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Civil Money Penalties, Removal and Prohibition Actions, and Restitution Orders The Requirement for a Specific Finding of Culpability/Scienter



One of the elements of actionable misconduct for the assessment of a Second Tier civil money penalty action under section 8(i)(2)(B) of the Federal Deposit Insurance Act ("FDIA") is that respondent "recklessly" engaged in an "unsafe or unsound practice" or breached a "fiduciary duty."

The first question presented is whether the culpability factor embodied by the term "recklessly" applies to conduct that constitutes a "breach of fiduciary duty," or whether such term is only applicable to conduct that constitutes an "unsafe or unsound practice." A literal reading of the organizational structure of the statute - particularly the utilization of separately identified numbers and letters to designate the different components reflected therein, supports a first-glance conclusion that the term "recklessly" modifies only "unsafe or unsound practice" and that it does not relate to conduct that constitutes a "breach of fiduciary duty." If such conclusion is correct, a Second Tier civil money penalty of $25,000 per day can be imposed for each day any breach of fiduciary duty continues, regardless of whether the breach occurred as a result of recklessness or through simple negligence or oversight. On the other hand, a different result is required if the overall scheme of the multi-tiered penalty structure in the statute is examined in the context establishing graduated levels of more severe penalties for escalating levels of culpable misconduct. The latter interpretation of section 8(i)(2) is more appropriate and consistent with the legislative history and purpose of the establishment of a multi-tiered system of civil money penalties by Congress.

The second question is: What constitutes conduct (whether an "unsafe or unsound practice" or a "breach of fiduciary duty") which is engaged in or committed "recklessly" within the meaning of section 8(i)(2)(B)? There are no reported cases that interpret the term "recklessly" as used in section 8(i)(2) [or its predecessor section 18(j)(4)] of FDIA. Virtually the same concept, however, is employed in section 8(e) of FDIA pertaining to removal and prohibition actions. Hence, the cases and authorities interpreting that statute are instructive.

Removal Order ["Continuing Disregard" for Bank Safety] - Section 8(e)of FDIA

One of the elements of a removal action under section 8(e) is that the actionable misconduct reflects either personal dishonesty or a "continuing or willful disregard" of the safety of the bank. The FDIC Board and reviewing appellate courts have consistently held that the standard of "continuing disregard" in section 8(e) is tantamount to "recklessness" and "heedless indifference" evidencing a "deliberate" course or pattern of misconduct which exposes the bank to a known hazard or risk of serious harm. See, Brickner v. FDIC, 747 F.2d 1198, 1203 (8th Cir. 1984), and Recommended Decision of ALJ Cross in In the Matter of *** Bank, FDIC Enf. Dec. ¶5069 at A-936, 946-49. The following excerpt from the latter opinion captures the essence of the standard of conduct contemplated by section 8(e):

Congress endorsed the new standard [of "willful or continuing disregard"] and was fully aware that it allows agencies the opportunity to move against individuals who may not be acting in a fraudulent manner [i.e., with "personal dishonesty"], but who are nonetheless acting in a manner which threatens the soundness of their institutions.

The willful or continuing disregard criteria [in section 8(e)] were adopted with the idea that these two gauges of conduct would encompass those practices which though not fraudulent were deliberate and effectuated in the face of an inauspicious outcome or were knowingly repeated over a period of time and threatened the safety or soundness of the bank ... continuing [disregard] conduct is that conduct which is voluntarily engaged in over a period of time with heedless indifference to the prospective consequences. Id. at A-947-48. [Emphasis added.]

In Brickner, the Eighth Circuit cited the FDIC construction of the "continuing disregard" in its holding that such standard of conduct is the equivalent of "recklessness:"

We also agree with the agency's contention that although "continuing disregard" may require some showing of knowledge of wrongdoing, it does not require proof of the same degree of intent as "willful disregard." [Cited footnote states in part: The FDIC concedes that Congress intended some sort of scienter requirement, and contends that the "continuing disregard" standard refers to a mental state short of "willfulness" and akin to "recklessness." Id. at 1203 fn. 6 [Emphasis added.]

The Ninth Circuit's discussion of the element of culpability in Kim v. OTS, 40 F.3d 1050, 1054 (9th Cir. 1994) is probably the most comprehensive:

In Seidman v. Office of Thrift Supervision, 37 F.3d 911 (3rd Cir. 1994), the Court of Appeals for the Third Circuit held that, before the OTS could impose [a removal order] against a banker, it had to prove by substantial evidence that ... [the offending person's conduct] "is accompanied by a culpable state of mind." [Citations omitted and emphasis added.]

Similarly, in Doolittle v. National Credit Union Admin., 992 F.2d 1531 (11th Cir. 1993), the Court of Appeals for the Eleventh Circuit held that "willful or continuing disregard" under section 1818(e)(1)(c)(ii) "must have the same magnitude as personal dishonesty." 992 F.2d at 1539 (citing decisions from the Fifth, Eighth, and D.C. Circuits). Accord, Oberstar v. Federal Deposit Ins. Corp., 987 F.2d 494, 502 (8th Cir. 1993) ("The most severe sanction of a Prohibition Order may only be imposed if the misconduct was more than inadvertent or technical," i.e., "the FDIC ... must prove ‘some scienter' to establish culpability."). Cf., Grubb v. Federal Deposit Ins. Corp., 34 F.3d 956,961 (10th Cir. 1994) (under the FDIC's interpretation of its own regulations, "continuing disregard" requires a showing of at least "heedless indifference to the prospective consequences").

These decisions all hark back to the Eighth Circuit's seminal opinion in Brickner v. Federal Deposit Ins. Corp., 747 F.2d 1198 (8th Cir. 1984). ... While acknowledging that "willful disregard" required a showing of a higher degree of culpability than "continuing disregard," the court noted that "some sort of scienter" was nevertheless required for the latter, i.e., "a mental state ... akin to ‘recklessness.'" Id. at 1203 & n. 6.

Based upon the foregoing analysis of prior decisions in the D.C., Third, Fifth, Eighth, Tenth and Eleventh Circuits, the Ninth Circuit in Kim held that in order to prove the required element of "continuing disregard" [i.e., a mental state akin "recklessness"], the agency "must show a degree of culpability well beyond mere negligence, i.e., there must be a showing of scienter." Id. at 1054. [Emphasis added.]

Thus, in order for conduct to rise to the level of that which is engaged in recklessly, it must be shown that the perpetrator had knowledge of wrongdoing and a conscious mental state or scienter which evidenced a heedless indifference to a known hazard or serious risk of loss or other harm to the Bank. There must be a showing of a conscious culpability that is significantly more egregious than mere negligence.

There must be knowledge or an awareness of wrongdoing. An allegation that the alleged offender "should have known" will not suffice as a substitute for the required showing of scienter. [It may also be necessary to determine whether the regulatory agency has employed an unorthodox interpretation of any term or condition relative to the conduct in question.1

Even assuming, arguendo, that the loans were made or caused by the alleged offender with knowledge of wrongdoing, there must also be a showing that the offending conduct exposed the Bank to a known or obvious risk of loss or other harm with heedless indifference of the prospective consequences of such risk. If the actions (or inactions) of the alleged offender did not result in or threaten any increase in the amount or degree of risk of loss to the Bank, such conduct cannot be deemed to have been engaged in "recklessly" within the meaning of section 8(i)(2)(B) of FDIA.

The element of added risk of loss or harm to the Bank due to the alleged misconduct proved to be the "Achilles Heel" of a very protracted and bitterly contested enforcement action initiated by the OTS in Kaplan v. Office of Thrift Supervision, 104 F.3d 417 (D.C. Cir. 1997):

[W]e do not think OTS has established that Kaplan breached any standard of care that could be deemed to apply to his behavior. Whether one speaks of a breach of fiduciary duty or an unsafe or unsound practice, the common element that OTS must show is behavior that creates an undue risk to the institution. See e.g., Grahan v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963); In Re Seidman, 37 F.3d 911, 928-29 (3rd 1994) [additional citations omitted] Any such risk must of course be foreseeable. That is not to say that the exact series of events that cause injury or loss to the institution must be perceived or even perceivable, but surely no director can be faulted [or held liable] for [conduct] that does not pose an increased risk of some kind to the financial institution.
* * *
The acting director's opinion, although based upon unreasonable judgments which could be characterized as arbitrary and capricious, is probably better described as lacking substantial evidence - in our view, any evidence - that Kaplan [engaged in actionable misconduct.] Indeed, OTS' position in this case comes perilously close to treating those who serve on the boards of both savings and loans and their parents as absolutely liable in the event any transaction between the two injures the savings and loan - which is a backhanded way to prohibit such dual service. This will not do as a matter of administrative law. But whatever OTS' object, the acting director as we read the record, has made Kaplan something of a scapegoat. See, Wachtel v. OTS, 982 F.2d 581, 586 (D.C. Cir. 1993).

Accordingly, actions and conduct (regardless of whether they are characterized as unsafe or unsound practices, or breaches of a fiduciary duty) are not actionable for the assessment of a Second Tier civil money penalty if they did not result in or otherwise create an additional undue risk of loss or harm to the Bank. There is no evidence in the record of this action which supports such a finding.

Restitution Order ["Reckless Disregard" of Law] - Section 8(b)(6) of FDIA

The following interpretation of the term "reckless disregard" as used in section 8(b)(6) of FDIA by the Office of Thrift Supervision was approved by the Ninth Circuit Court of Appeals in Simpson v. OTS, 29 F.3d 1418 (9th Cir. 1994):

In determining that Simpson acted with reckless disregard, the Director looked to the meaning of "reckless" in other statutory schemes. For purposes of the [restitution statute], the Director concluded that reckless disregard for the law exists when:

(1) the party acts with clear neglect for, or plain indifference to, the requirements of the law, applicable regulations or agency orders of which the party was, or with reasonable diligence should have been, aware; and (2) the risk of loss or harm or other damage from the conduct is such that the party knows it, is so obvious that the party should have been aware of it. [Id. at 1425; emphasis added]

The second element of "reckless disregard" conduct in Simpson clearly encompasses the notion of a deliberate course of conduct which is engaged in notwithstanding a known risk of loss or harm to the bank. Thus, in order to determine that "recklessness" exists, there has to be a serious hazard or risk of loss or harm that is either known (or with reasonable diligence should have been known) which is ignored with heedless indifference to the prospective consequences of such hazard or risk of harm. It is therefore impossible to act "recklessly" or with "reckless disregard" if there is no known or obvious hazard or risk of harm. Conduct may be improper (or even illegal), but it is not recklessly engaged in unless the conduct also unduly exposes the bank to a known or obvious risk of financial loss or other undue harm.

Other Cases to Review

Doolittle v. NCUA, 992 F.2d 1531 (11th Cir. 1993)
Rapaport v OTS, 59 F.3d 212 (D.C. Cir. 1995)

1. Even though the term "accommodation loan" is not used in any statute or regulation administered by the FDIC, the admonishments of the D.C. Circuit in Wachtel v. OTS, 982 F.2d 581 (D.C. Cir. 1993) are nevertheless instructive in respect of the FDIC's interpretation of that term. See, 982 F.2d at 582 ("We reject the OTS's rather bizzare [sic] construction of the statute."); 982 F.2d at 585 ("[T]he agency's construction is capricious."); and 982 F.2d at 586 ("OTS's efforts in this case ... strike us as attributable not so much to creative lawyering as to excessive zeal.")


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