Opinion ID: 3009588
Heading Depth: 1
Heading Rank: 4

Heading: The Charges Against Bailey

Text: Section 1818(b)(1) prohibits unsafe and unsound practices. OTS argues that Bailey's commitment to the Levine loan conflicts with Crestmont's policy of prohibiting purchase money loans on the security of real property in which a Crestmont officer or director had an interest. An officer's violation of a banking institution's policy, however, is not enough to justify a cease and desist order under section 1818(b)(1). While the statute gives the Director considerable discretion, it nevertheless requires substantial evidence showing that the violation of policy amounted to an unsafe and unsound practice. Section 1818(b)(1) provides: If, in the opinion of the appropriate Federal Banking Agency . . . any institution- affiliated party . . . has engaged . . . in an unsafe or unsound practice in conducting the business of [a] depository institution, . . . the agency may issue and serve upon the . . . party a notice of charges in respect thereof. . . . [I]f upon the record made at . . . [a] hearing, the agency shall find that any . . . unsafe or unsound practice specified in the notice of charges has been established, the agency may issue and serve upon . . . the institution-affiliated party an order to cease and desist from any such . . . practice. 12 U.S.C.A. § 1818(b)(1).20 20 . Bailey and Seidman are institution-affiliated parties. See 12 U.S.C.A. § 1813(u)(1) (West 1989). Because the statute itself does not define an unsafe or unsound practice, courts have sought help in the legislative history. See, e.g., Northwest Nat'l Bank v. United States, 917 F.2d 1111, 1115 (8th Cir. 1990); Gulf Federal Sav. & Loan Ass'n v. Federal Home Loan Bank Bd., 651 F.2d 259, 264 (5th Cir. 1981), cert. denied, 458 U.S. 1121 (1982). In hearings before Congress prior to its adoption in the Financial Institutions Supervisory Act of 1966, Pub. L. No. 89-695 (1966) John Horne, Chairman of the Federal Home Loan Bank Board (FLHBB), OTS's predecessor, testified: 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 be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds. Financial Institutions Supervisory Act of 1966: Hearings on S. 3158 and S. 3695 Before the House Committee on Banking and Currency, 89th Cong., 2d Sess. 49-50 (memorandum submitted by John Horne) (citations omitted). Thus, courts have generally interpreted the phrase unsafe or unsound practice as a flexible concept which gives the administering agency the ability to adapt to changing business problems and practices in the regulation of the banking industry. See Groos Nat'l Bank v. Comptroller of the Currency, 573 F.2d 889, 897 (5th Cir. 1978) (The phrase 'unsafe or unsound banking practice' is widely used in the regulatory statutes and in case law, and one of the purposes of the banking acts is clearly to commit the progressive definition and eradication of such practices to the expertise of the appropriate regulatory agencies.). Among the specific acts that may constitute an unsafe and unsound practice are paying excessive dividends, disregarding a borrower's ability to repay, careless control of expenses, excessive advertising, and inadequate liquidity. Gulf Federal Sav. & Loan Ass'n, 651 F.2d at 264. In Gulf Federal, the court had to decide whether a bank's breach of contract was an unsafe or unsound practice that justified an FHLBB order to cease and desist. Id. at 262. The FHLBB concluded that the bank's potential liability for breach and possible loss of public confidence in the institution meant the breach was an unsafe and unsound practice that authorized the agency to order the bank to perform its contract. Id. at 264. The court disagreed and held that a breach of contract is not an unsafe or unsound practice that threatens a bank's financial soundness. Id. The court expressly rejected FHLBB's conclusion that liability for breach and consequent loss of public confidence in the bank's willingness to honor its commitments give rise to an unsafe or unsound practice that authorized a cease and desist order. Id. It stated: Such potential risks bear only the most remote relationship to [the bank's] financial integrity and the government's insurance risk. . . . We fail to see how the [FHLBB] can safeguard [the bank's] finances by making definite and immediate an injury which is, at worst, contingent and remote. Approving intervention under the [FHLBB's] loss of public confidence rationale would result in open-ended supervision. . . . The [FHLBB's] rationale would permit it to decide, not that the public has lost confidence in [the bank's] financial soundness, but that the public may lose confidence in the fairness of the association's contracts with its customers. If the [FHLBB] can act to enforce the public's standard of fairness in interpreting contracts, the [FHLBB] becomes the monitor of every activity of the association in its role of proctor for public opinion. This departs entirely from the congressional concept of acting to preserve the financial integrity of its members. Id. at 264-65 (footnote omitted). In Northwest National Bank the court upheld the Comptroller of the Currency's (Comptroller's) conclusion that evidence showing failure to maintain an adequate loan to loss reserve and inadequate capital, together with deficient loan administration, established unsafe or unsound banking practices. Northwest Nat'l Bank, 917 F.2d at 1113-14. The court agreed with FHLBB that the bank's failure to maintain adequate reserves and capital was an unsafe or unsound practice. Id. at 1115. The court defined the phrase unsafe and unsound banking practices in general terms similar to those that appear in the legislative history: Unsafe and unsound banking practices are . . . 'conduct deemed contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder.' Id. (quoting First Nat'l Bank of Eden v. Department of the Treasury, 568 F.2d 610, 611 n.2 (8th Cir. 1978) (per curiam)). The court in Northwest National Bank decided that the poor state of the bank's loan portfolio and the insufficient level of its capital and reserves permitted an inference that unsafe lending practices had occurred. Id. Accordingly, it upheld the Comptroller's finding that the bank had engaged in unsafe and unsound banking practices. Id. at 1115-16; see also First Nat'l Bank of Eden, 568 F.2d at 611 (upholding Comptroller's issuance of cease and desist order for unsafe and unsound banking practices when record showed accumulation of unsafe assets, inadequate internal controls and auditing procedures, lack of credit information on certain bank investments in violation of federal regulations and payment of excessive bonuses to bank officers). In MCorp Financial, Inc. v. Board of Governors, 900 F.2d 852 (5th Cir. 1990), aff'd in part, rev'd in part on other grounds, 112 S. Ct. 459 (1991), the Board of Governors of the Federal Reserve concluded that MCorp's failure to provide capital to its subsidiary banks was an unsafe or unsound practice and entered a cease and desist order directing MCorp to transfer assets to its banking subsidiaries. MCorp Fin., Inc., 900 F.2d at 862. On review, the court of appeals concluded that Congress had failed to provide a clear definition of unsafe or unsound practice. Id. at 862. Limited by Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), but relying on Gulf Federal Savings & Loan Association, the court concluded that the Board of Governors' order directing MCorp to transfer assets to its troubled subsidiaries was itself contrary to 'generally accepted standard[] of prudent operation.' Id. at 863 (quoting Gulf Federal Sav., 651 F.2d at 254). Such a transfer of funds would require MCorp to disregard its own corporation's separate status; it would amount to a wasting of the holding company's assets in violation of its duty to its shareholders. Id. We think at least one common element of an unsafe or unsound banking practice relating to the health of the institution can be deduced from these cases and the legislative history. The imprudent act must pose an abnormal risk to the financial stability of the banking institution. This is the standard that the case law and legislative history indicates we should apply in judging whether an unsafe or unsound practice has occurred. With this in mind, we turn to the specific imprudent acts OTS charges against Bailey. They are: (a) failing to disclose Seidman's interest in Fulton Street Associates to the Senior Loan Committee . . ., (b) approving the Levine Loan without presenting the loan for review to Crestmont's Senior Loan Committee . . ., and (c) approving the Levine Loan even though Bailey knew that Seidman had an interest in Fulton Street Associates. Bailey App. at 20. Only one of them has any potential for causing Crestmont loss--Bailey's premature issuance of the commitment letter.21 21 . The first two grounds relied upon by the Director--a failure to disclose Seidman's interest in FSA to the Senior Loan Committee and Bailey's approval of the loan without submitting it When Bailey issued the commitment letter, he made Crestmont responsible for the Levine loan. He did this despite the fact that Seidman had not extricated himself from the FSA partnership or from the UJB guarantee. When Levine accepted the commitment, Crestmont remained ineligible to make the loan. Thus, Crestmont became responsible for the loan despite the potential illegal conflict. We think this act was imprudent. Although all parties testified that their understanding was that the loan would not go through absent Seidman's complete withdrawal, Bailey had nevertheless obligated Crestmont to a loan it might not be able to make. Obligating one's institution to transactions that might be illegal is not in accord with generally accepted standards of prudent operation. See MCorp Fin., Inc., 900 F.2d at 862. After Levine accepted the commitment letter, Crestmont either had to make the loan, breach the agreement to make it or place the loan with another institution regardless of Seidman's position. Although, as it turned out, Crestmont was able to place the loan without incident or loss, we recognize that a risk was present when Bailey issued the commitment. Obliging an institution to choose between (..continued) to the Senior Loan Committee--were not material to Bailey's act of approving the loan and issuing a commitment letter. The record establishes that all the members of the Senior Loan Committee were fully aware of Seidman's interest and had agreed that the Levine loan was not to be approved until Seidman fully disassociated himself from FSA. Moreover, reliance on the omission of Seidman's interest on the Credit Summary form is misplaced. Undisputed testimony supported Bailey's claim that the entry on the form referred to an affiliated party's interest in the borrower. See supra note 5. covering fluctuations in the interest rate, engaging in an illegal transaction or breaching a binding agreement is not prudent. Imprudence standing alone, however, is insufficient to constitute an unsafe or unsound practice. A cease and desist order is designed to prevent actions that if repeated would carry a potential for serious loss. Although issuance of even this single commitment exposed Crestmont to some potential risk of loss, that potential risk did not begin to approach the abnormal risk involved in Northwest National Bank, where the bank was exposed to a serious threat to financial stability by its general failure to monitor its loans adequately and to maintain adequate reserves and capital. The potential loss to which Bailey subjected Crestmont is rather like that present in Gulf Federal. Contingent, remote harms that could ultimately result in minor financial loss[es] to the institution are insufficient to pose the danger that warrants cease and desist proceedings. Gulf Fed. Sav. & Loan Ass'n, 651 F.2d at 264. Though it is not particularly onerous to require a loan officer to satisfy himself that the institution may legally make a loan before the commitment is issued, we cannot conclude that the commitment Bailey authorized posed such an abnormal risk that Crestmont's financial stability was threatened. We hold that Bailey's approval of the Levine loan and the commitment he issued on behalf of Crestmont in violation of its policies, while imprudent, did not pose an abnormal risk to Crestmont's financial stability and therefore was not an unsafe or unsound practice within the meaning of section 1818(b). Accordingly, we will grant Bailey's petition for review and vacate the part of the Director's order pertaining to Bailey.