“Dos” and “Don’ts” When Facing a Regulatory Enforcement Action
Michael C. O’Brien
"Dos" and "Don'ts"
When Facing a Regulatory Enforcement Action
As seen in the Utah Banker journal, issue ----, published by the Utah Bankers Association in cooperation with the Media Communications Group.
by
Michael C. O'Brien
Van Cott, Bagley, Cornwall & McCarthy
The recent economic recession and financial crisis has resulted in a significant increase in regulatory enforcement actions by state and federal banking regulators against FDIC-insured institutions. For example, a search of the FDIC's enforcement database shows that Cease & Desist (C&D) Orders issued by the FDIC have risen from approximately 45 in calendar-year 2006, to 78 in calendar-year 2007, to 142 in calendar-year 2008, to 219 for the first eight months of 2009. When we note that some enforcement actions, such as a Memorandum of Understanding (MOU), are not publicly disclosed, we can see that an institution's chance of facing an enforcement action has increased as much as 1,000% over the past few years.
For many Utah banks, the primary culprit is often losses resulting from write-downs and charge-offs in their loan portfolios, as well as significant increases in the allowance for loan losses, which themselves are simply the consequence of the local and national downturn in real estate assets. Almost all bankers, with the benefit of 20/20 hindsight, would have made fewer acquisition-and-development loans and implemented stricter underwriting for most types of credit earlier in the economic cycle. The challenge, of course, is handling an enforcement matter with the balance sheet that you have - not that you wished you had.
Each credit cycle brings its own unique set of circumstances. There are certain constants as well. With that in mind, the following list comprises some "dos" and "don'ts" for officers and directors of institutions in the unlucky position of having to deal with an enforcement action by their federal and/or state regulators.
1. Don't Panic. The threat of a regulatory enforcement action and related tools, such as civil money penalties and prohibition orders, is the "big stick" carried by each banking regulator. It therefore serves a purpose whether it is used or not. Good bankers will address any problems with their institution in pretty much the same way regardless of whether they are acting under an enforcement order or not. So, although the publicity or enhanced regulatory reporting that comes with an enforcement action is unpleasant, bankers should remember that the core problems at issue would have to be addressed anyway. The substance of the situation does not change because it is accompanied by an enforcement action. Seasoned bankers will therefore stay cool during the process and act accordingly.
2. Don't Treat the Enforcement Action Like Ordinary Litigation. A rare but potentially serious mistake is to see and treat an enforcement action like ordinary litigation, sometimes upon the advice of attorney who has much experience with litigation but little experience with financial regulation. The differences between an ordinary plaintiff in litigation and a regulator such as the FDIC are immense. An ordinary plaintiff bears the burden of proof, while the FDIC's actions are presumed by the courts to be reasonable and entitled to deference. Thus, the bank has the burden to prove its case against the FDIC. An ordinary plaintiff is subject to the Rules of Civil Procedure and the slow-turning wheels of justice; it can be months before the bank has to really do anything in response to a complaint filed in court. The FDIC and other regulators have special rights granted by statute to protect depositors. The deck is stacked in their favor. While a banker can and should disagree with the regulator's initial conclusions if there is a reasonable basis for disagreement and the banker in fact disagrees, an informal approach that treats the regulator as business partner, as opposed to adversary, is almost always the better approach to start.
3. Do Manage the Process Deliberately. As soon as executive management becomes aware that the regulator is considering an enforcement action, the bank should put a plan in place to manage the process. An internal point of contact should be identified. Customary candidates include the bank President, the Chairman if different, or another director. The bank's chief compliance officer is sometimes considered to be the appropriate contact person. In particularly contentious situations, the bank may want outside counsel to handle formal correspondence. With respect to the substance of the plan, the bank should consider the possibility of avoiding any enforcement action, the ability to negotiate a private MOU instead of a public C&D, and the particular terms of the order. Many issues are negotiable, as with a commercial transaction. The key is to be proactive, as opposed to reactive.
4. Do Consider Your Capital Options. The root of many current problems for Utah banks is simply loan losses and the resulting hit to the bank's capital position. Raising new capital is therefore essential and, indeed, the core directive of many enforcement actions. Executives must consider (i) if existing shareholders will contribute more capital or if new investors are needed, (ii) whether common stock, preferred stock, or subordinated or other debt is the appropriate instrument for the most efficient capital raise, (iii) whether the bank or any holding company is the appropriate issuer, and (iv) how the issuer is going to comply with federal and state securities laws.
5. Do Act with the End in Mind. The goal of every bank facing an enforcement action should be the same: Get the problems resolved and avoid the action if possible, or, in the alternative, have the action terminated and any restrictions lifted as soon as practicable. Management should plan the steps that must occur to achieve the realistic and desired result. If an enforcement action is inevitable, plan a realistic timeline (often nine to 18 months) to resolve the problems and have the order or MOU terminated. Based on historical statistics, the vast majority of enforcement actions are terminated in due course with the bank emerging stronger than at the inception of the action. Although this credit cycle has been particularly harsh, there is reason to believe that historical patterns will continue, which is good news for Utah banks.
Michael C. O'Brien is an attorney and shareholder with Van Cott, Bagley, Cornwall & McCarthy and a member of its Financial Services practice group. He has advised banks, holding companies, officers and directors in a host of banking matters before federal and state regulators. The foregoing is presented for information purposes only and should not be considered as legal advice.
Copyright 2010. Published for general informational purposes only, and should not be construed as legal advice. If you need legal advice please consult with your attorney.