Disclosing Examination Matters and
Enforcement Proceedings

Jeffery E. Smith
Bricker & Eckler LLP
January 2008

Bankers are often faced with a difficult and complex dilemma when it comes to whether, and to whom, information concerning examination activities (including exam ratings and findings) and informal enforcement proceedings may be disclosed outside the organization.

Improper disclosure can result in both civil as well as criminal penalties for both the disclosing and the receiving parties. And it can generate significant regulatory relations and reputation risk issues along with shareholder exposure. State and federal law dictates a "just say no" response in most instances, however the reality of the banking business is not always that simple or clear.

So just when do these issues arise, and how can banks properly respond while avoiding exposure?

When do issues arise?

Protected examination and enforcement information is construed very broadly to include not only examination reports, findings, and ratings but virtually everything related to the examination process (including "informal" enforcement proceedings as well as the fact that an examination has taken or will take place). Questions regarding matters potentially subject to the prohibition on disclosure arise in a myriad of instances, including in conjunction with inquiries from shareholders, rating agencies, insurers and bonding companies; in due diligence by third parties (including prospective M&A participants and prospective new officers and directors); covenants in loan agreements and fiduciary relationships (where the bank is the debtor and/or trustee); general operating and vendor contracts; and in litigation where the bank may or may not be a party.

Regulatory agencies zealously guard examination information, and state and federal statutes provide not only protections from discovery in litigation but as noted earlier potential civil and criminal penalties may apply for the disclosing party as well as the recipient in the event of inappropriate disclosure. Regulatory agencies even intervene from time to time in litigation where examination information is sought, irrespective of whether the agencies are actual parties to the litigation, and can be a strong bank ally in such situations.

Importantly, significant issues also arise with regard to shareholder disclosure obligations by institutions (whether or not they are "publicly-traded") and with regard to "insider trading" by executives and directors. These situations raise important and very sensitive conflicts between the need to maintain confidentiality of examination matters and shareholder disclosure obligations, and extreme care must be taken to address the often-competing issues in compliance with applicable law.

What can be disclosed?

When it comes to examination information, there is no "safe harbor" for disclosure short of receiving the prior consent of the agencies, which they are typically reticent to provide. "Confidentiality agreements" between the institution and the recipient are not sufficient by themselves. Some disclosure may be permitted by the agencies for viewing by prospective new executive officers and directors and in other very limited specific instances, but only with their express prior consent. Examination ratings and reports are the property of the agencies, and the very strong presumption is that examination information may not be disclosed to third parties (subject to certain exceptions for legal counsel, consultants, and other parties related to the organization) unless the institution receives the prior consent of the agencies. And it is important to keep in mind that the agencies construe what constitutes "examination information" very broadly, including again the fact that an examination has taken or will take place.

The same applies to informal enforcement actions (ie MOU's, board agreements and resolutions, etc) which are viewed by the agencies generally as an extension of the examination process.

Again, conflicts may (and often do) arise in conjunction with shareholder disclosure obligations as discussed below.

What about shareholders?

Real and very serious issues can arise when examination results raise concerns and/or require actions that may be material to existing and/or prospective shareholders. While the ROE (including ratings) cannot be disclosed, there are methods of describing the issues raised by the ROE which, if carefully crafted, will not directly run afoul of the disclosure prohibitions. However, any such proposed discussion should be carefully considered with legal counsel. It is also recommended that the matter be reviewed with appropriate agency representatives to make them aware of the concern and the relevant shareholder disclosure issues. Those discussions can go a long way to making the situation less difficult with the agencies in recognizing and accommodating their disclosure concerns.

The same thing applies to "informal" enforcement actions, including board resolutions and MOU's. The terms of the actions, such as limitations on dividends, may trigger shareholder disclosure obligations which directly conflict with the institution's confidentiality obligations. Again care must be taken to review the matter with legal counsel and with agencies to review how to address the issues without generating additional liability and exposure for the institution and its board.

Formal enforcement actions, such as formal written agreements, C&D proceedings, and other agency directives are required by law to be made public by the agencies. Again shareholder disclosure issues are involved, including statutory timing issues for publicly-traded institutions, and care must be taken to coordinate disclosures with relevant regulatory agencies.

What about "insider" transactions?

Non-public examination results and enforcement proceedings can place officers, directors, and others (including consultants, accountants, auditors, legal counsel, and others working with the institution) in the position of having material non-public insider information concerning the institution. In those instances, erring on the side of being conservative is always the best approach and individuals in possession of such information should refrain from trading in company shares (buying or selling) unless and until the information is fully and adequately disclosed to the investing public. When and where the issues arise varies, and depends on the nature of the examination results and enforcement proceedings.

However, such actions are typically viewed with 20-20 hindsight and if something revealed in an examination report or which is the subject of an informal enforcement proceeding may be material to an investor in buying, selling, or holding shares, "insiders" should not be trading unless and until the matters are adequately disclosed. The general rule is to refrain from trading (and institute a board-directed trading ban for directors and appropriate insiders) until the issues are adequately disclosed, and even then to be very circumspect in permitting any trading as long as significant issues continue to exist. Care must be taken to include "outsiders" also in possession of the information in that ban. The better rule is to await resolution of the outstanding issues altogether prior to lifting a trading ban.

Practical considerations

As a practical matter, prospective officers and directors as well as investors, lenders, transaction participants, underwriters, insurers, and others have a vested interest in the regulatory condition of the institution. It is very difficult to recruit new officers and directors to an institution, particularly one with significant regulatory issues, without being able to explain the issues and the steps the institution is taking to resolve them. The same goes for potential transaction participants, lenders, underwriters, insurers, and anyone having a current or prospective interest in the institution.

The inability of the institution to disclose examination matters and informal enforcement proceedings, even with a confidentiality agreement, in many instances hampers the ability of the institution to undertake important remedial steps to help the institution in its recovery efforts, including the ability to attract and engage new senior officers and directors to assist in a "troubled institution" setting. However, the potential civil and criminal consequences are too significant to ignore.

Conclusion

Bankers need to take care to recognize, understand, and avoid the potential exposure that comes with the inappropriate disclosure of exam information. It seems only normal and appropriate that the information should be available to those with a vested interest in the institution and those considering joining, but disclosure without regulatory consent will expose both the provider and the recipient to significant civil and criminal penalties.

Regulatory agencies and banks alike would be well-served to establish an agreed protocol which would allow institutions to disclose certain limited examination and enforcement matters under the protection of a strong confidentiality agreement in order to enable the institution to address both normal operating issues, and the special issues which accompany "troubled institution" status.