By Jonathan Joseph*
Since the initial crush of the financial crisis in the summer of 2008, 406 banks have failed. As of October 24, 2011, the FDIC has authorized suits in connection with 34 failed institutions and 308 officers and directors for D&O liability of at least $7.3 billion.
The current cycle of litigation initiated by the FDIC has begun slowly, however, now that that more than three years has elapsed since the first major bank failure occurred in July 2008, the pace of lawsuits against former bank officers and directors will increase markedly. Since more than 335 of the current round of bank failures didn’t occur until July 2009 or later, at this point, most of the FDIC’s suits have focused on the earliest failures. As receiver, the FDIC has three years to file civil damage actions for tort claims from the time a bank is closed. If state law permits a longer time, the state statute of limitations is followed.
To date, only 15 of the FDIC’s civil lawsuits have actually been filed against former officers and directors of failed banks including suits against five former officers of IndyMac Bank in California (but none of its directors). Two-thirds of the fifteen suits were filed in Georgia, California and Illinois and claims included negligence, gross negligence and breach of fiduciary duty. Some of the suits have also included claims for recklessness, corporate waste and willful misconduct. In the prior era, the FDIC brought suit against directors and officers in 24% of the bank failures from 1985 and 1992. With 38 failures in California, 17 in Washington and failures in Arizona (11), Nevada (11) and 6 in Oregon since 2008, if the past is prologue, the FDIC will bring additional civil damage claims against a significant number of bank officers and directors in the Western states during the next 24 months.
San Francisco based United Commercial Bank (UCB), with $11.2 billion in assets, was closed on November 6, 2009. On October 11, 2011, just prior to the second anniversary of UCB’s failure, the U.S. Attorney for Northern California unsealed a criminal indictment that resulted in the arrest of two former UCB executives. The investigation is “ongoing,” meaning more indictments are possible. The dame day, the Securities and Exchange Commission brought civil charges against UCB’s former CEO, Tommy Wu, as well as the two indicted executives for securities fraud, falsifying corporate books and records and false statements to the outside auditor. The FDIC also commenced enforcement actions seeking permanent banking industry bans against 10 former UCB officers (including Tommy Wu and the two indicted officers) and civil money penalties. Three additional officers, who cooperated in the FDIC’s investigation, consented to prohibition orders and civil money penalties. As of October 24, 2011, there had been no announcement of any civil damage suit by the FDIC against any directors or officers of UCB.
This is the environment in which commercial bank D&O’s are operating today. Important lessons can be distilled from the current round of FDIC lawsuits, criminal indictments and regulatory enforcement actions – applicable to sound and troubled banks. The current lawsuits and enforcement actions challenge past conduct and recount recurring themes that help further define corporate best practices and delineate strategy and duties for bank leaders in the future.
The following guidelines are derived from the author’s experience in the “trenches” advising banks and defending officers and directors of failed and distressed banks:
1) Adopt Corporate Best Practices. Well-drafted board minutes should demonstrate directors have exercised reasonable business judgment. Use outside experts as needed to help show that decisions were prudent and made in good faith. Take regulatory criticisms seriously. Address them promptly and responsibly. Hold management accountable. Develop practices and procedures to identify conflicts of interest and don’t approve transactions premised on conflicts without thorough vetting. In connection with complex transactions, management succession, board compensation, bank agency enforcement issues and guiding a “distressed” bank, outside directors should consider retaining independent board counsel to assist in understanding and satisfying fiduciary duties, documenting reasonable business judgments, addressing conflicts of interest and responding to regulatory matters.
2) Director & Officer Liability Insurance. Annually, directors should assess whether coverage is tailored specifically to the current profile of the bank and its D&O’s. The D&O insurance market is fluid. Consequently, a specialty broker and independent counsel with banking and coverage expertise should guide the board. Regulatory exclusions should be avoided. Don’t wait until trouble brews to obtain policies without such exclusions. Consider purchasing policies at both the bank and the bank holding company level since such policies often play out differently in the event of a bank failure. D&O’s should consider purchasing (solely with individual funds) endorsements or separate policies that cover civil money penalties since the FDIC will not allow a bank to fund this type of coverage.
3) Be Aware that Outside Directors Are Not Treated Equally. In several recent suits, the FDIC has focused on outside directors that had elevated banking industry expertise compared to ordinary businessmen. For example, in August 2011 the FDIC sued 14 outside directors of Georgia’s Silverton Bank. The complaint alleged that these directors were either CEO’s or presidents of other banks and asserted they were more “skillful and possessed superior attributes in relation to fulfilling their duties” compared to other directors that were not professional bankers. The FDIC’s position is that these individuals should be held to a higher standard of care. Arguably, the FDIC could assert this position as to any outside director with superior skill or experience. Such individuals should document vigilance in the boardroom and understand how their duties may differ from other directors and officers.
4) Establish and Follow Sound Loan Underwriting Policies and Avoid Rapid Growth. Many recent FDIC suits assert that board’s approved deficient loan underwriting policies and further exacerbated this conduct by repeatedly permitting exceptions to weak standards. Many failed banks were alleged to have implemented “unsustainable business models pursuing rapid asset growth concentrated in high-risk” loans that violated the bank’s underwriting policies. Some banks permitted extremely high CRE/ADC concentration levels even after repeated regulatory warnings. One failed California bank had ADC loans to total capital ten times the regulatory guideline prior to failure.
5) Evaluate Bank and Holding Company Interests. In one-bank holding companies, the interests of the bank and the holding company are often similar. However, when a holding company is controlled by a single person or small group, the interests of the bank may not align with the parent. Where a holding company or bank becomes troubled or holds insufficient capital, the interests of the two companies could significantly diverge. In such cases, directors and officers will need to well understand conflicting duties and interests and address them suitably.
* * * *
*About the author: Jonathan Joseph has focused for over 30 years on regulatory, corporate and transactional matters for community and regional banks and officers and directors of distressed and failed institutions. He is a member of the Financial Institutions Committee of the Business Law Section of the California State Bar and the managing partner of Joseph & Cohen, Professional Corporation (www.josephandcohen.com) in San Francisco, CA.
Joseph & Cohen’s Facebook site offers blog posts with business and banking information which the firm finds interesting or whimsical.
The comments herein do not constitute legal opinion and are not a substitute for legal advice. © Joseph & Cohen, Professional Corporation 2011. All Rights Reserved.
By Jonathan Joseph*
The total number of bank failures since the banking crisis began in 2008 is now dangerously close to 400. To date, the FDIC has only filed 14 lawsuits against failed bank directors and officers from thirteen different failed banks. A total of 103 former bank directors and officers have been named in these suits.
Based on published statistics and our own analysis of U.S. bank failures from 2008 to September 16, 2011, we believe that approximately 80 additional suits will be brought by the FDIC, as receiver, in the next two years. While the FDIC’s investigation and claim process has moved slowly, the number of damage suits authorized and filed is quickening and, we expect, will spike in 2012.
In August 2011, 5 new suits were filed, more than double any previous month. Currently, the FDIC’s website states it has authorized suits in connection with 32 failed institutions against 294 individuals for D&O liability with damage claims of at least $7.2 billion. All but one of these suits involved banks that failed prior to July 2009. Consequently, while 14 lawsuits have been filed and the FDIC has approved claims against an additional 191 directors and officers who served 18 different failed banks, this significantly understates the number of new suits to be filed and D&O’s to be named.
The current round of bank failures began somewhat slowly in 2008. The closing of IndyMac Bank in July 2008 marked the beginning of a huge acceleration of failures with 140 failures in 2009 and 157 in 2010. The pace has slowed in 2011 with 71 failures year to date. Some of the 18 authorized FDIC lawsuits not yet filed may settle; however, the FDIC will approve additional lawsuits against bank directors and officers at an increased pace in the ensuing months because 252 or 64 percent of the current round of bank failures occurred between July 9, 2009 and December 31, 2010. The FDIC is now approaching the decision point in many of these pre-2011 failures including the retention of outside law firms to prosecute damage claims on its behalf, as receiver.
D&O liability suits are generally only pursued if the FDIC concludes they are both meritorious and cost-effective. Before seeking recoveries from individual directors and officers, the FDIC conducts an investigation into the causes of the failure. The FDIC states on its website that investigations are usually completed within 18 months from the time the institution is closed, but lawsuits typically aren’t filed for another few months to a year. Investigations can extend longer and lawsuits are sometimes filed just before the third anniversary of a bank’s failure.
Here are some illustrations: Georgia’s Silverton Bank failed on May 1, 2009 and suit was filed on August 22, 2011 (27 months). Haven Trust Bank in Georgia failed on December 12, 2008 and suit wasn’t filed until July 14, 2011 (32 months). Cooperative Bank in North Carolina was closed in June 2009 and suit was filed August 10, 2011 (26 months). On the other hand, Wheatland Bank in Illinois failed on April 23, 2010 and suit was filed on May 5, 2011 (13 months). With $11.2 billion in assets, San Francisco based United Commercial Bank was closed and most of its assets were assumed by East West Bank on November 6, 2009. Yet after almost two years, no public announcement of FDIC damage claims against any of UCB’s executive officers and directors have surfaced. United Commercial Bank was California’s largest ever commercial bank failure.
Not all bank failures result in Director and Officer (D&O) lawsuits. The FDIC brought claims against directors and officers in 24 percent of the bank failures between 1985 and 1992. Since July 2009, the FDIC was named receiver at 323 failed banks. Bank failures have been most heavily focused in Georgia (70), Florida (56), Illinois (45), California (37), Washington (17) and Minnesota (16). If one assumes the same 24 percent ratio of suits from the 1985 – 1992 era will be repeated in connection with failures since June 2009, former directors and officers of about 80 additional banks could be targets of FDIC damage suits in the next two years in addition to the 14 suits already underway. The actual number could be somewhat higher but we doubt it will be much lower.
Prior to filing a lawsuit against a director or officer of a failed bank, staff for the FDIC, in its capacity as the receiver (or outside counsel representing the FDIC as receiver), will mail a demand letter to the bank’s officers and directors asserting the FDIC’s claims for monetary damages arising out of the bank’s failure. These demand letters typically do not distinguish between the different roles that officers and directors may have played under the circumstances nor is much effort made (at this point in the process) to determine which officers and directors in a particular organization may have been negligent, grossly negligent, breached fiduciary duties or wasted assets.
In a number of recent suits, the FDIC has focused on outside directors that had more banking industry expertise than other directors (i.e., directors of Silverton Bank) who were not themselves professional bankers. Directors with lending, accounting and CPA expertise may potentially be held by FDIC to higher standards, which could make them more visible targets. Often the FDIC’s demand letter is sent to trigger a claim under the bank’s director and officer liability policy and as part of an attempt to settle with the responsible parties. If a settlement cannot be reached, however, a complaint will be filed, typically in federal court. Thus, in many of the upcoming lawsuits, the FDIC may pursue claims against individuals but will also focus on the insurance proceeds that could be available in connection with many failures especially those that occurred prior to 2011 (when regulatory exclusions were not as widespread).
It is crucial that officers and directors of a troubled or failed bank retain knowledgeable insurance coverage and bank regulatory counsel to assert rights to coverage under the bank’s liability policies and to determine whether the facts and circumstances raise unique or special legal defenses. Officers and directors of all distressed banks should attempt to retain experienced outside counsel prior to a bank’s failure as the bank’s existing counsel will usually be conflicted out upon failure. Notice of circumstances that could give rise to coverage under a policy should be filed with insurers on a timely basis (usually pre-failure) and written follow-up by coverage counsel with insurers post-failure is often be necessary. If a director or bank officer hasn’t done so prior to failure, they should always retain experienced counsel at the first hint of an investigation or demand arising out of the bank failure.
In many of cases, the FDIC’s ultimate objective will be the recovery of D&O insurance proceeds. For this reason, it is often advisable to retain a combined legal team that has the capability to address insurance issues, liability and damage claims, regulatory enforcement actions (such as banking industry bans and civil money penalties) and, in rarer cases, criminal probes and indictments.
*About the Author: For over thirty-two years, Jonathan Joseph has focused on the representation of community and regional banks and officers and directors of distressed and failed banking organizations in connection with regulatory, transactional and corporate matters. He is a member of the Financial Institutions Committee of the California State Bar and a leading banking industry lawyer in California. Mr. Joseph founded the firm of Joseph & Cohen, Professional Corporation, in 2006 and is its Chief Executive Officer. Joseph & Cohen currently represents financial institutions and officers and directors of troubled and failed banks from its office in San Francisco, CA.
For additional information, please email the author: Jon@JosephandCohen.com.
© Joseph & Cohen, Professional Corporation. 2011. All Rights Reserved.