Bankers Digest Article: Understanding and Avoiding Unsafe and Unsound Banking Practices

I’m honored that Bankers Digest has published my article, “Understanding and Avoiding Unsafe and Unsound Banking Practices,” in this week’s issue.  The article expands on my two posts (Part 1 and Part 2) about recent developments in this area of the law.  The full article is available here and is reproduced below.

Understanding and Avoiding Unsafe and Unsound Banking Practices

Tyler Bexley,
Reese Gordon Marketos LLP, Dallas, Texas

As every banker knows, federal regulations prohibit banks and their officers and directors from engaging in “unsafe or unsound banking practices.” But the phrase “unsafe and unsound banking practice” is not defined in the federal regulations. So what exactly is an “unsafe or unsound banking practice”? The authoritative historical definition comes from a memorandum submitted to Congress by John Horne, then the chairman of he Bank Board: Generally speaking, “unsafe or unsound practice” includes any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.

The regulators have consistently used the Horne definition in enforcement proceedings, but federal courts have expressed disagreement, suggesting that unsafe and unsound practices should be limited to actions that threaten the financial condition of a bank.

The conflict between the regulators and the courts came to a head a few years ago in an OCC enforcement action against Patrick Adams. The OCC accused Mr. Adams, then the President and CEO of Dallas-based T-Bank, of unsafe and unsound practices stemming from his management of the bank’s relationship with a processor of remotely created checks. After a rare administrative trial, the OCC’s Administrative Law Judge (ALJ) dismissed the OCC’s claims and completely exonerated Mr. Adams. The ALJ rejected the OCC’s definition of unsafe and unsound practices (the Horne definition), relying on guidance from federal courts to define an unsafe or unsound practice as conduct that threatens the financial stability of the bank. The ALJ also took issue with the OCC’s aggressive enforcement action in the absence of guidance surrounding remotely created checks. The OCC appealed to the Comptroller, who rejected the ALJ’s definition of unsafe and unsound practices and instead reiterated the long-standing Horne definition. The Comptroller, moreover, upheld the dismissal of charges against Mr. Adams on equitable grounds, preventing the court of appeals from reviewing the case.

The Adams case provides the most recent comprehensive guidance from a regulator as to what constitutes an unsafe and unsound practice. Unfortunately, the OCC’s definition allows the regulators to determine after-the-fact and with little advanced guidance whether a given practice is unsafe or unsound. Because of the lack of concrete rules or guidance, banks should look to recent enforcement actions to get a clearer picture of what the regulators consider unsafe and unsound.

The following are some of the recent actions and omissions by bank officers and directors that have drawn enforcement actions from the regulators:

• Failing to follow the loan approval process, provide accurate information to the loan committee, adequately monitor loans, ensure independent inspections on construction loans, ensure compliance with loan ovenants, and obtain accurate collateral valuations.

• Extending nonperforming loans while failing to obtain an appraisal or a personal guaranty, allowing the borrower to make interest-only payments, and knowing that a borrower had previously defaulted and had no ability to repay the loan.

• Disregarding bank policy in the allocation of bank funds for civic contributions.

• Misrepresenting personal assets and liabilities in order to obtain a loan from the bank.

As these recent actions illustrate, banks can minimize risk by establishing a comprehensive diligence policy, ensuring that the policy is consistently followed, and documenting compliance with the policy in each loan file. Banks should also avoid any loans or other transactions that give even an appearance of a conflict of interest. For example, loans to directors and senior officers, while permissible, are fraught with risk, which banks can avoid by declining to make such loans. Although the regulators have broad discretion in defining and taking action against unsafe and unsound practices, following these common sense practices goes a long way in helping banks minimize the risk of an enforcement action.


About the author: Tyler Bexley is a commercial litigation attorney at Reese Gordon Marketos LLP in Dallas, TX. He represents community banks and their officers and directors in litigation and enforcement proceedings. He also authors a blog that follows recent trends in banking litigation, regulation, and enforcement He may be contacted at 214.382.9805.