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Insider Problems Frequently Contributed to
Bank Failures and Were Also Evident in
Open Banks

Federal Regulators
Also Took
Post-Failure

Enforcement Actions

The three federal bank regulators can also take post-failure enforcement actions against former bank officers and directors of failed banks. FDIC, as the federal bank insurer, has the authority to pursue post-failure enforcement actions against any of those officers and directors who are found to be negligent in discharging their fiduciary responsibility, regardless of the failed banks' primary regulator. Some of these actions against the former officers and directors have involved the pursuit of financial recoveries. FDIC has pursued and ultimately received some financial recoveries in about 25 percent of the banks that failed.

The post-failure enforcement actions available to primary federal bank regulators include supervisory letters, letters of reprimand,9 CMPS, and removal and/or prohibition orders banning officers or directors from the banking industry.

For the 286 banks that failed in 1990 and 1991, we found that primary federal regulators took 167 post-failure enforcement actions against 167 officers and directors. The most common enforcement action taken was a letter of reprimand. As shown in table 2.8, there were 68 letters of reprimand, 42 CMPS, and 35 supervisory letters.

'Letters of reprimand and supervisory letters are issued only by OCC. According to officials in OCC's
Enforcement and Compliance Division, a letter of reprimand is a substitute for a CMP when it has
been determined that the CMP is not cost-effective to pursue. A supervisory letter is a less formal
letter highlighting the need for corrective action. However, in the case of failed banks, a supervisory
letter informs former officers and directors that certain banking practices are considered unsafe and
unsound and should not be continued at other financial institutions. The continuance of such practices
can warrant formal enforcement actions, such as CMPs.

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Similar Insider
Violations and
Enforcement Actions
Were Identified by
Federal Examiners in
Our Sample of Open
Banks

Note 1: The Securities and Exchange Commission, although not a bank regulator, has initiated
post-failure enforcement actions when it has been determined that bank insiders and other
parties violated antifraud, reporting, internal accounting, and other provisions of federal securities
laws.

Note 2: As of March 31, 1993, federal regulators had proposed, but had not yet taken, an
additional 26 enforcement actions.

"The Federal Reserve did not take any post-failure enforcement actions but had actions under consideration at the time of the bank failures.

DOCC is the only federal regulator that issues supervisory letters and letters of reprimand.

Source: Federal bank regulator data.

The number of post-failure enforcement actions that were taken varied by regulator. Occ took 90 percent of the post-failure enforcement actions. Occ also was more likely to issue several enforcement actions against individual former officers and directors. For example, on the basis of our analysis, we found that occ issued CMPS and removals and/or prohibitions simultaneously against 10 individuals.

When we reviewed the case studies of 13 generally financially safe and sound open banks, we found that federal examiners identified insider violations and took enforcement actions that were similar to those identified in our analysis of the failed banks. Although these problems were not severe enough to have affected the banks' financial health, such problems-if left uncorrected—could, in time, have major negative effects on the viability of these banks.

Insider Problems Frequently Contributed to
Bank Failures and Were Also Evident in
Open Banks

Review of Federal
Examinations Found
Insider Violations in
Sampled Open Banks

Although we did not find that the examiners identified evidence of insider fraud, insider abuse, or loan losses to insiders in our review of open banks, we found 10 of the banks in our sample had insider violations. The most common insider violation cited was preferential terms on loans to insiders, which was reported in six of the open banks. For example, an examination report cited two insiders as being granted automobile loans at preferential interest rates of 9 percent and 10.5 percent when regular bank customers were charged 12 percent and 13.5 percent, respectively, for identical automobile loans. (See table 2.9.)

Table 2.9: Insider Violations Found in the Open Banks as Identified by Bank Examiners

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Enforcement Actions in
Open Banks We Reviewed

In the 13 open banks we reviewed, regulators took 6 enforcement actions and recommended 4 others at 7 banks. Almost all of the enforcement actions taken or recommended were commitment letters or MOUS. The remaining six banks we reviewed had no enforcement actions for the

Insider Problems Frequently Contributed to
Bank Failures and Were Also Evident in
Open Banks

5-year period before and including the most recent examination for each bank.

Conclusions

On the basis of our analysis of the 286 banks that failed in 1990 and 1991, we found that FDIC investigators frequently identified banks with insider problems, such as insider fraud, insider abuse, and loan losses to insiders. We also found that federal regulators cited many insider violations and took many enforcement actions before and after these banks failed. Federal regulators may have been able to act more forcefully or in a more timely manner to compel bank management to address safety and soundness problems. However, such actions may be effective only when bank management is both capable and willing to address those problems identified by regulators. In chapter 3, we discuss how insider problems can indicate broader managerial problems.

Chapter 3

Insider Problems Are Indicative of Poor
Management Practices

On the basis of our analysis of the 175 failed banks that had insider problems, we believe that the failure of the banks' management and boards of directors to effectively address insider violations and other problems identified by examiners indicate a much larger problem. We believe the problem is poor administration by bank management and inadequate oversight by the boards of directors. Further analysis of the failed banks showed that a bank was more likely to be cited for a problem of poor management when it was also cited for an insider violation in the same examination.

In our review of 13 open banks, we found that examiners frequently identified management problems in those banks that were also cited for insider violations. We found negligent management and poor bank oversight to be the most significant problems in our analysis of both failed and open banks.

Banks Cited for
Insider Violations
Were More Likely to
Be Cited for Problems
Related to Poor
Management

Of the 175 failed banks that were cited by federal examiners for insider
violations, banks cited for insider violations were also more likely to be
identified by federal regulators for having various management problems.
To assess the underlying causes of insider problems, we used odds ratios.
Odds indicate the tendency for an outcome to occur, and odds ratios show
how much that tendency is affected by different factors. If there is no
difference in the odds across the factors that are compared, the odds ratio
will equal 1.0. The extent to which odds ratios are greater or less than 1.0
indicates how sizable the difference is across the factors that are
compared. Table 3.1 shows the ratios of the likelihood that a management
problem is cited given that an insider violation is also cited in the same
examination. A ratio greater than 1 means that it is more likely that a
particular management problem is cited when a particular insider violation
is cited than when an insider violation is not cited. Some of the odds ratios
are statistically significant.

For example, in our analyses we looked at the odds of a bank being cited for a dominant board member and then calculated odds ratios to determine how much those odds differed for banks that were also cited for excessive insider loans. One of the more significant findings is that when examiners cited loans to insiders exceeding the loan limits, they were four times more likely to cite the management problems of a dominant board member than when they did not cite loans to insiders

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