Glen Garrett
First State Bank, Monett, Mo.

Federal banking regulatory agencies have been likened by critics to runaway freight trains--derailing any individuals or financial institutions in their path. But they say they are just doing their job. Who's right?

A poster-sized copy of the smoking-gun document from eight years ago leans against the wall in one corner of Glen Garrett's office. He is chairman and owner of First State Bank in Monett, Mo. He keeps the trial exhibit around to show that even in the 1990s, David can still beat Goliath--if he has the resolve and resources.

It's an odd trophy, considering that Garrett can't read or write. He did, though, serve 19 years as chairman of the nearby Purdy school board. He has someone read important papers to him privately before signing off on them. And more than a few, like this one, he easily memorizes.

The single page is a laundry list of Garrett's alleged wrongdoings, given to a state bank examiner by a competitor faced with the expansion of Garrett's bank. None of it would pan out, but when passed along to the Federal Deposit Insurance Corp., the fdic launched an investigation that the 67-year-old businessman says chewed up 12 percent of his life--Garrett is keen with figures. And he can read people. And deals. And business matters. He wishes those city slickers from Kansas City and Washington, D.C., could read plain- old country h-o-n-e-s-t-y. Reputation is important enough to Garrett that, as a matter of principle, he spent more than $2 million in his battle to keep from paying the fdic a comparatively paltry $25,000 civil money penalty.

He said all along he did no wrong and would make no such admission. Ultimately Garrett won his battle with the FDIC--albeit a settlement last March that calls for no penalty, just his agreement to adhere to a technical lending regulation that experts say didn't apply at the time, anyway. In the Matter of Glen Garrett, fdic-94141k; fdic-99-032B.

Though the FDIC spent millions of dollars before finally walking away empty-handed from the Glen Garrett matter, the agency portrayed itself as settling its eight-year pursuit out of expediency. "If [defendants] have the resources to engage in a protracted process, they can stretch it out for a consider- able period of time," fdic spokes-man Stephen Katsanos told a Joplin, Mo., newspaper.

Garrett's lawyer, Stephens B. Woodrough of Tampa, Fla., who spent 25 years as an FDIC attorney, interprets the settlement document itself: "There is no finding of any wrongdoing in this, and it doesn't prohibit him from doing anything in the future, which makes it the most unusual cease-and-desist order ever entered with the fdic. There's nothing about ceasing or desisting anything."

If Garrett's story were an isolated instance of mistaken analysis by the banking regulators, it could be chalked up as an aberration. His case is unusual only because he fought back. It seems he was simply guilty of being in the wrong business at the wrong time. He was the owner of a small bank during the great savings-and-loan and bank crises in the late 1980s and early 1990s. Those scandals, the congression- al overreaction to them, and the news media's endless repetition of the mantra "fraud" unleashed regulatory forces that have been compared by some courts and many defense lawyers to witch-hunts.

Garrett brought to light abuses that apparently were not so unusual but instead raised disturbing questions about overzealous banking regulators who developed an abusive culture much like that of the Internal Revenue Service--except who cares about bankers?

A Background Check

The bigger questions are why and how it happened.

There indeed were some bad actors bilking financial institutions. But the greater causes were a collision of tight monetary policy that led to rocketing interest rates and the Reagan administration's agenda for broad-gauge deregulation.

When interest rates shot up in the early 1980s, the Reagan administration pushed legislation that let thrifts venture into commercial real estate, which had been the province of banks.

Helping them along, government insurance of financial institutions was increased, rising dramatically from $40,000 per depositor to $100,000.

Many thrift managers had never done anything more complex than pay depositors 4 percent on money that was then loaned at 6 percent for home mortgages. They took the deregulation and increased insurance on deposits as a mandate to go to the casinos and make up for all those low-interest mortgages they held.

Then, Congress knocked the pins from under the industry in 1986 with the Tax Reform Act, which abolished significant tax write-offs for certain real estate loans.

A lot of loans went unpaid and many thrifts, as well as banks, had to eat them. And despite what was said in headlines and hearings, there was little fraud involved--maybe in 10 percent or 15 percent of cases, according to the government's own estimates, or as little as 3 percent according to outside experts.

There were many more financial train wrecks than frauds. Nevertheless, the sudden, unprecedented numbers of failed and troubled banks and thrifts required action by regulators who for decades had been as challenged as so many Maytag repairmen.

But given the tactics and strategies in the Garrett case and some others that worked their way for years through a long pipeline, the regulatory juggernaut probably swept up a lot of innocent bankers, thrift executives, officers and directors, and their lawyers and accountants. Most of these targets quiet- ly paid with both money and careers--for nuisance value and out of fear of even greater damage.

Some simply didn't have the resources to fight. They sometimes were attacked by regulators who themselves used dirty tricks and fraud to build or continue cases that should never have been brought or should have been dropped, according to critics who offer numerous examples.

In other instances, those regulators manipulated administrative procedures that already are weighted against the targets.

Recoveries Defended

The fdic counters with statistics showing that, for example, in professional liability recoveries from officers, directors, lawyers and accountants, it has had a high monetary recovery rate for its efforts.

In 1998, for example, the agen-cy recovered $186.5 million and in doing so spent only $28.9 million: $5.8 million in-house, $1.2 million for investigations, $21.9 million for outside counsel. It was the agency's highest-ever ratio of recoveries to expenses--6.45-to-1.

Many agency critics complain that a few big cases account for much of the money, and that many more would fail cost-benefit analysis. In response to a Freedom of Information Act request from the ABA Journal, the agency said it was unable to break down the figures in particular cases for particular years and to compare the costs with the benefits.

"I'm certain many of the cases are what I call the dregs," says Arthur Leibold, a prominent banking lawyer in Washington, D.C. "You can never pin them down on cases that never should have been brought."

The fdic faced even stronger criticism at a conference it sponsored in April 1998. Paul Horvitz, who from 1967-77 was the agency's director of research and later deputy to the chairman, blasted a gathering of top current and former leaders, lawyers and examiners with the fdic, the defunct Resolution Trust Corporation and the Office of Thrift Supervision by saying he had witnessed fraud by agency employees in pushing cases.

Horvitz, now a business professor at the University of Houston, has worked as an expert in recent years for both sides in regulatory matters. He told the regulators they often were overreaching and had an attitude of "Let's sue them all and let the courts sort them out." Further, Horvitz dropped what he thought would be a bombshell: "I have seen several cases in which government employees have given untruthful deposition testimony." But he got no response.

"Most surprising to me is that none of the fdic lawyers disagreed with my claim that examiners and analysts perjure testimony," Horvitz recalls in a recent interview.

Horvitz expands the criticism to include some of the lawyers in matters he worked on for the government. He says that in one case, when the other side deposed him they showed him documents that the government lawyers obviously had kept from him.

"They thought they would be able to exclude it from evidence, and it clearly would have affected my opinion," says Horvitz. "That's dirty pool."

But it was a way for staffers to make cases clear the cost-benefit-analysis hurdles at higher levels in the agency.

Part of the problem, says Paul Fritts, former executive director of supervision at the fdic, is that once the economy improved, too many new and inexperienced examiners and lawyers "had time on their hands and got involved in cases that, maybe in different times, you wouldn't bother with."

Fritts retired from his post, the fdic's highest nonappoint-ive position, in 1993 after 35 years. He cautions that he's talking about all the various banking agencies, and fears that any outside attempt to rein them in will cause more harm than good. But, he says, the Garrett matter, in which he eventually became an expert witness for the defense, "was the worst case of regulatory overkill I've ever seen. It had no regulatory purpose."

The Garrett case actually started on Fritts' watch but stayed at the regional level during a couple of years of negotiations with the Kansas City office. Still, a truism was at work: Once a case was started, it lived by momentum.

In part, Fritts blames a system of agency review and administrative procedures that "is almost corrupt." He offers two examples. First, at the FDIC the director of bank supervision who signs off on cases is then, later, part of the group that reviews them.

Second, the two administrative law judges handling cases for all the bank-ing regulatory agencies overwhelmingly favor the government. They work in the Office of Financial Institution Adjudication, which is part of the ots.

The ALJs make only recommended decisions, not binding ones, and tend to go with the government agencies that hire them, Fritts and other critics argue. Since the creation of the adjudication office nine years ago, for example, one alj has issued 40 recommended decisions without once ruling against the government. Critics say the other has done so only in matters concerning individuals, not financial institutions.

What's worse, says Leibold, who was general counsel at the old Federal Home Loan Bank Board for three years beginning in the late 1960s, the FDIC, in some thrift cases, has been trying to avoid the federal District Courts and their more user-friendly rules of evidence, depositions, juries and shorter statute of limitations.

Instead, the FDIC has been paying the ots to take those cases through the administrative process and the ALJs. Leibold questions the statutory and constitutional validity of what he calls a "shovel pass" from the FDIC to the OTS.

U.S. District Judge Lynn N. Hughes, of the Southern District of Texas, was so exasperated by the maneuver, as well as critical of other questionable tactics, that he sarcastically demanded in 1995 that the FDIC appear before him to "disclose the government's whole position in its choice of remedies, whether judicial, administrative or military." Fdic v. Hurwitz, CA-H-95-3956.

In deciding whether to take cases to the administrative law judge or federal District Court, fdic General Counsel William Kroener III says the agency is simply using its judgment as to the legitimate tools at its disposal. "The question is what avenue will be utilized."

OTS Chief Counsel Carolyn Buck says when a thrift is shut down, both agencies "operate in parallel."

But Leibold and others have been attacking the administrative procedures, including the shovel pass, through pleadings, FOIA requests and scholarly articles. A major law firm in Washington, D.C., has analyzed the ALJs' recommended decisions during the nine years since their office was created and recently began preparing a motion to disqualify one of the ALJs for bias because he never has ruled against the government.

Generally, a reason for having administrative hearings, rather than full-blown Article III court trials, is the routineness of the problems and usually small amounts of money involved. But that is rarely the case with financial institutions. "You need more third-party independence in the system," says Fritts. "It's almost self-corrosive."

And, critics complain, the process lends itself to manipulation.

OTS Misinformation

Last year, the Department of Justice learned that ots lawyers had misinformed its Civil Division in getting a favorable amicus curiae brief from the DOJ. The case had come out of administrative procedures and into the sunlight of an Article III court. Appeals of agency cases go directly to the federal appellate courts, which must rely solely on the administrative record for the facts.

Misinformation from the ots about the authorities and duties of OTS officials found its way into the heart of the DOJ's amicus brief, and DOJ lawyers, once they learned of it, sent a strongly worded message to the District of Columbia U.S. Circuit Court of Appeals complaining that they had been misled.

"[O]TS examined our brief prior to its filing and we specifically discussed this point with attorneys for the agency, who confirmed this version of the facts," wrote Douglas N. Letter of the DOJ's Civil Division, in a July 1998 filing titled "Regarding Impact of New Information." Doolin Security Savings Bank v. Nicolas P. Retsinas, No. 97-1222, (D.C. Cir.).

The DOJ's alarmed report to the court noted that OTS litigation counsel subsequently explained to the department that the problem occurred because the OTS lawyers were unaware, or had no recollection, of the facts in question.

Buck says, "There certainly was no indication anybody was trying to hide anything."

The lawyer on the other side in that case, John Deal, of Columbus, Ohio, has handled a lot of matters involving the banking regulatory agencies and has been a vocal critic of their tactics. "Once is an accident, twice is a mistake, but three is a trend," says Deal, who was FDIC regional counsel for nine years.

Only now are some of the more serious and blatant abuses coming to light as they emerge from years in the pipe-line. Many prob- lems were built into the system, others grew logically from its flaws.

Most of this stems from Congress' panicked legislation that gave regulators unprecedented powers in 1989 with the Financial Institutions Reform, Recovery and Enforcement Act. FIRREA restructured old agencies and created new ones. In some ways, they became the Frankenstein monster cobbled together from ill-fitting body parts.

Their new powers were the envy of other agencies, such as the staggering increase in civil money penalties to a maximum of $1 million a day during violations, up from $1,000; expanded jurisdiction to include lawyers and accountants who did work for financial institutions; and the ability to freeze targets' assets.

The old cozy-with-the-industry Federal Home Loan Bank Board was abolished and the Office of Thrift Supervision was created within the Treasury Department to oversee savings and loan associations. The Resolution Trust Corp. was created to take over failed S&Ls and get what it could for their assets, and to pursue lost money through lawsuits against former officers and directors as well as their lawyers and accountants.

The fdic was changed. From its inception the agency primarily regulated state-chartered banks and operated the deposit insurance fund for state and federal banks. Under firrea, it was given the added responsibility of insuring deposits in S&Ls, taking over that function when the statute abolished the Federal Savings and Loan Insurance Corp.

Thus, the FDIC found itself working closely with the new regulatory creatures, the OTS and RTC. The link was formal, by statute, through board directorships and duties. This inevitably led to turf battles and tensions.

The OTS and RTC grew like weeds and developed other weed-like characteristics, as well. That couldn't help but rub off on the fdic, which had been sober, solid and careful since it was formed in 1933 to provide insurance and assurance after the huge number of bank failures during the Great Depression.

But the FDIC also had been on automatic pilot for decades, handling just 10 or 15 bank failures a year. Then, by the mid-1980s, it suddenly faced more than 100 a year.

Actually, the agency was gearing up in response to the problem even before FIRREA was enacted. When L. William Seidman took over as FDIC chairman in 1985, he inherited a legal staff that by then already "reveled in litigation," he wrote in his memoirs, Full Faith and Credit. At that point, though, most of the litigation was for simple debt collection for the spate of failed and troubled banks.

Breathing fire with FIRREA, the OTS and RTC quickly earned reputations for suing first, or threatening with notice pleadings, then building cases later. That behavior was somewhat understandable given the pressures from Congress--OTS and RTC officials were grilled by congressional committees for not being tough enough--and from the Government Accounting Office.

The crises, particularly with thrifts, clearly were running into the hundreds of billions of dollars. In 1991 the GAO declared the losses from both banks and thrifts had rendered the now-combined FLIC-FDIC insurance fund itself insolvent, though that analysis is questioned by some experts. Still, it brought enormous pressure on the FDIC, as well as the other agencies.

In perhaps the most notorious and still-debated case, the OTS used its potent new powers in 1992 to freeze the assets of New York's Kaye, Scholer, Fierman, Hays & Handler, and some of the partners and their immediate families. The law firm allegedly did not report problems with client Charles Keating's Lincoln Federal Savings and Loan Association.

Kaye Scholer was presented with a Hobson's choice: It could try to defend itself with all assets frozen, personal and professional, which could mean the end of the firm, or reach some kind of settlement. It ponied up a staggering $41 million.

Going After the Money

Following the Kaye Scholer freeze order by the OTS, former RTC General Counsel Ira Parker caused a stir in September 1992, four months after he left the agency. He told a conference audience that, in the RTC, most enforcement matters and lawsuits resulted from agency fears of outside pressure.

Parker said only about 10 percent of the cases clearly had merit. In 90 percent of them, deciding whether to sue was "like balls you toss into the air," he added. He pointed to agency officials' fears of C-Span coverage of congressional grillings and "Sam Donaldson glaring in your face. ... [T]hat's how you make your decision ... in a McCarthy-like hearing."

The OTS had a similar way of evaluating cases, according to critics and former insiders. "The only subjective calls I saw had to do with who had money to go after," says Rosemary Stewart, who left her job as OTS director of enforcement in 1990. "It had nothing to do with how serious the regulatory matters were."

According to other former OTS insiders, Stewart, now with Washington, D.C.'s Spriggs & Hollingsworth, had to leave the agency because her insistence on screening cases carefully for merit ran against the new mandate to get as much money back as possible, as soon as possible.

On the contrary, says OTS Chief Counsel Buck, some who left the agency had a different philosophy. "There was a perception that they would never bring a case, never find enough evidence."

Longtime close observers of the FDIC, including some who spent many years working for "The Corporation," as insiders call it, say the agency couldn't help but take on some of the aggressive urgency and abusive tactics of its newly created cousins.

Even the two other major bank regulators, which did not have those family ties, were swept along in the jihad. There was no official change in the roles of those other agencies: the Office of the Comptroller of the Currency, which is part of the Treasury Department and charters national banks; and the Federal Reserve system, which regulates state banks that choose to be part of the federal system.

They could not simply watch the others' stepped-up enforcement and litigation, and they, too, joined in the frenzy. There was interagency competition to protect turf, and one-upmanship to see who could be the toughest now that Congress and the news media were keeping close watch on what had been backwater bureaucracies.

"I began to see evidence of young examiners as gunslingers in the late 1980s and early '90s," says Sidney Bailey, who for 20 years was commissioner of the Virginia Bureau of Financial Institutions and for 20 years before that a national bank examiner with the comptroller's office. "They'd strut around like Billy the Kid. It was a power trip."

In its first year, 1989-90, the RTC had grown to 8,000 employees and thousands of independent contractors, and had launched more than 150 lawsuits with its more than 1,500 staff-member legal division.

It hired more than 1,000 outside law firms at about $1 billion a year, some of them getting more than $20 million a year in fees to handle both the investigations and the lawsuits they recommended--a perverse incentive system that has been much criticized.

Driven to New Directions

As the economy improved in the 1990s, far fewer banks and thrifts were in distress, but there was a lag of two or three years before downsizing of the regulatory machinery began.

In 1995 the RTC, by sunset provision, handed its matters over to the FDIC and closed shop. And at about that time, the handful of banking regulatory agencies, particularly the fdic, began scaling back enforcement actions and lawsuits for the most basic of reasons--a better economy and fewer troubled banks and thrifts.

Around then Ricki Tigert Helfer came in as FDIC chairwoman and set about cutting the staff by 36 percent. And tried to rein in the regulators. She brought in William Kroener, an experienced lawyer in the field from Davis, Polk & Wardwell, as general counsel.

They inherited a legal staff of 1,300 lawyers, which included those brought over from the defunct RTC. Of the total, 160 lawyers handled professional liability suits against officers and directors, as well as lawyers and accountants. (Now there are just 19 of them, Kroener says.)

Helfer and Kroener instituted tighter reviews of proposed cases, and winnowed out many of those inherited from the RTC. Kroener points to one in which the targets put a $200,000 offer on the table and the agency declined, dropping the case instead, "because it had no merit."

Early on Kroener even instituted an open-door policy in response to complaints he was hearing from lawyers who felt their clients were being pursued unjustly and unfairly. But he and Helfer had taken over an agency that was, in many ways, a staff-driven freight train. Apparently, in the face of reductions in force and fewer good cases, some felt the need to justify their jobs by making cases when they shouldn't have.

One apparent example came to light in a federal criminal trial last year involving a prominent state senator in Virginia and his son, who own and run a small-town bank. (See "The Zealots and the Senator," ABA Journal, Oct. 1998.)

U.S. District Judge Henry Morgan threw out the case as soon as the prosecution completed its presentation. In February he ordered the Department of Justice and the fdic to pay the defendants $570,000 to cover their legal fees and costs because the prosecution was "vexatious."

That judgment, now on appeal, was the first successful one under the so-called Hyde Amendment of 1997 that calls for the government to pay when a case proves to be "vexatious, frivolous or in bad faith." The judge found that the FDIC had gotten the U.S. attorney to pursue a criminal matter based on evidence that hadn't been strong enough for the agency's initial civil complaints through administrative proceedings. He ordered the FDIC to pay a third because the two agencies acted "in concert."

The judge found so many dirty tricks involved that he noted some evidence that the FDIC might have been even more than vexatious and acted in bad faith. The FDIC regional counsel pushing the case wrote several memoranda that came back to haunt him in court. In one, he said the DOJ wouldn't take such a case built on a minor technical violation, except that the target, owner of a small-town bank, also was a well-known state senator.

At one point--a fact not brought out in trial or noted by the judge--a witness called before FDIC counsel for a sworn statement became spooked by the questions. He said he wanted to have his lawyer present. He was cajoled into not doing so.

"[Y]ou are not a focus of the investigation; that means you are not affiliated as a director and officer, somebody managing the bank," the witness was told by then-fdic regional counsel John J. Rubin from the Atlanta office. "We do not have jurisdiction over you."

What Rubin did not say was that just three months earlier the FDIC had named the witness as a target in a criminal referral to the U.S. attorney.

Judge Morgan determined that the FDIC wanted to punish the bankers, not regulate them, and blasted as inexperienced the regional counsel, Richard Fraher, who pushed the case as "an overzealous bureaucrat."

"More difficult to understand," the judge wrote in his opinion, "is the failure of the many layers of supervision between [Fraher] and indictment to understand and appreciate the unreliability [of the government's key bit of evidence] and the weakness of any other evidence of wrongdoing."

The judge was pointing a finger directly at a culture of abuse in the agency. It was the way, in too many instances, the business of regulating banks and thrifts was conducted. The reasons are many and complex. They go back decades. They resulted from good people work- ing with bad law and bad people working with good law.

"I don't blame them for taking that first look at me," says Glen Garrett, the blue-jeaned banker in small-town Missouri.

"But there came a time early on when they knew better. And they didn't stop."

Terry Carter is a reporter for the ABA Journal. His e-mail address is
Copyright American Bar Association.

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