Enforcement Actions: Has much changed in the last decade?
By: KAREN L. GRANDSTRAND
September 2002
When Jane Ball, the editor of Bank Focus, asked whether it would be appropriate and timely to include an article on enforcement actions, I thought back to the last article on enforcement actions that I wrote. It was in September 1992, almost 10 years ago to the day. At the time, I was an Assistant Vice President in the Banking Supervision Department at the Minneapolis Federal Reserve Bank. One of my areas of responsibility was enforcement actions. My article, which appeared in The Region, was titled "Are Banking Regulators Tough Enough?" and gave an analysis of enforcement actions. The intro to the story indicated that a recent House subcommittee investigative report accused banking regulators of lax supervision and recommended that regulators more strongly enforce banking rules and regulations. The banking industry, however, had a very different perspective and felt that the regulators had become "overzealous bloodthirsty bureaucrats." I, as a regulator, was feeling very much caught in the middle.
The climate that I was experiencing and writing about in 1992 is beginning all over again. Given the number of recent bank failures, the economy and the overall climate created by recent corporate scandals, regulators and the industry are under increased scrutiny. While everyone acknowledges that engaging in the business of banking has some risks and that we should expect bank failures from time to time, no regulator ever wants that failure to be one of its banks because of the Monday morning quarterbacking that occurs and the questions that always arise as to whether earlier, more aggressive intervention by the regulator would have saved the bank.
To confirm my view that enforcement actions are on the rise, I recently scanned the number of enforcement actions issued by the Federal Reserve over the past year. I was amazed at what I found. Press releases on enforcement actions may soon outnumber press releases on application approvals.
Similarities Between 1992 and 2002
The types of enforcement actions that are being issued by the regulators in 2002 are similar to those issued during the last enforcement action cycle. Actions against banking organizations, while they differ somewhat by agency, can generally be grouped into formal and informal actions. Formal actions against banking organizations are, for example, cease and desist orders, written agreements or formal agreements, and civil money penalties. Formal actions against individuals include removal actions, civil money penalties, cease and desist orders, and restitution orders. Informal actions consist of memoranda of understanding and board resolutions or commitments.
In 1992, the regulators and Congress focused on the insiders and others who were responsible for the banking organization's troubled condition. You might recall the Lincoln Savings and Loan case that specifically questioned why the nation was not focusing on the private sector individuals involved in the transactions that led to the looting of Lincoln. The judge in that case questioned why none of the accountants, attorneys and other professionals had blown the whistle on the wrongdoing. These questions from the early '90s sound eerily similar to statements and questions being raised today.
Further, capital continues to be a critical factor in terms of how and when the regulators take action. In 1991, a Government Accounting Office (GAO) report criticized federal supervision and enforcement practices and recommended that the process be more predictable, more credible and less discretionary. The GAO envisioned an approach where the regulators would be required to take specific, increasingly more severe actions against an institution as its condition deteriorated. Following the GAO report and related calls for reform, Congress passed the Federal Deposit Insurance Corp. Improvement Act (FDICIA) of 1991. FDICIA incorporated a "tripwire" approach to supervision and enforcement. The regulators have less discretion and are required to pursue prompt corrective action against institutions based primarily on five levels of capital adequacy.
Finally, disagreements between the industry and regulators on questions of appropriate due process continue. Ten years ago, the Court of Appeals for the Fifth Circuit issued an opinion that sent shock waves through the banking industry. In the case, the Fifth Circuit upheld a directive that the FDIC had issued against a bank and its directors, requiring them to increase the bank's capital. Prior to issuing the directive, the bank and its directors were not given a hearing, but simply given notice and 14 days to respond. The district court upheld the directive and the bank and directors appealed arguing that the FDIC's action violated Fifth Amendment due process requirements. The Fifth Circuit upheld the lower court indicating that the FDIC's procedures (notice and an opportunity to respond) were sufficient. Recent supervisory and enforcement actions appear to continue this trend. For example, some recent OCC orders contain provisions under which the banking organization has to submit a plan on how it will, if needed, liquidate the bank with no loss to the insurance fund - this is a disturbing end-run around the due process that is supposed to be afforded to a bank before it loses its FDIC insurance.
Differences between 1992 and 2002
One key difference between now and 1992 is the increased involvement by the SEC and FTC in bank affairs, an outcome of Gramm-Leach-Bliley and related developments. The recent enforcement action against The PNC Financial Services Group, Inc. was issued jointly by the Federal Reserve and SEC.
Another difference between 1992 and 2002 is that fewer banks will be subject to enforcement actions. Given the overall strength of the industry, banks should be able to sustain their financial performance despite the weakened economy.
As in 1992, regulations will continue to focus accountability on bank CEOs and professionals. Because of highly publicized insider lapses, the focus will now also rest more heavily on outside directors.
Finally, the regulators will likely attempt to place banks under enforcement actions before banking organizations are experiencing financial difficulties - before financial condition ratios indicate a problem. Risk-focused examinations, introduced by the regulators about six years ago, emphasize that examiners must determine whether a banking organization's level of risk is increasing and, if so, make sure action is being taken to stem the risk. Thus, the regulators will likely be inclined to issue enforcement actions based on risk management trends and concerns.
Summary
Given the economy and regulatory climate, enforcement actions are on the rise. Review your corporate governance and board practices with counsel. Before entering into any enforcement actions, bank directors and management need to fully understand the provisions, the ramifications of agreeing to abide by certain provisions, and the ramifications of failing to comply with executed enforcement actions. Enforcement actions, as originally drafted and presented by the regulators, are broadly worded, leaving maximum discretion and interpretation with the regulator. Thus, enforcement actions need to be carefully evaluated and discussed with counsel.