When Lenders Exercise Too Much Control

This can and does happen. The 1989 Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) amendments to the Federal Deposit Insurance Act gave federal banking agencies express authority to assess whopping civil fines against FDIC-insured banks and their holding companies, officers, directors, and other "institution affiliated parties" (IAPs) (including, in some circumstances, the banks' lawyers) for violations of federal banking laws. The statute defines three tiers of maximum penalties, based on the character, consequences, and culpability of violations. Within those tiers, the banking agencies have broad discretion to determine the amount of penalties to assess and against whom to assess them. Ability to pay is one of the "mitigating factors" the agencies are directed to consider in determining whether and how to assess a large penalty for legal violations.

This article reviews the federal banking agencies' procedures for assessing civil money penalties for violations of the federal banking laws and suggests some strategies for defending banks and their IAPs from such assessments.

Civil Money Penalties under FIRREA
Authority for banking agency assessment of civil money penalties for violations of the banking laws is found in section 8(i)(2) of the Federal Deposit Insurance Act, 12 U.S.C. § 1818(i)(2). Office of the Comptroller of the Currency, Laws and Regulations, Enforcement Actions Types. The statute establishes three tiers of maximum penalties. The first tier—covering violations of laws, regulations, regulatory orders, regulatory approval conditions, or written agreements with a regulatory agency—provides for penalties of up to $5,000 per day of continuing violation. The second tier—covering violations that cause "more than minimal loss" to a financial institution or pecuniary gain to the violator—provides for penalties of up to $25,000 per day. Tier 3 provides for penalties of up to $1 million per day for "knowing" violations that cause "substantial loss" to a bank or "substantial pecuniary gain" to the violator or another person. The statute provides for periodic inflation adjustments to the maximum tier 3 penalty. The current adjusted maximum is $1,425,000 per day for continuing violations.

While paragraphs (A), (B), and (C) of 12 U.S.C. § 1818(i)(2) provide for mandatory penalties ("shall forfeit and pay"), paragraph (F) authorizes each agency to "compromise, modify, or remit" any penalty it assesses under the statute. Section 1818(i)(2)(G) lists "mitigating factors" the agencies "shall take into account" in determining the amount of civil money penalty assessed:

(i) the size of financial resources and good faith of the insured depository institution or other person charged;

(ii) the gravity of the violation;

(iii) the history of previous violations; and

(iv) such other matters as justice may require.

The reference to "good faith" as a "mitigating factor" is interesting because it suggests that a civil money penalty may be imposed even when an institution or IAP has acted in complete good faith. "Good faith" would, however, appear to negate the "reckless" or "knowing" state of mind required for imposition of a tier 3 penalty.

The last mitigating factor specified by paragraph (G), "such other matters as justice may require," gives the agencies very broad discretion to consider—and the parties concerned very broad license to offer in mitigation and defense—evidence of circumstances, states of mind, or conditions that are even arguably relevant to an assessment of penalties.

As prescribed by the statute, the agencies assess civil money penalties by issuing a "notice of assessment" to the institution or individuals concerned. The recipients have 20 days to request a formal administrative hearing before an agency administrative law judge (ALJ), in which the agency will bear the burden of proving a violation. If no hearing is requested, the right to contest or appeal the assessment is waived. Following the hearing, the ALJ makes a recommendation to the agency head, who may or may not follow the recommendation. If, following a hearing, the agency head issues an order of assessment of civil money penalties, the party assessed can obtain review of the assessment in the U.S. Court of Appeals for the D.C. Circuit or the circuit in which the bank concerned is located. In any such appellate review, the agency's findings of fact will be upheld if supported by "substantial evidence."

Usually, civil money penalties are assessed without a hearing by stipulation and consent of the bank and any individuals concerned. A party consenting to the issuance of an order of assessment thereby waives any right to appeal. Often the stipulation will recite that there is no adjudication or admission of any violations and that the party is consenting to the assessment to settle a matter of dispute with the agency while avoiding the burden or expense of formal litigation.

Agency Policies and Procedures
Within that statutory framework, the federal banking agencies have adopted internal policies and procedures to guide their examiners and supervisory and enforcement staffs in determining whether to assess civil money penalties for violations of banking laws and regulations, breaches of fiduciary duty, and other legal transgressions, against whom and in what amounts to assess such penalties, and to ensure consistency in their determinations. The FDIC's internal guidelines are set forth in its Manual of Examination Policies; the internal guidelines of the Office of the Comptroller of the Currency (OCC) appear in the Bank Supervision section of its Policies and Procedures Manual. In February 2016, the OCC announced revisions to its civil money penalty policy and procedures. Revised Civil Money Penalty Policy, OCC Bulletin 2016-5.

First Level of Defense—The Examination
The agency level at which assessment of civil money penalties is normally first considered is the bank's on-site examination by its "appropriate federal supervisory agency," i.e., the OCC for national banks and federally chartered thrifts, the FDIC for state-chartered banks and thrifts that are not Federal Reserve System members, and the Federal Reserve Board for state-chartered member banks and all bank and thrift holding companies. The on-site examination is where apparent violations of laws and regulations by an institution or its IAPs are first detected, flagged, and investigated. If an institution has a history of prior violations, these will be identified in advance for focused review during the examination. In addition, if the institution or any of its IAPs are subject to a regulatory order or agreement or have accepted written conditions in connection with the agency's approval of a prior regulatory application, examiners will review the institution's and IAP's compliance with the order, agreement, or condition.

The on-site examination offers the first and best opportunity to head off a possible civil money penalty assessment. Examiners' inquiries and requests for additional information may reveal areas of particular examiner concern and focus. Such inquiries can provide a timely heads-up to bank management to make sure the examiner is made aware of facts and circumstances that may negate a finding of a violation or militate against a recommendation of civil money penalties or other enforcement action. At this level, it is usually best not to engage the examiner in a legalistic argument, which could prematurely attract higher levels of agency attention. Rather, institution personnel may, in a low-key and non-defensive manner, bring additional facts and documents that provide context for the bank's or IAP's conduct to the attention of the examiner.

If examiners believe imposition of civil money penalties may be warranted, they may consult with the agency's supervisory and legal staffs to test their initial findings and identify areas for further inquiry during the examination. At this stage, the focus of examiners' concerns may be apparent to the bank's staff. Bank personnel should be alert to such indications and flag them for bank management to develop an appropriate game plan and response. If an examiner indicates expressly that a finding of a legal violation is under consideration, it may be appropriate to involve the bank's legal counsel and request an opportunity to review and discuss the issues with the agency's legal and supervisory staffs before any finding of a violation is made.

Early Intervention
Occasionally, the first indication of a possible violation finding may come in the exit meeting between the agency's examiners and the bank's management or in the written report of examination delivered to the bank following the conclusion of the examination. In either case, it is important for bank counsel to move quickly to address potential violation findings directly with the agency's legal and supervisory staffs before any formal or informal supervisory proceeding is commenced. It may be appropriate to request an in-person meeting with the agency's legal and supervisory staff at the agency's offices to discuss the examination findings and recommendations. In advance of the meeting, the bank and its counsel should collect and review all of the internal documents and agency correspondence and legal precedents relevant to any apparent violation identified. Following the meeting, it may be appropriate to submit a formal written follow-up presenting the facts, circumstances, and applicable law from the bank's perspective and addressing any specific concerns identified by the agency during the meeting. Often the result of such a meeting and follow-up submission will be to head off an examination finding of a violation and any internal examiner recommendation of a civil money penalty, before either occurs.

Agency Request for Information
If the bank's presentations to this point are insufficient to allay the agency's concerns, the agency may seek additional information to better inform its examination and, if applicable, its supervisory findings and actions. This may take the form of further examiner inquiry or requests for information from the agency's supervisory or legal staff. Among other things, the agency may request information regarding the financial resources of any individual IAPs suspected of having participated in violations. To protect the privacy and separate legal interests of any individuals involved, the agency may address requests for any such personal information directly to the individual directors or officers concerned. Ordinarily, such requests for information will specify a deadline, e.g., 15 days, for a written response.

An agency request for additional information provides the last clear chance to head off a formal civil money penalty assessment or proceeding. The bank may request a meeting with the agency's supervisory and enforcement staffs at the decision-making level, either in the agency's regional office or in Washington. The bank's presentation should address both the factual and legal merits of the bank's defense and each of the civil money penalty assessment factors identified as relevant in the agency's own published civil money penalty policies and procedures. (In 1998, the federal banking agencies' jointly published a matrix of 13 factors relevant to the issuance and amount of a civil penalty assessment. The OCC recently revised its version of the matrices—one for institutions, one for individuals—in conjunction with its February 2016 revision of its civil money penalty policy.)

If possible, the bank and its IAPs should strive to present a united front in their discussions with the agency, and not invite the agency to play directors off against management or vice versa. To the extent there is an identity of interests, a joint defense agreement may be appropriate. In many cases, it will be both appropriate and effective for the bank and its management to accept full responsibility for any violations that may have occurred and urge that the bank's directors and other IAPs be excused from personal liability for transgressions not of their own making.

Addressing Supervisory Objectives
In seeking to head off civil money penalties, the bank and its counsel should directly address the agency's principal supervisory concerns and objectives and the purposes to be served by an assessment of civil money penalties. These are usually to terminate immediately the actions or conduct constituting the alleged violation or violations; remedy any resulting injury, damages, or adverse conditions; and prevent any recurrence of violations in the future. To the extent counsel can demonstrate that these supervisory objectives can and have been achieved—for instance, by restitution or reimbursement to the bank or its customers; resignation, reassignment, or enhanced training or supervision of bank personnel; changes in bank policies or procedures; reallocation of management attention and resources; or informal supervisory actions, such as a confidential memorandum of understanding between the bank and the agency—the agency's need to impose civil penalties can be reduced.

Informal supervisory actions are usually kept confidential by both the agency and the bank concerned. In some instances, it may not be possible to achieve all of the agency's supervisory objectives—principally deterrence of other financial institutions from engaging in similar practices—by informal means. In such instances, the agency may need to take formal supervisory action, which is public and which can be highlighted by an agency press release, in order to achieve the desired deterrent effect. Where such concerns are important, the bank may argue that its entry into a formal and public written agreement or consent supervisory order with the agency will accomplish the desired deterrent effect without the need to assess a civil money penalty.

Conclusion
The OCC's issuance of a revised civil money penalty policy is a useful reminder that a bank's and its IAPs' best defense against assessment of civil money penalties is to be alert for early warning signs that a finding of legal violation is being considered and to be proactive in addressing and disarming the agency's concerns.

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