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OVERSIGHT HEARINGS INTO THE EFFECTIVENESS
OF FEDERAL BANK REGULATION
(Franklin National Bank Failure)
HEARINGS
BEFORE A
SUBCOMMITTEE OF THE
COMMITTEE ON
GOYEENMENT OPERATIONS
HOUSE OF EEPEESENTATIYES
NINETY-FOURTH CONGRESS
SECOND SESSION
FEBRUARY 10; MAY 25, 26; AND JUNE 1, 1976
Printed for the use of the Committee on Government Operations
U.S. GOVERNMENT PRINTING OFFICE
74-M8
WASHINGTON : 1976
C O M M I T T E E ON G O V E R N M E N T O P E R A T I O N S
J A C K BROOKS, Texas, Chairman
L. H. FOUNTAIN, North Carolina
F R A N K HORTON, New York
J O H N E. MOSS, California
J O H N N. ERLENBORN, Illinois
D A N T E B. FASCELL, F l o r i d a
J O H N W. WYDLER, New York
1
T O R B E R T H. MACDONALD, Massachusetts CLARENCE J. BROWN, Ohio
W I L L I A M S. MOORHEAD, Pennsylvania
G I L B E R T GUDE, Maryland
WM. J . RANDALL, Missouri
P A U L N. McCLOSKEY, J R . , California
SAM S T E I G E R , Arizona
B E N J A M I N S. ROSENTHAL, New York
J I M W R I G H T , Texas
GARRY BROWN, Michigan
F E R N A N D J . ST GERMAIN, Rhode Island
C H A R L E S THONE, Nebraska
ALAN STEELMAN, Texas
FLOYD V. H I C K S , W a s h i n g t o n
DON FUQUA, Florida
J O E L P R I T C H A R D , Washington
J O H N CONYERS, JR., Michigan
E D W I N B. F O R S Y T H E , New Jersey
R O B E R T W. KASTEN, J R . , Wisconsin
B E L L A S. ABZUG, New York
J A M E S V. STANTON, Ohio
W I L L I S D. GRADISON, J R . , Ohio
LEO J. RYAN, California
CARDISS COLLINS, Illinois
J O H N L. BURTON, California
RICHARDSON P R E Y E R , North Carolina
M I C H A E L HARRINGTON, M a s s a c h u s e t t s
R O B E R T F . DRINAN, Massachusetts
EDWARD MEZVINSKY, Iowa
BARBARA JORDAN, Texas
GLENN E N G L I S H , Oklahoma
E L L I O T T H. L E V I T A S , Georgia
DAVID W. EVANS, I n d i a n a
ANTHONY MOFFEiTT, Connecticut
ANDREW MAGUIRE, New Jersey
L E S A S P I N , Wisconsin
W I L L I A M M. J O N E S , General Counsel
J O H N E. MOORE, Staff
Administrator
W I L L I A M H. COPENHAVER, Associate
Counsel
L Y N N E H I G G I N B O T H A M , Clerk
J. P . CARLSON, Minority
Counsel
COMMERCE, CONSUMER, AND MONETARY A F F A I R S SUBCOMMITTEE
B E N J A M I N S. ROSENTHAL, New York, Chairman
CARDISS COLLINS, Illinois
GARRY BROWN, Michigan
R O B E R T F . DRINAN, Massachusetts
W I L L I S D. GRADISON, J R . , Ohio
E L L I O T T H. L E V I T A S , Georgia
J O H N N. ERLENBORN, Illinois
DAVID W. EVANS, I n d i a n a
ANTHONY M O F F E T T , Connecticut
A N D R E W MAGUIRE, New Jersey
E D W A R D MEZVINSKY, I o w a
EX OFFICIO
JACK BROOKS, Texas
F R A N K HORTON, New York
P E T E R S. BARASH, Staff Director
H E R S C H E L F . CLESNER, Chief Counsel
ROBERT H. DUGGER,
Economist
RONALD A. K L E M P N E R , Counsel
J E A N S. P E R W I N , Counsel
D O R I S F A T E TAYLOR, Clerk
ELEANOR M. VANYO, Assistant
1
Deceased May 21, 1976.
(II)
Clerk
CONTENTS
Pa e
Hearings held on—
^
F e b r u a r y 10
I
M a y 25
57
M a y 26
109
June 1
147
S t a t e m e n t of—
Donner, Aaron B., former director, First National B a n k of E a s t Islip,
Long Island, N . Y
94
Greene, Theodore J., a t t o r n e y
98
Heinemann, H . Erich, former vice president, Franklin National Bank_
117
Hoppler, H e n r y L. and C. T h o m a s Metz, subcommittee staff investigators, on detail from t h e General Accounting Office
58
Luftig, Paul, former president, Franklin National B a n k ; accompanied
b y Samuel R. Pierce, Jr., counsel
135;
R o t h , Arthur T., former chairman of t h e board, Franklin National
Bank
2
Rosenthal, Benjamin S., a Representative in Congress from t h e State
of New York, and chairman, Commerce, Consumer, and M o n e t a r y
Affairs Subcommittee: Opening s t a t e m e n t
1
Smith, J a m e s E., Comptroller of t h e Currency; accompanied b y
Charles Van Horn, Regional Administrator of National Banks,
Second National Bank Region; and J o h n Fleming, National Bank
Examiner
14$
Weatherstone, Dennis, senior vice president, Morgan G u a r a n t y T r u s t
Co.; accompanied by F r a n k Moselet of Davis, Polk & Wardwell__
10&
Letters, statements, etc., submitted for the record b y —
Heinemann, H. Erich, former vice president, Franklin National B a n k :
Charts which show a n u m b e r of money m a r k e t interest rates and
how the.y related one to t h e other
119-120*
M a y 1, 1974, letter to Paul Luftig, president, Franklin National
Bank, from Gordon J. Crook, president, Lesta Research, Inc.,
re conclusions and recommendations for t h e future
124-127
Hoppler, H e n r y L. and C. T h o m a s Metz, subcommittee staff investigators, on detail from t h e General Accounting Office: Prepared
72-93.
statement
Rosenthal, Hon. Benjamin S., a Representative in Congress from t h e
State of New York, and chairman, Commerce, Consumer, and
M o n e t a r y Affairs Subcommittee: J u n e 1, 1972. letter to board of
directors, First National Bank of E a s t Islip, E a s t Islip, N . Y . , from
Gerald H . Lipkin. D e p u t y Reaional Administrator of National
Banks, re report of examination of the bank
^
105-10(>
R o t h , Arthur T., former chairman of the board, Franklin National
Bank:
April 27, 1972, letter to shareholders concerning problems of t h e
b a n k and actions to be taken to resolve problems
4-«>
Article from F o r t u n e magazine of October 1974, entitled " W h a t
Really W e n t Wrong a t Franklin N a t i o n a l "
34.-45
Article from t h e Wall Street Journal of February 10, 1976, entitled
"Review & Outlook—Bored b y t h e Bank F l a p "
51
July 18, 1972, letter to Laurence A. Tisch, director, Franklin
New York Corp., re Michele Sindona of Milan, Italy
7-&
Material relative to t h e hearings
45-5$
October 13, 1972, letter to Chairman Arthur F. Burns, Federal
Reserve Board, re speculation and overexpansion
31!
October 25, 1972, m e m o r a n d u m concerning meeting with Michele
Sindona
,__
&
Smith, James E., Comptroller of the Currency:
Amount of personnel in the Securities Disclosure Division of t h e
Law D e p a r t m e n t
165'
Meeting arrangements with Mr. Sindona
177
Prepared s t a t e m e n t
180-19&
APPENDIX
Additional material and correspondence submitted for the record
(in)
195
OVERSIGHT HEARINGS INTO THE EFFECTIVENESS OF
FEDERAL BANK REGULATION
(Franklin National Bank Failure)
TUESDAY, PEBBUABY 10, 1976
HOUSE OF REPRESENTATIVES,
COMMERCE, CONSUMER,
AND MONETARY AFFAIRS SUBCOMMITTEE
OF THE COMMITTEE ON GOVERNMENT OPERATIONS,
Washington^ D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in room
2247, Kayburn House Office Building, Hon. Benjamin S. Rosenthal
(chairman of the subcommittee) presiding.
Present: Representatives Benjamin S. Rosenthal, Cardiss Collins,
Elliott H. Levitas, Edward Mezvinsky, Garry Brown, Willis D. Gradison, Jr., and John N. Erlenborn.
Also present: Peter S. Barash, staff director; Robert H. Dugger,
economist; Ronald A. Klempner, counsel; Eleanor M. Vanyo, assistant
clerk; and Henry C. Ruempler, minority professional staff, Committee
on Government Operations.
OPENING STATEMENT 0E CHAIRMAN ROSENTHAL
Mr. ROSENTHAL. The subcommittee will be in order.
The Subcommittee on Commerce, Consumer, and Monetary Affairs,
pursuant to its oversight responsibilities, is continuing its investigation of the adequacy and effectiveness of Federal supervision and regulation of commercial banks. As a part of its investigation, the subcommittee is taking a close look at the way in which Federal bank
regulators have handled the management and financial difficulties that
confronted and eventually caused the failure of Franklin National
Bank.
Today's hearing is the first of a series of hearings into the Franklin
National situation. Arthur Roth, chairman of the board of Franklin
National Bank until 1968 and a major stockholder, will testify today
concerning the origins of the bank's problems, his knowledge of the
regulatory responses to those problems, and, in his opinion, the adequacy of the banking services being offered by European-American
Bank, the successor bank to Franklin National.
Mr. Roth, we are very pleased that you could be with us. You may
begin your testimony.
(1)
2
STATEMENT OP ARTHUR T. ROTH, FORMER CHAIRMAN OF THE
BOARD, FRANKLIN NATIONAL BANK
Mr. ROTH. Thank you, Mr. Chairman.
Mr. ROSENTHAL. Mr. Roth, if you have no objection, would you
please stand and take this oath.
Do you solemnly swear that the testimony you are about to give
this subcommittee will be the truth, the whole truth, and nothing but
the truth, so help you God ?
Mr. ROTH. I
do.
Mr. ROSENTHAL. Thank you. You may proceed.
Mr. ROTH. Mr. Chairman, I am one banker who is glad to see this
investigation of banking and the supervisory agencies. Much good can
come of this. I t will result in a stronger and safer banking system.
But I must warn, in taking corrective action, that we do not cause
overkill. Because there has been laxity and negligence, don't set up
an ICC-type of agency which will ruin banking and ruin the economy
of our country. That can very easily happen.
I t is the strengthening of our existing supervisory agencies that is
needed. They have been lax and they have been negligent. And it is
more disclosure, such as this, that is required.
Above all, I would like to say that the Federal Deposit Insurance
Corporation must never, never allow a depositor in the United States
t o lose money. If that does occur, fear is going to set in and they are
going to worry about the biggest banks in the country. So the F D I C
must pursue the kind of action that they have pursued in recent months
of seeing to it that the depositors are made whole.
Now I will cover these things in detail, but I would like to give
some background about myself. I am 70 years of age, and I am retired.
My banking career started in 1923 with Manufacturers Trust Co. as a
messenger.
I n 1930, I spent Thanksgiving Day, and a period of about 1 month,
in the city of Toledo, Ohio, which was the hardest hit city in bank
closings in the United States at that time. I n that big city, there were
only two small banks that were left open. I was a part of team of five
that went there to help to reopen the banks in the city of Toledo.
I n 1931 I was in charge of the operations of the merger of the Chatt a m and Phoenix National Bank with Manufacturers Trust Co.
I had activity with Manufacturers Trust Co. in the many openings
of closed banks and the mergers that took place. I also had activity
with them during the bank holiday.
I was the so-called efficiency expert. My iob, which I did not like,
was to fire people. But it was necessary at that time in order to save
banks.
On April 30, 1934, I came to Franklin Square National Bank. I t
was a very small bank. There were five people. Their deposits were
$470,000. I t was insolvent at that time,
I moved to this small bank because my wife was a country girl and
w^as expecting our first child. So I wanted to go to the country. Also,
T couldn't take the firing of people, which, as I said, was my job at
Manufacturers Trust Co.
As you know. Franklin National Bank became one of the great
banks of the United States, and one of the great banks of the world.
3
For a period of 20 years, net profits after taxes were over 20 percent
on capital equity.
Mr. ROSENTHAL. W h a t was your position with the bank during that
period of time ?
Mr. R O T H . I was always the chief executive officer of the bank from
the very time I came with the Franklin Square National Bank. Even
though my title upon entering the bank was "cashier," it was, nevertheless, chief executive officer.
Mr. ROSENTHAL. During that period of time, the assets of that bank
went from what amount in what year to what amount at the time you
left the bank?
Mr. ROTH. The day I entered it in 1934, the deposits were $470,000.
They were $2 billion in 1968 when I was forced out.
Mr. ROSENTHAL. Were you also a stockholder in the bank?
Mr. ROTH. I was a large stockholder. There are 70,000 shares in the
family.
At age 62, I employed a firm to search for a successor to me. I t
was mandatory that I retire at age 65.
Mr. ROSENTHAL. W h a t year was that ?
Mr. ROTH. That was 1967.
Mr. BROWN. Mr. Roth, may I clarify this? I n 1967 you were 62,
and you were required to retire at age 65. So you would have been
required to retire in 1970. Is that right ?
Mr. ROTH. I would have been required to retire at the end of 1970;
yes. T h a t is right.
During the time that we were searching for a successor to me, Harold
Gleason pressured me constantly and said that he felt that he should
be the one to succeed me. For a while, I thought perhaps this was
so. But then I realized that he was not competent, and I told him
that he was not competent to succeed me.
Mr. LEVITAS. Who was Gleason ?
Mr. ROTH. Harold V. Gleason was the president of the bank at that
particular time. And he is the one primarily responsible for the downfall of Franklin National Bank. This was through his incompetence.
I also told Gleason that there were two directors, Merkin and Hein,
who were bad directors and that they should be removed from the
bank. My telling Gleason he was not competent to succeed me and that
two other directors were bad directors started the conspiracy to push
me out of the bank. They did so in July of 1968. They did so by
changing the bylaws of the bank to state that the president was
the chief executive officer and the chairman of the board, which title
I held, had no duties whatsoever except as a paper chairman to preside at board meetings.
I actually left the bank as paper chairman of the board in early
1970 when my name was not placed in nomination as a director.
Although I felt very strongly that Gleason was not competent, I
kept silent for 2 years. And of course the earnings of the bank increased substantiallv in those 2 vears. For example, in 1968, there were
$13,300,000; in 1969, it was $18 million; in 1970, it was $19,600,000.
And then thev started to fall off. I n 1971, it was $15,400,000 and in
1972 it was $11,200,000.
The reason for the increase was solely the momentum that the bank
had. I t had nothing to do with Gleason's being in charge. H e started
to do the damage immediately, but it was not seen until 1971.
4
I n November of 1971, I wrote a letter to Mr. Tisch of Loews, a
director owning over 20 percent of the common stock, and said: "You
must be seeing what is happening at Franklin National Bank. You
are an astute businessman. T h e earnings of the bank are declining*
You are a substantial stockholder and I am looking to you to take the
necessary corrective action.
Mr. EOSENTHAL. A t that time, you and your family owned 70,000
shares?
Mr. ROTH. Yes; 70,000 shares.
Mr. KOSENTHALU How much were they worth ?
Mr. ROTH. They were worth close to $3 million.
Mr. Tisch h a d his attorney answer me. But of course he was on
the spot. If he took more than the usual responsibility of a director,
his Loews might have been declared to be a bank holding company—
which he did not want to see happen. H i s attorney said that ne was
carrying out his responsibility just the same as any other director of
the bank,
I received the annual report of the bank around March of 1971,
This was the report for the year ending December 31,1970.1 analyzed
the report. After analyzing it, I decided to write a letter to the shareholders of the bank. I t was distributed at a meeting of the shareholders.
And the day before the shareholders' meeting, it was mailed to all of
the supervisory authorities—the Federal Eeserve Board, the Federal
Deposit Insurance Corporation, the State Banking Department, and
the Comptroller of the Currency.
I would like to read that letter to you. I t is dated April 27,1972.
When I retired from Franklin National Bank, I resolved that because of my
long influence over the bank
I would not attend meetings of stockholders. However, I am shocked by wThat has been happening at the bank. Therefore, I have
decided to write this letter to you.
The upward momentum of the bank has stopped. It is now declining and
immediate drastic action is required in order to reverse this adverse trend.
The annual report shows the following: (1) A substantial reduction in earnings; (2) a heavy loan loss; (3) $32,500,000 in tax loss carryovers, which good
accounting practice dictates should not have been capitalized, but should have
been charged off; (4) a similarity in some respects with the Bank of the Commonwealth of Detroit, Michigan, and their problems with regard to a heavy concentration in municipal securities and municipal deposits which now have adverse
effects upon the bank's liquidity and earnings : (5) overstating which has caused
high salary expenses accompanied by heavy occupancy and equipment costs.
This overstaffing ran to almost 1,000 employees. There was $15
million wasted, when you consider space costs and all the other additional costs.
Mr. EOSENTHAL. Without objection, this letter, dated April 27,1972,
will be included in the record.
[The letter referred to follows:]
To: Shareholders of Franklin New York Corporation Assembled at their Annual
Stockholders Meeting held at the Barbizon-Plaza Hotel, 106 Central Park
South, New York, New York, on April 27,1972.
From: Arthur T. Roth.
When I retired from Franklin National Bank, I resolved that because of my
long influence over the bank, I would not attend meetings of stockholders. However, I am shocked by what has been happening at the bank. Therefore, I have
decided to write this letter to you.
The upward momentum of the bank has stopped. It is now declining and
immediate drastic action is required in order to reverse this adverse trend.
The Annual Report shows the following:
5
1. A substantial reduction in earnings.
2. A heavy loan loss.
3. $32,500,000 in tax loss carry-overs which good accounting practice
dictates should not have been capitalized but should have been charged off.
4. A .similarity in some respects with the Bank of the Commonwealth of
Detroit, Michigan, in their problems with regard to a heavy concentration in
municipal securities and deposits which now have adverse effects upon the
bank's liquidity and earnings.
5. Overstafiing which has caused high salary expenses accompanied by
heavy occupancy and equipment costs.
In addition to the aforesaid, there are intangible losses which have an important effect upon the successful operation of the bank. Morale is low; there
is a lack of communication; there is a lack of confidence in top management;
there is a lack of confidence in most of the directors and many good officers are
leaving. This bank always enjoyed a very high esprit de corps which was one
of its great assets. This asset no longer exists.
What is to be done? There must be an immediate change in top management.
Also, there must be a change in the majority of the directors.
How is this corrective action to be accomplished ? There are four general areas
that we must look to for this needed corrective action :
First: The primary responsibility should rest with the Board of Directors. I
have stated that a majority of the Board needs to be changed. This majority will
not purge themselves nor purge management.
Second: We must also look to the banking supervisory authorities, the Office
of the Comptroller of the Currency, the
Federal Reserve Board and the Federal
Deposit Insurance Corporation. I wTould hope that their action would not be
unduly delayed nor that their action will be less than sufficient in nature.
Third: Mr. Laurence A. Tisch who represents Loews Corporation on the Board
of Directors of the Franklin New York Corporation, which owns 20.2 percent of
the outstanding voting securities of Franklin should be a prime mover for needed
action. However, in order for Mr. Tisch to take action, it will be necessary for him
to resign from the Board of Directors of Franklin, otherwise Loews will risk
being declared a bank holding company which will be to their disadvantage. When
Loews purchased this substantial interest in the bank, they assumed a responsibility to take a leadership role in the interests of the stockholders.
Fourth: Stockholder action should not be needed, as it is both costly and time
consuming and will cause a great deal of adverse publicity for the bank. I am
sure that the vast majority of stockholders would act for a change in management and directors if it is decided to take stockholder action.
What can be done today at the annual meeting? I believe that it is fitting and
proper at this time to request that the Board of Directors agree now, at this
annual meeting, to call a special meeting of the shareholders to be held three
months from this date, on Thursday, July 27th, 1972. This entire special meeting
should be devoted to discussing the condition of the bank at that time and the
corrective action which has been taken to rectify the deficiencies. To wait a full
year for another meeting of shareholders is too long.
Yours for a better Franklin,
ARTHUR T. ROTH,
Dated: April 27,1972.
c/o Bracken and Jacoppi, Esqs.,
191f Maine Street, East Setauket, N.Y.
Mr. ROSENTHAL. YOU said this letter was sent to the Comptroller of
the Currency and the Federal Reserve. To whom else, in addition to
the shareholders, was it sent ?
Mr. ROTH. The Federal Deposit Insurance Corporation and the State
banking authorities.
Mr. ROSENTHAL. Subsequent to that, did you at any time write to the
Comptroller of the Currency or the other Federal regulatory
authorities ?
Mr. ROTH. Yes; I did.
Mr. ROSENTHAL. Tell us about that.
Mr. ROTH. Don't you want me to cover this letter ?
Mr. ROSENTHAL. We will put it in the record. I think
if we go through a narrative.
it will be better
6
Mr.
mind.
ROTH.
I would like to read one part of this letter, if you don't
Mr. ROSENTHAL. G O ahead.
Mr.
ROTH.
I said :
What is to be done about this situation? The primary responsibility should
rest with the Board of Directors. I have stated that the majority of the Board
needs to be changed. This majority will not purge themselves nor purge management. We must look to the banking supervisory authorities—the Office of the
Comptroller of the Currency, the Federal Reserve Board, and the Federal Deposit
Insurance Corporation. I hope that their action would not be unduly delayed nor
that their action will be less than sufficient in nature.
T h a t is the section that I wanted to read to you. T h a t is the warning
that I gave to them. I sent it to them and it received headline publicity in the newspapers.
Mr. ROSENTHAL. Tell us what happened. Did you receive a response ?
Did you write a second letter ? What happened ?
Mr. ROTH. I received only indirect response to this letter. These
were responses such as: "You are out of the bank and have been out for
a couple of years. W h y don't you keep your mouth shut and let them
run the bank?" Eeactions such as that were the responses that I
received.
Mr. BROWN. Mr. Roth, the letter was sent to shareholders, with copies to the regulatory agencies. Is that correct ? This was not a letter
to the regulatory agencies.
Mr. R O T H . N O ; it was a letter to the shareholders, but it was sent to
the regulatory agencies. That is right.
Mr. ROSENTHAL. Did you write to the Federal regulators at any
point in time ?
Mr. ROTH. I wrote directly to the regulators.
Mr. ROSENTHAL. T O whom did you write and when did you write ?
Mr. ROTH. I only sent copies of material to the regulators and asked
them to acknowledge receipt of it. F o r example, a few months after
this letter that went to the shareholders, Mr. Sindona bought the Loews
stock from Tisch. I t was at that time that I wrote a letter to Mr. Tisch
and sent the copies of the letter by registered mail to the regulators.
And of course Mr. Sindona, to a large extent, is the straw that broke
the camel's back. He, with his manipulation in foreign exchange, is
the one that broke the camel's back and finally caused the closing and
the large loss that they sustained at that time.
Mr. ROSENTHAL. Did you at any point in time have a meeting with
Mr. Van Horn of the Comptroller's Office?
Mr. ROTH. Yes. If I may, I would like to refer to Mr. Sindona's letter
and then I will get to that.
Mr. ROSENTHAL. YOU may.
Mr. ROTH. On July 18, 1972,
I wrote the following letter to Mr.
Tisch of Loews Corp. They had sold their 20-odd percentage of ownership of common stock to Mr. Sindona. This letter was sent by registered
mail to all of the supervisory authorities. I would like to read this to
you. I think it is important because of the great damage he did to the
bank.
The newspapers of July 13, 1972, reported Loews Corporation, of which you
are its Chief Executive Officer, the sale of 1,000,000 shares of stock of Franklin
New York Corporation for $40,000,000. The sale was to a company controlled by
Michel Sindona of Milan, Italy.
7
Your sale of this stock may have been advisable insofar as Loews is concerned,
but it raises some serious questions for the stockholders and depositors of
Franklin National Bank. (1) Do you know enough about Michel Sindona to unconditionally recommend him as a person who will be good for the bank? (2)
Will there be a full disclosure of his finances, his backers in detailed biographies ?
(3) Why would he pay $40.00 a share for stock that is currently selling for $32.00,
having run up from $28.00 per share apparently as a result of rumors of the
sale? (4) What are his intentions regarding additional purchases and what role
will he play in the operation of the bank? (5) When you sold your holdings at
$40.00 a share, did you arrange to see that other shareholders could obtain the
same price? (6) Don't you think that you could have found many eminent buyers
in the United States if you asked a reasonable price for the stock? Would not
these prospective buyers also have offered the same deal to other stockholders?
(7) Franklin has a serious problem in covering its $32,500,000 tax loss carryover.
Would not the sale and merger with a United States corporation'aid in resolving this problem? (8) A bank is built on confidence. Have you considered whether
or not this transaction will cause a loss of confidence in the bank?
I could ask many more pertinent questions, but this letter is now long enough. I
also call your attention again to the questions I raised in my letter to stockholders, delivered at the annual meeting held on April 27, 1972.
May I hear from you in an open letter because the stockholders, depositors, and
the banking fraternity will be interested in your answer.
I have written this letter because I felt a continuing responsibility to my family
and many loyal stockholders, depositors, and employees that helped to build the
bank from deposits of less than a million dollars to become the eighteenth largest
in the nation. I only want to see good things happen to Franklin National Bank.
Mr. ROSENTHAL. T O whom did you send copies ?
Mr. R O T H . I sent copies to all of the supervisory agencies. I have
acknowledgments from all of them—the Federal Deposit Insurance
Corporation, the Federal Reserve Board, the Comptroller of the Currency, and the State Banking Department.
Mr. ROSENTHAL. Without objection, that letter of July 18,1972, will
be included in the record.
[The letter referred to follows:]
NEW YORK, N.Y., July 18,1972.
Mr. LAURENCE A. TISCH,
Director, Franklin New York Corp.,
New York, N.Y.
DEAR MR. TISCH: The newspapers of July 13, 1972, reported Loews Corp., (of
which you are its Chief Executive Officer) sale of 1 million shares of stock of
Franklin New York Corporation for $40,000,000.00. The sale was to a company
controlled hy Michele Sindona of Milan, Italy.
Your sale of this stock may have been advisable in so far as Loews is concerned, but. it raises some serious questions for the stockholders and depositors of
Franklin National Bank.
1. Do you know enough about Michele Sindona to unconditionally recommend him as a person who will be good for the bank?
2. Will there be a full disclosure of his finances, his backers, and detailed
biographies ?
3. Why would he pay $40.00 a share for stock that is currently selling for
$32.00, having run up from $28.00 per share apparently as a result of rumors
of this sale?
4. What are his intentions regarding additional purchases and what role
will he play in the operation of the bank?
5. When you sold your holdings at $40.00 a share, did you arrange to see
that other stockholders could obtain the same price?
6. Don't you think that you could have found many eminent buyers in the
United States if you asked a reasonable price for the stock? Would not
these prospective buyers also have offered the same deal to other stockholders?
7. Franklin has a serious problem in covering its $32,500,000.00 tax loss
carry over. Would not the sale and merger with ,a United States corporation
aid in resolving this problem?
8
8. A bank is built on confidence. H a v e you considered whether or not t h i s
t r a n s a c t i o n will cause a loss of confidence in t h e bank ?
I could a s k many more p e r t i n e n t questions, but this letter is now long enough.
I also call your attention again to the questions I raised in my letter to Stockholders delivered a t the Annual Meeting held on April 27,1972.
May I h e a r from you in an open letter because the stockholders, depositors
a n d t h e banking fraternity will be interested in your answer.
I h a v e w r i t t e n this letter because I feel a continuing responsibility to my
family a n d many loyal stockholders, depositors a n d employees who helped to build
t h e bank from deposits of less t h a n $1,000,000.00 to become the 18th largest in t h e
nation. I w a n t only good things to happen to F r a n k l i n National Bank.
Sincerely,
A R T H U R T.
ROTH.
Mr. ROSENTHAL. W h a t happened then?
Mr. R O T H . A friend of mine said that he was Mr. Sindona's personal
attorney. And he said, " I would like to have you meet Mr. Sindona
even though he hates you for what you have said about him and the
questions you have asked about him. But I would like to get him to
know you."
So on October 25, 1972, I visited Mr. Sindona at the St. Regis in
New York City. His attorney, who introduced me to him, was present.
I have a memorandum here of the topics we covered.
[The memorandum referred to follows:]
MEMORANDUM
October 25, 1972
Visited Sindona a t Apt. 705 St. Regis. Also present Andrew Miller who a r r a n g e d
app't.
TOPICS COVERED
Sindona says can increase foreign deposits 1-2 billion
Will r u n foreign business
Continental Bank, Chicago, earned 55 percent total from foreign
H a s been a p a r t n e r with Continental in B k in Europe 12 yrs
Sees Luftig more t h a n Gleason
Luftig to spend % day reviewing big loans
Loan losses—1971—14 Mil 1972—10 Mil
Luftig to reduce personnel this year by 250
H a s sold Hanover Sq for $6 million profit with lease back
T h i s profit will cover 1972 t a x loss carry forward
Apparently h a s not bought any stock since Loews
Asked to be given year 1973 to show accomplishments
Believes in team play—himself r u n n i n g things in background
W a t e r g a t e is his venture
E u r o p e a n banks sell a t 52-100 multiple
Avoided discussion of Gleason—Does not knew well enough to evaluate yet
I said 3-4 times Gleason was my mistake ( B o a r d s )
Sindona objectives (1) stop loan losses (2) increase foreign business
I added (3) new top executive (4) efficient (5) esprit de corps
COMMENTS
Sindona is good for bank,—is s t r a i g h t forward—appears honest, intelligent,
knows where he is going
I s not disturbed for paying $40 with m a r k e t $30
Says will pay off in a year or so
F r a n k l i n h a s a good n a m e in Europe
A p p a r e n t l y is not buying a n y new stock
W a n t s to buy a mortgage co. for bank
A big one—for about $100 million cash
9
Mr. ROTH. Sindona said he was going to increase the foreign deposits of the bank by 1 to 2 billion dollars. That was one of the causes
of the downfall of the bank. The bank went ahead and loaned these
short deposits long. And when the adverse publicity hit the bank, these
foreign deposits were withdrawn.
He said that he was going to run the foreign business. He said that
the Continental Bank of Chicago earned 55 percent from their foreign
activity and he was looking to Franklin's doing the same thing. He
said he had been a partner with Continental Bank in Europe for 12
years. Now the Chairman of the Board of Continental Bank of Chicago was David Kennedy, who became the Secretary of the Treasury,
and who, I believe, appointed Mr. James Smith as Comptroller of the
Currency.
He said that he sees Luftig more than he sees Gleason. He said
Luf tig was going to reduce the personnel that year by 250. He said he
sold the Hanover Square Office at a $6 million profit on a sale-andlease-back basis in order to cover some tax loss carryforward. He said
that he believed in team play, with himself running things in the background. He said that Watergate was his venture with the Vatican.
He built Watergate.
Mr. ROSENTHAL. Sindona built the Watergate building ?
Mr. ROTH. Yes; he did, with the Vatican. And he created the
"Watergate" in Franklin.
I said to him three or four times that Gleason was the great mistake.
Every business is the length and shadow of one man, and Gleason's
length and shadow is bad.
I said, "You said your objectives are to stop loan losses and to increase foreign business. I would like to add that you need a new top
executive officer; you need efficiency in the bank; and you need esprit
de corps, which has gone to pieces."
I received the annual report of the bank for the year of 1973. I
analyzed it. I made my comments on it. I went to see Mr. Van Horn
who is the Regional Director of the Comptroller of the Currency in
NewT York. I gave him a copy of this on March 19,1974.
Mr. ROSENTHAL. W h a t is Mr. Van Horn's first name ?
Mr. ROTH. Charles.
Mr. ROSENTHAL. I S he still with the Comptroller of the Currency ?
Mr. ROTH. He is still in the same position today.
Mr. ROSENTHAL. Tell us what happened.
Mr. ROTH. I gave him this sheet which listed municipal bonds, with
the size and the value of the portfolio both unsatisfactory. The amount
of the trading account in size and profitability was unsatisfactory.
The loss ratio of loans was unsatisfactory; the high ratio of term loans
against volatile deposits was unsatisfactory; the high ratio of loans
to stable funds was unsatisfactory; the amount of bank premises and
equipment, unsatisfactory; tax loss carryforward, unsatisfactory; the
amount of volatile deposits the bank had, unsatisfactory. The amount
of high-rates-interest funds was unsatisfactory. High-rate funds,
such as the certificates of deposit and Federal funds, were unsatisfactory.
Mr. ROSENTHAL. Where did you have this meeting with Mr. Van
Horn?
10
Mr. EOTH. The meeting was in his office. There was present in his
^office at the time his counsel, Mr. Nathans. The meeting took place in
his office from 10:10 a.m. to 11:10 a.m.—1 hour.
I would like to read a few other things here and get to a very
important point. The adequacy of capital funds was unsatisfactory;
the retention of earnings after dividends, unsatisfactory; liquidity,
unsatisfactory; profit margin, unsatisfactory. All of the trends were
unsatisfactory. Morale was unsatisfactory; communication, unsatisfactory ; the overall rating, unsatisfactory minus.
And I put down that the cause of this was: (1) Incompetence
stemming from top management; (2) Negligence of the directors to
take full remedial action; (3) The lack of full disciplinary action by
the supervisory authorities.
H e read it. He said:
I agree with you on everything that you have there except one point. That
is what you say about the lack of disciplinary action by the supervisory
authorities.
I said, " I am sorry, but that is my analysis of it and that is the way
I feel about it."
H e said to me:
Fortunately, I have some good news for you. You may have read in the newspaper that the bank has now employed Mr. Schreiber, who is the retired Chairman of the Board of Walter E. Heller, one of the finest finance companies in the
country, and which is located in Chicago.
H e said that Mr. Schreiber felt that he would completely turn the
bank around by the end of the year, and that he had already made
substantial progress in that direction.
He asked me whether I knew Mr. Schreiber. I said, "No."
He said, "Would you like to meet him ?"
I said, "Absolutely."
H e said, "Why don't you call him ?"
I said, "No; you should call him."
H e said, "What should I say ?"
I said:
You say just what happened here today—that I gave you an analysis of the
bank of everything that I found to be unsatisfactory; that you said to me that
I should meet Mr. Schreiber because he would have some good news for me.
H e turned to Mr. Nathans, his counsel, and said, "Do you think I
should do i t ? "
Mr. Nathans said, "Yes; you should do it the way Mr. Eoth has
said."
The next day Mr. Van Horn called me and said, " I spoke to Mr.
Schreiber. He would like to talk to you."
I called Schreiber on the telephone and then met with him for dinner that same night. I reviewed with Mr. Schreiber the things I felt
were necessary in order to turn the bank around.
Now I have read to you from my comments with regard to my
analysis of the annual statement of the bank. These were completely
unsatisfactory. There is one other important thing which is written
here.
I have: "What is the solution?" And I have written down: "An immediate takeover—promptly." I felt the merger was needed immediately because it was so bad.
11
I would like to read to you now what the Chief Executive Officer
of the bank said in his annual report to the stockholders, and the way
in which he painted the picture of the bank.
In 1973 Franklin crossed an important threshhold so that it is now in the
position to move forward in establishing itself as a major worldwide financial
service institution and a leading money center banking operation. The past few
years have been a period of transition for our organization. The restructuring
of Franklin from a regional bank satisfying the capital markets of Long Island
to a major money center institution offering a wide range of sophisticated financial services to both a national and international market has been most difficult.
This transition has required redefining our market scope and revisiting our
operational techniques and our management approach.
During almost any period of major change, there is uncertainty. The uncertainty which has accompanied Franklin's transitional period has been reflected
in our financial performance in the last few years. To eliminate this uncertainty,
we have directed our efforts to the development of a management team which
could effectively respond to the challenges inherent in the banking industry, and
in a broader sense, to the financial service market in the 1970's.
The design and implementation of asset and liability management techniques
into our organization required restructuring of key areas of operations. The
management programs which in turn focus on major profit centers, operational
problems, and proper market direction are being actively developed and applied.
After thorough investigation of domestic and international markets, Franklin
New York Corporation has set for itself a series of precise objectives. To obtain these objectives, specific sources and uses of capital and manpower have
been identified and appropriate programs developed.
The 1973 Annual Report for Franklin National Corporation is therefore divided into sections that allow you to accurately focus not only on our present
position, but our future direction as well.
My comment is, "Hogwash. Coverup." The front page of the report
tells the story. I t shows warm and beautiful sunshine and a nice climate. But it is a setting sun for Franklin National Bank. T h a t is
what it is.
So, I met Mr. Schreiber.
Mr. ROSENTHAL. Did you subsequently meet Mr. Smith, the Comptroller of the Currency ?
Mr. ROTH. Yes; I did.
Mr. ROSENTHAL. Would you tell us when that was, the circumstances, and what happened ?
Mr. BROWN. I think he wants to talk to us about his meeting with
Schreiber.
Mr. ROTH. I think I ought to talk for a minute about Schreiber, and
then I will get to that.
Mr. ROSENTHAL. G O ahead.
Mr. ROTH. I met Mr. Schreiber, as I said, on March 21,1974. I was
very much impressed with him. H e is a doer. There is no doubt that he
was largely responsible for the great things that happened at Walter
E. Heller. Although it was a finance company, he was knowledgeable
in the banking field because he said he made Walter E . Heller a great
company by going around to the banks and saying: " W h a t problem
loans do you have ? T u r n them over to me and I will see t h a t you are
paid off." And he turned the loans around and made good loans out of
bad loans.
I said to h i m :
You must shrink the size of the bank. It is a $5 billion bank and it has no
right to ibe. It should be $3.5 billion. You have a lot of hot money in there in
Federal funds—which is overnight money—and over $1 billion in foreign deposits and certificates of deposit.
12
Mr. LEVITAS. Excuse me, Mr. Eoth. Would you explain what you
mean by "hot" money ?
Mr. ROTH. The bank had over $1 billion in Federal funds. All banks
are required to maintain certain reserves. The members of the Federal
Reserve System carry their reserves with the Federal Reserve. Others
carry them with their correspondent banks. The excess money that
they have over and above what is required to be kept with the Federal
Reserve and correspondents are Federal funds available to be sold to
banks that are short of money.
Franklin was always short of money during this period. So they
bought these funds from the other banks. Now in order to buy the
tremendous sums that they always had to buy, they paid one-eighth of
1 percent over the going market. That is hot money.
Mr. LEVITAS. Was this short term or long term ?
Mr. ROTH. I t was only overnight. The next day it had to be paid
back again. I t was just for 1 day that you were borrowing this
money—over $1 billion.
Mr. LEVITAS. And were they using this to lend out ?
Mr. ROTH. Oh, yes. They were lending it out long. They did the
same thing with certificates of deposit. They were 30, 60, and 90 days.
And then they had foreign deposits of $1,200 million. Some of the
foreign deposits were 30, 60, and 90 days. But they were loaning it
out on term loans running into the years.
Mr. LEVITAS. Thank you.
Mr. ROTH. So I said, "Mr. Schreiber, you have to shrink the size of
the bank to $3.5 billion. You must stop your speculation in foreign
exchange."
Do you know, I have heard that their speculation in foreign exchange at times ran $1 billion ? And they were speculating t h a t the
dollar would improve in value when it was constantly going down in
value. That was $1 billion.
Manufacturers Trust Company, for example, never speculated. The
only time they were in foreign exchange was to take care of the needs
of some of their foreign customers.
Morgan Guaranty on two occasions came into the bank and said,
"You will have to stop this or else we will stop doing business with
you."
This is Mr. Sindona.
Mr. BROWN. I n connection with your memo here, Mr. Roth, you
said, "Shrink size of bank to $3.5 billion." What was its size at that
time?
Mr. ROTH. Five billion.
I said, "You have to stop this speculation in foreign exchange. You
have to reduce your loans by $700 million to $2 billion. Three, you
have to reduce your municipal bonds by $100 million to $180 million.
You have to reduce your other securities to $10 million." I t was around
$100 million.
"You have to reduce your trading account." They were trading for
huge sums of money—as big as Chase and National City. Now "trading" is when you buy securities hoping that they are going to go up in
value and then selling them again. T h a t is trading.
Mr. BROWN. Were they not also engaging in rather risky loans to
growth industries ? Weren't they always
13
Mr. E O T H . No. The only securities they had wrere the $100 million
corporate bonds, I believe. Plus a sizable amount of municipal bonds.
Mr. BROWN [continuing]. Looking for the upswing companies?
Mr. R O T H . Do you mean in their lending activities to corporations ?
Mr. BROWN.
Yes.
Mr. ROTH. Not so badly; no, I wouldn't say that. Their portfolio of
loans on Long Island was pretty clean. Their portfolio of foreign loans,
which they made at one-half of 1 percent under the going rate, I don't
know about. I don't know the story there. I understand that there are
losses, but that they are not really too bad. They had over $500 million in foreign loans.
Now some of their loans outside of New York City were on the
speculative side; yes. But as a whole, their loan portfolio was not
bad when compared with what you see today in National City and
Chase and other banks. I t was not bad.
They went haywire on their lending in the last couple of years to
try to increase their profits. Yes; they did that, but that was only
in the last few years.
So, I said that their trading account should be reduced to $50
million. And they had to reduce their municipal time deposits on which
they were paying high rates of interest.
He agreed with me on all of these points except that he said that
the loans should be reduced by $500 million and not $700 million.
He also made up charts on this program and presented it to the
board of directors of Franklin National Bank. I understand they approved of the program.
Now I will come to my visit with Mr. Smith on April 4. When I
saw Mr. Van Horn on March 19, he said to me, "Have you met our
new comptroller, Mr. Smith ?"
I said, "No."
He said, " I think he would welcome a visit from you when you are
down in Washington."
On April 4, 1974, I was in Washington. I had made no previous
appointment, when I stopped in his office, he was out. I went next
door to see his first deputy, Justice Watson, whom I knew very
well. I told him what Van Horn had to say and I gave him the
memorandum that I discussed with Van Horn and discussed it with
him too.
I also said to h i m :
I see an awful lot of gambling going on in banks in foreign exchange. What
I don't understand is that you have no limit on the amount of gambling that
can go on in foreign exchange, such as the kind of limitation you have on the
amount of loans that can be made to any one borrower. In other words, you
cannot loan to one borrower more than 10 percent of the capital funds of the
bank. Why don't you have the same limit on speculation in foreign exchange—
that it shall not exceed more than 10 percent of capital to any one country?
He said:
I am not familiar with that. I will have to get our foreign exchange man
down and let you talk to him.
H e telephoned, b u t t h e foreign e x c h a n g e m a n was out for t h e d a y .
I t d r o p p e d t h e r e , w i t h t h e exception of m y t a l k i n g a b o u t it w i t h
Smith.
74-548—76
2
14
H e went in to see Smith's secretary and came back and said, " I
made an appointment for you to see Smith this afternoon."
At 1:30, I went in to see Smith. I spent an hour with him. Once
again, I gave him this same memorandum which I had given to Van
Horn. And after I got through with that, he said, "Thank you,
Mr. Roth."
I think that in the hour I spent with him, he didn't say more than
15 words.
I then spoke to him and said, "There are a lot of other things I
want to talk to you about." I spoke to him about the gambling in foreign exchange by banks. I didn't mention Franklin, but I guess he
knew I meant Franklin. But I meant banks generally because many
were doing it. Too many of them were doing it.
I also said to him, "You know, when I was with Franklin, I thought
it was kind of ridiculous to have dual examinations by banks." I n
other words, if a State bank that is a member of the Federal Reserve
System has the State bank examiners examine the bank at the same
time the Federal examiners come in, they both come in at the same time
and they write up their own reports of examination.
And I said to h i m :
You know, that is a good thing. I used to think it was a foolish thing, but
I think the wool is pulled over the eyes of the examiners too often and it will
happen less often if you have dual examinations. And I would certainly recommend to you that you have another examination by another agency when a
bank is on a problem list. Certainly, every 3 years all banks ought to be examined by two agencies. As a matter of fact, I would like to see it the way it is
done by the Federal Reserve at the present time.
I further said to h i m :
I know that you are now in the course of having an accounting firm make
recommendations to improve the examinations of the banks—Haskins and Sells.
And I would like to give you my thoughts on what should be done to improve
examinations of banks in addition to the dual examinations I just mentioned.
Mr. BROWN. Mr. Roth, may I
Mr. E O T H . Yes.
Mr. BROWN. YOU mentioned
interrupt you for a second ?
that you talked with Smith about regulation of investment in foreign countries, et cetera.
Mr. ROTH. That's right.
Mr. BROWN. YOU said that they should have a limit such as 10 percent in each foreign country.
Mr. ROTH. That's right.
Mr. BROWN. I think you would agree, would you not, that the authority for the regulator to limit a bank's exposure to any one person
to 10 percent of capital stock is a statutory provision.
Mr. ROTH. Oh, yes.
Mr. BROWN. And there is no statutory basis for a similar limitation
on foreign investments. Isn't that correct ?
Mr. ROTH. That is right.
Mr. BROWN. S O really the regulator would have no authority to
do that, would he ?
Mr. ROTH. H e had no authority, but it is unsound and unsafe banking practice to go beyond that. And he can raise the devil over it and
he can ask that the law be changed.
Mr. BROWN. OK. But, Mr. Roth, if you were the banker and if
you felt what you were doing was not unsafe and unsound, and if the
15
regulator, without any statutory authority, attempted to impose a
restriction upon your investments, wouldn't you contest the authority
to issue such a regulation %
Mr. R O T H . Someone might. But if I were a regulator, I wouldn't let
the bank get away with it. I would make such a thorough examination
of what was going on and I would find so many things going wrong
with that kind of speculation that he wouldn't get away with it.
That is the trouble with our regulators. They don't know how to get
tough when they should get tough.
Mr. ROSENTHAL. G O ahead, Mr. Roth. We break up about 12 o'clock,
so I want to get your full story concerning the seven pages of this
memorandum. Then everybody will have a chance to ask some questions.
Mr. ROTH. I said with regard to examinations that as soon as the
bank examiners came in, I would require management to prepare their
list of assets they considered to be subject to criticism, with their classifications and comments. I n other words, I said that the lending offices
and the bank offices should know what assets should be criticized and
they should make up their own lists.
Mr. ROSENTHAL. Mr. Roth, did you conclude the Franklin matter
with Mr. Smith ? W h a t did he say and what did you say ? How was
the matter concluded insofar as Franklin was concerned ? We need to
keep the record clear.
Mr. ROTH. The Franklin matter was concluded; yes. I had nothing
more to say about the Franklin matter except as it involved examinations.
Mr. ROSENTHAL. Did Smith say that he would do anything or that
he would not do anything ? W h a t did you ask him to do or not to do ?
Mr. ROTH. D O you mean wTith regard to my recommendations on how
to examine the banks ?
Mr. ROSENTHAL. With specific reference to Franklin, how did the
meeting end ?
Mr. ROTH. Nothing was said. He was silent. He said about 15
words—"Thank you" and "Yes" and "Is there anything else?"
And when I got through with this, he handed my sheet with my
analysis of the annual report of Franklin to me, as if to say, "Here.
I am not interested."
I took it and said, "These are for you, Mr. Smith." I put them on
his coffee table and left.
Mr. ROSENTHAL. Then what happened ?
Mr. ROTH. I left his office.
Then I went in to see Brenton Leavitt. I said, " I would like to talk
to you about the Franklin National situation. I have discussed it with
the Comptroller. Also, I would like to talk to you about the Talcott
matter that you have under consideration now as to whether or not
you are going to allow Franklin National Bank to take over Talcott."
I gave him a memorandum of what my thoughts were with regard
to the takeover of Talcott. I said that I thought Talcott should be good
for Franklin New York Corp. mainly because Norman Schreiber, who
ran the Walter E. Heller Co., ran one of the finest finance companies.
And I thought that he could do a job wTith Talcott.
"However," I said, "you should not allow them to take it over
unless Franklin increases its capital by $30 million; that no pay-
16
ments are made to Sindona for the interest, and expenses he has had
in connection with Talcott; that Franklin National Bank is to discontinue cash dividends and pay stock dividends; that Franklin National Bank is to shrink in size from $5 billion to $3.5 billion." I n
other words, this was the same kind of thing that I had told Norman
Schreiber.
Mr. KOSENTHAL. When did you have this meeting with Brenton
Leavitt?
Mr. BOTH. On the same day—on April 4. I might also say that
I have the highest regard for him. He spoke and he discussed things
with me. He was intelligent and he knew what it was all about. I am
afraid I cannot say the same thing about Mr. Smith.
I said t h a t the bank should prepare a 3-year forecast of where
they are going, a balance sheet of where they are going for the next
3 years; they have to find a replacement for the chief executive officers; and that each director should sign an agreement with regard
to the quarterly progress being made, which would be submitted to
the Federal Reserve and the Comptroller of the Currency.
I also told Brenton Leavitt about what I said to the Comptroller
about dual examinations.
And Leavitt said me, "What did the Comptroller say?"
I said, "not a single word, but I could see that he didn't like it."
And I said to Leavitt, "We are in serious times and you had better
start beefing up your examination force. I am worried about what
is happening in banking."
Mr. ROSENTHAL. Did you and Leavitt have anything to say about
what actually should or should not be done as far as the Franklin
National Bank was concerned ?
Mr. ROTH. NO—except that he did agree with me on all of the
things I said with regard to the shrinking of the size of the bank
and the actions that should be taken. He did agree with me.
Mr. ROSENTHAL. Who had the principal responsibility or the exclusive responsibility in this area ?
Mr. R O T H . The Comptroller of the Currency. I t is only a courtesy
on the part of the Comptroller to allow the Federal Reserve to have
a copy of the report of examination.
When J i m Saxon was Comptroller for a period of time, he didn't
even give the reports of examination to the Federal Reserve Board.
Mr. ROSENTHAL. And the reason that Franklin is a client of the
Comptroller is because Franklin was a national bank.
Mr. R O T H . That is right.
Mr. ROSENTHAL. D O they pay a fee to the Comptroller of the Currency for this relationship ?
Mr. ROTH. Yes; they pay a fee. The Office of the Comptroller is
self-supporting. I t does not have to look to the Congress for any
money to support the Office of the Comptroller of the Currency.
Mr. ROSENTHAL. D O you have any notion of how much the Franklin paid a year to the Comptroller of the Currency for this relationship?
Mr. ROTH. N O , I don't recall that. But they surely did not make
any money on them.
Mr. ROSENTHAL. At any time thereafter, did you have a meeting
with Mr. E d Langdon, one of the examiners for the Franklin National Bank ?
17
Mr. ROTH. Yes. E d Langdon is a good examiner, and E d Lake is
another very good examiner. Both of them are very competent
examiners.
Mr. ROSENTHAL. By whom are they employed ?
Mr. BOTH. They are employed by the Office of the Comptroller of
the Currency.
Mr. ROSENTHAL. What happened at this meeting?
Mr. ROTH. This meeting with E d Langdon occurred in the Office
of the Criminal Division of the Department of Justice in New York
City, which is, of course, investigating the Franklin National Bank
matter.
I also discussed these kinds of things with the Department of
Justice. And E d Langdon said to me, "Well, you know, Arthur, we
brought those kinds of things out in our reports, too. But down in
Washington, they did otherwise."
Mr. ROSENTHAL. Did he further explain that ?
Mr. ROTH. He did
not.
Mr. ROSENTHAL. What did you understand him to mean by that
statement ?
Mr. ROTH. There are a lot of surmises. I mentioned one of them.
Certainly, Smith, by his actions, was incompetent and negligent, to
say the least. And Sindona had entree, I wouldn't be surprised, to
Smith through David Kennedy, the former Secretary of the Treasury. That is what I surmised.
Mr. ROSENTHAL. Mr. Roth, you realize you are under oath now,
don't you ?
Mr. ROTH. I surmised this; that is all. I said I surmised this. I t is up
to you to investigate these things further.
Mr. ROSENTHAL. We will.
Mr. BROWN. What is the total content of your surmise?
Mr. ROTH. Just that. You see, we are getting now to May 12, 1974.
On May 12, 1974, there was a meeting at the Federal Reserve in New
York, 1 understand, between the Federal Reserve Board, the Comptroller of the Currency and the Federal Deposit Insurance Corporation.
Manufacturers Hanover had made an offer to buy the bank, and pay
$17 a share for the bank. I understand that the Department of Justice
said that they would interpose no objection because of the condition
of Franklin National Bank.
That takeover was disapproved. And the disapproval of that takeover caused great economic harm to Long Island. Unemployment
went u p ; many businesses went bankrupt. If Manufacturers Hanover
had taken over Franklin National, these things would not have
occurred.
But before we get there, I have something else to say, if I may, which
leads up to this crisis. May I ?
Mr. ROSENTHAL. Please.
Mr. ROTH. We are in the crisis period now. I mentioned before that
1 had met with Schreiber on March 21 and on April 4 in Washington.
On April 29 I wrote a letter to all of the supervisory authorities, in
which I once a^ain sent my Sindona letter and the stockholders' letter.
In it I said: " I n your present deliberations you may have overlooked
the contents of my two letters, copies of which are enclosed." I wanted
to again bring to their attention that Sindona was bad. I questioned
18
that, and I questioned the condition of Franklin going all the way
back to 1972.
Mr. KOSENTHAL. H a d Sindona been a partner with David Kennedy
in any matter that you know of ?
Mr. R O T H . Mr. Sindona told me so.
Mr. ROSENTHAL. W h a t did Mr. Sindona tell you about his relationship with David Kennedy ?
Mr. ROTH. Well, you know that David Kennedy was a director of the
Fasco Corp., which is the corporation that held the Franklin National Bank's stock. And Mr. Sindona, when I saw him, said that
he had been a partner with Continental Bank in Europe for 12 years.
Now David Kennedy was chairman of the board of Continental Bank.
Now we are getting to the crisis period. The real crisis occurred on
Mother's Day, May 12. But let me give you some of the highlights and
some of the notes I made just a few days before May 12.
I met Mr. Schreiber in his office on May 2,1974.1 made no previous
appointment. I told him that he, Schreiber, should replace Gleason as
chairman of the board; Sadlik should become president; and this
should be done before the stockholders meeting which was supposed to
take place shortly. I n that way Schreiber could help to restore confidence in the bank. People had no confidence in Gleason.
Schreiber said to me, "Arthur, I can't do these kinds of things. Gleason and Merkin control the board. Numerically, I can't do anything. I
am the chairman of the executive committee, but they control the
board,"
I said, " I am shocked that you have been brought into this bank
without the control that you should have and that these people who are
responsible for the unsafe and unsound banking conditions that exist
are still in control. I don't understand it."
H e said, "Arthur, I would suggest to you that you don't come in and
see me again. I am embarrassed by your walking in like this because
Gleason and others will find out about it."
On May 2, Viscardi, who is chairman of one of the great companies
on Long Island, Abilities Inc., telephoned me. He said he had a $3 million CD at Franklin. His financial adviser said, "Pull it out. Don't
keep it in there for a day. Take it out."
I said to him, "He is going overboard. I wouldn't be concerned about
it, Hank."
On May 6,1974, Steven Andredda of Barron's magazine phoned me
for an appointment the next day. I met him the next day, on May 7,
and I made it clear three or four times that I wanted only good things
to happen at Franklin. Most of my life was spent at Franklin. My family holds 70,000 shares and many of my friends and relatives are investors. I said, "Norman Schreiber can turn the bank around, but he
needs to be chief executive officer with Sadlik as president. Gleason and
Merkin should be out."
I warned Andredda that a bad story could do great damage to the
economy of our country and have international repercussions. I told
him that he should write a story to achieve corrective action and to
restore confidence because of Schreiber and Sadlik. He said that he
would.
19
I said to him, "There is no question about the solvency of the bank;
there is only a problem of liquidity. The Federal Reserve and other
banks will not allow anything to happen to Franklin."
I advised him to speak to the supervisory authorities. These are
critical periods we are in now.
On May 8, the Financial Chronicle phoned me. I immediately asked 7
"What caused you to decide to write a story on Franklin?"
They answered, "The unusual release by the Federal Reserve Board
with regard to the turndown of Talcott and the 2-cents-a-share earnings of Franklin which was reported."
I said to them the same things that I had said to Steven Andredda.
On May 9 , 1 phoned Van Horn. I said, "This situation is getting to
be very serious." I told him about Barron's and Financial Chronicle's
telephone calls.
Mr. ROSENTHAL. Mr. Van Horn was the regional administrator of
the comptroller's office, wasn't he ?
Mr. ROTH. That is right.
I also told him of the questions I had been asked by three or four
people who had large sums of money in the bank. They said, "Is the
bank safe?"
I said, "Yes; it is. Don't worry about it. I wouldn't be concerned."
The stock went off 2 points. I told Van Horn, "This thing feeds upon
itself. I have been through runs of banks and I am worried about this."
Van Horn said, "Well, Mr. Smith is not concerned. He is very calm
about this whole thing."
I told Van Horn that he must have Schreiber as chief executive officer and Sadlik as president.
Van Horn said, " I can't run the bank."
I said to him, "Unsafe and unsound practice is there. You have the
right to ask for the removal of these people."
Van Horn said, "Yes; that is so."
I said, "You have been taken in by this fellow Gleason, I think. He
is a super con man."
He said, "No, no; I know him. We know Gleason and also Smith
knows him."
I said, "There are questions arising because of the Federal Reserve
release on Talcott."
H e said, "Well, there are many other banks that have problems
around the country."
I said:
Franklin is the largest and has immediate problems and may cause national
and international repercussions. You don't seem to realize this.
On May 9, Eugene Nickerson, a former Nassau County executive,
called me. He said:
The head of Supermarket General that has a couple of million dollars in
Franklin National is hearing rumors about Franklin. They are big depositors.
Is the money safe?
I said, "Yes; it is safe. Banking cannot permit anything to happen
to the Franklin National Bank. Don't worry about it."
On May 9, Viscardi called again.
20
On May 9 , 1 spoke to Van Horn and related the conversations with
regard to Nickerson and Viscardi and other people who had called me.
H e said:
Thank you. Keep me advised because you are closer to these things than
I am. I would like to have you keep me advised so I can let Smith know what
goes on.
I told him again that he had to get rid of Gleason and Merkin. I
told him that if he did, I would make a public statement which I felt
would help in restoring confidence in the bank, but that I couldn't do
it as long as those two bad people were with the bank.
On May 9, Tatro and Company, a brokerage house, phoned and
said that Franklin was bid at 8%. He said, " W h a t is the cause?"
I said, " I don't know. Maybe it is the turndown of Talcott."
On May 9, at 12:35 p.m., I phoned Van Horn about it. H e said he
was just on the wire with Al Hayes, president of the Federal Reserve
Bank in New York, who had said that this made it an international
situation. Hayes is a great banker.
At 2 o'clock in the afternoon, I telephoned M. A. Shapiro, a bank
stock specialist. I said to h i m :
Look, Morris, you are the only one that can save this situation. You must call
a meeting of the Clearing House banks tonight and request a $100 million loan
to Franklin New York Corporation, and a stand-by by the Federal Reserve Bank.
You have to tell them that Schreiber should be Chief Executive Officer and
Sadlik should be President, and that Gleason and Merkin have to get out.
S h a p i r o said, " W h y me? W h y should I do i t ? "
I said:
You know Al Hayes; you know the people down there. They all respect you.
You know what the consequences are. You take fast action. Get going, Morris.
It is getting too late.
H e said, "OK, let me go; let me go."
Then of course you had the Mother's Day weekend when the three
supervisory agencies met to decide what should be the fate of Franklin
National Bank.
Manufacturers Hanover was willing to pay $17 a share for the bank.
But they turned it down. Why ?
Mr. ROSENTHAL. Was this the Mother's Day weekend massacre ?
Mr. ROTH. That was it all right. They massacred the people on
Long Island mainly.
Mr. ROSENTHAL. And the subheading is: "Get going, Morris."
Mr. ROTH. Yes; "Get going, Morris," is right.
Now if that merger with Manufacturers Hanover had been approved, the Long Island economy would not have been critically
damaged the way it was. Long Island's businesses would not have gone
bankrupt the way they did. Long Island's unemployment rate would
not have risen so high. The common stockholders, exclusive of
Sindona, would have received about $60 million from Manufacturers
Hanover. And in addition to that, another $80 million would have gone
to debenture holders and preferred stockholders.
Yes—why, why was this turned down ?
I can tell you that it smells. And it smells bad. And whoever is
guilty of causing so much damage to so many people, and of causing
almost an international calamity, belongs in jail.
Mr. LEVITAS. T O which merger are you referring ?
21
Mr. EOTH. The Manufacturers Hanover of May 12, 1974.
Mr. LEVITAS. Were there not two occasions when Manufacturers
Hanover wanted this merger ?
Mr. E O T H . Yes. They made another bid for the bank on October 8,
1974. That is a very questionable item too.
Mr. LEVITAS. But you, in your last comments, were referring to the
May of 1974 merger, were you not ?
Mr. ROTH. May 12,1974.
Mr. LEVITAS. And you were not referring to the October date.
Mr. ROTH. Not to October 8; no, sir.
Mr. ROSENTHAL. Then what happened ? Who turned down the merger
with Manufacturers Hanover ?
Mr. ROTH. I don't know. I just hear stories that it was the Comptroller. But I don't know. You will have to investigate that.
Mr. BROWN. Would you mind telling us who told you it was the
Comptroller ?
Mr. ROTH. Newspaper people told me. I heard it from three or four
newspaper people.
Mr. BROWN. What was their source ?
Mr. ROTH. I don't know. I didn't ask their source.
Mr. ROSENTHAL. This matter is being looked into by the Department
of Justice right now.
Mr. ROTH. I hope so.
Mr. ROSENTHAL. I t is. After the turndown of Manufacturers Hanover, what happened ? Bring us up to date chronologically.
Mr. ROTH. The deposits drained out of the bank. Joe B a r r came in
to try to save it. H e is a great guy, but it was too late to do anything.
On October 8, 1974, the Fed had loaned the bank $1,700 million.
And they asked for bids. The bids were called for at 10:30 a.m. on
October 8, I understand. Manufacturers Hanover and Chemical submitted their bids. European-American asked for a delay in order to get
in touch with Europe. That was until 1:30 in the afternoon.
I don't know whether you know what happens when bids are made.
Almost 5 minutes before the bid is made, everybody gets on the telephone to one another and says, "What did you bid? What did you
bid?"
'
m m
And so it is known even before the bids are opened. That is a couple
of minutes before. But here this bid was asked for at 10:30 in the
morning and then it was delayed until 1:30 in the afternoon—at
European-American's request.
Now you are going to ask me who told me this. And I will tell you
that a number of people have told it to me. But you will have to
investigate it.
, European-American jacked up their bid from $120 million to
$125 million, to beat Manufacturers Hanover at $122 million.
Investigate it. I am telling you what I hear.
Mr. BROWN. Mr. Roth, who conducted the procedure ?
Mr. ROTH. The bids, as I recall it, were under the direction of Oren
Judd, a Federal judge in New York. What Oren had to do with the
delay and the bidding and so forth, I have no idea. I know Oren and he
is a very fine person.
Mr. BROWN. What regulatory agency is responsible ?
22
Mr. EOTH. The Federal Deposit Insurance Corporation is responsible at this particular point. The bank was declared insolvent; they
asked for bids for the bank; it was then up to Federal Deposit Insurance to accept the bids.
Mr. BROWN. But the F D I C conducts that ?
Mr. ROTH. That phase of it is F D I C .
Mr. BROWN. I t is totally up to F D I C , and not the Comptroller?
Mr. E O T H . T h a t is right.
Now, here is European-American, which for weeks before have said
that they were going to take over Franklin, buying Franklin. They
were a $500 million bank; and when they bought Franklin, they became $2,500 million. A mouse was taking on the burdens of an elephant.
They knew nothing about small business loans, loans to builders,
community obligations, or anything such as that. They were an international bank doing business with big accounts. And yet they were
allowed to take over the bank.
If Manufacturers Hanover had taken over the bank, they would
not have taken over only assets equal to the deposits, which was the
requirement of the F D I C . They could have taken over a great, great
many more assets and loans.
We have seen the loans in the F D I C and we know that on Long
Island, almost 80 percent of them were loans that were not classified—
good loans. But European-American didn't have the resources to take
over anything more. When loans are with the FDTC, borrowers become
tainted. People think there is something wrong that they are with the
F D I C , and they can't get loans elsewhere.
Furthermore, you may have read Business Week's story of December 22, 1975, in which thev quoted the bank as saying that the bank's
earnings in the 2 years prior to the takeover was $11 million and $15
million. And then the year when they took over Franklin, they dropped
to $5 million. And last year it was $5 million again.
They are losing money on Franklin. What happens when a bank
loses money? Do they give better service? Of course not. I t thinks of
ways of cutting expenses and retrenching.
They didn't gain back any of the deposits they lost. The name,
European-American, was against them. They knew nothing about
how to run a bank on Long Island. They didn't have the management
to do it. All of the good people in Franklin left.
I don't know why the F D I C ever allowed it—yes; I do; yes; I do,
but you will have to check into it. National City and Chase and all of
the big banks were running all over Europe establishing branches.
More than half of their earnings came from international operations.
The banks in Europe became upset and said, "We are letting you run
all over Europe with your branches and we are not able to do the same
thing in the United States. We want to have an opportunity to do the
same thing in the United States."
European-American is owned by five of the largest banks in Europe—Germany, Holland, France, Belgium, and England. But they
made a grave mistake.
Mr. ROSENTHAL. Who made the trade off ?
Mr. ROTH. Who made the trade off? I don't follow the meaning of
that.
Mr. ROSENTHAL. The implication is that somebody arranged it so
that the European-American could get into this deal.
23
Mr. KOTH. I don't know. That is for you to investigate.
Mr. ROSENTHAL. What happened to you and your 70,000 shares ?
Mr. ROTH. I still have most of it.
Mr. ROSENTHAL. H O W much are they worth today ?
Mr. ROTH. I reported on my income tax that they were worth
nothing.
Mr. ROSENTHAL. Mrs. Collins is asking how much they were worth
3 or 4 years ago.
Mr. ROTH. Three million dollars.
Mr. ROSENTHAL. S O to describe you as an unhappy man is a fair
statement ?
Mr. ROTH. Yes—unhappy about the way things occurred here. Here
was a great bank that was allowed to go down the drain—one of the
greatest banks in the country. And my only purpose in being here and
saying the things I am saying right now is that I wTant to see our banking system improved and strengthened. I don't want to see these things
happen again. And you are only going to stop these kinds of things
from happening by doing the kind of investigating that you are doing
and the kind of talking that I am doing.
Mr. ROSENTHAL. Mrs. Collins.
Mrs. COLLINS. Mr. Roth, is it true that a Peter Shaddick was recruited by Sindona from the Bank of Montreal to head up the international department of the bank ?
Mr. ROTH. That is what I understand. I only met the man once.
Mrs. COLLINS. Did you hear of any problems he encountered when
he handled this responsibility ?
Mr. ROTH. Yes. I heard talk that he had problems along the same
lines with one of the other banks that he was with. That is right.
Mrs. COLLINS. Actually, I think you probably did all that you could
to make all of the officials of the banking industry aware of what was
happening. And your conclusion is that they just disregarded everything that you suggested, and that was the end of it. Is that right?
Mr. ROTH. I would say so.
Mrs.
COLLINS.
Thank you.
Mr. ROSENTHAL. Mr. Brown.
Mr. BROWN. Mr. Roth, you have indicated in your testimony that the
turndown of Talcott was one of the crucial items as far as the soundness and the future of Franklin was concerned.
Mr. ROTH. Yes.
Mr. BROWN. F o r
an acquisition of that nature to occur, it requires
the Comptroller's approval, does it not ?
Mr. ROTH. NO ; it is a Federal Reserve approval primarily that is
required because the Federal Reserve supervises bank holding companies. I t is their approval that is required.
I would think that they have discussions with the Comptroller.
They should.
Mr. BROWN. S O you think the Comptroller would have had some input into that ?
Mr. ROTH. Oh, yes; I would say so.
Mr. BROWN. Mr. Roth, for the Comptroller to exercise his authority under the general statutory language of "unsafe and unsound banking practices," isn't his authority under that section of the law pretty
much limited to refusing to grant requests of banks, such as for
24
branches or for acquisitions, et cetera ? Isn't that about the only way
he can exercise that portion of his authority ?
Mr. BOTH. Pretty much so. And of course that has to be strengthened a great deal. That is one of the things that you have to do.
Mr. BROWN. S O what I am saying, Mr. Roth, is that this whole list
of recommendations that you discussed which should have been done,
and which Mr. Schreiber apparently somewhat agreed with—to shrink
the size of the bank to $3.5 billion; to stop speculation in foreign exchange ; to reduce loans to $2 billion; to reduce municipal bonds by
$100 million to $180 million; and on and on—were not within the purview of the statutory powers of the Comptroller. The only way the
Comptroller could have used his authority to implement such recommendations was in connection with a request made by Franklin National for the approval of the Comptroller to do something. And he
could say, " N o ; I won't grant you this authority to branch, et cetera,
unless you do these things."
Isn't that about right ?
Mr. ROTH. That is right. But he can also say, " I want to see the
board of directors of the bank down in my office and I am going to
read the riot act to them about their unsafe and unsound banking
practices."
That used to occur in years gone by. And when you tell a board of
directors of their responsibilities, that is very effective. But you have
to really get tourfi with them.
Mr, BROWN. Who was the Comptroller on April 27,1972 ?
Mr. ROTH. I don't recall who he was. I don't know whether it was
Smith or not. He came in about that time, but I am not so sure.
Mr. BROWN. I think that Smith didn't come on board until some
time in 1973.
Your first exhibit is the letter you first sent to the shareholders. The
second exhibit is the letter you wrote to Laurence Tisch on July 18,
and sent a copy by certified mail to the regulators. These were the same
kinds of recommendations that you made to Schreiber later on and discussed with Smith. Did you discuss any of these with Mr. Camp who
was the Comptroller at that time?
Mr. ROTH. N O ; T did not discuss them with Camp. But Camp may
have been Comptroller at that time.
Mr. BROWN. The issues you raised about the conduct of the business
of Franklin National were raised first in 1972, during a period of time
when a Comptroller other than Smith was Comptroller. Is that right ?
Mr. ROTH. That is right. On the other hand, it is a problem bank and
it is the responsibility of a new Comptroller to look at the file.
Mr. BROWN. I just want to put this into context with respect to the
time sequence.
According to your memos, apparently the first time that you advocated a takeover was in March of 1974.
Mr. R O T H . That was March 19; yes. But the Sindona letter covers
the takeover. And that was before that. In the letter to Tisch, I said,
"Don't vou think that another American corporation could have taken
it over?"
Mr. BROWN. But insofar as that recommendation is made directly to
a regulatory agency, this is the first time. At the bottom of your exhibit D, you say, "Solution—a takeover promptly. On March 19,1974,
25
I delivered the original of this to Mr. Van H o r n and discussed items
in detail."
Mr. ROTH. That's right.
Mr. BROWN. Then apparently that proposal was adopted by both
Franklin National and the Comptroller in April of 1974. These things
which you recommended to Schreiber were pretty much adopted. I s
that not right?
Mr. R O T H . The things that I recommended to Schreiber were
adopted. Yes; they tried to adopt some of them.
Mr. BROWN. And that was in April of 1974.
Mr. R O T H . But you must remember that if I could see these things in
an annual report, they, when they examined a bank, saw these things
long before—or should have seen them long before I did.
Mr. BROWN. Don't get me wrong, Mr. Roth. W e are trying to see
whether the regulatory system failed in this case, to the extent that
they had the responsibility. And I think that the things that you have
mentioned that were wrong with Franklin National all fall under a
failure of the Congress to enact appropriate regulatory legislation. Do
you not agree ?
Mr. R O T H . I think it needs that kind of legislation; yes. T h a t is
right.
Mr. BROWN. And I think you would agree that the Comptroller
really did not have the authority to do any of these things you mention,
such as the limitation on foreign investments or all of the things that
you have listed as unsafe or improper banking practices. Isn't that
pretty much correct ?
Mr. ROTH. But you did find that banks that had good management
adopted many of these.
Mr. BROWN. I quite agree with you.
Mr. ROTH. And you see, the thing that is wrong with regard to the
examinations of the regulatory bodies is that the one who has to be
examined most of all is the chief executive officer. And they do write a
report on the chief executive officer. But they never disclose that information to the board of directors. They never disclose what they
think of the competency of the chief executive officer.
Mr. BROWN. Mr. Roth, do you think that everyone shares the opinion
that you have expressed here today as to what went wrong with Franklin National ? I don't mean that as a trick question.
I only ask that question because of the Fortune article back in
October of 1974, in which it is stated:
The Franklin tale reads like a modern-dress Greek tragedy. Error begot error,
and events moved inexorably to a denouement that the bank's management
feared, but seemed powerless to prevent. Roth started it all by making a lot of
risky loans. When the loans went bad, Roth turned to bonds. When the bonds fell
in value, they could not be sold because of the loan losses. And so the bank ended
up trapped with a wad of low yielding assets that had to be financed from progressively higher cost money. Meanwhile, non-interest expense was increasingly
sharply because of wreckless branching and the inflation of personnel costs.
Would you care to comment on that ?
Mr. E O T H . That is absolutely a lie. That story, under the byline of
Alex Rose, was said to have been partly written by Erich Heinemann.
Erich Heinemann was in the employ of Franklin National Bank. I t
was his job to get as much of Federal funds and other short-term
26
money as the bank needed. That was his area of responsibility, as I
recall it.
So Erich Heinemann, who was brought in by Luf tig, wrote a coverup
story to cover up his own deficiencies and the deficiencies of those with
whom he worked.
I have the answer to that. I gave it to Mr. Dugger this morning, I
never sent it to Fortune magazine because I felt that it wouldn't do
any good to send it to them and to dispute what they had said. But I
did write it just for the record, and Mr. Dugger has the letter that I
gave him this morning. And that is my answer to that.
Mr. BROWN. If you were to list on a priority basis the things that
should be blamed for Franklin's failure, it would seem, according to
your exhibits and your testimony, that you would first blame management. And to a certain extent, you blame the stockholders for not concurring with you in forcing the management to act differently.
Mr. ROTH. N O ; not at all. I don't blame the stockholders at all.
No. 1,1 blame the management of the bank; No. 2, I blame the directors ; and No. 3,1 blame the supervisory authorities.
Mr. BROWN. But with respect to the supervisory authorities, do you
still feel that they had the authority to do the things that you recommended to be done as of 1972 ?
Mr. ROTH. I feel that if they had done what they should have done,
by raising hell with the directors about their practices and what was
going on and not by going in there as southern gentlemen and milquetoast and talking in a weak manner, that the directors would have seen
to it that corrective action would have been taken.
Mr. BROWN. I think you suggest in your testimony that you blame
Smith, the Comptroller, for not taking some action because of a
relationship that existed among the parties involved. Is that not
correct ?
Mr. R O T H . I surmise that and other people surmise it too.
Mr. BROWN. Then why for the year or so that Mr. Camp was Comptroller did he not take any action ?
Mr. ROTH. I don't know. I would have to look at the dates and at
what occurred during that period of time. I don't know when Camp
left there. H e was a pretty good Comptroller.
Mr. BROWN. Mr. Roth, in testimony before what was then called
the Subcommittee on Bank Supervision and Insurance, the St Germain subcommittee of the Banking and Currency Committee, when
that subcommittee was looking into the failure of Franklin National,
this issue about the potential takeover by Manufacturers Hanover was
discussed. I n his testimony on that matter, which was fairly thoroughly gone into by the committee, Mr. Smith said that Manufacturers Hanover lost interest in the acquisition.
But it was your position that the Comptroller turned it down.
Mr. ROTH. That is right. That is how I understand it.
Mr. BROWN. But your understanding comes from talking with
newspaper people and so on.
Mr. ROTH. That is right.
Mr. BROWN. If there were to be a takeover by Manufacturers Hanover at that time, that would have required shareholder approval,
would it not, unless the Comptroller exercised his extraordinary au-
27
thority to waive shareholder voice in that transaction? I s that not
right?
Mr. ROTH. That is right.
Mr. BROWN. I S that a very usual thing for the Comptroller to do ?
Mr. ROTH. NO ; it is not/ I t is an unusual thing, but it has been
happening recently.
Mr. BROWN. With Mr. Sindona's owning the amount of stock that
he did in Franklin National, do you think that Smith could have
gotten shareholder approval of that takeover?
I think it was Smith's position, in view of the way in which the
discussions had gone in the three agencies, the Fed, the F D I C , and
the Comptroller, that he couldn't have gotten shareholder approval
and that, therefore, if the takeover were to take place, he would have
to exercise that authority. And when Manufacturers Hanover knew
that he would have to exercise that kind of authority, it is then that
they lost interest. Does that sound plausible ?
Mr. ROTH. I t could be. But I don't know whether they knew what
a precarious situation Franklin National Bank was in. They should
have acted then and there. That is where I see the negligence.
Mr. BROWN. But that is where we have a bit of a problem. The
question is what authority did they have. And that gets into the general scope of this subcommittee's activities.
Mr. ROTH. That is right.
Mr. BROWN. YOU obviously feel that if the authority does not exist,
the regulatory authority should be given greater authority than they
presently have in these different areas.
Mr. ROTH. Absolutely.
Mr. BROWN. And you feel this both with respect to foreign investment limitations and with respect to the recommendations which you
made with respect to Franklin National as being applied to all institutions. Is that right ?
Mr. ROTH. That is right.
Mr. BROWN. And I think that you will agree that if the authority
is there, it is fuzzy at best. Is that not right ?
Mr. ROTH. Yes; it is very fuzzy. That is true.
Mr. BROWN. S O legislation should be enacted to make this authority
clear.
Mr. ROTH. That is right.
Mr. BROWN. I think you said in your opening remarks that you
hoped we wouldn't throw the baby out with the bathwater—or words
to that effect.
Mr. ROTH. Absolutely.
Mr. BROWN. There is much discussion in the other committee about
having one regulatory agency.
Mr. ROTH. I would be very much concerned about that. I think that
it might become a regulatory agency such as some of the other regulatory agencies that we have. I mentioned the ICC before. That could do
immense damage to the banking system and to the economy of our
country. I would be very fearful of that.
The Comptroller's Office has to be reorganized. The laws have to be
strengthened to pive the Federal Reserve and the F D I C and the Comptroller more authority in the case of problem, banks and how to deal
28
with them. But I would still leave the Office of the Comptroller of the
Currency the way it is, as well as the others. And I would get into dual
examinations, as I recommended, too. And I would have more disclosure with regard to the examinations. Also, your oversight committee has to do what it is doing now more often.
Mr. BROWN. I couldn't agree with you more.
Mr. Roth, you talk about dual examinations. As far as Statechartered banks, we do have dual examinations now.
Mr. ROTH. Yes; we do.
Mr. BROWN. And with the
examinations that I have come in contact with some time back, they don't always appear at the same time.
Often they are separate and independent examinations.
Mr. ROTH.
Yes.
Mr. BROWN. D O you think that that second look is a good thing?
I guess you do think so.
Mr. ROTH. Absolutely. I surely do.
Mr. BROWN. Are you saying that there should be a second Federal
regulatory look at them?
Mr. ROTH. "We have the State Banking Department; we have the
Federal Reserve; we have the F D I C ; and we have the Comptroller
now. All are doing examinations. I say that there should be dual
examinations of all banks of whatever combination you may want to
use of those.
I n the case of the national banks, it is only the Comptroller's Office.
Mr. BROWN. And you are saying that if it is a national bank, it
should be examined by the F D I C and by the Comptroller or by the
Federal Reserve?
Mr. ROTH. Yes.
BROWN. My
Mr.
time has expired. Thank you, very much.
Mr. ROSENTHAL. Mr. Levitas.
Mr. LEVITAS. Thank you, Mr. Chairman.
I'd like to t r y to clear u p this chronology again, Mr. Roth. Mr.
Brown suggested that the first communication you had with the regulatory agencies may have occurred in 1973. Did you send copies of vour
April and July 1972 letters to F D I C and the Comptroller of the
Currency ?
Mr. ROTH. I surely did.
Mr. LEVITAS. S O they would have had this information brought
to their attention early in 1972.
Mr. ROTH. And you should have seen the newspapers at that time.
All of the newspapers carried big stories about this. They could not
have missed it.
Mr. LEVITAS. Who hired Harold Gleason as president of the Franklin National Bank?
Mr. ROTH. I hired him originally as our public relations officer.
Mr. LEVITAS. H O W long had he worked for you before you came to
the conclusion that he was incompetent?
Mr. ROTH. When I started to seek someone to replace me as president, when I became 62 years of age and had to retire at 65,1 thought
we ought to get someone in for a couple of years so I could sit by his
side to see how he was doing. I initially did not think of Gleason, but
he brought himself forward constantly and pressured me and the
directors that he was the one that was competent to succeed me.
29
I left that question open and kept on looking for an officer to succeed me. Finally, when he pressured me so much, I said, "You are
not competent enough to succeed me."
Mr. LEVITAS. When was the Franklin Bank first designated or
considered as a bank needing special attention by the regulatory agencies? Do you know?
Mr. ROTH. I think it occurred on two or three occasions. Sometimes
there were minor matters that needed some corrective action.
Mr. LEVITAS. I am referring specifically to the last time before
the final collapse.
Mr. ROTH. I would not know that.
Mr. LEVITAS. YOU don't know whether it occurred when you first
called this matter to their attention in 1972 ?
Mr. ROTH. N O . I don't have any information on that.
Mr. LEVITAS. The concern toward which this committee is properly
directing its attention is why didn't the regulatory agencies identify
Franklin as a problem early enough to take sufficient corrective actions
to avoid its failure. W e were told at an earlier hearing that if the regulators had looked at the traditional ratios that they look at in designating banks as problem banks that they would not have discovered the
inherent weakness in Franklin that led to its ultimate collapse other
than, as you have indicated, management. Can you shed any light on
why the regulators did not identify Franklin as a problem bank in
time and take the necessary steps to avoid the ultimate failure?
Mr. ROTH. N O ; I can't. After all, when I wrote my letter on April 27,
1972,1 indicated that it was a problem bank—if you read between the
lines. I t was a very strong letter. I don't know whether they had
Franklin down as a problem bank at that time or not; but, certainly
I did.
Mr. LEVITAS. A n d you had recently been the chief executive officer
of that bank.
Mr. ROTH. Absolutely.
Mr. LEVITAS. I n that connection, Mr. Roth—and this will be a subjective evaluation on your part—did you, in your various dealings
with the regulatory officials, both in New York City and here, and
with Mr. Schreiber and some others, get the feeling at any time that
you were being humored or patronized by them ?
You were a person who had been forced out as chief executive
officer. You obviously had a great deal of animosity toward the people
responsible—a feeling that you had done a good job and that nobody,
or certainly none of these people, could follow in your footsteps.
Did you feel that these people were merely listening to you as a
disgruntled former chief executive of this organization and not really
paying attention to what you were saying ?
Mr. ROTH. I think that to an extent that is true. But I tried to be
very specific in what I found wrong in the bank. I was specific in
stating what corrective action had to be taken. I did not speak in
generalities.
But I think what you say is true.
Mr. LEVITAS. I n answer to Mr. Brown's question of whether you felt
there had been a failure of Congress to enact sufficient legislation to
deal with corrective regulatory steps, you said, "Yes." I am inclined
to agree with you in that regard.
74-548—76
3
30
But you are not also suggesting, are you, that if the existing regulating authorities saw that a bank was heading for a collapse that they
would stand by and do nothing? There are things that they could do.
For example, suppose they found that the management of the bank
was corrupt or so incompetent as to constitute gross negligence on the
part of the board to keep the management in. Isn't there something
that the existing regulators could do under their existing authority?
Or would they just have to stand by and see a bank collapse?
Mr. E O T H . 1 don't know what there is in the law. If they are corrupt
or if a man has been indicted or something like that, certainly they
can ask that he be removed. They can go to the board of directors
and ask that he be removed.
Now I don't know whether the law is specific in saying that they
have to remove such a man or not. I don't recall anything in the law
with respect to that.
Regulators should regulate as tough regulators. They can't be weak
about these situations.
Mr. LEVTTAS. Let me get back to that question because I think it is
an extremely important question in our committee's evaluating the
significance, if you will, of the existing regulatory agencies.
W h a t should a bank regulator do under existing authority when he
finds the type of situation that you have outlined to him, including
incompetent management, including speculative dealings with depositors' money, including a decline in profits and the incurring of losses,
and when this has gone on over a period of time and the bank is headed
for an inevitable collapse? What should and could an examiner, a
regulatory agency, do about such a situation at the present time ?
Mr. ROTH. All he could do is meet with the board of directors. He
should have them go down to Washington to meet with the Comptroller
of the Currency and tell them the facts. He should tell them that they
are headed for trouble and that it is the responsibility of the board
of directors to take the necessary corrective action. He should tell them
that if they don f t do it, they are going to have examiners in there
looking over their shoulders constantly. He should tell them that they
are going to be subject to lawsuits, the chances are, and that they had
better take this corrective action and do it immediately.
Mr. LEVITAS. To your knowledge, did the Comptroller of the Currency, Mr. Smith or any of his predecessors, do that with respect to
the Franklin Bank from 1972 on ?
Mr. BOTH. I understand that Mr. Van Horn did meet with the board
of directors of the bank after each examination. But you have to know
Mr. Van Horn. He is a southern gentleman.
Mr. LEVTTAS. Southern gentlemen can be mean sometimes.
Mr. ROTH. But you know the kind of southern gentleman that I
mean—a real southern gentleman.
Mr. ROSENTHAL. I understand, but he doesn't. Mr. Levitas is from
Atlanta, Ga.
Mr. ROTH. He is not strong. He doesn't pound the table. He doesn't
warn them of what they are headed for.
Mr. LEVITAS. I understand that in October 1972, you wrote Dr.
Arthur Burns, the Chairman of the Federal Reserve, making certain
recommendations to him relative to the problems that you foresaw
in the regulatory process during an expanding economy. Did you
write such letter ?
31
Mr. R O T H . Yes; I did.
Mr. LEVITAS. I would like to ask that this be made a p a r t of the
record.
Mr. ROSENTHAL. Without objection.
[The letter referred to follows:]
B A N K OF SUFFOLK COUNTY,
Stony Brook, N.Y., October IS, 1972.
Dr. ARTHUR F. BURNS,
Chairman, Federal Reserve Board,
Washington, B.C.
DEAR DR. BURNS : Permit me first to introduce myself. I am the retired Chairman of the Board of the Franklin National Bank, New York City. I sat next to
you at the Economics Seminar at Long Island University (of whicli I am a
Trustee) about four or five years ago. We have a mutual friend in Dr. R. Gordon
Hoxie.
Today's New York Times quotes you giving a "jawboning" warning to banks
and other lending institutions on interest rates. I agree with you. But I advocate
that much more should be done promptly than "jawboning."
A period of economic expansion is always accompanied by a heavy increase in
speculation and overexpansion. Speculation and overexpansion feed the fires of
inflation. When the boom recedes it is speculation and overexpansion that leads in
bankruptcies and loan losses in banking.
Therefore,
1. Banks must exercise credit restraints,
2. The bank examiners, in times of economic expansion, should list or
classify loans made for purposes of speculation and overexpansion,
3. The 100 largest banks, in particular, should be told that the welfare of
their country is more important than higher earnings.
During the last period of economic expansion the banks used Eurodollars and
foreign deposits to finance a great deal of speculation and overexpansion. The
supply of these funds negated the efforts of the Federal Reserve. The prime rate
borrower was able to obtain loans. Also, the temptation was engaged in to make
loans at rates up to 15 percent to high risk borrowers.
The money going to prime and high risk borrowers often left those borrowers
rated in between with credit unavailable or available at high rates.
Therefore,
4. The use of Eurodollars and foreign funds should be controlled,
5. The maximum rate of interest should be set at 3% over prime.
I hope my comments will be of help.
Cordially,
ARTHUR T. ROTH,
Chairman of the Board.
Mr. LEVITAS. W h a t response, if any, did you receive from Mr. Burns ?
Mr. ROTII. I received just an acknowledgement. T h a t is all.
Mr. LEVITAS. Were there no comments on the points that you made ?
Mr. ROTII. N O comments. And I might add t h a t the things that I
said in this letter really occurred. This was in 1972.
I said:
A period of economic expansion is always accompanied by a heavy increase
in speculation and over-expansion. Speculation and over-expansion feed the
fires of inflation. When the boom recedes, this speculation and over-expansion
leaves bankruptcies and loan losses in banking.
And that is what is occurring right now.
Mr. LEVITAS. I was looking at that in the letter. I thought perhaps
you could do as well as Jean Dixon has in some of her predictions.
Let me ask a question that ties in with this. Do you feel t h a t during periods of economic expansion that the bank examiners are less
careful and prudent in their examination process than they are during
periods of recession—that when things are going up, they may be a
little more lax ?
32
Mr. R O T H . Yes; of course they are. But they should remember what
may happen later on. And the trouble writh a lot of our regulators
and other people is that they are not practical bankers. They do not
have the years of experience necessary to know all of the things that
have happened in the past, such as bank failures and troubles of that
sort. I wrote this from my experience of a period of 50 years in
banking.
Mr. LEVITAS. Was Mr. Sindona or his company an owner of a sufficient amount of stock in Franklin New York to constitute it as a
holding company ?
Mr. ROTH. Definitely, in my opinion; yes.
Mr. LEVITAS. If that is true, did it not render it subject to the jurisdiction of the Federal Reserve Board and Dr. Arthur Burns ?
Mr. ROTH. That is right; it would have.
Mr. LEVITAS. I n the process of Mr. Sindona's company becoming
a bank holding company, would it have been appropriate for the Federal Reserve Board to investigate the people who controlled that bank
holding company as to their backgrounds, their character, and their
prior dealings? Would that have been clone by the Federal Reserve
Board?
Mr. ROTH. Yes; it would have been. That is what I had in mind
when I wrote the letter and sent it to the Federal Reserve.
Mr. LEVITAS. But they did not do that ?
Mr. ROTH. I don't know. I don't know what investigating they did.
Mr. LEVITAS. Do you know whether the Sindona operation was regulated as a bank holding company ?
Mr. ROTH. I t was not.
Mr. LEVITAS. Then presumably
the investigations of the type that I
refer to were not performed.
Mr. ROTH. They may have been performed and maybe they thought
that it didn't come under their jurisdiction as a bank holding company.
Mr. BROW^N. Will the gentleman yield ?
Mr. LEVITAS. Yes.
Mr. BROWN. Of course
there was the one-bank holding company
exemption for some time.
Mr. R O T H . That is right.
Mr. BROWN. My memory is foggy as to when that law ending the
one-bank holding company exemption became effective.
A member of the staff says that became effective in 1970.
Isn't that why Tisch decided to dispose of it ?
Mr. ROTH. Oh, yes. The Federal Reserve was investigating it. I think
he was fearful that Loews Inc. would have been declared to be a bank
holding company.
I think also, after writing my letter as I did, that he was smart
enough to get rid of the stock. But he got rid of it to the wrong person.
Mr. LEVITAS. Didn't Mr. Sindona then become the bank holding
company—or his company ?
Mr. ROTH. I don't think the Fasco Corp. was declared to be a bank
holding company by the Federal Reserve. I don't know, but I don't
believe so.
Mr. LEVITAS. Should it have been ?
Mr. ROTH. Yes; I say that it should have been.
33
Mr. LEVITAS. If it had been, then there could have been the opportunity for investigation into the background, character, and prior experience of the people involved.
Mr. ROTH. Any time anybody buys 20 percent of the stock of an important bank, and a bank that has problems, that person should definitely be investigated. That should be done whether or not the law
requires it.
Mr. LEVITAS. Let me ask one last question which calls upon your
experience as a banker for many years. This committee, along with
other committees of the Congress, is trying to discharge its constitutional dmry in the investigation and oversight of the bank regulatory
system. I t is being said that we are undermining confidence in the
banking system by raising questions and that we may be creating problems rather than leading to their solution. Do you, based on your experience of many years as a successful banker, have any thoughts on
that?
Mr. ROTH. Yes. I think a lot of people feel that way about it. But the
very fact that the Federal Deposit Insurance for quite a number of
years now has not allowed any depositor to lose any money has restored confidence. But once the F D I C allows any money to be lost
at any time from now on, I am afraid of wmat may happen. So I am
thinking that we have to do things with the F D I C to increase the
amount of insurance. I t wouldn't cost them any more. Maybe instead
of $40,000, it should be increased to $500,000 or so. After all, this increase is primarily going to help small banks. So why not do it. The
cost is no more to the F D I C because they have adopted a very sound
policy of selling the bank to competitors and seeing to it that nobody
loses any money.
Mr. LEVITAS. Do you think that hearings of this t}^pe are good for
the banking industry and for the public ?
Mr. ROTH. Thank goodness we are having this hearing. Yes, it is
going to be very, very good. I t is going to have a salutary effect. But
as I have said, if we had an overall supervisory group, as has been
recommended by the Reuss committee, I see great damage not only to
banking, but to the economy of our country.
I would want you to continue doing the things you are doing today
and to get into it in great detail. The public has confidence only because no money has been lost. But you have to do something about
F D I C insurance, as I see it, and see to it that the depositors don't lose
money.
Mr. LEVITAS. I believe I am correct in saying that after some of the
banks were named recently in press reports and listed as problem
banks and so forth that the market impact on the price of their shares
was not negative. I think some of them even increased.
Mr. ROTH. That is right.
Mr. LEVITAS. That proves that the public pays pretty close attention
to what they read, for the most part. Thank you very much, Mr. Roth.
Mr. ROSENTHAL. Before I turn it over to Mr. Gradison, I have two
questions which I want the record to show.
What was the change, either plus or minus, in the number of
branches that Franklin had before Franklin went under and now that
European-American has out on Long Island? Do you know?
34
Mr. E O T I I . On Long Island, they didn't close any branches, to my
recollection. I n New York City, they only closed a limited number of
four or five, as I recall.
Mr. ROSENTHAL. W h a t was the total stockholder loss as a result of
Franklin's problems ?
Mr. ROTH. There were 4,600,000 shares which were, you might say,
at $30 or $40 a share. So it is $125 to $175 million. And I don't know
what will happen to the preferred stockholders and the debenture
holders. There is another $G0 or $70 million there. But I think they
are going to be paid in full.
I question whether the common stockholders will get anything out
of it, but I think everyone else will be paid. And there will be no loss
to the Federal Deposit Insurance.
Mr. ROSENTHAL. Mr. Gradison.
Mr.
LEVITAS. Will the
Mr. GRADISON. Yes.
Mr. LEVITAS. For the
gentleman yield ?
purpose of completing the record, I ask unanimous consent that the letter which Mr. Roth drafted to send to Fortune magazine, but did not send, dated October 17, 1974, be made a
part of the record.
Mr. ROSENTHAL. Without objection, it will be a part of the record.
Mr. BROWN. I n order to make it complete, the article should also be
included.
Mr. ROSENTHAL. We will put both of them in.
[The information referred to follows:]
[From Fortune magazine, October 1974]
W H A T REALLY W E N T WRONG AT F R A N K L I N NATIONAL
T H E DEBACLE THAT SHOOK T H E U . S . BANKING SYSTEM WASN'T CAUSED BY THOSE
WELL-PUBLICIZED FOREIGN-EXCHANGE LOSSES T H E REAL PROBLEM WENT DEEPER:
F R A N K L I N ' S MANAGERS DIDN'T KNOW H O W TO RUN A BIG-LEAGUE BANK
(By Sanford Rose)
T h e nation's financial system is facing its gravest crisis since t h e B a n k Holid a y of 1933. The crisis is one of confidence. T h e public h a s become increasingly
worried about the solvency of even t h e most profitable banks. I n t h e p a s t few
months, bank-stock prices have fallen far more rapidly t h a n the stock m a r k e t a s
a whole—which is saying plenty. T h e prices of bank stocks a r e now lower in
relation to earnings a n d book value t h a n they were on Friday, March 3, 1933,
t h e day before t h e B a n k Holiday. Says Morris Schapiro, t h e dean of American
b a n k a n a l y s t s : "We don't have a bank holiday yet, but we already have a bankholiday stock m a r k e t . "
The weakening of public confidence in the b a n k s is traceable, to a considerable
extent, to the well-puhlieized misadventures of the F r a n k l i n National B a n k of
New York. I n May, F r a n k l i n National, then t h e twentieth-largest bank in t h e U.S.,
w i t h deposits of close t o $3 billion, canceled its second-quarter dividend a n d announced foreign-exchange losses in t h e neighborhood of $40 million. Many people
believed t h a t Franklin, which h a d been a weak-earning b a n k for years, would
he promptly liquidated by t h e regulatory authorities and i t s deposits assumed by
a stronger banking institution. Instead, F r a n k l i n retained a precarious hold on
life during t h e subsequent months. Aided by a massive loan from t h e F e d e r a l
Reserve, the b a n k was able to meet deposit w i t h d r a w a l s t h a t exceeded $1.5 billion by September.
F r a n k l i n ' s miseries have affected public confidence in two ways. F i r s t , the
spectacle of a major b a n k being propped u p for months was itself r a t h e r unnerving. I n addition, t h e p a r t i c u l a r ailment t h a t most people associate with
Franklin—foreign-exchange losses—seems to have afflicted a fair n u m b e r of
o t h e r b a n k s recently. Several small European b a n k s had large foreign-exchange
35
losses and subsequently failed. It seemed reasonable, then, to wonder whether
Franklin's problems might be typical of the banking industry.
The answer happens to be no. To be sure, many banks speculate in foreign
exchange. But no U.S. bank speculated as heavily or as recklessly as did Franklin.
Most banks can make money in much less risky ways. Franklin could not; it is
now clear that the bank had to speculate in foreign exchange because it could
earn virtually nothing on normal operations. Not counting foreign-exchange
transactions, Franklin made just about $5 billion in 1973. That amounted to
about one-tenth of 1 percent of the bank's assets. The average U.S. bank made
more than eight times as much on assets during 1973.
The details of Franklin's foreign-exchange operations are lurid enough—as
we shall see—but the real story of the bank's downfall has to do with normal
banking deteriorating rapidly after the middle of 1973. Data available to FORTUNE indicate that the bank lost money on a pre-tax basis from July through
September of 1973—not counting foreign exchange. Indeed, were it not for a
phony foreign-exchange profit in September, 1973, Franklin might have been
forced to cancel its third-quarter dividend—an action that would have terrified
its creditors and probably triggered the inevitable crisis eight months earlier.
Operating profits reappeared briefly in late 1973. But from February through
April, 1974, the bank continued to lose money. And during April its controller's
office projected losses of between $5 million and $7 million for the entire second
quarter.
Although the total operating shortfall does not equal the foreign-exchange
loss—now estimated at about $46 million—it is much more significant. A foreignexchange loss, even a series of losses, constitutes an extraordinary event. On the
other hand, persistent operating deficits betoken fundamental rot. The plain fact
is that Franklin could not manage the spread between the yield on loans and
bonds and the cost of investable funds, personnel, and occupancy. If Franklin
had not received massive assistance from the Federal Reserve, the bank would
have been forced to shut its doors sometime in 1974 even if it hadn't lost a dollar
in foreign exchange.
The statement seems almost incredible. Most Americans assume banks don't
fail unless there is fraud, and that large banks just don't fail at all. Why couldn't
Franklin make money doing what other banks do ?
Perils of a one-man show
An answer begins with the dearth of professional-caliber management at the
bank. It has been run amateurishly for decades. In the 1950's and early 1960's
Franklin enjoyed two advantages not given to many other banking institutions.
It was located in one of the fastest-growing market areas of the country, Long
Island. And it was insulated from serious competition by branching restrictions
placed on New York City banks. Embosomed in the soft plush of this uniquely
favorable environment, Franklin saw no need to professionalize its management.
Even if it had perceived the need, it is doubtful that anything would have been
done about it. The bank was headed in those years by Arthur Roth, a hard-driving
autocrat whose favorite homily is "every organization is but the shadow of one
man." Roth ran Franklin as a one-man show, surrounding himself with malleable
subordinates who had no particular aptitude for banking.
One of these was Harold Gleason, a good public-relations man and a smooth
and persuasive talker. Gleason was Roth's faithful subordinate for about a dozen
years. Ultimately, though, the two fell out after Roth told Gleason that he didn't
measure up and would never be chief executive. Of Gleason, Roth now says
bitterly: "I treated him like a son. Little did I imagine that the man was just
a faker, an egotistical incompetent."
Another of Roth's proteges was John Sadlik, who eventually became the bank's
chief financial officer. Sadlik's knowledge of the finer points of finance has always
been somewhat sketchy. He would generally approve an investment if its yield
was at least one percentage point above the bank's average cost of money. That
might sound reasonable to nonbankers. But in a period when demand and savings
deposits are declining, average cost can understate the true cost of financing asset
growth.
During late 1973, for example, nearly every asset acquired by Franklin had to
be financed by borrowings in the money market at rates of between 9 and 11
percent. This marginal cost was about 2 to 4 percent above the average cost of
Franklin's funds, which, of course, included low-cost demand deposits and pass-
36
book-savings accounts. Clinging to the one-percent-above-average standard, Sadlik
and others approved the acquisition of many assets on which the bank inevitably
lost money.
Waving aside the balance sheet
Despite managerial shortcomings, Roth was able to propel Franklin forward
at a frantic pace during the bank's golden age. From 1950 to 1962 Franklin's
assets grew from $78 million to over $1 billion. Earnings averaged between 15 and
20 percent of stockholders' equity.
Roth and his epigones could not dispense money fast enough in those early
years. The flavor of the bank's lending operations was recalled recently by Roger
Elton, a banker who later joined Franklin and rose to become executive vice
president. Said Elton: "In the early 1950's, the Long Island contractor who built
my house needed $25,000. He went to Franklin and they gave him the money
before he even showed them his balance sheet. When he produced the statement,
they waved it aside."
Clearly, Roth was not averse to risk. Indeed, he often stated that he was willing
to take loan losses equal to twice those of the average bank, provided he could
earn 0.75 to 1.25 percentage points above the national average on his loan portfolio. But there were years in which loan losses reached three to five times the
average.
During the late 1950's and early 1960's, some of the losses grew out of loans
made by Franklin in anticipation of public offerings. Small businessmen would
come into the bank with letters from underwriters promising to help them raise
funds in the capital markets. Franklin would provide the interim financing. But
after the stockmarket collapse of 1962, many of these offerings had to be withdrawn, and a lot of borrowers defaulted. At about the same time, the apartment
boom in the metropolitan New York area collapsed, and a number of Franklin's
real-estate equity loans went sour.
The alarming rise in loan losses helped change Roth's mind about the kind of
assets Franklin should be acquiring. In the early 1960's, the emphasis shifted
from loans to municipal bonds. The bank more than doubled the size of its securities portfolio, loading up on 3 to 4 percent Long Island school-district bonds.
In buying municipals, Franklin acquired what looked like attractive tax-free
assets, while at the same time ingratiating itself with town treasurers, whose
deposits—both demand and time—came pouring into the bank.
But Roth overdid it. He bought so many municipals that in later years the bank
was stuck with far more of them than were justified by its tax position. Franklin
hasn't paid any federal income taxes for most of the last decade. Instead, largely
because of its municipal bonds and the slow growth of its taxable revenues, the
bank started accumulating a tax-loss carry-forward, which it carried on its balance sheet as an asset.
Without taxable income, it is no fun owning a lot of low-yielding tax-exempt
bonds. At the time of the crisis last May, Franklin held close to $300 million in
municipal bonds with an average yield of only 4 percent. That yield was about
three to 3.5 percentage points below the bank's average cost of money and about
seven percentage points below its marginal cost. Just comparing average yield
with average cost, the bank was losing about $10 million a year on its municipalbond holdings.
Most other banks would have shed this albatross a long time ago, even if that
meant taking sizable capital losses on the sale of bonds. And there were times
in the past when the capital penalty would not have been too onerous. Says Harold
Kurtz, a former Franklin vice president: "As late as 1968, we could have disposed
of many of those bonds without hurting ourselves too much. But by then our
loan losses were so high that we could not afford to take additional losses in the
bond account."
Ironically, Franklin's oversized municipal-bond portfolio eventually resulted
in the loss of its public deposits. Because Franklin had bought so many municipals
in the early and mid-1960's, it was out of the market by the end of the decade.
Predictably, the officials of Long Island communities did not at that point dwell
on the bank's earlier heavy purchases; instead, they just seemed irritated that
Franklin, a local bank, was not now picking up its share of the increase in
municipal debt. So they began moving their deposits out of the bank and into
competitive institutions like Security National.
37
He couldn't find "21"
By the early 1960's the wall that separated Queens from the rest of Long Island
had begun to crumble. The New York City banks had been given the right to
branch into Nassau County. Commercial and savings banks alike began pushing
into the new territory, poaching on Roth's once inviolate preserve. Roth mapped
a counterstrategy. He would go to New York.
Many believe that the decision to enter New York was Roth's most egregious
blunder. The bank did not have the ability to compete in the New York market.
Says Mike Merkin, the eighty-year-old vice chairman of Franklin: "What business had Roth coming to New York? He didn't even know the way to '21.' "
The move to New York need not have been a mistake however. Meadowbrook
National Bank—now the National Bank of North America—came from Long
Island to New York and managed fairly well. It was the way Roth entered New
York that hurt him.
First he tried to buy a New York bank, the Federation Bank & Trust. He could
not get Federation right away, at least not on terms that satisfied him. Not being
one to wait, Roth started branching into the city in 1964. And he arrived traveling first class. Says Jerome Twomey, a former executive vice president at Franklin : "Roth came to New York building monuments—impressive and very costly
structures." The move to New York enormously inflated the bank's occupancy
expense.
A newcomer to New York City, Franklin could not hope for the choicest bank
credits ; it had to content itself with shards. The bank fought for small participations in major loans syndicated by the larger New York banks. If the bank won
a place in these syndicates at all, it was often because it lacked the nerve to ask
for decent compensating balances—i.e., non-interest-bearing funds that must be
kept on deposit at all times. Says David Dowd, a former Franklin vice president:
""I went directly from Irving Trust to Franklin in the mid-Sixties. At Irving we
had a piece of the Woolworth account and we got a compensating balance of
between 20 and 30 percent. At Franklin we would not have dared to ask for more
than 10 percent. We knew we couldn't get it."
Finding it both difficult and unprofitable to attract national customers, Franklin began to concentrate on a somewhat specialized clientele. The bank soon acquired a reputation as a primary lender to "growth companies"—which usually
turned out to mean companies that were promoting their stocks heavily. Says
Twomey, who was responsible for a part of the business: "To be perfectly frank,
in those years nearly every company that was written up in the Wall Street
Journal for unusual accounting practices became our customer."
Although this was high-risk business, Franklin did not earn especially high
rates. The bank was so committed to rapid growth that its loan officers often
shaved rates in order to show volume and remain members in good standing of
a go-go shop. When they did reach for yield, it was sometimes in exotic and
unproductive forms. For example, a number of loan officers took "shadow warrants," i.e., they included clauses in the loan agreement providing for additional
interest payments if the price of the borrower's stock rose above a certain figure.
Ordinarily, the stock did not go up enough, and Franklin was left holding a risky
loan with a modest yield.
Triumph of a generous man
In 1967, Franklin finally merged with the Federation Bank & Trust. Roth
got the Federation, but in turn the Federation got him. Allying himself with the
new directors on Franklin's board, Gleason managed to supplant Roth as chief
executive in 1968, and finally pushed him off the board altogether in 1970. Roth
retired to the role of gadfly, stinging management, and particularly Gleason, in
angry letters to the shareholders.
With Gleason enthroned as chief executive, the bank's fortunes began a serious
further declension. An easy-going and generous man, Gleason lacked the disposition to control personnel expenses, and they soared. Under Gleason's guiding
hand, the number of employees increased sharply, salaries and bonuses rose, and
expense accounts became much more lavish. From 1968 to 1970, the bank's salary
expense increased by 50 percent.
At about the same time, Franklin's earnings began to suffer alarmingly from
a change in the accounting procedures governing loan losses. Before 1969 banks
did not have to show loan losses on their income statements. Instead of reducing
reported earnings, the losses were a below-the-line deduction from reserves, in
38
effect a direct charge to capital. Beginning in 1969, however, the supervisory
agencies insisted that banks put at least a portion of their losses onto their
income statements.
Banks that did not wish to take the full yearly loss against income could
choose one of two moving-average procedures. They could compute the ratio of
net losses to average loans during the five years ending in the current year
(initially 1969), apply that ratio to all current loans, and reduce income by the
resulting figure. Alternatively, they could decide that the ratio to be used would
be net losses to average loans for 1969-73, or as much of the period as had been
completed.
Since Franklin had had a miserable loan-loss experience in the mid-1960's, and
a good performance in 1969, it elected the second alternative. That worked out
tolerably well until 1971, when losses were horrendous. And with only two other
years represented in the average, the 1971 losses had a terrific impact on income;
they socked it for a dizzying $7.2 million.
By the early 1970's, Franklin was beginning to show signs of terminal illness.
The fall in interest rates from mid-1970 to 1972 reduced loan yields, but the
bank's interest expenses did not fall commensurately, in part because the cost
of passbook savings—a sizable chunk of Franklin's deposits—remained relatively
stable.
Franklin's miseries in this period can be summarized by a comparison of its
1972 operating results with those of a representative group of peer banks—that
is, banks of similar deposit size and roughly similar deposit composition. According to unpublished Federal Reserve data, Franklin had a net return in 1972 of
less than three-quarters of a cent per dollar of investable funds, i.e., deposits
and borrowed money. Its peers made more than twice that. Franklin paid more
for its money than its peers, and it earned less on its bread and butter, commercial loans, on both a gross and a net basis. Moreover, by 1972 the bank had
become almost unbelievably inefficient. Expenses per dollar of commercial-loan
volume totaled 50 percent more than at banks of comparable size.
New faces of the 1970's
Since the late 1960's Laurence A. Tisch, head of Loews Corp., had been quietly
buying up Franklin stock. By 1971 he had accumulated a controlling 20 percent,
and in mid-1972 he became alarmed at what was happening to his investment.
Tisch decided on a major rescue effort. He reached into Bankers Trust and persuaded Paul Luftig, the highly respected head of Bankers' metropolitan division, to come aboard as Franklin's president.
An energetic and ambitious man in his early forties, Luftig took the job in
May, 1972—fully expecting to succeed Gleason as chief executive officer within
a matter of weeks. But in July Tisch undercut Luftig by selling nearly all his
stock to Michele Sindona, the Italian financier.
Sindona's reasons for buying into the bank remain an enigma, as do many of
Sindona's moves. He apparently did not research the acquisition very thoroughly,
however; shortly after he bought the bank, he confessed to a reporter that he
had never heard of Arthur Roth. When the two men finally met later in 1972,
Roth, still a substantial Franklin shareholder, asked Sindona what he was
going to do about earnings. Sindona replied: ''Don't worry. I'm going to make
most of my money in foreign exchange. That's the way I do it in my Italian
banks."
Meanwhile, Gleason had been reprieved. He began to cultivate Sindona, traveling to Italy every second weekend for "talks"; he also took Italian lessons.
Luftig was isolated, in effect a lame-duck president. Still, he held on tenaciously.
He had a five-year contract and he was determined to make a serious effort to
get things organized.
Early in 1973, another new face appeared in the top management ranks. Peter
Shaddick was recruited by Sindona from the Bank of Montreal to head up the
international department. Although Shaddick entered the bank with the title of
senior executive vice president, it was clear from the beginning that he intended
to function as a sort of co-president. It was also clear that he was going to run
the international department as a bank within a bank. He scorned Franklin's
internal auditors and requested his own auditing group. Shaddick was a tiger;
and since he was Sindona's man, no one messed with him.
The scandal in real estate
While Shaddick busied himself with his palatinate, Luftig tried to cut operating costs. He fired some people, although probably not as many as he should
have. Overall, Luftig was able to slow down the rate of increase in operating
39
costs, but he was never able to reduce costs absolutely. One of the main reasons
was occupancy expense, which increased substantially following the move to 450
Park Avenue in November, 1972.
The bank's real-estate situation had become nothing short of scandalous.
Luftig found that Franklin didn't really need about 25 percent of the space it
was paying for. In some cases the bank was renting space far above market
prices. And at the same time it was charging less than market price for the space
it subleased to others.
One problem was that the bank had no effective supervision over small leases.
In an uncharacteristic effort to save a few pennies on legal fees, the bank had a
policy of allowing the other party's lawyer to draw up small leases. The terms
of these leases were naturally unfavorable to the bank.
The real-estate problem was aggravated by Franklin's sale-leaseback arrangements. The bank had a continuing, desperate need to show taxable income in
order to avoid wasting a portion of its tax-loss carry-forward. In several years,
to avoid this waste, Franklin sold a large amount of property and simultaneously
leased it back. The bank booked a capital gain, which it used to offset the
ordinary income losses of previous years. Unfortunately, these transactions also
inflated rental costs: the bank's lease payments exceeded the property taxes it
would have paid had it continued to own the buildings.
Gambling on leverage
Finding it impossible to reduce expenses, Luftig made a procrustean adjustment in his thinking. If the bank's expenses could not be cut down to a level
appropriate to its asset size, asset size would have to be expanded. In late
1972 Luftig began borrowing money in order to finance a major expansion of
the bank's lending activity. By increasing the bank's already substantial
leverage—i.e., the ratio of assets to equity capital—Luftig hoped to raise
earnings per share despite the burden of outsize expenses and the handicap
of an anemic profit margin. At the time, this seemed a reasonable step, given
the bank's predicament. Yet it proved disastrous.
In the first eight months of 1973, Franklin's domestically financed loans grew
by nearly 25 percent. But the bank had the bad luck to be expanding its assets
in a period when bank lending rates were artifically depressed by Federal
Reserve pressure. For a considerable part of 1973, the prime rate remained threequarters to a full percentage point below the level it would have reached if
the Fed had not been trying to hold it down.
Meanwhile, bank borrowing rates were not placed under comparable pressure.
The rate on certificates of deposit remained relatively free to rise. The rate
on federal funds—the reserve balances that banks borrow from other banks—
was artificially held down only until about April, then was more or less allowed
to move up.
The behavior of federal funds, which Franklin borrowed heavily, was a special
problem. The rate on federal funds eventually rose to higher levels than it otherwise would have precisely because the prime rate was being contained. A
bargain prime increases the demand for credit. As more loans are extended^
demand deposits also increase, raising the level of required reserves. In turn,
the scramble for reserves puts upward pressure on the funds rate. Hence any
bank that financed itself with a large amount of federal funds during 1973 faced
extraordinary pressure in earnings. At Franklin, profit margins virtually evaporated. At times during the year the bank put assets on its books at a negative
earnings spread—i.e., the yield on the asset was less than the cost of financing it.
If Franklin had been able to finance its asset growth by expanding core
deposits—demand and passbook-savings money—it would undoubtedly have
prospered. Franklin's average monthly prime rate rose from 6 to about 10 percent during 1973. The cost of its demand deposits totaled only about 2% percent
and the cost of passbook savings averaged just over 4 percent. But Franklin's
demand deposits were actually falling in this period. Passbook savings were
also eroding, as savers moved their money into Treasury bills and other moneymarket instruments. That left Franklin scrambling for funds in the money
market, where rates kept rising.
Banks normally strive to hold on to at least enough cheap core money
to finance their fixed-rate assets—e.g., bonds, mortgages, consumer loans, and
some commercial loans. That way, even if interest rates rise, they are guaran*
teed a positive earnings spread on a part of the total portfolio. But once the
size of the fixed-rate portfolio exceeds the amount of core funds, a bank can end
up financing rate-insensitive assets with highly rate-sensitive liabilities.
40
And that was what happened to Franklin. At the beginning of 1973, the
bank's core money just about equaled its fixed-rate portfolio. But during 1973,
while the core money eroded, fixed-rate assets increased. At the end of the
year the bank wa,s going to the money market for about $500 million to finance
the part of its fixed-rate portfolio that was no longer covered by its core
deposits. It was also borrowing $1.2 billion to finance its fluctuating-rate loans—
i.e., those tied to movements of the prime rate. It made a little money on the
spread between the yield and the cost of these loans, but not as much as it
lost on the fixed-rate portfolio. On balance, Franklin was losing money on its
$1.7 billion in borrowed funds. Luftig's gamble on capital leverage had backfired.
Mired in federal funds
Having become dependent on borrowed funds in a period of rising rates,
Franklin might still have effected some substantial economies by lengthening
the maturity structure of its borrowings. There were days during 1973 when
the bank was borrowing over $1 billion—about 25 percent of total liabilities—
in the form of one-day federal funds. At midyear the federal-funds figure was
running about $750 million, at a cost of about 8 ^ percent. The cost of six-month
certificates of deposit was approximately the same. If Franklin had locked up
$750 million in six-month money just past midyear, it would not have had to
borrow some $930 million in federal funds, at a cost of about 10 percent, during
December, 1973. Franklin would have saved about $1 million in interest costs
for that one month alone.
But at midyear, 1973, Franklin's management expected interest rates to
fall dramatically. And why lock up a lot of expensive money when day-to-day
funds would soon be available at much lower rates?
While the bank was playing Russian roulette with its debt structure, it was
passing up opportunities to increase the return on its assets. Franklin's overall
yield on assets was badly depressed by its huge fixed-rate portfolio, which
constituted about half of all domestic earning assets. But even the variablerate portion of Franklin's portfolio was outrageously underpriced. Loans that
other banks made at the prime rate plus 2 percent could be obtained from
Franklin at prime plus % or 1 percent.
There was nothing irrevocable about these prices. About 45 percent of Franklin's domestic-loan portfolio—over $900 million—matured every three months.
The figure includes all the bank's ninety-day discounted loans as well as over
$500 million in other loans. The bank could have raised its rates on these
maturing assets to competitive levels; alternatively, it could have turned
away the business. Eventually, Franklin did some of each, but not soon enough
to raise earnings in 1973.
Earning less on more
Shaddick was not doing much better abroad. It is true that foreign assets
nearly doubled during 1973; by year-end they exceeded a billion dollars, about
& quarter of the bank's total earning assets. The only trouble with this growth
is that it was totally unprofitable. At the end of 1973 the international department was actually earning fewer dollars on its $l-billion portfolio than it had
earned on $600 million the previous December. Profit margins abroad—i.e., the
difference between interest earned and interest paid as a proportion of a s s e t s had fallen from about a half cent per dollar of assets in the middle of 1973 to
.one-tenth of a cent at the end of the year. Adding in the cost of running the
overseas branches, Franklin was plainly losing money abroad.
Shaddick's problems mirrored those of the rest of the bank. He was borrowing too short and lending too long, at rates of % percent to % percent over his
cost of funds. As the cost of day-to-day Eurodollars crept up, margins fell and
disaster threatened. Like Luftig, Shaddick had guessed wrong on interestrate movements.
In July, 1973, Luftig left on vacation, still convinced that interest rates
would soon peak. While on vacation, he telephoned William Hitchborn, the con-
41
troller, to ask how the bank was doing. Hitchborn, who worked for John Sadlik,
told him not to worry—the bank was having a banner month. Luftig returned
to find that the bank had lost nearly $700,000 in July, the worst month in history. Hitchborn had badly miscalculated.
In the latter half of 1973, a deepening sense of gloom pervaded the bank.
Luftig now realized that he had to reduce assets, not increase them. Jolted
by the Hitchborn incident and others like it, he demanded better and more
comprehensive financial data. Luftig also tried to fire Sadlik, but Gleason intervened to save him.
By late summer, the mood in the bank was approaching panic. The thirdquarter dividend looked shaky, and this in turn could have jeopardized a plan
of Sindona's to help the bank. He had been pushing a merger between Franklin
and Talcott National, a factoring and finance company that he also controlled.
Since Talcott had profits, Franklin would find a use for its tax-loss carryforward. But if Franklin omitted its third-quarter dividend, the merger would
be in trouble.
Suddenly, as if by magic, earnings appeared. Franklin recorded a $2-million
profit in foreign exchange during September. Sometime during the month, it
is now known, Franklin's foreign-exchange department received a call from
a member of senior management. The traders were instructed to arrange offsetting currency transactions with a Swiss bank called Amincor. Franklin
bought four or five separate currencies from Amincor and soon thereafter resold
them to the iSwiss bank at a $2-million profit.
But it was later established that the currencies in question had not risen sufficiently in the interim to produce a $2-million gain. The exchange rates placed
on the contracts were plainly phony, rigged by agreement with Amincor to guarantee Franklin's profit. At the time, however, no questions were raised. The
bank received a check for $2 million from Amincor. The check was addressed to
P. R. Shaddick. Buttressed by the bogus foreign-exchange profit, Franklin declared its dividend.
During the waning months of 1973, interest rates fell slightly from their September peak, and operating results improved. The bank's earnings were now so
sensitive to the movements of the federal-funds rate that a decline of less than
a percentage point in October sufficed to raise its gross interest differential by
close to $2 million. In November Shaddick added to the good news by coming
up with some sizable additional foreign-exchange profits. These appear to
have been legitimate.
Beginning in the fourth quarter of 1973, Franklin began gambling heavily
in the bond market. Management was convinced that the slight easing of interest
rates presaged a sharp further decline. And so the bank authorized its securities
department to go long in five- to ten-year government and federal agency bonds.
J. Michael Carter, the head of the securities department, ended up buying much
more than he was authorized to buy. From late in 1973 until March, 1974,
Franklin's bond holdings rose by about $200 million. The yields on these bonds
averaged between 7 and 8 percent, which was two to three percentage points
less than the cost of the money used to purchase them. Unless interest rates fell
substantially in 1974, the bank was obviously headed for further sizable operating deficits.
Once more with Amincor
By early 1974, the bank was almost a complete hostage to the vagaries of the
federal-funds rate. When the rate fell in January, the bank remained marginally profitable. When it started to rise strongly in April, the bank's monthly
operating deficit soared to $3 million.
Well aware of the bank's precarious operating position, Shaddick redoubled
his efforts to make extraordinary gains in foreign exchange. There were profits of
$3.8 million in January, but losses of $2.5 million in February. By March it was
time for another Amincor deal. On March 28, the bank arranged a transaction in
42
future foreign exchange (currencies bought and sold for future delivery), and
these netted a phony unrealized profit of another $2 million. As a result, a prospective March foreign-exchange loss of $1 million was converted into a $l-million
profit. The following month, Shaddick cracked up under the strain and jspent two
weeks in a hospital.
By April, Luftig was spending about half his time on the telephone trying to
persuade other banks to continue selling Franklin federal funds. Morgan, then
Franklin's major correspondent bank, had stopped selling it funds in the fall of
1973. Now Bank of America was cutting back its allotment, from $50 million to
$30 million. Gradually, as word spread through the banking business that Franklin might fail, a growing number of banks either reduced or suspended sales.
Despite enormous difiiculties, Franklin was still able to buy more than $500
million a day in federal funds during the first week of May. But it was* clear
that, within a short period of time, the bank would simply be unable to finance
itself. Given the continued high level of the federal-funds rate, the bank was sure
to continue losing money throughout the second quarter. By the end of the quarter, it would very probably face a massive run on its deposits.
Lurching toward merger
On May 6, Luftig told the bank's executive committee that Franklin had to be
merged. By the end of the day the committee voted unanimously to authorize
him to seek a merger. Luftig informed the Federal Reserve of the bank's predicament on the following day and started talks immediately with John McGillicuddy,
president of Manufacturers Hanover. McGillicuddy liked the idea of a merger, but
he had some conditions. He wanted antitrust clearance from the Justice Department. He wanted a guarantee that he would not have to bring any of Franklin's
top executives into Manufacturers' senior management. In addition, McGillicuddy had a record of earnings growth at Manufacturers that he cherished. If
he took on Franklin's losses, the record would surely be tarnished. And so some
form of subsidy from the Federal Deposit Insurance Corporation would be
required.
During the week of May 6, progress was made on at least two of the three
issues raised by McGillicuddy. The Fed agreed to intercede with the Justice Department on the antitrust issue. And Franklin's executive committee agreed to the
personnel condition. There was, moreover, some reason to expect a favorable response from the FDIO. It had provided a subsidy to the Crocker National Bank
when it absorbed U.S. National in October, 1973. It would probably do the same
in this case. In any event, on Friday Luftig called McGillicuddy and said: "I
think we've got a deal." But then a bombshell exploded.
During the week, Franklin's top management had been getting intimations
that the bank had suffered additional foreign-exchange losses—losses not recorded on the bank's books. But it wasn't until Friday night, May 10, that some
idea of the magnitude of the losses emerged. That night Luftig apprehensively
passed the news to Manufacturers that Franklin had apparently sustained a
huge lose in foreign-exchange trading. To his relief, Manufacturers indicated
that it was still willing to negotiate. On the weekend teams from both banks sat
down to work out merger arrangements.
But on Sunday, May 12, Sindona moved to quash the effort. He managed to set
up a remarkable high-level meeting at the Federal Reserve Bank of New York
with representatives of the Fed, the Securities and Exchange Commission, and
the Comptroller of the Currency. Representing Franklin were Sindona; his
personal lawyer, Randolph Guthrie, of Mudge Rose Guthrie & Alexander; Carlo
Bordoni, a close Sindona associate who was also a member of Franklin's board;
Harold Gleason; and the bank's public-relations man, Arthur Perfall. Of this
group, the only one who could conceivably claim a nodding acquaintance with
Franklin's operating problems was Gleason.
Sindona had excluded from the meeting all the bank's top operating executives. And while he brought along his own personal lawyer, he did not invite the
hank's longtime law firm, Kaye, Scholer, Fierman, Hays & Handler. It is little
43
wonder, then, that the regulatory authorities received a badly garbled account
of the bank's situation at the meeting. What is puzzling is that the regulators
accepted this account without too much question.
After pondering the condition of the bank, regulators approved a Sindona
plan to salvage Franklin by raising $50 million in additional capital from the
bank's shareholders. Then a most astounding press release was prepared. The
release, which was distributed by the Federal Reserve as well as by Franklin,
implied that the entire $39-million or $40-million foreign exchange loss had
occurred during the second quarter; whereas at least $14 million had plainly
occurred during the first quarter. The release also stated that Franklin believed
it was insured "for a substantial portion of the loss." Some of the bank's top
executives knew that it wasn't true. In fact, Kaye, Scholer had just reported that
the bank was probably not insured for any part of the loss.
The release further stated that the Comptroller of the Currency had assured the Federal Reserve that Franklin was a solvent institution and therefore eligible for loans at the Fed's discount window. It is hard to see how the
Comptroller could have offered any such assurances. When Luftig was informed
by telephone of the contents of the release, he called in Edward Lake, the bank
examiner from the Comptroller's office who had been assigned to the Franklin
account. Asked Luftig : "Are we solvent?" Replied Lake : "No."
A special kind of insolvency
Considering only its liquidation value, Franklin was obviously insolvent on
May 12. It could be argued that, in one sense, most other banks were also insolvent.
After years of rising interest rates, the market value of their bond portfolios
and their fixed-rate loans is appreciably below their liabilities.
But most other banks are going concerns that earn profits and pay dividends;
it is reasonable to ignore their technical insolvency. Franklin was not at all a
going concern on May 12. The bank had ho prospects of making money then or
in the foreseeable future.
The bank had no very good way of dealing with its central problem: its dependence on fixed-rate assets. As of May 12, Franklin had about $1.6 billion in
fixed-rate assets—$900 million in bonds and another $700 million in loans. The
bank had unrealized depreciation of about $100 billion in the bond account alone.
If Franklin had tried to cut its fixed-rate portfolio to manageable proportions, it
would have had to take huge losses—in addition, that is, to its operating losses
and those already sustained on foreign-exchange transactions. Sindona's plan for
a 850-million capital increase would not have helped much.
It is, in fact, hard to see what merit the regulators saw in Sindona's rescue
plan. Why didn't they reject it and push hard to get Franklin merged with Manufacturers? With any encouragement from the 'regulators, a merger would have
been speedily arranged. Manufacturers would have quietly assumed Franklin's
deposit obligations, and there would have been no mass withdrawals. Franklin's
troubles would not have remained in the headlines for many months.
Luftig calls Ms lawyer
After the session at the Fed broke up, Gleason returned for an emergency
meeting of Franklin's executive committee later that evening. He confirmed
that merger talks were suspended. Then Luftig told Gleason that his press
release was inaccurate. Gleason said nothing, except that certain management
changes would be discussed the next day. Whereupon Gleason left the meeting and
Luftig called his lawyer.
The following day, Shaddick resigned and Luftig was fired. Gleason was
named president as well as chairman. Five weeks later, on June 20, the bank
revised that press release. It raised the figure for foreign-exchange losses from
about $39 million to $45.8 million and assigned $26.7 million of this amount
to the first quarter. The second release said that the first-quarter loss had resulted from falsified or unauthorized foreign-exchange contracts.
44
There is still very little known about those mysterious foreign-exchange transactions. At the end of June, however, it was learned that Sindona had had
previous dealings with the Amincor Bank of Switzerland and had used the bank
in his acquisition of Interphoto Corp. in 1970. Moreover, Carlo Bordoni, who
continued on Franklin's board until late June, 1974, had also seen service on
Amincor's board from the 1969 to early 1973.
Sources in the SEC now confirm that the $4 million in foreign-exchange profits
realized in September, 1973, and in March, 1974, was the result of self-dealing
transactions. But what about the huge losses? Did they result from legitimate
gambles that did not pay off? Or did Sindona give up on his attempt to prop
up the bank after the two Amincor incidents? Did he instead decide that, since
Franklin was in any case lost, it was now time to (recoup his $40-million stock
investment by sticking the bank with some foreign-exchange losses? Both the
FBI and the SEC are still pursuing the answers.
To be sure, some of the circumstances surrounding the foreign-exchange losses
are highly suspicious. A big chunk of these losses was attributable to a single
trader, Donald Emrich, who had been hired by Shaddick in July, 1973. He was
scarcely what one would call a topflight candidate for a trading job. He had
previously been fired by Continental Illinois for the precise offense he committed
at Franklin—unauthorized trading in foreign exchange. Before that he had been
fired from Marine Midland Bank for irregularities pertaining to petty cash.
Perhaps Shaddick did not bother to inquire closely into Emrich's background.
And since Shaddick was a law unto himself at Franklin, perhaps nobody bothered
to check up on his choice. But there are other possibilities too. Shaddick himself
had previously wTorked at Continental Illinois and many contacts in the foreign-exchange department. It is conceivable that Shaddick may have known all
about Emrich and decided that he might be just the right man to have around.
It is also conceivable that the foreign-exchange losses were simply the result
of some desperate gambles. There is no doubt that, during much of the second
half of 1973 and early 1974, Shaddick was putting enormous pressure on the
foreign-exchange department to show profits. In that sort of atmosphere, a trader
like Emrich might conceivably have felt justified in taking some fairly wild
gambles—and then hiding the results from management if they proved unfavorable.
Barr goes shopping
On the same day that the bank revised its figures on foreign exchange, Gleason
resigned as chairman and president, turning over both jobs to Joseph Barr, a former Secretary of the Treasury in the Johnson Administration. Barr spent most
of his time attempting to sell the bank. He asked bank analyst Morris Schapiro
to try to persuade would-be foreign and out-of-state acquirers that it was worthwhile paying a substantial premium to get a foot into the New York market.
Schapiro and Barr shopped around for buyers during the rest of June. But as
Franklin continued to lose deposits, live prospects became increasingly scarce.
Finally, on July 2, the Comptroller of the Currency asked Frank Wille, Chairman of the FDIC, to try to arrange a government-assisted purchase of Franklin.
For the last three months Wille has been trying to dispose of Franklin by offering what amounts to a huge subsidy. Under one plan, the FDIC would assume
all of Franklin's debt to the Federal Reserve.
As this article went to press, the best guess about Franklin's fate was that
it would disappear as an independent banking entity sometime in late September
or October. There is a plan to preserve Franklin as a purely Long Island bank,
but, in mid-September, the regulators did not seem convinced that the plan was
viable. It seems likely that Franklin's assets will shortly be auctioned off to one
or more big banks. Wille will then have done essentially what Luftig tried to
do four to five months earlier: merge Franklin into a stronger institution.
In the interim, Franklin will have lost a minimum of 50 percent of its deposits,
45
its stockholders will have lost most, if not all, of their investment, and the country's financial system will have received its worst scare since the Depression.
The Franklin tale reads a modern-dress Greek tragedy. Error begat error,
and events moved inexorably to a denouement that the bank's management
feared, but seemed powerless to prevent. Roth started it all by making a lot of
risky loans. WThen the loans went bad, Roth turned to bonds. When the bonds
fell in value, they could not be sold because of the loan losses. And so the
bank ended up Itrapped with a wad of low-yielding assets that had to be financed
with progressively higher-cost money. Meanwhile, non-interest expense was increasing sharply because of reckless branching and the inflation of personnel
costs.
By 1972 the only way to raise earnings to tolerable levels was by vastly increasing capital leverage. But there never w^as a more inopportune time to leverage a bank than in late 1972 and 1973. The cost of borrowed money increased
much more rapidly than the return on assets. Profit margins were nearly obliterated, and the stage was set for a final desperate gamble. Hoping for a drop in
interest rates, the bank bought still more bonds. But interest rates rose even
higher. By then the bank was mortally wounded. The foreign-exchange losses
were merely the proverbial coup de grace.
In one respect, certainly, Franklin's problems were not at all typical of U.S.
banking. Just about every big-league bank in the country has had better management. But in another respect, Franklin does fairly represent a powerful new
current in the banking industry: a zeal for endless growth is shared by many
other banks, including some big ones. It might ultimately prove to be a problem
for some of them too.
AFTER WRITING T H I S LETTER, I DECIDED To KEEP I T AS MY RECORD OF THE ANSWER
AND NOT To MAIL IT
OCTOBER 17, 1974.
FORTUNE MAGAZINE,
Time & Life Building,
New York, N.Y.
GENTLEMEN : "The Inside Story of What Really Went Wrong at Franklin National Bank" obviously represents a good deal of research and explains many of
the management and financial problems that led to the collapse of that institution. In general, the article's judgments are supported by verifiable fact; but in
several places, opinions are given for which there is neither factual basis nor
balancing judgments and which mar an otherwise interesting piece of reporting.
In an article as long as yours, there are inevitable errors. Thus, the anecdote
about Franklin lending a builder $25,000 in 1950 without a financial statement
turns out to be inaccurate. I checked with Roger Elton, the source given, and his
recollection is that the loan was made by Pat Clifford. A financial statement was,
indeed, demanded and produced.
The opinion of Jerry Twomey that we entered the New York market "building
monuments, impressive and very costly structures," is given without any caveats
or criticisms; actually, there are countervailing opinions and facts. Those buildings are functional, beautiful and, because of their unique design, perennial
advertisements for the bank's special character. The land could not be bought
for anything close to what we paid, nor the buildings constructed today for twice
their original cost. They were so valuable that later management was able to
realize important profits from their sale when forced to increase profits. It is
indeed unfortunate that their destructive financial policies pushed them to this
extremity.
There are several more serious lapses in your story which might mislead the
reader unfamiliar with all of the facts, partly because it collapses time in a confusing way when it apportions blame for the bank's downfall. It raises a very
important question for any interested executive: Where, in time, does executive
responsibility begin and end?
74-548—76
4
46
Franklin went under in October 1974. I was forced out as chief executive officer
in July 1968, more than six years earlier, and left the bank entirely in March
1970, four and one-half years before it collapsed.
When I was forced out, the bank was in excellent condition by any objective
test:
—Bottom line earnings were 50 percent above (as a percentage of common
stockholders' equity) those of other large New York banks.
—Loans were demonstrably healthy (losses were 2 cents a share in 1969).
—Liquidity and capital position were good and getting better.
—Municipal obligations (one-third short-term) were a good source of profit.
I might add that we had no foreign currency transactions nor foreign loans,
both of which your article accurately identifies as sources of grave trouble in
later years.
To support my statements, I enclose a page from Morris Schapiro's Bank Stock
Quarterly for March 1970, which gives a rather complete record of Franklin's
earnings, loan charge-offs, etc., during 1960-69, the period of Franklin's entrance
into the New York market with all the attendant start-up expenses. These facts
alone would destroy your statement that Franklin's entrance into New York
was my "most egregious blunder."
Franklin's healthy condition, after we left the "soft plush of our uniquely
favorable environment" and entered banking's toughest market, New York City,
was achieved by those "malleable subordinates who had no aptitude for banking."
This, it seems to me, is where your article departs seriously from reality and
damages, as well, the reputations of a number of competent executives. It compounds this error by singling out John Sadlik for malignment. Sadlik was, and
is, a knowledgeable and prudent banker (retained by the perceptive people who
took over Franklin and changed its name), whose knowledge of the fine points
of finance cannot seriously be questioned by anyone informed in this area. If
Franklin management had listened to Sadlik—his memoranda to management
bear this out—the bank would be a living and profitable institution today.
The article's analysis of Franklin's problems with municipal bonds is a model
of unjustified conclusions drawn from inaccurate evidence. The facts are simple.
The municipals we held when I left were profitable to the bank. One-third of
these were short-term (maturing in twelve months or less). (Forty-two million
dollars worth of long-term municipals came with the acquisition of the Federation
Bank.)
No bank, no business, is static. Management is supposed to make investments in
anticipation of economic conditions; when conditions change, they're supposed
to anticipate the changes, or, at the very least, to react swiftly when changes are
perceived. Franklin's feckless management did neither. They increased their
investments in longer term municipals after I left. They became speculators in
foreign exchange. They borrowed huge amounts overnight and loaned it out
long. They sought and obtained equally huge short-term high-interest-rate foreign
deposits and loaned it long term. They built up their officers and personnel onethird more than required. They lacked leadership. The bank was badly
mismanaged.
There is no point in elucidating all the "egregious errors" in your article—
the ones above are the most serious.
One point the article does not make is that all criticisms it contains are
hindsight. From my evaluation of the personnel that forced me out of the bank,
I was certain in 1970 that they would do badly. But I decided to say nothing in
public for two years to give management a chance to prove their astuteness.
When it became obvious, however, that my privately held predictions were
coming disastrously true, in November 1971 I issued the first of three letters
warning of impending calamity. In April 1972 and again on July 18, 1972,1 wrote
detailed letters of warning and gave copies to the press, which published much
of the material. Copies were also sent by registered mail to the Comptroller of
the Currency, the Federal Reserve Board, and the Federal Deposit Insurance
Corporation.
There was then still time to force Franklin management to correct its errors
or to step down in favor of competent people. This was not done, and the result
makes sad treading.
Franklin has now been reborn as The European-American Bank and Trust
Company. I shall do all I can to help it to again become the great bank it was
in years gone by.
Whatever harm your article has done to the reputations of those not responsible
for Franklin's downfall cannot be mended.
ABTHUB T. ROTH.
NET OPERATING EARNINGS AND THE BOTTOM LINE, PER SHARE 1960-69 (AFTER APPLICABLE TAXES)
Common stockholders equity
Year
Franklin New York Corp.:
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
Common
shares
4,570,067
4,298,193
3,981,454
3,981,454
3,981,454
3,981,454
3,981,454
3,981,454
3,981,454
3,950,245
Actual
net loan
Operating charge-offs
earnings (recoveries)
$4.11
3.63
3.39
3.09
2.51
2.34
2.46
2.46
2.36
2.25
$0.02
.51
.85
1.68
.98
.33
.68
.17
.02
.07
Average
Charter New York Corp.:
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
Average.
Percent of
average
loans
Net
operating
earnings
0.007
.177
.308
.655
.465
.195
.476
.125
.021
.068
$4.09
3.12
2.54
1.41
1.53
2.01
1.78
2.29
2.34
2.18
Cash
dividends
Payout
declared (percent)
$1.44
1.51
1.00
.98
.95
.93
.90
.88
.85
.20
35.2
48.4
39.4
69.5
62.1
46.3
50.6
38.4
35.3
9.2
Net securities losses (gains) and
net sundry debits (credits)
•
SecuTotal
rities
Sundry
$0.20
.03
.15
.18
.18
.12
(.15)
.08
(.73)
$0.20
.03
.15
.18
.18
.12
(.15)
.08
(.73)
Bottom
line (net
income)
$3.89
3.09
2.39
1.23
1.53
1.83
1.66
2.44
2.26
2.91
Average
Net
operating
earnings
(percent)
Bottom
line
(percent)
$22.51
20.69
18.65
17.03
16.06
15.68
15.22
14.31
13.18
11.06
18.2
15.1
13.6
8.3
9.5
12.8
11.7
16.0
17.8
19.7
17.3
14.9
12.8
7.2
9.5
11.7
10.9
17.1
17.1
26.3
.249
6,914,696
6,914,696
6,914,696
6,914,696
6,914,696
5,858,300
5,858,300
5,858,300
5,858,300
5,858,300
3.88
3.89
3.48
3.05
2.65
3.04
2.90
2.83
2.80
3.11
.20
.19
.14
.10
.09
.06
.04
.02
.21
.07
.048
.057
.115
.087
.032
.024
.016
.010
.114
.042
.054
14.5
3.68
3.70
3.34
2.95
2.56
2.98
2.86
2.81
2.59
3.04
1.97
1.74
1.61
1.60
1.48
1.56
1.54
1.51
1.48
1.45
53.5
47.0
48.2
54.2
57.8
52.3
53.8
53.7
57.1
47.7
.33
.88
(.01)
.44
.20
.10
(.06)
(.17)
(.30)
.09
.33
.88
(.01)
.44
.20
.10
.06
(.17)
(.30)
.09
($0.12)
3.35
2.82
3.35
2.51
2.36
2.88
2.92
2.98
2.89
2.95
34.23
32.93
31.89
30.45
29.16
29.76
28.49
27.37
26.27
25.05
10.8
11.2
10.5
9.7
8.8
10.0
10.0
10.3
9.9
12.1
9.8
8.6
10.5
8.2
8.1
9.7
10.2
10.9
11.0
11.8
9.9
NET OPERATING EARNINGS AND THE BOTTOM LINE, PER SHARE 1960-69 (AFTER APPLICABLE TAXES)-Continued
Common stockholders equity
Year
Chase Manhattan Corp.:
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
Common
shares
31,878,666
31,428,393
31,426,937
31,426,997
31, 26,997
31,426,937
31,426,997
31,426,997
31,426,997
31,426,997
Actual
net loan
Operating charge-ofls
earnings (recoveries)
$3.74
3.8)
3.35
3.14
2.93
2.G8
2.47
2.30
2.25
2.37
$0.13
.13
.13
.17
.05
.18
.23
.02
.06
.03
Average
Chemical New York Corp:
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
Average.
percent of
average
loans
0.038
.041
.043
.060
.023
.040
.138
.015
.042
.022
Net
operating
earnings
$3.61
3.67
3.22
2.97
2.88
2.60
2.24
2.28
2.19
2.34
Cash
dividends
Payout
declared (percent)
$1.75
1.56
1.46
1.32
1.33
1.27
1.15
1.15
1.10
1.02
48.5
42.5
45.3
44.4
46.2
48.8
513
50.4
50.2
43.6
Total
0.67
.55
(.17)
.50
(.08)
.23
(.21)
(.54
(.43)
.34
Securities
0.67..
.60
(.10)
.51
(.01)
.12
(.28)
(.53)
(.24)
.37
Bottom
line (net
Sundry
income)
(.05)
(.07)
(.01)
<:!?
.07
(.01
(.19)
(.03)
$2.94
3.12
3.39
2.47
2.96
2.37
2.45
2.82
2.62
2.00
Net
operating
earnings
Average
(percent)
$32.33
31.37
29.77
28.46
27.58
26.82
25.82
24.35
22.90
21.80
11.2
11.7
10.8
10.4
10.4
9.7
8.7
9.4
9.6
10.7
.046
13,408,967
13,207,128
13,140,344
13,139,049
13,139,049
13,138,384
12,840,885
12,714,885
12,714,885
12,714,885
5.28
5.10
4.65
4.14
4.01
3.88
3.53
3.60
3.45
3.22
.06
(.04)
.17
.32
.17
.06
.11
.06
(.02)
.26
Average
First National City Corp:
1969
1968
1967
1366
1965
1964
1963
1962
1961
1960
Net securities losses (gains) and
net sundry debits (credits)
.015
(.010)
.044
.103
.053
.027
.052
.029
(.009)
.150
5.04
4.66
4.22
3.94
3.52
3.26
2.89
2.79
2.75
2.80
.20
.17
.18
.23
.20
(.01)
.06
.14
.26
.65
.044
.044
.052
.070
.069
(.004)
.030
.081
.164
.397
9.1
9.9
11.4
8.7
10.7
8.8
9.5
11.6
11.4
9.2
10.0
5.22
5.14
4.48
3.82
3.84
3.82
3.42
3.54
3.47
2.96
2.60
2.45
2.20
2.10
2.10
1.87
1.84
1.83
1.73
1.60
49.8
47.7
49.1
55.0
54.7
49.0
53.8
51.7
49.9
54.1
.66
.82
.12
1.14
(.04)
.16
.15
(.23)
(.10)
(.64)
.66
.82
.15
1.13
(.04)
.09
.16
(.21)
(.08)
(.61)
(.03)
.01
.07
(.01)
(.02)
(.02)
(.03)
4.56
4.32
4.35
2.68
3.88
3.66
3.27
3.77
3.57
3.60
43.86
42.35
41.05
40.22
39.25
38.14
16.94
35.51
33.85
32.16
11.9
12.1
10.9
9.5
9.8
10.0
9.3
10.0
10.3
9.2
.045
27,035,196
26,813,473
25,705,064
26,648,871
26,639,838
26,616,912
26,601,980
26,601,880
26,497,940
26,497,940
Bottom
line
(perce
10.4
10.2
10.6
6.7
9.9
9.6
8.9
10.6
10.5
11.2
9.8
4.84
4.49
4.04
3.71
3.32
3.27
2.83
2.65
2.49
2.15
2.30
2.10
1.90
1.75
1.60
1.53
1.47
1.44
1.41
1.39
47.5
46.8
47.0
47.2
48.2
46.8
51.9
54.3
56.6
64.7
.54
.38
.20
.26
.21
.08
(.18)
.28
(.46)
.13
.41
.42
.20..
.20
(.01)
.04
(.19)
.09
(.51)
.10
.13
(.04)
.06
.22
.04
.01
.19
.05
.03
4.30
4.11
3.84
3.45
3.11
3.19
3.01
2.37
2.95
2.02
42.72
41.21
39.75
38.36
37.15
35.93
34.65
33.57
32.30
30.84
11.3
10.9
10.2
9.7
8.9
9.1
8.2
7.9
7.7
7.0
10.1
10.0
9.7
9.0
8.4
8.9
8.7
7.1
9.1
6.5
8.7
00
49
FRANKLIN NATIONAL BANK STATEMENT OF CONDITION
June 30
Sept. 30,1968
(millions)
Cash and due from banks
U.S. Government obligations
Municipal obligations
Federal agency obligations
Other securities
_
_
__
Total securities
Federal funds sold
Loans.-.
.
...
_
Less—Reserve for loans
Net loans
Bank premises and equipment
Customers'liability on acceptances
Accrued interest receivable
Other resources
Bank premises and other resources
Total resources...
iLiabilities:
Deposits:
Demand
Time.
.
_
-
1967
(thousands)
$218
$216,257
$236,352
400
404
36
18
365,247
390,971
40,150
17,265
276,444
459,691
34,757
23,161
860
147
813,633
19,303
794,053
93,015
1, 256
20
1,241,306
20,158
1,172,874
20,000
1, 236
1,221,148
1,152,874
46
23
19
10
100
2,561
47,243
26,823
16,154
10,826
101,046
2,371,387
40,985
24,607
12,765
4,719
83,076
2,359,370
800
_
Total deposits
Securities sold under agreement to repurchase
Federal funds purchased
Mortgages payable
Acceptances outstanding
Unearned income.._
Accrued interest, taxes and other liabilities
'Dividends payable
_
1968
(thousands)
_
Total other liabilities
Total liabilities
Capital funds:
Capital debentures ( 4 ^ percent—due 1988)
Equity capital:
Preferred stock ($4.60—$100 par)
Convertible preferred stock ($2.45—$25 par)
Common stock($5 par)
Surplus
Undivided profits
704,300
1,149,875
1,243,140
2,053
1,905,060
1,947,440
16
241
25
110,134
93,070
25,781
29,065
151,180
26,422
23
17
13
27,459
16,853
24,182
2,098
25,150
15,777
17,399
54
70,592
58,326
2,390
2,204,637
2,212,433
30
30,000
30,000
20
20.5
22.7
65
13
20,000
20,523
22,751
65,000
8,476
20,000
20,523
19,907
50,000
6,507
Total capital funds
1,71.2
Total liabilities and capital funds
2,561
755,185
1,252
166,750
146,937
2,371,387
2,359,370
50
FRANKLIN NATIONAL BANK STATEMENT OF EARNINGS
6 mo ending June 30,
9 mo ending
Sept. 30, 1968
(millions)
Operating income:
Interest and fees on loans
Income on U.S. governments, municipal and other securities
Service charges on deposit accounts
Other income
Total operating income
Operating expenses:
Staff expenses:
Salaries
Profit sharing, pension and other employee benefits
Total
Interest expense:
On deposits
On borrowed money
Total
Net occupancy costs—bank premises
Equipment, stationery, telephone and postage
Advertising and business development
Other expenses
Total operating expenses
Operating earnings:
Operating earnings before income taxes
Income taxes applicable to operating earnings
Net operating earnings
Per share of common stock outstanding (4,043,953—1968 average
and 3,981,450—1967) after deducting preferred dividends of
of $1,466,000 in 1968 and $460,000 in 1967
Nonoperating (additions) or deduction, net of tax:
Security (profits) or losses
Transfer to reserve for loans to restore losses
Other deductions
Total nonoperating deductions
Transferred to undivided profits
1968
(thousands)
1967
(thousands)
70
30
3.6
3.8
$44,888
20,115
2,443
2,535
$37,167
14,088
1,922
1,825
107
69,981
55,002
15.5
2.5
10,059
1,665
6,929
1,027
18
11,724
7,956
46
11
30,896
6,726
26,287
3,518
57
37,622
29,805
4.8
4.8
1.5
3.8
3,139
3,132
1,028
2,522
2,695
2,827
1,406
1,633
90.4
59,167
46,322
17.4
3.5
10,814
1,816
8,680
1,253
13.9
8,998
7,427
2.78
1.86
1.75
.136
205
426
431
48
65'
.139
13.755
270
905
8,728
6,522
148.2
$148,244
$120,796
13.7
8,728
6,522
20, 523
1, 522
STATEMENT OF CHANGES IN CAPITAL ACCOUNTS
Balance, beginning of year
Add:
Transferred from statement of earnings
Issuance of convertible preferred stock
From merger federation bank & trust co
Issuance of additional common stock
Total
Less:
Cash dividends on common stock
Cash dividends on preferred stock
Cash dividends on convertible preferred stock
Total deductions
Balance, end of period
15.0
15,043
177.0
172,015
149,363
3.5
.7
1.5
3,555
537
1,173
1,966
460
5.7
5,265
2,426
171.3
166,750
146,937
Mr. ROSENTHAL. Mr. Gradison.
Mr. GRADISON. Thank you, Mr. Chairman.
At this point, Mr. Chairman, I would ask to put into the record the
lead editorial from today's Wall Street Journal, entitled "Bored by
the Bank Flap."
Mr. ROSENTHAL. May I take a look at it ? I have not seen it.
Without objection, it will be included in the record.
[The article referred to follows:]
51
[From the Wall Street Journal, Feb. 10, 1976]
R E V I E W & OUTLOOK—BORED BY T H E B A N K
FLAP
" I hold in my h a n d a list of 28 American banks t h a t a r e in trouble through
having made bad loans," says one of t h e g r e a t liberal newspapers of the land.
"I hold in my h a n d a list of umpteen other banks t h a t have m a d e risky loans to
X, Y and Z," says a n o t h e r of t h e great liberal newspapers of the land. Congressional committees hold investigations. Presidential candidates fulminate. Bank
reform legislation is d r a w n u p to deal with t h e situation.
Until now, we have not commented on this latest sport. F r a n k l y , we've been
bored by it. T h e "troubled b a n k " story is last year's story a n d the story of
1974, when i t really looked dicey as to whether t h e banks had sufficient capital
to get through the squeeze. (See for example, " B a n k Soundness" in these columns,
November 24, 1974.) T h e reason the liberals in Congress and on t h e great liberal
newspapers of the l a n d were not then wringing their h a n d s is not h a r d to recall.
They were then worried about the faltering economy and were exhorting t h e
banks to make bad loans.
T h e banks, you'll recall, were told they had to be socially responsible. The liberal
commentators fumed t h a t banks were actually refusing to lend money to "redlined" neighborhoods. The New York banks were being vilified and picketed for
their hesitation in buying Mayor Beame's municapal bonds and tax-anticipation
notes. House Banking Chairman H e n r y Reuss, for gosh sakes, was pushing credit
allocation legislation t h a t would have required the banks to make loans to suit
his tastes. Mass t r a n s i t projects seemed to be the favorite idea. Wouldn't it be
swell if everyone h a d a Metro like Washington, D.C. ?
At the same time, you m u s t recall, the liberals were screaming at A r t h u r Burns
to gun the money supply faster. I n t h e current sport, which The Economist of
London calls "Bashing a t the American Banks," t h e r e h a s not been one word
in all t h e newspaper stories and all the congressional testimony t h a t makes the
connection between an increase in the money supply a n d bad bank loans to
X, Y and Z. Members of the congressional banking committees, if not the great
liberal newspapers of the land, a r e supposed to know of this connection:
1. The Fed increases the money supply by monetizing debt, i.e., buying interestbearing bonds from t h e banks with printing-press money. 2. The banks have more
cash as a result. 3. The supply of good customers w a n t i n g to finance profitable
projects h a s not increased. 4. The banks a r e losing money by sitting on cash.
5. They make loans to riskier customers. 6. They form Real E s t a t e Investment
Trusts. 7. They t h r o w money a t anyone who doesn't look like an out-and-out
burglar. 8. A Go-Go E r a is born. 9. Roaring inflation develops, followed by 10.
Collapse.
I t is thus deliciously clear why the liberals have had to w a i t until recovery
seems to be u n d e r w a y before they decide to talk about a year-old story. By now,
we a r e all supposed to have forgotten their prescriptions when the banks really
were in trouble, so they can piously proclaim how much more prudent they would
have been t h a n those reckless bankers.
The liberals a r e still after A r t h u r B u r n s to gun t h e money supply. But they
w a n t the banking l a w s reformed so t h a t for every bank lending officer there is a
government b a n k regulator, who will be wise and prudent in seeing to it t h a t
monetized debt goes, not into those awful R E I T s , but into socially desirable
projects, like big MAC bonds and New York S t a t e TANs.
We're bored by it all. I t ' s too t r a n s p a r e n t . The liberals have learned a thing
or two in t h e last few years, but so have we all. When Mr. Reuss tried to r a m
his credit allocation legislation through the veto-proof Democratic Congress last
year he w a s almost laughed off Capitol Hill. He's not going to do any better with
a phony hoorah about troubled banks and a " m o d e r a t e " approach to bank reform.
We don't need any new banking laws and regulations. Bank lending officers
and loan committees don't need bank examiners at their elbows to tell them X is
socially desirable a n d Y is not. The important thing is t h a t A r t h u r B u r n s doesn't
forget w h a t he's learned and s t a r t pumping out printing-press cash. With or
without further "reform," the banks will be as sound as a dollar.
Mr. GRX\DISOX. This editorial makes the point that whatever problems we have had with regard to banks and bank regulations will be
made worse if we move in the direction of encouraging overexpansion
of bank loans during periods of expansion of the economy. This is the
point you made.
52
I t also makes the point that one of the most dangerous things that
can be done with regard to the quality of bank loans would be for the
Congress to step in, as some of the leaders of the Congress have advocated, and regulate who should be able to borrow money in the
United States. This was a proposal which only lost by one vote in the
Banking Committee last year. I t was, in other words, that the Government should regulate the allocation of credit among all borrowers and
lenders in the country.
Mr. ROTH. I don't go for allocation of credit, but I do go for some-
t h i n g that I asked the Federal Reserve to send out on April 4,1974.1
would like to read that to you.
I was very much concerned about the Federal Reserve's inability to
restrain the inflationary trends to the extent that they hoped that they
could. They tried to do it almost entirely by jacking up interest rates
so that they became so high that they bankrupted many concerns
around the country.
I asked to see Arthur Burns on April 4, 1974. He was at the White
House, so I saw Governor Wallich. I thought I knew him, but I found
t h a t I didn't know him.
I said:
I have written a short letter that I think you ought to consider sending out to
all of the banks in the country because I see that your efforts are not bearing
fruit the way they should.
This simple letter said:
The Federal Reserve's efforts to restrain inflation could be aided by the
• cooperation of banks in restraining their lending activities. Loans for speculative
purposes and for over-expansion and those that feed the fires of inflation in particular should be most carefully examined. At a time when loan demands are
heavy, many banks have inadequate ratios of capital and loans are being made
using short-term funds which could create liquidity problems. Please fill in and
return in the next ten days your loans, the amount of your capital funds ratio,
and your loans to regular deposits
^^
Mr.
time?
GRADISON.
Mr. Both, may I interrupt because of the shortage of
Mr. BOTH. Yes.
Mr. GRADISON. I
am aware that the Fed did send out a commentary
not unlike this as an outgrowth of the recommendations of the Advisory Committee.
Mr. BOTH. Five months later. That is right. But I met one of the
members of the Advisory Committee when they had a meeting on that
same day. He said, "What are you doing here, A r t h u r ? "
I told him.
He said:
Ridiculous, ridiculous. Banking is a competitive business.
This is the same thing that Wallich said to me.
I said:
It is a quasi-public business and we have a public responsibility. That responsibility has to do with the fact that we cannot allow this inflation to get
out of hand because we are making so many loans.
He said:
Oh, we are going to take care of that by increasing the discount rate.
I said:
53
That is ridiculous.
Mr. GRADISON. Mr. Both, the first general area I would like to explore with you has to do with whether the regulatory agencies were
picking up the problems of Franklin and reflecting them back to the
management and directors for action.
According to testimony taken last July before Mr. St Germain's
subcommittee, on page 753, Mr. St Germain said:
The examination report of March 1972 to May 1972 contained a volume of
criticized loans then of 74 percent of gross capital funds—plus notations by
examiners. I quote: "An intolerably high volume of loans subject to adverse
comments. Suggest strong corrective measures."
Then the examination of November 1973 to March 1974 volume of
criticized loans contained 111 percent of gross capital funds. The
notation by the examiner is alarming.
Now this gives me the impression that the examiners were picking
up these problems. Once these are found, are they not made available
to the management and to the board of directors of the subject bank?
Mr. ROTH. Absolutely. And the board of directors has to record it
in the minutes and it has to be discussed and submitted to all of the
entire board of directors. That is right.
Mr. GRADISON. I S it your impression then that the problems of
Franklin were being picked up on a reasonably current basis as part
of the examination process ?
Mr. ROTH. I think the examiners did a competent job. I know E d
Langdon and I know E d Lake. I know they are very competent examiners.
Mr. GRADISOIST. Mr. Roth, much of your opening statement was
based upon the events of May, 1974, and leading up to the Mother's
Day events which you described earlier. In a symposium of the American Bar Association, held in Montreal, Joseph Barr commented upon
that period. Now he, of course, had earlier been Secretary of the
Treasury and, as you indicated, was called in, perhaps tco late, to
save Franklin.
But my understanding is that he stated at the Montreal symposium
that all three Federal banking agencies performed very well during
the Franklin crisis of 1974. How do you feel about that ?
Mr. ROTH. The Federal Reserve, of course, was supplying all of
the money that was needed. They did try to take corrective action—
as much as they could—but it was too late. They had gone too far by
then. They did the best they could, I would say.
Mr. GRADISON. My impression, from what you said before, was that
you didn't think they performed very well with regard to the way
in which they reacted to the Manufacturers Hanover bid, the time
they took to resolve the problem, and the decision that was made with
regard to the ultimate takeover by European-American.
Mr. ROTH. I didn't have those things in minds when I said that.
The Federal Reserve supplied the money that was needed; yes, they
did.
Mr. GRADISON. I yield such time as I may have remaining to Mr.
Brown.
Mr. BROWN. I was interested in your comment about Joe Barr. I
remember Joe Barr too, of course.
Joe Barr took over the chairmanship in June of 1974.
54
Mr. BOTH. That is right.
Mr. BROWN. At that point in time, he thought there was a chance of
saving it. And I don't think that anybody thinks that Joe B a r r wasn't
qualified to make that observation.
Mr. ROTH. Oh, no; oh, no.
Mr. BROWN. But he did think there was a chance of saving
Mr. ROTH. That is right.
Mr. BROWN. He thought that it could be carried along with
it.
some
Federal assistance and a merger worked out where there wouldn't
be the kind of loss that eventually occurred.
Mr. ROTH. That is right.
Mr. BROWN. So even as late as June of 1974, there was a pretty
competent individual who thought it could be saved. Is that right ?
Mr. ROTH. Yes. And I think that at about the same time I wrote
an article that appeared in the Journal of Commerce in New York
outlining a plan that I felt would save Franklin National Bank too.
That is right.
Mr. BROWN. I think that Joe at that time said that there was more
than $2 billion in good collateral, against which the bank could borrow $1.5 billion from the Federal Reserve. A further estimate was
made that a financial run would total approximately $400 million and
still leave a narrow margin of $200 million to $300 million.
Mr. ROTH. Yes. But in talking to Joe, I said to him, "Look, you have
to clean house here and get rid of this fellow Gleason and of Merkin."
H e said, " I can't do it."
I said, "Why can't you do i t ? "
He said, "Because the directors are in control."
Mr. BROWN. But you see, Mr. Roth, that is what bothers me. You
want the shareholders to be completely exonerated from any responsibility in this area. Who elects directors ?
Mr. ROTH. Sure, the shareholders do. But you know how the directors of any corporation are elected. I t is up to the chief executive
officer to say who he would like to have and then the balance of the
directors go along with him.
Mr. BROWN. Nonetheless it is the duty of the shareholders as owners
to hold the management accountable for the well-being of the
corporation.
Mr. ROTH. That is right.
Mr. BROWN. That is where the buck stops, doesn't it ?
Mr. ROTH. Well, but you have to have a dissident stockholder who is
going to spend all of the money that is necessary to rally support on
his side in order to overthrow a director and put a new director in.
That is a very costly procedure.
I said in my letter that this could be done, but that it would be
damaging to the bank and very costly and should not have to be done.
Mr. BROWN. But that is where I have a difficult time comprehending
what you would have done. We have already established that the regulatory authority does not have the power to do the specific things that
you recommended. The people who could do those things were the
management and the directors through the management.
Mr. R O T H . The examiners have the authority to come in and talk
to the directors and lay the cards on the table and pound the table
and tell them of what disasters they are heading for. They can tell
55
them about the unsafe and unsound banking practices. I t has been
done over the years, and has been done successfully. But you need
that kind of a tough guy.
Mr. BROWN. But you were a pretty tough guy. You tried to work
on shareholders and everybody else and you couldn't affect those
directors.
Mr. ROTH. N O ; I never tried to work on the shareholders. I told
the shareholders the facts. I said I was not going to do these things
as far as the shareholders were concerned.
Mr. BIIOWN. I have no further questions.
Mr. ROSENTHAL. Thank you very much, Mr. Roth, for this very informative testimony which you have given. I want you to be assured
that this subcommittee will continue this investigation no matter
where it may go. The subcommittee stands adjourned.
[Whereupon, at 12:10 p.m., the subcommittee adjourned, to reconvene subject to the call of the Chair.]
OVERSIGHT HEARINGS INTO THE EFFECTIVENESS OF
FEDERAL BANK REGULATION
(Franklin National Bank Failure)
TUESDAY, MAY 25, 1976
HOUSE OF REPRESENTATIVES,
COMMERCE, CONSUMER,
AND MONETARY AFFAIRS SUBCOMMITTEE
OF THE COMMITTEE ON GOVERNMENT OPERATIONS,
Washington, D.O.
The subcommittee met, pursuant to notice, at 10 a.m., in room 2247,
Ray burn House Office Building, Hon. Benjamin S. Rosenthal (chairman of the subcommittee) presiding.
Present: Representatives Benjamin S. Rosenthal, Robert F . Drinan,
Elliott H. Levitas, David W. Evans, and Willis D. Gradison, J r .
Also present: Peter S. Barash, staff director; Robert H . Dugger,
economist; Ronald Klempner, counsel; Doris Faye Taylor, clerk; and
Henry C. Ruempler, minority professional staff, Committee on Government Operations.
Mr. ROSENTHAL. The subcommittee will be in order.
Today, the Commerce, Consumer, and Monetary Affairs Subcommittee continues its oversight review of the effectiveness of Federal
regulation of commercial banks. Earlier this year, the subcommittee
heard testimony from Arthur Roth, former chairman of the board of
Franklin National Bank, about the problems of Franklin National and
the efficacy of Federal regulation of the bank. Our hearings this week
and next will explore the findings and implications of a 3-month subcommittee investigation of the Comptroller of the Currency's examination and supervision of Franklin.
The hearings represent the first in-depth and direct review by Congress of the efficiency of the Comptroller's examination and supervision of a major money market national bank. While other interested
committees have inquired into the circumstances surrounding the Federal Reserve's loan of $1.9 billion to Franklin after May 1974 and the
declaration of its insolvency in October 1974, this subcommittee will
be examining the crucial regulatory actions from 1969 until May 1974
which failed to halt Franklin's slide into insolvency.
Many of the problems which caused Franklin to be declared insolvent only iy2 years ago are presently being experienced by some of our
large national banks. These are: excessive "criticized" loans for real
estate construction and development projects, real estate investment
trusts, oceangoing tankers and underdeveloped countries; large portions of liabilities are from costly and volatile, interest sensitive
(57)
58
sources; inadequate capitalization; unwarranted involvement in speculative areas, such as foreign exchange trading; rapid expansion of
branch offices, lending areas and other business activities without a
commensurate improvement in management's ability to cope with the
added responsibilities; and, high operating expenses, in part attributable to costly investment in new and expensive headquarter facilities.
The manner in which the Comptroller's office identified and supervised Franklin's problems will provide us with a valuable point of
reference in evaluating the effectiveness of present-day regulation.
That is why today's hearing will also focus on the Comptroller's regulation of the First National Bank of East Islip, N.Y., a small ongoing
bank in the same region as Franklin National.
We will attempt to determine what similarities and differences exist
between the effectiveness of the Comptroller's past supervision of
Franklin and present supervision of East Islip. Our study of the relationship between the Comptroller's office and the First National Bank
of East Islip will also examine the manner in which the Comptroller
forces compliance with accurate disclosure of a bank's affairs in proxy
statements, annual reports, and other public pronouncements.
Today's witnesses will be Messrs. C. Thomas Metz and Henry Hoppier, subcommittee investigators, who have studied the Comptroller's
regulation of Franklin National Bank and have interviewed numerous
examiners and other personnel of the Federal banking agencies involved in the affairs of Franklin. They will also testify on the results
of their investigation.
The second witness for today will be Aaron B. Donner, a former
director of First National Bank of East Islip. Mr. Donner will testify
about the bank's lending practices and the Comptroller's response to
those practices.
On Wednesday, the subcommittee will hear testimony from Mr. Dennis Weatherstone, senior vice president of Morgan Guaranty Trust
Co. and an expert in international and foreign exchange operations,
who will testify about his bank's reaction to Franklin National's foreign exchange activities, the effect of those activities on Franklin, and
the reaction of the Federal regulatory agencies when he discussed these
activities with them prior to May 1974.
On Tuesday, June 1, the subcommittee will hear testimony from Mr.
James E. Smith, Comptroller of the Currency: Charles Van Horn,
Regional Administrator of National Banks for the Second National
Bank Region; and Mr. John Fleming, National Bank Examiner.
Mr. Hoppler and Mr. Metz, you have a prepared statement. Why
don't you begin.
STATEMENT OP HENRY L. HOPPLER AND C. THOMAS METZ, SUBCOMMITTEE STAFF INVESTIGATORS, ON DETAIL FROM THE
GENERAL ACCOUNTING OFFICE
Mr. HOPPLER. Mr. Chairman, at this time we would like to read portions of our prepared statement and we would like our prepared statement to be entered into the record.
Mr. ROSENTHAL. Without objection, the whole statement shall be included as a part of the record.
59
Mr. HOFPLER. Mr. Chairman and members of the subcommittee, for
the past 4 months, we have been working as staff investigators for the
Commerce, Consumer, and Monetary Affairs Subcommittee to assist
in its oversight investigation of the Office of the Comptroller of the
Currency. Our efforts combined with those of the subcommittee's regular staff have been directed toward determining the adequacy and effectiveness of the Comptroller's examination and supervision of
Franklin National Bank, the subject of today's hearing. Our review
focused on the years 1969-74. The Comptroller of the Currency from
1969 to July 1973 was Mr. William Camp, now deceased. The present
Comptroller, James Smith, took office in July 1973. The New York regional administrator since 1969 has been Mr. Charles Van Horn.
Our evaluation of the Office of the Comptroller of the Currency's
examination and supervision of Franklin National Bank is based on
(1) an analysis of Franklin National Bank's examination reports and
related files in the Washington headquarters and New York regional
office of the O C C ; (2) a review of OCC operating manuals, examination procedures, and documents; (3) discussions with OCC officials
in Washington and New York; (4) a review of an October 1974 draft
report on Franklin by Haskins and Sells, a well-known management
consulting firm; and (5) a review of the May 30, 1975, report on the
operations of the Office of the Comptroller by Haskins and Sells.
We did not examine the accounting records of Franklin and, therefore,
are unable to comment on the accuracy of the financial data included
in the examination reports.
Franklin National Bank was declared insolvent by the Comptroller
of the Currency on October 8, 1974. However, as our testimony will
indicate, Franklin had serious problems which were identified in its
examination reports as early as 1969, and may have been insolvent as
early as May 1974.
National bank examinations are designed to determine the condition and performance of banks, the quality of their operations, the
capacity of their management, and the degree of compliance with
Federal laws. Without such an audit and review process, an adequate
system of national bank supervision and Federal law enforcement
would be impossible.
Mr. Chairman, our 3-month review in behalf of the subcommittee
of the Comptroller's examination and supervisory processes as they
were applied to Franklin National Bank leads us to the following
conclusions:
One, OCC enforcement and compliance documents do not clearly
establish the division of responsibility and authority among examiners, regional administrators, and Washington officials to require a
bank to take corrective actions on problems identified during examinations. As a consequence, there exists among the OCC staff a difference
of opinion as to who has the responsibility and authority to require
such corrective action.
Two, the management and portfolio problems that plagued Franklin
since the late sixties and led to its eventual failure in 1974 were amply
documented by national bank examiners over a 5-year period. We
found that OCC failed to utilize fully its supervisory options to
correct the problems identified by examiners. F o r example:
60
Though OCC representatives frequently discussed examiner findings with senior bank officials and received numerous promises that
corrective actions would be taken, subsequent examinations did not
indicate substantive improvements.
Despite constant critical examination reports, the OCC allowed
Franklin to open 17 branches in New York and 1 branch in London
between 1969 and 1973. Denial of these branches could have been used
effectively to discipline Franklin,
I t was not until February 1974, only 3 months before the beginning
of massive Federal Reserve support, that the OCC took aggressive
supervisory actions to force Franklin to correct problems which had
been repeatedly identified by examiners since 1969.
Three, though examiners generally identified Franklin's problems,
we found two notable exceptions:
First, in February 1973, OCC examiners failed to include in their
report a $50 million instance of balance sheet "window dressing"
wThich resulted in an overstatement of the bank's resources.
Second, in June 1973, during a 1-day check of the bank's foreign
exchange profit and loss statements, the OCC examiner apparently
did not verify the foreign exchange rates used in preparing these
schedules. We believe that had he verified these rates, the OCC would
have become aware in June 1973 of Franklin's misrepresentations of
foreign exchange profits rather than almost a year later in May 1974.
Though examiners generally identified Franklin's problems, the
critical comments found scattered throughout the examination reports
frequently did not get recorded on page 2 of the report, "Comments on
Matters Requiring Attention." Page 2 is important because it is on
that page that examiners are supposed to itemize areas of concern.
Noninclusion may suggest to bank officers and directors that a problem is not important. For example, in the 1970, 1971, 1972, and 1973
reports, capital was regarded as inadequate and criticized. However,
capital was not itemized on page 2 until 1973.
FREQUENCY
Mr. METZ. The National Bank Act, U.S.C. 481, requires the Comptroller of the Currency to examine every national bank twice in each
calendar year. The Comptroller, at his discretion, however, may waive
one examination or examine a bank more frequently, if necessary.
The waiver of one examination cannot be exercised more frequently
than once during any 2-calendar-year period.
During the 1969-1974 period, nine reports of examinations were
prepared on Franklin. Six of the nine reports were "regular" and
three were "special visitations." Table 1 shows the starting and closing dates and the man-days used on each examination.
RATINGS
Examination reports contain comments by the examiner concerning
the following categories: Condition of bank; management; earnings;
capital; internal controls and audit procedures; and future prospects.
The comments include a descriptive word rating, such as excellent,
good, fair, poor, et cetera, for each category. Table 2 presents the
rating in each of these categories.
61
The descriptive word ratings reveal that Franklin's overall condition was only fair and its capital was borderline in 1969. By 1972,
its condition was unsatisfactory; its management only fair; its earnings poor; and its capital inadequate.
At the completion of each regular examination, Franklin was further rated in three categories: capital position, quality of assets, and
management. A composite or group rating of Franklin was also
made. Capital position is rated from 1 to 4, with 1 being adequate,
based on such factors as management, liquidity, earnings, et cetera.
Quality of assets is rated from A to D, A being good, based on the
ratio of classified and speculative assets to gross capital. Management is rated S, strong or competent; F , fair; or P , poor, incompetent
or integrity questioned. The composite or group rating is from 1 to
4, 1 being a sound institution, based on consideration of all ratings.
Ratings were made by the regional administrator, although in
1972 the composite rating was revised downward in OCC/Washington. Table 3 shows Franklin's rating at each regular examination.
Franklin's composite rating declined from 2 to 3 in 1970, and remained a 3 through early 1974. OCC procedures provide that banks
having a composite rating of 3 or 4 require special attention. OCC
Deputy Comptroller John Gwin, who wTas responsible for the New
York region, informed Comptroller William Camp in March 1971
that Franklin was in need of close supervision. The New York regional administrator at that time was Mr. Charles Van Horn.
SUPERVISORY OPTIONS AND E N F O R C E M E N T F 0 L L 0 W I T P
I n testimony before this subcommittee on January 20, 1976, the
Deputy Comptroller of the Currency, Robert Bloom, identified supervisory methods available to the OCC for correcting deficiencies in
banks identified as requiring special supervisory attention. He stated
that special supervision begins with the examiner's comments on matters requiring attention in the examination report. Next, the regional
administrator can request a bank's board of directors and executive
management to institute corrective measures, request monthly progress reports, and conduct frequent visitations and examinations. O C C /
Washington personnel can be involved in any of these aspects. Additionally, OCC can withhold approval on applications for various
corporate changes, such as opening a new branch or approving investments in banking premises. Other actions include initiation of cease
and desist proceedings, certification to the Federal Reserve for removal of a bank official or criminal referral to the Department of
Justice. Though Mr. Bloom failed to enumerate it, the OCC also had
the authority to publish all or part of Franklin's examination reports.
The OCC did not fully utilize its options, and what actions it
did take clearly were not adequate for the purpose of getting Franklin
to work out its problems.
EXAMINER
COMMENTS
The examiner's conclusions regarding aspects of a bank's affairs that
should be brought to the attention of the Comptroller and the bank's
directors are found on page 2 of the examination report. Our review
of these comments reveals several important instances in which strong
74-548 O - 76 - 5
62
examiner criticisms found elsewhere in the Franklin examination
reports were not included on page 2. This is a problem because noninclusion may suggest to bank officers and directors that a problem
is not important.
Nevertheless, even the problems cited on page 2 were not always
effectively dealt with by Franklin's management. Succeeding examination reports evidenced no significant improvement in some of the
problems cited on page 2 during 1969 to 1973.
CREATIVE
MEASURES
After each examination report was completed, the OCC regional
administrator and the examiner-in-charge met with Franklin's board
of directors to discuss the condition of the bank. The regional administrator, Mr. Charles Van Horn, told us in a recent interview that
:requests to the board to take corrective actions should have been
made at these meetings and that these requests should be reflected in
OCC memoranda of these meetings.
These memoranda indicate that only after the 1970 examination
was a request made for corrective action. This request was simply
"to keep us—the OCC/New York office—currently informed with
respect to alleviating criticisms." The bank gave assurances that
monthly progress reports on criticized loans were to continue to be
forwarded.
EXAMINATIONS AND VISITATIONS
Despite the steadily deteriorating condition of Franklin from
1969 through 1973, the frequency of examinations was not increased.
Even the three examinations every 2 calendar years, required by law,
were not conducted from 1969 through 1971.
Special 1-day visitations were made in February 1973, June 1973,
and February 1974 to review Franklin's foreign exchange operations.
APPLICATION
APPROVALS
Applications for new branch offices of a national bank require
approval by the Comptroller. I n practice, when an application is
considered, it is circulated to examiners in the region, regional administrators, Director of the Bank Organization Division and Deputy
Comptroller for recommendations and comments. Comments are also
requested from the State banking department. I n the Franklin case,
all reports by these individuals wTere reviewed and provided the basis
for the final decision by the Comptroller. Table 4 shows the domestic
branches approved and opened and disapproved through December
31, 1973.
From 1969 to year end 1973, Franklin received approval from the
Comptroller and opened 17 new branches. Eleven of the branches
were approved at a time when the condition of the bank was rated as
only fair, and its capital as borderline. One branch was approved
despite a condition rating of unsatisfactory and a capital rating
of inadequate.
Similarly, despite critical examination findings, OCC/Washington
did not object in March 1971 to the Federal Reserve's Board of Governors' approval of Franklin's London branch application.
63
I n order to perform full banking services in England, a bank must
be formally recognized by the Bank of England. I n October 1972,
the Bank of England wrote the OCC asking if there were any problems
with Franklin that would prevent recognition— "* * * our basic principle is that we only recognize in London those banks which are in
good standing in their own markets, with their competitors and with
their authorities." The OCC Director of International Operations,
Robert Mullin, recommended the Bank of England recognize Franklin's London branch.
OTHER ENFORCEMENT
OPTIONS
We found no evidence that the OCC threatened to initiate cease
and desist proceedings or publish portions of Franklin's examination
reports, sought to remove an officer or director of Franklin, or
attempted to make a criminal referral to the Justice Department prior
to May 1974.
I n short, the OCC failed to utilize fully its available enforcement
powers to correct deficiencies in the Franklin bank.
SOLVENCY A N D E X A M I N A T I O N REPORT F I N D I N G S
According to the Comptroller's Handbook of Examination Procedures, the examiner is responsible for determining if a bank is solvent,
both in having collectable assets sufficient to pay depositors and other
creditors and in its ability to meet maturing and usual demands.
The examination report includes a question as to whether a bank
is solvent in both respects.
In 1969 to 1972, the examiner answered "yes" to this question. I n
the November 1973 report, he referred to the narrative comments on
the condition of the bank, which stated: "* * * The bank has not been
able to meet the day-to-day requirements placed upon it in the ordinary conduct of its business and simultaneously sustain its overly
ambitious growth program without the heavy and continuous use of
borrowings, particularly in the Federal funds market." The May
1974 visitation report stated: "Bank condition remains hazardous and
bank is only able to meet its day-to-day requirements through the
assistance of the Federal Reserve Bank."
In October 1974, the Comptroller of the Currency declared Franklin to be insolvent. The affidavit cited certain statistical data to show
that Franklin's equity capital would be reduced from $175 million
to $19 million because of losses, doubtful assets and securities depreciation. According to the affidavit, the remaining equity capital would
undoubtedly be eliminated by the discount factor involved in the sale
of sufficient loans to pay off Franklin's obligation to the Federal
Reserve Bank of New York.
The affidavit further stated that the Comptroller is not required
to wait until the losses he finds in a bank's assets are actually charged
against the bank's book equity capital. The Comptroller's duty is
to determine when a bank has reached the point that it will not be
able to meet obligations to its depositors in the near future. According to the affidavit, Franklin would have reached that point many
months before without the aid of the Federal Reserve Bank of
New York.
64
Thus, while Franklin did not actually become insolvent, its solvency
was due only to Federal Reserve Bank funds borrowed on a daily
basis from May 10 to October 8,1974.
CONDITION OF T H E
BANK
According to the Comptroller's handbook, the major factor used
in determining the rating of a bank's condition is the amount of low
quality, questionable, and unsound assets owned by a bank in relationship to the reasonable loss eliminating capacity afforded by its capital
structure. If the amount of such assets is excessive in relationship to
the capital structure's reasonable loss eliminating capacity, the bank's
condition is poor regardless of any other factors. Franklin's condition
was rated "fair" in 1969; "poor" in 1970; "fair" in 1971 and March
1972; "unsatisfactory" in December 1972; and 'extremely poor" in
1973.
Q U A L I T Y OF LOANS
Mr. HOPPLER. The main factor critically commented on in Franklin's
examination reports was the quality of its loan portfolio and the resulting impact of liquidity. Loans are assigned a classification based
on the examiner's best judgment concerning the degree of risk and the
likelihood of orderly liquidation. Loans can be classified "substandard", "doubtful", or "loss". Substandard loans must have a positive
and well-defined weakness that jeopardizes the liquidation of the
debt. A doubtful loan has all of the weaknesses inherent in an asset
classified substandard and its collection or liquidation in full is highly
questionable. Loans classified "loss" are considered uncollectable and
of such little value that their continuance as active assets of the bank
is not warranted. These three categories make up "total classified
loans".
Additionally, loans may be listed as "other loans especially mentioned." Such loans must constitute undue or unwarranted credit risks,
but not to a point justifying classification in the above categories.
"Total criticized loans" consist of total classified loans plus other loans
especially mentioned.
According to the Haskins and Sells Franklin report, as early as the
1964 examination, the examiners commented that classified and criticized loans were very high in relation to total loans and to Franklin's
total capital. Table 5 shows the ratio of total criticized loans to gross
capital as cited in the 1970-73 examination reports and examiner
comments made.
I n every examination report from 1969 on, the quality of the loan
portfolio was cited as a "matter requiring attention," frequently as
the most important problem. Each report also stated that Franklin's
management was deeply concerned about asset quality.
Loan quality was discussed at the -meetings with Franklin's board of
directors after each examination. However, we found no evidence of
the regional administrator's requesting a definitive commitment from
the board of directors and executive management to institute appropriate corrective measures to its lending policies until directed to do so by
the Comptroller of the Currency in February 1974.
65
LIQUIDITY
Set forth below are the examiner's comments on Franklin's liquidity
in the six regular examination reports. As you can see, the 1969 report
said "very low liquidity." The 1970, 1971, and 1972 reports used the
term "marginal" to describe liquidity. The 1973 report used the term
"hazardous."
Despite the seriousness of these comments, and particularly the 1973
comment calling the bank's liquidity position "hazardous," only in the
1969 examination report was liquidity cited on page 2 as a "matter
requiring attention." That report recommended management continue
their efforts to improve liquidity and noted that liquidity improved by
the close of the examination. The report did not specifically identify
the efforts taken by management, but OCC files showed that in October
1969 Franklin sent the regional administrator a copy of a plan to
improve liquidity through a loan restraint program.
I n analyzing the 1969 report, the Assistant Chief National Bank
Examiner in OCC/Washington commented that liquidity management
was inadequate as evidenced by the sharp growth in loan accounts during a period when deposits were declining. I t was his opinion that
Franklin's liquidity position should be followed closely. According to
the regional administrator, the bank submitted monthly liquidity
reports.
Except, however, for the Assistant Chief National Bank Examiner's
comments concerning the 1969 report, we found no indications that
Franklin's marginal liquidity was the subject of discussions within the
Comptroller's office until early 1974 when Regional Administrator
Van Horn informed a Deputy Comptroller that virtually the entire
investment portfolio was pledged and, therefore, it offered no liquidity
protection. The Comptroller's handbook states that when an examiner
determines a bank's liquidity position to be inadequate or marginal, he
should also determine the bank's plans to achieve and maintain its
liquidity at a level commensurate with accepted industry standards.
The examiners found Franklin's liquidity to be "marginal" in 1970,
1971, and 1972; and "hazardous" in 1973. Nevertheless, we found no
evidence that the examiners or OCC officials made the required determination of Franklin's plans to improve its liquidity.
INVESTMENT SECURITIES
According to the Comptroller's handbook, a suitable investment account should be of a type quickly convertible into cash.
The six regular examination reports stated that Franklin's overall
bond account was of good quality and diversification; however, the
amount of bond depreciation as a percentage of adjusted capital funds
was considered high or disproportionate. Maturities were considered
long in most reports.
A measure of the quality of a bank's investment account is the
ability of a bank's investment account to absorb the depreciation which
would have to be taken on the investments should a bank have to
liquidate its assets to meet other demands. Also, as a general rule,
maturities should be reasonably spaced with a fair preponderance in
short- and medium-term obligations.
66
Table 6 shows the estimated depreciation on Franklin's investment
account and the percentage of investments with maturities over 5 years.
Evidence in the files indicate that bond depreciation was referred to
in board of directors" meetings following the 1969, 1970, 1971, and
March 1972 examinations. The length of maturities was discussed with
the board after the 1970 and 1971 reports. However, there is no evidence that Franklin was urged to take action to reduce bond depreciation or shorten maturities. Likewise, there was no evidence that either
depreciation or maturities received any special attention within the
MANAGEMENT
Mr. METZ. According to the Comptroller's handbook, the OCC must
be provided with a clear evaluation of management. The name of the
individual or individuals of primary importance in management, or
who dominate policies to any extent, must be stated, and a concise estimate made of their ability.
I n the five examinations during 1969-72, the examiners characterized the chief executive officer as basically a public relations man attempting to build a competent management team.
I n the September 1969 examination report, OCC examiners rated
Franklin's management as "Good." Most of the senior management
team received favorable comments and the other officers were noted to
be performing satisfactorily with a good young nucleus developing.
The directors were reported to be kept well-informed and exercised
reasonable and independent supervision.
OCC examiners rated Franklin's management only " F a i r " in the
1970,1971, and 1972 reports.
I n the March 1972 report, the examiner began to criticize senior
management. H e noted that the head of the International Division
was basically uninformed of the serious deficiencies in that area because
of a breakdown in communications prompted by a lack of adequate
supervision. The leadership in two other divisions were also criticized
for lack of aggressiveness and not providing adequate management
direction and control. Weaknesses in senior management were reported to be compounded by a serious lack of middle management personnel, especially in the lending area.
I n the December 1972 report, the examiner rated the management as
"Fair." But he commented on "considerable changes in senior management between examinations," including a new president and senior
vice president of the International Department. He also commented
that the new personnel "have not been with the bank long enough to
demonstrate whether they can develop into a competent team and provide the management depth this bank so badly needs." He noted that
Michele Sindona, a well-known Italian financier, had recently purchased 21.7 percent interest in the common stock of the Franklin New
York Holding Co., the bank's parent corporation, and that management believed this action would lead to substantial growth in Frank] in's international activities.
I n the November 1973 report, OCC rated management as "Poor."
The chief executive officer was still described as "basically public-relations oriented." The president of the bank and the head of one department were criticized for poor management. Additionally, the report
stated:
67
The extent of turnover in both the senior and junior management groups in
recent years h a s been staggering. Numerous inept lending officers were let g o ;
however, the bank also lost several competent officers due to the turmoil of the
senior management level. Morale in the entire organization is a t an all time low
and the bank lacks strength and experience a t the middle management level. Top
management continues to seek outside help, but, in view of the bank's reputation
in the industry, is finding it exceedingly difficult locating suitable candidates.
There a r e indications t h a t management is over-reacting in various problem areas,
and t h a t the bank is being run by crisis. With the tempest and turmoil involved,
this examiner h a s serious reservations whether or not the bank will ever develop
a competent management team.
While the November examination was in process, the examiner-incharge informed officials of the Federal Reserve Bank of New York
that he believed the senior executive vice president was, in fact, the
chief executive officer operating Franklin in accordance with Mr.
Sindona's wishes and that the bank had serious management problems.
Although the examination reports identified major personnel
changes which took place in the bank between 1969 and 1973, the significance of these changes was not explained. Therefore, OCC was not
provided with a clear, concise evaluation of Franklin's management
as required by the handbook.
EARNINGS
According to the Comptroller's handbook, satisfactory earnings and
profits are ont only necessary to, but indicative of a sound, wellmanaged bank. The ratings of Franklin's earnings went from "Good"
in 1969, to " F a i r " in 1970 and 1971, "Marginal" in March 1972, and
"Poor" in December 1972 and 1973. Table 7 shows the net operating
income of Franklin as discussed in each examination report.
Despite the declining ratings, Franklin's earnings were not cited on
page 2 as a "matter requiring attention" in any of the examination
reports. The evidence available to us indicates that earnings were discussed with the bank's board of directors only after the 1971
examination.
CAPITAL
According to the Comptroller's handbook, when an increase in a
bank's capital is believed to be necessary, the examiner should so state
in the confidential section of the report. The regional administrator
will then initiate such action as deemed necessary. The examiner should
not make specific recommendations as to the amount of new capital a
bank should raise unless the matter has first been cleared with their
regional administrator.
Franklin's capital position was rated "borderline" in the 1969 and
"inadequate" in the 1970-73 examination reports. The file indicates
that capital adequacy was nevertheless discussed at meetings with the
bank's board after each examination from 1970 to 1973; and after the
1970 examination the file indicates that Mr. Van Horn "suggested that
consideration be given, in due course, to an appropriate increase of
capital funds." There is no indication, however, that Franklin was requested to increase its capital until the Comptroller of the Currency
requested, in February 1974, a definite program for adjusting the imbalance between Franklin's capital and the size of its operations.
68
INTERNATIONAL
I n addition to its domestic activities, Franklin conducted an international banking business through its International Division located in
New York City, branches in London and Nassau and representative
offices in Singapore and Mexico City. Table 8 shows the growth in
Franklin's foreign exchange transactions from 1969 through 1974.
Franklin's foreign exchange transactions volume grewT from $13.6
million in September 1969 to $19.0 million in May 1971, and to $3.7
billion in November 1973. I n 1969,1970, and 1971 examination reports,
the examiner commented on this growth pattern and stated Franklin's
need to develop a system which would provide adequate controls and
reliable information to management.
OCC began its next examination on March 6, 1972, and found that
the division's operations were in chaos and ". . . internal controls are
virtually nonexistent." The examiner-in-charge reported the problems
to the bank's chief executive officer and requested corrective action.
Meanwhile, because of the seriousness of these deficiencies, the
regional administrator contacted the OCC Director of International
Operations and requested that he meet with Franklin's officers to discuss these matters. OCC's Director of International Operations visited New York, reviewed the problems with the examiners and the
bank's officials, and was assured that corrective actions were being
initiated.
I n letters dated May 15 and June 9, 1972, Franklin's executive vice
president sent the OCC Director of International Operations evidence
that actions wxre being taken by the bank to correct the problems noted
in the March examination report.
I n response to the June letter, the OCC Director replied that he was
fully satisfied with the bank's foreign exchange operations as reported
and that all segments of the operations appeared to be operating
efficiently. We were informed by the director that OCC's examiners
did not conduct an onsite verification that these actions were being
taken, but relied on the newly established operating procedures and the
bank's copies of documents implementing these procedures.
The December 11,1972, examination report noted that the bank had
substantially improved its international accounting procedures since
the last examination; however, the head trader had been replaced twice
and the department still had internal control deficiencies such as the
absence of trading limits.
OCC completed the international portion of the November 1973
examination about the end of December. According to the report, foreign exchange trading had increased to $3.8 billion resulting in a profit
of about $7.5 million. The examiner cautioned senior management on
the risks of large open positions and gaps, the large volume of trading,
and the rumors concerning other banks closing their lines with Franklin. He added that if "the currencv markets had reacted contrary to
the expected," Franklin's $7.5 million profit could have ended up as
a loss. The report rated the condition, management, and future prospects of the International Division as "good."
At the board meeting following the November 1973 examination,
the directors were advised that the foreign exchange position was extremely heavy and that consideration should be given to establishing
69
guidelines for keeping the foreign exchange position within more
reasonable bounds.
On Friday, May 3, 1974, the bank was advised by the London
branch that the National Westminster Bank had objected to the
volume of the bank's sterling clearings through its account. Senior
officials of the bank conducted an investigation which resulted in a
trader admitting that he had entered contracts which he had not
recorded. On May 14, the OCC Director of International Operations
called for a special examination of the foreign exchange activities as of
May 10, 1974. The examination found that the total losses of the department due to the use of false exchange rates and unrecorded contracts were over $43 million compared to the bank's earlier loss examination of $609,000 for the same period. As a result, OCC made criminal referrals to the U.S. Attorney General with the result that several
of the bank's officials were convicted of conspiracy and fraud.
Though the OCC's supervision of Franklin's international activities
was more stringent than its oversight of the bank's domestic operations, as we indicated at the outset of our testimony, there are at least
two notable exceptions.
First, on February 1, 1973, an OCC Deputy Comptroller asked the
New York regional office to determine if the bank was engaging in
some apparent "window dressing." The OCC Director of International
Operations advised the Deputy Comptroller that, according to the
international examiner in New York, there had been a $50 million
"window dressing" transaction between Franklin and the Banco De
Roma. The examiner had further stated that when he had completed
the international portion of the examination, he would state his views
on this window-dressing transaction on page 2 of the report. The director stated that he would fully support the examiner's criticism.
The December 1972 report did not contain any reference to the window-dressing transaction. The examiner-in-charge stated that the
regional administrator and the international examiner discussed the
problem and decided not to include it in the report. The regional
administrator informed us that he did not recall any such meeting
and stated that if he did instruct the examiner to delete it from his
report, he would not have done so without first discussing it with the
Deputy Comptroller. We were unable to determine precisely why
the window-dressing transaction was not included in the report.
The second instance occurred on June 13, 1973, when the New York
regional administrator sent the same international examiner into the
bank to conduct a 1-day check of its foreign exchange operation. In a
letter to the regional administrator, the examiner noted that all position limits had been canceled and, although the volume of foreign
exchange transactions and positions had increased, the bank had not
taken any undue risk in its foreign exchange trading. He stated that
all internal control procedures seem to be well observed and a new
internal auditor had been put into the department to oversee its
activities.
Apparently the examiner did not verify the exchange rates in his
review of the international department's profit and loss statements.
If he had, we believe he would have discovered that Franklin officials
were misrepresenting the profitability of their foreign exchange operations. Actual foreign exchange losses amounting to $43 million were
70
discovered during the May 10, 1974, special examination mentioned
earlier.
OPERATING PROCEDURES A N D
GUIDELINES
Our review shows that OCC documents do not clearly identify
the responsibilities and authority of examiners, regional administrators, and Washington officials to require a bank to take corrective
actions on problems identified in the examination reports. As a result,
there exists within OCC a difference of opinion as to who has the
responsibility and authoriyt to require a bank to take corrective actions
to problems identified during examinations.
We were informed by the examiners-in-charge of the 1969-74
Franklin examinations that they do not believe they have the authority or responsibility to require a bank to take corrective actions.
The examiners view their responsibility as verifying the accuracy of
a bank's records, evaluating the adequacy of management, and reporting their findings to the regional office. According to the examiners,
the regional administrator and OCC/Washington have responsibility
for enforcement actions.
The duties of the regional administrator are set forth in various
documents, such as the OCC's directory, examining circulars, and
other office memoranda. However, the regional administrator stated
that these documents are not sufficiently clear in identifying his enforcement authority and responsibility.
At OCC/Washington, the former First Deputy Comptroller told
us that he believed both the examiner and the regional administrator,
as duly authorized representatives of the Comptroller, had the authority and responsibility to require Franklin to take those actions
which were finally taken by the Comptroller in February 1974; that
is, Franklin was required to submit a statement of the names of the
bank's officers and their responsibilities; a plan to reduce all forms of
borrowing; a clearly defined loan policy; the bank's future program
in foreign exchange; and a plan to improve the bank's capital.
I n a subsequent discussion with the Regional Administrator Charles
Van Horn, he advised us that he or the examiner could have requested
Franklin's officials to submit the same written plans requested by the
Comptroller.
HASKINS AND SELLS REPORT
I n May 1974, the Comptroller and Haskins and Sells entered into a
contract calling for a study of all functions and related activities
of the OCC.
The Haskins and Sells report issued May 30, 1975, recommended
the development of a written statement of policies and decision guidelines to insure a greater delegation of decisionmaking authority within
the OCC. These sruidelines ". . . should clearly describe the authorities and responsibility assigned to each of the managerial persons
employed within the OCC. They should describe the nature of the
information to be compiled under the supervision of the person assigned to each function, the extent to which the information compiled should be verified or reconciled with other data, and the person
or persons to whom the information should be sent. The guidelines
should also define the conditions under which decisions could be made
at various levels of authority."
71
We were advised that OCC has begun preparing job position descriptions for its employees, apparently in an effort to implement the
recommendation.
That concludes our statement, Mr. Chairman.
Mr. ROSENTHAL. Thank you very much. I want to commend both of
you for a first-rate and very thorough review.
We shall forgo questions at this time because the statement shall
be included in the record. But we shall hold you available for further
discussion subsequent to the testimony of the Comptroller.
We thank you both very much.
[Messrs. Hoppler's and Metz' prepared statement follows:]
72
P R E P A R E D STATEMENT OF HENRY L. HOPPLER AND C. THOMAS METZ,
SUBCOMMITTEE S T A F F INVESTIGATORS, ON DETAIL FROM THE GENERAL
ACCOUNTING OFFICE
Mr. Chairman and Members of the Subcommittee:
For the past 4 months, we have been working as staff investigators for the
Commerce, Consumer and Monetary Affairs Subcommittee to assist in its oversight
investigation of the Office of the Comptroller of the Currency.
Our efforts
combined with those of the subcommittee's regular staff have been directed toward
determining the adequacy and effectiveness of the Comptroller's examination and
supervision of Franklin National Bank, the subject of today's hearing.
Our
review focused on the years 1969-1974. The Comptroller of the Currency from
1969 to July 1973, was Mr. William Camp, now deceased.
James Smith took office in July 1973.
The present Comptroller
The New York regional administrator since
1969 has been Mr. Charles Van Horn.
Our evaluation of the Office of the Comptroller of the Currency's (OCC)
examination and supervision of Franklin National Bank is based on (1) an analysis ;
of Franklin National Bank's examination reports and related files in the Washington
headquarters and New York regional office of the OCC; (2) a review of OCC operating
manuals, examination procedures and documents; (3) discussions with OCC officials
in Washington and New York; (4) a review of an October 1974 draft report on Franklin
by Haskins and Sells, a well-known management consulting firm; and (5) a review of
the May 30, 1975, report on the operations of the Office of the Comptroller by
Haskins and Sells. We did not examine the accounting records of Franklin and,
therefore, are unable to comment on the accuracy of the financial data included
in the examination reports.
Franklin National Bank was declared insolvent by the Comptroller of the Currency on October 8, 1974.
However, as our testimony will indicate, Franklin had
serious problems which were identified in its examination reports as early as 1969,
and may have been insolvent as early as May 1974.
National bank examinations are designed to determine the condition and performance of banks, the quality of their operations, the capacity of their management and the degree of compliance with Federal laws.
Without such an audit and
review process, an adequate system of national bank supervision and Federal law
enforcement would be impossible.
Mr. Chairman, our 3-month review in behalf of the subcommittee of the
Comptroller's examination and supervisory processes as they were applied to
Franklin National Bank leads us to the following conclusions:
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2
(1) OCC enforcement and compliance documents do not clearly establish
the division of responsibility and authority, among examiners,
regional administrators and Washington officials, to require a bank
to take corrective actions on problems identified during examinations.
As a consequence, there exists among the OCC staff a difference of
opinion as to who has the responsibility and authority to require
such corrective action.
(2) The management and portfolio problems that plagued Franklin since the
, late 1960's and led to its eventual failure in 1974, were amply documented by national bank examiners over a 5-year period.
the OCC failed
We found that
to utilize fully its supervisory options to correct
the problems identified by examiners.
For example:
- Though OCC representatives frequently discussed examiner findings
with senior bank officials and received numerous promises that
corrective actions would be taken, subsequent examinations dfd not
indicate substantive improvements.
- Despite constant critical examination reports, the OCC allowed
Franklin to open 17 branches in New York and one branch in London
between 1969-1973.
Denial of these branches could have been used
effectively to discipline Franklin.
- It was not until February 1974, only 3 months before the beginning
of massive Federal Reserve support, that the OCC took aggressive
supervisory actions to force Franklin to correct problems which had
been repeatedly identified by examiners since 1969.
(3) Though examiners generally identified Franklin's problems, we found
two notable exceptions:
- First, in February 1973, OCC examiners failed to include in their
report a $50-million instance of balance sheet "window dressing"
which resulted in an overstatement of the bank's resources.
- Second, in June 1973, during a 1-day "check" of the bank's foreign
exchange profit and loss statements, the OCC examiner apparently did
not verify the foreign exchange rates used in preparing these schedules.
We believe that, had he verified these rates, the OCC would have
become aware in June 1973 of Franklin's misrepresentations of foreign
exchange profits rather than almost a year later in May 1974.
74
3
(4) Though examiners generally identified Franklin's problems, the critical
comments found scattered throughout the examination reports frequently
did not get recorded on page 2 of the report, "Comments on Matters
Requiring Attention."
Page 2 is important because it is on that page
that examiners are supposed to itemize areas of concern.
Non-inclusion
may suggest to bank officers and directors that a problem is not important.
For example, in the 1970, 1971, 1972 and 1973 reports, capital was
regarded as inadequate and cri'ticized.
itemized on page 2 until 1973.
However, capital was not
75
4
EXAMINATIONS
Frequency
12. U.S.C. 481 requires the Comptroller of the Currency to examine e^ery
national bank twice in each calendar year.
The Comptroller, at his discretion,
however, may waive one examination or examine a bank more frequently, if
necessary.
The waiver of one examination cannot be exercised more frequently
than once during any two calendar
year period.
During the 1969-1974 period, nine reports of examinations were prepared
on Franklin.
Six of the nine reports were "regular"\and three were "special
visitations."
Regular examinations were made as of September 29, 1969, August 31,
1970, May 17, 1971, March 6, 1972, December 11, 1972 and November 14, 1973.
Special visitations were made as of May 10, May 14 and August 14, 1974. The
first of these visitations related to foreign exchange activities and the
second two were to obtain current evaluations of loan portfolio and investment
account quality.
While the examinations took from 1 week to almost 4 months to complete,
the bank's financial data are verified as of the commencement date of the
examination.
Table 1 shows the starting and closing dates and man-days used
on each examination.
On three other occasions, February 1973, June 1973 and February 1974, the
regional administrator sent examiners into the bank to obtain data on certain
aspects of Franklin's international operations.
Ratings
Examination reports contain comments by the examiner concerning the following categories:
(1) Condition of Bank; (2) Management; (3) Earnings; (4) Capital;
(5) Internal Controls and Audit Procedures; and (6) Future Prospects.
The com-
ments include a descriptive work rating (Excellent, Good, Fair, Poor, etc.)
for each category.
Table 2 presents the rating in each of these categories.
The descriptive word ratings reveal that Franklin's overall condition was
only Fair and its capital was Borderline in 1969.
By 1972 its condition was
Unsatisfactory, its management only Fair, its earnings Poor, and its capital
Inadequate.
At the completion of each regular examination, Franklin was further rated
in three categories:
Management.
(1) Capital Position, (2) Quality of Assets and (3)
A Composite or Group rating of Franklin was also made.
Capital
position is rated from 1 to 4 (1 being adequate) based on such factors as
management, liquidity, earnings, etc.
Quality of assets is rated from A to D
76
5
(A being good) based on the ratio of classified and speculative assets to gross
capital.
Management is rated S (strong or competent) F (fair), or P (Poor,
incompetent or integrity questioned).
The Composite or Group rating is from 1
to 4 (1 being a sound institution) based on consideration of all ratings.
Ratings were made by the regional administrator, although in 1972 the
composite rating was revised downward in OCC/V/ashington.
Table 3 shows Franklin's
ratings at each regular examination.
Franklin's Composite rating declined from 2 to 3 in 1970, and remained a 3
through ,early 1974.
OCC procedures provide that banks having a' Composite rating
of 3 or 4 require special attention.
OCC Deputy Comptroller John Gwin, who was
responsible for the New York region, informed Comptroller William Camp in March
1971 that Franklin was in need of close supervision.
The New York Regional
Administrator at that time was Mr. Charles Van Horn.
ENFORCEMENT FOLLOW-UP
Supervisory Options
In testimony before this subcommittee on January 20, 1976, the Deputy
Comptroller of the Currency, Robert Bloom, identified supervisory methods available to the OCC for correcting deficiencies in banks identified as requiring
special supervisory attention,
He stated that special supervision begins with
the ex^mijTe_r^s_ comments on matters requiring attention in the examination report.
Next, the regional administrator can request a bank's board of directors and
executive management to institute corrective measures, request monthly progress
reports and conduct frequent visitations and examinations.
sonnel can be involved in any of these aspects.
OCC/Washington per-
Additionally, OCC can withhold
approval on applications for various corporate changes, such as opening a new
branch or approving investments in banking premises.
Other actions include initia-
tion of cease and desist proceedings, certification to the Federal Reserve for
removal of a bank official or criminal referral to the Department of Justice.
Though Mr. Bloom failed to enumerate it, the OCC also had the authority to publish
all or part of Franklin's examination reports.
The OCC did not fully utilize its options, and what actions it did take
clearly were not adequate for the purpose of getting Franklin to work out its
problems.
77
6
Examiner Commen_ts_
The examiner's conclusions regarding aspects of a bank's affairs that
should be brought to the attention of the Comptroller and the bank's directors
are found on page 2 of the examination report.
Our review of these comments
reveals several important instances in which strong examiner criticisms found
elsewhere in the Franklin examination reports were not included on page 2.
This
is a problem because non-inclusion may suggest to bank officers and directors
that a problem is not important.
Nevertheless, even the problems cited on page 2 were not always effectively
dealt with by Franklin's management.
Succeeding examination reports evidenced
no significant improvement in some of the problems cited on page 2 during 19691973.
Corrfctive Measures
After each examination report was completed, the OCC regional administrator and the examiner-in~charge met with Franklin's board of directors to discuss
the condition of the bank.
The regional administrator, Mr. Charles Van Horn,
told us in a recent interview that requests to the board to take corrective
actions should have been made at these meetings and that these requests should
be reflected in OCC memoranda of these meetings.
These memoranda indicate that only after the 1970 examination was a request
made for corrective action.
This request was simply "to keep us [OCC/New York]
currently informed with respect to alleviating criticisms."
Ex_a_mijidj:ions and_ Vi_si tations_
Despite the
steadily deteriorating condition of Franklin from 1969 through
1973, the frequency of examinations was not increased.
Even the three examinations
every two calendar years, required by law, were not conducted from 1969 through
1971.
Special 1-day visitations were made in February 1973, June 1973 and February
1974 to review Franklin's foreign exchange operations.
A
£Pj 1(:ation Approvals
Applications for new branch offices of a national bank require approval by
the Comptroller.
In practive, when an application is considered, it is circu-
lated to examiners in the region, regional administrators, Director of the Bank
Organization Division and Deputy Comptroller for recommendations and comments.
Comments are also requested from the State banking department.
In the Franklin
case, all reports by these individuals were reviewed and provided the basis for
the final decision by the Comptroller.
Table 4 shows the domestic branches
approved (and opened) and disapproved through December 31, 1973.
74-548 O - 76 - 6
78
7
From 1969 to year end 1973, Franklin received approval from the Comptroller
and opened 17 new branches.
Eleven of the branches were approved at a time when
the condition of the bank was rated as only Fair and its capital as Borderline.
One branch was approved despite a condition rating of Unsatisfactory and a capital
rating of Inadequate.
Similarly, despite critical examination findings, OCC/Washington did not
object in February 1971, to the Federal Reserve's Board of Governors' approval
of Franklin's London branch application.
In order to perform full banking services in England, a bank must be formally
recognized by the Bank of England.
In October 1972, the Bank of England wrote
the OCC asking if there were any problems with Franklin that would prevent recognition; "...our basic principle is that we only recognize in London those banks
which are in ijood standing in their own markets, with their competitors and with
their authorities."
The OCC Director of International Operations Robert Mull in
recommended the Bank of England recognise Franklin's London branch.
0_ther En_f oreement_0p_t_ions_
We found no evidence that the OCC threatened to initiate cease and desist Droceedings or publish portions of Franklin's examination reports, sought to remove
an officer or director of Franklin, or attempted to make a criminal referral
to the Justice Department before May 1974.
In short, the OCC failed to utilize fully its available enforcement powers
to correct deficiencies in the Franklin bank.
L-.XAM INA1I ON_RE_P_qRT__FI NDI.NGS.
Solvency
According to the Comptroller's Handbook of Examination Procedures, the
examiner is responsible for determining if a bank is solvent, both in having
collectable assets sufficient to pay depositors and other creditors and in its
ability to meet maturing and usual demands.
The examination report includes
a question as to whether a bank is solvent in both respects.
In 1969 to 1972 the examiner answered "yes" to this question.
In the
November 1973 report, he referred to the narrative comments on the condition
of the bank, which stated "...The bank has not been able to meet the day-today requirements placed upon it in the ordinary conduct of its business and
simultaneously sustain its overly ambitious growth program without the heavy
and continuous use of borrowings, particularly in the Federal funds market."
79
8
The May 1974 visitation report stated:
"Bank condition remains hazardous and
bank is only able to meet its day-to-day requirements through the assistance
of the Federal Reserve Bank."
In October 1974 the Comptroller of the Currency declared Franklin to be
insolvent.
The affidavit cited certain statistical data to show that Franklin's
equity capital would be reduced from $175 million to $19 million because of
losses, doubtful assets and securities depreciation.
According to the affidavit,
the remaining equity capital would undoubtedly be eliminated by the discount
factor involved in the sale of sufficient loans to pay off Franklin's obligation
to the Federal Reserve Bank of New York.
The affidavit further stated that the Comptroller is not required to wait
until the losses he finds in a bank's assets are actually charged against the
bank's book equity capital.
The Comptroller's duty is to determine when a bank
has reached the point that it will not be able to meet obligations to its deposit
tors in the near future. According to the affidavit, Franklin would have reached
that point many months before without the aid of the Federal Reserve Bank of New :
York.
Thus, while Franklin did not actually become insolvent, its solvency was
due only to Federal Reserve Bank funds borrowed on a daily basis from May 10 to
October 8, 1974.
Condition of the Bank
According to the Comptroller's Handbook, the major factor used in determining the rating of a bank's condition is the amount of low quality, questionable,
and unsound assets owned by a bank in relationship to the reasonable loss eliminating capacity afforded by its capital structure.
If the amount of such assets
is excessive in relationship to the capital structure's reasonable loss eliminating capacity, the bank's condition is poor regardless of any other factors.
Franklin's condition was rated "Fair" in 1969, "Poor" in 1970, "Fair" in 1971
and March 1972, "Unsatisfactory" in December 1972 and "Extremely Poor" in 1973.
Quality of Loans
The main factor critically commented on in Franklin's examination reports
was the quality of its loan portfolio and the resulting impact on liquidity.
Loans are assigned a classification based on the examiner's best judgment concerning the degree of risk and the likelihood of orderly liquidation.
be classified "substandard", "doubtful", or "loss".
Loans can
Substandard loans must have
a positive and well-defined'weakness that jeopardizes the liquidation of the
debt.
A doubtful loan has all of the weaknesses inherent in an asset classified
80
substandard and its collection o.r liquidation in full is highly questionable.
Loans classified "loss" are considered uncollectable and of such little value
that their continuance as active assets of the bank is not warranted.
These
three categories make up "total classified loans."
Additionally, loans may be listed as "other loans especially mentioned."
Such loans must constitute undue or unwarranted credit risks, but not to a point
justifying classification in the above categories.
"Total criticized loans"
consist of total classified loans plus other loans especially mentioned.
According to the Haskins and Sells Franklin report, as early as the 1964
examination the examiners commented that classified and criticized loans were
very high in relation to total loans and to Franklin's total capital.
Table 5
shows the ratio of total criticized loans to gross capital as cited in the 19701973 examination reports and comments made.
In every examination report from 1969 on, the quality of the loan portfolio
was cited as a "matter requiring attention," frequently as the most important
problem.
Each report also stated that Franklin's management was
deeply concerned
about asset quality.
Loan quality was discussed at the meetings with Franklin's board of directors
after each examination.
However, we found no evidence of the regional adminis-
trator requesting a definitive commitment from the board of directors and
executive management to institute appropriate corrective measures to its lending
policies until directed to do so by the Comptroller of the Currency in February
1974.
Liquidity
Set forth below are the examiner's comments on Franklin's liquidity in the
six regular examination reports.
Examination
9/29/69
Comments
"...very
low liquidity.
at this examination."
This is the main area of concern
8/31/70
"...marginal due to the heavy volume of problem loans."
5/17/71
"...marginal due to the heavy volume of problem loans
currently reflected."
3/6/72
"...marginal due to the heavy volume of problem loans currently reflected."
12/11/72
"...marginal due to the heavily loaned position, volume of
problem credits, unused commitments and the need for consistent large borrowings."
11/14/73
"Bank's liquidity position is considered hazardous by the
examiner..."
81
10
Despite the seriousness of these comments, and particularly the 1973 comment
calling the bank's liquidity position "hazardous," only in the 1969 examination
report was liquidity cited on page 2 as a "matter requiring attention."
That
report recommended management continue their efforts to improve liquidity and
noted that liquidity improved by the close of the examination.
The report did
not specifically identify the efforts taken by management, but OCC files showed
that in October 1969 Franklin sent the regional administrator a copy of a plan
to improve liquidity through a loan restraint program.
In-analyzing the 1969 report, the Assistant Chief National Bank Examiner
commented that liquidity management was inadequate as evidenced by the sharp
growth in loan accounts during a period when deposits were declining.
It was
his opinion that Franklin's liquidity position should be followed closely.
According to the regional administrator, the bank submitted monthly liquidity
reports.
Except for the Assistant Chief National Bank Examiner's comments concerning
the 1969 report, we found no indications that Franklin's marginal liquidity was
the subject of discussions within the Comptroller's office until early 1974,
when Regional Administrator Van Horn informed a Deputy Comptroller that virtually
the entire investment portfolio was pledged and, therefore, it offered no liquidity
protection.
The Comptroller's Handbook states that, when an examiner determines
a bank's liquidity position to be inadequate or marginal, he should also determine
the bank's plans to achieve and maintain its liquidity at a level commensurate
with accepted industry standards.
The examiners found Franklin's liquidity to
be "marginal." in 1970, 1971 and 1972 and "hazardous" in 1973.
Nevertheless, we
found no evidence that the examiners or OCC officials made the required determination of Franklin's plans to improve its liquidity.
Investment Securities
According to the Comptroller's Handbook, a suitable investment account
should be of a type quickly convertible into cash.
The six regular examination reports stated that Franklin's overall bond
account was of good quality- and diversification; however, the amount of bond
depreciation as a percentage of adjusted capital funds was considered high or
disproportionate.
Maturities were considered long in most reports.
A measure of the quality of a bank's investment account is the ability of
the bank to absorb the depreciation which would have to be taken on the investments should a bank have to liquidate its assets to meet other demands. Also,
82
n
as a general rule, maturities should be reasonably spaced with a fair preponderance in short- and medium-term obligations.
Table 6 shows the estimated depreciation on Franklin's investment account
and the percent of investments with maturities over 5 years.
Evidence in the files indicate that bond depreciation was referred to in
board of directors' meetings following the 1969, 1970, 1971 and March 1972 examinations.
The length of maturities was discussed with the board after the 1970
and 1971 reports.
However, there is no evidence that Franklin was urged to take
action to reduce bond depreciation or shorten maturities.
Likewise, there was
no evidence that either depreciation or maturities received any special attention
within the OCC.
Management
According to the Comptroller's Handbook, the OCC must be provided with
a clear evaluation of management.
The name of the individual or individuals of
primary importance in management, or who dominate policies to any extent, must
be stated, and a concise estimate made of their ability.
In the five examinations during 1969-1972, the examiners characterized
the chief executive officer as basically a public relations man attempting to
build a competent management team.
In the September 1969 examination report, OCC examiners rated Franklin's
management as "Good."
Most of the senior management team received favorable
comments and the other officers were noted to be performing satisfactorily
with a good young nucleus developing.
The directors were reported to be kept
well-informed and exercised reasonable and independent supervision.
OCC examiners rated Franklin's management only "Fair" in the 1970, 1971,
and 1972 reports.
In the March 1972 report, the examiner began to criticize senior management.
He noted that the head of the International Division was basically
uninformed of the serious deficiencies in that area because of a breakdown in
communications prompted by a lack of adequate supervision.
The leadership in
two other divisions were also criticized for lack of aggressiveness and not
providing adequate management direction and control. Weaknesses in senior
management were reported to be compounded by a serious lack of middle management
personnel, especially in the lending area.
In,the December 1972 report, the examiner rated the management as "Fair."
But he commented on "considerable changes in senior management between examinations",
including a new president and senior vice president of the International Department.
83
12
He also commented that the new personnel "have not been with the bank long
enough to demonstrate whether they can develop into a competent team and
provide the management depth this bank so badly needs."
He noted that Michele
Sindona, a well-known Italian financier, had recently purchased 21.7 percent
interest in the common stock of the Franklin New York Holding Company (the
bank's parent corporation), and that management believed this action would lead
to substantial growth in Franklin's international activities.
In the November 1973 report, OCC rated management as "Poor."
The chief
executive officer was still described as "basically public-relations oriented."
The president of the bank and the head of one department were criticized for
poor management.
Additionally, the report stated:
"The extent of turnover in both the senior and junior management groups in recent years has been staggering. Numerous inept
lending officers were let go; however, the bank also lost several
competent officers due to the turmoil on the senior management
level. Morale in the entire organization is at an all time low
and the bank lacks strength and experience at the middle management level. Top management continues to seek outside help, but,
in view of the bank's reputation in the industry, is finding it
exceedingly difficult locating suitable candidates. There are
indications that management is over-reacting in various problem
areas, and that the bank is being run by crisis. With the tempest
and turmoil involved, this examiner has serious reservations
whether or not the bank will ever develop a competent management
team."
While the November examination was in process, the examiner-in-charge
informed officials of the Federal Reserve Bank of New York that he believed
the senior executive vice president was, in fact, the chief executive officer,
operating Franklin in accordance with Mr. Sindona's wishes and that the bank
had serious management problems.
Although the examination reports identified major personnel changes which
took place in the bank between 1969-1973, the significance of these changes
was not explained.
Therefore OCC was not provided with a clear, concise evalua-
tion of Franklin's management as required by the Handbook.
Earnings
According to the Comptroller's Handbook, satisfactory earnings and profits
are not on^ly necessary to, but indicative of, a sound, well-managed bank.
The
ratings of Franklin's earnings went from "Good" in 1969, to "Fair" in 1970 and
1971, "Marginal" in March 1972 and "Poo**" in December 1972 and 1973. Table 7
shows the net operating income of Franklin as discussed in each examination
report.
84
13
Despite the declining ratings, Franklin's earnings were not cited on page 2
as a "matter requiring attention" in any of the examination reports. The evidence
available to us indicates that earnings were discussed with the bank's board of
directors only after the 1971 examination.
Capital
According to the Comptroller's Handbook, when an increase in a bank's
capital is believed to be necessary, the examiner should so state in the confidential section of the report. The regional administrator will then initiate
such action as deemed necessary.
The examiner should not make specific recom-
mendations as to the amount of new capital a bank should raise unless the matter
has first been cleared with their regional administrator.
Franklin's capital position was rated "borderline" in the 1969 and "inadequate" in the 1970-1973 examination reports. No examiner, however, specifically
stated an increase in capital was necessary.
Franklin's capital position was not cited on page 2 as a "matter requiring
attention" until the 1973 examination report. The file indicates that capital
adequacy was nevertheless discussed at meetings with the bank's board after each
examination from 1970 to 1973; and after the 1970 examination the file indicates
that
Van Horn "suggested that consideration be given, in due course, to an
appropriate increase of the capital funds." There is no indication, however,
that Franklin was requested to increase its capital until the Comptroller of the
Currency requested, in February 1974, a definite program for adjusting the
imbalance between Franklin's capital and the size of its operations.
.International
In addition to its domestic activities, Franklin conducted an international
banking business through its International Division located in New York City,
branches in London and Nassau and representative offices in Singapore and Mexico
City. Table 8 shows the growth in Franklin's foreign exchange transactions from
1969 through 1974.
Franklin's foreign exchange transactions volume grew from $13.6 million
in September 1969, to $19.0 million in May 1971, and to $3.7 billion in
1973.
November
In 1969, 1970 and 1971 examination reports, the examiner commented on
this growth pattern and stated Franklin's need to develop a system which would
provide adequate controls and reliable information to management.
0CC began its next examination on March 6, 1972, and found that the division's operations were in chaos and "...internal controls are virtually non-existent."
85
14
The examiner-in-charge reported the problems to the bank's chief executive officer
and requested corrective action.
Meanwhile, because of the seriousness of these deficiencies, the regional
administrator contacted the OCC Director of International Operations and requested
that he meet with Franklin's officers to discuss these matters. OCC's Director
of International Operations visited New York, reviewed the problems with the
examiners and the bank's officials and was assured that corrective aetior.s wore
being initiated.
In letters dated May 15 and June 9, 1972, Franklin's executive vicr president sent the OCC Director of International Operations evidence that actions were
being taken by the bank to correct the problems noted in the March examination
report.
In response to the June letter, the OCC Director replied that he was fully
satisfied with the bank's foreign exchange operations as reported and that all
segments of the operations appeared to be operating efficiently. We were
informed by the director that OCC's examiners did not conduct an on-site verification that these actions were being taken, but relied on the newly established
operating procedures and the bank's copies of documents implementing these procedures.
The December 11, 1972, examination report noted that the bank had substantially improved its international accounting procedures since the last examination; however, the head trader had been replaced twice and the department still
had internal control deficiencies such as the absence of trading limits.
OCC completed the international portion of the November 1973 examination
about the end of December. According to the report, foreign exchange trading
had increased to $3.8 billion resulting in a profit of about $7.5 millio".
The
examiner cautioned senior management on the risks of large open positions and
gaps, the large volume of trading and the rumors concerning other banks closing
their lines with Franklin. He added that if "the currency markets had reacted
contrary to the expected," Franklin's $7.5 million jrofit could have end^d up
as a loss. The report rated the condition, management and future prosoects of
the International Division as "Good."
At the board meeting following the November 1973 examination, the directors
were advised that the foreign exchange position was extremely heavy and that
consideration should be given to establishing guidelines for keeping the foreign
exchange position within more reasonable bounds.
86
15
On Friday, Kay 3, 1974, the bank was advised by the London Branch that the
National Westminster
Bank had objected to the volume of the bank's sterling
clearings through its account. Senior officials of the bank conducted an investigation which resulted in a trader admitting that he had entered contracts
which he had not recorded. On May 14 the OCC Director of International Operations called for a special examination of the foreign exchange activities as
of May 10, 1974. The examination found that the total losses of the department
due to the use of false exchange rates and unrecorded contracts were over $43
million compared to the bank's earlier loss estimation of $609,000 for the
same period. As a result, OCC made criminal referrals to the U.S. Attorney
General with the result that several of the bank's officials were convicted of
conspiracy and fraud.
Though the OCC's supervision of Franklin's international activities was
more stringent than its oversight of the bank's domestic operations, as we
indicated at the outset of our testimony, there are at least two notable exceptions.
First, on February 1, 1973, an OCC Deputy Comptroller asked the New York
regional office to determine if the bank was engaging in some apparent "window
dressing." The OCC Director of International Operations advised the Deputy
Comptroller that, according to the international examiner in New York, there
had been a $50-million "window dressing" transaction between Franklin and the
Banco De Roma ($50 million due to and due from Banco De Roma, all in U.S.
dollars, and all with same maturity dates and rates of interest). The examiner
had further stated that when he had completed the international portion of the
examination (December 11, 1972), he would state his views on this window-dressing
transaction on page 2 of the report. The director stated that he would fully
support the examiner's criticism.
The December 1972 report did not contain any reference to the windowdressing transaction. The examiner-in-charge stated that the regional administrator and the international examiner discussed the problem and decided not to
include it in the report. The regional administrator informed us that he did
not recall any such meeting and stated that if he did instruct the examiner
to delete it from his report, he would not have done so without first discussing
it with the Deputy Comptroller. We were unable to determine precisely why the
window-dressing transaction was not included in the report.
The second instance occurred on June 13, 1973, when the New York regional
administrator sentvthe same international examiner into the bank to conduct
87
16
a 1-day check of its foreign exchange operation.
In a letter to the regional
administrator, the examiner noted that all position limits had been cancelled
and, although the volume of foreign exchange transactions and positions had
increased, the bank had not taken any undue risk in its foreign exchange
trading.
He stated that all internal control procedures seem to be well-
observed and a new internal auditor had been put into the department to oversee
its activities.
Apparently the examiner did not verify the exchange rates in his review
of the international department's profit and loss statements.
If he had, we
believe he would have discovered that Franklin officials were misrepresenting
the profitability of their foreign exchange operations.
Actual foreign exchange
losses amounting to $43 million were discovered during the May 10, 1974, special
examination mentioned earlier.
OPERATING PROCEDURES AND GUIDELINES
Our review shows that OCC documents do not clearly identify the responsibilities and authority of examiners, regional administrators and Washington officials to require a bank to take corrective actions on problems identified in the
examination reports.
As a result, there exists within OCC a difference of
opinion as to who has the responsibility and authority to require a bank to
take corrective action to problems identified during examinations.
We were informed by the examiners-in-charge of the 1969-1974 Franklin
examinations that they do not believe they have the authority or responsibility
to require a bank to take correction actions. The examiners view their responsibility as verifying the accuracy of a bank's records, evaluating the adequacy
of management and reporting their findings to the regional office.
According
to the examiners, the regional administrator and OCC/Washington have responsibility for enforcement actions.
The duties of the regional administrator are set forth in various documents,
such as the OCC's Directory, examining circulars and other office memoranda.
However, the regional administrator stated that these documents are not sufficiently clear in identifying his enforcement authority and responsibility.
At OCC/Washington, the former First Deputy Comptroller told us that he
believed both the examiner and the regional administrator, as duly authorized
representatives of the Comptroller, had the authority and responsibility to
require Franklin to take those actions which were finally taken by the Comptroller
88
17
in February 1974; that is, Franklin was required to submit (1) a statement of
the names of the bank's officers and their responsibilities; (2) a plan to reduce
all forms of borrowing; (3) a clearly defined loan policy; (4) the bank's future
program in foreign exchange; and (5) plan to improve the bank's capital.
In a subsequent discussion with the Regional Administrator, Charles Van
Horn, he advised us that he or the examiner could have requested Franklin's
officials to submit the same written plans requested by the Comptroller.
Haskins and Sells Report
In May 1974, the Comptroller and Haskins and Sells entered into a contract
calling for a study of all functions and related activities of the OCC.
The Haskins and Sells report issued May 30, 1975, recommended the development of a written statement of policies and decision guidelines to ensure a
greater delegation of decision-making authority within the OCC.
These guide-
1 i nes
"...should clearly describe the authorities and responsibility assigned
to each of the managerial persons employed within the OCC. They should
describe the nature of the information to be compiled under the supervision of the person assigned to each function, the extent to which the
information compiled should be verified or reconciled with other data,
and the person or persons to whom the information should be sent. The
guidelines should also define the conditions under which decisions could
be made at various levels of authority."
We were advised that OCC has begun preparing job position descriptions for
its employees, apparently in an effort to implement the recommendation.
89
TABLE 1
EXAMINATION DATA
TYPE
COMMENCED
CLOSED
MAN-DAYS
9/29/69
Regular
12/24/69
2,175
8/31/70
Regular
12/24/70
2,594
5/17/71
Regular
8/6/71
1,749
3/6/72
Regular
5/23/72
1,603
12/11/72
Regular
3/2/73
1,454
11/14/73
Regular
3/8/74
1,486
5/13/74
Special
5/21/74
5/14/74
Special
5/20/74
8/14/74
Special
8/27/74
"
-
TABLE 2
EXAMINATION DESCRIPTIVE WORD RATINGS
12/11/72
8/31/70
Condition of
the Bank
Fair
Poor
Fair
Fair
Unsatis.
Management
Good
Fair
Fair
Fair
Earnings
Good
Fair
Capital
Borderline
Inadequate
Internal
Controls
Adequate
Adequate
Future
Prospects
Good
Good
5/17/71
3/6/72
9/29/69
11/14/73
11/14/73
International
Department
Extremely
Poor
Good
Fair
Poor
Good
Fair
Margina'1 Poor
Poor
Inadequate
Inadequate
Inadequate
Inadequate
-—
Adequatie Weak
Generally
Adequate
Adequate
Good
Good
Fair
Fair
-Good
90
TABLE 3
CATEGORY AND COMPOSITE RATINGS
OF
FRANKLIN NATIONAL BANK
Date of
Examination
Capital
Position
Quality of
Assets
Management
Composite
Rating
9/29/69
2
B
F
2
8/31/70
2
C
F
3
5/17/71
2
C
F
3
3/6/72
2
C
F
3a
12/11/72
2
C
F
3a
11/14/73
2
D
F
3
a
Rating revised from 2 to 3.
TABLE 4
FRANKLIN NATIONAL BANK
LIST OF BRANCHES OPENED OR DISAPPROVED
JANUARY 1, 1970 to DECEMBER 31, 1973
DATE BRANCH
APPROVED OR
DISAPPROVED
9-14-64
5-24-67
1-30-G8
5-27-68
2-4-69
4-7-69
5-5-69
7-10-69
11-5-69
1-13-70
1-22-70
2-16-70
2-18-70
3-11-70
4-16-70
6-10-70
6-22-70
8-4-70
8-31-70
11-4-70
3-27-73
RATING OF BANK AT DATE OF
LAST COMPLETED EXAMINATION
CAPITAL
CONDITION
REGIONAL
EXAMINER
F
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Fair
Unsatisfactory
Adequate
Inadequate
Inadequate
Inadequate
Strengthened
Strengthened
Strengthened
Strengthened
Strengthened
Borderline
Borderline
Borderline
Borderline
Borderline
Borderline
Borderline
Borderline
Borderline
Borderline
Borderline
Inadequate
U
F
F
F
F
F
F
F
F
F
F
U
F
F
F
U
F
F
F
F
Fair
Fair
Fair
Poor
Borderline
Borderline
Borderline
Inadequate
F
U
U
F
i
RECOMMENDATION FOR APPROVAL BY
DIRECTOR BANK
ORGANIZATION
REGIONAL
ADMINISTRATOR
DIVISION
DEPUTY
COMPTROLLER
OF CURRENCY
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
U
F
F
F
F
F
F
F
F
U
F
F
U
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
F
U
U
U
U
U
U
U
5*F
BRANCHES
niSAPPROVED
2-27-70
4-1-70
VI-9-70
2-19-71
T - F - Favorable; U - Unfavorable
2 - Deputy Regional Administrator
u
u
co
92
TABLE 5
Total Criticized Loans
to Gross Capital Funds
Comments
8/31/70
109%
Increased substantially
5/17/71
92%
Slight improvement; unprecedented
increase in volume of doubtful and
loss
3/6/72
82%
Remains in deteriorated state;
improvement wholly due to capital
increase
12/11/72
74%
Remains extremely high
11/14/73
111%
Marked deterioration; classified loans
increasing 32% and special mention up
78%
TABLE 6
INVESTMENT ACCOUNT
ESTIMATED DEPRECIATION
Examination
Bond
Depreciation
(miliions of dollars
Depreciation
as Percent of
<
Adjusted Cap ital
Length of
Maturities
Over 5 Years
9/29/69
$ 107.2
52%
68%
8/31/70
109.0
52%
63%
5/17/71
62.9
31%
55%
3/ 6/72
58.9
24%
58%
12/11/72
55.3
23%
75%
11/14/73
58.3
25.6%
77%
5/14/74
110.3
82%
8/14/74
127.4
82%
93
22
IABLE 7
NET OPERATING INCOME
Examination
Yeair_
Net Operating Income
9/29/69
1968
1969 Est
$24,636,000
26,750,000
8/31/70
1969
27,602,000
5/17/71
1970
1971 Est
26,493,000
37,000,000
3/6/72
1970
1971
1972 Est
26,500,000
15,800,000
22,200,000
12/11/72
1971
1972
15,800,000
10,950,000
11/14/73
1972
1973
10,950,000
11,568,000
TABLE 8
FOREIGN EXCHANGE GROWTH
Date of Examinaition
9-29-69
8-31-70
5-17-71
3-6-72
74-548 O - 76 - 7
Total Foreign Exchange
Bought and Sold
(million)
$
13.6
10.7
19.0
422.4
12-11-72
1,375.2
11-14-73
3,760.7
5-14-74
3,332.6
8-14-74
1,900.2
94
Mr. ROSENTHAL. The next witness is Mr. Aaron B. Donner, former
director of First National Bank of East Islip, Long Island, N.Y.
Mr. Donner, you have no objection to being sworn and testifying
under oath, do you ?
STATEMENT OP AARON B. DONNER, FORMER DIRECTOR, FIRST
NATIONAL BANK OF EAST ISLIP, LONG ISLAND, N.Y.
Mr. DONNER. N O , sir.
Mr. ROSENTHAL. Would
you please stand and raise your right hand.
Do you swear to tell the whole truth and nothing but the truth, so
help you God?
Mr. DONNER. I do, sir.
Mr. ROSENTHAL. We will
proceed. Mr. Donner, you are here today,
as I understand it, to testify regarding a number of matters concerning the First National Bank of East" Islip. Included in these matters
are matters you learned of during your tenure as a director of the
First National Bank of East Islip.
I am advising you that you are directed to testify to all matters
within your knowledge regarding the First National Bank of East
Islip, this being a committee of Congress specifically directed to investigate all matters relating to bank regulations in the United States.
Mr. DONNER. I understand, Mr. Chairman.
Mr. ROSENTHAL. Are you ready ?
Mr. DONNER. Yes, sir.
Mr. ROSENTHAL. Would you state your name and occupation ?
Mr. DONNER. Mr. Chairman, my name is Aaron Donner. I
am a
lawyer with a law office in Bay Shore, N.Y. I have been a lawyer
since 1952.
Mr. ROSENTHAL. For the record, include your address.
Mr. DONNER. My address is 2115 Union Boulevard, Bay Shore, N.Y.
Mr. ROSENTHAL. Do you have a prepared statement ?
Mr. DONNER. N O , sir; I do not. I have some notes from which I am
prepared to testify.
Mr. ROSENTHAL. YOU may proceed and then we will question after
that.
Mr. DONNER. All right. I n about January of 1974, our firm was consulted bv a Walter Lang, who was a former director and an attorney
for the First National Bank of East Islip, in connection with certain
litigation involving the First National Bank of East Islip.
I n the course of the representation of Mr. Lang, we also met and
were retained by other individuals who were substantial stockholders
of the First National Bank of East Islip and who expressed a concern and a desire to commence a stockholders' derivative action involving the First National Bank of East Islip. Our firm was retained to
represent them.
During the course of that representation, we gained certain information. So many things happened simultaneously that I do not want
to express that there is a sequential order. But I will relate the ones
that I think are particularly pertinent to your committee.
The first item that we reached, which was almost rushed upon us,
was the annual election for the board of directors.
95
Mr. ROSENTHAL. Were you ever a director of the First National
Bank of East Islip?
Mr. DONNER. Yes; I was. That was later on, sir.
Mr. ROSENTHAL. GO ahead.
Mr. DONNER. I n connection with that, there was a feeling among
certain stockholders that the proxy statement for that election to be
held in February of 1974 contained inaccurate or misleading
statements.
With reference to trying to hold off this election and trying to
have the Comptroller of the Currency withdraw his approval of the
proxy statement, Mr. Lang and I made an appointment, through a
Mr. Jacobson, who was a counsel in the Office of the Comptroller
of the Currency, to see a gentleman who was, according to my recollection, a Mr. Gwin. H e was presented to us as a Deputy Comptroller.
We met with him on February 27, 1974, in his office in Washington.
I n that meeting, we related certain specifics in which we thought the
proxy statement was inaccurate as far as certain matters which were
to be the subject of this election.
At this point, I will digress. We did not realize it at the time, but the
items that we complained of that were inaccurate in the proxy statement had been the subject of the Comptroller's comment in his examinations preceding February 1974. One of the items that we complained
of in the proxy statement of 1974 that was inadequately disclosed was
the fact that there were loans in excess of the statutory limit by the
bank. And these loans were in trouble. We thought that these items
should be presented in the proxy statement.
As a matter of fact, as I have been advised, in April of 1972, the
Comptroller of Currency's report regarding the bank stated:
A review of the report discloses that total criticized loans represent 113 percent of gross capital funds; past due obligations are heavy at 8.6 percent; 13
percent of total loans lack adequate credit data; the bank has not established
limits or proper controls on its indirect lines of credit, some of which have
reached unwarranted levels; three loans in excess of the bank's legal lending
limit are presently outstanding, including the Orest Affiliates Line in which
there appears to be substantial losses; and the bank's capital is considered
inadequate in relation to the risks taken and the volume of business transacted."
So in other words, when we went to Washington in 1974 to see the
Deputy Comptroller of the Currency, presumptively, if he did not
have them available, he certainly did have access to his own reports.
The report went on to consider other items. We contended also that
there were loans made to members of the board of directors. Again, I
am trying to be objective in saying that some of these items are the
subject of litigation and will be decided by another forum. But I am
saying that these items were raised in the Comptroller's reports prior
to our visit to Washington.
To end this particular episode, Mr. Gwin listened to us patiently
and politelv declined to participate in any manner in this particular
problem. He contended, and he was in part correct, that this was a
fight between stockholders and that the Comptroller was not going
to participate in it.
Our thrust, mind you, was not the question of his taking sides, but
whether or not a proxy statement was an accurate reflection of substantial matters of condition relating to the bank's affairs.
96
The next pertinent part of this, and to bring you up in seriatim, is
that the action proceeded; the action is still pending. There were numerous motions and resolutions which, unless the committee wants to hear
about them, I will not go into.
Mr. EOSENTHAL. We are not interested in the private litigation. As
you know, it is the mission of this committee to review and oversight
the efficiency and operation of the Office of the Comptroller of the
Currency. We are keenly interested in anything pertinent to that.
Mr. DONNER. As a part of the 1972 report of the Comptroller of the
Currency, I am advised by someone else, although I do not have direct
access to this report myself, that this report contained the following
language:
The Directors will either remove that portion of the Crest Affiliates Line presently considered loss ($464,776) on or before June 9, 1972, or furnish this Office
with a written guarantee of this portion signed jointly and severally by the entire
Board with the understanding that the loss portion will be removed within six
months.
This was in the 1972 statement.
A t a later time, in the latter part of November of 1975,1 was a candidate and became elected to the board of directors of the First National
Bank of East Islip. At some time in January or February of 1975,
the Comptroller's report for 1974 became available. This was read by
the members of the board of directors.
I do not have a written copy of it, and I call the committee's attention to the fact that the procedure is that there is only one copy of the
report which is available to be read by the members of the board of
directors. There is no circulation of this report. The report must be
read at the bank without notes. So I am going by recollection.
But this report contained substantially the same recommendation in
1974 that was expressed here in 1972—in effect that there were loans in
excess of the statutory limit, requiring them to take the subject action
as outlined here by the board of directors.
I was concerned about the existence of these items. In January or
February of 1975, I commenced telephoning respective counsel in the
Comptroller's Office. I do not know the substance of these conversations, but I spoke to three gentlemen—a Mr. Sorrino, a Mr. Rosten,
and a Mr. Klein. Substantially, as a result of those conversations, I
asked them "What is the effect of your report ?"
Their reply was that the Comptroller's report is an administrative
determination. I t requires action by the bank. It is not just an advisory
opinion.
I asked them, "What is the usual procedure ?"
They said :
First of all, on these reports, we direct a written reply to each one of the items
which we raise as requiring response. And such an item as this, in effect raising
a question of a statutory violation of—I can't remember the section of 12 United
States Code—requires substantial action.
I said, "What if nothing is done ?"
They said, "We will take action."
I said, "What action can you take ?"
They outlined a whole number of possibilities that could be taken by
the Comptroller's Office.
Anyway, to come to the point, when the matter was considered by
the board of directors, the majority of the board substantially stated in
97
writing what their reply was. And I will emphasize that I was a minority on the board; I was not coinciding with the majority. The reply
was that they would decline to take action as requested by the Comptroller of the Currency.
Upon further query by myself of the counsel who was present, I said,
"Can you take a response such as this to the Comptroller of the
Currency?"
He said, "We have always done it that way. We have Washington
counsel who specialize in these matters and they have advised us that
this is what will happen."
I said, "What does the Comptroller of the Currency do when you
resnond in such a manner ?"
They said, "Nothing."
Mr. ROSENTHAL. Did you ask the name of the Washington counsel ?
Mr. DONNER. No, sir. Or if I did know the name, it escapes me at
the moment.
Mr. ROSENTHAL. Have you learned the name since then ?
Mr. DONNER. No, sir. And apparently they were correct. Nothing did
happen. I called the Comptroller's office, I think, one more time and
asked about it.
The reply was, "Well, when we get the report, we will do something."
But nothing happened and it did not seem fruitful to continue telephoning. And substantially with regard to my experience with the
Comptroller's office, that would seem to summarize my own direct
contact with it.
Mr. ROSENTHAL. W h a t else did you want to tell us about your experience with the bank since you were a director, or prior thereto, about its
relationship with the Comptroller of the Currency ?
Mr. DONNER. Again, passing on the question of what parties contend
in lawsuits, I was impressed by the fact—and I must admit that as a
lawyer, it is almost a naive statement to make—that I thought the
function of the Comptroller of the Currency was that that agency, as
most Government agencies are, was one where an individual would
have some sort of access or recourse, whether as a depositor or as a
stockholder, to the institution of a federally chartered bank.
Apparently, it is not a device to which the public, through an
attorney or otherwise, has any access or recourse for complaint.
As a matter of fact, as I have examined it a little more closely, the
Comptroller's office seems to be one of those anomalous agencies that
exists only in relation to banks and does not exist in relation to other
agencies of Government.
I gather, as I later learned, that the Comptroller's office is not
funded by Congress so it has no direct congressional controls.
If I may digress, I was impressed when I first went to Washington
in 1974 that the Comptroller's office had become the subject of the S E C
regulations. And I. having at least a reading familiarity with the SEC
regulations, thought that the SEC always erred on the side of full
disclosure and that the public or persons dealing with it would be
fully apprised of the nature of what they were dealing with. And I
assumed that this obligation would be even greater with a federally
chartered or licensed agency.
Instead, once again, the cloak of secrecy regarding the findings of
the Comptroller's office, the apparent lack of responsiveness to individual complaints, in my limited experience, would seem to belie that
98
which the public expects from other Federal agencies in the classic
role of protecting the public interest.
Mr. EOSENTHAL. Are you still a director of the bank ?
Mr. DONNER. No, sir; I have resigned.
Mr. EOSENTHAL. Very briefly, how would you characterize your
experience with the Comptroller's office ?
Mr. DONNER. I n one word, I would say frustrating.
Mr. EOSENTHAL. Were some of the loans of the First National Bank
of East Islip that were in excess of its limits made to insiders at the
bank?
Mr. DONNER. N O , sir. There were two separate questions presented:
One was loans to excessive limits and the other was one which was
characterized as insider's loans.
Mr. EOSENTHAL. H O W about loans to officers or directors of the
bank?
Mr. DONNER. I am trying to choose my words carefully because,
again, some of this is the subject of litigation. I might present one
side and somebody else might legitimately dispute it. I have been
advised by other people who were involved and I am quoting other
people, but at the time these loans were made—which, mind you, in
the context of as small a bank as this, are very large loans, with
$200,000 for 20 years at 7.5 percent to one director and $100,000 for
20 years at 7.5 percent to another—there was a question as to whether
or not the directors, at the time the loans were made, were also functioning as officers of the bank; and, therefore, would come within the
prohibition of being executive officers.
Again, I have been advised that Mr. Van Horn discussed this matter
with the directors involved and in effect counseled them of what they
would have to do to relieve themselves of the requirement of being
executive officers so they would not fall within the prohibition of an
insider's loan to executive officers.
Mr. EOSENTHAL. Did they follow through with that advice ?
Mr. DONNER. Yes, sir; they did follow through with that advice.
But of course that was after the loan was made.
Mr. EOSENTHAL. Were those the only loans to directors that you
were aware of during your tenure of office ?
Mr. DONNER. That is correct.
Mr. EOSENTHAL. Mr. Evans, do you have any questions ?
Mr. EVANS. I have none at this moment.
Mr. EOSENTHAL. Thank you very, very much.
Is Mr. Greene here ? Do you want to testify ?
STATEMENT OF THEODORE J. GREENE, ATTORNEY
Mr. GREENE. Yes, Mr. Chairman.
Mr. DONNER. May I remain here ?
Mr. EOSENTHAL. I S he a friend of yours ?
Mr. DONNER. He is the adversary—in the friendly sense of the
word, I would say.
Mr. EOSENTHAL. YOU may stay where you are seated, Mr. Donner.
As I understand it, Mr. Greene, you represent some of the parties
and interests to the litigation that we have just been discussing. I take
it that you have never been a director or officer of a bank.
99
Mr. GREENE. That is correct, sir; but, the first part of your statement is incorrect. We are special counsel to the bank. The individual
directors and officers are represented by another firm as special counsel.
The reason for the split in representation is because of a potential
conflict of interest between defendants.
Mr. ROSENTHAL. Just for the record, I will defer taking your testimony under oath simply because you were not an officer or director of
a bank. You do not feel any compulsion to take the oath and I do not
feel any compulsion to ask you to.
Mr. GREENE. Very well, sir.
Mr. ROSENTHAL. YOU may proceed to tell us what you want.
Mr. GREENE. My name is Theodore J. Greene. My firm has offices at
425 Park Avenue, New York. I am an attorney.
As I noted, my firm is special counsel to the First National Bank
of East Islip. We were retained in the first instance upon the occasion
of the suit by plaintiffs represented by Mr. Donner's law firm, to attempt to enjoin the 1974 annual meeting.
I am here in the nature of a rebuttal witness. I would, therefore, like
to mention only a few points that I think perhaps Mr. Donner was in
some possible error.
No. 1, I think Mr. Donner's notion of the function and responsibilities of the Comptroller's Office is rather off base. I t is, of course,
the principal regulating agency of all national banks.
Mr. ROSENTHAL. I want you to have an opportunity to explain your
position, but we will not become mediators between two lawyers to an
ongoing litigation. We cannot resolve it.
I am interested in learning of any facts or knowledge—and I will
take circumstantial knowledge—or any experience that anybody has
in dealing with the Comptroller of the Currency. Our mandate from
the Congress is the oversight and review of the efficiency of the operation of the Office of the Comptroller of the Currency.
So if you have anything you want to tell us which sheds light on that
area, we would be very grateful to you.
Mr. GREENE. Very good, Mr. Chairman.
I would say that as counsel for three separate national banks, including East Islip, each of whom is in the New York City metropolitan area, and each of which is a small or community-sized bank, that
the report of the Comptroller's Office issued on the occasion of an
examination of their national bank examiners is treated almost as the
equivalent of marching orders. When the recommendations are set
forth on page 2 of the examiner's report, while the recommendations
are couched in polite and almost diplomatic language, the boards of
the banks that I have represented have always considered them to be
mandates of things that had to be done. And, to the best of my knowledge and experience, these suggestions have always been complied
with.
Now, in the specific instance of the First National Bank of East
Islip, we have a legal question of whether certain loans exceeded the
lending limit that was permitted to the bank. The loans were charged
off as directed by the Comptroller's Office. And I might say parenthetically that there wTas a very full and complete disclosure of these loans
in an earlier proxy statement, which Mr. Donner did not mention.
Now it is up to the appropriate forum, which in this case will be
the U.S. District Court of the Eastern District of New York, to deter-
100
mine in due course, upon the conclusion of the litigation which is now
pending, whether these loans indeed exceeded the lending limit.
Mr. ROSENTHAL. I have before me a letter dated June 1, 1972, from
the Regional Administrator of National Banks, the Second National
Bank Region, addressed to the Board of Directors of the First National Bank of East Islip. Do you have a copy of that letter ?
Mr. GREENE. I do not, but I believe I have seen the letter to which
you are referring. I suspect that it is an exhibit in the litigation.
Mr. ROSENTHAL. I suppose so. I will read the letter to you. I t says:
Attached is the report of examination of the bank, made on April 24, 1972, by
National Bank E x a m i n e r Royal B. Dunham, J r .
A review of the report discloses t h a t total criticized loans represent 113 percent of gross capital f u n d s ; past due obligations are heavy a t 8.6 p e r c e n t ; 13
percent of total loans lack adequate credit d a t a ; the bank has not established
limits or proper controls on its indirect lines of credit, some of which have reached
u n w a r r a n t e d levels; three loans in excess of the bank's legal lending limit a r e
presently outstanding, including the Crest Affiliates Line in which there a p p e a r s
to be substantial looses; and the bank's capital is considered inadequate in relation to the risks taken and t h e volume of business transacted.
Confirming our discussions a t the Board meeting held on May 9, 1972, attended
by National Bank E x a m i n e r Royal B. Dunham, Jr., Regional Counsel Wallace S.
Nathan, B a n k ' s Counsel W a l t e r F . Lang, Jr., all Board members, and the undersigned, it was understood t h a t :
P r o m p t corrective attention would be given to each of t h e loans criticized in
the report of examination ;
Current and satisfactory credit information would be maintained on all l o a n s ;
Controls would be established over all indirect paper and such paper would
receive closer supervision by the Board ;
P r o m p t a t t e n t i o n would be given to rectifying each of the loans in excess of
the limits prescribed by 12 U.S.C. 84 ;
A program for the raising of a t least $1.3 million in capital funds would be
formulated on or before July 9, 1972, a n d efforts would be made to have these
funds in t h e bank on or before September 9, 1972 ;
The Directors will either remove t h a t portion of the Crest Affiliates Line presently considered loss ($464,776) on or before J u n e 9, 1972, or furnish this office
with a w r i t t e n g u a r a n t e e of this portion signed jointly and severally by the entire
Board with t h e understanding t h a t the loss portion will be removed within six
months ;
Consideration would be given to improving the supervision of the loan account
through t h e expansion of the senior lending staff of the bank ;
T h e bank will be kept on our list for more frequent examinations and periodic
visitations until the adverse t r e n d in the affairs of the b a n k is reversed.
It is signed:
Very truly yours, Gerald H. Lipkin, Deputy Regional A d m i n i s t r a t o r of National
Banks."
My question to you, sir, is: Do you have any personal knowledge as
to whether any of these directions were met and, if so, wThen and how ?
Mr. GREENE. I do. I believe that virtually all of those requirements
were met in full or at least in substantial part.
Additional capital was raised; the bank, over a period of approximately 2 years, brought in new and experienced high-level officers;
tighter controls or new controls were implemented with regard to
credit analysis, control of books, records, and the like. The proof of
the pudding was, if I may, that the bank, after sustaining these very
substantial losses—and I am not about to try to minimize the losses—
has been able to turn itself around and showed a very handsome profit
last year. And in the first 4 months of this year, it is continuing to
show a very nice profit.
101
Mr. ROSENTHAL. I appreciate that. With regard to the requirement
that prompt attention would be given to rectifying each of the loans
in excess of the limits prescribed by § 12 U.S.C. 84, what was done?
Mr. GREENE. I n the first instance, approximately $450,000 of those
loans was charged off. I n the second instance, the bank then and
thereafter continued to attempt to collect every single penny of those
loans.
The borrower was in the business of constructing what are called
modular homes. These are prefabricated units which are put onto a
site in a substantially completed form. The bank lent these moneys
under two assumptions: First, that the modular homes would be
delivered only because there had been a signed contract with a thirdparty purchaser; and second, that an agency of the Federal Government had a commitment to give a permanent first mortgage.
Mr. ROSENTHAL. Had loans been made in excess of the limits prescribed by the code ?
Mr. GREENE. The Comptroller has taken that point of view and the
plaintiffs in the litigation have taken that point of view. The bank and
the directors have taken a contrary point of view. So the courts will
determine this point.
Mr. ROSENTHAL. YOU either complied with this or you did not. What
is the answer?
Mr. GREENE. Compliance was made by charging off the amount indicated—over $400,000. Compliance was also done in that the bank undertook its best efforts to try to collect these loans. And the bank took title
to 50 of the properties and attempted to sell them.
Mr. ROSENTHAL. Don't get me involved into the litigation. Has the
Comptroller deemed that to be compliance ?
Mr. GREENE. I don't know that the Comptroller has taken any further position as to its characterization of the loans as having been
illegal in the first instance.
Mr. ROSENTHAL. Then your answer is "no ?"
Mr. GREENE. To my knowledge, the Comptroller has said nothing
further as regards the characterization of the loans.
Mr. ROSENTHAL. His mandate to the bank, dated June 1, 1972, has
yet to be met ?
Mr. GREENE. NO, Mr. Chairman; I do not think that is correct.
Mr. ROSENTHAL. Either you complied or you didn't comply.
Mr. GREENE. The board of directors was advised to do two things.
Mr. ROSENTHAL. Counsel, you cannot try the lawsuit here. Incidentally, I think we ought to put on the record another factor.
The fact is that former Mayor Wagner called me yesterday and
asked me to provide an opportunity for you to appear here today. He is
your law partner.
Mr. GREENE. That is correct.
Mr. ROSENTHAL. This committee wanted to cooperate in that regard.
And only because it is equitable and fair, we afforded you an opportunitv to rebut anything Mr. Donner had to say.
The distinction between you and Mr. Donner is that Mr. Donner
not only wTas a lawyer, but he was a member of the board of directors
and can personally testify to the facts in the case. You, as I understand
it, can only tell us wThat you want to tell us in your position as counsel
to some of the parties and/or the bank. Isn't that correct ?
102
Mr. GREENE. I can tell you of the personal knowledge I have which is
gained from conversations with the bank's officers and directors and
the examinations of the books and records. So if that is considered
derivative knowledge, then that is what it is.
Mr. ROSENTHAL. YOU well know that that is what it is.
Again, I must repeat, we are only interested in the performance of
the Comptroller of the Currency, and not necessarily to the skill of the
counsel to the litigants.
Mr. GREENE. Mr. Chairman, with all due respect, I think perhaps
you are missing the point on the Comptroller's directive as regards the
so-called illegal loans. The Comptroller directed that they be charged
off; they were charged off.
Mr. ROSENTHAL. YOU say one thing but Mr. Donner shakes his head.
Has the Comptroller ever sent the bank a letter saying that the loans in
excess of the limit have been cleared to their satisfaction ? Can you tell
me that?
Mr. GREENE. N O ; they have never sent such a directive.
Mr. ROSENTHAL. Then the answer to that is "no." In view of the fact
that your response to that was "no," has the Comptroller ever pursued
that matter any further ? Or, how has the Comptroller pursued it ?
Mr. GREENE. The Comptroller is fully aware of the litigation because
we have made reports and delivered copies of the pleadings and other
documents to them at their request.
I want to stress that inasmuch as the loans have been charged off—
now that is historical fact—the consequences that may flow from illegality of the loan, if that is the court's determination, can only occur
in the future. I do not know what further thing the Comptroller or
any governmental agency can do after the loan has been charged off.
There is a remedy, of course, for the plaintiffs. They may obtain
a recovery.
Mr. ROSENTHAL. I am not interested in the plaintiffs or the courts
or you or anybody else. I am only interested in whether the Comptroller followed up his direction in the letter of June 1,1972. And the only
conclusion I can draw is that the answer is "no."
Mr. GREENE. The Comptroller certainly is aware that the loans
were charged off.
Mr. ROSENTHAL. How do you know that? How can you testify to
that?
Mr. GREENE. Because the reports are filed with the Comptroller's
office and the annual reports indicate that.
More recently, a form F - 2 , which is a rather comprehensive financial
statement, was filed. And the Comptroller receives it.
Mr. ROSENTHAL. Why did you want to appear here today to testify?
Mr. GREENE. I was concerned that Mr. Donner might make statements concerning The First National Bank of East Islip which were
inaccurate. I was specifically concerned because there was a newspaper
item in the New York Daily News last Friday which coupled The
First National Bank of East Islip with the Franklin National. Any
casual reader of that article, having read about Franklin, a failed, defunct bank, and then reading what was said about East Islip could
very easily draw the conclusion that East Islip was about to go under.
And that is just not the fact.
I had no idea how well reported this meeting would be or what
would be said.
103
Mr. EOSENTHAL. I do want to state for the record that the fact that
we are inquiring into two different banks on the same day is purely
coincidental. I t is merely logistical timing of when we can hold these
hearings. Perhaps we should have held the hearing with regard to this
bank on another day, and that problem with the newspaper story in
the New York Daily News would not have occurred.
On June 1,1972, they also said that the directors will either remove
that position of the Crest Affiliates Line presently considered loss—
$464,776—on or before June 9,1972, or furnish this office with a written guarantee of this portion signed jointly and severally by the entire board with the understanding that the loss portion will be removed within 6 months. Did either of those take place ?
Mr. GREENE. Yes; the first of the alternatives was what happened.
Mr. ROSENTHAL. H O W did they do that ?
Mr. GREENE. I t wTas a chargeoff. I t appears as a loss; it reduces the
capital position if other profits are not adequate to cover it.
Mr. EOSENTHAL. Did you ever receive a letter of any memorandum
from the Comptroller saying that they were generally satisfied with
what had taken place in response to this letter of June 1 ?
Mr. GREENE. T O the best of my knowledge, the Comptroller does
not send out that type of letter, ever. They just tell you what to do,
and they follow through to make sure it is done. If it has not been done,
they remind you that it is to be done. If you have done it, it is history.
Mr. EOSENTHAL. They never send you a letter when you have complied?
Mr. GREENE. They do not give out pats on the back for having
done what you are told to do.
Mr. EOSENTHAL. NOW you said that there is a question of whether
section 12 U.S.C. 84 was complied with or not because that is a matter
for litigation.
Of course, Mr. Smith will testify to what his procedures were.
And the only reason we are examining this bank is that it is one way
for us to find out whether or not the Comptroller did in fact live up
to what Mr. Smith will tell us, presumably, is policy.
But from your knowledge and experience, when the Comptroller of
the Currency sends a letter indicating things to be done, do they never
send you a followup letter of your having done it or not having done
it?
Mr. GREENE. When the letter comes in to do things, as I have said,
in my experience with three 'banks, the letter is the equivalent of
marching orders. This means that the board does it.
Now some things cannot be done in 1 day. Some things can be done
onlv within a period of several months.
The president is required to send a letter to the Comptroller's
Office reciting that the comments on page 2 of the report were read
to the full board; and, to set forth in considerable detail all of the corrective measures that will be taken by the bank; and, to report any of
the corrective measures that have theretofore been taken. This is
standard operating procedure, in my experience.
Mr. EOSENTHAL. Did the board or the president ever respond to
this letter of the Comptroller, dated June 1,1972 ?
Mr. GREENE. I have no personal knowledge about that. That was
before my time.
Mr. EOSENTHAL. But that is a key element in this inquiry.
104
Mr. GREENE. I can speculate, for whatever it is worth, that there
was compliance.
Mr. ROSENTHAL. Don't speculate. Did you bring with you a file that
would have this material in it ?
Mr. GREENE. NO. I was unaware that that letter would be so important in these hearings. I brought certain things with me, but not that.
Mr. ROSENTHAL. D O you know the name of the special counsel to
whom Mr. Donner referred that the bank hired here in Washington ?
Mr. GREENE. This is the first time I have ever heard that the bank
had done it.
Mr. ROSENTHAL. Mr. Donner, when was the special counsel hired ?
Mr. DONNER. We have special counsel Mr. Greene who was hired in
connection with the litigation. I do not know whether there is other
special counsel who would counsel them in matters relating to the
Comptroller's Office. I have no knowledge of that.
Mr. ROSENTHAL. D O you know, Mr. Greene ?
Mr. GREENE. I have never heard before about other special counsel. I n addition to counseling them on this litigation, my firm has been
retained to counsel them generally with respect to compliance with the
Comptroller's regulations and other matters pertaining to national
banks.
I would have guessed that I was their special counsel.
Mr. ROSENTHAL. Have you formerly been associated with the Comptroller of the Currency ?
Mr. GREENE. N O , sir.
Mr. ROSENTHAL. Has
any member of your firm ever been employed
by or associated with the Comptroller of the Currency ?
Mr. GREENE. N O , sir.
Mr. ROSENTHAL. Has
any member of your firm ever been associated
with any banking authority ?
Mr. GREENE. N O , sir.
Mr. ROSENTHAL. There
must be some question I am missing, but you
are not going to tell us, are you ?
Mr. GREENE. NO ; there isn't. I have been representing national banks
for approximately 11 years, and we represent three. I n that period
of time, I have learned a little about how things are done and what you
have to do. Maybe I am sort of a quasi-expert by now, and maybe
not.
Mr. ROSENTHAL. I do want to say for the record that you are associated with a very distinguished New York law firm, and one for
whom I have great respect.
Mr. GREENE. Thank you, sir.
Mr. ROSENTHAL. Mr. Donner, do you want to say anything ? I don't
want to get into the litigation.
Mr. DONNER. I want to say something here that really gets down, I
think, to the heart of this.
Mr. ROSENTHAL. We are only interested in the Comptroller.
Mr. DONNER. That is what I want to get to, Mr. Chairman.
This stricture re2fardin<? loans in excess of limits and the responsibilitv of directors is not that maybe someday we will get the money
back. I t is not "We can charge it off."
I state that it imposes a legal obligation on directors who act in
such a manner knowledgeably.
105
I t is not a punishment. I t is the idea that these men are entrusted to
the responsibility. If they exceed the statutory limit, they incur a
personal liability for the loan.
I t is not just some sort of a semantic game. I t isn't even dependent
upon recovery for the debtors. I t isn't an answer to say, "We will get
the money back from the guy that owes it." The liability is there for
the director.
Therefore, when the Comptroller of the Currency requests it—and
I do not know what is in his mind, but I am assuming from the plain
intent of the language—it is that they are concerned that the bank will
incur a liability which, if incurred by the bank, should be apportioned
to the directors who share the responsibility for making the loan in
excess of the statutory limits.
I t is not just a rule game or a word game with the Comptroller of
the Currency and how you will answer their letter. I t is a legal fact.
I t is a violation of the United States Code.
I will agree that there may be questions of whether people are in
violation of United States Code. That is why lawyers like Mr. Greene
and myself pursue each other around. But the law is there. The interpretation of the law might be a game for lawyers. But as far as the requirement of the intent of that letter, it was "We want the directors
liable; we want them to agree to be liable." And that was the intent
of it.
At a meeting in 1975, and I cannot remember the exact language,
the question was still being raised about the Comptroller's Office.
And whatever the charge-off factor, it doesn't recover the loan. I t
is just a bookkeeping transaction. So let's get back to basics. A loan
was made in excess of limits and which was in default. A charge off
does not recover the money; it is a bookkeeping adjustment. I t shows
on a financial statement, but it does not get the money back to the
bank.
Mr. ROSENTHAL. And your point is vis-a-vis the Comptroller?
Mr. DONNER. Vis-a-vis the instructions of the Comptroller. I assume
it is based upon the violation of a statutory stricture. And that is the
plain question involved. And that was the question presented, I think,
by the Comptroller's letter. And I said that the board declined—or
whatever the word was, I do not remember the exact words—to comply with that.
Mr. ROSENTHAL. Thank you both very much. I wish you both well
in your lawsuit.
Without objection, the letter dated June 1, 1972, will be read into
the record.
[The letter referred to follows:]
T H E REGIONAL ADMINISTRATOR OF NATIONAL B A N K S ,
SECOND NATIONAL B A N K REGION,
New York, N.Y., June
1,1912.
BOARD OF DIRECTORS,
First National Bank of East Islip,
East Islip, N.Y.
GENTLEMEN : Attached is the report of examination of the hank, made on
April 24,1972, by National Bank Examiner Royal B. Dunham, J r .
A review of the report discloses t h a t total criticized loans represent 113% of
gross capital f u n d s ; past due obligations a r e heavy a t 8.6%; 1 3 % of total loans
lack adequate credit d a t a ; the bank h a s not established limits or proper con-
106
trols on its indirect lines of credit, some of which have reached unwarranted
levels; three loans in excess of the bank's legal lending limit are presently outstanding, including the Crest Affiliates Line in which there appears to be substantial losses; and the bank's capital is considered inadequate in relation to
the risks taken and the volume of business transacted.
'Confirming our discussions at the Boar"d meeting held on May 9, 1972, attended
by National Bank Examiner Royal B. Dunham, Jr., Regional Counsel Wallace
S. Nathan, Bank's Counsel Walter F. Lang, Jr., all Board members, and the
undersigned, it was understood that:
Prompt corrective attention would be given to each of the loans criticized in
the report of examination ;
Current and satisfactory credit information would be maintained on all loans;
Controls would be established over all indirect paper and such paper would
receive closer supervision by the Board;
Prompt attention would be given to rectifying each of the loans in excess of
the limits prescribed by 12 U.S.C. 84 ;
A program for the raising of at least $1.3 million in capital funds would be
formulated on or before July 9, 1972 and efforts would be made to have these
funds in the bank on or before September 9,1972.
The Directors will either remove that portion of the Crest Affiliates Line
presently considered loss ($464,776) on or before June 9, 1972, or furnish this
Office with a written guarantee of this portion signed jointly and severally by
the entire Board with the understanding that the loss portion will be removed
within six months;
Consideration would be given to improving the supervision of the loan account through the expansion of the senior lending staff of the bank;
The bank will be kept on our list for more frequent examinations and periodic
visitations until the adverse trend in the affairs of the bank is reversed.
Very truly yours,
GERALD H. LIPKIN,
Deputy Regional Administrator of National Banks.
Mr. ROSENTHAL. Mr. Metz and Mr. Hoppler, will you come back,
please. Mr. Ruempler has some questions regarding your report. We
will proceed with that.
Mr. RUEMPLER. When Arthur Roth testified before the committee
in February, he was asked a question by Mr. Brown about the legal
authority of the Comptroller to require the bank to take certain actions. And Mr. Roth testified in effect that their legal authority was a
little fuzzy.
And yet you have indicated that the OCC failed to exercise all
of their supervisory options and you have detailed some of those
items.
Is there some difference of opinion here between you and Mr. Roth
as to what could have been done with respect to specific items ?
Mr. HOPPLER. We were speaking within the context of the options
that Mr. Bloom had spelled out before this subcommittee. We did
not consider what legal actions may have been available strictly considering the law. Mr. Bloom provided the frame of reference within
which we were speaking.
Mr. RUEMPLER. Let me pose the question a little more specifically.
On page 7 of your testimony, under "Other Enforcement Options,"
you state: "We found no evidence that the OCC threatened to initiate
cease and desist * * * sought to remove an officer * * * or attempted
to make a criminal referral * * *" Did you find indications that there
were grounds for doing those things ?
Mr. HOPPLER. NO ; we did not. After we had identified options, we
felt that we should make the statement that we found no evidence that
they had been used. We were not attempting to make any kind of
judgmental statement.
107
Mr. KUEMPLER. Could you discuss further the significance of the
fact that the examiner did not cite the bank problems on page 2 of the
examination report ?
Isn't the information elsewhere in the report % Is there some special
significance to having it on page 2 ?
Mr. HOPPLER. According to the procedures that the Office of the
Comptroller of the Currency has established for conducting an examination of a bank, page 2 is considered to be one of the most important
pages because it is supposed to summarize the matters which the
examiner feels warrant attention. In fact, the examiner's handbook
emphasizes that this is one of the most important pages. It is supposed
to be prepared for both the Comptroller and the bank's board of
directors as an action document. Therefore, one would assume, by
following that logic, that the matters which they felt warranted attention should have been pulled forward onto that page.
Mr. METZ. I would also like to add that much of the information
that was critical of the bank or the management is shown in the confidential portion of the report which the bank's officers and boards of
directors are not privy to.
Mr. KUEMPLER. Are you aware of any changes in the Comptroller's
procedures on this item ?
Mr. METZ. Yes, sir. We reviewed the Haskins and Sells May 1975
report and, although I would not say we are thoroughly familiar
with the report, we do understand that there are new procedures
whereby much of the information in the confidential part of the report
would be moved up into an open section of the report and it will be
made available to the banks and their boards of directors.
Mr. KUEMPLER. YOU have suggested that the opportunity to deal
with branch approvals, which is presented to the Comptroller on those
occasions, is a good way to discipline a problem bank. I think we have
had testimony on other occasions which would agree with that.
But are you leaving the impression that the rejection of these
applications is always the wisest course ? Do you have any figures to
indicate whether the branches which were approved provided the bank
with deposits in excess of loans which might have helped to ease its
liquidity problems ?
Mr. METZ. NO, sir; we do not.
Mr. KUEMPLER. I have nothing further.
Mr. ROSENTHAL. I have no further questions.
Again, I want to thank you and compliment you both on a very
productive and exhaustive study.
The subcommittee stands adjourned.
[Whereupon, at 11:50 a.m., the subcommittee adjourned, to reconvene subject to the call of the Chair.]
OVERSIGHT HEARINGS INTO THE EFFECTIVENESS OF
FEDERAL BANK REGULATION
(Franklin National Bank Failure)
WEDNESDAY, MAY 26, 1976
HOUSE OF REPRESENTATIVES,
COMMERCE, CONSUMER,
AND MONETARY AFFAIRS SUBCOMMITTEE
OF THE COMMITTEE ON GOVERNMENT OPERATIONS,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in room
2247, Rayburn House Office Building, Hon. Benjamin S. Rosenthal
(chairman of the subcommittee) presiding.
Present: Representatives Benjamin S. Rosenthal, Robert F . Drinan,
David W. Evans, Anthony Moffett, Andrew Maguire, Edward Mezvinsky, and Willis D. Gradison, J r .
Also present: Peter S. Barash, staff director; Robert H. Dugger,
economist; Ronald Klempner, counsel; Eleanor M. Vanyo, assistant
clerk; and Henry C. Ruempler, minority professional staff, Committee on Government Operations.
Mr. ROSENTHAL. The subcommittee will be in order. We will continue this morning the examination of the affairs of the Comptroller
of the Currency's regulation and activities with regard to the Franklin
National Bank and matters associated thereto.
Our first witness this morning will be Mr. Dennis Weatherstone,
senior vice president, Morgan Guaranty Trust Co.
At some point thereafter, we will take the testimony of other witnesses and proceed accordingly.
Mr. Weatherstone, we are very pleased that you could join us this
morning. I have a number of questions in which your experience and
expertise can be verv useful to this subcommittee and to the record and
to the decisionmaking process of this subcommittee. These questions
are within your experience and knowledge, and I will ask them, hopefullv, in an orderly fashion.
What are the mechanics and risks involved in spot and forward
foreign exchange transactions ?
STATEMENT OF DENNIS WEATHERSTONE, SENIOR VICE PRESIDENT, MORGAN GUARANTY TRUST CO.; ACCOMPANIED BY FRANK
MOSELET OF DAVIS, POLK & WARDWELL
Mr. WEATHERSTONE. There are two distinct risks on a spot contract
and on a forward contract. On a forward contract, one risk is at
maturity of the contract. These maturities are generally 30, 60, 90,
(109)
74-548 O - 76 - 8
110
and 180 days ahead. At the maturity date, for some reason, the counter
party may be unable to fulfill the contract. If that is so, the other
party then will have to find a separate party to replace the original
party. The exchange rate, meantime, may have moved and cause a
loss.
We, in our bank, for administrative purposes, assess such fluctuation risks as 10 percent of the amount of the contract.
I n the case of a spot contract or a maturing forward contract, there
is a settlement risk. That means that when the currency is paid over
in one center against receipt in the other center, one of the parties
may have made his payment, but meanwhile during the day, the
other party may have a problem and be unable to make his side of
the payment. Therefore, one side of the contract is paid out and the
*»ther side is not received and one is exposed to loss. This would be a
100-percent risk exposure as opposed to the other 10-percent type.
Mr. ROSENTHAL. Was Franklin National Bank, to your knowledge,
a major participant in spot and forward foreign exchange markets?
Mr. WEATHERSTONE. Are we talking about the years 1973 and 1974?
Mr. ROSENTHAL. 1972, 1973, 1974, 1975—particularly 1974.
Mr. WEATHERSTONE. They progressively became a bigger participant. I n 1972, from our observation and our business with them, we had
a bigger volume than in 1971. I n 1973, it was more than in 1972. And
of course, in 1974, we ceased doing business with them halfway through
the year.
Mr. ROSENTHAL. Did Morgan Guaranty ever become reluctant to
engage in foreign exchange transactions with Franklin National
Bank?
Mr. WEATHERSTONE. We have a distinction there between spot exchange and forward exchange. We did become somewhat reluctant to
do forward exchange with them during 1973, but we did continue to
do spot exchange right up until May of 1974.
Mr. ROSENTHAL. Can you tell us why the reluctance in one area
and not the other, and the risks inherent thereto ?
Mr. WEATHERSTONE. I n doing spot exchange, if a problem should
arise, we could stop instantly and decide not to enter into any more
contracts.
I n the case of forward exchange contracts, if we saw problems arising, we would have contracts on our books until the maturity date.
We thought that by stopping the forwards, if problems should develop
later, we would need to do nothing about it. I n the case of spot business, if a problem developed, we could promptly stop business.
Mr. ROSENTHAL. When did this reluctance first begin to show itself
and when did you notify them, if you did ?
Mr. WEATHERSTONE. The reluctance began in the spring of 1973
when we observed that they were rather more active in the market
than they had previously been. We began to lessen our activities with
them in the forward exchange market. I n about May, I believe, it so
happens that we did our last forward exchange contract. That was
May of 1973. But we continued to do spot exchange.
Mr. ROSENTHAL. H O W much money was involved in these transactions ? Can you in any way describe the extent ?
Mr. WEATHERSTONE. During 1973, the total volume was several billions of dollars.
Ill
Mr. ROSENTHAL. Several billions of dollars at any one time ?
Mr. WEATHERSTONE. N O ; that was the total volume during the whole
of the year.
Mr. ROSENTHAL. W e are going to break off your testimony for just
a few moments for some administrative matters.
Mr. Clesner wants to release the testimony of a closed hearing which
we had on November 4, 1975. I t was in connection with the testimony
of Richard E. Jaffe, special agent, I R S , Miami, F l a . ; and another
special agent who was identified in that hearing as TW-24.
The reason we held a closed hearing at that time was at the request
of the attorneys for the parties. The Justice Department had requested
that it be held in closed session because there was a grand jury proceeding pending.
Those matters have concluded and there are no further objections
by any of the parties thereto to the release of this testimony.
I would ask that, without objection, this testimony migh be released
at this time.
The other matter, and one for which we need a quorum to act, is that
we have two witnesses this morning who were former high-level officers
of the Franklin National Bank. They were intimately involved in the
efforts to save the Franklin National Bank through a merger with
another bank in the early part of May of 1974.
Both men are currently associated with New York financial firms and
are in constant contact with banks and other members of the financial
community. There is a good deal of interest within the financial community regarding current lawsuits involving the events which they
will testify about today.
Both of these prospective witnesses have given their full cooperation to this subcommittee. And we are sensitive to the potentially
prejudicial impact their testimony might have on other parties to a
number of these pending lawsuits involving significant sums of money.
We are equally sensitive to the effects that public testimony would
have both on their current positions and on their current relationships
with others within the banking community.
Both of these witnesses have requested that we receive their testimony in executive session so that the testimony will not be inhibited
in any way. We are interested in accommodating them. If the testimony is received in executive session, they will have the opportunity
to present it fully and fairly, without anv inhibitions and without
fear that it will in any way affect either their personal careers or the
lawsuits that are presently pending.
Therefore, I would at this moment entertain a motion that we could
at the appropriate time this morning go into executive session to hear
the testimony of Mr. Luftig and Mr. Heinemann.
Mr. DRINAN. Mr. Chairman, I so move.
Mr. GRADISON. Mr. Chairman.
Mr. ROSENTHAL. Mr. Gradison.
Mr. GRADISON. I am going to vote "no" on this motion. I t seems to me
that the most appropriate step would be to skip this testimony entirely. My reading of the staff documents suggests that we already
have the benefit of a very thorough series of conversations with the
witnesses, which should give us an adequate basis for questioning
112
future witnesses, including Mr. Smith, on matters of great importance
to us.
I am at a loss to understand how the taking of additional testimony
in executive session can add in any substantial way to what we already
have. I t would seem to me that obtaining information in that way
might in subtle, and not so subtle ways, inhibit our use of the information in the questioning of future witnesses that we might have
on these points.
I do not want to belabor the matter, but I did want to explain, because I felt this was the appropriate time, why I intend to vote "no"
on the motion.
Mr. ROSENTHAL. The clerk will call the roll.
The CLERK. Mr. Rosenthal.
Mr. ROSENTHAL. Aye.
The CLERK. Mrs. Collins.
Mrs.
COLLINS. [ N O
response.]
The CLERK. Mr. Drinan.
Mr. DRINAN. Aye.
The CLERK. Mr. Levitas.
Mr. ROSENTHAL. Aye, by proxy.
The CLERK. Mr. Evans.
Mr. EVANS. Aye.
The CLERK. Mr. Moffett.
Mr. MOFFETT. Aye.
The CLERK. Mr. Maguire.
Mr. MAGUIRE. Aye.
The CLERK. Mr. Mezvinsky.
Mr. MEZVINSKY. Aye.
The CLERK. Mr. Brown.
Mr.
BROWN. [ N O
response.]
The CLERK. Mr. Gradison.
Mr. GRADISON. N O .
The CLERK. Mr. Erlenborn.
Mr. ERLENBORN. [ N O response.]
The CLERK. The vote is seven "ayes" and one "no."
Mr. ROSENTHAL. The "ayes" have it with a vote of
sevjn "ayes" and
one "no". The motion is carried.
I apologize for this interruption, Mr. Weatherstone, but we do have
some administrative problems. We will now resume your testimony.
At any point, if you can recall, what was the extent of the financial
relationship, in amounts of dollars, between Morgan Guaranty and
Franklin National ?
Mr. WEATHERSTONE. I t is a little difficult to answer when you say
"the extent of the relntionshijV The size of any foreign exchange deal
would be, say, $3 million to $5 million. One would not expect to do a
lot of those in a day.
We were also, of course, engaged in other business with the Franklin
National Bank besides foreign exchange business and Euro business.
We did Fed funds business with them as well. Those would be amounts
per day, I would imagine, of $5 million or $10 million.
And of course the number of forward contracts would tend to accumulate. I would not have thought that they got beyond, say, a
maximum of $50 million.
113
Mr. ROSENTHAL. I assume this was profitable business to Morgan
Guaranty ?
Mr. WEATHERSTONE. As a part of our foreign exchange and money
market business, we would hope it would be.
Mr. ROSENTHAL. What is the Euro-dollar market ?
Mr. WEATHERSTONE. Could I just get back to the other question for
a moment ?
Mr. ROSENTHAL. Surely.
Mr. WEATHERSTONE. I think we were occupied more on the when
than on the why, which we did not quite finish. I should mention why
we became reluctant. I t was partly because of what appeared to be
excessive trading on the part of a bank who had not been a major
trader previously.
Mr. ROSENTHAL. D O you mean Franklin ?
Mr. WEATHERSTONE. Yes; Franklin. Also, from what we could see
in the market, it did seem that some of the positions which they appeared to be taking were not profitable ones. I t is very difficult to know
for sure whether transactions are profitable or not because one only
sees a small segment of the market, but the segment that we saw did
not look very profitable. That was part of our concern.
Mr. ROSENTHAL. What is the Euro-dollar market?
Mr. WEATHERSTONE. Let me first define a Euro-dollar. A Euro-dollar, I do not believe, has any precise legal definition, but the generally
accepted definition is that it is a U.S. dollar placed on deposit with a
foreign bank or a branch of a U.S. bank located outside the United
States.
The Euro-dollar market is the system whereby those deposits are
exchanged between banks.
Mr. ROSENTHAL. I n general, what is the relationship between a foreign bank's willingness to engage in spot and forward foreign exchange
transactions with another bank and the foreign bank's willingness to
deposit Euro-dollars with that other bank ?
Mr. WEATHERSTONE. Both types of transactions should be based, and
I believe they are, on the credit standing of the other bank. One would
examine the bank's balance sheet, the management, and general market abilities in making some kind of credit assessment. Then one would
determine how much spot exchange, how much forward exchange, and
how much Euro-dollar business one wanted to do with them.
Mr. ROSENTHAL. T O your knowledge, was Franklin National a heavy
user of Euro-dollar funds during 1973 or 1974 ?
Mr. WEATHERSTONE. I think that is a published number. I t was a
fairly substantial number.
Mr. ROSENTHAL. In addition to your bank's feelings about Franklin,
did you become aware that other foreign and domestic banks were becoming reluctant to deal with Franklin during late 1973 or early 1974 ?
Mr. WEATHERSTONE. Yes; we did.
Mr. ROSENTHAL. H O W did you become aware of that ?
Mr. WEATHERSTONE. This would be in conversations
with other participants in the international money markets. During the day, we talk
with banks all over the world about market conditions and try to get a
feel of what is happening. And during the course of those conversations and from conversations with brokers, we were aware that
Franklin had problems.
114
Mr. ROSENTHAL. HOW did you assess the seriousness and the nature
of concern of these banks who were becoming reluctant to deal with
Franklin had ?
Mr. WEATHERSTONE. That is very difficult. There were so many facts
that we did not know. We were concerned over a bank who had previously not been that active in the international money markets and
was without what we would call natural commercial business in that
area. We were curious and concerned as to exactly what they were
doing.
With those uncertainities, we were somewhat worried. And with the
numbers involved, we would imagine that other banks had questions
in their minds.
Mr. ROSENTHAL. Did there come a time when you or other officers of
your bank met with any of the Federal bank regulators about the matters you have just testified to ?
Mr. WEATHERSTONE. Yes. We met with the Federal Reserve Bank of
New York in November of 1973.
Mr. ROSENTHAL. With whom did you meet ?
Mr. WEATHERSTONE. Mr. Hayes, Mr. Coombs, Mr. Bodner, and Mr.
Tinman.
Mr. ROSENTHAL. Was that in their offices ?
Mr. WEATHERSTONE. That was in their offices.
Mr. ROSENTHAL. Can you be more precise about the time of that
meeting ?
Mr. WEATHERSTONE. I think it was November 28,1973.
Mr. ROSENTHAL. What was the purpose of the meeting? Did you
ask for the meeting ?
Mr. WEATHERSTONE. We asked for the meeting. We wanted to tell
the Federal Reserve of our concern at the training activities of the
Franklin Bank.
Also, at that time there were other problems in the market. I t was
not long after the U.S. National Bank difficulties, which were in
October of 1973.
We were concerned about the Franklin Bank if there should be problems and if they had difficulties, and we had difficulty in putting our
finger on exactly what they were doing, we were concerned about
whether this wouM affect the banking system generally.
Mr. ROSENTHAL. Is it common practice within the banking community for one bank to have a meeting with the Federal regulators to
discuss the conduct and activities and condition of another bank ?
Mr. WEATHERSTONE. I n my experience it is not common practice.
Mr. ROSENTHAL. Had you ever heard of it before?
Mr. WEATHERSTONE. Personally, no. But you must bear in mind that
I have only been here 5 years. Others may have done it.
Mr. ROSENTHAL. I n the meeting, what took place? Tell us about the
discussions and what hapnened.
Mr. WEATHERSTONE. We told the Federal Reserve of our concern
with the trading activities; that we had had some direct discussions
with the Franklin Bank to try and get explanations from them of what
they were doing; that we were not completely happy with the explanations; that we had no way of checking them; that the atmosphere in
the international money markets was becoming rather tense; and that
115
we were really considering stopping doing spot exchange wTith the
Franklin Bank.
To stop doing spot exchange would be quite a serious step. I t would
have to be notified to all of the foreign exchange brokers in New York
and, by that means, all of the banks in New York. We would be telling
the New York banking community, in effect, that we did not want to
do business with this bank. That is a fairly serious step to take.
Mr. ROSENTHAL. Did you or your colleagues or associates tell the
Federal Reserve Bank people that the situation was potentially explosive ?
Mr. WEATHERSTONE. I do not remember whether those particular
words were used, but I think our concern was such that if on examination there was a dangerous situation, it could easily spread throughout
the system. But I cannot remember the exact words we used at the
meeting.
Mr. ROSENTHAL. At any rate, you were serious in your approach ?
Mr. WEATHERSTONE. We were very serious about the problems that
might arise.
Mr. ROSENTHAL. Did you or your associates suggest that another
bank take over Franklin's forward foreign exchange book?
Mr. WEATHERSTONE. We suggested that if the Franklin problems
were purely matching up dates on their forward book, and we really
did not know if that were the only problems they had, that it could
be helpful in those circumstances if another bank were to save their
going into the market with the embarrassment of having their name
turned down or having to constantly roll over on a short-date basis
their forward foreign exchange position.
Mr. ROSENTHAL. H O W did the people at the Federal Reserve Board
react to these things ? What do you recall was their response ?
Mr. WEATHERSTONE. I think they listened most of the time to our
remarks; they obviously said that they would look into what could be
done. I do not recollect any specific suggestions which came from
them.
Mr. ROSENTHAL. Did you or your bank receive any evidence in either
late 1973 or early 1974 that the Federal Reserve Bank of New York
or the Comptroller of the Currency was taking actions that were
having the effect of improving the financial market's confidence in
Franklin National Bank ?
Mr. WEATHERSTONE. Nothing that we could directly associate with
that. We did understand that the chairman of the Franklin National
Bank had gone to see the Comptroller of the Currency to explain his
problems to him. But I do not recollect any particular actions that we
could relate to anything they had done publicly that would change
the situation.
Mr. ROSENTHAL. And that continued for a period of months after
the November 28 meeting.
Mr. WEATHERSTONE. There was another particular concern after
November. In January 1974, there was a report in the newspapers
that the Franklin had had some problems in Paris with a French
franc contract where they had been unable to deliver the francs. And
at another point earlier in November 1973, there had been a market
rumor, which was confirmed to us by the Franklin, that their major
German bank correspondent had requested them to close their account.
This, again, was a rather serious step.
Mr. ROSENTHAL. Did vour bank continue to deal with Franklin?
Mr. WEATHERSTONE. We continued to deal with Franklin on a spot
116
basis, but with no forwards and no Euro business, and with a very
limited Fed funds business. This was done with a very close monitoring of their day-by-day outstandings.
Mr. ROSENTHAL. And there was never any further discussion about
either your bank's or any other bank's taking over part of this business?
Mr. WEATHERSTONE. The forward book ?
Mr. ROSENTHAL. Yes.
Mr. WEATHERSTONE. I
did not have any particular discussions, but
there may have been one more conversation that took place in which
we were asked if we had given any further thought to taking over the
book. We were not prepared to take over the book unless we had some
kind of better assurances as to what was happening at the Franklin
bank.
Mr. ROSENTHAL. Mr. Ruempler.
Mr. RUEMPLER. I have just a couple of questions. Is it accurate to say
that your information about Franklin was derived from your role as
a participant in the foreign exchange market?
Mr. WEATHERSTONE. That is correct.
Mr. RUEMPLER. Would it be possible for a nonparticipant to have
the same information ?
Mr. WEATHERSTONE. I t would be very difficult.
Mr. RUEMPLER. At the time a bank is being examined by the regulator, certainly the regulator could acquire information of this nature.
But between examinations, would there be some way that the Comptroller of the Currency could get information on the status of, for
example, Franklin's position in this market?
Mr. WEATHERSTONE. If you had gone back historically, I would
have said it was rather difficult. Today, it would not be so difficult
because I think the Federal Reserve has a number of meetings on a
fairly regular basis with market participants to chat about the state
of the market. This may be on about a monthly basis. I would think
that would give opportunities to them to get a quicker insight.
Mr. RUEMPLER. And that would be a good idea ?
Mr. WEATHERSTONE. That is a good idea; yes.
Mr. RUEMPLER. That is all I have, Mr. Chairman.
Mr. ROSENTHAL. Thank you very, very much for a significant
and important contribution. We appreciate particularly the effort
you made in coming down here from New York. We thank you both
very, very much.
Mr. WEATHERSTONE. Thank you.
Mr. ROSENTHAL. The subcommittee will now go into executive
session.
[Whereupon, at 10:30 a.m., the subcommittee went into executive
session.]
EXECUTIVE
SESSION
[SUBCOMMITTEE NOTE.—The Commerce, Consumer, and Monetary
Affairs Subcommittee met on Tuesday, July 20, 1976, at 10 a.m., in
room 2203, R H O B , pursuant to notice from Chairman Benjamin S.
Rosenthal.
[Those present were Representatives Benjamin S. Rosenthal (chairman of the subcommittee) presiding, Robert F . Drinan, Elliott H.
Levitas, Andrew Maguire, Garry Brown, and Willis D. Gradison,
J r . Subcommittee staff present were Ronald A. Klempner, counsel;
117
Eleanor M. Vanyo, assistant clerk; and Henry C. Ruempler, minority
professional staff, Committee on Government Operations.
[The purpose of the meeting was to authorize the release and printing of testimony taken in executive session on May 26, 1976, regarding the Franklin National Bank failure. The witnesses were Paul
Luftig and H . Erich Heinemann who had requested that their testimony be received in executive session and now no longer objected
to its release.
[Chairman Rosenthal moved that, without objection, the subcommittee authorize the release and printing of the testimony and, there
being no objection, the motion was carried and the meeting was
adjourned.]
Mr. ROSENTHAL. We will call Mr. Luftig and Mr. Heinemann
up to the witness table, if we might. Others who are not members of
the subcommittee staff will, regretably, have to leave us.
My reputation for open hearings has taken a beating this morning
pursuant to the request of you two fellows. I had to make what
is known as a pragmatic decision.
Do either of you object to being sworn and having your testimony
given under oath ?
Mr. LUFTIG. N O .
Mr. ROSENTHAL.
Mr. Heinemann, do you object?
STATEMENT OF H. ERICH HEINEMANN, FORMER VICE PRESIDENT,
FRANKLIN NATIONAL BANK
Mr. H E I N E M A N N . I t was indicated to me that my testimony would
not be sworn. On that basis, I chose not to be accompanied by counsel.
I will obviously testify to the best of my recollection, but I had a representation explicitly on this issue from Mr. Klempner that the testimony would not be sworn. I chose to try to avoid the considerable
personal expense of having counsel accompany me.
Mr. ROSENTHAL. We will forgo it. But it is your intention to be
fully forthright in all of your answers, isn't it?
Mr. HEINEMANN. Absolutely.
Mr. ROSENTHAL. I am sure of that.
Will vou identify yourself for the record ?
Mr. PIERCE. My name is Samuel R. Pierce, Jr., a partner in the
law firm of Battle, Fowler, Lidstone, Jaffin, Pierce, & Kheel. That
is at 280 P a r k Avenue, New York, N. Y.
Mr. ROSENTHAL. We are honored to have you this morning.
We will begin with your testimony, Mr. Heinemann.
Mr. Heinemann, yould you give your name and address?
Mr. H E I N E M A N N . My name is H . Erich Heinemann. My address is
7 Woodland Place, Great Neck, N. Y., 11021.
Mr. ROSENTHAL. At any time were you in anv wav associated as
an officer or director of the Franklin National Bank?
Mr. H E I N E M A N N . From the first of August of 1973 through the
12th of Mav of 1974, I was a vice president of the bank. I had no
other titled function there.
Mr. ROSENTHAL. Prior to that, what had been your professional
experience ?
118
Mr. H E I N E M A N N . From 1965 through 1973, I was an assistant to
the financial editor of the New York Times. Prior to that, I was an
associate economist with Morgan Guaranty Trust Co.; and, prior
to that, I was an assistant finance editor of Business Week magazine.
Mr. ROSENTHAL. Generally, could you ascribe to yourself a particular expertise in the banking arena ?
Mr. HEINEMANN. I have been a financial journalist and an analyst
of banking affairs for nearly 20 years.
Mr. ROSENTHAL. Can you tell us something about your experience
with Franklin? Tell us in narrative form what you did and what
happened.
Mr. HEINEMANN. My role at Franklin was that I was hired by Mr.
Luftig, who was president of the bank, with the responsibility for
long-range corporate planning. I n practice my function involved
analyses of the bank's current operations and reporting on those
analyses to Mr. Luftig personally.
Mr. ROSENTHAL. Tell us about some of the specific activities you
pursued.
Mr. HEINEMANN^ They ranged over virtually all of the bank's domestic operations, involving data processing, analysis of the earning
characteristics of the bank, personnel problems, strategy questions,
questions dealing with current administrative procedures, the collection of information about the bank's operations in the money market,
and suggestions as to ways those operations might be improved.
Mr. ROSENTHAL. In the summer of 1973, did the Federal Reserve
take any action regarding commercial banks to hold the prime interest
rate from rising from above the 6-percent level ?
Mr. HEINEMANN. The actions to which you refer actually occurred
somewhat prior to that and were not taken by the Federal Reserve
per se, but rather by the Committee on Interest and Dividends, which
was an agency created under the price control program that President
Nixon announced on August 15, 1971. Arthur Burns, who is Chairman of the Federal Reserve Board, was Chairman of the Committee
on Interest and Dividends.
I have collected from my news files from my years at the New York
Times a number of the press releases that were issued by the Committee on Interest and Dividends during that period. The first relevant
document which came to my attention was about the 26th of January of 1973. I t was in that period that the Committee on Interest and
Dividends, under Dr. Burns' leadership, exerted very considerable
pressure on banks to prevent the prime rate from rising, including,
specifically, Franklin National Bank.
I was deeply involved as a reporter for the New York Times in
reporting those stories on a daily basis. This was through the winter
and early spring of 1973.
Mr. ROSENTHAL. During the summer of 1973, did the rate for Federal funds and short-term certificates of deposit (CD's) in fact rise
above 6 percent ?
Mr. HEINEMANN. Very substantially. I t may be useful to the
committee that I, in preparation for this hearing, have assembled
some charts which show a number of money market interest rates
and show how they related one to the other.
Mr. ROSENTHAL. Without objection, that shall be included in the
record.
[The material referred to follows:]
119
CHART 1
-—
Prime Rate
90-119 Day Commercial Paper Rate
3-Month. CD Rate, Secondary Market
14.0%-]
12.0 -
1
1
8.0 -
1
6.0 -
1
4o.
4/1 2/72
Source:
V
;W
10.0 -
I/*sr£s
T
8/30/72
1—
T—
f
1/17/73
6/6/73
10/24/73
Weekly- Mid-1972 to Mid-1974
3/13/74
Federal Resei^ve Board
CHART 2
Prime Rate
Federal Funds Rate
3-Month, CD Rate. Secondary Market
14 . 0-: ^
6.0 H
4.0
4/12/72
8/30/72
Source:Federal Reserve Board
1/17/73
6/6/73
10/24/73
Weekly- Mid-1972 to Mid-1974
3/3/74
120
CHART 3
$123.0
1
Commercial and Industrial Loans All Large Banks
($ Billions)
115.0
107.0
99.0
4
91.0
83.0 |
4/12/72
Source:
|
f
8/30/72
i
|
1/17/73
6/6/73
10/24/73
Weekly- Mid-1972 to Mid-1974
i
3/3/74
Federal Reserve Board
CHART 4
Cormiercial Paper Outstanding
(S Billions)
$52.0
44.-0 J
32.0
4/12/72
Source:
I
8/30/72
Federal Reserve Board
1/17/73
6/6/73
10/24/73
Weekly- Mid-1972 to Mid-1974
3/3/74
121
Mr. ROSENTHAL. Was Franklin National Bank at some time during
this period required to purchase a considerable amount of Federal
funds and CD's to meet the demands on its unfunded lines of credit
during the summer of 1973 ?
Mr. H E I N E M A N N . Yes; it was. I t was prior to my association with
the bank. My impression would be, from the few documents that I
have available to me, that the bank's CD's in January of 1973 averaged $350.1 million a day. In August of 1973 when I joined the bank,
they averaged $598.2 million. Gross Federal funds purchased averaged $425.1 million a day in January of 1973, and $797.8 million a
day in August of 1973. The net Federal funds position, less Fed funds
sold, was $235.9 in January—that is hundreds of millions of dollars,
obviously—and $530.2 in August of 1973.
Mr. ROSENTHAL. During the summer of 1973, was Franklin thinly
capitalized ? In other words, did Franklin have an inordinately large
amount of liabilities, especially interest sensitive liabilities, in relation
to its capital ?
Mr. HEINEMANN. That would be my opinion as a bank analyst,
and certainly that would be so in comparison to other banks of similar size at that time.
Mr. Luftig, I think, would perhaps be a better one to whom to
address that question. He had a much broader involvement in the
banking affairs at that time than did I. I had just joined the bank as
a brand new officer of the bank at that time.
Mr. ROSENTHAL. Of what consequence was it to Franklin and its CD
position that the interest rates rose ?
Mr. HEINEMANN. The general characteristic of Franklin's money
market liabilities was that they were extremely responsive to changes
in short-term interest rates in the open market. When interest rates
in the open market rose, Franklin felt the impact of those cost increases almost at once.
Mr. ROSENTHAL. During the fall of 1973, or at any time, as a matter
of fact, had you received any indication that other banks were not
willing to sell Federal funds to Franklin or to purchase Franklin's
CD's?
Mr. H E I N E M A N N . I can recall a specific instance in which Mr. Howard
Crosse, who was a vice chairman of Franklin, indicated in a management meeting that 70 out of 100 of the largest commercial banks in the
country were not willing to sell Federal funds to Franklin. As a matter of general recollection, I would put the date of that statement as
sometime during October or November of 1973.
Mr. ROSENTHAL. Were you the person who wTas responsible for setting up a computer-based model of Franklin's operation? Was that
your baby ?
Mr. HEINEMANN. Yes. I worked on that very extensively.
Mr. ROSENTHAL. Why did you set up such a model ? What was it intended to do ?
Mr. H E I N E M A N N . The purpose of that effort was to provide and
create a management tool which would allow us to see the consequences in terms of earnings of a variety of different managerial
strategies.
As the model was finally completed, we were able to look at a combination of three different liability strategies and three different asset
122
strategies which gave us a matrix of nine different results relative to
two different interest-rate forecasts. So we could put a set of assumptions into the computer and almost literally press a button and get 18
different earnings forecasts of the results of a variety of different management courses of action which would then perhaps be useful to management in making decisions about actual operations.
Mr. ROSENTHAL. When did you first make use of this computer
operation ?
Mr. HEINEMANN. The work was essentially complete in late February or early March of 1974. There were some minor refinements and
additions that were made to the system subsequent to that, but the
thing was basically in usable form by that time.
Mr. ROSENTHAL. W h a t were the results of the first use of it ?
Mr. H E I N E M A N N . Initially, it was simply used to speculate, assuming
the market behaved in a certain way, as to what the results would be.
These were "what if" calculations—calculations which were intended
to be suggestive.
Mr. ROSENTHAL. Was that the entire purpose of this computer
operation ?
Mr. H E I N E M A N N . That was the purpose for which it was designed.
Subsequently, and I think this may be the point at which you are
driving, we did enter into the system specific indications or specific
data regarding the actual operations of Franklin and run the system
on the assumption that actual money market conditions at a particular point in time were to continue.
I n other words, we used it to forecast earnings in a specific way.
That was not the purpose for which it was designed; it was designed
to be a management tool and as an analytical tool. But it was, in fact, at
various points in time used to actually predict earnings.
Mr. ROSENTHAL. Did you actually do a computer run of Franklin
in late 1974; and, what were the conditions upon which you based that
computer run ?
Mr. HEINEMANN. I n the latter part of April, we did do such a computer run. The results of that was a forecast on our part that the bank
was likely to show an operating loss, exclusive of any losses in the foreign exchange area about which we were not then informed, of between $5 million and $7 million during the second quarter—the April,
May, and June period of 1974.
Mr. ROSENTHAL. W h y were you not informed of the foreign exchange situation ?
Mr. H E I N E M A N N . I was personally not involved in the international
department in any way at that particular point in time. I t was simply
not known within the bank's management that there were problems or
losses. They had not been uncovered at the point when that particular
forecast was made, to the best of my recollection.
Mr. ROSENTHAL. Did the conditions upon which you based that computer run actually exist in May of 1974 ?
Mr. H E I N E M A N N . Yes; that was the intention. Our assumption was:
Let's assume that the Federal funds rate continues at 11 percent
through the second quarter. What will be the results ?
Eleven percent was the actual rate that Franklin was paying in the
Federal funds market at that time. Actually, the 11 percent would
have been slightly higher than the bank was paying at that time, but
123
those were essentially the conditions at that time. So assuming they
continued for the next 2 months, this was to determine what would be
the results for Franklin's earnings. And that forecast was that Franklin would lose, solely from operations, between $5 million and $7
million.
Mr. ROSENTHAL. And did you conclude from that that the bank
could not survive then ?
Mr. H E I N E M A N N . My personal conclusion was that it was unlikely
that if an operating loss of that magnitude were reported publicly that
the market would be willing to continue to sell Federal funds or Eurodollars to Franklin so that it could continue to roll over, to renew its
maturing short-term obligations.
Mr. ROSENTHAL. What would the effect of that be ?
Mr. HEINEMANN. The bank would have been out of business.
Mr. ROSENTHAL. Did you convey this information or your opinion
to anybody else ? Did other people have the same opinion ?
Mr. H E I N E M A N N . I think this was a point of view which a number of
us who were in touch with the situation held. I n the narrative that Mr.
Klempner prepared, there was a reference to a consultant to the bank
who was working for us at that time and the letter that he
conveyed
Mr. ROSENTHAL. Who was that ?
Mr. HEINEMANN. Mr. Klempner had indicated that we could not
identify him. I have subsequently gotten permission from him to give
you a copy of that particular letter. I t was a Mr. Gordon J. Crook of
Lesta Research, Inc. I have a copy of his letter.
[The letter referred to follows:]
124
Lesta Research,
Inc.
MANAGEMENT CONSULTANT
111 JOHN STREET • NEW YORK, N. Y. 10038
May 1, 1974
Mr. Paul Luftig, President
Franklin National Bank
450 Park Avenue
New York, New York 10022
Dear Paul,
The purpose of this memorandum is to summarize our conclusions
stemming from work carried out by Lesta Research, Inc. for the bank
since October 1973, and to indicate our recommendations for the future.
We wish to acknowledge the fact that our work has been carried
out with the full participation and cooperation of yourself, Erich
Heinemann and other Bank staff.
Conclusions
As a result of our analyses, and in light of the present
actions being taken by Bank management, ve must advise you that
we believe that the Bank is in immediate danger of becoming insolvent.
Although this danger appears to be partially recognized by
senior management, we believe that the seriousness of the situation
is not fully appreciated. We also believe that the necessary
corrective action is not being taken at all in certain instances,
and in others the action taken is doomed to failure as a result of
lack of communication and coordination between members of senior
management. In many instances, the information needed to make
rational decisions is either not collected, or, if collected, is
withheld from management.
We therefore urge that immediate_ action as indicated below be
taken by the Board of Directors and the Executive Committee to avoid
a financial collapse of the Bank.
A more detailed review of the basis of these conclusions and
recommendations will be contained in a separate memorandum.
Financial and Qnrrating Character i st ics of Frank1in National J* ank
Our reasons for the above conclusions are a result of our analyses
of the financial ^nd operating characteristics of th«° Bink ap follnvs:
125
Mr* Paul Luftig
Kay 1, 197*+
Page two
1 # Net Money Margin - Domestic
Tke present structure for pricing loans is in and of
itself guaranteed to lead to bankruptcy in the long run.
The recognition of this fact by the money markets will
probably lead to insolvency in the short run.
The average spread over prime, on prime related loans,
appears to be some 90 basis points for domestic loans.
This spread is quite insufficient to cover loan losses,
money costs, and operating costs. The paucity of the
spread has been apparent to management for some time,
yet at this date work has barely begun to rectify the
situation.
It is essential that the domestic spread over prime be
increased to between 150 and 200 basis points within
the next "*Q days in order to avoid a repetition of the
first quarter's disastrous earnings. It is our opinion
that the action currently being taken is insufficient
to accomplish any measurable change in the spread over
prime within the next six months.
2. Net Honey Margin - International
The historical behavior of the money spread for the
international operation is so erratic as to be incomprehensible. Since there is no reason why the international
spread should behave this way, we can only conclude that
a totally ineffective management team has been at work
without any rational set of policies or management tools.
In view of the massive size of the London activity, we
feel it is imperative that the management situation
there be brought under control at once.
In order to accomplish this, we urge the Bank to dispatch
a. team led by Peter Shaddick together with someone of
Erich Heinemann's calibre, and a programmer who is
competent enough to put up a rudimentary asset and
liability management system on time-sharing within a
fortnight.
In order to minimize the exposure to money market
fluctuations in London, the maturity and pricing
characteristics of the assets must be made to
closely aatch those of the liabilities. Otherwise,
the potential short term losses that might be incurred
could easily amount to $10 to $100 million.
74-548 O - 76 - 9
126
Mr. Paul Luftig
May 1, 1974
Page three
Finally, London must be required to coordinate with
New York daily their asset and liability position in
order to minimize total Bank liability costs and to
ensure that a money squeeze in London does not force
the Bank under.
3.
Bank Leverage
Franklin is one of the most, perhaps the most, leveraged
banks in the country in terms of its recent reliance on
rolling over almost $1 billion of Fed Funds each day.
We believe that the enormous risk inherent in this
leverage is totally unjustified in that the interest
earned tfn the money acquired from Fed Funds barely covers
the borrowing costs at Fed Funds rates, particularly at
the present level of interest rates.
It is our opinion that all that this leverage accomplishes
is to leave the Bank highly vulnerable to the classic
squeeze of borrowing short and lending long.
4.
International Currency Trading
Although past activities of the Bank in the International
Currency Market have been relatively profitable, again,' the
risk inherent in the tremendous leverage that is used in
such dealings is grossly excessive considering the overall
financial conditions of the Bank.
We strongly recommend that this activity be terminated
forthwith.
5.
Board of Directors
It is not apparent whether the Board of Directors has been
kept fully and currently informed of the Bank's financial
difficulties. We urge that the Board be immediately
informed and be kept informed on a day to day basis until
the situation is rectified.
6.
Senior Management Coordination
It l? transparently r»pp/»rfnt rhit thp virions combers of
senior rru?pa°;pir"»nt of the P-^nk b"vr> act°d in »*» unilateral
and uncoordinated fashion in taking executive actions
127
Mr. Paul Luftig
May 1, 1974
Page four
that should have been totally coordinated with other members
of senior management. Typical of this is the current withholding of relevant financial information from members of
the staff reporting directly to senior management.
This lack of coordination and withholding of information
should cease forthwith because, if it does not, it is
inevitable that management will be acting at cross purposes
which, in light of the current precarious position, will
lead to immediate disaster.
7.
Money Market Trading
It is apparent that the chain of command from senior management
to the trading area at Hanover Square has impeded the timely
flow of information to senior management regarding the attitude
of the money markets towards providing the Bank with adequate
funds. We again recommend that direct communication be established
between senior management and the traders on an hourly basis.
Gordon J. Crook, President
LESTA RESEARCH, INC.
128
Mr. ROSENTHAL. Briefly and generally, what were his conclusions ?
Mr. H E I N E M A N N . His conclusion, bluntly put, in a letter dated
May 1,1974, was that the bank was in immediate danger of becoming
insolvent.
Mr. ROSENTHAL. Did all of the officers and directors have this
general information which you have described ?
Mr. HEINEMANN. I think very few of them did.
Mr. ROSENTHAL. Why is that ?
Mr. HEINEMANN. Perhaps because they were not involved in the
kinds of analytical work in which I and others were; perhaps because
they simply could not believe that an organization the size of Franklin
was not in fact viable.
Mr. ROSENTHAL. Did any of them have the benefit of Gordon J .
Crook's report?
Mr. HEINEMANN. Mr. Crook's report was addressed in a letter to
Mr. Luftig. Mr. Luftig certainly had the benefit of it.
Mr. ROSENTHAL. D O you, yourself, know whether or not Mr. Luftig
circulated it among the others ?
Mr. HEINEMANN. N O ; I do not. Mr. Luftig would have to answer
that.
Mr. ROSENTHAL. At any point in May, did Franklin's executive committe meet to discuss the possibility of seeking a merger with
anybody else ?
Mr. H E I N E M A N N . I was not a member of the executive committee,
obviously, and had no direct knowledge of what it did or did not do.
My understanding is that it did meet on the afternoon of Monday,
May 6,1974, to discuss this possibility. But I cannot speak to that of my
own knowledge. Mr. Luftig was, of course, a member of the executive
committee.
Mr. ROSENTHAL. When you joined Franklin in August 1973, were
you told that you should not become involved in the international
department ?
Mr. H E I N E M A N N . I was told this was not necessary; yes.
Mr. ROSENTHAL. Did you draw any specific conclusions about that ?
Did t h a t seem strange to you or anything like that ?
Mr. H E I N E M A N N . I had more work than I could handle. I was glad
that that was one area I did not have to work in. I was working alone
and had virtually no assistance. I had more than my hands full in
trying to understand the bank's domestic operation.
Mr. ROSENTHAL. Essentially you have told us about the factors that
caused you to come to the conclusion that the bank was in serious
trouble. Do you think this information was generally known within
the financial community ?
Mr. H E I N E M A N N . My impression is that in the investment community, certainly, there were widespread fears about Franklin's ability to
survive. There were certainly very widespread rumors circulating at
that time that the bank was in trouble. There was a constant drumfire
of inquiry from my former colleagues in the press who were seeking
information from me about the condition of the bank.
Mr. ROSENTHAL. Were you present at any meetings that either Mr.
Luftig or Mr. Gleason or anybody had with Federal or State banking
agencies during May 1974 ?
129
Mr. HEINEMANN. Only once. This was a meeting on May 8, when
Mr. Luftig and I went down to the Federal Reserve to arrange some of
the mechanical details which might possibly be involved in a large
Franklin borrowing from the Federal Reserve System.
Mr. ROSENTHAL. Who was there and what took place at that
meeting ?
Mr. HEINEMANN. Mr. H. David Willey and Mr. Henry S. Fujarski,
Jr., were there.
Mr. ROSENTHAL. D O you know whether Mr. Willey is related to
Frank Wille?
Mr. HEINEMANN. N O ; he is not. He spells his name in a different
way and, to the best of my knowledge, he is not related.
Mr. ROSENTHAL. What took place at that meeting ?
Mr. H E I N E M A N N . As I recall, it involved a setting forth of a series
of requirements that would have to be met in terms of the transfer of
collateral from Franklin to the Federal Reserve Bank of New York in
order for extensive borrowings to be undertaken by Franklin, under
the authority that the Fed has under section (10) (b) of the Federal
Reserve Act which allows borrowings which are other than normal
discount window borrowings.
Mr. ROSENTHAL. D O you have anything to do with the marshaling
of assets for the Federal Reserve %
Mr. H E I N E M A N N . This is the process about which I was speaking.
The arrangements were to physically transfer the loan documents from
Franklin to the Federal Reserve Bank of New York so they could be
held as collateral or to physically segregate them under Federal Reserve control on Franklin's premises.
I worked on this mechanical problem of physically transferring
pieces of paper from the Franklin to the Fed.
Mr. ROSENTHAL. H O W much money was involved ?
Mr. HEINEMANN. We did not know how much was going to be involved. We were making arrangements essentially to transfer virtually
the entire loan portfolio of $2.5 billion over to the Fed. We did not
know how much was going to be needed. Basically, we were going
around trying to scare up every available piece of paper that had any
value as collateral.
I worked on this from Wednesday, May 8, through Sunday, May 12.
I was fired on the 13th, so I do not know what happened after that.
Mr. ROSENTHAL. Were you involved in any merger discussions with
anybody ?
Mr. HEINEMANN. I was physically present on Saturday, May 11,
1974, when a large contingent of senior officers from the Manufacturers
Hanover Trust Co. came to Franklin to discuss the bank's problems
and to see whether or not it would be possible to arrange some kind of
p. business combination.
I was a relatively junior officer of the bank, and at no time did I have
the authority nor was I ever involved in any actual merger negotiations. I had no authority to do that and did not do that. But I was
phvsically present when discussions of this nature were taking place.
Mr. ROSENTHAL. D O you have an opinion as to what the attitudes of
the other bank people were toward a merger—the people of Manufacturers Hanover ?
130
Mr. H E I N E M A N N . The fact is that virtually the entire senior management of the Manufacturers Hanover came in to work on Saturday
morning, May 11, 1974, to the offices of Manufacturers Hanover at
350 P a r k Avenue in New York City, and walked up P a r k Avenue to
Franklin's offices at 450 P a r k Avenue. I am told, although I do not
know this to be a fact, that they came in small groups to avoid attracting attention.
I would assume that they would not have come to Franklin under
those circumstances if they had not been serious about it. But I cannot
go into their minds; I do not know what their attitudes actually were.
Mr. ROSENTHAL. They were serious ?
Mr. H E I N E M A N N . That would be my impression based on their actual
behavior.
Mr. ROSENTHAL. Can you briefly tell us the nature and the extent of
the discussions of that Saturday meeting ?
Mr. H E I N E M A N N . A S I recall it, the Manufacturers team, which was
headed by Mr. John McGillicuddy, president of Manufacturers Hanover, arrived and then split up with each person of Manufacturers
Hanover pairing up with his counterpart at Franklin.
I was physically present in Mr. Luftig's office while Mr. McGillicuddy was there. I was not physically present in any of the other meetings. I do not know what was going on in the other meetings.
The discussion in Mr. Luftig's office involved general descriptions
of the characteristics of Franklin and some very general comments by
Mr. McGillicuddy about his concern about not becoming too deeply
involved in Franklin's problems.
Mr. ROSENTHAL. Did Mr. McGillicuddy at any point say why he was
there?
Mr. HEINEMANN. They very clearly, in my opinion, were there because they wanted to explore the possibility of an acquisition. After
all, Manufacturers Hanover Trust Co., the principal operating subsidiary of Manufacturers Hanover Corp., had just made a $30 million
loan just a few weeks before to Franklin New York Corp. And I think
the Manufacturers Hanover people were concerned about the possibility of protecting the funds they had just disbursed.
But, again, I cannot speak for them. I do not know what their intentions were. That would be my presumption.
Mr. ROSENTHAL. Was Mr. Gleason present that day?
Mr. HEINEMANN. I am sure he was present at one time or another.
Whether he was physicallv present though during those discussions,
I do not know. I cannot recall that.
Mr. ROSENTHAL. Did you see him there that day ?
Mr. H E I N E M A N N . I saw him at least once or twice in the morning.
Whether he was physicallv present when the Manufacturers Hanover
people were there or not, I cannot recall.
Mr. ROSENTHAL. Did you see him leave the office?
Mr. HEINEMANN. N O . There were a great many people milling
around on several floors of the bank. I cannot recall either having seen
him arrive or depart.
Mr. ROSENTHAL. After that Saturday meeting, were there anv further meetings in which you were involved or know about with Manuf ucturers Hanover ?
131
Mr. H E I N E M A N N . Certainly there were none that I was involved in;
and, to the best of my recollection, there were none that I know about.
Mr. ROSENTHAL. Could you in any way characterize the progress
made at the meeting toward a merger or in any other way?
Mr. HEINEMANN. I believe that I would not be comptent to make
such a characterization. I believe Mr. Luftig can.
Mr. ROSENTHAL. D O you have any opinion as to whether it would
have been necessary, if Franklin and Manufacturers were to engage in
a merger, to have the support and assistance and cooperation of both
the Federal Reserve and the Comptroller of the Currency ?
Mr. HEINEMANN. Yes; I believe that would have been the case. Our
discussions were predicated on the assumption that such assistance
would be forthcoming not only from the Fed and the Comptroller's
office, but also from the Federal Deposit Insurance Corporation.
Based on the precedent of assistance that the Federal Deposit Insurance Corporation and, I might add, the Federal Savings and Loan
Insurance Corporation has extended to companies which had acquired
troubled institutions prior to that, we felt there was ample precedent
on the record for F D I C to provide some assistance to the Manufacturers Hanover in order to make this transaction possible.
Mr. ROSENTHAL. Were you present at any meetings with any Federal regulators from either F D I C , the Federal Home Loan Bank
Board, the Federal Reserve Board, or the Comptroller pursuing the
kind of discussions you have just responded to?
Mr. HEINEMANN. N O ; none.
Mr. ROSENTHAL. D O you know the approximate amount of Federal
funds and CD's that came due on Monday, May 13, 1974?
Mr. HEINEMANN. This has to be a guess. On May 9, 1974, Franklin
had $81.7 million in CD's coming due within 1 week after that date.
On May 9, Franklin had a total of $561.1 million in Federal funds purchases outstanding; of which, all but about $42 million came due the
next day.
There were—and this is a recollection based on informal reports
within the bank because I never saw any document or piece of paper
that would have confirmed it—approximately $60 million or $70
million of overnight Euro-dollars coming due on a routine basis and
being renewed on a routine basis.
So by adding those up in round numbers, that would be about $670
million of overnight obligations or CD's coming due at approximately
that point in time.
Mr. ROSENTHAL. H O W did they handle that? W h a t happened?
Mr. HEINEMANN. Our opinion that weekend was that absent a firm,
definitive merger agreement, the market would not be willing to renew
those obligations and that the bank, while possibly solvent in an accounting sense in that it had a positive net worth, would be incapable
of meeting its obligations as they became due and, thus, would be
unable to open its doors absent the Federal Reserve support.
Mr. ROSENTHAL. W h a t happened ?
Mr. HEINEMANN. I was fired on Monday morning, May 13.1 do not
know what happened.
Mr. ROSENTHAL. Who fired vou ?
Mr. HEINEMANN. I guess Mr. Gleason did. I do not know. I never
got official notice as to who was responsible for my firing.
132
Mr. ROSENTHAL. Do you have any thoughts as to why you were fired ?
Mr. HEINEMANN. I never received a formal communication from the
bank setting forth the reasons for my dismissal. A public relations
spokesman for the bank asserted in a press conference that 1 was fired
for failing to perform my assigned responsibilities. That is the only
formal statement that was ever made.
Mr. ROSENTHAL. Why did you fail to perform your assigned responsibilities ?
Mr. HEINEMANN. I believe that that was a totally unjustified allegation regarding me. I tried for a long time to get a formal retraction
from the bank. I was unable to do so prior to the bank's failure on
October 8 and I eventually decided to drop the matter.
Mr. Luftig was my de factor superior and supervisor; I think he
can perhaps testify as to whether or not I was performing my responsibilities.
Mr. ROSENTHAL. My question as of three questions ago was: Do you
have any opinion as to why you were fired ?
Mr. H E I N E M A N N . I think, as the committee knows, Mr. Luftig also
left Franklin on that same day. As a practical matter since I was working for him and was closely identified with him, 1 think that if for no
other than political reasons, I would have left very quickly after his
departure.
My departure was probably hastened because on Sunday evening,
May 12,1 made a statement to a reporter for the Wall Street Journal
that certain items in a press release, issued under Mr. Gleason's name,
were in fact inaccurate. Those specific items related to whether or not
the foreign exchange loss was attributable just to the second quarter
or whether it in fact also applied in part to the first quarter and
whether or not the foreign exchange loss was going to be covered by insurance.
I felt that Mr. Gleasoirs statements in his press release were inaccurate. Subsequently, in civil litigation filed by the Securities and Exchange Commission, one of the allegations regarding Mr. Gleason was
that he had issued an inaccurate statement on May 12, and essentially
on those points.
Mr. ROSENTHAL. When did Sindona come into the bank ?
Mr. HEINEMANN. Mr. Sindona's acquisition of 1 million shares of
Franklin New York Corporation's stock at $40 a share was announced
on July 12,1972,1 believe. I wrote the story for the New York Times.
Mr. ROSENTHAL. YOU had obviously heard of Sindona before this
hadn't you ?
Mr. H E I N E M A N N . Only in very vague terms. I had to #o to the Times
morgue to really find out who he was. I really did not know anything
about him.
Mr. ROSENTHAL. Have you learned more about him since that time ?
Mr. HEINEMANN. By hearsay; yes.
Mr. ROSENTHAL. Had you ever heard of an enterprise in which Mr.
Sindona had been involved with David Kennedy from Chicago ?
Mr. HEINEMANN. I am aware that Mr. Kennedy, the former Secretary of the Treasury and former chairman of the Continental Bank in
Chicago, was, to the best of my knowledge, on Mr. Sindona's payroll.
He was an officer of Mr. Sindona's holding company, to the best of my
133
knowledge. So I would assume there was a common interest of some
kind.
Mr. ROSENTHAL. D O you have the newspaper clippings that indicate
what you have just told us ?
Mr. HEINEMANN. NO ; I do not. I did not maintain a clip file of my
own work at the Times. I t is actually much too voluminous to be
worth keeping.
Mr. ROSENTHAL. I n your opinion, wxould a merger between Franklin
and Manufacturers in May of 1974 have been less destructive to the
financial community than permitting Franklin to continue as it did
in May of 1974?
Mr. HEINEMANN. Yes. I feel that very strongly. I feel very strongly
that in a technical sense the subsequent acquisition bv the Chemical
Bank of the Securitv National Bank under remarkably similar circumstances indicated that the merger that Mr. Luftig and others were
trying to arrange in that fateful May weekend was in fact technically
feasible.
Mr. ROSENTHAL. Why did it not take place ?
Mr. H E I N E M A N N . I do not know.
Mr. ROSENTHAL. D O you have an opinion ?
Mr. HEINEMANN. Apparently the regulatory authorities did not
share the opinion that we had of the gravity of the situation. They
believed, apparently, that it would be possible, if Mr. Sindona made
an additional $50 million investment in Franklin, for the bank to continue as an independent enterprise.
Mr. ROSENTHAL. Did Mr. Sindona make that additional $50 million
investment ?
Mr. HEINEMANN. NO ; he simply offered to do so.
Mr. ROSENTHAL. Would the $50 million have been adequate to save
Franklin ?
Mr. HEINEMANN. NO—not in my opinion.
Mr. ROSENTHAL. Why ?
Mr. H E I N E M A N N . I think,
to use a metaphor, that Humpty Dumpty
had fallen off the wall. The Qgg was broken and there was no way to
put it back together again.
The deposit base had started to fall apart.
Mr. ROSENTHAL. Why do you think the regulators took that position ?
Mr. H E I N E M A N N . I do not know why they took it. I am at a loss to
understand why this occurred.
Mr. ROSENTHAL. When you say the "regulators," whom do you
mean?
Mr. H E I N E M A N N . In this case, I think that we are really talking
about all three regulatory agencies—the Federal Reserve, the Office
of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation.
Mr. ROSENTHAL. D O you have any hypothesis on which you could
base a judgment as to why they did that? Do you have any conjecture
as to why they did that ?
Mr. H E I N E M A N N . N O ; not really. I have nothing which is based on
any knowledge of any kind.
Mr. ROSENTHAL. H O W about an opinion based on surmise or suspicion ?
134
Mr. H E I N E M A N N . As a matter of pure speculation, the regulators
apparently felt that the so-called Sindona plan, which was announced
in Mr. Gleason's press release of May 12, would be adequate.
I felt that position was "an incorrect one and that it would not be
adequate. I do not know how they came to that conclusion. I do not
know what political influences may or may not have been brought to
bear on the regulators to make the decision that they made.
Mr. ROSENTHAL. What kind of political influences are you talking
about ?
Mr. HEINEMANN. A S I have said, I don't know whether there were
any. There were many connections though. Mr. Sindona's counsel was
Mudge, Rose, which was Mr. Nixon's law firm. I do not know what
happened.
Mr. ROSENTHAL. Did Mr. Gleason leave the office of the bank that
day to go down to Mudge, Rose during these negotiations?
Mr. HEINEMANN. YOU are referring now to Sunday, May 12,
Mother's Day ?
Mr. ROSENTHAL. Saturday.
Mr. HEINEMANN. I do not know whether he did or not.
Mr. ROSENTHAL. Did you ever see David Kennedy in the bank?
Mr. HETNEMANN. Frequently. We knew each other from my days
as a reporter and on half a dozen occasions, there was a cordial helloand-how-are-you kind of thing.
Mr. ROSENTHAL. Would a merger between Franklin and Manufacturers Hanover in May of 1974 have been less disruptive to Franklin's
customers and the economy of the Long Island market than permitting
Franklin to operate as it did after May 1974 and eventually having
its assets and operations managed by both F D I C and, thereafter.
European-American ?
Mr. HEINEMANN. I think that is probable. I think that Manufacturers
Hanover, from my point of view, since it is a large, very well-established, very well-run New York City and New York region institution,
understands the market well. I think that if a merger of that sort had
been consummated, there would have been no significant or discernible impact on the Long Island business community of any kind.
My personal opinion is that Franklin, despite its deep trouble and
deep distress, as of that weekend in May 1974, represented substantial
potential value to Manufacturers Hanover Trust Co.
Mr. ROSENTHAL. On the other side of the question, were there any
economic or financial factors which would have dictated against a
merger between Franklin and Manufacturers ?
Mr. H E I N E M A N N . Franklin, as we all know, was a deeply troubled
organization. I t would have been very difficult and very complex and
it would have been a risky transaction. There were lots of things that
could have gone wrong. There could have been problems that we did
not know about.
There were leases on branches which were uneconomic which would
have been very hard to break. I t would have been a tough job to do.
My personal opinion is that there were no obstacles of a sufficient
order of magnitude to prevent a transaction of that sort from going
through.
Mr. ROSENTHAL. And on balance, it would have been better to do it
that way than the way it happened ?
135
Mr. HEINEMANN. That is my personal belief. I t was my personal
belief very strongly at that point in time.
Mr. ROSENTHAL. Do you know of your own knowledge or have you
heard of any particular special relationship between David Kennedy
and any of the Federal regulators ?
Mr. HEINEMANN. Since he was a former Secretary of the Treasury,
I would assume that he had close relationships with essentially all of
them. And since he was a former chairman of one of the largest banks
in the country, I would assume that he knows them all very well.
But I have no direct knowledge. The present Comptroller of the
Currency became a Treasury official during the period when Mr. Kennedy was Secretary of the Treasury. He became the Comptroller of
the Currency, however, after Mr. Kennedy had left Government service, to the best of my knowledge.
Mr. ROSENTHAL. Was that on Kennedy's recommendation, do you
know?
Mr. H E I N E M A N N . I do not know.
Mr. ROSENTHAL. Where is Kennedy now ?
Mr. HEINEMANN. I assume he is retired; but, I have no knowledge.
Mr. ROSENTHAL. Thank you very much. Don't go away.
Mr. H E I N E M A N N . May I make just one comment ?
Mr. ROSENTHAL. YOU did very well without a lawyer.
Mr. H E I N E M A N N . I am not in any way involved in any of the litigation involving Franklin National Bank. I think the record should
be clear on that. As a factual matter, I am not named in any of the litigation and I have no role in any part of it.
Mr. ROSENTHAL. Did you escape with your scalp generally unscathed ?
Mr. H E I N E M A N N . I hope so.
Mr. ROSENTHAL. Mr. Luftig, we are deeply grateful that you could
be with us today. I am sure you can shed considerable light on the matter we are interested in.
I should say for the record that you are represented by a very distinguished and eminent counsel for whom I have a great personal respect.
Mr. PIERCE. Thank you very much.
Mr. ROSENTHAL. Would you give us your name and address, Mr.
Luftig, and your present employment ? And if you have an opening
statement, you may then tell us about it.
STATEMENT OP PAUL ITJPTIG, FORMER PRESIDENT, PRANKLIN
NATIONAL BANK; ACCOMPANIED BY SAMUEL R. PIERCE, JR.,
COUNSEL
Mr. LUFTIG. My name is Paul Luftig. My home address is 83 Willow
Avenue, Larchmont, N. Y. 10538.
I am presently executive vice president of Commercial Funding,
Inc., New York City, N.Y.
I would like to read my statement.
Mr. ROSENTHAL. YOU may proceed.
Mr. LUFTIG. YOU have asked me before this committee to discuss
events preceding and during the weekend of May 13, 1974. As you
are aware, I was president of Franklin National Bank from June
136
1972 until May 13, 1974, on which date I was dismissed by its board
of directors. I was also president of Franklin New York Corp., the
parent bank holding company, during the same period of time. Prior
to joining Franklin I was employed by the Bankers Trust Co. in New
York for 21 years and my title when I left was senior vice president.
I think it is important that you understand that the financial condition of Franklin in May 1974 was brought about by certain management decisions dating back a decade or more. Given those decisions
coupled with the unprecedented high level of interest rates, the bank
was a troubled institution by May, 1974.
The decisions to which I refer are:
1. I n the years prior to 1972, the bank had decided to expand its
facilities into New York City from Long Island where it had its
origins. The expansion came about through merger, new branch openings, and through a new business effort geared at the national name
accounts in New York City. The branch openings particularly hurt
the bank since they led to an inordinately high level of fixed costs for
rent in prime locations. The bank's new main office in New York City,
at 450 P a r k Avenue, increased these fixed costs tremendously.
2. The bank bought hundreds of millions of dollars of tax-free, long
maturity securities. At the time that it was earning money, these securities provided it with a sound earnings position; but, by the latter part
of the sixties, the bank had experienced high loan losses and consequently a lower tax rate. The tax-free securities were therefore a drain
on earnings since their pretax yield was so low.
3. The bank, in its zeal to enter the New York and national markets,
had attracted a lot of marginal business that caused high loan losses.
I t also gave very advantageous terms to national accounts and other
banks in order to have "quality business" on its books. As a result, its
ratio of deposits to loans was very low and it had to purchase funds
in the form of certificates of deposits and Federal funds to support
its loans. Of course, other banks were doing the same thing, but Franklin's percentages were far in excess of the competition. A drive to improve the loan-to-deposit ratio and loan rates was conducted during
1973 and 1974, but results in this area are long range.
4. The bank was making fixed-rate loans at what were then high
interest rates. As interest rates increased and the bank's cost of acquiring time deposits and Federal funds went up, the yield on these loans
was less than the cost of acquiring liabilities to cover them. I n effect,
it was borrowing short at variable rates, and lending long at fixed
rates. When in late 1973 and 1974 rates began their rapid acceleration,
the precarious earnings position of the bank began to turn perilous.
Since costs of operations were so high, the already thin margins of
profit evaporated in the second quarter of 1974.
5. The bank's financial reporting system was of such poor quality
that much of what I am reporting to you today was virtually unknown
to its management until it was too late. There was no adequate measure
of fixed and variable rate liabilities and assets and their relationship
until a few months prior to my dismissal. Efforts to improve this system by hiring of a top-quality financial officer were frustrated time
and time again. As a result, I was working in the dark in trying to
solve the bank's problems since, not only was its then present condition
137
a matter of guesswork, but the effect of actions to be taken could not
be measured.
6. The bank's management was not of a quality to cope with these
situations. There were cliques and intrigues prevalent that made it
almost impossible to get things done. Simple plans did not take effect;
face-saving and image were more important than results. With the
bank's change in minority ownership in 1972, these intrigues deepened
almost to the point where there were pro-ownership and anti-ownership
groups fighting each other. The selection of very senior officers of the
bank without my knowledge, even though I was nominally chief
administrative officer, did not help the situation.
As rates increased in the 6 months prior to May 1974, it became
harder and harder for the bank to go about its daily business. We
were terribly dependent upon Federal funds to keep us going; and
as rumors about the bank's financial problem increased, it became a
daily chore to convince other banks to lend us Federal funds. There
were also rumors about overextension in foreign operations, and Mr.
Sindona's presence did not help us to assuage our lenders.
The management of the bank assumed a character of crisis. We
were dealing with potentially damaging rumors one moment and
the inability to fund our assets the next. As rates continued to escalate
during early May 1974, a few of us became aware that it was in the
best interest of a majority of our shareholders and all of our depositors
to try to merge the bank. This action was formally approved at an
executive committee meeting on May 6, 1974, prior to the knowledge
that there were foreign exchange losses in the bank. I t is important
to remember that it was after merger talks were started that we
learned of the extent of those foreign exchange losses. This action to
merge was formally approved in an executive committee meeting on
May 6.
During the week of May 6, we informed the Federal Reserve Bank
of the possible foreign exchange losses and of our inability to meet
our dividend payment. We also told the Fed of our efforts to attempt
a merger with the Manufacturers Hanover Trust Co. I am sure that
you are aware of the events of the weekend of May 10 when merger
talks intensified. At that point I realized I was attempting the merger
against the wishes of Mr. Sindona who informed me that if I proceeded, I would "be in trouble." I proceeded. I was in trouble and
was fired by the Sindona-dominated board on Monday, May 13, 1974.
During the weekend, various things happened that trouble me to
this day. The most troubling is of course the change in the attitude and
the lack of support I received from the regulatory agencies. They
must have known of the bank's condition through examinations they
had conducted. I had discussed these problems with the resident
examiner of the Comptroller of the Currency who concurred that
my efforts at merger were directed properly. And yet sometime during
that weekend, regulatory support for the merger dissolved and support
for Mr. Sindona's solution grew—culminating with my dismissal on
Monday, May 13.
The merger which I had suggested involved F D I C and Comptroller's
assurances. This had been done in the past and of course was successful
several times since the Franklin collapse, particularly in the Security
National acquisition by Chemical Bank. But the regulatory agencies
138
chose the much more hazardous route of lending huge sums of money
to a bank that could not exist, supported by the word of a minority,
but controlling shareholder.
I t will, of course, take years to see how much of this money is
returned to the Government and at what expense to the taxpayer. I
hope it takes less time to determine how the bank regulatory authorities came to the positions they took during that weekend.
I am a professional banker and I know that merger, with some
moderate Government help at that time, was in the best interests of
depositors, shareholders, and the Government itself. I hope you gentlemen can determine what caused the regulatory authorities to think
otherwise.
Mr. ROSENTHAL. I was just going to ask you that question. Why
do you think they changed ?
Mr. LUFTIG. I do not know.
Mr. ROSENTHAL. Are you reluctant to speculate?
Mr. LUFTIG. I think a committee such as this should really be the
one that investigates it. I just do not know.
Mr. ROSENTHAL. Tell us more about the change. Was it an abrupt
thing ? When did you have the first meeting with any regulator concerning a merger? •
Mr. LUFTIG. I believe it was the afternoon of May 6, 1974, but it
could have been either May 6 or May 7. I am not sure. I t was early
in the week.
Mr. ROSENTHAL. Who was it with and where wTas it ?
Mr. LUFTIG. I t was in the Federal Reserve Bank in New York. The
early meetings, I believe, were with Mr. Hayes, Mr. Debbs, Mr. Willey,
and a number of others.
Mr. ROSENTHAL. Are these all second- or third-level types ?
Mr. LUFTIG. NO, no; Mr. Hayes was president of the Federal Reserve
Bank of New York.
Mr. ROSENTHAL. That is first-level. Did you have a conversation
with him?
Mr. LUFTIG. Yes. We had gone down to the Federal Reserve several
times during that week. I do not recall exactly on which dates that
occurred.
Mr. ROSENTHAL. I am interested in finding out Mr. Hayes' attitude
and the only way I can find that out is to ask you what you said and
what he said. But I am more interested in what he said.
Mr. LUFTIG. I was down there to try to impress upon the Fed the
condition that the bank was in. I think he understood it in that we
were directed to marshal the assets of the bank in the event of a possible loan of the Fed to the bank. And we worked on that during that
week.
Mr. ROSENTHAL. I am interested in what Hayes said. I should like
to know what his response was and, if you would like to tell us,
your perception of Hayes' remarks.
Mr. LUFTIG. I think that instead of getting to the earlier meetings
which were concerned with the condition of the bank, we announced
to the Fed on Friday, May 10, that we had talked to the Manufacturers and that they were willing to discuss a merger with us.
The Manufacturers, in discussing it with me, had imposed some
conditions upon which they would continue merger talks. One of the
139
conditions was that the Fed would help in marshaling Justice Department support for such a merger.
Mr. ROSENTHAL. D O you mean to eliminate the antitrust problem ?
Mr. LUFTIG. To eliminate the antitrust problems; yes. And this was
communicated to the Federal Reserve Bank through Mr. Hayes, 1
believe, on May 10. I was led to assume that the Fed had such discussions with the Justice Department or other people in Washington.
I know there had been talk of that sort.
I n any case, I was also led to believe all through this period, up until
Sunday, May 12, that the Fed was very much in favor of trying to
merge the banks and had gone so far as to call other banks and ask
them about a merger just in case the merger with Manufacturers did
fall through.
Mr. ROSENTHAL. Was Manufacturers Hanover serious?
Mr. LUFTIG. I certainly believed so. We had a meeting on Friday
night, May 10, in the Manufacturers, with our attorneys, the attorneys
from Manufacturers, the chairman of the board of Manufacturers, the
president of Manufacturers, and a number of their senior officers.
We went through the condition of the bank, telling them exactly
what it was like. During the discussions of Friday night, May 10, with
Manufacturers, I received a call from the foreign department of the
bank in which we were first told of the magnitude of the foreign exchange losses. And during that meeting, I told the Manufacturers
people what these numbers appeared to be. I asked if they were going
to call off discussions, and they said, "No; it is just a question of price.
Let's continue to talk."
Mr. ROSENTHAL. When you say "price," do you mean price to the
stockholders ?
Mr. LUFTIG. Yes; the price of the purchase of the bank.
Mr. ROSENTHAL. What price are we talking about ?
Mr. LUFTIG. We had never discussed the price.
Mr. ROSENTHAL. That would have been a very important thing for
Sindona and his group, because they were significant stockholders.
Isn't that correct?
Mr. LUFTIG. I assume so.
Mr. ROSENTHAL. At some point you did discuss a price, though,
didn't you?
Mr. LUFTIG. N O .
Mr. ROSENTHAL. Never?
Mr. LUFTIG. NO. We decided that before a price could be arrived at,
we would have to have a very intense investigation of the bank—which
led to the Saturday meeting of all senior officers of Manf acturers and
all senior officers of Franklin.
Mr. ROSENTHAL. After all of the events that have taken place, what
is the net effect on the stockholders ? Are there significant losses ?
Mr. LUFTIG. A S of today?
Mr. ROSENTHAL. A S of today.
Mr. LUFTIG. I assume so.
Mr. ROSENTHAL. From the point of view of the stockholders and
the point of view of the Long Island community, would things have
been better or worse had the merger with Manufacturers gone through
rather than the takeover by European-American ?
140
Mr. LUFTIG. I n my opinion, obviously, a merger with Manufacturers
would have been certainly far superior to the route that was finally
taken. Of course.
Mr. ROSENTHAL. Was there any discussion about the taking over of
officers and personnel of Franklin bv Manufacturers ? In other words,
would your personal future have been better off had there been a
merger ? Did they offer any jobs or any security ?
Mr. LTJFTIG. NO. One of the conditions of the proposed merger that
Manufacturers insisted on was that there were to be no commitments
to any senior officer or to any member of the board of Franklin.
Mr. ROSENTHAL. Tell us about the Saturday meeting and about
Gleason and about Sindona and anything else about which you want
to tell us.
Mr. LUFTIG. I did not see Sindona during that whole weekend. Mr.
Gleason was in and out of the bank that Saturday.
Mr. ROSENTHAL. YOU told McGillicuddy about the extent of the
foreign exchange losses and he said that that did not slow down the
negotiations.
Mr. LTJFTIG. No.
Mr. ROSENTHAL. A S
the chief operating officer, why did you not
know about these foreign exchange losses ?
Mr. LUFTIG. We were told at the same executive committee meeting
on May 6 when the merger was discussed that there were some f oreign
exchange losses. No dollar amount was ever mentioned and we did
not know the full extent of them until later on in the week.
However, I think the point you are gettmg at is that in Mav of
1974, the foreign department of the bank did not report to me. Further, as I understand it, although most of these things came out
after I left, there was falsification of the books. So I certainly would
not have known of that while I was there.
Mr. ROSENTHAL. I n your original presentation, you talked about a
press release that Gleason issued which was erroneous. After learning
of the press release, did you meet with Eel Lake and others? If so,
what was the discussion about the solvency of Franklin ?
Mr. LUFTIG. I do not think I alluded to the press release in my
statement, but I will answer the question.
I don't believe I met with E d Lake after the press release. I think
that was prior to the press release. At one point, either on Friday
or Saturday or Sunday—I think it was Sunday—Ed Lake, who was
the resident representative of the Comptroller of the Currency, did
meet with me in my office.
I don't remember the exact words, but in effect, I asked him if
the bank were a viable institution. He sa ; d: "No; it was not."
I told him of my efforts which were directed solelv toward merger
and he thought that was a correct solution. He said that it was.
Mr. ROSENTHAL. While vou were in an operating position at Franklin, did you meet with Mr. Van Horn on any occasion ?
Mr. LUFTIG. Oh, yes; many times.
Mr. ROSENTHAL. Did you discuss the examination findings with
him?
Mr. LUFTIG. The examination findings were discussed with the
entire board.
141
Mr. ROSENTHAL. D O you mean the board of directors of Franklin ?
Mr. LUFTIG. The board of directors discussed it with Mr. Van
Horn.
Mr. ROSENTHAL. Mr. Van Horn met with the board ?
Mr. LUFTIG. Yes.
Mr. ROSENTHAL. During what
Mr. LUFTIG. I do not recall the
period of time was this ?
dates.
Mr. ROSENTHAL. Was it 1972,1973,1974 %
Mr. LUFTIG. I t was 1973 or 1974, but it might have been both.
Mr. ROSENTHAL. Generally, what did Van Horn say? Do you recall anything at all at any time ?
Mr. LUFTIG. Generally, he said that the bank should be reduced in
size to reduce the reliance on borrowed funds and that he was concerned about the reliance on borrowed funds of the bank. Everything
really came down to that.
Mr. ROSENTHAL. Were the corrective actions the reports called for
responded to generally ? Were they met ?
Mr. LUFTIG. We tried to do what they had asked us to do. I do not
think there was enough time. With the rates going up, we ran into
the earnings problem that really became paramount before we had a
chance to correct the things that were called for.
Mr. ROSENTHAL. Were Van Horn and his associates forceful and
persistent in trying to get you to make the corrections that were shown
on page 2 of the reports ?
Mr. LUFTIG. I believe so.
Mr. ROSENTHAL. I am interested in getting down to the nitty-gritty
of the operation, the final hours of the last weekend. At what point
did you get the feeling that the regulators had changed gears and
that they were not supportive of a merger with Manufacturers?
Mr. LUFTIG. We had been working Friday night, all day Saturday
and Saturday night
Mr. ROSENTHAL. What were those dates ?
Mr. LUFTIG. That was Friday night, May 10; all day Saturday,
May 11; and Saturday night, May 11, toward the merger. We had met
most of the day with the Manufacturers Hanover Trust Co. and later
in the day with the Bank of New York also to talk about a merger
which they felt right on the spot that they could not handle.
On Saturday night, May 11, I had suggested to somebody from the
Fed, although I do not recall to whom, that there would have to be
some type of Government assurances of loans, similar to the wTay other
mergers had taken place, to support this. I also told this to Mr.
McGillicuddy.
We left late Saturday night. May 11. On Sunday morning, I came
into the bank wanting to pursue the merger further. I t was my belief
that the bank just could not open its doors if not with a merger which
I knew could not take place over the weekend. But certainly an announcement of intent to merge would have helped tremendously.
On Sunday morning when I arrived in the bank, Mr. Gleason came
into my office and said, "You might as well go home."
I found this an incredulous statement, but I got the idea that something was out of my hands. I did not go home; I staved there most of
the day. I knew there were meetings going on outside—down at the
Fed and I don't know where else—but I was no longer a part of them
74-548 O—76
10
142
from Sunday morning, May 12, on. I knew something was happening.
Mr. ROSENTHAL. Was Gleason chairman of the board ?
Mr. LUFTIG. Yes; and chief executive officer.
Mr. ROSENTHAL. And he represented a majority of the voting stockholders or a ma j ority of the board ?
Mr. LUFTIG. I don't know what you mean by represented.
Mr. ROSENTHAL. Did he have within his confluence of interests the
majority of the board ?
Mr. LUFTIG. I found out the next day that he did.
Mr. ROSENTHAL. Did you ever meet with the Comptroller of the
Currency ?
^ Mr. LUFTIG. No.
Mr. ROSENTHAL. At any time ?
Mr. LUFTIG. A t any time.
Mr. ROSENTHAL. T O this day ?
Mr. LUFTIG. T O this day.
Mr. ROSENTHAL. And all of your
dealings that weekend were with
officials of the Federal Reserve Board in New York ?
Mr. LUFTIG. Yes. There were representatives of the Comptroller at
the meetings with the Fed and while we were discussing it with the
Fed. Mr. Van Horn was present at at least one and probably several
of the meetings.
Mr. ROSENTHAL. I asked you earlier, but we got sidetracked. When
did you get the notion that the Federal regulators were cooling off
on a merger—if they had ever been warm at all ?
Mr. LUFTIG. That Sunday morning when I came in and I was told
to go home. I was told that there would be no merger.
Mr. ROSENTHAL. Gleason told you ?
Mr. LUFTIG. Yes.
Mr. ROSENTHAL.
But he did not say to you that the Feds had called
off the merger and that they would not support a merger?
Mr. LUFTIG. I was not told any reasons for the thing. I was just
told there was nothing to be done.
Mr. ROSENTHAL. Why did you assume the Federal regulators had
cooled off on the merger? In other words, maybe Gleason just did not
like you from before. Why did you say that the regulators had cooled
off?
Mr. LUFTIG. The regulators up until this point were working with
us toward the merger. When I was told that there would be no merger,
obviously since the regulators knew the condition of the bank because
we had told them and they certainly had access to their own examinations and were as aware as I was of the conditions of the bank, everything lead toward the merger in my own logic. When I was told there
would be none, I assumed it was done with the full concurrence of the
regulators. That was an assumption on my part.
Mr. ROSENTHAL. That is what I am trying to find out. Did Gleason
say anything to you to indicate that the Feds had withdrawn their
support or that he capriciously did not want a merger?
Mr. LUFTIG. I do not think that he made either of those two statements.
Mr. ROSENTHAL. Did you have any conversation with anybody after
that event which you would want to tell us about and which is pertinent to this point ?
143
Mr. LUFTIG. Do you mean the regulators ?
Mr. ROSENTHAL. Yes—about the support of the regulators.
Mr. LUFTIG. I am not sure, but I do not believe I spoke to the regulators that Sunday.
Mr. ROSENTHAL. Did you at any time thereafter ?
Mr. LUFTIG. NO. From that point on, I was no longer with the bank
and never met with them again. I did speak to Mr. McGillicuddy from
Manufacturers that Sunday at his home. I don't remember the exact
words, but I told him that something had gone wrong and it was out
of my hands and I did not know what was happening.
Mr. ROSENTHAL. What did he say ?
Mr. LUFTIG. He said, "It sounds like you are right"—or words to
that effect. And that was the last time I spoke to Mr. McGillicuddy
in that capacity.
Mr. ROSENTHAL. But did the regulators withdraw their support or
didn't they ? Presumably, you do not know the answer to that.
Mr. LUFTIG. Obviously they supported another position, which was
the Sindona suggestion to put more capital in the bank as against a
merger; yes. I think that is logical to assume.
Mr. ROSENTHAL. Did Sindona ever in fact put the capital in ?
Mr. LUFTIG. NO ; he did not.
Mr. ROSENTHAL. SO that was just a holding action.
Mr. LUFTIG. That is what it turned out to be.
Mr. ROSENTHAL. Did you ever compose a letter
to the Federal
Reserve Board which you never had a chance to send as to the conditions of the bank ?
Mr. LUFTIG. Yes. Mr. Heinemann and I did compose such a letter
which we did not have a chance to send.
Mr. ROSENTHAL. When was that ?
Mr. LUFTIG. Some time after May 9, I believe. I t was May 9, 10, or
11.1 do not recall the exact date.
Mr. ROSENTHAL. Was your intent to alert them to the seriousness of
the condition of the bank ?
Mr. LUFTIG. N O , no, no. The Fed, in effect, was asking us how, if
they loaned us large amounts of money, we would repay it. We told
them there was no way to repay it except through merger.
They said, "Give us your ideas anyway on how you would pay us
back." They insisted on such a letter.
Mr. Heinemann and I sat down and wrote such a letter.
Mr. ROSENTHAL. But you had difficulty composing it.
Mr. LUFTIG. I t was impossible to compose. I t really turned out to be
more of a comic letter than an actual letter.
Mr. ROSENTHAL. I n the totality, how much money did the Federal
Government put into Franklin—either before or after the takeover by
European-American ?
Mr. LUFTIG. I do not know. Of course, I have no access to that.
Mr. ROSENTHAL. D O you know, Mr. Heinemann ?
Mr. HEINEMANN. Yes. The public record would indicate that the
aggregate Fed lending to Franklin was about $1.7 billion—slightly in
excess of that.
Mr. ROSENTHAL. D O you know, from the public record, whether that
has been repaid at all ?
144
Mr. H E I N E M A N N . The entire amount has been assumed as an obligation of the Federal Deposit Insurance Corporation. The F D I C publishes reports on its receivership of Franklin on a quarterly basis. I
believe they have repaid about $700 million of the $1.7 billion. And
they are in the process of liquidating the remaining Franklin portfolio and will pay it off as time goes on.
I think as of the last public statement, there was something like $164
million in accrued interest which was owed the Fed which had not
been paid by F D I C . This is working out over time and the F D I C has
stated publicly that it will take a period of, I believe, from 9 to 14
years.
Mr. EOSENTHAL. Who loses by these events ? What elements of the
public have lost anything by these events? And presumably F D I C
will eventually be totally paid back.
Mr. H E I N E M A N N . The F D I C has stated that it believes that it will
recover its advance. But of course there is great uncertainty about
that statement.
There are creditors of the Franklin New York Corporation, including the Manufacturers Hanover Trust Company, stockholders in the
Franklin New York Corporation, creditors of the Franklin National
Bank, and preferred stockholders of the Franklin National Bank, all
of whom have lost substantial amounts of money.
Many people believe that since the holders of these obligations include many large investing institutions that these possible losses have
helped to raise the cost of capital to other banks simply by, shall we
say, souring the investment atmosphere.
There are many large institutions that will not today consider the
purchase of debentures or notes of a bank holding company no matter
what the company is. They have a flat rule of "We don't want bank
obligations."
Mr. EOSENTHAL. Should the general public be at all concerned by
what happened ?
Mr. LUFTIG. Yes; the general public should be concerned.
Mr. EOSENTHAL. Why ?
Mr. LUFTIG. The Government
has stepped in and loaned $1.7 billion
in a situation where I do not think it was needed, and with some doubt
as to whether they are going to get it back.
Mr. EOSENTHAL. D O either of you have any information or knowledge as to whether David Kennedy had anything to do with
European-American ?
Mr. LUFTIG. I have no knowledge.
Mr. H E I N E M A N N . Nor do I.
Mr. EOSENTHAL. Or of any
of the banks overseas that formed the
European-American consortium ?
Mr. LUFTIG. I have no knowledge.
Mr. H E I N E M A N N . I have no knowledge.
Mr. EOSENTHAL. Are there any other questions by the staff ?
Mr. EUEMPLER. You have made several references to a possible
merger with Manufacturers Hanover. Was that contemplated as a
statutory merger under New York State law, or was that contemplated
to be a financially assisted transaction ?
Mr. LUFTIG. A financially assisted transaction.
Mr. EUEMPLER. That is all I have.
145
Mr. ROSENTHAL. Thank you very much. You have been very helpful.
We shall continue to pursue this investigation with vigor.
Mr. H E I N E M A N N . May I add one thing ?
Mr. ROSENTHAL. Yes, Mr. Heinemann.
Mr. H E I N E M A N N . There is one cautionary comment I should have
made initially, but did not. My comments here today were purely personal and were in no way a reflection of viewpoints that might or
might not be held by my employer.
Mr. ROSENTHAL. With that understanding, the committee stands
adjourned.
[Whereupon, at J l :50 a.m., the subcommittee adjourned, to reconvene subject to the call of the Chair.]
OVERSIGHT HEARINGS INTO THE EFFECTIVENESS OF
FEDERAL BANK REGULATION
(Franklin National Bank Failure)
TUESDAY, JUNE 1, 1976
HOUSE or REPRESENTATIVES,
COMMERCE, CONSUMER,
AND MONETARY AFFAIRS SUBCOMMITTEE
OF THE COMMITTEE ON GOVERNMENT OPERATIONS,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:10 a.m., in room
2247, Rayburn House Office Building, Hon. Benjamin S. Rosenthal
(chairman of the subcommittee) presiding.
Present: Representatives Benjamin S. Rosenthal, Cardiss Collins,
Robert F . Drinan, and Garry Brown.
Also present: Peter S. Barash, staff director; Robert H . Dugger,
staff economist; Ronald A. Klempner, counsel; Doris Faye Taylor,
clerk; and Henry Ruempler, minority professional staff, Committee
on Government Operations.
Mr. ROSENTHAL. The subcommittee will be in order.
Today, the Commerce, Consumer, and Monetary Affairs Subcommittee continues its oversight review of the effectiveness of Federal
regulation of commercial banks.
The subcommittee is studying the findings and implications of a 3month investigation of the Comptroller of the Currency's examination
and supervision, and its processes, involving the Franklin National
Bank.
While other interested congressional committees have inquired into
the circumstances surrounding the Federal Reserve's loan of $1.7 billion to Franklin after May 1974 and the declaration of its insolvency
in October of 1974, this subcommittee has been examining crucial regulatory actions from 1969 until May 1974—actions which failed to halt
Franklin's slide into insolvency.
Last week the subcommittee heard testimony from two subcommittee
investigators. They advised the following: That the Office of the Comptroller of the Currency's enforcement and compliance documents do
not clearly establish the division of responsibility and authority among
examiners, regional administrators, and Washington officials to require
a bank to take corrective actions on problems identified during examinations. As a consequence, there exists among OCC staff a difference of
opinion as to who has the responsibility and authority to require such
corrective action.
(147)
148
I t was revealed that the management portfolio problems that
plagued Franklin since the late 1960's and led to its eventual failure
in 1974 were amply documented by national bank examiners over a 5year period.
However, it was not until February 1974—only 3 months before the
beginning of massive Federal Reserve support—that OCC took aggressive supervisory action to force Franklin to correct problems.
The committee examiners found that OCC failed to utilize fully its
supervisory options to correct the problems identified by the national
bank examiners. Though the examiners generally identified Franklin's
problems, there were two notable exceptions. First, in February 1973,
OCC examiners failed to include in their report a $50 million instance
of balance-sheet window dressing which resulted in an overstatement
of the bank's resources. Second, in June 1973, in a 1-dav check of the
bank's foreign exchange profit and loss statement, the OCC examiner
apparently did not verify the foreign exchange rates used in preparing these schedules.
The subcommittee investigators believe that had these rates been
verified, the OCC would have become aware in June 1973 of Franklin's
misrepresentations of foreign exchange profits, rather than almost a
year later in May 1974.
Though examiners generally identified Franklin's problems, the
critical comments found scattered throughout the examination report
frequently did not get recorded on page 2 of the report, which is titled
"Comments on Matters Requiring Attention."
Page 2 is important because it is on that page that examiners are
supposed to itemize areas of concern. Noninclusion could suggest to
bank officers and directors that a problem is not of great importance.
F o r example, though examiners regarded Franklin's liquidity as very
low or marginal from 1969 through 1972, and even hazardous in 1973,
liquidity was cited on page 2 only in 1 year, 1969.
Today's witnesses are Mr. James E. Smith, Comptroller of the Currency; Mr. Charles Van Horn, Regional Administrator of National
Banks, Second National Bank Region; and Mr. John Fleming, National Bank Examiner.
Mr. Smith, we are very pleased that you could be with us this morning. We know that you have a prepared statement. Feel free to read
all of it or as much as you would like.
STATEMENT OP JAMES E. SMITH, COMPTROLLER OP THE CURRENCY; ACCOMPANIED BY CHARLES VAN HORN, REGIONAL
ADMINISTRATOR OP NATIONAL BANKS, SECOND NATIONAL
BANK REGION; AND JOHN PLEMING, NATIONAL BANK
EXAMINER
Mr. S M I T H . Thank you, Mr. Chairman. I appreciate this opportunity to appear before the committee in connection with its inquiry
into the Comptroller's regulatory processes. I n this hearing the committee is attempting to evaluate those processes through a study of the
Franklin National Bank, which was placed in receivership on October
8,1974.
149
I believe that we can learn from our past experiences, both good and
bad. Thus, as the committee staff testified last week, I initiated even
before the failure of the Franklin National Bank a special study of
the events leading to the bank's difficulties.
This committee's record on Franklin National Bank would be incomplete, however, without including information on the behavior of
the financial marketplace during the critical years of 1970-74. Also, I
think the committee should take note of changes that have occurred
in the Comptroller's Office since that period of time,
I will endeavor to be as brief as I can, Mr. Chairman, and to summarize the statement as I move through it.
Mr. ROSENTHAL. Without objection, the entire statement will be included in the record.
Mr. S M I T H . National banks are privately owned corporations. The
most important decisions made in each bank are those of the bank's
own board of directors and management, responding to competitivepressures and opportunities. Thus no inquiry into the failure of Franklin National Bank can be complete without an examination of the decisions made by the Franklin management in the context of the then
existing marketplace environment.
Inflation during the 1970-74 period was rampant. Because of the
effects of the Vietnam war, an expansionary monetary policy and
other such factors, consumer prices increased by 31.9 percent from
1970 to 1974. At the same time, the steepest recession since the Great
Depression of the 1930's had begun to set in.
From the banker's point of view, the greatest problem was the
enormous increase in interest rates. The Federal funds rates during
the summer of 1974 rose to an unprecedented 12.9 percent and the
prime rate was at a staggering 12.1 percent. The basic cost of monev
to banks aggressively using liability management during the 1970—74
period had increased an incredible 105.3 percent during this time
Franklin was particularly ill-suited to survive these economicpressures.
Franklin was a marginal operation throughout the 1960's, yet the
bank managed to operate and grow to a $3 billion institution by the or>d
of 1969 without arousing any significant concerns by this office or the
financial industry. Despite its apparent progress, however—particularly in the 1968 and 1969—the bank had neither the management
depth and acumen nor the operational systems and controls to cope
with its ambitious expansion program and the financial perils of the
1970's. Had the bank curtailed its activities after 1969 and solidified its
position in the marketplace, the results may have been different.
By December 31, 1973, Franklin's resources exceeded $5 billion. The
bank's management proved incapable of developing and handling the
sophisticated asset and liability management techniques necessary for
a bank of this size.
During the 1960's and early 1970's, the money market banks, faced
with declining rates of growth in deposits, sought new ways to meet
the heavy credit demands of their customers. In consequence, Franklin
and other banks placed less and less reliance on the generation of
liquidity through asset composition and cash flow. Instead, increasing
emphasis was given to acquisition of deposits and the purchase of a
150
wide array of borrowed money, including Federal funds, Eurodollars,
negotiable CD's and long-term debt.
Franklin thus was able to buy its liquidity in the marketplace to
support its rapid asset growth. In retrospect, Franklin's liability
structure and asset structure made the bank exceptionally vulnerable
to the confidence of the money markets.
Confidence in financial institutions declined significantly in 1973
and 1974 as a result of bank failures, both here and abroad, significant
foreign exchange losses in several major banks, and evidence of deterioration in bank loans to struggling real estate firms, airlines, public
utilities, and the like. This decline in confidence, coupled with steadily
rising interest rates, tight money conditions, high inflation, and the
beginnings of a recession led to a rush to safe havens for funds.
The very largest banks with unquestioned national and international reputations were the direct beneficiaries since the money market
participants seemed to be making the judgment that biggest also meant
safest. Marginally operated and smaller money center banks like
Franklin were often denied funds altogether or were forced to pay
high premiums for a limited amount of funds.
The tiered markets which developed forced many banks to scramble
to avoid negative margins and to assure liquidity adequate to meet the
claims against them. Franklin had long-term, low-yielding assets in
both its loan and its investment portfolios, and thus was locked into
a negative margin between the cost of the funds it borrowed and the
uses it made of those funds.
Under these turbulent market conditions, Franklin struggled. The
money market's continuing concern about Franklin was greatly aggravated in the spring of 1974 when significant problems were disclosed and market rumors about substantial losses became generally
known. A loss of confidence occurred and a massive outflow of funds
resulted, from which Franklin never recovered. The specific actions
taken by the Comptroller's office during the November 1973 through
October 8,1974, period are detailed in appendix I I .
The lesson that all banks could not always be assured of equal access
to the money markets was a rude awakening for many banks practicing
liability management, and an important lesson for us in the bank
supervisory field.
We believe we now have the sophisticated analytical techniques and
a far better understanding of money market banks to taken remedial
action early and effectively. However, because our powers—by design—fall far short of actually running a bank, there will alwavs be a
limit on our capacity to insure a fail-safe national banking system.
Mr. Chairman, if I may, I would like to briefly detail the remainder
of my presentation since I have your assurance that this will appear in
the record.
Changes have occurred in the Comptroller's office since the Franklin
experience. These changes are due in part to a study which was set in
motion in early 1974 by an outside consulting group, as well as by
reasons of some decisions that we made internally in terms of improving our performance.
I n terms of dealing with banks which we believe have performed
significantly below the norm, we first initiated, in 1974, what became
known as the victor program. I t is now known as our special situations
151
program. This was primarily an in-house technique for us to better
assess problems and banks needing very close supervisory attention
from the office. Second, it was designed to create a more coordinated
system for the performance of the office with respect to those banks.
Under this program, Washington becomes more deeply involved in
the supervision of difficult problem situations. Washington does not
take the lead at the bank level; that responsibility continues at the
regional administrator level, but with considerably more backup from
Washington. This would even include Washington's presence, where
it is deemed necessary, at board meetings.
Out of the consultant's study of the office, we are now implementing
an entirely new format of examination procedures. Our examination
handbook has been entirely rewritten, covering 42 or 43 separate
examination functions and giving more attention than we have ever
given heretofore to the banks' policies. I t begins right at the top with
what management perceives its credit and investment policies to be;
what the board perceives them to be; how they have spelled out those
policies in terms of written documents; how they communicate that
policy down the line in the bank to the various lending and investment
departments; and what kinds of controls and other operating systems
they have within the bank to assure that policies that have been
determined and enunciated are in fact being implemented and affected
by the operating units of the bank.
We believe that with this examination procedure that our examiner
in the field and his supervisory personnel will have a far better understanding of their roles and of what is expected of them. We believe that,
through these procedures, we will make more effective use of our human
resources by having a better road map as to how we are going to
examine banks. And as I have said, we are giving more attention
today to procedures and to internal controls and operating systems
so that we can begin to detect weakness and deterioration before it
evidences itself in a sufficient and severe degree in the loan portfolio.
I n the past, the principal focus of the bank examination was on
the quality of the loan pouch. And we are going to continue to give a
considerable degree of attention to that. But the problem is that that
is a lagging indicator. By the time you have significant problems in the
loan portfolio, it is often difficult to treat with and to remedy them.
We think the problems in the loan pouch generally reflect a breakdown
in systems and in management policymaking well before the problem
loans appear in any great number.
We are augmenting our onsite examinations by a new effort at early
warning. This is called the National Bank Surveillance System. I t is a
computer based data and ratio analysis system not unlike the systems
employed by financial analysts. I t is a system designed to permit us to
keep better track of the condition of a bank during the period when
we are outside the bank, during the intervals between onsite examination, and to make better and more effective use of the reporting formats,
which we have on a quarterly basis. I t would permit us, when going
onsite to an examination, to plan more effectively and more efficiently
for that examination through indication of deterioration in the bank's
condition. This would allow us to focus our onsite examination
resources at those indicated problems.
152
I n terms of the examination itself, we are also making considerable
modifications in the report of examination. Mr. Chairman, you referred
to matters discussed or not discussed on page 2—the so-called lead
page of the open section of the report. Under the new format of examination, we are now going to make certain that every major criticism
that we have of a bank which can be documented will appear in the
open section of the report in narrative form that can be understood by
operating bankers as well as by directors of banks who are not necessarily well-schooled in all of the custom and practice and terminology
of banking. There can be no question by management and the directorate of the bank as to what we regard a bank's current problems and
deficiencies to be.
We will continue in the new report of examination to have what
is known as a confidential section. That was the section, unfortunately, in the past which tended to contain the most detailed description
of the examiner-in-charge's judgment of a bank's condition. We will
continue a confidential section. I t will, however, be for three principal
reasons.
First, where we have suspected violations of law which the examiner does not feel competent to resolve himself, those suspected
violations will be moved up in the system for analysis by the chief
counsel's office and others. And, of course, if they are determined t o
be violations, they will then be communicated to the bank.
Second, we will use the confidential section for critical comments
about management in those cases where the office may desire to take
formal enforcement action. We obviously would not want to tip our
hand on that until we had made that decision.
Last, the confidential section of the examination, which goes only
to us and not to the bank, will be utilized to permit a seasoned examiner
to make those sorts of instinctive judgments that a good professional
can make where documentation is not possible. Where he or she feels
something in the pit of his stomach that he thinks is not right, it is
important that that be communicated up the line as well.
If I may refer back to our National Bank Surveillance System, that,
as I have said, is our principal means of keeping in touch with the
bank while we are out of the bank. We will be using the financial
analysts' techniques and grouping banks in peer groups as to size,
similar markets, and similar structure. And by going into extensive
ratio analysis, we think we can begin to detect problems early on
through a bank's performance being out of line with what is demonstrated by other peer group institutions.
Using the computer, those kinds of anomalies can be identified and
brought to our attention. The human analyst then applies his or her
skills to those indicated problems. If necessary, we go to the region or
into the bank itself to get clarification for this anomalous performance on the part of this bank. And all of that activity and all of those
inquiries are going to become part of a recorded, computerized action
control system. So we will always knowT when a query has been made
by a bank. And if there is no timely response from the region or from
the field with respect to this inquiry, that lack of response or inadequacy of response will be a recorded matter and will constantly be
brought to our attention in Washington through a, I guess you could
153
call it, computerized tickler system that will be keeping us regularly
in touch with how we are performing our job.
Furthermore, we have created for the first time in the office, a
performance audit unit, known as an operations review group. I t is
headed by a very seasoned Deputy Comptroller who has over 25 years
of experience. Through regularized sampling of our examinations,
we are going to begin to make judgments ourselves as to how we are
performing.
For the moment, we have that unit reporting directly to me. But I
have recommended to the Treasury Department that I think it, as
any internal auditing unit, would have a far higher degree of credibility if we could have created within the Treasury Department a
senior review group that did not involve the Comptroller at all. I t
would be like a board of directors and would perhaps include a couple
of senior career people from the Treasury Department—the Deputy
General Counsel or individuals of that type—to whom this operations
review group might periodically report on its judgments as to the
performance of the office.
I n an area critical to the final days of the Franklin, our examination of foreign exchange operations, we have made numerous and important changes. You referred, Mr. Chairman, to our failure on one
occasion to reach back and to test the valuations being used in the reconciliation of the Franklin's foreign exchange position. I t is true that
under previous procedures, examinations were always conducted on
an "as of" basis and an "as of" date. And we rarely went back to that
date to see what had been occurring prior to our entry into the bank.
Under new procedures, we will be sample testing the valuations used
in reconciling foreign exchange positions. We are also recommending
to banks various types of internal and dual control systems. I must
say that the banking system itself has given this matter a high degree
of attention since the Franklin, the Herrstadt and other major foreign
exchange problems.
But I am satisfied that our procedures today would clearly pick up
the kind of behavior that was occurring in the Franklin in early 1974.
We think, Mr. Chairman, that we have procedures and systems
which are far improved over those which were in place in early 1973
and 1974. We believe that we, along with the banking industry, have
learned some important lessons. I do not think that any of us had
the real sensitivity to the explosive problem that could be provided by
a combination of a high utilization or a liberal utilization of liability
management in terms of funding assets largely with short-term interest rate sensitive funds coupled with a declining and deteriorating
earnings performance.
I think we are far more sensitive to that today and I think the
banking system itself is. I have pointed out to banking groups in the
past that what occurred at the Franklin in that critical period of late
1972 to late 1973, when the bank's assets grew nearly one-third, was
that its conventional deposits in fact declined. I t funded that entire
growth out of highly volatile short-term funds. I think that could
not happen today because the market is so sensitive to those kinds of
events that it would simply not be possible for a bank wishing to
follow such a strategy to acquire the funds. And that was certainly
154
an important aspect of Franklin's development during that period
of time.
We think too, that we perhaps need some additional enforcement
and supervisory tools. We have recommended to the Congress that we
be given certain money-damage remedies for banks which fail to
comply with certain key provisions of law and certainly for banks
which fail to comply with cease-and-desist orders.
We also think that the present law with respect to officer and director removal, especially as it relates to officers and directors of national
banks, is needlessly cumbersome. We have recommended, along with
the Federal Eeserve, that there be some streamlining of its procedural
operation. Also, we have recommended that we be relieved of the
onerous standard in proceeding for an officer or director removal for
demonstrating elements of personal dishonesty. We think that it is
equally possible through gross negligence, gross mismanagement, or
outright stupidity for management to seriously affect the future of
a bank.
I think that personal dishonesty is certainly not the solely important
factor that need be considered in such cases. And I am pleased to
say that your standing Committee on Banking in the House of Representatives and the standing Committee on Banking in the Senate are
moving forward on those recommendations for additional enforcement powers. And I would fully expect that we will have that additional authority before this Congress is adjourned.
Mr. Chairman, I would conclude by merely making this closing
observation. I think there were a whole host of factors that went into
the final demise of the Franklin. The conventional wisdom, in looking back, has been, "If that marvelous bank on Long Island had never
gone to the big city, everything would have been lovely."
And I think that Franklin's entry into the Manhattan market was
a factor. But, clearly, if any bank supervisory agency had told this
bank in the early sixties that it could not come into Manhattan, that
agency, I think, would have properly been charged with conducting
some sort of anticompetitive policy.
Franklin's management during that period, I think, contributed.
And its lack of management obviously contributed at the end.
But Mr. Roth, who deserves a great deal of credit for having taken
this bank on Long Island and having built it into a very significant
institution, was also a unique manager in that he was a kind of oneman show. And little was done to develop the necessary management
succession during those periods of the sixties.
And as a consequence, when Mr. Roth left the bank, it simply was
not equipped with skillful personnel to manage an institution of that
size.
Our customs and practices of that time, which were no different than
the customs and practices of other bank regulatory and bank supervisory agencies, were probably also a factor which cannot be ignored.
We typically did not give the detailed and objective attention to management qualifications that we are doing today. We, as I have said, addressed most of our attention to the loan portfolios of banks and reported on the condition of that loan portfolio to the directorate and
management of banks, and urged them to take remedial and correc-
155
tive steps depending upon the situation. That was done with this bank
after every examination.
I n the mid-sixties, we gained some new enforcement tools in terms
of cease-and-desist powers. But to be perfectly honest, these were not
actively employed by this agency or any other banking agency until
the early 1970s. And even now we are still learning the utilization of
those enforcement powers. Even today, we are still on a learning curve.
We then take the bank's assumed judgment. I n 1973 the bank, seemingly unable to deal with its increasing problems of overhead and expense and apparently not wanting to undertake an austerity program
or feeling that that was not the quickest route to solution, decided to
grow and to try and overwhelm its expense problems through a growth
in assets. And in that 10-month period between our last two full-scale
examinations, the bank grew nearly one-third. All of that growth was
funded by highly volatile, short-term liabilities, Fed funds, Eurodollar placements and the like.
Mr. ROSENTHAL. Mr. Smith, I want to get a couple of things into the
record and then begin questions.
Without objection, we shall include into the record the material that
has been furnished to the subcommittee staff investigators which was
backup material for some or all portions of their examination.
These include: (1) an affidavit by James E. Smith in the matter of
liquidation of the Franklin National Bank; (2) a letter to Mr. Charles
Van Horn, dated February 22,1974, from James E. Smith, the Comptroller of the Currency; (3) a memorandum to Deputy Comptroller
John Gwin, dated February 1, 1973; (4) a letter to Mr. Charles Van
Horn, dated June 18, 1973; (5) a memorandum to Mr. Charles Van
Horn, dated February 1, 1974; (6) office procedure for rating national
banks; (7) a memorandum from Mr. John Gwin, dated March 19,
1971; (8) statement of Robert Bloom before the Subcommittee on
Commerce, Consumer and Monetary Affairs, dated January 20,1976;
(9) a memorandum for the files, dated March 28, 1974; (10) a memorandum for the files, dated June 15,1972; (11) an agenda for a meeting, dated September 6,1971; (12) a memorandum for the files, dated
January 21, 1971; (13) a letter to Mr. Charles Van Horn, dated January 16, 1970; (14) a Haskins and Sells draft report, dated October 4,
1974; (15) an interoffice letter, dated October 2, 1969; (16) a memorandum to Mr. William B. Camp, dated March 5,1970; (17) a memorandum for the files, dated January 24,1974; (18) a memorandum for
the files, dated January 29, 1974; (19) a letter to Mr. Robert Mullin,
dated May 15, 1972; (20) an interoffice letter, dated April 24, 1972;
(21) an interoffice letter, dated May 3,1972; (22) a letter to Mr. Robert
Mullin, dated June 9, 1972; (23) a letter from Mr. Robert Mullin,
dated June 14, 1972; and (24) a memorandum to James E. Smith,
dated May 31,1974.
[The material referred to may be found in the appendix.]
Mr. ROSENTHAL. Would you identify your colleagues ?
Mr. S M I T H . On my right is Mr. Charles Van Horn, regional
administrator for region 2, which includes New York, New Jersey,
Puerto Rico, and the Virgin Islands.
To my left is Mr. John Fleming, a national bank examiner in
region 2.
156
Mr. ROSENTHAL. When were you sworn in as Comptroller of the
Currency ?
Mr. S M I T H . July 5,1973.
Mr. ROSENTHAL. When did you assume your duties ?
Mr. S M I T H . July 5,1973.
Mr. ROSENTHAL. S O in normal parlance, in terms of assessing responsibility, you were prepared to accept responsibility for everything
that was or was not done from that date on ?
Mr. S M I T H . That is when I began my watch; yes, sir.
Mr. ROSENTHAL. And in the sense of equity and fairness, we recognize that you were in no way responsible for what took place prior
to that date.
What amount of Federal Reserve funds, or any other Federal regulatory or insurance agency funds, has gone into the Franklin
operation ?
Mr. S M I T H . At one point, the Federal Reserve note was in the order
of $1,7 billion. I guess that is where it was on the day we announced
the receivership. That obligation was assumed by the Federal Deposit
Insurance Corporation in connection with the purchase and assumption transaction in which the F D I C took somewhat over $2 billion
of Franklin assets to be liquidated.
Mr. ROSENTHAL. Has some of that money been repaid ?
Mr. S M I T H . Yes, sir.
Mr. ROSENTHAL. H O W much has been repaid ?
Mr. S M I T H . The F D I C is the better source on
this; but, it is something over $700 million. I think the Federal Reserve obligation is
now beneath $1 billion. I t is earning interest at about 7.5 percent,
which is, I assume, a little above the normal portfolio yield at the Fed.,
And the provision is, as I recall it in the purchase and assumption
agreement and in the arrangement between the F D I C and the Fed,
that if at the end of 3 years from the date of the receivership the
F D I C has not liquidated sufficient of the Franklin's asset portfolio
to pay off the note, it will pay it off in one lump sum and then it will
continue wTith the process of liquidation.
Mr. ROSENTHAL. Hopefully, the Federal Reserve will be repaid the
entire $1.7 billion plus the interest.
Mr. S M I T H . Yes; plus the interest yielding at 7.5 percent, which was
deemed a fair return by the Board of Governors.
Mr. ROSENTHAL. I S it your testimony that the Office of the Comptroller of the Currency did not have timely warning of Franklin's
weaknesses ?
Mr. S M I T H . Mr. Chairman, I think that throughout the period of
the sixties and into the period of the seventies, there were obvious,
indicated weaknesses in this institution. And those weaknesses, by and
larsre, were criticized. Mr. Van Horn and a series of examiners met
regularly after each examination with the bank management and
directorate.
Our criticisms tended to dwell upon the quality of the bank's loan
portfolio because, frankly, that is the way bank examinations were
directed in that period.
Those were certainlv factors in the final collapse. But the real factor
in the collapse was this bank's declining earnings performance and
157
its total incapability to do an effective job of liability-asset
management.
Mr. ROSENTHAL. I n other words, OCC had some warnings, but they
were not anything that got anybody overheated ?
Mr. S M I T H . I think that that is true. They were not the kinds of
indicated problems that would cause you to believe that this bank was
going to the wall. And the fact is that during the latter period of the
sixties—and I am certain in part because of criticism by this office
of the bank's loan portfolio—there were improvements in the quality
of that loan portfolio.
But then beginning in 1969, the subpar quality reappeared and it
never improved until the closing of the bank.
Mr. ROSENTHAL. For the record, I want to read to you from comments made in the examination reports in the areas of liquidity.
On September 29, 1969, the examiner said: "Very low liquidity.
This is the main area of concern at this examination."
On August 31, 1970, he said: "Marginal due to the heavy volume of
problem loans."
On May 17, 1971: "Marginal due to the heavy volume of problem
loans currently reflected.1'
On March 6, 1972: "Marginal due to heavy volume of problem
loans currently reflected."
On December 11, 1972: "Marginal due to the heavily loaned position, volume of problem credits, unused commitments and the need
for consistent large borrowings."
Now, all of those comments were made before you became Comptroller of the Currency. And as I said earlier, we do not hold you
accountable for them. But during that same period of time, did the
examiners ever waive an examination of Franklin? In other words,
the law requires either one or two examinations each year. Is that
correct ?
Mr. S M I T H . The law requires two each year, and permits the waiving
of one examination in any 2-year period.
Mr. ROSENTHAL. At any time during this period, to your knowledge
or to Mr. Van Horn's, did the Comptroller ever waive an examination
of Franklin ?
Mr. S M I T H . As a general rule, Mr. Chairman, we waive that one
examination in the 2-year period so that we, in effect, conduct three
examinations in a 2-year period.
Mr. ROSENTHAL. Did the Office of the Comptroller of the Currency
at any time prior to your assuming this office wraive the required statutory examinations? Can anybodv answer that question "yes" or "no"?
Mr. VAN HORN. NO, sir; to my knowledge, nobody specifically waived
an examination of the Franklin National Bank.
Mr. ROSENTHAL. Did your office conduct the two examinations as
required by law every year—say from 1969 until 1972?
Mr. VAN HORN. The law permits the waiving of one examination
within each 2-year period, as I understand. Now you are asking if
there were two each year. The answer is "no.'' They did not conduct
two examinations during each year of that period.
Mr. ROSENTHAL, Mr. Smith, you came aboard on July 5, 1973. This
is what the examiner said on November 14,1973—after you were here.
"Bank's liquidity position is considered hazardous by the examiner."
74-548 0—76
-11
158
When did you first have notice of that kind of comment? That is
obviously a serious comment.
Mr. S M I T H . YOU are right.
Mr. ROSENTHAL. And I would add, it is one warranting remedial
action.
Mr. S M I T H . I n February 1974, as Examiner Lake was completing
that examination which he had started on November 14, 1973, I met
in Washington with Regional Administrator Van Horn and Examiner
Lake and a number of my senior associates in Washington. Examiner
Lake gave us the rundown on the examination. His conclusion was
perfectly accurate.
The bank, by that time, had a liability structure, close to 50 percent
of which was comprised of liabilities such as Eurodollar placements
through its London branch, Federal funds purchases in the order, as I
recall, of $700 million or $800 million—all funds which are exceedingly lacking in any loyalty to a particular institution. I t was a very
sensitive liquidity situation.
Mr. ROSENTHAL. The situation was lousy.
Mr. S M I T H . I t was a very sensitive liquidity situation.
Mr. ROSENTHAL. A very sensitive liquidity situation which the people
in Wall Street could describe as lousy. What did you do about it?
Mr. S M I T H . We instructed Mr. Van Horn and Mr. Lake to meet
with the bank's management and then with its directorate, and to give
to them a specific series of requests for actions to be taken to reduce
the liability on this short-term and highly volatile funding.
Mr. Van Horn returned to New York and met with the bank's management the following week. Thereafter, Mr. Gleason, the chief executive officer of the bank and Mr. Norman Schreiber came to Washington
to meet with me.
Norman Schreiber had just joined the bank, having recently retired
as the chief executive officer of Walter Heller. He was an exceedingly
competent financial manager. He was in the process of a very indepth
analysis of the bank at that point.
We all agreed as to what had to be done—that the bank had to be
shrunk, if you will. And that is a process which cannot, unfortunately,
be achieved overnight.
Mr. ROSENTHAL. I n that same November 1973 report, the examiner
described the management as "poor." Could poor management have
done the job which you mandated ?
Mr. S M I T H . I felt, based on my meetings with Mr. Schreiber and
what he told me of some other people who had come into the bank,
that they probably had the horses at that point to do the job.
I think it is very difficult in the aftermath to judge if that were entirely true. Obviously we learned some things later on about the foreign
exchange operations of that bank which would raise questions about
the competency and maybe the ethics of those who were overseeing the
international operation. But the task Mr. Schreiber and his associates
had before them at that point in time was an exceedingly tough one.
Mr. ROSENTHAL. A t that time, was Mr. Luftig still president ?
Mr. S M I T H . Mr. Luftig was still in the bank. Mr. Ray Anderson,
who had come over with Mr. Luftig from Bankers Trust, was also
there.
159
Mr. ROSENTHAL. With the cooperation of my colleagues, I am going
to proceed for 5 more minutes and then recognize others.
When did Sindona purchase a major share in this bank?
Mr. S M I T H . My recollection is that that occurred sometime in the
middle of 1972.
Mr. ROSENTHAL. Did you at any time meet with Mr. Sindona ?
Mr. S M I T H . I met with Mr. Sindona late in 1973. He came to Washington with Mr. Gleason. I t was what I guess you could call a
courtesy call.
He made it clear to me that he knew little about American bank
regulatory practices and that if I found deficiencies in the bank, he
wanted to be advised of them.
He also took that occasion to talk with me about a proposed acquisition that was in the mill at the Fed—the acquisition by the Franklin
National Corp. of the Talcott Corp., another corporation in which
Mr. Sindona had a substantial ownership interest.
Mr. ROSENTHAL. During this period of time when Frankin was
described to have problems of low liquidity, Franklin acquired 17
banks. There were 17 acquisitions by Franklin during that 5-year
period.
Mr. S M I T H . N O — I think you are referring to branch office approvals
during the early 1970's. Those were de novo branches; they were
branches organized by the Franklin.
Mr. ROSENTHAL. Did each of those branch acquisitions require
Comptroller approval?
Mr. S M I T H . Yes, sir.
Mr. ROSENTHAL. The
Comptroller, had they wanted to exercise some
restraint or some slowing down of this phenomenon, could have
rejected the approval of all or any 1 of those 17, couldn't they?
Mr. S M I T H . We think, Mr. Chairman, that we have the authority to,
in effect, use a branch approval or disapproval as a supervisory lever,
if you will, on a bank that is recalcitrant.
I have not looked at these particular branch applications in depth,
but after superficially looking at them, 12 of them, as I recall, are
situated in what was the home country of the Franklin—Suffolk and
Nassau Counties. They were applications which indicated on a pro
forma basis that they were going to generate a good degree more in
the way of deposits than they would of loans. And that is exactly the
type of branch the Franklin needed.
I n other words, they needed a branch that would generate more
deposits than loans.
Mr. ROSENTHAL. But it had the exact opposite effect. The expansion
was deleterious to the bank's interests.
Mr. S M I T H . I do not think that you can necessarily say that these
acquisitions or expansions were deleterious. You would have to examine each one of them. There may have been a couple that were. The
Park Avenue one is in there, and that was certainly a high-cost operation and didn't help them at all.
Mr. ROSENTHAL. By unanimous consent, we will each take 10 minutes and then come around again.
Mr. V A N HORN. Mr. Chairman, may I have one moment, please?
Mr. ROSENTHAL. Certainly.
160
Mr. V A N HORN. I would like to get back to your question about the
statutory examinations. That statute, as you may know, is imprecise.
I t does not say there shall be a written report made. I t does not say,
for example, that an examiner shall visit the bank. There is just no
prescription for an examination under that statute, as I understand it.
Conceivably, a board meeting could be considered an examination.
Conceivably, or at least it seems to me, a report from the bank could
be considered an examination.
Mr. ROSENTHAL. Mr. Van Horn, do you consider a board meeting
or a report from the bank, in common terminology, as an examination ?
Mr. VAN HORN. Not in the traditional sense; no. I am merely saying
that the statute in that respect is imprecise.
And I also want to assure this committee that during that period of
1968 to 1974, that bank was under very close surveillance by the Office
of the Comptroller of the Currency.
Mr. DRINAN. Will the chairman yield ?
Mr. ROSENTHAL. I will be happy to.
Mr. DRINAN. On December 11,1972, the bank was examined. Almost
an entire year, until November 14,1973, went by before another examination took place. And the prior year, the same thing had occurred.
Almost a whole year went by between examinations.
I think the statute is quite precise; examinations are required twice
every calendar year. An exam may be waived once in every 2 calendar
years. So I think the key question is: Were these examinations waived
when people knew that the bank was marginal or in a perilous condition '(
Mr. S M I T H . Mr. Drinan, let me say that you referred to an examination in December of 1972. That, again, is the "as of" date. That is
when the examination was begun.
Mr. DRINAN. And lasted for 3 months; yes, I know.
Mr. S M I T H . Yes. And then we went back into the bank in November
of 1973. So there was perhaps a 7- or 8-month interval between those
two examinations.
Mr. DRINAN. But, Mr. Smith, the statute says that you are supposed
to do that every 6 months.
Mr. S M I T H . If we want to take this to the absurd, let's assume that
we had an examination that was so difficult that we went into the
bank in January and did not come out of it until December. We have
had some examinations that have taken 7 and 8 months. Are we then
going to say that we are in noncompliance with the statute because
we did not stop somewhere and start up again ?
Mr. DRINAN. Yes,
sir.
Mr. S M I T H . YOU are a lawyer; I am a lawyer. We are each open to
learn.
Mr. DRINAN. The statute means something, sir. Were there any
formal waivers of this examination ?
When the Congress puts through a statute, we have the right to
say that when you waive something, you waive it. And you can't say,
"We were in there all of the time and the other examination is still
going."
I t seems to me that you should ask for the repeal of the statute if
you are going to defy it.
161
Mr. S M I T H . I do not regard it as defying the statute. 1 may well
recommend to Congress some improvements in that statute to permit
us to do what I think would be a more effective job of examining. I
think it places a time burden on the office which often cannot be justified in terms of the conditions of many banks.
Mr. KOSENTHAL. Mr. Brown.
Mr. BROWN. Thank you, Mr. Chairman.
May I first go back to a technical matter. There were certain things
which you asked to be included in the record without objection. But
I do not think you ever put the question as such.
I want to reserve the right to object only until I make inquiry of
Mr. Smith.
I think you understand, Mr. Smith, what he asked to be put in the
record; do you not ?
Mr. S M I T H . Yes.
Mr. BROWN. And
I presume that these documents have been supplied to the committee ?
Mr. S M I T H . Yes.
Mr. BROWN. And
that any information which should remain confidential has been deleted. Is that right ?
Mr. S M I T H . That is my understanding; yes.
Mr. BROWN. Thank you. I have no objection, Mr. Chairman.
We kick around the term "liquidity" all of the time, Mr. Smith.
And I think there are many who look upon the term "liquidity" as
meaning solvency. You may have a liquidity problem and not have
a solvency problem. Isn't that correct?
Mr. S M I T H . YOU may have a liquidity problem and also have a
solvency problem.
Mr. BROWN. But one may occur without the other ?
Mr. S M I T H . Yes. You can be in a position of determined low liquidity, when looking at your asset structure, and still not have an insolvency problem simply because you do not have the claims that
require the liquidation of assets.
Mr. BROWN. YOU as Comptroller have no authority to intervene in
a bank's operation because of a liquidity problem as you do if the
bank has a solvency problem, have you ?
Mr. S M I T H . When we have deemed a bank insolvent, we have an
obligation to declare it so and to seek the appointment of a receiver.
When we find a bank whose liquidity is lower than we think it appropriately should be for its type of operation, our remedy is to bring
that matter to the attention of the directorate and of the management.
And as I have said, on the learning curve that we are on today, it
might be that, if we deemed the problem serious enough and were
receiving so little cooperation, we might find it an unsafe and unsound
banking practice and formally enter a cease and desist order against
the management of the bank.
Mr, BROWN. The chairman discussed with you these branches that
were approved during a time when the examination reported serious
liquidity problems.
Isn't it true that an argument could have been made by management that by the addition of these branches they would be able to
improve their liquidity situation somewhat since they would probably
162
be able to develop funds at a lower cost than if they had to go into
the market for funds ?
Mr. S M I T H . I think you could make that argument. As I have said,
my review has been pretty superficial. But a lot of those branches were
situated in the heart of Franklin's retail banking market. And the
objective of the branch was to generate more deposits which had some
loyalty to the bank. And in doing so, yes; you would improve their
overall liquidity position.
Mr. BROWN. Since there is no way in which we can determine why
some of the things occurred or did not occur prior to your regime,
and under the regime of the late Mr. Camp, let us look at the period
while you have been Comptroller. You came in in July. As of some
7 or 8 months later, you had then had your meeting with Mr. Van
Horn, with Mr. Lake, and with others. And you did put forth in
letter form some rather stringent requirements concerning the bank.
Is that correct?
Mr.
S M I T H . Yes,
sir.
Mr. BROWN. I S there anything to indicate why all of the bad information that had been developed by examination reports in the
past had not resulted in a comparable action during Mr. Camp's
regime ?
Mr. S M I T H . I think the problems indicated in Mr. Lake's 1973-74
report were of a higher degree of severity, if you will, than anything
that had been indicated heretofore.
I have referred to the learning curve, Mr. Brown. We were in a
period in which larger banks were making increasing use of the socalled technique of liability management. Both the industry and we,
ourselves, were not as sensitive, I think, as we should have been to the
dangers inherent in a liberal utilization of that technique coupled
with a declining earnings position in which the market ultimately loses
confidence in the purchaser of the funds.
So I find it a little difficult to look back and say, "Gee, look how
smart I was." I have been through some damn tough problems in the
banking system and I am smarter for them. When you look at 1968,
1969,1970, and 1971, you are talking about a period representing some
35 to nearly 40 years of relative tranquility in the American bankingsystem. That was the period since the big collapse of the thirties.
And I think the conventional wisdom of that time was that banks of
this size may have problems, but they just do not get to be the kinds of
problems that would take them to an insolvent status.
We now know that that is not the case. We learned it first in U.S.
National in October of 1973. And we learned it again in October
of 1974 with the Franklin.
Mr. BROWN. We know that the real crux of your ability is when
the insolvency issue is raised or exists.
Isn't it true that the F D I C , in connection with its handling of
Franklin, either is bringing or has brought or contemplates bringing
an action against the directors for not complying with certain of the
OCC directives and requests that wTere made of them?
Mr. S M I T H . I do not know what their specific plans are; but, that
is a fairly customary occurrence in F D I C receivership.
Mr. BROWN. If the F D I C does bring such an action and if it is successful, then directors that fail to conform to the things that you
163
require do possibly place themselves in jeopardy of some action. Is
that not correct ?
Mr. S M I T H . Yes, sir.
Mr. BROWN. SO that
Mr. S M I T H . Yes. We
is an authority that you possess?
do have the authority today and have had
since 1966. We are using it with increasing frequency. I t is the power
to either bring through voluntary entry or through formal entry a
formal cease and desist agreement or a formal memorandum of
understanding between us and the management and directorate of
a bank as to what we deem to be unsafe and unsound practices in that
bank, and practices which need to be corrected.
Now in the case of the Franklin, we did not have a cease and desist
order. But we had a formal request made to them in February
1974. That agreement was fully accepted by the management of that
bank. They said, "Yes; you are right. We must do these things."
And Mr. Schreiber, who had taken the bull by the horns up there,
was developing such a program. I t included, for example, the liqu idation of the bank's trading account and the insistence that borrowers
of the bank comply with contractual requirements for compensating
balances or get their loans out of the bank. And he concluded that out
of these actions alone they might be able to reduce their requirements
for these short-term funds by as much as $500 million.
We figured the bank had to be shrunk about $1 billion to $1.5 billion to turn it into a safe institution. And as he was beginning that
program in March and April, he just found himself putting out one
fire after another. At first it was this bank calling to shut off its Fed
funds sales and then another bank. And then the whole thing just unraveled in early May.
Mr. BROWN. With that chronology, it is difficult—having known
Joe Barr—to see that as of September 16,1974, in a letter to Bloom, he
said, "This bank is solvent."
Mr. S M I T H . I t was solvent, Mr. Brown. I t was solvent so long as
the Federal Reserve Bank of New York was willing to support its
needs for liquidity.
Mr. BROWN. I n that letter he also pointed out the things that were
being done which he thought would phase the Fed out of the picture.
Mr. S M I T H . He was convinced that some things could be done with
the assistance which the F D I C can provide under section 13(c) of the
Federal Deposit Insurance Act to permit the Franklin to continue on
an independent basis.
Now from the standpoint of the corporation, if one has to make a
finding that that institution is providing in the market an essential
banking service, I think that would have been a fairly tough showing
to make in the New York market. And second, there had to be some
real, reasonable prospect that certain types of assistance by the F D I C
would, over time, return this bank to a viable position.
I n an effort of good faith with the corporation and with Mr. Barr,
I employed the investment banking firm of Blythe, Eastman, Dillon to
review the so-called Barr proposal. And they concluded that there were
a variety of assumptions in there concerning interest rates and so forth,
anv one of which, if it did not hit right on the target, could throw the
whole proposal in the ashcan. And it was their reasoned judgment
that the proposal did not have a great deal of merit.
164
But Mr. Barr is to be commended for having tried.
Mr. BROWN. My time is just about up, but let me ask one further
question. What is there about your new procedures and operations, had
they been applicable to Franklin National Bank, that would have prevented a Franklin National ?
Mr. S M I T H . I have referred to the National Bank Surveillance
System.
'Mr, BROWN. Could you be a little more specific as to which things
you would have picked up.
Before you proceed, I presume that you are going to come to the
conclusion that with the new system of regulations and the new auditing methods, there will not be another Franklin National—at least
under the conditions under which Franklin National occurred.
Mr. S M I T H . I cannot make an absolute flat assurance of that. I t would
depend too on economic and financial market conditions.
But, for example, with an efficiently functioning National Bank
Surveillance System, I think we would have tracked the growth of the
Franklin in that critical 10-month period much more closely and much
more intensively than in fact was the case.
I think that, coupled with our new emphasis in examination on
starting at the top of a bank to ascertain what that bank perceives its
lending and investment policies to be and then moving down through
the bank to chart how that has been communicated and how, in fact,
it is being effected in the bank, would have indicated to us in a much
more specific way the lack of management systems in this bank fairly
early on.
Now our examiners were satisfied that this bank was not well managed. But our process of examination did not give them the kinds of
detailed evidence to say to a bank's directorate, "We think it is badly
managed for these reasons: ( a ) , (b), (c), ( d ) , (e), ( f ) , and ( g ) . "
And in today's world, I think that, with that kind of documentation
and that kind of declaration, you will have management replaced.
We simply, I think, had not given the examiner enough tools to do
that kind of job. Also, I think that we, along with our sister agencies,
have in the last 3 years been making increasing use of the formal
agreement. And it is altogether possible that in the case of the Franklin, that we might have done that at an earlier stage—based on what we
kno** today, not what we knew then.
I think all of those actions combined might have saved the day.
Mr. ROSENTHAL.. Mrs. Collins.
Mrs. COLLINS. Mr. Smith, what is your policy in regard to the bank's
relationships with, and disclosure of information to, shareholders and
the investing public? Have you adopted regulations along the lines of
the Securities and Exchange Commission in connection with your
regulation of national banks ?
Mr. S M I T H . Yes. Our sole legal authority there, Mrs. Collins, is
under the 1934 Securities Exchange Act with regard to so-called covered banks. These are banks having 500 or more shareholders and $1
million or more assets.
Frankly, in the case of the Franklin, they were not a covered bank
because their shareholder was the Franklin National Corp.—the holding company. And disclosure for the Franklin National Corp., of
165
which the bank was its principal subsidiary, would have been subject
to the oversight of the Securities and Exchange Commission.
But we do have regulations for banks which are subject to our securities oversight which are nearly identical to the regulations of the
Securities and Exchange Commission.
Mrs. COLLINS. T O what extent do you actively oversee and enforce
these regulations ?
Mr. S M I T H . I would say that we are very active in that field through
reviewing proxy materials, through reviewing offering circulars for
new debt and debenture issues.
Mrs. COLLINS. Is that a separate department?
Mr. S M I T H . I t is a division of our law department.
Mrs. COLLINS. Who is in charge of that ?
Mr. S M I T H . Mr. David Jacobsohn is in charge of that division today.
Mrs. COLLINS. H O W much personnel do you have in that division ?
Mr. S M I T H . I think we have approximately six or seven attorneys
working in that area. I can get you the exact number.
[The information referred to follows:]
The Securities Disclosure Division of the Law Department of the Comptroller
of the Currency had, as of June 1, 1976, six attorneys and two senior accountants.
Mrs. COLLINS. What is your policy for handling complaints by
shareholders or directors of a bank that the bank is making misleading
statements in its proxy materials, annual reports or other public
disclosures?
Mr. S M I T H . I think if we were to receive such a complaint, we would
review it on the basis of what we know about the bank. We would certainly make recommendations to the bank based on that judgment. It
may finally turn on shareholders bringing suit and those involved
having liability.
You could conceivably have a situation which involved a so-called
10(B) (5) violation, which is a fraud violation, in which the matter
would be in the hands of the SEC.
Mrs. COLLINS. Mr. Roth was here and testified in February of this
year and spoke about a meeting that you attended. With reference to
your policy in handling complaints by shareholders of a bank that the
bank was being poorly managed, Mr. Roth has told us that you had
little to say at a meeting which you attended. Could you possibly tell us
about that?
Mr. S M I T H . Yes; I did have little to say. If you have ever had a
meeting with Mr. Roth, it is, to begin with, not easy to have very much
to say.
But, second, we were right in the midst of dealing with the problem.
I knew that there was a lot of unrest within the directorate of that
bank. Some of it, in part, I think was encouraged by Mr. Roth.
There was nothing Mr. Roth, frankly, could tell me about the current status of that bank that I did not know in spades. So I thought
my role was to sit courteously and listen to Mr. Roth and let him go
about his business. And that is what I did.
Mrs. COLLINS. Can you tell me what steps you took on the questionable practices of the Franklin National Bank in the foreign exchange
market ? Was there any coordination with the Federal Reserve in this
matter?
166
Mr. S M I T H . The practices that have been most promimently discussed, Mrs. Collins, we did not discover until the spring of 1974. By
that time the fat, so to speak, was in the fire. We worked with everybody to see what we could do to make the best of a bad situation. This
included our taking the rather unusual role of going out and recruiting for the bank a highly skilled foreign exchange trader by the name
of Edwin Eeicher, who had formerly been the chief of foreign exchange trading at the First National City Bank. That followed a
spirited discussion between Mr. Sindona and myself one day.
Mrs. COLLINS. I have one final question. I am wondering about the
critical problem of undercapitalization. That is a problem that seemed
to have been known to examiners from 1970 until 1974. Do you know
why that was not included in examination reports in such a way that
the bank should have known that this was a matter requiring special
attention ?
Mr. S M I T H . I would doubt that there was ever any question in the
minds of the management or the directorate as to how we felt about
the capital of the bank. Indeed, as I look back over the record, on one
occasion during the acquisition proceeding, the bank did agree, once
the acquisition was completed, to increase its capital. And it did,
although it was not quite to the level that it had promised.
When you are talking about very big banks with very big numbers,
it is one thing to criticize; but, it is another thing for the bank to go
out and acquire capital. And we do not have the power to mandate
them, if you will, into the market to acquire the capital.
Mrs. COLLINS. Thank you, Mr. Chairman.
Mr. ROSENTHAL. Congressman Drinan.
Mr. DRINAN. Thank you, Mr. Chairman.
I suppose, Mr. Smith, that we cannot establish the ultimate culpability for what transpired at Franklin. But I suppose that is our task
to some extent. The loss is obviously very substantial. Can you give us
a ball park figure of what it is going to cost the F D I C to monitor this
bank over 9 or 13 years and try to restore it ?
Mr. S M I T H . The F D I C , of course, Congressman Drinan, would give
the best evidence there. I have recently read a press release from the
corporation in which they anticipate, at this point, that through their
liquidation of the assets of the Franklin, which they acquired in the
process of the purchase and assumption transaction, they are going
to be able to"fully liquidate the obligation to the Federal Reserve with
the accruing interest; that they will be able to fully cover
Mr. DRINAN. That is not my question. How many dollars will the
taxpayer pay because of the failure of the bank ? Millions of dollars are
going to the supervisory personnel over an extended period of time.
Mr. S M I T H . NO. The supervisory agencies that look after banks are
funded entirely by assessments of banks. I n the case of the F D I C , that
is from the assessment for insurance purposes and the investment of
those assessments.
W h a t I was about to say was that it was the conclusion of the F D I C
at this point that the liquidation of that loan portfolio which they now
have will also cover the corporation's costs and conceivably—conceivably, but not certainly—may even include at the end a sufficient
surplus to take care of some of the other creditors of the bank. These
would primarily be debenture holders.
167
Mr. DRINAN. I have tried to follow this closely with the subcommittee staff's report and all. But I come to the inevitable conclusion that
there is a division of authority and a confusion as to where the lines
run, and that nobody really has any unquestioned authority.
For example, Franklin's foreign exchange transactions volume grew
from $19 million in May 1971 to $3.7 billion in November 1973. And
the OCC, in the report of the examination that began on March 6,
1972, found that the foreign division operations were in chaos and
internal controls are virtually nonexistent.
This is March 6,1972. And I see that nothing was done.
Mr. S M I T H . That is not correct.
Mr. DRINAN, Obviously, it was not corrected.
Mr. S M I T H . I t was corrected.
Mr. DRINAN. Are you telling me that all of this did not contribute to
Franklin's eventual bankruptcy ?
Mr. S M I T H . I would say that the announced losses in its foreign
exchange operation in the spring of 1974 was a further straw in terms
of the loss of market confidence in that bank. But that process was well
underway before that announcement was made. What I am saying is
that during the time that we severely criticized the bank for a lack of
adequate procedure in its foreign exchange operation, recommended
procedures were put in place. Then apparently sometime in 1973 or
early 1974, they were neglected in one important term: that is that the
auditor of that operation became a working part of the trading operation, entirely contrary to any acceptable practice. So the system, while
ostensibly in place, broke down.
But they had taken very considerable steps after our criticisms. Mr.
Fleming could probably go into that in much more detail.
Mr. DRINAN. Mr. Smith, the record seems to contradict you. I have
here the very detailed report of two subcommittee staff investigators,
on loan from the GAO, who spent 4 months on that. And in 1969,1970,
1971, and 1972, all of the examinations reported about Franklin's need
to develop a system which would provide adequate controls over this
foreign operation.
You say that it did not contribute, but nothing seemed to happen.
There must be a division of authority where either the Comptroller or
the Federal Reserve or other officials are not given clear statutory or
regulatory power because no one really exercised the full power to
move in on Franklin, starting in 1969, and correct this situation. Do
you think that there was a division of authority ?
Mr. S M I T H . N O ; not with respect to the supervision of that bank. I
think that was clearly the responsibility of this office. I t was the principal subsidiary of a registered bank holding company and, therefore,
would get some secondary oversight from the Federal Reserve; but,
the responsibility, such as the law imposes, was clearly the responsibility of this office.
Mr. DRINAN. Of the 17 branches that wTere organized, you say that
your review has been superficial. Has anybody in your office done an
indepth review? Do we have any hard knowledge as to whether or not
these did or did not contribute ?
I t was said that the P a r k Avenue branch did not help. But someone
here at the panel denied that these acquisitions were deleterious. And
frankly, we have no hard information.
168
Mr. S M I T H . Father, I think I can say that it is inconceivable to me
that a bank of $5 billion in total resources with over 100 branches could
have had as a pivotal factor in its demise the approval of a relative
handful of branches—most of them small retail branches in Long
Island.
I say that if there were any shortcomings on our part in the approval
of those branches, that it was in not using them for whatever value
they might have had as a lever to obtain better compliance with our
directives to the bank.
Mr. DRINAN. I think, Mr. Smith, that that may or may not be so. But
we have to respond to the public on whether or not the Comptroller's
Office utilized the applications as a device to discipline the bank, and
on the fact that someone rubber-stamped these branches when your
predecessors or you knew that this bank was not shaping up.
Mr. S M I T H . A S I have said, I think the failure to use them as a lever
to obtain from them improved performance may have been a shortcoming on our part. But I do not think that the creation of the branches
was in any sense pivotal in the final analyses.
Mr. DRINAN. Someone admitted that the P a r k Avenue branch did
not help.
Mr. S M I T H . I t did not help. I t was a very high-cost operation.
Mr. DRINAN. That means it was a disaster.
Mr. S M I T H . I t was a very high-cost operation.
Mr. DRINAN. On the famous weekend in New York and Washington
when a merger was attempted—you know all of the facts far better
than I—was there anything that you would have done differently if
you had had all of the foresight then that you have hindsight now ?
Mr. S M I T H . NO. We concluded, obviously, that the likely candidate
for the merger was Manufacturers Hanover.
Mr. DRINAN. Who is we ?
Mr. S M I T H . There were interagency discussions going on. I was talking with the Fed, with the F D I C , and within Treasury with some very
knowledgeable people about that market—including the now Secretary, who was then the Deputy Secretary.
And Manufacturers Hanover in fact, had had some of its key credit
people and auditors in the Franklin. I talked on at least three occasions
with Gabriel Hauge, whom I have known well for many years. And I
went so far, Congressman Drinan, as to say this. I said, "Before you
make a decision in this matter, I ask that you please have your counsel
review the Wellsville case."
Now that is a case involving a small bank in Pennsylvania, in which
the Comptroller exercised his powers of conservatorship to complete a
sales transaction. Another one had been informally agreed to and it
was felt unlikely that they could get timely approval of it by the
shareholders.
The Comptroller moved in and took control of the bank under his
powers of conservatorship and consummated the sale. That sale was
latter challenged by the shareholders, but the Comptroller's action was
upheld in the United States Court of Appeals.
There was no mystery in Mr. Hauge's mind as to what I had in mind
when I suggested that that be reviewed. When he came back to me on
Monday, I expressly asked him if he had considered a Wellsville approach in his decision not to merge.
169
He said, "We have. And it would not be an important consideration
in that decision."
Mr. DRINAN. D O you think your office and the other regulatory agencies exercised all of the options they could have during the fatal week
that began on May 6,1974 ?
Mr. S M I T H . Congressman Drinan, I will always ask myself that. I
am afraid that the smell of death somehow got out into the marketplace. And when that happens, banks decide that if they want to
swoop in on the situation, they will swoop in on it via an FDTC
receivership.
Throughout the month of May and into early June, I endeavored,
utilizing the good offices of former Secretary Kennedy, to have contact made with London banks to see whether they were interested in
coming in either as sort of a partner, acquiring a piece of the Franklin
Corp., or to come in, in effect, as sole owners.
As I have said, I think the rumors were running sufficiently at that
time that to complete a commercial transaction then was impossible.
And something that I did not know at that time was that the London
clearing banks had their hands full with lots of fringe bank problems
in London and were probably not looking for any more problem
situations.
Mr. DRINAN. Could you state a simple reason why you apparently
changed your mind about the possibility of a merger after your meeting with Gleason and Sindona ?
Mr. S M I T H . I never changed my mind.
Mr. DRINAN. But you lost enthusiasm ?
Mr. S M I T H . I never lost enthusiasm. If there had been a merger
partner, that bank would have been merged. I would have been out of
my mind not to have done that. The fact is that there was no merger
partner.
And even after we decided to go the route of an F D I C transaction,
we had to include in the prospective merger bidders, London banks. We
endeavored to interest Canadian banks because it would have been a
very unique opportunity for Canadian banks to have entered the New
York market. And even with the significant assistance offered by the
F D I C in that transaction, we were not bowled over by participants.
Mr. DRINAN. I have one last question. Do you have any thoughts
as to whether Mr. Gleason was justified in firing Mr. Luftig and Mr.
Heinemann for their allegedly unauthorized efforts to seek a merger?
Mr. S M I T H . I do not know the details of that situation well enough
to comment on your specific question. I think Mr. Luftig has been
unfairly dealt with, perhaps, in terms of his role in the bank. I think
he arrived at a point when it was probably too late to achieve any
great improvements there. From all I know, he is a very competent
bank officer.
Mr. DRINAN. My time has expired. Thank you very much.
Mr. ROSENTHAL. We will attempt to come around again if we can.
I want to pursue the merger phenomena, Mr. Smith. Obviously, I
gather from your testimony and from the testimony of others, merger
would have been a far more acceptable route than what in fact took
place.
Mr. S M I T H . Yes. There would have been the hope that we could
have done something very quickly. As you know, we had been through
the San Diego case.
170
Mr. ROSENTHAL. Then the answer is that a merger would have been
far more acceptable ?
Mr. S M I T H . Yes, sir.
Mr. ROSENTHAL. And
for a whole host of reasons financial, psychological, community-oriented, Lon<i Island-oriented—it would have
been better. And in answer to Mr. Drinan's question, you said that you
were a supporter of a merger if there were a willing partner available.
Mr. S M I T H . There is no question about it.
Mr. ROSENTHAL. On Saturday, May 12, McGillicuddy and his
Manufacturers Hanover group met with their counterparts at Franklin and apparently spent a great deal of time reviewing the facts and
figures and so forth.
Mr. S M I T H . Yes,
sir.
Mr. ROSENTHAL. Mr. Luftig testified here that he understood you
were an active merger supporter and that, obviously, the cooperation
of both the Comptroller and the F D I C was necessary. And Mr. Luftig
testified also, I think, that he was stunned when Gleason told him
that you had turned off your support for the merger. That, presumably, is incorrect.
Mr. S M I T H . I would much prefer that Mr. Luftig get it from me
rather than through Mr. Gleason. There was no question that I was
fully in support of a merger if we could find one.
Mr. ROSENTHAL. I want to be perfectly candid with you. Mr. Roth
also testified. I have every confidence that your staff brought to you
Luftig's testimony, Heinemann's testimony, and Roth's testimony.
Mr. S M I T H . Yes, sir.
Mr. ROSENTHAL. And
there has been smoke raised that because of
the intercession of David Kennedy and his 12-year partnership with
Sindona in Europe that that was a factor in your cooling off as to the
merger prospect—that Sindona was not in favor of merger and had
hoped to turn the situation around.
Mr. S M I T H . Let me, if I may, deal with that episode. There was no
intercession by David Kennedy. Indeed, the contact with David Kennedv was made by me to him. rather than bv him to me.
Mr. ROSENTHAL. YOU called David Kennedy ?
Mr. S M I T H . I called David Kennedy.
Mr. ROSENTHAL. On what day ?
Mr. SMITH. On Sunday morning.
Mr. ROSENTHAL. I want to have the record absolutely clear. Was
David Kennedy instrumental in your appointment as Comptroller?
Mr. S M I T H . N O , sir, he was
not.
Mr. ROSENTHAL. Did he recommend you to Secretary Schultz ?
Mr. S M I T H . Not that I am aware of. no. sir.
Mr. ROSENTHAL. YOU surely would have been aware of it if he had ?
Mr. S M I T H . I would think that I would have been. But I have no
knowledge that he was involved in that decision at all.
Mr. ROSENTHAL. What had been your prior association with Mr.
Kennedy, and for how long had it existed ?
Mr. S M I T H . I had known him since the mid-sixties, when I was a legislative counsel with the American Bankers Association. I was deeply
involved in a controversial piece of legislation now known as the Bank
Merger Act.
171
David Kennedy was then the chief executive officer of the Continental Illinois Bank, a bank which had a very considerable interest
in that legislation because, but for it, the bank would have had to
unwind a merger that had already been consummated.
So I knew him for 5 years before he became the Secretary of the
Treasury. When he was about to become the Secretary, I decided that
I was ready to move back into the public sector and asked if he would
be interested in having me come into the Department as the congressional representative for the Department. He so appointed me. I served
under him for 2 years in that capacity.
That really is the extent of it.
Now if I could tell you about what happened on Sunday morning,
I would like to do so.
Mr. ROSENTHAL. First, Jet me ask this. We have been told that Kennedy has been a partner of Sindona for many years in European
transactions.
Mr. S M I T H . I think the Continental Illinois Bank had had a common ownership of a small bank in Italy with the Sindona interests.
I t was not a controlling interest, but an equity position in a bank that
Sindona was apparently a controlling factor in.
Mr. ROSENTHAL. Did Kennedy have any official interest in Franklin
National ?
Mr. SMITH. NO. He was a director of the Sindona personal holding
company, which was the entity which held the Franklin National
Corporation's stocks—some 21 to 22 percent.
And as the story will unwind, I will tell you that I found out, in the
course of my Sunday morning discussions—first, with Mr. Sindona
and later with David Kennedy, that he had
Mr. ROSENTHAL. I am sorry to interrupt you, but is it common practice for a Comptroller of the Currency to talk to a stockholder—even
one of Sindona's size in Franklin ?
Mr. S M I T H . N O ; it is probably not common practice. In this particular case, Mr. Sindona was proposing to do something which seemed
at the time to be useful. He was proposing to guarantee a $50 million
rights offering if the directorate of the Franklin National Corporation
decided to offer $50 million in stock to the other shareholders. He said
he was willing to inject an additional $50 million.
Mr. ROSENTHAL. Would that have had any effect on this situation?
Mr. S M I T H . Nobody can say for sure. We thought at the time, since
we knew that at sometime during that day the corporation was going
to be reporting foreign exchange losses which might exceed $40 million, that the infusion of new capital slightly in excess of that amount
might—and I underline "might"—stabilize the market situation.
Mr. ROSENTHAL. The merger operation never went through. Did he
ever put up the $50 million ?
Mr. S M I T H . N O : he never put up the $50 million because we never
got to that point. By the time it would have gone through the course
of shareholder approval, the inevitable was so obvious that it was not
done.
Mr. ROSENTHAL. YOU could have avoided a shareholder approval,
pursuant to the Wellsville case.
Mr. S M I T H . NO. I could only have done that, Mr. Chairman, in the
case of a purchase and assumption transaction.
172
Mr. ROSENTHAL. With Manufacturers Hanover?
Mr. S M I T H . I could have. I t would have been a very, very unusual
undertaking, but I was prepared to engage in that sort of unusual
undertaking.
Mr. ROSENTHAL. I n hindsight,-the stockholders might have been happier under those circumstances than they are today.
Mr. S M I T H . This is in effect what we hinted that we would do in
the Security takeover by Chemical. And the fact is that those shareholders have got some $30 million or $35 million to look forward
to in that case—versus zip.
Mr. ROSENTHAL. Was Sindona opposed to the merger ?
Mr. S M I T H . I never discussed it specifically with him; but, my guess
is that he probably would have been; yes. Obviously, any commercial
merger would have occurred at a per-share value far below what he
had paid to come into the bank. I can't explain it, but I had the feeling that this guy somehow thought this was going to get turned around.
Mr. ROSENTHAL. Did David Kennedy at any time convey to you
Sindona's opposition to the merger ?
Mr. S M I T H . He indicated to me, at one time when he agreed to go to
London in pursuit of interests, that Sindona would be more interested
in a London bank's coming in as a coowner of the Franklin Corporation, rather than in selling all of his stock. But he told me that Sindona
had agreed that if that were the only way to go, he w^ould be willing
to sell his stock. I t was a kind of a borderline position, as I understood
it.
Mr. ROSENTHAL. H O W many conversations did you have with David
Kennedy about the Franklin situation ?
Mr. S M I T H . The first occurred, as I have said, on Sunday morning.
Let me describe the background of that.
We were preparing to meet at the Federal Reserve to discuss whether
or not the New York Federal Reserve Bank should be prepared
to extend liquidity support to the Franklin Bank. As I recall it, we
had received a call from Mr. Gleason, and later from Mr. Sindona,
indicating that if the Franklin National Corporation's directorate
would recommend, and if its shareholders would approve, the issuance of an additional $50 million in capital stock to be offered on a
preemptive rights basis, that Mr. Sindona would be willing to guarantee that rights offering and pick up any stock not purchased by other
shareholders.
I conveyed that proposition to those Governors who were present
at the Fed. George Mitchell, the Vice Chairman, was presiding. We
were really in an informal session at that point.
And all of us were not particularly pleased with enlarging Mr.
Sindona's ownership interests because he was obviously a negative factor in the market's reaction to this institution. There were a lot of
stories about him. I did not know whether they were true or false; but
I did know that he was not helping the market's appraisal of this
institution.
After we had chatted about it for awhile, they said, " I t is really
the only game in town at this particular point. Why don't you talk to
Sindona and see whether he would be willing to set up any sort
of voting trust for both the stock he holds today and the additional
17H
stock that he would acquire for some stated period—a year or 2—and
appoint a trustee acceptable to us as well as to him."
I got Mr. Sindona on the phone; I made the proposition to him.
I told him why we felt that was necessary. And I suggested to him
that a likely trustee of the stock would be Norman Schreiber.
Something had happened between Schreiber and Sindona. They
were having personality difficulties at that point. And Sindona said
"No; I will not accept Schreiber. But I will accept David Kennedy,
who happens today to already have the coequal authority to vote this
stock."
Mr. ROSENTHAL. I hate to interrupt }Tou, but this is what was happening on Sunday. I would like to turn back to Saturday.
On Saturday, McGillicuddy and his team and their lawyers met
with the Franklin team and their lawyers.
Mr. S M I T H . Right. We are moving on two tracks at the same time,
Mr. Chairman.
Mr. ROSENTHAL. As of Saturday, Mr. Luftig testified that Mr. McGillicuddy was very keenly interested in a merger if everything could
fit into place.
Mr. S M I T H . That was my impression, too.
Mr. ROSENTHAL. At some point Gleason left the meeting and went
down to the office of Mudge, Rose. That is the firm that John Mitchell
was a partner in.
Mr. S M I T H . Yes, sir.
Mr. ROSENTHAL. They are also Sindona's lawyers.
Mr. S M I T H . I think Mr. Guthrie of that firm is
Sindona's lawyer;
yes.
Mr. ROSENTHAL. Were either you or Mr. Van Horn down in that
office on that Saturday ?
Mr. V A N HORN. I was not.
Mr. S M I T H . I know I wasn't
because I was in the Treasury Department in Washington.
Mr. Chairman, I can understand the question that you are having
because we were, at that point, moving on two alternative courses. A
final decision had not yet been forthcoming from the Manufacturers
Hanover as to whether or not they were interested in a merger. And
we were exploring anv and every other possibility.
Mr. ROSENTHAL. Did Manufacturers Hanover at any time say that
they had turned around and w^ere definitely not interested in a merger?
Mr. S M I T H . Yes. That is what Gabriel Hauge said to me at, I think,
noon on Monday—whatever that date was.
Mr. ROSENTHAL. Did he tell you when they reached that decision?
Mr. S M I T H . NO, sir: he did
not.
Mr. ROSENTHAL. Was Hauge the chairman of the board of Manufacturers ?
Mr. S M I T H . He was the chief executive officer; yes, sir.
Mr. ROSENTHAL. What was McGillicuddy ?
Mr. S M I T H . President and chief operating officer. I think that is still
the designation.
Mr. ROSENTHAL. And it is clearlv your position that Kennedy's relationship with Sindona had nothing to do with the breaking off of
the merger possibilities ?
74-548 0—76
12
174
Mr. S M I T H . I am certain that it did not because Kennedy did not
even know what was happening over that weekend until I called him on
Sunday morning. I do not know what time that was out in Seoul,
Korea. I insisted on calling him because if Sindona said, " I am willing
to surrender my voting position to David Kennedy," I obviously was
not going to accept that unless I had David Kennedy's concurrence
to perform in that role.
And I said, " I t is probably going to become a publicized fact. Does
that trouble you ?
And he said, "No, I will accept that responsibility."
Mr. ROSENTHAL. I S Kennedy still a partner of Sindona ?
Mr. S M I T H . I don't have any idea of what their relationship is, Mr.
Chairman.
Mr. ROSENTHAL. Sindona has been indicted or wanted for extradition, hasn't he ?
Mr. S M I T H . I think he has. I do not know what the circumstances
are in Italy. He has not been indicted here.
Everything that I know is hearsay. And to be perfectly honest,
that is about all I knew in May of 1974, too.
Mr. ROSENTHAL. There is something that still troubles me. On Saturday afternoon, Manufacturers Hanover was keen about the merger.
But apparently something happened between Saturday and Sunday.
Mr. S M I T H . My guess of what happened was that it was on Sunday
that the full extent of that unauthorized foreign exchange trading
came to light, with the magnitude of that possible loss in excess of
$40 million. My guess is that that was enough to cut off a budding
marriage.
Mr. ROSENTHAL. A S I recall, Luftig testified that that information
was available and that he, Luftig, said to McGillicuddy, "You now
have all of the information about the foreign exchange loss. Are you
still interested?"
And McGillicuddy said, "yes."
Mr. S M I T H . I t may have been known, but, according to my recollection—and I will check with Bob Mullin—that number was going up
almost by the hour on late Saturday and early Sunday. When we first
heard about it, they were talking about, as I recall, something on the
order of $25 million. And by Sunday evening, they were up over $40
million.
I might say that if I had been on the other side of the transaction, I
would have been a little uneasy too as to how much I actually knew.
I t is a very tough call, Mr. Chairman, to come into a $5 billion institution over the weekend and decide whether you are going to commit
yourself.
Mr. ROSENTHAL. I t may be my inexperience, but in a $5 billion
institution, does the difference between $25 million and $40 million
make much difference ?
Mr. S M I T H . I t did with the capital position of this bank. There is
no possibility, if you had to put $30 million or $40 million or $50 million or $60 million into that bank with its locked-in portfolio, that
you would earn anything on that money for quite a period of time.
Mr. ROSENTHAL. Let me ask one last question and then I want to
get to my colleagues. Manufacturers was particularly interested in
this bank because it gave them an outlet into the Long Island market.
175
Mr. S M I T H . They seemed the absolute natural. And the fact also
that they had just, a matter of 30 or 60 days before, advanced the
holding company a $30-million loan made them a likely candidate to
protect what they already had invested.
Mr. ROSENTHAL. Was David Kennedy in any way associated with
the European-American group that finally came in ?
Mr. S M I T H . No; I am certain that he is not. That is a consortium
of about six major European banks.
Mr. ROSENTHAL. And to the best of your knowledge, he has no association either with that consortium or with any of the six banks.
Mr. S M I T H . Yes,
sir.
Mr. ROSENTHAL. Mr. Brown.
Mr. BROWN. Mr. Smith, we have talked about the Saturday and
Sunday. And you have said that there were two parallel transactions
going on. Did you at any time on Saturday participate or have any
input into the discussions which Manufacturers Hanover was having
with Franklin?
Mr. S M I T H . Only to the extent that I have talked with Gabriel
Hauge and indicated through the reference to the Wellsville case my
willingness, if it became necessary, to undertake that very unusual position of perhaps standing in for the bank's owners in order to consummate a sale.
Mr. BROWN. And to the extent that you participated, limited though
it was, your participation was consistent with and encouraged a
merger.
Mr. S M I T H . Yes, sir. As I have said, I would have been a damned
fool not to have supported the merger. I am a lot of things, but I do
not think that I am a damn fool.
Mr. BROWN. And what you were doing when you were contacting
Sindona and Kennedy was to see what could happen in that option
in the event the merger discussions did not prove satisfactory ?
Mr. S M I T H . Yes, sir. This was constantly a balancing of alternatives
as we proceeded after that time to seek out merger partners abroad.
When Manufacturers Hanover said, "No," we were all satisfied that
no other New York bank was going to step up in a normal commercial
transaction. So from that date and beyond, we were still proceeding to
seek out a possible commercial transaction abroad. But at the same
time, we brought about the unusual undertaking of asking the New
York Clearing House to go in and give us its management judgments
as a group about the bank.
Now that was bona fide in the sense that we did indeed welcome
their considerable expertise. But it was also to serve a secondary
purpose of beginning to acquaint every member of that clearing house
with the Franklin in the likelihood that we had to move to an F D I C
assisted transaction. We at least had that step up on the learning curve
already accomplished.
Mr. BROWN. I gather, from what has been a rather interrupted discussion of the Sunday telephone calls, that David Kennedy agreed to
act as the voting trustee.
Mr. S M I T H . Yes, sir; he did.
Mr. BROWN. But you never went
Mr. S M I T H . I t went to the point
through with that transaction.
that the proposal was presented to
the Franklin board during the following week. We asked Mr. Sindona
176
to tender his proposal to the board in writing—which he did. So to
that extent, it proceeded ahead. But it was then going to have to be
approved by a shareholders' meeting which never in fact occurred.
And by the time we got to that point, it was apparently going the
F D I C route anyway. So we just did not continue to pursue it.
Mr. BROWN. But you did attempt to pursue the Sindona infusion of
capital proposal until after you had heard on that Monday that the
merger discussions had broken up?
Mr. S M I T H . Yes,
Mr. BROWN. I t
sir.
bothers me that we have name dropping and that
we have in this committee tried to indicate that there is some hankypanky going on or something. I t seems to me that it should be fairly
easy and simple to get Manufacturers Hanover to come in and say
whether or not, as you say, you were supporting the merger or if you
were telling them something different. I happen to prefer to believe
you and I think that wTe should not just leave this up in the air. I
think we ought to bring in somebody from Manufacturers.
Mr. S M I T H . Clearly, the best evidence is Mr. Hauge.
Mr. BROWN. I have no further questions.
Mr. ROSENTHAL. Congressman Drinan.
Mr. DRINAN. Thank you, Mr. Chairman.
On that weekend, Mr. Smith, did you feel that you had adequate
information about the status of Franklin to come to some conclusion
as to which option you should recommend?
Mr. S M I T H . Clearly, the merger option was the preferable one. We
knew that we were in extremis; we knew that this bank was exceedingly vulnerable to a liquidity hit once the bank opened on Monday.
And, of course, that in fact happened. In 10 days, nearly $1 billion
rolled out of there. So we were fully aware of that likelihood.
Mr. DRINAN. Was there any way by which Mr. Hauge's offer to
take over the Long Island branches could have been accepted ?
Mr. S M I T H . NO. I do not think that we would have seriously entertained that even on Sunday. That becomes an exceedingly difficult
operation. Later on, well down the road, when the F D I C was in the
picture, we considered a proposal at one point from First National
City that they would come in and be the original acquirer and then
disseminate branches to various banks in New York.
I t was their idea. But once they got into the details of it, they
finally came back about 2 weeks later and threw their hands up in the
air and said, "Forget it; it just cannot be done."
The difficulty is trying to balance assets and liabilities—loans with
deposits. And it is just an enormously complex undertaking.
Mr. DRINAN. Coming back to the relationship between David Kennedy and Mr. Sindona, my understanding from what we have heard
before is that Mr. David Kennedy phoned you in January of 1974 and
set up a meeting between you and Mr. Sindona and Mr. Kennedy—
or at least between you and Mr. Sindona. Is that an accurate statement?
Mr. S M I T H . I think that Secretary Kennedy did call me. I am not
certain whether it is with respect to that meeting or whether it was
the meeting in late 1973. I will have to go back and check my own
records. They may be one and the same meeting.
177
But the purpose was for Sindona to make a courtesy call and to
talk to me about the proposed Talcott transaction which never came
off.
[The information referred to follows:]
Mr. Kennedy called Mr. Smith on January 17, 1974, and requested an appointment for Mr. Sindona. The meeting with Mr. Sindona was held on January 23,
1974.
Mr. DRINAN. Did you make any memos for the file about your
meeting with a shareholder of a bank?
Mr. S M I T H . NO, sir, I did not. I am not in the habit of writing a
lot of memos for the file. Maybe I am at fault in that.
Mr. DRINAN. D O you think there should be regulations about a thing
like that?
Mr. S M I T H . This was not a shareholder of a bank as such; it was
a shareholder of the holding company that owned the bank. He was
talking to me about a proposed acquisition of the holding company,
and one which he deemed was going to strengthen the whole organization.
The Federal Reserve, which was charged with making the decision
in that matter, reached a contrary decision. And I would be hard put
to say that it was a wrong decision.
Mr. DRINAN. Have the regulations which you have been telling us
about brought about a situation where a case like the Franklin could
never happen again ?
Mr. S M I T H . I am not talking about regulations, in large p a r t ; I am
talking about procedures. And I think that, barring extreme circumstances in the financial market, we feel that we have the tools today
to never let a situation in a major money market bank develop to the
point that it would be threatened with insolvency.
I am not going to make the same guarantee for very small banks
because it does not take a very sizeable event to threaten one of those
with insolvency.
Mr. DRINAN. D O you think that the procedures that you developed
will correct the situation that we have discovered in the First National
Bank of East Islip?
We had Mr. Aaron Donner testify that he was assured regularly
that the provision of law which makes acquiescing directors personally
liable for losses on loans in excess of legal lending limits was not enforced by the Comptroller. He learned that from all types of important
sources.
One, is that assertion true; and two, has there been any correction ?
Mr. S M I T H . I t is not a clear-cut legal judgment, to begin with, Congressman. Where we find a loan made in excess of the bank's legal lending limits approved by the directorate and where loss accrues on that
loan, we regularly endeavor to persuade the directors to hold harmless,
in effect, the bank—to either take the loan out or to guarantee the
margin of loss.
Sometimes we are successful in those persuasive undertakings; sometimes we are not. I think there is open question as to whether we have
further authority. There is the possibility that we could undertake
initiatives to cause the bank itself to sue the directorate. But we do
not have any independent authority to do that. That is something
178
which I think is worthy of consideration—whether or not the supervisory agency should have the authority to sue in behalf of the bank.
Mr. DRINAN. SO Mr. Donner's contentions are correct. And when
he talked to Mr. Jacobsohn of the legal department of the Comptroller's Office, he discovered that Mr. Jacobsohn, said that theoretically
the Comptroller should respond to loans in excess of the statutory
limit by holding the directors individually liable, but that they do not
do it. Do you want statutory power to do t h a t ; or do you need such
statutory power ?
Mr. S M I T H . We clearly do not have the statutory power today to
bring suit ourselves.
Mr. DRINAN. But that is not in the recommendations that you made
to us this morning ?
Mr. S M I T H . N O , sir.
Mr. DRINAN. SO, therefore,
you have not corrected this situation in
East Islip.
Mr. S M I T H . But what did happen in that case was that we did,
through our securities unit, cause disclosure to occur, which caused
the minority shareholders to bring suit, which suit is still ensuing.
And that is the best of all courses of action. There you have litigation
between the real parties.
But failing that, I think it is worth considering whether or not the
banking supervisory agencies should have the authority to bring suits
themselves.
Mr. BROWN. Would the gentleman yield ?
Mr. DRINAN. Yes.
Mr. BROWN. What would the
Mr. S M I T H . The suit would
suit seek ?
seek restitution in behalf of the bank,
and, thus, the bank's shareholders. In other words, this is a loan which
has been approved in violation of the law by the directorate of the
bank. I t has resulted in a loss to the bank, and, thus, to the bank's
shareholders.
Mr. BROWN. But would you have to wait until there has been a loss ?
Otherwise, what is the damage ?
Mr. S M I T H . I t is a question of time. We always seek to have the overline corrected—usually through a sale of all or a part of the loan to
another lender.
Mr. DRINAN. I have one last question, Mr. Smith. Your Deputy
Comptroller, Mr. Bloom, testified in the recent past here that the policy
is not to disclose any of these bank examination reports. He said that
this would jeopardize the relationship.
You said something here about disclosure. But is it still the policy
of your Office not to disclose under any circumstances the adverse reports that your examiners might make about a particular bank ?
Mr. S M I T H . Yes. I do not think that we, Congressman Drinan, ought
to be disclosing our judgment.
Mr. DRINAN. Then there is no way by which the depositors or consumers can be warned. This is important. Mr. Bloom insisted upon
that. And I think that is a wrong policy and that the depositors of the
Franklin should have gotten some warning. And I think that you
have the duty of going to them. If you do not have sufficient statutory
power to do that, I think that we ought to give it to you.
Who is going to warn the depositors ?
179
Mr. S M I T H . We have all kinds of public disclosure about banks.
Banks and bank holding companies are subject to the disclosure requirements of the Federal Securities law. And that is the way the
disclosure should occur.
Banks are privately owned corporations which have to compete in
the capital market, Congressman Drinan, for their capital, along with
all other business corporations. Now there is no Federal agency which
discloses to the public its subjective judgments about General Motors
or A.T. & T. I say cause banks and bank holding companies to disclose
four-square with other sellers of public securities, but do not impose
more disclosure.
Mr. DRINAN. General Motors is not a regulated industry. That
analogy is absurd.
Mr. S M I T H . I do not think it is absurd at all. I n other words, if you
wish to have a special market that funds only regulated industries
and figure out how you are going to dragoon people into participating
in that market, then maybe your point of view will be sustained.
Mr. DRINAN. A simple warning to Franklin, saying, "We are going
to disclose these objective facts, not subjective conclusions, a week
from Monday." would have caused Franklin to shape up. Thank you
very much.
Mr. EOSENTHAL. Has the Victor group listing replaced what we had
read about at one time as the "Problem Bank" list ?
Mr. S M I T H . Yes, sir.
Mr. EOSENTHAL. H O W many banks are
Mr. S M I T H . At the last report that I
in this Victor group ?
made—and I think it is still
current—we have some 27 banks under intensive surveillance by the
special situations group; and another 50 to 60 banks which we have
doing more than normal reporting, but which we do not regard as
problem banks.
Mr. EOSENTHAL. Of the 27, are any of them of the size of Franklin or
are they major money market banks ?
Mr. S M I T H . We have a couple of banks in the $1 billion plus class.
But I would not categorize them with Franklin. Their liquidity situation is nothing like Franklin's either.
Mr. EOSENTHAL. Thank you very much, Mr. Smith, for appearing
today.
The subcommittee stands adjourned.
[Mr. Smith's prepared statement follows:]
180
PREPARED
STATEMENT
OF
JAMES
E.
SMITH,
COMPTROLLER OF THE CURRENCY
I appreciate this opportunity to appear before the
Committee in connection with its inquiry into the Comptroller's regulatory
processes.
In this hearing the Committee is attempting to evaluate
those processes through a study of the Franklin National Bank, which
was placed in receivership on October 8, 1974.
I believe that we can learn from our past experiences, both
good and bad.
Thus, as the Committee staff testified last week,
I initiated even before the failure of Franklin National Bank a
special study of the events leading to the bank's difficulties.
This Committee's record on Franklin National Bank would be
incomplete, however, without including information on (a) the
behavior of the financial market place during the critical years
1970-1974 and (b) the changes that have occurred in the Comptroller's
Office.
I. The Financial Market Place and Its Effect on Franklin
National banks are privately owned corporations.
The most
important decisions made in each bank are those of the bank's own
board of directors and management, responding to competitive
pressures and opportunities.
Thus no inquiry into the failure of
Fran's- lin National Bank can be complete without an examination of
the decisions made by the Franklin management in the context of
the then existing market place environment.
Inflation during the 1970-1974 period was rampant: because
of the effects of the Vietnam war, an expansionary monetary policy
and other such factors, consumer prices increased by 31.9% from
1970 to 1974. At the same time, the steepest recession since the
Great Depression of the 1930's had set in.
From the banker's point of view, the greatest problem was the
enonr.ous increase in interest rates: the Federal funds rates during
the summer of 1974 rose to an unprecedented 12.9% and the prime rate
181
-2was at a staggering 12.1%.
The basic cost of money to banks
aggressively using liability management during the 1970-1974 period
had increased an incredible 105.3% during this time.
Franklin was
particularly ill-suited to survive these economic pressures.
Franklin was a marginal operation throughout the 1960's, yet
the bank managed to operate and grow to a $3 billion institution by
the end of 1969 without arousing any significant, concerns by this
Office or the financial industry.
Despite its apparent progress,
however-particularly in 1968 and 1969-the bank had neither the management depth and acumen nor the operational systems and controls to
cope with its ambitious expansion program and the financial perils
of the 1970's.
Had the bank curtailed its activities after 1969
and solidified its position in the marketplace, the results may have
been different.
By December 31, 1973, Franklin's resources exceeded $5 billion.
The bank's management proved incapable of developing and handling
the sophisticated asset and liability management techniques necessary
for a bank this size.
During the 1960's and early 1970* s, the money market, banks,
faced with declining rates of growth in deposits, sought new ways
to meet the heavy credit demands of their customers.
In consequence,
Franklin and other banks placed less and less reliance on the generation
of liquidity through asset composition and cash flow.
Instead,
increasing emphasis was given to acquisition of deposits and the purchase of a wide array of borrowed money, including Federal funds,
Eurodollars, negotiable CD's and long-term debt.
Franklin thus was able to buy its liquidity in the marketplace
to support its rapid asset growth. In retrospect, Franklin's
liability structure and asset structure made the bank exceptionally
vulnerable to the confidence of the money markets.
182
-3Confidence in financial institutions declined significantly
in 1973 and 74 as a result of bank failures, both here and abroad,
significant foreign exchange losses in several major banks and evidence
of deterioration in bank loans to struggling real estate firms, airlines, public utilities and the like.
This decline in confidence,
coupled with steadily rising interest rates, tight money conditions,
high inflation and the beginnings of a recession led to a rush to
safe havens for funds.
The very largest banks with unquestioned
national and international reputations were the direct beneficiaries,
since the money market participants seemed to be making the judgment
that biggest also meant safest.
Marginally operated and smaller money
center banks like Franklin were often denied funds altogether or were
forced to pay high premiums for a limited amount of funds.
The tiered
markets which developed forced many banks to scramble to avoid negative margins and to assure liquidity adequate to meet the claims
against them.
Franklin had long term, low yielding assets in both
its .loan and its investment portfolios, and thus was locked into a
negative margin between the cost of the funds it borrowed and the
uses it made of those funds.
Under these turbulent market conditions, Franklin struggled.
The money market's continuing concern about Franklin was greatly
aggravated in the spring of 1974 when significant problems were disclosed and market rumors about substantial losses became generally
known.
A loss of confidence occurred and a massive outflow of funds
resulted, from which Franklin never recovered.
The specific actions
taken by the Comptroller's Office during the November 1973 through
183
-4October 8, 1974 Franklin difficulties are detailed in the Appendix
to my statement.
The lesson that all banks could not always be assured of equal
access to the money markets was a rude awakening for many banks
practicing liability management, and an important lesson for us.
We believe we now have the sophisticated analytical techniques and
a far better understanding of money market banks to take remedial
action early and effectively.
However, because our powers —
by design -- fall far short of
actually running a bank, there .will always be a limit on our capacity
to insure a fail-safe national banking system.
II.
Changes in the Comptroller's Office
The Committee staff's testimony last week mentioned several
times the year-long study and report on the Comptroller's Office by
the nationally known management consulting firm of Haskins & Sells.
There was apparently no direction to the Committee staff, however,
to evaluate the many changes which have resulted from implementation
of the recommendations in that report.
As the Committee knows, the General Accounting Office is now
undertaking a full scale review of the operations of the Comptroller's
Office.
GAO's report is expected to deal with these changes in our
regulatory and supervisory procedures.
Meanwhile, however, I should review for the Committee some of
these changes in order to dispel the erroneous impression that might
be left in the record from the limited scope of the testimony already
presented to this Committee.
Domestic Examination Procedures
Substantial improvements in national bank examination procedures
now are being adopted.
184
-5The new procedures will gear examination efforts more precisely
to the needs of the Comptroller's Office and the particular bank
being examined and will stress review of bank internal controls, such
as credit and investment rules, and internal audit procedures.
Examiners
will devote more time to the review and evaluation of the bank's own
policies and procedures, its decision-making process, and its management information system.
Had these new examination procedures and
processes been in place earlier, they may have enabled the examiners of
the Franklin National Bank to perceive much earlier the inherent weaknesses in the bank's philosophy, policies, and procedures which
eventually created the problems leading to its demise.
In addition to these new examination processes, major revisions
are being made in the examination report itself.
The primary purpose
of the revised report of examination is to communicate meaningful
information effectively to both the Office of the Comptroller of the
Currency and to bank directors and management.
The report must clearly
identify the problems of special concern to the examiner, the factors
that have caused the problems, and the remedial action that is suggested.
To promote effective communication of these matters to the intended
recipients, the new report of examination is divided into three sections
designed to explain the relative importance of the examiner's findings
of problems and causes and to indicate recommended corrective action
to the applicable recipient.
The first section of the report is designed specifically for the
immediate benefit of the Board of Directors and its Examining Committee,
as well as senior management.
It is to be in letter form and will set
forth the scope of the examination plus a summary of all critical
comments, in narrative form, backed by appendices and schedules that
will support the conclusions in sufficient detail to enable the Board,
185
-6or its representatives, to take specific corrective action.
The
examiner's comments are to include probable problem causes and
recommended actions to assist the Directorate with this aspect of
remedial responsibility.
The second section of the report consists of various schedules,
technical irregularities and deficiencies, and comments by the examiner
relative to the conclusions and evaluation of specific areas.
This
section will be a checklist against which a bank's auditor, cashier,
or other designated officer can effect correction and against which the
bank's Board of Directors and/or senior management can measure the
progress of the corrective action.
The third section of the report is designed specifically for the
Comptroller's Office, although we will receive copies of all three
report sections.
The third section will include confidential information
and a certain amount of additional informative data necessary to the
operation of our Office.
The confidential section will set forth matters
requiring the prompt attention of our senior staff, such as:
-Suspected violations of law uncovered during the course
of the examination reported, or to be reported, to the
appropriate Comptroller officials or other regulatory
an enforcement agencies.
-Critical comments relating to senior bank officers which
may require official remedial action by the Comptroller's
Office such as the threat of cease and desist orders or
officer removal.
-Subjective comments regarding management or other matters which
have not been factually proven by the examiner but which,
nevertheless, constitute areas of concern.
As is evident, the report of examination and related procedures
have undergone substantial change.
Perhaps the most important change
is that most of the information previously "hidden" in the confidential
section of the report of examination is now presented in the open
section.
Directors and management of the bank will have no excuse for
186
-7doubt concerning our Office's evaluation of the condition of
the bank.
National Bank Surveillance System
We are also implementing a bank evaluation and monitoring system
called the National Bank Surveillance System (NBSS).
Had this system
been in operation at the time when Franklin's earnings problems were
developing, the system - in coordination with the new examination
procedures -
would have assisted in detecting the detailed causes of
those problems and, more importantly, it could have helped management to correct those problems in a timely manner.
The NBSS consists of four elements:
a data collection system;
a computerized analysis system which detects unusual or changing conditions in any national bank; an analysis of those changes by trained
NBSS specialists; and, of primary importance, an Action Control System.
Rapidly processed reports of condition and income from each
national bank are entered into the system at quarterly intervals.
The
computer calculates fifteen pages of meaningful ratios and percentages
for each bank.
A second computer program summarizes these performance
reports and ranks each bank in an "Anomaly Severity Ranking Report."
This report simply designates those banks in the national banking system
which deserve a priority review.
re-enters the process.
At that point the human element
The trained NBSS specialists review each of
the fifteen page reports and all other relevant data on each bank which
the Anomaly Severity Ranking Report has designated for priority review.
The Anomaly Severity Ranking System covers three basic aspects
of a bank's condition in relation to that of other banks in its peer
group.
It considers the bank's current position in each ratio, its
short term trend in the most recent quarter and its long term trend
over the past five years.
Had the NBSS been in use earlier, it would
have designated Franklin for priority review.
The NBSS specialists
would have noted a number of conditions in the Franklin report,
187
-8including its low and declining earnings; its sources of
those earnings; its inadequate provisions for its reserve for possible loan
losses; and its inability to utilize fully its municipal tax exempt
income.
In view of all of those factors, the hazards involved in its
large, volatile liabilities would have been flagged.
With the Anomaly Severity System having designated Franklin for
priority review, the NBSS specialist would have reviewed the performance report, noted conditions of concern, and then turned to the
Action Control System.
All banks designated for priority review are placed in the Action
Control System quarterly.
The bank cannot be removed from the
Action Control System until the conditions of concern have been corrected.
While the bank remains in the Action Control System, reports will be
made every two weeks showing the progress or the lack of progress in
correcting conditions of concern.
The conditions of concern must be acknowledged by the Regional
Administrator, who has the responsibility for the initiation of
corrective action.
He must respond to the conditions cited in the
Action Control System.
He can achieve correction at his discretion,
but correction and/or his response must be made within 30 days.
The Action Control Reports will also be utilized by various
functional units of the Washington office.
If those reports show a
bank or a region as delinquent or unsuccessful in its corrective
efforts, they can be assisted by other appropriate units such as our
Special Projects staff or the staff of our Enforcement and Compliance
Division.
The NBSS does exist now to this extent.
is flowing into the system.
Fast and accurate data
The fifteen page performance reports are
being produced and they are being utilized in most of our geographic
188
-9regions.
Seven trained NBSS specialists are now in regional offices
and all fourteen regional offices will have trained specialists before
the end of June, 1976.
The Anomaly Severity Ranking Reports have
been utilized repeatedly and they have proven reliable.
We have used
in the banks the results of the reports and the specialists to cause
the correction of serious problems which would otherwise not have
been detected at an early date.
The Action Control Program is a crucial part of the system.
Its
programming is nearly complete; its action, condition and response
codes have been tested and, with the input of the next quarter's data,
the Action Control System is to be implemented.
We will then be using a new system of bank supervision.
We know
that system must remain flexible to cope with the rapid changes in
the banking system.
It must also maintain the proper balance between
its machine-operated segments and those involving good human judgment.
Foreign Exchange Procedures
We are in the process of finalizing a new examination procedures
manual which covers every aspect of foreign exchange trading and
requires written policy goals and guidelines, segregation of specific
duties by trading and bookkeeping personnel, specific confirmation
requirements, internal controls and audit programs.
Recognizing that with relatively minor changes in our old
techniques we might well have found reason to suspect some less than
prudent action on the part of Franklin's personnel, we now require
that the examiner review, not just the most recent, but all monthly
revaluation worksheets since the last examination to insure that
proper market rates were in fact used.
The new procedures, under
appropriate circumstances, require the examiner to intercept all mail
189
-10to insure that all incoming confirmations can be identified with
contracts on the bank's books.
These new examination procedures are
the most comprehensive guidelines written to date.
We have made other modifications in personnel, training, and
examining procedures and policies.
These are designed to help prevent
the occurrence of similar situations in other banks.
We insist that the Board, through senior management, set up
strict segregation of duties and responsibilities for every function
of this and every other area.
Traders should trade and nothing else.
Accounting personnel should be responsible for all accounting, confirmation, revaluation, and other recordkeeping functions, completely
independent of all trading functions.
This would include sending
and receiving trade confirmations and checking discrepancies directly
with the counterparties and reporting these activities to the audit
department, obtaining forward rates for revaluations
independently
and performing these revaluations without interference from the traders.
Auditors must be truly independent from influence by senior management
or by the personnel they are auditing.
They must feel free to report
their findings to proper Board-level committees.
The Position Clerk
should only keep records for the trader and not prepare reports for
management.
This should be a function of the accounting department.
Examiners are evaluating the organization and effectiveness of
this separation of duties and commenting upon deficiencies or overlapping of responsibilities.
Critical comments are made directly
to senior management and the Board.
Examiners include in their examina-
tion procedures an inspection of internal bank reports from periods
between examinations to insure their accuracy and the correctness of
their content.
74-548 O - 76 - 13
190
-11In addition, as part of the "ongoing examination" concept,
while examiners are in the bank they review reports, daily activities,
and similar matters, at least on a test basis, to ascertain if required
procedures are followed as a regular practice and also to determine
any major changes in positions and policies.
The International Banking Group continues its efforts at upgrading
the quality, knowledge, and experience of personnel engaged in examining
international activities.
Examiners-in-Charge of international divisions
are now recommended by the Regional Administrators and final selections
are made by the International Banking Group, based on experience, ability,
and availability.
Additional personnel are participating in quarterly
training sessions on international banking.
This training, both in
general international banking and in foreign exchange, is conducted
by Washington staff personnel, as well as by other authorities from
government agencies such as the Ex-Im Bank and the Federal Reserve,
and by experienced bankers.
An advanced seminar on foreign exchange
trading is also given at least twice annually to help disseminate
knowledge of this subject to as many of our examiners as possible.
In addition, international examiners travel to other areas of the
country in order to help where experienced support personnel are needed,
and gain experience from this increased exposure.
Branch and Other Approvals
Procedures for actions on corporate activities, such as new
branches, mergers and other applications in the corporate area, are
being developed to examine more closely the expansion policies of
a national bank in light of its historical and current condition.
The Comptroller's Office will soon announce policy statements
which will be published for comment by the public prior to their
adoption.
These policies will set forth guidelines under which the
191
-12Comptroller's Office will either grant or deny branches, mergers and
other applications of a corporate nature.
These guidelines will
specify that, if a Regional Administrator wants to approve a branch
or merger which falls outside the guidelines, the application will
get close scrutiny in Washington.
If a particular bank is subject
to special surveillance, its application will undergo special analysis
by the Bank Organization and Structure Division in consultation with
the special surveillance units in Washington.
In short, our new policies in regard to corporate expansion will
permit closer monitoring, in conjunction with our new examination
and analysis techniques, both at the regional and Washington levels.
Operations Review
Prior to 1976 the Comptroller's Office had no formal process
for reviewing in a systematic way the manner in which national bank
examiners perform their examinations to assure that they are performed
consistently in accordance with established instructions and procedures.
Such a formal operations review process is now in place.
It is headed
by a Deputy Comptroller with 27 years examining experience who reports
directly to me.
He is our own internal inspector general.
Under his supervision, examiners in each of our 14 regions have
been specially trained to review the procedures by which banks in
other regions are examined and supervised.
Any exceptions from
established procedures and instructions are noted and reported to the
Washington Office.
Additionally, our Deputy Comptroller for Operations Review is
the person to whom a banker who is fundamentally aggrieved by any
of our regulatory activities can bring his complaint.
These operations review procedures should lessen the possibility
of examinations being conducted improperly or not in accordance with
192
-13the new procedures which are being established by our Office.
Recommended Enforcement Legislation
Although these changes should make our Office more effective,
there are still more tools we need that only the Congress can provide.
The Congress is currently considering enforcement legislation
recommended jointly by the Comptroller, the Federal Reserve Board,
and the FDIC to enable us better to deal with problem banks.
I
urge prompt consideration and passage of this legislation.
The legislation has several provisions.
The first empowers
the banking agencies to assess civil penalties for violations of
various banking statutes and cease and desist orders.
I endorse
the idea of giving the agencies this authority.
Another provision of the bill which I heartily support would
give the banking agencies power to remove an officer, director,
or other person participating in the affairs of the bank from his
position upon being able to show gross negligence in the operation
or management of the bank, or a willful disregard for the bank's
safety and soundness.
Under the present statute, bank officials
can be removed only if the agency can establish "personal dishonesty."
The judicial review provisions already contained in the statutes
are ample to protect against arbitrary or capricious use of this
power.
The procedures by which an officer or a director of a national
bank can be removed also need amendment.
Under existing law, the
Comptroller lacks power to remove a bank official unless that official
has been indicted.
If he has not been indicted, the Comptroller can
do no more than certify facts to the Federal Reserve Board.
The
Federal Reserve is given the responsibility for issuing a notice
of proposed removal, prosecuting the case, hearing the evidence
193
-14and making the final decision.
The Comptroller cannot even
institute the proceeding.
This procedure is so cumbersome to use that neither the Federal
Reserve Board nor ray Office believes that it has been very effective.
We thus have recommended a provision which would empower the
Comptroller to institute and prosecute proceedings.
The Comptroller
also would have the power to suspend a bank official pending completion of the proceedings.
The Federal Reserve Board, however, would
retain its authority to hear the case and make final decisions.
I
am in complete agreement with this recommendation.
In addition to this general statement on Franklin and the
operations of our Office, responses to specific questions in your
letter of invitation of May 4, 1976 are addressed in the Appendix!/
to the statement.
1/ Appendix is in the subcommittee's files.
[Whereupon, at 12:15 p.m., the subcommittee adjourned, to reconvene subject to the the call of the Chair.]
A P P E N D I X
ADDITIONAL MATERIAL AND CORRESPONDENCE SUBMITTED FOR
THE RECORD
U.S. District Court, E a s t e r n District of New York
Civ. No. —
AFFIDAVIT
I n the m a t t e r of the liquidation of
F R A N K L I N NATIONAL B A N K , A NATIONAL B A N K I N G ASSOCIATION
STATE OF N E W YORK,
County of New York, ss:
J A M E S E. S M I T H , being duly sworn, deposes and s a y s :
1. I a m the Comptroller of the Currency of the United States. I have held t h a t
position since July 5, 1973. I submit this affidavit in support of the petition of the
F e d e r a l Deposit I n s u r a n c e Corporation ( " F D I C " ) as receiver for court approval p u r s u a n t to 12 U.S.C. § 192 of a proposed sale of assets and transfer of
liabilities of F r a n k l i n National Bank.
2. I make this affidavit upon t h e basis of personal knowledge and the official
records of the Office of the Comptroller of the Currency.
3. The Office of the Comptroller of the Currency w a s established in 1863 a n d
is a bureau of the United States Department of the Treasury. T h e Comptroller
supervises the national banking system and is charged with t h e responsibility for
executing laws relating to the national banking system (12 U.S.C. §§ 1 and 2 ) .
There are more t h a n 4,600 national banks located throughout the United States.
The Comptroller's Office is required to examine each of these banks three times
in every two years (12 U.S.C. § 4 8 1 ) . To perform this task, the Comptroller's
Office employs 1,952 persons as national bank examiners or assistant national
bank examiners. T h e Comptroller also approves or disapproves the c h a r t e r i n g of
new national banks (12 U.S.C. § 2 7 ) , applications by existing national banks
to establish branches or to relocate banking offices (12 U.S.C. §§ 30 and 36), applications to merge or consolidate banks when the surviving bank is a national
bank (12 U.S.C. §§ 214, 214a, and 1 8 2 6 ( c ) ) , and changes in the capital structure
of a national bank (12 U.S.C. §§ 57 and 5 8 ; 12 C.F.R. P a r t 14). T h e Comptroller
also determines when a receiver should be appointed to close up a national bank
because the Comptroller has become satisfied of the bank's insolvency (12 U.S.C.
§191).
4. One of the national banks supervised by the Comptroller of the Currency is
F r a n k l i n National Bank, Brooklyn, New York. F r a n k l i n National B a n k was
chartered by the Comptroller's Office in 1926. In 1969 the Comptroller approved
the corporate reorganization under which all outstanding shares of F r a n k l i n
National Bank, except for directors' qualifying shares, were acquired by F r a n k l i n
New York Corporation. F r a n k l i n New York Corporation is a publicly owned
company whose securities a r e registered with t h e Securities Exchange Commission ("SEC") and whose only substantial asset is shares of F r a n k l i n National
Bank. As of December 31, 1973, Franklin National B a n k was the twentieth largest bank in the United States with total resources of $5 billion, total deposits of
$3.7 billion, and total loans of $2.4 billion. I t has a main office and 103 branches,
most of which a r e located in Long Island, New York.
5. A regular examination of F r a n k l i n National Bank by the Office of the Comptroller of the Currency p u r s u a n t to 12 U.S.C. § 481 began on November 14, 1973,
and concluded on March 8, 1974. This examination disclosed t h a t F r a n k l i n had
serious financial problems. As of November 14, 1973, total resource had grown to
(195)
196
$4.9 billion, or 29 percent greater t h a n shown by the prior examination of t h e
bank on December 8, 1972. I n the same period, however, the capital of t h e bank
h a d increased less t h a n one-half of one percent, and demand and savings deposits h a d declined by 5.5 percent. The bank's growth h a d been financed almost
entirely by the use of short-term borrowed funds, including so-called money-market certificates of deposit, and time deposits of other banks. These borrowings
were as follows:
Type of borrowing
Net Federal funds purchased l
Bonds sold under agreements to repurchase
All certificates of deposit
Time deposits of other banks
Borrowed securities
Total
Nov. 14, 1973 Dec. 8, 1972
(millions)
(millions)
Difference
(millions)
Percentage
increase
$570
$221
$349
124
16
475
535
48
108
151
421
-45
158
675
32
79
-94
984
76
2 626
956
3
2,279
1,295
1
Computed for each date by subtracting Federal funds sold by Franklin to other banks from Federal funds purchased by
Franklin from other banks.
2
1 ncludes $445,000,000 of so-called money market certificates of deposit, which are (a) in amounts greater than $100,000;
(b) unregulated as to interest rate; and (c) of short-term maturity, usually less than 1 yr.
These funds totaling $2.3 billion, or 50 percent of the bank's liabilities, were of a
highly volatile n a t u r e a n d were likely to be w i t h d r a w n from the bank rapidly
in the event t h a t there w a s any reason to question the soundness or stability
of F r a n k l i n National Bank. For example, as to Federal funds, which a r e excess
reserves of one bank loaned (or "sold") to another bank, usually on an unsecured overnight basis, there is no assurance t h a t the funds may be borrowed
(or "purchased") again t h e next day.
I n addition, t h e November 14, 1973 examination showed uncollectible loans
totaling $10 million, and loans whose credit quality was criticized, although the
loans were not necessarily deemed uncollectible, of $275 million. The amount of
the criticized loans equaled 162 percent of the bank's equity capital of $170
million. The bank also had outstanding $3.8 billion in contracts to buy or sell
foreign currency at a future date, a volume which far exceeded the bank's
n o r m a l needs and showed heavy speculation in foreign currency. Additionally,
t h e bank's operating income was poor. I t w a s apparent t h a t the bank's poor
earnings, potential loans losses, or extended foreign exchange position might
easily cause a loss of confidence in the bank, which in t u r n would result in a
serious and overwhelming liquidity crisis. Representatives of the Comptroller's
Office met with the bank's board of directors to advise them of my concern
about the bank's condition and to seek corrective action.
6. On April 18, 1974, F r a n k l i n New York Corporation announced net opera t i n g income, after securities transactions and preferred dividends, for t h e first
q u a r t e r of 1974 of $79,000, or two cents per share. The comparable earnings
figure for the first q u a r t e r of 1973 was $3,123,000, or sixty-eight cents per
share, the announcement stated in p a r t t h a t income was " . . . adversely
affected by the s h a r p rise in the cost of short-term borrowings needed to c a r r y
assets during the 1974 quarter."
7. During the week of May 6, 1974, the Comptroller's Office and t h e F e d e r a l
Reserve System learned from F r a n k l i n National Bank t h a t severe losses, whose
exact amount h a d not yet been determined had occurred in F r a n k l i n ' s foreign
exchange department. The management of F r a n k l i n New York Corporation
decided to announce these losses, and it was apparent t h a t such a n announcement would dry up the bank's sources of borrowed funds, thus resulting in a
severe liquidity crisis. I n anticipation of this liquidity crisis F r a n k l i n sought
approval for an immediate and massive loan from the Federal Reserve B a n k
of New York should it become necessary.
8. On Friday, May 10, 1974, F r a n k l i n New York Corporation announced t h a t
its mangement would recommend to its board of directors at the board's n e x t
scheduled meeting on Thursday, May 16, t h a t the board not declare the regular
dividends on the company's common stock and convertible preferred stock. The
announcement attributed this recommendation to the small profit for the first
q u a r t e r of 1974 and to management's preliminary estimate of operating results
for the second quarter. On Sunday, May 12,1974, F r a n k l i n New York Corporation
197
announced t h a t the foreign exchange department of the bank had discovered
that, because of a t r a d e r in t h a t department operating beyond his a u t h o r i t y
and without the bank's knowledge, the bank h a d sustained losses of $12 million,
and additional losses might be as high as $25 million. I n addition, t h e Corporation requested the SEC to suspend t r a d i n g in the company's securities. The SEC
did so suspend trading, and t h a t suspension is still in effect. The SEC h a s since
been conducting a private investigation into the accuracy of F r a n k l i n New
York Corporation's financial statements.
9. These announcements caused a d r a m a t i c decline in t h e ability of F r a n k l i n
National Bank to borrow funds from the sources listed in P a r a g r a p h 5 of this
Affidavit, as follows:
Type of borrowing
Net unsecured Federal funds purchased.
Bonds sold under repurchase agreement
Money market certificates of deposit
Other certificates of deposit
Time deposits of other banks
Borrowed securities
Total
May 10, 1974 June 28, 1974
(millions)
(millions)
Difference
(millions)
Percentage
decrease
103
45
68
52
42
50
$330
-$11
$341
341
468
242
689
16
186
151
116
399
8
155
317
126
290
8
849
1,237
59
This large run-off of borrowings and money-market instruments created a
severe cash d r a i n which the bank could meet only by massive borrowings from
the F e d e r a l Reserve Bank of New York. I n its press release of May 12, 1974,
F r a n k l i n had announced t h a t the Federal Reserve System was prepared to
advance funds to F r a n k l i n as needed, within the limits of acceptable collateral—
an a r r a n g e m e n t which prevented F r a n k l i n ' s immediate collapse. By May 22,
1974—just ten days after the F r a n k l i n announcement—the Federal Reserve
B a n k loan h a d reached $1,125 billion. F r a n k l i n National Bank was unable to
meet its need for cash by selling the bank's portfolio of securities because the
m a r k e t value of its portfolio had declined due to a general rise in interest r a t e s
and because many of the bank's securities were pledged to secure public deposits
or t r u s t department obligations. As of J u n e 28, 1974, depreciation in t h e bank's
securities portfolio was $129 million. Thus, any sale would have required F r a n k lin National Bank to realize the enormous loss between the cost of these securities
and the m a r k e t value at which they could be sold.
10. On J u n e 20, 1974, F r a n k l i n New York Corporation announced the bank's
foreign exchange and other losses, the Corporation's restated earnings for the
first q u a r t e r of 1974 and the Corporation's projected earnings for t h e first half
of 1974. Aggregate foreign exchange losses were $45.8 million. Realized losses in
the bond t r a d i n g account of $5.6 million were announced. Additionally, the
Corporation stated t h a t deferred taxes which had been carried on the books of
the bank as an asset of $7.9 million were being written off on recommendation of
the bank's accountants and under generally accepted accounting principles.
Restated earnings for the first q u a r t e r of 1974 showed a net loss, after preferred
dividends and securities transactions, of $40.4 million, or a loss of $8.75 per share,
compared to the net income of $79,000 or $0.02 per share originally reported on
April 18, 1974 for t h a t period. F r a n k l i n New York Corporation estimated t h a t it
would incur a substantial loss for the second q u a r t e r of 1974 and for the year
1974 as a whole.
The announcement also stated t h a t average net domestic deposits of t h e
bank had declined from $2,078 million for the week ended May 8, 1974, to $1,570
million for the week ended J u n e 12, 1974. Average net foreign branch deposits
for the same period declined from $916 million to $613 million. F r a n k l i n New
York Corporation announced t h a t it was unlikely t h a t payments upon the company's common or preferred stock would be resumed in t h e n e a r future, and
t h a t dividends would be suspended for an undetermined period on the bank's
common stock held by F r a n k l i n New York Corporation and on the bank's publicly held cummulative preferred stock. Operation of the sinking fund for the
preferred stock also was suspended. The announcement also pointed out that,
because of the bank's inability to pay dividends to F r a n k l i n New York Corporation, the Corporation would not be able to meet its existing debt obligations
without using the proceeds of a proposed $50 million new stock offering, the
first portion of which was to be completed by early 1975.
198
11. F r o m the middle of May until the end of September, I pursued various
possible long-term solutions to the problems of F r a n k l i n National Bank. I assisted the bank in obtaining a new chief executive officer and a new foreign
exchange officer. On May 18, 1974, I requested the member b a n k s of the New
York Clearing House Association to review the problems of F r a n k l i n National
Bank. The purpose of this review w a s threefold: (A) to advise me and my staff
of the views of other bankers on the condition of F r a n k l i n National B a n k ; (B)
to establish a basis of information upon which the clearinghouse association
members might act to help with F r a n k l i n ' s liquidity problems; and (O) to
provide information to members of the clearing house who might be interested
in acquiring F r a n k l i n National Bank. In this regard it was agreed t h a t any
information received through this process by members of the clearing house also
would be made available to any non-clearing house member interested in acquiring F r a n k l i n National Bank.
12. On J u n e 11, 1974, with the encouragement of the Federal Reserve System,
an a r r a n g e m e n t was reached whereby members of the clearing house individually would lend federal funds to F r a n k l i n in an amount which aggregated $225
million. A security agreement was signed among Franklin, the Federal Reserve
B a n k of New York, and t h e participating clearing house banks under which the
clearing house banks, in the event of non-repayment of these federal funds
by F r a n k l i n National Bank could look to the assets already held by the Federal
Reserve B a n k of New York as security for its loan to Franklin. Under this
agreement, the participating clearing house banks had a security interest in
those assets prior to the interest of t h e Federal Reserve Bank of New York.
The insistence of the clearing house banks on obtaining such a security agreement w a s in itself an indication to me of the difficulties faced by Franklin,
because such federal funds transactions normally a r e done without any security
and, indeed, with no more formality t h a n a telephone call and a wire transfer.
13. On July 22, 1974, a representative of my staff convened a meeting of
representatives of more t h a n two dozen of the largest banks in the United States,
commencing w h a t proved to be an unsuccessful effort to sell to them a $350
million portion of F r a n k l i n National Bank's considerable portfolio of E u r o currency loans. If a sale could have been effected it wrould have infused a large
amount of cash into F r a n k l i n National Bank and reduced reliance on t h e Federal
Reserve Bank loan. F r a n k l i n wTas reluctant to consummate the sale, however,
because the m a r k e t value of the loans was below their book value, and the sale
would have required F r a n k l i n to realize an immediate capital loss. I n addition,
many of t h e potential buyers were reluctant to deal with F r a n k l i n National
B a n k without a g u a r a n t e e against losses in these loans. For these reasons, the
proposed sale of Euro currency loans never took place.
14. While I was attempting to restore confidence in F r a n k l i n National B a n k
a n d to stabilize its situation, I also believed t h a t a prudent discharge of my
s t a t u t o r y responsibilities required the development of a plan to protect the
bank's uninsured depositors and other general creditors and to minimize the
impact on the country's and the world's banking systems if I should become
satisfied t h a t the bank was insolvent. In May and J u n e 1974. I m a d e inquiries
of other banks which might be large enough and have enough management
resources to t a k e over F r a n k l i n National Bank. None of these banks wTere
interested in taking over F r a n k l i n without protection from undisclosed liabilities
and without other financial assistance from the F D I C .
15. On July 2, 1974, I wrote the F D I C requesting it to contact other banking
organizations which were potential purchasers of some or all of the business and
assets of F r a n k l i n National Bank. The F D I C developed a plan to assist a bank
to assume liabilities and purchase assets of Franklin, and began negotiations
w i t h interested banks to draft a set of acquisition papers upon which banks
could bid competitively. As set forth in the petition, p a r a g r a p h s 8-10 and
Exhibits A t h r o u r h C, it w a s proposed t h a t t h e F D I C , as receiver of F r a n k l i n
National Bank, would t r a n s f e r all of F r a n k l i n ' s deposits and certain other
liabilities to an assuming bank, wThich would select assets of F r a n k l i n in an
amount equal to the liabilities assumed, less the purchase price bid. The assuming bank would be required to keep most of F r a n k l i n ' s banking offices open for
30 days, and would have the right to select any of these offices permanently.
In its corporate capacity the F D I C (1) would indemnify the assuming bank
against losses from unassumed liabilities, (2) would purchase the remaining
assets of Franklin, and (3) would assume F r a n k l i n ' s obligation to the Federal
Reserve Bank of New York, which would be repaid to the extent possible out
199
of the assets purchased by the F D I C , but would be fully repaid in any event
a t the end of three years whether or not sufficient collections had been made by
t h a t time.
16. On August 23, 1974, F r a n k l i n ' s new Chairman and Chief Executive Officer
presented to the Comptroller's Office and the other federal regulatory agencies
a plan by which, wTith substantial assistance from the F D I C and the prolongation for three years of F r a n k l i n ' s indebtedness to the Federal Reserve Bank
of New York, F r a n k l i n National Bank might give up most of its national and
international business and become an approximately $2 billion bank wTith its
business oriented almost exclusively toward Long Island. F r a n k l i n ' s plan was
formally submitted to the F D I C by letter on September 16, 1974. A t r u e copy is
annexed hereto as Exhibit 1. On September 4, 1974, I requested the investment
firm of Blyth E a s t m a n Dillon & Co. to advise me concerning F r a n k l i n National
B a n k ' s proposal. On October 3, 1974, the firm advised me that, in its opinion,
the prospects of F r a n k l i n achieving both financial viability and viability as an
independent banking institution were unlikely. This conclusion was based upon
the weakness of the plan's underlying assumptions. For example, the success of
the plan wras dependent upon an assumed deposit growth from September 13,
1974, of 26 percent by J u n e 30, 1975 and 45 percent by J u n e 30, 1977. This
assumption was considered unrealistic in light of: (a) the competitive n a t u r e
of the banking m a r k e t faced by F r a n k l i n ; (b) the lack of public confidence in
F r a n k l i n which has precipitated a severe deposit run-off over the last six months ;
(c) the proposed reduction of the bank's loan portfolio which would probably
result in a decrease in F r a n k l i n deposits by corporations who also a r e borrowers
from F r a n k l i n ; and (d) a growth r a t e in deposits for all members of t h e Long
Island Bankers Association over the last year of approximately 3.4 percent.
Additionally, this plan contained no provision for dividend payments by the
bank to F r a n k l i n New York Corporation to service the Corporation's debt. The
Corporation's outstanding debt of $65 million includes $35 million of notes held
bv members of the public. Unless the Corporation a r r a n g e s a moratorium on
interest payments on its publicly held debt, or unless it raises funds through
a new stock issue—both of which a r e unlikely—the Corporation, a s foreseen in
its press release of J u n e 20, 1974, soon will not be able to meet its existing debt
obligations. In the experience of this office, a national bank cannot be a viable
institution when wholly owned by a holding company in financial difficulty.
17. On August 14. 1974, at my direction, a special examination of F r a n k l i n National Bank was begun. T h a t examination showed book equity capital on August 14 of $175 million. The examiner found loan and other losses of $3 million.
He also found $53 million in loans of doubtful collectibility. The Comptroller's
experience has been t h a t 50 percent of loans so classified—or, in this instance, $26
million—become losses. Thus, F r a n k l i n National Bank h a d equity capital, after
adjusting for estimated losses, of $146 million. Additionally, depreciation in the
securities account of F r a n k l i n National Bank was $127 million. Banks ordinarily
hold securities in their investment portfolios until maturity, never realizing before m a t u r i t y any m a r k e t gain or loss. Such securities t h u s a r e usually carried
on the bank's books a t cost, without giving effect to either appreciation or depreciation as compared to the current market. When, however, a bank is in a
severe liquidity crisis, the m a r k e t value of t h e securities must be considered because these assets may have to be sold to meet demands for cash. F r a n k l i n ' s own
proposal, described in P a r a g r a p h 16 of this affidavit; involved selling these
securities to the F D I C a t a price set higher t h a n their m a r k e t value. W i t h
F r a n k l i n ' s dire need for cash, depreciation in the value of its securities portfolio (amounting to 87% of book equity capital) must be taken into account in
any determination of whether the bank could continue to meet the demands of its
depositors and other creditors. Giving effect t o the securities depreciation, the
net equity capital of F r a n k l i n National Bank as of August 14, 1974, was $19
million.
F o r purposes of liquidation, F r a n k l i n ' s loan portfolio m u s t be depreciated
in a m a n n e r similar to t h a t of the bank's securities portfolio. The amount of this
depreciation is difficult to estimate because, unlike securities, there is no regularly established m a r k e t with quoted prices for loans. In the absence of a quoted
m a r k e t price, the estimation of the t r u e value of loans is complex because the
credit risk on each individual loan must be considered in addition to any difference in yield caused by a change in interest r a t e s since the loan w a s made. The
attempt described in P a r a g r a p h 13 of this affidavit to sell F r a n k l i n ' s portfolio
of E u r o currency loans would have resulted in a multi-million dollar loss to
200
F r a n k l i n because the m a r k e t value of these loans was less t h a n their face amount
on the F r a n k l i n books. The examiner who supervised the August 14, 1974, examination thus h a s advised me t h a t the discount factor invol\ed in the sale of
sunicient loans to pay off F r a n k l i n ' s obligation to the New York Federal Reserve
B a n k undoubtedly would eliminate F r a n k l i n ' s book equity capital. I n evaluating
F r a n k l i n ' s condition, and considering the bank's need for liquid funds, I therefore
have concluded t h a t F r a n k l i n h a s no real equity capital.
18. Based on all the facts available to me, including F r a n k l i n National B a n k ' s
own proposal, which virtually conceded t h a t the bank could not survive without
substantial government assistance, and t h e Blyth E a s t m a n Dillion & Co. report,
I concluded t h a t F r a n k l i n National Bank did not appear to be a viable institution. On October 4, 1974, I wrote to the F e d e r a l Reserve Bank, which was F r a n k lin's major creditor, with a loan which, on October 2, 1974, amounted to approximately $1,768 billion. I briefly reviewed t h e situation, and asked for the F e d e r a l
Reserve Bank's views with respect to its outstanding extension of credit to
F r a n k l i n . A t r u e copy of my letter is attached hereto as Exhibit 2. On October 7,
1974, t h e Federal Reserve Bank replied, stating t h a t its emergency credit assistance to F r a n k l i n was based on public policy considerations arising from the
responsibility of the F e d e r a l Reserve System as a lender of last resort and w a s
designed to give F r a n k l i n and the F e d e r a l banking regulatory agencies concerned
a sunicient period to work out a permanent solution to t h e bank's difficulties. The
F e d e r a l Reserve Bank also h a d concluded t h a t the F r a n k l i n proposal of September 16, 1974, to the F D I O did not offer a feasible means of achieving the continuation of F r a n k l i n as an independent bank. The F e d e r a l Reserve Bank believed t h a t t h e plan developed by the F D I C , as described in P a r a g r a p h 15 of this
affidavit, offered a viable long t e r m solution to the problems of Franklin. I n these
circumstances the F e d e r a l Reserve Bank advised me t h a t it would not be in the
public interest for t h a t bank to continue its program of credit assistance to
F r a n k l i n . A t r u e copy of the F e d e r a l Reserve Bank's letter is attached hereto a s
Exhibit 3.
19. Based upon my examination of the bank's affairs, including the facts
recited in this Affidavit, I became satisfied f)f t h e insolvency of F r a n k l i n National
Bank, Brooklyn, New York. The Comptroller, as the official charged with the
responsibility of determining insolvency and protecting a bank's depositors, is
not required to w a i t until the losses he finds in the bank's assets a r e actually
charged against the bank's book equity capital. A computer could perform t h a t
function. The Comptroller's duty is to determine when a bank h a s reached
the point t h a t it will not be able to meet obligations to its depositors in t h e n e a r
future. There can be no doubt that, without the aid of the Federal Reserve
Bank of New York, F r a n k l i n would have reached t h a t point many months ago.
T h e F e d e r a l Reserve B a n k h a s indicated that, in all of t h e circumstances, a n d
with t h e F D I C plan available, it would not be in the public interest for the
F e d e r a l Reserve Bank to continue its program of credit assistance to F r a n k l i n .
I t is impossible for F r a n k l i n National Bank to survive without such credit
assistance. I t is not in t h e best interests either of F r a n k l i n ' s depositors or
other creditors or of its shareholders to w a i t for further deterioration in the
bank's condition, particularly when the alternative of an FDIC-assisted purchase
of the bank, a t a price including a substantial premium for going concern value,
is available.
20. On October 8,1974, a t 3 p.m., having become satisfied t h a t F r a n k l i n National
Bank, Brooklyn, New York, w a s insolvent, and acting p u r s u a n t to 12 U.S.C. §§ 191
and 1821(c), I appointed the F D I C as receiver of F r a n k l i n National Bank. A t r u e
copy of this appointment is attached to the petition as Exhibit F .
21. As of August 30, 1974, F r a n k l i n National Bank h a d approximately $1515
million in deposits belonging to 631,163 depositors. If the agreements proposed
by the F D I C to effectuate the purchase and assumption transaction a r e not
approved by the Court, t h e impact on all of these depositors will be substantial.
The approximately 625,000 depositors who are insured would be paid by the F D I C ,
but even these depositors would have their funds tied up for weeks while the
F D I C makes the necessary arrangements. The 5,941 uninsured depositors, whose
deposits amount to more t h a n half of F r a n k l i n ' s total deposits (approximately
$771 million, some 307 million of which a r e interbank transactions a t F r a n k l i n ' s
London b r a n c h ) , would share r a t a b l y with the other general creditors of Franklin,
and would have to a w a i t liquidating dividends for the repayment of their deposits. There is a strong possibility t h a t such creditors would never be paid completely, and t h a t F r a n k l i n ' s subordinated noteholders and shareholders would
201
receive nothing if a payout became necessary. Thus, a liquidation and payout by
the F D I C , which would result if the proposed purchase and assumption agreement were not approved, would cause considerable disruption to the banking public in New York and to the international monetary markets. The effect of such a
liquidation and payout would also, in my opinion, severely damage the public confidence which is necessary to the operation of the banking system of the United
States. Approval of the purchase and assumption transaction, on the other hand,
will avoid any disruption in service for the depositors of the bank, will increase
t h e chances of creditors for full repayment of their claims will preserve for the
subordinated noteholders and shareholders the going concern value of F r a n k l i n
National Bank to be realized through t h e payment of a premium by the assuming
bank, and will help to retain confidence in the banking system. Thus, it is in
the interest of creditors and the public for the purchase and asssumption agreement to be approved a s rapidly as possible so t h a t all banking offices of F r a n k l i n
can open as offices of the assuming bank on the next business day.
J A M E S E. S M I T H ,
Comptroller
of the
Currency.
Sworn to before me this 8th day of October, 1974.
Notary Public
FEBRUARY 22,
1974.
Re F r a n k l i n National Bank, Brooklyn, New York.
Mr. CHARLES M. V A N HORN,
Regional Administrator
of National
Banks,
New York, N.Y.
DEAR MR. V A N HORN : You and I recently have discussed in some detail the
situation revealed by National Bank E x a m i n e r E d w a r d Lake's current examination of F r a n k l i n National Bank. This letter confirms those discussions.
The bank h a s grown too fast in the last year, basing its growth on the use of
high cost borrowed money. The bank's capital accounts have not kept pace with
the volume of business handled. This rapid growth also seems related to a number
of loans and other investments with an undue degree of risk. Additionally, the
responsibilities of and line of authority among the senior officers of the bank are
unclear. The bank needs for a period of time to de-emphasize growth, to reduce
greatly all forms of borrowings, to strengthen its management and capital, and
to exercise greater control and discretion in the making of new loans and the
supervising of existing loans.
Please meet as soon as possible with the senior management of the bank and
express to them our views about the bank. Additionally, you a r e to request and
receive from the bank a w T ritten program, satisfactory to the Comptroller's Office,
by which the bank proposes to deal with these problems. This program shall
include:
1. A list by name of the senior officers of the bank, together with a description
of the responsibilities of each and who reports to whom. I also wish to know t h e
bank's plans for recruiting a new controller and a new head of the national division, or for otherwise assigning the responsibilities formerly associated with
those positions.
2. A definite plan with stated goals for reducing all forms of borrowings, including (but not limited to) : certificates of deposit, time deposits of other banks,
federal funds purchased, and securities sold subject to repurchase.
3. The means and s t a n d a r d s by which the granting of new loans and the servicing of existing loans will be policed by senior management, with a view t o w a r d
upgrading the quality of the loan portfolio. A method should be established by
which written loan policies of the bank will be adhered to strictly.
4. A definite program for adjusting the imbalance between the bank's capital
and the size of its operations.
5. A description of the bank's plans in the international field, including its foreign currency operations.
(>. Whatever other m a t t e r s you and E x a m i n e r Lake believe should be dealt with.
1 further request you to meet with the bank's board of directors to discuss
these problems at the board's next regularly scheduled meeting, which T understand will be on March 28, 1974. At t h a t meeting the board should approve the
written program outlined above.
Very truly yours,
J A M E S E.
Comptroller
SMITH,
of the
Currency.
202
FEBRUARY 1,
1973.
R e Current E x a m i n a t i o n F r a n k l i n National Bank.
JOHN
Deputy
GWIN,
Comptroller
of the
Currency.
ROBERT A. M U L L I N ,
Director, International
Division.
E x a m i n e r El-Dada was contacted today by telephone. He had reviewed all of
F r a n k l i n ' s foreign bank accounts a n d found no evidence of window-dressing
except for $50 million due to and from Banco de Roma, all in U.S. dollars,
and all with the same m a t u r i t y dates and r a t e s of interest.
The head of the bank's international department told him t h a t this was not
window-dressing a n d t h a t the Banco de Roma h a d initiated the t r a n s a c t i o n by
placing the $50 million with them. I told him t h a t banks do not accept deposits
unless they w a n t them, and t h a t only F r a n k l i n National Bank could have placed
the deposits with Banco de Roma. I asked him if he still consider t h e result of
the transaction as window-dressing and he said he believed t h a t it was. I asked
if his belief or his opinion in the m a t t e r was stated in his report, and he said
t h a t it was not.
I told him quite frankly t h a t when an examiner finds a problem in a bank, his
comments on t h a t problem should appear in the report and this is especially
t r u e if the problem is not resolved during t h e examination and if the examiner
expects the Comptroller's Office to take action.
I told him additionally t h a t t h e r e was no need for him to repeatedly call me
for assistance on bank problems if he was not willing to record those problems
in his report of examination. He said t h a t while he had completed t h e international portion of the examination yesterday, he would now s t a t e his views on
this window-dressing transaction on P a g e 2 of the report. I told him I wrould
fully support his criticisms.
T H E REGIONAL ADMINISTRATOR OF NATIONAL B A N K S ,
SECOND NATIONAL B A N K REGION,
New York, N.Y., June
R e F r a n k l i n g National B a n k Foreign Exchange Position.
18,1973.
Mr. C. M. V A N HORN,
Regional Administrator
of National
Banks,
New York, N.Y.
DEAR MR. VAN HORN : I n accordance with your telephone instructions, I have
examined t h e foreign exchange position of t h e above captioned bank and conducted such tests deemed necessary to check its accuracy. I n addition, I have
checked the monthly profit and loss schedules for t h e first five months of 1973.
My findings and conclusion a r e heretofore :
Size of Positions.—Total
spot and future contracts purchased and sold as of
J u n e 8, 1973 amounted to U.S. dollar equivalent $814,213M and $798,107M respectively, compared to $683,638M and $691,537M as of last examination December 11, 1972. The increases a r e large, however, the risk the bank h a s taken is
not affected materially since the net positions in the different currencies a r e
not out of the ordinary, for a bank of this size. No speculative activities were
discerned.
Customer Liabilities.—I
have reviewed the customer liability ledger as to t h e
amount outstanding and name. All but a few of the customers are well known
banks a n d / o r corporations.
Limits.—All
position limits were cancelled on F e b r u a r y 15, 1973 as per a
memorandum dated same date and signed by Mr. Peter Shaddick, Senior Executive Vice President. Instead of established limits all approvals for overnight
positions will be given by either one of the three top officers in the I n t e r n a t i o n a l
Division. Mr. Shaddick is keeping a very close supervision over the activities
of the department, through his frequent daily visits to the t r a d i n g room.
Profit and Loss.—The monthly profit and loss registered since the beginning
of 1973 reveal the following:
J a n u a r y , $9,444; February, $72,310; March, ($58,941); April, $42,239; May,
$43,414.
Conclusion.—Even
though t h e volume of the foreign exchange transactions a n d
positions have increased, the bank has not taken any undue risk in its foreign
exchange trading. T r a d i n g is still largely with well known international and
domestic banks where the risk is minimal.
203
All internal control procedures seem to be well observed and the undersigned
examiner was introduced to a new internal resident auditor whose sole job will
be to keep a constant eye on the workings of the foreign exchange department.
Respectfully,
H U S S E I N B.
EL-DADA,
National Bank
Examiner.
T H E REGIONAL ADMINISTEATOR OF NATIONAL B A N K S ,
SECOND NATIONAL B A N K REGION,
New York, N.Y., February
1,1974.
To : Mr. C. M. Van Horn, Regional Administrator.
From : John A. Fleming I I I , National Bank Examiner.
Subject: F r a n k l i n National Bank, Foreign Exchange Department.
Today I met with Messrs. A. Garafolo, vice president and head trader, George
Hermann, senior vice president, and H. B a r r a n d , executive vice president of
F r a n k l i n National Bank a t 1 AYorld Trade Center. The topic of discussion was
about " . . . due to a bookkeeping error, it ( F r a n k l i n National B a n k ) underestimated its requirements for French franc balances . . .", New York Times,
F e b r u a r y 1, 1974.
Every week, a daily cash flow sheet is prepared by currency, showing each
day's net overbought or oversold position (same as a daily gap report—not to be
confused with the net overall currency position) to allow the t r a d e r to cover
shortages or sell overages.
Apparently, the t r a d e r mistakenly believed he had covered the Jan-31-74 F / F
shortage of 2O0MM (approximately $40MM). When this was discovered it was
too late to obtain the needed francs because French banks a r e forbidden to lend
F / F to non-residents. Therefore several m a t u r e d F / F contracts went unpaid for
one day. Today those contracts were paid, including any loan a n d / o r overdraft
charges (this e x t r a cost should not exceed $11M).
A simple parallel is an individual made a mistake in his checkbook, and a
check bounces. The bank calls for immediate cover. Other t h a n an outright cash
deposit no settlement would clear in time. The bank, unable by law to g r a n t a oneday loan must bounce the check. These errors do happen occasionally to most
banks. T h a t an occurence of this insignificance was publicised is unfortunate.
Apparently the P a r i s correspondent of the New York Times got wind of the
error and cabled New York t h a t F r a n k l i n was not meeting its obligations abroad.
When confronted with this story, F r a n k l i n officials clarified the issue and stated
their case.
OFFICE PROCEDURE—RATINGS OF B A N K S
1-A-S
1
Capital Position-Quality of Assets-Management
Composite or Group Rating
I t is desired t h a t the following instructions pertaining to the composite or
group r a t i n g of banks and the ratings accorded Capital, Quality of Assets and
Management be considered carefully and placed in use at once.
Group R a t i n g s : Range from 1-4.
No. 1. Sound institutions in every respect.
No. 2. Those institutions with :
A. Asset weaknesses ranging from relatively moderate to moderately
severe; or
B. Negligible asset problems but definitely undercapitalized ; or
C. Unsatisfactory m a n a g e m e n t ; or
D. A modified combination of these and other weaknesses.
No. 3. Those institutions, which have, in relation to capital protection, an
immoderate volume of asset weaknesses which, in view of the (A) character of
the asset problems, or (B) management deficiencies, or (C) economic conditions,
or a combination of those and other points, could reasonably develop into a situation urgently requiring aid from the shareholders or otherwise. B a n k s in this
category require special attention.
No. 4. Banks rated No. 4 are those confronted with asset weaknesses of a
character and volume, in relation to capital protection and quality of manage-
204
ment urgently requiring aid from the shareholders or otherwise and whose
failure, if such aid is not forthcoming would appear to be probable. These a r e the
serious or hazardous cases requiring constant supervisory attention.
Capital Position : Range 1-4.
The following factors will be considered by the Comptroller in assessing the
adequacy of c a p i t a l :
No. 1. Capitalization adequate in relation to factors :
A. T h e quality of management.
B. The liquidity of assets.
C. The history of earnings and of the retention thereof.
D. The quality and character of ownership.
E. The burden of meeting occupancy expenses.
F. The potential volatility of deposit structure.
G. The quality of operating procedures ; and
H. T h e bank's capacity to meet present and future financial needs of its
t r a d e area, considering the competition it faces.
No. 2. Capitalization inadequate in relation to factors A through H, above.
No. 3. Deterioration of bank's condition to a point where it is considered
hazardous. This normally will include all banks whose aggregate of classified
assets is sufficient to impair the capital account.
No. 4. Capital impaired by losses.
Q U A L I T Y OF A S S E T S
Quality of A s s e t s : Range from A - D .
Rating A :
Good. Ordinarily banks so classified will not have an aggregate total of
(1) classified assets, plus (2) unclassified speculative bonds, stocks, and
O.R.E., t h a t is in excess of 20 percent of the gross capital s t r u c t u r e and
the character of the problems in such assets is not severe in the judgment
of the Regional Administrator. An aggregate total somewhat in excess of
20 percent of the gross capital structure will not preclude an A rating, provided the actual or potential seriousness of the problems in the assets concerned is regarded as relatively moderate. However, if the p r i m a r y asset
problems a r e regarded a s severe, or if additional problems exist in large
lines, bond concentrations, or a heavy investment in fixed assets, a less
favorable r a t i n g should be used even though the aggregate total of p r i m a r y
asset problems is less t h a n 20 percent of the gross capital structure.
Fair. Instructions, and elasticity to exercise judgment t h r o u g h use of a
more favorable or less favorable rating, a r e the same as noted u n d e r r a t i n g
A, except banks so classified ordinarily will not have an aggregate total of:
(1) classified assets, plus
(2) unclassified speculative bonds, stocks and O.R.E. t h a t is in excess
' of 40 percent of the gross capital structure.
Rating C:
Poor. Instructions, a n d elasticity to exercise judgment through use of a
more favorable or less favorable rating, a r e the same as noted under R a t i n g
A, except banks so classified will not have an aggregate total of:
(1) classified assets, plus
(2) unclassified speculative bonds, stocks and O.R.E. t h a t is in excess
of 80 percent of the gross capital structure.
Rating D :
Hazardous. Any bank will be so classified when the total of:
(1) classified assets, plus
(2) unclassified speculative bonds, stocks and O.R.E. is in excess of
80 percent of the gross capital structure.
Management
Rating: R a n g e : S
F
P
S
Strong or Competent.
F
Fair.
P
Poor, Incompetent, Integrity Questioned.
I t is desired t h a t the Capital, Asset, and Management ratings be entered a t
t h e bottom of page 3 by Regional Administrators (initial opposite r a t i n g ) as
follows:
205
2 - C - F (initials)
Assistant Chief E x a m i n e r s will, in addition, show the Capital, Asset and
Management ratings and group r a t i n g on page 1 as follows :
2-C-P
3
All reports other t h a n 1-A-S or 1-A-F are to be sent to respective Deputy
Comptroller.
MARCH
19,
1971.
Memorandum to Mr. C a m p :
Based on the recent report of examination, the following bank is in need of
close supervision by the Regional Administrator of National B a n k s : F r a n k l i n
National Bank, Mineola, New York.
JOHN
Deputy
74-548 O - 76 - 14
Comptroller
D.
of the
GWIN,
Currency.
206
Statement of
Robert Bloom
First Deputy Comptroller of the Currency for Policy
before the
Subcommittee on Commerce,
Consumer and Monetary Affairs
of the
House Government Operations Committee
January 20, 1976
207
I have been asked by the Subcommittee to discuss the
examination practices and procedures of the Office of the
Comptroller of the Currency.
In view of recent newspaper
articles on the subject of so-called "problem banks," it is
important to shed light on this topic as the publicity has
tended to confuse rather than enlighten the public.
The term "problem bank" is a vague term which has become
banking agency jargon without precise definition.
If what is
meant is a bank, the liquidity and solvency of which is in
serious question, let me hasten to assure you that very few
national banks, and none of the money center national banks,
are considered by our Office to be "problem banks."
On the other hand, many national banks receive extra
analysis and attention for a variety of reasons. The degree
of supervision is determined through objective and subjective
judgments made by field examiners, Regional Administrators
and Washington staff.
The Comptroller's Office maintains no list
of such banks that could be characterized as a "problem bank
list."
Each bank is handled on a case-by-case basis.
There is no magic formula or ratio which is capable of
identifying banks for special supervision with any degree of
accuracy. As a practical matter, however, we have used in the
past a quantitative formula based on examination report data which
identify those banks to be given further analysis at all staff
levels. All banks with criticized assets (100% of substandard,
50% of Other Loans Especially Mentioned, 50% of doubtful) aggregating 65% or more of adjusted capital funds (Equity accounts,
208
reserves for loan losses and capital notes less losses and 50%
of doubtful) are given special analysis and attention by this
Office.
It is apparently a list of banks with classified assets
over 65% of capital which was referred to in the "Washington Post"
story as the Comptroller's "problem bank" list. As the Comptroller
stated in his press release following the "Post" story, the
labeling of every bank with a ratio of criticized assets to
capital of 65% or more as a "problem bank" is a misstatement and
over-simplification.
The volume of criticized loans in a particular
bank, taken alone without further information as to the strength
of management, earnings, liquidity, ability to raise additional
capital, access to the money markets and other factors, is not
significant.
In addition, a great deal depends on the state of
the economy during the period in question.
The significance of
classified asset ratios as a supervisory tool is greater during
prosperous times than it is during periods of recession such as
1974 and 1975. A ratio of 65% or more of classified assets in a
prosperous economy could be reflective of poor management. A ratio
of 65% or more during 1975 and at present does not necessarily
reflect adversely on management.
It is common knowledge in financial
circles that many banks, both large and small, well managed and
poorly managed, today have ratios in excess of 65% to capital.
Indeed, any bank whose volume of criticized loans did not increase
during 1975 probably had not been performing the normal risk-taking
functions through which a commercial bank serves its community.
209
There are two principal aspects in singling out banks for
special supervisory attention.
First, there are the procedures
and criteria to be used in identifying such banks, and second,
there are the procedures and methods for correcting whatever
deficiencies exist in such banks. This Office is now engaged
in a major revision and improvement of its operations in both
of these areas, based largely on the recommendations of Haskins
and Sells, an outside consulting firm retained by the Office
in May, 1974. The Haskins and Sells recommendations have been
made public and copies of the report have been sent to each member
of Congress.
Existing Grading Systems
Under the traditional system for pinpointing banks for
special attention, a great deal of emphasis was placed on the
ratio of classified assets to gross capital. Classified assets
are those assets which are singled out by the examiner as having
credit weakness of varying degrees of intensity.
The classi-
fications in ascending order of severity are Other Loans Especially
Mentioned (OLEM), Substandard, Doubtful and Loss.
Banks are
graded in four groupings according to the ratio of assets classified
as loss, doubtful or substandard to gross capital funds. The four
groupings are:
Group A - zero to 20%
Group B - 20% to 40%
Group C - 40% to 80%
Group D - 80% or more
In addition to the above classified asset categories, the
examiners rate capital adequacy on a one through four scale taking
210
into account the quality of management, the liquidity of assets,
the history of earnings, the quality and character of ownership,
the burden of meeting occupancy expenses, the potential volatility
of the deposit structure, the efficiency of operations, and certain competitive factors. Bank Management is rated as well in
three categories, Strong, Fair or Poor. After the Capital Position,
the Quality of Assets and Management are scored, the examiners
assign a Composite or Group rating to the bank.
Group 1 banks are
those considered to have good capital, competent management, good
operations, good liquidity and less than 20% of classified assets
to gross capital. On the other end of the spectrum, Group 4 banks
include those which could be approaching insolvency, thus requiring immediate injection of capital, new management or both.
In the past, this Office has maintained lists of banks falling
within Groups 3 & 4 as described above. For your information, a
schedule is attached to this statement which reflects the number
of banks on these lists from July 5, 1972 to July 1, 1974. Such
lists, because of the primary emphasis placed on the volume of
classified loans, are not considered under present economic conditions as particularly meaningful.
This Office still reviews each
examination report on a case-by-case basis and, after discussions
with our Regional Administrators and the national bank examiners,
determines whether or not additional supervision is necessary.
In
those cases where it is decided that such supervision is required,
personnel from Washington work closely, in some cases on a daily
basis, with personnel in the region and with personnel from the
bank.
211
The New System
As I have noted, our Office is presently actively engaged in
modernizing its system for identifying and dealing with banks
requiring special attention.
A computerized "early warning system"
called the National Bank Surveillance System (NBSS) will consist of
four basic elements:
(1) A data-collection system.
(2) A computer-based monitoring system that would detect
unusual or significantly changed circumstances within a
bank and within the national banking system.
(3) An evaluation by experienced personnel of the impact of
such changes on bank soundness.
(4) A review procedure that would provide administrative
controls over all proposed Office of the Comptroller of
the Currency remedial actions, including those of
Washington personnel.
A Deputy Comptroller of the Currency and a project manager
from Haskins and Sells initiated the NBSS in September, 1975.
Their efforts have beeen directed toward steps 1 and 2, a datacollection system and a computer-based monitoring system.
They
also have begun work on step 3 by selecting experienced examiners
who will analyze the importance of the computerized data.
The data which have been reported to the three Federal regulatory agencies by their respective banks have traditionally been
utilized for historical statistical purposes.
Major portions of
this data have, by joint agreement of the three agencies, been
stored in the FDIC's computer.
Since this Office decided to use
that data for supervisory purposes, one of the first steps in
creating the NBSS required the transfer of portions of the
212
data in the FDIC's computer to a data base in a separate computer
which could be used by our Office for supervisory purposes. The
data base has been transferred and it essentially covers the
condition and income reports of national banks during the past
five years.
Three additional steps are being taken to improve and expand
the data base. First, we are conducting frequent, almost daily,
discussions with representatives of the Federal Reserve and the
FDIC to amend the banks' condition and income reports so that the
facts in these reports will be more meaningful for supervisory
purposes.
When information desired by this Office is not deemed
necessary by the other two regulators, we will acquire that data
through special reports submitted by the bank separately from the
customary call and earning reports. Second, certain portions of
the non-public reports of examination will be included in our
data base. Third, if all of this data is to be analyzed on a timely
basis, it must be processed rapidly.
To accomplish this objective,
the Management Services Division of the Comptroller's Office has
made two trial runs on the direct processing of NBSS data from
reports of condition and has concluded that this data can be processed within 45 days of the date of the call in lieu of the fivemonths period normally required for the combined production by the
three Federal bank regulators.
The NBSS will work with banks that are segregated into peer
groups in our data base. The statistical trends of each peer
group and of each bank within the peer group will alert this
Office to exceptional banks or groups of banks on no less than a
quarterly basis.
In view of today's rapidly changing economy,
this system will be more timely than the traditional
213
system of supervision through the receipt of reports of examination which are required only three times in each two-year cycle.
The fourth element of the system involves an administrative
review procedure or monitoring system which would stem from the
quarterly analysis of data.
The review and monitoring system
will enable a staff of experienced examiners to make recommendations on a bank-by-bank basis to each of fourteen Regional
Administrators as to the type and scope of examination which may
be required promptly for individual banks. The monitoring system
will also be computer assisted to the extent that the recommendations and the reactions, both positive and negative, by both
examiners and bankers will prompt successive steps of recommended
corrective action as needed.
What we are developing is an NBSS which will serve the
regulator and the banker in maintaining a sound financial system
to serve the public needs. The NBSS will help in the detection
and the correction of impending problems before they become
serious cases. This system will neither eliminate the human
element from bank regulation nor will it eliminate the human
element from the management of individual banks.
It should,
however, substantially aid in the prevention of future bank
failures.
Enforcement Follow-up
Once significant problems of a national bank have been
identified through the examination process, the examiner commences
the supervisory action process by commenting in the report of
214
examination on important matters requiring attention of the
Comptroller, the Board of Directors and the active executive
management.
The examiner's comments are supplemented by a letter
from the Regional Administrator which highlights the bank's problems
and requests the Board of Directors and executive management to institute appropriate corrective measures.
Depending on the circumstances
and severity of problems, the bank's executive management may be
requested to submit monthly reports regarding progress it has
made toward improving unsatisfactory areas of the bank.
In addi-
tion, frequent visitations and examinations may be conducted.
When an examination or special visitation of a national bank
discloses a condition so unsatisfactory as to warrant that the
Board of Directors should be promptly and personally informed,
a special meeting with the Board is called by the examiner or
his Regional Administrator.
Special representatives of the
'Comptroller's Office may attend the meeting depending on the
circumstances and severity of the problem.
The objectives of
meeting with a Board of Directors are to discuss the conditions
and affairs of the bank that were observed during the most recent
examination, to reach an agreement on any significant problems
in the bank, to obtain a definitive commitment from the Board,
to institute the proper corrective actions, and to obtain information concerning future plans and proposed changes in bank policy
that may have a significant impact on the future condition of
the bank.
Bank supervision provided at the regional level is coordinated with the Washington staff which provides additional legal
215
assistance, coordination with other regulatory agencies, attendance
at Board meetings, analytical support, and follow-up review. Where
the facts indicate a serious problem, a possible violation of
law, or unsafe and unsound practices, we may call upon the
Enforcement and Compliance Division of our Law Department.
This
assistance may consist of the attendance of an attorney from the
Enforcement Division at a Board of Directors meeting to discuss
with the bank the problems and the suggested corrective action.
In other cases it may require the investigation by the Enforcement
Division to determine whether sufficient facts justify the commencement of a cease and desist proceeding or the certification to the
Federal Reserve Board for removal of an official or the making of
a criminal referral to the Department of Justice.
In the latter
two situations, the investigation must disclose that the particular
activities of an individual constitute evidence of personal dishonesty.
In addition the bank must come to the Comptroller for
approvals of various corporate changes, such as the opening of
a new branch, dividend restrictions, investments in premises and
other approvals. The Comptroller may withhold his approval on
such applications until he is satisfied concerning the responsiveness of a bank to his recommendations.
In determining the appropriate remedy for a particular bank,
the Comptroller, together with the Deputy Comptrollers, Regional
Administrators, examiners and the Legal Division, must determine
which type of action will be the best rehabilitative type of
216
remedy to assist the bank.
VThere the facts indicate that there
are serious problems or that there are repeated violations of law
or unsafe and unsound practices, this Office has a wide range of
administrative remedies to deal with the situation.
These reme-
dies, however, are not punitive but are of a rehabiliative nature.
One of the principal remedies available to the Comptroller is the
power given under the Financial Institutions Supervisory Act of
1966 to commence cease and desist proceedings. Cease and desist
proceedings are rehabilitative, intermediate tools which allow
the Comptroller to force a bank to work out its problems without
resorting to the more drastic measures of receivership, conservatorship, termination of insurance, forfeiture of charter, or forced
merger.
Our experience has indicated that the threat of a cease
and desist proceeding enables this Office to handle the majority
of bank problems through the less formal techniques of persuasion,
frequent examinations and meetings with directors.
Of course, the success of all these efforts will depend
on the quality of information we receive. While our examiners
independently search for information in examining banks, much
information is derived from a candid exchange of views with
bank directors and officers and other members of the public
conducted on a strictly confidential basis.
If the rules
are changed to require public disclosure of what is in the
examination report, there is no doubt that we will be hampered
considerably in obtaining a complete picture of national
banks.
Likewise, the disclosure of which banks are subject to
217
special supervision will make correction of problems incomparably
more difficult, if not impossible, in some cases.
The confidentiality of government examinations, however,
does not impair the public's right to obtain necessary financial
information about banks. Banks are subject to the disclosure provisions of the Securities Exchange Act of 1934 to the same extent
as are other publicly held companies.
In addition to what non-
bank corporations must disclose, banks must publish quarterly a
report of condition, which includes both balance sheet and income
and expense information.
The three federal banking agencies have
recently increased substantially these disclosure requirements.
Beginning with the March 31, 1976 report of condition, banks
will be disclosing publicly more financial information than any
other major category of publicly-owned companies.
We thus respectfully must decline to comment specifically
on the affairs of any particular bank, including Chase Manhattan
Bank and First National City Bank.
To violate confidences which
we have elicited in order to investigate more thoroughly these
and other banks would run counter to the venerable Congressional
policy of protecting the confidentiality of bank records and
examination reports.
(See 5 USC 552(b)(8), 12 USC 1817(a)(2),
12 USC 1442, 12 USC 481, 12 USC 484, 18 USC 1905, 18 USC 1906).
Thank you for this opportunity to discuss the examination
and supervisory activities of the Comptroller's Office.
Attachment
Date of
List
July
Jan.
July
Jan.
July
5. 72
10,, 73
3. 73
11,, 74
1, 74
Total Number
of National
Banks
4607
4614
4629
4661
4695
Number of
Banks on
List
Banks Listed
as % of
Total Banks
122
110
94
109
133
2.67.
2.47.
2.0%
2.37.
2.87.
Date of
Call Reports
Jun.
Dec.
June
Dec.
June
30,
31.
30,
31.
30,
72
72
73
73
74
Total
Assets
(in
millions)
Total
Deposits
(in
millions)
Total Assets
of Bank on
L i s t as 7. of
Total Assets
of N a t ' l Banks
Total Deposits
on Bank L i s t as
7. of Total
Deposits of All
National Banks
18,661
21,796
21,095
22,924
42,086
15,222
18,282
16,723
18,146
31,282
4.87.
5.07.
4.77.
4.77.
8.17.
4.77.
5.17.
4.67.
4.67.
7.77.
to
00
219
M A R C H 28,
1974.
Re F r a n k l i n National Bank, Brooklyn, New York.
Memorandum for the files:
National B a n k E x a m i n e r E d w a r d B. L a k e and I met with t h e Board of
Directors of the captioned bank today to discuss the conditions of the bank
as revealed by t h e report of examination made on November 13, 1973. All directors
were in attendance. Secretary to the Board of Directors George E. B e c h t ; Senior
Executive Vice President P e t e r R. Shaddick and Executive Vice President J o h n
Sadlik were also present.
Loans classified Substandard, Doubtful and Loss aggregate $141 million versus
.$109 million a t t h e previous examination made on December 12, 1972. Other
Loans Especially Mentioned aggregate $149 million a t this examination versus
$84 million a t the previous examination. E x a m i n e r L a k e reviewed, in detail,
some of the larger loans which a r e criticized for t h e first time at this examination. H e pointed out t h a t further deterioration of t h e loan portfolio can be
a t t r i b u t e d to t h e fact t h a t established lending policies had not been adhered to.
H e emphasized the need for strengthening the bank's liberal lending policies
and for improved loan administration.
Mr. Lake pointed out t h a t borrowings during the year 1973 ranged from a low
point of $450 million in J a n u a r y to a high point of $1.1 billion in December. H e
emphasized t h a t immediate consideration be given to reduction of all forms of
borrowings to a more p r u d e n t level. H e pointed out t h a t capital protection is
inadequate and t h a t consideration should be given to the injection of additional
capital funds to bring the level of capital protection within a more acceptable
range.
The directors were informed t h a t during the course of t h e examination, it was
noted t h a t foreign exchange position was extremely heavy and t h a t consideration should be given to establishing guidelines for keeping the foreign exchange
position within more reasonable bounds.
I told the Board of Directors t h a t E x a m i n e r Lake and I had discussed the
affairs of the bank with the Comptroller of t h e Currency J a m e s E. Smith and
his staff and t h a t Mr. Smith had requested t h a t Mr. Lake and I meet with
senior officers of t h e bank to ascertain the n a t u r e of the problems involved and
t h e steps taken or contemplated to alleviate t h e problems. On F e b r u a r y 28, 1974,
E x a m i n e r Lake and I met with Chairman of t h e Board and Chief Executive
Officer Harold V. Gleason; Senior Executive Vice President Peter R. Shaddick;
President P a u l L u f t i g ; Senior Vice President Raymond Andersen and Chairman
of t h e Executive Committee Norman Schreiber to outline the concerns of the
Comptroller. I t was requested t h a t we be furnished with a written program,
satisfactory to the Comptroller of the Currency, by which the bank proposes to
deal with the problems. To avert t h e possibility of a misunderstanding on the
p a r t of the bank's officers, I presented Mr. Schreiber with an outline of the a r e a s
of concern. A copy of the outline is attached. Management gave assurance t h a t
they would prepare a comprehensive written report on their plans to deal with
the problems; t h a t they would present it to the Board of Directors for affirmation and forward it to us over the signature of each member of t h e Executive
Committee.
When Examiner L a k e and I entered the Board meeting today a t 11:0O A.M.,
Chairman of the Board Harold Gleason reported t h a t he had read verbatim to the
directors, page 2 and continuation of the current report of examination. Mr.
Gleason reported, and Mr. Schreiber affirmed, t h a t they had discussed with the
directors each of the items listed on the outline which I had left with
Mr. Schreiber.
Chairman of the Board Gleason gave assurance t h a t we would receive the
w r i t t e n program within one week. I told the directors t h a t if there is any
significant change in basic policies set forth in the written program, we wish
to be informed promptly. Also I requested t h a t we be furnished with written
monthly reports of progress in eliminating or strengthening t h e weaknesses
associated with t h e criticized loans. I expressed the hope t h a t future reports
would show better progress in eliminating criticized loans t h a n such reports
received during 1973.
C. M.
Regional
VAN
HORN,
Administrator
of National
Banks,
Second National Bank
Region.
220
AGENDA
I. M a n a g e m e n t :
(a)
Name of each of the senior officers, D e p a r t m e n t by Department,
of t h e b a n k :
1. description of responsibilities of each ;
2. to whom each reports ;
3. management c o n t r a c t s ; and
4. extent of influence of Mr. Sindona.
(b) Plans for recruiting a new financial officer.
(c) New director of National Division or otherwise reassign responsibilities formerly associated with these positions.
I I . B o r r o w i n g s : (a) Stated goals for reducing all forms of borrowings :
1. E u r o d o l l a r s ;
2. Certificates of Deposit;
3. Time deposits of other b a n k s ;
4. F e d e r a l funds p u r c h a s e d ; and
5. Securities sold subject to repurchase.
I I I . Lending Policy:
(a) Methods and s t a n d a r d s for g r a n t i n g new l o a n s ;
(&) Methods and s t a n d a r d s for administration of existing l o a n s ;
(c) Correcting or eliminating weaknesses associated with criticized
loans;
(d) Up-grading for quality and liquidity of the loan portfolio;
(c) Formation a n d / o r enforcement of a w r i t t e n lending policy.
IV. Capital Adequacy: (a) A definite program for adjusting the imbalance between the bank's capital and t h e volume of its operations.
V. I n t e r n a t i o n a l O p e r a t i o n s : (a) A description of the bank's plans for f u r t h e r
expansion in the I n t e r n a t i o n a l field, including foreign currency operations.
1. London Branch—clean letters of credit not recorded: (a) P l a n s for
expanding I n t e r n a t i o n a l staff.
2. Details of a loan commitment to construct a steel plant in Spain.
Request a w r i t t e n program, satisfactory to the Comptroller of the Currency,
by which the bank proposes to deal with the above problems.
Meet with Board, discuss problems, and obtain approval by Board of written
program outlined above.
J U N E 15,
1972.
MEMORANDUM FOR T H E F I L E S :
R e F r a n k l i n National Bank, Brooklyn, N.Y.
National Bank E x a m i n e r W a l t e r R. Schlicht and I met today with the Board
of Directors to discuss the affairs of the bank as revealed by t h e report of
examination made by E x a m i n e r Schlicht on March 3, 1972. All directors except
Vice Chairman Howard Crosse were in attendance. In addition, Executive Vice
P r e s i d e n t — I n t e r n a t i o n a l Banking Group H a r r y B a r r a n d and Executive Vice
Presidents Jerome Twomey a n d John Sadlik were in attendance.
Loans classified Substandard, Doubtful and Loss aggregated 46 percent of
Gross Capital F u n d s versus 51 percent a t the 1971 examination. Other Loans
Especially Mentioned aggregated 36 percent of Gross Capital F u n d s versus 42
percent a t the previous examination. E x a m i n e r Schlicht pointed out, however,
t h a t the improvement is a t t r i b u t e d primarily to a $30 million increase in capital.
Also, he pointed out t h a t $24 million or 25 percent of the loans classified Subs t a n d a r d a r e concentrated in three loans (i.e. $6.3 million; $5 million and $12.8
million). Of the $217 million Classified or Especially Mentioned a t t h e previous
examination, aggressive collection efforts reduced this a m o u n t by $53 million
p a i d ; a n additional $24 million have been improved to the extent t h a t they a r e
no longer subject to criticism. However, of the $216 million reflected in t h e
current report, $76 million appear for the first time which would indicate weaknesses in supervision and follow-up after the loan is booked.
T h e directors were also informed of the serious operating and internal control
deficiencies brought to light in the Foreign Exchange D e p a r t m e n t of the bank.
The need for a top-level operations officer was stressed.
D e p a r t m e n t a l problems were reviewed briefly with emphasis placed on the
much-improved real estate equities and instalment loan areas. Comparison of the
221
investment portfolio was discussed on 50 percent write off of the hank's $1 million
investment. The unsound practice of appropriating securities held as loan collateral and utilizing these to secure Federal Funds transactions was discussed in
detail. Assurances were given that such practices will not reoccur.
It was stated by Mr. Gleason that an intermediate and long-range capital needs
program was in process of formulation.
The trend in the affairs of the bank is favorable. The matter of greatest concern is the relatively heavy volume of loans, classified doubtful.
C. M.
VAN
HORN,
Regional Administrator of National Banks,
Second National Bank Region.
FRANKLIN
NATIONAL BANK,
SEPTEMBER 6,
1971
Opening remarks—Mr. Van Horn.
Loan Review:
Comparison of criticized assets with last examination.
Substantial increase in Doubtful and Loss aggregate.—relation to bad debt
reserve loss history since 1966- .
Review some of larger credits—causes of problems: Overexpansion; mismanagement ; sale of equity or refunding could not be accomplished.
Past due—5.9 percent versus 4.8 percent L/X Mortgage Dept. 11 percent excessive (includes construction loans).
Departmental problems:
Mortgage Dept. & R / E Equities—memos; documentation—mostly old
workout situations. Large new—Southgate State Bank—$3MM.
Installment Loans—Inaccurate reports from Eastern States Bancard
Assoc. Both reported insufficient number of personnel in Collection Dept.
rectified.
Special Loans—Residue of high risk credits from branches—workouts.
Sheffield Watch $1MM loss—transferred to depart, during exam.
Operating results for 1970 and (6) months earnings 1971- . Heavy interest
costs on time deposits and borrowed money. Retained earnings suffering from
heavy loan losses.
Investment Portfolio—maturities materially shortened (see memo)—liquidity
conscious (21.3 percent). Depreciation in relation to capital 31 percent—considered disproportional in view of unsettled market. Virtually all transactions
through Trading Account.
Capital—prospects for raising.
Management Realignment—comments.
Cooperation excellent—Solid senior management team.
Closing Remarks—Mr. Van Horn.
FRANKLIN NATIONAL BANK—COMPARISON OF CRITICIZED ASSETS
[In millions of dollars]
Examination date
January
1966
October
1966
September
1967
September
1968
September
1969
August
1970
May
1971
Substandard
Doubtful
Loss
32.7
10.2
5.8
48.5
0
7.8
36.7
0
5.9
30.6
1.7
4.8
29.4
3.9
1.6
98.3
10.3
6.8
80.5
21.7
14.0
Subtotal
OLEM
48.7
42.2
56.3
75.3
42.6
61.0
37.1
56.9
34.9
57.7
115.4
126.6
116.2
100.4
Total
Capital
Deposits
Reserve for loan losses
90.9
131.6
103.6
94.0
92.6
Note: Corrective action program commenced in early 1967.
74-548—76
15
242.0
220.6
2,241.3
31.1
216.6
230.2
2,406.2
30.3
222
[In thousands of dollars]
This examination
Metropolitan division
National division
International department
Real estate equities
Special loan department
Property acquired for lease. _
International department
Installment loan department.
Accounts receivable department
Branches
Industrial credit department..
0. R. E
Unpaid accrued interest
Miscellaneous
Totals
Last examination
OLEM
Substandard
Doubtful
Loss
OLEIVI
Substandard
Doubtful
Loss
26,253
16,357
14, 581
12,882
0
0
703
0
14,061
31, 882
11,230
1,822
10, 652
0
2,237
0
9,022
7,110
130
0
2,947
0
1,187
0
2,950
4,600
0
27
2,409
0
125
2,109
27,158
38, 743
7,247
13, 470
0
547
14, 837
0
23, 099
36, 739
16, 473
2,965
8,016
0
1,029
0
5,228
2,590
186
0
984
0
0
0
0
0
413
103
2,135
0
0
1,854
1,106
28, 554
0
0
0
0
381
6,229
0
1,996
46
0
797
0
0
0
0
500
12
100
89
331
554
701
0
24, 567
0
0
0
0
0
8,521
0
724
696
0
0
1,269
0
0
0
0
0
1,496
0
549
273
100,436
,536
21,693
14,007
126,569
98,262
10,257
6,831
Note: See table below:
Substandard
Doubtful
Loss
Total classified..
OLEM..__
Total criticised _..
_
This
examination
Last
examination
80, 536
21, 693
14, 007
98, 262
10, 257
6,831
115, 236
100, 436
115,350
126, 570
216, 672
241,920
FRANKLIN NATIONAL BANK--RECAP OF CONTINGENT LIABILITIES INCLUDED IN CRITICIZED LOANS
Classified
loans
Letters of credit:
Metropolitan division
National division
International departmentSpecial loan department..
New York City branches..
Subtotal.
OLEM
$227, 400 .
4, 410, 000 $4, 868, 475
591,195 .
533, 000 .
3, 722,000
5, 761, 595
8, 590, 475
Total
$227,400
9, 278, 475
591,195
533,000
3,722,000
14, 352,070
Loan commitments:
Metropolitan division
Real estate department-.
Special loan department.
478,800 . .
139,154 _.
117,375 _.
478,800
139,154
117,375
Subtotal
Disputed return item: Hanover Square Branch-
735,329 _
500,000 __
735, 329
500,000
Grand total.
6,996, 924
8, 590, 475
15, 587,399
223
FRANKLIN NATIONAL BANK—LETTERS OF CREDIT INCLUDED IN CRITICIZED LOANS
Division
OLEM
Metro
National
International
Do
Special loans
National
Substandard
$227, 400
4,410,000
520,000
71,195
_
Doubtful
Loss
.
.
.
.
$533,000
$4, 545, 562
240,000
82,913
2,700,000
1,022,000
New York City branches.
Coliiseum, 90 Park Ave..
.
.
.
.
.
8, 590,475
Total.
533, 000
5,228, 595
LOAN COMMITMENTS INCLUDED IN CRITICIZED LOANS
Metro....
Real estate...
Special loans.
$478,800 .
139,154 .
117,375 .
0
735,329
Note: Disputed ilem included in criticized items p. 4, Delafield Capital (Hanover Square Branch)—$500,000.
FRANKLIN NATIONAL BANK
[Amount in thousands of dollars]
Last examina- This examination
tion
Other real estate
Installment loans—delinquencies
Loss:
Installment loans
Master charge
Military purchase
Steady credit
Food purchase plan
Bond account:
Book value all bonds
Maturities:
Up to 1 yr
1 to 5
5 to 10
10 to 20
20 and over
Secured liabilities
Earnings:
Total operating income
Total operating expenses
Income before taxes and securities..
Net income
Add:
Provision for loan losses
Recoveries
Less losses charged to reserves
Adjusted net income
Total dividends
Profits retained
Capital funds—end of year
1,272.0
* 1.4
2, 534.0
13.1
258.0
1, 334.0
60.0
4.0
0
525.0
1,400.0
67.0
7.0
12.0
561,602.0
746,406.0
.7
26.8
7.4
24.1
41.0
631, 345.0
29.3
14.5
6.2
21.3
28.7
475, 873.0
1S69
1970
173,123
145, 521
191,129
164,636
27, 602
27,102
26, 493
23, 816
285
3,067
1,674
7,523
21,034
10, 508
10, 526
218, 477
2,138
2,423
27,102
9,946
17,156
207,952
Last examination
Loans (in millions of dollars):
Real estate mortgages
Installment loans
Commercial loans
Special and accounts receivable
Past due
--
l7657
i Percent.
This examination
217
207
1,115
51
36
1,626
224
Newly criticized loans on since last examination:
Special mention (9)
Substandard (16)
Doubtful (2)
8,382
5,945
i 022
Total
15> 949
JANUARY 21,1971.
MEMORANDUM FOR THE FILES :
Re Franklin National Bank
Mineola, N.Y.
National Bank Examiner Edward B. Lake and I attended the regular meeting
of the captioned bank today to discuss the adverse trend in the affairs of the
bank as revealed in the report of examination made on August 28, 1970 by
Examiner Lake. All Directors except Director Prosswimmer were present. Also
in attendance were Executive Vice President and Cashier Becht, Executive Vice
President Sadlik and Toomey.
The report reveals aggregate classified assets equal to 52% of Gross Capital
Funds; Substandard represents $98 million, Doubtful $10.3 million and Loss
$0.8 million. In addition, loans aggregating $126.6 million are Especially Mentioned. Combined criticized loans represent approximately 110 percent of Gross
Capital Funds.
Examiner Lake reviewed the trend of criticized loans over the last five-year
period. He discussed briefly each of the larger loans summarizing the causes
of the lending weaknesses. He observed that between examinations, the bank
has made substantially larger loans than heretofore, i.e. $5—$10 million vs. $2—
$3 million loans previously. Chairman Gleason replied that they had inaugurated
a "house rule" which would limit the size of any single line of credit.
It was pointed out to the Directors that vigorous management effort is needed
to rectify the heavy and increasing volume of criticized loans. Management
presented the December 31, 1970 Corrective Action Program Report. (See
attached copy). According to this report, criticized loans have been reduced in
the aggregate of $9 million as of that date. After the meeting, Senior Executive
Vice President Lewis informed Examiner Lake he anticipates a further reduction of $25 million in criticized loans in the next 3-4 months.
The Investment Account was reviewed and it was pointed out that over 65
percent of the Investment Account is centered in securities with maturities in
excess of ten years. Also it was noted that on examination date, August 31, 1970,
depreciation was $109 million. However, management reported that by yearend
the depreciation had shrunk to $57 million due to improvements in the long-term
bond market.
The Directors were informed that in light of the potential loan losses centered
in the loan portfolio and the volume of business handled, capital protection is
considered somewhat marginal. It was suggested that consideration be given, in
due course, to an appropriate increase of the capital funds. Liquidity at 21.9
percent is within an acceptable range.
The Directors were informed that the unsatisfactory condition of the bank
may cause a problem in connection with domestic branch expansion. Mr. Gleason
stated that they had already decided that further branch expansion will be on
a highly selective basis.
Pursuant to the suggestion of Deputy Comptroller of the Currency John D.
Gwin, the Directors were informed that the condition of the bank may cause
a problem with the bank's London Branch application. After the meeting, Chairman Gleason expressed concern that an adverse ruling on the London Branch
might focus unfavorable publicity on the bank.
Management was requested to keep us currently informed with respect to
alleviating the criticisms. They gave assurance that they will furnish this
Office with Corrective Action Program Reports monthly.
C. M. VAN HORN,
Regional Administrator of National Banks,
Second National Bank Region.
225
COMPTROLLER OF THE CURRENCY,
Washington, D.G., January 16,1970.
Re Franklin National Bank.
Mineola, New York.
Mr. C. M. VAN HORN,
Regional Administrator of National Banks,
New York, N.Y.
DEAR MR. VAN HORN : The following is a resume of the Board Meeting attended
by yourself and the undersigned on January 15,1970. All directors with the exception of Messrs. Gibson, Kittay and Prosswimmer were present.
The first matter of discussion was the bank's liquidity, which on examination
date was 2.3 percent according to our liquidity formula on an adjusted basis
(giving credit for Farmers Home Loan Notes and Municipal Notes). By the end
of the examination, this had improved to 12.9 percent. President Gleason advised
the liquidity has improved further, and that commercial loans are back at their
March, 1969 level.
The second matter of discussion was the amount of assets subject to criticism,
comparing this examination to last examination:
I In thousands of dollars]
Last examination
Special mention
Substandard
Doubtful
__
Loss
This examination
57,685
29, 383
3,919
1,73/
56,863
31,678
1,702
5,259
President Gleason advised that after the very heavy charge offs from 1964
through 1968 (Losses were $39,261M before recoveries of $5,473M), the net loss
for 1969 was about $300M.
The ratio of Loans to Capital Funds was discussed; on examination date it was
rather high at 1 to 7.6. The Bond depreciation of 52 percent of adjusted capital
funds was also mentioned.
The Board was advised that the progress made in correcting the bank's condition was considered very good.
Very truly yours,
EDWIN K.
LANGDON,
Senior National Bank
COMPTROLLER
Jr.,
Examiner.
OF T H E CURRENCY
Preliminary Draft by Haskins and Sells (Draft of October 4, 1974)
OBSERVATIONS
Hon.
JAMES E.
AND COMMENTS CONCERNING SPECIAL REVIEW OF FRANKLIN
NATIONAL BANK
SMITH,
Comptroller of the Currency, the Administrator of National Banks,
Washington, D.C.
Scope
DEAR MR. SMITH : In accordance with your request, we have read the files
relating to Franklin New York Corporation ("Franklin") and Franklin National
Bank (the "Bank") maintained in the Office of the Comptroller of the Currency
(the "Comptroller") in Washington and in the Regional Office in New York that
were provided to us (includiing examination reports prepared by your examiners
as of various dates between June 15, 1964 and May 14, 1974). The information
obtained from these files has been supplemented by data obtained from (1) the
annual reports to stockholders of Franklin or the Bank for the years 1964 through
1973, (2) a Registration Statement prepared in connection with a proposed
merger with Talcott National Corporation dated March 29, 1974, (3) an Offering
Statement relating to the sale of $35 million of 7.30% notes dated November 16,
1971, and (4) readings of the minutes of the Boards of Directors of Franklin
and the Bank from 1968 to July 11, 1974, copies of which were made available to
us.
226
For reference purposes, we have included herein a consolidated statement of
condition of Franklin (or the Bank) as of December 31 for the ten years from
1964 to 1973 (Exhibits A and B), a consolidated statement of earnings for the
ten years ended December 31, 1973 (Exhibits C and D), and a summary of
changes in capital funds for the same period (Exhibit E ) . In certain instances,
reclassifications of amounts were made in the interest of presenting the information for all years on a comparable basis.
We did not examine the accounting records of Franklin or of the Bank and
are therefore unable to express any opinion with respect to the accuracy of the
financial data included in this report.
Our comments on the following pages are intended to inform you of the facts
which were known (or which should have been known) to the members of the
staff of the Comptroller and their reactions to the conditions revealed in those
facts. We have, in preparing these comments, relied almost entirely on the
documentary evidence made available to us and have had only limited discussions
with certain of those persons in the Comptroller's Office who were involved
directly or indirectly in the examination of the Bank or the discussions with the
officers of the Bank or Franklin.
Conclusions
The information which came to our attention during the course of our work
has led us to the following conclusions :
1. The National Bank Examiners (the "Examiners"), during their examinations, developed significant information which indicated the condition of the
Bank was at best only fair. The quality of the loan portfolio and the status
of the investment portfolio were commented upon critically in virtually
every examination report we read.
2. The critical comments of the Examiners were given to the Regional
Administrator in New York and to the Deputy Comptrollers in Washington.
There is evidence that the situation at the Bank was called to the specific
attention of the Comptroller by the Regional Administrator as early as 1964.
3. Representatives of the Comptroller's Office (the "Comptroller's Office")
frequently discussed the condition of the Bank with the directors and with
the senior officers of the Bank. While the senior officers of the Bank apparently promised to take corrective actions, the actions appear to have
been only minimal and temporary, and over the years there was no substantive improvement in the situation discovered by the Examiners.
4. In retrospect it appears that the Comptroller's Office did not aggressively attempt to force the Bank to adopt more drastic measures to correct
the situations criticized by the Examiners. Inasmuch as the statutory rights
of the Comptroller in this area are limited, the steps that might have
been taken would necessarily be informal. For example, there is no provision in any of the statutes which permits the Comptroller to exercise
supervision over the day-by-day lending policies of a bank, nor does the
Comptroller's Office have the right to approve new loans. Nevertheless,
had the Comptroller's Office successfully attempted to exercise suasion,
it is possible that many of the classified and criticized loans would not
have been made.
5. Despite the constant criticism to which the Bank was subjected, the
Comptroller's office, beginning in 1964, approved the expansion of the Bank
into the highly competitive New York City market, which expansion was
accelerated through the merger with Federation Bank & Trust Company
in 1967 and the opening of 21 new branches since 1969. The Comptroller's
Office also approved the expansion of the Bank into the international field
with the opening of the London office in 1972.
6. There were several areas in which neither the Examiners, the Regional Administrator, nor the Deputy Comptrollers appear to have expressed
concern, but which were, in retrospect, potentially troublesome. The significant depreciation in the investment portfolio was noted by the Examiners,
but apparently was not considered as an element to be used in measuring
capital adequacy. The significant rise in the cost of borrowed funds and
the diminishing spread between the cost of such funds and the interest
on earning assets does not appear to have been critically reviewed by the
Comptroller's Office in evaluating the Bank's earnings record. The substantial rise in foreign deposits (which by the end of 1973 represented 30 per-
227
cent of total deposits) does not appear to have prompted any special
investigation as to the nature of the deposits.
The situation at Franklin illustrates the need for the Comptroller's Office
to establish uniform procedures for handling problem bank situations (short of
the legal remedies of officer removal, "cease and desist" orders, and bank
closing). It also demonstrates the need to establish objective criteria for approving bank expansion plans (whether by merger or new branches) and
having them understood by all persons charged with the responsibility for
making recommendations to the Comptroller. Furthermore, the Franklin situation serves to illustrate the need for a greater critical analysis of the financial
statements of a bank, including financial ratios, trends, and comparisons with
other banks, in order that potential problems can be discovered before they
occur.
In subsequent sections of this report, as shown in the accompanying index, we
are commenting on these matters in greater detail.
Yours truly,
INDEX
History and Business of the Bank and Franklin.
General Overview of the National Bank Examiners' Ratings.
Branch Expansion:
Merger with Federation Bank & Trust Company.
New Branches.
London Branch.
International Division.
Condition of Bank :
General.
Loans.
Reserve for Loan Losses.
Investments.
Liquidity.
Management.
Earnings.
Capital.
Internal Controls.
Future Prospects.
Overall Rating.
Exhibits:
Consolidated Statement of Condition :
Millions of Dollars.
Percentage of Total Resources.
Consolidated Statement of Earnings :
Thousands of Dollars.
Percentage of Total Operating Income.
Consolidated Changes in Capital Funds.
List of Branches Opened Or Disapproved.
Summary of Foreign Exchange Positions.
Classified and Criticized Loans.
Analysis of Reserve for Loan Losses.
Investments.
Investment Maturities:
Thousands of Dollars—Par Value.
Percentage of Total Investments at Par Value.
Summary of Bank Liquidity.
Return on Earning Assets.
Cost of Funds.
HISTORY AND BUSINESS OF THE BANK AND FRANKLIN
The Bank was incorporated in 1926 and until 1964 had offices only in Nassau
and Suffolk Counties on Long Island. Franklin was organized by the Bank in
1965 and remained inactive until 1969 when it acquired all the voting capital
stock of the Bank, which has been its only subsidiary.
The Bank opened its first New York City offices in May 1964. At December 31,
1966 the Bank had total resources of $1,966 million and 68 banking offices. In
228
1967 the Bank acquired, by merger, Federation Bank & Trust Company, which
company had total resources of $291 million and 13 banking offices in New York
City. Before its expansion into New York City, substantially all of the Bank's
deposits were derived from Long Island sources, but in recent years a majority
of its deposits have been derived from New York City and national and international sources.
As of December 31, 1973 the Bank was ranked twentieth in the United States
and ninth in the State of New York in order of deposits. Since then, as a consequence of withdrawals, it has dropped in rank. The Bank is a member of the
New York Clearing House Association and the Long Island Bankers Association,
Inc.
The Bank conducts a general commercial banking business through its offices
in the Greater New York City area. At December 31, 1973 there were 31 offices
in New York City, 49 in Nassau County, and 24 in Suffolk County. The Bank
conducts an international banking business through its International Banking
Division with headquarters in the World Trade Center in New Y'ork City, foreign branch offices in London (opened in 1972) and Nassau, Bahamas (opened
in 1969), and representative offices in Singapore and Mexico City.
At December 31, 1973, the Bank had correspondent relations with over 400
banks in other parts of the United States and also maintained correspondent
relations with over 300 banking institutions in over 70 foreign countries.
The Bank provides investment and administrative services to individuals and
estates, acts as trustee for personal, pension, and profit sharing trusts, and provides investment management services to individual investors, corporations,
partnerships, and non-profit organizations. The Bank offers stock transfer,
stock registration, trustee, and paying agency services to corporations and
municipalities.
Pursuant to an agreement with Bradford Computer & Systems, Inc. the Bank,
in effect sold in January 1973 its stock transfer, registrar, and other corporate
agency activities to the Bradford Group for a purchase price equal to 125 percent
of the average annual revenues, as defined, to be derived from such corporate
agency business over a three-year period.
The financial difficulties of Franklin became publicly known in May 1974 as a
result of announcements relating to the passing of the dividend payment and to
the existence of foreign exchange losses.
GENERAL OVERVIEW OF THE NATIONAL BANK EXAMINEES' RATINGS
During the past ten years the National Bank Examiners (the "Examiners")
have examined the Bank thirteen times, or on the average of once every ten
months. The Examiners' comments relating to the specific problems noted with
respect to the Bank and the actions of the Comptroller's Office in New York and
Washington are discussed separately in the sections of the report that follow.
At the conclusion of each examination the Examiners rated the Bank in various
categories. A summary of the rating is as follows :
Condition
of bank
Examination date
June 15,1964
Apr. 26, 1965
Jan. 10.1.966
Oct. 3,1966
Sept. 25, 1967
Sept. 30, 1968
Sept. 29,1969
Aug. 31,1970
May 17, 1971
Mar. 6, 197?
Dec. 11,1972
Nov. 14,1973
May 14,1974
Management
Fair
._ Good
Fair
_ Good
. Good
Fair
Fair
_ Good___
Fair
_ . Good
Fair
_ Good
Fair
_ Good
Poor
_ Fair
Fair
_ Fair
Fair
_ Fair
UnsatisFair
factory.
Poor
.__ Extremely
2
.__
.__
.__
.__
...
.__
.__
.__
.__
___
.__ 0_..;.___ - ( )
__
__
__
__
__
_
__
__
_
_
__
Internal
controls
Earnings
Capital
Excellent.._
Good
_
Fair
_
Fair
_
Fair
_
Fair
_
Good
_
Fair
_
Fair
_
Marginal.. .
Poor
Adequate
.
.
Good
Inadequate._..
Inadequate....
Inadequate. ..
Strengthened.
Borderline
.
Inadequate....
Inadequate. ..
Inadequate....
Inadequate....
_. Poor
_. (2)
(2)
(2)
(2)
Future
prospects
. <*)
.
.
.
0>
.
(2)
.
(2)
Adequate....
Adequate....
Adequate....
Weak
.
Generally
adequate.
Inadequate.... Adequate....
- <*>—-
-.
(2)
Good
Good
Good
Good
Good
Good
Good
Good
Fair
Good
Fair
. (2)
Overall
rating i
.. 1-B-S
.. 1-C-F
- 2-C-F/3
(*)
._
._
._
..
..
._
.
2-B-F
l-B-F/2
2-B-F/2
2-C-F/3
2-C-F/3
2-C-F/2
2-C-F/2
. 2-D-P/3
- (2)
* The overall rating of the hank by the examiners is based upon the following formula: Capital position minus Quality of
assets minus management divided by composite or group rating. Capital position is rated from 1 to 4 (1 bein? adequate
based upon the examiners' considering such factors as management, lianidity, earnings, etc. Quality of assets is rated from
A to D (A being good) based unon the ratio of classified and speculative assets to grn*s capital. Management is rated
as S (strong or competent), F (fair), or P (poor, incompetent, or integrity questioned). The composite or group rating is
from 1 to 4 (1 being a sound institution) based upon consideration of all ratings.
2
Ratings were not shown in the examination report. In the case of the May 14, 1974 examination, the ratings were
not prepared due to the limited nature of the examination.
229
BRANCH EXPANSION
Merger tvitJi Federation Bank & Trust
Company
I n 1967 t h e B a n k merged with F e d e r a t i o n B a n k & T r u s t Company ("Federation") and, as a result, acquired thirteen additional branches, all located within
New York City.
The first indication in the files reviewed by u s of the pending merger is a
November 10, 1966 memorandum by Mr. C. F . West, Deputy Regional Administ r a t o r of National Banks, relating to a meeting with Mr. A. T. Roth, Chairman
of the B o a r d of the Bank. T h e purpose of the meeting was to inform t h e Comptroller's Office of the proposed merger and to discuss t h e procedures to be followed by the E x a m i n e r s in classifying loans in connection with their then
c u r r e n t examination.
At this meeting Mr. Roth stated t h a t he h a d discussed with E x a m i n e r Langdon the minimum use of the "doubtful" classification of loans because of the
merger negotiations then being held with the directors of Federation. Mr. Roth
stated t h a t he would r a t h e r h a v e all possible losses charged off immediately a n d
the balance of loans considered subject to classification shown as "substandard".
I n order to p u t this meeting in proper perspective, it should be noted t h a t
a t the conclusion of t h e prior examination a s of J a n u a r y 10, 1966, the Examiners h a d classified t h e condition of the B a n k and its earnings as "fair"
and its capital as "inadequate". As discussed in greater detail under t h e heading "Condition of Bank-Loans", t h e lending policies of the B a n k h a d been subject to criticism for several years. I n the judgment of t h e Examiners, the
quality of t h e B a n k ' s loans h a d declined as shown by the following classifications :
[In millions of dollars]
Loss
Doubtful
Substandard
Total
classified
Special
mention
June 15, 1964
Apr. 25,19^5
$3.1
7.6
$14.9
13.2
$25.1
35.3
$43.1
56.1
$16.6
21.2
Jan. 10, 1986
5.7
9.5
32.7
47.9
42.2
Examination date
As a result the bank w a s required to report, commencing in May 1986, to t h e
regional a d m i n i s t r a t o r as to t h e status of loans classified in t h e previous examination.
At the conclusion of the October 1966 examination it appears t h a t the E x a m iners complied with Mr. Roth's request since there were no loans classified as
"doubtful".
On J a n u a r y 20, 1967 Peat, Marwick, Mitchell & Company rendered a letter
report on their review of the E x a m i n e r s ' report on the B a n k as of October 3,
1966 to Mr. J. P . DeSantis, President of Federation. The following is a summary
of such r e p o r t :
(1) Based on their limited review of classified loans it appeared to them
t h a t the reserve for loan losses was adequate.
(2) Based on their brief review of the B a n k ' s loan policies and m a n u a l
entitled "Commercial Loan Policies" issued in J a n u a r y 1966, they were of
the view t h a t the B a n k h a d taken definitive steps to improve the quality of
its loan portfolio and eliminate prior practices t h a t may have been responsible for the high level of classified loans.
(3) They noted t h a t the B a n k h a d entered into a sale and leaseback
a r r a n g e m e n t with an affiliate and recognized a gain of $10.4 million on such
a r r a n g e m e n t which w a s added to undivided profits by the B a n k and was
being amortized by t h e affiliate as p a r t of the total purchase price over the
lives of the leases. At September 30, 1966 the unamortized portion of t h e
gain included in capital funds amounted to approximately $9.5 million. They
stated t h a t although the transaction was not uncommon in b a n k i n g and was
undertaken with the approval of supervisory authorities, the transaction was
not recorded in accordance with generally accepted accounting principles in
t h a t no gain or loss should be recognized on transactions entered into with
affiliates for financing purposes.
In 1967, the 1966 financial statements were restated for the above transaction
and the following appeared in the notes to the financial s t a t e m e n t s :
230
"The financial statements include the accounts and operations of the Bank
combined with those of F r a n k l i n Buildings, Inc. (lessor of certain premises
occupied by t h e B a n k ) whose outstanding capital stock is under option to the
B a n k a t a nominal amount. The combination h a s been m a d e on t h e basis
of regulations issued by the Comptroller of the Currency during 1967.
Accordingly, in t h e accompanying financial statements the balance in
Capital Accounts a t J a n u a r y 1, 1966 has been reduced by $9,850,000 as a
result of eliminating from undivided profits the remainder of amounts
credited thereto in 1962 and 1963 on recording a gain on the sale of certain
properties to F r a n k l i n Buildings, Inc."
On March 1, 1967 Mr. J. L. Donovan, Assistant Chief National B a n k Examiner,
sent a memorandum to Mr. F. H. Ellis, Chief National B a n k Examiner, stating
t h a t he was not in favor of the proposed merger. I n the memorandum Mr. Donovan, among other things, listed the following points :
(1) Condition of the merged banks would only be fair.
(2) Management would be aggressive and would have a liberal lending
policy.
(3) E a r n i n g s of the merged bank would only be fair as the earnings of
neither bank were good a t t h a t time.
(4) Capital protection would be strained but within desired proportions
a t t h a t time.
(5) F u t u r e prospects would be reasonably good.
(6) Various banking factors were not favorable.
(7) The asset condition of the tfwo banks would a t best be fair and would
not improve greatly until there w a s a change in the business climate, especially t h e real estate sector, and the money m a r k e t s .
On March 27, 1967 Mr. F . H. Ellis and Mr. W. B. Camp, Comptroller of the
Currency met with Mr. A. T. Roth and Mr. II. D. Crosse. Vice Chairman of the
B o a r d of t h e Bank, to discuss the proposed merger. Mr. Camp specifically pointed
out the following unfavorable factors relating to the B a n k :
(1) I m p r u d e n t banking practices t h a t were common knowledge to t h e
public as well as to the banking industry.
(2) Transactions with "unsavory individuals" and "hoodlums".
(3) Acceptance of weak loans which h a d been ferretted out of other
n a t i o n a l banks.
(4) The existence of an inordinate volume of classified assets and loans
subject to criticism representing in the aggregate some $124 million, or more
t h a n 80 percent of gross capital s t r u c t u r e of $150 million.
(5) E x o r b i t a n t loan losses amounting to $31.6 million during the prior four
years with recoveries of only $2.9 million during the same period,
(6) Unsatisfactory composition of loans with principal criticism directed
t o w a r d inordinate volume of real estate equity loans.
(7) Unsatisfactory composition of deposits, with savings bonds and certificates of deposit aggregating 44 percent of the total.
(8) I n a d e q u a t e capital s t r u c t u r e which included an undesirable level of
senior securities. I t appeared obvious to him t h a t an additional $25 million
in common equity funds were needed.
T h e memorandum stated t h a t although Messrs. Roth and Crosse concurred
w i t h Mr. Camp's position on t h e unsatisfactory condition of t h e B a n k and
offered no defense a s to t h e unfavorable banking conditions, Mr. Roth stated
t h a t more p r u d e n t banking policies h a d been adopted and t h e b a n k w a s on
an improving trend. T h e memorandum indicated t h a t Mr. Camp stated he w a s
not a s optimistic a s m a n a g e m e n t about moving t h e B a n k to a fully acceptable
condition a t an early date.
As a result of the meeting Mr. Roth provided Mr. Camp, on April 12, 1967,
w i t h t h e following:
(1) An analysis of s u b s t a n d a r d loans as of April 5, 1967 showing a 27
percent reduction since t h e October 3, 1966 examination.
(2) An analysis of "less desirable special mention loans" a s of April 5.
1967 showing a reduction of 15 percent since t h e October 3, 1966 examination.
(3) An analysis of "desirable accounts with good prospects" but listed a s
special mention loans as of April 5, 1967 showing a reduction of 44 percent
since th^ October 3,1966 examination.
(4) An analysis of deposits a n d loans as of December 1966 and March
1967 a n d estimated December 1967.
281
(5) An analysis of m a r k e t values of government and agency obligations
as of March 31,1967.
(6) An analysis of the municipal bond evaluations a s of March 31, 1967.
(7) An analysis of the B a n k ' s liquidity.
(8) The B a n k ' s statement of condition as of March 31, 1967.
I n a n April 17, 1967 letter Mr. Roth asked Mr. Camp to a r r a n g e to h a v e t h e
loans which were classified as " s u b s t a n d a r d " a n d "special mention" in the
October 3, 1966 examination report re-examined to determine their present
s t a t u s . T h e E x a m i n e r s were asked to review all such loans and all new loans
of $500,000 and over m a d e a t the F r a n k l i n Square a n d Madison Avenue offices
since t h a t date.
On May 9, 1967 Messrs. W a t s o n a n d Gwin, Deputy Comptrollers, met with
Messrs. Roth, Crosse, a n d DeSantis to discuss the results of the E x a m i n e r s '
special review of classified loans. The E x a m i n e r s reported t h a t t h e r e h a d been
a substantial improvement in the loans classified a t the previous examination
a n d the great majority of the new loans reviewed were of better quality t h a n
th,e B a n k ' s previous loans. At the prior examination in October 1966 classified
assets plus 50 percent of loans classified "special mention" represented 02 percent
of capital funds. Based on the figures prepared by the E x a m i n e r s t h e amount
h a d been reduced to 42 percent by April 1967.
As a result of t h e improvement in the loan porfolio a n d on the condition
t h a t a commitment be received from t h e Board of Directors of t h e merged bank
to u n d e r t a k e a capital revision program in the fall of 1967 to produce a t least
$20 million new capital in the form of common stock, Messrs. Watson and Gwin
said t h a t they would recommend approval of t h e merger by the Comptroller.
On May 22, 1967 t h e Directors sent a letter of their intentions to increase
capital funds by $20 million through the sale of additional common stock a n d
on May 26, 1967 Mr. W a t s o n informed Mr. Roth t h a t the Comptroller h a d approved t h e merger.
Management of t h e B a n k , despite its earlier commitment to raise capital
funds through the sale of common stock, proposed in August 1967 to issue $30
million convertible debentures. I n September 1967 Mr. M. Goodman, Chief of t h e
Capital Increase Section, recommended t h a t the proposal by the B a n k be rejected, but Mr. T. M. Brezinski, Director of the B a n k Organization Division
recommended approval. I n October 1967 Mr. Gwin recommended approval "provided t h a t t h e examination in process shows satisfactory progress in improving
asset condition." The E x a m i n e r s ' report on the September 25, 1967 examination
r a t e d the condition of the B a n k as "fair" and its capital as "inadequate." which
r a t i n g s were unchanged from t h e previous examination on October 3, 1966. The
a m o u n t of loans classified and criticized as of September 25, 1967 had, however, declined to $104.6 million from $129.9 million a t t h e prior examination.
I n 1968 the B a n k raised $15 million dollars in new capital through the sale of
common stock. This increase in equity funds was $10 million less t h a n the amount
Mr. Camp indicated a s being needed by the B a n k in March 1967. F u r t h e r , such
increase was $5 million less t h a n t h e above-mentioned commitment of the
Board of Directors upon wThich approval of t h e merger by t h e Comptroller w a s
granted in May 1967.
Neiv 'branches
A national bank may not open a branch office w i t h o u t t h e approval of t h e
Comptroller. I n t h e discharge of this responsibility the Comptroller is given wide
discretion. I n practice, when an application is received, it is circulated to the
following persons for recommendations and c o m m e n t s :
E x a m i n e r s in the Region,
Regional Administrator,
Director of the B a n k Organization Division, and
Deputy Comptroller.
I n addition, comments a r e requested from t h e S t a t e B a n k i n g D e p a r t m e n t .
The reports of the aforementioned parties a r e reviewed and provide t h e basis
for the final decision by the Comptroller.
At December 31, 1969 t h e B a n k h a d 86 domestic branches. F r o m such date
through December 31, 1973, information provided to u s indicates t h a t 21 domestic
branches were opened and 3 were closed. Thus, as previously indicated in "History
a n d Business of the B a n k and F r a n k l i n " t h e r e were 104 domestic branches a t
December 31,1973.
232
A listing of the branches opened during the four years ended December 31,1973,
together with a summary of the recommendations of the aforementioned parties,
is shown in the accompanying Exhibit F. In connection with an application for a
new branch an Examiner is assigned to review the application. Various Examiners were so assigned to the applications shown in Exhibit F. Except for the
application relating to the Lake Success Quadrangle branch, for which Mr. A. E.
Wilkens, Jr., Deputy Regional Administrator, reviewed the application with an
unfavorable recommendation, all recommendations from the Regional Administrator were favorable and were made by Mr. C. M. Van Horn. Except for the
application relating to the 475 Park Ave. So. branch, for which Mr. B. G. Glisson
made the review, all recommendations from the Director of the Bank Organization Division were made by Mr. T. M. Brezinski. The recommendations from the
Deputy Comptroller, with respect to all of the listed applications, were made by
Mr. R. J. Blanchard.
The information provided to us with respect to such branch approvals indicates
that either a letter was received from the New York State Banking Department
without comment or no letter was received.
Comments from the "Senior Economist" were received with respect to several
of the applications. For example, Mr. E. W. Hanczaryk recommended approval
of the application relating to the 535 7th Avenue branch, and Mr. S. I. Greenbaum,
while stating that approval of the application for the Lake Success Quadrangle
branch appeared to be warranted, commented as to a possible negative effect on
competition.
Except for the Southampton branch, all of the applications shown in Exhibit F
were primary (original) applications. The primary application for the Southampton branch was filed on August 6, 1968 and disapproved on February 28, 1969 and
a new application was filed on December 23,1969.
Final approval for each of the branches was granted by Mr. W. B. Camp as
Comptroller or by Mr. J. T. Watson or Mr. T. DeShazo, as Acting Comptroller.
A listing of the branches disapproved during the four years ended December 31,
1973, together with a summary of recommendations of the above-mentioned
parties, is shown in the accompanying Exhibit F. All recommendations from the
Regional Administrator, Director of Bank Organization Division, and Deputy
Comptroller were made by Mr. Van Horn, Mr. Brezinski, and Mr. Blanchard,
respectively. A letter w^as received from the New York State Banking Department without comment as to each application disapproved. There were no comments from the "Senior Economist" as to the disapproved applications. The final
disapproval was made by Mr. Camp, as Comptroller or Mr. Watson, as Acting
Comptroller.
London branch
According to the information provided to us, the Bank made formal application
on November 4,1970 to the Board of Governors of the Federal Reserve System for
permission to open a London branch. A copy of this application, accompanied by
a notice of intent to establish such a branch, was sent to the Comptroller's Office.
The procedures followed by the Comptroller's Office under such circumstances
provide for a member of the International Division to review the files on the
applicant, to discuss the application with the appropriate Assistant Chief National
Bank Examiner, and to review the latter's examination report summary file.
Because the Bank was classified as a "problem" bank, the International Division
also was required to discuss the application with the appropriate Regional Administrator, the Deputy Comptroller for the region, and the First Deputy
Comptroller.
The files include numerous letters and memoranda indicating that the over-all
problems of both the Bank and Franklin, as well as the prospects for the London
branch, were discussed at the various levels mentioned in the preceding paragraph. There is evidence in the letters and memoranda that the application was
also discussed frequently with various officers of the Bank.
In a memorandum dated January 13, 1971, Mr. R. A. Mullin, Director, International Division stated that the Bank's international capabilities appeared to be
of a higher quality than those of most other banks and it was regretful that they
were tied to a poorly managed problem "parent". He stated further that he was
delaying a final conclusion until the Examiners' report for the xlugust 31, 1970
examination was completed and reviewed with the Bank's Board of Directors.
This memorandum was initialed by Mr. J. D. Gwin, Deputy Comptroller.
233
The August 31, 1970 examination report was reviewed by Mr. Van Horn and
Examiner Lake with the Board of Directors on January 21, 1971. At this meeting
the continuing problems with loans, liquidity, and capital adequacy were discussed.
The directors were advised that capital protection was considered marginal and
that consideration should be given to an appropriate increase in capital funds.
A memorandum prepared with respect to the meeting states that, at Mr. Gwin's
suggestion, the directors were informed that the condition of the Bank might
cause a problem with the pending London .branch application. After the meeting,
Mr. H. V. Gleason, Chairman of the Board, expressed concern that a delay of
approval of the London branch might focus unfavorable publicity on the bank.
Mr. Mullin in a memorandum dated February 12, 1971 reiterated the problems
noted in the August 31,1970 examination report. He concluded by stating he could
not recommend approval of the London branch application on a basis of potential
growth when so many adverse factors were involved. He further stated that he
believed that the Bank should withdraw its application or the Board of Governors
of the Federal Reserve System should deny approval of the application.
In a March 1, 1971 letter to the Board of Governors of the Federal Reserve
System, Mr. Mullin stated that the basic domestic problems of the Bank had
been reviewed with the Bank's Board of Directors and that corrective measures,
which were considered satisfactory, had been initiated by the Bank's management.
He concluded by stating that, with full consideration granted to all of the
present and future aspects of the proposal, "we have concluded that we do not
object to your approval of the application to open the London branch." The letter
was initialed by Mr. Gwin.
Mr. Gleason, on December 2, 1971, wrote to Mr. A. F. Burns, Chairman of the
Board of Governors of the Federal Reserve System, with reference to the delay
in approving the establishment of a London branch. In his letter Mr. Gleason
pointed out that a successful capital offering of $35 million had been completed
.by Franklin, of which $30 million had been added to the Bank's capital funds.
On December 31, 1971, Mr. T. Smith, Secretary of the Board of Governors of
the Federal Reserve System, wrote to the Comptroller, enclosing a letter from
the Board granting permission for the Bank to establish a branch in London,
on the condition that it be established and open for business prior to January 1,
1973.
The foregoing is a chronological summary of the events leading to United
States regulatory authority approval of the Bank's London branch. In addition,
however, permission for the branch to deal in the London interbank market
required the approval of the Bank of England.
During 1972 various letters were exchanged between Mr. Mullin and Mr. P. J.
Keogh, Principal, Discount Office, Bank of England. Various aspects of the Bank's
London branch, including meetings by Mr. Keogh in London with various officers
of the Bank (Messrs. Gleason, Crosse and H. P. Barrand, Executive Vice President), were discussed in the letters. Throughout the correspondence, Mr. Keogh
repeatedly stated that his sole interest was in being assured that Franklin was
in good standing with the regulatory authorities in its own country.
During the period in 1972 that Messrs- Mullin and Keogh were exchanging
letters, an examination was made of the Bank. This examination, as of March 6,
1972, disclosed significant problems in the Bank's New York International Department. The specific problems are set forth in greater detail under "International
Division". In an April 12, 1972 memorandum to Mr. Gwin, Mr. Mullin referred to
a meeting he had had with various officers of the Bank at which the problems
disclosed in the March 6, 1972 examination were discussed. The memorandum
includes a comment that Examiner Schlicht emphasized that the London branch
should not be opened until the International Department in New York wTas
operating properly. In a June 14, 1972 letter to Mr. G. G. Herrmann, Senior Vice
President of Franklin, Mr. Mullin acknowledged the former's letter of June 9,
1972 with which he had enclosed a progress report on the Bank's international
operations in New York. In his letter Mr. Mullin indicated that he was satisfied
with the Bank's foreign operations as reported and that since all segments of the
operations appeared to be operating efficiently, no further progress reports would
be required.
In an August 10, 1972 letter to Mr. Mullin, Mr. Keogh inquired, "Am I right in
assuming that you are reconciled to the situation in Franklin and that no further
action is likely to arise? The matter is of some importance to me because we are
currently delaying Franklin's authorization under the Exchange Control Act.
You will appreciate that I would not like to recommend a name to our own
234
Treasury if there was any possibility that some action might follow in your
country which caused doubts on the status of that name."
Further, in a letter of August 18, 1972, Mr. Keogh informed Mr. Mullin, "I am
telling Franklin today that they must apply again for authorization and in not
less than three months time." Finally, in a letter dated October 26, 1972 Mr.
Keogh asked Mr. Mullin, "Can you tell me you have no problems with Franklin
which would lead us to postpone recognition for a further period?"
During this period Mr. Mullin had been responding in general terms, suggesting that Mr. Keogh make his decision without concern about embarrassing the
Comptroller's Office or Franklin. In response to Mr. Keogh's letter of October 26,
1972, Mr. Mullin stated, in a letter dated October 31, 1972, that Franklin's problems had not only been apparent to the public but also, in detail, to the Examiners. He further stated that senior management was required to file monthly
progress reports. He discussed other matters including the possible effect Mr.
M. Sindona, a director and major stockholder of Franklin, might have on senior management and concluded by stating, "In view of all of these factors, we
believe Franklin should be recognized in London."
Thus, during a period of approximately two years the Comptroller's Office
changed from a position favoring disapproval of the application for the London
branch to one recommending to the authorities in London that the branch be recognized and be permitted to commence operations. Since the principal reasons for
initially opposing approval were the numerous adverse factors present within
the New York operations of the Bank, it is difficult to understand the change in
position in the absence of any significant improvement in the Bank's operations.
Although management had indicated that action was taken to correct the weaknesses in the International Department disclosed in the March 6, 1972 report,
there is no evidence, in the material provided to us. that any significant tests were
made by the Comptroller's Office to ascertain that improvement had in fact
been made.
INTERNATIONAL
DIVISION
As mentioned under "History and Business of the Bank and Franklin" the
Bank conducts an international banking business. In addition to services provided through its International Division located in New York City, significant
international activities are conducted through branches in London and Nassau
and services are provided through representative offices in Singapore and Mexico City.
Prior to 1969 the international banking business was solely conducted through
the International Division in New York City, and did not represent a significant
part of the total operations of the Bank. Based on the information provided to
us, the growth in international banking commenced in 1969 with the opening of
the Nassau branch and accelerated in 1972 when permission was granted for the
London branch to commence operations.
The following table presents information, in millions of dollars, obtained from
published information as of December 31 for the years shown:
Deposits in
foreign
branches
Percent of
total deposits
Foreign branch
loans
Percent of
total loans
$159.7
209.6
256.1
771.6
1,136.0
7.7
8.2
9.0
22.3
30.5
$30.0
108.9
192.6
243.8
549.3
2.0
6.8
11.2
11.7
19.8
A principal activity of the New York International Division was foreign exchange trading on both spot and future bases. A summary of foreign exchange
positions as of the various dates of examinations made by the Examiners from
August 31, 1970 to May 14, 1974 is shown in the accompanying Exhibit G. The
growth in the magnitude of such positions, other than positions in U.S. dollars,
is evident from the following summary (in thousands of dollars) :
235
Long positions
Aug. 31, 1970..
May 17,1971..
Mar. 6,1972...
Dec. 11,1972..
Nov. 14,1973..
May 14,1974..
Short positions
$9, 368
18,448
211,249
678,439
:, 037,741
53, 562
$6, 817
17, 880
210, 251
683,644
1,100, 356
286,146
Net long (short)
positions
$2, 551
568
998
(5, 205)
(62, 615)
(232, 584)
Data shown above as of May 14, 1974 are after the revaluation of foreign exchange positions made as of May 10, 1974, which resulted in the disclosure of
previously unrecognized foreign exchange losses aggregating approximately $43
million.
The operations and procedures of the International Division were comprehended in the regular examinations of the Bank made by the Examiners. In
addition, the material provided to us indicated that the independent accountants
for the Bank had rendered a report, addressed to Mr. H. P. Barrand, Executive
Vice President in charge of international operations, which included recommendations for improvements in internal control, developed as a result of a surprise
examination of the International Division as of October 1,1971.
The Examiners' report on examinations made as of September 29, 1969, August 31, 1970, and March 6, 1972 include comments regarding the International
Division. The growth pattern was noted, as well as the need to develop a system
which would provide for adequate controls and reliability of management information to meet the anticipated requirements resulting from continued growth.
The report rendered by the Bank's independent accountants as a result of their
examination of the International Division as of October 1, 1971 pointed out
several significant weaknesses and included recommendations for improvements
in internal control. Significant items pointed out in their report included:
1. Subsidiary records for open foreign exchange future contracts did not
agree with the general ledger control.
2. The foreign currency account included amounts for transactions already
sold, but for which payment had not been received.
3. The foreign exchange section appeared to be experiencing difficulty in
handling the expanding volume of activity.
In view of the above, recommendations were made to establish formalized
procedures, preferably through a "procedures manual", with the inclusion of the
reconcilement of subsidiary accounts to general ledger controls as a basic procedure and the utilization of bookkeeping control over foreign currency transactions
by means of an account receivable procedure for protection in situations where
cash receipts were delayed. Further, there was concurrence with management as
to the need for an overall systems review in light of expanding activity and a
suggestion for independent audit or verification of basic transactions.
In the March 6, 1972 examination report the Examiner assigned to the International Division stated that he had been unable to balance the foreign exchange
contracts, that entries in the accounts contained many errors, and that his general
reaction was that the Division was in a state of "chaos".
Specific comments included in the report were:
1. Internal controls were virtually non-existent.
2. Too many specific functions were being handled by the trader.
3. Nostro accounts, maintained in Westbury, Long Island, were not being
reconciled. Open items were present dating back to 1970.
4. Minimum accounting procedures and formalized records were lacking.
5. There was an absence of subsidiary foreign currency ledgers for forward contracts purchased or sold.
6. Review of data available revealed unrecorded contracts, mispostings,
and other errors which obviated the value of position records.
7. Forward contract forms were neither prenumbered nor controlled, making it possible for such contracts to remain unrecorded until liquidation.
8. Official gap reports were lacking.
9. Aggregate limits, necessary for management to control growth rates
within limits deemed reasonable, were lacking.
236
When senior management was made aware of the above-mentioned deficiencies,
trading in foreign exchange was sharply curtailed and a crash program was
instituted by the Bank to ameliorate the disorganized condition of the foreign
exchange department. The program was four-pronged:
1. The responsibility of the foreign trader would be limited solely to
foreign exchange trading. He would have nothing to do with the preparation of the paper work, the accounting, and the follow-up.
2. Permanent operational procedures for a more orderly flow of transactions would be finalized by the Systems & Standards Department. An
interim
system coupled with temporary forms would be installed, which,
it wTas expected, would improve the efficiency of the operations of the department.
3. The Nostro (due from) accounts would be moved to the International
Division at Hanover Square. The majority of the accounts were properly
reconciled and in most cases all open items were cleared. Write-offs in this
area were expected to be nominal.
4. New experienced personnel would be employed to insure the proper
implementation of the procedures and systems that were being formulated.
The Examiner concluded that prompt and proper corrective action had been
taken by the Bank; however, he stated that the efficacy of the measures taken
could only be judged when the volume of activity in the foreign exchange department returned to preexamination levels.
The December 11, 1972 report indicated that growth in foreign exchange
transactions was substantial. The Examiner stated that the department had made
substantial improvements in its acccounting procedures since the prior examination, but still had internal control deficiencies. He specifically recommended that
the internal audit department assist in the development of required internal
controls. The Examiner was also critical of the problems of "limits", specifically,
net position limits, trading limits, customer limits, and future contract net
position limits. He stated that even where limits had been established, the examination disclosed instances where they had been exceeded.
The Examiner, in the November 14, 1973 examination report, did not mention
any significant problems in the foreign exchange operating areas. His comments
indicated that the accounting system then employed was adequate for the existing daily volume.
The May 14, 1974 examination was a limited examination specifically directed
to known problem areas. Because of the public announcement regarding losses
in the foreign exchange department, this became an area for special attention.
The Examiner stated that the foreign exchange exposure was substantial. The
following is a quote from the report:
The bank is faced with the critical situation of determining the exact
positions, arriving at the proper loss calculation, Tand the inability to obtain forward cover. Senior management was unaw are of the magnitude of
the Sterling, Swiss Franc, Deutsche Mark, French Franc, Dutch Guilder,
and Lire positions and the loss contained therein. Actually, the last revaluation (April 26, 1974) indicated nominal net positions and substantial
profits in the forward contracts. Based on an appraisal of the positions as
of May 10, 1974, as adjusted, the actual unrealized loss exceeds $43 million. The fault for these losses lies with senior management. Their failure
to supervise the activities of the foreign exchange traders, their failure
to review profit and loss calculations, and their failure to enforce a system
of proper safeguards are responsible for the bank's predicament.
The investigations into the activities of personnel of the department disclosed
unbooked future contracts, as well as speculation on the forward movement of
rates. The submission of the adjusted position information to management in
May 1974 was followed by a series of resignations from senior officers down to
the head exchange trader.
The foregoing sets forth the information obtained from the examination reports. Subsequent to the March 6, 1972 examination Mr. It. A. Mullin requested
and received progress reports from Mr. G. G. Herrmann, Senior Vice President of
the Bank, as to the specific procedures being implemented by the Bank to correct the weaknesses noted by the Examiner. In addition, Mr. O. M. Van Horn,
Regional Administrator, requested his Examiner, H. B. El-Dada, to make a
special examination of the foreign exchange operations in mid-1973. In a letter
to Mr. Van Horn dated June 18, 1973 Mr. El-Dada stated that he had made the
requested examination and commented on the continued growth in transactions. He stated, however, that he did not believe the net positions to be unusual.
He stated that no speculative activities were discerned. His conclusions, as
stated in his letter, follow:
237
Even though the volume of the foreign exchange transactions and positions
have increased, the Bank has not taken any undue risk in its foreign exchange trading. Trading is still largely with well known international and
domestic banks where the risk is minimal.
All internal control procedures seem to be well observed and the undersigned examiner was introduced to a new internal resident auditor whose sole
job will be to keep a constant eye on the workings of the foreign exchange
department.
From the foregoing it is apparent that the existence of problems in the Bank's
International Division were known to the Comptroller's Office and senior management of the Bank.
The files indicate that management of the Bank appeared to have been taking
corrective action when the Examiners brought weaknesses to its attention but
the corrective action taken does not appear to have been effective. Included in
such actions was the institution of procedures designed to keep management currently informed as to the operations of the International Division, particularly
those relating to foreign exchange trading. Despite these actions and the recognition by management of the existence of problems, the internal controls were circumvented as disclosed in the May 1974 examination report.
Based on the information provided to us it does not appear that any attempt
was made to determine the extent to which unrecorded foreign exchange losses
existed at the date of the November 1973 examination or the extent to which
erroneous foreign exchange rates were used in valuing open foreign exchange
positions.
CONDITION OF BANK
General
The ratings of the Examiners as to the condition of the Bank have been set
forth previously under "General Overview of the National Bank Examiners'
Ratings". The various reports indicate that the principal items considered in
determining the ratings were the amount of "classified assets" and the relation
of such assets to total capital and, in an overriding sense, the potential effect on
liquidity. In their comments, the Examiners appear to have concentrated primarily on the overall problems relating to loans, with more generalized comments
as to the investment portfolio. In certain examinations some attention was directed to other assets, such as the future tax benefit of operating loss carryforwards. The following sections summarize problems noted with regard to loans,
investments, and liquidity.
Loans
The Examiners, as evidenced by the comments included in their reports, have
been acutely aware of the unsatisfactory condition of the loan portfolio and the
sizeable amount of loan losses. At each examination they classified and criticized
substantial amounts of the loan portfolio. As early as the June 15, 1904 examination, the Examiners commented that classified and criticized loans were very
high in relation to total loans and to the Bank's total capital. The substance of
this comment has appeared in every examination report issued between June 15,
1964 and November 14,1973.
The following is a summary (in millions of dollars) of loans classified and
criticized by the Examiners :
Percent of loans
classified and
criticized t o -
Examination date
Loss
Doubtful
June 15,1964
Apr. 26, 1965
Jan.10,1966
Oct. 3,1966
Sept. 25,1967
Sept. 30,1968
Sept. 29, 1969....
Aug. 31, 1970
May 17, 1971
Mar. 6,1972
Dec. 11,1972
Nov. 14, 1973
May 14,1974
$3.1
7.6
5.7
6.4
5.9
4.8
1.4
6.0
12.4
9.3
6.8
10.4
13.4
$14.9
13.2
9.5
74-548—7
1.7
3.7
10.3
20.7
15.4
21.7
39.5
36.6
16
Sub- Total loans
standard
classified
$25.1
35.3
32.7
48.5
36.7
30.6
24.6
90.4
72.5
92.3
77.3
90.1
97.2
$43.1
56.1
47.9
54.9
42.6
37.1
29.7
106.7
105.6
117.0
105.8
140.0
147.2
Special
mention
$16.6
21.2
42.2
75.0
62.0
56.9
57.0
126.6
100.4
94.1
83.6
148.6
155.7
Total loans
classified and
Total
criticized
loans
$59.7
77.3
90.1
129.9
104.6
94.0
86.7
233.3
206.0
211.1
189.4
288.6
302.9
8.1
8.4
8.6
10.9
7.9
7.3
5.4
12.7
12.7
11.6
9.3
11.2
11.6
Total
capital
48.4
63.3
72.4
100.8
66.8
53.7
47.5
128.0
102.2
91.2
82.1
126.3
120.7
238
In their reports, the Examiners have commented on :
1. The effect of the heavy volume of classified and criticized loans on the
liquidity of the Bank.
2. The high ratio of classified and criticized loans to total capital funds.
3. The large number and amount of initially classified or criticized loans.
4. The apparent laxity and inadequacy of supervision and follow-up after
loans are made.
5. The potential losses reflected by the substantial amount of loans classified as doubtful.
6. The small percentage of recoveries on loans charged off.
Through the years the Examiners have also commented that many of the loans
were not supported by current or satisfactory credit information and that such
information is essential for the proper supervision of the loan portfolio. The
Examiners did not appear, however, to have stressed the need for immediate
attention to this matter by management.
There are several references in the examination reports to the liberal lending
policies of the Bank. For example, in the June 15, 1964 examination report the
Examiners commented that, in the Bank's 1959 annual report to shareholders,
Chairman Roth stated that a review of 500 of the Bank's loans by ten lending
officers who had previously been with other New York City banks disclosed that
66.2% of the 500 loans reviewed would not have been granted by such officers in
their capacities as lending officers with their former banks.
In several examination reports the Examiners stated that they were encouraged
by the Bank's progress in eliminating
loans classified or criticized in the prior
examination. They also noted, howTever, that substantial amounts of loans were
being initially classified or criticized. For example, the March 6, 1972 examination report stated that $53 million in previously criticized loans had been collected
since the last examination but that $76 million of loans were being initially
criticized.
At the conclusion of each examination, the examination report, except for the
confidential to the Comptroller section, was reviewed with the Board of Directors
of the Bank and a memorandum was prepared in the Regional Office describing
the corrective action to be taken by the Bank. For example, in a January 5, 1967
memorandum, Mr. C. M. Van Horn, Regional Administrator, stated that the Bank
had agreed to take the following corrective actions :
1. Continue vigorous efforts to strengthen or eliminate the weaknesses
associated with each of the criticized loans.
2. Prepare and furnish to the Comptroller detailed monthly reports on
progress in eliminating the criticized loans.
3. Consider employing additional competent lending officers.
In a follow-up to this memorandum, on January 6, 1967 Mr. H. D. Crosse, Vice
Chairman of the Board, informed Mr. Van Horn that Mr. A. T. Roth, Chairman of
the Board, would parcel out the classified loans to senior officers for appropriate
attention.
The files contain a copy of a June 28, 1965 letter from Mr. W. B. Lewis, Jr.,
President of the Nassau Division of the Bank, to Mr. A. T. Roth, Chairman of
the Board, concerning a re-evaluation of the Bank's lending policies. In the
memorandum, Mr. Lewis stated that the examination report of April 26, 1965
clearly indicated that the Bank has suffered from the following unsatisfactory
lending policies:
1. Inadequate and unreliable financial statements and supporting data.
2. Lending to people of questionable integrity.
3. Failure to control borrowers in their expansion programs.
4. Acceptance of representations of Certified Public Accountants and
attorneys without verification.
5. Poor administration and follow-up of existing loans.
6. Inadequate credit files which, in many instances, made it difficult to
evaluate credit extension.
7. Failure to establish and conform to standard loan policies.
8. Lack of a written statement of loan policies.
In summary, Mr. Lewis stated that the Examiners' report as of April 2o, 1965
indicated that while there had been an improvement in the standards for making
new loans a complete reappraisal of the Bank's lending policy should be made.
He further stated that unless "drastic action" was taken future losses might continue to be excessive.
239
There is no indication in the files of the reason why the letter was received
or of any meetings held to discuss the contents of the letter. The problems noted
by Mr. Lewis for the most part appear to be the same problems commented upon
by the Examiners in subsequent examinations.
As indicated above, the Washington Office was furnished with copies of the
memoranda relating to the meetings held with the Board of Directors of the
Bank. In addition, at the conclusion of the June 15,1964 and April 26, 1965 examinations, the Regional Administrator sent letters directly to the Comptroller, in
which he noted a heavy and increased volume of criticized loans, heavy loan losses,
an extremely liberal lending policy, and a lack of adequate supervision of the
loan portfolio. There is no indication that any such letters were sent subsequent
to the April 26, 1965 examination. During the January 10, 1966 examination,
however, Mr. J. T. Watson, First Deputy Comptroller, prepared a memorandum
dated March 9, 1966 concerning a telephone conversation with Mr. Van Horn
regarding the latter's preliminary review of the examination report which disclosed that the ratio of criticized assets to capital funds was 47% and that loan
charge-offs would be in the neighborhood of $11 million.
Commencing in May 1966 and almost continuously thereafter the Bank has
been providing the Regional Administrator, at his request, with copies of the
monthly status reports to the Board of Directors of loans classified at the prior
examination. After being reviewed in the Region the reports were sent to Washington. Generally, they showed that the Bank was making progress in reducing
loans previously classified. Some of these reports on file in Washington have
been initialled by Messrs. J. D. Gwin, Deputy Comptroller, and L. T. Gerzema,
Assistant Chief National Bank Examiner.
On occasion, the Regional Administrator wrote to the Bank complimenting
it on the progress being made in reducing loans previously classified. The Regional Administrator appears, however, to have ignored the fact that at the
same time the total loans classified or criticized were, in general, increasing both
in amount and in relation to the total loan portfolio.
At the conclusion of each examination, the examination report was reviewed
in Washington by the Assistant Chief National Bank Examiner who prepared a
memorandum to the Comptroller or his Deputy on the review. The memoranda
sumarized the classified and criticized assets, the problems noted by the Examiners, and any corrective actions noted in the examination reports. The memoranda
were apparently reviewed at a high level in the Office of the Comptroller, since
several bear the initials of Messrs. W. B. Camp, J. T. Watson, or J. D. Gwin.
^Further indication that the Bank's loan problems were known in Washington
is a March 19, 1971 memorandum from Mr. L. T. Gerzema, Assistant Chief National Bank Examiner, to Mr. J. D. Gwin, Deputy Comptroller. Mr. Gerzema
stated that the Bank was faced with some serious problems in its loan account
and with the possibility of additional losses of substantial amounts in the future.
In his opinion, management would not be able to turn the loan portfolio around
in the near future.
In a letter dated February 22, 1974 to Mr. Van Horn, Mr. J. E. Smith, Comptroller, instructed Mr. Van Horn to meet with the Board of Directors to arrange
to have the Bank prepare a written program for clearing its problems. One item
that Mr. Smith wanted the Bank's program to include was, "The means and
standards by which the granting of new loans and the servicing of existing loans
will be policed by senior management, with a view toward upgrading the quality
of the loan portfolio. A method should be established by which written loan
policies of the Bank will be adhered to strictly." Mr. Van Horn and Examiner
Lake met with key officers of the Bank on February 28,1974 to discuss Mr. Smith's
concerns. Mr. Van Horn gave Mr. N. Schreiber, Chairman of the Bank's Executive Committee, an outline of the areas of concern. The following are the items
concerning loans which were requested in Mr. Van Horn's outline:
1. Methods and standards for granting new loans.
2. Methods and standards for administering existing loans.
3. Correcting or eliminating weaknesses associated with criticized loans.
4. Up-grading quality and liquidity of the loan portfolio.
5. Formation and/or enforcement of a written lending policy.
In a letter dated April 4, 1974, Mr. H. V. Gleason, Chairman of the Board,
responded; a summary of the contemplated actions described in the section of
the letter pertaining to loans is" as follows:
1. The establishment of a formal loan amount authorization policy.
240
2. The establishment of ,a special task group of five experienced lending
officers to effect a reduction in classified and criticized loans.
3. The review of the Lending Officer's Manual in order to improve the
quality and liquidity of the loan portfolio.
In reviewing the files, it is clear that the unsatisfactory condition of the loam
portfolio was known to the Examiners, the Regional Administrator, and the
Washington office for at least the past ten years. It is also clear that the Comptrollers Office recommended that the Bank take appropriate action to strengthen
its lending policies and improve both the quality and liquidity of its outstanding
loans.
In retrospect, it appears that the corrective actions taken by the Bank were
not effective and that the conditions found by the Examiners at each examination remained virtually unchanged. Even in retrospect it is difficult to assess
additional steps' that might have been taken by the Comptroller's Office, other
than the statutory right of officer removal or the formal cease and desist procedures. One course of action (which does not appear to have been considered)
would have been to assign an Examiner to the Bank to maintain active daily
supervision over the loan portfolio when it became obvious that the corrective
actions reported by the Bank were not effective.
Reserve for loan losses
In making their examinations the Examiners' do not appear to consider the
adequacy of the Reserve for Loan Losses. Rather, they include such reserve as
part of total capital funds and they relate their appraisal of the condition of the
bank to such total capital funds.
The amount of loans classified and criticized in examination reports and the
percentage relationship of such amounts to total loans and total capitial are
shown in the accompanying Exhibit H. The loans classified and criticized and the
balance in the Reserve for Loan Losses as shown by Examiners' reports is summarized as follows:
[Dollar amounts in millions!
May 14,1974
Nov. 14,1973
Dec. 11,1972
-.
-.
$28.7
13.4
$31.4
10.4
$28.6
6.8
$31.1
9.3
Balance.
Less 50 percent of loans classified as
doubtful. _
15.3
21.0
21.8
21.8
17.9
18. 3
19.8
10.8
7.7
10.3
(3.0)
1.2
11.0
14.1
7.6
18.3
97.2
155.7
2, 310.9
19.8
90.1
148.6
2,295.1
10.8
77.3
83.6
1,839.4
7.7
92.3
94.1
1,614.6
10.3
72.5
100.4
1, 419. 0
2, 582.1
2, 553.6
2,011.1
1, 808.7
1, 602. 2
11.4
5.3
.6
16.2
7.5
.8
22.0
11.9
1.1
20.2
10.8
1.2
19.2
9.2
1.1
Reserve for loan losses
Less loans classified as loss.
Balance available for remaining
loans.
Remaining loans:
Remaining 50 percent of doubtful...
Substandard
Special mention
—
Not classified or criticized
Total..
Percentage relationship of reserve for
loan losses, after assumed writeoff of
loans classified as loss, to loans, after
assumed writeoff of loans classified as
loss:
Classified
Classified and criticized
Total..
.-
Mar. 6,1972
May 17,1971
$30.3
12.4
An analysis of the activity in the Reserve for Loan Losses, obtained from published information, is presented in Exhibit I. The following is a summary of the
transactions reported in the Reserve for Loan Losses for the five years ended
December 31,1973:
241
[In millions of dollars]
Portion of reserve provided by charges to
income (described by bank as valuation portion)
Less net leans charged off
1973
1972
1971
1970
1969
12.5
(12.6)
8.1
(8.8)
7.2
(13.6)
3.0
(5.8)
0.3
(.3)
(-D
(.7)
(6.4)
(2.8)
Net increase (decrease) in valuation portion
Portion of reserve provided by charges to
retained earnings (described by bank
as contingency portion)
Portion of reserve provided by deferred
tax benefits
__
(3.0)
Net change
Balance at beginning of year
(3.1)
30.4
27.3
Balance at end of year
_
3.0
1.5
5.3
3.4
1.3
5.9
(.7) ___
31.1
31.1
31.1
11.2
20.0
30.4
31.1
31.1
31.2
Investments
A summary of the investment portfolio, as shown by Examiners' reports, is
presented in the accompanying Exhibit J. This summary shows that the carrying
value of the securities was substantially ia excess of the related market value at
the dates of the examinations, as follows:
Depreciation as a
percentage of—
Examination date
Sept. 29,1969
Aug. 31,1970
May 17, 1971
Mar. 6,1972
Dec. 11,1972
Nov. 14, 1973
May 14, 1974
_
_
_
I"_I_~_I
__
Depreciation
(millions)
Book value of
investments
Total capital
funds
$107.2
109.0
62.8
58.9
55.3
58.4
110.4
18.0
19.4
8.4
9.3
11.2
9.0
12.2
58.6
59.8
31.2
25.5
24.0
25.5
44.0
"
____
"
The Examiners were aware of the unrealized depreciation in relation to capital
funds, but there is no evidence that such depreciation was considered in determining capital adequacy. Furthermore, there is no evidence in the files that this
depreciation was discussed with the Bank as a matter of concern. The comments
on the depreciation were included in the Confidential to the Comptroller section
of the Examiners' reports, but there is no evidence that these comments received
any special attention.
In connection with their examinations, the Examiners customarily analyzed
the investment portfolio in terms of maturities. A summary of these maturities,
as shown by examination reports, is presented in the accompanying Exhibits K
and L in dollars and as a percent of total investments. These summaries show
that there has been a considerable lengthening of the maturities, as follows:
[In percent]
Maturities
Examination date
Sept. 29, 1969
Aug. 31, 1970
May 17,1971
Mar. 6, 1972
Dec. 11,1972..
Nov. 14, 1973...
May 14, 1974
"
"
'
--"""""_""""™"I"II"II"Z
Up to 5 yr
In excess of 5 yr
31.60
27.58
43.81
42.06
25.37
22.56
18.48
68.40
72.42
56.19
57.94
74.63
77.44
81.52
A general criticism of the length of maturities is included in each report of
examination. The Examiners did note improvement in connection with the
May 17, 1971 and March 6, 1972 examinations but in subsequent reports observed
242
a reversal in the trend, with significant increases in long-term maturities. The
comments are brief and only commencing with the report on the December 11,
1972 examination are there notations in the Examinees' reports indicating that
the lengthening of maturities was due principally to the sale of short-term investments, rather than new purchases. The files we have seen do not indicate that
the Examiner's criticisms of the maturities were ever communicated to the Bank
nor that suggestions were made that the Bank take action to shorten maturities.
While the comments were included in the Confidential to the Comptroller section
of the Examiners' reports, there is no evidence that this matter became the
subject of discussion between personnel in Washington and the Regional
Administrator.
Liquidity
The computation of the Bank's liquidity positions is shown in the accompanying Exhibit M. Following is a summary of these positions:
Liquidity
Examination date:
percentage
September 29, 1969
23. 7
August 31, 1970
20. 6
May 17, 1971
21.3
March 6, 1972
20. 7
December 11, 1972
28. 8
November 14, 1973
11. 2
May 14, 1974
14.1
The liquidity percentage referred to above is the percent of "Net Liquid Assets"
to "Net Deposits and Unsubordinated Short-term Liabilities".
The first indication, in the files reviewed by us, of a potential liquidity problem was in the April 26. 1965 examination report, in which the Examiners
stated that, as a result of the sizable amount of criticized paper and the high
total of certificates of deposit, the Bank could have a serious liquidity problem.
The Examiners commented upon the Bank's weak liquidity position, generally, in
each subsequent examination report.
Mr. C. M. Van Horn, Regional Administrator, in a July 27, 1965 letter to Mr.
J. J. Saxon, Comptroller, stated that the liquidity position of the Bank was
unsatisfactory, being 12.8 percent at April 26, 1965 as compared to 31 percent at
the date of the previous examination.
As a result of a meeting on March 29, 1966 between Mr. H. D. Crosse, Vice
Chairman of the Board, and Mr. C. F. West. Deputy Regional Administrator,
the Bank agreed to provide the Comptroller's Office with semi-monthly computations of the Bank's liquidity position. The Bank generally continued to send such
computations until Mr. Van Horn informed Mr. Crosse on June 23, 1967 that the
Bank would no longer be required to send periodic reports of liquidity position
as long as such position remained at an acceptable level. The Bank's liquidity
position during the first six months of 1967, based upon the information provided to us, appears to have ranged from 20 percent to 30 percent.
On April 4, 1969 Mr. Van Horn informed Mr. H. V. Gleason, President of the
Bank, that, because the Bank's liquidity position of 18.6 percent was significantly
below the acceptable level of 25 percent, the Bank would be required to provide
periodic liquidity reports to the Comptroller's Office. Except for the liquidity
reports furnished with "Call" reports, ther^ is no indication in the files provided to us that the Bank complied with this requirement after April 15. 1969.
In a March 5, 1970 memorandum to Mr. W. B. Camp, prepared on the September 29, 1969 examination report, Mr. L. T. Gerzema, Assistant Chief National
Bank Examiner, stated that the Bank's liquidity position should be followed
very closely.
As indicated above, the Bank's liquiditv position, except at the March 6. 1972
examination, was below the level described by Mr. Van Horn as acceptable.
There is no indication that the liquidity reports in the files nrovided to us had
been the subject of discussions between the Bank and the Comptroller's Office
or within the Comptroller's Office, except as mentioned above.
MANAGEMENT
As shown above in "General Overview of the National Bank Examiners' Ratings", management was rated as "srood" until the August 31, 1970 examination
when the rating was reduced to "fair". The rating was further reduced to "poor"
in the November 14,1973 examination.
243
Prior to the September 30, 1968 examination report, the Examiners commented
upon the dominance over the Bank's affairs of Chairman of the Board, Mr. A. T.
lioth. In the April 26, 1965 examination report the Examiners stated that such
dominance was not considered detrimental.
In the September 30, 1968 examination report, the Examiners stated that the
one-man reign of Chairman Roth wTas ended in that the duties of the Chairman of
the Board had been reduced solely to presiding over Board meetings. The Examiners stated further that Mr. H. V. Gleason, President, who was basically a
public relations man, had assumed the duties of Chief Executive Officer and was
endeavoring to build a competent management team. This was the first reference
in the files reviewed by us to any problems with the Bank's management team.
The comment concerning Mr. Gleason being public relations oriented and endeavoring to build a competent management team was repeated in the next five
examination reports through December 11,1972. Although the same comment was
not made in the November 14, 1973 examination report, it was stated in such
report that ''the senior management situation has still not stabilized."
Commencing with the August 31, 1970 examination report, the Examiners commented upon the lack of depth in both senior and middle management and a lack
of seasoned lending officers. In the November 14, 1973 examination report, the
Examiner stated that it appeared that management was over-reacting to various
problem areas and that the Bank was being run by crises. The Examiner concluded by stating that he had serious doubts that the Bank would ever be able
to build a competent management team.
The ratings of management of the Bank were the subject of discussions between the Comptroller's Office and the Board of Governors of the Federal
Reserve System in connection with the London branch opening and the proposed
merger with Talcott National Corporation. The lack of seasoned lending officers
was discussed on various occasions with the Bank's management whose response
was always that attempts would be made to employ qualified lending officers. In
addition, discussions were held with respect to obtaining a qualified operations
officer to supervise the international operations, and the Bank, in 1972 responded by engaging Mr. P. R. Shaddick to assume general supervisory respom
sibility in this area.
EARNINGS
As shown in "General Overview of the National Bank Examiners' Ratings", the
Examiners' ratings of earnings have declined from "excellent" in the June 15,
1964 examination report to "poor" in the November 14, 1973 examination report.
Commencing with the January 10, 1966 examination report, the Examiners
commented, generally, that increases in operating income were being offset by
increased interest expense. The accompanying Exhibits N and O summarize the
return on earning assets and the related cost of funds, respectively, for the five
years ended December 31, 1973. The following is a summary of the dollar and
percentage spreads between the return on earning assets and the related cost of
funds, as shown in those exhibits :
[Dollar amounts in millions]
Return on
earning
assets
Cost of funds
$188.8
229.6
202.6
198.6
335.9
$97.8
121.1
100.4
100.3
235.8
Spread
Return on
earning
assets
(percent)
Cost ot funds
(percent)
Spread
(percent)
$91.0
108.5
102.2
98.3
100.1
7.88
9.09
7.68
4.85
8.66
5.71
6.51
5.08
4.85
7.66
2.10
2.57
2.60
1.68
1.00
Year ended Dec. 31:
As shown above, the dollar spread between the return on earning assets and
the related cost of funds has remained fairly constant. As shown in the accompanying Exhibit C, operating expenses, exclusive of interest expense, have
increased from approximately $56 million in 1969 to approximately $95 million
in 1973. Although such increase has been partially offset by increases in items
of operating income other than return on earning assets, the failure by the Bank
244
to achieve an increase in the interest spread has been a significant factor in the
decline in the Bank's earnings.
The Examiners also commented on the effect of the "heavy" loan losses on the
Bank's earnings. Following is a comparison of provisions charged to income for
possible loan losses and the net loan charge-offs (in thousands of dollars) during
the five years ended December 31,1973 :
Excess of net loans
written off over
provision charged
to income
Provision charged
to income
Net loan
chargeoffs
$285
3,087
7,200
8,100
12,488
$285
5,849
13,624
8,817
12,565
$2,782
6,424
31,140
41,140
10,000
Year ended Dec. 31:
1969
1970
1971
1972....
1973
Total
717
77
As shown above, the provisions charged to income were $10 million less than
the net loans charged off during the five years ended December 31, 1973. There is
no indication in the files provided to us that this fact was considered by the
Examiners in rating the Bank's earnings.
CAPITAL
A summary of the changes in capital funds during the ten years ended December 31,1973 is set forth in the accompanying Exhibit E.
The composition of capital funds at December 31, 1973 was as follows:
The Bank:
Capital debentures (4.75 percent—1988)
$28,500,000
Preferred stock ($4.60—$100 Par)
18, 879, 000
Franklin:
Convertible preferred stock ($2.45—$25 par)
20, 523, 000
Common stock ($5 par)
23,102,000
Capital surplus
66, 953, 000
Retained earnings
41, 435, 000
Total
,
199, 392, 000
The terms of the capital debentures of the Bank provide for redemption of
$1,500,000 principal amount during each of the years 1973 through 1987 and the
balance in 1988. The preferred stock of the Bank became callable after October 15,
1972. The Bank is required annually to offer to purchase up to $700,000 of such
stock. In 1973, 11,214 shares of the preferred stock of the Bank were repurchased
at a cost of approximately $615,000.
The Examiners rated the capital of the Bank as "borderline" in the September 29, 1969 examination and as "inadequate" in subsequent examinations. The
ratings were based primarily on the substantial amount of classified and criticized loans, significant loan losses, and general growth trend. There is no indication in the various reports that depreciation of the investment portfolio was
considered in determining capital adequacy.
There are shown below the calculations of adjusted gross capital of the Bank
as computed by the Examiners. There are also shown below certain further reductions in adjusted gross capital which were not made by the Examiners, but
which relate to the underlying asset valuations.
245
[In millions of dollars]
May 14,
1974
Nov. 14,
1973
Dec. 11,
1972
Mar. 6,
1972
May 17,
1971
Aug. 31,
1970
Sept. 23,
1969
Capital funds:
Capital note
Capital debentures
Equity capital:
Preferred stock
Commonstock
Surplus
Undivided profits
30.0
28.5
30.0
28.5
30.0
30.0
30. 0 __
30.0
30.0
30.0
30.0
17.7
33.3
106.2
35.2
18.9
27.4
81.7
42.2
20.0
27.3
81.3
42.2
20.0
27.3
81.3
42.9
40.5
23.1
65.1
43.0
40.5
23.1
65.2
23.5
40.5
23.1
65.1
24.2
Total capital funds
Reserve for loan losses
250.9
28.7
228.7
31.4
230.8
28.6
231.5
31.1
201.7
30.3
182.3
31.1
182.9
27.2
279.6
260.1
295.4
262.6
232.0
213.4
210.1
13.3
18.3
10.4
19.8
6.8
10.8
9.3
7.7
12.4
10.3
6.0
5.2
1.4
1.9
31.6
30.2
17.6
17.0
22.7
11.2
3.3
248.0
229.9
241.8
245.6
209.3
202.2
206.8
110.4
58.4
55.3
58.9
62.1
109.0
107.2
s15.2
23.0
19.2
15.7 .
TotaL
Less adjustments made by examiners:
Loans classified as:
Loss
(Doubtful (50 percent of total)__
Total
Adjusted gross capital as
computed by examiners
Less adjustments not made by examiners
but which relate to underlying asset
valuations:
Depreciation in security portfolio i._.
Capitalization of operating loss
carryforward 2
Minimum loss reserve (1 percent of
total loan portfolio (excluding
loans classified as "Loss") Loss
amounts specifically provided for
doubt-loans)4
7.7
5.9
9.4
10.5
5.8
13.1
14.0
Total
133.3
87.3
83.9
85.1
68.6
122.1
121.2
Net capital funds as adjusted
114.7
142.6
157.9
160.5
140.7
80.1
85.6
1
The amount of depreciation in the carrying value of the security portfolio is shown in the accompanying exhibit J.
* This amount represents the potential tax benefit that could result from future utilization of the net operating loss
carryforward for Federal income tax purposes. Since this amount can be used only to offset taxable income in future years
its realization is, in the light of the present circumstances, doubtful. The examiners in the Mar. 6,1972 examination report
criticized the capitalization of this amount. In June 1974, Franklin announced that the amount previously capitalized had
been written off.
* Actual amount not known in information provided to us; the amount shown is the amount as of Dec. 31, 1973 per
Franklin's 1973 annual report.
4
There is no generally accepted standard for the amount of valuation reserve required against loans, and the amount
will vary by circumstances. Many accountants hold the view, however, that, as a minimum, the reserve should equal 1
percent of the total loan portfolio after all known losses have been charged off. For purposes of these caluclations, the 1percent guideline has been applied.
The determination of the adequacy of capital is made pursuant to the individual judgment of the Examiners and takes into consideration such factors as
the quality and character of the risk assets, competency of management, and the
relative stability of the local currency where balances are in currencies other
than United States dollars. We have been informed by Mr. Van Horn that the
calculation of adjusted gross capital is solely for the purpose of determining legal
lending limits.
INTERNAL CONTROLS
As shown above in "General Overview of the National Bank Examiners' Ratings", the Examiners' initial rating of internal controls appeared in the September 29, 1969 examination report. Except for the March 6, 1972 examination, in-
246
ternal controls have been rated as "adequate". As a result of the serious internal
control problems noted in the International Division in the March 6, 1972 examination (see "International Division" above), internal controls at that examination were rated "weak".
The March 6, 1972 examination report contained a comment that the Bank's
Audit Department had experienced "growing pains" as a result of the transition
from a manual to a fully automated operation and aggressive branch expansion.
Based upon the Examiners' comments, it appears that a primary factor in
rating the internal controls of the Bank was the degree and nature of confirmation procedures employed by the internal and external auditors.
FUTURE
PROSPECTS
As shown above in "General Overview of the National Bank Examiners' Ratings", the ratings of the Bank's future prospects have been "good" except for the
June 15, 1964 examination when they were not rated and the March 6, 1972 and
November 14,1973 examinations when they were rated as "fair".
In their comments on the Bank's future prospects, the Examiners made reference in several examination reports to the asset problems of the Bank, primarily
the amount of classified and criticized loans. The Examiners referred to the
rapid expansion of the Bank, both in branches and in deposits, in all reports.
In the January 10, 1966 examination report, the Examiner characterized the
Bank as "one of the fastest growing banks in the nation over an extended period
(of time)".
In rating the future prospects of the Bank the Examiners apparently failed to
take into consideration that the increase in the Bank's total resources was due
primarily to increased loans which were being financed mainly through costly
time deposits and borrowings. The following is a summary of loans and time
deposits and borrowings as of December 31 for the years 1964 to 1973:
[In millions of dollars]
Dec. 31:
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
Loans
Time deposits
and borrowings
765.1
921.9
1, 079. 3
1F 245.9
1,348.4
1, 490.3
1,596.9
1,719.3
2,078. 5
2,767.0
853.5
953.3
1,148.6
1,537.4
1,583.8
1, 578.7
1,937.0
1,853.3
2,446.5
3,164.5
The above information was summarized from the consolidated statement of
condition in the accompanying Exhibit A. Included in time deposits and borrowings above are time and savings deposits, foreign deposits (including demand
deposits which we were unable to segregate based on the available information),
Federal funds purchased and securities sold under agreement to repurchase,
and other liabilities for borrowed money.
During the same period total resources increased from $1,521 million to
$5,006 million, an increase of $3,485 million. In addition to the $2,002 million
increase in loans shown above, cash and due from banks increased by $1,041
million, which, in total, accounts for significant part of the aforementioned
increase in total resources. The increase in cash and due from banks was offset
by an increase in demand deposits amounting to $916 million. (See "Earnings"
for the effect of the above on the income of the Bank and Franklin.)
247
OVERALL RATING
The overall ratings of the Bank are shown above in "General Overview of the
National Bank Examiners' Ratings". The overall rating has declined from 1-B-S
at the June 15, 1964 examination to 2-D-P/3 at the November 14, 1973 examination. For certain of the examinations the information provided to us did not
disclose the Group or Composite Rating.
A review of the Examiners' ratings shown in "General Overview of the National Bank Examiners' Ratings" reveal several inconsistencies. At the conclusion of the October 3, 1966 examination the overall rating of the Bank was
2-C-F/3. However, at the conclusion of the September 30, 1968 examination the
Examiners' ratings of Condition of Bank, Management, Earnings, and Future
Prospects had not changed, but capital was rated "Strengthened" as compared to
"Inadequate" and as a result the overall rating was improved to l-B-F/2. A
comparison of the ratings based upon the May 17, 1971 and March 6, 1972
examinations reveals that the ratings of Earnings went from "Fair" to "Marginal" and Internal Controls went from "Adequate" to "Weak" while the Group or
Composite Rating improved from 3 to 2. A comparison of the ratings based upon
the March 6, 1972 and December 11, 1972 examinations reveals that the ratings
of Condition of the Bank went from "Fair" to "Unsatisfactory" and Earnings
went from "Marginal" to "Poor" while Future Prospects improved from "Fair"
to "Good" and the overall rating remained unchanged.
EXHIBIT A
FRANKLIN NEW YORK CORP.
{in millions of dollars]
Consolidated Statement of Condition as of Dec. 31
Resources:
Cash and due from banks (including interest bearing time deposits—1973, $595,421; 1972, $534,816; 1971, $68,837)
7973
1972
1971
1970
1969
1968
1967
1966
1965
1964
1,200.7
1,200.9
583.4
456.6
389.8
305.3
317.9
193.6
177.8
159.4
U.S. Treasury securities....
Securities of other U.S. Government agencies and corporations....
Obligations of States and political subdivisions.
Other securities-
95.2
150.7
281.1
107.0
7.4
91.9
312.6
83.3
108.3
134.6
396.3
175.3
158.0
147.1
472.2
59.1
211.6
127.8
415.2
57.5
388.2
36.1
426.6
16.0
361.7
51.7
485.0
20.2
164.5
21.2.
382.5
9.1
182.3
212.5
356.6
4.6
289.0
4.5
Total investment securities..Trading account: securities
Federal funds sold and securities purchased under agreement to
634.0
103.2
495.2
159.1
814.5
51.0
836.4
103.9
812.1
70.3
866.9
101.7
918.6
577.3
543.5
506.0
110.5
2,767.0
271.3
2,078.5
182.5
1,719.3
319.9
1,596.9
111.6
1,490.3
163.1
1,348.4
71.8
1,245.9
42.0
1,079.3
14.5
921.9
49.2
765.1
54.0
27.7
59.8
49.8
55.2
45.0
27.5
33.6
54.1
54.8
23.2
32.0
46.2
43.7
27.0
23.5
44.5
45.1
19.1
19.5
42.9
20.9
20.7
25.7
45.0
20.4
17.3
9.0
37.5
22.3
8.3
5.6
19.8
19.7
6.8
4.0
18.0
13.9
resell
Loans
Bank premises and equipment
Customers'liability on acceptances outstanding
Accrued interest receivable
Other resources
Bank premises and other resources
Total resources
—
_
191.3
5,006.7
161.3
164.1
140.4
128.2
110.2
91.7
4,366.3
3,514.8
3,454.1
3,002.3
2,895.6
2,645.9
73.7
1,965.9*
9.8
50.3
41.7
1,708.0
1,521.4
Liabilities:
Deposits:
Demand
Time and savings
Foreign
_
Total deposits
1,408.7
1,177.8
1,136.0
1,506.9
1,181.9
771.6
1,266.8
1,315.9
256.3
1,153.6
1,193.9
209.6
1,035.0
804.8
159.7
1,032.4
1,269.0
849.7
1,321.8
598.7
1,039.5
562.7
854.5
432.3
777.5
3,722.5
3,460.4
2,839.0
2,567.1
2,060.3
2,301.4
2,171.5
1,638.2
1,417.2
1,269.8
Federal funds purchased and securities sold under agreement to
repurchase..
_.
Other liabilities for borrowed money
Mortgage indebtedness
7.30percent notes percent—due 1979
Acceptances outstanding.
Dividends payable
795.4
55.3
21.6
35.0
28.5
2.6
472.7
20.3
22.4
35.0
45.4
2.6
277.6
3.5
23.1
35.0
56.3
2.6
466.2
67.3
24.1
496.8
117.4
24.8
314.8
215.6
109.1
98.8
76.0
25.5
26.1
26.7
47.0
2.6
45.7
2.4
21.5
2.3
20.8
23.6
19.9
14.0
Other liabilities
119.0
79.1
52.3
60.9
47.4
40.1
43.7
31.6
22.1
15.5
Total I labilities
_
4,779.9
4,137.9
3,389.4
3,235.2
2,794.8
2,705.6
2,477.7
1,829.2
1,558.0
1,375.3
Reserve for possible loan losses
27.4
30.4
31.1
31.1
31.1
20.0
20.0
16.0
25.3
23.0
Capital funds:
Capital debentures of bank (4.75 percent—due (1388)
Preferred stock of bank ($4.60—$100 par)..
28.5
18.9
30.0
20.0
30.0
20.0
30.0
20.0
30.0
20.0
30.0
20.0
30.0
20.0
30.0
20.0
30.0
20.0
30.0
20.0
47.4
50.0
50.0
50.0
50.0
50.0
50.0
50.0
50.0
50.0
20.5
20.5
20.5
20.5
20.5
20.5
20.5
23.1
67.0
41.4
23.1
66.4
38.0
23.1
66.5
34.2
22.9
65.5
28.9
22.9
65.0
18.0
22.8
65.0
11.7
19.9
50.0
7.8
Total
Stockholders'equity:
Convertible preferred stock ($2.45—$25 par)...
Common stock ($5 par)....
Capital surplus
Retained earnings
19.4
50.0
1.3
18.9
50.0
5.8
18.5
50.0
4.6
Total stockholders'equity....
152.0
148.0
144.3
137.8
126.4
120.0
98.2
70.7
74.7
73.1
Total capital funds
199.4
198.0
194.3
187.8
176.4
170.0
148.2
120.7
124.7
123.1
5,006.7
4,366.3
3,514.8
3,454.1
3,002.3
2,895.6
2,645.9
1,965.9
1,708.0
1,521.4
Total liabilities, reserve for possible loan losses and capital
funds
Note: The above is based upon annual reports of Franklin New York Corp. for the years 1969 to 1973 and Franklin National Bank for years prior thereto and does not include certain other information such
as that shown in notes to financial statements.
EXHIBIT B
FRANKLIN NEW YORK CORP.
[Percentage of total resources]
Consolidated statement of condition as of Dec. 31—
1973
1972
1971
1970
1969
1938
1967
1966
1965
1964
bO
Oi
O
)urces:
Cash and due from banks
24.0
27.5
16.6
13.2
13.0
10.6
12.0
9.8
10.4
10.5
U.S. Treasury securities
Securities of other U.S. Government agencies and corporation.__
Obligations of states and political subdivisions
Other securities
1.9
3.0
5.6
2.1
.2
2.1
7.2
1.9
3.1
3.8
11.3
5.0
4.6
4.2
13.7
1.7
7.1
4.3
13.8
1.9
13.4
1.2
14.7
.6
13.7
2.0
18.3
.7
9.4
1.1
19.5
.5
10.7
14.0
20.9
.3
19.0
.3
Total investment securities
Trading account securities
Federal funds sold and securities purchased under agreement to
resell
Loans
12.6
2.1
11.4
3.6
23.2
1.5
24.2
3.0
27.1
2.3
29.9
3.5
34.7
29.5
31.9
33.3
2.2
55.3
6.2
47.6
5.2
48.9
9.3
46.2
3.7
49.6
5.6
46.6
2.7
47.1
2.1
54.9
.8
53.9
3.2
50.3
Bank premises and equipment
Customers'liability on acceptances outstanding
Accrued interest receivable
Other resources
1.0
.6
1.2
1.0
1.3
1.0
.6
.8
1.5
1.5
.7
.9
1.3
1.3
.8
.7
1.5
1.5
.6
.7
1.5
.7
.7
.9
1.7
.8
.7
.3
1.9
1.1
.4
.3
1.2
1.2
.4
.2
1.2
.9
Bank premises and other resources
3.8
3.7
4.6
4.1
4.3
3.3
3.5
3.7
3.0
2.7
100.0
IO0T0
100.0
TooTo
iooTo
100JO
10oTo
looTo
lobTo
lGoTo
Total resources
.6
Liabilities:
Deposits:
Demand
Time and savings
Foreign
28.1
23.5
34.5
27.1
36.0
37.4
33.7
34.6
36.5
25.8
35.7
43.8
32.1
50.0
30.5
52.9
32.9
50.0
32.4
51.1
22.7
17.7
7.3
6.0
5.3
74.3
79.3
80.7
74.3
68.6
79.5
82.1
83.4
82.9
83.5
15.9
1.1
.4
.7
.6
.1
10.8
.5
.5
.8
1.0
.1
13.5
1.9
.7
16.6
3.9
.8
10.8
8.1
5.6
5.8
5.0
1.4
.1
1.5
.1
1.6
95.5
.5
94.8
.7
93.6
.9
93.6
.9
.6
.4
.8
.5
1.0
.7
.4
1.1
.4
.5
1.3
.8
Total stockholders' equity
Total capital funds
Total deposits
Federal funds purchased and securities sold under agreement to
repurchase
Other liabilities for borrowed money
Mortgage indebtedness
7.30 percent notes—due 1979
__
Acceptances outstanding
Dividends payable
Other liabilities
Total liabilities
Reserve for possible loan losses
Capital funds:
Capital debentures of bank (4.75 percent—due 1988)
Preferred stock of bank ($4.60-$100 par)
Stockholders' equity:
Convertible preferred stock ($2.45-$25 par)
Common stock ($5 par)
Capital surplus
Retained earnings
Total liabilities, reserve for possible loan losses and
capital funds
7.9
.1
.7
1.0 _
1.6
.1
.9
.9
.7
.1
.8
1.2
1.2
.9
1.4
1.7
1.6
1.3
1.0
93.1
1.0
93.4
.7
93.6
.8
93.2
.8
91.2
1.5
90.4
1.5
1.0
.7
1.0
.7
1.1
.7
1.5
1.0
1.7
1.2
2.0
1.3
1.3
.9
.6
1.5
1.7
1.7
1.8
2.5
2.9
3.3
.5
.5
1.5
.9
.6
.7
1.9
1.0
.6
.7
1.9
.8
.7
.7
2.2
.6
.7
.8
2.3
.4
.8
.8
1.9
.3
_ _
.9
2.5
.1
1.2
2.9
.3
__ 1.2
3.3
.3
3.0
3.4
4.2
4.0
4.2
4.2
3.8
3.5
4.4 _.__
__ 4.8
4.0
4.5
5.5
5.5
5.9
5.9
5.6
6.0
7.3
8.1
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
2.4
1.8
1.5
_
__
1.7
1.4
_
_
fcO
EXHIBIT C
[In thousands of dollars!
Franklin New York Corporation Consolidated statement of earnings for the year ended Dec. 31—
1973
Operating income:
Interest and fees on loans:
Commercial
Personal and installment
Mortgage
Total
Interest and dividends on investments:
U.S. Treasury securities
Securities of other U.S. Government agencies and corporations
Obligations of states and political subdivisions
Other securities
Total
Other interest income
Trading account income
Service charges on deposit accounts
Foreign exchange trading income
Other operating income
Total operating income
Operating expense :
Staff expenses:
Salaries
Profit sharing, pension and other benefits
Total
1972
1971
1970
1969
1968
1967
1966
1965
1964
188, 659
27, 414
25, 579
96,373
23, 435
18, 857
94, 510
23, 494
17,271
107, 770
23,148
19, 265
95,176
18,147
18, 329
67, 015
14,971
15, 207
51, 984
12, 847
14,171
49, 289
7,468
10, 392
36, 000
6,484
7,024
27,636
5,465
6,902
241, 652
138, 665
135, 275
150,183
131,662
97,193
79, 002
67,149
50,108
40,003
4,989
5, 856
1, 689
1,870
10, 768
13, 506
18, 928
14, 009
8,331
12,277
6,647
7,350
14,199
4,729
6,142
19, 888 1
2,297
4,376
22, 388
1,360
1,678
17,274
873
2,459
16,010
1,752
2,222
15, 640
926
1,291
12, 339
276 ._
28,944
32, 797
19, 762
16, 585
14,889
3,167
28,148
33, 316
38, 892
33,331
39,149
45, 349
8, 875
5,971
7,754
5, 439
8,714
10, 446
5,683
384
8,282
7,136
8,806
5,714
442
8,120
7,841
8,420
5,735
243
7,283
865
3,910
5,352
244
6,384
4,804
4,198
3,891
3,498
7,149
4,744
3,625
4, 779
4,081
343,984
200,322
198, 809
218, 597
181,738
148, 295
120, 741
94, 427
74, 970
62,140
37, 783
6,224
37, 429
5,541
35, 843
5,292
32,568
5,062
26, 720
4,175
21, 230
3,404
16, 145
2,574
12,188
1,760
11,165
1,460
9,282
1,253
44,007
42,970
41,135
37, 630
30, 895
24,634
18,719
13, 948
12, 625
10, 540
to
.,
2
i,
<j°
Interest expense:
On deposits
On Federal funds purchased and securities sold under
agreement to repurchase
On borrowed money
_.__
Total.
Occupancy expense of bank premises (net of rental income)
Furniture and equipment—depreciation, rental costs and servicing
Provision for loan losses
Other operating expenses
Total operating expenses
156,085
71,259
79,165
69,194
55,151
61,914
72,049
7,563
23,900
5,047
17,131
4,062
37,706
14,212
38,847
3,845
16,848
1,425
8,445
4,303
235,697
100,206
100,358
121,112
97,843
80,187
66,514
49,996
14,542
13,606
10,446
4,629
12,488
19,416
4,973
8,100
18,388
4,666
7,200
18,542
4,094
3,067
17,572
182,347
3,536
285
14,486
32,939
25,856
3,936
2,275
-
£36,875
28,131
5,891
4,851
4,964
4,183
2,883
4,752
11,124
2,307
6,883
9,855
1,821
12,933
8,424
1,592
7,438
6,449
1,301
2,641
5,970
110,169
6,541
191,916
154,470
130,121
91,973
69,943
52,766
13,205
(285)
12,079
(1,050)
16,462
(1,740)
26,681
2,354
27,268
5,359
18,174
1,842
10,572
(1,733)
2,454
(4,346)
5,027
(2,266)
9,374
738
Total
Less dividends on preferred stock of the bank
13,490
870
13,129
920
18,202
920
24,327
920
21,909
920
16,332
920
12,305
920
6,800
920
7,293
920
8,636
920
Income before securities transactions and extraordinary items.
Net securities cost (less) (less applicable income taxes)
Extraordinary items
12,620
195
12,209
536
i 483
17,282
206
23,407
(1,771)
20,989
(937)
15,412
(105)
11,385
(612)
5,880
(685)
6,373
140
7,716
(554)
12,815
13,228
17,488
21,636
20,052
15,307
10,773
5,195
6,513
7,162
Gain on sale of building, less applicable income taxes of $539.
188,243
7,425
45,693
Income report taxes, securities transactions and extraordinary item_.
Applicable income tax
Net income
330,779
8,441
58,059
Note: The above is based upon annual reports of Franklin New York Corp., for the years 1969 to
1973 and Franklin National Bank for years prior thereto and does not include certain other information
such as that shown in notes to financial statements.
EXHIBIT D
FRANKLIN NEW YORK CORP.
(Percentage of total operating income]
Consolidated statement of earnings for the year ending Dec. 31—
1973
1972
1971
1970
1969
1968
1967
1966
1965
1964
to
Operating income:
Interest and fees on loans:
Commercial
Personal and installment
Mortgage
^
'
Total
Interest and dividends on investments:
U.S. Treasury securities
Securities of other U.S. Government agencies and corporations
Obligations of States and political subdivisions
Other securities
Total.
Other interest income
Trading account income
Service charges on deposit accounts.
Foreign exchange trading income
Other operating income
Total operating income....
ZJI
^
54.8
8.0
7.4
48.1
11.7
9.4
47.5
11.8
8.7
49.3
10.6
8.8
52.4
10.0
10.1
45.1
10.1
10.3
43.1
10.6
11.7
52.2
7.9
11.0
48.8
8.6
9.4
44.5
8.8
11.1
70.2
69.2
68.0
68.7
72.5
65.5
65.4
71.1
66.8
64.4
.5
.9
2.5
4.9
7.4
12.8
11.6
6.2
2.4
3.6
1.9
3.7
7.1
2.4
3.1
10.1
1.2
2.0
10.3
.6
.9
9.5
.5
1.7
10.8
1.2
1.8
13.0
.8
1.4
13.1
.3
8.4
14.1
16.8
17.8
18.3
26.5
27.2
21.0
22.1
23.9
13.2
2.6
1.7
2.3
1.6
4.4
5.2
2.8
.2
4.1
3.6
4.4
2.9
.2
4.1
3.6
3.9
2.6
.1
3.3
3.2
3.5
4.1
._
4.7
_.
5.1
100.0
100.0
100.0
100.0
.5.
2.2
2.9
.1
3.5
100.0
4.8
3.9
3.8
6.4
6.6
100.0
100.0
100.0
100.0
100.0
Operating expenses:
Staff expenses:
Salaries..
Profit sharing, pension, and other benefits
Total
Interest expense:
On deposits
On Federal funds purchased and securities sold under
agreement to repurchase
On borrowed money
Total
Occupancy expense of bank premises (net of rental income)
Furniture and equipment—depreciation, rental costs, and
servicing..
Provision for loan losses
Other operating expenses
Total operating expenses
Income before taxes, securities transactions, and extraordinary items.
Applicable income tax.
Total
Less dividends on preferred stock of the bank
Income before securities transactions and extraordinary
items
Net securities gain (loss) (less applicable income taxes)
Extraordinary items
Netincome
11.0
1.8
18.7
2.8
18.0
2.7
14.9
2.3
14.7
2.3
14.3
2.3
13.4
2.1
12.9
1.9
14.9
1.9
15.0
2.0
12.8
21.5
20.7
17.2
17.0
16.6
15.5
14.8
16.8
17.0
48.1
48.4
44.0
41.6
5.2
3.7
45.4
35.6
39.8
31.6
30.3
41.7
20.9
2.2
11.9
2.5
8.6
2.1
17.2
6.5
21.4
2.1
11.4
1.0
7.0
4.6
68.5
50.0
50.5
55.3
53.8
54.1
55.1
53.0
49.2
45.3
4.3
6.8
5.3
3.9
4.1
4.4
4.9
5.1
6.6
6.7
1.3
3.7
5.6
2.5
4.0
9.2
2.3
3.6
9.3
1.9
1.4
8.1
1.9
.2
8.0
1.9
3.2
7.5
1.9
5.7
8.1
1.9
13.7
8.9
2.2
9.9
8.6
2.1
4.2
9.6
96.2
94.0
91.7
87.8
85.0
87.7
91.2
97.4
93.3
84.9
3.8
(.1)
6.0
(.5)
8.3
(.9)
12.2
1.1
15.0
3.0
12.3
1.3
8.8
(1.4)
2.6
(4.6)
6.7
(3.0)
15.1
1.2
3.9
6.5
9.2
11.1
12.0
11.0
10.2
7.2
9.7
13.9
.3
.4
.5
.4
.5
.6
.8
1.0
1.2
1.5
3.6
.1
6.1
.3
.2
8.7
.1
10.7
(.8)
11.5
(.5)
10.4
(.1)
9.4
(.5)
6.2
(.7)
8.5
.2
12.4
(.9)
3.7
6.6
8.8
9.9
11.0
10.3
8.9
5.5
8.7
11.5
Note: The above is based upon annual reports of Franklin New York Corp. for the years 1969 to 1973 and Franklin National Bank for years prior thereto and does not include
certain other information such as that shown in notes to financial statements.
EXHIBIT E
FRANKLIN NEW YORK CORPORATION
[In thousands of dollars]
Consolidated changes in capital funds for the year ended Dec. 3 1 —
TOTAL capital funds:
Beginning of year
Increases (decreases):
Operations:
Net income
_
Cash dividends
Transfer from (to) reserve for loan losses.
Net..
Capital transactions:
Issuance of convertible preferred stock
Exercise of common stock options
Sale of common stock
Retirement of convertible preferred stock_.
Redemption of debentures
Net..
1973
1972
1971
1970
1969
1968
1967
1966
1965
198,096
194,272
187,986
176, 721
170, 018
148, 244
120, 796
124,661
123,064
12,815
(9,404)
13,228
(9,404)
17, 488
(9,404)
(3, 023)
21, 636
(9, 352)
(1, 488)
20, 052
(8, 646)
(5,246).
15, 307
(8, 691)
10,773
(4,962)
90
5,195
(3, 860)
4,650
6,153
(3, 766)
(1,150)
3,411
3,824
5,061
10, 796
6,160
6,616
5,901
5,985
1,597
122,077
7,162
(3,675)
(2, 500)
987
to
20, 523 .
1,225
469
637
76
15, 039
1,225
469
637
15,115
(615)..
(1,500).
(2,115).
Other:
Restatement for 1962 and 1963 gain on sale of buildings..
From merger
Organization costs
Other
20, 523
(9,850).
1,260 .
(94).
43
Net..
End of year..
1964
(94)
199,392
198,096
194,272
187,986
176,721
""(236)1
43
1,024
170,018
148,244
(9,850).
120,796
124,661
123,064
Note: The above is based upon annual reports of Franklin New York Corp. for the years 1969 to 1975 and Franklin National Bank for years prior thereto and does not include certain other information such
as that shown in notes to financial statements.
257
EXHIBIT F
FRANKLIN NATIONAL BANK—LIST OF BRANCHES OPENED OR DISAPPROVED, JAN. 1, 1970, TO DEC. 31, 1973
Recommendation for approval by
Rating of bank at date of last
completed examination
Date branch approved or
disapproved: Branch
Condition
Director bank Deputy
Regional
organization comptroller
administrator division
of currency
- Regional
examiner
Capital
Branches opened:
Adequate
Sept. 14,1964: World Trade Fair
. Favorable...
Center.
do
Inadequate.... Unfavorable.
May 24,1967: Lake Success
Quadrangle.
Jan. 30, 1968: 535 7th
do
do
Favorable
Ave.
do
do
June 27, 1968: Motor
do
Parkway.
Feb. 4,1969: Smith-Haven..
do
Strengthened.
do.
Apr. 7,1969: Lefrak City...
do
do
do
May 5,1969:475 Park Ave.
do
do
do
South.
do
do
July 10,1969: Paragon Bldg.
do
Nov. 5, 1969: 111 Livmgsdo
.do
do
ston St.
Jan. 13, 1970: 450 Park
do
Borderline
do
Ave.
Jan. 22, 1970: West Babydo
do
do
lon.
Feb. 16,1970: Farmingdale
do
.do
do
Drive-ln.
Feb. 18, 1970: Veterans .
do
do
. Unfavorable.
Memorial.
Mar. 11, 1970: Southampdo
do
Favorable...
ton.
Apr. 16,1970: 800 3d Ave..
do
do
do
June 10,1970: Centereach-..
do..
_
do
do
Selden.
do
do
June 22, 1970: Columbus .
. Unfavorable.
Circle.
Aug. 4, 1970: Great Neck .
do
do
Favorable...
Plaza.
do.
do.
Aug. 31,1970: Bayport
do
Nov. 4, 1970: Lynbrook
do
..do
do
Mar. 27,1973: Hewlett
Unsatisfactory.. Inadequate...
do
Branches disapproved:
Feb. 27, 1970: Mitchell
.....do
Field vicinity.
Apr. 1,1970: Islip
do
do
Unfavorable.
Nov. 9,1970:Oceanside__.
do
do
do
Feb. 19, 1971: Malverne. Poor
Inadequate... Favorable...
Favorable... Favorable... Favorable-.
Unfavorable
do
Favorable
do
Do.
Do.
do
Unfavorable.
Do.
do
do
do
Favorable
do
do
Do.
Do.
Do.
do
do
do
do
Do.
Do.
do
do
Do.
do
Do.
do
Unfavorable.
Do.
do
Favorable
Do.
Do.
do
do
do
Unfavorable.
Do.
Da.
do
Favorable...
Do.
do
do
Do.
do
do
do
do
do
do
Do.
Da.
Do.
do
Unfavorable. 1Unfavorable.
do
do
Unfavorable
do.
do
do
Do.
Do.
Do.
EXHIBIT G
FRANKLIN NEW YORK CORP.
SUMMARY OF FOREIGN EXCHANGE POSITIONS AS OF DATES OF EXAMINATIONS BY NATIONAL EXAMINERS
{In thousands]
Foreign currency
Pounds sterling:
Aug. 31,1970
May 17,1971
Mar. 6,1972
Dec. 11,1972
Nov. 14,1973
May 14,1974
Swiss francs:
Aug. 31,1970
May 17, 1971
Mar. 6,1972
Dec. 1 1 , 1 9 7 2 . . . .
Nov. 14.1973
May 14,1974
Dutch guilders:
Aug. 31,1970
May 17,1971
Mar. 6,1972
Dec. 11,1972
Nov. 14,1973
May 14,1974
U.S. dollars
AssetsLong
Liabilities—
Short
NetLong
(short)
330
699
35,373
116,625
94,323
353
300
632
35,218
117, 387
98,025
76,843
30
67
155
(762)
(3,702).
(76,490).
100
250
250
250
786
1,668
90,172
279,637
226,727
3,861
716
70
167
1,501
474
89,698
(3,439) (1, 306)
283,076
237,152 (10,425)
175, 560 (171,699) (19,150>
10,899
24,221
90,046
452,006
322,109
82,320
7,477
22,687
88,200
451,700
341,283
103,258
3,422
1,534
1,846
306
(19,174).
(20,938).
1,000
2,000
2,000
2,000
2,535
5,737
23,476
121,311
105, 549
29,781
1,744
5,312
23,079
121,193
112,632
32,012
791
425
397
118
(7,083)
(2,231)
* 30J
....
(8,503>
28
998
10,958
240,202
147,983
895
1,500
13,541
240,851
160,455
3,528
28
(502)
(2,583)
(649)
(12,472).
(2,633).
1,000
1,000
1,000
1,000
8 .
281
423
3,443
4,255
75,475
75,851
57,310
62, 580
1,642
1,379
8
(142)
(812)
(376)
(5,270)
263
(2,261)
Limitation
(note)
AssetsLong
Liabilities—
Short
Net—
Long
(short)
Estimated
profit
(loss)
„
146
258
FRANKLIN NEW YORK CORP.
[In thousands]
Foreign currency
Assets—
Long
Liabilities—
Short
NetLong
(short)
Deutsche marks:
5,941
Aug. 31,1970.
12,304
6,363
483
May 17,1971..
19,020
18,537
Mar. 6,1972...
202,239
199,802
2,437
Dec. 11, 1972..
526,639
529,037
(2,398)
Nov. 14,1973.
1,103,049
1,112,392
(9,343)
May 14,1974..
11,647
7,286
4,361
tire:
3,507
3,507
Aug 31, 1970..
May 17,1971..
1,912,211
1,900,000
12,211
Mar. 6, 1972...
Dec. 11,1972
23, 888, 577 32,091,045 ( 8,202, 468)
Nov. 14, 1973..
428,624 6, 622,353 ( 6,193,729)
May 14,1974.,
French francs:
Aug. 31,1970.
32
32
May 17,1971.
Mar. 6,1972...
14,073
250
14,323
Dec. 11, 1972..
584,403
602, 754
(18,351)
Nov. 14,1973..
226, 590 (216, 572)
May 14,1974.
10,018
Yen:
Aug. 31,1970..
926,700
7
926,707
May 17,1971.
Mar. 6, 1972
._
Dec. 11,1972 .
Nov. 14,1973
62, 581
600,000 (537, 419)
May 14, 1974.
Belgian francs:
589
Aug. 31,1970..
589
May 17,1971 .
Mar. 6,1972..
634
29,965
30, 599
Dec. 11,1972
260,025
(80, 530)
Nov. 14,1973.
179, 495
(11,541)
May 14,1974
27, 500
15,959
Canadian dollars:
57
Aug. 31,1970..
57
(142)
May 17,1971..
2,408
2,550
Mar. 6,1972..
28, 060
302
27, 758
Dec. 11,1972..
33, 681
(682)
34, 363
Nov. 14,1973
30, 629
(1,168)
31, 797
8,666
May 14,1974..
566
8,100
Other minor currencies:
Aug. 31, 1970 (Australian Dollar)...
21
21
May 17, 1971, various
small positions not
reported...
Mar. 6, 1972, :Spanish
1,606
1,606
pesetas
Dec. 11, 1972, various
small positiions not
reported _
Nov. 14,1973, various
small positions not
reported .
.
May 14, 1974, various
small positions not
reported.. .
Total:
Aug. 31,1970
May 17,1971..
Mar. 6,1972..
Dec. 11,1972..
Nov. 14,1973
May 14,1974.
IMote: The limitation is on the net long or short position.
U.S. dollars
Limitation
(note)
1,000
1,000
2,000
620
10,000
10,000
250
1,000
None
Assets—
Long
LiabilitiesShort
3,331
5,358
62,629
167,774
438,268
5,421
1,748
5,116
62,071
168,704
452,285
10, 808
5
3,038
3,019
5
19
40, 644
789
55,026
10,612
(14,382)
(9, 823)
6
NetLong
(short)
1,583
242
558
(930)
(14,017)
(5,387)
Estimated
profit
(loss)
232
(4,259)
(1,621)
6
2,804
2,750
134,000
2,540
141,788
44,688
2,608
2,609
232
2,039
54
(7,788)
(42,148)
(6, 836)
(1,807)
(186)
_
2,000
2,000
250
250
500
500
12
12
743
730
13
4,576
446
6,772
637
(2,196)
(191)
54
2,366
27,958
34, 242
30, 667
8,850
2,509
27, 668
34,820
32,121
8,411
54
(143).
290
(578)
(1, 454)
439
None
23
23
1,000
24
24
--
(156)
(113)
(51)
-
11
9,368
6,817
18, 448
17, 880
211,249
210,251
678, 439 683, 644
1,037,741 1., 100,356
53, 562 286,146
2,551
568
998
(5,205)
(62,615)
(232,584)
1,601
(43,012)
259
EXHIBIT H
FRANKLIN NEW YORK CORP,
CLASSIFIED AND CRITICIZED LOANS, AS OF DATE OF EXAMINATIONS BY THE NATIONAL BANK EXAMINERS
[Dollar amounts in thousands]
May 14,
1974
Nov. 14,
1973
Dec. 11,
1972
Mar. 6,
1972
May 17,
1971
Aug. 31,
1970
Sept. 29,
1969
Loss
Doubtful
Substandard..
$13,359
36,620
97,240
$10,439
39, 541
90,102
$6,759
21,666
77,334
$9, 305
15,415
92,319
$12,421
20, 660
72, 531
$6,001
10, 257
90, 394
$1,445
3,712
24, 599
Total classifiedSpecial mention
147,219
155,672
140,082
148, 571
105,759
83,645
117,039
94, 088
105,612
100,436
106,652
126, 570
29,756
57,03b
Total classified
and criticized. .
302,891
Other loans not classified or criticized
. 2,310,894
288,653
189,404
211,127
206, 048
233,222
86,791
2, 295,147
1,839, 389
1,614, 598
1, 419, 040
1,606,144
1,506,840
2, 613,785
2, 583, 800
2, 028, 793
1,825, 725
1, 625, 088
1,839,366
1,593,631
0.51
1.40
3.72
0.40
1.53
3.49
0.33
1.07
3.81
0.51
.84
5.06
0.76
1.27
4.46
0.33
.56
4.91
0.09
.23
1.54
5.63
5.96
5.42
5.75
5.21
4.12
6.41
5.15
6.49
6.18
5.80
6.88
1.86
3.58
11.59
11.17
9.33
11.56
12.67
12.68
5.44
Total loans
Percent of total loans
represented by loans
categorized as:
Loss
Doubtful
Substandard
Classified
Special mention..
Classified and
criticized
Other loans not
classified or
criticized
88.41
88.83
90.67
88.44
87.33
87.32
94.56
100.00
100.00
100.00
100.00
100.00
100.000
100.00
$250,913
$228,638
$230,320
$231,472
$201,657
$182,161
$182,829
5.32
14.60
38.75
4.57
17.29
39.41
2.93
9.39
33.50
4.02
6.66
39.88
6.16
10.25
35.97
3.29
5.63
49.62
0.79
2.03
13.45
58.67
62.04
61.27
64.98
45.82
36.24
50.56
40.65
52.38
49.80
58.54
69.48
16.27
31.20
120.71
126.25
82.06
91.21
102.18
128.02
47.47
Total loans..
Total capital
Percent of total capital
represented by loans
categorized as:
Loss
Doubtful
Substandard
Classified
Special mention..
Total
EXHIBIT I
ANALYSIS OF RESERVE FOR LOAN LOSSES
[In thousands of dollars]
1972
1971
1970
Balance beginning of year
30,398 31,115
31,115
31,115
Deductions:
Loans charged off
Less recoveries
15,080
2,515
11,301 15, 493
2,484
1,869
7,523
1,674
2,424
2,139
5,849
285
1973
Net loans charged o f f - 12,565
Total
Additions:
From merger—Federation Bank & Trust
Co
Charged to earnings
12, 488
Transfer from (to) retained earnings
Deferred taxes related to
transfer
(2,965)
Total
8,817
17,833 22,298
8,100
20, 000 20,000
17, 491 25, 266 19,715
7,200
3,067
285
3,023
1,488
5,246
3,401
1,294
13, 624
5,849
1968
5, 869 .
1967
1964
16,000 25, 300 23,000
18, 000
6,335
1,583
8,364
1,481
13,842
909 .
4,752
6,883
12,933
7,438
2,641
15, 248
9,117
12,367
15, 562
15,359
4,180
6,883 12,933
7,438
2,641
1,150
2,500
1,150
2,500
4,752
(90) (4,650)
(90) (4, 650)
4,752 10,883
Balance end of year. __ 27,356 30,398 31,115 31,115 31,115
20,000 20,000
1966
1965
11, 400
9,523
8,100
13,642
1969
9,738
7,641
16,000 25,300
23,000
3,633
260
EXHIBIT J
INVESTMENTS, AS OF DATES OF EXAMINATIONS BY THE NATIONAL BANK EXAMINERS
[In millions of dollars]
Carrying values:
U.S. Government and government
agencies
General obligations of States and
political subdivisions
Investment securities
Trading account securities
Other
Total
Market values:
U.S. Government and government
agencies
General obligations of States and
political subdivisions
Investment securities
Trading account securities
Other.,
Total
Depreciation (appreciation) in values:
U.S. Government and government
agencies
,
General obligations of States and
political subdivisions
Investment securities
Trading account securities
Other
Total
May 14,
1974
Nov. 14,
1973
Dec. 11,
1972
Mar. 6,
1972
May 17,
1971
Aug. 31,
1970
Sept. 29
1969
425.6
212.3
112.1
190.9
152.7
131.4
144.9
235.6
191.9
46.6
3.3
145.6
232.0
59.6
.8
148.2
184.2
47.3
3.3
213.8
175.0
52.9
3.8
289.9
184.3
116.9
2.6
204.1
187.3
36.2
2.5
236.2
171.3
41.4
2.5
903.0
650.3
495.1
636.4
746.4
561.5
596.3
399.1
209.1
108.6
190.1
149.5
121.9
131.3
187.1
159.4
44.6
2.4
113.9
205.2
62.9
.8
126.3
157.7
44.9
2.3
180.3
151.5
52.8
2.8
264.2
154.4
114.2
1.3
156.0
136.7
36.5
1.4
182.0
132.1
41.1
2.6
792.6
591.9
439.8
577.5
683.6
452.5
489.1
26.5
48.5
32.5
2.0
.9 ..
110.4
3.2
3.5
.8
3.2
9.5
13.6
31.7
26.8
(3.3)
21.9
26.5
2.4
1.0
33.5
23.5
.1
1.0
25.7
29.9
2.7
1.3
48.1
50.6
54.2
39.2
.3
(1)
58.4
55.3
58.9
62.8
109.0
i(:P
107.2
261
EXHIBIT K
INVESTMENT MATURITIES, AS OF DATES OF EXAMINATIONS BY THE NATIONAL BANK EXAMINERS
IIn thousands of dollars, par value]
May 14,
1974
Nov. 14,
1973
Dec. 11,
1972
Mar. 6,
1972
May 17.
1971
Aug. 31,
1970
Sept. 29,
1969
U.S. Government and Government
agencies:
Uptolyr
18,865
105,191
Over 1 yr, not over 5 yr
Over 5 yr, not over 10 yr.
234,108
Over 10 yr, not over 20 yr
18,159
Over 20 yr
__.. 53,245
13,626
98,692
46,608
14,363
43,104
35,678
49,426
14,858
9,364
3,000
71,200
91,636
18,998
2,364
7,000
63,480
64,083
10,272
14,943
301
2,220
11,6481
0
5,556
7,300
9,500
110,327
12,300
5,556
7,300
429,568
216,393
112,326
191,198
153,079
131,557
144,983
General obligations of States and other
political subdivisions:
Uptolyr
18,197
Over 1 yr, not over 5 yr
14,349
Over 5 yr, not over 10 yr
34,457
Over 10 yr, notover 20 yr___
._ 102,565
Over 20 yr
_
70,631
5,209
14,067
21,390
41,630
65,763
4,620
20,144
19,625
70,066
35,715
34,360
45,906
16,926
65,309
52,855
121,725
26,993
19,881
59,959
62,606
1,040
21,209
29,237
78,510
76,446
2,224
43,409
43,810
70,066
74,810
240,199
148,059
150,170
215,356
291,164
206,442
234,319
Investment securities (primarily revenue
obligations of State and political subdivisions):
Uptolyr
.__.
440
Over 1 yr, not over 5 yr
2,410
8,375
Over 5 yr, not over 10 yr
Over 10 yr, not over 20 yr
32,303
Over 20 yr
149,459
435
2,930
9,160
50,332
170,579
395
3,481
8,960
53,032
120,064
265
2,700
6,102
50,010
119,449
375
855
8,917
59,909
119,134
590
3,940
9,641
43,171
132,298
759
9,313
10,447
32,911
122,808
233,436
185,932
178,526
189,190
189,640
176,238
Subtotal
Subtotal
Subtotal
_
Total:
Up to 1 yr
_.
Over 1 yr, not over 5 yr
Over 5 yr, not over 10 yr
Over 10 yr, notover 20 yr._
Over 20 yr
_
Total
_
_ 192,987
_
„
37,502
19,270
40,693 105,825 185,580
3,850
121,950 115,689
73,051 140,242
91,931 141,630
276,940
77,158
43,443
42,026
39,070
38,878
153,027 106,325 132,462 117,683 134,811 127,237
273,335 279,446 158,779 179,304 182,041 216,044
12,483
163,049
66,557
108,533
204,918
862,754
555,540
597,888
448,428
585,080
633,433
527,639
262
EXHIBIT L
INVESTMENT MATURITIES, AS OF DATES OF EXAMINATIONS BY THE NATIONAL BANK EXAMINERS
[Percentage of total investments at par value]
U.S. Government
agencies:
and
May 14.
1974
Nov. 14,
1973
Dec. 11,
1972
Mar. 6,
1972
May 17.
1971
Aug. 31,
1970
Sept. 29,
1969
2.19
12.19
27.14
2.10
6.17
2.28
16.50
7.80
2.40
7.21
7.96
11.02
3.31
2.09
.67
12.17
15.66
3.25
.40
1.20
10.02
10.12
1.62
2.36
.05
.42
22.08
0.00
1.05
1.38
1.71
19.86
2.21
1.00
1.32
49.79
36.19
25.05
32.68
24.17
24.93
26.10
2.11
1.66
3.99
11.89
8.19
.87
2.35
3.58
6.97
11.00
1.03
4.49
4.38
15.63
7.96
5.87
7.85
2.89
11.16
9.04
19.22
4.26
3.14
9.47
9.88
.20
4.02
5.54
14.88
14.49
.40
7.81
7.89
12.61
13.47
27.84
24.77
33.49
36.81
45.97
39.13
42.18
.05
.28
.97
3.75
17.32
.07
.49
1.53
8.42
28.53
.09
.78
2.00
11.82
26.77
.05
.46
1.04
8.55
20.41
.06
.13
1.41
9.46
18.80
.11
.75
1.83
8.18
25.07
1.4
1.68
1.88
5.92
22.10
22.37
39.04
41.46
30.51
29.86
35.94
31.72
4.35
14.13
32.10
17.74
31.68
3.22
19.34
12.91
17.79
46.74
9.08
16.29
9.69
29.54
35.40
18.09
23.97
7.18
20.11
30.65
29.30
14.51
6.17
21.29
28.73
.73
26.85
7.37
24.11
40.94
2.25
29.35
11.S8
19.53
36.89
100.00
100.00
100.00
100.00
100.00
100.00
100.00
Government
Uptolyr
Over 1 yr, not over b yr
Over byr, not over 10 yr.___
Over 10 yr, not over 20 yr
Over 20 yr
Subtotal
General obligations of States and other
political subdivisions:
Uptolyr
Over 1 yr, not over 5 yr
Over5yr, notover 10 yr.___
Over 10 yr, notover20yr.__
Over 20 yr
___.
Subtotal
_
Investment securities (primarily revenue
obligations of State and political subdivisions):
Uptolyr
Over 1 yr, not over 5 yr
Over 5 yr, not over 10 yr
Over 10 yr, not over 20 yr
Over 20 yr
Subtotal
Total:
Uptolyr
Over 1 yr, not over b yr
Over 5 yr, not over 10 yr
Over 10 yr, not over 20 yr
Over 20 yr
_
Total....
_
_.
263
EXHIBIT M
SUMMARY OF BANK LIQUIDITY AS OF DATES OF EXAMINATIONS BY THE NATIONAL BANK EXAMINERS
[In thousands of dollars]
Description
1. Total liabilities
(exclude valuation reserves and
capital)
l.A. Less: Deductions
(Liabilities
secured by U.S.
Governments and
other eligible
assets. Interest
collected not
earned.)
2.
Net liabilities.
May 14,
1974
Nov. 14,
1973
Dec. 11,
1972
Mar. 6,
1972
May 17,
1971
Aug. 31,
1970
Sept. 29,
1969
4, 347,695
3,653, 428
3, 507,707
3,019,828
2, 918, 844
2,925,172
2, 314, 769
1, 416, 863
392, 414
279,970
443, 517
496, 579
653,030
243, 405
2,932,812
3,261,014
3,227, 737
2, 576, 311
2, 422, 265
2, 272,142
2,071, 364
774, 202
476, 345
821, 543
490,601
421, 797
392, 697
241, 306
73, 419
62, 095
55, 463
47,663
36, 212
68,658
3. Cash and due from
banks
4. Unpledged U.S.
Governments
(market value)
5. Other unpledged
securities—2-yr
maturities or less
(market value)
6. Federal funds sold;
U.S. securities
and other
securities with up
to 2 yr maturities
purchased under
agreements to
resell _
7. Gross liquid
assets (sum
of lines 3,
4, 5, and 6)
4. Less: Deductions
(reserve requirement (do not
deduct vault
cash))
9. Net liquid
assets (line
7 minus
line 8)
10. Percent of net liquid
assets to net
deposits and unsubordinated shortterm liabilities
(line 9 as a percent of line 8)
376, 362
3,909
22,350
8,361
43,123
52,957
6,209
40,450
200,700
140, 864
197,013
183,025
1,100,056
722,251
707, 979
650, 589
658,118
169, 558
186, 719
191, 472
182, 005
166, 346
366,103
930,498
535, 532
516, 507
468,584
491,772
11.2
28.8
21.3
20.6
50,000 .
905,982
542,349
491,679
176, 246
414, 303
14.1
20.7
23.7
264
EXHIBIT N
[Dollar amounts in millions]
Return on earning assets, for the year ended Dec. 31—
Average earning assets:1
Loans:
Commercial
_
Mortgage
Personal and installment
Total loans..
Investments:
U.S. Treasury securities
Government agencies
States and political subdivisions.
Other securities....
1971
1970
1969
$1,846.0
309.0
269.0
$1,386.0
256.0
258.0
$1,179.0
227.0
254.0
$1,060.0
239.0
245.0
$998.0
253.0
239.0
2,424.0
1,900.0
1,660.0
1,544.0
1,490.0
45.1
117.1
339.0
74.0
110.3
95.4
457.5
42.0
196.1
65.8
480.4
21.7
243.8
40.1
427.0
25.5
_
544.3
575.2
705.2
764.0
736.4
__
112.3
134.0
81.2
64.2
73.1
565.1
301.8
34.4
_
Others:
Interest bearing time deposits..
Federal funds sold and securities purchased under basic
agreements
Total other
Total average
assets
1972
26.9
120.7
300.1
96.6
Total investments...
Trading account securities
1973
__
235.4
167.3
155.3
153.1
95.8
800.5
469.1
189.7
153.1
95.8
3,881.1
3,078.3
2,636.1
2,525.3
2,395.3
earning
Income:
Loans:
Commercial
Mortgage..
Personal and installment
__
189.0
25.0
27.0
96.0
19.0
23.3
95.0
17.0
23.0
108.0
19.0
23.0
95.0
18.0
18.0
Total loans
_.
241.0
138.0
135.0
150.0
131.10
1.7
8.3
1.9
7.4
5.0
6.1
10.8
4.4
13.5
1.7
23.9
6.7
27.5
4.7
38.3
2.3
46.8
1.4
36.9
.9
40.6
41.5
51.7
63.4
53.0
8.9
45.4
10.4
8.7
8.8
7.1
8.4
7.8
3.9
.9
Investments:
U.S. Treasury securities
__
Government agencies
States and political subdivisions—tax adjusted
Other securities
_
Total investments!
Trading account securities
Other interest
Total income
assets 2
on earning
335.9
198.6
202.6
229.6
188.8
Return on earning assets:
Loans:
Commercial
Mortgage
Personal and installment
10.24
8.09
10.04
6.93
7.42
8.91
8.06
7.49
9.06
10.19
7.95
9.39
9.52
7.11
7.53
Total loans
9.94
7.26
8.13
9.72
8.79
6.35
6.88
4.21
6.32
4.53
6.39
5.50
6.69
5.53
4.23
7.97
6.94
8.10
6.35
8.38
5.48
9.74
6.45
8.64
3.52
7.46
7.93
5.67
7.21
7.76
1.85
7.33
10.84
3.74
8.30
13.08
5.49
7.20
5.34
.94
8.66
6.45
7.68
9.09
7.88
Investments:
U.S. Treasury securities
Government agencies
States and political subdivisions—tax adjusted. __
Other securities
Total investments.....
Trading account securities
Other
Total
___
i Average represents, except for interest bearing time deposits, a daily average. Average interest bearing time deposits
represent an average of the balance at the beginning and end of the year.
2 The return on investments in obligations of States and political subdivisions, which is per the annual reports of
Franklin, has been tax adjusted. The income on such investments, as shown above, has been derived by multiplying
the average investment in such obligations by such return.
265
EXHIBIT 0
[Dollar amounts in millions]
Cost of funds for the year ended Dec. 31-—
Average funds:
Deposits:
Time and savings
Foreign *
Total deposits
Federal funds purchased and securities sold under repurchase agreements
Other borrowed money
Total....
_
Interest expense:
Deposits
Federal funds purchased and securities sold under repurchase agreements
Other borrowed money
Total....
_-
Cost of funds (percent):
Deposits
Federal funds purchased and securities sold under repurchase agreements
Other borrowed money
Total
—
1973
1972
1971
1970
1969
$1,318.4
851.3
$1,112.0
342.0
$1,271.6
233.5
$971.1
189.7
$1,042.9
59.5
2,169.7
1,454.0
1, 505.1
1,160.8
1,102.4
785.6
124.1
514.6
99.7
363.1
106.6
552.2
146.8
496.9
113.8
3,079.4
2, 068.3
1,974.8
1,859.8
1,713.1
156.1
71.3
79.2
69.2
55.2
72.1
7.6
23.9
5.1
17.1
4.1
37.7
14.2
38.8
3.8
235.8
100.3
100.4
121.1
97.8
7.19
4.90
5.26
5.96
5.01
9.18
6.12
4.64
5.12
4.71
3.85
6.83
9.67
7.81
3.34
7.66
4.85
5.08
6.51
5.71
i Foreign deposits include both time and demand deposits.
WORK PROGRAM FOR NATIONAL BANK EDP
Name of B a n k
National Bank Region
Examination Commenced
Examination Closed
EXAMINATION
City
Charter Number
M., on
Day
M., on
Day
State
Date
Date
Examiner in Charge
INSTRUCTIONS
This program sets forth the required procedures for the conduct of an examination of a bank's electronic data processing system. The purpose of the
program is to assist the examiner in determining the extent and quality of the
bank's EDP internal control procedures. The program is designed to be used
in conjunction with the EDP Examination Handbook.
The applicable work program sections should be completed in pencil for each
national bank data or service center. If the data center being examined functions as a servicer of other national banks, the examiner should also complete
the section of this program regarding examination of computer service centers.
For purposes of this program a data center may be considered to include
multiple computers located in the same general area subject to common administration. The work program should comprehend conditions during extra shifts
and overtime hours as well as the normal working hours.
The EDP examination should be conducted concurrently with the commercial
examination, where possible, especially if a weak internal control situation is
anticipated.
The EDP examiner should review the most recent commercial report. If
examination of the EDP and commercial examinations are not being conducted
concurrently, the examiner should obtain all materials necessary to complete
266
the questionnaire for each section of the program. In most instances, this material
should be retained until the specific examination area is completed. If a step in
the work program is marked with an asterisk (*), the material obtained from
the data center or developed by the examiner should be included in the work
papers, together with any other material that may be needed in order to fully
describe the existent internal controls. Exhibits should be page numbered, indexed and cross referenced to the appropriate work program steps and initialed
by the examiner. If the exhibits are voluminious, they should be bound separately from the work program. Exhibits having continuing significance may be
carried forward from workpapers of previous examinations.
FRANKLIN NATIONAL BANK,
October 2,1969.
To: Division Heads.
From: William B. Lewis, Jr., Senior Executive Vice Pres.
Subject: Loan restraint program.
The purpose of this memorandum is to make sure that our loan policies are
thoroughly understood. Please see to it that all loan officers reporting to you are
thoroughly familiar with our policies and the program which we are pursuing.
1. New loans are not to be permitted. The only exception to this may be where
funds are provided by the borrower through a Certificate of Deposit.
2. Increases in existing lines or approvals are subject to the same restrictions
as (1) above.
3. Loans are to be under constant review with the thought of eliminating those
which do not hold forth the potential for further growth of the bank. Loans
which are marginal in terms of credit, rate or balances, or which require considerable administrative effort are to he eliminated.
4. The Division Head or his Assistant is to initial all notes of $300,000 or
more and he is to delegate the same responsibility for loans of smaller amount.
5. Neither commitments nor disbursements are to be made in advance of approval by the Loan Control Committee.
W. B. LEWIS.
OFFICE MEMORANDUM
U.S. GOVERNMENT,
COMPTROLLER OF THE CURRENCY,
March 5,1970.
To : Mr. William B. Camp, Comptroller of the Currency.
From: Larry T. Gerzema, Assistant Chief National Bank Examiner.
Subject: Franklin National Bank, Mineola. N.Y. Examination report dated
9/29/69; received in this Office 1/22/70. Rank: 12th of all banks, 21st of all
National and D.C. banks,
2-B-F/2.
Condition
\Fair. The loan account continues to improve with both classified and chargeoff totals showing a decline from the previous exam. The bank's major problem
is a low liquidity position which was computed at only 2 percent on the date of
the exam. It was raised to 12 percent at the close of the exam by selling $100MM
in loans to its one-bank holding company. At year end the bank w*as in a net
borrowed position of $388MM (borrowings, plus federal funds purchased, less
federal funds sold). The net borrowings are equal to about 200 percent of the
legal reserve balance required with Fed and are equal to 20 percent of deposit
totals. Liquidity was 16 percent on January 31, 1970 computed under the new
formula but the amount of borrowings is not known. The sharp drop in liquidity
between exams was due to a $290MM increase in loan totals and a deposit decline of $150201.
The bank's investment portfolio had a market depreciation of $107MM which
is equal to 52 percent of capital funds. The portfolio's long maturity schedule
is the principal cause of the heavy depreciation. The bank's maturity schedule
is as follows: (1) only 2 percent of the account comes due within one year; (2)
267
29 percent in t h e 1-5 year category ; (3) 12 percent in the 5-10 year r a n g e ; (4) 19
percent in the 10-20 year r a n g e ; (5) 37 percent out over 20 years. Most of t h e
portfolio is pledged to secure public deposits or is sold under agreements to repurchase. T h e m a r k e t depreciation represents a potential problem in view of
t h e bank's tight liquidity position. Comparative figures taken from the last two
reports of examination follow:
Total resources (thousands)
Adjusted capital funds (thousands)
Total loans and overdrafts (thousands)
Total deposits (thousands)
Loans times gross capital funds
Percent of loans to deposits
Percent of classified assets to gross capital funds
Percent of net liquid assets to net deposits
Percent of time deposits to total deposits
Rate paid on saving accounts
Rate paid on majority of CD's
Sept. 30,1968
Sept. 29,1969
$2,646,445
$189, 503
$1, 290, 690
$2,017, 540
$2,602,156
$205,927
$1, 584,293
$1, 860,076
6.6
64
19
23
61
4
7.6
85
16
2
55
4
5-6^
5H
Management
Fair. President Gleason is the bank's chief executive officer. His background
h a s been in public relations and administration, however, h e is getting increasingly involved in lending and policy m a t t e r s . T h e bank's second man is Senior
Executive Vice President Lewis, who is in charge of loan administration a n d
branch activities. Vice Chairman Crosse is responsible for investment activities
and money m a r k e t transactions. C h a i r m a n R o t h resigned from t h e bank a few
days ago.
Earnings
<*ood. The bank's operating record showed substantial improvement in 1969
with net profits after taxes rising to $17.1MM, a n increase of nearly $11MM
over the previous year. Approximately one half of t h e increase in profits was
due to a decline in loan losses. The dividend policy is not subject to criticism.
Capital
Marginally adequate. Management states t h a t t h e r e a r e plans to raise new
money, but the amount a n d timing a r e uncertain.
Ownership
F r a n k l i n New York Corporation, a one-bank holding company, owns control.
Future
Prospects
Good. T h e subject bank serves all of Long Island a n d also h a s 24 offices In
New York City. Overseas expansion is going according to plan and should
continue.
Corrective
Action
Most of the severe asset problems t h a t plagued t h e h a n k in recent years a r e
now behind them. Liquidity m a n a g e m e n t is inadequate as evidenced by the s h a r p
growth in the loan account d u r i n g a period when deposits were declining. T h e
regional office passed the report although it is my opinion t h a t the bank's
liquidity position should be followed closely.
LARRY T.
Assistant
Chief National
GERZEMA,
Bank
Examiner.
268
J A N U A R Y 24,
1974.
R e F r a n k l i n National Bank, New York, N.Y.
MEMORANDUM FOR T H E F I L E S
[ I n millions]
Last exam
$3, 767
2,041
260
422
16
47
24
This exam
$4,974
2,584
260
917
124
3
0
Total
509
1,044
Federal funds sold
200
371
Due to b a n k s :
D e m a n d deposits—domesetic
Demand deposits—foreign
63
140
217
28
203
245
3
532
25
931
535
956
Resources
Loans
Capital
F e d e r a l funds purchased ($147 over 1 d a y )
Repurchase agreement—securities
Borrowed securities
Short sale securities
Total
Time deposits—domestic
Time deposits—foreign
Total
Total borrowings and due to b a n k s :
Time
1,044
2,000
1973 daily average b o r r o w e d :
January
448
February
470
March
540
April
552
May
662
June
800
July
930
August
948
September
919
October
955
November
1, 075
December
1,100
I n a telephone conversation this morning, Regional Administrator Van H o r n
informed me t h a t virtually t h e entire investment portfolio is pledged and therefore, it offers no liquidity protection.
J.
Deputy
Comptroller
T.
WATSON,
of the
Currency.
J A N U A R Y , 29,
1974.
R e F r a n k l i n National Bank, Brooklyn, N.Y.
MEMORANDUM FOR T H E F I L E S :
L a s t F r i d a y , Mr. Benjamin Rafanello, Assistant Vice President, F e d e r a l Reserve B a n k of New Y o r k ; telephoned t h e Office to inform us t h a t Mr. Brenton Levitt, B o a r d of Governors, Federal Reserve System, Washington had suggested t h a t
it might be helpful in reaching a decision on the acquisition of Talcott by F r a n k lin Corporation if representatives of the Examining Division of t h e F e d e r a l
Reserve B a n k of New York met with National B a n k E x a m i n e r E d w a r d B. Lake,
who is conducting t h e c u r r e n t examination of the bank. I told him t h a t t h i s
would be agreeable and the meeting w a s arranged for 9:15 A.M. today in
this Office. I n attendance w e r e : Mr. Fred Piderit, Vice P r e s i d e n t ; Ben Rafanello,
Assistant Vice P r e s i d e n t : J a m e s Booth, Manager. Regulations & B a n k Analysis
D e p a r t m e n t ; E d Kipstuhl, Manager, Foreign B a n k i n g Regulations D e p a r t m e n t
269
and Robert Relyca, Special Assistant. E x a m i n e r Lake, Deputy Regional Administrator Lipkin and I also attended.
E x a m i n e r Lake outlined the current s t a t u s of the examination and gave
estimates a s to the dollar a m o u n t s in classified assets ( S u b s t a n d a r d $100
million, Doubtful, $40 million, Loss, $12-$15 million, O L E M : $100 million).
The bank's earnings s i t u a t i o n ; liquidity; and capitalization were also discussed.
The principal concern of the F e d e r a l Reserve officials w a s the strength
and depth of the bank's management. E x a m i n e r Lake reviewed the status
and qualifications of each of the senior officers of the bank. He emphasized t h a t
Executive Vice Chairman P e t e r Shaddick is, in fact, the Chief Executive Officer, operating the bank in accordance with Mr. Sindona's wishes. Examiner
Lake feels t h a t while Mr. Shaddick appears to be an able administrator, the
bank lacks management depth on both the senior a n d junior levels.
I n view of the management upheaval over the last couple of years, it can
only be concluded t h a t a serious management problem exists.
C. M. V A N HORN,
Regonal
Administrator
of National
Banks,
Second National Bank
Region.
F R A N K L I N NATIONAL B A N K ,
New York, N.Y., May
Mr.
15,1972.
ROBERT M U L L I N ,
Director-International
Division, Comptroller of the Currency,
Washington,
D.C.
DEAE MR. MULLIN : We have been making excellent progress in correcting the
deficiencies in our foreign exchange operation a s reported by the National Bank
Examiners during their present examination. Corrective action h a s been taken
in the a r e a s criticized and new systems and procedures a r e in the process of
being implemented.
A copy of Mr. Herrmann''s memorandums to Mr. H a r l d V. Gleason dated
April 24 a n d May 3, 1972 a r e enclosed. Mr. W a l t e r Schlicht has received copies
of these memorandums and made t w o excellent suggestions which will be included in our final written procedure. They are,
(1) T h a t the w r i t t e n revaluation policies for profit a n d loss computation be
sufficiently detailed to include the a r e a responsible for its preparation, t h e
manner in which rates a r e set for each currency, etc.
(2) When the monthly revaluation report is prepared, any substantial profits
or losses in specific currencies should be explained by means of footnotes. This
will give senior management the opportunity to review the performance of the
t r a d e r and his general t r a d i n g philosophies.
If t h e r e is any further information t h a t you should require, please do not
hesitate to contact me directly.
Sincerely yours,
H. P. BARRAND,
Jr.
F R A N K L I N NATIONAL B A N K ,
April 24, 1972.
T o : Mr. Harold V. Gleason, Chairman of t h e Board and Chief Executive Officer.
From : George G. H e r r m a n n , I n t e r n a t i o n a l Division, Hanover Square.
Subject: Comptroller of the Currency examination as of March 3,1972.
T h e purpose of this memorandum is to provide you w i t h a current s t a t u s
report outlining the steps already taken and those to be taken to correct the
serious deficiencies in our foreign exchange operations as reported by t h e Comptroller of the Currency E x a m i n e r s a t the s t a r t of their examination on March 3,
1972. Their principal criticisms can be grouped into the following areas :
Organization
The Foreign Exchange t r a d e r was responsible for all phases of the t r a d i n g
operation. H e originated the transactions and supervised the preparation of the
paperwork, the accounting, the follow-up and t h e preparation of reports. From
the standpoint of good controls, this was unacceptable.
Corrective
action
We have already separated the functions of our foreign exchange operation.
T h e t r a d e r ' s responsibility is now limited to t r a d i n g and his staff consists of
two assistant t r a d e r s and two position clerks. All of these staff positions have
74-548 O - 76 - 18
270
now been filled, including an assistant t r a d e r who will join the bank on May 8.
The responsibility for the preparation and confirmation of t h e contracts, t h e
record keeping, accounting and report preparation is now under t h e direct
responsibility of a n a s s i s t a n t operations officer, Mr. John Kruse, who h a s a strong
background in accounting a n d auditing. Reporting directly to Mr. K r u s e will be
the foreign exchange operations supervisor. We have interviewed candidates
for this position a n d have made a n offer to one person with 6 years experience in
this field. He will also be joining our bank on May 8. T h e remaining foreign
exchange operations staff will consist of two clerks, three typists and one file
clerk. Their function is to handle the typing and checking of contracts and
tickets, maintaining the foreign exchange ledgers, p r e p a r i n g position a n d gap
reports, checking and filing all t r a d e confirmations, running of proofs, preparing monthly P & L calculations and clearing any open items on Nostro accounts
pertaining to foreign exchange trading. These organizational changes h a v e been
made and a r e now fully operational.
Foreign exchange forward
contracts
At t h e time of examination the outstanding forward contracts, both purchases and sales, were not in proof to the general ledger contingent liability
control accounts. This was caused by numerous posting errors, improper adjustments, and an inadequate system and lack of proper forms.
Corrective
action
F o r w a r d sales and purchase contracts outstanding a r e now in proof and we
a r e presently verifying the daily transactions to the control account on the
general ledger. I n addition to the position sheets maintained in the t r a d i n g
room, a foreign exchange j o u r n a l is maintained by F X operations where purchases a n d sales a r e posted daily for each currency and the U.S. dollar
equivalent.
Nostro
accounts
The foreign currency Nostro accounts maintained with our foreign correspondents were being posted and reconciled by General Accounting in Westbury.
Due to reconciling problems and numerous posting errors by the foreign banks
and incorrect accounting entries on our books, there were many open items on
t h e Nostro accounts.
Corrective
action
Our bank m a i n t a i n s 56 Nostro accounts, all of which have now been properly
reconciled and almost all of the open items have been cleared. There a r e no
large open items outstanding beyond two months. Mr. Sadlik h a s given instructions to General Accounting to station in the I n t e r n a t i o n a l Division two employees of t h e Financial Division handling the reconciling and researching of
the Nostro accounts. This should simplify reconciling these accounts and t h e
clearing of open items. We a r e establishing a newT procedure whereby a monthly
report is to be submitted by General Accounting to the I n t e r n a t i o n a l Division
H e a d and to the Controller, listing all Nostro account open items which a r e
more t h a n one month old and large foreign exchange open items t h a t have not
been cleared within two weeks. This will be followed up weekly by the Controller to insure t h a t research is completed on these items and cleared as
quickly as possible. As p a r t of the Systems D e p a r t m e n t review of our foreign
exchange procedures they will also include an analysis and a p p r o p r i a t e recommendations for maintaining these Nostro accounts. The target date for the
completion of the formal w r i t t e n system is J u n e 15, 1972. The necessary autom a t e d bookkeeping equipment for the posting of these accounts will be ordered
as soon as the formal system h a s been approved.
Foreign exchange position
limits
W e h a v e for some time h a d position limits established permitting the
foreign exchange t r a d e r to m a i n t a i n open positions up to certain limits established for e^ch currency. However, no formal foreign currency gap limits have
been established nor have aggregate limits of foreign currency dealings been
set.
Corrective
action
Discussions have been held with Mr. Aloi and Mr. Corcut to consider the
establishment of gap limits and aggregate limits. Recommendations will be
m a d e based upon our f u r t h e r investigations in this area. T a r g e t date is
J u n e 15.
271
Systems and FOE's
As a result of our request of J u l y 1971, the B a n k Systems Department
assigned an analyst in F e b r u a r y 1972 to study the I n t e r n a t i o n a l Division needs
to handle more efficiently the expanded activity in foreign exchange. The Systems Department was delayed in s t a r t i n g this study due to other priorities
including the preparation of procedures for the handling of the New York Clearing House C H I P S system and the Nassau, B a h a m a s Branch accounting system.
Systems D e p a r t m e n t have been most cooperative in providing us with an
interim system and temporary forms t h a t will greatly improve the efficiency
of the operations and reduce the chance of error in our passing of the bookkeeping entries. T h e following points a r e to be incorporated in the new foreign exchange procedure as agreed to by all units involved, i.e., International,
General Accounting, and Auditing.
(1) Clearly defined organizational lines separating t r a d i n g responsibility
from operating responsibility have already been agreed to and established.
(2) I n the foreign exchange operations a r e a all contracts should be prepared by one clerk, proof read by another, signed by an operations officer
and confirmed by the customer. This procedure is now being followed in the
foreign exchange operations a r e a which will be under the supervision of an
experienced foreign exchange operations supervisor.
(3) A fanfold from is being designed which will eliminate typing tickets
more t h a n once. The fanfold should be serially numbered, with one form for
purchases and a separate form for sales. The completed fanfold form should
be available by J u l y 1. I n the meantime, a temporary fanfold form has been
designed to consolidate four separate typings of tickets into one. This form
h a s already been placed into operation. A similar form to meet the requirements of the Bank of England will be designed for use of our London Office.
(4) A written revaluation policy for profit and loss computation will be p a r t
of the final procedure which will be ready by July 1.
(5) A system which will utilize a foreign exchange future journal and a
customers contingent liability ledger for contTol of future contracts is being
designed. We have already instituted a procedure employing a foreign exchange
future journal where outstandings a r e proved to t h e general ledger on a daily
basis. We expect to have in operation by J u n e 1 a customer contingent liability
ledger where all future contracts a r e posted, initially by h a n d but subsequently by
machine posting.
(6) Deferred settlement accounts for controlling "spot" t r a d e s a r e to be
established, together with a related proof procedure. Implementation of t h i s
system will be p a r t of the overall final procedure to be put in operation in the
I n t e r n a t i o n a l Department. I t is hoped t h a t we will have this system in effect
by July 1.
(7) A daily report of the t r a d e r ' s position, including a gap report, will be
prepared from the accounting records maintained by the foreign exchange
operations section and will be submitted regularly to t h e division head for
review. The t r a d e r presently provides the division head with a daily position
report and regular meetings a r e held with him to discuss policy a n d m a r k e t
trends.
(8) Foreign currencies now being handled by the foreign exchange department are to be t u r n e d over to a designated foreign current teller. Systems
D e p a r t m e n t will be studying this question and when we move to the World
T r a d e Center we will request t h a t provisions be made to have foreign currency
handled at the World T r a d e Center Branch.
I feel t h a t with the help of the Auditing, General Accounting and System
D e p a r t m e n t s we have made good progress in correcting wThat can only be described
as very serious deficiencies in our foreign exchange operations.
We have met with E r n s t and E r n s t w^ho have made a number of recommendations which will be incorporated in our final foreign exchange procedure. We
plan to review t h e procedure with them, prior to full implementation, in the
event any additional controls a r e needed.
To help us develop a 'proper operational system for our London Office which
will interface with the bank's domestic operations, we have engaged P e a t Marwick
Mitchell & Co., hoth in London and New York, to assist us in t h i s project.
A s t a t u s report will be sent to you bi-weekly outlining t h e progress we a r e
making in implementing the procedures and systems t h a t wre have outlined
above.
GEORGE G. HERRMANN.
272
F R A N K L I N NATIONAL B A N K ,
May 3,1972.
T o : Harold Gleason, Chairman of the Board and Chief Executive Officer.
F r o m : George G. H e r r m a n n , I n t e r n a t i o n a l Division, Hanover Square.
Subject: Comptroller of the Currency examination a s of March 3, 1972.
As a followup to my memorandum of April 24, we a r e continuing to m a k e
excellent progress in the foreign exchange area. Additional developments a r e as
follows:
Organization
Mr. John Kruse, Assistant Vice President, w a s permanently assigned to our
division as of May 1 and, a s Assistant Operations Officer, is responsible for the
foreign exchange operations unit, the cable department, and the I n t e r n a t i o n a l
bookkeeping d e p a r t m e n t which includes t h e posting of t h e Nostro accounts.
On Monday, May 8, an experienced foreign exchange operations supervisor
joins our staff, together with an assistant foreign exchange dealer. T h e foreign
exchange operations area now seems to be working smoothly and h a s been
separated from the responsibility of the foreign exchange trader.
Foreign exchange forward
contracts
There is nothing new to 'report here since we h a d already corrected the e r r o r s
a t the time of my last report. All foreign exchange forward contracts outstanding
a s of March 3 h a v e been confirmed with copies given to the Comptroller of the
Currency examiner. All forward sales and purchase contracts a r e now in proof
a n d a r e being verified daily to the control account on the general ledger.
Nostro accounts
The National Bank E x a m i n e r s have completed their analysis of the Nostro
accounts as of examination date. A recap of their analysis is as follows:
Open items now cleared, resulting in increased income
$325. 2
Open items now cleared which have now been charged to operating
expenses covering mostly overdraft interest, telegraphic expenses,
commissions, etc
$11, 311
Open items not yet cleared which have been outstanding in excess of 60
days (we have cabled or w r i t t e n letters on all of these items and
will clear them as soon as a reply is received from our correspondents).
These items are considered as doubtful
$5, 035
General Accounting h a s now stationed in the I n t e r n a t i o n a l Division two
employees of the Financial Division to handle the reconciling and researching
of the Nostro accounts. These accounts a r e now being reconciled as soon as
statements are received and the open items checked and cleared as quickly as
possible.
Foreign exchange position limits
There is nothing further to report in this area. We a r e studying the establishment of gap limits and aggregate limits and expect to have this m a t t e r cleared
by our original target date of J u n e 15.
Systems and forms
T h e Systems Department, with the assistance of Peat Marwick Mitchell & Co.
a r e developing systems and forms as reported in my memorandum of April 24.
They a r e making excellent progress in this area and we expect t h a t the target
dates outlined in my previous memorandum can be met.
We have just concluded our profit and loss analysis for t h e period J a n u a r y 28,
1972 to April 21, 1972. Our net profit during t h a t period was $284,013.36, which
h a s been passed to earnings today. A copy of our analysis is enclosed.
F u r t h e r status reports will be sent to you bi-weekly as previously indicated.
GEORGE G.
HERRMANN.
273
F R A N K L I N NATIONAL B A N K ,
INTERNATIONAL D I V I S I O N ,
New York, N.Y., June
9,1972.
ADMINISTRATOR OF NATIONAL B A N K S ,
Office of the Comptroller of the Currency,
Washington,
D.C.
A t t : Mr. Robert A. Mullin, Director, I n t e r n a t i o n a l Division
DEAR MR. M U L L I N : As you will see from the attached memorandum of J u n e 7
addressed to Mr. Harold V. Gleason, almost all of the problems in foreign exchange have now been corrected. We have implemented new systems and procedures and the foreign exchange operation is now running very smoothly.
Copies of future progress reports t h a t a r e m a d e to Mr. Gleason will, of course,
be sent to you as requested.
Very truly yours,
GEORGE G.
HERRMANN.
J U N E 14,
1972.
Mr. GEORGE G. H E R R M A N N ,
Senor Vice President, Franklin National Bank, International
Division, New York,
N.Y.
DEAR MR. HERRMANN : This is to acknowledge your letter of J u n e 9, 1972 enclosing a progress report on the bank's international operations in New York.
I am fully satisfied with the bank's foreign exchange operations, as reported. All
segments of the operation appear to be operating efficiently and further progress
reports will not be required by this office.
Your efforts in correcting a hazardous situation a r e appreciated.
Very truly yours,
ROBERT A.
MULLIN,
Director, International
Division.
OFFICE MEMORANDUM
U.S. GOVERNMENT,
T H E COMPTROLLER OF T H E CURRENCY,
May 31,1914.
To : J a m e s E. Smith, Comptroller of the Currency.
From : Robert B. Serino, Director, Enforcement and Compliance Section.
Subject: I n t e r n a t i o n a l B a n k i n g Department, F r a n k l i n National Bank, Investigation into the Foreign Exchange T r a d i n g Department.
i. DISCOVERY
On F r i d a y , May 3, 1974, t h e F r a n k l i n Bank was .advised by t h e London Branch
t h a t the National Westminister B a n k had objected to t h e volume of F r a n k l i n
Bank's sterling clearings through their account. Apparently, they had averaged
over ,a period of the prior week between 40 to 60 million pounds sterling per day.
The Executive Vice-Chairman, Mr. P e t e r R. Shaddick, who w a s responsible for
the I n t e r n a t i o n a l D e p a r t m e n t of the bank, commenced an investigation and requested t h a t the Senior Foreign Exchange Trader, Vice President Andrew
Garofalo, determine w h a t had happened (Exhibit 1 ) . Mr. Garofalo questioned
Assistant Cashier Donald H. Emrich, the t r a d e r responsible for sterling trading.
On May 5 Emrich admitted active t r a d i n g in sterling in excess of his authorized
position and indicated t h a t he had entered into contracts which he neither booked
nor reported. Emrich w a s immediately suspended from t h e bank.
On May 11, 1974, Mr. George G. Hermann, the Senior Vice President in the
I n t e r n a t i o n a l B a n k i n g Department, together with H a r r y P. B a r r a n d , Jr., the
Executive Vice President, and others interviewed Mr. Donald H. Emrich con-
274
cerning this matter (Exhibit 2). Mr. Emrich, the bank's trader in French francs
and sterling, admitted that in the middle part of January he started to hide in
his desk drawer future contracts for the sale of French francs and sterling. He
explained this was done because he had exceeded his authorized limits. He
believed that the dolLar would increase in value and by making these contracts
he would then be able to recoup the bank's losses in these currencies (Exhibit 3).
On May 6 when Emrich was dismissed, a search was made of his desk and it
was discovered that there were 12 French franc contracts totaling Fr F. 325MM
(equivalent 64,463,692 American dollars) ,and 27 contracts in sterling totaling
85MM Lb (equivalent U.S. $132,860,575). Emrich admitted hiding otherT contracts
approximately ten other times and when the contracts matured, he w ould clear
them through the bank's books. Emrich explained that he did not want to take
the loss and felt th,at if he did not disclose his excess position, the dollar would
recover and the loss would be eliminated.
Emrich admitted that the profit or loss figures could be manipulated by using
the most favorable rates on the Profit and Loss Statement produced at the end
of each month's activity.
A review of the profit and loss sheets prepared by the Foreign Exchange
Processing Department indicates that the rates inserted by the traders for the
future contracts were inserted at figures which were most favorable to the
traders and which would reflect a profit or a minimal loss. This occurred not
only in the French francs and pound sterling profit and loss statements that
were the responsibility of Emrich, but also in several other currencies that
Emrich did not trade in. Thus, it is probable that the other traders were responsible for concealing losses. The rates inserted unquestionably were false and
Emrich clearly is culpable for inserting false rates for the purpose of concealing the losses.
Based on the concealing of contracts by Emrich and his insertion of false rates
in the profit and loss statement, there is no question that he caused false entries
to be made in the books and records of the bank and has violated 18 United States
Code § 1005. The only question left open at this time is whether or not other
traders wTere responsible for similar acts or whether or not other individuals in
the bank participated in and furthered these false reports by Emrich or any
other trader.
II. FUNCTION
OF T H E FOREIGN E X C H A N G E TRADER
The foreign exchange traders negotiate via telephone or telex with banks
and brokers all over the world for the purchase and sale of foreign currency.
When a contract is completed by a trader, he is responsible for filling out a
prenumbered sequential form with the terms of the contract, the foreign amount
and the rate at which the purchase or sale was made (Exhibit 4). He then passes
the contract, which is in a triplicate form, to the Position Clerk, Mr. Fakhry
Ilanna. Hanna then posts the contract on a daily activity sheet which he prepares for each currency traded (Exhibit 5). (If a contract is not delivered to
Hanna, he would not have any record of its being made, thus if a trader completed a contract and failed to deliver it to Hanna, there would be no record in
the bank that a contract existed). After Hanna posts the contract on the daily
activity sheet, he delivers the contract to the Foreign Exchange Processing Department, which is physically located outside of the trading room. The Processing
Department then completes the contract by inserting the U.S. dollar equivalent,
and the payment instructions and returns a copy to the trading room. The
Processing Department then prepares a multi-copy form, a portion of which is a
confirmation ticket to be sent to the counterparty (Exhibit 6). (The Processing
Department also checks out any confirmations that come into the bank from
counterparties and verifies any contracts that were made). Copies of the multicopy confirmation form are also used for posting daily entries to the bank's
general ledger.
On the last Friday of each month the Processing Department prepares a profit
and loss report for each currency which lists all future contracts by their maturity dates (Exhibit 7).
The purpose of the P & L Sheet is to reevaluate the forward position of the
bank at the end of each month. After filling these sheets, they are delivered to
the traders in each particular currency. The traders are to insert the present
rate for each period of time. The present rate is the rate as established in the
275
market on the date the P & L Sheet is prepared. Such figures are published in
the Wall Street Journal daily and they also come into the bank via telex (Exhibit 8). The rate for the particular date is that established by the market
for the future and is not the rate on the contract. The reason for using the
market rate is to reevaluate the bank's position as of the P & L date. Rather
than using market rates, certain traders inserted rates which were most favorable to them and which would indicate either a minimal loss or a profit. The
traders would either insert the rates on the P & L sheet or would insert them
on a separate sheet of paper which would be given to the Processing Department. The Processing Department personnel who were interviewed (Arthur
Slutzky and Allan Goudey) indicated that they did not check the rates inserted
by the traders. The processing people stated that this was the function of the
Audit Department. They testified that they would have no knowledge as to the
rates. This is incredible to believe as the processing people handle the contracts
daily and the P & L Sheets which will be discussed later. The Processing people
knew that the rates could in no way be as low as listed. For example, on the
sterling sheet prepared by Emrich on April 26, 1974, the contracts coming due for
the period April 26-30 have rates listed as 2.09 whereas the spot rate as listed
on the bottom of the sheet was 2.43 (Spot rates are contracts maturing in two
or three days.)
After the P & L Sheets were prepared and the figures were sent to the ledger
as to the profit and loss of the exchange account, the sheets would be sent to the
auditors who supposedly were to recapitulate the calculations and to independently obtain the rates. The head auditor, Robert Panapinto, indicated that he
did not check the rates at an outside source and that whatever rate the trader set
was the rate that was used. The auditor, Panapinto, stated that after the P & L
Sheets were prepared, they could be sent to the Auditing Department. The Auditing Department would prepare its own P & L Sheets from the audit copies of the
contracts and was supposed to check the rates from an independent source (i.e.,
N.Y. Times, Wall Street Journal or another bank). Any significant variations
were to be called to the attention of the trader for an explanation. Panapinto
indicated that on two or three occasions he questioned a trader about rates and
on each occasion the trader told him not to worry about it.
Amin I. Amin was the Assistant Auditor and indicates that he questioned the
rates on the March 28, 1974 P & L Sheet and was told by Panapinto and others
not to worry about them.
I I I . F O R M S UTILIZED I N
T H E FOREIGN E X C H A N G E
DEPARTMENT
Various forms are filled out by the Trading Department clerk, Hanna, which
show the contract made in each currency and the position of each trader. These
are sent to various people in the bank. If a contract is entered into but is
not written up and given to Hanna, the books of the bank will be false.
1. Contract (Exhibit 4)—prepared on a preprinted, prenumbered triplicate
form. Prepared by the trader and given to Hanna with the rate, amount, maturity
date. This is logged in by Hanna and sent to the Processing Department.
2. Daily Activity Sheet (Exhibit 5)—This is a sheet maintained by Hanna
reflecting the contracts and the details. It shows the running position and the
position at the end of the day for each currency.
3. Confirmation Contract (Exhibit 6)—Prepared by the Processing Department with copies being sent to the counterparty for confirmation.
4. Nostro Balance Control Sheet—This is kept by Hanna to indicate the future
balance maintained by Franklin with other banks (Exhibit 9).
5. Interoffice Letter of Overdraft—This is prepared by Hanna and indicates
whether there is an ovedraft in any of the bank's Nostro accounts. It is sent to
various people (Exhibit 10).
6. Net Position Sheet—This is prepared by Hanna and indicates for each day
the Net Position in each currency. It is given each day to each trader so that they
will know their position (Exhibit 11).
7. Dealer's Operation Overall Position Sheet—This is prepared by Hanna
and indicates the overall position of each currency. This was sent to Messrs.
Peter Shaddick, iVndy Garofalo and George Herrmann (Exhibit 12).
8. Profit and Loss Statement—This is prepared each month by the operation's
personnel to reevaluate the future contract position and determine the profit and
276
loss (Exhibit 7 ) . T h e t r a d e r s fill out the rates. T h e profit or loss results a r e posted
to the bank's books.
9. F u t u r e Diary—Kept by H a n n a and indicates for each currency which cont r a c t s come due during the week (Exhibit 13).
IV. H I D D E N CONTRACTS
W h e n foreign exchange t r a d e r Donald H. Emrich (Sterling and French franc
t r a d e r ) w a s terminated on May 6, 1974, he admitted t h a t he h a d not booked in
in t h e bank's records many contracts t h a t he had entered into. The reason for this
was t h a t he was trying to recoup his losses and did not w a n t to disclose t h a t he
h a d overtraded (been longer or shorter t h a n a u t h o r i z e d ) . By not booking the contracts, t h e records of the bank were falsified a s they did not reflect the t r u e
obligation of the bank. Emrich's desk was searched by Garofalo when he was terminated and 39 unbooked contracts were located. Emrich admitted ten other
instances where he h a d unbooked contracts which he would run through the
bank's books as "spot" contracts when they matured.
Attached hereto is a list of the 39 contracts located in Emrich's desk which
document from December 1973 through May 2, 1974, contracts which were not
entered in the bank's records (Exhibit 14). T h e amount of the contracts a r e 325
million French francs (64,463,692 U.S. dollars) and 85,387,376 pound sterling
(132,086,575 U.S. d o l l a r s ) .
By t h e failure to enter these contracts in the books and records of the bank,
Emrich on each "date of t r a d e " caused the ledger of the bank to be false.
a. Violation of law.—For each unbooked contract, this constitutes a violation of
18 U.S.C. 1005. A false entry made to deceive t h e bank's officers and the Office of
t h e Comptroller of the Currency. The false entry would be the false position
of t h e bank for t h a t day.
b. Further investigation necessary.— (1) When a contract was made by F r a n k lin, the Processing Department would prepare confirmation tickets to be sent
to t h e counter party. The counter p a r t y would sign and receipt on t h e confirmation. Likewise t h e counter p a r t y would send to F r a n k l i n their own confirmation
ticket which was to be receipted for by F r a n k l i n and returned. T h e Processing
D e p a r t m e n t w a s responsible for checking these incoming confirmations. The
counter parties' records a r e being reviewed to determine w h e t h e r they had
received their own confirmation back and who signed the confirmation.
A request has been made for each of the 39 contracts to see who in the Processing D e p a r t m e n t had receipted for the contract. A r t h u r Slutzky h a s testified t h a t
he would check the confirmations with the t r a d e r and if the t r a d e r said it was
o.k., Slutzky would send it back to the counter party.
This is incredible to believe and if it can be established t h a t Slutzky signed
counter p a r t y confirmation tickets when there was no contract, he could be a defendant bcause of his actions to conceal the fact t h a t there were unbooked
contracts.
V. UNBOOKED R E C E N T L Y
CONFIRMED
CONTRACTS
After May 10, 1974, the bank w a s notified by counter parties t h a t thirteen (13)
other contracts were entered into by the bank (Exhibit 15). These contracts were
entered into by the bank, however, no contract was recorded. T h e contracts
were in Swiss francs, Dutch gilder, and pound sterling, with t h e earliest t r a d e
date being December 19, 1973, and the latest being March 29, 1974. Emrich would
be responsible for the four contracts in pound sterling. Martin Keroes would be
responsible for the two contracts in Dutch gilders. I t is believed t h a t the head
t r a d e r , Andrew Garofalo would be responsible for t h e seven contracts in Swiss
francs. Martin Keroes h a s testified t h a t it was a mere oversight t h a t he failed
to fill out the two contracts in Dutch gilders. The counter p a r t y confirmation
tickets should be reviewed to determine whether the contracts were acknowledged.
Garofalo h a s yet to testify.
<a. If it can be shown t h a t these t r a d e r s intentionally failed to book these contracts, it would be a violation of 18 U.S.C. 1005. We have no evidence a t t h e
present time t h a t it was intentional.
lb. (1) F u r t h e r investigation—same a s (b) under hidden contracts (i.e., check
counter parties confirmation t i c k e t s ) .
(2) F u r t h e r investigation: Of the 39 unbooked contracts, several were made
with F r a n k l i n National Bank's London Office. A review will be u n d e r t a k e n to
determine whether these contracts a r e properly booked in London a n d whether
confirmations were forwarded to F r a n k l i n New York.
277
On May 30, 1974, London National B a n k E x a m i n e r Kohler indicated t h a t the
London ofiice of F r a n k l i n holds confirmations on all contracts between F r a n k l i n
New York and F r a n k l i n London. These would include confirmations sent by New
York and confirmations originating in London, sent to New York, signed in New
York, and returned to London. Mr. Kohler h a s taken copies of these confirmations
and will forward them to the Comptroller's Ofiice. Since these confirmations
will include contracts hidden by the bank's former trader, Donald H. Emrich,
from December 1973 through May 6, 1974, we may now be able to ask certain in*
dividuals in New York how they could sign confirmations for contracts which
were hidden in the t r a d e r ' s desk and not on the books of t h e bank.
Mr. Kohler will also forward copies of the bank's P & L Sheets and the names
and addresses of people in New York to whom they were forwarded.
A. Sample Unbooked
Contract
1. On May 15, 1974, the B a n k of America, Amsterdam, by telex, contacted
the F r a n k l i n National Bank ( T r a d e r Martin Keroes) to find out where their 10
million gilders were t h a t were sold by F r a n k l i n National B a n k on F e b r u a r y 13,
1974 (Exhibit 16). The bank reviewed the telex for F e b r u a r y and found t h a t
a contract h a d been entered (Exhibit 1 6 - a ) . The bank searched its files and
could not find a w r i t t e n contract. The bank, therefore, filled in a contract (Exhibit 1 6 - b ) , sent a confirmation (Exhibit 16-c) and sent a telex confirming the
delivery.
I t is t h u s a p p a r e n t t h a t a contract h a d heen entered into, however, no record
was made hy Keroes. Keroes has testified t h a t he j u s t forgot.
2. On May 15, 1974, the Continental B a n k I n t e r n a t i o n a l notified F r a n k l i n
National Bank t h a t F r a n k l i n National Bank had not confirmed a sale to Continental entered on March 11, 1974 for Swiss francs in the a m o u n t of 6,000,000 to
be delivered on J u n e 13, 1974 (Exhibit 17).
3. On May 13, 1974, the Irving T r u s t Company notified F r a n k l i n National Bank
t h a t they had not received a confirmation for a sale by F r a n k l i n National B a n k
on F e b r u a r y 13, 1974 of Dutch Gilders in the amount of 5MM for delivery J u n e
17, 1974 (Exhibit 18).
T h e r e were several other confirmations from bankers indicating t h a t they h a d
entered into contracts with F r a n k l i n National B a n k and h a d not received confirmations or delivery. T h e auditors of the bank should have a complete list
with the documents.
VI. F A L S E N E T P O S I T I O N
SHEETS
At the close of business each day, the position clerk, F a k h r y H a n n a , was to prep a r e a sheet captioned "Overall Position for Major Foreign Currency" (Exhibit
12). This sheet would be submitted to Mr. George H e r r m a n n and Mr. Peter Shaddick. The figures on this sheet showed for each currency w h a t the net position
(short or long) was for each currency.
On May 29, 1974, H a n n a admitted to Mr. J o h n Kirby of the law firm of Mudge,
Rose (representing the bank in its insurance claim) t h a t he was directed by
Garofalo (head t r a d e r ) and Emrich to submit false position sheets to H e r r m a n n
and Shaddick. H a n n a originally refused and Emrich a n d Garofalo submitted the
false sheets. H a n n a then did it when he was told he would be fired.
The law firm h a s obtained 44 position sheets filed from F e b r u a r y 19, 1974
through May 10, 1974 (58 t r a d i n g days) with Mr. H e r r m a n n and when compared
with the daily activity sheet maintained by H a n n a (Exhibit 2 ) , there is no question but t h a t the position sheets submitted were false.
Thus, there is no question a s to the culpability of H a n n a , Emrich and Garofalo
and the only question is whether others were involved. I t looks like they were
trying to hide from H e r r m a n n and Shaddick the fact t h a t they h a d exceeded their
positions.
Garofalo on May 30, 1974, admitted t h a t he directed H a n n a to file false position sheets to H e r r m a n n and Shaddick. He indicated t h a t the false sheets were
filed in Swiss francs, D e u t c h m a r k s and I t a l i a n lira. This would indicate t h a t
the t r a d e r s dealing in these currencies were a w a r e of the concealment of
positions.
Shaddick cannot be completely ruled out as he w a s in almost daily telephone
contact with Garofalo according to Shaddick's testimony. Likewise Shaddick has,
according to his testimony, been in contact a t least on two occasions with Garofalo since he was fired.
278
V I I . PROFIT AND LOSS REVALUATION
T h e bank a s close to the last day of the month prepares profit and loss sheets
for each currency (Exhibit 7 ) .
This is prepared by the Foreign Exchange Processing D e p a r t m e n t ( A r t h u r
Slutzky or Allan Goudey). They list on columnar paper ail t h e future contracts
t h a t will m a t u r e in ten day periods. This is prepared from the Processing Dep a r t m e n t ' s copies of the contracts made by F r a n k l i n National Bank. For each
period they net out the contracts and determine whether the bank is in a long
or short position. As shown on the attached P & L Sheets (Exhibit 7 ) , the first
column sets forth the period; column number 1 and number 2 sets forth the
the purchases in both foreign and U.S. currency; column number 3 and number 4
sets forth the sales in foreign and U.S. currency. Columns number 5-8 set forth
whether the bank is long or short.
After this portion of the P & L Sheet is prepared, it will be given by the Processing D e p a r t m e n t to t h e t r a d e r who deals in the p a r t i c u l a r currency. The trader
is supposed to ascertain from the m a r k e t or from the newspaper the present r a t e
for the contracts m a t u r i n g in the future periods. The t r a d e r s would either insert
t h e r a t e directly on the P & L Sheet or would write them out on a separate piece
of paper. By multiplying the r a t e times the value, they determine the m a r k e t
value (column number 11) by subtracting the m a r k e t value from the U.S. dollar
value from column number 6 or number 8 the profit or loss is determined for each
period. The P & L sheets also have a r a t e inserted at the bottom for spot cont r a c t s (contracts m a t u r i n g in 2 or 3 d a y s ) .
After the t r a d e r inserts the rates and determines the profit or loss the sheet
is then sent to the Processing Department which sends the figures of profit or
loss to the general ledger of the bank.
T h e sheets a r e then sent to the I n t e r n a l Auditing Department. The I n t e r n a l
Auditing Department was supposed to prepare their own P & L Sheet from their
copies of the contracts and w a s supposed to independently ascertain the rates.
There is much confusion in the Auditing Department a s to w h a t they did or were
supposed to do.
After Donald F . Emrich was terminated by the bank, he indicated t h a t he had
inserted false r a t e s on the P & L Sheets to conceal his losses. A review h a s been
made of the P & L Sheets for March 28, 1974 and April 26, 1974 and i t h a s been
determined t h a t many of the P & L Sheets prepared by the t r a d e r s bore false
rates. A high r a t e shown when the bank was short (net sold position) would
p u t the bank in a better position and a low r a t e when the bank was long (net
purchase position) would p u t the bank in a better position.
1. Donald F. Emrich, P & L Sheets March 28, 1974—a. British pound sterling
(exhibit 19a) P & L Sheet
As well as this sheet failing to list the hidden contracts, Emrich inserted a
false r a t e of 2.10 for the period March 29-31, 1974, and a spot r a t e of 2.3950. The
2.16 r a t e was used for all of the periods on the sheet and caused the transactions
to reflect a future profit of +4,982,319. When this was combined with the future
reversals, spot reversal and Nostro profit it reflected a loss of —626,833.
Outside auditors have recently reevaluated the position with the correct rates
as of March 28, 1974, including the hidden contracts and have determined t h a t as
of March 28, 1974, the total future loss should have been —5,163,507 as opposed
to the profit (+4,982,319) reflected by Emrich (Exhibit 1 9 a - l ) , a total loss of
—10,772,660 r a t h e r t h a n —626,833. As can be seen, the rates on the auditing firm's
reevaluation are no where near the 2.16 put on the Emrich sheet.
There a r e b l a t a n t problems with the Emrich sheet t h a t should have been detected by the head trader, Garofalo, (Garofalo has testified t h a t he did not
review these sheets although this was his responsibility), the Processing Department, A r t h u r Slutzky or Allen Goudey (Slutzky testified t h a t it was not his
job to check the rates—this is an incredible statement—Goudey testified t h a t
if he h a d seen the sheet he would have checked i t ) , or the internal auditors
Robert Panepinto—or Amin Amin.
Robert Panepinto indicated t h a t on occasions he would question the t r a d e r s
as to the rates but t h a t this sheet was Amin Amin's job and Amin Amin did not
bring it to his attention.
Amin Amin said he worked for Panepinto and t h a t if he questioned an entry,
he would speak to Panepinto who was to check with the traders. Amin said he
279
brought it to t h e attention of Panepinto as the spot r a t e was 2.35 even though
the March 28 r a t e was 2.16. Amin said t h a t Panepinto said t h a t he checked and
the r a t e was correct. Amin also testified t h a t he approached Emrich as he was
not satisfied. Emrich referred him to Slutzky who said it was alright. Amin
believes t h a t Panepinto told Peter Shaddick about the rate. Both Panepinto and
Shaddick deny this. Amin Amin's testimony raises substantial questions about
this revaluation.
The b l a t a n t problems on the sheet are :
(1) Only one r a t e of 2.16 was inserted a t the top of the sheet. (Amin
Amin believes he saw a P & L Sheet with 2.16 filled in t h r o u g h o u t ) .
(2) The spot r a t e was 2.3950 whereas the March 29-31 r a t e was 2.16.
(3) The statements of Amin Amin should be reviewed and the events
and individuals who could corroborate his story should be questioned.
2. Donald F. Emrich, P & L Sheet March 28, 1974—b. French F r a n c s
Emrich's sheet fails to reflect the hidden contracts on this sheet, however, the
rates appear to be relatively accurate (Exhibit 19b ; Exhibit 1 9 b - l ) .
3. Donald F. Emrich P & L Sheet April 26, 1974 (Exhibit 20a)—a. British pound
sterling
Emrich's P & L Sheet failed to list the hidden contracts. He likewise used
false rates to conceal his losses. For the period 4/26-4/30 he used a r a t e of 2.09
and reflected spot rates as 2.43. This is impossible and must have been seen by
someone.
By using the phoney rates, Emrich reflected a future profit of $7,108,319 with
a total position of a loss of only —527,238. When this was redone by the external auditors on 5/10/74, they reflected a loss of —18,437,278. The April rates
should have been for spot 2.41 and one month 2.40, two month 2.39, three month
2.38, six month 2.34, one year 2.28. None of these rates a r e similar to those used
by Emrich which ranged from a high of 2.10 to a low of 2.03. The external
auditors have prepared an overlay to show the true rates.
The auditor, Amin Amin, h a s testified t h a t on the April 26,1974 reevaluation, he
w a s instructed by Garofalo to prepare a P & L Sheet from his contracts and then
give it to the t r a d e r s for the insertion of the rate. This was different from the
normal procedure in which Amin would receive a completed P & L Sheet. While
he was preparing the sheet, A r t h u r Slutzky came and took the position sheets
from him. Amin testified t h a t he never again audited this P & L Sheet. Emrich's
P & L Sheets are substantially false.
4. Donald F . Emrich P & L Sheet French F r a n c April 26, 1974 (Exhibit 20b)
The P & L Sheet prepared by Emrich fails to list t h e hidden French F r a n c
contract. Likewise, the r a t e s used were false. T h e sheet indicates t h a t t h e loans
m a t u r i n g on April 29-30 were a t a r a t e of .220 whereas the spot r a t e was indicated as .200. Using the rates given by Emrich, he came up with a profit of
T h e external auditors did a reevaluation using t h e correct r a t e s and determined t h a t
.
5. Martin Keroes P & L Sheet Deutsche Marks (April 26, 1974) (Exhibit 21a)
M a r t i n Keroes was the t r a d e r in Deutsche Marks and prepared the rates to be
inserted in the P&L Sheets for t h a t currency. The rates he used indicated t h a t he
had a future profit of 11,252,122 with a total profit of $10,111.
He reflected a spot r a t e on the P & L Sheet of 378 which gave him a spot profit
of 181,900 whereas if he used the t r u e spot r a t e (he obtained these r a t e s after
testifying on 5/20/7^ (Exhibit 2 1 a - l ) for April 26, 1974 he would have used a
spot r a t e of 4065. If he had used this rate, he would have reflected a spot loss of
-49,000.
Likewise after utilizing the correct rates, the a u d i t o r s came up with a total
figure in Deutsch Marks of a loss of —4,139,399 r a t h e r t h a n a profit of 10,111.
Keroes testified he could not understand how he used the false r a t e . (This is an
incredible statement.)
280
6. Martin A. Keroes P & L Sheet Dutch Guilders, April 26, 1974 (Exhibit 22a)
Keroes' P & L Sheet of April 26, 1974 failed to reflect t h e two contracts t h a t
were made by Keroes a n d not booked. (Both made on 2/13/74 with m a t u r i t y of
5/15/74 and 6/17/74) (See Exhibit 15). Keroes h a s testified t h a t he j u s t forgot to
fill out a contract form. The telex reflects t h a t Keroes in fact h a d entered into a
contract.
Keroes figures a r e false for this sheet and he reflected therefore a loss of only
—91,105 whereas when this sheet w a s redone, the loss w a s —$1,813,875.
7. Andrew Garofalo P & L Sheet Swiss Francs—April 26, 1974 (Exhibit 23a)
Seven contracts m a d e by Garofalo were found to have not been booked and
therefore were not reflected on t h e P & L statement.
The r a t e s he utilized are substantially false. I t is noted t h a t his April 25-30
r a t e was reflected as .310 with his spot being .340. The spot r a t e a t t h a t time was
.337. By using the spot r a t e of .337, he would have reflected a spot loss of
—16,146 r a t h e r t h a n a spot profit of +23.041. Garofalo reflected a loss of
—227,129 whereas the a u d i t o r s have reevaluated the position a n d have determined the loss to be —7,548,443.
I n evaluating the r a t e s put on the P & L Sheets by the t r a d e r s and those used
by the auditing firm the profit and loss is as follows as of April 26, 1974.
Traders
Swiss francs
French francs
Pounds sterling
Dutch gilders
Lire
Belgian francs
Dutch marks
Canadian dollars
Yen
Auditing firm
same P&L
Auditing firm
with total
contracts
-227,129
+224,536
-527,236
-91,015
+130,781
-117,430
+10, 111
-46,619
- 7 , 548, 443
-6,774,950
-18,437,278
-1,613,075
-1,558,857
+18,635
+195,707
-46,905
The external auditors have prepared a reevaluation of all the P & L Sheets
in each currency for March 28 and April 26, 1974. When these a r e compared with
t h e sheets of the t r a d e r s , they will indicate which of the other t r a d e r s submitted
false rates.
Attached hereto are interviews taken by this Office or by Mr. J o h n Kirby of
the law firm of Mudge Rose, Guthrie and Alexander. All interviews taken by t h e
Comptroller's Office were taken after the witness was advised of his constitutional
rights and the penalties for false statements 18 IJ.S.C. 1001. The interviews taken
by the Comptroller's Office were t a k e n by Deputy Comptroller of t h e Currency
Robert Mullin and Director of Enforcement and Compliance, Robert B. Serino,
except t h a t of Mr. Shaddick which was taken by Messrs. Serino and National
B a n k E x a m i n e r Malay.
Attachment.
VIII. SUSPECTS AND/OR WITNESSES
Donald F . E m r i c h : T r a d e r — a d m i t t e d false rates and bidding contracts.
Andrew Garofalo : Head t r a d e r — a d m i t t e d filing false position sheets.
F a k h r y H a n n a : Position clerk—admitted submitting false position sheets.
Robert P a n e p i n t o : Audit supervisor—denies knowledge of false rates—but see
Amin testimony. P e r h a p s Emrich, Garofalo or H a n n a would confirm t h a t he was
a w a r e of the false rates.
Amin Amin : Audit clerk—indicates t h a t he tried to h a v e t h e r a t e s checked.
Martin K e r o e s : Trader—denies inserting false rates—denies t h a t he intentionally failed to enter contracts.
P a u l S a b a t e l l a : Trader.
Michael Romersa : Trader—Garofalo has testified t h a t he submitted false position reports in Romersa's currency—lira.
A r t h u r S l u t z k y : Processing department—handling of P & L's and incoming
and outgoing confirmations. See Amin Amin Testimony.
Allan Goudey: Processing department—handling of P & L's and incoming and
outgoing confirmations. See Amin Amin testimony.
281
Peter Shaddick: Head of International Department. No evidence at this time
that he was aware of the false rates or false position. Garofalo and Panepinto
could give information in this area.
George G. Herrmann: Senior Vice President—He received the false positions
reports but there is no present evidence that he was aware.
Harry P. Barrand, Jr.: Executive Vice President.
Jay Saporta : Position clerk in Trading Room. He has not been questioned.
He might be able to confim Hanna's testimony.
Vincent Franzitta: Proof clerk Foreign Exchange processing department.
Thomas De Feis : Clerk foreign exchange processing department.
282
I. Franklin National Bank - November, 1973 - October 8, 1974
On November 14, 1973, our Office began a regular examination of
Franklin.
This examination, which was not to conclude until March
8, 1974, disclosed that Franklin had serious financial problems.
These problems included a low-yielding loan portfolio, depreciation
in the muncipal and investment portfolios, heavy reliance by the bank
on short term borrowed funds (so-called hot money) and the bank's
poor management.
Uncollectable loans totalled $10 million.
The
operating income of the bank was poor, which, being public information, affected public confidence in the bank.
Total resources of the bank had grown to $4,852,999,972, or
29% higher than the previous December 8, 1972 examination.
The
capital, however, had increased by less than one half of one per
cent; demand and savings deposits actually had declined 5.5%.
The
bank's recent growth had been financed almost entirely by using
short term borrowed funds, including time deposits of other banks and
money market certificates of deposit.
These types of funds totaled
$2.3 billion, or 50% of the bank's liabilities.
They had increased
dramatically by $984 million, or 76%, since the last examination.
Such borrowed funds are volatile and likely to disappear quickly if
creditors have reason to question a bank's stability or soundness.
I instructed Regional Administrator Van Horn by letter of
February 22, 1974, to meet with the senior management of Franklin in
order to formulate a plan with the bank for remedial action in such
areas as reduction in all forms of borrowings, standards of new loan
extensions and adjustment of the imbalance between the bank's capital
and the size of its operations.
Mr. Van Horn met with the senior
officers of Franklin on February 28, 1974, and with the Board of
Directors on March 28, 1974.
The bank agreed to reduce its borrowings
283
by $500 million through liquidating $260 million carried in its
bond trading account, selling $100 million of loans to another bank,
reducing new loan commitments, increasing compensating deposits
maintained at the bank by borrowers.
On April 18, 1974, Franklin New York Corporation (FNYC) announced
net operating income for the first quarter of two cents per share
or $79,000, down from the previous year of sixty-eight cents per share
or $3,123 million.
The holding company release stated that income
was "adversely affected by the sharp rise in the cost of short-term
borrowings needed to carry assets during the 1974 quarter."
On May 1, 1974, the Federal Reserve Board announced its denial
of the holding company's application to acquire Talcott National
Corporation, a business financing and factoring firm.
for this acquisition on August 13, 1973.
FNYC had applied
The Board decided that "this
proposal may constitute an undue drain on Applicant's managerial and
financial resources."
On May 10, 1974, the Comptroller's Office and the Federal Reserve
Board learned from Franklin that heavy losses in an undetermined amount
had occurred in the bank's foreign exchange department.
ment decided to announce these losses.
Bank manage-
It was clear that an announcement
of this kind would dry up the bank's sources of borrowed funds, thereby
creating a severe liquidity crisis.
In anticipation, the bank sought
from the Federal Reserve Bank of New York a huge loan to cover this
expected run-off.
On May 10, 1974, management announced that, in light of the small
profit for the first quarter of 1974 and management's estimate for
the second quarter, it would recommend that Franklin's Board of Directors
not declare the regular dividend on Franklin's common stock and
convertible preferred stock.
284
We advised the FDIC of these events.
Taken together, the bank's April 18 release, the May 1 Talcott
turndown, and the May 10 release caused large scale institutional
withdrawals and forced the bank to the Fed discount window to obtain
the liquidity funds it needed.
At this time, management of the bank and representatives of this
Office began exploring merger possibilities.
The only possible,
immediate merger partner showing serious interest was ManufacturersHanover Trust Company of New York.
Manufacturers-Hanover in April, 1974
had loaned FNYC $30 million on a long term basis.
After intensive
discussions with the officers of Franklin, the management of ManufacturersHanover determined on May 12 that an immediate merger was not feasible.
On Friday and Saturday, May 10 and May 11, 1974, an internal review
of the foreign exchange department was taking place and by Saturday
evening, May 11, 1974, a relatively large loss was estimated.
On
Sunday, May 12, 1974, Franklin issued a press release, wh:ch stated
in part:
The bank also reported that its foreign currency exchange
department has realized losses since March 31, 1974, of
approximately $2 million. In addition, it has recently
been discovered that because of a trader in that department
operating beyond his authority and without the bank's knowledge, it will have sustained losses, as of May 13, 1974,
of $12 million, and has potential losses of $25 million
at May 10, 1974 rates.
The bank also noted that earlier in the day on May 12, 1974
Vice-chairman Mitchell of the Federal Reserve Board, after having
been assured by our Office that Franklin was solvent, advised in a
press release that "as with all member banks, the Federal Reserve System
stands prepared to advance funds to this bank as needed."
FNYC asked
the Securities and Exchange Commission to suspend trading in its
securities.
The SEC did suspend trading and conducted an investigation
285
into the accuracy of FNYC financial statements.
Ultimately a lawsuit
was instituted by the SEC.
On May 13, 1974, at a special meeting of the bank's Board of
Directors, the President of the bank and the head of its foreign exchange
department were fired.
These events further eroded confidence in the
bank so that by close of business on Wednesday, May 15, 1974, the
bank's loan at the Federal Reserve window reached $780 million.
Much of the public attention at that time was focused on Michele
Sindona, an Italian lawyer and resident of Switzerland, who had purchased
through his holding company, Fasco, 1,000,000 shares of FNYC in July, 1972.
This stock constituted 21.6% of the outstanding shares of the common
stock of FNYC.
Mr. Sindona became a director of FNYC in August 1972.
In view of the public concern over Mr. Sindona's association with
the holding company, Mr. Sindona agreed that he would relinquish for
one year his rights to vote the FNYC stock held by Fasco and give the
sole voting rights to former Treasury Secretary David Kennedy.
This
was completely agreeable to me and an announcement to this effect
was made by Franklin in a press release dated May 12, 1974.
Franklin
also announced plans to raise additional capital of $50 million, as
well as several major management changes to be put into effect at the
bank's Board meeting the next day.
On Monday, May 13, the bank accepted
the resignations of Paul Luftig, the President and Chief Executive Officer
of the bank and Peter Shaddick, Vice Chairman of Franklin in charge
of its international department.
On Tuesday, May 14, 1974, a new examination of the bank was
commenced in order to update the value of its loans, its securities
and foreign exchange position.
The May 14 examinations showed large
foreign exchange losses, accelerated depreciation in securities and a
general lack of improvement in the bank's condition since November 1973.
74-548 O - 76 - 19
286
On May 13, 1974, I requested the member banks of the New York
Clearing House Association to explore Franklin's affairs.
The purpose
of this review was threefold:
1) To advise me and my staff as to how other bankers would
view the condition of Franklin National Bank;
2) To establish a foundation upon which the Clearing House
Association members might act to help with Franklin's
liquidity problems; and
3) To provide information to members of the Clearing House
who might be interested in acquiring Franklin National Bank.
In this regard, it was agreed that any information received
through this processing by members of the Clearing House also
would be made available to any non-Clearing House member
interested in acquiring Franklin National Bank.
On June 11, 1974, with the encouragement of the Federal Reserve
System, an arrangement was reached whereby members of the Clearing
House individually would loan Federal funds to Franklin in an amount
which aggregated $225 million.
Meanwhile, efforts had been made to attract stronger management.
With my assistance, Mr. Edwin Reichers was brought into Franklin on
May 17, 1974, as an Executive Vice President in charge of Franklin's
foreign exchange operations.
He had for 40 years been with First
National City Bank of New York, and headed that bank's foreign exchange
operations.
A long search for a new head of Franklin culminated on June 21,
when Joseph W. Barr was brought into Franklin as its Chief Executive
Officer.
287
Mr. Barr, who is well known to many members of this Committee
as a former colleague in the House, had a distinguished background
in the fields of government and finance, having served as Chairman
of the FDIC, Under Secretary and Secretary of the Treasury Department,
and as the Chairman and Chief Executive Officer of American Security
and Trust Company of Washington, D.C.
He was well and favorably
known by foreign financial institutions, and a man with whom I was
confident we could work effectively under most demanding conditions.
My confidence in him was fully justified by his performance.
Without
him and the qualities of integrity, courage, and decisiveness which
he brought to bear on the myriad of problems, I frankly doubt that
the successful result on behalf of Franklin's depositors could have
been achieved.
On July 2, I wrote the FDIC requesting it contact other banking
organizations which were potential purchasers of some or all of the
business assets of Franklin National Bank.
The FDIC developed a
plan to assist a prospective purchaser to assume liabilities and
purchase assets of Franklin and began negotiations with interested
bankers to draft a set of acquisition papers upon which banks could
bid competitively in the event the FDIC became the receiver.
In an effort to alleviate further liquidity problems, I
requested a meeting of representatives of 17 large U.S. banks to
discuss selling Franklin's portfolio of Euro-currency loans.
meeting took place in Chicago on July 22.
were offered for sale.
The
Some $300 million of loans
This proved to be an unsuccessful effort,
however, because of the interest rates on these credits in comparison
with the then prevailing high interest rates, and because of the liquidity
problems of all large banks at that time.
288
In September, Mr. Barr presented the regulatory agencies a
plan by which, with substantial assistance from the FDIC, Franklin
would retrench, give up most of its national and international
business, and become a Long Island bank.
I requested the investment
banking firm of Blyth Eastman Dillon & Co. to advise us concerning
Mr. Barr's proposal.
On October 3, the firm advised that the prospects
of Franklin's achieving financial viability as an independent banking
institution were bleak.
Mr. Barr also suggested that in the event a takeover of Franklin
became necessary, it would be beneficial to the interests of the
shareholders and to the competitive situation to widen as much as
possible the list of potential purchasers.
The greatest obstacle to
this was the legal situation which limited the list of potential
U.S. buyers to New York State-chartered institutions and national
banks located in New York.
Mr. Barr requested that, not only for this
case, but also for the future, Congress should act quickly on
legislation which would permit the purchase and operation of banks
across state lines where necessary to prevent the probable failure
of a large institution.
Time did not permit the adoption of such
legislation before the end came for Franklin, but I hope that the
Congress will soon provide for such a situation.
As a result of continuing negative publicity, continuing
deposit decline, and management's continued inability to reduce the
loan portfolio, on September 30, Franklin's total borrowings from
the Federal Reserve Bank of New York exceeded $1.7 billion.
By the
end of September, total deposits were rapidly declining to the $1
billion mark and total other liabilities, principally borrowings,
were rising to nearly $2 billion.
The bank was unable to retain
large maturing certificates of deposits or other maturing money market
liabilities.
289
Based on all facts available, including Mr. Barr's proposal
which conceded that the bank could not survive without massive
government assistance, the Blyth Eastman Dillon report, and the
negative reports by the New York Clearing House banks, I concluded
that Franklin did not appear to be a viable institution.
On October 4, I wrote to the Federal Reserve bank, briefly
reviewing the situation, and asking for the Federal Reserve Bank's
views with respect to its continued willingness to lend funds to
Franklin.
On October 7, the Federal Reserve Bank replied, stating
that its emergency credit assistance to Franklin was based on public
policy considerations arising from the responsibility of the Federal
Reserve System as a lender of last resort and was designed to give
Franklin and the concerned Federal bank regulatory agencies a sufficient
period to work out a permanent solution to the bank's difficulties.
The Federal Reserve Bank also had concluded that the Franklin proposal
of September 16, to the FDIC did not offer a feasible means of achieving
the continuation of Franklin as an independent, viable bank.
The
Federal Reserve Bank advised that it would not be in the public interest
for that bank to continue its program of credit assistance to Franklin.
It was no longer in the best interest either of Franklin's
depositors and other creditors or of its shareholders to wait for further
deterioration in the bank's condition, especially when the alternative
of the FDIC-assisted purchase of the bank at a price including a
substantial premium for a going concern, became available.
By October
8, Franklin was no longer the 20th largest bank in the country but
had become about the 46th largest bank.
Of the 65 banks in its size
cateogry ($1 to $5 billion in deposits) Franklin had ranked 65th in
earning power.
This lack of ability to generate earnings, combined
with heavy reliance on purchased money, finally created a set of
290
circumstances which the bank could not bear.
On October 8, having
become satisfied that Franklin National Bank was insolvent, and
acting pursuant to 12 U.S.C. 191, I declared the Bank insolvent and
appointed the FDIC as receiver.
In order to protect all of the depositors of Frankl
, the FDIC
moved immediately to accept bids from several major New York banks
upon a pre-negotiated contract wich provided full protection for
all Franklin depositors and other normal banking creditors.
All
bids were opened simultaneously in the presence of the entire FDIC
Board of Directors.
The high bidder was the European-American Bank
and Trust Company, a federally insured, New York State chartered
institution owned by six large European banks.
The following day
every banking office of Franklin was opened at the regular banking
hour by the European-American Bank.
All depositors in Franklin,
including holders of certificates of deposit, savings accounts,
time accounts, and checking accounts, automatically became depositors
of the European-American Bank.
The European-American Bank also
assumed all existing liabilities to trade creditors of Franklin.
The approval of the purchase and assumption transaction avoided
any disruption in service for depositors and increased the chances
of subordinate creditors for full repayment of their claims.
In summary, our number one goal was to protect the depositors
and the banking system of this country, and that goal was achieved.
291
[Office correspondence:
Strictly confidential]
NOVEMBER 30, 1973.
To : Federal Reserve Bank of New York
From : David E. Bodner.
Re F r a n k l i n National Bank.
On Wednesday, November 28, Messrs. Page and Weatherstone of Morgan
G u a r a n t y called on Mr. H a y e s to discuss their concern aboult t h e situation t h a t
was developing in the foreign exchange m a r k e t with respect to Franklin. Also
present a t the meeting were Messrs. Coombs, Timlen, Bodner, and Piderit. Mr.
P a g e said t h a t Morgan had been concerned for some time about the volume of
exchange t r a d i n g being done by F r a n k l i n and was no longer prepared to deal in
the forward m a r k e t with F r a n k l i n although it w a s still dealing with them in spot.
I t was their understanding t h a t a number of banks in New York (mainly foreign
banks) also would not take F r a n k l i n ' s name on forward transactions. In addition, they understood t h a t several banks were now refusing to deal with F r a n k l i n
even on spot exchange. Moreover, it had recently come to their attention t h a t
the Deutsche Bank, F r a n k f u r t , had informed F r a n k l i n t h a t it would no longer
clear for them. In addition, they understood t h a t the Commerzbank, F r a n k f u r t ,
w a s considering closing out F r a n k l i n and t h a t same day they had received an
inquiry from the Dresdner Bank regarding F r a n k l i n ' s credit worthiness. Their
understanding was t h a t F r a n k l i n had a large forward book which, while balanced
overall, contains substantial mismatches in forward dates. In view of the fact
t h a t a number of banks now would not take F r a n k l i n ' s name on forwards they
were afraid t h a t F r a n k l i n could have considerable difficulty in matching up its
forward book and might be forced increasingly into the spot market. In addition,
they were afraid t h a t the reluctance of other banks to deal with F r a n k l i n in
forward exchange might spill over into a reluctance by banks to lend Euro-dollars
to Franklin, and they understood t h a t F r a n k l i n was a heavy user of Euro-dollar
funds. With respect to the forward book, Weatherstone suggested t h a t one possibility would be for another bank to, in effect, "take over" F r a n k l i n ' s book and
do the necessary offsetting forward transactions for its own account on behalf
of Franklin, thereby lending its name. H e said, however, t h a t he had not discussed
this with Franklin.
At the conclusion of this meeting, it was agreed among the officers of this Bank
present t h a t the situation w a s a potentially explosive one which deserved immediate further investigation to determine the facts. Mr. Hayes then informed
Governor Mitchell of the substance of this meeting and also spoke with Mr. Van
H o r n to coordinate with the national bank examiners. I t was also agreed t h a t
it would be desirable for me to meet with Mr. Shaddick of F r a n k l i n as soon as
possible.
I then met with Mr. Van H o r n and the foreign examiners of his office who are
presently examining Franklin. The examiners were greatly concerned about
Franklin's foreign exchange operations in t h a t they felt t h a t F r a n k l i n was clearly
trading foreign exchange to make a profit r a t h e r t h a n to service customers and
because they thought the net positions were excessive. In fact, as of the examination date, F r a n k l i n had a total book, spot and forward, of approximately $2.1
billion equivalent with a net over-sold position of about $60 million. The proportion of business considered spot, t h a t is under ten days, relative to the amount in
the forward book was comparatively high. This would tend to confirm t h a t
F r a n k l i n was having trouble dealing in the forward m a r k e t and, therefore, was
being forced to do more of its business at the spot end of the market. I told the
examiners t h a t in my view the total volume of commitments on the books at the
examination date did not seem excessive for a bank of F r a n k l i n ' s size compared
with w h a t we know about the size of the books of other banks. I also said t h a t
trading foreign exchange for profit r a t h e r t h a n simply as a service for customers
was now common practice among maior banks in this country, as it had been for
years in Europe, and that, personally, I considered it perfectly appropriate.
W i t h respect to the open position, the examiners said t h a t they really had no
s t a n d a r d s for measuring appropriate size although they were disturbed by
Franklin's position. I said t h a t it seemed to me t h a t one would have to look at
the potential loss in the position relative to the capital and earnings of the bank,
and also t h a t it was important t h a t the senior management of the bank be
a w a r e of the size of the position and the potential risks involved. Leaving aside
the question of F r a n k l i n ' s relatively low earnings and weak capital position, the
292
size of the open position relative to the overall size of the bank did not seem
to me to be alarming.
Following the above described meeting with the Federal examiners, I met
with Peter Shaddick and Howard Crosse at Franklin's head office on Thursday,
November 29. I described in a general way the rumors and reports that we have
been receiving with respect to Franklin, told them that we were concerned, and
that I wanted to get their reaction and discuss how they saw the situation.
Shaddick confirmed that many .banks will not take Franklin's name on forward
contracts and, indeed, spoke of it being virtually impossible for him to do forwards. He said that they had been forced to rely almost exclusively on very short
date swaps and that recently he was having trouble doing anything beyond
overnight rollover transactions. This of course made it difficult for him to manage
his forward position and, in addition, was expensive. He felt that Franklin had
not been over-trading and that there was no real justification for banks refusing
to deal with him, but he recognized by virtue of the considerable expansion in
their foreign exchange activity this year, they had simply used up their lines with
most banks. He also recognized that because of Franklin's poor earnings and
weak capital position and because of unfavorable reaction in the market place
to the Sindona interest in Franklin, banks were reluctant to increase their lines
with Franklin. He did not provide me with any figures on his current book
except to say that the total contracts outstanding in marks were approximately
$300 million equivalent on each side, with a net over-sold mark position of DM
30 million, and that this was his largest position. I told Shaddick that I had
heard from several sources that the Deutsche
Bank had refused to clear for
Franklin and he confirmed that this wTas true. He said they had discussed it
with Deutsche Bank but were unable to get a clear explanation of that bank's
refusal to handle their account any longer except an indication that Deutsche
Bank was concerned about the Sindona interest and had become increasingly
worried in view of the recent failure of the U.S. National Bank of San Diego.
Shaddick recognized that the situation, while merely uncomfortable at the
moment, was potentially explosive since there was a risk that banks wThich now
refuse to deal with them on forward contracts could begin to close their Eurodollar lines and even their Federal funds lines to Franklin. Since Franklin uses
about $1.2 billion in Euro-dollars to fund its London branch operations, a sharp
cutback on its ability to get such funds could have serious repercussions on the
bank. Shaddick said that their foreign exchange business was almost entirely
for their own account and represented a conscious decision of the management
to attempt to bolster their weak earning's position and take advantage of tax loss
carry forwards through trading in exchange. The exchange operations had in
fact been quite profitable and he expected that their current positions would
continue to generate profits for the bank.
He did not regard their trading activity as excessive in relation to the size
of the bank. I told Shaddick that I agreed that the volume of business on their
books and the size of their positions, insofar as he had revealed them to me, did
not seem excessive to me given the size of Franklin, I said further that the
relevant question clearly was whether his volume was excessive in relation to the
willingness of other banks to deal with him, regardless of his judgment or mine
on the appropriateness of such position, and from that point of view his volume
evidently was excessive, and he agreed that this was the case. I impressed upon
Shaddick and Crosse our concern that the situation was a potentially explosive
one and that they ought seriously to consider prompt action to rectify it. They
said that many of the bad loans that had been made earlier were now off the
books, that the fourth quarter earnings would be good, and that they felt there
had been a substantial improvement in the overall manner in which the bank
was operating. They felt, therefore, that given time the situation would improve
significantly. I told them that our concern was precisely whether there would be
sufficient time in the absence of positive steps on their part. Shaddick suggested
that one possibility that he had been considering was asking one of his friends in
the exchange market, such as Lantz of Chase, to do forward transactions on his
behalf. This would, of course, involve the willingness of Chase to take Franklin's
name for substantially larger contracts than at present. I said that I thought
that this might be very useful in enabling them to reduce their presence in the
market, but it seemed to me that it might be necessary for them to go beyond
that.
We then discussed briefly the question of Franklin's capitalization. They
recognize that Franklin is undercapitalized at the moment and that injection
293
of additional capital would probably help to calm some of the disquiet in the
market with respect to Franklin. Crosse indicated.that he was in favor of their
going to the market even if they have to accept an unattractive price for the
stock in order to get funds promptly. At this point, Mr. Luftig joined the meeting.
He indicated that he found it very difficult to see how they could go to the
market for capital at this point when they would be only able to get a price
substantially below the book value of the stock and, moreover, he was concerned
as to whether an issue would even be successful. We then reviewed the overall
situation once again and I concluded by reiterating our concern about the position
and our willingness to be of whatever help that we could. I said that I thought
it was essential for them to take some measures to rectify their difficulties in the
exchange market and generally reassure the market. I said that it seemed to
me that the situation was potentially a very dangerous one for them. How they
weighed those dangers against the costs of whatever steps they might consider
taking to improve the position was, of course, a management decision for them,
but it was my personal view that they ought to seriously consider some early
action. I left with the feeling that they recognized the nature of the problem
that appeared to be facing them and would attempt to take them in hand soon.
CHANGING CHARTERS—DID THE BANK SWITCH RATHER THAN FIGHT THE FED
EXAMINERS?
First Pennsylvania's
Chief Denies Any Such Motive for Move to Comptroller
QUESTIONS ABOUT THE SYSTEM
(By Thomas J. Bray)
First Pennsylvania Bank was for many years a state-chartered institution and
a member of the Federal Reserve System. As such, it was regulated by the Fed
and the Pennsylvania Banking Department. But in April 1974, not long after an
examination by Fed and state officials that produced a strong recommendation
for a slowdown in the bank's growth, First Pennsylvania applied for a national
charter from the Comptroller of the Currency.
The charter was granted in early June 1974. As a result, the prime responsibility
for supervising the bank switched to the Comptroller's office.
High-level Fed officials, some of whom suspected that the switch was prompted
by the Fed-state examination, reacted strongly. Arthur F. Burns, the chairman of
the Federal Reserve Board, "was furious," says one former insider. Another
adds: "We felt it was a pretty clear example of a bank that felt it was getting
a little too much criticism from one regulator and thought it might get more
consideration from another."
Some sources say it was First Pennsylvania's switch that triggered the remarks
Mr. Burns made to a bankers' convention in Honolulu in October 1974 about the
present system of bank regulation. Supervision of the nation's 14,000 banks is
split among the Fed, the Comptroller, the Federal Deposit Insurance Corp. and
state banking authorities. "Even viewed in the most favorable light," Mr. Burns
said, "the present system is conducive to subtle competition among regulatory
authorities—sometimes to relax constraints, sometimes to delay corrective
measures."
THE SYSTEM IN ACTION
Whatever the reasons for First Pennsylvania's change of charter, the case
offers an intriguing, and relatively rare, view of the bank regulatory system in
action.
First Pennsylvania officials reject any implication that the switch was sparked
by the Fed-state examination. "That's just plain stupid," says a director of the
bank. John Bunting, the bank's chairman, adds: "I don't mean to say that once
you've seen one examiner you've seen them all, but the Comptroller's people are
just as tough on us as the Fed. Maybe tougher."
Indeed, First Pennsylvania, the nation's 19th largest bank, was listed on the
Comptroller's "watch" list of problem banks at the end of 1974. The hank also
made the Comptroller's 1975 list.
Mr. Bunting himself says that First Pennsylvania sought a national charter to
escape certain aspects of its prior Fed and state supervision, particularly the
294
state's power over the establishment of new branches. Some sources note that the
switch came in the midst of a nationwide Fed campaign to force banks to increase
their capital because of worries that the banking system had overextended itself
in the boom years of 1972 and 1973. The Comptroller tended to take a more
liberal view of capital adequacy.
The story of First Pennsylvania's regulatory relationships also may reflect a
conflict between two strong personalities—the Fed's Mr. Burns, an elder statesman who takes a dim view of the growth cult among bankers, and First
Pennsylvania's Mr. Bunting, a brash, assertive young executive who was determined to convert an essentially regional bank into a national powerhouse among
financial institutions.
A HIGH
PROFILE
Mr. Bunting, a former economist with the Federal Reserve Bank of Philadelphia, joined First Pennsylvania in 1964. In 1968, he leapfrogged over several
other executives to become president. In 1971, he was named chairman and chief
executive of both the bank and its parent holding company, First Pennsylvania
Corp.
Mr. Bunting emphasized diversification, aggressive lending strategies and
earnings growth. Between 1968 and the end of 1973, assets more than doubled, to
$5.28 billion. Net income increased to $43.3 million from $20 million.
First Pennsylvania also adopted a high public profile. Analysts were invited to
Philadelphia frequently for rundowns on the bank's successes, and Mr. Bunting
traveled often to other cities to spread the word. A favorite pitch: that First
Pennsylvania's stock should carry at least as high a price-earnings multiple in
trading on the Big Board as the New York banks did.
Fed officials in Washington weren't altogether enthusiastic about Mr. Bunting's
attention-getting schemes and banking policies.
A DAY OF R E C K O N I N G
"Every time you'd pick up the paper," there would be another article about
Bunting running off somewhere to give a speech," says one Fed source. "You had
to wonder who was running the bank. I remember (one of the Fed's seven
governors) saying, 'This guy Bunting is a wild man. We ought to get a harness
on him.' "
The opportunity wasn't long in coming. On Sept. 7, 1973, examiners from the
Fed, accompanied by Pennsylvania Banking Department examiners, arrived for
the annual surprise examination. The findings of that examination are secret,
but a look at First Pennsylvania's public financial reports issued around that
time indicates what the findings must have been. Loan volume, for example, had
been growing 20% to 25% a year since 1971, yet reserves to cover bad loans had
actually declined somewhat—fine if management was making only good loans,
but risky if it wasn't or if the economy suddenly turned sour.
Moreover, to support the rapid loan growth, First Pennsylvania had become
increasingly dependent on such sources of funds as certificates of deposit
(negotiable receipts for short-term interest-bearing deposits) and so-called
"federal funds" (uncommitted reserves that banks lend one other). 'Some Fed
officials worried that such sources might dry up in a pinch and leave a bank
unable to meet its commitments.
Also, as of Sept. 30, 1973, First Pennsylvania's ratio of capital (stockholders
equity, subordinated notes and loan-loss reserves) to "risk" assets (total assets,
primarily loans and investments, less cash, time balances with other banks and
U.S. government securities) was only 8%. The Fed usually regards any bank with
a ratio of less than 12.5% as undercapitalized. That's no small matter. Capital is
a bank's cushion against disastrous loan losses or other serious reverses.
The examination was completed near the end of the year. When the results
circulated in Washington, there reportedly was consternation. "We were very
alarmed at that point," a source recalls. "All the ratios appeared under strain."
In early February 1974, a Federal Reserve governor wrote a letter backing a
suggestion that the Federal Reserve Bank of Philadelphia meet with First
Pennsylvania's directors and review the results of the exam. Fed examiners
normally meet with management to review their findings, but in cases where
the bank is deemed to have unusual problems, a meeting with directors is also
sought. Such a meeting had never before been requested during Mr. Bunting's
tenure as chief executive.
295
Obtaining the meeting apparently wasn't easy. "Bunting used every device he
could think of" to avert or put off a meeting, according to a source close to the
situation. Finally, a letter was dispatched across town seeking a definite commitment, say several sources. Back came a letter, a source says, saying that "his
directors wouldn't understand the technical language" used by examiners and
that "he himself should be the one to tell his directors about the results of the
exam."
The Fed persisted, however, and in late March a meeting was finally held. The
examiners strongly suggested that the bank slow its growth and improve its
capital position. Mr. Bunting describes the meeting as "blunt but not acrimonious." A regulatory source says, "The examiners read the riot act and Bunting
didn't say a word." Behind the scenes, however, Mr. Bunting was already taking
steps to change the bank's regulator. In early March, soon after the Fed began
seeking the board meeting, a delegation of First Pennsylvania representatives
went to Washington to meet with officials of the Comptroller's office to obtain
procedural information about applying for a national charter. And in midApril, three weeks after the board meeting, First Pennsylvania issued a press
release announcing that directors had approved an application for a national
charter.
The charter was granted by Currency Comptroller James E. Smith and became
effective in early June. The hank's name, formerly First Pennsylvania Banking &
Trust Co., became First Pennsylvania Bank. (The holding company's other
operations, a small proportion of the total remained under the Fed.)
CHAIRMAN'S VERSION
Mr. Bunting, in an interview, denied that he tried to put off a board meeting
with the Fed and state examiners. He said he couldn't recall any exchange of
letters with the Fed on the subject. He also denied that there was any connection between the meeting and the decision to seek a national charter.
"We'd been thinking about taking a national charter ever since I've been at First
Pennsylvania," he said.
The real reason for the switch, Mr. Bunting said, was that branch applications
from national banks are judged only by the Comptroller, who historically has
favored extensive branching. Branch applications from state banks, however are
subject to approval of state banking authorities. Mr. Bunting said that First
Pennsylvania had had problems in obtaining state clearance for new branches
because Pennsylvania banking officials tended to be protective of smaller banks
and other financial institutions.
A branching decision by any regulator, state or national, has to conform with
state law. In Pennsylvania's case, that means that banks may branch only in
counties adjacent to their headquarters. But in 1973 and 1974, Mr. Bunting
noted in the interview, Gov. Milton Shapp was pushing for a law permitting banks
to put regulator-approved branches anywhere in the state. The proposal was never
enacted, but the prospect of its passage, Mr. Bunting said, spurred First
Pennsylvania to switch charters so as to keep up with national banks in the
expected competition for new locations.
Also, Mr. Bunting said, "right at that time there was a tripping incident" that
made up his mind to seek a national charter. An application by First Pennsylvania
for an Allentown branch was turned down by the state, and "two or three weeks
later a national hank went in there."
A DIFFERENCE OF A YEAR
The Allentown application, however, had been turned down in May 1973,
nearly a year earlier. A similar application by First Pennsylvania had been turned
down in 1971. Of 19 other First Pennsylvania branch applications since 1969, the
state has rejected only two.
First Pennsylvania's 1973 annual report, issued in March 1974, discusses the
possibility of statewide banking and says: "We have a mature branch system
which covers Southeastern Pennsylvania thoroughly, a portion of the state we
consider the most desirable. This permits us to wait with equanimity for statewide banking." No mention is made of applying for a national charter.
First Pennsylvania did take steps to comply with the wishes of Fed examiners.
It began to rein in its growth. Loan growth slowed to 7% in 1974's second quarter
and to 3% in the third quarter. The bank's borrowed funds declined slightly in the
second quarter in comparison with the first quarter (though they were still nearly
296
double the year-earlier figure). Applications for approval of the acquisition of
two small loan companies were withdrawn in August 1974.
"The examiners' advice was good, and we took it," says Mr. Bunting, who notes
that many other big banks were in even more precarious condition.
(Even so, a number of sources close to the Federal Reserve System profess
shock that Comptroller Smith—who at that time was presiding over the failure
of two large national banks, Franklin National of New York and U.S. National
of San Diego—would accept an application from yet another troubled institution.
"First Pennsylvania's troubles weren't anywhere near as great," says one, "but if
I had been Smith, I would have told First Pennsylvania to stay right where it
was until its problems were worked out.")
Some sources close to First Pennsylvania say management felt that, over the
long run, regulation by the Comptroller might simply be less confining than Fed
and state regulation. One source says:
"I think Bunting was embarrassed by the board meeting and tried to slap
back at the Fed by switching charters at that time. But it was something he had
been thinking about for a long time."
(Mr. Bunting denies any embarrassment, but agrees that a switch had been
under consideration for some time.)
The differences between the Fed and the Comptroller are subtle but important,
observers say. For one thing many bankers say it's easier to deal with the Comptroller's office, where decisions are a one-man affair than with the Fed, with its
seven governors and 12 quasi-independent branches.
"You can call up Smith and get a reading on a matter you're concerned
about," says one Philadelphia banker. "With the Fed, you're never quite sure
where you stand until a final order is issued."
Also, the Fed. under the stern traditionalism of Chairman Burns, has projected
an image in banking circles of being more restrictive and hostile to innovation
than the Comptroller. The Comptroller, for example, allows banks to count subordinated debt as capital; the Fed prefers to leave it out when testing a bank's
solvency. The Comptroller also has warmly embraced such technological innovations as remote banking terminals that could be placed in shopping centers. The
Fed has been cool to such ideas.
CALLS ON CAPITAL
At the time of First Pennsylvania's switch to a national charter, the Fed
"was much more concerned about capital adequacy than the Comptroller," says
one former Fed governor. In early 1974, numerous calls were made by the Fed's
chief of bank supervision, Brenton Leavitt, to banks' chief executives suggesting in no uncertain terms that additions to capital would be welcome in the wake
of the rapid expansion of 1972-73. (The phone calls became known in banking
circles as Leavitt-tation calls.)
It isn't surprising that a man of Mr. Bunting's aggressive temperament might
find the Comptroller more compatible under such circumstances. But many
critics of the bank regulatory system fear that the ability to switch regulators
leads inevitably to a deterioration in standards. They argue that a unified regulatory system is needed.
Others, Mr. Bunting included, disagree. They say a unified system would likely
be a creature—and therefore a captive—of Congress, and thus more subject to
passing whims.
As for First Pennsylvania, it has had rocky going since it became a national
bank in June 1974. Net income in 1974 declined to $35.7 million from $43.3 million ; in 1975, it declined again, to $18.2 million. Recently Mr. Bunting predicted
a gain for 1976 as a whole.
[From the New York Times, Feb. 17, 1976]
6 3 - S A V I N G S U N I T S ON " P R O B L E M " L I S T
BANK BOARD SAYS 1 5 U N I T S ARE L I K E L Y TO REQUIRE AID OF GOVERNMENT ; TOTAL W A S
5 1 I N 1 9 7 4 ; 4 8 I N S T I T U T I O N S ARE SAID TO "GIVE C A U S E FOR MORE T H A N ORDINARY
CONCERN"
WASHINGTON, Feb. 17 (AP)—A Government agency reported today that 63
savings and loan institutions were listed as "problem institutions" in 1975.
297
A spokesman for the Federal Home Loan Bank Board said 15 of the institutions
were in the most serious category where they are considered as likely to require
government financial help unless "drastic changes" occur.
The remaining 48 on the list are in a less serious condition but "give cause
for more than ordinary concern and require aggressive supervisory attention,"
the spokesman said. He declined to name the institution.
DEPOSITS INSURED
The bank board is the Federal regulatory agency for the 4,079 state and federally chartered institutions whose deposits are insured by the Federal Government.
The number of institutions on the problems list is up from 1974, when the total
was 51, but below the 96 problem institutions reported at the end of 1970.
The spokesman said the current number was not considered by the bank
board. He said the board stepped up its supervision of the institutions that
were listed as problems.
He also said that since the regulatory system was established in 1934 there
had been only 110 cases where the bank board had had to extend aid to a savings
and loan institution.
There were only 13 instances where a savings and loan institution actually
failed and went into receivership, he said. "The others were either saved or a good
part of them saved through merging into stronger institutions," he added.
GRANTS MAY BE MADE
The most common form of Government aid to problem institutions is through
"contributions," which are grants from the agency do that not have financed by
insurance fees paid by the savings and loans [sic].
A total of $450 million in contributions has been made in 59 different cases, the
spokesman said. The agency also makes loans and may purchase questionable
assets from institutions in trouble.
The making of a contribution is an avenue of aid that is not available to banks,
where several problem institutions to banking regulatory agencies [sic].
The spokesman said Congress granted the Federal Home Loan Bank Board
System greater flexibility for providing help because savings and loan institutions could be hurt more by events over which they had little or no control." The
63 problem institutions listed at the end of 1975 had assets totaling nearly $5.6
billion, which was 1.7 percent of all assets of insured institutions, totaling $330.3
billion.
[From the New York Times, Feb. 22, 1976]
A 'PROBLEM' BANK GOES UNDER—HAMILTON NATIONAL'S FAILURE WAS THIRD
LARGEST
(By Fred Travis)
NASHVILLE—Two weeks ago the Comptroller of the Currency, James E. Smith,
told a Senate committee that there were seven national banks in "immediate"
danger of collapse. Now there are six.
Last Monday one of the seven—the Hamilton National Bank of Chattanooga—
went under. Hamilton was Chattanooga's largest, oldest and most prestigious
bank, and the flagship of Hamilton Bancshares Inc., a holding company with
interests in Tennessee and Georgia.
Hamilton Bancshares itself filed for bankruptcy four days later, along with
three of its non-banking subsidiaries.
The failure of Hamilton National was the third largest bank failure in United
States history, surpassed only by Franklin National Bank in New York last
year and the United States National Bank in San Diego in 1974.
Rumors of trouble accelerated early this month with reports that the Federal
Deposit Insurance Corporation was actively searching for a merger for the
Chattanooga bank.
A year before its collapse, Hamilton National Bank was the sixth largest in
Tennessee. Before formation of Hamilton Bancshares, the Chattanooga bank had
been the flagship of Hamilton Associates—a group of East Tennessee banks that
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joined together early in the 1930's to weather the Depression. Hamilton Associates confined itself almost entirely to banking and directly related activities.
Hamilton Bancshares started new ventures and just three years ago the organization was cited before the Tennessee legislature as a fine example of what a
bank holding company can do to provide a large and flexible supply of credit. But
it was these ventures, especially those in real estate investment, that led to the
collapse.
During the holiday last Monday 150 F.D.I.C. agents swooped upon the 71year-old Hamilton Bank in downtown Chattanooga and its 22 branches and
seized the assets.
The Comptroller of the Currency's lawyers immediately filed a bankruptcy suit
in Federal District Court and an hour later Hamilton's assets were sold to First
Tennessee National Corporation, a Memphis-based bank holding company. First
Tennessee offered $16.3 million for selected assets of the bank, but the price is
subject to adjustment after more study of the assets and ultimately may be
reduced to as litle as $7.5 million. On Tuesday it opened as the First Tennessee
National Chattanooga. Top executives of Hamilton National were replaced by
new officials from the Memphis holding company but otherwise the institution
resumed normal operation.
George W. Hill, chief of the F.D.I.C. Division of Liquidation said the failed
bank's stock is virtually worthless.
The Comptroller's affidavit noted: "The poor condition of Hamilton National
was directly attributable to the large number of real estate loans originated or
acquired from Hamilton Mortgage Corporation." (Hamilton Mortgage was one
of the subsidiaries that filed for bankruptcy along with Hamilton Bancshares.)
An examination of bank last September, the affidavit said, showed that assets
acquired from the mortgage subsidiary accounted for 87 percent of those assets
of the bank which were considered to have questionable value.
The heavy losses of Hamilton Mortgage had also been a drain on the parent
company—Bancshares. At one time Hamilton Bancshares controlled about 20
banks, but almost half of them were sold off in a desperate search for cash to
offset the mortgage company's losses. By last Monday, Hamilton Bancshares was
down to 11 banks, and two of these—in Nashville and Memphis—were sold later
in the week to a growing banking group in which the dominant figures are Jake
Butcher of Oak Ridge and his brother C. H. Butcher Jr. of Knoxville.
In New York it was reported before the bankruptcy occurred, that Hamilton
Bancshares might have to sell some of its remaining banks to reduce its debt to a
syndicate headed by Manufacturers Hanover Trust Company of New York. Most
of the stock in Bancshares banks had been pledged as security for loans—reportedly less than $75 million—obtained in am effort to keep the parent and
Hamilton National Bank in business.
[Interoffice letter]
To: Mr. Andrew Garafalo, Assistant Vice President, Foreign Exchange.
From: George A. Hermann, International Division.
AUGUST 27,
1973.
Subject: Foreign Exchange Position Limits.
Mr. Shaddick's instructions of Feb. 15, 1973, cancelling all previous foreign
exchange position limits and requiring that approval for overnight positions be
given by either Messrs. Shaddick, Barrand or me, is hereby rescinded.
The following overnight foreign exchange position limits have now been
authorized by Mr. Shaddick and are to take effect immediately:
Sterling
:
5 million
Deutsche marks
25 million
French francs
25 million
Swiss francs
25 million
Guilders
10 million
Canadian dollars
5 million
Lira (U.S. $ equivalent/million)
2.3 billion
If you anticipate being in excess of these overnight position limits please refer
the matter to either Messrs. Shaddick, Barrand or the undersigned for approval.
299
[Interoffice letter J
To: Mr. Andrew Garafalo, Assistant Vice President, Foreign Exchange.
From: George G. Herrmann, International Division.
NOVEMBER 29,
1973.
Subject: Foreign Exchange Position Limits.
The limits approved by Mr. Shaddick as set forth in my memorandum of August 27 are hereby cancelled. The following overnight position limits have now
been authorized by Mr. Shaddick and are to take effect immediately:
Sterling
2.5 million
Deutsche marks
12 million
French francs
__ 12 million
Swiss francs
12 million
Guilders
5 million
Canadian dollars
2 million
Lira (U.S. equivalent $2 million)
1.2 billion
These position limits are to be strictly maintained, but if you anticipate being
in excess of these overnight position limits due to unusual circumstances, please
refer the matter to either Mr. Shaddick or the undersigned for approval.
OCTOBER 7,
1974.
To: Secretary William E. Simon.
Thru: Deputy Secretary Stephen S. Gardner.
From: James E. Smith, Comptroller of the Currency.
Subject: Sale of the Franklin National Bank.
As you are aware, for the past five months the FDIC, the Federal Reserve
Board, and the Comptroller have been searching for a solution to the unstable
condition of the Franklin which would protect all depositors of the bank and
which would minimize the impact of the bank's probable demise upon the confidence of the public in the banking system. We believe that a solution has been
devised which will achieve these two goals. The prospects appear to be good
that we will obtain on Tuesday, October 8, satisfactory bids from one or more
of four large banking organizations for the purchase of a substantial portion
of the assets and all of the deposit liabilities of the Franklin. Deposit liabilities
presently approximate $1.4 billion. The transaction contemplates that the depositors will have uninterrupted use of their funds, with the acquiring bank opening all of Franklin's offices and accounts as their own the next morning.
We are assured of bids from two of the four banks: Manufacturers Hanover
($18 billion) and European American (an association of six large European
banks with combined assets of $85-90 billion). We believe that two additional
banks, Chemical Bank ($16 billion) and First National City Bank ($38 billion)
will also probably bid on the Franklin.
Citibank has voluntarily suggested that, if it should be the successful bidder,
it would divest or close 45 of the branch offices' within 24 months to reduce anticompetitive effects. The Ainti-Trust Division is not entirely satisfied with this
proposal, although it has assured Citibank it will not sue. However, Anti-Trust
may endeavor to persuade me, in the conduct of my duties under the Bank
Merger Act, or the receivership Court to reject a Citibank assumption if European-American makes an acceptable bid close in amount to Citi's. My present
thinking is to approve a Citibank takeover if it is in fact the high bidder. I believe that the Franklin debenture holders and shareholders will have a legitimate complaint if the high bid is not approved.
The procedure for this acquisition will be for the interested banks to submit to
the FDIC on Tuesday morning their bids for the .assets and liabilities package,
on the assumption that I will declare the Franklin insolvent later on Tuesday.
If there is a satisfactory bid, I will in fact declare the bank insolvent at 3 P.M.
Tuesday, appoint the FDIC as receiver, and the FDIC will immediately proceed
to accept the most satisfactory bid. The bid amount will be the premium for the
going concern aspects of the purchase. The assuming bank will be allowed to
"cherry pick" all of Franklin's assets (including those securing the FRBN'S
loan) to obtain assets equal to the deposits and other liabilities it will assume.
The FDIC will give an interest-bearing note to the Federal Reserve Bank of
New York lor the release of its $1.7 billion note of the Franklin and receive in
300
return the $2.0 billion in assets of the Franklin being held by FRBNY as collateral. The FRBNY note will be paid out as the assets are liquidated by the receiver. Any balance remaining at the end of three years will be paid in a single
payment by the FDIC. Any net return to the FDIC from the premium and the
assets, after paying the note to the FRBNY and covering the FDIC's receiver
costs, would be applied to the claims of the bank's creditors.
If none of the bids received should meet the FDIC's minimum figure, I would
not proceed to the declaration of insolvency on Tuesday. The regulators would
have to reconsider the possibility of an expensively-asssisted Franklin continuing independently, versus the alternative of a payout. However, on the basis of
our present knowledge of the bidding banks' intentions, I consider the possibility
of receiving no adequate bid as very remote. The FDIC's minimum figure is required by statute to be sufficient to assure that in all probability the assisted sale
will result in a lower cost to the government than a payout on the closed bank.
We expect to receive bids comfortably above the FDIC's calculated target.
Assuming that the receiver has accepted a satisfactory bid on Tuesday shortly
after 3 P.M., we will proceed to a pre-briefed federal judge who will hear the receiver's and the Comptroller's arguments as to the necessity and fairness of the
proposed purchase-and-assumption transaction, and presumably he will approve
it. The Comptroller's affidavit will contain an extensive explanation of the circumstances leading to the declaration of insolvency, including the temporary
nature of the Fed's financial assistance and their recent determination in a letter
to me that it is not in the public interest for the note to continue to remain unamortized, a condition which the Franklin cannot remedy in the foreseeable
future. Also described will be the effort made by all parties concerned to develop
a resolution of the problem in the form of the continued existence of the
Franklin with certain FDIC financial assistance; after extensive study it was
concluded that the cost would be too great for the FDIC. I also had Blyth Eastman Dillon analyze the financial prospects for Franklin if it received substantial
FDIC assistance, and tljey concluded that there was no realistic prospect even
then that the bank would become financially viable in the foreseeable future.
Because of the possibility of immediate litigation for a restraining order from
some shareholders and creditors, the whole transaction must remain undisclosed
until shortly after 3 P.M. Tuesday. The increasing prospect of advance restraining
litigation and the possible dissolution of the remaining going-concern value of
the bank is one of the key factors in the decision to press ahead with the bidding procedure at the earliest time. We will notify interested members of Congress shortly after 3 P.M. Tuesday.
In conclusion, I should point out that the Franklin situation is a relatively unique one that we do not expect to see repeated. It had a ten-year history of only
marginal existence as a New York City bank and an unimpressive management
reputation that undercut confidence in it in financial circles. Most importantly,
it had expanded in the purchased money area during 1973 at an incredible rate,
leaving it no ability to handle the tight money situation and the "move to
quality" by money market participants. At the time our November 1973 examination revealed to us the serious state of affairs at the bank, about 50% of its
liabilities were in the form of purchased money. We have no other banks in such
a drastic and unfavorable configuration as Franklin was, and the greatly heightened awareness of both bankers and examiners to the importance of liquidity
should help prevent future over-extension in this area. In addition, our agency's
own analytic and predictive skill in the liquidity area is being expanded by an
extensive liquidity data collection program, which we will analyze ultimately
with computer models. Our Haskins and Sells study will also equip our agency
during the next year to better detect and deal with problem banks generally,
and particularly to curtail major problems in their incipient stages.
o
@FedFRASER