Double Jeopardy: SEC and FRB Sanction Bank and its CEO

Ronald D. Paul, now 66, was described in the December 12, 2019, issue of the Washington Business Journal as a “long time Washington real estate developer” who was a founder of Eagle Bank (“Bank”), a Maryland-chartered commercial bank, headquartered in Bethesda, Maryland. Mr. Paul served as President and CEO and chairman of the board of the Bank from its founding in 1997 until his retirement in March 2019. He also served as chairman of the board of the Bank’s holding company parent, Eagle Bancorp, Inc.(“Bancorp”), from its inception in 1997, and as its CEO from June 2006, in both cases until his “sudden retirement” (per the Washington Business Journal) in March 2019. In addition, Mr. Paul had his own real estate firm, RDP, which he apparently continued to operate during his tenure as the leader of the Bank and the Bancorp. According to its June 30, 2022, financial statements Bancorp has assets of more than $10.9 billion. The Bank has 17 branches and five loan offices in suburban Maryland, Washington, D.C., and northern Virginia, and is, according to its website, “the go-to community bank” in the D.C. metro area. Bancorp shares are traded on NASDAQ.

“Community banks play a vital role in the functioning of the U.S. financial system and the broader economy,” according to the Federal Deposit Insurance Corporation in a June 23, 2022, Community Banking Research Report. The Independent Community Bankers of America (ICBA), the national trade association of community banks, poses the question “What Sets Community Banks Apart?” on its website. The ICBA then answers its question with the following, highlighting aspects of community banking: local focus; relationship banking; innovation; lending leadership to small businesses; timely decision-making; and community engagement and accessibility. The website of the Bank emphasizes many of the same features, which helps explain its growth from inception to $10.9 billion in assets in 25 years of operations. The Bank’s website expressly speaks to the need for personal relationships with customers, something very dependent upon the management of a bank and especially the persona of its leader, Mr. Paul in the case of the Bank.

Both the Bank and PDP were clients of a consulting firm owned by Jack Evans, Esq., a Wharton School economics honors graduate, and a lawyer who worked at the Securities and Exchange Commission (SEC) before winning election to the D.C. Council in 1991 and serving until his forced resignation in 2020 for conflict-of-interest violations, arising in part from his position as chair of the Washington Metro Area Transit Authority. According to published reports, Mr. Paul gave Mr. Evans the idea to set up his consulting business as a mechanism to increase his income. In testimony Mr. Evans asserted that he performed no services for the fees paid to his consultancy. While not the main violative conduct involving the Bank, the Bancorp, and Mr. Paul, it was a basis for part of one of the enforcement actions taken against Mr. Paul.

The Bank, as a state-chartered Maryland bank which elected to be a member of the Federal Reserve System, is subject to the jurisdiction of the Board of Governors of the Federal Reserve System (FRB), as its principal prudential regulator, as well as to the oversight authority of the Office of the Commissioner of Financial Regulation of the State of Maryland. The Bancorp is also regulated by the FRB, and, as a public company, is subject to the regulatory jurisdiction of the SEC with respect to its securities and financial disclosures. Regulation O of the FRB requires any executive officer, director, or principal shareholder of a bank, or of any related bank holding company or affiliate, or any entity controlled by any of them, to report to the bank involved, the amount and terms of any loan or other extension of credit, none of which may be made on terms or conditions more favorable than an unrelated borrower would receive. In addition, a financial institution like the Bank is required by its Federal prudential regulator to have a third-party risk management program adequate to protect the institution from unsafe or unsound arrangements.

On August 15, 2022, the FRB issued an Order of Assessment of a Civil Money Penalty Issued Upon Consent (‘the “FRB Order”) to the Bank. In the FRB Order the FRB found (based on an investigation conducted by the Federal Reserve Bank of Richmond, Virginia, the Federal Reserve Bank for the Federal Reserve District in which the Bank is located) that the Bank from May 1, 2015 until May 1, 2018 (the “Relevant Time Period”) that the Bank: violated Regulation O “by extending credit to the related interests of insiders, including entities owned or controlled by the Bank’s then-CEO without the requisite approval from a majority of the Bank’s directors.” The FRB also found that the Bank “suffered from internal control deficiencies, including deficiencies related to the supervision of lending staff, which permitted the Bank’s then-CEO to engage in conflicts of interest, including on behalf of his family trusts and wholly-owned real estate development company and for his own personal gain.” Further, the FRB found that the Bank “failed to maintain an adequate third-party risk management program to evaluate and oversee the Bank’s entry into, and extension of services agreements” with Jack Evans’ consulting business.

The FRB concludes that the “internal control deficiencies caused reputational harm and heightened legal risks to the Bank,” and that the “violations of law and unsafe or unsound practices warrant the assessment of a civil money penalty” of $9,524,000, to which the Bank consented. Both Mr. Paul (for violating Regulation O and for unsafe and unsound banking practices) and the former general counsel of the Bank, Laurence E. Bensignor, Esq. (for unsafe and unsound banking practices) were barred by the FRB from ever serving as an officer or director of a banking institution.

As noted above, Bancorp is a public company whose shares are traded on NASDAQ; accordingly, Bancorp and its executives are subject to the jurisdiction of the SEC. It is particularly significant that, during the Relevant Time Period, Bancorp sold securities to the public pursuant the deficient registration statements filed with the Commission. During that same period, the SEC asserted in its August 16, 2022, Order instituting cease-and-desist proceedings that the Bancorp made material misstatements and omissions “about related party loans extended … [by the Bank] to family trusts affiliated with Ronald D. Paul…and to other related parties”. These “undisclosed loans – which were hundreds of millions of dollars in the aggregate and over twice the amounts…publicly disclosed… [were required by] SEC regulations and Generally Accepted Accounting Principles…[to be disclosed as] material related party transactions.”

“[F]ollowing a report by a short seller in December 2017…[asserting] that Bancorp had made significant undisclosed loans to Paul’s family trusts, …[Bancorp] and Paul falsely asserted that those loans were not related party loans and that…[Bancorp] was compliant with all…[disclosure] requirements” in two separate press releases denying the allegations in the short seller report. Thereafter, Bancorp and Paul made materially false statements in response to investor inquiries about related party transactions, including asserting that the family trusts had independent trustees, which was not true. In fact, the trustee of the family trusts was an employee of Mr. Paul’s real estate development company, who was subject to the supervision of, and potential removal by, Mr. Paul. Mr. Paul had the authority to swap trust assets and had the power under management agreements to manage the trusts. Mr. Paul also, according to the SEC Order, “exercised control over the Trusts…by routinely directing the Trusts to invest in real estate and other business ventures”. Mr. Paul “served as a manager of certain entities owned by the Trusts that received loans from” …the Bank. The SEC asserts that Mr. Paul “engaged in these activities for his own personal gain,” including as an agent of RDP, his personal real estate development company.

The nature and amount of insider loans was concealed from both the Bancorp’s accounting department and from its outside auditors. This concealment continued through the filing of its 2014 annual report, its 2015 annual report, its 2016 proxy statement, its 2016 annual report, and its 2017 proxy statement, and in a Form 8-K filed in December 2017 which attached a December 4, 2017, letter from Mr. Paul to Bancorp and Bank customers rebutting the short seller report. Even after the Bancorp had been confronted by FRB examiners about the potential applications of Regulation O to the trust loans, the Bancorp concealed the full extent of them. Finally, in the 2018 annual report filed on March 1, 2019, the Bancorp “fessed up” that insider loans totaled $238 million as of December 31, 2017 – up from a previously reported $61 million; and $138 million as of December 31, 2016 – up from a previously reported $53 million.

The Commission found that Bancorp during the Relevant Time Period violated its books and records obligations and had wholly insufficient internal controls. The SEC charged Bancorp with violating: i) Sections 17(a)(2) and(3) of the Securities Act of 1933, as amended (the “33 Act”) for selling securities using material misstatements or omissions; ii) Section 13(a) of the Securities Exchange Act of 1934, as amended (the “34 Act”) and Rule 13a-1 thereunder for filing materially false periodic reports with the Commission; iii) Section 13(b)(2)(A) of the 34 Act for failing to keep accurate books and records; iv) Section 13(b)(2)(B) of the 34 Act for failing to maintain an accurate an adequate system of internal accounting; and v) Section 14(a) of the 34 Act and Rule 14a-9 thereunder for using proxy statements containing materially false statements or materially misleading omissions. None of the foregoing require proof of scienter in order to support liability.

As a result, the Commission ordered Bancorp: to cease and desist from future violations of the cited sections; to disgorge $2.6 million plus prejudgment interest of $750,493; and to pay a civil penalty of $10 million. Between October 23, 2017, and November 3, 2017, Mr. Paul sold 50,000 shares of Bancorp stock for proceeds of approximately $3.35 million, according to a Complaint (the “Complaint”) filed by the SEC in the Federal Court for the Southern District of New York on August 16, 2022. The Complaint alleges that Mr. Paul violated: i) Section 17 (a)(2) and/or (2) of the 33 Act for securities sale with false information; ii) Section 14 (a) of the 34 Act and Rule 14a-9 thereunder for material misstatements or omissions in proxy statements; and iii) Rule 13a-14 under the 34 Act for signing materially false certificates in connection with reports filed with the commission. The Commission sought: a cease and desist order; a permanent injunction against future violations; disgorgement of $109,000 plus prejudgment interest of $22,216; a civil money penalty of $300,000; and a two year bar from serving as an officer or director of a public company.

Greed and hubris – two serious deficiencies which can undermine a life and a community bank. In this case Ronald D. Paul cost himself all the regard he had built up as a Washington D.C. real estate developer and the well-regarded founder of the “go-to community bank” in the metro D.C. area. The Bancorp and its subsidiary Bank are poorer by something approaching $25 million dollars – the civil penalties of $19,524,000; plus, i) the disgorgement of $2.6 million and prejudgment interest of $22, 216; and ii) the costs of legal representation of the Bank and the Bancorp. How shall we be remembered?

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