The Federal Deposit Insurance Corp. (FDIC) suffered a rare court defeat Tuesday, as a federal judge sided with a bank that had challenged an enforcement order.
The FDIC had attempted a preemptive order against the $10 million-asset Advanta Bank in December to prevent dealings with its bankrupt parent from harming the institution, citing special authority to preclude Advanta from challenging the order.
But U.S. District Court Judge John Facciola agreed with Advanta, a limited-purpose bank based in Delaware, that the FDIC misused its authority. The bank's rapid dissolution was not related to problems with its owner, he said.
"The deference due to the agency in interpreting" its authority "is not limitless and does not allow for the contravention of the law which gave that agency its authority," Facciola, a magistrate judge in the Washington, D.C., district, said in his order. "Because the agency's issuance of a temporary cease and desist order was outside the bounds of a clear grant of authority from Congress, the plaintiff's motion for an injunction setting aside the temporary cease and desist order … must be granted."
While the bank is small, and the decision does not rule out future regulatory action, observers said it was significant. Not only is it unusual for institutions to challenge enforcement orders, it is rare for them to succeed.
"It's very difficult to get a court to intervene in an enforcement proceeding like that," said Ron Glancz, a partner at Venable and a former legal counsel at both the FDIC and the Office of Thrift Supervision. "It's not unusual that the agencies are given a lot of deference, particularly when it comes to bank regulation and safety and soundness."
Andrew Sandler, who co-chairs Buckley Sandler and is Advanta's attorney, said the rulings should serve as a "wake-up call" to regulators that their reach has limits.
"This decision is a welcome reminder from the federal judiciary that the FDIC and other bank regulators must be careful to stay within their authority in exercising their extraordinary powers to address the current financial crisis," Sandler said.
An FDIC spokesman said the agency was still reviewing the decision.
The decision came after the November bankruptcy filing of the credit card giant Advanta Corp. Its two bank subsidiaries, the Delaware bank and the $2 billion-asset Advanta Bank Corp. — a Utah industrial loan company that has its own regulatory problems and that could soon face failure — both stayed open.
In December, the FDIC said in a notice of charges and hearing that the turmoil at the parent company was prompting concerns at the Delaware bank, including that the subsidiary lacked independent board control and had failed to keep adequate records for examiners.
That, in concert with the deterioration of the ILC, meant there was "substantial threat that the bank has engaged in or will engage in violations of law and/or unsound banking practices," the FDIC said.
After the bank said it would challenge the FDIC's issuing a preemptive cease-and-desist order in administrative court, the FDIC attempted to issue a "temporary" order to be in effect until the administrative proceeding concluded.
Under existing law, the FDIC can issue a temporary order without challenge from the administrative court if it believes a bank's unsafe practices will likely cause its "insolvency or significant dissipation of assets."
The case presented evidence that the Delaware bank was indeed dissolving. From Sept. 30 to Nov. 30 its deposits had fallen 97%, to just over $268,000, and its assets were halved, to $10 million. But that resulted from an ongoing downsizing at the bank, which has essentially chosen to end its existence. After a 2008 ultimatum from the FDIC to either become profitable or terminate, the bank appeared to choose the latter, beginning in January on a process to end its FDIC guarantee.
Facciola ruled that for the FDIC to impose the temporary cease-and-desist order, it needed to prove that the bank's dissolution somehow related to dealings with its parent.
"It is not the unsafe banking practices which are causing the dissipation of assets, but rather the process of termination, which the FDIC started, which are 'dissipating' the assets," he said in the order. "Under the statute, the FDIC can only issue a temporary cease and desist order where the possibility of the dissipation of assets is more than a theoretical consequence of the unsafe or unsound practice."
The ruling noted the rarity of a bank even attempting to challenge such an order. Only two cases on recent record involve a plaintiff trying to throw out a temporary order, Facciola's ruling said, one involving the Federal Reserve and the other involving the Office of Thrift Supervision. In both cases the agencies prevailed.
But Glancz said the case may signal more scrutiny by the courts of aggressive actions by the regulators.
"When the courts see enough of these cases, they look more closely and in fact question some of the regulatory actions," he said.