10 Things Non-Bank Lawyers Need to Know about Banks

There are a handful of lawyers in Tennessee who call themselves “bank lawyers.” For everyone else, here are 10 things that you need to know about banks.

Number 10: Banks are highly regulated and supervised deposit-taking and lending companies. To be able to call itself a bank, a company must both lend money and take deposits that are withdrawable upon demand (“demand deposits”). A company that just lends money is not a bank and cannot use the word “bank” in its corporate name in Tennessee without the prior consent of the Tennessee Commissioner of Financial Institutions. Banks can be chartered under state or federal law. A bank that is chartered under federal law is called a “national bank,” and its regulator is the Office of the Comptroller of the Currency, a division of the United States Treasury. A bank that is chartered under state law is supervised by the state’s bank regulatory agency (in Tennessee, the Department of Financial Institutions) and either the Federal Deposit Insurance Corporation (FDIC) or the Federal Reserve System (the Fed) through the Federal Reserve Bank of the district in which the bank is located. In Tennessee, banks west of the Tennessee River that are Fed-member banks are supervised by the Federal Reserve Bank of St. Louis, and banks east of the River, by the Federal Reserve Bank of Atlanta. Typically, the location of the legal main office of the bank determines the district within which the bank is supervised, even if most of the branches of the bank are located in other districts or outside the state. The deposits in all banks in Tennessee are insured by the FDIC up to the legal maximum, which is now $250,000 per account in each bank. Banks that are deemed to be in “troubled condition,” whether or not they are national banks or banks that are members of the Fed, will also have the FDIC as a “back-up” regulator.

Number 9: Banks are examined periodically by their regulators. Reports of examination and other communications from a bank’s regulators are confidential and remain the exclusive property of the agency, not the bank. In litigation, if a party seeks to produce a bank’s report of examination or other supervisory communications, certain procedural safeguards must be employed. Confidential supervisory information owned by the FDIC is protected under Part 309 of the FDIC Rules and Regulations, 12 C.F.R. Part 309. The privileges that apply to FDIC records include, but are not limited to (i) the bank examination privilege (In re Subpoena Served upon the Comptroller of the Currency, 967 F. 2d 630 [D.C. Cir. 1992]); (ii) the government deliberative privilege (Environmental Protection Agency v. Mink, 410 U.S. 90 (1973); (iii) the law enforcement privilege (In re Department of Investigation of the City of New York, 856 F. 2d 481 [2d Cir. 1988); (iv) the attorney-client privilege (Upjohn Co. v. United States, 449 U.S. 383 [1981]); and protected privacy interests of individuals (see Privacy Act of 1974, 5 U.S.C. § 552a).

The FDIC will not release exempt records, as defined in section 309.5, for use in third-party litigation unless there is a clear showing “that the production is in the best interest of justice.” 12 C.F.R. §309.6(b)(8). In Tennessee, the party seeking to produce exempt records should contact the Legal Division of the Memphis Area Office of the FDIC, 5100 Poplar Ave., Suite 1900, Memphis, TN 38137. Likewise, a party seeking to produce exempt records belonging to the Tennessee Department of Financial Institutions, the OCC, or the Fed, should contact the legal departments in those agencies for guidance on how to proceed. See also Exemption 8, Freedom of Information Act Guide [5 U.S.C. § 552(b)(8) (2000)]; Tenn. Code Ann. §45-2-1603; and SR 97-17 (SUP), June 6, 1997.

Number 8: There are dozens of consumer protection laws and regulations on the books. From the Real Estate Settlement Protection Act (RESPA) to the Fair Debt Collection Practices Act, Congress and the states have sought to provide safeguards for consumers of financial products and services. All banks are subject to these consumer protections and spend a great deal of money being sure that their policies and procedures designed to comply with these strict requirements are effective. Banks are examined by their state and/or federal regulators for compliance. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which created a new, federal consumer watch-dog bureau, banks expect to see stepped-up scrutiny, if not by the Consumer Financial Protection Bureau (“CFPB”), then by its prudential regulators.

For example, the “alphabet regs” promulgated by the Federal Reserve System run from Reg A, which governs extensions of credit by Federal Reserve Banks through, at this writing, proposed Reg YY, Restoration Plans and Credit Exposure Reports. Among the alphabet regs are no fewer than 15 that directly impact consumers. Coupled with regulations promulgated by other agencies, there is no lack of rules with which a bank must comply, most of which are costly in terms of both capital outlay for compliance and the human resources required. Regulations are designed to protect consumers, but they are not free.

Number 7: Banks that are in troubled condition, as defined by Part 359 of the FDIC Rules and Regulations, may not pay departing executives or employees golden parachute payments, regardless of the terms of any employment agreement between the parties. Banking regulators have begun requiring language in employment agreements to that effect, as well as a “claw back” provision that confirms that a bank or its successors in interest retain the right to demand the return of any golden parachute payments from an executive in the event that a bank regulator determines that the executive has committed any fraudulent act or omission, breach of trust or fiduciary duty or insider abuse with regard to the bank that has had or is likely to have a materially adverse effect on the bank; the executive is substantially responsible for the insolvency of the bank or its troubled condition; or has materially violated any applicable banking laws or regulations that has had or is likely to have a materially adverse effect on the bank. Banks can also force the return of performance bonuses under these types of circumstances.

Number 6: Banks are risk-averse. Litigators will be heroes to their bank clients if they can find ways to avoid litigation and keep any controversy out of the public domain. With the general public already wary of the condition of the banking industry because of the national media’s attention of the Wall Street investment banking firms, mediation, arbitration, or quiet settlements are usually preferable to front page law suits.

Number 5: A public source of information about the condition of a bank is a report of its “Texas ratio.” This is a measure of how likely a bank is to be impaired by its troubled loan and foreclosed real estate portfolios. The Texas ratio was developed by RBC Capital Markets. The ratio is calculated by dividing the value of a lender’s non-performing assets, including non-performing loans and foreclosed real property, by the sum of its tangible common equity and allowance for loan and lease losses. In the 1980’s RBC noticed that banks that tended to fail had Texas ratios of approximately 1:1 or 100 percent or more. The rule of thumb is that a Texas ratio over 100 percent denotes a bank in troubled condition. This doesn’t mean that the bank will fail, but it is one indicator of its financial condition. The Texas ratios of all insured depository institutions in the United States can be found in the Internet, or for the hands-on types, a bank’s quarterly report of condition (commonly called a “Call Report”) can also provide the numerator and denominator.

A bank’s Call Report can be accessed through the FDIC’s website, www.fdic.gov. Regulatory ratings — called CAMELS ratings — are not public information. CAMELS is an acronym for Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risks. CAMELS is a five-point scale with a composite CAMELS rating of “1” being practically perfect and “5” being on the way to the closed-bank list. A bank with a CAMELS rating of “4” or “5” will be placed under a formal supervisory action by its state and/or federal regulators. A bank with a CAMELS rating of “3” is likely to be operating under an information supervisory action that can take the form of a less restrictive board resolution or a memorandum of understanding. Informal supervisory actions are not public documents unless a bank is raising capital and has to make the public disclosure in its offering materials or unless a bank or its bank holding company is a reporting company required to file periodic public filings with the SEC, FDIC, OCC or Federal Reserve. Banks are not permitted to disclose their CAMELS ratings for fear that depositors will misinterpret the rating and assume that deposits are in jeopardy.

Number 4: As of the publication date of this article, no Tennessee bank has failed since 2002. The last new commercial bank established in Tennessee was CapStar Bank, Nashville, formed in 2008.

Number 3: Structuring is a money laundering scheme designed to evade currency transaction reporting. When cash in excess of $10,000 is deposited at a bank in several transactions under that amount, the depositor may be guilty of structuring. Cash deposits of $10,000 or more are reported to federal law enforcement agencies under the Money Laundering Control Act of 1986. Everyone, even lawyers who get paper bag payments from clients in excess of the ceiling amount, are required to file a CTR at the time of deposit. These transactions must be reported not only to banking authorities but to the U.S. Secret Service and the IRS.

Number 2: As receiver for a failed financial institution, the FDIC may sue professionals who played a role in the failure of the institution in order to maximize recoveries. These individuals can include officers and directors, attorneys, accountants, appraisers, brokers, or other institution-affiliated parties. Professional liability claims also include direct claims against insurance carriers such as fidelity bond carriers and title insurance companies. As of Sept. 13, 2011, the FDIC has authorized suits in connection with 32 failed institutions against 294 individuals for D&O liability with damage claims of at least $7.2 billion. This includes 14 filed D&O lawsuits (one of which has settled) naming 103 former directors and officers. The FDIC also has authorized 20 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits. In addition, 175 residential malpractice and mortgage fraud lawsuits are pending, consisting of lawsuits filed and inherited. Of particular interest to many Tennessee banks is FDIC as Receiver for Silverton National Bank N.A. v. Bryan, Case No. 1:11-cv-02790-JEC (U.S. District Court for the Northern District of Georgia Filed Aug. 22, 2011). Silverton Bank N.A. was a correspondent bank that did business with other banks, including many Tennessee banks, offering correspondent banking services, loan participations, funds management, bank holding company loans, and other banking services. When Silverton failed, banks that had invested in Silverton’s stock lost their entire investment, impairing many of those bank’s balance sheets. Banks that had loan participations with Silverton found themselves doing business with the FDIC and various servicing companies, trying to work out respective rights and responsibilities. Bank holding companies that received loans from Silverton secured by their subsidiary banks’ stock were then indebted to the FDIC as receiver, which, because the agency did not want to foreclose on bank stock, is stuck with either trying to collect these loans or selling them to investors. Lions and tigers and sharks, oh, my!

Number 1: When in doubt, call a bank lawyer.


Kathryn Reed Edge KATHRYN REED EDGE is a member of Miller & Martin PLLC, a regional law firm with offices in Nashville, Chattanooga and Atlanta. She heads the firm's Financial Services Practice Group and concentrates her practice in representing regulated financial services companies. She is a past president of the Tennessee Bar Association and a former member of the editorial board for the Tennessee Bar Journal.