Banking StandardsWritten evidence from the Federal Deposit Insurance Corporation

SANCTIONS FOR BANK DIRECTORS

Enforcement Actions

The Commission understands that the FDIC has the authority to bring a broad range of enforcement actions against banking organizations and their Institution-Affiliated Parties (IAP).

1. Has the FDIC historically brought more civil suits or enforcement actions against bank directors as IAPs?

Uniquely among the various federal banking regulators in the United States, the FDIC acts as an insurer, a supervisor, and sometimes a receiver.1

The FDIC insures deposits of approximately 7,100 banks and thrifts of all charters. As supervisor, the FDIC is the primary federal regulator for state-chartered banks and savings institutions that are not part of the Federal Reserve System, generally known as state nonmember banks and state-chartered thrifts. The FDIC directly supervises approximately 4,500 insured state nonmember banks and savings institutions. As insurer, the FDIC has special (back-up) examination authority for over 2,600 FDIC-insured depository institutions for which the FDIC is not the primary federal regulator. These include state member banks that are supervised by the Federal Reserve Board and national banks, thrift institutions and insured branches of foreign banks supervised by the Office of the Comptroller of the Currency.

The FDIC’s roles as an insurer and primary supervisor are complementary, and many activities undertaken by the FDIC support both the insurance and supervision programs. In these roles, the FDIC regularly monitors the potential risks at all insured institutions. If weaknesses are identified through the examination process, the FDIC promptly takes appropriate supervisory action. Formal and informal enforcement actions may be issued for institutions identified as having significant weaknesses or found to be operating in a deteriorated financial condition. Actions may also be taken, in appropriate circumstances, against individual directors or other IAPs of FDIC-supervised institutions for civil money penalties, restitution, or to remove them from banking.

In 2012, the FDIC issued 121 Cease and Desist (“C&D”) orders under Section 8(b) of the Federal Deposit Insurance Act (“FDI Act”), 12 U.S.C. § 1818(b), all of which were issued pursuant to stipulation. The FDIC issued 108 stipulated orders of prohibition and/or removal against individuals pursuant to 8(e), 12 U.S.C. § 1818(e), and, where stipulations could not be obtained, filed Notices of Charges in 8 such cases. The agency issued 157 Orders to Pay under Section 8(i), 12 U.S.C. § 1818(i). Finally, the FDIC entered into 224 informal Memoranda of Understanding relating to safety and soundness matters during 2012.

The FDIC exercises its supervisory and regulatory authority over open institutions and their IAPs almost exclusively through the administrative (ie enforcement) process. By contrast, civil actions are generally the province of the FDIC in its capacity as receiver.

When an FDIC-insured institution fails, the FDIC is appointed as receiver. The FDIC’s role as receiver is independent of its corporate role as supervisor and insurer. In its receivership capacity, the FDIC steps into the shoes of the failed institution and assumes responsibility for maximizing recovery for the receivership estate. This includes the pursuit of the receivership’s claims against professionals who caused losses to the failed institution. Funds collected from the sale of assets and the disposition of valid claims are distributed to the receivership’s creditors under the priorities set by law.

As receiver for a failed FDIC-insured depository institution, the FDIC, where appropriate, brings civil actions against the former directors and officers of the failed institution who caused losses to the institution in order to maximize recoveries to the receivership. (Professional liability claims also include claims against fidelity bond insurance carriers, appraisers, attorneys, accountants, mortgage loan brokers, title insurance companies, securities underwriters and issuers, or other professionals who caused losses to the failed institution.) Professional liability suits are pursued if they are both meritorious and expected to be cost-effective. Before seeking recoveries from directors, officers, and professionals, the FDIC as receiver conducts a thorough investigation of whether they breached duties to, and the extent to which they caused losses to, the failed institution. Most investigations are completed within 18 months from the time the institution is closed. Prior to filing a civil action, staff will attempt to settle with the responsible parties. If a settlement cannot be reached, however, a complaint will be filed, typically in federal court.

Not all bank failures result in civil actions against directors and officers. The FDIC brought claims against directors and officers in 24 percent of the bank failures between 1985 and 1992. As of December 11, 2012, the FDIC has authorized civil actions in connection with 89 failed institutions against 742 individuals for director and officer liability. (Of the 742 authorized director and officer defendants, 11 were authorized in 2009, 98 were authorized in 2010, 264 were authorized in 2011, and 369 were authorized in 2012.) This includes 41 filed civil actions (4 of which have settled and 1 of which resulted in a favorable jury verdict) naming 324 former directors and officers.

2. Are formal enforcement actions usually preceded by informal actions or warnings by the FDIC?

The FDIC has a variety of formal and informal remedial and supervisory tools at its disposal, and endeavors to match the tool to the circumstances. Where a problem is of only moderate supervisory concern and management appears willing and able to resolve the matter, the FDIC is likely proceed informally via, for example, a resolution adopted by the bank’s board of directors or a written Memorandum of Understanding between the bank and the FDIC. By contrast, where a bank’s actions or inaction threaten immediate or substantial harm to the institution, or management appears unwilling or unable to address FDIC concerns, the FDIC will proceed formally even in the absence of prior informal actions. In most cases involving IAPs, the objectionable conduct has already taken place and thus the FDIC typically proceeds directly to formal action.

3. Of the various types of enforcement actions (including civil money penalties, cease and desist orders (both permanent and temporary) and removal, prohibition and suspension orders), which has been the most effective tool for the FDIC?

As noted, the FDIC undertakes in all cases to employ the tool most effective for the problem at hand. C&D orders for example are well suited to correcting unsafe and unsound or other poor banking practices. Civil money penalties can be imposed as punishment for violations of law and extreme or repeated forms of misconduct, and may also be employed when the objectionable behavior is not sufficient to warrant removal or prohibition. Finally, removal and prohibition orders have a largely preventative effect, by ensuring that persons who are unfit to serve at an insured financial institution are prevented thereafter from doing so.

4. In your view is the threat of a formal enforcement action taken seriously by bank directors?

Yes. The possibility of formal enforcement actions is an effective deterrent from misconduct or haphazard management of an institution’s affairs. Directors understand that formal enforcement actions can result in serious personal consequences, including the imposition of money penalties or an industry-wide ban. In addition, formal enforcement actions are public, and thus may entail unwelcome attention.

Civil lawsuits by the receiver of a failed institution against its former directors or officers for breaches of duty, while not “enforcement actions” as such, also serve to deter misconduct and mismanagement.

5. Do you think that the possibility of enforcement actions deters capable individuals from working in the banking industry?

This claim surfaces during times when bank failures are high, but the FDIC has not seen evidence of qualified individuals actually foregoing bank service out of concern for unwarranted enforcement actions.

6. Does the FDIC have broad rule-making authority? If so, can the violation of a rule by an IAP lead to an enforcement action?

The FDIC has authority to issue regulations pertaining to banks it supervises as well as to all depository institutions with FDIC deposit insurance. Violations of these or any other banking law or regulation can result in civil money penalties against an IAP, as well as in a C&D order (against the institution) or a removal or prohibition action (against IAPs), provided that the other elements of such claims are met. Enforcement actions based on violations of law or regulation are not uncommon.

Civil Money Penalties

The Commission understands that three tiers of civil money penalties can be assessed by the FDIC against an IAP after written notice and, if requested, a hearing.

Tier I civil money penalties can be assessed for a (i) violation of any law or regulation, (ii) violation of certain final and temporary orders issued by the bank regulators, (iii) violation of written conditions imposed by the bank regulators and (iv) violation of written agreements entered into between the banking organization and the bank regulator.

Tier II civil money penalties can be assessed if the IAP has committed a Tier 1 violation and recklessly engages in an unsafe or unsound practice in conducting the affairs of an insured depository institution or breaches any fiduciary duty. Tier II also requires that the violation, practice or breach was part of a pattern of misconduct, caused or was likely to cause more than a minimal loss to such banking organization or resulted in pecuniary gain or other benefit to the IAP.

Tier III civil money penalties are assessed for knowingly committing a Tier I violation or engaging in unsafe or unsound practices or breaking a fiduciary duty.

7. In respect of the various Tier I violations listed above, which occur most frequently in your experience?

Violations of law or banking regulation are the most frequent basis for Tier I penalties.

8. Does the FDIC frequently enter into written agreements with banking organizations?

Stipulated C&D orders rather than formal “written agreements” are the most common enforcement mechanism employed by the FDIC against banks. Such orders are enforceable by civil money penalties or other enforcement actions. While the FDIC has authority to enter into other forms of “written agreement,” such agreements are relatively uncommon.

9. In your experience, are breaches of a fiduciary duty by the IAP often the basis for Tier II and Tier III penalties?

Breaches of fiduciary duty often form the basis for Tier II penalties. In most such cases, the conduct at issue constitutes an unsafe and unsound activity as well. Tier III penalties are assessed very rarely, and it is difficult to generalize about them.

10. How often are civil money penalties assessed against IAPs with the consent of the banking organization?

It is common for civil money penalties assessed against a financial institution to be assessed with the institution’s consent. A banking organization has no role, formal or informal, in the assessment of penalties against its IAPs (versus the organization itself).

11. Do the “Interagency Guidelines Establishing Standards for Safety and Soundness” provide the basis for what practices may be considered “unsafe and unsound”?

The Interagency Guidelines reflect developments in the law defining “unsafe and unsound” practices (largely developed through bank agency determinations and decisions) but do not provide rules of decision. The concept of unsafe or unsound practices is one of general application which touches upon the entire field of operations of a banking institution. The spectrum of activities that may be included cannot be captured by a single rigid or all-inclusive definition. Thus, an activity not necessarily unsafe or unsound in every instance may be so in a particular instance when considered in light of all relevant facts pertaining to that situation. Generally speaking, an unsafe or unsound practice embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would result in abnormal risk of loss or damage to an institution, its shareholders, or the insurance fund administered by the FDIC. Courts have given the banking agencies broad discretion to define this term, and in turn give agency examiners substantial deference in opining about what activities are “unsafe and unsound”.

Cease and Desist Orders

The Commission understands that the FDIC, upon consent or notice and a hearing, can issue cease and desist orders against any IAP when that party has engaged or is about to engage in an “unsafe or unsound” banking practice, a violation of a law, rule, or regulation, any condition imposed in writing by the FDIC, or any written agreement entered into between the banking organization and the FDIC. Cease and desist orders can also require that certain affirmative acts be taken by the IAP including to pay restitution to or to reimburse, indemnify or guarantee the banking organization against the loss.

12. Can cease and desist orders be combined with other enforcement actions?

Yes. C&D orders, issued under the authority of Section 8(b) of the FDI Act, are most commonly issued against institutions, rather than against IAPs. C&D orders may be accompanied by a civil money penalty, but in most cases the C&D order stands alone.

13. Is it common for cease and desist orders to be issued upon consent?

Yes. Most FDIC C&D orders are issued pursuant to stipulation.

14. Are temporary cease and desist orders frequently accompanied by asset freezes and prejudgment attachments?

The FDIC has the authority to freeze assets and attach assets prior to judgment, but the power is not frequently exercised.

Removal and Prohibition Authority

The Commission understands that the FDIC has the authority to issue orders removing or suspending bank directors from office and prohibiting them from participating in any banking organization. In addition to a violation similar to the other enforcement actions discussed above, a removal or prohibition order requires a showing that (i) the banking organization has suffered or will suffer a financial loss, (ii) the interests of the banking organization’s depositors have been or could be prejudiced or (iii) such bank director has received financial gain or other benefit by reason of the violation, practice or breach, and (iv) the violation, practice or breach involved dishonesty or (v) demonstrates wilful or continuing disregard by such party for the safety and soundness of such banking organization.

15. Do removal and prohibition orders always result in the bank director being prevented from working in the banking industry in the future?

Yes. The FDI Act, pursuant to which such orders are issued, sets forth the broad scope of such orders. See 12 U.S.C. § 1818(e)(7). Any person subject to an removal/prohibition order is prohibited from holding any office in or participating in the conduct of the affairs of: i) any insured depository institution; ii) any Federally-insured credit union; iii) any Farm Credit Bank; iv) any Federal depository institution regulatory agency; v) any Federal home loan bank; and vi) the Federal Housing Finance Agency.

Removal and prohibition orders continue in effect indefinitely. Each of the federal banking agencies has the authority to terminate an order of prohibition or removal that it has issued, but the authority is exercised very rarely. In addition, exceptions to permit a prohibited individual to become an IAP of a particular insured institution may be made on a case-by-case basis with the consent of the issuing agency and the agency with supervisory authority over the subject institution. This authority, too, is exercised only very rarely. Indeed most modifications of removal/prohibition orders approved recently by the FDIC are to permit the individual to sell or otherwise dispose of bank stock that the individual owned prior to the order’s entry.

16. Is it usual for the board of directors of the banking organization to dismiss the culpable director before the FDIC issues a removal order?

It is not uncommon. In many cases, the bank itself discovers the objectionable behavior and both dismisses the culpable person and alerts the FDIC. In some instances the bank will retain the subject as an employee pending resolution of the FDIC’s charges. In some cases the culpable director is in a position of control at the bank and is not removed from the institution until the FDIC’s order is litigated and becomes final.

17. If the FDIC is unable to obtain a removal and prohibition order but can bring another formal enforcement action against the bank director, is there a way to ensure that the culpable bank director will not be reemployed by the banking industry in the future?

Orders of removal and prohibition are the only supervisory means for obtaining a blanket prohibition on an individual’s involvement in the banking industry. There are, however, other mechanisms that may limit or prevent certain individuals from serving in the banking industry.

Under Section 19 of the FDI Act, 12 U.S.C. § 1829, any person who has (among other things) been convicted of any criminal offense involving dishonesty, breach of trust, or money laundering, may not, without the prior written consent of the FDIC, act as an IAP of any FDIC-insured depository institution.

Under Section 8(g), 12 U.S.C. § 1818(g), the FDIC may issue a Notice of Suspension and/or Prohibition when an IAP is charged with a felony involving dishonesty or breach of trust with potential punishments above certain levels, whose continued service or participation might threaten the interests of the institution’s depositors or threaten to impair public confidence in the institution. This action is typically temporary, and will remain in effect until the charges are resolved, allowing the FDIC to pursue a permanent prohibition if the IAP is convicted.

Under Section 32 of the FDI Act, 12 U.S.C. § 1831i, any bank deemed to be in “troubled condition” (ie a composite CAMELS rating of 4 or 5) is required to obtain FDIC approval before adding new directors or executive officers. The FDIC may in appropriate circumstances use this authority to ensure that an individual does not gain employment at any troubled institution even when such individual is not subject to a general prohibition.

18. Does the FDIC have the authority to approve the appointment of senior bank directors and officers?

The FDIC has no general authority to approve or disapprove the appointment of bank directors or senior officers of well-run institutions. However, the FDIC must be satisfied that management is satisfactory before approving an institution’s application for deposit insurance, and the FDIC reviews and may object to the appointment of directors or executive officers at banks deemed to be “troubled” under Section 32 of the FDI Act. C&D orders issued pursuant to Section 8 of the FDI Act also from time to time include a remedial provision requiring the subject bank to retain qualified management acceptable to the FDIC.

Civil Suits

19. Does the FDIC frequently institute civil suits against bank directors?

The FDIC brings administrative enforcement actions against directors and officers of open banks. These actions are subject to judicial review after final agency action. When banks fail the FDIC as receiver may bring civil actions to recover damages suffered by the bank.

Not all bank failures result in civil actions against former directors and officers of a failed institution. The FDIC brought claims against directors and officers in 24 percent of the bank failures between 1985 and 1992. As of December 11, 2012, the FDIC has authorized civil actions in connection with 89 failed institutions against 742 individuals for director and officer liability. (Of the 742 authorized director and officer defendants, 11 were authorized in 2009, 98 were authorized in 2010, 264 were authorized in 2011, and 369 were authorized in 2012.) This includes 41 filed civil actions (4 of which have settled and 1 of which resulted in a favorable jury verdict) naming 324 former directors and officers.

20. In what circumstances, can the FDIC institute a civil suit against a bank director and what is the standard for director liability?

The FDIC follows the policies adopted by the FDIC Board in 1992, Statement Concerning the Responsibilities of Bank Directors and Officers, which can be found at http://www.fdic.gov/regulations/laws/rules/5000–3300.html#fdic5000statementct, and require Board approval before actions are brought against directors and officers.

Professional liability suits are only pursued if they are both meritorious and expected to be cost-effective. Before seeking recoveries from professionals, the FDIC conducts a thorough investigation of professionals who caused losses to the failed institution. Most investigations are completed within 18 months from the time the institution is closed. Prior to filing the claim, staff will attempt to settle with the responsible parties. If a settlement cannot be reached, however, a complaint will be filed to initiate a civil action, typically in federal court.

As receiver, the FDIC has three years to file tort claims and six years to file breach-of-contract claims from the time a bank is closed. If state law permits a longer time, the state statute of limitations is followed.

Professionals may be sued under tort or contract theories available under applicable state law. Generally, for directors and officers, potential causes of action include breach of fiduciary duty and/or gross or simple negligence. Federal law pre-empts state law that insulates directors and officers from gross negligence or worse conduct. Bank directors are allowed to exercise their business judgment without incurring legal liability. Further information can be found in Managing the Crisis: The FDIC and RTC Experience, Chapter 11, Professional Liability Claims, http://www.fdic.gov/bank/historical/managing/history1–11.pdf.

21. What steps can the FDIC take when the bank director is suspected of committing a crime?

The FDIC does not have authority to bring criminal actions either as a supervisor or as a receiver.

When the FDIC as supervisor identifies possible criminal activity at an open bank, it will encourage the bank to gather supporting evidence and file a Suspicious Activity Report (“SAR”) with the Financial Crimes Enforcement Network (“FinCEN”) (a division of the U.S. Department of Treasury) regarding the activity. The FDIC itself may file SARs and refer matters to the FDIC’s Office of Inspector General for investigation and possible referral to the Federal Bureau of Investigation.

For those convicted of criminal wrongdoing against failed financial institutions, a court may order a defendant to pay restitution or to forfeit funds or property to the FDIC as receiver for the failed institution as part of the criminal sentencing process. As of year-end 2012, there were 4,860 active restitution and forfeiture orders.

Other

22. How are enforcement actions or civil suits by the FDIC funded?

Enforcement actions are paid for out of FDIC general funds, which are made up of deposit insurance assessments paid by insured financial institutions.

Professional liability investigations and civil actions brought by the FDIC as the receiver for a failed institution are funded through the individual receiverships. Professional liability claims are brought if they are both meritorious and expected to be cost-effective. Any funds recovered from those investigations and civil actions are returned to the receivership and are used to pay claims against the receivership estate in accordance with the priorities established by statute. These priorities generally provide first for payment of the receiver’s administrative expenses, second for any deposit liability, and third for general creditor claims.

23. Please could you give us an indication of the average internal (for example, staffing) and external (for example, legal fees) costs for bringing an enforcement action against an IAP.

The costs of enforcement actions vary according to many factors, including the type, size and complexity of the claims, the number of respondents, the experience and/or tactics of opposing counsel, and whether the matter is resolved by stipulation prior to either the filing of a Notice of Charges or the administrative hearing. Most enforcement actions are resolved via stipulation and do not cause the agency to incur significant incremental costs. In contrast, a contested case that proceeds through the hearing stage may require the full-time attention of two or more attorneys for a year or more, plus administrative staff and expenses such as document retrieval and production, and expert witness expenses. FDIC enforcement cases are litigated by FDIC staff attorneys and almost never involve outside counsel.

24. Please could you give us an indication of the average internal (for example, staffing) and external (for example, legal fees) costs for bringing a civil suit against an IAP.

The cost to bring professional liability lawsuits varies depending on a variety of factors and may involve the retention of outside counsel to assist the FDIC as receiver with the investigation and litigation of a particular matter. The FDIC tracks the expenses associated with the overall professional liability program in comparison to the recoveries. From 1986 through 2012, the FDIC and the former Resolution Trust Corporation (1989–1995) collected $6.8 billion from professional liability claims. Over that same time, they spent $1.87 billion to fund all professional liability claims and investigations. Early in the process of professional liability claims, expenses will often exceed recoveries due to the costs incurred in handling new investigations. Professional liability program recoveries lag expenses by several years until settlements occur and judgments are awarded.

25. Does the FDIC conduct periodic on-site examinations of banking organizations? If so, how frequently?

The FDIC is required to conduct a full-scope, on-site examination of every insured state nonmember bank at least once during each 12-month period. The FDIC may extend the period to 18 months for institutions that meet certain criteria (broadly, “well capitalized” institutions of less than $500 million in assets that were rated a composite “1” or “2” at their last examination and which are not subject to a formal order by a federal banking agency). In addition, the FDIC may accept reports of examination by state authorities and conduct its own 12 or 18 month examinations on an alternating basis with the state banking authority.

26. Are banking organizations required to submit periodic reports to the FDIC? Is there a penalty for failing to make required reports?

A variety of reports are required. The most common—required to be filed by all banks—is the quarterly Consolidated Reports of Condition and Income, or “Call Report”. Banks with total assets of $500 million or more are also required to submit annual audited financial statements. Periodic progress reports are typically required at least quarterly when a bank is subject to a formal or informal enforcement action. Daily or weekly liquidity reports may also be required for troubled institutions.

Civil money penalties against an institution for late filing of Call Reports are not common and will vary depending on duration of the violation and whether the violation is deemed intentional or unintentional. The late filing of Call Reports typically results in penalties in the low thousands of dollars, but has in some cases exceeded $100,000. Tier I penalties may also be assessed against individual board members for allowing their institution to file a Call Report with false information.

18 January 2013