2011 Policy Positions
Beginning in 1966, the U.S. Congress expanded the enforcement powers of the federal banking agencies based on the belief that they lacked sufficient authority to force banks and related parties to take corrective action to prevent unsafe and unsound banking practices where moral suasion was ineffective. Since that time, the Congress has continued to add to the enforcement arsenal of the agencies, particularly in the period 1989-1993. In 2006, Congress is poised to pass legislation that will repeal existing law that protects bank directors against the agencies enforcing written agreements and written conditions to applications, notices, and requests that would compel bank directors and others to provide personal financial guarantees such as achievement and maintenance of capital ratios.
AABD believes that the federal banking agencies need enforcement powers necessary to help assure the safety and soundness of the banking system, and to use those enforcement powers in a fair and proportionate manner.
AABD also believes that certain federal banking laws grant federal banking agencies too much power, both substantive and procedural – more than they need to supervise banks and their insiders effectively. “Too much power” means more than the agencies need to supervise banks and their insiders effectively while also having the counterproductive result of erecting a barrier to the finding of qualified persons to serve as directors and having a potentially chilling effect on the willingness of board members to authorize their banks to engage in legitimate and beneficial banking activities that entail prudent risk-taking. These laws impact bank directors because they represent a substantial personal liability risk that is difficult to avoid or defend. While the agency powers are used sparingly when the economy is strong, they have been used broadly and aggressively when the economy declines and banks’ financial condition deteriorates.
Examples of these banking agency powers, all of which were granted by Congress during the savings and loan crisis in 1989-1993, include the following:
- Freezing personal assets without a prior hearing
- Imposing $1,000,000 (plus an inflation multiplier) a day civil fines on directors and other insiders
- Imposing large fines based on inadvertent violations of law and regulation or violations of safe and sound banking practices
- Forcing directors to make restitution for bank losses through administrative means, with only limited judicial review
- Imposing large fines based on violations of the agencies’ concept of fiduciary duty that would not pass muster under standards of care required of directors under state law
- Removing directors of troubled banks from office, without a hearing or evidence of wrongdoing
These powers were granted to the agencies at a time when many members of Congress, driven by a media frenzy and political pressure, believed that the banking crisis was caused by unchecked excess, fraud and dishonesty on the part of officers and directors. Subsequent studies, however, cast doubt on this theory. See, for example the National Commission on Financial Institution Reform, Recovery and Enforcement, Origins and Causes of the S&L Debacle: A Blueprint for Reform, July 1993. Yet the laws passed in 1989-2003 remain intact. Congress has not undertaken any meaningful review of these laws to determine whether they serve the interest of maintaining a safe and sound banking system.
AABD does not question the integrity, competence and professionalism of those who work for the federal banking agencies. The agencies have attracted qualified personnel. Abuses of power have been infrequent. Nevertheless, the potential for abuse remains, given the vast powers granted to the agencies by Congress. AABD recommends that Congress and the agencies undertake a review of the enforcement powers of the agencies in light of the due process and public policy issues described in this position paper and the need to promote a safe and sound banking system.
Over the past decade, the federal banking agencies have infrequently used their most potent weapons. Bank failures have declined to a trickle, and problem institutions are few. Consequently, the number of enforcement actions against banks and bank insiders has declined when compared to the early 1990s..
Those who subscribe to the theory that the U.S. has figured out a way to prevent future severe recessions may see little to worry about. But those who accept the reality of future recessions and banks getting into trouble, even failing, during such downturns, understand that banking agencies can be expected to use the powers at their disposal, including some or all of those enumerated above. Although it is anticipated that the agencies will use these powers responsibly and fairly, there have been occasions where that is not the case.
That “power corrupts and absolute power corrupts absolutely” is not a new idea. Our Founding Fathers were driven by a fear of an overly powerful government. That is one reason the Constitution provides for a division of powers among three branches of government. The banking agencies, however, seemingly have the powers of all three branches of government.
The banking agencies possess a potent combination of executive, judicial and legislative powers. They act as prosecutor, judge and jury in assessing civil money penalties, removing directors from office, requiring restitution and freezing assets. Like other federal agencies, they have the power to write rules and regulations, but they also apply many informal, unwritten rules and guidance during the examination of banks.
The administrative law judges assigned to the banking agencies oversee fact-finding administrative hearings and make recommendations to the agency heads for final determinations. These judges are chosen by the agencies through a process that involves the enforcement personnel of each agency – including interviews and other evaluations conducted by such agency staff. In other words, the prosecutors choose the judge, or at least the fact-finder.
In 1994, AABD reviewed more than forty cases over a period from 1991 to 1999 involving the two administrative law judges assigned to the banking agencies at that time. We found that one of the judges recommended, as requested by the agency staff, an administrative order against the bank, banker or director in every case, but one. This near unanimity in support of the prosecutors is noteworthy but it also should be noted that the other administrative law judge assigned to the banking agencies exhibited a strong streak of independence and made a number of recommendations to the head of the agency at variance with the prosecutors’ requests.
It is not the administrative law judge who decides the administrative law case; he or she makes a recommendation to the head of the federal banking agency, who makes the decision on whether to grant the action requested by the agency’s enforcement personnel. Therefore, like other federal agencies, the banking agency heads decide the case initiated by their own employees.
If a bank director wishes to appeal an order approved by an agency head, he or she may do so to the federal circuit court having jurisdiction over the case. But the appeals court is not a fact-finder and can overrule an agency decision only if it finds that the agency acted arbitrarily or capriciously.
To be sure, the banking agencies need certain enforcement powers in cases where moral suasion does not work or where the condition of the bank warrants formal action. Those should be left intact.
It is only those powers that raise issues of fairness, proportionality and due process that concern us. Good banking supervision does not require the use of government powers that deprive directors and officers of basic due process protections.
Excessive enforcement powers and excessive use of those powers erode the safety and soundness of the banking system in several ways.
They discourage qualified persons from accepting offers to serve as bank directors. AABD’s periodic surveys of bank and savings association directors continue to reflect the loss of qualified people who refuse to serve as directors for fear of personal liability.
Agency threats, backed by the threat of enormous administrative penalties, can discourage bank boards from making prudent corporate decisions that could benefit shareholders and their communities. The credit crunch in the early 1990s was exacerbated by director fears of personal liability from making bad loans, even though the borrowers were creditworthy.
Erosion of due process protections also can encourage undisciplined and uninformed supervisory decisions that regulators know will not receive any meaningful review by an independent third party.
Unfair federal banking laws that represent disproportionate punishment or raise due process concerns need to be addressed. These laws are not needed by the agencies to meet their supervisory responsibilities and, in fact, can undermine the effort to maintain the safety and soundness of the banking system by discouraging qualified persons from serving as bank directors.
Civil money penalties. Federal banking agencies administratively may impose civil money penalties of up to $1,000,000 a day (plus an inflation adjustment) on individual directors and officers for, among other things, violations of law and regulation and breaches of duty. In comparison, the highest administrative penalty that the Securities and Exchange Commission can impose on directors of securities firms is $100,000, and that’s not per day.
Banking agency powers should be comparable with those of the SEC because securities firms and mutual funds now hold more financial assets than the banking industry, and both industries are vital to the U.S. economy. Moreover, the securities firms also hold insured accounts, under the insurance system known as SIPC.
Banking agencies can impose penalties on directors of up to $25,000 a day without showing that the directors knew or should have known that the bank was violating the law. Such penalties may also be imposed on a director for breach of his or her fiduciary duties, but the statute does not define the standard of care required of a director. Although we believe that the standard of care applicable in any particular case will be the standard of care applicable in the state in which the bank is based or incorporated, the agencies historically have believed that the standard of care is that of federal common law, not state law, and some of the agencies in the past have argued that the standard of care under federal common law is simple negligence. Most state statutes of case law interpreting state law have adopted a gross negligence standard for directors. Supreme Court decisions now support AABD’s position.
In stark contrast to the banking statutes, the SEC’s authority to impose administrative civil penalties is limited to demonstrating that the director “willfully” violated the law, or did not reasonably supervise the person who violated the law. See 15 U.S.C. 78u-2. That is the standard to which bank directors and other institution-affiliated parties should be subject for purposes of imposition of civil money penalties.
Restitution. The banking agencies have broad powers to force directors to make restitution to their institutions. There is no dollar limit. The grounds for restitution do not require the agency to prove that the person received an improper personal benefit; if the agencies cannot prove that the person was unjustly enriched, the statute permits the agencies to prove that the person acted in “reckless disregard” in violating a law, regulation or prior order of the agency. In contrast, the SEC may force directors administratively only to disgorge what they personally took out of their institutions.
The fairness of having a potentially limitless restitution claim being adjudicated by the agency whose staff is recommending the action is questionable. Congress should amend the restitution provision to require a banking agency to make its case in a court of law, where a totally independent judge will preside and a jury can hear the evidence.
Freezing of assets. Beginning in 1989 and through amendments in the early 1990’s, the Federal banking statutes authorized the federal banking agencies to freeze the personal assets of bank and savings institution directors and other insiders either by requesting a federal court to freeze the assets following a showing that the facts warrant it, or by simply doing it themselves through the issuance of a temporary order to cease and desist.
Congress should require the banking agencies to prove, at the outset, before an independent court of law, the justification for freezing the personal assets of bank directors, officers and other institution-related parties, including, as in other cases before the federal courts, how the injury, loss or damage is irreparable and immediate if the court were not to issue an order freezing the assets.
On June 19, 2003, the AABD Task Force on Asset Freezes, consisting of three former General Counsels of federal banking agencies, released a report in which it found that the administrative “do-it-yourself” asset freeze authority is excessive an unneeded by the federal banking agencies. The Task Force urged the Congress to require the agencies to seek relief solely in a civil court.
Dismissal powers. In 1991, Congress authorized the agencies to dismiss directors and officers of below par banks without cause and without a hearing. This dismissal procedure is totally incompatible with the due process protections guaranteed by the U.S. Constitution.
Congress should repeal this provision. The agencies will still have the power under separate provisions to remove insiders for cause, through an administrative hearing and court review.
Pending Legislation. Under current law, the federal banking agencies cannot enforce personal financial guarantees of bank directors and others without proving that the director or other person was unjustly enriched or recklessly violated a law, regulation, or a prior order of an agency.
Proposed language in the Financial Services Regulatory Relief Act (Section 405 of HR 3505 and Section 702 of S 2856) will repeal current law by permitting the agencies to enforce such guarantees without having to prove any wrongdoing by the director or other person.
AABD is strongly opposed to the proposal and urges its members and others to communicate to Members of Congress to request that those sections be deleted from the legislation.
AABD’s proposals are modest. They address only the most egregious of the banking agency powers, none of which the agencies require to supervise effectively the banking system. Following repeal of these powers, the agencies would still have a vast array of enforcement tools – for example, removal and suspensions of insiders, prohibitive orders concerning safety and soundness, closing of institutions, appointment of conservators, and substantial civil money penalties – to ensure the safety and soundness of the banking system.
AABD is also in favor of changes in federal laws that interfere unnecessarily with the exercise of reasonable discretion and authority by the Board of Directors of banks and savings institutions.
These laws apply primarily to depository institutions that are federally chartered, i.e. national banks and federal savings institutions.
The National Bank Act was first enacted in 1863, and still has corporate concepts that date back to that period. There have been many changes at the state level since that time in corporate law that are not reflected in the National Banking Act. For example, modern state statutes permit state banks to create blank check preferred stock, by approval by the shareholders of an amendment to the bank’s articles of incorporation, which enables a bank board of directors to decide the terms of preferred stock shortly before the board decides that the bank should issue such shares. In contrast, the Office of the Comptroller of the Currency has interpreted the National Banking Act to require that the detailed terms of the preferred stock be stated in the Articles of Incorporation. This means that any change in the terms required for valid business reasons must be submitted by a national bank for approval at a shareholder meeting. In addition, the requirement in the National Banking Act for cumulative voting for the election of directors is antiquated and unnecessary. Most state laws permit the shareholders to decide whether to have cumulative voting.
Agency Limitations On Discretionary Authority Of Bank Directors
The federal banking agencies have regulations or policy statements that limit the exercise of reasonable discretion by the Board of Directors of a bank or savings institution. These include numerous references to the responsibilities of boards of directors that do not recognize the board’s authority to rely in good faith on officers and employees, advisors, and Board committees. Yet, reasonable reliance by the Board of Directors is a foundation of all modern state corporate statutes, and is a hallmark of the modern corporation, for it is quixotic to expect that members of a board of directors will personally verify every action taken by the corporation’s officers and employees.
Some federal banking agency regulations also place unnecessary limitations on a board’s powers to supervise the bank or savings institution. OTS regulations create so many restrictions on the power of the board of directors of a federal savings institution to govern the institution and unreasonable requirements in the articles of incorporation or bylaws of the institution that many banking lawyers counsel federal savings institutions that do not have holding companies to form them so that the parent company will be governed by state, rather than federal law.
AABD is opposed to these kinds of restrictions on the reasonable discretion of Boards of Directors and has urged the federal banking agencies to amend their regulations and policy statements to permit Boards the widest discretion possible within the constraints of safe and sound banking practices.
Heavy burdens of bank directors imposed in law, regulation, and regulatory guidance.
Bank directors have a fiduciary duty of care and loyalty that is substantial and burdensome. However, they also face significant additional burdens imposed by federal banking laws, regulations, and regulatory guidance.
To appreciate the extent of these burdens, one need only to read the list of requirements imposed by law, regulation, and regulatory guidance that is available on AABD’s website.
It is essential that the federal banking agencies undertake a thorough review of the burdens on bank directors imposed by statute, regulation, or regulatory guidance. The agencies have reviewed the regulatory burdens of banks and savings institutions, but, to our knowledge, have not undertaken such a review of regulatory burdens on bank directors.