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Library STATEMENT ON THE FDIC's USE OF CIVIL RICO ACTIONS J(JN 1 3 1985 FEDERAL DEPOSIT INSURANCE . CORPORATION PRESENTED TO COMMITTEE ON THE JUDICIARY UNITED STATES SENATE BY DANIEL W. PERSINGER DEPUTY GENERAL COUNSEL FEDERAL DEPOSIT INSURANCE CORPORATION 10 :00 a .m. Tuesday, May SK 1985 Room 226 , Dirksen Senate Office Building Mr. Chairman Dan Persinger. Banks. I and members of the Committee, my name is I am the FDIC's Deputy General Counsel for Closed appreciate this opportunity to give my views on the FDIC's use of civil RICO actions under Title 18 U.S.C. § 1964(c). THE RICO STATUTE The Racketeer U.S.C. §§ Influenced 1961-1968 (1982), Organized Crime Control Act of authorizes a private right of and Corrupt Organizations Act, 18 was enacted as of the (1970). It Title 1970, Pub. Law 91-452 action for "any person IX injured in his business or property by reason of a violation of Section 1962". 18 U.S.C. ■ § 1964(c). RICO Section 1962 makes it unlawful, with respect to an enterprise affecting interstate or foreign commerce, for a person to (a) invest income derived from a pattern of racketeering activity in acquiring an interest in, or establishing or operating of such racketeering enterprise; an enterprise; activity, an (b) acquire, interest in or through control a pattern of such an (c) conduct or participate in the conduct of the affairs of such an enterprise through a pattern of racketeering activity; or (d) conspire to violate (a), (b) or (c). 18 U.S.C. §§ 1962 (a)-(d). RICO was designed to combat the efforts of organized criminal activity. a In enacting broadly—based it determined law RICO, which threatened Congress would the recognized counter stability of such the the need activities Nation's for which economic 2 system, with harmed free innocent investors competition, threatened domestic seriously security and competitors, burdened and interfered interstate undermined the commerce, general welfare of the Nation and its citizens. The Organized Crime Control Act expressly to provides that RICO is be "liberally construed" to effectuate its purposes. Under RICO, a private citizen can sue for and recover treble damages as a result of injury to his business or property. private the right Attorney pursue of General civil divestiture imposition action to actions of of a is in addition institute seeking person's not on a the criminal only interest restrictions to in authority RICO actions damages an but future given and to also (1) (2) the enterprise, person's This activities or investments, particularly in enterprises of the same type as that involved the in an enterprise, persons. A action, making 18 U.S.C. number or due (3) dissolution provision for or the reorganization rights of of innocent § 1964 (a) and (b). of controversies have arisen as to the scope of RICO and its applicability to so-called "garden variety" criminal fraud cases. expansive of acts Some commentators construction formerly of deemed RICO and courts effectively criminal only have argued federalizes under state that an a variety laws. Others have argued that such a reading would have RICO supplant existing remedial arrangements, such as under the Federal securities laws. those afforded private litigants 3 The recently United States narrowed Court the of scope limitations on its use: First, Appeals of for civil the RICO Second by Circuit imposing two in Sedima, S.P.R.L. v. Imrex Co., Inc., 741 F.2d 482 (1984), and the companion case of Bankers Trust Co. v. Rhoades, 741 F.2d 511 (1984), the Second Circuit held that the plaintiff in a civil RICO case was required to plead and prove a "racketeering injury" separate and caused by the predicate criminal acts distinct from set forth any injury in the statute. Second, in Sedima, the Second Circuit also held that the plaintiff must plead and prove that the defendants the alleged predicate criminal offenses. had been convicted of Both of these limitations are now under review by the Supreme Court. ROLE OF THE FDIC IN FAILED BANKS CASES The FDIC insures deposits in the United States. is closed by its the bank's of creditors in virtually all When a bank insured by the FDIC fails and chartering authority, receiver and commercial banks to liquidate shareholders. its the FDIC is appointed as assets Whenever an and to insured pay claims bank fails, the FDIC must draw upon its insurance fund to pay the claims of insured depositors bank's deposits In either case, or to facilitate the assumption of the failed and other the FDIC has estate for monies liabilities paid out of by another insured bank. a claim against the failed bank's its insurance fund. As receiver, the FDIC acts in a private capacity not only by standing in the I shoes of the creditors failed bank but by acting and shareholders on its assets assets for their in excess assets 4 of associated transaction) in seeking benefit. the belonging to to is Continental failed the the today (not including 281 of maximize The FDIC $6.5 billion with on behalf recovery liquidating $3.5 billion Illinois banks, bank's in assistance including the responsible for approximately 30 which have failed so far this year. The FDIC's policy causing a failed bank is to to pursue suffer all those loss, whether that major contributing cause of the bank's failure or not. serves the dual to the FDIC as purpose of receiver maximizing the loss was the This policy recoveries available for the benefit of the bank's creditors and shareholders, and insuring that the FDIC will be able to recover as much of FDIC will its have insurance used its money insurance payment of the bank's depositors their claims assumed alternative is used, general creditor. to pay other the by In many fund to arrange cases for the the full and general creditors by having another insured bank. Where this the FDIC winds up as the failed bank's only Since the bank's assets are usually insufficient FDIC's sources as possible. will claim in reduce full, that any amounts shortfall and it recovers directly from benefit the FDIC's insurance fund. After a bank fails, the FDIC will conduct an investigation and, depending on the results, may file a claim against the bank's 5 directors and officers its operations. blanket bond The for negligence or misconduct in overseeing FDIC may insurance also file a claim with the bank's carrier to recover monies lost by reason of dishonest acts committed by its employees. FDIC will against the bank's outside accounting firm for proceed In some cases the losses attributable to its negligence in auditing the bank. The persons responsible for allowing a failed bank to suffer losses are in a usually close accountants. its officers relationship such or employees, or those who stand as its outside directors and These are the people to whom FDIC has traditionally looked for compensation. There are, however, a small but increasing number of failed banks which have suffered losses due to fraudulent schemes perpetrated by outsiders. themselves been sufficient Regardless of theextent of the invariably indicative of Sometimes to cause the losses, efforts on these failure however, the losses of the have bank. they are almost part of bank management to deal with the bank's financial problems - such as low earnings or excessive loan losses — by making a quick profit time through a series of questionable transactions. does not schemes, have or even to be be an aware active in a Bank management participant in such of their real nature. short It fraudulent is enough that those in charge are so concerned with the precarious condition of the institution that they neglect to take simple precautionary • measures and wind up being victimized. As banking becomes more increasing pressure engage more in for those who enter hazardous When those bank fail. areas They are of when cause thus the serious harm is coming under business become easy prey to a variety schemes Even banks unfamiliar practices. see them as schemes. may to competitive, of so targets fraudulent financial not or to harm, the extensive, the precarious financial condition of the bank, coupled with the losses caused lead by management's to the same to salvage what misguided result. it can. Once efforts to save that happens, It is in this it, the context will FDIC that often steps civil in RICO cases promise to be extremely valuable. Over evidence the of are willing past the it" borrow and harm that illegal "Borrow a million recent past years, the can FDIC has result encountered when certain to translate the following maxims for their own own few has and ends: a own shown that individuals "common wisdom" "The best way to rob a bank thousand you of tangible dollars the and bank". individuals the The bank owns experience are willing to is to you; of the engage in organized criminal activity involving banks which goes far beyond what has been viewed "run-of-the-mill litigation". by business the courts disputes" the has a "garden-variety or "ordinary fraud", commercial Rather, such illegal activity has been well organized and carried out on a sustained to as target institution. substantial economic basis, resulting When and such legal a case interest in serious arises, in the utilizing harm FDIC the benefits of the civil RICO statute to (1) deter similar activity, 7 ■ (2) as recoup to financial the bank's important legal loss to the creditors and precedents to FDIC's insurance shareholders, help and proscribe fund (3) as well establish future illegal activity. The first civil RICO action filed by FDIC to recover treble damages for losses suffered by a failed bank involved an alleged scheme which, in its complexity, went far beyond the mere commission of two predicate "garden-variety" involve been I a new around criminal fraud. and (and offenses and Ironically unfamiliar criticized enough, activity by involved the but bank much the more scheme rather than did not one which has regulators) for a long time. THE INDIAN SPRINGS STATE BANK CASE On April 3, 1985 the FDIC filed a 66 page, RICO complaint in the U.S. That complaint conspired to detailed and did nine count civil District Court in Kansas City, Kansas. an alleged acquire and scheme whereby conduct their the defendants own enterprise, the affairs of several limited partnerships, and a money brokerage business the in failed such a manner bank in artificial market a captive market Bso excess as to of for the bank's fraudulently its lending certificates for the properties secure limits, of loans create deposit, from an create controlled by the defendants as to sell such properties at inflated prices, and to otherwise act in such a manner that each defendant could unlawfully enrich 8 himself. The partnerships, defendants' activities soliciting the in failed organizing bank to the provide limited financing for the purchase of partnership interests, use of "straw borrowers", and the solicitation partnerships, are of alleged persons to have to invest in constituted the common various law fraud, violation of federal and state securities laws, violation of wire and mail fraud statutes, and violation of the RICO statute. In that defendants estate complaint we alleged set up a series of speculation in the following facts: The limited partnership deals for real Kansas, Missouri and Hawaii. Bank loans were then sought to provide financing for the limited partnership interests in the approximate amount of $3 million. Individuals, some of them only "straw borrowers", were solicited to participate. The proceeds from these loans were deposited directly into bank accounts controlled by the defendants, where the money disappeared. Some of the borrowers were given a cash fee to execute blank loan documents later submitted to the bank. assets, understated liabilities and Other borrowers overstated exaggerated their net worth. Even though the bank sought to collect on the loans, it was unable to do so. Normally consider making such the bank would not even have been able to loans because of its relatively small size. The defendants, however, overcame this problem by offering "courtesy deposits" through institutional a investors moneybroker. would be The bank directed was to told purchase that its certificates of deposit if the bank could issue such certificates 9 above prevailing the differential the usual was fee deposited. rate rebated to the to of interest. the bank which moneybroker for That interest did not have causing the rate to pay funds to be The moneybroker was also a beneficiary of the limited partnerships and received other compensation for his participation in the scheme. In effect, the FDIC alleged a scheme where the bank was offered a series of deals whereby it could make a I millions of dollars of loans. I I to be true. The loans substantial profit on In the end, the deal was too good werenever repaid and the bank failed. The FDIC charged that as a result of the pattern of racketeering [ and other violations of law, the Indian Springs State Bank suffered I a $3 million loss as well as the loss of its I because of its resulting insolvency and failure. banking business The FDIC alleged I that its insurance fund suffered a loss as a result of the bank's Iinsolvency and sought damages for that loss. In addition, the I FDIC as receiver alleged that the hank suffered losses as a result I of the specific predicate acts committed. I FUTURE USE OF RICO We believe that the Indian Springs case illustrates the value of civil RICO to the FDIC where it is attempting to deter criminal 1 10 conduct aimed at banks which are already in a precarious financial condition. It is also useful as a means of compensating the FDIC for to losses statutory its insurance responsibility fund to incurred protect the in carrying insured out its depositors in a bank failure. Banks are an essential element in the Nation's economic system. Organized criminal activity which affects banks can have a profound effect on the stability of the banking system and can hurt innocent depositors, creditors and investors. It is exactly of activity with which Congress was concerned in 1970. Report No. a 617, legitimate commercial 91st Cong., concern banks 1st Sess., today. simply do The not 81-82 vast have of financial type (See Senate (1969).) majority the this It remains FDIC-insured resources or the expertise to protect themselves from organized criminal activity and less fraud. than Ninety-seven $500 million, percent of eighty-four these percent banks have have assets assets of of less than $100 million and sixty-six percent have assets of less than $50 million. The FDIC would not favor changes in the present law that could significantly curtail its usefulness as a basis for dealing with organized criminal conduct aimed at federally-insured banks. Since the FDIC would only be filing RICO actions in cases of failed banks, the requirement of a separate racketeering injury would 11 seem to have little impact on FDIC-related lawsuits. In such cases the banks have not only sustained a loss from the criminal activity well. but Of the equal loss contributed importance FDIC's prospective conduct of has use of is the civil legitimate business to fact the bank's that we failure as do not view the RICO actions as a threat to the activities. The type of organized conduct which would take advantage of a bank's precarious financial condition, from it or can its lack hardly be of diligent considered management, "legitimate" to in steal any money sense of the word. We do, however, permit it to be suggest one minor change to RICO which would used more effectively in cases of bank fraud. On October 12, 1984, Congress amended the Federal criminal statutes to make it a crime financial $10,000 "to defraud a federally chartered or insured institution". or 18 U.S.C. The penalty of not imprisonment § 1344. action to enjoin While more a violation bank fraud case of mail or wire denominated, damages where thus a fraud five not more years, or of the bank fraud statute, than both. just as there is no provision in RICO "predicate fraud. allowing such than of the Attorney General may bring a civil in the case of mail or wire fraud, denominating is a fine act", as there is in the We believe bank fraud should be so a private amounts to right a of pattern action of for treble racketeering.
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