GAO-01-322R Financial Regulators’ Enforcement Authorities

United States General Accounting Office

Washington, DC 20548

January 31, 2001

The Honorable Richard H. Baker

Chairman, Subcommittee on Capital

Markets, Insurance, and

 Government Sponsored Enterprises

Committee on Financial Services

House of Representatives

Subject: Comparison of Financial Institution Regulators’ Enforcement and Prompt

Corrective Action Authorities

Dear Mr. Chairman:

This letter responds to your October 10, 2000, request that GAO review and compare

the legal authorities available to the federal bank regulators, the Office of Federal

Housing Enterprise Oversight (OFHEO), and the Federal Housing Finance Board

(FHFB) (collectively referred to as financial institution regulators) for taking actions

when issues arise regarding the capitalization and safety and soundness of the

institutions they supervise. The federal bank regulators, OFHEO, and FHFB are

responsible for ensuring that the institutions they supervise are in a safe and sound

condition and that the activities of the regulated institutions and their managing

officials do not raise safety and soundness concerns. To fulfill this responsibility,

each financial institution regulator has an array of statutory supervisory authorities,

regulatory powers, and enforcement tools. In your request letter, you expressed

concern that OFHEO and FHFB may not have the same supervisory and enforcement

powers as the bank regulators. As agreed, our objective was to describe the types of

supervisory and enforcement authorities (including prompt corrective action

provisions) available to financial institution regulators and highlight distinctions

between the specific authorities of the bank regulators, OFHEO, and FHFB.

Enclosure I provides a detailed side-by-side analysis of the respective enforcement

and prompt corrective action authorities of the bank regulators, OFHEO, and FHFB.

To respond to this request, we reviewed relevant statutes, legislative histories, agency

opinions, and secondary sources relating to the supervisory and enforcement

authorities of the financial institution regulators. We also met with agency officials

from OFHEO and FHFB. We conducted our work at OFHEO and FHFB headquarters

between October and December 2000.
Page 2 GAO-01-322R Financial Regulators’ Enforcement Authorities

Results in Brief

The financial institution regulators have similar types of powers and authorities, but

they are not identical. Each financial institution regulator administers its own

statutory scheme that contains authority to address unsafe and unsound conditions

and practices, as well as certain violative conduct. The tools generally available to

these regulators include informal supervisory actions; formal enforcement actions

involving notice to the affected institutions, the opportunity for a hearing, and, if

warranted, the imposition of sanctions such as a cease and desist (C&D) order or

civil money penalties; and capital-based actions and restrictions generally referred to

as prompt corrective action (PCA) provisions.

Based on each regulator’s powers and authorities, it appears that each regulator has

statutory tools available to address significant safety and soundness concerns.

However, because of differences in existing authorities and regulatory discretion, it is

likely that these regulators may approach similar concerns differently. For example,

some differences appear to exist between OFHEO and the bank regulators regarding

the grounds for issuing C&D orders. In addition, in contrast to the bank regulators

and FHFB, OFHEO lacks authority to remove officers and directors, place an

enterprise into receivership, or bring suit on the agency’s behalf (OFHEO must rely

on the Attorney General). These differences, in certain cases, may cause OFHEO to

rely on less direct measures.

In addition to these general enforcement authorities, the bank regulators and OFHEO

are required, or in certain instances authorized, to take specified supervisory actions

based on an institution’s capital under the PCA provisions.1

 Supervisory actions

based on the PCA provisions differ from formal enforcement actions in that they do

not typically involve notice and an opportunity for hearing. In addition, certain of the

PCA provisions are mandatory, thereby eliminating the regulator’s discretion in

deciding whether or how to act.

Although FHFB’s enabling statute requires FHFB to ensure that the Federal Home

Loan Banks (FHLB) remain adequately capitalized, it does not contain provisions

specifying particular supervisory actions that the Board must or may take in response

to an FHLB’s undercapitalized condition, as is the case for the bank regulators and

OFHEO. The capital provisions of FHFB’s enabling statute do place certain

restrictions directly on the FHLBs linked to the statutorily prescribed capital

requirements. FHFB officials pointed out that they can use their other statutory tools

to take the discretionary actions found in the bank regulators’ or OFHEO’s PCA

provisions; however, they are not required to take such actions.

Although the classifications triggering PCA actions are the same for both the bank

regulators and OFHEO, the capital requirements underlying these classifications are

different. Certain differences also exist between the bank regulators and OFHEO’s

PCA provisions. For example, it appears that OFHEO’s PCA scheme, in some

 1

 Each agency is required to ensure that the institutions it regulates comply with capital requirements

established by statute or regulation. As noted later, OFHEO is in the process of adopting risk-based

capital rules. FHFB adopted final rules implementing a new risk-based capital structure for the FHLBs

that includes a statutory minimum capital standard.
Page 3 GAO-01-322R Financial Regulators’ Enforcement Authorities

instances, may provide for regulatory action at a lower level of capital classification

than the bank regulators’ PCA scheme, has fewer required actions imposed, and

provides OFHEO more discretion in determining specifically what action to take. In

addition, OFHEO’s PCA provisions contain more notice and comment provisions for

the enterprises. These statutory notice and comment requirements, which are absent

from the bank regulators’ PCA provisions, may result in a longer PCA process for

OFHEO.

Background

Four federal regulators oversee federally insured banks and thrifts and are referred to

in this report as the bank regulators. The Comptroller of the Currency regulates

nationally chartered banks; the Board of Governors of the Federal Reserve System

(FRS) regulates state-chartered banks that are members of FRS, bank holding

companies, and financial holding companies; the Federal Deposit Insurance

Corporation (FDIC) regulates state-chartered, nonmember banks; and the Office of

Thrift Supervision regulates all federally insured thrifts, regardless of charter type,

and their holding companies. The bank regulators have a wide array of supervisory

authorities (including their examination and application review functions), regulatory

powers, and enforcement tools to monitor the safety and soundness of the

institutions they regulate. Under the Federal Deposit Insurance Act, each of these

regulators is charged with taking supervisory and enforcement actions based on

safety and soundness concerns, including capital-related concerns.

OFHEO is an independent regulator, within the Department of Housing and Urban

Development (HUD), whose primary mission is to oversee the financial safety and

soundness of Fannie Mae and Freddie Mac (collectively referred to as the

enterprises).2

 It was established by the Federal Housing Enterprises Financial Safety

and Soundness Act of 1992 (Safety and Soundness Act).3

 OFHEO’s primary means of

fulfilling its mission include establishing and ensuring compliance with capital

standards for the enterprises, conducting on-site examinations to assess their

management practices and financial condition, rulemaking, and taking enforcement

actions as authorized under the Safety and Soundness Act.

FHFB is an independent federal agency created by the Financial Institutions Reform

Recovery and Enforcement Act of 1989.4 FHFB administers the Federal Home Loan

Bank Act (FHLB Act), under which its primary duty is to ensure the safety and

soundness of the FHLBs.5

 FHFB also is responsible for mission oversight. FHFB

supervises the FHLBs by, among other things, ensuring that they satisfy capitalization

requirements established pursuant to the act and maintain the ability to raise funds in

the capital markets. FHFB is authorized to promulgate and enforce such regulations

and orders that it determines are necessary to carry out the provisions of the FHLB

Act. The Federal Home Loan Bank System Modernization Act of 1999 specified

 2

 The statute separately designates HUD as having oversight over the enterprises’ mission. This report

does not address HUD’s oversight function. 3

 12 U.S.C. § 4511. 4

 12 U.S.C.§ 1422a(a)(1)(2000). 5

12 U.S.C. § 1422a.
Page 4 GAO-01-322R Financial Regulators’ Enforcement Authorities

FHFB’s administrative enforcement powers with respect to safety and soundness

matters.6

A Range of Enforcement Tools Is Available to Financial Institution Regulators

The tools available to financial institution regulators include informal supervisory

actions; formal enforcement actions involving notice to the affected institution, the

opportunity for a hearing, and, if warranted, the imposition of sanctions, including

civil money penalties; and PCA. Although there are statutory, regulatory, and

procedural differences among the financial institution regulators, we have used these

three basic categories of enforcement tools for ease of description in this report.

Informal Supervisory Actions

The most frequent and informal means by which financial institution regulators

address a safety and soundness or other supervisory concern occurs in connection

with a regulator’s exercise of its general supervisory function, such as examinations

or reviews of reports. For example, in the course of an examination, an agency might

become aware of a condition or conduct that it considers relevant to the institution’s

safety and soundness or that raises other supervisory concerns. In such a case, the

agency typically will notify the institution of its determination and give the institution

an opportunity to correct the problem to the regulator’s satisfaction. This interaction

is characterized as “suasion.”

On the basis of the prevalence and severity of the circumstances and other

considerations, the regulator may require an action in which the institution formally

acknowledges the problem and commits to correct it. This type of action may be a

board of directors’ resolution, a commitment letter, or a memorandum of

understanding.7

 An institution’s failure to make a commitment or honor the

commitment it undertakes may justify a more formal enforcement action.

The bank regulators, OFHEO, and FHFB rely most often on these types of

supervisory actions.8

 In fact, to date, OFHEO has relied exclusively on these types of

supervisory actions. OFHEO officials pointed out the enterprises’ willingness to

 6

 The Modernization Act is contained in Title VI of the Gramm-Leach-Bliley Act, Pub. L. No. 106-102; 12

U.S.C. § 1422b. 7

 See Jackson, Howell E. and Symons, Edward L., Regulation Of Financial Institutions 334-335 (1999).

The board of directors’ resolution involves a commitment by the institution to respond to the

deficiency in a way approved by the regulator. The commitment letter is often used with respect to

institutions that are in good condition but have minor problems in isolated areas of activity. It is

prepared by the regulator and sent to the institution for execution. The written memorandum of

understanding reflects an agreement between the regulator and the institution on what actions are to

be taken. Typically, it also is prepared by the regulator and contains provisions requiring the

institution to establish a business plan to correct the problems identified by the regulator.

8

 FHFB has a mechanism for achieving compliance with a supervisory determination that operates in

the context of the supervisory process, but which can have the same effect as a formal enforcement

proceeding. Under FHFB’s regulations, a supervisory determination requiring mandatory actions, such

as a finding in an examination report, order, or directive, as well as any FHFB order or directive

concerning a safety and soundness or compliance matter, is final unless the affected FHLB petitions

FHFB for a review of the determination. The determination remains in effect while the petition is

pending. 12 C.F.R. part 907 (2000). In December 2000, FHFB approved additional regulations

governing formal enforcement actions, such as C&D proceedings.
Page 5 GAO-01-322R Financial Regulators’ Enforcement Authorities

resolve issues early and expeditiously. Under the Safety and Soundness Act, the

Director of OFHEO is required to provide Congress with an annual report that

includes a description of any actions taken by the Director, as well as the results of

enterprises’ examinations. These disclosure provisions may encourage early

resolution of issues to avoid disclosure of OFHEO’s concerns. The bank regulators

and FHFB do not have such a disclosure requirement.

Formal Enforcement Actions

In the event informal action is ineffective or inappropriate, each financial institution

regulator has more formal enforcement tools available. Formal enforcement actions

may include the formal written agreement, the issuance of C&D orders, the

suspension or removal of officers and directors (except for OFHEO as discussed

below), and civil money penalties. A formal written agreement sets forth the specific

corrective and remedial measures that the regulator determines are necessary to

return the institution to a safe and sound condition.9

 A C&D order may require an

institution to halt specified conduct or to take affirmative action to correct conditions

resulting from the conduct.

Based on the respective statutory authorities of the bank regulators, OFHEO, and

FHFB, each appears to have statutory tools available to address significant safety and

soundness concerns. For example, all can issue written agreements and C&D orders

and impose civil money penalties. However, there are differences between the bank

regulators’ authorities and those of OFHEO regarding aspects of their C&D

authorities; removal and prohibition authorities applicable to officers and directors;

and receivership and litigation authorities, as highlighted below. These differences,

in certain cases, may cause OFHEO to rely on less direct measures.

Cease and Desist Authorities

The Safety and Soundness Act specifically provides OFHEO with authority to issue a

C&D order and impose civil money penalties based on (a) conduct having an adverse

effect on capital; (b) misconduct by an executive officer or director resulting in

unjust enrichment or actual or likely substantial loss to the enterprise; (c) conduct in

violation of the Safety and Soundness Act and the enterprises’ charter acts, as well as

conduct in violation of any order, rule, or regulation under those laws (enforcement

of HUD established housing goals is excepted); and (d) the violation of any written

agreement between the enterprise and OFHEO.10 The Federal Deposit Insurance Act

(FDI Act) provides that the bank regulators may issue a C&D order and impose civil

money penalties based on (a) an unsafe or unsound practice; or (b) a violation of a

law, regulation, or any condition imposed in writing by the agency or any written

 9

 The formal written agreement, which must be signed by the institution’s board of directors, is used to

address situations that may be serious, but in which the regulator has confidence that the institution’s

management can and will correct the problem by performing the agreed-upon measures. The

agreement has the effect of a consent order in that it obviates the need for a notice and hearing to

determine whether the condition or conduct at issue violated any legal standard. An institution’s

breach of the agreement can serve as grounds for issuance of a C&D order. Although an institution

cannot be forced to enter into a formal written agreement, it has an incentive to do so because failure

to enter such an agreement might raise the potential for a more formal enforcement proceeding.

10 12 U.S.C. § 4631 (2000).
Page 6 GAO-01-322R Financial Regulators’ Enforcement Authorities

agreement entered into with the agency.11 FHFB also has specific authority to issue a

C&D order based on safety and soundness grounds or violative conduct.

A few differences exist in these authorities. First, the OFHEO C&D provision does

not specifically list an unsafe and unsound practice as grounds for issuing an order

(the bank regulators and FHFB have this ground listed). However, OFHEO maintains

that unsafe and unsound practices are violations of the Safety and Soundness Act

and, therefore, fall within the third listed ground for issuing a C&D order. Second,

the bank regulators can issue a C&D order to any institution–affiliated party (IAP),

which includes an institution’s directors, officers, controlling stockholders, and

independent contractors.12 OFHEO may issue such an order only against an

enterprise or its affiliates, an executive officer, or director.13 Similar to OFHEO, FHFB

may issue a C&D order against an FHLB, an executive officer, or director. Finally, in

contrast to the bank regulators and FHFB, there is no specific statutory authority for

OFHEO to issue a C&D order if an enterprise were to violate conditions imposed in

writing. Often, bank regulators issue approvals of some action subject to conditions.

Violations of conditions that a bank regulator imposes in writing may be grounds for

a C&D order and may even subject bank officers to removal. Although OFHEO lacks

this explicit authority, it typically does not issue the type of conditional approvals

that the bank regulators issue.

Removal and Prohibition Authority

OFHEO does not have the same direct removal and prohibition authorities applicable to

officers and directors as the bank regulators and FHFB have. The bank regulators may

remove officers, directors, and other specified parties or prohibit them from participating in

the affairs of the institution if the agency determines that the affected individual or entity

violated a law or regulation, a final C&D order, or a written condition or agreement; or if it

engaged in an unsafe or unsound practice; or breached a fiduciary duty. The conduct must

adversely affect the institutionís financial condition or have other specific consequences and

must involve either personal dishonesty or a willful disregard of the institutionís safety and

soundness.14 Under its statute, FHFB may take a similar action if it determines that cause

exists. OFHEO does not have similar explicit removal or prohibition authorities. Rather,

OFHEO, in connection with the issuance of a C&D order, can, among other actions, direct

 11 12 U.S.C. § 1818(c) (2000). 12Under the FDI Act, an IAP is any director, officer, employee, or controlling stockholder of an insured

institution, other than a bank holding company; any person who has filed or is required to file a

change-in-control notice as required under 12 U.S.C. 1817(j); any shareholder (other than a bank

holding company) or other person who participates in the conduct of the affairs of the institution; and

any independent contractor who knowingly or recklessly participates in a violation of any law or

regulation, any breach of fiduciary duty, or any unsafe or unsound practice, where such conduct

caused or is likely to cause more than a minimal financial loss to, or a significant adverse effect on, the

institution.

13 The Safety and Soundness Act defines “executive officer” of an enterprise to mean the chairman of

the board; the chief executive officer; chief financial officer; president; vice chairman; any executive

vice president; and, any senior vice president in charge of a principal business unit, division, or

function. It also provides that affiliates of Fannie Mae and Freddie Mac are considered to be parts of

the enterprise. Except as provided by OFHEO, an affiliate is any entity that controls, is controlled by,

or is under common control with an enterprise. 12 U.S.C § 4502 (2000). 14 12 U.S.C. § 1818(e) (1994). In addition, an IAP may be suspended, removed, or prohibited from

participating based on a final judgment, conviction, or plea agreement (and suspended as a result of

specified criminal charges).
Page 7 GAO-01-322R Financial Regulators’ Enforcement Authorities

the affected enterprise to hire a new employee to perform the job of the officer or director at

issue.15 This action appears to be a less direct measure than the removal authority afforded

the bank regulators.

Litigation Authority

Finally, in connection with the implementation of these formal enforcement actions

through the court system, only OFHEO must rely on the Attorney General to bring

suit on the agency’s behalf. The bank regulators and FHFB have independent

litigation authority, which allows them to bring suit on behalf of the respective

agency.

Prompt Corrective Action

In addition to authorizing the use of formal enforcement proceedings, Congress

established PCA schemes for both the bank regulators and OFHEO (and not for

FHFB, as discussed below) to mandate early regulatory intervention for institutions

having capital adequacy problems. The purpose of PCA is to ensure that regulatory

action is taken at the time an institution becomes financially troubled in order to

prevent a failure or minimize resulting losses.16 Under the PCA scheme applicable to

the bank regulators, the regulator is required to have regulations specifying capital

levels at which an institution is to be classified as well capitalized, adequately

capitalized, undercapitalized, significantly undercapitalized, or critically

undercapitalized. OFHEO’s PCA scheme does not provide for the well-capitalized

classification. With respect to both the bank regulators and OFHEO, a PCA action is

triggered by an institution’s classification as undercapitalized, significantly

undercapitalized, or critically undercapitalized. However, although the classification

names triggering PCA actions are the same for both the bank regulators and OFHEO,

the definitions of these classifications are different.17 For example, as OFHEO

officials noted, an undercapitalized bank does not become significantly

undercapitalized until its capital diminishes by 25 percent below the levels at which a

bank becomes undercapitalized. Under the OFHEO PCA scheme, an

undercapitalized enterprise becomes significantly undercapitalized as soon as the

capital falls beneath the minimum capital standard. Furthermore, the stringency of

the capital standards differs because it reflects, in large part, the difference in capital

structures and risks of the regulated institutions. Certain of the regulators’ respective

capital standards are specified in statute, while others are set forth in regulation. In

conjunction with its PCA scheme, OFHEO is required to adopt risk-based capital

requirements and is in the process of doing so.18

 15 12 U.S.C. § 4631(d) (2000). 16See Macey, Jonathan R. and Miller, Geoffrey P., BANKING LAW AND REGULATION, 294-296 (2d. ed. 1997);

See also Jackson, Howell E. and Symons, Edward L., Regulation Of Financial Institutions (1999).

These publications contain informative discussions of the enforcement and supervisory authorities of

the federal banking agencies.

17 The minimum capital standards for financial institutions are set forth in both statute and/or required

to be set forth in regulation. In the case of the enterprises (unlike banks), the risk-based capital

component as set forth in statute is a forward-looking measure with a 10-year time horizon. The

required risk-based capital regulations, which have been proposed, have not yet taken effect.

18 OFHEO’s minimum capital rule is set forth at 12 C.F.R. pt. 1750 (2000). OFHEO’s most recent

proposed rules for risk-based capital were published in April 1999 (64 Fed. Reg. 18083). In December

2000, a final rule had not been promulgated, although OFHEO announced that the final rule had been
Page 8 GAO-01-322R Financial Regulators’ Enforcement Authorities

Certain differences, in addition to different capital requirements underlying the

classifications, exist between the bank regulators and OFHEO’s PCA provisions.

Generally, the bank regulators’ PCA provisions require the regulator to take more

actions at an earlier classification point.19 For example, all banks (including

adequately capitalized ones) are generally barred from making capital distributions if

doing so would leave the institution undercapitalized.20 In the case of OFHEO, the

statute does not explicitly impose this restriction until the enterprise is

undercapitalized, and the distribution restriction is limited to those distributions that

would result in the enterprise being reclassified downward. However, the enterprises

must secure approval for any dividend that would leave them less than adequately

capitalized. In addition, the bank regulators are required to take more actions against

an undercapitalized institution than OFHEO is. Specifically, a bank regulator is

required to (1) increase its monitoring and periodic review of the institution’s efforts

to restore capital (2) have the undercapitalized institution submit a capital restoration

plan acceptable to the regulator (3) restrict its asset growth unless its growth falls

within specified exceptions and (4) provide prior approval of any acquisition,

branching, and new lines of business. The statute does not require that the institution

receive a notice or hearing in connection with any of these required actions.21

OFHEO does not have the same range of required (or discretionary) actions in

connection with an undercapitalized enterprise. Instead, under OFHEO’s PCA

provisions, only two actions are to be imposed upon an undercapitalized enterprise–

the submission of an acceptable capital restoration plan and the capital distribution

restriction set forth above.22

Similarly, the bank regulators are required to take a defined set of actions against

significantly undercapitalized institutions. For example, in such cases, the bank

regulator must (1) require the sale of shares or obligations sufficient to become

adequately capitalized, or in specified instances, require the merger or combination of

the institution; (2) restrict affiliate transactions; (3) restrict interest rates paid on

deposits; and (4) restrict senior executive officers’ compensation.23 In addition, the

bank regulators are provided the authority to take numerous other discretionary

actions.24 In response to a significantly undercapitalized enterprise, OFHEO is

 sent to the Office of Management and Budget for clearance. On December 20, 2000, FHFB approved

final rules implementing a new risk-based capital structure for the FHLBs that includes a statutory

minimum capital standard.

19 This letter does not evaluate the distinctions (or their effect) between the classification categories.

20 This provision contains an exception that would allow an institution to repurchase, redeem, retire, or

otherwise acquire its own shares if (1) an equivalent amount of shares or obligations are issued

concurrently, and (2) the transaction improves the institution’s financial condition. 21 In addition, the bank regulators have discretion to take additional actions relating to an

undercapitalized institution normally applicable to significantly undercapitalized institutions if the

regulator determines that those actions are necessary to carry out the purpose of the PCA provisions.

22 This provision governing supervisory actions applicable to undercapitalized enterprises (12 U.S.C. §

4615(c)) has an effective date of one year later than the date of the risk-based capital regulations,

which is later than the effective dates of OFHEO’s other PCA provisions (which take effect upon the

first capital classification of the enterprises). Because these regulations are not yet effective, this

provision is also arguably not yet effective.

23 The first three actions are mandatory unless the regulator determines that they would not further the

purpose of the section.

24 In response to a significantly undercapitalized classification, a bank regulator can take one or more

actions prescribed by regulation for institutions that are critically undercapitalized if necessary to
Page 9 GAO-01-322R Financial Regulators’ Enforcement Authorities

required to take the same two actions as described above–requiring an acceptable

capital restoration plan and ensuring compliance with capital distribution

restrictions. In addition, OFHEO has discretion to (1) limit the increase in or order

the reduction of the enterprise’s obligations, (2) limit or prohibit growth of assets or

require a contraction of assets, (3) require acquisition of new capital, (4) restrict

activities, (5) reclassify the enterprise as critically undercapitalized under certain

circumstances, and (6) appoint a conservator should certain financial conditions

exist.

Receivership Authority

With respect to critically undercapitalized institutions, the bank regulators must

appoint a receiver, appoint a conservator with FDIC’s concurrence, or take other

action with FDIC’s concurrence if it would better serve PCA purposes. Under

OFHEO’s PCA provisions, OFHEO may appoint a conservator for a significantly

undercapitalized enterprise and, after appropriate notice, generally must appoint one

for a critically undercapitalized enterprise.25 Unlike the bank regulators, OFHEO

lacks the authority to place an enterprise into receivership. FDIC, as receiver, is

empowered to take over the assets and operate an insured depository institution,

assuming all of its powers and conducting all of its business. It may place the failed

institution into liquidation and sell its assets. A conservator, on the other hand, is

typically appointed to conserve (not dispose of) the assets of the entity. Under

OFHEO’s conservatorship authority, it may terminate the conservatorship if it is in

the public interest and may be safely accomplished and permit the institution to

resume its operations. FHFB has the statutory authority to liquidate or reorganize an

FHLB “whenever [FHFB] finds that the efficient and economical accomplishment of

the purposes of the [FHLB Act] will be aided by such action....”

26 To date, neither

OFHEO nor FHFB has had to rely on these provisions.

Capital Reclassification Authority

In addition, both the bank regulators and OFHEO have authority to reclassify an

institution downward, into a lower capital classification category, for statutorily

prescribed reasons. In the case of a bank, reclassification can occur if the regulator

(1) determines that the institution is in an unsafe or unsound condition, or (2) deems

the institution to be engaging in an unsafe or unsound practice. Notice and a hearing

are required in connection with the first type of discretionary reclassification action.27

Further, an undercapitalized institution is treated as a significantly undercapitalized

institution if it fails to submit or implement an acceptable capital plan. OFHEO has

discretion to reclassify an enterprise downward if (a) the enterprise engages in

conduct that could result in a rapid depletion of core capital, (b) there are significant

 carry out the purposes of PCA. These actions include activities restrictions and requiring regulatory

approval of: (a) any material transaction other than in the normal course of business, such as

investments, expansion, acquisitions, and asset sales; (b) extending credit for highly leveraged

transactions; (c) amendments to the charter or bylaws; and (d) material changes in accounting

methods and other matters listed by statute. See 12 U.S.C. § § 1831o(f)(5) & 1831o(i) (2000). 25 OFHEO’s conservatorship authority is not limited to the PCA regime. 26 12 U.S.C. § 1446. 27 Notice and an opportunity for a hearing are not required if a reclassification action is in response to

the banking agency’s having deemed an institution to be engaging in an unsafe or unsound practice

based upon a less-than-satisfactory rating for asset quality, management, earnings, or liquidity.
Page 10 GAO-01-322R Financial Regulators’ Enforcement Authorities

declines in housing prices, or (c) the enterprise fails to submit or comply with an

acceptable capital restoration plan. Although these bases for reclassification are

different, both sets of regulators are afforded broad authority to reclassify their

regulated institutions.

PCA Notice and Comment

The bank regulators are authorized to take all but two types of PCA actions

(dismissal of certain directors or officers and reclassification based on an unsafe or

unsound condition) without giving the subject institution notice and an opportunity

to respond to the action. OHFEO, on the other hand, must provide the affected

enterprise a notice and comment period in connection with a number of its PCA

actions. Specifically, OFHEO may not reclassify an enterprise or take any

discretionary PCA-type action, including the appointment of a conservator, without

first notifying the enterprise of the proposed action. The enterprise has 30 days from

the date it receives the notice to comment on the proposed action. OFHEO has

authority to shorten (or extend) the comment process.28 After the comments are

received or the comment period expires, OFHEO must consider and respond to the

comments. Because of the statutory notice and comment requirements contained in

OFHEO’s PCA provision, it may take OFHEO longer than the bank regulators to

implement many of its PCA actions.

Lack of Specific FHFB PCA

FHFB’s enabling statute does not contain provisions specifying particular supervisory

actions that the Board must or may take in response to a FHLB’s undercapitalized

condition, as is the case for the bank regulators and OFHEO. The capital provisions

of FHFB’s enabling statute do place certain restrictions directly on the FHLBs linked

to the statutorily prescribed capital requirements. Specifically, the FHLB Act (a)

restricts an FHLB from redeeming its capital stock if, following the redemption, the

bank would fail to satisfy any minimum capital requirements; (b) restricts an FHLB

from making any distribution of its retained earnings unless, following the

distribution, the FHLB would continue to meet all applicable capital requirements;

and (c) requires each FHLB’s capital plan to provide for continuing FHLB review and

adjustment of the minimum investment required of each member of the FHLB to

ensure that the FHLB remains in compliance with the minimum capital requirements,

and for prompt compliance with such adjustments by each member.29 The FHLB Act

also requires FHFB to ensure that the FHLBs remain adequately capitalized and

provides FHFB with authority to enforce its capital regulations. In addition to these

prohibitions and authorities, FHFB officials maintain that they can use their statutory

supervisory and enforcement tools to take the discretionary actions found in the

bank regulators’ or OFHEO’s PCA provisions; however, they are not required to take

such actions. The PCA provisions applicable to bank regulators specifically state that

PCA does not limit their authority to take action in addition to (but not in derogation

 28 The timing and comment procedures are different in connection with the appointment of a

conservator.

29 These restrictions and requirements do not specify particular actions for FHFB to take when a FHLB

becomes undercapitalized at a particular classification level, unlike the case with the bank regulators

and OFHEO.
Page 11 GAO-01-322R Financial Regulators’ Enforcement Authorities

of) actions required under PCA. Similar language is found in OFHEO’s PCA

provisions.30

Conclusions

The bank regulators, OFHEO, and FHFB each have an array of statutory supervisory

and enforcement powers for ensuring that the institutions they supervise are in a safe

and sound condition. Each regulator has its own statutory scheme that contains

specific authorities to address unsafe and unsound conditions and practices, as well

as certain violative conduct. Although it appears that each regulator has statutory

tools available to address significant safety and soundness concerns, differences do

exist in their authorities and OFHEO lacks certain authorities afforded the bank

regulators. For example, differences exist between OFHEO and the bank regulators

regarding the grounds for issuing a C&D order; and OFHEO lacks authority to remove

officers and directors and does not have receivership or independent litigation

authority. It is difficult to determine the impact of these differences, particularly

since OFHEO, to date, has not had to take formal enforcement actions.

In connection with PCA authority, FHFB’s enabling statute does not contain

provisions specifying actions to be taken should an institution become

undercapitalized, as is the case for the bank regulators and OFHEO. OFHEO’s PCA

scheme differs in certain respects from that of the bank regulators. OFHEO’s PCA

scheme, as compared to the bank regulators’, may provide for regulatory action later

(in terms of capital classification) than the bank regulators’ PCA scheme, has fewer

required actions imposed, and provides OFHEO more discretion in determining

specifically what action to take. In addition, OFHEO’s PCA provisions contain more

opportunity for notice and comment than the provisions applicable to the bank

regulators. In light of these differences, as well as the different capital requirements

imposed on the various regulated institutions, it is difficult to ascertain the impact of

the variations in the two PCA schemes.

Agency Comments and Our Evaluation

We obtained oral comments from FHFB and OFHEO on a draft of this letter. FHFB’s

Managing Director and General Counsel and OFHEO’s General Counsel provided a

number of technical comments, which we incorporated where appropriate. The

FHFB officials stated that in their view, certain FHFB authorities were similar to PCA

provisions. Specifically, they stated that the capital provisions of FHFB’s enabling

statute do place certain restrictions directly on the FHLBs linked to the statutorily

prescribed capital requirements. We revised our discussion to clarify the restrictions

cited by the FHFB officials.

As agreed with your office, we plan no further distribution until 30 days from the date

of this letter unless you publicly release its contents earlier. We will then send copies

to the Ranking Minority Member of the Subcommittee on Capital Markets, Insurance,

 30 See 12 U.S.C. § 4616(b).
Page 12 GAO-01-322R Financial Regulators’ Enforcement Authorities

and Government Sponsored Enterprises; Representative Michael Oxley, Chairman,

and the Ranking Minority Member, House Committee on Financial Services; Senator

Phil Gramm, Chairman, and Senator Paul Sarbarnes, Ranking Member, Senate

Committee on Banking, Housing, and Urban Affairs; Armando Falcon, Jr., Director of

OFHEO; Allan I. Mendelowitz, Chairman of FHFB; and Mel Martinez, Secretary of

HUD. The letter will also be available on GAO’s home page at http://www.gao.gov.

If you have any questions, please contact Thomas J. McCool at (202) 512-8678, Lynn

H. Gibson at (202) 512-8153, or William B. Shear at (202) 512-8678. Key contributors

to this letter were Rosemary Healy and Paul G. Thompson.

Sincerely yours,

Thomas J. McCool

Managing Director

Financial Markets and Community Investment

Lynn H. Gibson

Associate General Counsel

Office of the General Counsel
ENCLOSURE I ENC

GAO-01-322R Financial Regulators

Enforcement and Prompt Corrective Action Authorities

A. Formal Enforcement Authority

Bank Regulators OFHEO Finance B

Formal Agreement Implied from general supervisory

powers and enforcement authorities.

Implied from general supervisory andenforcement authorities.

Implied frenforceme

C&D Order Against: insured depository

institutions (IDI) and institutionaffiliated parties (IAP).1Specified Grounds: (1) unsafe orunsound practice;2 (2) violation of anylaw, rule, regulation, written conditionimposed in connection with grantingan application or request, or anywritten agreement.C&D order may include affirmativeorder to correct conditions resultingfrom violations and practices andlimitation on activities or functions ofan institution or IAP.

Against: enterprises (includesaffiliates), their executive officers, anddirectors.Specified Grounds: (1) potentialimpact of conduct on core capital(separate provisions for adequatelycapitalized and undercapitalizedenterprises)--conduct that either“threatens significant depletion”(undercapitalized) or is “likely to resultin material depletion”(undercapitalized); (2) misconduct byan officer or director resulting in unjustenrichment or actual or likelysubstantial loss to the enterprise;

Against: a (FHLB), adirector.Specified unsound plaw, orderwritten coconnection application written agC&D may correct coviolations of activitie

1 Under the Federal Deposit Insurance Act (FDI Act), an IAP is any director, officer, employee or controlling stockholder of an insured instit

company; any person who has filed or is required to file a change-in-control notice as required under 12 U.S.C. 1817(j); any shareholder (otcompany) or other person who participates in the conduct of the affairs of the institution; and any independent contractor who knowingly or violation of any law or regulation, any breach of fiduciary duty, or any unsafe or unsound practice, where such conduct caused or is likely to financial loss to, or a significant adverse effect on, the institution.

2 In addition to a firm’s capital status and practices relating directly to its financial health, factors indicative of safety and soundness include t

standards set forth in 18 U.S.C. § 1831p-1 for federal banking agencies to promulgate in regulations or guidelines. These standards relate to matters such as, but not limited to, internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth, asset qualvaluation standards, and compensation.
GAO-01-322R Financial Regulators

3) conduct that violates the Safety andSoundness Act or enterprise charteracts (except for provisions pertaining toHUD housing goals), or any order, ruleor regulation under those laws, or anywritten agreement with OFHEO.C&D order may include affirmativeorder to correct conditions resultingfrom violations and practices and anorder limiting activities or functions ofthe enterprise or any executive officeror director.

IAP.

Removal andProhibition

Removal or prohibition action can betaken against any IAP. Grounds:violation of law, regulation, final C&Dorder, written condition, or writtenagreement, engagement in unsafe orunsound practice or breach of fiduciaryduty, where the conduct relates toactual or probable financial loss orother damage or has other specifiedconsequences and involves dishonestyor mental culpability. Suspension orprohibition can be taken against anyIAP if necessary to protect institutionor interests of depositors. Additionalgrounds for removal or prohibitionrelate to certain officers, directors andIAP for culpable violations of specificstatutes related to banking.Additional grounds exist for IAPsuspension or removal based on

No specific authority, but authorityexists to require enterprises to hirequalified officers or directors to remedyconditions resulting from conduct orviolations upon which a C&D order hasbeen entered.

May remodirector, oan FHLB 
GAO-01-322R Financial Regulators

criminal proceedings: Suspension orprohibition pending outcome ofcriminal charges against IAP for crimeof dishonesty or violation of specifiedstatutes; removal or prohibition forconviction or plea agreement involvingsame offenses.

Civil Money Penalties First tier: violation of law, regulation,

final enforcement order, writtencondition or agreement or temporaryC&D order; violation of removal,suspension, or prohibition order;violation of monetary transaction andreport requirements. Amount: Notmore than $5,000 for each day theviolation continues.Second tier: any violation of law, etc.,reckless unsafe or unsound practice, orbreach of fiduciary duty, that is part ofa pattern of misconduct, causes morethan a minimal loss, or results inpecuniary gain or benefit.Amount: Not more than $25,000 foreach day the violation, practice, orbreach continues.Third tier: knowing violation of law,etc., engagement in unsafe or unsoundpractice, breach of fiduciary duty andknowingly or recklessly causessubstantial loss or substantialpecuniary gain or benefit. Amount:

Grounds: (1) violation of the Safetyand Soundness Act, the charter acts(except for provisions relating tohousing goals) and any order, rule, orregulation under any such act; (2)violation of any final or temporaryPCA-type order or final or temporaryC&D order; (3) violation of writtenagreement; or (4) conduct that causesor is likely to cause a loss to theenterprise.First tier (available against enterprisesonly): may be imposed only forviolations described in paragraphs (1)through (3), above. Amount: not morethan $5,000 for each day of theviolation.Second tier: any violation or conductconstituting grounds for CMP that ispart of a pattern of misconduct orinvolved recklessness and caused orlikely would cause a material loss.Amount: Against an officer or director– no more than $10,000 for each day

Same as Othe pertine
GAO-01-322R Financial Regulators

(1) persons other than IDI – not morethan $1,000,000 for each day theviolation, practice of breach continues;(2) IDI--not to exceed the lesser of$1,000,000 or 1 percent of total assetsper day the violation, practice, orbreach continues.

that the violation or conduct continues;against an enterprise–not more than$25,000 per each day the violation orconduct continues.Third tier: any violation or conductconstituting grounds for CMP if it wasknowing and caused or would likelycause a substantial loss to theenterprise. Amount: Against an officeror director--not more than $100,000 foreach day the violation or conductcontinues; against an enterprise–notmore than $1,000,000 per each day theviolation or conduct continues.

Termination ofInsurance

FDIC may terminate deposit insurancebased on (1) unsafe or unsoundpractice by the IDI, its directors, ortrustees; (2) unsafe or unsoundcondition to continue operations; (3)violation by institution, directors, ortrustees of any applicable law,regulation, order, written conditionimposed by FDIC or written agreementbetween the IDI and FDIC.

N/A N/A

B. PCA Provisions

Bank Regulators OFHEO Finance B

Undercapitalized Mandatory: (1) timely submission of

acceptable capital restoration plan(CRP); (2) close monitoring ofcondition and compliance with CRP;

Mandatory: (1) timely submission ofacceptable CRP; (2) statutoryprohibition on capital distribution if itwould make undercapitalized enterprise

FHFBís encontain prsupervisoror may tak
GAO-01-322R Financial Regulators

(3) statutory restrictions on assetgrowth; (4) agency approval ofacquisitions, branching, and newbusiness lines.Discretionary: regulator has discretionto take actions applicable tosignificantly undercapitalizedinstitutions, if necessary.

significantly or criticallyundercapitalized.Discretionary: reclassification if (a)enterprise fails to submit a timely CRP“substantially in compliance” withstatutory requirements for CRP orOFHEO does not approve CRP; or (b)enterprise failed to make, in good faith,reasonable efforts necessary forcompliance and fulfill the complianceschedule approved by OFHEO.

undercapitcase for thOFHEO. FHFBís encertain resFHLBs linprescribed Specificalan FHLB stock if, fobank woulminimum restricts an distributiounless, folFHLB woapplicable (c) requirplan to prreview anminimum each memthat the Fcompliancapital reprompt cadjustmeFHLB Acensure thadequatelFHFB witcapital rethese prohFHFB offi
GAO-01-322R Financial Regulators

use their senforcemediscretionregulatorsprovisions

SignificantlyUndercapitalized orUndercapitalizedand fails to submitor materiallyimplement CRP.

Mandatory: regulator shall take thefollowing actions unless they do notserve PCA purposes: (1) require saleof shares or obligations sufficient tobecome adequately capitalized or, ifone or more grounds exist forappointing a conservator or receiver,require institution to be acquired by aninsured depository institution holdingcompany or combine with anotherinstitution; (2) restrict transactionswith affiliates; and (3) restrict interestrates paid on deposits. Also, agencyapproval is required for bonuses orincreased compensation to seniorexecutive officers.Discretionary (or mandatory use of atleast one of the following, if agencydetermines combined actions (1)through (3), above, would not furtherPCA purposes): (1) recapitalization;(2) restrict affiliate transactions; (3)restrict amounts of interest paid ondeposits; (4) restrict asset growth; (5)restrict activities by institution orsubsidiary posing excessive risk to theinstitution; (6) require improvement ofmanagement (including dismissal of

Mandatory: (1) require timelysubmission of an acceptable CRP; (2)prohibit any capital distribution thatwould result in reclassification ascritically undercapitalized and requireOFHEO approval for any other capitaldistribution.Discretionary: OFHEO may (1) limitincrease or order reduction ofobligations of enterprise; (2) limit orprohibit asset growth or requirecontraction of assets; (3) requireacquisition of new capital in form andamount determined by OFHEO; (4)require termination, reduction, ormodification of any activity determinedto create excessive risk; (5) reclassifyas critically undercapitalized if (a) CRPis not in substantial compliance withstatutory requirements or is notapproved, or (b) enterprise failed tomake in good faith reasonable efforts tocomply with CRP (same asreclassification standards forundercapitalized); (6) appointconservator subject to statutorystandards if OFHEO determines corecapital to be less than statutory

See above
GAO-01-322R Financial Regulators

directors and senior executiveofficers); (7) prohibit deposits fromcorrespondent banks; (8) require priorapproval by the Federal Reserve Boardof capital distribution by controllingholding company; (9) requiredivestiture actions under certaincircumstances; (10) require any otheraction the agency determines to servePCA purpose better than those listed,including actions specificallyapplicable to critically undercapitalizedinstitutions.Discretion to impose additionalrestrictions if necessary: agency mayimpose one or more activitiesrestrictions prescribed by FDICregulation for criticallyundercapitalized institutions.

minimum capital and alternativeremedies are unsatisfactory. (Statutorystandards include written determinationthat enterprise (a) is not likely to payobligations in the normal course ofbusiness, (b) has incurred or facessubstantial depletion of core capital andtimely replenishment is unlikely, (c)concealed or refused inspection ofmaterial books and records, or (d)willfully violated or is in violation of afinal C&D order.)

CriticallyUndercapitalized

Statutory requirements: (A)compliance with FDIC-prescribed (byorder or regulation) activitiesrestrictions and prohibitions againstthe following: (1) entering materialtransactions outside the normal courseof business; (2) extending credit forhighly leveraged transactions; (3)amending charter or by-laws (unlessnecessary to comply with

Statutory requirement: Conservator tobe appointed unless OFHEO, withconcurrence of Treasury, determinesthat appointment would have seriousadverse effects on economic conditionof national financial markets or thefinancial stability of the housingfinance market and the public interestwould be better served by taking someother authorized enforcement action.

See above
GAO-01-322R Financial Regulators

requirements); (4) material change inaccounting methods; (5) engaging incovered transactions with affiliates (asdefined in 12 U.S.C. § 371c(b)

(Section 23A of the Federal ReserveAct); (6) paying excessivecompensation or bonuses; (7) payinginterest on new/renewed liabilitiesabove prevailing rates; (B) stoppayments of principal and interest onsubordinated debt; (C) agency mustappoint a receiver or FDIC-approvedconservator or take other FDICapproved action if it better achievesPCA purposes; (D) receiver must beappointed if institution remainscritically undercapitalized for 270 daysunless agency and FDIC seeimprovement and certify the institutionis not expected to fail.

Reclassification If an agency determines an institution

to be in unsafe or unsound conditionafter notice and an opportunity forhearing, or deems the institution to beengaging in an unsafe or unsoundpractice based on a less-thansatisfactory examination rating forasset quality, management, earnings, orliquidity, the agency may:(1) reclassify a well capitalizedinstitution as adequately capitalized;(2) treat an adequately capitalizedinstitution as undercapitalized; (3)subject an undercapitalized institution

Based on conduct or asset valuesOFHEO may reclassify an enterpriseone grade lower if (a) conduct notapproved by OFHEO could result in a“rapid depletion of core capital”; or (b)

the “value of the property subject tomortgages held or securitized by” the

enterprise has decreased significantly(OFHEO may reclassify adequate–toundercapitalized, under-to significantlyundercapitalized, and significantly–to

critically undercapitalized.)(Reclassification also may be based on

See above
GAO-01-322R Financial Regulators

to one or more actions authorized forsignificantly undercapitalizedinstitutions.

undercapitalized or significantlyundercapitalized classifications ifstatutory requirements for capitalrestoration plans are not satisfied.)

Conservatorship, orReceivership,Closure

Authority to appoint a receiver orconservator; receiver required if otheraction fails to restore capital. See PCAbased on “critically undercapitalized”classification.

Authority only to appoint aconservator. See PCA based on“significantly undercapitalized,” or“critically undercapitalized”classifications.

FHFB maFHLB if it economicapurposes oaided by s

C. Ancillary Authorities

Bank Regulators OFHEO Finance B

Independentlitigation authority

Have independent litigation authority. Has no independent litigation authority.

OFHEO may request Attorney Generalto bring judicial enforcement actionwith respect to “any effective notice ororder” issued in formal enforcement

proceedings or pursuant to its PCAtype authority. Judicial enforcement ofCMP by Attorney General or byOFHEO under direction and control ofAttorney General.

Has indep

Subpoena authority Has subpoena authority in connection

with administrative enforcementproceedings.

Same as bank regulators. Same as O

(250004)