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"VIOLATION" OF LAW - ACTIONABLE CONDUCT UNDER SECTION 8 OF FDIA
BY STEPHENS B. WOODROUGH

Prior to the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ["FIRREA"] (Pub. Law 101-73, effective August 9, 1989), section 18(j)(4)(A) of the Federal Deposit Insurance Act, 12 U.S.C. §1828(j)(4)(A), provided:

The term "violation" includes without limitation any action (alone or with another or others) for or toward causing, bringing about, participating in, counseling, or aiding or abetting a violation. [Emphasis added.

When Lowe v. Federal Deposit Insurance Corporation, 958 F.2d 1526 (11th Cir. 1992) was decided by the Eleventh Circuit, the pre-FIRREA definition was applicable to the case. The phrase "without limitation" in section 18(j)(4)(A) was specifically emphasized by the Court to support the conclusion:

This extremely broad definition clearly includes any action, intentional or inadvertent, by which a director "participates in" the bank's violation of the FDIA. See, Fitzpatrick v. FDIC, 765 F.2d 569,576-77 (6th Cir. 1985). To hold otherwise, would render the explicit language in section 1828(j)(4)(A) meaningless surplusage. Id., at 1535

The Court in Lowe then focused its attention on a determination of what type of conduct constitutes "participation" within the meaning of the cited statutory definition. To do this, the Court noted that in the absence of any case law on the subject, it was forced to rely solely on the "legislative history and the purpose of the FDIA" [It is important to keep in mind here that the Court was specifically focused on the "legislative history and purpose" of the prior approval requirement in section 215.4(b) of Regulation O. See footnote 1, below.] In reviewing such history, the Court announced the following holding:

Specifically, Congress places two affirmative duties on bank directors under the FDIA;1 the duties fully to investigate and to disclose interests in insider loans, for which, if violated, the director is found to have participated in the bank's violation of the statute. [Emphasis added, and footnote omitted.]

The holding that "Congress placed two affirmative duties on bank directors under the FDIA" is an interpretation of the prior approval requirement in Section 215.4(b) of Regulation O. In essence, the Court held that the prior approval requirement imposed by that provision of Regulation O on certain loan transactions imposes corresponding duties upon directors to investigate and make certain disclosures regarding such loans, and that any breach or failure to perform such duties will be deemed to be evidence of "participation in" a violation of the prior approval requirement imposed by Regulation O. The repeated references to "the statute" and "the FDIA" in the Court's underlying analysis of the origin of the two duties are clearly references to the prior approval requirement in Regulation O. Id. at 1536. This is confirmed explicitly in footnote 38 with the statement: "the legislative history states that the primary purpose of the prior approval provisions of the FDIA." The only "prior approval provisions" in the FDIA are those in section 215.4(b) of Regulation O incorporated by reference in section 18 of the FDIA. The comment in footnote 39 of the Lowe opinion is more oblique. It rationalizes the existence of a duty to disclose an insider's interest in a loan based upon the existence of a duty in Regulation O requiring directors to disclose their interests in loans made by correspondent banks. Aside from the erroneousness of such reasoning,2 it is nevertheless clear that the duty to disclose in Lowe is premised upon Regulation O.

The central holding in Lowe regarding the duties of directors to investigate and make certain disclosures states that a breach of such duties will constitute "participation in" a violation of the prior approval requirement of Regulation O. The Lowe Court did not hold that the failure of a director to disclose his interest in any given loan, standing alone, constitutes a violation of law. For example, if a given loan transaction is not subject to the prior approval requirements of Regulation O, there is nothing in the Lowe decision which requires a finding that a director who failed to disclose that he had an interest in such loan "participated in a violation of law" within the meaning of the civil money penalty statute. If a particular loan is not subject to the prior approval requirement of Regulation O, then the failure of a director to disclose his interest in such loan cannot constitute "participation in" a violation of such requirement. Again, the holding in Lowe only states that the failure of a director to disclose his interest in a particular loan constitutes "participation in" a violation of the prior approval requirement of Regulation O. Such holding necessarily subsumes the applicability of such requirement to the loan in question. If such requirement is not applicable, there is no "violation" for the director to "participate in" by failing to disclose his interest in such loan..

Accordingly, the Lowe decision holds (at best) that a director has a duty to disclose his interest in a loan in order to fulfill his responsibility to comply with the prior approval requirement imposed in section 215.4(b) of Regulation O. The holding of the Eleventh Circuit in Lowe does NOT stand for the proposition that Regulation O imposes a general fiduciary duty upon directors to voluntarily disclose their interest in the proceeds of any loan made by the bank in which they serve. Again, the present disclosure requirement in section 215.5(d) of Regulation O was not applicable or effective as to Respondent Lowe.


ENDNOTES

1. The operative law that was violated under discussion in Lowe were the prior review and approval requirements in section 215.4(b) of Regulation O, not the Federal Deposit Insurance Act. Section 18(j)(2) of the Federal Deposit Insurance Act incorporates the requirements and prohibitions of subsections (g) and (h) of section 22 of the Federal Reserve Act, 12 U.S.C. §375b, which is implemented by Regulation O. The Court's reference to the "bank's violation of the FDIA [Federal Deposit Insurance Act]" is therefore generic and actually refers to a violation of the prior review and approval requirements in Regulation O. Accordingly, the repeated references in the Lowe opinion to "violations of the FDIA" and the "legislative history and purpose of FDIA" [Id., at 1535-37] are more accurately read as references to prior review and approval requirements in section 215.4(b) of Regulation O, as promulgated pursuant to 12 U.S.C. §375b.

2. The footnote reasons that since Regulation O requires a director to disclose his interest in loans made by correspondent banks, "it would defy all logic, as well as the stated purpose of the statute [as cited in footnote 38 which refers to the purpose of the prior approval requirement], not to extend this affirmative duty of disclosure to the director's loans at his own institution. Such reasoning is erroneous and totally disregards two important facts: (1) at the time the disputed loans in the Lowe case were made, section 215.5(d) of Regulation O imposed an explicit disclosure requirement mandating that executive officers (but not directors or institution affiliated parties) disclose their interest in any loan made by their institution (which is precisely the same disclosure requirement rationalized in the footnote), and (2) section 215.5(d) of Regulation O did not apply to Respondent Lowe as a matter of law. Such requirement was not imposed upon insured nonmember banks until 1992 when FDICIA became effective. Prior to FDICIA, member banks were subject to section 215.5 of Regulation O, but nonmember banks were not.

ADDITIONAL NOTATIONS AND QUESTIONS:

FIRREA amended the definition of "violation" in section 18(j)(4) of the FDI Act by deleting the phrase "without limitation." [FIRREA also amended the civil money penalty enforcement sanctions by establishing tiered system of penalties.] Query: Why was the definition of "violation" changed? Is there any explanation in the legislative history of FIRREA? Arguably, the change was intended to place more emphasis on the active nature of the types of misconduct deemed to be actionable such as causing, bringing about, aiding, abetting, etc., as opposed to conduct that is more passive in nature such as inadvertent violations that might occur as a result of negligent oversight or carelessness - such as those which occurred in Fitzpatrick as cited in the Lowe decision. In other words, by deleting the sweeping "without limitation" provision, is it tenable to argue that Congress sought to eliminate the assessment of civil money penalties for "inadvertent" violations due to negligent oversight or carelessness?

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