Banking Law -- Aug 26, 2013

by Manatt, Phelps & Phillips, LLP

In This Issue:

What Many Foreign Banks and Community Banks Have in Common

Author: T. J. Grasmick

This article was previously published in Bank News.

Strange as it may seem, community banks and the U.S. operations of foreign banks are often treated similarly; their interests are usually legislative and regulatory afterthoughts. Stated differently, the uncertainty that arises with new legislation or regulation forces these banks to mark time for years because their special interests are ignored. If the legislators and regulators had given first consideration to what was not broken in the resultant financial crisis over the last five years without the need for a sweeping Dodd-Frank law, traditional foreign and community bank lending might have better supported the struggling economy when it most needed it.

As an example, some may recall the eight-year lag after Gramm-Leach-Bliley before new Regulation R resolved the uncertainty endured by community banks as to whether they would be permitted to offer certain securities and trust-related services, as they had for decades, or whether those activities would have to be pushed out into a securities affiliate — which many community banks did not have and simply could not afford to establish or operate.

Playing the Wait-and-See Game

With the issuance by the federal banking agencies of their final rules to implement Basel III in the United States, community banks now will finally have certainty on how the 2010 Dodd-Frank capital directives will affect them. Community banks will not have increased risk-weightings if they elect to make traditional “qualified mortgages.” However, smaller banks with stretched staff must now bear increased underwriting costs if they wish to invest in mortgage securities because they may no longer rely on the credit agencies. Many community banks can now also continue the transition from including trust preferred securities in their capital ratio calculations as originally mandated by Dodd-Frank.

Meanwhile, many foreign bank operations in the United States (whether through agencies and branches or in smaller U.S. subsidiary banks), which predominantly engage in commercial lending and trade finance, and not complex trading, derivative or broker-dealer affiliate activities, still await the outcome of the Federal Reserve’s proposed rule to impose new U.S. capital and liquidity “ring fence” requirements that are aimed at the several mega-international banks that were at the epicenter of the recent financial crisis.

New Legislation and Regulations Always Trickle Down

Common to the legacy of most foreign bank and community bank legislation and regulations are exemptions (such as those for banks with less than $500 million or $10 billion assets) usually conceded after trade associations make a case for their constituencies. However, politically negotiated safe harbors in response to lobbying cries of overreaching are then commonly followed by predictions that what has been dictated by the problem-solvers for the large problem-causers will eventually trickle down as new expected best-practice standards. For community banks, the most notorious example is stress testing. While not officially required, stress testing is now expected by regulators in some form at all banks. And, while some say it is unrelated, the establishment of the Consumer Financial Protection Bureau seemed to be immediately followed by more thorough and aggressive examinations of banks for fair lending and other consumer laws compliance by the federal banking agencies as the industry awaited CFPB pronouncements and enforcement actions at larger banks.

Foreign Banks Are Community Lenders, Too

Few of the many foreign bank U.S. operations present the potential systemic threat that prompted to the Fed’s foreign bank proposal earlier this year. Most foreign bank U.S. operations are not significant players with respect to funding, liquidity, derivatives, proprietary trading and counterparty limits; instead, most foreign banks follow their home country customers to the United States and provide trade financing and/or are smaller players in participations and syndicated loans to U.S. commercial borrowers. Several foreign banks’ principal U.S. activity is to own a subsidiary community bank that caters to a local ethnic culture. These foreign banks may or may not have an intermediary U.S. bank holding company which, although looked to by the Fed as a source of strength for its insured U.S. subsidiary bank, commonly are little more than a non-operating company with the subsidiary bank as its principal non-cash asset.

Ring-Fencing Foreign Banks Could Have Unintended Consequences

The rush to ring-fence foreign bank U.S. operations is reminiscent of the early regional barriers to interstate banking and the subsequent opt-in/opt-out era that unnecessarily stunted the growth and efficiencies obtained from the consolidation of banking across state lines, which is now widely accepted and more-than-adequately supervised under the current regulatory structure. Requiring foreign banks with only modest and generally core banking operations in their U.S. agencies and branches or subsidiary banks to boost the capital and liquidity to be kept onshore cannot be expected to have any material effect on diluting the international and potential systemic risks that concerned the Fed.

Frequently, many of these foreign banks have or exercise little or no U.S. deposit-taking authority or discount window borrowing. Thus, they do not or simply cannot pose a significant threat of draining funds from the U.S. market to prop up their parent’s non-U.S. operations in times of crisis. Imposing new formulaic regulatory requirements on many modest foreign bank U.S. operations could result in the departure of a number of foreign banks from the U.S. market. This is akin to the projected involuntary consolidation of community banks by mergers and acquisitions in the aftermath of the costly implementation of Dodd-Frank.

Leave Community Banks With Adequate Capital Alone

Similarly, few community banks trade derivatives or have private equity fund investments, which are the target of the still uncertain Volcker rule, and most already have way more capital than may be required after filtering through all of the tier, leverage, buffer, supplemental and countercyclical new capital jargon. Community banks would generally best be left alone by politicians and regulators to tend to the risks they historically have managed well — serving their communities’ lending needs and generating earnings to satisfy the expectations of their often local shareholder bases.

Will Next Time Be Different?

It would be a refreshing change the next time Congress feels the urge to jerry-rig the U.S. financial industry if the interests of traditional community bank and modest foreign bank operations could be given early assurances by politicians and regulators that they could continue their banking business as they had before without the fear and indefinite uncertainty that enormous sea changes in laws, regulations or international accords may well wash over them directly or trickle down on them sooner or later.

T. J. Grasmick is a partner with the law firm Manatt, Phelps & Phillips LLP in Los Angeles.

Prosecutors Getting Tougher on Bankers

Author: Harold P. Reichwald

This article was previously published in the ABA Banking Journal.

The recent indictments of the founder and chairman of Premier Bank of Wilmette, Ill., together with his wife, who was an officer of the bank, and two directors, and last week’s indictment of three insiders of Coastal Community Bank in Panama City, Fla., including the bank’s counsel, seemed to hark back to the savings & loan bank fraud prosecutions in the early 1990s.

They come almost three years after the FDIC Inspector General publicly announced that the agency had opened 50 criminal investigations into the circumstances surrounding the failure of banks caused by the financial collapse that began in 2008 and which frequently was the result of heavy construction lending activity.

However, since that time, there have been few criminal prosecutions, nowhere near the number of civil suits FDIC has brought or settled against former directors and officers of failed banks alleging negligence, gross negligence, and breach of fiduciary duties.

Criminal cases harder for government

Criminal prosecution has always been in the government’s arsenal in connection with financial institution matters. However, since the government must prove criminal charges beyond a reasonable doubt, such investigations are often lengthy and more frequently than not the government declines to proceed.

In addition, FDIC has rarely used its power to seek civil monetary penalties and bar orders against individual directors and officers.

At the end of the day, the primary focus of FDIC has been and continues to be seeking civil recovery for losses to the insurance fund alleged to have resulted from bank failures, which usually means going after D&O insurance coverage where possible.

Delving into new cases

The Premier Bank and Coastal Community Bank prosecutions are therefore instructive as rare recent examples where the government has sought criminal sanctions for director and officer misconduct.

In the Premier Bank case, the Office of the Special Inspector General for the Troubled Assets Relief Program (SIGTARP) stepped in to provide some prosecutorial muscle in pushing criminal prosecutions because the bank received TARP funds. SIGTARP has drawn upon retired FBI agents and postal investigators, and other investigatory resources, and works with a variety of federal and state prosecutors to bring cases. SIGTARP did the underlying investigation and then turned to the Attorney General of Illinois to actually seek the indictment of the individuals and prosecute the defendants. While the FDIC’s Inspector General participated in the investigation, it does not appear that the Department of Justice played any significant role.

In the Coastal Community Bank case, it appears that FDIC referred the matter to the Department of Justice and the indictment arose from a grand jury presentation by the U.S. Attorney.

A close examination of the allegations of the two indictments should not raise alarms in most bank boardrooms. That’s because the facts alleged are quite egregious and likely would astonish most people, even experienced bankers who may see all types of peculiar behavior in the course of a typical banking day.

The Premier Bank indictment accuses the defendants of conducting a “criminal enterprise” to defraud the U.S. Government’s TARP program. Among the alleged scandalous conduct, the defendants are accused of shaking down potential borrowers for personal gain, using bank funds for personal benefit, and lending money to borrowers to buy out failing projects of other borrowers so as to hide the true condition of the bank’s loan portfolio and the bank’s true financial condition.

In the Coastal Community Bank case, the indicted insiders allegedly defrauded the U.S. Government’s Temporary Liquidity Guarantee Program or TLGP, which was created in 2008 to encourage bank lending using a federal guarantee to backstop the loan. The defendants allegedly attempted to avoid foreclosure on their stockholdings in Coastal by another lender by fraudulently arranging for a TLGP guaranteed loan to repay the original loan.

Allegations of insider abuse—using bank resources or power for personal gain—has always been the subject of regulatory scrutiny and was a major factor in the criminal cases brought as a result of the S&L crisis in the late 1980s and early 1990s. The FDIC and other bank regulatory agencies most often have used the power conferred by the Federal Deposit Insurance Act in seeking monetary damages, restitution, asset freezes, civil money penalties, and removal and prohibition orders.

Perspective on the cases

Over the years, cases of egregious insider abuse have been addressed most often through a combination of one or more of these procedural tools. However, these cases take time to wend their way through the administrative adjudication process and the use of criminal statutes, as in the Premier Bank case, makes this an attractive alternative, especially when an institution like SIGTARP can be the investigating agency.

These two indictments make it very clear that using an FDIC-insured bank, and the availability of federal programs offered to banks, for personal gain ultimately attracts a federal investigation and in the most egregious cases criminal prosecution of the insiders involved. As far as the FDIC is concerned, it is always on the lookout for situations with which they can make an example for the financial community.

These two cases fit that bill very nicely.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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