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resulted from computer error which had the effect of not posting the deposit to the proper account in a timely manner.
Another 65 of the 130 banks erroneously reported overdrafts to corporate interests of insiders. The survey instructions did not include corporate interests within the reporting requirements. These 65 banks therefore, by definition, constitute a reporting error. Although shortness of time precluded detailed questioning about the nature of each corporate overdraft some questions were asked which revealed the same lack of exposure on the part of these banks as the 38 discussed above. Thus, 28 of the 65 corporate overdrafts were covered before the midnight deadline and 12 others were reported because of delays in: (1) Posting intra-bank transfers; (2) disbursing prior approved loan proceeds; or (3) wire transfers from other banks.
In 7 of the 130 contacted, the banks experienced no exposure on the overdrafts because they were covered by wire transfers. In each of these 7 cases, the wire transfer was delayed for technical reasons. In six of the other instances, the bank reported, or the FDIC's computer picked up, an incorrect amount which, if reported correctly, would have reduced each of the six below the $50,000 level.
With respect to the remaining 14 of the 130 banks contacted, 6 appear to involve an abusive practice. However, the information obtained from the telephone contacts indicated that correction has been made in five of the six instances either through a change in ownership of the bank, a change in policy at the bank, or resignation or dismissal of the individuals involved. In one case, an interest charge was imposed. In the other eight, the overdrafts were those of insiders who were significant customers of the bank, and the overdrafts were of short duration (no more than 5 days) in all but one case. In two of these cases, rates above the bank's normal lending rates were charged. In the one instance which extended beyond 5 days, the overdraft was outstanding for at least 60 days but was collateralized by marketable securities and was one of the two on which interest was charged (the interest rate was 10 percent).
In summary, based upon this limited and hurried telephone followup of reported overdrafts of $100,000 or more, it seems clear that the numbers in the tables do not accurately portray industry practice and may be misleading. Furthermore, only 3 of 86 banks reporting no interest rate assessed against the overdraft showed evidence of abusive preferential treatment. In one of the three, the overdraft was covered in 3 days. The FDIC will instruct its regional offices to investigate each State nonmember bank where abusive overdraft practices are indicated by the survey data, regardless of the amount reported.
În a more general followup, the Corporation will identify each State nonmember bank which reported anything in the survey which implies a possible abusive practice with respect to loans secured by the stock of other banks or bank holding companies; loans to insiders of the lending bank; loans to insiders of other banks; and overdrafts to insiders of the bank, to insiders of other banks, and to public officials. A list of these banks will be forwarded to the appropriate Regional Office with instructions to take whatever steps, are necessary to determine whether the bank has in fact engaged in, or is engaging in, any of these practices. This list will include all those state nonmember banks identified in the survey which extended credit to their own insiders at rates of interest clearly below the average prime rate. The list also will include those banks on both ends of stock loans transactions which involved low interest rates and a demand deposit balance placed at the lending bank by the bank whose stock secures the loan. In addition, in those cases where abusive practices exist, the Regional Offices will be instructed to point out to the bank how correction can and should be effected and then to ensure that correction is taken. If necessary, formal enforcement action will be instituted.
As you will recall, in my testimony before this committee on September 26, 1977, I discussed at length the various guidelines provided to examiners and the examination methodologies employed to assist in the detection of abuses relating to insiders of a bank; possible preferential treatment accorded to insiders of other banks, especially in connection with bank stock loans and compensating balances; loans to favored customers; and overdrafts (see “Hearings before the Senate Committee on Banking, Housing and Urban Affairs," 95th Cong., 1st sess., pp. 57-79, and 89-99, Sept. 26, 27, and 28, 1977). The FDIC believes that the current guidelines and examination techniques are adequate to detect the vast majority of these types of abusive practices. Furthermore, I am confident that our examiners assiduously and conscientiously strive to root our abuses committed in these and other areas by banks under the FDIC's direct supervision by carefully commenting on them in the reports of examination.
In the course of each examination, examiners are required to list all loans to officers of other banks, except for loans of insignificant amounts, on FDIC form 6500/23. The form was included as an exhibit to my testimony before this Commit
tee on September 26, 1977, in the hearings print referred to previously on page 122. Loans secured by stock of other banks, which in the aggregate amount to 5 percent or more of each bank's outstanding shares, must also be listed at each examination by examiners on FDIC form 6500722. This form was also reprinted in the hearing print of September 26, 1977, on page 121. Furthermore, section 7(j) of the Federal Deposit Insurance Act (12 U.S.C. 1817 (j)) requires that federal authorities be notified when there is a change of control of an insured bank or when there is a loan secured by 25 percent or more of an insured bank's outstanding stock.
To detect overdrafts to insiders a list of bank directors, officers and employees is obtained from the bank or it is developed independently by examiners or by some combination of the two preceding methods. Identification of insider relatives is a difficult process. However, an adequate list usually can be put together by reviewing the stock ledger, insider transactions records, and the minutes of meetings of the loan committee and the board of directors. Any overdrafts to insiders are flagged to ensure follow-up action at a later point in the examination. The overdraft listing is also compared with loans to individuals made by other departments of the bank to determine tie-in relationships. Also, since the issuance of the FDIC's insider regulation, which specifically mandates recordkeeping requirements for insider transactions, the identification of overdrafts, as well as other insider activities, has been enhanced.
Examiner review and analysis of overdrafts also result in the detection of overdrafts to officers, directors and stockholders of other banks. Large overdrafts and frequent use of overdrafts are flagged automatically for an appraisal of repayment capacity. Furthermore, it is standard procedure to determine the obligor's place of employment and position for those overdrafts that are relatively large and are not repaid during the course of an examination. This procedure permits detection of overdrafts to other bankers.
I believe that these procedures are generally successful in detecting insider abuses. Nevertheless, in light of some of the findings in the special survey, I have instructed the staff to review in detail and, where necessary, to take or recommend any requisite actions to improve the current guidelines provided to examiners and examination techniques used in the supervision of insider or other preferential practices. We are also in the process of evaluating the practicality and utility of incorporating the date gathered from these various sources into our computer base for ready access and analytical review in keeping track of trends.
REGULATION AND RECOMMENDED LEGISLATION I do wish to emphasize that the FDIC is deeply concerned about and responds vigorously to overreaching and abusive conduct by bank insiders. Although I do not believe that data from the survey indicate basic weaknesses in the bank regulatory structure, I do believe that the tolls of law and public policy must evolve apace with changing times and events. To underscore the fact that I am not wedded to the existing framework and approaches of bank regulation, the FDIC published for comment on January 30, 1978, proposed amendments to the Corporation's regulations dealing with insider transactions. Included in the proposal are a number of substantive amendments:
1. A new provision specifying that an insider transaction is an unsafe or unsound practice if it is preferential and results in, or is likely to result in, loan losses, excessive cost, undue risk, or other economic detriment to the bank. The amendment also would clarify that the FDIC will take appropriate supervisory action against a bank whose insider transactions are found to be unsafe or unsound and that technical compliance with the regulation's requirements would not be a basis for justifying an otherwise unsafe or unsound insider transaction. Thus, the posed amendments would make it clear that the FDIC will not tolerate any insider transaction that affords preferential treatment to an insider or person related to an insider and results, or is likely to result, in economic detriment to the bank.
2. A new provision would be added related specifically to correspondent accounts. A survey finding that troubles me is that lower rates are charged on loans to insiders when a correspondent relationship exists with the insider's bank than when such a relationship does not exist. To determine whether an abuse exists in such cases, we would require each insider to report in writing to the bank's board of directors all extensions of credit that are: (a) Made by a financial institution with which the bank maintains a correspondent account; and (b) made for the purpose of enabling the insider to purchase, carry or own a beneficial interest in securities issued by the bank, its holding company, or any other insured bank or holding company. The bank's board would be required to review, at least annually, all of the bank's correspondent accounts with other financial institutions to ensure that these
accounts are fair and in the best interests of the bank. In making the review, the board would have to consider, among other things, bank stock loans reported by insiders. Furthermore, any deposit placed by a bank in another financial institution solely to compensate that institution for making a loan to an insider of the depositing bank would, ipso facto, be considered an insider transaction.
3. The proposed amendments would expand the definition of "person related to an insider" and substantially revise the definition of “business transactions."
4. Under the proposed revision, the bank's board of directors would be required to review and approve insider transactio when practical prior to consummation of the transaction. In any case, review and approval would be required no later than the next regularly scheduled board meeting following consummation of the transaction.
There are other amendments to the insider regulation which are mainly of a clarifying nature or are intended to tighten the regulation. Overdrafts by insiders of a bank have been and are included within the meaning of insider transactions under the amended regulation. We have attached for your convenience a copy of the January 30, 1978 press release on the proposed amendments to the FDIC insider regulation as well as the entire proposal itself.
Focusing specifically on the amendments addressed to bank stock loans and correspondent accounts, the approach proposed would ensure meaningful analysis of the bank's correspondent relationships by boards of directors and would thereby significantly minimize the likelihood of abuse. Of even greater importance, this approach would also provide FDIC examiners with a better and more convenient data base for use in detecting other abuses associated with bank stock loans.
As I have already testified, I also support passage of several proposed amendments to the statutory powers of the federal banking agencies which are now pending in Congress.
We urge the enactment of S. 71. Our cease and desist power under section 8(b) of the Federal Deposit Insurance Act would be more effective if it could be use directly against the individual or individuals responsible for the commission of the abusive practice. In addition, to suspend or remove certain individuals under section 8(e) of the FDI Act, the FDIC has the burden of proving, among other things, that the individual's act involved personal dishonesty, a burden of proof not unlike that required in a criminal proceeding. It is a difficult burden to carry and, therefore, inhibits the usefulness of the suspension or removal power. S. 71, as recently passed by the Senate, would largely remedy these shortcomings and generally enhance our ability to deal with abuse. Thus, the proposed amendments to Section 8 would enable the FDIC to proceed directly against officers, directors and persons in control of a bank who abuse the resources of the bank.
S. 71 would also permit suspension or removal of officers, directors and other persons from participating in a bank's affairs where their actions evince a willful disregard of the bank's safety and soundness. Although this amendment would certainly be an improvement over the current heavy burden of showing personal dishonesty, we would prefer a less burdensome test. As we indicated in our comments on S. 71, we would prefer, in addition to the personal dishonesty standard, to be able to suspend or remove the individual within the class covered who operates or manages the bank in a grossly negligent manner, or threatens the safety and soundness of the bank by evincing a continuing disregard for its financial safety.
We also favor the various civil penalty provisions contained in S. 71, especially the provision authorizing the imposition of a monetary penalty against individuals and banks for violation of a final cease and desist order. Similarly, the proposed amendments to section 22 of the Federal Reserve Act, which would impose additional restrictions on loans extended by state member and nonmember banks to their own officers, directors and major stockholders and to corporations affiliated with those individuals, are desirable.
Another desirable legislative provision is that which allows the three Federal bank regulatory agencies to disapprove changes in bank control on the basis of express standards spelled out in the statute. Although I assume the power to disapprove changes in control would be used sparingly, this type of legislation, if properly employed, would enable the agencies to anticipate and avoid problems which they can only react to at present. I believe that its mere presence would have a far-reaching deterrent effect and would minimize certain types of abuses. We would be happy to coordinate drafting of such legislation with this committee.
As I have stated on many occasions, I have long favored the elimination of the prohibition on the payment of interest on demand deposits as well as the elimination of interest rate ceilings generally on a loans and deposits. I will not burden you at this time with the details of my rationale on this subject. Suffice. it to say that it is my firm belief that allowing the payment of interest on correspondent balances would be a major step in minimizing the potential for abuse arising out of the use of correspondent balances in connection with bank stock loans.
In summary, I perceive that the most pressing legislative need at present is the passage of S. 71, with perhaps the amendment I suggested previously regarding the agencies' suspension and removal power. Passage of S. 71 would significantly buttress existing enforcement tools.
[For Immediate Release]
FDIC PROPOSES AMENDMENTS TO INSIDER TRANSACTION REGULATION
Chairman George A. LeMaistre of the Federal Deposit Insurance Corporation today announced that the Board of Directors has proposed amendments to Section 337.3 of the Corporation's regulations which deals with "insider transactions” of FDIC-insured State-chartered banks that are not members of the Federal Reserve System (insured State nonmember banks). The insider transaction regulation, which has been in effect since May 1, 1976, is intended to minimize abusive self-dealing and overreaching by bank insiders through the establishment of procedures designed to ensure that bank boards of directors supervise insider transactions effectively, and to better enable FDIC examiners to identify and analyze insider transactions.
The proposed amendments would: (1) Specify the circumstances under which the FDIC considers an insider transaction to be an unsafe or unsound banking practice; (2) make clear that the FDIC will take appropriate supervisory action when it determines that an insider transaction is an unsafe or unsound banking practice; (3) clarify what transactions are subject to the regulation's requirements; (4) clarify the regulation's recordkeeping requirements; and (5) prescribe specific reporting review requirements with respect to correspondent accounts and certain bank stock loans.
Chairman LeMaistre stated that “The proposed amendments are designed to emphasize and clarify the FDIC's policy with respect to insider transactions. The Corporation believes that transactions with insiders, their close relatives, or their business interests are not improper per se. Accordingly, the proposed amendments seek to treat as unsafe or unsound banking practices those transactions in which insiders or their interests receive preferential treatment not afforded to noninsiders under comparable circumstances and which result in, or are likely to result in, loan loss, excessive cost, undue risk, or other economic detriment to the bank. Upon determining that a bank has entered into an insider transaction which is an unsafe or unsound banking practice, the Corporation will take appropriate supervisory action against the bank-ranging from informal efforts to obtain voluntary correction to formal proceedings under Section 8 of the FDI Act.” (Section 8 of the FDIC Act provides, among other things, for the issuance of cease and desist orders against banks that engage in unsafe or unsound banking practices.)
One of the principal proposed amendments is a specific provision relating to correspondent accounts. The new provision would require each insider to report in writing to the bank's board of directors all bank stock loans made to the insider and certain of the insider's relatives by a financial institution with which the bank maintains a correspondent account. The bank's board of directors would be required to review, at least annually, all of the bank's correspondent accounts to ensure that such accounts are fair to and in the best interest of the bank. In making the review, the board would be required to consider all relevant facts, including the bank stock loans reported by the bank's insiders.
In addition, a number of other amendments are proposed, some having substantive effect and some simply for purposes of clarity. All the proposed amendments are being published for comment in the Federal Register. Interested persons are invited to submit written data, views, or arguments regarding the proposed amendments no later than March 10, 1978, to the Office of the Executive Secretary, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, D.C. 20429. All written comments submitted will be made available for public inspection.
A copy of the proposed amendments as submitted or publication in the Federal Register is available from the Corporation's Information Office at the above address.
25-629 0 - 78 - 2
FEDERAL DEPOSIT INSURANCE CORPORATION
[12 CFR Part 337]
Summary: The FDIC proposes to amend 12 CFR § 337.3 dealing with "insider transactions” of insured State nonmember banks to: (1) Specify the circumstances under which the FDIC considers an insider transaction to be an unsafe or unsound banking practice; (2) make clear that the FDIC will take appropriate supervisory action when it determines that an insider transaction is unsafe or unsound banking practice; (3) clarify what transactions are subject to the regulation's requirements; (4) clarify the regulation's recordkeeping requirements; and (5) prescribe specific reporting and review requirements with respect to correspondent accounts and certain bank stock loans. The proposed amendments are generally designed to clarify the FDIC's policy with respect to insider transactions and to respond to questions that have been raised since the FDIC's insider transaction regulation took effect on May 1, 1976.
Date: Comments must be received on or before March 10, 1978.
Address: Interested persons are invited to submit written data, views or arguments regarding the proposed amendments to the Office of the Executive Secretary, Federal Deposit Insurance Corporation, 550 17th Street, N.W., Washington, D.C. 20429. All written comments submitted will be made available for public inspection at the above address.
For further information contact: Alan J. Kaplan, Attorney, Federal Deposit Insurance Corporation, 550 17th Street, N.W., Washington, D.C. 20429, telephone (202) 389-4433.
Supplementary information: The FDIC's insider transaction regulation (12 CFR $ 337.3) took effect on May 1, 1976. As was stated at the time of its proposal and adoption, the regulation is aimed at minimizing abusive self-dealing by "insiders” of insured State nonmember banks through the establishment of procedures designed (1) to ensure that bank boards of directors supervise insider transactions effectively and (2) to better enable FDIC examiners to identify and analyze such transactions. The regulation seeks to achieve these goals by prescribing review, approval, and recordkeeping requirements with respect to certain transactions which are defined in the regulation as "insider transactions."
In addition, the regulation currently in effect states that, notwithstanding compliance with the prescribed review and approval requirements, the FDIC will take appropriate supervisory action (including, in an appropriate case, the institution of formal proceedings under Section 8 of the Federal Deposit Insurance Act) against the bank, its officers, directors, or trustees if the FDIC determines that an insider transaction is indicative of unsafe or unsound practices. The regulation lists several factors which the FDIC will consider in determining the presence of unsafe or unsound banking practices involving insider transactions, but does not specifically describe the circumstances under which an insider transaction will be considered an unsafe or unsound banking practice.
Since the regulation took effect, questions have been raised from time to time as to the proper interpretation of various provisions and as to the FDIC enforcement policy with respect to those insider transactions that may involve abusive selfdealing. Accordingly, the FDIC has reviewed the regulation in light of the purposes it was designed to serve and now proposes to amend the regulation to better achieve those purposes and to promote greater clarity and understanding.
Numerous provisions of the regulation have been rewritten for purposes of clarity and readability, without affecting the substance of the regulation. However, a number of substantive amendments are also proposed, the most significant of which are described as follows:
1. A new definition would be added, defining the term “preferential" as it is applied to insider transactions. Under this definition, an insider transaction is preferential if, in light of all the circumstances, an insider or person related to an insider obtains a benefit or advantage which would not be afforded in a comparable arm's length transaction to a noninsider of comparable creditworthiness or otherwise similarly situated.
2. A new provision would be added to specify those circumstances under which the FDIC considers an insider transaction to be an unsafe or unsound banking practice. Under this provision, an insider transaction is an unsafe or unsound banking practice if the transaction is preferential and results in, or is likely to result in, loan