Federal Deposit
Insurance Corporation

{{9-30-91 p.A-1697}}
   [¶5164A] In the Matter of Stanley A. Smith, Docket No. FDIC-90-182jj (3-19-91).

   FDIC denies Section 32 application to serve as director or officer of a troubled institution. By a preponderance of the evidence FDIC concludes that Respondent's record shows a pattern of inaction and disregard for banking laws and regulations, demonstrating that Applicant does not have requisite competence, experience, character or integrity.

   [.1] FDI Act Section 32—Application for Employment—Standard of Proof
   Preponderance of the evidence is the appropriate standard of proof in reviewing a Section 32 application.

   [.2] FDI Act Section 32—Application for Employment—Competence and Experience
   Applicant's involvement in adversely classified loans to insiders, acquisition of a controlling interest without prior notice to the FDIC, and approval of loans without adequate documentation plus recent further deterioration in Bank's condition, demonstrate lack of requisite competence, experience, character or integrity to head a troubled institution.

In the Matter of
STANLEY A. SMITH
LANDMARK THRIFT AND LOAN
ASSOCIATION
SAN DIEGO, CALIFORNIA
(Insured State Nonmember Bank)
Decision and Order

   This proceeding arises out of an application submitted July 16, 1990 ("Application"), by Stanley A. Smith ("Applicant" or "Smith") submitted to the San Francisco {{9-30-91 p.A-1698}}Regional Office of the Division of Supervision under section 32(a) of the Federal Deposit Insurance Act ("the FDI Act"), 12 U.S.C. § 1831(i), seeking approval to be employed as a director or senior executive officer of Landmark Thrift and Loan Association, San Diego, California ("Landmark"), a troubled institution. The San Francisco Regional Office of the Federal Deposit Insurance Corporation's ("FDIC") Division of Supervision disapproved the Application on August 14, 1990, based on a determination that the Applicant lacked the statutory prerequisites of competence, experience, character, and integrity to become a director or senior executive officer of Landmark. By letters dated August 24 and August 31, 1990, the Applicant and Landmark appealed the Notice of Disapproval. On September 27, 1990, the Director of the FDIC's Division of Supervision ("Director") denied the Applicant's appeal from the Regional Director's disapproval. On October 18, 1990, the Applicant requested a hearing before a presiding officer but later waived, in writing, his right to a hearing.
   The Presiding Officer recommended that this Application be denied after finding, based on a preponderance of the evidence that the Applicant lacked the "competence, experience, character or integrity" required of a section 32 applicant and that this Applicant's service as a director or senior executive officer of Landmark would not be in the best interests of Landmark or the public. The Presiding Officer found that the Applicant failed to protect the interests of the banks of which he served as an officer or director. Accordingly, the Presiding Officer concluded that the Director acted properly in denying the Applicant's request to serve as director or senior executive officer of Landmark.

A. Application

   One July 16, 1990, Applicant and Landmark submitted a Notification of Addition of a Director or Employment of a Senior Executive Officer ("Application") to the FDIC's San Francisco Regional Office in compliance with section 32 of the FDI Act. The Regional Director (supervision) of the FDIC's San Francisco Regional Office ("Regional Director") disapproved the Application on August 14, 1990, based on a review of the Applicant's competence, experience, fitness of character, and integrity under section 32(e). The Applicant and Landmark were informed by letter dated August 14, 1990, that, based on the Applicant's prior performance at Landmark and * * *, Smith's addition to the board of directors of Landmark would not be in the best interests of Landmark, its depositors, or the public.

B. Appeal

   The Applicant and Landmark appealed the decision of the Regional Director. On September 27, 1990, the Applicant and Landmark were notified of the decision of the Director not to reverse the Regional Director's disapproval of August 14, 1990. Thereafter, by letter dated October 18, 1990, the Applicant requested a hearing pursuant to section 308.97 of the FDIC Rules of Practice and procedures, 12 C.F.R. § 308.97. Subsequently, pursuant to section 308.98(9)(c) and by agreement of the parties and the Presiding Officer, the Applicant waived in writing a hearing and elected to have the matter determined on the basis of written submissions.
   On December 14, 1990, the FDIC submitted a statement of the case, affidavits of examiners, a list of exhibits, and exhibits. The Applicant's December 14, 1990, submissions included a brief, declarations, and exhibits. On December 20, 1990, the FDIC filed an additional statement of the case with supplemental supporting affidavits to which the Applicant filed its reply brief and declarations on December 21, 1990.

C. The FDIC's Evidence

   Evidence submitted by the FDIC¹showed that the Assistant Regional Director from the San Francisco Regional Office ("ARD") reviewed and investigated an application for deposit insurance submitted by * * *, Commonwealth of the Northern Marianas, in 1984, which was later withdrawn, and a second application submitted in 1985. At the time of each application, Smith was chairman of the board of directors, a controlling shareholder of * * * and president of * * *, the wholly-owned subsidiary of * * *. After each review and investigation, the ARD determined that the management was unfavor-

D. Applicant's Evidence

   The Applicant submitted evidence of his education, employment and banking expe- {{9-30-91 p.A-1698.2}}rience, and overall fitness to serve as director or senior executive officer of Landmark. The Applicant's evidence relied significantly on contributions he made at Landmark subsequent to many violations of Federal banking regulations and to the issuance of the Order.
   The Applicant denied responsibility for the growth and lending strategies observed at Landmark in 1985 and attributed the high growth and numerous adversely classified loans to an aggressive auto lending program initiated by the former president of Landmark. R.D. at 7.
   The chairman of Landmark's board of directors stated that the Order resulted from loans made during the rapid growth period in 1985 through 1987, which were initiated by the former president. R.D. at 8.
   The Applicant's response to the FDIC's evidence of questionable loans made by * * * was that the loans were not excessive and were not bad loans and the loans were generally paid off. R.D. at 8. The Applicant presented evidence to show that the preferred stock dividends criticized by the FDIC were made in accordance with a dividend policy, that, for tax reasons, varied for each shareholder and that the difference had no economic effect on * * *. R.D. at 8–9.
   The Applicant stated that many of the * * * insider loans were not loans but were notes owned by directors and shareholders which were contributed to * * * as additional capital and that virtually all of the loans were good loans paid off in accordance with their terms. R.D. at 9.
   The Applicant submitted a report by the Financial Institutions Analysts & Consultants, Inc. ("FIAC"). FIAC is an independent consulting firm, retained on behalf of the Applicant and Landmark, to provide expert opinion on matters raised in connection with the FDIC's Notice of Denial of Appeal. The report stated that many of the insider loans were not typical bank loans since no funds were actually disbursed; rather, most of the loans originated from the sale of real estate, generally secured by notes and deeds of trust. The sellers were * * * shareholders who would exchange the notes for * * * preferred stock. R.D. at 9. The FIAC report also stated that the credit file documentation on these loans was not as complete as would be expected on actual loans due to the nature of the transactions. R.D. at 9. Despite the absence of some appraisals and title policies, FIAC's analysis found sufficient documentation of the loans to support both value and * * *'s lienholder position. R.D. at 9. The FIAC report stated that Landmark's current financial problems were tied to its auto lending program and did not reflect on Smith's banking abilities. R.D. at 9. It also stated that the significant number of real estate classifications in the 1988 FDIC examination were not supported and were without merit and stated that the FDIC acknowledged that a substantial portion of the classified real estate loans were not substandard and were removed from the Order. R.D. at at 9.

E. FDIC Supplemental Evidence

   The FDIC presented additional support for its original evidence and added significant new evidence regarding the number of real estate classifications in the 1988 FDIC examination and the current condition of Landmark.
   The FDIC challenged the FIAC's statement that the FDIC acknowledged that a substantial portion of the classified real estate loans were not substandard and were removed from the Order. Instead, the Assistant Regional Director Paul Jennison, by letter dated September 23, 1988, to Landmark's board of directors, stated that, although certain loans classified as substandard did not appear in the Order the FDIC still believed the loans to be substandard. R.D. at 10.
   As of November 5, 1990, the FDIC was in the process of completing an examination of Landmark concurrently with the California Department of Corporations. R.D. at 10. The examination revealed a deterioration of Landmark's financial health and a preliminary rating of "5" was assigned. R.D. at 10. The Order is expected to remain in effect, and the examiner-in-charge was considering recommendations of civil penalties against Landmark's board of directors and Smith for violations of the Order and termination of deposit insurance. R.D. at 10.

F. Applicant's Rebuttal

   The Applicant argued that the * * * loans only lacked "documentation which examiners are accustomed to seeing". R.D. at 11. the FIAC report supported the quality of the loans and stated they were not third-party loans but were notes owned by insiders and contributed to * * * to increase its capital in exchange for preferred stock. R.D. at 11. In {{9-30-91 p.A-1698.3}}support of its transactions regarding issuance of preferred stock, the Applicant produced preferred stock ledgers and a Business Plan of * * * which allowed for alternative forms of consideration for payment of stock. R.D. at 11.
   The Applicant again denied exercising control over Landmark and stated that the investment of stock in Landmark's parent company "was a passive one that was divested once Smith learned he had violated an arcane regulation of the FDIC." R.D. at 12.

   In a thorough analysis of the documentary evidence presented by the FDIC and the Applicant, the Presiding Officer concluded that on the basis of Smith's record at Landmark, * * * and * * *, the Division of Supervision was fully justified in denying approval for him to serve as a director or senior executive officer of Landmark. In reaching this decision, the Presiding Officer considered the evidence of the FDIC and the Applicant and concluded that Smith's action or inaction during his tenure at Landmark, * * * and * * * demonstrated his lack of competence, experience, character, and integrity. The Presiding Officer focused largely on the following factors in reaching his decision:
   1. Smith's actions at * * * and its whollyowned subsidiary, * * *, including his involvement in adversely classified loans to insiders and circumstances surrounding issuance of preferred stock which artificially inflated the capital of * * *.
   2. Smith's presumptive control of Landmark from July 23, 1987 to August 4, 1988, through purchase of approximately 12 percent of the voting shares of Landmark's holding company, * * * by * * * a corporation Smith controlled. Thus, Smith acquired a controlling interest in Landmark without prior notice to the FDIC, as required by the Bank Control Act, 12 U.S.C. § 1817(j)(i).
   3. The 1988 FDIC examination of Landmark that revealed Smith's approval of loans which lacked adequate documentation at inception and resulted in numerous adverse classifications and the Order.
   4. A recent FDIC examination of Landmark revealing further deterioration of Landmark's condition which may result in additional FDIC sanctions and possibly the closing of Landmark.

   [.1] Based upon a thorough review of the written submissions and evidence and the Presiding Officer's Recommended Decision, the Board agrees with the Presiding Officer's conclusion and Recommendation. The Board also finds that the preponderance of the evidence standard of proof is appropriate in reviewing a section 32 application and adopts the Presiding Officer's Recommended Decision with respect to this standard. See, e.g., Herman & McClean v. Huddleston, 459 U.S. 375 (1983).
   The FDIC presented abundant evidence of questionable and deficient banking practices by the Applicant during his tenure with * * * and Landmark. The Applicant's competence, experience, character, and integrity first came into question in 1984 when he applied to the FDIC, on behalf of * * *, for deposit insurance. At that time the ARD in charge of investigating the application for deposit insurance noticed deficiencies in the management of * * *, for which the Applicant was directly responsible at that time. The ARD and the Applicant discussed, at length, the deficiencies which resulted in the Applicant withdrawing the application for deposit insurance. In 1985, the Applicant resubmitted an application for deposit insurance. The ARD conducted an investigation of that application and again found deficiencies related to management. For example, in 1984, an asset review of * * * revealed 92 percent of total loans were adversely classified, and in 1985, 65 percent of total loans were adversely classified. In 1984, adversely classified loans to insiders were $536,500 and in 1985, $389,200. The $329,200 represented 48 percent of total loans, and 64 percent of all loans to insiders. The Applicant did not present evidence that satisfactorily explained the deficiencies at * * * or distanced the Applicant from responsibility for them.
   The ARD's investigation also produced evidence of a high level of preferred stock purchases which artificially inflated * * * capital. The record is unclear as to the exact nature of the transactions and whether the transactions were allowed by * * *'s Articles of Incorporation and By-Laws. Nevertheless, the transactions were at the very least questionable, and documentation supporting the transactions was inadequate as to repayment, underlying collateral and finan- {{9-30-91 p.A-1698.4}}cial condition of the borrower or the original obligor.
   The 1988 FDIC examination of Landmark showed a deterioration in the condition of Landmark since the 1986 examination. During that time Landmark experienced rapid growth, partly due to an aggressive auto lending program and real estate loans. Many of the loans were deficient at inception because of inadequate documentation. Even if Landmark suffered no loss from these loans, the improper documentation evidences carelessness, excessive risktaking and disregard by management not only for its own lending policies but also for state and federal banking rules and regulations. Many of the real estate loans were adversely classified in the 1988 FDIC examination and were the subject of the Order. Smith's failure to file a change in bank control application and explanation, in part, that it was a violation of an "arcane" regulation further exhibits his lack of attention and cavalier attitude toward banking laws and regulations.
   Finally, the evidence of Landmark's current condition is disturbing. The FDIC's evidence showed that, as of November 5, 1990, Landmark was being reviewed and examined by the FDIC and the California Department of Corporations and at that time was given a preliminary rating of "5", the worst possible rating indicating severe problems threatening the viability of Landmark. Moreover, the Order was to remain in effect at that time.

   [.2] The entire record reflects a pattern of poor management, failure to comply with state and federal banking requirements and failure to exhibit the competence, experience, character, or integrity required and expected by banking institutions, their depositors, and the public.
   As early as 1984, the Applicant was given notice of the need to improve management of the institutions for which he was directly responsible. * * * was denied deposit insurance based on deficient management twice. Moreover, the Applicant faced the threat of civil penalties for noncompliance with federal banking regulations from a failure to file a change in bank control application when he increased * * * ownership of Landmark to 12 percent. Further, the Applicant is party to an existing Order which outlined massive changes required in the management of Landmark for which the Applicant is directly responsible. Finally, as of a November 1990 report from the FDIC and the California Department of Corporations, Landmark was given a CAMEL rating of "5", which indicates its condition is seriously deficient and it faces potential insolvency and a possible termination of its deposit insurance.
   It is not enough to have written lending policies and procedures in place. Those policies and procedures must be implemented and followed. The Applicant, throughout his tenure with * * * and Landmark, has displayed a reactive approach to management. The Applicant's response to charges of deficient management occurred only after he was threatened with penalties and made subject to an Order. This pattern occurred throughout the Applicant's tenure with * * * and Landmark. This is not the type of management required by state and federal banking laws and regulations or expected by the depositors of insured institutions and the public.
   It is clear from the entire record before the Board that the Applicant has failed to rebut the evidence underlying the FDIC's prima facie case, which established by a preponderance of the evidence, that the Applicant's lack of competence, experience, character, or integrity is sufficient to warrant the disapproval of his Application to serve as a director or senior executive officer of a troubled institution. Therefore, the Board adopts the Presiding Officer's Recommended Decision to affirm the Notice of Disapproval.

   Section 32 is a regulatory tool by which the FDIC may further the safety and soundness of insured depository institutions by screening those persons who seek to manage the affairs of institutions that have been newly chartered, have recently changed control, and/or are in a troubled condition. The senior officials of a troubled institution must be persons with demonstrated management ability. The Applicant's record demonstrates a pattern of inaction and disregard for federal banking laws and regulations and for the trust and confidence placed in him by the institutions and public he served. Actions taken by the Applicant were contrary to the best interests of * * * Landmark, their depositors, and the public. The Applicant implemented corrective actions at Landmark only after violations were reported and penalties threatened.
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   This decision is not based on any one isolated transaction, but rather, on the record as a whole and the patterns evident from the record. The preponderance of the evidence demonstrates that the Applicant does not possess the requisite competence, experience, character, or integrity required to serve as a director or senior executive officer of Landmark.

   The Board of Directors of the Federal Deposit Insurance Corporation, having considered the entire record in this proceeding, hereby adopts the recommendation of the Presiding Officer to continue the Notice of Disapproval of Stanley A. Smith.
   ACCORDINGLY, IT IS HEREBY ORDERED THAT, the Notification of Addition of a Director or Employment of a Senior Executive Officer, submitted by Stanley A. Smith and Landmark Thrift and Loan Association on July 16, 1990, be and is hereby denied.
   IT IS FURTHER ORDERED, that the Executive Secretary, or his designee, is instructed to execute and serve copies of this Decision and Order on all parties, on the Presiding Officer, and on the Superintendent of Banks for the State of California.
   By direction of the Board of Directors.
   Dated at Washington, D.C. this 19th day of March, 1991.
/s/M. Jane Williamson
Assistant Executive Secretary

   Pursuant to the authority vested in the Executive Secretary by § 308.98 of the Federal Deposit Insurance Corporation ("FDIC") rules and regulations, I was designated as presiding officer by letter dated November 21, 1990, to conduct a hearing in this matter and to submit a recommendation to the Board of Directors of the FDIC. The hearing was scheduled to begin on Monday, December 17, 1990 in San Diego, California.
   As provided in § 308.98(9)(c), the Petitioner, pursuant to an agreement of the parties and the presiding officer, waived in writing a hearing and elected to have the matter determined on the basis of written submissions.
   Written submissions of both parties were received by the presiding officer on December 17, 1990. Additional submissions of the FDIC were received on December 21, 1990 and those of the Petitioner on December 24, 1990.
   Michael D. Schley for Petitioner.
   Joseph J. Sano for Federal Deposit Insurance Corporation.

   This matter arose when Smith signed a Notification of Addition of a Director ("Notification") of Landmark Thrift and Loan Association ("Landmark") as provided in Section 32 of the Federal Deposit Insurance Act ("FDIC Act"). 12 U.S.C. 1831(a). Smith signed the Notification on July 13, 1990.
   On August 14, 1990, John R. Sexton, Regional Director of the San Francisco Regional Office ("SFRO") notified Smith and Landmark that based on unfavorable findings with respect to the standards in Section 32(i)(e) of the FDIC Act, the Notification was disapproved. (FDIC Exh 2).
   Landmark appealed the Notice of Disapproval by letters dated August 24 and 31, 1990 from James S. Marinos, Chairman of Landmark's Board of Directors and General Counsel. (FDIC Exh 3).
   On September 27, 1990, Paul Fritts, Director of FDIC's Division of Supervision advised that, pursuant to delegated authority, the appeal had been denied. The Notice of Denial stated that after reviewing all available information pertaining to Smith's tenure and as controlling shareholder of Landmark's holding company and as President and principal shareholder of * * *, the FDIC was unable to find favorable with respect to Smith's competence, experience, character or integrity. The reasons set forth in the Notice of Denial were that while a previous director at Landmark, Smith's liberal lending philosophies and rapid growth strategies contributed to Landmark's troubled condition and his actions at * * * and its whollyowned subsidiary, * * *, included the extension of a high level of classified insider credits and the payment of preferred stock dividends on a preferential basis and without approval of * * *'s board of directors. (FDIC Exh 6).
   Smith by letter dated October 18, 1990 requested and was granted a hearing.

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   Petitioner contends in its December 14 brief that the FDIC has the burden of proving by clear and convincing evidence, and not a mere preponderance of the evidence that the competence, experience, character or integrity of Smith to be a director of Landmark are inconsistent with the best interests of its depositors or the public.
   Unlike Sections 19 or 8(e) of the FDIC Act, Petitioner argues that no standards are set forth in Section 32 of the FDIC Act or § 303.14(d) of the FDIC regulations. The standard to which the FDIC should be held should be higher than a mere preponderance of evidence since any sanction against Smith's serving as a director would effectively preclude him from working for any other troubled institution and thus depriving him of a means of livelihood.
   Petitioner cites Woodby v. Immigration and Naturalization Services, 385 U.S. 276 (1966) to the effect that in deportation proceedings, the government was held to a higher standard than a mere preponderance of the evidence because of the consequences of deportation. The Court held that the government case must be supported by "clear, unequivocal and convincing evidence that the facts alleged as grounds for deportation are true."
   The FDIC in its reply brief, cites Steadman v. Securities and Exchange Commission 450 U.S. 91 (1981) wherein the Supreme Court distinguished Woodby and held that the burden of proof in an administrative proceedings, unless otherwise provided by statute, is on the agency to prove its case by a preponderance of the evidence.
   In Woodby, the Court noted that deportation proceedings were not subject to the Administrative Procedure Act and that the Immigration and Naturalization Act did not prescribe a standard of proof, only the scope of judicial review.
   No standards of proof or rules of evidence are prescribed in Section 32 of the FDI Act. Absent such statutory language the FDIC has the burden of providing by a preponderance of evidence standard of proof, as set forth in the Administrative Procedure Act, 5 U.S.C.A. § 556(d), in a hearing involving Section 32.
   Although a person denied an appeal to be a director in a certain bank may have difficulties becoming a director or senior executive officer of a "troubled" bank as defined in the FDIC regulations, he is not denied employment in some other capacity in a "troubled" bank or in any capacity, including as a director or senior executive officer, in an untroubled bank.

   The remaining issue is whether Smith possesses the competence, experience, character and integrity to permit him to be a director of Landmark.

   The FDIC December 14, 1990 submissions include a statement of the case, affidavits of examiners and a list of exhibits.
   The affidavit of J. George Doerr, Assistant Regional Director of the San Francisco Regional Office, states that he has been an employee of the FDIC for approximately twenty years and has participated in approximately one hundred and fifty examinations.
   Doerr states that he reviewed the application and investigation regarding the application submitted by Smith in 1984 for deposit insurance for * * *, located in Garapan, Saipan, Commonwealth of the Northern Marianas. Smith was Chairman of the board of directors and a controlling shareholder of * * * and was President of * * *, its wholly owned subsidiary. (Doerr, p.2 para. 8–9).
   Doerr states that he noted deficiencies in * * *'s application and the investigation thereof and discussed them with Smith on December 20, 1984. (Doerr p.2 para. 9) By letter dated January 24, 1985, the deposit insurance application was withdrawn. (FDIC Exh 12).
   A second application, dated June 25, 1985, was submitted to the SFRO and was also investigated. Both the application and the investigation were again reviewed by Doerr. He states that management remained an unfavorable factor because of questionable activities engaged in by Smith and * * * and * * *, and he again met with Smith on September 20, 1985 (Doerr p.3 para. 10).
   Specifically, Doerr states that in 1984, an asset review of * * * disclosed that loans of $604,200 or 92 percent of total loans were adversely classified, in 1985, loans of $522,300 or 65 percent of total loans were adversely classified, which continued to be excessive. (Doerr p.3 para. 11).
   In 1984, adversely classified loans to insiders amounted to $536,500 and in 1985, {{9-30-91 p.A-1698.7}}$389,200. The $389,200 total of adversely classified insider loans represented 48 percent of total loans, and 64 percent of all loans to insiders (Doerr p. 3 para. 12).
   Doerr states that a substantial portion of insider loans were made to purchase preferred stock of * * *, $299,500 in 1984 and $281,900 in 1985. The $299,500 represented 46 percent of total loans, 48 percent of preferred stock outstanding and 33 percent of total contributed capital. The $281,900 represented 35 percent of total loans, 33 percent of preferred stock outstanding and 24 percent of total contributed capital. (Doerr p.3 para. 13).
   Doerr concludes that heavy reliance was placed on * * * loans to insiders to fund purchases of * * * preferred stock, thus artificially inflating its capital. (Doerr p. 4 para. 14).
   The 1985 adversely classified insider loans totaling $281,900 were made to three individuals, Smith, * * * and the * * * also a * * *. The total amount of these classified loans represented 44.5 percent of total dollar volume of capital contributed by these three individuals and was in apparent contravention of * * *'s Articles of Incorporation which require that no stock be issued until fully paid. (Doerr p.4 para. 15).
   Further, Doerr concludes that loans at * * * are considered the issuance of promissory notes for the payment of stock in apparent contravention of * * *'s by-laws prohibiting the payment of shares by promissory notes or future services. (Doerr p.4 para. 15).
   Doerr also states that dividends on preferred shares were not distributed to all preferred shareholders. (Doerr p.4 para. 16). Doerr further states that Smith was unable to satisfactorily explain the inconsistent treatment of shareholders. Doerr was informed that two classes of preferred stock existed, but no documents were furnished to substantiate that statement. However, subsequently, in August 1985, documents were furnished showing two classes of preferred stock, but only one class outstanding. (Doerr p.4 para. 17). At a meeting on September 20, 1985, a new explanation was given by Smith that shareholders could elect to take cash or accrue dividends, but no documentation was presented to show that any preferred shareholder actually exercised the election. (Doerr p.5 para. 17).
   Preferred stock dividends were required to be declared by the board of directors before being paid, pursuant to documents prepared after December 20, 1984, but no such declarations were made for $42,900 in dividends paid from November 1, 1984 to August 1985. (Doerr p.5 para. 18).
   Deficiencies in loans made by * * * included missing or outdated financial information on borrowers, sources of repayment were undetermined and terms of promissory notes were inexplicably altered reflecting undesirable lending practices. (Doerr p.5 para. 19).
   Doerr states that he was directly involved in a request by Smith to have * * *'s application for deposit insurance reconsidered. However, the unfavorable findings in 1984 and 1985 were not resolved. By letters dated February 10, 1986 and July 22, 1986, which included orders and statements of the FDIC's Board, Smith was advised that, among other things, the lack of demonstrated ability of management to operate * * * and the unfavorable general character of management were the basis for denial of deposit insurance and denial upon reconsideration. (Doerr, 5–6 para. 20–22) (FDIC Exh 13 & 14).
   In Doerr's opinion, Mr. Smith's activities at * * * and its subsidiary reflect unfavorably on his competence, experience, character and integrity and, therefore it would not be in the best interest of the depositors of a troubled institution or the public to permit him to become a director of such an institution. (Doerr p.6 para. 23).
   Leslie K. Matthews' affidavit states that she is a Review Examiner in the SFRO and has been an employee of the FDIC for approximately seven years, the last three as a commissioned examiner.
   Matthews states that a February 29, 1988 FDIC examination of Landmark reflects that Smith was exercising a significant degree of influence over Landmark's lending functions through approval of a large number of new loans. (Matthews p.2 para. 8).
   Matthews states that on May 10, 1988, Smith sent a letter responding to Assistant Regional Director Paul Jennison's request to know the reason Smith had not filed a change in bank control application when * * * increased its ownership in Landmark to approximately 12 percent (FDIC Ex 4). In the letter, Smith admitted to recent stock acquisitions resulting in * * * ownership of over a 10 percent interest in Landmark and a de- {{9-30-91 p.A-1698.8}}sire to exercise influence in the affairs of Landmark. (Matthews p.3 FDIC Exh 4)
   Matthews refers to § 303.4 of the FDIC rules and regulations, 12 C.F.R. 303.4, which provides that the power to vote 10 percent or more of a class of voting securities in an insured depository institution will be presumed to be an acquisition of the power to direct that institution's management or policies if immediately after the transaction no other person will own a greater proportion of that class of voting shares. (Matthews p.3 para. 10).
   Matthews states that at the time Smith increased his ownership interest in Landmark to approximately 12 percent, no other person held an interest in excess of ten percent. (Matthews p.3 para. 11).
   Matthews states that on August 24, 1988, Smith, as a director of Landmark, signed a stipulation consenting to an Order to Cease and Desist Agreement ("Order") which was issued against Landmark on September 23, 1988 (FDIC Exh 11). The Order has never been terminated and Landmark continues to operate under its requirements. (Matthews p.4 para. 17).
   The FDIC Examiner-in-Charge of the February 1988 examination of Landmark, Carol A. Raplee, states in her affidavit that she has been an employee for over nine years, the last five and one-half as a commissioned examiner. She has participated in approximately 115 examinations.
   Raplee states that as part of normal preparation for the 1988 examination, the previous FDIC examination of Landmark in February 1986 was reviewed and that Landmark was found to be in good condition. However, substantial deterioration was noted between the 1986 and 1988 examinations. (Raplee p.2).
   Raplee states that Smith joined Landmark's board in 1986, was elected Vice Chairman in 1988, and had, at the time of the 1988 examination presumptive control of Landmark through a 12 percent ownership interest of its holding company, * * * by * * * a company Smith controlled. Landmark was 100 percent owned by * * *. Several other directors at Landmark were former directors of * * * prior to and during the 1988 examination of Landmark, subleased space from * * * which was located within Landmark's premises. (Raplee p.2 para. 9–12).
   Raplee states that Smith, although not a titled officer of Landmark, was active in day to day management, aided by the close proximity of * * * (Raplee p.3 para. 13). Smith was a member of the loan committee as was Landmark's President, also a director. The loan committee policy for approval of larger loans was to require a second director's signature. Since his company, * * *, was within the bank's premises, Smith frequently signed his name on such large loans. (Raplee p. 3 para. 14).
   Many of the loans approved by Smith were deficient at inception, lacking adequate purpose, repayment source, basic credit analysis and undue reliance on collateral (Raplee p.4 para. 15). Total adverse classified real estate loans amounted to $2,056.653 or 79 percent of total classified. Smith approved $1,509,120 of classified real estate loans, which amounted to 73 percent of all adversely classified real estate loans. (Raplee p.3–4 para. 15).
   Raplee states that she believes that the actions of Smith reflect a very liberal lending philosophy, not expected from a prudent banker, which contributed to Landmark's deterioration. (Raplee p. 4 para. 16).
   Between 1986 and 1988, Landmark tripled in size and increased funding occurred in significant part through the use of volatile deposits. Capital was reduced to an inadequate level at the time of 1988 examination and earnings changed to a loss figure in 1988. Raplee believes Smith had "... a powerful negative influence..." over Landmark's management and "... is significantly responsible for its deterioration." (Raplee p.4–5 para. 17–19). This deterioration Raplee believes, reflects on Smith's experience, competence, integrity and character and that is would not be in the best interests of the depositors of Landmark or the public to have Smith again become a Landmark director. (Raplee p.5, para. 20).

   Accompanying Petitioner's brief is a declaration of Smith which sets forth his educational, employment and banking experiences, including a B.A. in Political Science from the University of Washington, an M.B.A. in Finance from San Diego State University and a Doctor of Business Administration from United States International University.
   He states in addition to a real estate business he runs and operates, he served as Chair- {{9-30-91 p.A-1698.9}}man of the board and President of * * * from 1982 to 1990 and in the same capacities with * * *.
   He further states that he is an indirect shareholder of * * * since 1980.
   Since May 1986 Smith states he has been associated with Landmark as a director. He resigned in early 1990 to make room for new purchasers of Landmark on its board. The purchase failed to materialize and he was worked as a consultant to Landmark since June 1990. Smith reviews his role as director and consultant which included various initiatives referred to in Petitioners brief and included as exhibits thereto. (Declaration of Stanley A. Smith).
   Petitioner's December 14, 1990 submissions included a brief, declarations of various individuals and exhibits.
   In its brief, Petitioner contends that Smith is not responsible for the growth and lending strategies commenced by Landmark in 1985. An aggressive auto lending program was set in motion by a former president which caused a period of high growth by the time Smith joined Landmark's board and in no way reflected on Smith's banking abilities. (brief p.5) The brief refers to an independent consultant's analysis of Smith's role in lending at Landmark which draws the same conclusions. (Financial Institutions Analysts & Consultants, Inc's letter of December 11, 1990 submitted by William F. Gavin p.4 ("FIAC"), Petitioner Exh 17)
   In his declaration, Gavin states that he has been a banking consultant since 1984. He joined FIAC after 11 years of examination experience with the FDIC in various regions involving all phases of the examination process in banks ranging up to $200 million in assets. (Declaration of William F. Gavin).
   In his declaration, Chairman of Landmark's board James S. Marinos, declares that the FDIC Order presently outstanding against Landmark was the results of loans made during a period of rapid growth in 1985–1987, executed by the former president. (Marinos p.1 para. 2).
   Marinos further states that Smith never exercised controlling influence over Landmark (Marinos p.1 para. 3).
   Moreover, Smith made many invaluable contributions including, as chairman of the loan Committee, improvement of real estate lending programs and policies. (Marinos p.2 para. 4 Petitioner Exh's 2–9). As vice-chairman of the board, Smith enhanced board oversight. (Marinos p.2–3, Petitioner Exh's 10–12). Smith was an active participant in board discussions (Marinos p.3, Petitioner Exh 12, 19–22). Beginning in June 1990. Smith as "Board Liaison" has worked on projects designed to correct the outstanding Order against Landmark. He also was instrumental in organizing of $100,000 earlier in 1990. Petitioner further contends that Smith is largely responsible for Landmark's good performance in its real estate loan portfolio, substantiated by a recent FDIC examination, as yet unissued (Brief p.6). The recent loss experiences of Landmark, although not surfacing until 1987 and thereafter, were the direct results of a growth strategy, an auto lending program and investment practices started before Smith joined the Board. (Marinos p.4 para. 6).
   Marinos states said that it is the unanimous position of Landmark's board of directors that it would be in the best interest of Landmark to permit Smith to rejoin the board. (Marinos p.4 para. 7). Also accompanying Petitioners brief is a declaration of James T. Schuller, Sr. stating that he believes Smith possesses the knowledge and ability to function in a bank's management, that he has made valuable contributions to Landmark, and he supports Landmark's petition to add Smith to its board.
   In its brief, Petitioner also contends that the loans made by * * * to related parties were not excessive and were not bad loans. Loans made by * * *, through * * *, to all related parties, including small shareholders not considered insiders, totaled 30 percent of the bank's equity capital. The Federal Reserve Act, section 22(h) and regulations of the Board of Governors, Regulation O, 12 C.F.R. 215, although not applicable to * * * provide that federally insured banks may not lend more than 15 percent of capital to any one director, officer or principal shareholder. Thus, an aggregate level of related party loans equal to 30 percent of capital does not appear excessive. (Brief p.7).
   Petitioner, in his brief, p.8, argues that the preferred stock dividends criticized by the FDIC were made in accordance with a dividend policy that, for tax reasons, permitted cash dividends to some shareholders and dividend accrual for others and the dif- {{9-30-91 p.A-1698.10}}ference had no economic effect on the bank. (Declaration of Arlen T. Beatty p.2)
   Petitioner contends that several of the * * * insider loans were not actually loans, but notes owned by directors and shareholders which they contributed to * * * as additional capital. Also, virtually all of these loans were good loans paid off in accordance with their terms. (Brief p.7).
   The report of FIAC also states that many of the insider loans criticized by the FDIC during its investigation of * * * application were not typical bank loans since no funds were actually disbursed, rather, most of these notes [loans] originated from the sale of real estate, generally secured by notes and deeds of trust. The sellers, who were * * * shareholders, on occasion exchanged the notes for * * * preferred stock. (FIAC, p.2).
   Although the credit file documentation on these loans was not as complete as would be expected on actual loans where funds are disbursed, the value of the collateral as evidenced by the sales price in the signed escrow statements adequately supports the book value of these notes. (FIAC p.2)
   In addition, FIAC's analysis of the credit quality of some classified loans listed in the "August 1988 report" takes issue with FDIC classifications. In the opinion expressed in FIAC's letter, despite the absence of some appraisals and title policies, sufficient documentation was found to support both value and lienholder position. (FIAC p.2)
   With respect to Landmark, the FIAC analysis is of the opinion that Landmark's current financial problems are directly related to its auto lending program and in no way reflect adversely on Smith's banking abilities. Further, the FIAC report is of the opinion that a significant number of real estate loan classifications in its February 28, 1988 examination were not adequately supported and were without merit. This concern was communicated to the FDIC by Charles E. Doster, Managing Principal of FIAC in a letter dated May 27, 1988. (Petitioner Exh 17). Subsequently, the FIAC report assets that the FDIC acknowledged that a substantial portion of the classified real estate loans were not substandard and they were removed from the FDIC Order. (FIAC p.4).

   The FDIC's additional statement of the case states that contrary to the assertion in the Petitioner's brief, the FDIC does not argue that Smith was responsible for Landmark's growth in 1985 nor for initiating the troubled auto lending program. However, the statement refers to comments made by Examiner Raplee in her affidavit that Smith, as an approving director, was directly responsible for approximately one and one-half million dollars of real estate loans, deficient at inception and argues that although loans may ultimately be collected doesn't diminish risk of loss if made without proper documentation at inception.
   The FDIC's additional statement takes issue with Gavin's assertion in his December 11, 1990 letter to Petitioner's counsel (FIAC, Petitioner Exh 17) that certain adversely classified loans from the February 1988 examination were not included in the 1988 Cease and Desist order against Landmark because the FDIC acknowledged that they were not of substandard quality. To rebut this assertion, the FDIC statement refers to a letter dated September 23, 1988 to Landmark's board, from ARD Jennison wherein he stated that although provision 3 of the Order excluded certain loans classified substandard, it in no way "blesses" these loans. The FDIC still believed the loans of subquality at time of examination and forbids additional credit on such loans without prior approval of a majority of the bank's board or the loan committee. (FDIC Exh 16 additional submissions).
   Matthews in her additional affidavit of December 18,1990 states that the FDIC is in the process of completing an examination of Landmark concurrently with the California Department of Corporations as of November 5, 1990. The examination reveals a deterioration of Landmark's financial health and a preliminary composite rating of "5" has been assigned. Capital and management, two provisions of the outstanding Order remain deficient and therefore the FDIC will not revoke the Order. On the contrary, the examiner-in-charge is considering recommendations of civil penalties against Landmark's board and Smith for violations of the Order and also a Section 8(a) to terminate deposit insurance. (Matthews p.1 para. 1–2).
   The current examination further reveals that poor quality auto loans continue to impact negatively on Landmark's earnings and that the bulk of these loans were generated while Smith was a director, vice-chairman of the board and loan committee chairman. {{9-30-91 p.A-1698.11}}The low-quality auto loans totaled approximately $5,800,000 in April 1987, but through additional bookings increased to approximately $16,000,000 by September 1988. (Matthews p.2 para. 4).
   In his affidavit dated December 19, 1990 accompanying the FDIC additional submissions, Doerr states that several references to classified insider loans made in his December 13, 1990 affidavit were apparently notes owned by insiders and contributed to as addition capital. (FDIC Exh 17). Doerr states that he considers such contributed notes to be "insider loans" to the same extent as when case proceeds were disbursed in that the tangible economic benefit to insider (preferred stock in * * * is the same as cash proceeds. (Doerr p.2 para. 4).
   Doerr also states that these assigned notes were apparently not separately guaranteed by insiders and repayment is totally dependent on the original obligor and/or the underlying collateral. (Doerr p.2 para. 5).
   Doerr points out several statements in the FIAC report which do not comport with FDIC statistics or reports of examination dates and states it is unclear where FIAC derived the data for its submission. (Doerr p.2–3 para. 6–8).
   Doerr takes issue with the contention put forth in the FIAC report that the insider loans exchanged for * * * preferred stock were not typical banks loans and therefore did not need credit file documentation. As previously noted, payment of the notes was dependent on the original obligor and/or the value of the underlying collateral. The financial condition of the obligor and the collateral values were mostly unsupported by documentation, resulting in adverse classification. (Doerr p.3 para. 9).

   Petitioner in its reply brief argues that the * * * loans criticized by FDIC lacked only documentation which only examiners are accustomed to seeing. The FIAC report supports the quality of these loans which claimed no losses to * * * and questions the need for documentation when the loan amount if $25,000 or less and the loans could be justified on the basis of unremitting standards applied to unsecured loans. (Reply brief p.1).
   Loans were not made by * * * to insiders to finance purchase of preferred stock. The FIAC report shows that these were not loans, but third party notes owned by insiders and contributed to * * * to increase its capital in exchange for preferred shares. Contrary to Doerr's views that this type of consideration violated * * * Articles of Incorporate and By-Laws which do not permit a shareholder to receive stock until "fully paid" nor to pay for stock "with promissory notes or future services," the By Laws, dated July 7, 1982 (Reply brief Exh 4, p.12) specifically provides that stock must be paid in lawful U.S. Money "or in kind considerate acceptable to the corporation." Petitioner states that the acceptance of non-cash consideration as payment is not unusual and is specifically authorized by most corporate laws. (Reply Brief p.2).
   Petitioner refers to a Business Plan approved by * * * in 1983 which provides for alternative forms of consideration for payment of stock, such as good quality notes, bonds etc. (Reply Brief Exh 5).
   Also included with Petitioner's Reply Brief are preferred stock ledgers of * * * showing dividends accrued and/or paid on preferred stock. (Reply Brief Exh 1.)
   Petitioner contends that its written submissions show that Smith did not control unprofitable growth and lending policies of Landmark. (Reply brief p.4). If refers to the December 12, 1990 declaration of Marinos, Chairman of Landmark's board since 1986 and a supplemental declaration of Marinos dated December 20, 1990, as evidence that Smith did not control Landmark.
   Contrary to the FDIC's contention that because Smith was president of a company that owned, for a short period, more than 10 percent of the stock of Landmark's parent company, the Petitioner states that the investment was a passive one that was divested once Smith learned he had violated an "arcane regulation" of the FDIC. (Reply Brief p.5).
   In an exchange of correspondence between Smith and the FDIC (Reply Brief Exh 6–8) Smith contends the Change in Bank Control Act was intended to require those persons who seek or propose to acquire control to file advance notice and not those who purchase stock but do not seek control as was the case in his purchase of * * * stock through ***.

{{9-30-91 p.A-1698.12}}

   Smith's actions at * * * and its whollyowned subsidiary * * * which are detailed in Doerr's affidavits reflects adversely on his qualifications to be a director at Landmark.
   The record is not clear to what degree preferred stock of * * * was purchased with loan proceeds from the bank itself (through * * *) or by assignment of third-party notes.
   References in * * * Article of Incorporation and By-law's stating that stock must be "fully paid" and cannot be paid with "promissory notes or future services" would appear to prohibit the payment for stock through the proceeds of loans financed by the bank itself (or its wholly owned subsidiary) or by shareholders own notes or services. Thus, to the extent that loan proceeds were, in fact, disbursed by * * * to insiders and used to purchase * * * stock, such an arrangement would artificially inflate its capital, since the bank would be using its own funds to create its own capital. However, it would appear that the exchange of notes of third parties assigned to * * * as payment for * * * preferred stock is not prohibited and would not be an artificial inflation of capital since the bank, through its subsidiary * * * was receiving value in consideration for the issuance of such stock. Although the record is not clear to what extent * * * loan proceeds or third-party notes or a combination of both were involved, in either case, as to repayment, underlying collateral, financial condition of the borrower or the original obligor on the notes, lack of documentation appears to be a valid reason to adversely classified what were listed as loans on the books of
   Additional, it is noted, that the Business Plan approved by * * * in 1983 and put in evidence by the Petitioner as permitting an alternative form of consideration for payment of stock such as "good quality notes," provides: "These notes from shareholders would carry the shareholder's personal guarantee as to repayment." (Petitioner reply brief p.3) As Doerr states in his affidavit accompanying FDIC's additional submissions p.2 para. 5, the assigned notes were apparently not separately guaranteed by the insider assignor in violation of * * * own Business Plan.
   Whether some cash dividends were paid on some preferred stock and not others is also not clear from the record. The ledgers furnished by the Petitioner as evidence of accrual as well as cash payments (Reply Brief Exh 1) may be only ledgers of insiders. Moreover, even though some accruals appear to be on some ledgers, as well as cash dividends, no evidence has been presented by Petitioner that preferred stockholders were, in fact, given an option of accruals in lieu of cash or exercised such an option. Further, no record of * * * board approving dividends in presented. Smith's explanations given Doerr in 1984 and 1985 of the lack of documentation and the apparent inconsistencies as to the treatment of preferred shareholders were inadequate.
   Petitioner's contention that loans made to insiders by * * * were not excessive, (Petitioner brief p.6–7), does not appear to be what Doerr refers to in his affidavit. Doerr states that an excessive number of insider loans were adversely classified, not that such insider loans were necessarily excessive in relation to total capital.
   The February 1988 FDIC examination of Landmark reflected an excessive volume of adversely classified loans, inadequate supervision and direction by the bank's board, operation with inadequate capital and operational losses and numerous other deficiencies resulting in a uniform bank rating of 4. (FDIC Exh 10). The bank's condition led to the issuance of a Cease and Desist Order against the bank on September 23, 1988, seeking to correct the bank's problems. (FDIC Exh 11). The Order is still in effect. A recently concluded FDIC examination of Landmark, as yet unissued, reveals a further deterioration in the bank's condition with the possibility of further FDIC sanctions against the bank, or its imminent closing.
   From April 1, 1986 to February 1990, Smith was a director of Landmark and became Vice-Chairman of its board in 1988. He also became chairman of its loan committee in 1987. Smith worked as a consultant to Landmark for several months, beginning in June 1990. (Smith Declaration, Petitioner's Written Submissions of December 14, 199).
   A a member of the loan committee, Smith signed and approved $1,509,120 of the total real estate classified adversely in the 1988 FDIC examination. Notwithstanding the fact that a number of these loans were subsequently not included in the FDIC Cease & Desist Order, they remained a source of concern because of lack of proper documentation at inception and the fact that the bank {{3-31-92 p.A-1698.13}}may not or did not suffer loss from these loans should have no bearing on the examiners' opinions expressed at the time of the examination that Smith was deficient as a director in approving these loans.
   Smith had presumptive control of Landmark from July 23, 1987 to August 4, 1988 through the purchase of approximately 12 percent of the voting shares of the bank's holding company, * * *, by * * * a corporation Smith controlled.
   Petitioner's argument that the FDIC regulations, requiring prior notification of a controlling interest in a bank where no intent or purpose of control accompanies such purchase is arcane and subverts the intent of the Bank Control Act is without merit. The Act requires such notice. 12 U.S.C. § 1817(j)(i). The regulations creates a rebuttable presumption of control and gives an acquiring person the opportunity to rebut such presumption. § 303.4(a)(2). Smith did not avail himself of that opportunity and for approximately one year had presumptive control which could or may have been exercised.
   During the period of Smith's controlling interest, as well as during his tenure as a director, Landmark's financial condition deteriorated. This despite the many programs reflected in the record as having been instituted by him or at his direction to the betterment of the bank.
   The responsibility of a bank director is not just as part of the board of directors as a whole, but also individually. Landmark's serious financial condition, which has increased in severity since 1986 reflects adversely on Smith's ability to be a capable director of this troubled bank.
   The FDIC written submissions have established a prima facie case supporting the FDIC's findings that Smith should not be permitted to serve as a director at Landmark.
   Notwithstanding the evidence put forth by the Petitioner and the supporting declarations of various Landmark board members, the Petitioner has not sustained the burden of rebutting the FDIC's case.
   It is therefore recommended that the notice of disapproval be continued.
/s/ Reford J. Wedel
Presiding Officer
Dated: January 29, 1991