oversight

FCA's Use of Enforcement Actions

Published by the Farm Credit Administration, Office of Inspector General on 1998-05-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

       FCA's Use of
Enforcement Actions

            A97-03
Farm Credit Administration	                             Office of Inspector Ge'1era
                                                        1501 Farm Credit Dnve
                                                        McLean, Virginia 22102-5090
                                                        (703) 883-4030



May 27,1998


The Honorable Marsha Pyle Martin
Chainnan and Chief Executive Officer
Fann Credit Administration
McLean, Virginia

Dear Ms. Martin:

We have completed our evaluation of the Farm Credit Administration's (FCA or Agency) use of
enforcement actions. The objectives of this audit were to (1) evaluate FCA's use of enforcement
actions in obtaining corrective actions in Farm Credit System institutions; and, (2) document and
evaluate FCA's current organizational structure and process as it pertains to achieving enforcement
objectives.

The Agency's enforcement actions have, for the most part, been effective. Our review identified
opportunities to enhance the timeliness and efficiency of enforcement actions by: eliminating the
use of supervisory letters as enforcement documents; establishing due dates for completing key
steps in enforcement actions; establishing fonnal criteria for tenninating enforcement actions and
returning the institution to a nonnal level of supervision; and reviewing reporting requirements
imposed on institutions under enforcement actions for duplicative or nonessential aspects. The
transfer of the enforcement function from the fonner Office of Policy Development and Risk
Control to the Office of Examination addresses the need to streamline the Agency's organization
of enforcement activities. Increased delegations of enforcement authority by the Board may
further improve timeliness and efficiency of enforcement actions taken.

This audit was conducted in accordance with Government Auditing Standards issued by the
Comptroller General for audits of Federal organizations, programs, activities, and functions.
Fieldwork was conducted from November 1997 to January 1998 at FCA headquarters in
McLean, Virginia. An entrance conference was held on November 25, 1997. A draft of this
report was provided to management on March 25, 1998 and, based on a report conference with
management, revised and reissued on April 30, 1998. Their written response is included in this
report.

Resrctfully,         II       :~


 n~~c:/zfa6f
Eldon W. Stoehr
Inspector General
                                  Table of Contents




Objectives, Scope and Methodology                                                          1

Background                                                                                 1

Findings, Conclusions and Recommendations                                                 2

     FCA's Enforcement Actions Have Generally Been Effective.
     However, Opportunities Exist to Enhance the Timeliness and
     Efficiency of Enforcement Actions                                                     2

            The Agency should eliminate the use of supervisory
            letters as enforcement documents                                               2

            Criteria should be established for determining when
            termination of enforcement actions should occur
            and institutions returned to a normal level of supervision                     2

            The Agency should review its reporting requirements
            for institutions under enforcement actions and
            eliminate any that are duplicative or non-essentiaL                            3

     The Organizational Structure and Practices ofFCA's Enforcement Activities..·......... 3


            The recent transfer of enforcement responsibilities
            between the former OPDRC and OE has improved
            the organizational structure and process related
            to the Agency's use of enforcement actions                                     4

            The Board may wish to delegate authority for some
            enforcement actions                                                            5

            Enforcement activity has significantly declined                                5


Management's Response
                                    FCA Office ofInspector General

                            Audit A97-03: FCA's Use of Enforcement Actions





OBJECTIVES, SCOPE AND METHODOLOGY

The objectives of this audit were to: (1) evaluate the Fann Credit Administration's (FCA or
Agency) use of enforcement actions in obtaining corrective actions in Farm Credit System (System)
institutions, and (2) document and evaluate FCA's current organizational structure and process as it
pertains to achieving enforcement objectives.

We reviewed selected enforcement action activity taken by the Agency from January 1, 1990 to
September 30, 1997. We reviewed the case files for those institutions with enforcement actions
in place for more than five years and reviewed a sample of actions proposing conditions of
mergers or reorganizations taken during each fiscal year. We also reviewed Agency policy and
procedures guiding the use of enforcement actions.

We documented the Agency's organization and practices for enforcement activity and surveyed
five other Federal financial regulatory agencies' characteristics and guidelines for enforcement
actions. The survey was conducted through telephone interviews with individuals in those
agencies who were either directly involved in or knowledgeable about their respective agency's
enforcement action process. In addition, we interviewed Agency staff involved in the
enforcement process.


BACKGROUND

The FCA is an independent Federal financial regulatory agency of the United States government
with regulatory, examination, and supervisory responsibilities for the System banks, associations,
and related institutions that are chartered under the Farm Credit Act of 1971, as amended (Act).

FCA derives its enforcement authority from the 1985 Amendments to Title V, Part C, of the Act,
(12 U.S.C. Section 2261 et seq.) which grants the Agency certain enforcement powers for the
purpose of effecting corrective action in System institutions. It is FCA's practice that institutions
requiring "more than normal supervision" be considered for enforcement action. Generally,
"more than normal supervision" is given to System institutions which: (1) are assigned a Fann
Credit Administration Rating System composite rating of 3, 4, or 5; (2) exhibit individual
characteristics that pose excessive risk to the institution regardless of its composite rating; and/or
(3) may require punitive action to effect correction. This special supervision has included
supervisory letrers, supervisory conditions of merger or corporate restructuring, written
agreements, cease and desist orders, and civil money penalties. The Agency also has the
authority to remove officers; however, this authority has not yet been used.




May 27,1998                                                                                Page 1 of5
                                   FCA Office of Inspector General

                           Audit A97-03: FCA's Use of Enforcement Actions




FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

FCA's Enforcement Actions Have Generally Been Effective. However, Opportunities Exist
to Enhance the Timeliness and Efficiency of Enforcement Actions.

Recommendation No.1: The Agency should eliminate the use of supervisory letters as
enforcement documents.

The Agency should make a clear distinction between supervisory correspondence and
enforcement documents. During the review period, supervisory letters were commonly
considered enforcement documents even though they are, in fact, a warning or supervisory
direction and not enforceable. Sixty-nine percent (233 out of 337) of all "enforcement actions"
taken (as defined by Agency enforcement statistics) during the period reviewed were supervisory
letters. Most supervisory letters we reviewed were essentially a restatement of actions requested
in the report of examination. The process for deciding to send a supervisory letter primarily
involved Office of Examination (OE) and the Office of Policy Development and Risk Control
(OPDRC) without review or approval by the FCA Board.

Notwithstanding the absence of legal enforceability, there was a deliberate Regulatory
Enforcement Committee (REC) strategy to use supervisory letters as warnings and to exert
pressure on institutions to correct weaknesses identified in reports of examination. We think the
use of supervisory letters as enforcement documents does not properly distinguish between the
separate supervision and enforcement responsibilities of the Agency and may dilute the impact of
the report of examination.

We believe the supervisory benefits that may have accrued from the previous use of supervisory
letters can be obtained more efficiently within the examination process. When an examination
identifies supervisory concerns, the examination report transmittal letter can communicate a
warning, and the gravity of Agency concerns could be underscored by having higher ranking OE
officials present such reports; i.e., the field office director or the Chief Examiner.

 Recommendation No.2: Criteria should be established for determining when termination
of enforcement actions should occur and institutions returned to a normal level of
supervision.

Some articles in enforcement documents, designed to improve a condition, lacked appropriate
focus or specificity. In some instances, the goal to be achieved was imprecise or ambiguous.
"Full compliance" with the articles in the enforcement document did not always eliminate the
conditions which caused the enforcement action nor was the action always terminated when full
compliance was documented.

Our discussions with staff in the Risk Control Division (RCD) disclosed an informal target that
institutions under enforcement action should improve sufficiently to permit the enforcement



May 27, 1998                                                                           Page 2 of5
                                   FCA Office of Inspector General

                           Audit A97-03: FCA's Use of Enforcement Actions




action to be lifted within three years. The majority of enforcement actions were, in fact, removed
within the three-year period; however, there were several instances in which the Agency found
insufficient improvement to support removal of the action within that time. Sometimes one
enforcement document was lifted but was replaced with another document. We also found five
individual enforcement documents, which were in effect for in excess of five years. In those
cases, subsequent examinations identified new concerns which the institutions were required to
resolve before the document was lifted, even though there was "full compliance" with the articles
of the original enforcement document for a prolonged period of time. Documentation in the
enforcement files evidenced frustration and confusion by System officials over this situation.

We believe the lessons learned through past enforcement experiences should equip Agency staff
to now establish specific criteria to identify the conditions for lifting an enforcement document.
Performance measures developed for FCA's enforcement activities should integrate the
objectives and criteria for placing and lifting enforcement documents.

Recommendation No.3: The Agency should review its reporting requirements for
institutions under enforcement actions and eliminate any that are duplicative or non­
essential.

Some enforcement actions imposed burdensome reporting requirements.                  The Agency's
enforcement practices have steadily evolved over the past decade; nevertheless, we noted
numerous instances in which enforcement documents required initial copies and continuing
reporting to both the Director of the respective OE field office and the Director of the RCD. This
practice is not only burdensome to institutions but also contributes to an inefficient use of
Agency resources through the redundant processing and reviewing by two or more, separate FCA
organizations. We did note instances in which reporting requirements were reduced, but only
after institutions complained or requested relief--not because of Agency monitoring or
assessment of information needs. As a general rule, internal FCA distribution should be an
Agency responsibility.

The Organizational Structure and Practices of FCA's Enforcement Activities.

The enforcement practices reviewed during this audit were performed under the joint
administration practices of OE and the OPDRC. The OE and the OPDRCIRCD were jointly
responsible for regulatory oversight of institutions under enforcement action. OE had
responsibility for examining and monitoring the performance and condition of all System
institutions, while the RCD was responsible for oversight of institutions operating under
enforcemefit documents.

Enforcement actions were initiated by findings of an OE examination or through monitoring
activities. When these activities identified conditions in institutions calling for "more than
normal supervision," OE would recommend an enforcement action, supported by a Supervisory
Action and Monitoring (SAM) form which detailed the basis for the enforcement action and



May 27,1998                                                                            Page 3 of5
                                  FCA Office ofInspector General

                          Audit A97-03: FCA's Use of Enforcement Actions




recommended specific articles for inclusion in the document. The report of examination
transmittal letter to the institution normally included a comment that the report had been
forwarded to the OPDRC for consideration of enforcement action.

OPDRC staff would then perform an independent evaluation of the basis and appropriateness of
OE's enforcement recommendation and draft an enforcement document, usually by tailoring
model articles developed to correct similar deficiencies in other System institutions. The
OPDRC draft action (with supporting documents) would then be forwarded to the Regulatory
Enforcement Division (RED) of the Office of General Counsel (OGC) for legal review. The
draft action (amended as appropriate) would then be forwarded to the responsible OE field office
for any further input. The draft action was then submitted to the REC comprised of the Director
of OE, Director of OPDRC (Chairman), and the Agency's General Counsel. The REC
deliberations included non-voting participatiop. from the Director of the RCD, Associate General
Counsel of OGC's RED and the Official for Risk Management of the Farm Credit System
Insurance Corporation. The REC would review the draft action, make revisions as appropriate,
and then forward the recommended action to the Board. Upon Board approval, staff would be
delegated appropriate authority to negotiate and execute the document with the System
institution.

The recent transfer of enforcement responsibilities between the former OPDRC and OE
has improved the organizational structure and process related to the Agency's use of
enforcement actions.

Subsequent to the December 19, 1997 FCA Board action which transferred enforcement
responsibility from OPDRC to OE, the Special Examination and Supervision Division within OE
assumed the duties previously performed by the OPDRCIRCD. The OE Director now chairs the
REC. In addition, OE field offices now prepare a new document called the Recommendation for
Enforcement Action Memorandum that replaces the SAM and a portion of the evaluation
previously drafted by the enforcement examiner. OE is currently developing procedures to
reflect these organizational and procedural changes.

Our review of the Agency's former structure and process identified streamlining opportunities.
These opportunities became more evident through our benchmarking of other regulators, which
had also organized enforcement functions similar to the recent FCA Board action. The recent
actions taken by the Agency have addressed several of the opportunities to eliminate redundant
activities and make the process more efficient. Other regulators have also delegated some
authority to tak(}-enforcement actions, primarily for actions of a remedial nature. However, some
regulators have also delegated authority for imposition of civil money penalties and removal of
officers. Currently, the FCA Board approves all enforcement actions.




May 27,1998                                                                           Page 4 of5
                                   FCA Office ofInspector General

                           Audit A97-03: FCA's Use of Enforcement Actions




The Board may wish to delegate authority for some enforcement actions.

The involvement of the Board in enforcement actions increases the time needed to place an
institution under enforcement. The average time from the exit conference date of the
examination until the placement of the action was over five months (160 days) for the sample of
actions we reviewed, with a range of 90 days to 254 days. The average for the last ten actions
showed an improvement as the average was lowered to 133 days with a range of 90 to 175 days.
The importance of serving the document in a timely manner is self-evident in terms of the
Agency mission to promote the safety and soundness of the System. Further, institutions have
stated that the time afforded them to take corrective action is not sufficient when the next full
examination follows closely behind the date of the enforcement action. The recent transfers
within FCA should help to reduce the time lag between the date of the examination exit
conference and the placement of the enforcement document. However, the delegation of
additional authority would also help to expedite the process.

Enforcement activity has significantly declined.

The number of enforcement actions sharply declined during the period from December 31, 1989
to December 31, 1997, reflecting the tremendous improvement in the fmancial condition of the
System. This decline is illustrated by the yearend statistics in the following.



                                                                          Total Assets Under
         December 31,                Number of Institutions              Enforcement Actions
             1989                            72                               $45 Billion
             1990                            88                               $52 Billion
             1991                                77                           $50 Billion
             1992                                65                           $33 Billion
             1993                                49                           $23 Billion
             1994                                26                           $27 Billion
             1995                                08                           $ 8 Billion
             1996                                06                           $ 1 Billion
             1997                                05                           $ 3 Billion


The composite CAMEL (Capital, Asset quality, Management, Earnings, and Liquidity) ratings
for individual -institutions for the same period also illustrate this marked improvement in the
condition of System institutions. Only 8 of 208 institutions (3.8%) carried a composite CAMEL
rating of"3" or lower at December 31,1997, compared with 150 of257 institutions (58.4%) at
December 31, 1989.




May 27, 1998                                                                           Page 5 of5
Management's

  Response

    A97-03

 Memorandum	                                         Farm Credit Administration
                                                     1501 Farm Credit Drive
                                                     McLean, Virginia 22102-5090




May 15,1998


To:	          Eldon Stoehr
              Inspector General

From:	        Marsha Pyle Martin
              Chief Executive 0

Subject:      Final Draft of Audit #97-03, FCA's Use of Enforcement Actions


Thank you for the opportunity to comment on the final draft report entitled "FCA's Use of
Enforcement Actions" (report). I am pleased with your conclusion that the Farm Credit
Administration's (FCA) enforcement actions have, for the most part, been effective.
Notwithstanding this conclusion, improvements should be made and, as noted in the attached
memorandum from Roland Smith, management agrees with the recommendations contained in
the report.

I am not inclined to delegate authority for some enforcement actions now held by the FCA
Board any further as discussed on page 4 of the report. Our process is designed to ensure the
Board's understanding and support of each recommended enforcement action. There should
be no reason the Board involvement would slow this process down in any way. I would expect
that the level of preparation required for presentation of an enforcement action to the Board
would be standard operating procedure.

Should you have questions or wish to discuss the response, please contact me or Roland.


Attachment

Copy to:	     James Ritter
              Roland Smith
              Tom McKenzie
              Jean Noonan
"   ~'.
          t'




               Memorandum	                                                 Chief Examiner's Office
                                                                           Farm Credit Administration
                                                                           1501 Farm Credit Drive
                                                                           McLean, Virginia 22102-5090




                                                                            FC~
                                                                            FAAW CIIEOlT ACWINISTMrION



               May 12,1998




               To:	        Marsha Pyle Martin
                           Chairman and Chief Executive Officer

               From:	      Roland E. Smith, Chief Examiner
                           Office of Examination

               Subject:	   Response to Office of Inspector General Audit #97-03
                           FCA's Use of Enforcement Actions


               We received a copy of the Final Draft, dated Apri130, 1998, of the above-mentioned report. We
               believe each of the recommendations of the Office of the Inspector General (OIG) has merit and,
               thus, were incorporated in the Office of Examination's (OE) operations and procedures for
               enforcement actions earlier this year. Weare in the process of documenting these procedures to
               reflect these changes. The following response addresses the recommendations contained in the
               audit.

               Recommendation 1: The Agency should eliminate the use of supervisory letters as·
               enforcement documents:

               We agree with the recommendation and had changed operating procedures when the
               enforcement function was transferred to OE in January 1998.

               The us~ .of supervisory letters, prior to the transfer of the enforcement function to OE's Special
               Examination and Supervision Division (SESD), was used by the EnforceIIlent Division as an
               indication to an institution's board of directors that conditions existed in the institution serious
               enough to require more than normal monitoring and/or supervision. The use of these letters was
               a decision of the Chief of the Enforcement Division as recommended by staff. With the transfer
               of the function to SESD, we believe the benefits that were gained using supervisory letters can
               be obtained more efficiently within the examination and oversight process carried out by OE
               field offices. The audit states that the Regulatory Enforcement Committee (REC) used
               supervisory letters in the past as warnings and to exert pressure on institutions to correct
                                                                                                  2


weaknesses identified in Reports of Examination. Nonnally, the use of supervisory letters did
not include a decision by the REC.

OE Approach

Since the enforcement function has been placed in OE, the use of supervisory letters as described
in the audit has been eliminated. The letter to a System institution board chainnan included in
the Agency's Report of Examination is the vehicle to infonn the institution board of matters
serious enough to require corrective action and more than nonnal monitoring and supervision.
The responsibility for monitoring an institution's progress will reside with the applicable field
office under the supervision of the OE Field Office Director. We believe this will result in a
more efficient and effective process, streamline reporting and communications, and improve the
timelines for obtaining corrective actions from institutions.

Recommendation 2: Criteria should be established for determining when termination of
enforcement actions should occur and institutions returned to a normal level ofsupervision.

While we agree with the overall intent of the recommendation, it is difficult to establish specific
criteria for tennination of enforcement actions. Some articles included in an enforcement
document can be very specific, and some need to be somewhat less specific. To correct an
unsafe and unsound practice, a very specific article can generally be utilized. However, to
correct an unsafe and unsound condition, the wording of an article and timeframe required to
effect corrective action may often need to be much less specific, and time needed to correct the
condition can vary greatly and depend on the commitment of management and board. Wording
of enforcement actions placed on System institutions is such that either party can make
amendments and/or modifications to the requirements of individual articles for cause. In fact,
much of the presentation time of an enforcement document to a board of directors is spent
negotiating the wording of articles. This is necessary so that what is required of the institution is
clear to both partie~. Each party must be satisfied that remedial change can and will take place.

The Agency's Financial Institution Rating System (FIRS) sets supervisory levels of concern for
institutions. With composite ratings of 3, 4, or 5, the level of monitoring and supervision is
increased. The CAlYfELS factors, except "M," are generally objective in nature. The
management factor is -I!lUch more subjective and can affect ratings for the other factors.
Nonetheless, the component ratings for assets, capital, earnings, liquidity, and sensitivity to
market risk include objective criteria that quantitatively measures the institutions' position
relative to specific performance data. This criteria, commonly referred to as the FIRS
benchmark¥-defines the ranges of operating perfonnance for critical elements of these
component factors that will be used to help determine when perfonnance achieves an acceptable
level. Accordingly, this and the management component benchmarks will be used to help
detennine when results have been sufficient to consider removing the enforcement action.

When staff presents an enforcement document, institution boards often ask when the document
will be lifted. The response is that as soon as the condition of the institution improves to a point,
no unsafe or unsound condition exists, violations (if any) of law or regulations have been
corrected, and the board and management have demonstrated they can handle identified
weaknesses in the normal course of business without the need of a remedial action, the action
                                                                                              3


will be recommended for termination. We hope that the end result of placing an enforcement
action will be the correction of unsafe and or unsound conditions or practices in a reasonable
time. However, many variables come into play when looking into the future condition of a bank
or association, such as the economy (local, regional, national, and global), weather, Government
programs, administration of credit, availability of new business, loan growth rate, and the
capacity of the institution-to recover financially. Management can control only some of these
variables.

The Agency has established a 3-year period as a performance measure (standard) for evaluating
our performance in dealing with enforcement actions. Presently, the 3-year performance
measure is reasonable to assume. With all controllable factors being adequately addressed and
no new unsafe or unsound conditions becoming evident, a System institution can assume that an
enforcement document should be lifted within 3 years. Some documents can be lifted sooner;
some documents will remain longer. We believe the FIRS benchmarks provide sufficient criteria
that defines when institutions have reached a level of condition and performance that would
prompt consideration to terminate an enforcement action. Accordingly, OE's operating
procedures will incorporate this criterion to better define when institutions should return to a
normal level of supervision.

Recommendation 3:   The Agency should review its reporting requirements for institutions
under enforcement actions and eliminate any that are duplicative or non-essential

We agree that, as a general rule, internal FCA distribution should be an Agency responsibility.
OE's operating procedures will incorporate this concept.

When the Agency first obtained enforcement powers, institutions under action were required to
report actions completed to comply with the articles of the enforcement documents to the
Enforcement Division and the OE field office responsible for the examination of the institution.
This reporting was deemed necessary due to the financial and credit condition of institutions in
the System and the ~ck of internal controls that existed in many System institutions. As System
institution boards of dIrectors and management improved their oversight of operations, credit and
economic conditions improved, and as the Agency's process of examination has evolved, the
majority of reporting has been to a single Agency contact, most often the OE field office.

 OE Approach

 Now that the enforcement function resides in OE, even though purposefully kept separate and
 apart from the examination function, reporting by an institution under enforcement action to the
 field officeis-more appropriate. This is because the responsibility to measure the compliance to
 requirements of an enforcement action resides at the field office leveL Reporting requirements,
 however, will continue to be assessed on a case-by~ase basis. If the condition of a System
 institution under enforcement action is such that monitoring by SESD is necessary, information
 that has been submitted to the field office will be forwarded to the SESD enforcement examiner
 in McLean. Additionally, if an institution fails to respond appropriately to the field office,
 consideration will be given to transferring oversight of the enforcement -action to the
 enforcement examiner in SESD.
                        AUDIT USER RESPONSE QUESTIONNAIRE


Audit Report Title: FCA's Use of Enforcement Actions                              Number: A97-03

Respondent's Name:                                                                Telephone:

Respondent's Office:                                                              Today's Date:


                                                                                       Strongly                       Strongly
                                                                                        Agree                        Disagree
Quality ofthe Audit Work and Report                                                    Circle the number that best describes
                                                                                       your response to the question.
l.   The audit report clearly indicates what areas were reviewed.                        5        4       3       2        1
2.   The audit report was clear, logical and understandable.                             5        4       3       2        1
3.   The audit recommendations, if any, were appropriate to the conditions and are       5        4       "
                                                                                                          .)      2        1
     achievable.
4.   The OIG staff conducting this audit were professional, knowledgeable and            5        4      3       2         1
     objective.
Relevance to Your Work

l. The audit report was timely for your purposes.                                        5       4      3       2        1
2. The areas addressed by the audit were of concern to your office.
                     5
      4
     3
      2
       1

3. Your comments, if any, were fairly stated and adequately addressed.                   5       4      3       2        1
Please add any explanatory comments here, particularly for those rated 1 or 2: (Use an   additional sheet if necessary.)




Please return this form to:
                          -                FCA Office of Inspector General
                                              1501 Farm Credit Drive
                                               McLean, VA 22102

Ifyou would like to discuss your responses with the DIG,   check the box and be sure

to include your telephone number at the top o/this/orm or call us on 703/883-4030.                     D