Capital Directives: Obey 'Em or Else!

Banks concerned about minimum capital-ratio requirements should be alert to a court decision that will have major impact on the way the Federal Deposit Insurance Corp. and other regulators administer this regulation.

The May 13 decision, by the U.S. Court of Appeals for the Fifth Circuit, New Orleans, involves several important issues that had never been addressed by any other court.

This case focuses on the authority of the FDIC over the Bank of Coushatta. But the reasoning and conclusions expressed in the opinion will have an equal effect on the use of capital directives by the other bank regulatory agencies.

At issue is the FDIC's decision to issue a capital directive against a bank for failure to comply with the capital maintenance requirements set forth in the regulation.

What the Banks Lose

The Coushatta opinion makes three distinct conclusions regarding this decision:

* The bank is not entitled to any type of hearing before an impartial or neutral officer regarding the factual basis upon which the directive is predicated and/or the reasonableness of the terms of the directive.

* The bank is not entitled to obtain any type of judicial review of the decision and action of the agency to issue the capital directive.

* The issuance of a capital directive without the benefit of any hearing and without the right of any type of judicial review does not violate the due-process requirements of the Fifth Amendment of the Constitution.

The court determined that the FDIC's decision to issue a capital directive is final and unreviewable. Issuance of such a directive is therefore committed to the exclusive "discretion and expertise" of the agency. Period.

Legislative Background

The authority of federal banking agencies to issue capital directives is based on legislation enacted by Congress. It was expressly designed to overrule a decision of the same appellate court that issued the Coushatta decision.

The Comptroller of the Currency had sought to issue a cease-and-desist order against the First National Bank of Bellaire. This order required the bank, among other things, to maintain a specified minimum capital ratio.

The Fifth Circuit ruled in 1983 that this requirement in the order, for a minimum capital ratio, was not supported by substantial evidence.

Congress acted immediately to reverse the Bellaire decision with the enactment of the International Lending Supervision Act of 1983.

The lending supervision law authorizes each agency "to establish such minimum level of capital for a banking institution" as the agency "in its discretion, deems necessary or appropriate.

Role for Directives

It authorizes each agency to determine that the "failure of a banking institution to maintain capital at or above" the minimum level prescribed by the agency constitutes an "unsafe or unsound practice."

This 1983 law authorizes each agency to issue a directive requiring the banking institution to submit and adhere to an acceptable plan for achieving its required capital level.

The agencies were further authorized to interpret and define the terms used in the International Lending Supervision Act of 1983 and to prescribe rules and regulations or issue orders as necessary. Section 325.6 of the FDIC rules and regulations governs the issuance of capital directives by the FDIC. It was adopted in the implementation of section 908 of the lending supervision act.

The potential consequences of the Coushatta decision are profound. They must not be ignored or otherwise minimized by bank officers and directors charged with managing the affairs of banking institutions subject to federal regulation.

No Authority over Individuals

Consider the fact that a capital directive can be issued only to the corporate entity of the bank. The agency does not have the authority to issue a directive to individual bank officers, directors, or shareholders, requiring them to purchase additional stock or to assume personal responsibility for fulfilling the capital needs of the bank.

The enforcement sanctions may be both criminal and civil. For example, a capital directive can be enforced by court order requiring compliance. Violation of such order could result in a criminal contempt citation with an attendant fine or sentence.

A very dangerous compliance and enforcement scenario thus emerges, as a result of the Coushatta decision. The agency has the unfettered discretionary authority to issue a capital directive against the bank.

Subsequently, the agency can enforce the requirements of the directive by initiating certain types of actions against one or more individuals. These actions can result in either criminal or civil penalties, or both.

This can only be viewed as an extremely hazardous situation for any director or officer of a bank that may be vulnerable to the issuance of a capital directive by the FDIC.

More Directives Likely

Predictions are always perilous. But it is probably a safe bet that there will be an increase in the number of capital directives issued to banks as a result of the Coushatta opinion.

The notice of charges requires giving the bank an opportunity to contest the allegations in a hearing before an impartial judge. The bank also has a right to see the independent review of any final agency action by a court of competent jurisdiction.

Use of the directive does grant these rights. If the Coushatta decision becomes final and nonappealable, I predict that the federal banking agencies will opt for the path of least resistance. They will accept the invitation embodied in the decision to issue capital directives - without fear of any charge that they are violating due process of law.

At the same time, of course, there will be a corresponding decrease in use of the cease-and-desist power to administer the minimum-capital-maintenance requirements imposed on all insured banks.

Hopefully, a petition to the Supreme Court will be filed for the review of the Coushatta decision. It is also hopeful that such petition will be granted, and that the petitioners are successful in reversing the decision of the Fifth Circuit.

In the meantime, specific measures should be undertaken immediately to reduce any risk of the issuance of a capital directive. The failure to do so could have very dire and costly consequences.

Stephens B. Woodrough, an attorney in private practice in Atlanta, was regional counsel of the Federal Deposit Insurance Corp.'s Atlanta region from 1973 to 1989.

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