A recent Decision by the Board of Governors of the Federal Reserve System (the Board) sheds light on certain rights that banks may have when their employees engage in improper behavior when moving to a competing bank — and issues a stark warning for bank employees looking to do so. The Decision highlights the risk not only of civil litigation but also of an order of prohibition from further participation in banking under the Federal Deposit Insurance Act (the FDI Act), 12 U.S.C. § 1818(e).

The Decision, In re Frank E. Smith and Mark A. Kiolbasa, No. 18-036, 2021 OFIA Lexis 2 (Off. of Fin. Inst. Adjud. March 24, 2021), addresses the conduct of two former employees and officers of Central Bank & Trust (Central), a Wyoming state bank, who were exploring opportunities for Central to partner with and possibly acquire a competitor, Farmers State Bank (Farmers). The employees eventually resigned from Central to pursue personal opportunities with Farmers but improperly moved business, information, and documents with them to Farmers. For example, the employees improperly moved loans they had managed from Central to Farmers by circumventing the usual preliminary step of a competitor bank submitting formal, written payoff information requests for these loans; instead, Farmers sent Central checks for exact loan payoff amounts, which deprived Central of the opportunity to engage in its typical practice of contacting and attempting to retain its customers. The employees also appropriated more than a dozen Central bank forms and documents, which were sent from the employees’ personal email accounts and bank email accounts without Central’s authorization. The employees also took Central’s confidential financial, business, and customer information, such as lists of investors and potential customers.

Litigation ensued. Central filed a civil lawsuit against the employees in Wyoming state court. After a lengthy discovery process, the jury awarded Central more than $1million dollars in damages, finding the employees liable on three claims: misappropriation of trade secrets, breach of fiduciary duties, and tortious interference with contract or prospective economic advantage. The jury also awarded punitive damages for the employees’ willful, malicious, and wanton conduct. The parties entered into a global settlement while the appeal was pending.

Shortly thereafter, an administrative law judge (the ALJ) undertook a determination of whether to enter a prohibition order against the employees under section 8(e) of the FDI Act, 12 U.S.C. § 1818(e). The ALJ issued a recommended decision for entry of a prohibition order, which the Board reviewed and largely affirmed, providing insight into the governing statutory framework.

• A prohibition order. Under the FDI Act, the Board may prohibit an “institution-affiliated party” (IAP) from further participation in banking. To issue an order pursuant to 12 U.S.C. § 1818(e), the Board must make three findings: “(1) There must be a specified type of misconduct — violation of law, unsafe or unsound practice, or breach of fiduciary duty; (2) [t]he misconduct must have a prescribed effect — financial gain to the respondent or financial harm or other damage to the institution; and (3) [t]he misconduct must involve culpability of a certain degree — personal dishonesty or willful or continuing disregard for the safety or soundness of the institution.” Stated more succinctly, the Board must prove (1) an improper act, (2) that had an impermissible effect, and (3) was accompanied by a culpable state of mind.

  • Misconduct. In the Decision, the Board found that the first element for a prohibition order (misconduct) was met through the employees (1) usurping Central’s customers or business opportunities for the employees’ own benefit and (2) taking or sharing Central’s information or that of its customers without authorization. In its findings, the Board reiterated several legal precepts. Officers and directors of a depository institution have a “strict fiduciary duty” to act in the institution’s best interests. Bank officers and directors have two overarching fiduciary duties: the duty of care and the duty of loyalty. The duty of loyalty requires fiduciaries to “put the interests of the bank before their own[] and not use their positions at the bank for their own personal gain.” “Self-dealing, conflicts of interest, or even divided loyalties are inconsistent with fiduciary responsibilities.” “A crucial component of the duty of loyalty is the duty of candor, which requires that corporate fiduciaries disclose all material information relevant to corporate decisions from which they may derive a personal benefit.” Omissions are sufficient to trigger a violation of this duty. The Board concluded that the employees engaged in multiple breaches of their fiduciary duties and participated in “unsafe or unsound practices” by willfully misappropriating Central’s trade secrets and interfering with its contracts or prospective economic advantage to Central’s detriment.

  • Effects. In the Decision, the Board found that the second element for a prohibition order (an impermissible effect) was met. The Board pointed out that the “effects” prong may be established if, inter alia, the IAP “received financial gain or other benefit” as a result of the misconduct or if the misconduct caused an insured depository institution to suffer “financial loss or other damage.” This element was established because the employees personally gained from their misconduct and because their misconduct harmed Central.

  • Culpability. In the Decision, the Board found that the third element for a prohibition order (culpability) was met. The Board pointed out culpability may be shown by evidence of “personal dishonesty” or a “willful or continuing disregard by such party for the safety and soundness of such insured depository institution or business institution.” The Board found, for example, that the employees “coordinated their efforts to transfer forms, analyses, and other information from Central for use by Farmers, without informing anyone at Central or obtaining authorization for the transfers.”

• The Board’s expansive jurisdiction. The Decision also reinforces the Board’s expansive reach to issue a prohibition order against “any IAP” who has violated “any law or regulation,” “engaged or participated in any unsafe or unsound practice in connection with any insured depository institution or business institution,” or “engaged in any act . . . which constitutes a breach of such party’s fiduciary duty.” 12 U.S.C. § 1818(e)(1). The Board has jurisdiction over IAPs who formerly worked at an FDIC-supervised institution.

Ultimately, the Board concluded that a prohibition order against the employees was warranted, largely affirming the recommended decision of the ALJ. The Decision highlights the potential legal ramifications of civil litigation and a prohibition order under the FDI Act when employees engage in improper behavior when moving to a competitor.