Between January 2008 and March 2012, the Federal Deposit Insurance Corp. (FDIC) took over a staggering 427 banks. In the preceding five-year period, the agency shuttered only 10. The rate of bank failures dramatically peaked in 2010, and has been dropping off in each subsequent year. But the financial sector isn’t resting easy during this slow recovery. According to a new report issued by Cornerstone Research, 2013 has seen a precipitous increase in FDIC litigation against the directors and officers of failed financial institutions, even as new bank closures slow down and mortgage lending recovers. At press time, the agency had filed 19 suits in 2013 and was on pace to file 39 such lawsuits by year’s end, the greatest number in a single year since the financial crisis began.
Beyond a mere increase in the number of financial institutions targeted for litigation, there also has been a marked change in the FDIC’s approach to such cases. Emboldened by the $169 million verdict in the FDIC’s favor in litigation against three former officers of failed California bank IndyMac in December 2012, the agency is taking an aggressive position, going after the personal assets of directors and officers, and filing more lawsuits rather than settling claims.
“The fact that all FDIC settlements are made public puts pressure on the FDIC to maintain a hard stance,” says Catherine Galley, a senior vice president of Cornerstone Research and one of the report’s authors. “And the IndyMac success allows them to be a lot more aggressive because people have seen that [the] FDIC can be successful at trial.”
When a federally insured bank fails, the FDIC covers customers’ losses and steps into the shoes of the bank as a receiver. As the receiver, the FDIC’s goal is to salvage as much of the lost assets as possible for the federal insurance fund, typically by looking for the decision makers within the institution that can be held responsible for its insolvency.
The vast majority of the cases filed since the 2010 crisis began allege that the directors and officers were negligent and breached their fiduciary duties to the organization by failing to ensure sound lending practices. More rarely, the cases allege fraud or self-dealing on the part of the officers.
“Most of the cases follow the same pleading pattern, alleging negligent lending by directors and officers who were caught up in the frenzy of the time and in their eagerness to grow lost sight of the proper lending practices,” says Randy Lehner, a partner at Ulmer & Berne, who has represented the FDIC in several such cases.
According to the Cornerstone study, 417 former directors and officers have been named as defendants in FDIC suits since the financial crisis began. The most common executive targets of such suits were chief executive officers (named in 88 percent of cases), chief credit officers (named in 34 percent of cases) and chief loan officers (named in 18 percent of cases). The banks’ directors were defendants in 75 percent of cases.
The current onslaught of lawsuits corresponds with the 2010 peak in bank failures. Regulators work with the failed institutions to try to settle claims prior to filing suit. But there is typically a three-year statute of limitations on such claims. The FDIC has authorized litigation against the former leaders of approximately 100 failed banks, among 476 total failures since 2007. The deadline to file many of those suits is now approaching.
Matter of Perception
For the first few years of the financial crisis, FDIC settlements with directors and officers of failed banks were often kept confidential, fueling a public perception that the wrongdoers behind the housing crisis and financial sector meltdown were getting off the hook too easily. In response to that pressure, the FDIC began making all settlements public in 2013.
This has led the agency to take a hard line in settlement negotiations—both to send a message to other potential defendants and to show the public that it is being tough on corporate wrongdoers. The agency is frequently reaching beyond the limits of directors and officers’ insurance policies and going after personal assets of executives. According to Cornerstone’s report, 39 percent of settlements since 2010 required out-of-pocket payments by the directors and officers, often in conjunction with insurance payments. Often, the amounts paid by the individual executives are small as a component of the full value of the bank failure. For instance, in a settlement agreement executed in August 2012 regarding the 2009 failure of Illinois-based Bank of Lincolnwood, former executive James Hamilton agreed to pay $125,000. The full value of that bank failure was $81.4 million. But recovery of funds isn’t the only goal of these settlements.
“The symbolism is important, even if the figures are not significant,” says Kevin LaCroix, executive vice president of D&O insurance intermediary RT ProExec. “[The] FDIC is showing toughness for Congress and members of the banking public.”
Echoes of S&L
Many observers are looking to the regulatory aftermath of the savings and loan crisis of the late 1980s for clues as to how bank failures will ultimately be resolved. As is now occurring with bank failures, it took approximately three years for regulators to bring most of their suits against failed savings and loan institutions. Ultimately regulators prosecuted approximately 25 percent of the failed S&Ls, which indicates that more FDIC litigation over bank failures is still to come.
“There are several parallels,” Galley says. “But these suits are a little less general than the claims made during the S&L crisis. During the S&L crisis, the trend was just allegations of general abandonment of underwriting standards. These are more refined, focused on specific, large loans that were made.”