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LEGAL ASPECTS OF PREPARATION OF REPORTS
FOR POSSIBLE SUBSECTION (i) PROCEEDINGS
BY
G. J. OPPEGARD
Counsel, Federal Deposit Insurance Corporation

Presented at the
Conference of Supervising Examiners
Washington, D. C.

April 2^, 1950

April 2k, 1950

LEGAL ASPECTS OF PREPARATION OF REPORTS
FOR POSSIBLE SUBSECTION (1) PROCEEDINGS

It appears to me that in order to properly consider
what are the "Legal Aspects of the Preparation of Reports for
Possible Subsection (i) Proceedings", we should first refresh
our minds on what are the legal aspects of the proceedings them­
selves.
To correctly appraise the significance and the proper
use of these proceedings, it is helpful to first take a fast
look at the Federal Deposit Insurance law -- its purpose and
objectives.

This is particularly Important now when we are

being charged from many quarters with appropriating supervisory
powers.
Preliminarily, let us be reminded that, although bank­
ing is a private business, It Is affected with a public interest.
A bank operates almost exclusively on the funds of the public and,
accordingly, it has its roots in, and gains its strength from,
public confidence.

This public interest Is the touchstone for

providing official supervision of the business.

The purpose of

such official supervision is to assure and Justify that confidence.
In other words, the primary purpose of all bank supervision
is to protect deposits and, incidentally, to thereby permit checks to




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circulate freely as money.

2-

That purpose Is also the primary

purpose of Federal deposit insurance.

Of course, technically

speaking, the FDIC should not he denominated a supervising
agency hut, regardless of the connotation given it, Congress
placed in the FDIC the duties and responsibilities of a
supervising agency.

In subsection (i) Congress said to our

Board, in effect, it is your duty and responsibility to keep
the insured banks within the well-marked channels of safe and
sound banking. It did not give our Board any discretion in that
respect.

See for yourselves.

The law reads:

"Whenever the board of directors shall find that
an insured bank or its directors or trustees have
continued unsafe or unsound practices in conducting
the business of such bank, or have knowingly or
negligently permitted any of its officers or agents
to violate any provision of any law or regulation
to which the insured bank is subject, the board of
directors shall first give to the Comptroller of
the Currency in the case of a national bank or a
District bank, to the authority having supervision
of the bank in the case of a State bank, or to the
Board of Governors of the Federal Reserve System
in the case of a State member bank, a statement
with respect to such practices or violations for
the purpose of securing the correction thereof."
And here I might suggest the anomaly of placing on our Board the
duty and responsibility to make banks stay within the confines
of safe and sound banking.

But Congress did not give our

Board visltorial powers over all insured banks.

In fact our

effective visitorial powers are applicable to banks having only

1 % of the insured deposits.

As to insured banks carrying

of the deposits, we must rely on other agencies advising us




85*f>

-3-

of whether the "banks are engaged in any unsafe or unsound
practices or violations of law.

Yet, the duty of maintaining

a safe and sound banking system is ours by Congressional
mandate.
Another thing I want to point out and emphasize
is that the Statute is primarily a so-called preventive
Statute, i.e. its main purpose is, not to terminate the in­
surance, but to obtain corrections and thus to prevent bank
failures.

Purpose is to cure the corporate sickness, not to

destroy it. The Statute affords our Board the opportunity to
provide guides for the conduct of safe and sound banking by
prescribing corrective measures.

It proceeds on the theory

that an ounce of prevention is worth a pound of cure by making
it unnecessary to wait for insolvency in order to proceed against
the bank.

It is not necessary that the misconduct be so culpable

as to justify receivership.

The purpose is to nip misconduct

before it renders the bank insolvent.

(Obispo case).

The statute

also smacks of benevolence (to sin comes natural - to forgive is
devine) in that it recognizes repentance.

As noted, it provides

a period in which corrections may be made and It follows that
If corrections are made, the proceedings must be terminated.
So much for a brief reminder of what are the legal aspects
and primary purpose of such a proceeding.
our subject, let us discuss the terms used.

Now to move closer to
To properly utilize

these proceedings, It is, of course, necessary that we know what




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constitutes "unsafe and unsound practices".

Violations of law

or regulations are, in this respect, quite self-explanatory.
The FDI Act does not define the terms "unsafe or unsound
practices", and I have found no other law - State or Federal defining them.

We must, therefore, resort to custom and cases.

Although Congress has not defined the terms, our Board of
Directors has done so and has advised Congress thereof a number
of times through its Annual Reports.
Annual Report, on page 18, it listed

For instance, in its 1936

58

unsafe and unsound bank­

ing practices and violations of law and regulations for which

2k insured banks were proceeded against under subsection (i)
during the year 1936.

We presume that there is legal precedence

for assuming that since Congress has taken no action to repudiate
these characterizations by our Board as being unsafe or unsound
banking practices under the FDI law, that it acquiesces in our
Board’s interpretations of that provision of our law.
However, there is some case law on this subject.

It

was held in Dickenson vs. Cass Co. Bank, (Iowa, 1895) 6^ N.W. 395>
that a showing that the bank was continuing business at a loss
and allowing assets to become of such a character and so scattered
as not to be readily realized on was unsound banking practices.
In the case of Robinson vs. Parker (Wise. 1927) 213 N.W.

653 at p. 655> the Court said:




-5-

”But by far the most dangerous and serious
condition in a bank is met where the capital
is either substantially impaired or entirely
wiped out. Such a condition manifests imminent
danger to depositors, and requires prompt and
efficient action on the part of the banking
department. But even under such a situation
the commissioner, in the exercise of a wise
judgment, in many instances, by his advice and
suggestion, has averted many a disastrous
failure.”
Harley vs. Peoples (Mo.) 9^ S.W. 953.

The Court upheld

the right of the Commissioner to request the change in the directo­
rate of a corporation for unsafe and unsound practices.
In In re S. Lunghino & Sons, 163 N.Y.S. 10, the appellate
court agreed with the lower court that the following were unsafe
and unsound practices:

dealing in purely speculative securities,

running of business as a speculation, placing of inflated valua­
tions on properties owned, the hypothecation of good securities
as collateral for loans, failure of officers to devote sufficient
tin» to banks’ business, and allowing the capital to become heavily
impaired.

The appellate court said that:

”Such were some of the

utterly reckless and irresponsible methods of (bank) at the time
of the refusal of the superintendent to grant (it) permission to
continue its business.”

856,

In Leary vs. Capital Trust C o ., 265 N.Y.S.

the appellate court said that the lower courts refusal to

permit a trust company to invest one-third of its assets in a
lease and furniture and fixtures was not an arbitrary exercise of




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power on the part of the Superintendent.
Title and Mortgage Co. vs. White,

296

See also Harlan Valley

N.Y.S. ij-2^. * See extra

sheet.
However, I am not going to spend much time with you on
the question of what constitutes unsafe or unsound practices.
After all, the Legal Division must largely rely on you examiners
as to what constitutes unsafe and unsound practices.
perts, the technicians, in that respect.

You are ex­

At this point, I want to

refer you to the instructions governing the examination procedure
for the preparation of subsection (i) cases as set out in the
black instruction book.

These instructions have been very care­

fully prepared and no examiner should endeavor to prepare a record
for such a proceeding without being thoroughly familiar with them.
You will observe that we have there defined "unsafe and
unsound practices" as those practices "which are contrary to ac­
cepted banking standards and the continuance of which are hazar­
dous and may result in ultimate loss to depositors, this Corporation,
and its stockholders."

You will further observe that such practices

may consist of either affirmative or negative action, or both.
Needless to say, great caution must be observed in invoking these
proceedings and greater caution must be observed in so denominat­
ing a practice.

We must be sure that the practice complained of

is in fact an unsafe and unsound practice.

For instance, I have a

report on my desk now in which the examiner has charged the bank




-7-

with an unsafe and unsound practice in investing
assets in loans.

38 .6$

of its

He points out, in support of this charge

that the national average of loans to total assets of all insured
commercial "banks is
the "bank has

38 .6$

27 .6$.

I do not "believe that the fact that

of its assets in loans is per se an unsafe or

an unsound practice, nor do I believe that the fact that the
national average of loans to total assets in all insured banks
of 27.6$ proves the charge
In determining whether a particular practice is an
unsafe or unsound practice, consideration must be given to the
statutes under which the bank is operating.

These governing

statutes express the public policy in respect to the operation
of the banks within their purview.

The people of a State, for

instance, have prescribed the powers of its State banks, and
have marked the boundaries of their activities.

This does

not mean, however, that unless a bank violates the governing
law, it cannot be proceeded against in these proceedings.
Congress recognized that a bank may not violate any law yet it
may be engaging in unsafe and unsound practices - because the
law reads - unsafe or unsound practices or violations of law.
Furthermore, a bank may comply with the State law, yet be
engaged in an unsafe and unsound practice.

The bank may

erroneously do that which it is authorized to do when done properly.
(Improvident loans - unwise investments).




It may have the minimum

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capital required under the State law, yet our Board may find
that its capital is inadequate in view of its asset condition,
and that the operation with such inadequate capital is an un­
safe and unsound practice.
control over the FDI law.

Nor does it mean that State statutes
Where the two clash, the FDI law, being

a Federal law, prevails.
For instance, the State statutes prescribe the minimum
capital requirements for a State bank.

Query - is this Corporation

bound by such statutes either in admitting a bank to deposit in­
surance or in continuing its insured status.

The Attorney General

of Iowa, in an opinion of April 28, 19^9, to the State Superin­
tendent of Banking, Mr. Newton P. Black, advised him that this
Corporation could not require Iowa banks to provide capital funds
in excess of the amount required by the State statutes.

His

position, as I read his opinion, is that if a bank has the minimum
capital required under the State statute, this Corporation would
have to find favorably upon the factor of ’’adequacy of its capital
structure" in admitting the bank to deposit insurance; and that an
insured bank meeting the requirements of the State statutes in that
respect could not be proceeded against under subsection (i) for
inadequacy of capital.
tions.

We do not agree with either of his posi­

As stated, in admitting a State bank to deposit insurance

one of the factors to be considered by our Board is the ’’adequacy
of its capital structure". In addition to that, the Board must




-9-

first determine, upon the basis of a thorough examination of
the bank, that its assets in excess of its capital requirements,
are adequate to meet all of its liabilities. If Congress had in­
tended that the Board should be restricted to a consideration of
meeting the State requirements in respect to capital funds, it
could have said so.

This it did not do.

On the other hand,

Congress expressly said our Board should determine the adequacy
of the capital.

Provided, in doing so, it shall not discrimi­

nate against a State bank because its capital is less than the
amount required for admission into the Federal Beserve System.
This proviso means that our Board shall not deny a bank deposit
insurance simply because its capital is less than that required
for admission to the Federal Beserve System.

As we know, the

minimum capital requirements vary in the several states.

To say

that our Board’s discretion is controlled by the State statutes
is to say that our Board must apply a variable standard which
will necessarily result in discrimination.

And it follows, that

our Board Is not bound by the State authority in determining the
adequacy of the capital of an operating insured bank.

OFFICIAL STATEMENT
I shall now briefly discuss the statement of unsafe or
unsound practices which is sent to the Supervising Authority.
The law says that when our Board of Directors finds
that an insured bank Is engaged in unsafe or unsound practices or




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violations of law, it must send a "statement with respect to
such practices or violations of law, for the purpose of
securing the correction thereof."

This statement is the equiva­

lent of a complaint in a civil action or an indictment or in­
formation in a criminal action.

The statement must show a prima

facie case and we must remember that - on him who avers - is the
burden of proof.
is the defendant.

The Corporation is the plaintiff and the bank
The burden of proving its case is on the

plaintiff, the Corporation.

The defendant - the bank - need not

disapprove anything until the Corporation has proven the unsafe
or unsound practice against the bank or the violation of law.
The examination reports are admissible in evidence and their
contents constitute evidence and, in so far as our Board of
Directors is concerned in making its original findings of un­
safe or unsound practices or violations, constitute the only
evidence upon which it preliminarily acts.

The examination re­

ports must, therefore, support each and every charge of unsafe
or unsound practice or violation or, to put it another way,
only unsafe or unsound practices or violations which are thus
established, i. e. proven by the evidence contained in the
examination reports, can be included in the official "statement".
At the hearing, the examiner may enlarge upon the contents of his
examination report from his memory or notes.

However, such testi­

mony is not available for the Board in the first instance in




making

- li­

lts findings.

I point this out merely to emphasize that the

reports themselves must he sufficiently complete with factual
information so that they will afford the basis for and support
the Board*s findings.
The most important thing from your standpoint as
examiners, in the preparation of a case for proceedings under
subsection (1 ), is to have the necessary facts to support each
charge and that such necessary facts are recorded upon the report.
This cannot be over-emphasized.

It is the crucial test by which

your case will either stand or fall.

In this respect, I want to

caution you that conclusions are not facts. I am speaking of facts
supporting the charges, not the conclusions or opinions of the
Field Examiners.

Please be sure that your examiners know the

difference between the two.

Unless they know the difference be­

tween the two, they cannot properly prepare an examination report
to support such a proceeding.

And, of course, their success in

supporting the charges will depend upon the extent of their
knowledge of the facts and their ability and care in recording
them.
We all realize the difficulties confronting the
examiner in acquiring the facts.

He cannot take the time to go

out and inspect the security supporting loans or appraise the
assets or solvency of the borrowers but that is a difficulty
inherent in the proceedings and which he must do his best to




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overcome.

12-

An apology is inadequate to prove a charge.

Please hear in mind that the legal presumptions are all
in favor of the bank.

For instance, the solvency of the

borrower is presumed until the contrary is shown.

The

integrity of the notes and securities is presumed until
the contrary is shown.

A note is presumed to be worth its

face value until the contrary is shown.

Therefore, when

an examiner places a note in a substandard, doubtful or loss
classification, the evidence he has in his possession must
overcome the presumptions mentioned and must affirmatively
show that the classification is proper.

It isn*t sufficient

for the examiner to merely state his opinion in that respect.
His classification expresses his opinion.

What he must put

in the record is the facts on which hie opinion is based
and the probative value of his opinion is measured by his
factual statement in support thereof.

REQUESTED CORRECTIONS
As pointed out, the "statement" is sent to the
Supervising Authority for the purpose of securing the correction
of the unsafe or unsound practices or violations complained

of.

The law then says that, unless the corrections shall be made
within the time specified, our Board "if it shall determine to
proceed further" shall give the banks not less than

30

days

written notice of intention to terminate the status of bank as




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an insured bank and shall fix the time for hearing, etc.”
This, no douht, means that if corrections have not teen
substantially made, the Board should proceed with the termi­
nation.
To determine whether the required corrections have
been made, it is necessary to make a reexamination of the
bank.

This reexamination may be confined to ascertaining

whether the necessary corrections have been made.

I observe,

however, that it is the practice to also make a regular exami­
nation of the bank.

The instructions to examiners contained

in the black book are very comprehensive in this respect and
must, of course, be carefully followed.

The examiner, in the

confidential section of the report, must take up each charge
of unsafe and unsound practice and violation and show in
detail Just what the bank has done by way of correction.
There is one point X want to make and it is this.
X frequently find that the bank in making all or a major
portion of the corrections requested In respect of substandard,
doubtful or loss classifications, winds up on such reexamination
with totals of such classifications larger than tliose on the
previous examinations on which the proceedings were based.

If

the examiners were lawyers, X would say that it looks like they
were building a case.

In other words, on such reexamination,

the examiner reclassifies the assets and gives them a much more




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severe classification than h© did on previous examinations.
It is difficult to prove that the assets have deteriorated
so rapidly between the examinations.

Furthermore, such

reclassification cannot be used In determining either (1)
whether the corrections have been made or (2) the asset
condition of the bank, for the purpose of the pending subsection
(i) proceedings.

Any required correction so broad as to Include

such a prospective classification would be of doubtful legitimacy.
To make myself clear, let me cite an illustration.

Say John

Jones has a $10,000 note in the bank during the examinations
on which the subsection (i) proceedings are based, which note
was not classified.

Such note if classified in the reexamination

should not be considered In determining whether the necessary
corrections have been made.

Clearly, if the Corporation may

reclassify assets more severely upon such reexamination, and
such reclassification Is to be taken into consideration in
determining whether the necessary corrections have been made,
then the bank should in Justice be entitled to a further period
for corrections and the proceedings could run on ad infinitum.
Furthermore - suppose bank says - we have corrected all these
since Examiner was there.

How can we refute it?

The Corporation may, of course, since the examiner Is
in the bank make a general regular examination at the time.
However, proper segregations should be made in the white section




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of the report to show the portions thereof which pertain
to the subsection (i) proceedings and the portions which have
no beaming thereon.

In fact, the reports should be so drawn

that a separation may readily be made of the pertinent portions
of the report from the impertinent portions thereof.

I am always

fearful that some good lawyer will object to the introduction
of our reexamination report on the ground that it contains con­
siderable material which is immaterial to the proceedings' and
prejudicial to the case.

I am going to go into a huddle with

your Chief, Col. Sailor, about changing our instructions in this
respect.

I want you gentlemen also to give it some thought.

The

Job is to do it in a way least difficult for the examiners.
In summary.

These proceedings were designed by Congress

to provide means by which insured banks may be compelled to con­
duct their affairs in a safe, sound and legitimate manner.

The

power carries with it an opportunity and, of course, a corres­
ponding responsibility.

The opportunity to confine bank

operations within proper banking channels and thus to provide
the country with a strong and sound banking system - and the
concomitant responsibility of so doing.

The power must, of

course, be used Judicially and impartially.

Let us remember

that the letter killeth - but the spirit giveth life.

In

instituting the proceedings, be sure of three things - (1 ) that
the practice complained of is an unsafe or unsound practice




-1 6 or a violation of law; (2) that the facts support the charge;
and (3) that the facts are recorded in the examination report.
In conclusion, let me compliment you examiners on
the splendid Job you have done in the preparation of reports
for subsection (i) proceedings.

You have exercised skill and

care, and have meticulously followed instructions in that
respect.