Appeal of 12 CFR 359 Determination—Golden Parachute and Indemnification Payments Regulation (Second Quarter 2017)
A bank supervised by the Office of the Comptroller of the Currency (OCC) appealed to the Ombudsman the supervisory office's (SO) determination that a proposed payment to the bank's former institution-affiliated party (IAP) does not meet the definition of a "golden parachute payment" under 12 CFR 359.1(f). The term "institution-affiliated party" includes any director, officer, employee, or controlling stockholder of an insured depository institution (other than a bank holding company or savings and loan holding company).
The SO concluded the proposed payment is not a golden parachute because it failed to satisfy the third criterion under the definition at 12 CFR 359.1(f)(1), which addresses the timing of the termination of the IAP. That is, the SO concluded that the payment to the IAP would not be a golden parachute payment because the IAP was not terminated when the bank was in troubled condition, nor was the IAP terminated in contemplation of the bank being determined to be in troubled condition.1
The bank disagreed with the SO's conclusion and argued that the primary issue is the SO's interpretation of the "in contemplation of" clause in the regulation. The appeal asserted that the bank's board terminated the IAP's employment "in contemplation of" a troubled condition status. In support of this assertion, the bank cited a 2016 letter from the SO (2016 letter) warning the bank that the OCC has the authority to appoint a receiver/conservator within 30 days if the bank's violation of 12 USC 71a remained uncorrected, and advising the bank that the OCC has the authority to issue a cease-and-desist order or formal agreement under 12 USC 1818(b)(8), if component rating deficiencies were not corrected. In addition, the 2016 letter informed the bank that the full scope examination would begin nine months earlier than planned. The appeal argued that the bank's board of directors terminated the IAP's employment because the board interpreted the SO's statements in the 2016 letter as "in contemplation of" troubled condition status.
Finally, the appeal argued that the bank was designated as being in troubled condition as of the date of the appeal and, as a result, the bank is prohibited by applicable statute from paying the IAP the proposed payment because it would be "received on or after an institution becomes troubled" and it would be a prohibited golden parachute payment.
The Ombudsman conducted a comprehensive review of information provided by the bank and the SO, and relied on the following statutes and regulations as standards:
- 12 USC 1828(k), "Authority to regulate or prohibit certain forms of benefits to institution-affiliated parties"
- 12 CFR 359, "Golden parachute and indemnification payments"
- 12 CFR 5.51, "Changes in directors and senior executive officers of a national bank or Federal savings association"
- 12 USC 1818(b), "Cease and desist proceedings"
- 12 USC 71a, "Number of directors; penalties"
- 12 CFR 4.6, "Frequency of examination of national banks and Federal savings associations"
Although each of these standards was applied in some respect in the Ombudsman's determination, the primary standards relied upon were in 12 USC 1828(k), 12 CFR 359, and 12 CFR 5.51.
The Ombudsman concurred with the SO that the proposed payment to the IAP does not meet the definition of a golden parachute payment under 12 CFR 359.1(f), therefore, the golden parachute restrictions do not apply. 12 USC 1828(k) authorizes the Federal Deposit Insurance Corporation (FDIC) to prohibit or limit, by regulation or order, any golden parachute payment or indemnification payment. 12 CFR 359 is the implementing regulation and includes three criteria for a payment to be a golden parachute under the definition at 12 CFR 359.1(f)(1).
First, the payment must be contingent upon the termination of the IAP's primary employment. Second, the payment must be received on or after the institution is in troubled condition (or satisfies one of the other enumerated conditions in the regulation). Third, the IAP must be terminated while the institution is in, or in contemplation of, troubled condition (or satisfies one of the other enumerated conditions). The Ombudsman agreed that the proposed payment failed to satisfy the third criterion because the IAP was not terminated while the bank was in troubled condition, nor was the IAP terminated "in contemplation of" the bank being designated in troubled condition by the OCC.
The Ombudsman determined the bank could not have acted "in contemplation of" a troubled condition designation from the OCC when it terminated the IAP. 12 CFR 5.51 defines when a national bank or Federal savings association is deemed to be in a troubled condition. The condition of the institution at the time of the termination of the IAP, as determined by the appropriate federal banking agency, is critical to the golden parachute determination. Under 12 CFR 5.51(c)(7), a national bank or Federal savings association is in troubled condition if it: (i) has a composite rating of 4 or 5 under the Uniform Financial Institutions Rating System; (ii) is subject to a cease-and-desist order, a consent order, or a formal written agreement, unless otherwise informed in writing by the OCC; or (iii) is informed in writing by the OCC that, based on information pertaining to such national bank or Federal savings association, it has been designated in "troubled condition" for purposes of this section.
The Ombudsman determined the bank did not have any form of notice of troubled designation from the SO at that time, and the deficiencies yielding the troubled condition determination had not yet manifested, been known or been verified at the time of the IAP's termination. The SO did not determine the bank was in a troubled condition until after the start of the subsequent examination of the bank, and nearly two months after the board terminated the IAP.
The Ombudsman determined that the 2016 letter did not support the bank's claim that the IAP's employment was terminated "in contemplation of" the SO designating the bank in troubled condition, as defined in 12 CFR 5.51(c)(7). The Ombudsman made the following determinations:
- Composite Rating
The Ombudsman determined the facts did not support that the bank terminated the IAP "in contemplation of" the SO downgrading the bank's composite rating to a 4 or 5, one of three criteria for a troubled condition designation. The 2016 letter communicated that the bank's composite rating remained a 2 and the bank's financial condition was generally sound, changed the management component rating from a 2 to a 3, and maintained a 3 rating for earnings. When the SO subsequently downgraded the bank's composite rating approximately two months later, the composite rating was changed to a 3 rather than a 4 or 5.
- Subject to a Formal Written Agreement
The Ombudsman determined the facts did not support that the bank terminated the IAP "in contemplation of" a formal written agreement from the OCC, a second criterion for a troubled condition designation. The 2016 letter did not provide the bank notice that it would be subject to a cease-and-desist order, consent order, or formal written agreement triggering troubled condition. The bank entered into a formal agreement with the OCC several months after the IAP was terminated.
In regard to the warning in the 2016 letter referencing OCC's statutory authority under 12 USC 1818(b)(8), the Ombudsman determined that the OCC routinely cites this language in any examination report where an institution has received a less than satisfactory (3) rating in asset quality, management, earnings, or liquidity. The Ombudsman determined that the 2016 letter did not indicate that the bank was engaged in unsafe or unsound practices or that a cease-and-desist order or formal agreement was being contemplated for the bank. The 2016 letter served as a notice that if the bank failed to correct the deficiencies in management and earnings, the OCC may deem the bank to be engaging in practices statutorily defined as unsafe or unsound, which provides the OCC authority to commence cease-and-desist proceedings pursuant to 12 USC 1818(b). This statutory warning language ensures that the bank understands the seriousness of the deficiencies, the potential consequences, and the need for the institution to direct its efforts at curing the noted deficiencies as soon as practicable.
- Informed in Writing of Troubled Condition
The Ombudsman determined the facts did not support that the bank terminated the IAP "in contemplation of" a troubled condition designation in writing from the OCC. The 2016 letter did not contain any notification or warning language under 12 USC 1831i and/or 12 CFR 5.51, informing the bank that a troubled condition designation was forthcoming or imminent. The Ombudsman concluded the 2016 letter was to communicate to the bank the identified deficiencies needing correction, including a downgrade in management, high management turnover and board resignations, and the 12 USC 71a violation.2 The Ombudsman determined that if the SO had intended to put the bank on notice in the 2016 letter of an impending troubled condition designation, then the SO would have done so in writing and clearly, as it did several months after the 2016 letter was issued.
In regard to the warning that the OCC may appoint a receiver or conservator, the only context in which this was mentioned in the 2016 letter was in reference to the potential consequences of failure to correct the violation of 12 USC 71a. The Ombudsman determined the violation language was taken almost verbatim from the statute and is routinely used when the OCC cites a violation of that statute. Further, the bank corrected the violation within the 30-day timeframe. The Ombudsman also determined that a warning of consequences resulting from a bank's failure to address a violation may result in the appointment of a conservator or receiver, is separate and distinct from a warning or notification, under 12 USC 1831i and 12 CFR 5.51, that troubled condition either exists, or is imminently likely to exist.
With respect to the accelerated examination schedule, the Ombudsman determined that the SO's moving up the full scope examination from its 18-month supervisory cycle is not indicative of the OCC contemplating a troubled condition designation. 12 CFR 4.6 requires the OCC to change the bank's supervisory cycle to a 12-month period if the management rating is downgraded to a 3, as was the case at the bank. Furthermore, the change of an examination schedule is not a trigger for a troubled condition designation under 12 CFR 5.51.
With respect to the appeal argument regarding application of the statutory language, the Ombudsman determined the statute itself does not prohibit the payment of golden parachutes. Rather, the statute authorizes the FDIC to "prohibit or limit, by regulation or order, any golden parachute payment." The statutory definition does not distinguish between IAPs terminated before or after any of the enumerated events. Through regulation, the FDIC narrowed the types of payments that constitute golden parachute payments and are therefore prohibited or restricted. The FDIC regulation, 12 CFR 359.1(f)(l)(iii), confirms that the prohibition applies only if an IAP is terminated when a bank is troubled (or satisfies one of the other enumerated conditions) or "in contemplation of" troubled condition, as determined by the appropriate federal banking agency. If an IAP is terminated when a bank is not in troubled condition, and is not terminated in contemplation of a troubled condition designation, payments to the IAP are not golden parachutes, even if paid after the bank subsequently is in troubled condition. Based on the facts and circumstances of this case, the Ombudsman determined the proposed payment is not a golden parachute.
2 12 USC 71a requires a national bank to have at least five directors and provides that if a national bank violates this requirement, and continues such violation after a 30-day notice from the OCC, the OCC may appoint a receiver or conservator.