THE OCC HAS SPOKEN: Unsafe or Unsound Banking Practices

By Philip Chiaviello, Attorney at Law

For more than 30 years, our federal appellate courts have applied conflicting definitions of unsafe or unsound banking practice in the context of regulatory enforcement. With a recent decision from the Office of the Comptroller of the Currency, the definition should be clear; at least as far as the federal regulators are concerned.

Patrick Adams was the President, CEO, and director of T Bank of Dallas, Texas (“Bank”) until he resigned in 2010. From December 2005 until August 2007, T Bank maintained an account relationship with Giact Systems, Inc. (“Giact”), a third-party processor, and approximately 60 merchant retail businesses for which Giact processed payments. Giact used a remotely created checks (“RCCs”) payment system to facilitate the transfer of funds from customer accounts to the merchant accounts for goods and services sold over the internet and by mail order. Although T Bank earned approximately $1.9 million in income through the processing of RCCs it ultimately paid out approximately $2.8 million in restitution pursuant to a Formal Agreement with the OCC.

Charges Against Adams

In September 2011, the OCC filed a Notice of Charges against Adams alleging he engaged in unsafe or unsound practices by failing to, among other things, ensure the Bank performed due diligence in opening accounts for the merchants and by failing to have adequate policies and procedures to deal with customer complaints. The OCC sought a cease-and-desist order and a $100,000.00 civil penalty. The case went to trial in February 2012 before an administrative law judge (“ALJ”) and in November, the judge recommended dismissal of the action. As expected, enforcement counsel for the OCC filed exceptions and the judge’s recommended decision went before the OCC Board of Directors for a final decision.

On September 30, 2014, the OCC issued its Final Decision terminating the enforcement action against Adams.[1] One would think that, in terminating the enforcement action, the OCC affirmed the ALJ. Not so. In this unusual decision the OCC adopted most of Enforcement Counsel’s arguments and disagreed with the ALJ. After expressly stating it was not making any findings of fact, the OCC stated throughout the 68 page Decision that a trier of fact could conclude Mr. Adams’ conduct was unsafe or unsound.

The OCC used this case as an opportunity to set the record straight on its definition of Unsafe or Unsound banking practice. Although the OCC adopted Enforcement Counsel’s arguments and disagreed with the ALJ it terminated the enforcement action without a reason as to why. One can only speculate why the OCC did not continue the enforcement action. This author believes the OCC may have wanted to express its views without leaving the door open for an appeal to the circuit court. 

The OCC’s Decision

The Comptroller of the Currency, Thomas J. Curry, a former FDIC Director and current Chairman of the Federal Financial Institutions’ Examination Council, reaffirmed the OCC’s interpretation of the phrase “unsafe or unsound practice” within the meaning of the enforcement provisions of the Federal Deposit Insurance Act (“FDI Act”). Interestingly, the FDI Act contains no definition of the phrase. The definition adopted by the OCC and other Federal banking agencies derives from material provided to Congress in 1966 by John E. Horne, then Chairman of the Federal Home Loan Bank Board. Chairman Horne described the term as:

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.

The OCC and the Federal banking agencies have consistently relied on the definition provided by Chairman Horne when bringing enforcement actions. The courts, however, have not uniformly applied this definition and thus have created some confusion within the industry. Some appellate courts have applied a more restrictive definition than Horne. The ALJ in the Adams case followed the decisions that applied the more restrictive definition that defined “unsafe or unsound practices” as:

conduct that, at the time it was engaged in, was contrary to generally accepted standards of prudent operation (that is, it constituted an imprudent act), the possible consequences of which, if continued, created an abnormal risk or loss or damage to the financial stability of the Bank.

Comptroller Curry rejected this definition and, in doing so, removed an often-used defense from future enforcement actions. Banks can no longer successfully argue that the alleged conduct is not subject to enforcement because the conduct did not create an abnormal risk to the bank’s financial stability. In the past banks argued that since the institution was financially sound the alleged imprudent conduct was not actionable because it posed no risk to financial stability.

Conclusion

Although this decision comes from the OCC it will impact all federally insured financial institutions that face enforcement actions. It will be interesting to see if the OCC’s decision is the last word on the definition of “unsafe or unsound practice” or, if the issue will be addressed in future cases before circuit courts of appeal or possibly the United States Supreme Court. Until then it is best practice to heed the OCC’s definition and avoid conduct that would be abnormal risk, loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.


[1] For a copy of the decision see: http://montanabankinglawyer.com/uploads/3/4/0/1/3401471/padamsfinaldecision093014.pdf In The Matter of Patrick Adams, OCC AA-EC-11-50.

Philip S. Chiaviello is an attorney in Livingston, Montana practicing banking, litigation, and regulatory law.  He recently completed a 3½ year appointment as counsel to the FDIC in Chicago and Washington, DC.  Prior to joining the FDIC, Mr. Chiaviello was a litigator in Chicago since 1983 where he represented a broad variety of commercial and business clients.  Mr. Chiaviello has dedicated his current law practice to serving Montana community banks.  You may reach him at PhilipC672@aol.com or visit his web site, www.montanabankinglawyer.com.

 

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