Formal and informal enforcement proceedings by bank regulatory agencies can, and do, present significant challenges for bank management, staff, boards and other institution-affiliated parties. A number of visible, high-profile institutions have become the unfortunate recipients of bank agency enforcement activities, particularly in the current environment of enhanced risk management, antimoney laundering and controls oversight. These materials focus on the bank regulatory enforcement actions that become publicly disclosed, whether (1) directly by the agencies as a result of statutory disclosure requirements; (2) directly by the institution (due to shareholder or other disclosure obligations); or (3) indirectly as a result of improper discussions by bank insiders. As banks engage directly or indirectly in non-traditional expanded activities, such as providing insurance and securities products and services, it is also important to keep in mind that enforcement activities by other relevant state and federal agencies, such as the Securities and Exchange Commssion and state insurance regulators may come into play. Although not directly addressed in these materials, banks should be aware that actions by those agencies can also impact the institution and its constituencies.
While it always happens to the “other guy”, it is important to understand the regulatory enforcement process and how to react to minimize potential long-term adverse effects on the institution and its constituencies. While regulatory enforcement actions bring an unwanted environment of heightened shareholder, press, organizational and regulatory scrutiny, which can seem overwhelming, every cloud has a silver lining. If carefully managed, institutions (and their boards) can successfully emerge from regulatory enforcement proceedings stronger, better-positioned and with more industry and regulatory credibility than before the actions commenced. Important lessons are learned and important issues are resolved in the enforcement process, which may benefit the institution in the long run. The key lies in managing the process and not allowing the enforcement action to overly distract and divide the institution and its constituencies. Addressing the issues aggressively and head-on can actually serve to unite the constituencies in a common effort to enhance the credibility and reputation of the institution and its board and management. This will improve the overall performance of the institution, as well as enhance the value of the franchise and its position in the community and in the industry.
First and foremost, it is important to understand that while the initial reaction is often to become defensive and even hostile with the enforcement agency, the reality is that these actions do not occur in a vacuum; there is very likely a reasonable basis for the action arising as a result of long-time, unresolved, and probably valid, regulatory concerns. While some actions are instituted with little or no warning depending on the nature and severity of the underlying regulatory concern (such as recently-discovered significant fraud or loss), the vast majority of enforcement actions result from long-time unresolved regulatory concerns which have accrued over time and which, for better or for worse, the agency feels compelled to “turn up the heat”. It is important to keep in mind that there is generally no upside and no gain for regulators in the enforcement action process. It is a drain on their resources and can provide unwanted questioning of the adequacy of their prior oversight. In the best interests of all involved, it’s important to provide prompt recognition of the issues and establish a working relationship with the agencies to resolve whatever problems have arisen quickly.
A basic fact of life in the American banking industry, arguably the most highly-regulated industry in the world, is that it is absolutely critical to make certain that the regulatory agencies are comfortable with the institution and its board, management and operations. Although agencies aren’t perfect either, it is important to understand the operating environment and recognize that no institution helps its constituencies, including its shareholders, by trying to buck the system. The world of former banks and former bankers is littered with institutions and individuals who thought they could ignore regulatory concerns, operate in an openly hostile and confrontational fashion with banking agencies, try to politically override agency personnel, and generally “take on” the system. That attitude is often fatal in the banking industry. It is perfectly acceptable and expected that the institution and its board vigorously advocate on behalf of the institution and its constituencies. Absent overreaching by the agency or blatantly wrong facts, however, it is generally in the best interests of the institution to cooperate with the agencies to aggressively address and promptly resolve the underlying issues facing the institution so as to get on with the business of banking.
And, believe it or not, the interests of the agencies are nearly always consistent with those of the shareholders and other constituencies. It is also consistent with what should be, as well as the interests of the directors in discharging their fiduciary obligations. Once identified, those interests and concerns need to be addressed in a reasonable, prompt, objective and rational fashion.
Securing an objective analysis of the issues and potential avenues of resolution can be difficult, at best, without some form of outside perspective utilizing the services of professionals who are familiar with the enforcement process and its impact on institutions. Insiders with a vested interest in the issues and outcome may have significant difficulty remaining objective when their work is the subject of agency criticism and proposed change. Therefore, it is advisable to retain the services of outside professionals as early as possible when facing the likelihood of regulatory enforcement proceedings, so as to endeavor to secure an objective understanding of what is happening, negotiate the best possible posture for the institution, and prepare a viable response plan.
Regulatory enforcement proceedings impact virtually all areas of the organization and its operations in a variety of ways. Enforcement proceedings can trigger difficult conflicts of interest between the parent holding company and subsidiary organizations (and their respective boards), and also between institutions, shareholders, directors (individually and as a group), and management. Surviving regulatory enforcement proceedings requires an understanding of what these proceedings mean to the regulators, to the institution and its various constituencies. Prompt and effective resolution of the proceedings can serve to restore and enhance the overall credibility and reputation of the institution and its board and management, which can result in a stronger and more viable institution.
Types of Regulatory Enforcement Actions
Regulatory enforcement actions can take many forms and vary depending on their nature and severity. In its most basic form, the process begins with regular examination proceedings and required actions taken in response to exam findings. Examination proceedings and findings nearly always remain confidential between the organization and the agency. “Informal” actions, such as “voluntary” board resolutions and MOUs may or may not become publicly disclosed due to the underlying issues and actions. Care must be taken not to incorrectly disclose information, which can lead to civil and criminal penalties. “Formal” actions, however, such as written agreements, cease and desist orders, and certain consent orders are de facto subject to public disclosure by the agencies and often by the institutions. It is primarily the more “formal”, publicly-disclosed actions that have the greatest impact on the institution and its constituencies, and therefore are the actions that typically provide the greatest challenge for the organization.
Enforcement actions may require affirmative acts on the part of the institution and/or institution-affiliated parties (IAPs), such as review or removal of management or directors, restatement of financial reports and capital directives. Affirmative acts may also entail negative covenants by the institution and/or IAPs, such as no new acquisitions, suspension of dividends, elimination of a line of business and/or no new or expanded business activities. The requirements vary with the nature and extent of the agency concerns, and it is critical that institutions understand what is expected and when. Enforcement actions can be isolated, serial or cumulative, and the requirements can be intensified if agencies become concerned that the institution is not sufficiently responsive or if further concerns or deterioration is noted. There is no “one size fits all”, and front-end negotiation of the nature and severity of the enforcement action, if available, is important to assure that the institution is able to, in fact, comply with the duties and obligations imposed by the action in order to mitigate its impact on the institution and its constituencies.
Impact on the Institution and its Constituencies
Perhaps no other industry in the world is as vulnerable to “reputation risk” as banking. Non-public enforcement actions impact the institution by distracting the management, staff and board, resulting in internal tension and concern, but once enforcement actions become publicly disclosed, a multitude of additional issues arise that the institution must be prepared to address.
From depositor concern to shareholder unrest, once regulatory enforcement actions are disclosed to the public it becomes even more important to rapidly and aggressively confront and resolve the issues so that the institution can return to normal business operations. Public disclosure of regulatory enforcement actions can occur directly by agencies as required by applicable law; through shareholder disclosure obligations; or as a result of “loose lips”. Once disclosed, the challenges can become magnified and may exacerbate the very problems the institution and the agencies seek to resolve. Enforcement actions bring an environment of heightened scrutiny, from shareholders and regulators to the press, employees and competitors; and each of these constituencies has a vested interest in resolution of whatever problems have been identified.
The reaction of depositors and creditors can result in strained or eliminated funding availability, pricing pressures and increased cost of funds. Borrowers can sense a weakened lender and attempt to take advantage; shareholders may see a reduction in market value and liquidity and perhaps reduced or eliminated dividends; competitors may take aim at good customers and employees; and potential acquirors may become emboldened to undertake aggressive overtures to acquire the institution in its weakened state. Operating costs increase in an effort to address the issues, while revenues and funding sources may decline as a result of customer and creditor concern. Agencies can, and sometimes do, impose significant civil money penalties and fines for noncompliance, which can represent personal liability for IAPs. There is virtually no area of bank operations or governance that is not somehow impacted by the imposition of enforcement actions. Therefore, proper management of the enforcement action and its impact on the institution is critical to navigate the multitude of resulting challenges and successfully resolve the outstanding issues. This will ensure the ongoing viability and, if desired, independence of the organization.
As noted previously, regulatory enforcement actions can result in significant personal financial, and even criminal liability for bank management, boards and other “institution-affiliated parties”. Civil money penalties can run in the millions of dollars per violation, per day, and industry headlines are replete with imposition of multi-million dollar fines by regulatory agencies. Shareholder lawsuits against directors can result in multi-million dollar personal judgments.
All the more reason to address enforcement actions head-on, and to resolve and seek relief from enforcement actions promptly, aggressively and effectively.
Responding to Regulatory Enforcement Actions
It is critical to keep the enforcement action in perspective and to avoid making matters worse through an openly hostile, confrontational and adversarial relationship with the regulatory agencies. It is equally critical to avoid internal finger-pointing and hostility within the institution. Establishing immediate credibility with the agencies is paramount and will provide long-term dividends to the institution. Recognizing problems and addressing them before they result in enforcement proceedings is obviously the preferred route, but once proceedings have commenced, the institution should promptly establish a credible, open plan for resolution of the issues, which is the key to successful survival. Establishment of an open and ongoing dialogue with agency personnel is one of the first steps. It’s also important to use individuals with strong regulatory credibility and preferably extensive experience in dealing with enforcement actions to work with the institution and its board. They will lay the groundwork for identifying and addressing the specific agency concerns. Communication is critical, and a lack of credible communication, whether real or perceived, will prolong and likely worsen the situation.
Additionally, it is important to document compliance with enforcement actions and be able to support responses to the elements of the actions in a real fashion. Care must be taken to avoid superficial and nonsubstantive attempts to appear responsive while not really addressing the underlying concerns. Ongoing written updates and responses should be filed with the agencies on a timely basis in an understandable, clear and concise format. If problems arise that may cause delay in response or an inability to hit designated compliance targets, it is important to make contact with the agency as early as possible to discuss resolution of the matter rather than simply avoid the matter and hope that it will go unnoticed. Communication and credibility are the keys, and it is critical that the institution maintain an ongoing dialogue with the agencies in order to avoid misunderstandings and misperceptions.
Fixing the problem so that the institution can get back to the business of banking is, or certainly should be, a critical priority for the board and management.
It is critical to ascertain that the institution speaks with one voice to the agencies, customers, employees, shareholders and the public. Inconsistent statements and positions can be devastating and will result in further eroding credibility at a time when institutional and board credibility is most important, and also most vulnerable. Inconsistent statements and positions can also result in substantial litigation concerns. The same consistent singleness of voice and action pertains to acquisition overtures that may arise during this troubled period. While the position of the institution may change as circumstances change, and boards must remain flexible to address changed circumstances, an acquisition taken under the cloud of a pending regulatory enforcement action may not result in a transaction that is in the best interests of the constituencies of the organization. The institution must take a position and must adhere to it in a consistent manner to avoid weakening the negotiating posture of the institution, which sends mixed messages at an extremely vulnerable time in the life of the organization. To do otherwise may generate results that the institution and its management and board hope to avoid.
While operating under regulatory enforcement proceedings may present the most challenging environment in the history of the target institution, it need not signal the end of the institution as a viable and independent going concern. It can be an opportunity to implement important changes which, many times, have been a long time coming. If properly managed, objectively addressing and resolving enforcement proceedings can result in a stronger, more credible and more viable surviving institution with enhanced potential for long-term growth and recognition in the market.