Judge recommends sustaining FDIC charges of unsafe and unsound banking practices

On January 11, 2017, an administrative law judge (ALJ) issued a 176-page recommended decision finding merit in the FDIC’s charges that a Texas banker engaged in unsafe and unsound banking practices and breached his fiduciary duties. The case arose out of the FDIC’s allegation that the Respondent ignored Bank policy and misused Bank resources by paying personal expenses from Bank funds, failing to keep adequate records of his expenses, and concealing information relating to his misuse of Bank funds. The ALJ sustained the FDIC’s charges and recommended that the Respondent be banned from banking activities and fined $200,000. The recommended decision contains important information for banks regarding proper business expense policies and the scope of unsafe and unsound practices.


The Respondent was the President of a community bank in Texas and currently serves as a director of the Bank. The FDIC accused the Respondent of using Bank funds to pay for personal expenses, including groceries, meals, liquor, home repairs, child care expenses, and non-Bank travel. The FDIC alleged that the Respondent did not comply with Bank policy in incurring and documenting these expenses, failed to keep records to substantiate the expenses, and concealed the expenses from the Bank’s board. The FDIC requested an order of removal and prohibition and a civil money penalty. In September 2016, the ALJ held a hearing and heard evidence from the FDIC and the Respondent. On January 11, 2017, the ALJ issued his recommended decision sustaining the FDIC’s charges.

Unsafe and Unsound Banking Practices

One of the interesting points in the ALJ’s decision is his brief discussion of the law on unsafe and unsound banking practices. As I have written about at length (here, here, and here) there is some disagreement between bank regulators and the courts regarding the definition of unsafe and unsound banking practices. As a reminder, the Gulf Federal standard is followed by certain courts and requires a showing that the challenged actions threatened the bank with failure. The Horne definition is the more lenient standard preferred by the regulators and defines unsafe and unsound practices to include “conduct deemed contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder.” The ALJ noted the tension between regulators and the courts and suggested that recent court cases “support [the FDIC’s] argument that the holding in Gulf Federal in defining what constitutes unsafe or unsound banking practices may be more limited.” But the ALJ declined to resolve the split, stating that he would sustain the FDIC’s charges under either definition.

Although the ALJ did not choose between the conflicting definitions, parts of his decision suggest that he leaned more heavily toward the Horne definition. For example, at the beginning of the decision, he quoted the Horne definition as the applicable standard for determining what constitutes an unsafe or unsound banking practice. He also relied on somewhat thin evidence to support the portion of his decision finding that the Respondent’s conduct caused a risk of bank failure. That evidence consisted primarily of findings that (a) the Respondent’s deviations from Bank policies “created the opportunity for unchecked exposure through withdrawals directly from the Bank’s general ledger and through unauditable debit and credit card expenditures”; and (b) expense practices that contributed to systematic degradations of the Bank’s CAMELS rating.

All of this suggests that banks should proceed under the assumption that regulators will continue to apply the more lenient Horne definition of unsafe and unsound practices. Of course, the Respondent has the opportunity to appeal the ALJ’s decision, ultimately to the same federal court of appeals that developed the Gulf Federal standard, so that may provide additional guidance.

Expense Management Practices

Another key takeaway from the ALJ’s decision is how the FDIC approaches expense management policies and practices. Useful information can be gleaned primarily from the ALJ’s summary of the testimony of Sonya Ramsey, the FDIC’s Case Manager for the Dallas Region. For example:

  • “If the bank is going to reimburse employees for something, it should be addressed under the bank policy[, which] should be approved by the board of directors.” Failure to have an expense policy and to consistently enforce it constitutes “weak internal controls” and “it’s not a prudent business practice.”
  • “A bank should have procedures in place where people in a position to make charges to a bank or pay for things at a bank provide support for those purchases to the bank to establish that they were, in fact bank expenses.” It may be a violation for the bank to pay even a proper business expense if it is lacking a receipt, and where necessary, an explanation of the expense.
  • The standard the FDIC uses when determining the business nature of a Bank expense is whether “the expense in question provides a direct or indirect benefit to the Bank that is obvious.” The burden of establishing that an expense is Bank-related is on the person incurring the expense.
  • “Bank supplies are things used during the conduct of business, so it would be office supplies, postage, forms, perhaps things . . . that the Bank needs to keep in the facilities, in the bathroom, paper towels in the break room, that kind of thing.” There is no formal policy, but this generally means “things that are slotted and classified under ‘overhead’ in General Ledger accounts when the Bank reports their condition and income.”
  • Regarding whether it is ever a reasonable bank expense to purchase alcohol for executives, Ms. Ramsey stated, “I can tell you that I haven’t seen it.”

Based on this testimony, banks, as a best practice, should have a formal policy regarding what qualifies as a proper business expenditure and how to document such expenditures, as well as adequate controls to monitor compliance with the policy. Additionally, banks need to be careful with borderline expenses, especially those involving alcohol (which should rarely be a business expense), meals (which must be directly related to conducting bank business), spouse travel (which should be approved by the board), and customer gifts (which must be specifically for business development and not just a gift to a friend who happens to be a customer).