Proposed Legislation Expands Enforcement Authority Against Bank Officers, Directors

The RECOUP Act (S.2190), which passed the Senate Banking Committee in June by a bipartisan 21-2 vote, would greatly expand the federal bank agencies’ authority to remove and permanently ban officers from the banking industry if it becomes law.

While styled as a bill to hold executives accountable for conduct that leads to a bank failure – a direct legislative response to the failures this spring – the act also includes changes to the agencies’ long-standing prohibition authority that would permit far more flexibility as to how and when they bring these cases. Importantly, these aspects of the bill would not only affect directors and officers of banks that are likely to, or have, failed.

Current law allows federal banking agencies to prohibit a director or officer from serving in the banking industry only if they satisfy a narrow set of elements. Because the consequences of this action are very harsh – it is known as the “death penalty” within the industry – the legal bar for these elements is appropriately high. The act would change these standards, and who is subject to a potential industry ban, in a few important ways.

The act creates a subset of prohibition actions specifically against “senior executives.” This newly defined term refers to individuals who have “oversight authority for managing the overall governance, operations, risk, or finances” of a bank or holding company. It includes the president, CEO, chief operating officer, chief financial officer, chief risk officer, chief legal officer, board chairman and any inside director.

The act would allow agencies to prohibit a “senior executive” from working in the industry for a failure to “carry out the responsibilities” for governance, operations, or risk or financial management. In addition, the act would allow agencies to prohibit a “senior executive” on a showing that he or she demonstrated “gross negligence” in the performance of his or her duties. Most importantly, these phrases and standards are not defined by the act. What may constitute “gross negligence” under the act could be interpreted in a variety of ways depending on the subject matter; if a state law standard is utilized, it may differ from state to state.

The existing statute has been subject to decades of litigation in administrative and federal courts. Through this process, the law’s terms have taken on meaning, as precedent cases provide useful guideposts for evaluating individuals’ conduct. Unlike the existing standards, however, the act’s new standards will be left in large part to regulatory discretion. The agencies will have substantial room to shape the meaning of these terms through enforcement actions.

The existing law also allows for the immediate removal of individuals from their positions in certain limited circumstances, such as intentional violations of the Bank Secrecy Act or conviction for certain criminal offenses. The RECOUP Act would add three new circumstances that the agencies could rely on to remove a “senior executive:”

• Grossly negligent, reckless or willful breaches of fiduciary duty.
• Failure to “appropriately implement” financial, risk or supervisory reporting or information systems or controls.
• Failure to oversee operations of such a system or controls.

As with other new terms, “appropriately implement” and “oversee” are not further defined in the act and would similarly be left to regulatory discretion, applied through individual removal actions.

For these reasons, the RECOUP Act would significantly extend the range of conduct subject to prohibition and removal actions. The high bar for taking these actions may be meaningfully lowered, facilitating the agencies’ ability to threaten these actions for alleged misconduct. Even if the action is not ultimately successful or if a banker wants his or her day in court to challenge an agency action, the public notice of a proposed prohibition could effectively end a banker’s career. The threat of a prohibition may also provide the agencies with additional negotiating leverage.

A lowered statutory threshold may also act as a catalyst for more agency investigations. Even if a bank agency brings a lesser action or no action, these sprawling investigations consume a vast amount of bank resources and can drain the attention of a bank’s leadership for years.

Importantly, these statutory changes impact potential cases against directors and officers of any bank – not just failed banks – despite the genesis for the act being the swift downfall and closure of several regional banks and the public outcry focused on those banks’ executives.

The act’s focus on individual accountability is not altogether new. Federal regulators, including the bank agencies, have noted the potential for enforcement actions against bank directors and officers with increasing frequency. For example, the Office of the Comptroller of the Currency highlighted that the agency may bring enforcement actions against individuals who “caused or contributed” to persistent weaknesses at a bank in its recently issued appendix to its enforcement action policy. This inclusion signals that the OCC continues to actively consider whether individuals should be held accountable for a bank’s deficiencies when it pursues actions against the institution.

While it remains to be seen whether the RECOUP Act will be signed into law, all bank directors and officers should be aware of the potential changes and understand how their decisions and actions may be viewed by their regulators in the future.