EU General Court holds that indictment of a controlling shareholder may justify withdrawal of bank licence

Background of the Pilatus Bank decision

Pilatus Bank (Pilatus) was supervised by the Maltese NCA (MFSA). In 2018, the bank’s sole shareholder (Shareholder) was arrested in the US on charges relating to his alleged breaches of US sanctions against Iran. The indictment received international media attention and also alleged that some illegal money was used to set up Pilatus. While the charges were later dropped, they had already resulted in significant withdrawal requests for over 40% of the deposits on the bank’s balance sheet, early termination of a contract with the bank’s main borrower and loss of the correspondent banking relationship.

Following a proposal by the MFSA, the ECB decided to withdraw Pilatus’ licence, arguing that since the Shareholder ceased to meet the suitability criteria, Pilatus no longer met the conditions for authorisation. A shareholder’s reputation could not only be called into question by a conviction but also by prosecution for certain offences that cast doubt on their integrity and consequently that of the supervised bank.

The ECB stressed that Pilatus’ structure meant that the Shareholder was the sole controlling entity and in these circumstances his indictment had led to considerable negative market sentiment as evidenced inter alia by the plethora of deposit withdrawal requests. In the ECB’s view, the forward-looking perspective of banking supervision, which takes into account the public’s confidence in the financial market participants, justified taking into account the indictment where its effect on the public’s perception of the Shareholder was so clearly evidenced.

The General Court’s decision

Pilatus sought to overturn the ECB’s decision on a number of grounds. Most notably, it claimed that: 

•  The ECB had made an error of assessment in that it relied on a mere indictment of the Shareholder which did not constitute a valid ground for the withdrawal of authorisation (Mere Indictment Argument); and
• The ECB did not take account of the fact that the indictment related to breaches of the rules relating to US sanctions against Iran, whereas the disputed conduct is not illegal from the perspective of EU law (No Illegality Argument).

The Court dismissed the action on all grounds and confirmed the ECB’s decision. 

Mere Indictment Argument

The Court considered that under Article 18(c) of the Capital Requirements Directive (CRDIV), the ECB may withdraw a bank’s authorisation if it no longer fulfils the conditions under which it was granted. In this regard, a decisive factor for granting authorisation is the suitability of the bank’s controlling shareholders under the CRD, including their “good repute”. Thus, if such a shareholder ceases to fulfil the suitability criteria, in particular the reputation criterion, it may result in the bank having its licence withdrawn.

Since the concept of “good repute” was not defined in CRDIV, the Court relied on a teleological interpretation to conclude that it depended “not only on a person’s conduct but also on the perception of that conduct by others”. Given the importance of public confidence in banking market participants, taking into account the perception of the good reputation by the public and financial market participants of a shareholder who has been charged is justified, in view of the objectives of prudential supervision, inasmuch as that supervision aims to further the objective of preserving the stability of the financial system within the EU and each Member State.

The General Court emphasised that while the indictment of a qualifying shareholder is not sufficient, in itself, to call into question their good reputation, the concomitant negative perception of that reputation by the public, if demonstrated on the basis of specific evidence, may justify the withdrawal of the authorisation of the bank concerned.

No Illegality Argument

The court also rejected the argument that the indictment could not be taken into account as it concerned violation of third country laws that were not unlawful in the EU. It held that the ECB’s decision was not based on the merits of the charges brought by US prosecution, but on their consequences for the reputation of the Shareholder and the negative perception in the market of him and the bank.

Perhaps surprisingly, the Court did not consider in detail in its argument the fact that the alleged offences concerned breach of US sanctions that are the subject of the EU blocking statute. The Court simply concluded that the ECB did not recognise or render enforceable the sanctions adopted by the US against operators engaged in trade with Iran, presumably based on the same argument – namely that it was not the merits of the prosecution that were determinative but the public reaction.

Outlook

The decision in Pilatus Bank shows that criminal charges (even in the absence of a final conviction) may, if accompanied by negative market sentiment, lead to a qualifying shareholder being considered not (or no longer) suitable and can result in the withdrawal of a banking licence. Although there was the additional circumstance of the bank being controlled by only a single shareholder, the Court’s reasoning does not rely on this and the reasoning may be extrapolated to any case where a qualifying shareholder is indicted and there is a severely negative market reaction to it.

The Court’s clarification on the meaning of “good repute” so as to include the public perception of one’s conduct is significant as it is of more general significance in the assessment of suitability even outside the context of a licence withdrawal situation. It will inform the ECB’s approach in routine assessments of the suitability of qualifying shareholders going forward.

Further Reading

Read the full Pilatus Bank judgment here.