4000 - Advisory Opinions
Illustrative Violation of Section 19 of the FDI Act
March 9, 1993
Joseph J. Sano, Deputy Regional Counsel
This is in reply to your February 26, 1993 letter to Senior Attorney Phillip Houle which seeks to withdraw the above-reference application under section 19 of the Federal Deposit Insurance Act ("Act"), 12 U.S.C. 1829 ("section 19") regarding *** ("Bank") and Mr. [X].
As you are aware, section 19 prohibits any person convicted of a crime involving dishonesty or breach of trust from engaging in any of the following activities in connection with an insured depository institution without the prior written consent of the Federal Deposit Insurance Corporation ("FDIC"): (1) becoming or continuing as a institution-affiliated party; (2) directly or indirectly controlling or owning any insured depository institution; or (3) otherwise participating directly or indirectly in the conduct of the affairs of an insured depository institution.
The provisions of section 19 are implemented by operation of law. Thus, when facts arise that would come within the parameters of section 19, such as a conviction for a crime of dishonesty or breach of trust, there is an automatic violation of section 19. When such a violation occurs, the person involved must get the sponsoring insured depository institution to file a section 19 application on that party's behalf with the FDIC. Further, the violation continues until either the section 19 application is approved by the FDIC or the activity which comes within the parameters of section 19 ceases.
The FDIC has grounds to believe that Mr. [X] comes within the parameters of section 19(a)(1)(A). First, Mr. [X] meets the test of directly or indirectly controlling or owning any insured depository institution. In order to come within the definition of control, a person must have "the power, directly or indirectly, to . . . vote 25 per centum or more of any class of voting securities of any insured depository institution." 12 U.S.C. 1817(j)(8)(B).
Based upon information presently available to the FDIC, it appears that Mr. [X] owns approximately 26% of the common voting shares of the Bank's holding company and 100% of the holding company's preferred non-voting shares. In addition, Mr. [X] is the primary beneficiary of a family trust established by his deceased first wife which owns another approximately 60% of the common voting shares of the Bank's holding company. Under the terms of the trust, Mr. [X] has the authority to replace trustees and recently named his current wife as co-trustee. Therefore, Mr. [X] controls 86% of the voting stock of the holding company. The holding company, in turn, owns 85.5% of the common shares of the Bank. Since the holding company is a one-bank holding company and since the holding company owns 85.5% of the outstanding shares of the Bank, Mr. [X] indirectly owns or controls approximately 74.3% of the Bank's shares of stock.
Second, as a controlling shareholder, Mr. [X] comes within the definition of "institution-affiliated party". "Institution-affiliated party" is defined in section 3(u) of the Act, 12 U.S.C. 1813(u), as "[a]ny director, officer, employee, or controlling shareholder of, or agent for, an insured depository institution." (Emphasis supplied.)
Finally, by voting his shares of stock, Mr. [X] is participating directly and indirectly in the conduct of the affairs of the Bank.
In light of the conclusions that Mr. [X] is a controlling shareholder of the Bank, is an institution-affiliated party, and is participating in the conduct of the affairs of the Bank, the FDIC finds that Mr. [X] is in violation of section 19. Further, as long as Mr. [X] remains a controlling shareholder of the Bank, he continues to be in violation of section 19.
Due to the continuing nature of the violation, and the possibility that divestiture of his stock will not occur immediately, it is incumbent upon Mr. [X] to take steps immediately to cease participation in the affairs of the Bank. This can be accomplished by placing the voting shares Mr. [X] personally holds in an escrow account or a trust managed by an independent party who is subject to review by the Regional Director. With respect to those shares of the holding company stock held in the [Y] Trust, arrangements should be made to have such shares placed under the management of an independent trustee, who is also subject to the prior review of the Regional Director.
You should be aware that violation of section 19 by an individual and/or a depository institution is punishable by imprisonment for up to five-years and/or a fine of up to $1,000,000 for each day that a violation continues. It is recommended that Mr. [X] reinstate his application promptly or the FDIC will consider appropriate administrative action against Mr. [X] and/or the Bank.
Further, please provide us with the information requested in Mr. Houle's February 9, 1993 letter within 21 days from the date of this letter. We understand that you have represented Mr. [X] for many years and that you have voluminous files relevant to our request on the information sought.
Finally, since Mr. [X] has indicated he is attempting to resolve this matter by divesting his interest in the Bank, you should be aware that the Change in Control Act, 12 U.S.C. 1817(j), prohibits any person from acquiring control of any insured depository institution without the appropriate Federal banking agency being given sixty days' prior written notice of such proposed acquisition. Given the size of Mr. [X]'s and his family trust's holdings in the Bank, any buyer probably would be required to submit an application to the FDIC under the change-of-control provisions of section 7(j) of the Act, 12 U.S.C. 1817(j), before consummating any transfer, even if section 19 were not involved here.
If you wish to discuss this matter further, please call Senior Attorney Michael Tisci at (415) 546-1810.