Bank Lawyer's Blog

From The Mailbag: Gripes About The OCC

An interested reader emailed me and offered a couple of thoughts about the United Western Bank/OCC litigation that was the subject of last night's post. First, he focused on the fact that the OCC's "statement of facts" (which the plaintiff has moved to strike) makes much of the fact that the bank "voluntarily" stipulated to the entry of a Cease and Desist Order against the bank, and that the stipulation contains "findings of fact" that concluded that the bank engaged in unsafe and unsound practices and violations of law. My correspondent found that disingenuous, inasmuch as the third recital to the stipulation provides that the bank does not admit or deny any statements or conclusions in the C&D other than two that relate to jurisdiction. This is typical of many consent orders entered into with the federal banking agencies. The bank does not agree that the stipulations of fact or the conclusions drafted by the OCC are correct. My correspondent thinks that the OCC is attempting to construe such "voluntary consent" into a consent that conditions exist that justify the appointment of a receiver. If so, that will have a negative impact on the willingness of banks to sign such agreements in the future.

I agree that there apears to be an attempt to use the bank's consent to the entry of the C&D as an argument that the facts and conclusions contained in the order, such as that the bank is in an unsafe and unsound condition, are somehow "true" and incontestable. I doubt whether that suggestion will have an impact on the judge. As to the willingness of banks to sign such stipulations in the future, it's too early to tell. However, a few more banks in the future might be inclined to fight a C&D rather than stipulate. As my correspondent also wryly observes, if Maxine Waters has her way, the era of consent orders may be coming to an end in any event. If that's the case, the administrative law judges are going to be awfully busy.

My correspondent also opined that the OCC's motion displays a clear bias against private equity investors. Although he didn't clarify the specific provisions of the motion that supported this contention, I assume they were the provisions that discussed the OCC's rejection of the conditions precedent imposed by the potential investors, including the waiver of certain restrictions of the C&D and other "unacceptable supervisory concessions." To me, this bias has been obvious in not only the OCC, but in the FDIC and the FRB, for the last several years. We've discussed this issue previously. The requests for supervisory concessions were normal (and sane) protections that any knowledgeable private equity group would impose before they infused hundreds of millions of dollars into a bank that had "issues."

PE legend Wilbur Ross told the American Banker last week (paid subscription required) that he's had it with the "Big Three." He's now focused on investing in European banks. From my discussions with private equity investors recently, others are following his lead overseas, even to Eastern Europe. It's a heck of a state of affairs when the Ukraine looks rosier than Utah, but there you have it.

United Western: The OCC Responds

Over the weekend, I had a chance to read the opposing motions for summary judgment filed by United Western Bank and the OCC in the lawsuit filed by the bank to overturn the order of the Acting Director of the OTS to place the bank into an FDIC receivership in 2011. Late last week, the bank filed a motion to strike the OCC's entire statement of facts on the grounds that it was a back-door attempt to circumvent local rules on the length of pleadings in this particular type of case. However, I'm basing my personal bloviations on the entire motion and accompanying statement of facts filed by the OCC.

In my comments on the plaintiff's motion, I stated that I thought that the OCC would have to rebut the facts as alleged by the plaintiffs in some detail , not merely focus on the high bar the law sets to overturn the decision of the OTS. The OCC did that, although we'll see what happens to those "facts" when the judge rules on the plaintiff's motion to strike. Regardless, the judge has access to the entire administrative record and isn't bound by a party's selective inclusions, omissions, and spin. Unfortunately, at this stage, I am.

Given my personal experiences in dealing with the OTS, the FDIC, the FRB, and the OCC over the past five years, and with the OTS in connection with a strikingly similar situation ten years ago, I believe the plaintiff's allegations that there were no serious criticisms of the bank's business plan, which involved a focus on institutional deposits as a major source of low-cost funding that the bank used to invest in mortgage backed securities and other mortgage-related assets, until the economy slowed and then crashed. Although earlier reports of examination (ROEs) may have mentioned the liquidity risk posed by a concentration on such funding sources, I suspect that the ROEs also stated that the bank was aware of and adequately managing that risk. It wasn't until the economy tanked that the senior management and directors of the bank transformed themselves, in the eyes of the OTS, from geniuses to cud-chewing bovines. At that time, the business plan suddenly made no sense, was unsafe and unsound, and had to be changed as quickly as possible in the face of the worst recession since the 1930s. While the bank's management and board was trying to steer the bank in a new direction, you can't turn an aircraft carrier as quickly as you can a cigarette boat, especially when the current is flowing strongly against you and icebergs are bearing down from the windward side.

Of course, that wasn't the concern of the OTS. It's concern was the fact that the bank's risk profile had suddenly turned unfavorable because of outside circumstances, and that if it failed, the OTS supervisory personnel responsible for overseeing the bank might be criticized by the Office of the Inspector General of the FDIC for not acting forcefully enough, early enough. Bureaucratic butt-covering trumped all other considerations. From then on, the OTS made sure that it didn't cut the bank any slack. That attitude led to aggressive mandated writedowns in the value of securities and other real estate-related assets, increases to reserves, and hits to capital.

I also accept the plaintiff's allegation that the OTS decided long before the bank actually failed that it was doomed, but allowed the bank's management to go through a Chinese fire drill of ultimately fruitless capital-raising and liquidity-stabilizing efforts in order to give the ultimate dropping of the hammer on the bank's head a patina of inevitability. Although it's not alleged in any of the pleadings, and I have no information from outside sources, I suspect that the OTS personnel with decision-making authority may have decided that they simply didn't "like" the ownership and senior management of the bank, didn't want them in "the business" any longer, and weren't going to approve any recapitalization plan that involved any concessions on the part of the OTS (such as waiving certain conditions of the Cease and Desist Order and agreeing to a non-standard holding company guarantee). I think that if it had desired to do so, the OTS could have worked with the bank to structure a recapitalization plan, including certain waivers of the C&D's terms, but chose not to do so for reasons that may not be expressly revealed by the administrative record.

Even if the above assumptions and outright speculations might be correct, the problem for the plaintiff is that, ultimately, all the OTS has to show in order to prevail is that there was a rational basis for the Acting Director's determination that one of the following three grounds existed for the appointment of a receiver: (1) the bank was in an unsafe and unsound condition to transact business; (2) the bank was likely to be unable to pay its obligations or meet its depositors' demands in the normal course of business; or (3) the bank was undercapitalized and failed to submit a capital restoration plan that was acceptable to the OTS. The court must defer to the opinion of the Acting Director of the OTS on these matters unless the court determines, based solely on the administrative record, that the decisions of the Acting Director were arbitrary or capricious or lacked any rational basis. The plaintiff must overcome the presumption that the decisions of the director were not arbitrary or capricious by a preponderance of the evidence, again as reflected solely in the administrative record. As I've observed previously, this a high hurdle for a plaintiff to jump and is one important reason that few such lawsuits are brought.

All three grounds for the appointment of the FDIC as receiver seem to hinge on the rejection by the OTS of the bank's capital restoration plan, the undercapitalized status of the bank (albeit at a 5% core capital level), and the perceived "instability" of the commitments of the remaining institutional depositors not to withdraw their funds. The OTS articulated seven grounds for the rejection of the capital plan, all of which the plaintiff alleges are without a rational basis. The OCC, on the other hand, articulates in its motion several reasons to support its decision to reject the capital plan (including, for example, disapproval of the acquisition by the bank of a securities clearing business, "excessive" planned growth of the bank, and requirements by investors that certain requirements of the Cease and Desist Order be waived by the OTS). The alleged instability of the institutional depositors is also an issue where the OCC appears to have demonstrated a rational nexus between the facts as shown in the administrative record and the Acting Director's determination that a potential "liquidity crisis" could occur in the near future due to the OTS' rejection of the capital plan. While the plaintiff argues that there was no evidence that the remaining institutional depositors were likely to withdraw their deposits in the near term, the OCC alleges that the administrative record shows that the largest depositor had given the bank until February 15, 2011 to recapitalize, following which date, if recapitalization did not occur, the depositor would withdraw its funds (in an amount which exceeded the entire liquidity of the bank, according to the OCC). 

My concern for the plaintiff's case is that while knowledgeable bankers can conclude that if the OTS was interested in working with the bank's management to reach an accommodation with outside investors that would have addressed their concerns and permitted the bank to be recapitalized and to survive, it could have done so, the OTS can articulate reasons for its decisions not to do so that are based solely on the administrative record to prevent the plaintiff from meeting its burden. This case appears to be a prime example of why it's so tough to overturn a receivership decision. You can think that the OTS made a series of bad judgments, but it's difficult to prove that those judgments were made without a rational basis.

The case is not over. Each side gets another shot at replies. Moreover, I'm not being paid to parse the nuances, so the views expressed in this post are not finely honed. However, at this point, no matter what my heart tells me, my head tells me not to bet against the OCC.

Callousness Looms Large

The ICBA's CEO, Cam Fine, isn't happy about the most recent Bank Fail Friday Bloodbath. He calls it a sad day for main street. He also discloses a portion of an email he received from someone with inside knowledge of the way the FDIC takeover team treated the employees of the Bank of Eastern Shore, the only one of the five "too-small-to-save" community banks for which the FDIC did not find a buyer. Cam thinks that the email "speaks volumes about the kind of unequal justice under law and lack of respect that ICBA speaks out against when comparing the treatment of Main Street institutions and their management and staffs with Wall Street, too-big-to-fail institutions and their managements and staffs." I'll let readers draw their own conclusions on that point.

I wish I could share Cam's sense of outrage. After 37 years of witnessing the truth of P.J. O'Rourke's maxim that "giving money and power to government is like giving whiskey and car keys to teenage boys," I'd be shocked if bureaucrats didn't act like what many (but not all) of them are: the folks the jocks in high school stuffed in their lockers and the cool crowd wouldn't talk to, finally getting their payback by using the power of a governmental position to treat others the way they'd been treated during their Wonder Years. Frankly, the only sane inmates seem to be those that escape the asylum. Many of those who become "careerists" support the astuteness of one of Dennis Prager's observations:

The larger the state, the more callous it becomes... the colder its heart. It is also true that the bigger the corporation, the more callous its heart. But unlike the state, corporations have competition and have no police powers.

On the other hand, Prager's assertion regarding corporations always being subject to competition is becoming uncomfortably questionable with respect to the big banks that the Occupy movements love to vilify. In today's Housing Wire, Christopher Whalen criticizes the Obama administration's proposed Homeowner Bill of Rights, and in the course of his critique, has some sobering words about what has become of "competition" among banks, at least with respect to the residential mortgage lending business.

The mortgage industry is comprised of a cartel of the four largest banks, which happen to be the largest loan servicers, as well as the owners of most second liens. Federal bank regulations reinforce the cartel structure of the secondary market for loans by allowing large banks to treat servicer and tax balances as core deposits.

This expanded balance sheet enables the large banks to hold equally big portfolios of mortgage servicing rights and also gives the top four banks — JPMorganChase, Bank America, Wells Fargo and Citigroup — a competitive advantage in dealing with the various federal housing agencies in the creation of mortgage-backed securities.

Thus, when a small bank wants to sell a loan into a securitization with a wrap from Fannie Mae or Freddie Mac, it typically sells the loan for as much as half the origination spread or more to one of the large banks.

The big bank then structures the RMBS that issues bonds to investors and retains the mortgage servicing rights. The large banks control the entire process, yet the Homeowner Bill of Rights does nothing to change this situation. Now you know why large banks seem to be more profitable than smaller banks.

Big government is callous, but so is big business. I think we've plenty to fear from both. Concentrating most of the mortgage business in the mitts of the Gang of Four cannot be a good thing for consumers over the long haul. Beyond the mortgage lending arena, in the banking business generally, the trend seems to be toward concentration in fewer, larger entities. To lovers of big government and big business, that's all fine and dandy, I suppose. To the rest of us, however, that trend is troubling.

Loaning To The Little Guys: A Dastardly Turn Of Events

Five years ago, when The Care Bair womanned the helm at the FDIC and was prodding banks to make payday-like loans to poor consumers, but to cap those loans at a 36 percent APR, most banks who experimented with the products were scratching their heads, trying to figure out how to make money on small loans made at those rates when the borrowers posed such a high default risk. These days, when banks of all sizes are strapped for income-yielding products and are dipping appendages bigger than than their pinky fingers into the icy waters of small loans, left-leaning propaganda rags main stream newspapers like The New York Times are aghast at how "big banks" are "preying" on "the little people."

An increasing number of the nation’s large banks — U.S. Bank, Regions Financial and Wells Fargo among them — are aggressively courting low-income customers like Mr. Wegner with alternative products that can carry high fees. They are rapidly expanding these offerings partly because the products were largely untouched by recent financial regulations, and also to recoup the billions in lost income from recent limits on debit and credit card fees.

Predictably, consumer advocates, including the chart-topping consumer band "Recess Richie and The Jackboots," are threatening to inspect these products with a bias-detecting electron microscope of political correctness to ensure that banks don't actually provide a needed service to lower-income consumers at a price that permits the bank to make a profit.

The Consumer Financial Protection Bureau, a new federal agency, said it was examining whether banks ran afoul of consumer protection laws in the marketing of these products.

[...]

“We look at alternative financial products offered by both banks and nonbanks through the same lens — what is the risk posed to consumers?” said Richard Cordray, director of the bureau. “Practices that make it hard for consumers to anticipate and avoid costly fees would be cause for concern.”

Buried in the middle of the piece is this disconcerting news for Cordray and his fellow-travelers.

Still, in an April survey of prepaid cards, Consumers Union found that some banks’ prepaid cards come with lower fees than nonbank competitors.

Wait a minute! If banks are jumping into these products and offering them at rates that are lower than those offered by non-bank predatory payday lenders, wouldn't it be logical to expect that this might eventually force the non-bank small-loan lenders to lower their prices in order to compete? Given most banks' funding advantage over most of their non-bank competitors, isn't it likely that if the banks are able to find a pricing model that allows them to expand this business while lowering existing rates and fees, this would ultimately benefit low-income consumers? Therefore, shouldn't consumer advocates, including the "We're Just Here To Help You" crowd from the KGB CFPB, think that banks entering this business is a potentially good thing for consumers? Shouldn't they encourage, rather than discourage, this trend?

Personally, I think bankers are thinking about getting into this line of business need to have thick hides, because it's a business in which the more successful you are in offering the right type of products and services to your targeted customer base, the greater your chance of being determined to be a discriminatory thug, fit only for being stretched on the rack, then drawn anhd quartered.

Mr. Wegner, the U.S. Bank customer, said that once he mentioned that he needed a bank account, an employee started selling him prepaid cards, check cashing and short-term loan options. Mr. Wegner, who makes about $1,200 a month, said that he felt like a second-tier customer.

“It was clear that I was not getting the same pitches that wealthy clients would,” he said. Since that initial visit, Mr. Wegner said he avoided the branch so he was not approached with offers. “I go through the drive-through now,” he said.

Next year, Mr. Wegner will be complaining that the bank never offers him any credit options at any price. He'll moan about having become invisible.

Mr. Wegner, wealthy clients have high incomes and substantial assets to pledge as collateral and, therefore, pose much less repayment risk to the bank. Of course they're not going to be offered products and services they won't purchase, just as you won't be offered products and services for which you do not qualify under prudent underwriting standards, the kind mandated by safety and soundness standards that are imposed upon banks by law. This is called "living in the real world."

It's obvious that there's an element of the chattering classes that desires that banks be run as public utilities that parcel out credit as mandated by politicians and bureaucrats at rates and fees deemed "fair" by government committee. Until that system's in place, banks will be damned if they do and damned if they don't.

There Is No Due Process?

Last night's post on United Western Bank generated a lot of traffic. Apparently, people are attracted by a David-versus-Goliath scenario. However, there's more to it than that.

In response to an earlier post on the attempt to give bankers a right to an "effective" appeal of examination decisions, one of the principal owners of a financial institution that failed during this latest crisis sent me an email that seems appropriate to post at this time. Obviously, this is only this individual's point of view, and the other "players" in the drama would likely disagree. However, his viewpoint is so well expressed, that I've decided to present it. I've changed some information to protect this individual from identification and retaliation (not that a federal regulatory agency would even THINK of EVER doing such a thing, of course). Other community bank owners, directors, and senior officers can share his pain.

It is my understanding that the processes you describe as set out in the Financial Institutions Examination Fairness & Reform Act have been  available to banks (at least [Bank Regulator] banks) for some time.  However, the ombudsman was more like a retired diplomat (for Monaco not Russia), rather than an informed, empowered decision maker.   And the administrative law judge is difficult to access (& triggers a severe adversarial breach in the relationship with the regulator), & the point at which it can be considered is too late in the process.

All of this discussion about oversight & review of due process presumes that the regulators basically know what they are doing, & exercise their regulatory authority in an appropriate manner.  The Office of Inspector General’s material loss review of the [Bank Regulator]’s handling of [The Bank] looked at the process the regulators went through & reviewed their narratives & calculations, but they never evaluated the validity of their loan evaluations nor whether the assumptions underpinning the subsequent reserve calculations could be substantiated.

So what recourse is there in the event the regulators don’t know what they are doing, or that they exercise malfeasance in their examination process?  At [The Bank] we had a complicated operation with large mortgage banking cash flow swings, complex servicing valuation issues, & large commercial real estate credits.  The field regulators were much more accustomed & qualified to review simple consumer credits.   Perhaps there were people up the chain of command at [The Bank Regulator] that could have weighed in in a more informed way, but they were embroiled in a political life & death struggle for their own survival & couldn’t be bothered to waste their time overseeing the destruction of a community bank.

[The Bank] was well capitalized [(Actual Precentage Omitted)] prior to the [Bank Regultor's] final examination in [Date Omitted].  They forced us to make a massive unsubstantiated addition to the bank’s loan loss reserve that immediately put us into a severely undercapitalized position.  And as you know we were extinguished within [A Short Period Of Time].  Now [A Number Of] years later we can look back & start to assess whether we, or the [Bank Regulator], was “right” in calculating the appropriate reserves.  If the books could ever be opened up & revealed in the bright light of day, the world would see that the [Bank Regulator]’s calculations were in fact totally wrong.  [The Bank]’s original reserve calculations very closely mirrored how the bank’s loans have actually performed (or not performed & subsequently liquidated).  Certainly, in these unprecedented market conditions, we didn’t dispute the need for added capital.  The question is, was it best for the FDIC, the depositors & the bank’s customers for the bank to be shuttered, or for it to work through its problems.  An informed & empowered ombudsman might have looked at the bank’s overall loan quality (delinquency rates: commercial RE0; consumer loans < 1%, etc.); profitability of the bank (earnings before reserves were about $[Substantial Dollar Amount] in [The Year Before The Bank Failed]; & history of operating in our market niche ([Many, Many] years), & decide that there should be an impartial, 3^rd party validation of the field examiner’s loan loss calculations before they pronounce the death sentence.

Instead, the government stole our life’s work, & destroyed an important community bank for the state [Where The Bank Was Located].  [The Acquirer From The FDIC] was able to swoop in & flip the bank in a [Relatively Short Peroid Of] time & walk away with a gain in excess of $[A Boatload].  This outcome is market validation of the error the regulators made.

But there is no due process, & this case will never see the light of day.  However, I don’t think this circumstance is unique to [The Bank].  If you look at the profile of the banks that have been put into receivership by the regulators in this cycle there appears, to me, to be a clear bias against private, closely held community banks.  Do the regulatory bureaucrats, with their mid-tier government pay scales secretly begrudge the entrepreneurs that run many community banks?  It bears closer examination, because the results of their bias will clandestinely define the future of the financial services industry & how communities & consumers are served.

As I said, that's one person's point of view. Each reader can decide for himself or herself where they stand on the primary causes of the community bank failures that have occurred thus far in the current cycle. Nevertheless, the foregoing illustrates why so many community bankers are following the United Western Bank litigation with much more than tepid interest.

United Western Makes Its Case

Last Friday, United Western Bank filed a motion for summary judgment against the OCC (as successor to the OTS), asking the federal district court to order the OCC to give the bank back to its rightful owners: the company that owned it immediately before the OTS placed it into an FDIC receivership in January of last year. We've been following this case since it was filed, and the latest motion contains a clear statement of the plaintiff's arguments as to why it believes that the decision of the OTS to seize of the thrift was "arbitrary, capricious, an abuse of discretion, and otherwise not in accordance with law."

Robert Barba, writing in yesterday's American Banker (paid subscription required), does a nice job of summarizing those arguments in much less than the fifty-seven pages that comprise the motion, although the full motion is worth the time it takes to read it. Among those allegations is that over six months prior to seizing the bank, the OTS had made up its mind to seize the bank and, therefore, all subsequent action and inaction by the OTS was designed to further this foregone conclusion.

"Though the bank did not know it at the time, the OTS had already determined as of June 2010 to seize the bank," the filing said. "Documents initially withheld by defendants but later obtained in court-ordered discovery revealed the true picture: by June, the OTS had begun writing the memorandum to justify the seizure and was already in discussions with the FDIC over how to handle an 'orderly resolution'."

The OTS, OCC, and FDIC fought tooth-and-nail to prevent the bank from gaining access to a raft of interagency documentation. The judge was insistent that they produce it and they eventually did (not wanting to be found in contempt). Although much of it is subject to protective orders, so that the rest of us can't see first-hand how the regulators made their decision to seize the bank, enough of the details are evident from the narrative contained in the motion to understand why the OTS never wanted its internal discussions and its discussions with other regulators to see the light of day. There are a number of "WTF?" moments contained in the narrative, and they might be laughable if they didn't involve the destruction of a business that had been built over the previous eighteen years, using a business model that was approved repeatedly by the OTS until the economy collapsed in the second half of 2008. Then, the entire business model suddenly sucked.

I'd encourage those interested (frankly, that should be any community banker, even those who think they've currently got the world by the tail) to read the motion from stem to stern. It's a disconcerting tale of how a business can be turned upside down overnight, not just by assets that go sour, but by a 180 degree turn in attitude by the bank's primary regulator. As I tell entrepreneurs who think they want to give the banking business a shot, there's no Chapter 11 for a bank. You don't get a "do-over" once things start going south. Moreover, once regulators at a high enough level "go negative" on you, they not only won't assist you to survive, they can occasionally actively impede your ability to survive. In this case, the plaintiff is alleging just that.

A few allegations stand out to me. One is that the bank's owner and senior management tried to address every concern raised by the regulators, often under ridiculously short time frames. That seems to be true. Also, the fact that the allegedly "unstable" deposit base hung in there through tough times bolsters the arguments of the plaintiff that the bank's business model (as far as liquidity was concerned) was a battle-tested one. Finally, the fact that the bank had proceeded so far down the path to raise capital (and appeared to be doing it successfully) in order to meet an individual capital requirement imposed by the OTS that was higher than that required of most other institutions, notwithstanding actions by the OTS that appear to have hindered that effort, bolsters the plaintiff's allegations that the OTS had "pre-determined" to seize the bank no matter what the bank did, and then threw roadblocks in the bank's way.

As Barba points out, the OCC has until May 18th to file a response, and there will be additional chances to reply by each side in June. All we've heard thus far is the plaintiff's story and until we get a chance to read the OCC's story, we won't know how much traction the plaintiff's spin might have with the court. Obviously, I represent people on the other side of the fence from the OCC (and the late OTS), and my bias is for the plaintiff. On the other hand, it ain't over until the federal judge sings (and I would never use the term "fat lady" to describe Judge Amy Berman Jackson). Therefore, we'll have to withhold final personal judgment until we see the repsonse.

As I said when I first discussed this case, "the terms 'arbitrary and capricious' and 'without any basis in law' are terms of art. They constitute the high bar over which United Western and the other plaintiffs must vault in order to triumph over the bureaucrats." I still think that's the case. However, based on the well-written motion, if there ever was a case where that burden had a chance of being met, this one is it. If the OCC's counterattack leaves the facts largely as they stand and, instead, focuses on the high bar the law sets for any plaintiff to hurdle, my personal, off-the-cuff belief is that the plaintiff has a real shot at winning (and a rare win it would be). Somehow, I don't think an argument that would consist of "Yeah, we were a pack of circus clowns, but you have to defer to us anyway" is going to be a winner.

Everyone understands that even if Judge Jackson grants the plaintiff's motion, the OCC will appeal that decision, and will never rest until its last right of appeal is exhausted. That's why battling the federal bank regualtors in court takes substantial patience, fortitude, and cash. The plaintiff appears to have all three.

Oh, yes, it also takes top-flight legal counsel. The plaintiff appears to have that base covered, as well.

Protecting Privilege From CFPB's Grasping Hands

Reed Smith's Travis Nelson recently wrote a pithy dissection of the CFPB's proposed rule to justify its argument that regulated entities be compelled to disclose to it material that is subject to attorney-client privilege. Coming on the heels of the recent FDIC "advice" that officers and directors of banks in distress, and their legal counsel, have only a limited ability, and apparently no right, to review and retain copies of records that might aid them in defending themselves against claims by the FDIC, the CFPB's proposal adds fuel to the fire of critics of federal regulatory overreaching.

The proposal is an attempt to codify the doctrine of "selective waiver."

Under the selective waiver doctrine, the disclosure of otherwise privileged materials to a party outside the attorney-client relationship (in this case the government) would not act as a waiver of applicable privileges to other third parties. Under the Proposal, the provision of documents to the CFPB that are otherwise subject to the attorney-client privilege or work product doctrine, would retain their privileged nature. In other words, the Proposal would provide that the act of producing such materials to the CFPB would not prevent the disclosing party from asserting the privilege as to other potential adversaries, including other governmental agencies. As discussed below, the Proposal raises several important concerns.

As Nelson explains, there's a slight preliminary problem with this "doctrine."

The vast majority of courts have rejected selective waiver.

Well, Travis, it's a brand new day in D.C. The forces that know what's good for the consumer even when he or she does not aren't going to be stopped, or even slowed down, by the speedbump of "judicial precedent." As long as there's a thin reed of plausibility to grasp, the CFPB is hanging on and pushing forward.

Travis takes apart the "legal reasoning" used by the CFPB to support its position.

As the primary basis for its purported authority to promulgate the Proposal, the CFPB claims that the ability to demand otherwise privileged materials from a supervised entity is part of the general examination “powers and duties” transferred from the prudential regulators.

[...]

However, the CFPB fails to recognize an argument that the ability to demand production of privileged materials without destroying the privilege may never have been a “power” of the prudential regulators that could have been transferred.

Citing the national Bank Act, Travis argues that if the OCC already had the power to compel privileged information, why was it necessary to codify that power in the Dodd-Frank Act.

It may be argued that the ability to review an institution’s privileged materials without destroying the privilege never existed prior to the FSRRA, and therefore it could not have been among the “powers” that transferred to the CFPB.

Even scarier is the position of the CFPB that the codification of the selective waiver doctrine in Dodd-Frank somehow created a new power to compel production of privileged material.

The FSRRA provides in pertinent part: “The submission by any person of any information to any Federal banking agency, State bank supervisor, or foreign banking authority for any purpose in the course of any supervisory or regulatory process of such agency, supervisor, or authority shall not be construed as waiving, destroying, or otherwise affecting any privilege such person may claim with respect to such information under Federal or State law as to any person or entity other than such agency, supervisor, or authority.” 12 U.S.C. § 1828(x)(1).

The CFPB appears to take the position that under FSRRA, an agency may demand, and the supervised entity may not refuse to provide, privileged materials.

[...]

The CFPB’s view does not appear to be supported by the plain language of the FSRRA. Rather than create a new power of the agencies, this provision only creates a layer of additional protection for the disclosing party. In other words, it does not vitiate the ability of a supervised entity to assert applicable privileges.

Obviously, you can see why those of us who represent banks are concerned. There appears to be a lack of appreciation on the part of the government for the need for banks, their officers and directors, to have "effective" legal representation. The government prefers its subjects abject and supine. I understand that. It's simply that there exist these pesky impediments called the Fifth and Sixth amendments to the US Constitution, one guaranteeing due process and the other assistance of counsel. We know they're a pain to those in power and have been for a couple of hundred years. Nevertheless, we're constitutional junkies and we simply can't kick the habit.

Nelson states that a legislative fix may be on the way. We'll see. We'll also see if November changes anything. If not, there's always the advice of former UN Secretary-General Butros Butros-Ghali: "The best way to deal with bureaucrats is with stealth and sudden violence."

Not Cancelable? Not Really

A recent story from Longmont, Colorado, contained some disturbing news about the consequences arising from last year's failure of Longmont-based (and ironically-named) First Tier Bank. No, it's not the fact that the bank's failure resulted in a developer losing the right to additional funding draws under his acquisition and development loan with the bank and the letter of credit that backed his obligation to the city to put in the top 1-1/2 inches of pavement on a residential development's streets (a condition for the City of Longmont to accept their dedication as public rights-of-way). Rather, it's the implications of this statement by the developer's CFO when the city tried to draw on the letter of credit of credit after the bank's failure and the FDIC told the city to take a hike.

"I didn't think you could cancel a letter of credit," Knirk said. "It says it's not cancelable. But they did. And we had no way of doing anything about it."

Dude, seriously? You had no idea that if a bank fails, the FDIC can reject contingent obligations such as those under a standby letter of credit?

John Podvin and Erin Burrows of Haynes & Boone wrote an article for the The Banking Law Journal a couple of years ago entitled "Revisiting The FDIC's 'Superpowers'." Reading that article could have saved the developer and the city a lot of surprise and (perhaps) frustration. As Burrows and Podvin note:

Virtually any type of contract to which the bank is a party can be repudiated, including financial instruments issued by the bank (such as loan agreements, bonds, certificates of deposits and certain letters of credit), leases, employment contracts, and employee benefits, to name just a few.

The subject matter is more complicated than that (lawyers are involved, after all), but that's a good basic starting point for any borrower or letter of credit beneficiary that is dealing with a bank that is in a potential death spiral. It's a good idea to involve knowledgeable counsel at an early stage and start looking for means to protect yourself, including securing alternative lenders. In the case of the development in Longmont, I'm guessing (because the article doesn't enlighten us) that the developer didn't have an alternative lender to which it could turn to take over the unfunded loan (and the letter of credit) obligations.

On the other hand, the city is willing to step in and finish the streets. The developer will have to find another source to fund the cost of the improvements and pay back the city or the city will slap a tax lien on the property and, eventually, foreclose on that lien, if necessary. The developer says that this alternative does have a silver lining.

[Developer Kiki] Wallace said there is one consolation. The city got better prices on the finishing work than he could have.

"Accidentally, I came out better, because the city has more purchasing power than I do," he said. "I couldn't have planned it. It's not like they go out planning to save developers money. The circumstances just dictated the situation here."

The developer assures the reporter that the last thing the developer wants to do is to "stiff the city," and that it plans to pay the city back. I hope that happens. It's always refreshing in times like these to read about a rare "lemons-to-lemonade" outcome.

I'm sure that whatever happens from hereon, both the developer and the city are going to treat letters of credit that state they are not "cancelable" with a healthy does of caution.

No Access, No How?

Yesterday's financial institution letter from the FDIC (FIL-14-2012) has raised the hackles of lawyers who represent officers and/or directors of banks that are "in distress." Last year, the FDIC got into a claymation Celebrity Deathmatch with a few law firms that, according to the FDIC, were putting the records of failing banks on a thumb drive and waltzing out the door. The firms represented the management or directors (or both) of banks that had one foot in the grave and the other on a banana peel and were trying to help their clients preserve records of the bank that would likely be useful in defending the officers and directors against later claims by the FDIC as receiver for the failed bank that the clients had breached their fiduciary duties to the bank.

One thing the FDIC loathes is giving potential sources of blood money a fair shot at mounting an effective defense. I mean, it's not as if the FDIC has enough arrows in its quiver already with which to impale the livers of its targets, including playing with house money when it comes to gambling on litigation outcomes. No, if officers and directors of failed banks have access to records that can refresh their memories of past events, they might actually be able to keep from becoming quivering masses of protoplasm when words like "negligent" and "grossly negligent" are whipped their way. It's tough to put a boot up someones posterior if they refuse to stand still and take it like a victim.

Thus, the FDIC was OUTRAGED that copies of these records, most of which, arguably, are owned by the bank (and the FDIC as receiver steps into the shoes of the bank when it fails) were falling into the hands of legal counsel for the officers and directors. Litigation ensued (some of it initiated by the accused), settlements were negotiated, and things, we thought, had quieted down. Then, suddenly, the FDIC issues a warning that it's mad as hell and not going to take it anymore. An objective observer might inquire as to what law firm most recently stepped in something unpleasant?

Regardless of the impetus for the timing of the issuance of the FIL, the immediate reaction was negative (paid subscription required).

David Baris, a Washington-based attorney who runs an association of bank directors, called the guidelines "threatening" and said if the FDIC wants to officially block access to financial institution records it should do so with a proposed rulemaking or through new federal legislation. He said most state laws "permit bank directors to access and make copies of bank records that they need to do their job or defend themselves for what they did."

"The FDIC is going about this in entirely the wrong way," said Baris, a partner at BuckleySandler LLP and executive director of the American Association of Bank Directors. "If they want to change a fundamental right of a director to have access to and copies of bank records the FDIC should either go to Congress for a law to be passed or at least go through rulemaking proceedings under the Administrative Procedures Act."

He added that despite FDIC claims that the agency will make documents available through formal agreements, it is still unclear when the agency will allow access and when it will not.

"The problem is we don't know what those 'appropriate circumstances' are, and there is no assurance — and the FDIC is not providing any assurance — that the records will in fact be available to the director," Baris said.

I understand why wholesale, batch copying of such documents as loan files and suspicious activity reports is of concern. I also understand that examination reports (ROEs) are considered "information of the agency" and need to be accorded confidential treatment. However, I share David's concern that directors of banks have rights under state law to have access to the records of the bank, and that when the directors' monthly board packets contain such items as copies ROEs, under the FDIC's position, not only can't the director retain that part of the board packet, but, applying strictly the regulations cited by the FDIC, the directors' legal counsel could not even review (much less copy) the ROE in order to advise the director with respect to its contents. I suppose a director, the attorney, or the bank could request the permission of the FDIC to permit the director's counsel to review the ROE, but what are the odds that permission will be granted? The same odds you would have given on Lehigh thumping Duke last week, right?

Directors' counsel shouldn't have to wait until a bank fails and then negotiate a confidentiality agreement with the FDIC in order to have access to documentation necessary to properly advise his or her clients, which is what the FIL appears to be requiring. If that's not the intent of the FIL, then how about explaining what the limits might be?

I have to agree with David: this matter deserves a lot more clarification.

Hat Tips

Once is a blue moon, I like to give a special shout-out to other lawyers whose work I admire, instead of simply stealing it and claiming it as my own. I realize that puts me at a competitive disadvantage versus Gen Y, but I figure what I lack in pilfered work product I can make up for in the sheer volume of hot air I vent.

The first hat tip goes to old friend Joe Lynyak, who's published a client alert entitled "Responding to Capital Directives and Related Enforcement Actions by Banking Regulators." As long as community banks continue to suffer, this topic will be current. As Joe observes, this problem isn't disappearing tomorrow.

In the past four years, the FDIC has closed approximately 400 insured institutions—as of January 1, 2012, the FDIC has indicated that there were over 800 banks on its "problem bank list." The difficulties experienced by many of these institutions are summarized in this analysis— and may provide useful guidance when attempting to resolve capital issues in the next few years.

A version of Joe's article will appear in the April issue of the Banking Law Journal.

Another bank lawyer whose work I admire is former OTS attorney Jerry Comizio. He and Amanda Jabour have written a well-reasoned critique of the arguments supporting and opposing Richard Cordray's recess appointment as Director of the CFPB. In a society suffering from perennial ADHD, this might seem like old news. However, the authors point out the "legal issues surrounding the appointment have significant implications for all institutions regulated by the CFPB." It's refreshingly free of partisan posturing, as well as any Bank-Lawyer's-Blog-like snark. I highly recommend it for those who care about the issue.

Finally, Kevin LaCroix asks the question "Is the FDIC Ramping Up Its Failed Bank Litigation"? He answers his own question and the answer is "yes." Again, this is an issue that is likely to linger, and, in fact, increase in importance over the next few years. Kevin is all over it, and if you're not already following his D&O Diary blog, you should be.