FDIC Ex. 1 at 2.)
The ALJ found that Chairman Smith's practice of conditioning the approval of loans or extensions of credit upon a fixed payment to Smith, or related interests by the borrower as a "fee" constituted a breach of fiduciary duty. (R.D. at 55). The Insured Institution objects to the ALJ's determination that this practice constituted an unsafe and unsound banking practice.
Both the Insured Institution and FDIC Enforcement Counsel filed exceptions to the ALJ's failure to decide the issue of publication of the Cease and Desist Order. The Insured Institution also challenged the Order as overbroad and the ALJ's failure to find that all of the alleged violations had been corrected before the Notice was issued.
The Insured Institution has requested that publication of any Cease and Desist Order be delayed on the ground that it will be unfairly prejudiced by disclosure. The ALJ, having concluded that the Respondent engaged in unsafe and unsound banking practices and committed violations of law and regulations warranting the issuance of a Cease and Desist Order, nevertheless declined to make recommendations as to whether the Insured Institution and its customers would be damaged by the publication of the Order as required under section 1818(u) of the FDI Act, 12 U.S.C. § 1818(u). Accordingly, the Board must review the Insured Institution's request for delayed publication of a Cease and Desist Order de novo.
Section 1818(u)(1) provides, in pertinent part, that "the [FDIC] shall publish and make available to the public any final order issued with respect to any administrative enforcement proceeding...."9 12 U.S.C. § 1818(u)(1)(A). This provision was added to the statute in response to congressional concern that bank regulatory agencies have traditionally kept enforcement actions secret which, in the opinion of Congress, does not deter financial institutions from misconduct. This concern was specifically ad-
Section 1818(u) of the FDI Act, 12 U.S.C. § 1818(u), directs the FDIC to publicly disclose final agency enforcement orders, but provides discretion to delay such publication under "exceptional circumstances" which would seriously threaten the safety or soundness of the insured depository institution. The Insured Institution has asserted that possible adverse publicity incurred by the Insured Institution, its directors and officers, and the twenty-one customers whose loans were classified creates an "exceptional circumstance" that warrants delay in publication. The Board disagrees. In this situation, the unsubstantiated assertion that adverse publicity would harm the Insured Institution and its customers does not warrant the delay of publication. To hold otherwise would undermine the disclosure policy and render the statutory requirement a nullity. The Board finds no evidence that would lead it to conclude that publication of the proposed Order would cause harm to the Insured Institution. Moreover, the Board has weighed the possible negative effects of publication against the interests of other customers and depositors of the Insured Institution and has determined that these customers have the right to disclosure of insider misconduct. Finally, the concerns for the customers whose loans were adversely classified can be adequately addressed by deleting their names and identifying information from the Decision and Order which is routinely done to protect such individuals.
Section 308(a)(3) gives the ALJ discretion, in evaluating the evidence underlying the Notice, to take into account, in appropriate circumstances, a financial institution's present condition when ordering a remedy, if the ALJ makes a specific finding of fact that the evidence is material and probative to the fashioned remedy. In the Recommended Decision, the ALJ notes the significant improvements in the Insured Institution's condition since the 1989 examination. Specifically, the ALJ noted that, as of April 30, 1990, Bank of Salem's capital to assets ratio was 7.72 percent, its capital-to-average adjusted assets ratio was 6.95 percent, its loan loss reserve had increased to $778,000, and substandard loans have been reduced substantially. (R.D. at 61). These conclusion were based upon evidence submitted by the Insured Institution regarding improvements as to its capital position and the condition of 23 of the loans adversely classified in the 1989 examination.
[.5] The Notice is based upon the state of affairs at the Insured Institution as of the May 23, 1989 examination and the unsubstantiated information on the institution's alleged improvements in its capital position and on the 23 classified assets that were provided by the Insured Institution at the hearing. The 1989 examination documents the Insured Institution's overall condition as of the date of examination. Subsequent events or information relating to the Insured Institution's condition is neither inconsistent with nor does it rebut the examination findings. Until the accuracy of the Insured Institution's post-examination data can be objectively verified and a determination made as to the remainder of the Insured Institution's financial condition (usually at the completion of the next full-scale examination), the data upon which the Respondent has computed the institution's alleged improvements, especially the Insured Institution's capital percentages, cannot be relied upon as conclusive.
[.6] Finally, as to termination of the Cease and Desist Order, the determination of whether the Insured Institution is in compliance with the Order and in sound financial condition is for the FDIC, not the institution, to determine. It is significant that this is not a cease in which the Insured Institution voluntarily ceased the complained of practices. Post-examination evidence that either these violations have been corrected or that the institution's condition has improved presents an unsubstantiated and incomplete picture of the Insured Institution's condition. The FDIC examiners assess an institution's complete financial condition based upon data obtained through the full scope examination process. In this case, there is justified basis to conclude that any corrective efforts by the Insured Institution are a direct result of the initiation of this enforcement action. Therefore, any cessation of unlawful practices and change in activities was directly in response to the FDIC's examination and the initiation of this action. Without a review of the Insured Institution's financial condition and practices in the verifiable and documented manner that the examination process yields, the FDIC has "no valid assurances that if the Insured Institution were free of the FDIC's restraint it would not continue its former course." Bank of Dixie v. FDIC, 766 F.2d 175, 178 (5th Cir. 1985); see also Zale Corp. v. FTC, 473 F.2d 1317, 1320 (5th Cir. 1973); and First National Bank of Bellaire v. Comptroller, 697 F.2d 674, 683 (5th Cir. 1983). Accordingly, the Board declines to adopt the provision of the Cease and Desist Order providing that the Order will terminate upon proof by the Insured Institution of substantial compliance. The Board therefore modifies the proposed Order (ALJ's Recommended Order at 19) by inserting the words "by the FDIC" at the end of the last sentence of the final substantive paragraph.
V. CONCLUSION
Having determined that the Respondent has engaged in numerous violations of unsafe and unsound banking practices and violations of law as set forth in the ALJ's Recommended Decision as modified, the Board finds that the issuance of a Cease and Desist Order is supported by substantial evidence and is in the best interests of the Insured Institution, its depositors, and the deposit insurance fund.
The Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC"), having considered the record and the applicable law finds and concludes that the Bank of Salem, Salem, Arkansas ("Insured Institution"), as set forth in this Decision, has engaged in unsafe and unsound banking practices and has committed violations of law and regulations, within the meaning of section 8(b)(1) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b)(1):
In the Matter of
On December 11, 1989, the Federal Deposit Insurance Corporation ("FDIC"), through the Memphis Regional Director acting under delegated authority from the FDIC's Board of Directors, issued a Notice of Charges and of Hearing ("Notice") against Bank of Salem, Salem, AR ("Bank") pursuant to the provisions of section 8(b)(1) of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. § 1818(b)(1), and Part 308 of the FDIC Rules of Practice and Procedures, 12 C.F.R. Part 308. Based upon the results of the FDIC examination conducted as of the close of business May 26, 1989, the Notice charged that the Bank engaged in unsafe or unsound practices and violations of law and regulation as prohibited by section 8(b)(1) of the Act.
In General
1. The Bank, a corporation existing and doing business under the laws of the State of Arkansas and having its principal place of business at Salem is and was, at all times pertinent to this proceeding, an insured state nonmember bank. The Bank is subject to the Act, 12 U.S.C. §§ 1811-1831k, the FDIC Rules and Regulations, 12 C.F.R. Chapter III, and the laws of the State of Arkansas. The FDIC has jurisdiction over the bank, persons participating in the conduct of the affairs of the Bank, and the subject matter of the proceeding. (Admitted in Answer)
* * * Transaction
5. As of March 15, 1983, the Bank had listed on its books as other real estate owned ("ORE") property know as the * * * property with a loan balance of $175,000. (Stipulated; TR 37)
* * * Transaction
15. As of May 23, 1985, the Bank had on its books an ORE known as the * * * Property with a loan balance of $79,000. Between May 23, 1985 and May 27, 1986 the Bank charged-off $12,300 of that amount as a loss, leaving a balance of $66,700. (Stipulated)
Unsafe and Unsound Practices
26. The Bank engaged in unsafe or unsound banking practices as evidenced by the following:
Violations of Law or Regulation
33. The Bank violated section 22(h) of the Federal Reserve Act, 12 U.S.C. § 375b, and section 215.4(a)(2) of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. § 215.4(a)(2), made applicable to the state nonmember banks by section 18(j)(2) of the Act, 12 U.S.C. § 1828(j)(2), in that the Bank extended and/or renewed credit to Director C. Dwayne Plumlee subsequent to November 1, 1985, which involved more than the normal risk of repayment and/or other unfavorable features as demonstrated, in part, by the "Substandard" classification which his line of credit received at the November 1, 1985 FDIC Report of Examination of the Bank. (TR 116, 118119; FDIC Ex. #1)
(Stipulated; TR 119121, 474, 734; FDIC Ex. #1, 48)
(TR 119120; FDIC Ex. #1)
36. The Bank violated section 22(h) of the Federal Reserve Act, 12 U.S.C. § 375b, and section 215.7 of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. § 215.7, made applicable to state nonmember banks by section 18(j)(2) of the Act, 12 U.S.C. § 1828(j)(2), in that the Bank failed to maintain records that identified Flying Star, Inc., with which the Bank had entered into a lease on September 1, 1988, as a related interest of Richard T. Smith, an executive officer and chairman of the board of directors of the Bank. (TR 122123, 735; FDIC Ex. #1, 50)
1. The FDIC has jurisdiction over the Bank and the subject matter of this proceeding and has the authority to issue an order to cease-and-desist against the Bank pursuant to section 8(b) of the Act. (Admitted)
A. Congress Granted The FDIC Broad
Congress has empowered the FDIC with board discretionary authority under section 8(b) of the Act to initiate a wide range of cease-and-desist actions and to fashion appropriate remedies. The FDIC authority includes the power to require affirmative actions be taken to correct the conditions resulting from unsafe or unsound practices. Further, reviewing courts have extended substantial deference to the expertise of administrative agencies in fashioning appropriate remedies.
B. Unsafe or Unsound Banking Practices
Section 8(b) of does not define "unsafe or unsound practices". However, the term "unsafe or unsound practice" has been in section 8(a) of the Act, 12 U.S.C. § 1818(a), since it was first enacted as part of the Banking Act of 1935, ch. 614, § 101(I), 49 Stat. 684, 690. In 1966, Congress enacted the Financial Institutions Supervisory Act of 1966, Pub. L. No. 89695, § 202, 80 Stat. 1028, which amended section 8 of the Act by adding, among other things, subsection (b), under which these proceedings are brought. The legislative history of this Act shows that Congress carefully considered the phrase "unsafe or unsound". By retaining that phrase in the final legislation, Congress concluded that the term "unsafe or unsound" was sufficiently clear and definite so as to be understood by those subject to its proscription. Both the Senate and House quoted with approval from a memorandum introduced by the chairman of the Federal Home Loan Bank Board, John E. Horne, which explained the meaning of the term "unsafe or unsound" as it is used in the context of the regulation of the nation's financial institutions. (112 Cong. Rec. 24022 (bounded. Oct. 4, 1966) (House); 112 Cong. Rec. 25416 (bounded. Oct. 13, 1966) (Senate). The concept of "unsafe or unsound banking practices" was described by Chairman Horne as follows:
FDIC Examiners are experts for purposes of evaluating the safety and soundness of a bank. FDIC examiners receive extensive training and go through a lengthy apprenticeship. Courts have held that an FDIC examiner's unique experience leads to the conclusion that their determinations are entitled to deference and cannot be overturned unless shown to be arbitrary and capricious or outside a "zone of reasonableness". Sunshine State Bank v. FDIC, 783 F.2d 1580 (11th Cir. 1986). The Court in Sunshine
{{5-31-91 p.A-1679}}adopted, in whole, a statement by the FDIC Board of Directors on the deference that must be given to Examiners. The opinion stated:
D. The Banks Capital is Inadequate
The Bank has argued that because its capital level is at a level above the minimum specified in the FDIC Regulations it is adequate. 12 C.F.R. § 325.3(b) states that a minimum capital requirement for a bank "shall consist of a ratio of total capital to total assets of not less than 6 percent and a ratio of primary capital to total assets of not less than 5.5 percent." However, this is for "banks whose overall financial condition is fundamentally sound, which are well managed and which have no material or significant financial weaknesses." 12 C.F.R. § 325.3(a). The FDIC has demonstrated to the contrary, that the Bank does not meet these criteria, and a higher capital ratio is required to insure the safety of the FDIC insurance fund.
E. The Authority of The FDIC to Issue an
The courts have held that the discontinuance of illicit practices or violation of law is not necessarily a defense against the issuance of a cease and desist order. This was articulated more than 20 years ago in Clinton Watch Company v. FTC, 291 F.2d 838 (7th Cir. 1961) cert. denied, 368 U.S. 952 (1962):
F. THE LOAN CLASSIFICATION
Respondent files twelve proposed findings of fact. Proposed Finding of Fact #1, which is some 26 pages in length, states that the Bank of Salem's classified assets are less than $2,453,000.
G. CONTENTIONS OF RESPONDENT
Respondent characterizes the payment of funds to Chairman Richard Smith as "incentive compensation". The record, however, is devoid of any testimony that such a plan was ever approved or that the board of directors were aware of such a plan.
H. CONTENTIONS OF RESPONDENT
Respondent seeks to characterize these two transactions as fully documented and as well argues that they did not result in "material" misstatements of the Bank of Salem's condition. This is incorrect, even though the basic transactions were innocent in purpose. Mr. Court's testimony shows that the * * * and the * * * transactions concealed the true income of the Bank, and caused it to file false Reports of Income and Condition (TR. 57 & 92).
I. RESPONDENT'S CONTENTIONS
Respondent attempts to mitigate the nature of the concentrations of credit to * * * and its related interest and to * * * and his related interests by pointing out that concentrations are not automatically a subject of criticism. However, in the present situation the concentrations were determined to be unsafe and unsound banking practices. The testimony of Mr. Court explains as follows:
Respondent argues that the extensions of credit to Director Dwayne Plumlee did not involve more than a normal risk of repayment or other unfavorable features because they were placed on a long term FHA loan basis, he reduced it to $70,000, and the loans were reviewed by the State of Arkansas in 1986 and 1988 and were not adversely classified.
K. RESPONDENT'S CONTENTIONS
Respondent correctly points out that the five directors and officers, Cochran, Atkins, Baines, Keesee and Montgomery, has preapproved lines of credit and that they eventually paid overdraft fees. Each of the overdrafts was in excess of $1,000 and each constitutes a violation of Section 215.4(d) of Regulation O of the Board of Governors of the Federal Reserve System, 12 C.F.R. § 215.4(d), made applicable to State nonmember banks by Section 18(j)(2) of the Federal Deposit Insurance Act, 12 U.S.C. § 1828(j)(2). The fact that the Bank had preapproved lines of credit to its officers and directors, is not sufficient to avoid a violation of § 215.4(d) of Regulation O. The fact that the overdrafts occurred is the violation.
{{5-31-91 p.A-1690}}
Respondent presents the argument that Chairman Richard Smith's interest in Flying Star, Inc., a company which he wholly owned, was disclosed because there existed in the Bank's file a lease agreement between Flying Star, Inc. and the Bank. Respondent admits the lease was signed by an employee of Smith Associated Banking Corporation, another wholly owned corporation of Chairman Smith. (TR 123; FDIC Ex. 50).
M. RESPONDENT'S CONTENTIONS
The Respondent makes the argument that because the FDIC Notice of Charges and of Hearing makes no mention of future violations, the FDIC has not determined that the Bank of Salem is likely to commit "such future alleged violations".
The Bank establishes that there are improvements in its condition. The evidence, not rebutted by FDIC, shows several favorable circumstances concerning the Bank. For example, Bank of Salem's capital to assets ratio equals or exceeds 7%. The Bank's capital account experiences some fluctuation based upon earnings, losses, and other events which have an impact in the institution. As of April 30, 1990, the Bank had $3,914,000 in capital, which yielded a capital to assets ratio of 7.72%. (TR. 697.) As of July 2, 1990, the Bank had a capital to average adjusted assets ratio of 6.95%. (TR. 1052.) Finally, even though the Bank's loan loss reserve as of March 26, 1989 was $423,000 (Joint Stipulation #14) as of April 30, the Bank's loan loss reserve was $778,000.
IT IS HEREBY ORDERED that the Depository Institution, its directors, officers, employees, agents, successors, assigns, and other institution-affiliated parties cease and desist from the following unsafe or unsound banking practices and violations:
/s/ By Paul S. Cross, |
|
Last Updated 6/6/2003 | legal@fdic.gov |