What Happens When Local Banks Falter?

In the wake of First NBC Bank’s failure, a look at the basics of FDIC enforcement.

08/01/2017

Joseph Briggett,

According to federal banking regulators, bank failures reached a peak in 2010 before subsiding in the years since. The specter of bank failures, however, remains a significant risk to the U.S. banking system. The recent failure of First NBC Bank reportedly cost the federal government approximately $1 billion. While a relatively small loss for the U.S. banking system overall, it is a reminder of the risks in the banking community, especially among local banks.

Local banks, including federally insured state chartered banks, are generally regulated by the Federal Deposit Insurance Corporation (FDIC). The FDIC has supervisory authority over these banks and conducts regular examinations of them. Many members of the banking community have pointed out the regulatory burden of these examinations on small banks in recent years. In an effort to ease these regulatory burdens — including financial institution examinations — the Financial CHOICE Act of 2017 was proposed and has made its way through the House, which passed it on June 8.

The FDIC also initiates enforcement action against banks and the people who work for them when it believes violations of the law have occurred. This includes a bank’s officers, directors, employees, controlling shareholders and agents, among others.

The FDIC pursues these actions against the aforementioned individuals for a number of reasons that may be based upon violations of specific laws, rules or regulations. The FDIC’s Statement of Policy indicates that driving factors include if the individual was engaged in dishonest conduct or was responsible for the bank’s failure to adhere to laws.

These actions may also be based upon “unsafe or unsound banking practices,” which is essentially a question of whether a person has acted as a prudent banker would. The FDIC may pursue enforcement actions based upon breaches of fiduciary duty, violations of pre-existing orders, or other written requirements that may have previously been imposed by regulators.

In a recent decision, the FDIC’s board of directors found a limit to actions against individuals who are not officers or directors. It determined that the agency’s enforcement division could not pursue an action against a bank’s outside lawyer in which it alleged the lawyer “knowingly and recklessly participated in improper loans.”

In that enforcement action relating to Park Avenue Bank — an FDIC-regulated financial institution located in New York — the board of directors affirmed the decision of Administrative Law Judge Richard Miserendino. The judge and the board both found that in order to be within the jurisdiction of the FDIC, an outside lawyer would have to be in a position to influence the bank’s affairs. The board noted that for a bank’s outside lawyer, giving good faith legal advice does not rise to this level. This decision will likely place a limit on the FDIC’s jurisdiction to pursue actions against outside professionals like lawyers, accountants and consultants.

"The specter of bank failures … remains a significant risk to the U.S. banking system."

In addition to the power to pursue enforcement actions against individuals affiliated with a bank, the FDIC has the statutory authority to terminate the deposit insurance of any insured bank. The FDIC may also seek several other remedies against the bank such as entry of an order to comply with certain conditions, or imposing civil money penalties.

The FDIC can exercise this authority based upon a specific violation, or if it can prove a bank is in “an unsafe or unsound condition” or engaging in “unsafe or unsound banking practices.” An important part of this enforcement power is to oversee and enforce the proper handling of requirements under the Bank Secrecy Act (BSA) and related statutes, which require banks to maintain reporting intended to detect money laundering and other illegal activities. These complex BSA regulations may lead the FDIC to seek large civil money penalties against banks for noncompliance.

While enforcement actions can be pursued at any time, the occurrence of a problem bank status or bank failure certainly increases the risk that the FDIC will pursue additional enforcement actions against a bank or its affiliated persons. When a bank failure results in large public losses of taxpayer money the tendency is to place the responsibility on individuals and attempt to recover losses from them.

The amount of actions pursued by the FDIC varies significantly on an annual basis. The FDIC’s statistics reflect that 2017 has been of low activity, with the FDIC as receiver having pursued only six actions against directors and officers nationwide as of late June. By comparison, in 2012, FDIC reached a high point of actions in the wake of the banking crisis, pursuing 369 actions against directors and officers.

Procedurally, an enforcement action is commenced by filing a notice of charges by FDIC enforcement counsel with an entity called the Office of Financial Institutions Adjudication (OFIA), headquartered in Arlington, Virginia. Although the OFIA is in the Washington, D.C. area, proceedings are required to be conducted in the jurisdiction of the bank’s headquarters. Therefore, an enforcement proceeding against a bank or persons affiliated with a bank in New Orleans would generally take place in the federal district court in New Orleans.

Administrative actions before the FDIC are conducted in accordance with rules similar to those that are applicable in federal courts. Certain traditional evidentiary rules, however, like the hearsay rule, are relaxed in FDIC proceedings. The proceedings are also generally open to the public, although efforts may be made, and indeed are required to be made, to maintain the confidentiality of sensitive information. The general rule is that the papers submitted to the OFIA, along with evidence, testimony and argument, are publicly accessible.

Congress established the OFIA to adjudicate these matters in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. In that law, Congress directed the federal banking agencies to “establish their own pool of administrative law judges.” Unlike federal judges, who are appointed by the president and enjoy life tenure, FDIC administrative law judges exist under the umbrella of the federal banking agencies. Ultimately, however, parties may appeal the decision of the administrative law judge to the FDIC Board, and thereafter, to the federal circuit court of appeals.