What happens when a bank examiner makes a mistake? Perhaps the examiner gave the bank a composite CAMELS rating of 4 when comparable banks typically receive a 2. Perhaps the examiner incorrectly concluded that the bank had inadequate reserves for loan losses. Perhaps the examiner concluded that the bank needs to improve its compliance with the Community Reinvestment Act. Under federal law, each of these decisions is a “material supervisory determination.”
To guard against erroneous material supervisory determinations, Congress in 1994 enacted a statute requiring that federal financial regulators provide an “independent intra-agency appellate process ... to review material supervisory determinations made at depository institutions.” The Office of the Comptroller of the Currency (OCC), the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (NCUA) each adopted different procedures for handling these appeals.
Although it has been roughly two decades since regulators adopted the material supervisory determination appeals processes, little has been done to analyze their effectiveness. I decided to undertake this task. In addition to scrutinizing each regulator’s policies and guidelines, I reviewed every available appeal. Only the OCC and FDIC publicly provide summary or redacted appeals decisions. When decisions were not generally available, I made Freedom of Information Act (FOIA) requests. The NCUA provided redacted decisions from its independent intra-agency panel. However, I did not convince the Federal Reserve to provide summary or redacted opinions. Instead, the Federal Reserve provided a table showing brief descriptions and resolutions for some appeals. With the data in hand, I interviewed present and past OCC and NCUA appeals officials.
Based on this review, I found three significant shortcomings of the material supervisory determinations appeals processes. First, there are few appeals. Any appeals process is unhelpful if it is never used. Second, regulators differ significantly in the type of review that they provide. Each regulator sets its own standard of review. This means that some financial institutions are entitled to a more thorough review of their appeals than others. Some regulators’ standards of review are so opaque that it is difficult to determine whether a bank is entitled to a meaningful review. Finally, material supervisory determinations are shrouded in secrecy. This makes it difficult for financial institutions and regulators to learn from past appeals. It is also difficult to determine if similarly situated institutions are treated similarly.
After describing these problems in more detail, I propose three changes to strengthen the material supervisory determination appeal processes. First, once a regulator issues a determination, financial institutions should have direct access to a dedicated appellate authority outside of the examination function. Second, the appellate authority should engage in a robust review employing a clear and rigorous standard of review. Third, regulators should release detailed information about each decision reached by the appellate authority.
The first problem is that few appeals are heard by the congressionally mandated “independent intra-agency” review authority. Before reporting data, some background on the appeals processes is helpful. Each bank or credit union may appeal a material supervisory determination to the regulator who made the determination.
Each regulator has its own multistage process for handling material supervisory determination appeals (Figure 1). The FDIC and NCUA both require a financial institution to appeal to an official within the examination function. At the FDIC, banks must appeal to the appropriate division or office director. At the NCUA, the credit union must “contact” the NCUA’s regional office that oversees the credit union. If an FDIC- or NCUA-regulated institution is unhappy with the initial official’s decision, the institution can then appeal to an independent intra-agency panel.
The panels are relatively static, with members serving for at least one year. At the FDIC, the independent panel is known as the Supervision Appeals Review Committee. At the NCUA, it’s the Supervisory Review Committee. The Federal Reserve’s appeals process is handled primarily by the regional Federal Reserve Banks. When a bank files an appeal, the appropriate Federal Reserve Bank chooses a review panel. The members of the panel must not have participated in the examination and can be chosen from other regional Federal Reserve Banks. The makeup of appeals panels is ad hoc; the panels change from appeal to appeal. If the bank is unhappy with the result, it can appeal to the regional Federal Reserve Bank president and then to the Federal Reserve Board. The OCC is unique because financial institutions can choose whether to address their appeals to the Deputy Comptroller overseeing the exam or to the OCC Ombudsman. The Ombudsman is independent and reports directly to the OCC’s Comptroller.
So how often did financial institutions avail themselves of that independent intra-agency appeal that Congress requires? Not very often (Figure 2). In fact, between 1995 and 2012, the NCUA Supervisory Review Committee issued only six decisions.
Perhaps these numbers would not be troubling if evidence suggested that appeals are being resolved at earlier stages in the appeals processes. However, confirming or disproving that the exam process is adequately handling disputes is difficult because none of the regulators regularly release information about early-stage appeals. Through FOIA, I requested information about early-stage appeals. Only the NCUA reported a significant number of appeals that were resolved at early stages in favor of the financial institution. The NCUA provided a summary table showing 140 “regional contacts” between 2005 and 2012. Twenty-five of those made a change to the initial material supervisory determination. Thus, even considering appeals resolved before reaching the independent review authority, the number of appeals is not large.
Admittedly, it is hard to decide how many appeals should have been filed, but there are reasons to suspect there should have been more. There are nearly 14,000 financial institutions (about 7,000 banks and 7,000 credit unions). Most of these are examined every year. Yet only a tiny number used the appeals process. Financial institution surveys conducted by the Alliance of Bankers Associations in 2011 and the Credit Union National Association in 2010 found that at least one-fourth of survey respondents were unhappy with their most recent examination and results. One-fifth of credit unions responding to the survey indicated that they wanted to appeal. Even if the surveys overstate dissatisfaction, the gulf between the reported dissatisfaction and actual number of appeals is huge.
Why don’t more banks appeal? The Credit Union National Association found that “[t]wo-thirds of the credit unions that wanted to appeal indicated they did not appeal for fear of retaliation by examination staff. Nearly the same number indicated they did not appeal because they did not believe it would make a difference in (Note: The Credit Union National Association performed a second survey about the examination process in 2012. While it did not specifically ask about the appeals process, it did ask about credit unions’ agreement with examination results. That survey found that 25% of respondents were unhappy with their most recent examination and results. Credit Union Nat’l Ass’n, 2012, Credit Union Exams Survey (on file with author) (N=1531, 10% very dissatisfied, 15% somewhat dissatisfied, 15% neutral, 39% satisfied, 21% very satisfied).
The survey respondents are probably right about the likelihood of winning an appeal (Figure 3). Here I considered the rate of success of all appeals, not just those that make it to each regulator’s independent authority. During the time periods for which the data is reasonably complete, the FDIC and the Federal Reserve adjusted the material supervisory determination in five cases each.
Limited and Inconsistent Standards of Review
This leads to the second problem: Regulators differ significantly in the type of review they provide. Regulators often do not engage in a robust review of appealed material supervisory determinations. One limiting factor in these regimes is the “standard of review” that is applied in the appellate process – the level of deference the appellate authority gives the earlier decision maker. Possible standards of review range from the deferential “abuse of discretion” standard to the nondeferential “de novo” standard. Because changing the standard of review adjusts the deference given to the earlier determination, the standard of review makes a difference in the outcome. Institutions appealing under a nondeferential standard have a better chance of success than those appealing under a deferential standard. The legislation requiring the regulators to provide an appeals process did not specify a standard of review. Without direction, regulators have adopted differing (and sometime opaque) standards.
In the early years of the appeals process, the OCC’s Ombudsman reviewed appeals de novo and often visited the appealing bank. As a former OCC Ombudsman Samuel Golden explained: “[I]f I want to know how you live, I’m going to go to your house. You can tell me about how you live, and then I go to your house and it’s junky as hell. ... If you want to know the real facts you literally go [to the bank].” Now, the OCC’s Ombudsman uses a more limited review asking whether the “examiners appropriately applied agency policies and standards.” The current OCC Ombudsman does not typically visit the appealing bank. Neither do the other regulators. (Note: Interview with Samuel P. Golden, Managing Dir., Alvarez & Marsal, former Ombudsman, Office of the Comptroller of the Currency, in Houston, Tex. (Nov. 9, 2012); Telephone Interview with Larry L. Hattix, Senior Deputy Comptroller for Enterprise Governance & Ombudsman, Office of the Comptroller of the Currency (June 14. 2013); Telephone Interview with Joy K. Lee, Supervisory Review Comm. Chair & Ombudsman, Nat’l Credit Union Admin. (Apr. 24, 2012); Telephone Interview with Hattie M. Ulan, Senior Ethics Counsel, former member Supervisory Review Comm., Nat’l Credit Union Admin. (June 18, 2013). The FDIC denied my repeated requests for an interview. The Federal Reserve lacks centralized officials who handle numerous appeals.)
The Federal Reserve Board has not adopted an agency-wide standard of review for material supervisory determination appeals. Left to their own judgments, the regional Federal Reserve Banks provide a potpourri of standards of review – from de novo at the Federal Reserve Bank of New York, to ad hoc (but probably not de novo) at the Federal Reserve Bank of Kansas City, to “findings and conclusions were based on sufficient evidence and were consistent with . . . policy” at the Federal Reserve Bank of Minneapolis, to no stated standard at other Reserve Banks.
The FDIC’s Supervision Appeals Review Committee “review[s] the appeal for consistency with the policies, practices and mission of the FDIC and the overall reasonableness of, and the support offered for, the positions advanced.”
NCUA policy statements do not provide a standard of review. Joy K. Lee, the NCUA’s Ombudsman and Chair of the NCUA’s Supervisory Review Committee, explained that she viewed herself “as a completely independent party.” However, she avoided using language that could easily be classified as a standard of review.
In sum, at present, three regulators (the OCC, some regional Federal Reserve Banks, and the FDIC) check to see if the material supervisory determination is consistent with regulatory policies and standards. This check is important; examiner decisions should be consistent with the law and previous regulatory pronouncements. However, it is not sufficient to ensure that examiner decisions are consistent. While some appeals may simply require the straightforward application of law or written policy, other appeals might present different issues.
Some appeals may involve questions of fact. For example, in rating the quality of a loan, one factor regulators consider is the value of the collateral securing the loan. The financial institution and the regulator may have differing conclusions about the value of that collateral. The examiner (or bank) may have properly classified the loan according to policy but nevertheless arrived at the wrong classification because the factual assessment of the value of the collateral was incorrect. A “consistent with agency policy” standard is also problematic when existing law and written policy do not cover the issue raised by the financial institution.
Given the confusing hodgepodge of standards of review and the low success rate, it is unsurprising that financial institutions believe that appealing a material supervisory determination will be unproductive.
The third problem with the material supervisory determination appeals processes is that they are not transparent. As I found out firsthand, it is challenging to get information about appeals decisions.
Written and regularly disseminated decisions serve several functions. First, written decisions can be a learning tool for regulators. If decisions are public, all regulators can review the decisions and compare them with their current practices. How can regulators be expected to achieve any measure of consistency (either within an agency or across agencies) if regulators have no idea what others within its own agency or at other agencies are doing? Second, written decisions act as guideposts for financial institutions. Institutions are better able to comply with regulator expectations when they understand what the regulators expect. Third, written decisions give the public a way to evaluate the material supervisory determination appeals processes and the examination function overall. The lack of transparency stands as a barrier to consistency and confidence in the examination process.
Improving Material Supervisory Determination Appeals
How could we make the process better? First, once examiners issue a material supervisory determination, financial institutions should have direct access to an appellate authority outside of the examination function. Second, the appellate authority should employ a clear and rigorous standard of review. The standard of review should be consistent across regulators. Third, regulators should release detailed information about each decision.
Strengthened Independence of Review
First, once examiners issue a material supervisory determination, financial institutions should have direct access to a dedicated appellate authority outside of the examination function. The OCC is the only regulator to provide this access; OCC-regulated banks can appeal directly to the Ombudsman. FDIC-regulated banks and credit unions first address an appeal to an official who oversees the examination function. Federal Reserve-regulated institutions first address an appeal to an ad hoc committee that changes with each appeal. I propose that FDIC-regulated banks be allowed to appeal directly to the Supervision Appeals Review Committee and credit unions be allowed to appeal directly to the Supervisory Review Committee. I also propose that the Federal Reserve create an independent appellate authority. The appellate authority should consist of people who are not part of the examination function. Moreover, members of the appellate authority should not change with each appeal.
The benefits of direct access to a dedicated appellate authority outside the examination function are threefold. First, consistent decisions are more likely to come from a single appellate authority (whether consisting of an individual or a small group) than from a number of different individuals who do not deliberate together (as is the case when appeals are first routed through division, region, or office directors).
Second, a single appellate authority promotes transparency. Regulators do not regularly release any information about early-stage appeals that are routed to a division, region, or office director. Perhaps this is partly because these officials are so connected with the examination function, a non-public process, that they presume complete secrecy is preferable. Allowing appeals to instead begin with a dedicated appellate authority outside the examination function may facilitate public release of summary or redacted opinions. A dedicated appellate authority outside the examination function may be better able to balance protection of information that could lead to banking runs with disclosure of information that could improve the examination function. Indeed, the OCC Ombudsman and FDIC Supervision Appeals Review Committee (appellate authorities outside the examination function) already strike a reasonable balance when they release their decisions.
Third, a more independent appellate authority may increase bank confidence in the material supervisory determination appeals processes. Financial institutions that disagree with a determination may view the regulator’s examination function with suspicion. Assigning the first step of the examination function to examination officials does little to assuage this concern. Institutions would likely view a dedicated appellate authority outside the examination function as more independent, particularly if that authority publicly disclosed its decisions.
The OCC gives its banks the choice of filing with the Ombudsman or the Deputy Comptroller of the supervisory district that oversees the bank. Current Ombudsman Larry Hattix estimates that about 80% start directly with the Comptroller. This suggests most banks prefer the appellate authority outside the examination function.
Clear & Consistent Standard of Review
Second, regulators should adopt a clear and robust standard of review. The bar is low here – nearly any clear and consistent standard would be an improvement. The scope of review that a financial institution receives should not depend on its charter type, membership in the Federal Reserve, or location. Choosing the appropriate level of deference is more difficult. I favor a de novo review because it would allow each independent appellate authority to correct a wider swath of erroneous decisions.
When I spoke with regulators, some worried that de novo review would encourage financial institutions to “sandbag” examination staff. Rather than raising relevant facts or concerns with examiners, financial institutions might remain silent and then seek to have material supervisory determinations overturned through the appeals process. This, however, seems unlikely for a variety of reasons. First, the appeals process cannot be used to stall enforcement actions. Financial institutions must comply with examiner instructions while any appeal is pending. Second, financial institutions are repeat regulatory players. It is not in their interest to antagonize regulators. Third, the historic success rate for material supervisory determination appeals suggests it would be foolhardy for a financial institution to think that winning on appeal is a foregone conclusion. Even if reforms strengthen the appeals process, financial institutions will face risks when using the process.
Finally, and perhaps most obviously, each appellate authority should provide summary or redacted decisions. The information provided should include (1) the reason the appealing financial institution believes the examiner erred; (2) the applicable law, regulation, or agency guidance; and (3) the decision and accompanying reasoning.
Regulators’ primary objection to releasing decisions appears to be that the appeals concern confidential information from bank examinations. While secrecy may be warranted with respect to the examination report itself, there is no need to extend complete secrecy to material supervisory determination appeals decisions. The OCC and FDIC have managed to strike a balance between releasing meaningful information and protecting sensitive information.
The bottom line is that it shouldn’t take a law professor with a fondness for the Freedom of Information Act to get access to basic information about material supervisory determination appeals.
When Congress that each federal financial regulator must provide “an independent intra-agency appellate process ... to review material supervisory determinations made at insured depository institutions,”11 it hoped the processes would “provide an avenue of redress ... from uneven treatment by examiners.” (Note: S. Rep. No. 103-169, at 51 (1993), reprinted in 1994 U.S.C.C.A.N. 1881, 1935).
Now, two decades later, the processes adopted pursuant to this mandate have hardly been used. Regulators differ significantly in the standards they use to evaluate appeals. And even finding basic information about appeals decisions can be difficult. In short, the existing material supervisory appeals processes do not provide a meaningful avenue for correcting uneven regulatory treatment.
To achieve Congress’s goal, regulators must strengthen their appeals processes. Financial institutions should have direct access to a dedicated appellate authority outside of the examination function. Regulators should employ a clear and rigorous standard of review. Finally, regulators should release appeals decisions in summary or redacted form.
I am hopeful that improvements can be made. The NCUA is already considering changes to its appeals process. The banking regulators should follow suit. To err is human; to correct, divine.
About the Author:
Professor Julie Andersen Hill joined the University of Alabama School of Law in 2013. She previously was a faculty member at the University of Houston Law Center. Hill teaches in the areas of banking and commercial law. She is a recognized expert on financial institution regulation. In 2015, the University of Alabama awarded Hill the President’s Faculty Research Award. She previously practiced law in the Washington, D.C., office of Skadden, Arps, Slate, Meagher & Flom. As part of the litigation group, she represented large financial institutions under government investigation.
Hill received her undergraduate degree in economics summa cum laude from Southern Utah University. She earned her J.D. degree summa cum laude from the J. Reuben Clark Law School at Brigham Young University. Hill clerked for Judge Wade Brorby on the United State Court of Appeals for the Tenth Circuit.