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THE ABUSE OF FEDERAL REGULATORY POWER

This article was originally published in August of 1998 by the Missouri Independent Bankers Association. The case discussed in the article was the subject of two Lead Editorials published in the Kansas City Star in March of 1998 and March of 1999. Subsequently, the action was resolved when the FDIC issued a Final Order that dismissed all charges, with prejudice, prior to the conclusion of the hearing.

The regulatory misconduct of the FDIC in the case discussed in the article was also the subject of a Special Report of the FDIC Inspector General conducted at the request of U.S. Senator Christopher S. Bond. A comprehensive analysis of the FDIC Report is detailed in a Reply to the Report of FDIC Inspector General forwarded to Senator Bond on October 3, 2001. The Reply exposes the FDIC Inspector General Report as sham cover up exercise replete with factual error and material omissions, supported only by self-serving rhetoric and twisted rationalizations. The Appendix to the Reply corroborates the Reply with supporting documents.


A New and Powerful Bank Regulatory Antidote

The bank supervision game may have a welcome new player. For the first time in the 65-year history of bank supervision by the Federal Deposit Insurance Corporation (“FDIC”), an outside government agency has asserted the authority to conduct an oversight review function regarding the manner in which the FDIC uses its regulatory and enforcement powers. In an unprecedented case involving a Missouri banker, 1 the National Ombudsman for the Small Business Regulatory and Enforcement Fairness Board has addressed a series of formal written requests to the FDIC Chairman asking that the FDIC investigate and respond to a listing of alleged regulatory misconduct and abuse. Thus far, the FDIC has refused to respond, arguing that the FDIC is exempt from the requirements of the Small Business Regulatory and Enforcement Fairness Act enacted in 1996.

In letters addressed to the FDIC Chairman in June, July, and September of 1998, the Regulatory Enforcement Fairness Board has repeatedly criticized the FDIC position, pointing out that the alleged regulatory abuses in question “raised serious questions” related to the enforcement activities of the FDIC. Specifically, the allegations of regulatory abuse included the following: (1) the suppression of exculpatory evidence by examiners, (2) instructions by senior management officials to examiners to adversely classify certain loans without regard to the actual credit quality of such assets, (3) instructions by examiners to a senior bank officer to lie to the chief executive officer of the examined bank, (4) false statements of material fact in an official written report of the FDIC to the U.S. Attorney to induce the conduct a criminal investigation of a banker targeted by FDIC management officials for administrative sanctions under section 8 of the Federal Deposit Insurance Act, (5) the utilization of the examination resources of the Office of the Comptroller of the Currency by the FDIC for an unauthorized purpose, and (6) the continued and protracted prosecution of an enforcement action notwithstanding the absence of a legitimate regulatory purpose to such action.

This article will review the circumstances that precipitated the FDIC enforcement action against Mr. Garrett, and will outline the regulatory practices and procedures employed by the FDIC in furtherance of such action which attracted the attention of the National Ombudsman of the Regulatory Enforcement Fairness Board. [Thus, it will not be the purpose of this article to examine the legal merit of the FDIC charges against Mr. Garrett. The sole focus of this article is on the practices and tactics employed by the FDIC in exercising its regulatory enforcement powers.] The asserted jurisdiction and authority of the National Ombudsman in the FDIC action against Mr. Garrett is unprecedented and has the potential to make a significant and lasting impact upon the manner in which the FDIC utilizes its enforcement powers against those financial institutions and persons subject to its supervision. 2 In the interests of clarity and ease of comprehension, the storyline of events pertaining to the FDIC enforcement action against Mr. Garrett will follow a simple chronological format.

The action against Mr. Garrett is based upon an FDIC examination of the Bank conducted in September of 1991. From the very outset, the FDIC ignored and violated its own established policies and procedures. The following “red flag” occurrences were cited by Paul Fritts, who served as the former FDIC Executive Director of Supervision and Resolutions, in a written presentation he made to the Regulatory Enforcement Fairness Board, as being in contravention of normal FDIC bank examination policies:3

(1) The timing of the 1991 examination violated FDIC policy. The Missouri Division of Finance had just completed a full-scope examination in April of 1991 and had assigned a uniform supervisory rating of “2” to the Bank. According to the published bank examination policies adopted by the FDIC, the normal examination cycle of a bank with a composite supervisory rating of “2" is between 12 and 18 months.

(2) The basis for the examination was extremely irregular. According to the testimony of the FDIC Examiner-in-Charge of the 1991 FDIC examination, the primary focus of the examination was based upon information provided by an anonymous informant. It is extremely rare for the FDIC to allocate 50% of an examination’s resources (which was done in this case) to investigate allegations made by an anonymous informant - particularly where the information had already been investigated less than six months earlier by the State in an examination which resulted in a composite supervisory rating of “2.”

(3) FDIC examiners instructed a senior officer of the Bank to lie to the chief executive officer (Mr. Garrett) regarding certain matters. Such conduct promotes deception and is contrary to FDIC policy.

(4) FDIC examiners assigned adverse classifications to certain loans involving Mr. Garrett based upon instructions received from managing FDIC officials in Kansas City without regard to the actual credit quality of such loans. The arbitrary assignment of adverse loan classifications undercuts the central purpose of the bank examination process and is contrary to well-established FDIC examination policies.

(5) FDIC examiners made a preliminary recommendation that the FDIC initiate several different types of enforcement actions against Mr. Garrett, which were summarily characterized by senior FDIC management officials as a necessary and appropriate “castration” of Mr. Garrett. 4 Such a comment demonstrated an intense personal bias against Mr. Garrett contrary to supervisory policies of FDIC.

(6) The recommendation for a civil money penalty against Mr. Garrett was made in violation of the written policy of the FDIC Division of Supervision. The recommendation was never supported by a required analysis of certain statutory and regulatory factors in aggravation and mitigation.

In addition to the foregoing incidents outlined by Mr. Fritts, there were two additional occurrences during the 1991 FDIC examination which showed bias and regulatory misconduct:

(7) Based upon a suspicion that Mr. Garrett had violated certain criminal laws, FDIC examiners conducted a special inquiry at another bank where Mr. Garrett had a personal business relationship. The sole purpose of the inquiry was to bolster a criminal referral being prepared by the FDIC by providing evidence of a possible criminal motive. None of the information obtained from the other bank was used to assess the Bank’s financial condition, or to otherwise facilitate the 1991 FDIC examination itself. Such conduct was contrary to FDIC examination policies and procedures since FDIC examiners do not have criminal law enforcement responsibilities or authority to conduct criminal investigations.

(8) FDIC examiners noted that several large deposits in Mr. Garret’s account were from the proceeds of cattle sales. The examiners knew that Mr. Garrett had pledged cattle on a loan from another bank and suspected that he had sold such cattle out of trust. At the same time this occurred, a senior field representative of the State (who had ongoing contact with the FDIC examiners during the 1991 examination) advised a senior loan officer at the other bank that there was a strong possibility the cattle pledged to secure Mr. Garrett’s loan may have been sold. Such suggestion was false and reckless. Worse, it was also a serious breach of examination policy as well as a violation of criminal law which prohibits examiners from revealing information they obtain in the examination process to other bankers.

As a result of the 1991 FDIC examination, the FDIC suspected that Mr. Garrett had engaged in dishonest activities. Virtually all of the suspected activities pertained to the construction of the Bank’s new main office facility. The FDIC suspected that Mr. Garrett had engineered an elaborate scheme to defraud the Bank of several hundred thousand dollars, and that he had engaged in other dishonest activities such as selling cattle out of trust, forging signatures on promissory notes, and making false applications for credit at other banks. After falsely informing the Bank’s board of directors in January of 1992 that the FDIC was considering the issuance of a cease and desist order against the Bank “pending consultation” with the State authority, 5 the FDIC forwarded a written report of apparent criminal conduct on Mr. Garrett in March of that year to the attention of the U.S. Attorney. The FDIC referral contained unsubstantiated statements of fact that were false, which were made to mislead and incite the interest of the U.S. Attorney to seek a criminal indictment of Mr. Garrett. The FDIC falsely stated that Mr. Garrett: (1) was responsible for a criminal defalcation of Bank funds totaling $500,000; (2) had caused the Bank to sustain a financial loss of $200,000; (3) had personally repaid five of six loans cited as being “nominee” or “straw-party” loans made for Mr. Garrett’s benefit; (4) had made a false loan application at another bank; (5) had sold collateral out of trust pledged to secure a loan at another bank; and (6) had forged the signatures on two loans made by the Bank for his benefit. Although the FDIC had determined by this time to issue an order of removal against Mr. Garrett based upon the suspected conduct outlined in the criminal referral, such action was delayed pending the outcome of the criminal investigation by the U.S. Attorney that followed.

In the meantime, the FDIC acted to facilitate its intention to remove and ban Mr. Garrett from banking permanently. In October of 1992, the FDIC “downgraded” certain State supervisory ratings of the Bank that were based upon the findings and conclusions of a State examination of the Bank. Such action by the FDIC was arbitrary and capricious. Indeed, it was openly criticized in writing by a senior management official of the State, who complained to the Missouri Commissioner of Finance that the FDIC action was “definitely slanted.” The State official accurately recognized that the FDIC had intentionally skewed the official supervisory ratings of the Bank in a self-serving effort to bolster its predetermination to issue an order of removal against Mr. Garrett.

The following month in November of 1992, the FDIC conducted another full-scope examination of the Bank for the express purpose of gathering needed evidence to support a removal action against Mr. Garrett. According to internal documents obtained from the FDIC and Missouri Division of Finance, the FDIC informed the State: (1) the FDIC intended to issue an order of a removal against Mr. Garrett; (2) FDIC lawyers had advised that there was insufficient evidence to warrant the issuance of such removal order; and (3) it was the intention of the FDIC to obtain the needed evidence at the 1992 FDIC examination of the Bank. As of November 1992, therefore, the FDIC knew it did not have sufficient evidence to support the issuance of a removal order against Mr. Garrett. The 1992 FDIC examination was conducted to obtain the needed evidence, but it was never found. According to the findings in the 1992 FDIC examination report and the testimony of the FDIC examiner who conducted that examination, no new evidence of any kind was found that would support the institution of the removal action against Mr. Garrett. That failing, however, did not deter the FDIC from abusing its power by threatening to take such action against Mr. Garrett.

After the U.S. Attorney determined there was insufficient evidence to warrant the indictment of Mr. Garrett based upon the results of a Secret Service investigation of the FDIC criminal referral, the FDIC proceeded to initiate the formal regulatory enforcement process. This was done in a letter addressed to Mr. Garrett in April of 1993 which stated that the agency had determined to institute a formal removal action against him and asking if he wanted to consent to such order. The primary basis of the proposed action was the alleged dishonest conduct of Mr. Garrett related to the construction of the new bank building. In effect, the FDIC attempted to obtain a removal order against Mr. Garrett by consent based upon the same activities contained in the criminal referral it had sent to the U.S. Attorney who had determined that such activities were not unlawful.

The threatened removal action by the FDIC in April of 1993 graphically illustrates the arrogant and abusive manner in which the FDIC utilized its regulatory enforcement authority. Even though the FDIC knew it did not have sufficient evidence to warrant a removal order if challenged in court, it nevertheless used its power to intimidate Mr. Garrett into signing a consent agreement. FDIC lawyers advised the Division of Supervision in October of 1992 that the agency did not have sufficient evidence to support a removal action. The Bank was examined the following month for the express purpose of gathering such evidence; however, none was found. The FDIC zeal to take regulatory action, however, was not to be denied. Even though the FDIC knew it did not have sufficient evidence to support a removal action, it simply resorted to “bluffing” Mr. Garrett into signing a consent agreement for such order. By any standard, such governmental action is wrong.

Mr. Garrett did not succumb to the FDIC threat and refused to sign a consent agreement for his removal. During the ensuing year, the FDIC tried a different tactic. It attempted to obtain Mr. Garrett’s consent for different types of regulatory orders which were less severe than removal, but which had a similar punitive result. It first tried to obtain a cease and desist order which would have prohibited the Bank from engaging in any type of business transaction with Mr. Garrett; it later proposed a consolidated cease and desist order against him personally coupled with a civil money penalty. None of the FDIC ploys worked. The reason was fairly simple: the FDIC never pointed to any evidence which showed that Mr. Garrett had done anything which justified the issuance of such orders against him. It was obvious the FDIC was convinced Mr. Garrett was dishonest and needed to be removed from banking; but it was equally clear that it was unable to provide any evidence which supported that conclusion.

One of the most outrageous examples of FDIC regulatory misconduct occurred in April of 1994 following a meeting that Mr. Garrett had with senior management officials of the FDIC Kansas City Regional Office to discuss the unresolved regulatory concerns of the FDIC. By this time, however, all of the regulatory focus was on a series of six small loans made by the Bank to three different borrowers over an 18-month period in 1989 and 1990. 6 The aggregate total of the loans was $137,000. Since each of the borrowers had transferred the loan proceeds to Mr. Garrett, the FDIC had concluded that the loans were “nominee” or “straw-party” loans. 7 Mr. Garrett denied the charge emphatically and explained that the loans were made so that the borrowers could repay prior debts that were owed to him. Since all of the loans in question had been paid in full without any loss to the Bank, the FDIC was asked whether any attempt had been made to trace the source of funds used to repay the six disputed loans? 8 The FDIC answered that no such effort had been made.

As one FDIC official later testified, the “light went on” with the suggestion. Immediately following the meeting with Mr. Garrett, the FDIC commenced another examination of the Bank and instructed that a special investigation be conducted to trace the source of funds used to repay the questioned loans. In order to do so, however, the FDIC needed the assistance of examiners from the Office of the Comptroller of the Currency (“OCC”), which has supervisory jurisdiction over national banks. One of the borrowers had used checks drawn on his account at a national bank to repay three of the disputed loans. The FDIC asked OCC examiners to determine if there were any deposits or other evidence which indicated that Mr. Garrett had provided the funds for such payments. 9 The OCC examiners conducted an investigation of the borrower’s account and prepared a written report which detailed the results of that inquiry. The bottom line conclusion was that there was no evidence of any kind which indicated that Mr. Garrett had provided any of the funds used by the borrower to repay any of the disputed loans. All of the evidence indicated that the named borrower used his own funds to pay the loans back to the Bank. Such findings, of course, contradicted the FDIC’s theory that the named borrower was acting as Mr. Garrett’s “nominee.” Incredibly, and contrary to normal examination results distribution procedures in the FDIC, the FDIC Kansas City Regional Office decided not to forward the results of the OCC report to supervising FDIC officials of the FDIC Division of Supervision in Washington. The suppression of the OCC report which contained clear evidence in support of Mr. Garret’s position was both inexcusable and highly prejudicial to Mr. Garrett. Such FDIC actions were culpable and in bad faith

In July of 1994 and after reviewing the results of further investigation, including the mentioned OCC report as well as the sworn affidavits of the persons alleged to be “nominees” (who reaffirmed their roles as bona fide borrowers), the FDIC notified Mr. Garrett in writing that unless he agreed to execute a consent agreement for his removal, the FDIC would issue formal charges for such an order. A draft notice of charges was actually enclosed with the letter. The FDIC had raised the art of “bluffing” to a new level. Unlike any of the prior threats to initiate enforcement actions against Mr. Garrett, the FDIC now provided a written statement of tentative charges. 10 The difference was in form only. Substantively, it was the same empty threat because the FDIC knew there was insufficient evidence of wrongdoing to support the issuance of a removal order. The FDIC lawyers had advised that the information in the 1991 FDIC examination report was insufficient to base a removal action against Mr. Garrett; the FDIC re-examined the Bank in 1992 to obtain that evidence, but no additional evidence was discovered; the State re-examined the Bank in 1993 without discovering any new evidence; and the FDIC conducted another examination of the Bank in 1994 which did not produce any new evidence, but which did result in an ancillary report from the OCC which actually supported Mr. Garrett. Accordingly, the FDIC never developed or obtained any new information or evidence following the 1991 FDIC examination which supported institution of a removal action against Mr. Garrett. Nevertheless and notwithstanding the advice of FDIC lawyers regarding the legal sufficiency of such evidence, the FDIC again abused its regulatory power by making another formal threat to take such action. Like all of the prior threats to remove Mr. Garrett, it also proved to be void of any substance. The FDIC never issued formal charges against Mr. Garrett for an order of removal.

For the next year (between July of 1994 and August of 1995), the FDIC procrastinated over whether to enter into a settlement agreement with Mr. Garrett, or whether to issue formal charges against him. The FDIC finally opted for the latter course and rejected a settlement agreement that had been favorably recommended by all levels of review in both the FDIC Division of Supervision and the FDIC Legal Division. In the final analysis, the FDIC Director of Supervision decided to issue formal charges against Mr. Garrett. In doing so, he refused to follow the advice of senior staff and that of the FDIC Legal Division and instead chose to follow a management policy which placed a premium on conducting bank supervision in secret. 11

On September 5, 1995, more than five years after almost all of the disputed loans had been made (all of which were paid in full by the named borrowers), the FDIC filed formal charges against Mr. Garrett - not for removal, but for a civil money penalty for certain alleged violations of law. 12 Although it is not the purpose of this article to argue the merits of alleged violations of law, the following undisputed factual recitations deserve mention: (1) none of the alleged violations were ever cited in any FDIC report of examination of the Bank; (2) none of the alleged violations were ever discussed with the Bank’s board of directors; (3) the alleged violations have never been used by the FDIC in any prior regulatory enforcement action as the sole basis upon which to assess a civil money penalty; and (4) all of the alleged violations were contradicted in two previously published interpretive opinions issued on October 21, 1994 by the General Counsel to the Board of Governors of the Federal Reserve System. 13

One of the most egregious tactics employed by the FDIC occurred in the middle of the conduct of the evidentiary proceeding in December of 1996. In order to intimidate and/or inhibit the testimony of two former FDIC examiners who had been subpoenaed to testify by Mr. Garrett, the FDIC addressed letters to them advising that by testifying they could run the risk of possible criminal prosecution. Such action was clearly unwarranted and was intended to disrupt (if not obstruct) the ability of Mr. Garrett to obtain testimony from such persons. 14

CONCLUSION

Based upon: (1) the purely technical and unprecedented nature of the alleged infraction; 15 (2) the fact that all of the loans were repaid in full by the borrowers with no loss to the Bank, (3) the fact that the alleged infraction did not result in any improper financial gain or benefit to Mr. Garrett; (4) the fact that the alleged infraction was never criticized or cited by FDIC examiners in any examination report; and (5) the fact that Mr. Garrett has already paid a financial “penalty” of more than $1.5 Million for expenses he has incurred over the past seven years 16 (and wholly aside from any consideration of the legal merit of the FDIC allegations), it is difficult to fathom the existence of any legitimate principle of bank supervision which requires that the FDIC continue its quest for the imposition of an additional penalty of $25,000.

In a formal presentation to the Regulatory Enforcement Fairness Board, Paul Fritts stated:

Simply put, in my judgement, there is absolutely no legitimate supervisory purpose to be served by the FDIC’s further prosecution of Mr. Garrett. In my opinion, the continuance of the penalty action against Mr. Garrett by the FDIC represents one of the worst, if not the worst, case of regulatory overkill that I have seen in my supervisory experience. I cannot cite and have not seen any evidence to indicate that any proper governmental regulatory purpose is being furthered by the continued prosecution of this case by the FDIC.

* * *

If I were still serving as the FDIC Executive Director of Supervision and Resolutions, I would direct that the FDIC discontinue any further prosecution of Mr. Garrett. The action was never properly evaluated and has been badly and unfairly handled by the FDIC from the outset. Nothing can be done now to undo that, but what can be done is to immediately end the action against Glen Garrett so that he can get back to running a high-quality community bank. Enough is enough.

Bureaucratic overzealousness alone cannot account for the abusive practices and procedures employed by the FDIC against Mr. Garrett. They have been too systematic and protracted, and they also reflected bad faith. Rather, Mr. Garrett’s experience with the FDIC can only be characterized as an appalling utilization of supervisory governmental power for the illicit purpose of covering up the mistakes of FDIC examiners and their supervisors. As mentioned, a senior FDIC management official in Kansas City casually referred to the use of FDIC regulatory enforcement powers as a license to “castrate” Mr. Garrett. Aside from the boorish nature of such a comment, it is nevertheless a tragically accurate metaphorical description of the painful ordeal he and his family have had to endure over the past seven years. Most importantly, however, the comment reflects an unwitting confession by the FDIC that the agency has chosen to use the regulatory enforcement powers granted to it by Congress for a non-governmental purpose - in this case, to impose severe personal hardship and to cripple a person’s will to challenge the agency. In short, the FDIC has employed the regulatory enforcement process itself as a means of inflicting punishment.

The most extraordinary aspect of the Garrett case is that the FDIC has admitted the following circumstances: (1) none of the six loans in question contained any preferential terms or conditions; (2) all of the loans were well below the Bank’s lending limit; (3) the Bank did not sustain any type of loss and no other harm was threatened; (4) Mr. Garrett did not profit or receive any improper benefit or gain; (5) Mr. Garrett can remain in his position as chief executive officer and chairman; (6) the Bank is in a safe and sound financial condition; and (7) there is no threat of any kind to the safety of the Bank or to the deposit insurance fund administered by the FDIC. Indeed, over the past several years and in the midst of intense litigation, the FDIC has granted regulatory approvals for the Bank to expand its business operations by opening two new branch offices.

The only infraction charged by the FDIC is that Mr. Garrett failed to notify the Bank’s directors that he received the proceeds of the six loans in payment of debts that were owed to him by the borrowers. The ultimate irony is that all of the Bank’s directors (including those called as witnesses for the FDIC) have testified that nothing - absolutely nothing - would have changed even if Mr. Garrett had given such notification. Neither the loans in question nor the transfer of the proceeds to Mr. Garrett would have been affected in any way as a result of such notification. As a result, the question begged is: What is the governmental regulatory purpose of determining whether Mr. Garrett’s failure to notify the board that he received the proceeds of the loans for debts owed to him constitutes a basis upon which a civil money penalty of $25,000 can be assessed?

Mr. Garrett has spent more than $1.5 Million over the past seven years defending his personal integrity and reputation as an honest banker. The FDIC says Mr. Garrett acted dishonestly by concealing his interest in the loans by failing notify the directors of such interest. Mr. Garrett says that creditworthy borrowers applied for and obtained legitimate loans for the purpose of repaying debts owed to him, and that he has not engaged in any dishonest act or committed any violation of law. The central issue is not which version is more accurate. Rather, the pivotal question is what legitimate regulatory purpose is served by spending so much time and effort (and financial resources) to find out? Why should Mr. Garrett be subjected to a process that will consume a decade of time 17 and require a personal expenditure over $2 Million to complete in order to determine the answer to a question that has absolutely no regulatory significance?

No citizen should be subjected to such treatment under the pretense of legitimate governmental supervision. It is contrary to fundamental principles of fairness and it is un-American. One promising hope is that the National Ombudsman of the Regulatory Enforcement Fairness Board will prevail in the jurisdictional dispute to hold the FDIC accountable for its exercise of regulatory power under the Small Business Regulatory Enforcement Fairness Act of 1996. If that occurs, it will mark a new era in bank supervision that could be very beneficial for the small community banker. To use a sports metaphor, it will certainly help level the playing field which is otherwise seriously and unfairly tilted in favor of the regulators. The National Ombudsman for the Regulatory Enforcement Fairness Board should therefore be a welcome new player to the bank supervision game.

* * * * *

ARTICLE POSTSCRIPT

Following the publication of this article by the Missouri Independent Bankers Association and similar commentary (including a lead editorial on the “Op-Ed” page) by the Kansas City Star, the FDIC finally conceded the misguided nature of its effort and agreed in March of 1999 to issue a final order with dismissed, with prejudice, all charges and allegations of wrongdoing against Mr. Garrett. Such Order also included the unprecedented provision of also “withdrawing all charges” against Mr. Garrett. There were several other unprecedented aspects of that Order: (1) it is the only order on record which dismissed all charges prior to the conclusion of the evidentiary hearing; (2) it is the only known final order issued by the FDIC pursuant to the provisions of section 8(b) of the Federal Deposit Insurance Act which does not use or include the phrase “Cease and Desist” in any part of such order, including the caption; (3) it is the only final enforcement order issued by the FDIC pursuant to section 8 of the Federal Deposit Insurance Act which does not include a single finding or conclusion regarding any of the wrongdoings charged in the Notice; (4) it is the only known “cease and desist” order issued by the FDIC under section 8(b) of the Federal Deposit Insurance Act which does not require the named respondent to cease and desist from doing anything; and (5) it is the only known final order issued by the FDIC which only requires that the named respondent comply with a specific requirement in a regulation that did not exist when the disputed conduct which gave rise to the charges occurred.


* Editor Note: The author is an attorney who defended the bank regulatory enforcement action which is the subject of the article. In view of the fact that a highly respected Missouri banker (Glen Garrett) was the target of that action and because of the unprecedented nature of the case, the Missouri Independent Bankers Association (MIBA) requested that Mr. Woodrough prepare the article. It has been reproduced here with Mr. Garrett's permission and that of MIBA. Mr. Woodrough is an experienced litigator having served with the FDIC Legal Division for more than 25 years, including 15 years as Regional Counsel for the FDIC Atlanta Region between 1973 and 1988. Over the past 12 years, he has confined his nationwide practice to bank regulatory enforcement matters before the FDIC and the other federal bank regulatory agencies. Mr. Woodrough’s office is in St. Petersburg, Florida.

ENDNOTES

1 His name is Glen Garrett. He is the sole shareholder and chief executive officer of the First State Bank, Purdy, Missouri (“Bank”). Based upon the results of an examination of the Bank conducted by the FDIC in 1991, and after several failed attempts to remove and permanently ban Mr. Garrett from banking, the FDIC initiated a formal regulatory enforcement action against him in 1995 under section 8 of the Federal Deposit Insurance Act for the assessment of a civil money penalty of $25,000. A public evidentiary hearing has been conducted over the past three years regarding the charges against Mr. Garrett and the defenses he has raised in response to those allegations. The hearing process, however, is not yet complete and is not expected to be concluded until the end of 1998. Thus far, the hearing has consumed 16 weeks of hearing time (conducted in segmented intermittent sessions) and almost 20,000 pages of testimony from numerous witnesses. All of the information pertaining to the events and circumstances outlined in this article has been taken from the testimony and documentary exhibits which are contained in the public hearing record.
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2 The impact will not be limited to the initiation of regulatory enforcement actions by the FDIC. The conduct of such actions by the other federal regulatory agencies, including the Board of Governors of the Federal Reserve Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration, will be similarly affected.
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3 Mr. Fritts is highly qualified to express such an opinion. He served with the FDIC Division of Supervision for almost 35 years, beginning as a trainee-examiner in 1959 and ending with his retirement in 1993 in the highest non-appointive officer position in the FDIC. Between 1985 and 1993, Mr. Fritts served as the FDIC Executive Director of Supervision and Resolutions and directed all bank examination and regulatory activities of the FDIC, reporting directly to the FDIC Board of Directors. Mr. Fritts has agreed to testify as an expert witness on behalf of Mr. Garrett.
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4 According to the sworn testimony of the FDIC Examiner-in-Charge of the 1991 FDIC examination, a senior FDIC management official in the Kansas City Regional Office informed him that his preliminary recommendations had been reviewed by senior regional staff representatives of the FDIC Division of Supervision and related the results of that review with the comment: “We agree that Mr. Garrett should be castrated.” Aside from the appallingly insensitive and unprofessional nature of such a comment, it nevertheless provided a chillingly accurate portrayal of the high degree of FDIC bias against Mr. Garrett that would continue to be manifested over the ensuing seven years.
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5 Such statement was false since the Missouri Division of Finance had previously advised the FDIC that the issuance of a cease and desist order against the Bank was not warranted.
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6 Although it is not clear from FDIC records exactly when the agency abandoned its effort to impose a regulatory sanction on Mr. Garrett based upon his suspected misconduct related to the construction of the new bank building, it appears to have occurred during the latter part of 1993. At that time, it was determined that based upon reconstructed and verified work and purchase invoices and an independent appraisal, the Bank’s actual cost for the construction of the facility was less than its appraised value by a factor of over $300,000. In effect, it was determined to the satisfaction of the FDIC that Mr. Garrett’s involvement with the construction project proved to be extremely beneficial to the Bank - hardly a basis for a regulatory enforcement action.
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7 The conclusion by FDIC that the loans were made to nominees or straw-parties for the benefit of Mr. Garrett was never mentioned in the 1991 FDIC examination report or the ensuing “exit review” meeting with the Bank’s board of directors in November of 1991. Rather, it appears that the theory of “nominee” loans was developed by the FDIC Legal Division to corroborate the scheme of dishonest activities outlined in the criminal referral forwarded by the FDIC Division of Supervision to the U.S. Attorney in March of 1992.
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8 It is generally agreed that persons who act as nominee or straw-party borrowers do not use their own funds to repay such loans. Indeed, the FDIC Board of Directors itself proclaimed that this is the essential litmus test of what constitutes a “nominee” loan, namely, a determination of whether the named borrower actually accepted and discharged the legal responsibility to repay the loan. If not, such person will be deemed to be a “nominee” borrower. See, In the Matter of Ramon M. Candelaria, FDIC Enf. Dec. ¶ 5242 at fn. 4 (1997). (“Respondent avoids the crucial issue here, which is whether the named borrower is the person who is responsible for the repayment of the loan.”)
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9 There are related issues of whether the investigation was requested by the FDIC in accordance with established inter-agency bank examination procedures, and also whether it was conducted in accordance with applicable Federal law governing certain privacy rights of bank customers. While those questions cannot be aired (or answered) here, the fact that they exist appears to confirm a prevailing FDIC practice of taking action without first making sure it conforms with applicable laws and established inter-agency bank examination procedures.
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10 All of the draft charges for the proposed removal action were related to the six disputed loans. The most unusual aspect of such charges, however, was the fact that exactly the same charges were used verbatim in the formal civil money penalty action that was initiated against Mr. Garrett over a year later in September of 1995. In effect, the FDIC used exactly the same charges to support a threatened removal action and a civil money penalty order.
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11 The FDIC Division of Supervision stated that the recommended settlement proposal would be acceptable provided that the terms of such settlement were not incorporated into the final FDIC order which is published and made available to the public. The FDIC Division of Supervision was therefore amenable to the settlement proposal made by Mr. Garrett that had been recommended by the FDIC Kansas City Regional Office and FDIC Legal Division, but only on the condition that the terms of such settlement were kept secret. Mr. Garrett declined to agree to such secrecy.
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12 The only violations charged by the FDIC pertain to the prohibition against loans with “unfavorable features” to bank insiders provided in section 215.4(a) of Regulation O of the Federal Reserve Board, 12 C.F.R. §215.4(a). The FDIC has charged that the failure of Mr. Garrett to notify the board of directors that the borrowers transferred the proceeds of their loans to him in payment of prior debts owed to them constituted an “unfavorable feature” within the meaning of section 215.4(a) of Regulation O. No other violations were charged. [The current reporting requirement in section 215.5(d)(1) of Regulation O was not applicable to the Bank at the time the disputed loans were made.]
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13 Copies of both opinions were provided to the FDIC by the Federal Reserve Board. As a result of one of the opinions, the FDIC Legal Division reversed a previously issued interpretive opinion it had issued which had effectively opined that the six loans in question were made in violation of section 215.4(a) of Regulation O.
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14 The timing of the letters was particularly egregious. In each instance, the letter was received by the witness only a few days before the date of his testimony even though the FDIC had known for over a year that such testimony was scheduled. It should be noted that the FDIC tactic, which FDIC Enforcement Counsel stated had been instigated by a senior representative of the FDIC Division of Supervision without his (counsel’s) knowledge, bordered dangerously upon obstruction of justice. Such tactic had never been seen previously by the presiding administrative law judge. For that reason, and because of the circular reasoning and threatening overtones of possible criminal prosecution in the letters, the presiding judge took the extraordinary measure of requesting that the FDIC address a clarifying letter to the witness specifically advising that the contemplated testimony was not prohibited or restricted in any way. The FDIC complied with the judge’s request. The question raised, of course, is why the latter letter was not written first.
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15 Again, the only alleged infraction is that Mr. Garrett failed to notify the board of directors of the Bank that he received the proceeds of the six loans in question in payment of prior debts owed to him by the borrowers. There is no allegation that the loans were made in violation of the prior approval requirements of Regulation O or that such loans violated the lending limitations of Regulation O. The only violation alleged is that Mr. Garrett’s failure to notify the board constituted an “unfavorable feature” and violated the prohibition in Regulation O against loans to insiders with such features, thus subjecting him to a “First Tier” civil money penalty of $5,000 per day. The FDIC later amended the charges and alleged that the same infraction also constituted a “breach of fiduciary duty” by Mr. Garrett, thus subjecting him to a “Second Tier” civil money penalty of $25,000 per day. The FDIC has never made such allegations the basis of any regulatory enforcement action it has initiated previously.
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16 Since the 1991 FDIC examination and the multitude of charges and threats of regulatory enforcement actions by the FDIC, Mr. Garrett has expended more than $1.5 Million in legal fees and related expenses (accountants, appraisers, expert consultants, court reporters, etc.) defending against allegations of wrongdoing made by the FDIC. It is estimated that the FDIC has expended a comparable amount - if not more. Additional sums will necessarily have to be expended in connection with any appeal of a final FDIC order adverse to Mr. Garrett. Regardless of the litigated outcome of the FDIC action, however, none of Mr. Garrett’s expenses can be recovered from the FDIC under the Equal Access to Justice Act, 5 U.S.C. §504. Thus, even if Mr. Garrett wins the technical legal issue of liability for the payment of the disputed civil money penalty, he still loses the cost and expense of waging that battle. The FDIC action, therefore, has never been about money or the assessment of a monetary penalty. It’s about a small community banker’s personal reputation for honesty and integrity in the community he calls home and served by his bank.
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17 It is anticipated that the FDIC action against Mr. Garrett will not be final until after it has been reviewed by a Federal appellate court. Such review is not expected to be completed until at least 2001 - 10 years after the tip by the anonymous informant and the resulting FDIC examination in 1991 which precipitated the action against Mr. Garrett.
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Last revised: June 1, 2012.