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A PRELIMINARY REPORT
AMERICAN ASSOCIATION OF BANK DIRECTORS

MAY 20, 2016

On February 26, 2016, the OCC adopted new civil money penalty matrices and rescinded the matrix it used since 1993.

Our reading so far is that the changes will likely increase the number and severity of CMPs for both banks and insiders, including directors, of OCC-regulated institutions.

This comes on top of record setting penalties on the banking industry.

A recent Deloitte study found that while the number of OCC enforcement actions is stabilizing at historic levels, “the associated fines have increased markedly since 2010…banks and IAPs [institution affiliated parties like directors and officers] have spent $4 billion on restitutions and $1.5 billion on CMPs since 2010.”

While the OCC states that the matrices are only guidance and that they do not reduce the CMP process to a mathematical equation, the matrices in fact do that, at least in part.

We’ll explain the statutory authority granting the OCC and the other federal banking agencies broad discretion to impose CMPs; how the OCC matrices work; how the new matrices increase the risk to banks and insiders of a large penalty; and how the public interest and a safe and sound banking system would be better served by using the CMP authority more sparingly. We will not address the authority of FinCEN or CFPB to impose penalties.

Statutory authority

Beginning in 1978, the US Congress granted the federal banking agencies broad authority to impose CMPs for violations of law or regulation, engaging in unsafe or unsound banking practices, breaches of fiduciary duty, and certain other bases.

The statute requires the agency to consider four statutory factors: (1) the size of financial resources and good faith of the institution or IAP charged; (2) the gravity of the violation; (3) the history of previous violations; and (4) such other matters as justice may require.

Given the broad Congressional mandate, matrices are essential to help guide the agencies to use their authority wisely and judiciously.

To their credit, the federal banking agencies – the OCC, Fed, and FDIC – all adopted matrices soon after their authority to impose penalties was granted.

In contrast, the CFPB and FinCEN, both of which also have CMP authority, have not adopted and published any CMP guidance. That will be the subject of another AABD report.

The OCC has stated that there are two purposes served by CMPs – deterrence and encouraging correction. The OCC also has stated that the matrices are “tools to quantify the degree of severity of violations, unsafe practices, and breaches of fiduciary duty” and that it “uses the [matrices]…as tools to help ensure that CMPs are imposed consistently and equitably.”

How the matrices work

The new OCC matrix for institutions sets forth 11 factors that might support the imposition of a penalty such as intent to violate, history of prior violations, insufficiency of internal controls and systems, and lack of promptness of corrective action.

Each factor is assigned a weight from 3 to 7. Each factor is then evaluated based on progressive levels of severity (from 0 to 4). The weight assigned to each factor is then multiplied by the level of severity to determine the factor score. The factor scores for the eleven factors are then added together.

The matrix also has 3 factors that will lower the overall factor score. Each factor is assigned a weight of 1 or 2. Each of those factors is then evaluated based on its strength (on a scale of 0 to 4). The weight assigned to each factor is then multiplied by the strength level to determine the factor score. The positive factor scores are added together, then subtracted from the negative factor score total.

That total is then applied to a chart titled “Suggested Action Based on Total Matrix Score and Total Assets of Bank.” This chart sets forth a range of total matrix scores and the resulting penalties assessed based on size of the institution and total matrix score. If the total matrix score is 40 or below, there is no penalty assessed.

A similar process also applies under a separate matrix for IAPs.

Changes and other provisions in the new matrices are likely to lead to more and higher CMPs

Is the sky the limit?

While the rescinded matrix would have produced a fine of $10,000 to $25,000 for banks of all sizes at a certain point level, the new matrix will produce fines at the same point level up to $30 million for banks with assets of over $100 billion. For banks with assets of $5 billion to $25 billion, the fine could total $25 million, and for banks with assets of $1 billion to $5 billion, up to $1 million.

Thresholds for imposing a penalty have been lowered

The new matrix has lowered the trigger (the total points after applying weights and degree of severity) to impose a fine from 51 to 41.

At the same time, the total weight assigned to the 11 factors supporting a fine has increased from 43 to 50, and the total weight assigned to the 3 factors that would support not imposing a fine has declined from 7 to 5.

The weight given to “good faith” is significantly diminished

The new matrices reduce the weight assigned to “good faith”, a statutory requirement for the OCC to consider, by one-third, from a 3 to a 2 weighting.

The definition of “fiduciary duty”

A breach of a fiduciary duty is a basis for imposing CMPs on directors.

The OCC defines the term as simple negligence. But there is no such definition in federal law. Absent federal law, the law of the state where the bank is headquartered applies.

Many states have adopted a gross negligence standard of care for directors, sometimes as a result of applying the Business Judgment Rule. See AABD’s Bank Director Standards of Care and Protections – a Fifty-State Survey, David Baris (Editor), available for sale on Amazon.

The OCC can impose a penalty on a director even if the director fully meets his or her fiduciary duties

The matrix for IAPs and its notes do not state that a bank director will not be fined if he or she met their fiduciary duties.

Intent and notification aren’t what you may think

The OCC’s definition of “intent” does not require a showing of intentional misconduct or even recklessness. The standard for a certain level of severity is “should have known”, a highly subjective standard that the agency, not the bank or IAP, will likely determine in hindsight.

Several factors in the matrices measure conduct before and after “notification” that the violation or breach occurred. Continuation of the misconduct following notification increases the points that would support a penalty.

But the definition of “notification” is different than what one might expect. Notification “…may include receipt of information tending to show that a violation or unsafe or unsound practice is occurring, even if the information does not clearly establish the existence of a violation or unsafe or unsound practice.” (Emphasis added.)

It appears that the OCC is expecting banks and their IAPs to take corrective action before they know what they did was wrong.

Recklessness

The federal statute authorizes fines for unsafe or unsound banking practices, but only if they are “reckless” and meet other requirements.

The notes to the new matrices define “reckless” broadly to include evidence of “disregard of, or indifference to, the consequences of the practice, even though no harm may have been intended.”

If one knows that the practice is unsafe or unsound, then indifference or disregard is reasonably interpreted to be reckless. But what if the practice is not known to be unsafe or unsound?

There is no statutory definition of “unsafe or unsound banking practice.” In the past, the OCC has argued in administrative and civil courts that the OCC has the power to make the determination of what constitutes an unsafe or unsound banking practice absent acting arbitrarily or capriciously.

With that flexibility, which many but not all courts have agreed with, there will be circumstances where a bank or its directors and officers will not realize or reasonably foresee that the OCC might consider a certain practice to be unsafe or unsound, and yet will become subject to a penalty.

A better definition of “reckless” would be “want of care” – a standard that many courts has used to determine recklessness or gross negligence.

Self-reporting

The matrices give no credit for a bank or IAP self-reporting a violation or breach.

Lack of consideration of concurrent fines from other agencies

Many of the CMPs recently imposed involve a number of different agencies, each having jurisdiction over the bank or IAP and the subject matter. This overlapping authority can cause total CMPs to mushroom, with each agency desiring to be part of the public resolution of the matter.

The matrices do not mention this issue but should by taking into account the CMPs to be assessed by other agencies on the same matter.

Lack of distinction between the board of directors and management

The instructions to the new matrices do not differentiate between the role of the board of directors and management. Yet there is a major difference – boards supervise, and management manages and implements.

The instructions also suggest that the board is charged with managing the bank. The OCC states that it is the responsibility of the board to “ensure that the policies were followed…” But the responsibility of the board is not to ensure results, but to adopt or direct the adoption of policies, procedures, and controls that are designed to assure the safe and sound management of the bank, and monitor management. That is different from guaranteeing the result.

The instructions do not state that a bank director may rely reasonably on management and others. But that is a principle adopted in every state law that addresses corporate director responsibilities and liabilities.

The overuse of CMPs is not in the public interest

AABD’s final report will be more detailed in addressing what it considers the overuse of CMPs and the need for reform.

We are concerned with the use of CMPs, sometimes in very large amounts, where the bank had acted in good faith, had adopted reasonable systems and controls, and could not have reasonably foreseen that a violation or misconduct would have occurred.

“Good faith” should be the most important factor in evaluating whether to impose a penalty and the amount of the penalty. Yet “good faith,” severely underweighted in the rescinded matrix, is further diminished in the new matrices.

If a bank and its board acted in good faith, they normally should not be penalized; all that the agency would need to do is to inform them of their mistakes, direct that they promptly correct them, and determine whether they have corrected them. The purposes set forth by the OCC for CMPs – deterrence and encouraging correction – are thereby served by a more efficient and less costly solution.

This is called “moral suasion.” Because banks are routinely examined, the agency can effectuate corrective action promptly without needing to resort to a time-consuming and onerous enforcement process for both the agency and the target institution or individual.

“Moral suasion” has been used by the banking agencies long before they had CMP authority. For many years, it worked well. It still works well.

The use of CMPs for infractions that are not foreseeable serves no public interest. Banking law is chock full of provisions that are subject to interpretation. “Unsafe or unsound,” “unfair, deceptive, or abusive,” “suspicious” – these are examples of language, absent specific regulations defining the terms, upon which agencies have relied to impose CMPs. Matrices need to avoid producing a result that is inappropriate.

AABD is in favor of the adoption and use of CMP matrices. They are essential to guiding the agency to appropriately use its broad authority to impose penalties. The agencies have immense powers to impose penalties under very broad powers authorized by Congress. The next AABD report on CMP matrices will detail how arduous it is for those who are under a demand to agree to a CMP to fight it out in court. That makes it even more important that the agencies show self-restraint and not penalize or over-penalize unless fully justified.

Matrices should be drafted in a manner that will employ penalties equitably and only when necessary to deter those who acted improperly. The OCC’s matrices need more work to achieve these objectives.

Copyright © 2016

American Association of Bank Directors