Opinion ID: 562132
Heading Depth: 1
Heading Rank: 3

Heading: Review of Director's Decision

Text: 49 On appeal from a district court's review of an agency action, the appellate court  'must render an independent decision on the basis of the same administrative record as that before the district court; the identical standard of review is employed at both levels; and once appealed, the decision of the district court is afforded no particular deference.'  Webb v. Hodel, 878 F.2d 1252, 1254 (10th Cir.1989) (quoting Brown v. United States Dept. of Interior, 679 F.2d 747, 748-49 (8th Cir.1982) (citations omitted)). As we have discussed, review of the appointment decision is governed by the APA. 5 U.S.C. Secs. 701-706. Accordingly, we must uphold the agency's actions, findings, and conclusions unless they are: outside the agency's statutory authority; unsupported by substantial evidence; found to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; contrary to a constitutional right or privilege; without observance of required procedure; or unwarranted by the facts to the extent the facts are subject to a trial de novo by the reviewing court. 5 U.S.C. Sec. 706(2)(A)-(F). A reviewing court may not substitute its judgment for that of the agency. Motor Vehicle Mfrs. Ass'n of the U.S., Inc. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29, 43, 103 S.Ct. 2856, 2866-67, 77 L.Ed.2d 443 (1983). 50 Franklin urges us to apply a clearly erroneous standard to the factual findings of the district court. This we decline to do. We review the agency action based on the same file and under the same standard as was proper for the district court. We further decline to apply the clearly erroneous standard to findings of the district court as we have decided the district court improperly exceeded its permissible scope of review. We feel compelled to observe that Franklin has consistently misunderstood that the fact finder in this case is Director and not the district court. It is to Director's findings that some deference is due and not to those later made by the district court. 51 As we have held, the trial court failed to confine its review to the agency record and failed to apply the proper standard of review. In view of the fact that our task as an appellate court is essentially the same as the district court's, we will proceed to review the agency record. We believe little would be accomplished at this point by a remand to the district court. 52 Our review commences with an examination of the statutory grounds for the appointment of a conservator. 12 U.S.C. Sec. 1464(d)(2)(A) sets forth at least eight separate grounds for the appointment of a conservator. In the instant case, Director found three of these grounds exist. We will examine each of these three grounds separately, although a determination that Director correctly found the existence of any one of the three statutory grounds is sufficient to uphold Director's appointment decision.A. Unsafe and Unsound Condition 53 The first statutory ground Director found to exist was 12 U.S.C. Sec. 1464(d)(2)(A)(iii), which is an unsafe or unsound condition to transact business including having substantially insufficient capital or otherwise. 54 Director found this circumstance to exist based on, among other things, Franklin's significant level of high-risk assets and its undue reliance on brokered deposits. 55 We turn our attention to the administrative record to search for evidence regarding Franklin's level of high-risk assets. We quote a portion of the voluminous data bearing on this subject: 56 [A] significant portion of the Association's asset portfolio is comprised of high risk assets such as principal-only and interest-only strips of mortgage backed securities, residuals of collateralized mortgage obligations (CMO) and real estate mortgage investment conduits planned amortization classes and targeted amortization classes of the CMO, and other high-risk derivative products.... These assets are subject to extreme price volatility, interest rate risk, as well as significant prepayment risk. As of January 9, 1990, the Association had High Risk Assets totaling $3,715,671,000, or 40.15% of total assets. 57 ... [B]ecause of the Association's tight interest margin, the Association will experience significant losses with respect to these High Risk Assets irrespective of whether interest rates increase or decrease. In addition, the prepayment risk cannot be hedged against with any certainty because it is affected by factors other than rising or falling interest rates, and many of the assets are keyed to varying speeds of prepayment. 58 ... [B]ecause the Association is considered a primary market maker in the residuals market, the Association may be unable to successfully liquidate its investments in the High Risk Assets in the event of a thin market. Therefore the Association's High Risk Assets are subject to significant liquidity risk due to the lack of an adequate secondary market. The Association's significant level of High Risk Assets thus places it in an unsafe and unsound condition to transact business. 8 59 After hearing the evidence presented at trial, the district court arrived at the following conclusions regarding Franklin's significant level of high-risk assets: (1) through the efforts of Franklin's management the sensitivity to interest rate risk and prepayment risk had declined and was anticipated to decline further, Franklin II at p 183; (2) markets exist for these high-risk assets as Franklin purchased them from dealers, id. at p 185; (3) Director's criticism about the level of these high-risk assets was inappropriate because Franklin is reducing the amount of these high-risk assets, id. at p 186; and (4) Franklin was properly monitoring and managing these assets, id. at p 187. 60 The district court failed to understand the significance of Director's concerns. Director's primary concerns involved the fact that Franklin's assets were not sufficiently diversified, and far too high a concentration of its assets existed in high-risk securities. Director opined this was undesirable as the markets were extremely volatile. In other words, the value of these assets could and would change significantly and rapidly. Director knew the assets had to be sold as they were matched to the maturity of the deposits, and Director predicted (and gave reasons supporting his prediction) that whether interest rates went up or down, Franklin would incur losses when it sold these assets. Director's evidence also established that Franklin was the primary market for these high-risk assets. The district court's factual findings fail to address any of these concerns. The fact that Franklin was doing a good job monitoring these assets, was reducing the level of these assets, and had reduced the sensitivity to interest rate risk and prepayment risk, is simply irrelevant to Director's determinations. Quite simply stated: the district court ignored the data contained in the administrative record and Director's concerns; substituted its judgment for that of Director's concerning the acceptable level of these high-risk assets; ignored the predictive judgment of Director that a sale of these assets would likely result in a loss; and afforded no deference to Director's knowledge and expertise. Again, the district court, while using the language employed in the proper, arbitrary or capricious standard, in fact applied a de novo standard in its review. 61 There exists ample evidence in the agency record to establish a high level or undue concentration of high-risk assets. The most that can be said of Franklin's evidence concerning these high-risk assets and their level of concentration is that experts may disagree. Director's experts opined that forty per cent of such assets was too much, and Franklin's experts opined this level was acceptable. Conflicting expert opinion, however, is not sufficient to allow a reviewing court to conclude the agency decision was arbitrary, capricious or an abuse of discretion, nor is such evidence sufficient to overcome the presumption of regularity and correctness afforded to the appointment decision. Overton, 401 U.S. at 415, 91 S.Ct. at 823; Guaranty Sav., 794 F.2d at 1432. 62 We next turn our attention to Director's finding that Franklin placed undue reliance upon brokered deposits. The administrative record reveals that over seventy per cent of Franklin's deposits were brokered. Again we quote from the agency file: 63 [T]he Association has funded its growth largely with brokered deposits. As of December 31, 1989, the Association had brokered deposits of $3,290,981,000, or 70.7% of total deposits.... [T]he high level of brokered deposits, an expensive source of funds, is contributing to the Association's narrow net interest margin and operating losses.... [T]he Association has no alternative, lower cost funding sources due to its limited amount of eligible collateral available to pledge against lower cost borrowings. The Association's excessive reliance on brokered deposits places it in an unsafe and unsound condition to transact business. 64 In looking to the district court's factual conclusions regarding Director's concerns over Franklin's high level of brokered deposits, Franklin II at pp 169-179, the court, based upon conflicting expert testimony, found the following: (1) Franklin's cost of brokered deposits was declining, Franklin II at p 172; (2) Franklin was setting an interest rate significantly under the market and yet consistently obtained brokered deposits at that below market rate, id. at p 173; (3) Franklin had a relatively low cost of these funds as Director failed to take into account the costs of servicing these accounts, id. at p 174; (4) Franklin's cost of these funds included its hedging costs while other institutions did not, id. at p 177; (5) Franklin's cost of funds plays no part in its investment decisions, id. at p 178; and (6) therefore Franklin's cost of funds do not present a safety or soundness concern, id. at p 179. 65 Again, the district court failed to appreciate the significance of Director's concerns. A financial institution obtains brokered deposits by soliciting these deposits. They are termed brokered funds because the financial institution pays a commission to the broker who obtains the funds. Indeed, the audit statement of Franklin's own accountants shows that Franklin paid such commissions in significant amounts--$1.9 million in the 1988-89 fiscal year, and $2.5 million in the 1989-90 fiscal year. These deposits are attracted by higher than normal interest rates from those persons wanting the best rate, but still wishing to maintain FDIC insurance. In reviewing Franklin's own evidence, specifically the June 30, 1989 Form 10-K filed by Franklin, we find warnings to the investing public such as [b]rokered deposits ... constitute a significant percentage of the Association's unsecured liabilities, and brokered [d]eposits ... may be withdrawn from a thrift in the event of availability elsewhere of higher interest-earning investments for such funds. Franklin's Form 10-K explicitly warned investors that its operating strategy had resulted in significant volatility in the earnings and was expected to continue to do so in the future. Brokered deposits present two problems to a financial institution: first, they tend to increase the cost of funds; and second, they impair the institution's liquidity as most brokered deposits are short term. This means the institution must sell investments in order to obtain the money to pay off the maturing deposits. It is also important to note Congress has condemned reliance on brokered deposits, describing such reliance as poor management. H.R.Rep. No. 101-54(I), at 299, U.S.Code Cong. & Admin.News 1989, p. 95. 66 The district court ignored the question of whether Franklin unduly relied upon brokered funds. Instead, it focused on Franklin's cost of funds being low and therefore determined that Franklin's reliance upon brokered deposits for over seventy per cent of its total deposits was neither unsafe nor unsound. In so doing, the district court disregarded Director's concerns and his expert judgment. The district court in effect substituted for the judgment of Director, as to what constitutes undue reliance upon brokered deposits, the judgment of Franklin's experts, thus failing to give any deference to Director's knowledge, expertise and judgment. Even if the trial court was correct in its finding that Franklin was able to set an interest rate significantly under the market and consistently obtain brokered deposits at that below market rate, Franklin II at p 173, it did so by ignoring the agency file containing Director's specific comparisons. Further, the district court completely ignored and failed to address the liquidity problems presented by Franklin's significant reliance upon these brokered deposits. 67 The fact that over seventy per cent of Franklin's deposits were brokered is clearly established in the agency record and is undisputed by Franklin. Director found this to be an unacceptable level or concentration of brokered deposits for a savings and loan association. Moreover, Congress has condemned such high reliance on brokered funds. Franklin presented experts who testified, in essence, that Franklin's reliance upon this level of brokered funds was acceptable. However, such contradictory expert testimony from a competing witness is not sufficient to allow a reviewing court to conclude the agency action was arbitrary, capricious, or an abuse of discretion, nor is it sufficient to overcome the presumption of correctness. Overton, 401 U.S. at 415, 91 S.Ct. at 823; Guaranty Sav., 794 F.2d at 1432. 68 When Director made the decision that reliance upon brokered funds for seventy per cent of total deposits was an unsafe or unsound condition, Director was making first, a policy decision, i.e., seventy per cent of total deposits being brokered is an unacceptable level, and second, a predictive judgment, i.e., Franklin had created an unacceptable level of risk for the depositors' funds. Substantial evidence existed to support this decision. 69 As discussed above, Director found Franklin was in an unsafe and unsound condition due to its significant level of high-risk assets and its undue reliance upon brokered deposits. Up to this point we have discussed Franklin's high concentrations of high-risk assets and brokered deposits, finding the administrative record clearly establishes both exist. We must still determine if the agency record justifies a finding these concentrations rendered Franklin's condition unsafe and unsound. What constitutes an unsafe and unsound condition is somewhat of an amorphous concept, as it varies depending on the circumstances involved. It is clear, however, that an unsafe or unsound condition exists where a financial institution is operated in such a manner as to cause unacceptable levels of risk to its depositors' funds. Since a particular condition may not necessarily be unsafe or unsound in every circumstance, it must be judged in relation to all relevant facts. One of the clear purposes of FIRREA is to commit the progressive definition and eradication of such conditions to the director. First Nat'l Bank of Lamarque v. Smith, 610 F.2d 1258, 1265 (5th Cir.1980). Whether a financial institution is in an unsafe or unsound condition is largely a predictive judgment (i.e., what may happen if this practice continues), and reviewing courts should be particularly deferential when they are reviewing an agency's predictive judgments, especially those within the agency's field of discretion and expertise. As we have pointed out, the role of a reviewing court is to determine whether the director's action was within his authority, was based upon a consideration of valid factors, and whether a clear error of judgment has occurred. See 5 U.S.C. Sec. 706(2). In reviewing the director's decision to appoint a conservator, courts need not slavishly follow the director's decision. Rather, it is the function of the reviewing court to determine whether there is substantial evidence to support the statutory grounds of appointment. Here, such evidence clearly exists. Reliance by the district court upon one expert to the exclusion of another is insufficient to overcome the deference due Director's appointment decision. A contrary ruling would effectively strip Director of his regulatory and enforcement powers and place this authority in the hands of the savings and loan association. B. Depletion of Capital 70 The second statutory ground for the appointment of a conservator Director found to exist was under 12 U.S.C. Sec. 1464(d)(2)(A)(vii), which allows for the appointment of a conservator if the director finds: [T]he association has incurred or is likely to incur losses that will deplete all or substantially all of its capital, and ... there is no reasonable prospect for the replenishment of the capital ... without Federal assistance.... 71 The administrative record reveals an abundance of evidence supporting Director's decision concerning the likelihood of depletion of Franklin's capital. Franklin's net income margin had steadily and progressively declined from 2.34 per cent as of June 30, 1984 to .94 per cent on June 30, 1989. Franklin, by its figures, had a $9 million loss from June 30, 1988 to June 30, 1989. Franklin was paying dividends and large bonuses notwithstanding the loss. During 1988 and 1989, after being ordered to stop growing, Franklin nevertheless continued an aggressive growth rate in its assets (22.3 per cent) while its capital was decreasing. Franklin was also unsuccessful in obtaining outside capital. Nonetheless, for its fiscal year ending June 30, 1989, Franklin paid its eight executive officers $3.5 million in cash compensation and paid its owners dividends of $15 million. It pumped up its capital by $120.7 million with an unauthorized tax forgiveness agreement between it and its holding company. Franklin's core capital was only 2.1 per cent on November 30, 1989, after an adjustment for the tax forgiveness contract. Director deemed this a clear capital failure. While this finding was sufficiently dire itself, Director also noted his deep concern regarding Franklin's deferral of actual cash losses, which understated its current losses. By June 30, 1989: the deferred hedging losses were approximately $374 million, of which Director ordered $127 million be taken immediately; Director had significant evidence that the entire economic value of Franklin was only $70 million; Director was concerned that Franklin ran the risk of default on the bonds Franklin had issued having a face value of $2.9 billion, but which could cost Franklin $185 million to defease the possible default; and Director felt Franklin should increase its valuation loss allowances to $49 million as a result of expected losses on its letters of credit. In sum, Franklin reported its capital to be $380 million, although Director felt there should be write-offs of $472 million. Under Director's most optimistic view Franklin had a net worth of only $70 million, falling well short of the capital requirements. Director believed there was no profit in Franklin's future; Franklin was only marginally profitable in one of the past five quarters; any gains on assets would be offset by future losses; Franklin was unable to restructure its portfolio to obtain profitability; and while the holding company had forgiven $110 million in deferred taxes, Franklin remained liable to the IRS and the holding company did not appear to have the resources to pay the taxes. Based on these and numerous other factors, Director concluded Franklin could not, in the foreseeable future, meet its capital requirements. 72 After hearing from both Franklin's and Director's expert accountants, the district court determined that although Franklin's methods of accounting for future losses was not widely used, Franklin II at 109, Franklin's deferral of its hedging losses was in accordance with GAAP, id. at p 110, and had been approved by Franklin's outside auditors, id. at p 111. The district court further determined Franklin's use of its absolute value method was a reliable method of testing correlation which was the keystone justifying Franklin's accounting deferral of its actual cash hedging losses, id. at p 128; Franklin's computer modeling of future losses was an accurate basis upon which to defer these losses, id. at p 189; and that it generally approved of the accounting methods of Franklin. 73 In making these findings, the trial court again rejected Director's expertise and experience and accepted the judgments and opinions of Franklin's experts in this eighteen-day de novo bench trial. The district court found that even though Director's accounting standards were within GAAP, it would apply Franklin's accounting standards as Director's were too conservative. 74 Director had ordered Franklin to increase its loan loss valuation by $47 million to cover future losses expected to arise from Franklin's letters of credit. The trial court simply decided Director failed to properly evaluate this expected loss as Director did not give weight to the fact that Franklin would provide favorable financing to those who purchased the properties at the foreclosure sales. The trial court substituted this predictive judgment of Franklin's expert for that of Director. Even if we assume the district court was correct in decreasing the amount of this expected loss due to the possibility of favorable financing, the district court was not correct in deciding there would be no loss. At the very minimum there would be a decrease in earnings. 75 Director had ordered Franklin to increase its loan loss reserve by $185 million to account for predicted expenses necessary to defease a possible default in Franklin's bonds. The district court found default had not occurred and was not an event likely to occur. Franklin II at p 157. Again, this finding was based on the court's substituting the predictive judgments of Franklin's experts for those of Director. 76 Following Franklin's unauthorized entry into a tax forgiveness agreement with its holding company--a device Franklin had used to increase its capital--Director ordered Franklin to write down its capital $110 million. Director reasoned that Franklin was still responsible to the IRS for the taxes and, in any event, the holding company lacked the ability to pay. Notwithstanding Director's reasoned analysis, the trial court found no taxes were due at the time the conservator was appointed, and the holding company did have the ability to pay any tax that might come due in that it could borrow the money, sell stock, or liquidate Franklin. Franklin II at p 165. These findings were again in disregard of Director's judgment and analysis. We feel compelled to observe that Franklin's holding company had virtually no assets except Franklin's stock and a small cash account. 77 When reviewing an agency's decision concerning matters lying within the agency's field of expertise, a reviewing court should begin by acknowledging that a presumption of procedural and substantive regularity attaches. Overton, 401 U.S. at 415, 91 S.Ct. at 823; Guaranty Sav., 794 F.2d at 1432. The reviewing court, particularly when reviewing such technical determinations and predictive judgments, must apply a deferential standard of review. Reliance on testimony of one competing expert to the exclusion of another is insufficient to overcome the presumption of correctness that the agency enjoys in its particular area. This presumption is even stronger where Congress has charged an agency with complex analytical responsibilities and the duty to make predictive judgments. 78 This does not mean all agency decisions are unimpeachable. A reviewing court should not blindly follow an agency decision. In the instant case, it is the responsibility of the reviewing court to determine if there is substantial evidence in the director's administrative file to support a finding of the existence of one of the statutory grounds for appointment of a conservator. A director's decision to appoint a conservator when based upon technical matters such as: unacceptable levels of high-risk assets and acceptable levels of liabilities; accounting standards; the level of loan loss reserves; and predictions of future losses, should not be set aside by the reviewing court unless the findings transgress the bounds of reason. 79 In reviewing Director's decision to appoint a conservator, we need only inquire whether this decision had a rational basis as shown by the administrative record. The focus of this inquiry is whether a statutory ground for the appointment of a conservator existed at the time the decision was made. The inquiry should not focus on credibility determinations as to which experts are more persuasive or which have the better analytical and predictive abilities. We find Director's second statutory ground upon which he based his decision is fully supported in the administrative record and provided a valid basis for the appointment decision. 80 C. Substantial Dissipation of Assets or Earnings 81 The third statutory ground for the appointment of a conservator that Director found to exist is contained in 12 U.S.C. Sec. 1464(d)(2)(A)(viii), which allows for the appointment of a conservator or receiver if there is a violation or violations of laws or regulations, or an unsafe or unsound condition which is likely to cause either insolvency or substantial dissipation of assets or earnings, or is likely to weaken the condition of the association or otherwise seriously prejudice the interests of its depositors. 82 Much of Director's evidence concerning capital depletion is also applicable to this statutory ground and need not be repeated. It is nevertheless appropriate to discuss briefly some of the remaining factors underpinning Director's finding. 83 The proper amount of capital is essential to the continued operation of any financial institution. Director's evidence established the probability of future capital inadequacy, yet the district court found that Franklin had the means to comply with all capital requirements. 84 We first examine Director's evidence. Franklin's net interest margin had been steadily shrinking, and in fact was negative in three of its last four quarters. In its fiscal year 1988-89, Franklin reported a net loss of $9 million. Franklin's operating trends revealed Franklin was likely to experience additional losses in the foreseeable future. In short, Franklin was unable to generate capital through earnings. Moreover, it was highly unlikely that Franklin could raise outside capital. Franklin II at p 52. Presumably its ownership was unable or unwilling to inject any additional capital of its own. Director opined that in light of Franklin's poor operating results and negative trends its recent aggressive and significant growth was not prudent and the institution was unable to provide the necessary capital to support such growth. 85 In order that Director could be assured of capital adequacy, Director ordered certain adjustments to capital. These adjustments included: (1) a $119 million write-down in order that the capital would accurately reflect hedging losses that Franklin had deferred (this also had the effect of understating current losses); (2) a $47 million write-down to accurately reflect a valuation allowance in loss reserves, and to accurately reflect the amount of losses Director predicted Franklin would incur as a result of letters of credit Franklin had issued guaranteeing payment of various industrial revenue bond issues; (3) a write-down of $185 million to provide an allowance to assure Franklin's $2.9 billion zero coupon bonds; (4) a write-down of $110 million to accurately reflect an unauthorized tax forgiveness agreement between Franklin and its holding company, which resulted in an increase in Franklin's stated capital; and (5) as Franklin had included in its capital investment Sun Life Insurance Company's purchase of a block of insurance policies, Director ordered a write-down of $33 million, which was included in Franklin's capital as a part of its supervisory goodwill. 86 A summary of Director's concerns about Franklin's lack of capital is simple. On June 30, 1989, Franklin reported its total capital requirements as being $274 million. Franklin's own Form 10-K report explicitly states: 87 Unless the Association significantly increases its capital, reduces its investments in an extension to such subsidiaries, or restricts the impermissible activities of such subsidiaries, on a fully phased-in basis this new requirement for calculating capital could have a material adverse effect on the Association's capital. 88 This Form 10-K also contains many warnings to potential investors that Franklin's capital structure may become inadequate. 89 Again we look at the district court's treatment of Director's concerns about Franklin's capital structure. The court found, based upon Exhibit 603, that Franklin had the ability to comply with all regulatory capital requirements through transactions already scheduled to occur. Franklin II at p 84. The district court then determined the investment in Franklin's Saver's Life subsidiary was properly included in its capital. Id. at p 86. It further found no write-down was necessary to properly reflect current losses on Franklin's hedging as Franklin used the better accounting standards. It determined Director had wrongfully valued the expected losses from Franklin's letters of credit in that Director failed to take into account the value of Franklin's financing of the anticipated buyers of these foreclosed properties. Id. at p 154. The court determined Director's prediction of the moneys needed to avoid default upon the bond issue was incorrect, id. at pp 155-158, and that it was acceptable for Franklin to apply the tax forgiveness to its capital, id. at pp 159-168. 90 To reach these results the district court had to ignore the evidence contained in the administrative record and accept without question Franklin's competing evidence. The district court furthermore had to ignore or disregard Director's predictive judgments and completely accept all the testimony given by Franklin's experts. Finally, the district court had to reject Director's accounting standards and adopt Franklin's. While both competing accounting standards were in accordance with GAAP, the district court failed to give the appropriate deference to the standards specified by Director, stating only that Director's standards were extremely conservative. Id. at p 101. Basically, the district court found Director's decisions arbitrary based upon competing expert testimony and gave no deference whatsoever to Director's expertise and predictive judgments. 91 The proper inquiry under the arbitrary and capricious standard is not which expert is more impressive, or even if the reviewing court agrees with a particular view over another. Rather, the appropriate inquiry of the reviewing court is whether a reasonable person considering the matters on the agency's table could find a rational basis to arrive at the same judgment as made by the director. 92 Reviewing the evidence contained in the administrative file and giving Director's predictive judgments due deference, we find: the decision to appoint a conservator supported by substantial evidence; the evidence clearly establishes the existence of the statutory grounds for the appointment of a conservator; and Director's conclusions were reasonable.