I think it is safe to say that the Federal Deposit Insurance Corporation, more than any other agency, is keenly aware of the potential ill effects bank insider activities may pose to financial institutions. It is for this reason many of our examination procedures and policies are targeted toward the identification of potential problems in this area. As indicated in our previous correspondence, the FDIC is in general agreement with the findings embodied in the draft report. Once your report has been finalized, it is our intention to provide copies to our field staff. This will afford us an opportunity to highlight the General Accounting Office's recommendations and reemphasize the importance of a thorough analysis of insider activities, effective communication with boards of directors, and adherence to established policies and procedures.

We look forward to receiving your final product. Please let me know if we may be of further assistance.

Sincerely,

Stanley J. Polig
Director

Comments From the Federal Deposit
Insurance Corporation

The following are GAO's comments on FDIC's letters dated December 9, 1993, and December 23, 1993.

GAO Comments

We address FDIC's substantive comments on the following pages. FDIC also included technical comments in their response letter. We have made suggested changes where appropriate. We have also responded to selected technical comments where appropriate.

1. We agree that an insider transaction, conducted in accordance with applicable laws and regulations, is a perfectly reasonable banking practice. We acknowledge this in chapter 1. (See p. 14.)

2. We agree that Part 363 of the FDIC Rules and Regulations, 12 C.F.R. 363,
"Annual Independent Audits and Reporting Requirements," which
implements section 112 of the FDIC Improvement Act, may result in
increased scrutiny of insider transactions by federal regulators. This
provision requires management of banks to prepare an annual assessment
of the degree of compliance with safety and soundness regulations,
including those related to insider activities. We agree that this assessment
may be useful to examiners in reviewing such activities. However, this
assessment will not fundamentally change the way in which examiners do
their work. The effectiveness of this regulation depends on the accuracy of
management's assessment. It also depends on the examiners' increased
scrutiny of insider transactions and their effectiveness in getting
management and bank boards to make necessary changes to correct
identified deficiencies in this area. Our recommendations were designed
to accomplish these objectives.

3. While FDIC's examination policies call for a thorough review of insider
transactions and the identification of "red flags" signaling potential fraud
and abuse, on the basis of our review of open bank examinations we noted
instances in which a separate review of insider transactions was not part
of the scope of an examination. In some of these cases, selected insider
loans were only reviewed as part of the overall review of the loan
portfolio. Though FDIC states that a review of Regulation O recordkeeping
requirements is standard procedure for FDIC examinations, as we discuss
in chapter 5, we found instances where examiners did not cite banks for
recordkeeping violations even though violations were apparent. FDIC also
states that a review of a bank's directors and officers liability insurance
policy is also standard practice. However, we found only a few instances
where FDIC verified the presence of a bank's directors and officers liability

Comments From the Federal Deposit
Insurance Corporation

insurance policy and no evidence that any analysis of the policy had been done.

4. In our analysis of failed banks we did not find it to be a common practice for FDIC to send individual letters to directors of banks highlighting the need for corrective action. In addition, from our review of open banks and from our interviews with the examiners-in-charge of these banks, we found that FDIC examination procedures conclude with the FDIC examiners meeting with bank management and the board of directors. Examination findings are presented and discussed at this meeting. However, the directors of our focus groups told us that the examiners' presentation of examination findings was not informative, leaving the board with the sense, in some instances, that corrective actions were not warranted. (See ch. 6.)

5. We agree, as outlined in our report, that post-closing reports frequently uncover potential insider problems at closed banks, more so than routine bank examinations. We also agree that investigators have the benefit of information developed by examination teams as well as the availability of information from other sources. While there may be a tendency for investigators to include instances of insider problems more frequently in their post-closing reports, the basic finding that insider problems contributed to a bank's failure seldom change. While conducting our audit, we reviewed a statistically valid sample of FDIC status reports, which are completed quarterly to update the investigators' findings. We did this in anticipation of some potential concerns of agency officials about the accuracy of investigator findings in post-closing reports. We found that the initial findings of insider abuse, insider fraud, and loan losses to insiders as identified by the investigators had not changed and were still considered to be contributing factors toward the failure of the banks.

6. As we noted in chapter 2, regardless of the actions that were taken, regulators may have been able to take stronger enforcement actions, considering that 72 percent of the banks had repeated insider violations. By taking stronger enforcement actions sooner, regulators may have been able to reduce the number of banks in which repeated insider problems led to failure.

7. We acknowledge that the insider credits being serviced by FDIC on its LAMIS database do not represent the universe of insider debt at any given bank. Because of the limitations of the LAMIS database, we attempted to use it to identify some minimum amount of insider lending. However, as

Comments From the Federal Deposit
Insurance Corporation

explained in chapter 4, we were unable to do so. In our work on this report and our other work in bank supervision, we found that the information available on the level of insider debt varied from bank to bank depending on the quality of the bank's recordkeeping system for insider transactions.

8. We did not find in our review of federal regulators' examination reports that examiners "almost always" reviewed insider activities. On the basis of our analysis, we believe a review of insider activities was done most often when it was brought to the attention of the examiner by other sources.

9. On the basis of our analysis of failed bank enforcement actions (see ch. 2) and our prior work on bank supervision,' we believe bank examiners have, at times, been reluctant to be critical of bank management, particularly in cases where bank management assures examiners that deficiencies would be corrected.

10. On the basis of our review of post-closing reports and conversations with FDIC and DOL Staff, we believe the language in the report accurately portrays that FDIC does not usually establish the extent of insider lending when pursuing a liability claim.

11. While examiners may be on the alert for insider problems, we believe they could take additional steps that would help them identify these problems. (See ch. 5.)

12. We are not suggesting that the absence of directors and officers liability insurance is a leading indicator of problems at banks. Nonetheless, we believe a review for the presence of such insurance and an analysis of any exclusions under the policy may be a useful additional tool for examiners in some situations. We found only a few instances where FDIC examiners had determined the presence of directors and officers liability insurance and the adequacy of coverage. In addition, we found no evidence that any analysis of the policy had been done.

13. We agree that it may be a natural human tendency for some directors to rely upon bank management for information concerning their banks. However, this only reinforces the need for examiners to emphasize to directors their responsibilities in ensuring that identified deficiencies are corrected.

'See for example, Bank Supervision: Prompt and Forceful Regulatory Actions Needed (GAO/GGD-91-69, Apr. 15, 1991).

Based primarily on the post-closing analyses conducted by FDIC investigators of the 286 bank failures that occurred during 1990 and 1991, the Report suggests that insider problems were excessive at these failed banks, and concludes that this link evidences a strong correlation between insider problems and bank failures. The Report's statistical analysis centers on 175 failed banks, the number of banks out of the 286 bank failures in 1990 and 1991 that were determined by the FDIC investigators to have had insider problems that were contributing factors in their failure. Within that universe of 175, a sub-category consisting of 74 banks was created, all having as a common thread, the determination by the FDIC investigators that insider problems were one of the major factors in their failure.