Appeal of Violation of Divident Calculation (Fourth Quarter 1996)

Background

A bank disagreed with a violation of 12 USC 60(b) pertaining to the declaration and payment of an illegal dividend in December 1994. The disagreement involves the calculation of the maximum allowable dividends the bank could have paid. Three issues are involved:

Stock Dividend. Bank managers do not believe that a stock dividend paid in 1993 is a dividend for purposes of 60(b). Therefore, they do not believe it should be included in the calculation.
Intercompany Payment. The appeal also disputes the designation of an intercompany payment as a dividend for the purposes of this statute. In early 1994, the bank's parent company formed the existing bank through a complex, multi-step, reverse acquisition of a predecessor bank. Among the steps in the transaction, the parent formed an interim national bank. With the prior concurrence of the OCC, the predecessor bank lent the parent a portion of the funds it used to initially capitalize the interim bank. The interim bank was then merged with the predecessor bank into the appealing bank's existing Charter. Immediately following the merger, the appealing bank "declared a cash dividend" to its parent in the amount of the initial capitalization. The parent then used the proceeds to repay the loan to the predecessor bank (now the appealing bank) and replenish the holding company's cash. The entries did not have any impact upon the bank's capital levels, i.e., its capital immediately following the merger and after the dividend was exactly the same.
Accounting Adjustments. The examiners identified errors in the bank's official reports during an examination that began November 28, 1994. Year-to-date September 30, 1994 earnings were revised from a small net income to a large net loss due to understated goodwill associated with certain acquisition costs, loan charge-off s, and ALLL balance. Additionally, the bank discovered in March 1995 that the intercompany payment was apparently not accurately reported on its call report. The bank believes it properly relied on its call report, as originally filed, in calculating the maximum dividend for purposes of the December 1994 dividend.

Discussion

The statute, 12 USC 60(b) requires a bank to obtain prior OCC approval if the total of all dividends declared in any one calendar year exceeds the total of its net income of that year plus the retained net income (net income less dividends) for the preceding two years.

Stock Dividends. The statute is silent on the application of stock dividends. The OCC's historical position has been that stock dividends are dividends for purposes of section 60(b). See, e.g., Letter from William B. Camp, Comptroller, to Manuel F. Cohn, Chairman, SEC (April 8,1968) and Letter from Donald G. Coonley, Chief National Bank Examiner (September10,1992). However, the OCC has not made its historical position clear to all banks by regulation or otherwise. Also, the Board of Governors of the Federal Reserve System has issued a policy statement specifically stating that stock dividends are not to be taken into account for purposes of section 60(b). See 1960 Fed. Res. Bull. 858. Since a stock dividend does not result in the distribution of cash or assets, the board does not consider the term "dividend" in this statute as including stock dividends.

Intercompany Payment. The bank made this intercompany payment solely to facilitate a complex, multi-step, reverse acquisition of another institution. The legislative history of the statute indicates that its intent was to protect the capital of national banks. It provides the OCC with a legal mechanism to prevent national banks from dissipating their capital through dividend payments. Despite the fact that the banks made this intercompany payment out of its undivided profits account, all of the bank's accounts after the acquisition were the same as all of the predecessor bank's accounts before the acquisitions. The acquisition merely involved a transfer of funds from its capital stock and surplus accounts to its undivided profits account. Viewing the bank as a de facto continuation of the predecessor bank, the multi-step transaction did not alter the bank's overall capital or cash positions.

Accounting Adjustments. The largest decrease to earnings resulted from an inadequate ALLL balance based upon loans downgraded by the OCC and external loan review. Two loan losses accounted for one-half of the increases to the ALLL. The examiners also identified inadequate accounting control that resulted in additional adjustments regarding prepaid expenses, accounts receivable, OREO losses, overdrafts, and miscellaneous other expenses. As a result, the examiners cited the bank in violation of 12 USC 161 (inaccurate call report). OCC Banking Bulleting 90-44 directs national banks to use the net income amount reported in its call report in calculating its dividend-payment capacity under 60(b). Underlying this guidance is the assumption that the net income amount in the call report is accurate, i.e., reported in compliance with all applicable reporting requirements.

Conclusion

The ombudsman concurs with the bank's appeal that both the stock dividend and the intercompany payment involve unique considerations. He also agrees that, in economic reality, neither payment contravenes the statutory purpose of preventing the dissipation of bank capital. Therefore, he decided that neither payment is a dividend for the purposes of 12 USC 60(b).

However, the violation of 12 USC 60(b) remains. The bank re-filed its March, June, and September 1994 call reports to correct the errors identified as a result of the examination. The income and dividend numbers based on those corrections still reflect the payment of excessive dividends, excluding the stock dividends and the intercompany payment.