OTS Chief On Temporary Leave As Treasury Inspector General Reviews BankUnited Backdating

Today’s Wall Street Journal reports here that Acting Office of Thrift Supervision (”OTS”) Director Scott Polakoff has been placed on leave pending Treasury OIG’s investigation into whether the OTS approved BankUnited Financial Corporation’s backdating of a capital transfer in August 2008.

According to the story by Damien Paletta and David Enrich:

“In August, BankUnited transferred $80 million from the parent company to its thrift subsidiary, which was running low on funds, according to people familiar with the matter. BankUnited officials said at the time that the transfer was effective as of June 30. The move had the effect of burnishing its capital levels for the quarter that ended June 30.”

“At the end of that quarter, BankUnited’s recorded Tier 1 capital — the measure regulators use to judge a bank’s health — was at 7.6%. That fell to 1.34% by Dec. 31. Regulators typically want a bank to have at least 6% in Tier 1 capital.”

Polakoff is a highly-regarded career federal employee. Treasury OIG revealed in December that the OTS had improperly allowed a similar backdated capital infusion by IndyMac Bank.

The whole scenario of OTS-approved backdating highlights a problem often faced by federal prosecutors when they are called to investigate fraud in the wake of financial debacles. These debacles typically occur during periods of lax regulation. Law enforcement agents discover during their investigations that regulators/examiners have tacitly approved, or at least failed to stop, actions that look like classic fraud to the FBI or an Assistant United States Attorney (”AUSA”).

This makes prosecution more difficult–and with reason. It is hard to justify criminally charging someone who did nothing to hide his/her questionable activities from on-the-scene regulators/examiners. But there are also situations where massive multi-year fraud occurred and the perpetrators sought to cover their actions by obtaining regulatory approval, without full disclosure, to an overworked examiner or regulatory official.

It is the task of the ethical federal fraud prosecutor to determine which of these two types of cases he/she has. The thing to be avoided is a rush to prosecute (in the wake of public rage and hysteria) people who took actions that, however negligent, greedy, or misguided, were entirely within the acceptable regulatory ethos of their times.