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FDIC Enforcement Decisions and Orders

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   [8007B] In the Matter of Southwestern Bank & Trust Company, Oklahoma City, Oklahoma, Docket No. FDIC-89-24a (8-14-90).

   Board reverses ALJ's order for FDIC enforcement counsel to produce documents concerning the costs of bank liquidation in a termination of insurance proceeding, finding such information not relevant to an inquiry into the safety and soundness of the institution.

   [.1] Evidence—Relevance—Standard
   Scope of permissible discovery is limited to matter which has material relevance, and which is of consequence to the outcome of a Section 8(a) proceeding.
   [.2] Termination of Insurance—Defenses
   Cost of liquidating other banks is not a defense to a termination of insurance proceeding, as the only standards for termination are that unsafe or unsound practices have taken place or that the institution is in an unsafe or unsound condition.

In the Matter of
(Insured State Nonmember Bank)

   This case is presently before the Board of Directors ("Board") of the Federal Deposit Insurance Corporation ("FDIC") as a result of the Board's Decision and Order dated June 5, 1990, granting the Motion of FDIC Enforcement Counsel for Special Permission to Appeal. The case involves a discovery issue arising in the course of a termination of insurance proceeding brought pursuant to section 8(a) of the Federal Deposit Insurance Act, 12 U.S.C. § 1818(a). Specifically, the Board must decide whether, in a termination of insurance proceeding,evi- {{9-30-91 p.I-27}]dence concerning the cost of liquidation of banks in a particular region of the country is relevant to the proceeding. The Administrative Law Judge ("ALJ") concluded that such evidence was relevant, and as a result, issued an order compelling Enforcement Counsel to produce evidence on the issue. The Board, after carefully considering the ALJ's order, as well as the submissions of the parties on appeal, has concluded that the ALJ committed legal error. Accordingly, the Board reverses that order and remands the case for further proceedings.


   On October 12, 1989, the FDIC issued a Notice of Intention to Terminate Insured Status, Findings of Unsafe or Unsound Practices and/or Condition, and Order Setting Hearing ("Notice") against Southwestern Bank & Trust Company, Oklahoma City, Oklahoma ("SWB"), pursuant to 12 U.S.C. § 1818(a). The Notice alleged that SWB "has engaged or is engaging in unsafe or unsound practices in conducting the business of the Insured Institution and/or is in an unsafe or unsound condition to continue operations as an insured depository institution, and...the insurance risk of the FDIC is unduly jeopardized...." The matter was assigned to ALJ James L. Rose for hearing.
   On November 20, 1989, SWB requested by letter that Enforcement Counsel produce certain documents including

    Copies of any document relating to costs of liquidation of banks in the Southwest region including but not limited to: (a) any documents showing comparisons of liquidation in open versus closed bank scenarios; (b) any documents showing average costs of liquidation as a percentage of assets; (c) any documents containing analyses, summaries, or studies of any of the above.
On December 8, 1989, Enforcement Counsel responded to the request by letter objecting to production of the documents specified, in part, on the grounds of relevancy and that the information would not lead to discovery of relevant evidence.1 Enforcement Counsel contended that the documents were not relevant because they had no bearing on the issue of "unsafe or unsound practices" addressed in the Notice. SWB applied for an order compelling production on April 13, 1990, and on May 3, 1990, Enforcement Counsel filed its response, again arguing that the documents sought were not relevant. On May 14, 1990, the ALJ entered an Order compelling production because he found that the documents were relevant to an affirmative defense proposed by SWB— that the cost to the insurance fund of terminating SWB's insured status might be greater than the financial risk SWB poses to the fund. The Order required that the documents be provided within 15 days of its receipt. On June 5, 1990, the Board, in response to Enforcement Counsel's Motion for Special Permission to Appeal, filed on May 31, 1990, granted the Motion and stayed the ALJ's Order compelling production pending appeal.


   [.1] A. The Legal Standard for Relevance

   The FDIC's Rules of Practice and Procedure, 12 C.F.R. Part 308, govern administrative proceedings such as this one to terminate a bank's insured status. The scope of permissible discovery is set forth in 12 C.F.R. § 308.25. Such discovery is limited to production of relevant, non-privileged documents. For purposes of this appeal, the crucial provision is subsection (b) governing relevance. That subsection provides:

       (b) Relevance. Parties may obtain document discovery regarding any matter, not privileged, which has material relevance to the merits of the pending action. It is not ground for objection that the information will be inadmissible at the hearing if the information sought appears reasonably calculated to lead to the discovery of admissible evidence.
12 C.F.R. § 308.25(b).2 Although Part 308 does not define relevance, the Board concludes that Federal Rule of Evidence 401 provides a satisfactory definition:
   [E]vidence having any tendency to make

1 Enforcement Counsel also objected to production of the documents on the ground that it would place an undue burden on the FDIC. Because of our disposition of this appeal, we do not have occasion to address this issue.

2 Section 308.25(b) differs from Fed. R. Civ. P. 26 because it limits discovery to documents which have "material relevance" to the proceeding as opposed to mere relevance. In light of the Board's disposition of this matter, the Board need not decide to what extent Section 308 imposes a more stringent requirement on a party seeking discovery to justify that discovery.
{{9-30-91 p.I-28}]the existence of any fact that is of consequence to the determination of the action more probable or less probable than it would be without the evidence.
Although Rule 401 addresses relevance at a hearing rather than in discovery, relevance for discovery is only broader to the extent set forth in the second sentence of § 308.25(b) (and Fed. R. Civ. P. 26(b)(1)): "a party may not object to discovery of information based on its inadmissibility at the hearing is that discovery may reasonably lead to the discovery of admissible evidence." See Smith v. Schlesinger, 513 F.2d 462, 472-73 and n.36 (D.C. Cir. 1975) (construing the scope of discovery under Fed. R. Civ. P. 26(b)(1)). The crucial portion of the Rule for the Board's inquiry concerns the words "of consequence to the determination of the action." Thus, the legal question faced by the Board is whether the documents on cost of liquidation are somehow "of consequence to the determination" of a section 8(a) proceeding.

B. Cost of Liquidation is not a Defense to a Termination of Insurance Proceeding.

   SWB's contention, adopted by the ALJ in his Order of May 14, 1990, was that:

    these documents relate directly to one of the Bank's affirmative defenses, i.e., that the FDIC's costs in terminating the Bank's insured status and placing the Bank into receivership or liquidation would be far greater than the alleged risk the Bank poses to the insurance fund.
Id. at 1. After thoroughly reviewing the arguments, the statute and the legislative history of the statute, the Board finds that the ALJ's conclusion that SWB may defend a section 8(a) action on the basis of the comparative costs of liquidation and continued operation is erroneous.
   The analysis of this issue is governed by the terms of the statute itself. Section 8(a)(2) provides for involuntary termination of insurance if the FDIC Board determines that one of three conditions is present:
       (1) the institution or its directors "have engaged or are engaging in unsafe and unsound practices";
       (2) the institution is "in an unsafe and unsound condition to continue operations as an insured institution"; or
       (3) the institution or its directors have violated a law, regulation, or order, a condition imposed by the FDIC in writing or an agreement entered into with the FDIC.
In this case, the Notice alleged that conditions (1) and (2) existed.

   [.2] Nothing in the statutory language or logic based on such language suggests that consideration of the potential cost of liquidation compared with the financial risk posed by continued operation was intended by Congress to be an aspect of the administrative determination required under section 8(a)(2). To the contrary, the statutory language is quite specific. In this case, the Board need only find that unsafe or unsound practices have taken place or that the institution is in an unsafe or unsound condition. Neither finding plausibly includes any consideration of the cost of liquidation. An "unsafe or unsound practice" is any action or omission which is contrary to generally accepted standards of prudent bank operation and, if continued, is likely to lead to abnormal risk or loss to the institution. E.g., First National Bank of Bellaire v. Comptroller of the Currency, 697 F.2d 674, 685 (5th Cir. 1983). An "unsafe and unsound condition" inquiry frequently focuses, for example, on the institution's low capital-to-asset ratio, 12 C.F.R. § 325.4(c), although a high level of classified assets has also been a basis for such an inquiry. See FDIC-87-4a (March 14, 1989) (WESTLAW, FFIN-FDIC). Thus, the focus of an inquiry regarding unsafe or unsound practices or an unsafe or unsound condition is the institution rather than the insurance fund. Of course, any potential loss or increased risk to the institution necessarily carries with it some potential for increased risk of loss to the insurance fund, but the inquiry under section 8(a), contrary to the ALJ's finding, does not require any quantification of that risk or comparison with costs of liquidation.3
   Thus, no language in section 8(a), either explicitly or by implication, imposes the sort of "cost test" on terminating insurance that the ALJ has found to be required. The Board has also examined the legislative history of section 8(a) and finds no support for the

3 The FDIC, in its discretion, may make such comparisons in determining how best to proceed to resolve the problems of a troubled institution. However, there is no statutory requirement that it undertake these calculations of interpret them in discharging its duties. A party attempting to challenge an action based on these cost calculations would lack standing to do so.
{{9-30-91 p.I-29}}ALJ's finding that SWB has an affirmative defense based on a comparison of the cost of liquidation and the cost of continued operation.
   The failure of the statutory language or legislative history to furnish support for the "cost test" posited by SWB as an affirmative defense is not surprising given the purpose served by a termination of insurance proceeding. Section 8(a) actions are designed to set an upper limit to the risk to the insurance fund. Once insured status is terminated, new deposits are not insured, and withdrawal of existing deposits decreases the risk by decreasing the amount of insurance coverage for the institution. Accordingly, a comparison of the costs of liquidation and continued operation is irrelevant to an action merely designed to limit the exposure of the insurance fund.4
   On the basis of the foregoing analysis, the Board concludes that the information sought by SWB concerning the historical costs of liquidation is not itself relevant to any issue arising in a section 8(a) action to terminate insured status. Moreover, SWB has failed to demonstrate how discovery of these documents, which would be inadmissible at the hearing, can reasonably be expected to lead to the discovery of other relevant evidence, and the Board is not aware of any way that they could. Accordingly, the discovery sought by SWB fails the test of relevance set forth in 12 C.F.R. § 308.25(b).


   The Board of Directors of the FDIC, having considered the statute, its legislative history and the record of this proceeding, including the briefs filed on behalf of Enforcement Counsel and SWB and the ALJ's Order dated may 14, 1990, makes the following finding. The Board finds on the record before it that SWB is not entitled to discovery of documents relating to the cost of liquidation in the Southwest region because they are not relevant as that term is used in 12 C.F.R. § 308.25(b).
   ACCORDINGLY, IT IS HEREBY ORDERED, that the ALJ's Order of May 14, 1990, granting SWB's Motion to Compel is reversed and the case is remanded to the ALJ for further proceedings consistent with this Decision and Order.
   By direction of the Board of Directors.
   Dated at Washington, D.C., this 14th day of August, 1990.

§Robert E. Feldman
Deputy Executive Secretary

4 SWB states that the evidence is relevant because there is no loss to the insurance fund and none anticipated if the bank is allowed to continue operation. This is because SWB believes that its excellent management is undisputed, its classified assets are declining, and it has enjoyed positive net income for 1989 and the first half of 1990. Assuming SWB can prove these contentions, the documents SWB seeks to discover are still not relevant.
   Presumably, the proffered evidence will be relevant to the issues presented by the Notice, i.e., whether SWB has engaged or is engaging in unsafe and unsound practices and whether it is in unsafe or unsound condition to continue to operate. However, the purpose of the Notice is to cause correction of the problem, or barring that, to fix the risk to the insurance fund at a particular number through the termination of insurance. Weighing the cost of liquidation against the cost of continued operation plays no role in this process.

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