The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

The number of bank failures has been winding down for a while now, but at same time the FDIC’s failed bank litigation has been ramping up. Through April 20, 2012, the FDIC has filed a total of 29 lawsuits against former directors and officers of failed banks, involving 28 different institutions. In a May 4, 2012 BankDirector.com post (here), Cornerstone Research takes a detailed look at the failed bank litigation so far. Cornerstone Research’s related May 2012 paper entitled “Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions” can be found here.

 

According to the paper, during 2012 the FDIC has been “intensifying its litigation activity associated with failed financial institutions.” So far, the FDIC has filed 11 lawsuits in 2012, compared with 16 during all of 2011. The 2012 filing activity is on pace for a total of 35 lawsuits this year.

 

Currently, about 6 percent of financial institutions that have failed since 2007 have been the subject of FDIC lawsuits. (That compares to about 24 percent of all institutions that failed during the S&L crisis.). According to the Cornerstone Research paper, the lawsuits filed during the current bank failure wave have targeted the larger institutions and those with a higher estimated cost of failure.

 

The median size of the 28 institutions targeted so far was approximately four times as large as the median size of all failed institutions and six times as large as the median size of currently active institutions. The 28 targeted institutions had median total assets of $973 million, compared with median total assets of approximately $241 for all failed institutions. The 28 institutions had a median estimated cost to the FDIC of $222 million at the time of seizure, compared to the median cost of failure of $59 million for all failed financial institutions. The median cost of failure for financial institutions that have been targeted in 2012 lawsuits was $355 million, compared with $158 million for institutions sued from 2007 through 2011.

 

The states with the largest numbers of bank failures during the period 2007 through April 2012 were Georgia, Florida, Illinois and California. With the exception of Florida, the percentage of FDIC lawsuits targeting failed institutions is slightly higher than the percentage of failed institutions in those states. Despite the large number of failed institutions in the state, there has only been one failed bank lawsuit filed in Florida so far.

 

The 29 lawsuits filed so far have targeted a total of 239 former directors and officers. Outside directors were named as defendants in 20 of the 29 lawsuits. The remaining lawsuits targeted only inside directors and officers. Three cases have also included insurance companies as named defendants, and one case included a law firm defendant. Three cases have included directors or officers’ spouses as named defendants.

 

Losses on Commercial Real Estate and Acquisitions, Development and Construction loans were the most common bases for alleged damages. 17 of the complaints identified CRE loans as the basis for claimed damages and 15 of the complaints identified ADC loans.

 

The most recent lawsuits have been filed just prior to the expiration of the three-year statutes of limitations. During 2012, the median time between an institution’s failure and the filing of an FDIC lawsuit was 2.97 years, compared with 2.26 years for the lawsuits filed during the period 2007 through 2011. Among the 11 lawsuits filed so far in 2012, five involved lawsuits that failed in 2010, five involve lawsuits that failed in 2008, and one involved a bank that failed in 2008.

 

The FDIC has indicated on its website that through April 25, 2012, the agency has authorized lawsuits involving 493 individuals at 58 institutions. As these figures are inclusive of the lawsuits already filed, the authorization figures imply a pipeline of as many as 30 additional lawsuits -- which were they to be filed would represent another 7 percent of all failed banks. That is, the filed and authorized lawsuits together could involve as much as 13 percent of all failed institutions. These figures of course represent only the lawsuits authorized to date; the FDIC has been increasing the number of authorizations monthly over the course of the past several months.

 

The FDIC’s latest authorization figures on its website did not specify an aggregate damages figure that the authorized lawsuits represent, but the figure the agency used (for a lesser number of lawsuits) in January 2012 was $7.7 billion, which compares to the aggregate damages claimed so far of $2.4 billion – which suggests that the authorized lawsuits may include some very significant additional claimed damages.

 

The Cornerstone Research report notes that a number of the large and costly bank failures during 2008 (and 2009) have not yet been the subject of an FDIC lawsuit. The report notes that the directors and officers of these institutions may be involved in negotiations with the FDIC. Whether these additional large bank failures will become the subject of future FDIC lawsuits “will depend on the outcome of such negotiations, statute of limitations restrictions, and tolling agreements that may be agreed upon during such negotiations.”

 

Only three of the FDIC’s failed bank lawsuits have settled so far, as discussed on page 13 of the Cornerstone Research report. These settlements include the WaMu settlement (about which refer here) and the First National Bank of Nevada settlement (about which refer here).

 

On a final note, the Cornerstone Research report projects that given the current pace of bank failures this year, we are on track for about 69 bank failures in 2012, compared to 92 in 2011 and 157 in 2010. With the addition of another failed bank this past Friday evening, there have been a total of 23 bank failures so far this year.

 

CalSTRS Takes on Wal-Mart Over FCPA Issues: As I have previously noted on this blog, a frequent accompaniment of an investigation of a Foreign Corrupt Practices Act investigation is a follow-on civil lawsuit, in which investors alleged either that the company’s management failed to properly supervise the company’s operations or that the company issued misleading statements about its internal controls or financial condition.

 

Given the relative frequency of this type of litigation, it was hardly surprising that Wal-Mart’s recent announcements of FCPA-related concerns involving its Mexican operations attracted litigation. Just the same, as Alison Frankel points out in a May 4, 2012 article on her On the Case blog (here), the filing of a lawsuit against Wal-Mart, as nominal defendant, and 27 of its current and former directors and officers, by the California State Teachers Retirement System (CalSTRS) represents a significant and noteworthy development.

 

In its May 3, 2012 complaint, which can be found here, CalSTRS alleges, among other things, that “prolonged failure to address detailed and credible allegations of criminal activity undertaken with the tacit or express consent of current and former senior corporate officials, and the complicity of the Company’s highest level executives in shutting down any investigation into those allegations, is causing and will continue to cause the Company substantial harm.”

 

As Frankel comments, when an “800-pound gorilla” like CalSTRS gets involved in this type of follow-on civil litigation, things have definitely become “serious.” The CalSTRS lawsuit will also set up a potential conflict between the actions previously filed in Arkansas in connection the Wal-Mart’s FCPA revelations and the CalSTRS action, which was filed in Delaware.

 

From my perspective, the CalSTRS lawsuit not only reinforces the view that follow-on civil litigation is an almost invariable accompaniment of FCPA-related investigations, but the involvement of CalSTRS itself highlights that FCPA-related exposures are a matter of serious shareholder concern. Taken collectively, the risk of an FCPA investigation as well of the related follow-on civil litigation are increasingly important liability exposures for companies and their directors and officers. 

 

Judge Wants to Know About Lehman Executives Wealth Before Approving D&O Settlement: Last August when it was first announced that the parties to the shareholder suit arising out of the collapse of Lehman Brothers had agreed to settle the case for $90 million – the amount of the remaining limits of the company’s D&O insurance program – I knew there could be trouble, especially since the settlement did not contemplate any contribution from the individual defendants themselves.

 

I was not the only one that anticipated possible problems. The plaintiffs lawyers themselves foresaw there could be trouble, as well. Aware of a possible “hue and cry” about the Lehman executives “getting off the hook without paying any money,” the plaintiffs tried to head off controversy by hiring John S. Martin, Jr., a retired federal judge, in order to determine whether the executives had a combined net worth of $100 million. Judge Martin prepared a report in which he concluded that “I am satisfied that the Liquid Worth of the Officer Defendants taken together, is substantially less than $100 million.”

 

The parties submitted their proposed settlement – including Judge Martin’s report -- to Southern District of New York Judge Lewis Kaplan. In a May 3, 2012 opinion that opens with a quotation from noted legal scholar Kenny Rogers, Judge Kaplan concluded that the information in Martin’s report was not sufficient to permit him to determine whether or not he should approve the settlement. Judge Kaplan’s opinion evinces full awareness of the fact that if the parties had failed to reach their agreement to settle the case for the remaining D&O insurance program limits, the amount of insurance remaining would rapidly have diminished, leaving the shareholders with perhaps an even smaller recovery.

 

Judge Kaplan’s concern has to do with the nature of the inquiry Judge Martin was asked to address. Specifically, Judge Kaplan was concerned with the fact that Judge Martin looked only at whether or not the defendants’ liquid net worth is less than $100 million. Judge Martin’s answer, Judge Kaplan said, “is not informative as is necessary and appropriate for this Court to consider” all of the requisite factors for class action settlement approval. In the end, Judge Kaplan called for the in camera production of all the information that had been submitted to Judge Martin, so that Judge Kaplan could consider all information (presumably including information about assets the defendants may have held that is not “liquid”) in order to determine how the settlement compared to possible available alternatives by assessing the extent to which the defendants could withstand a judgment in excess of the remaining amount of insurance.

 

Everything about this situation is highly unusual, starting with the fact that the case involved is perhaps the highest profile civil lawsuit arising out of the financial crisis and that the collapse of Lehman Brothers may have been the most critical development during the crisis. The fact that the case settled as it did may not have been all that unusual, as parties often reach compromises based on dwindling amounts of insurance. However, the plaintiffs, anticipating trouble, took extraordinary steps to try to substantiate the settlement, by hiring Judge Martin to assess the individual defendants’ net worth. By the same token, Judge Kaplan’s further consideration of the individual defendants’ collective net worth arguably is even more unprecedented.

 

The defendants have until May 10, 2012 to submit the information they had provided to Judge Martin to Judge Kaplan for in camera review.

 

Susan Beck’s May 4, 2012 Am Law Litigation Daily article about Judge Kaplan’s decision can be found here.

 

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Among the important questions that will need to be answered in connection with the current wave of failed bank litigation is the question of extent to which the non-director officers will be able to defend themselves in reliance on the business judgment rule.

 

 

In the following guest post, Jonathan Joseph (pictured to the left) takes a look at the extent to officers may defend themselves in reliance on the business judgment rule in cases to which California law applies. These questions go to the heart of the

officers’ potential liabilities and the legal standards that will be applied to address those questions.

 

 

Jonathan Joseph is a member of the California State Bar and has focused for over 33 years on regulatory, corporate, securities and transactional matters for banks and bank holding companies and officers and directors of distressed and failed institutions.  He currently serves as the Co-Vice Chair and Secretary of the Financial Institutions Committee of the Business Law Section of the California State Bar (2008 – present). He is the founder and managing partner of Joseph & Cohen, Professional Corporation in San Francisco, CA. Mr. Joseph is also a member of the Washington D.C. Bar and the State Bar of New York. He may be contacted at Jon@josephandcohen.com. A substantially similar version of this article was initially published in Issue No. 1 2012 of the Business Law News of the California State Bar. The original article on which this revised version is based was originally written before the initial decisio in FDIC v Perry was reported (about which decision, refer here).

 

 

Many thanks to Jon for his willingness to publish his article here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Jon's article follows. Footnotes appear below following the article text.

 

 

 

 

The exact nature of the duties and liabilities of corporate officers who are not directors is a subject that has received little attention from courts and commentators. [1]  Many cases which relate to the duties and liabilities of corporate fiduciaries explore whether negligence and breach of care claims are protected by the business judgment rule and the courts that have spoken have done so mostly in terms of its application to decisions or judgments of corporate directors. [2] While the standard of liability for non-director officers remains relatively unexplored, there is widespread consensus among the courts on the policy justifications for the deferential treatment of directors under the business judgment rule.[3]

 

 

Recently, two Federal banking agencies have brought civil damage actions in California against corporate officers of failed federally-insured depository institutions in which they assert that the widely recognized deference accorded by courts to decisions by directors does not apply to corporate officers. These cases seek damages for the alleged negligence of non-director officers as well as officers who were also directors for huge losses suffered when regulators closed the institutions based largely on pre-closure decisions made in good faith that didn’t turn out well. Three of these cases, which are all triangulating on the same issues, are discussed below. [4] 

 

 

While none of these cases has proceeded to trial, rulings at the motion to dismiss and judgment on the pleadings stage in two of these matters, all within the Central District of California, have emerged with contradictory results -- including one ruling in August to the effect that the business judgment rule doesn’t apply to non-director officers. This is troubling to some California practitioners as the great weight of authority by courts and commentators has favored application of the business judgment rule to officers acting in their capacity as officers within the scope of their delegated authority.[5] 

 

 

In most states, including California, Delaware and New York, despite the case law being sparse, there has been little dispute that the business judgment rule or BJR applies equally to corporate officers and directors. Consequently, these pending Central District cases are worthy of focus since any final rulings upholding the position asserted by the Federal banking agencies could have far flung effects. If the BJR is ultimately held not to protect good faith decisions by officers of California based banks, that holding would extend to officers of any California corporation.

 

 

These cases touch upon significant underlying themes being widely debated in American society today (e.g., Occupy Wall Street) as to who should be held responsible for the tremendous costs of bailing out the largest American banks in 2008, why more executives and directors of such institutions haven’t been held accountable and whether corporate executives and directors could have anticipated the acute global financial meltdown in 2008 and thereafter.[6]

 

 

 

The Standard of Conduct and Business Judgment Rule

 

 

The general standard of conduct applicable directors and officers of California corporations in the performance of their functions as they relate to matters in which they are disinterested is a corporate governance principle widely recognized throughout the United States. The standard is well summarized by the American Law Institute’s Principles of Corporate Governance [7]:

 

 

“A director or officer has a duty to the corporation to perform the director’s or officer’s functions in good faith, in a manner that he or she reasonably believes to be in the best interests of the corporation, and with the care that an ordinary prudent person would reasonably be expected to exercise in a like position and under similar circumstances.”

 

 

In California, as elsewhere, when it is applicable, the business judgment rule.[8] precludes judicial second-guessing of decisions made by corporate fiduciaries in good faith or where the decision can be attributed to any rationale business purpose.[9]  The rule is procedural and process oriented. It sets up a presumption that decisions are based on sound business judgment and the “presumption can only be rebutted by a factual showing of fraud, bad-faith or gross-overreaching" [10]  based on a widespread “judicial policy of deference to the business judgment of corporate directors in the exercise of their broad discretion in making corporate decisions." [11] The relevant consideration is whether the process employed was either rational or employed in a good faith effort to advance corporate interests even if a judge or jury considering the matter after the fact, believes a decision to have been “substantively wrong, or degrees of wrong extending through stupid to egregious." [12]

 

 

Two Federal Banking Agencies Seek Damages for Breach of the Duty of Care

 

 

Since the global financial crisis began in 2008, four hundred twelve banks have been closed across the United States through December 15, 2011 including thirty-eight banks in California. [13] As of December 8, 2011, the FDIC has authorized suits in connection with 41 failed institutions against 373 individuals for director and officer liability with damage claims of at least $7.6 billion. [14]  Credit unions also failed during this period, although the actual number of failures is lower. {15]  Federal banking regulators are required to investigate insured depository institution failures and bring lawsuits to recover damages. Enforcement authority under Federal law was strengthened in 1989 after Congress concluded that a large number of saving and loan failures during the 1980’s were due to outright fraud and other egregious conduct. [16]

 

 

Thus, it isn’t surprising that the banking agencies have instituted damage suits in connection with some of the most recent failures and more will undoubtedly be authorized in the coming months. [17] As stated above, both the Federal Deposit Insurance Corporation (“FDIC”), in Van Dellen and Perry, and the National Credit Union Administration (‘NCUA”), in Siravo, have asserted that corporate officers in California are not protected by the business judgment rule. [18] Their basic argument is that section 309 of the Corporations Code applies on its face to directors, not officers and that there is no common law business judgment rule in California case law that applies to limit the liability of officers.

 

 

The Aftermath of the Failure of IndyMac Bank

 

 

Van Dellen and Perry involve two different actions by the FDIC as receiver arising out of the failure of IndyMac Bank, FSB in 2008. On July 11, 2008, IndyMac Bank, Pasadena, CA was closed by the Office of Thrift Supervision and the FDIC was named Conservator. With about $32 billion in assets when it was closed, the failure is the second largest since 2008 and the FDIC has estimated that the loss was $8 billion. Van Dellen was filed in July 2010 against former officers of the homebuilder division of IndyMac Bank alleging breach of fiduciary duty and negligence in approving loans made by the division. 

 

 

The FDIC’s other companion IndyMac case is more recent. It was filed against former Chairman of the Board and CEO Michael Perry in July 2011 seeking $600 million in damages, alleging in a single count that Perry, solely in his capacity as an officer (i.e., CEO), had been negligent. [19]  The complaint in Perry is noteworthy for several reasons including that i) the allegations artfully bypass his actions as a director, ii) the complaint is comprised of a single claim for ordinary negligence, and iii) no outside directors were named. The latter is presumably due to the FDIC’s conclusion that the BJR would immunize the outside directors’ conduct. [20]  Alternatively, it is possible that the outside directors settled or are negotiating to settle the FDIC’s claims against them.

 

 

In addition to anticipating the weakness of claims for ordinary negligence against the bank’s directors when it filed the Perry action solely against Michael Perry, the FDIC may also have concluded that it couldn’t support gross negligence theories against directors (including Perry). In Siravo, the NCUA had originally named the former outside directors of WesCorp and alleged they had been negligent, but lost this argument on a motion to dismiss based on the courts assessment that the BJR was applicable. On August 1, 2011, after earlier allowing the FDIC to amend its complaint several times, Judge George Wu issued his Siravo Order in which he dismissed all claims against the directors on business judgment rule grounds – without leave to amend. [21].

 

 

The Failure of WesCorp Federal Credit Union - NCUA v. Siravo

 

 

Siravo involves losses arising out of the failure of Western Corporate Federal Credit Union (“WesCorp”), which was the largest corporate credit union in the United States when it was placed into conservatorship by the NCUA on March 19, 2009. On October 1, 2010, the NCUA placed WesCorp into involuntary liquidation. WesCorp was originally seized after the NCUA concluded that its liquidity was imperiled by $6.8 billion in anticipated losses stemming from investments in private-label mortgage-backed securities (“MBS”). The NCUA originally brought suit against former officers and directors of WesCorp alleging they breached their duty of due care and were grossly negligent when they approved investments in MBS. Due to Judge Wu’s decision to dismiss the NCUA claims against WesCorp’s outside directors, the only remaining defendants in Siravo, as of the date this article went to print, were five officers.

 

 

The Siravo Order was issued pursuant to a motion to dismiss brought by the officer and director defendants pursuant to Rule 12(b)(6). The standard for such a motion required the court to 1) construe the NCUA’s complaint in the light most favorable to the plaintiff, and 2) accept all well-pleaded factual allegations as true, as well as all reasonable inferences to be drawn from them. [22]  The court was not required to accept as true “legal conclusions merely because they were cast in the form of factual allegations." [23] and the complaint against the defendants will not be upheld if it “tenders ‘naked assertion[s]’ devoid of ‘further factual enhancement.'" [24] Rather, the court concluded that to survive a motion to dismiss, the plaintiff must allege facts that, if accepted as true, are sufficient to “raise a right to relief above the speculative level,” and to “state a claim to relief that is plausible on its face." [25]

 

 

The director defendants in Siravo argued that the facts as pled in the amended complaint made clear that they had operated far above the standard of culpability necessary for a claim to survive application of the business judgment rule. The director defendants further argued that the complaint failed to focus, as required, on the “process” in which they made their decisions, but rather attacked simply the content and results of their decision.

 

 

In considering director defendants’ motion to dismiss, Judge Wu held that the plaintiff would effectively have to plead “fraud, breach of trust, conflict of interest, bad faith, oppression, corruption, complete abdication of responsibility, willful ignorance or gross overreaching” in order to overcome the business judgment rule as applied to the directors. [26]  In the final analysis, Judge Wu concluded that the directors “may have made choices – or not made choices – with which the NCUA disagrees, but that does not mean they failed in their responsibilities so severely that they lose the protection of the business judgment rule." [27]

 

 

The director defendants also argued that the business judgment rule extends to officer defendants such as a WesCorp executive who had been the Chief Investment Officer. The NCUA argued that a 1989 California decision, Gaillard v. Natomas Co. [28]  held that only directors are protected in California by the business judgment rule. In denying the motion to dismiss the officer defendants from the breach of duty claim, the court focused on the plain language of section 309 of the Corporations Code (which is applicable only to directors) and refused to recognize the common law application of the BJR to an officer in California. The Judge noted that some California decisions had included officers within the scope of the BJR’s protection, but found nevertheless that Gaillard v Natomashad considered the issue and concluded that the WesCorp officer defendants did not enjoy the rules protection. The court may have been swayed by an inference that executives had received increased compensation as a result of a shift in WesCorp’s investment emphasis which increased the compensation paid to top executives. [29]

 

 

Judge Fischer Rules that the BJR May Be Raised by Corporate Officers

 

 

Just one month after Judge Wu’s ruling in Siravo, Judge Dale S. Fischer issued the Van Dellen Order which also considered the issue of whether the common law business judgment rule extends to good faith conduct by corporate officers in California. The procedural posture in Van Dellen was slightly different than in Siravo. In Van Dellen the officer defendants had filed an Answer raising affirmative defenses. The FDIC moved for partial judgment on the pleadings pursuant to Federal Rule of Procedure 12(c) as to some of the affirmative defenses including the business judgment rule. However, because a motion for judgment on the pleadings is functionally identical to a motion to dismiss, the applicable standard is essentially the same as for a Rule 12(b)(6) motion. [30]  Judge Fischer rejected the reasoning employed by Judge Wu and reached the opposite conclusion. The Judge distinguished Gaillard v. Natomas and held that as a matter of law the FDIC had failed to demonstrate that the business judgment rule is inapplicable to officers in Californa. [31]

 

 

The Van Dellen officer defendants had argued that the common law component of the BJR applies even if Section 309 does not apply to officers and that Gaillard v. Natomas was a duty of loyalty case inapplicable to whether the BJR is a defense to breach of care claims. Presumably, the Judge was aware of Professor Melvin Eisenberg’s criticism of Gaillardin his 1995 study for the California Law Revision Commission [32]  since her ruling closely tracked the Eisenberg Law Revision Commission Analysis. She held that “California has recognized that ‘[t]he common law business judgment rule has two components’ and ‘[o]nly the first component is embodied in Corporations Code section 309’… most California cases discussing § 309 involve directors and not officers, … the common law component of the business judgment rule may apply to officers even if § 309 does not." [33]

 

 

Motion to Dismiss Ruling in FDIC v. Perry Could Be Tie Breaker

 

 

The Perry case is also being considered in the Central District of California before Judge Otis Wright. Perry has filed a motion to dismiss pursuant to Rule 12(b)(6). The motion was considered on November 7, 2011 following briefing by the FDIC and Perry. Perry’s motion points the court to the Van Dellen Order and notes that the FDIC’s position that section 309 applies to directors only is beside the point since the second, uncodified component of the BJR, applies to directors and to officers. [34]

 

 

Perry also attacked the FDIC’s reliance on Gaillard. Perry pointed out that Gaillard related to golden parachutes provided to a corporation’s officers and involved self-dealing. Perry argues that Gaillard correctly held that the BJR was inapplicable because the officers therein had a personal interest in golden parachutes, but the second aspect of the court’s holding was incorrect because the officers were not entitled to the protection of the BJR only because they had engaged in self-dealing. [35] Perry does not involve any self-dealing or duty of loyalty allegations.

 

 

The officer defendants in Siravo intend to raise the Van Dellen Order at a hearing in early 2012. It is possible, therefore, that Judge Wu might modify his prior BJR ruling as it relates to officers. In Perry, the courtis expected to rule on Perry’s motion to dismiss in the next few months. While the issue may seem narrow, the implications in California could be far-reaching if the FDIC’s position prevails. The FDIC argues that good reasons exist as to why the BJR should not apply to corporate officers. In contrast to outside directors, they state that because officers receive higher absolute pay levels, they stand to reap substantial rewards for serving and taking risks and for this reason, the FDIC reasons they should face greater risks. [36]  Perry’s reply is that FDIC’s assertion that policy reasons support limiting the BJR protection only to directors is entirely off base. Perry asserts that not a single state has implemented such a policy. [37]

 

 

The BJR represents sound public policy that, as a general rule, should continue to be applied by the courts as a presumption that good faith judgments by officers and directors of California corporations can only be rebutted by a factual showing of fraud, bad faith or gross overreaching. To employ a different rule as advocated by the banking agencies – one that permits judging the content of decisions by corporate fiduciaries with the benefit of hindsight – would, in the long run, be injurious to shareholder interests. [38]  Such a holding would tend to chill the ability of corporate executives, including bankers, to take legitimate and reasonable business risks that could benefit their corporations and shareholders.

 

 

Professor Melvin Eisenberg has noted that the BJR is premised on the idea that business judgments are necessarily made on the basis of incomplete information and in the face of obvious risks, so that typically a range of decisions is reasonable. Fact finders are ill-equipped to distinguish between bad decisions and proper decisions that turn out badly based on 20-20 hindsight. If courts too often erroneously treat decisions that turned out badly as bad decisions, and unfairly hold directors and officers liable for such decisions, corporate decision makers might tend to be unduly risk-averse. The business judgment rule protects directors and officers from such unfair liability and encourages risk taking. [39]

 

 

The Van Dellen Order, dated September 27, 2011, and the Siravo Order, dated August 1, 2011, both considered the business judgment rule as it relates to tort claims against corporate officers under California law and reached conflicting results. The Perry cased involves the same issue. A motion to dismiss the single claim for negligence in Perry was heard on November 7, 2011. No ruling had been delivered as of early December 2011. The ruling, when issued by the Perry court, could be viewed as a tie-breaker. Alternatively, since the issue presents an unsettled question of an important legal principle in California, if the Court in FDIC v. Perry follows the Siravo result (i.e., ruling against Perry), it could pave the way for an appeal by Perry to the Ninth Circuit.

 

 

These decisions and future rulings in other FDIC civil damage actions against bank executive officers that have also been brought by the FDIC recently in California and appeals of District Court decisions could shape California law as it applies to officers of California corporations and federally-insured depository institutions headquartered in California for years. Consequently, California business leaders and corporate practitioners should follow these cases closely. 

 

 

Given the justifications and importance of the business-judgment rule and the uncertainty of its status and formulation in California, particularly as it applies to officers of corporations in the exercise of judgment when making business decisions, it may be desirable to codify the rule legislatively unless the Ninth Circuit or the California Supreme Court act first and find that the business judgment rule applies to officers.

 

 

Postscript

 

 

On December 13, 2011, the District Court in Perry denied Michael Perry’s motion to dismiss, holding that the business judgment rule does not apply to officers under California law. The Court’s order was based on the Judge’s conclusion that no authority exists for the proposition that the common law BJR applies to officers and he further inferred that when the legislature adopted section 309 it must have meant to eliminate the common law business judgment rule. His finding is surprising because the legislative history doesn’t explicitly state the legislature intended to override the common law business judgment rule when it enacted section 309 in 1977.   Consequently, the Court’s reasoning isn’t particularly persuasive.

 

 

In an amended order issued on February 21, 2012, Judge Otis Wright approved Perry’s request for an immediate interlocutory appeal of his order. Judge Wright found that his order involved “a controlling question of law as to which there is substantial ground for differences of opinion” and that the immediate appeal “may materially advance the ultimate termination of the litigation.”

 

 

This author’s view is that the Ninth Circuit should overrule the District Court’s decision in Perry. This can be accomplished by holding that Gaillard v. Natomas was misapplied by the District Court since Gaillard is only applicable to cases involving breach of the duty of loyalty. The Appellate Court should also correct the District Court’s unfounded conclusion regarding the legislative intent underlying section 309 by finding that in 1977 when section 309 was enacted the common law business judgment rule as applied to officers was not eliminated. Consequently, the BJR would continue as a valid defense for officers of California corporations and federally chartered institutions headquartered in the State.   Common sense and public policy call out for such a result.

 

*End*

 

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In an interesting variant on the kinds of claims that the former directors and officers of a failed financial institution can face, on April 6, 2012, the SEC charged two former officers of the publicly traded holding company for the failed Franklin Bank of Houston with securities fraud. In its April 6, 2012 complaint (here), the SEC alleges that the two former officers engaged in a fraudulent scheme designed to conceal the bank’s deteriorating loan portfolio and inflate its earnings at the outset of the financial crisis. The SEC’s litigation release about the case can be found here.

 

According to the SEC’s complaint, in the second and third quarters of 2007, the bank began to experience increased delinquencies in its mortgage loan portfolio. During this same period, the bank was considering “strategic alternatives” include the possible sale of the bank. Investment advisers told the bank’s CEO Anthony Nocella and its CEO Russell McCann that the bank needed to “polish the apple” by showing positive earnings “momentum” and “stable asset quality.”

 

The SEC alleges that in order to conceal the bank’s rising loan delinquencies and improve its earnings for the third quarter of 2007, Nocella and McCann instituted three loan modification schemes by which the bank was able classify non-performing loans as performing. These alleged modification schemes, with names like “Fresh Start” and “Great News,” allegedly enabled the bank to conceal from shareholders over $11 million in delinquent and nonperforming residential loans and $13.5 in nonperforming construction loans. The SEC alleges that the bank overstated its 2007 net income and earnings by 31% and 77% respectively.

 

On May 2, 2008, in a filing on Form 8-K, the bank acknowledged that the accounting for the loan modifications should be revised and that investors should no longer rely on the bank’s filing on Form 10-Q from the third quarter of 2007. On November 7, 2008, the bank was closed by Texas state banking regulators and the FDIC was appointed as receiver. The bank’s holding company also filed for bankruptcy in 2008.

 

In its April 6 complaint against Nocella and McCann, the SEC seeks financial penalties, officer-and-director bars, and permanent injunctive relief against the two individuals to enjoin them from future violations of the federal securities laws. In reliance on Section 304 of the Sarbanes Oxley Act, the complaint also seeks to “clawback” bonus compensation that Nocella and McCann received. (See the note below about another recent action in which the SEC has sought to use Section 304 to clawback bonus compensation from executives of a company that had restated its financial statements.)

 

In its litigation release, the SEC expressly acknowledges “the assistance of the Federal Deposit Insurance Corporation in this matter,” which suggests that at a minimum that two agencies were cooperating in this matter and also suggests the possibility that the FDIC may even have referred the matter to the SEC. The FDIC’s involvement is also a reminder that  as part of its post-failure post-mortem processes, the FDIC is not only attempting to determine whether or not it has a valuable civil suit on its own as receiver, but is also looking to see whether or not wrongdoing has occurred that warrants referral to other authorities. The FDIC has not on its own pursued any claims in connection with Franklin Bank’s closure. It is also interesting to note that the SEC is only now pursuing this enforcement action, though the events complained of took place well over four years ago, and the though the bank itself failed over four years ago.

 

The SEC’s filing of its action against the two former Franklin Bank officials is not the first time the SEC has pursued an enforcement action against former directors and officers of a failed bank. As noted previously (here, scroll down), in an October 11, 2011 complaint (here), the SEC filed a civil enforcement action against four former officers of UCBH Holdings, Inc., the holding company for United Commercial Bank, which failed in November 2009. According to the SEC’s October 11, 2011 litigation release, the complaint alleges that the defendants “concealed losses on loans and other assets from the bank’s auditors, causing the bank’s holding company UCBH Holdings, Inc. (UCBH) to understate its 2008 operating losses by at least $65 million.” The complaint alleges that the further loan losses ultimately caused the bank to fail. The SEC action seeks permanent injunctive relief, an officer bar, and civil money penalties.

 

Though the FDIC has not itself filed a civil action against the former directors and officers of Franklin Bank, in June 2008, as reflected here, the bank’s holding company’s investors did file their own securities class action lawsuit against the failed bank’s former directors and officers, its auditor and its investment banks. In a March 21, 2011 order (here), Southern District of Texas Judge Keith Ellison granted the defendants’ motions to dismiss. The investors have appealed to dismissal. The appeal remains pending.

 

The SEC action against the two former Franklin Bank officials, along with the investor lawsuit, serve as a reminder that the former directors and officers of a failed bank face significant additional litigation threats beyond just the possibility of a civil action by the FDIC in its role as receiver of the failed bank. Where, as here, the failed institution or its holding company were publicly traded, the potential liability exposures include the possibility of an SEC enforcement action or a securities class action lawsuit. Even though the penalties and clawback amounts the SEC is seeking in the enforcement action would not be covered under a D&O policy, the costs associated with defending this type of enforcement action would likely be covered (assuming that D&O insurance coverage is in fact available). These costs, along with the costs of defending the type of shareholder suit filed here, erode the limits of liability of any applicable insurance, while at the same time competing claimants may be in a race to try and claim a portion of the dwindling policy limits. All of which is a reminder of the strains that post-failure litigation can put on the D&O insurance resources of a failed bank.

 

The FDIC’s Latest Failed Bank Lawsuit: The FDIC may not yet have filed a civil action against the former directors and officers of Franklin Bank, but it has been active in pursuing claims against the former officials of other failed institutions. In the FDIC’s latest failed bank lawsuit, on April 4, 2012, the FDIC filed a lawsuit in the Eastern District of North Carolina against seven former directors and officers of the failed Cape Fear Bank of Wilmington, North Carolina. In the its complaint (here), the FDIC as receiver for the failed bank seek to recover $11.2 million in losses the bank allegedly suffered on 23 loans the defendants approved between September 27, 2006 and February 27, 2009. The FDIC asserts claims against the seven defendants for negligence, gross negligence and breach of fiduciary duty.

 

It is interesting to note that the FDIC’s April 4 action against the former Cape Fear Bank officials was brought just short of the third anniversary of the bank’s April 10, 2009 closure. The highest number of bank closures during the current wave of bank failures took place during 2009 and the pace of closures increased as the year progressed. The implication is that 2012 moves forward, the third anniversary of many of the class of 2009 bank closures will be approaching. The likelihood is that pace of FDIC failed bank lawsuit filings will increase for the rest of this year, as the FDIC tries to get out ahead of the rolling statute of limitations dates for the 2009 bank failures.

 

The latest suit is the 28th that the agency has filed as part of the current wave of bank failures and the tenth so far in 2012. This suit is also the third that the FDIC has filed so far in North Carolina.

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While the number of FDIC failed bank lawsuits seems likely to be cranking higher this year, the pace of the bank failures themselves clearly is slowing. Through the end of the first quarter, the FDIC has taken control of only 16 financial institutions so far this year, putting the agency on pace for a total of 64 this year, which would be the lowest number of annual failures since 2008. Given that even the pace so far this year seems to be slowing, the 2012 annual total may well come in below the projected total of 64 closures.

 

Scott Trubey has an interesting April 8, 2012 article in the Atlanta Journal-Constitution (here) about the failed bank litigation so far and yet to come, with a particular emphasis on the litigation involving failed Georgia banks. Among the many former bank officials that the FDIC has targeted is the former NFL quarterback, Jim McMahon, who was among seven former directors and officers named as defendants in the FDIC's lawsuit relating to the failed Broadway bank, as discussed in an April 9, 2012 Chicago Sun-Times article (here)

 

FDIC Settles Malpractice Claim Against Failed Bank’s Lawyers: According to an April 4, 2012 filing in the Western District of Oklahoma (here), the parties to the FDIC’s lawsuit against the former lawyers for the failed First State of Altus Bank of Altus, Oklahoma, have settled the case. An April 7, 2012 article from The Oklahoman newspaper describing the settlement can be found here.

 

The First State Bank of Altus failed on July 31, 2009. On October 26, 2011, the FDIC, as receiver for the failed bank, filed an action in the Western District of Oklahoma against the bank’s outside law firm, Andrews Davis, and two of its attorneys, Joe Rockett and Matthew Griffith. In its complaint (here), the FDIC as receiver for the failed bank asserted claims for professional negligence and malpractice.

 

The complaint alleges that the bank failed because of losses it suffered in connection with projects of what the complaint described as the Anderson-Daugherty Enterprise, which the complaint describes as the business efforts of the bank’s former CEO, Paul Daugherty, and Fred Don Anderson, who was CEO of a company called Altus Ventures, a substantial borrower of the bank. The FDIC alleges that the law firm assisted Anderson in planning and implementing the so-called Anderson-Daugherty Enterprise, while at the same time representing both Daugherty personally and the bank itself. The complaint alleges that as a result of these relationships, the law firm and the two individuals had substantial conflicts of interest. The law firm also was allegedly involved in counseling the bank in connection with certain loans to certain enterprises in which Daugherty and Anderson or their related entities had financial interests. The complaint alleges that the bank ultimately suffered losses of over $10 million on related loans.

 

Neither the April 4 court filing nor the newspaper article about the filing reflects any of the details of the settlement of the case. It is worth noting that though the FDIC filed the lawsuit against the failed bank’s former lawyers, it has not to date filed an action against any of the failed bank’s former directors and officers.

 

The suit against the lawyers for First State Bank is not the first instance where the FDIC has pursued claims against a failed bank’s former law firm. As discussed here, in October 2011, when the FDIC filed suit against the former directors and officers of the failed Mutual Bank of Harvey, Ill., the defendants included the bank’s former outside general counsel, as well as the former outside general counsel’s law firm. Indeed, on its website, the FDIC reports that as of March 20, 2012, the agency states, without providing any further breakdown, that it “has authorized 29 other lawsuits for fidelity bond, insurance, attorney malpractice, appraiser malpractice, and RMBS claims.”

 

SEC Files Another Strict Liability Clawback Action: The clawback action the SEC filed against the two former officers of Franklin Bank was not the only action under Section 304 of the Sarbanes Oxley Act that the SEC filed last week. In addition, on April 2, 2012, the SEC also filed a Section 304 clawback action in the Western District of Texas against the former CEO and CFO of ArthroCare. But unlike the case involving the action involving the former Franklin Bank executives, the action against the former ArthroCare executives does not allege that the two individual defendants were involved in or even aware of the alleged wrongdoing. The SEC is pursuing its action against the two ArthroCare executives on a strict liability basis.

 

In its complaint (here), the SEC alleges that during the tenure of the two ArthroCare executives, two sales ArthroCare executives engaged in a channel stuffing scheme in order to inflate the company’s revenue and earnings. The SEC has pursued a separate enforcement action against the two sales executives. ArthroCare was later required to restate its financial statements for 2006 and 2007. The former CEO and CFO both resigned from the company following the company’s own internal investigation of its revenue reporting practices.

 

In its compensation clawback complaint against the former CFO and former CEO, the SEC expressly states that it “does not contend” that the former CFO and CFO “participated in the wrongful conduct.” However, the SEC contends, Section 304 requires the former CEO and CFO to reimburse the company for their bonus compensation and stock sale profits garnered during the periods corresponding to the financial statements that were later restated.

 

The action involving the former CEO and CFO of ArthroCare is not the first occasion on which the SEC has used Section 304 to pursue a compensation clawback even though the targeted executives were not alleged to have been involved in the wrongdoing that caused their companies to have to restate the companies’ financial executives. The SEC previous pursued a clawback action against the CSK Auto; as discussed here, in that case the federal district affirmed the SEC’s authority to seek a clawback without a showing of complicity in the wrongdoing. The district court judge stated that “"the text and structure of Section 304 require only the misconduct of the issuer, but do not necessarily require the specific misconduct of the issuer’s CEO or CFO."

 

As discussed here, in a similar case, the SEC pursued a Section 304 clawback action against the former CFO of Beazer Homes, though the individual was not alleged to have been involved in any wrongdoing.

 

My thoughts on the deeply troubling implications of the increasing trend toward imposing liability even without culpability can be found here. As I have previously noted (here), these provisions allowing for the return of compensation without fault or culpability also raise a host of potentially troublesome insurance coverage issues. The D&O insurance marketplace has responded to these concerns, as many carriers are now willing in at least some cases to add a provision to their policy stating that the policy will cover defense expenses incurred in connection with a SOX 304 action.

 

An April 2, 2012 post on the SEC Actions blog about the SEC’s clawback action against the former ArthroCare executives can be found here.

 

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FDIC Files First Failed Bank Lawsuit in Florida: Even though Florida has had the second highest number of bank failures of any of the states during the current bank failure wave (trailing only Georgia), the FDIC had not filed any failed bank lawsuit in Florida—until now. On March 13, 2012, the FDIC filed an action in the Middle District of Florida in the agency’s capacity as receiver of the failed Florida Community Bank of Immokalee, Florida, against the failed bank’s former CEO and six of the failed bank’s former directors. A copy of the FDIC’s complaint can be found here.

 

The bank failed on January 29, 2010. In its complaint, the FDIC alleges that the bank’s collapse was caused by “grossly negligent loan underwriting and loan administration, resulting in excessive and dangerous concentrations” of commercial real estate loans and of acquisition and development loans. The FDIC seeks to recover on losses of in excess of $62 million dollars in connection with six specific loans. The FDIC asserts state law claims of negligence against the former directors and against the former CEO, as well as claims of gross negligence under FIRREA against all of the individual defendants.

 

The FDIC’s lawsuit in the Florida Community Bank case is the 26^th that the FDIC has filed in connection with the current bank failure wave. It is also the eighth that the FDIC has filed so far in 2012. Though the FDIC has now filed 26 lawsuits, according to the FDIC’s website and as of February 14, 2012, the FDIC has authorized suits in connection with 49 failed institutions against 427 individuals for D&O liability with damage claims of at least $7.8 billion. Thus, there are at least 23 additional lawsuits approved and in the pipeline. And it seems like that when the FDIC next updates the authorized lawsuit figures on its website, there will be yet other lawsuits authorized. As I have previously discussed, it seems likely that we will see many of these forthcoming lawsuits during 2012.

 

CIT Group Subprime-Related Suit Settles for $75 Million: In the latest of the subprime and credit crisis-related securities class action lawsuits to settle, on March 13, 2012, the parties to the CIT Group subprime suit filed with the court a stipulation of settlement reflecting that the case had been settled for $75 million. A copy of the parties’ settlement stipulation can be found here.

 

As reflected here, the plaintiffs first filed suit against CIT Group and certain of its directors and officers in July 2008. The plaintiffs alleged that CIT's public financial statements failed to account for tens of millions of dollars in loans to Silver State Helicopter, which loans were highly unlikely to be repaid and should have been written off. The plaintiffs also alleged that the company had misrepresented the performance of its subprime home lending and student loan portfolios.

 

In November 2009, CIT Group itself filed for bankruptcy and the company was dismissed out of the lawsuit. As discussed here (scroll down), on June 10, 2010, Southern District of New York Judge Barbara Jones denied the remaining defendants’ motion to dismiss. Following the dismissal motion ruling, the parties entered mediation that ultimately resulted in the settlement. The settlement is subject to court approval. (CIT Group rather conspicuously emerged from bankruptcy after only six weeks.)

 

The CIT Group settlement is noteworthy if for no other reason than that it came about in 2012. Even though there are many subprime and credit crisis-related securities cases pending, including many that have already passed the motion to dismiss stage, the pace of settlement of these cases seems to have slowed to a crawl (indeed, in its recently released annual study of securities class action lawsuit settlements, refer here, Cornerstone Research specifically noted the slow settlement pace of the credit crisis suits as one reason why both the number and aggregate monetary value of securities suit settlements was down significantly in 2011).

 

Readers of this blog may be interested to know whether or to what extent D&O insurance contributed toward the CIT Group settlement. The settlement stipulation is nonspecific, but it does suggest that insurance is playing a role in the settlement of this case. For example, in describing the settlement amount, the stipulation provides that within a specified time of the court’s preliminary approval of the settlement, the defendants or CIT shall pay or “cause their insurers” to pay into escrow the $75 million settlement amount. In his March 14, 2012 Am Law Litigation Daily article about the settlement (here), Victor Li reports that “all 13 current and former CIT executives named as defendants were indemnified by CIT and covered by D&O insurance.”

 

I have in any event added the CIT Group settlement to my running tally of subprime and credit crisis-related lawsuit settlements, which can be accessed here.

 

SEC Files Enforcement Action against Three Former Thornburg Mortgage Executives: In the latest civil subprime and credit crisis-related enforcement action, the SEC on March 13, 2012 filed a civil enforcement action in the District of New Mexico against three former executives of Thornburg Mortgage, including the company’s former CEO, Larry Goldstone. Prior to its 2008 collapse, Thornburg was the second largest mortgage originator in the United States. The SEC’s complaint can be found here. The SEC’s March 13, 2012 press release about the case can be found here.

 

The SEC alleges that the three defendants schemed to fraudulently overstate the company’s income by more than $400 million and falsely record a profit rather than an actual loss for the fourth quarter in its 2007 annual report. The complaint alleges that in the days before the company filed its 2007 10-K, the company was facing a severe liquidity crisis due to the company’s receipt of numerous margin calls totaling more than $300 million. The complaint alleges that the defendants withheld information about the margin calls from investors and even from the company’s own auditors. However, two hours after the 10-K filing, the company received additional margin calls that it was unable to meet. The company was forced to disclose these developments and soon thereafter the company disclosed that it would be filing an amended annual report. By the time the company filed its amended 10-K, its share price had collapsed. The company never recovered and ultimately filed for bankruptcy.

 

The March 13, 2012 statement of two of the individual defendants regarding the SEC’s enforcement action can be found here.

 

Neither the SEC’s press release nor complaint explains why the complaint is only being filed now, more than four years after many of the events described in the complaint. The SEC has faced some criticism for allegedly failing to act aggressively enough in the wake of the global financial crisis. Perhaps in recognition of these criticisms, the SEC itself emphasizes in its press release that with the Thornburg Mortgage enforcement action SEC has now filed financial crisis related enforcement actions against 98 individuals and entities.

 

The press release also links to a page on the SEC’s website, entitled “SEC Enforcement Actions: Addressing Misconduct That Led to or Arose from the Financial Crisis.” The website page makes for interesting reading, but it is hard to shake the impression that it is a relatively short list of items, in light of the magnitude of the financial crisis and in light of the over 230 subprime and credit crisis related securities class action lawsuits that investors have filed. Given the long lag between the events involved and the filing of the Thornburg Mortgage enforcement action, it may be that there are more cases that are still in the pipeline, perhaps many, relating to the financial crisis.

 

Thornburg Mortgage and certain of its directors and officers were also the subject of a separate investor lawsuit, although as discussed in detail here, the first of the investor lawsuits was filed in August 2007, well before the events described in the SEC’s enforcement action. As discussed here, in January 2010, District of New Mexico James Browning granted the defendants’ motions to dismiss large parts of the investors’ lawsuit, although parts of the case survived, and perhaps critically, the investors’ claims against Goldstone, the former CEO, largely survived. In February 2012, the parties to the investor suit advised the court that the plaintifs had reached a settlement with 13 individual defendants, including Goldstone. The parties hope to file their settlement documents with the court in April.

 

As Alison Frankel lnotes in her March 14, 2012 Am Law Litigation Daily article about the settlement (here), once again the SEC "once again lags the private bar." .(Hat top to Frankel for the link to the letter in which the parties to the securities suit advised the court of the settlement.)

 

A March 13, 2012 Huffington Post article discussing the SEC’s Thornburg Mortgage enforcement action can be found here.

 

Securities Suit Against U.S.-Listed Chinese Company Survives Dismissal Motion: In a recent post (here), I raised the question of how far the plaintiffs are really going to be able to go in the wave of securities class action lawsuits that have been filed against U.S.-listed Chinese companies. While it still remains to be seen how far these cases ultimately will go, at least one of these cases filed in 2011 has survived the initial dismissal motion.

 

As discussed here, in April 2011, the plaintiffs first filed their action in the Central District of California against ZST Digital Networks and certain of its directors and officers. The plaintiffs alleged the in 2008, the company reported to the SEC revenues of over $50 million and over $100 million in 2009, but reported to the Chinese governmental agency the State Administration of Industry and Commerce (SAIC) revenues of only a very small fraction of those amounts. The company’s 2010 10-K acknowledged the discrepancy between the figures and stated that the company’s reports to the SAIC were not in compliance with applicable regulations.

 

The defendants moved to dismiss the action on the grounds that the complaint failed to meet threshold pleading requirements. Among other things, the defendants argued that there was no particularized allegation that it was the SEC filings and not the SAIC filings that were untrue.

 

In a February 14, 2012 order (here) Judge Gary Allen Feess granted in part and denied in part the defendants’ motion to dismiss. In responding to the defendants’ argument that the plaintiffs have insufficiently pled which of the company’s filings were untrue, Judge Feess noted that the two filed reports “differ by a factor of over two thousand,” and the $6 million profit reported in the SEC filing contrasts particularly sharply with the loss reported in China. The Court said the defendants’ preferred explanation “merely dances around the issue” without explaining how the company came to report such widely different figures.

 

The court’s rejection of the defendants’ argument that the plaintiffs’ had insufficiently alleged which of the two filings was untrue stands in contrast to the November 2011 conclusion that a different Central District of California Judge reached in the China Century Dragon Media case (about which refer here). In that prior ruling, the court found that the plaintiffs had not sufficiently alleged, in connection with an alleged discrepancy in regulatory filings, that the SEC filings were untrue. The court in that prior case had allowed the plaintiffs leave to replead, however.

 

Judge Feess did dismiss certain other aspects of the plaintiffs’ case without prejudice. But his ruling that the discrepancy between the SEC filings and the SAIC filings was sufficient to overcome the initial pleading hurdles could be relevant in a number of the other pending cases involving U.S.-listed Chinese companies. Whether or not the plaintiffs ultimately succeed with many of these cases remains to be seen. But getting over the initial pleading threshold is an important first step.

 

A March 13, 2012 case study of the opinion in the ZST Digital Networks case written by Stephen Brodsky of the Bernstein LItowitz firm can be found here (registration required).

 

Four Say-on-Pay Lawsuits Are Dismissed in Quick Succession: In a recent post (here), I reported on comments from some observers that investors unhappy with companies’ responses to negative say-on-pay votes will likely continue to pursue say-on-pay related litigation in 2012. But any investor (or their counsel) considering filing a say-on-pay related lawsuit will want to take a look at David Bario’s March 12, 2012 Am Law Litigation Daily article (here) reporting that in quick succession, motions to dismiss recently have been granted in four of the pending say-on–pay lawsuits. (The original article listed only three, but an update at the bottom of the article adds the fourth case to the list.)

 

According to the article, dismissal motions have been granted just in the last two weeks in the say-on-pay lawsuits that were filed against the boards of Intersil Corporation; Umpqua Holding Corporation; Jacobs Engineering; and BioMed Realty Trust. As far as I know, only one of the say-on-pay lawsuits has survived the initial dismissal motion; as noted here, the say-on-pay suit involving Cincinnati Bell did survive the dismissal motion. However, there have been other cases that have been dismissed. Given that there were only ten total suits filed out of the approximately 41 companies that sustained negative say-on-pay votes, the track record for these case does not look great, and could not be encouraging for any prospective plaintiff that might consider filing a similar action in connection with any company that sustains a negative say-on-pay vote during the 2012 proxy season.

 

Speakers’ Corner: On Tuesday March 27, 2012, I will be participating as a panelist at the C5 Forum on D&O Liability Insurance in London. I will be speaking about the latest U.S. legal developments affecting the D&O exposure of non-U.S. companies. Information about the conference, including registration information, can be found here. If you are attending the conference in London, I hope you will take the time to introduce yourself, particularly if we have not previously met.

 

A Video for St. Patrick’s Day: You will definitely want to round up your mates to watch this St. Patrick’s Day video featuring Gareth Longrass and his faithful dog Roy. Roy is a legend is Gloucestershire. Cheers, everyone.

 

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Though the current bank failure wave has been rolling for several years now and though there have been over 425 bank closures during that period, the much anticipated FDIC failed bank litigation has been slower to gain momentum – that is, perhaps, at least until now. Through the end of 2011, the FDIC had filed 18 lawsuits against former directors and officers of failed banks. But now with the latest FDIC lawsuits, described below, the FDIC has already filed seven so far in 2012, three of which just in the last nine business days. There is a definite sense that the pace of litigation activity is picking up.

 

The latest FDIC failed bank lawsuit was filed in the Northern District of Illinois and relates to the failed Broadway Bank of Chicago, Illinois. Broadway Bank failed on April 23, 2010. The FDIC’s compliant, which can be found here, alleges that at the time of failure that bank had assets of 1.06 billion and that the bank’s failure cost the insurance fund $391.4 million. According to news reports, the failed bank is the former family bank of a former Illinois state treasurer.

 

The FDIC’s lawsuit, filed in its capacity as the failed bank’s receiver, seeks to recover over $104 million in losses the bank allegedly suffered on commercial real estate loans. The complaint names nine individuals as defendants, seven director defendants and two officer defendants. The complaint asserts claims against the nine defendants for gross negligence; breach of the fiduciary duty of care; and negligence.

 

The complaint alleges that the defendants “recklessly implemented a strategy of rapidly growing Broadway’s assets by approving high-risk loans without regard for appropriate underwriting and credit administration practices, the Bank’s written loan policies, federal regulations and warnings from the Bank’s regulators.” With regard to the regulators’ warnings, the complaint alleges that the Director Defendants approved “two of the worst Loss Loans” on June 24, 2008 after a meeting earlier the same day with the Bank’s regulators in which the regulators “specifically warned the Director Defendants about the risks that these types of loans posed to the Bank.” That same day regulators had discussed with the Director Defendants the need to “enter a Memorandum of Understanding” that would “impose restrictions on the Bank to stop this type of high risk lending.”

 

One of the director defendants, James McMahon, who served on the bank’s board from 2003 to December 22, 2008 issues a press release about the FDIC’s complaint, in which McMahon notes that the bank had been founded “by an immigrant who left Greece in 1962 to find a better life in America,” and had become a “vital force in the financial life of the community.” The bank had been “unable to withstand the greatest market decline since the Great Depression and, along with over 400 other community banks” had been “forced to close their doors.” With respect to the lawsuit, McMahon states “with the advantage of 20-20 hindsight, the FDIC now blames Broadway’s former officers and directors for not anticipating the same unprecedented market forces that also surprised central bankers, national banks, economists, major Wall Street firms and the regulators themselves.” McMahon concludes by noting that the allegations in the complaint are “utterly without merit and I expect to be fully vindicated by the Court.”

 

With this lawsuit, the FDIC has now filed 25 lawsuits against the former directors and officers as part of the current wave of bank failures. The Broadway bank lawsuit is the fifth that the FDIC has filed so far in Illinois, the most of any state except Georgia, where the FDIC has filed six suits. There clearly are more cases in the pipeline, as the FDIC has stated on its website that, as of February 14, 2012, the agency has authorized suits in connection with 49 failed institutions against 427 individuals for D&O liability with damage claims of at least $7.8 billion.

 

Thus the 25 lawsuits filed so far represent only about half of the lawsuits that had been authorized as of the middle of February, and the 205 individuals named in those 25 lawsuits represent less than half of the individuals against whom lawsuits have been authorized. The number of authorizations undoubtedly will continue to climb in the months ahead, as will the number of lawsuits.

 

With this latest suit, the FDIC has now filed three new lawsuits in just the last nine business days. These three cases include the February 24, 2012 lawsuit filed in the Northern District of Georgia involving two former officers of the failed Community Bank and Trust of Cornelia, Georgia (about which refer here, scroll down) as well as the March 2, 2012 lawsuit filed in the Northern District of Georgia against 12 former directors and officer of the failed Freedom Bank of Commerce, Georgia (about which refer here, scroll down). There is a definite sense that the pace of the FDIC’s litigation activity has picked up. Though this latest lawsuit was filed well in advance of the three-year statute of limitations, the two prior suits were much closer to the cut-off, and with the three-year deadline date looming for the failed bank class of 2009 – the largest year for failed banks – it seems likely there will be increasing numbers of suits ahead.

 

Very special thanks to John M. George, Jr. of the Katten & Temple law firm for sending me a copy of the Broadway bank complaint and for sending me James McMahon’s press release. The Katten & Temple law firm represents Mr. McMahon.

 

Corruption Investigation Follow-On Civil Suits Reach Canada: The occurrence of follow-on civil actions being filed in the wake of corruption and bribery investigations is a phenomenon I have noted frequently on this blog. It now appears this type of follow on civil suit has now reached Canada.

 

As discussed here, the share price of SNC-Lavalin Group recently declined sharply after the company announced an internal investigation of the accounting for certain payments in connection with a company project in Libya . As reflected in their March 1, 2012 press release (here), plaintiffs’ lawyers have now initiated a securities class action lawsuit in Quebec Superior Court against the Company and certain of its directors and officers.

 

The plaintiffs’ complaint, which can be found here, alleges that the company violated its continuing disclosure obligation by misrepresenting the company’s internal controls and accounting. Among other things the complaint alleges that an anonymous letter the company’s senior management alleged that for years shell companies had been used to funnel money from SNC-Lavalin to members of the Libya’s Gadhafi family. 

 

The phenomenon of follow on civil litigation has been a factor in the U.S. for years. As anticorruption efforts spread elsewhere, the likelihood is not only that more companies will face scrutiny from government officials, but they may also face civil litigation as well. At a minimum this case shows how Canada’s litigation environment is continuing to evolve, and its litigation landscape is becoming both more extensive and more complex.

 

Special thanks for a loyal reader for alerting me to this case.

                                                                    

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The FDIC’s latest Quarterly Banking Profile for the period ending December 31, 2011, released February 28, 2012 (here), reflects a generally improving banking landscape and a continuing reduction in the number of problem institutions. But though the industry is showing improvement, the number of problem banks, though down from immediately prior periods, still remains elevated compared to historical levels.

 

According to the report, as of year- end 2011, there were 813 problem institutions, compared to 844 as of the end of the third quarter and 884 as of year-end 2010. (A “problem” institution is a bank to which the FDIC has rated as either a “4” or a “5” on the agency’s 1-to-5 scale of ascending order of supervisory concern.) The quarterly decline in the number of problem institutions represents about a 3.6% drop, and the decline during calendar year 2011 represents about an 8% drop. According to the FDIC, the 4Q11 decline in the number of problem institutions represents the third consecutive quarterly decline.

 

The total assets of problem institutions also declined during the fourth quarter of 2011, from $339 billion at September 30, 2011 to $319.4 billion at year-end 2011. The $319.4 billion 2011 year-end total represents a substantial decline from the $390 billion at the end of 2010 and the $402 billion at the end of 2009.

 

Though the number of problem institutions began to decline during 2011, the number of problem banks remains at elevated levels compared to historical standards. At recently as year-end 2007, there were only 76 problem institutions listed. Even at the end of 2008 during the height of the global financial crisis, there were only 252 problem financial institutions. In other words, though the number of problem financial institutions is declining, that does not necessarily mean the current banking crisis has passed.

 

It should also be noted that the declining number of problem institutions does not necessarily mean that the number is declining because of improvement among problem institutions. It could just be that some of the problem banks no longer exist. For starters, the number of reporting institutions overall has been declining for several years. At year end 2011, there were 7,357 reporting institutions, down from 7,658 at the end of 2010 and 8,305 at the end of 2009. The overall decline is mostly due to mergers and failures. These same factors likely also account for much of the decline in the number of problem institutions.

 

It is impossible to know how much of the decline in the number of problem institutions is due to improvement and how much is due to these other factors. The good news is that the number of bank failures is definitely down. So far, YTD 2012, there have been only 11 bank failures, compared to 23 at this same point last year. The declining rate of failures seems like a positive sign. But again, as noted above, when there are over 800 problem institutions and when banks are continuing to fail, it is hard to conclude that we are entirely out of the woods on the current wave of bank failures and problem banks.

 

At the same time, much of the news In the FDIC’s latest Quarterly Banking Profile is positive. The overall picture for the industry is one of recovery, with growing net income, declining loan loss provisions, and declines in noncurrent loan balances. There is a concern that revenues appear to have slipped, but overall the picture for the banking industry is positive. With these positive signs, the hope is that the improving conditions will allow even the problem institutions to benefit and recover.

 

Another Failed Bank Lawsuit: As the number of failed banks and problem institutions continues to decline, the number of FDIC failed bank lawsuits is ramping up. On February 24, 2012, the FDIC filed its latest lawsuit. This one was filed in the Northern District of Georgia against two former a former director and officer and a former director of the failed Community Bank & Trust of Cornelia, Georgia. A copy of the FDIC’s complaint can be found here.

 

Community Bank & Trust failed on January 29, 2010. In its complaint, the FDIC seeks to recover in excess of $11 million in losses allegedly caused by the two defendants’ breaches of fiduciary duty, negligence and gross negligence related to the bank’s home loan program between January 6, 2006 and December 2, 2009. The complaint alleges that the bank’s senior head of retail lending violated his legal duties in approving loans in violation of the bank’s loan policies. The bank’s CEO is alleged to have breached his duties in failing to supervise the loan officer and in failing to take corrective measures.

 

The suit is the 23^rd that the FDIC has filed as part of the current wave of bank failures. According to its website, as of February 14, 2012, the FDIC has authorized suits in connection with 49 failed institutions against 427 individuals for D&O liability with damage claims of at least $7.8 billion. This includes the now 23 filed D&O lawsuits naming 184 former directors and officers. In light of the differences between the number of authorized suits and the number filed to day, there clearly are many suits yet to come – and the number of suits authorized has also been increasing monthly. The banking industry may be slowly improving but the litigation levels are just now starting to ramp up.

 

Special thanks to a loyal reader for sending me a copy of the complaint.

 

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During the current bank failure wave more banks have failed in Georgia than in any other state. For that reason, the recent dismissal motion ruling in  the first failed bank case the FDIC filed involving a failed Georgia bank takes on a heightened level of significance. Northern District of Georgia Judge Steve C. Jones’s February 27, 2012 ruling the FDIC’s lawsuit against eight former directors of the failed Integrity Bank (here) is not only the first to address the liability standard under Georgia law for directors of failed banks but also the ruling  addresses important issues regarding the defenses that defendant directors may raise and rely upon against the FDIC.

 

Background

Integrity Bank of Alpharetta, Georgia was one of the first in Georgia to fail when it was closed on August 28, 2008.  As discussed here, on January 14, 2011, in what was the third FDIC lawsuit overall against former officials of a failed bank and the first in Georgia, the FDIC filed a lawsuit against eight former officials of Integrity Bank. The FDIC’s complaint can be found here.

 

By way of important context, it should be noted that two former Integrity officials have already drawn criminal charges involving activities at the bank, as discussed here. One of the two indicted Integrity officials, Douglas Ballard, is also named as a defendant in the FDIC’s civil lawsuit. As noted here, in July 2010, the two individuals entered criminal guilty pleas in the case. 

 

The FDIC, which filed the lawsuit in its capacity as Integrity Bank’s receiver, seeks to recover “over $70 million in losses” that the FDIC alleges the bank suffered on 21 commercial and residential acquisition, development and construction loans between February 4, 2005 and May 2, 2007. The defendants filed a motion to dismiss. The FDIC filed a motion to strike certain of the defendants’ affirmative defenses.

 

The February 27, 2012 Ruling

In his February 27 ruling, Judge Jones denied n part and granted in part the defendants’ motions to dismiss. The defendants had first sought to dismiss the complaint in reliance on exculpatory provisions adopted in the bank’s articles of incorporation. Judge Jones concluded under Georgia law the exculpatory provisions would not be applicable to the action by the FDIC, and he therefore denied the defendants’ motion to dismiss to the extent reliant on the exculpatory provision.

 

The defendants also moved to dismiss the claims against them for ordinary negligence, arguing that the actions were protected under Georgia law by the business judgment rule and therefore they could not be held liable for claims of ordinary negligence. Judge Jones held, after reviewing case law interpreting the business judgment rule under Georgia law that “in light of this authority and the application of the business judgment rule, the Court finds that the Plaintiffs’ claims for ordinary negligence and breach of fiduciary duty based upon ordinary negligence fail to state a claim upon which relief can be granted.”

 

However, Judge Jones also held that FDIC’s remaining claims for gross negligence and breach of fiduciary duty based up on gross negligence remain, “as they encompass conduct which would fall beyond the ambit of the protections of the business judgment rule.” Judge Jones also separately held that the complaint raised allegations from which if true “a jury might reasonably conclude that Defendants’ were ‘grossly negligent’ as defined by Georgia law.” Accordingly, Judge Jones denied defendants’ motion to dismiss the acclaims for gross negligence and breach of fiduciary duty based on gross negligence.

 

Finally, the FDIC had moved to strike certain of the defendants’ affirmative defenses, arguing that the defenses were not available against the FDIC in its capacity as receiver of the failed bank. Judge Jones agreed with the motion to the extent the affirmative defenses sought to rely on the FDIC’s actions in its corporate capacity (FDIC-C) prior to the its takeover of the bank. However, Judge Jones denied the FDIC’s motion to strike the affirmative defenses based on a failure to mitigate, estoppel and reliance “ to the extent those defenses are based upon post-receivership conduct by Plaintiff in its capacity as receiver.”

 

Judge Jones did find, however, that while the defendants’ could not rely on the FDIC-C’s conduct as the basis of an affirmative defense, “the murkier question is whether the defendants can rely on the FDIC-C’s conduct to rebut causation or offer an alternative theory of causation.”  Judge Jones denied the FDIC’s motion to strike the causation defense, but indicated that he would call for further briefing on the question of whether or not the defendants can rely on the FDIC’s pre-receivership conduct to rebut causation or to support an alternative theory of causation.

 

Discussion

Judge Jones’s rulings in the Integrity Bank case may be the first under Georgia law in the failed bank context saying that, in light of the business judgment rule, the standard of liability for former directors and officers of the failed bank is gross negligence. To that extent, his ruling is positive for the many directors and officers of failed banks facing liability claims from the FDIC.

 

However, Judge Jones also found that the relatively unexceptional allegations in the FDIC’s complaint were sufficient to state a claim for gross negligence. To that extent, Judge Jones’s ruling is less helpful to those many Georgia failed bank officials, because it seems less likely those individuals might be able to get out of an FDIC failed bank lawsuit on a motion to dismiss.

 

Judge Jones’s rulings on the FDIC’s motion to strike may be even more interesting, however.  His rulings were not merely a matter of Georgia law, but rather were based on his interpretation of the U.S. Supreme Court’s 1994 decision in O'Melveny & Myers v. FDIC. His holding that affirmative defenses for failure to mitigate, estoppel and reliance could be raised against teh FDIC in its capacity as receiver (even if not available with respect to the agency's actions in its capacity as FDIC-C) could proved helpful to individual defendants in many FDIC failed bank lawsuits -- and not just those pending in Georgia.  

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By the same token, his unwillingness to conclude that the defendants cannot rely on the FDIC-C’s conduct to rebut causation or offer an alternative theory of causation at least potentially opens the door for other defendants to try to assert these defenses.

 

The ultimate significance of this decision, whether in the case itself or in other cases in Georgia or elsewhere, remains to be seen. Certainly, Judge Jones’s rulings will be looked to by other courts trying to sort out these issues. The suggestion on his standard of liability rulings is that cases in Georgia may be narrower but perhaps harder to dismiss outright at the motion to dismiss stage. On the other hand, his rulings on the defenses that may be raised against the FDIC may prove helpful for other defendants. In most instances, the FDIC has been able to argue that its conduct is not at issue in suits it brings in its capacity as receiver. Judge Jones’s ruling suggests that the FDIC’s conduct as receiver at least can at least potentially serve as the basis of an affirmative defense. His ruling on the causation question opens the door that the FDIC-C’s pre-closure conduct could also be brought into question as well.

 

With so many failed banks in Georgia, and with the likelihood of a proliferation of failed bank suits in that state, Judge Jones’s rulings could prove to be significant.

 

Many thanks to the several loyal readers who sent me copies of the Integrity Bank decision. Special thanks to Bob Ambler of the Womble Carlyle firm. Womble Carlyle represents one of the individual defendants in the Integrity Bank case.

 

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Even as the number of bank failures now appears to be winding down, the FDIC’s failed bank litigation filings seem to just be ramping up. With now 21 lawsuits filed as part of the current wave of bank failures, it may be possible to try to make some generalizations about the lawsuits so far. In a February 1, 2012 post on BankDirector.com entitled “Characteristics of FDIC Lawsuits against Directors & Officers of Failed Financial Institutions” (here), Cornerstone Research takes a look at the FDIC’s failed bank lawsuits to date and finds, among other things,  that the suits so far have involved larger institutions within the same geographic concentrations as the bank failures themselves.  As discussed below, Cornerstone Research’s various findings may have important implications for the lawsuit filings that are yet to come.

 

The Cornerstone Research study reports that the FDIC has filed lawsuits so far in connection with only about 4.7% of financial institutions failures since January 1, 2007. Two suits were filed in 2010, 16 in 2011, and three so far in 2012. The study also reports that on average the FDIC has waited about 2.2 years after the date of an institution’s failure to file a lawsuit.

 

The lawsuits so far have “tended to target larger failed institutions,” with the 20 institutions so far involved in the 21 lawsuits to date having had median total assets of $882 million, compared with median total assets of $241 million for all failed financial institutions. The 20 institutions have had a median estimated cost to the FDIC of $179 million, compared with the medial estimated costs of $60 million for all failed banks.

 

The geographic mix of lawsuits has paralleled the location of failed institutions, with the largest concentrations of both bank failures and lawsuits in Georgia, Illinois and California. The one exception, the report notes, is Florida, which has been the location of 14 percent of all failures since 2007, but where no FDIC failed bank lawsuits have been filed yet.

 

The 21 lawsuits so far have involved 178 former directors and officers. In six of the cases, only inside directors and officers have been named as defendants, but in the remaining 15 cases, outside directors were also named as defendants. Three of the suits have also named D&O insurers as defendants (about which refer, for example, here); and at least one suit has included the failed bank’s outside law firm as a defendant (refer here). Three cases have involved the spouses of former directors and officers (refer, for example, here).

 

The aggregate damages sought in the 21 complaints are $1.98 billion. The average and median damages sought is $104 million and $40 million, respectively. Losses on commercial real estate loans and on acquisition, development and construction loans are the most common bases of alleged damages. As the report notes about the sources of alleged damages, “despite the widespread problems in residential lending and residential real estate markets, fewer lawsuits focused on those types of lending.”

 

The report notes that three of the FDIC’s cases have settled so far: the WaMu case (about which refer here); the First National Bank of Nevada case (about which refer here); and the Corn Belt Bank & Trust Company case (the settlement details of which have not yet been publicly disclosed).

 

Discussion

Obviously there is a long way to go in the current bank failure litigation wave. The 4.7% percent of bank failures that have involved litigation so far compares to the rate during the S&L crisis, when the FDIC filed lawsuits against directors and officers of the failed institutions in about 24% of all bank failures. Indeed, though the FDIC has filed only 21 lawsuits so far, involving 20 institutions and 178 former directors and officers and aggregate claimed damages of $1.98 billion, , the FDIC’s website states that as of January 18, 2012, the FDIC has authorized lawsuits in connection with 44 failed institutions against 391 institutions, claiming damages of at least $7.7 billion.

 

Perhaps even more significantly, the FDIC has increased these authorization numbers each month for the past several months – and the number of failed institutions has also continued to increase, as well. In other words, just the suits authorized so far implies quite a number of lawsuits yet to come, and likelihood of increased numbers of future authorization suggests an even greater number of suits ahead. The FDIC may or may not wind up filings suits in connection with 24% of the failed institutions this time around as it did during the S&L crisis, but we still could be in for a substantial amount of future litigation.

 

The substantial gap between the $7.7 billion of claimed damages in the cases the FDIC has authorized to date, and the aggregate of $1.98 billion of claimed damages in the cases the FDIC has filed so far, suggests that the suits that have been authorized but not yet filed involve larger failed  institutions.

 

The Cornerstone Research report’s analysis supports this suggestion that there may be a backlog of as yet unfiled cases involving larger institutions, and not just because the report’s findings in general suggest that the FDIC has at least so far largely concentrated its litigation activities on larger institutions. As the report notes, though the FDIC has targeted two of the largest failed institutions (WaMu and IndyMac), “many of the other large or costly failures …have not yet been the target of FDIC lawsuits.” In light of the fact that many of the most costly failures occurred in 2008 and 2009 and given statute of limitations restrictions, “these would seem to be the most likely candidates for FDIC lawsuits in the near future. “

 

Taking this analysis and looking back at the costliest 2009 bank failures to assess the possible targets, some possible litigation examples might include Colonial Bank (August 2009 failure, $25 billion asset bank, $2.8 billion to the insurance fund); Guaranty Bank (August 2009 failure, $13 billion asset bank, $3 billion loss to the insurance fund); and Bank United (May 2009 failure, $12.8 billion asset bank, $4.9 billion loss to the insurance fund). Of course, whether or not there may be litigation involving these institutions remains to be seen, as would the merits of any litigation that might arise.

 

The report’s note that there has as yet been no litigation involving a failed bank located in Florida is an interesting insight. Given that over 60 institutions have failed in Florida since 2007, it seems likely that there future lawsuit filings might involve failed Florida banks.

 

One concluding note in the Cornerstone Research report that is worth emphasizing is that a number of potential lawsuits have been resolved without litigation through mediation or negotiation, often involving the failed bank’s D&O carriers. There are no publicly available statistics on these out of court resolutions and their overall impact is hard to assess. Though the impact is not quantifiable, these types of resolutions may be an important part of the FDIC’s post-failure salvage operations.

 

In any event, it does seem probable that the current wave of bank failure litigation not only has a long way to run but will also continue to grow in the near term. We can only hope that Cornerstone Research will continue to update and publish their analysis as the process unfolds.

 

Many thanks to a loyal reader for sending me a link to the Cornerstone Research report.

 

Carlyle Group Drops Bid to Require Investors to Arbitrate Claims: In a prior post (here), I commented on the unusual effort of the Carlyle Group in connection with its upcoming IPO to require investors to arbitrate rather than to litigate claims. As Victor Li discusses in a February 3, 2012 Am Law Litigation Daily article (here), Carlyle Group has announced that in response to pressure from the SEC and others, the company has dropped its efforts in required arbitration. As Li notes, Carlyle Group’s efforts had been sharply criticized by several U.S. senators and numerous others, and also ran contrary to long-standing SEC prohibitions against approval of arbitration provisions.

 

Notwithstanding Carlyle Group’s withdrawal of its arbitration proposal, the issue may yet come to a head in the weeks ahead, in light of the efforts of investors at Gannett and Pfizer to have included in their companies’ 2012 proxy ballots shareholder proposals to required investor claims to be litigated. The question of the propriety of a corporate provision requiring the arbitration of shareholder claims may yet be aired at the SEC.

 

The Week Ahead: This week I will be attending the PLUS D&O Symposium at the Marriott Marquis Hotel in New York City. On Wednesday, February 8, 2012, I will be moderating a panel entitled “Financial Institutions Underwriting: Is it Safe to Come Out Yet?” Joining me on the panel are my good friends Jennifer Fahey of AON; Tim Braun of AXIS; Steven Goldman of ACE: and Dan Gamble of Alterra.

 

I know many of the readers of this blog will also be attending the Symposium. I hope readers will feel free to greet me, particularly those whom I have not previously met.

 

I know that many attending this larger conference, particularly first time attendees, can find the crowded sessions and events a little intimidating. Some may even find that despite – or ironically because of – the crowds, it is hard to meet people. I can’t provide any sure fire way to overcome these challenges and to succeed in making many new professional contacts. But one loyal reader did send me a link to an article that may be useful to at least some conference attendees trying to work their way into the mix.

 

The January 25, 2012 article is from the Harvard Business Review blog, and it is entitled “The Introvert’s Guide to Networking,” which can be found here. There are a number of useful items in this short article, but the best piece is the author’s observation that she “stopped being afraid to be the one to reach out.” This observation is particularly useful in connection with the PLUS D&O Symposium.

 

My observations after many years in this industry are, first, that there are many people around who have trouble dealing the large crowds at industry events, so you are not alone, and, second, most people are as interested in meeting you as you are in meeting them, and so the best approach is just to go up to someone you don’t know and introduce yourself. Also, don’t be afraid to ask others to introduce you to people you would like to meet. The great thing is that we have a very friendly, sociable industry and most people are happy to be introduced.

 

I look forward to seeing everyone in New York.

 

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Recent sharply-worded accusations that the FDIC had failed to preserve documents attracted quite a bit of media attention. For example, a January 27, 2012 Wall Street Journal article reported the charges of counsel for two former IndyMac bank executives, repeating counsel’s remarks accusing the agency of a “stunning display of incompetence” for failing to preserve documents. Counsel made these statements in a filing in an action the FDIC had filed against fhe individuals in its capacity as receiver for the failed bank.

 

The Journal article also quoted the individual defendants’ counsel’s statement that “the breadth and depth of the government’s document-retention failures are staggering, and violations of this magnitude rarely occur,” and that “it is a stunning display of incompetence from an agency that is supposed to be an expert at seizing and managing banks.”

 

Based on these accusations, two of the inidividual defendants  sought sanctions against the government for willful spoliation of evidence, dismissal of the relevant counts of the lawsuit and an adverse instruction to the jury based on the government’s failure to preserve evidence.

 

The defense counsel’s provocative language may have succeeded in getting his accusations published in the Wall Street Journal. However, the language proved less successful when the matter came before Central District of California Judge Dale Fischer in a hearing on January 30, 2012. As reflected in a transcript of the hearing, Judge Fischer had quite a lot to say about counsel’s approach, including in particular, counsel’s use of language.

 

Judge Fischer started her remarks with a comment about counsel’s pleading tactics and then went on from there:

 

THE COURT: Now, there were a number of declarations attached to the reply that apparently were not filed immediately after they were signed. Why was that?

 

DEFENSE COUNSEL: Your Honor, we waited to file them with our reply.

 

THE COURT: And you seriously thought that was the appropriate approach?

 

DEFENSE COUNSEL: Yes, I did, your honor.

 

THE COURT: Well, for future reference, it wasn’t. Don’t hold back evidence that relates to your motion until after the opposing party files its opposition and then just stick it to them at the end. So I’m not sure why you thought that was appropriate, but now you know.

 

Along those lines: I also want to tell you, I don’t know why lawyers do this, and there’s a lot of them in the room so take heed, all of you, language like failures are staggering, violations of this magnitude rarely occur, stunning display of incompetence, bitter irony, breathtaking dereliction of duty are not only unpersuasive, they’re somewhat annoying. I don’t have time for rhetoric. I’m really, really busy. Why anyone would want this job, I don’t know…

 

But in any event, it’s just – I don’t know whether you stay up nights trying to think of clever phrases, but trust me, no judge that I’ve ever spoken to has ever said, Boy, can that guy turn a phrase. They only say, Boy, why didn’t he get to the point. So, please, in future pleadings, remember that.

 

DEFENSE COUNSEL: Yes, your Honor.

 

THE COURT: In addition to that, I’ve been around awhile both in practice and on the bench, so I suspect I’ve seen a few more cases than you, and really, it’s not all that staggering and it’s not all that great a magnitude, so when your experience and mine differ, it just takes all of the punch out of those comments.

 

To make matters even worse, Counsel, your statement that the government failed to make any effort to preserve the documents is simply false. And your statements in your papers so often go beyond the bounds of zealous advocacy that I have to say your papers had very little persuasive value. In fact, as I was trying to check some of the references you made to deposition testimony, I looked at it three or four times because I thought I must be searching for the wrong page because the pages you were citing to had oftentimes no relationship to the proposition you were citing them for. You started off extremely poorly as I started reading the papers, and I had little confidence in anything you had to say as I went through them.

 

Judge Fischer denied the defendants’ motion.

 

Readers of this blog may also be interested to read the discussion in the hearing transcript, beginning at page 27, about the role that the D&O insurance program in the ongoing case. From reading the transcript, it appears that the individual defendants contend that there a second $80 million insurance tower is relevant to this claim, although defense costs are being funded out of a first $80 million tower. The lawyers present at the hearing disagreed about the exact amount, but it appears that defense expenses to date in all of the various IndyMac-related lawsuits have totaled $35 million or $45 million. There were various references in the transcript to the lack of responses from the carrier. (The make-up of the two insurance towers and a prior coverage dispute involving IndyMac’s D&O insurance are discussed here.)

 

Also, and though it is difficult to discern from the bare face of the transcript, it appears that the reason that the FDIC wants to take this case to trial is to substantiate damages in excess of the applicable policy limits, in an apparent attempt to impose a judgment in excess of the limits on the D&O insurer(s).

 

As Judge Fischer commented at the outset of the discussion about the D&O Insurance, the case “seems to be insurance-company driven.” Which corroborates a point I have made before on this blog, that the D&O insurance may be the real battleground in the FDIC’s failed bank litigation.

 

This case, which was filed in July 2010, was the first that the FDIC filed against former officers of a failed bank as part of the current bank failure wave, as discussed at greater length here. It is also one of two FDIC actions against former IndyMac officials. The agency separately filed an action against the failed bank’s former CEO, as discussed here.

 

Judge Fischer’s aside that she doesn’t know why anyone would want to be a federal judge, triggered as it was by her frustration with the  matter before her, was remarkably like my own reaction as I read through the transcript. As I read along, my own decision years ago to walk away from the active practice of law seemed more and more like a really smart move.

 

Reading about the tone and temper of the parties’ pleadings in this case reminded me of the lyrics from the Crosby, Stills & Nash song “You Don’t Have to Cry,” which I often sing to myself when I hear about litigators bashing each other: “You are living a reality I left years ago, it quite nearly killed me/In the long run, it will make you cry, make you crazy and old before your time.”

 

What Do You Make, He Asked?: If you have not seen this video about teachers, drop everything and watch it right now. Thank you.

 

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In its latest failed bank lawsuit, the FDIC, in its capacity as receiver of the failed County Bank of Merced, California, has filed a complaint against five former officer of the bank. The FDIC’s complaint was filed in the United States District Court for the Eastern District of California on January 27, 2012, just short of three years from the date of the bank’s closure. A copy of the FDIC’s complaint can be found here.

 

County Bank failed on February 6, 2009 and the FDIC was appointed as its receiver. The FDIC’s lawsuit has been filed against five former officers of the bank, each of whom served on the bank’s Executive Loan Committee. The complaint alleges claims against them for negligence and breach of fiduciary duty, in connection with 12 loans the bank made between December 2005 and June 2008, which the FDIC says caused the bank losses in excess of $42 million.

 

The FDIC alleges that the five defendants caused or allowed the bank to make “Imprudent real estate loans, typically for the construction and development of residences.” The complaint alleges that the bank’s real estate lending represented “significant departures from safe and sound practices.” The complaint further alleges that the bank’s management “disregarded the Bank’s credit policies and approved loans to borrowers who were not credit worthy and/or for projects that provided insufficient collateral and guarantees for repayment.”  The complaint further alleges that the bank’s management “unwisely continued risky commercial real estate lending in a deteriorating market even after becoming aware of the market decline.”

 

The FDIC filed its complaint only days before the third anniversary of the bank’s closure – that is, just before the expiration of the statute of limitations period within which the FDIC could bring its claims. Up until this point during the current bank failure wave, the FDIC has been proceeding very deliberately, in most cases filing lawsuits only after two years or more has elapsed since the date of bank closure.

 

The FDIC’s filing of this action just before the end of the limitations period is reminder that notwithstanding the FDIC’s deliberate pace in filing these lawsuits, the FDIC does face certain absolute time deadlines. Moreover, this particular bank’s closure occurred at a time when the number of bank closures began to escalate rapidly. The FDIC took control of increasing numbers of banks as 2009 progressed and on in to early 2010, which means that the limitations period within which the FDIC will have to file lawsuits will be about to run out for a host of failed banks in the coming months.

 

There were a total of 140 bank failures in 2009, ten in February 2009 alone, after only 25 bank failures in all of 2008. The numbers of bank closures escalated even further after February 2009. Indeed, there 95 bank failures in the last six months of 2009. In other words, as we move through 2012, the FDIC will be approaching the statute of limitations deadline for increasing numbers of banks.

 

In light of the approaching limitations deadline the 2009 bank failures, it seems likely that over the next few months we will see a surge in case filings, many, like the complaint here, filed at the very end of the applicable limitations period.

 

In any event, the FDIC’s action in the County Bank case represents the twenty-first failed bank action the agency has filed so far as part of the current bank failure wave, and already the third so far in 2012. The FDIC’s first two actions this year, both of which were filed in Puerto Rico, are described here.

 

Year End Securities Litigation Review Webinar: On February 1, 2012 at 11:00 am EST, I will be participating in a year-end securities litigation review webinar sponsored by Advisen . The webinar will be moderated by Advisen’s Jim Blinn and will also include my good friend David Williams of Chubb. The webinar is free. To register and for additional information, refer here.

 

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In the FDIC’s latest lawsuit filed in its role as receiver of a failed bank, the FDIC not only named as defendants nineteen former directors and officers of the failed bank, but also included as defendants seventeen of their spouses and the failed bank’s D&O insurer. A copy of the FDIC’s January 18, 2012 complaint, filed in the agency’s capacity of receiver of the failed R-G Premier Bank of Puerto Rico, can be found here. UPDATE: See also the note below regarding the separate actoin filed in the District of Puerto Rico, involving the directors and officers of teh failed Westernbank Puerto Rico, which also involves D&O insurer defendants.

 

As discussed here, R-G Premier Bank failed on April 30, 2010. According to the FDIC’s complaint, its closure represented “one of the largest bank failures in Puerto Rico’s history, costing the Deposit Insurance Fund over $1.46 billion in losses.”

 

In its complaint, the FDIC asserts claims for gross negligence against certain former directors and officers of the failed bank, alleging that the bank’s losses and ultimate failure arose from the bank’s aggressive commercial lending. The complaint alleges that the commercial lending operations were essentially unsupervised, even though the commercial lending department “recklessly” pursued “explosive commercial loan growth.” The complaint alleges that the director and officer defendants “ignored numerous warnings from multiple sources about serious problems” in the bank’s management and lending operations.”

 

The complaint alleges that the director and officer defendants “exacerbated and accelerated” the bank’s loan losses “by robotically approving virtually any loan request that crossed their desks, even though such loan requests had been processed through the obviously deficient lending structure they had created at the Bank.” The FDIC bases its claims against the directors and officers on the individuals’ alleged “grossly negligent failure to exercise due care and any business judgment”; “grossly negligent failure to inform themselves about and to exercise adequate oversight over the Bank’s lending functions” and on the allegations that the defendants “knew or should have known” that the alleged problem loans identified in the complaint “were extremely unlikely to be paid back, and also the equally clear risks of injury to the Bank from the Bank’s inappropriate lending structure.”

 

The FDIC seeks to recover damages “in excess of $257 million” the bank allegedly incurred “as a result of the breaches of fiduciary duties and gross negligence” of the director and officer defendants in connection with 77 transactions identified in the complaint. The claims against the 17 spouses and conjugal partners who are also named as defendants “are based on their legal relationship to the Directors and Officers.”

 

The complaint also names as a defendant the insurer that issued two D&O liability insurance policies to the bank’s holding company. The two policies consist of a primary $25 million policy and a $10 million excess policy, both issued by the same insurer. Both policies are alleged to have had policy periods running from November 30, 2008 to December 30, 2009, with an optional extension period until December 30, 2010. The FDIC alleges in its complaint that the optional extension period was exercised on December 29, 2009. The complaint also alleges that on December 23, 2010, the FDIC sent a demand for civil damages to the directors and officers, with a copy of the demand also sent to the D&O insurer.

 

In Count III of the complaint, which is denominated as a “Claim for Direct Relief,” the FDIC alleges that its claims against the directors and officers “fall within the coverage provided” under its policies, and that the insurer is “liable” for “$35 million in damages caused to the Bank by the gross negligence of the Defendants.” The complaint seeks a judgment against the insurer “for at least $35 million.”

 

Discussion

In prior posts discussing the FDIC’s litigation against former director of failed banks, I have suggested that the real battleground for many of these suits may be the FDIC’s coverage disputes with the failed bank’s D&O insurer. This case, in which the FDIC named the D&O insurer as a defendant along with the former directors and officers, seems to make that aspect of these circumstances explicit.

 

This is not the first occasion on which the FDIC has directly named a failed bank’s D&O insurer as a defendant in a liability action. (For a prior example, refer here). Those readers uncertain how the FDIC is purporting to proceed directly against the insurer without first obtaining a judgment against the individual insureds may be interested to know that, at least according to sources I have reviewed online, Puerto Rico has a direct action statute, allowing those claiming injury from a torfeasor’s action to proceed directly against the tortfeasor’s liability insurer. At least based on my quick review of the subject, that would seem to explain the FDIC’s move of including the D&O insurer as a defendant in the suit.

 

Without being able to go behind the scenes it is hard to know for sure what the basis of the coverage action may be. Just based on the date on which the D&O policies originally incepted, it is not unlikely that the policies when issued included a regulatory exclusion. Some insurers have also taken the position that the insured vs. insured exclusion found in most D&O policies precludes coverage for claims brought by the FDIC as receiver, which is an issue that undoubtedly will be litigated heavily in connection with many of these failed bank coverage disputes.

 

It is also possible that the D&O insurer is asserting coverage defenses arising from the fact that the bank did not fail and the FDIC did not assert claims against the directors and officers until after the inception of the policies’ extensions. The insurer may be asserting defenses based on the timing of these various events relative to the policies termination dates and reporting deadlines. At least according to the FDIC’s recitation in the complaint, it appears that the FDIC did assert its claim against the directors and officers prior to the expiration of the extension.

 

The FDIC’s assertion of claims against the spouses and conjugal partners are obviously designed to allow the FDIC to be able to enforce any judgment against property jointly held by the individual directors and officers and their spouses. This is not the first occasion on which the FDIC has asserted claims against spouses of failed bank directors and officers. For example, in connection with the FDIC’s lawsuit against the certain former officers of Washington Mutual, the FDIC also asserted claims there against two of the officers’ spouses. The FDIC’s assertion of claims against the spouses is an illustration of the importance of the language found in many D&O policies which extends the definition of the term “Insured Persons” to include the spouses or domestic partners of the insured entity’s directors and officers, but only to the extent the spouses or partners is a party to a claim as a spouse to the director or officer.

 

One anomalous feature of the bank’s D&O insurance structure is that the both the bank’s primary D&O insurance policy and its excess D&O insurance policy were both  issued by the same D&O insurer. That is an unusual arrangement for many reasons, not the least of which is that many insurers would be reluctant to have such concentrated exposure to any one risk. The extent of the insurer’s exposure is one more reason I suspect that the insurer may considered its insurance of this risk as well defended, for example through the inclusion of a regulatory exclusion or even perhaps the preclusion of coverage for acts that incurred prior to the policies’ November 30, 2008 inception.

 

Of course, I could be wrong about the presence of these defensive features, but I still think it is unusual that the insurer would have take a full $35 million exposure to one financial institution, especially given the events that were taking place in the global financial marketplaces at that time.

 

The FDIC’s lawsuit against the former directors and officers of R-G Premier Bank of Puerto Rico is the nineteenth lawsuit the FDIC has filed in connection with the current wave of bank failures, and the second so far during 2012. The FDIC undoubtedly will be filing many more suits in the months ahead. Indeed, on the FDIC’s website page providing information about the agency’s litigation efforts, the FDIC states that as of January 18, 2012, the FDIC has authorized suits in connection with 44 failed institutions against 391 individuals for D&O liability with damage claims of at least $7.7 billion. This includes 19 filed D&O lawsuits (2 of which have been dismissed after settlement with the named directors and officers) naming 161 former directors and officers. In other words, even just looking at the suits authorized so far, there are many law suits yet to come. And the FDIC has been authorizing increased numbers of suits every month, so the likelihood is that many more lawsuits will be authorized and filed as we head forward in 2012 and beyond.

 

UPDATE: Following my initial publication of this post, a loyal reader provided me with a copy of the January 20, 2012 Amended and Restated Complaint in Intervention that the FDIC filed in the District of Puerto Rico in an action involving both the former directors and officers of the failed Westernbank and certain of their spouses, as well as the D&O insurers for Westernbank's holding company. A copy of the FDIC's complain can be found here.

 

Regulators closed Westernbank on April 30, 2010, which according to the FDIC's complaint, cost the insurance fund $4.25 billion. In October 2011, certain of the former Westernbank directors and officers had sued the bank's primary D&O insurer in state court in Puerto Rico. The FDIC as receiver for Westernbank moved ot intervene in the state court action, and on December 30, 2011, removed the state court action to the District of Puerto Rico. On January 20, 2012, the FDIC filed its amended complaint in intervention, in which it named as defendants certain additional directors and officers, as well as the excess D&O insurers in the bank's D&O insurers program. The FDIC expressly asserts its claims against the D&O insurers under Puerto Rico's direct action statute. Certain of the individual direcrors and officers have moved to remand the action back to state court.

 

The FDIC's action against the former directors and officers of Westernbank represents the twentieth action that the agency has filed so far as part of the current wave of bank failures, and also represents yet another example of a case where the real battleground may be the D&O insurance coverage dispute.

 

The First Bank Closures of 2012:  This past Friday night, the FDIC also took control of the first three failed banks of 2012, as reflected here. The FDIC closed banks in Florida, Pennsylvania and Georgia, the first three banks to fail in over a month. The presence of a Georgia bank among the first group of bank failures is hardly a surprise, as the bank’s 74 bank failures during the period January 1, 2008 through December 31, 2011 is by far the highest total for any state during the period. Florida, with 58 bank failures during that period, has the second highest total.

 

Is Morrison the "Global Securities Case of the Decade"?: In a very interesting and thorough January 20, 2012 article on the Am Law Litigation Daily (here), Michael Goldhaber asks the qustion whether or not the Supreme Court's 2010 decision in Morrison v. National Australia Bank is the Global Securities Case of the Decade (so far, at least). Among other things, Goldhaber reviews the wide swath that Morrison has cut through cases pending in the district courts, noting that "perhaps no other precedent has ever cut down so many claims of such value so rapidly." The article details the effects that the Morrison opinion has had and is likely to continue to have.

 

Teaching Fellowship at UCLA Law School: Some readers of this blog may be very interested to know that the Lowell Milken Institute for Business Law and Policy at the UCLA Law School is now accepting applications for the Lowell Milken Institute Law Teaching Fellowship. The fellowship is a full-time, year-round, one or two-year academic year-position beginning in July 2012. The position involves teaching, research and writing, as well as other duties. Applicants must already hold a JD. The application deadline is March 1, 2012. Further information about the fellowship program can be found here.

 

Now for Something Different: For today’s musical interlude, and as a complete contrast to the North Korean Kindergarten Guitar Quintet whose oddly disturbing video I posted a few days ago, here is a video of a very different kind of guitar quintet, involving as it does one guitar and ten hands. I understand this video and the song are both very popular in certain circles. I suspect it would not catch on in North Korea. The song is “Somebody That I Used to Know” by the group Walk Off the Earth.

 

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On December 29, 2011, in what appears to have been the final year-end step as the FDIC ramped up its failed bank litigation activity during 2011, the FDIC filed a civil lawsuit in the Western District of North Carolina in is capacity as receiver of The Bank of Ashville, of Ashville, North Carolina, against seven former directors and officers of the bank. Though this lawsuit is only the latest in a series of failed bank actions the agency has filed, there are some interesting aspects to the case, as discussed below.

 

The Bank of Ashville was closed on January 21, 2011, and the FDIC was appointed receiver (about which refer here). The FDIC’s complaint in the recently filed action alleges that during the period June 26, 2007 through December 24, 2009, the defendants, “enticed by the ‘bubble’ in the real estate sector of the Bank’s lending markets,” caused the bank to pursue a growth strategy concentrated in “higher risk, speculative commercial real estate loans.” This focus resulted in rapid growth during the period.

 

The complaint alleges that that the defendants’ all but one of who lacked previous banking experience were “ill-equipped to manage the risks associated with the nature and extent of the Bank’s growth,” and that they increased the Bank’s risks by “implementing policies and procedures void of the most basic lending controls and neglecting to adequately supervise inexperienced and under qualified lending personnel.” The complaint further alleges that the defendants’ “failures to establish and to adhere to sound policies and procedures resulted in the approval of poorly underwritten and structured real estate dependent loans.”  The complaint also alleges that the defendants ignored regulatory and audit warnings.

 

As the problems in the real estate market began to emerge in 2008 and 2009, the defendants allegedly “took actions that masked the Bank’s mounting problems,” including approving additional loans or advances to borrowers on nonperforming loans.

 

The complaint asserts claims against the defendants for negligence, gross negligence and breaches of fiduciary duty, and seeks to recover $6.8 million in losses that the bank suffered on thirty commercial real estate and business loans.

 

At one level, there is nothing particularly striking about the allegations in the complaint. The amount of the alleged losses in the grand scheme of things is relatively modest, at least by comparison to those alleged in connection with other failed banks.  There are no particularly egregious facts alleged, such as self-dealing or even person enrichment. There are no provocative aspects of the complaint, like the inclusion of the failed bank’s D&O carrier as a co-defendant (as was the case here), or the inclusion of the bank’s outside lawyer as a defendant (as was the case here).

 

On the other hand, it could be that the lower level temperature of the case it itself noteworthy. It is possible that the FDIC’s willingness to initiate a lawsuit even in these circumstances suggests a certain level of aggressiveness on the FDIC’s part. This suggestion is further reinforced by the fact that the FDIC has brought this action relatively quickly after the bank’s failure, at least by comparison to other situations where the FDIC has pursued litigation. In most of its other lawsuits so far, the FDIC has only filed its lawsuit after the lapse of two years or more from the date of the failed bank’s closure. The modest amount of the damages sought together with the relatively accelerated filing date makes me wonder whether or not there is a context for the lawsuit filing.

 

The litigation activity of the FDIC as receiver is essentially a salvage operation. The FDIC is trying to reduce, or at least offset, the failed banks’ losses. The salvage operation often consists of an effort to capture the proceeds of the failed bank’s D&O policy. (Indeed, even the FDIC’s lawsuit against three former officers of Washington Mutual, the largest bank failure in U.S. history, turned out to be largely about the D&O insurance, as discussed here.) More than one of the FDIC’s lawsuits has looked like negotiation with the D&O carriers pursued by other means (consider this prior case involving the First National Bank of Nevada, here).

 

All of which makes me wonder whether this latest lawsuit, particularly given its timing and the quantum of damages sought, might be directed at  the failed bank’s D&O carrier. I do not mean to suggest that I am questioning the merits of the FDIC’s lawsuit, as I have no basis one way or the other to assess the merits. I am simply saying that the motivations for the lawsuit’s filing could have a lot to do with the failed bank’s D&O insurance – as in, the FDIC felt it needed to make a little noise to get the D&O carrier’s attention.

 

In any event, this latest filing represents the FDIC’s 16^th lawsuit of 2011, brining the total number of failed bank lawsuits the FDIC has filed during the current bank failure wave to 18, involving 17 different institutions. Based on the number of lawsuit authorized (as disclosed on the FDIC’s website) there clearly will be many more lawsuits to come during the New Year.

 

Goal Kick, For Real: In what has to be one of the most insane soccer goals ever, in a January 4, 2012 match, Everton goalie Tim Howard (a U.S. national who was the goalie for the U.S team at the 2010 World Cup) scored a wind-blown goal on a field-length kick. Sadly it was not enough for his team as Bolton would go on to beat Everton, 2-1.

 

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The well-publicized settlement this past week of the FDIC’s lawsuit against three former officers of the failed WuMu bank was widely reported as having a value of $64.7 million. A closer look at the parties’ December 15, 2011 settlement agreement reveals some interesting details about the settlement, including the specifics of how the FDIC came up with the reported $64.7 million figure for the settlement. The settlement documents also raise some interesting questions.

 

Washington Mutual Bank failed on September 25, 2008, in the largest bank failure in U.S. history. As discussed here, in March 2011, the FDIC as receiver for the failed bank filed a lawsuit in the United States District Court for the Western District of Washington against WaMu’s former CEO, Kerry Killinger, its former President and COO, Stephen Rotella, and its chief of home lending, David Schneider. The FDIC’s complaint also names Killinger’s wife, Linda Killinger, and Rotella’s wife, Esther. The three former officers were alleged to have caused the bank’s demise through the aggressive residential lending strategy the bank pursued. The claims against the officials’ wives were based on claims that the spouses had arranged to transfer ownership of residential properties in order to evade creditors.

 

There was other litigation filed in connection with the events surrounding WaMu’s collapse, including a securities class action lawsuit separately filed against certain former directors and officers of WuMu; the bank’s offering underwriters; and its auditors. As discussed here, in July 2011, the securities class action lawsuit settled for $208.5 million, of which $105 million was to be paid on behalf of the former directors and officers. The entire $105 million amount was to be funded by the bank’s D&O insurance.

 

Although there were advance reports that the FDIC’s lawsuit against the former WaMu executives had settled, the FDIC did not formally announce the settlement until December 15, 2011. The FDIC’s press release announcing the settlement can be found here. The FDIC also released a detailed summary of the settlement, which can be found here.

 

As explained in the FDIC’s press release and in the accompanying summary, and as detailed in the parties’ settlement agreement, the $64.7 million settlement consisted of several components. The actual cash component of the settlement totaled only $40 million, of which $39.575 million is to be paid on the individual defendants’ behalf by the bank’s D&O insurers. The various insurers in the D&O insurance program that is contributing to the settlement are identified on page 2 of the settlement agreement, as well as in Exhibit A to the settlement agreement. In addition to the cash amount to be paid by the D&O insurers, a total of $425,000 in cash is to be paid by the three former officers ($275,000 from Killinger; $100,000 from Rotella; and $50,000 from Schneider). 

 

The remaining $24.7 million nominal value of the settlements consists of the transfer to the FDIC of certain claims the three individuals have filed in connection with the bankruptcy proceedings of WaMu’s corporate parent holding company. The amount and type of these claims varies among the three individuals, but basically the claims consist of various types of retirement, severance or bonus compensation to which the three individuals claim they are entitled.

 

In addition to the $64.7 million settlement of the FDIC’s action against the three former officers and two of their wives, the FDIC’s December 15 press release also mentions a separate $125 million settlement agreement. Though the information the FDIC provided about the $64.7 million settlement is quite detailed, the FDIC’s press release provides few details regarding this separate $125 million settlement. The press release says only that when the $64.7 million settlement is “combined with the $125 million settlement that the FDIC will receive under the settlement agreement with WMI [the bankrupt holding company] to release its claims against 12 former WaMu directors and other officers, this settlement will result in payments and turn over of claims totaling $189.7 million.”

 

There are a number of interesting things about the settlement and the settlement documents.

 

First, the settlement against the three executive officers may have a nominal face value of $64.7 million, but the actual value could prove to be substantially less. The individuals’ claims in the bankruptcy proceeding are among the many claims asserted by unsecured creditors and are also subject to whatever defenses the bankrupt estate may have. The ultimate value the FDIC actually receives from the assignment of these claims might be nowhere near the face values claimed in the various settlement documents.

 

Second, the D&O insurers’ $39.575 million contribution to the settlement could use a little more elaboration. The D&O insurance program described in the settlement agreement consists of $100 million, arranged in six layers. One might assume that the insurers’ $39.575 million contribution to this settlement represents all or substantially all of the proceeds remaining in the insurance program, owing to the erosion of the limits through the accumulation of defense costs. That is probably what happened, But what is hard to figure is how this insurance and the insurers’ $39.575 million settlement contribution fits in with the other settlements described above, particularly the securities class action settlement and the separate $125 million settlement mentioned in the FDIC’s press release.

 

As noted above, D&O insurers are to contribute $105 million to the securities class action lawsuit settlement. If this amount seems hard to square with the $100 million insurance program described in the FDIC’s settlement agreement with the three executives, it is probably because the D&O insurance contribution to the securities class action settlement was a drawn from a separate tower of insurance. Indeed, stipulation of settlement relating to D&O portion of the securities class action lawsuit describes a very different insurance program than the one the FDIC describes in the more recent settlement. The class action settlement documents describe a $250 million insurance program (not a $100 million program), consisting of a different line up of carriers than listed in the FDIC settlement documents. Although it is hard to tell from the much less detailed description of the insurance tower in the FDIC’s settlement documents, it looks as if the FDIC settlement is to be funded out of a separate tower of insurance, perhaps relating to a separate policy year.

 

If it is hard to square the details of the FDIC settlement and the securities class action settlement, the separate $125 million settlement is a real puzzle. The FDIC’s press release does not explain the source of funds for the $125 million settlement. Indeed, it is hard to tell from the FDIC’s press release exactly what is going on with the $125 million settlement. The FDIC’s press release describes it as a “settlement agreement with WMI to release its claims against 12 WaMu directors and other officers.” This sentence is confusingly written, but it seems to suggest that the settlement is between the bankrupt holding company and the FDIC, and the $125 million is to be paid (by whom?) in order to secure from the FDIC a release of the FDIC’s claims against the bank’s former directors and officers.

 

From the comments about the $125 million settlement in the press, I am making the guess that the bankrupt estate agreed to pay the amount on the theory that if the FDIC sued the various other directors and officers, these directors and officers would be entitled to indemnification. The estate agreed to pay the $125 million, in exchange for the FDIC’s release of its claims, without the FDIC having to actually go through the necessity of actually filing a lawsuit against the other directors and officers.

 

Whatever else may be said about the $64.7 million settlement, it is undeniable that the three executives were called upon to contribute to the settlement out of their own assets, both in the form of cash contributions and in the form of the surrender of rights the individuals themselves undoubtedly considered to be valuable. I emphasize this because one of the questions I have repeatedly asked during the current banking crisis is whether the FDIC will seek to recover from the personal assets of directors and officers of failed banks. The FDIC’s settlement with the three executive officers shows that the FDIC may indeed seek to recover from the personal assets of individuals. One might speculate that the FDIC’s actions may have something to do with the fact that the WaMu collapse was the largest bank failure in U.S. history. It is hard to know the extent to which that aspect of this settlement is relevant to what approach the FDIC might take in connection with its other failed bank lawsuits.

 

While the individual executives did indeed contribute toward the settlement out of their own assets, the settlement has been criticized, mostly on the theory that the individuals did not contribute enough. For example, in her December 17, 2011 column in the New York Times, Gretchen Morgenson referred to the $64.7 million settlement as representing only a “pittance” and as “small potatoes.” She gripped that much of the cash value is to be funded by D&O insurance.

 

For myself, I am unprepared to judge the settlement. I would need to know more about the amounts remaining under the insurance policies. I would also need to understand more about the interaction between the amount of the FDIC’s recovery from the three executives; the three individuals’ rights of indemnification from the bankrupt estate; and the $125 million settlement. (Morgenson suggests that any additional recoveries from the individuals, if indemnified by the estate, would simply reduce the $125 million settlement.)

 

The reality is that if the FDIC had pressed for greater recovery or a larger settlement, it is possible that all the FDIC would have accomplished would have been further erosion of the remaining D&O insurance limits through the accumulation of additional defense expenses. The end result likely would have been an even smaller recovery. The $64.7 million settlement may not satisfy Morgenson and others, but it may have been the best available.

 

I will say that one particular criticism of Morgenson’s is misplaced. She disparages the settlement as a “wrist slap” and “yet another example of the minimalist punishment meted out to major players in the credit boom and bust.” Morgenson’s criticism fundamentally misperceives the nature of the FDIC’s action against the WaMu executives.

 

The FDIC’s action, in its role as WaMu’s receiver, was never intended as a means to administer punishment. Receivership actions are simply salvage operations, intended to try to reduce (or rather, offset) the failed bank’s losses. Whether punishment is to be sought is the business of other agencies and regulators – the Department of Justice, the OCC and the SEC. (Indeed, in the FDIC has referred cases to the DoJ and the SEC where the circumstances surrounding a bank’s failure appear to warrant, as apparently was the case with the failed United Commercial Bank, about which refer here [scroll down]). Whether or not these agencies’ inaction in connection with WaMu’s failure may fairly be criticized, it is not a fair criticism here that the FDIC acting as WaMu’s receiver was insufficiently punitive. The administration of punishment is simply not the FDIC-R’s role.

 

The FDIC as receiver for the failed WaMu bank sought only to maximize its recovery of dollars, and that I strongly suspect that the settlement they reached with the three executives offered the best opportunity for the agency to maximize its dollar recovery.

 

Special thanks to a loyal reader for providing me with a link to the FDIC’s settlement agreement.

 

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A federal court has denied the motion of former IndyMac CEO Matthew Perry to dismiss the action that the FDIC, as the failed bank’s receiver, had filed against him. In a December 13, 2011 order (here), Central District of California Judge Otis D. Wright II held that under California law the business judgment rule does not protect officers’ corporate decisions and accordingly he rejected Perry’s argument that the FDIC’s complaint must be dismissed for failure to plead around the business judgment rule.

 

As discussed here, in July 2011, the FDIC as receiver for the failed IndyMac bank sued Perry alleging that as the bank’s CEO he had breached his duties to IndyMac and acted negligently in allowing IndyMac to continue to generate and acquire more than $10 billion in risky residential loans for sale into the secondary market. As the secondary market became unstable, the bank was forced to take the loans into its own investment portfolio, where the generated substantial losses, allegedly in excess of $600 million. IndyMac failed on July 11, 2008 and the FDIC was appointed as the bank’s receiver.

 

Perry moved to dismiss the FDIC’s complaint, arguing that the FDIC failed to allege facts sufficient to overcome the business judgment rule. Perry argued that the business judgment rule applies and insulates him from personal liability for his actions prior to IndyMac’s demise.

 

In opposing Perry’s motion, the FDIC argued that under California law the business judgment rule does not apply to officers. Judge Wright agreed. He concluded that the relevant legal authority does not support a conclusion that common law business judgment rule encompassing the general judicial policy of deference to business decisions should apply to officers. He also found that California’s statutory business judgment rule does not extend its protection to corporate officers. After reviewing the statute, applicable legislative history and relevant case law, he concluded that when the California legislature codified the business judgment rule, “it purposely excluded its application to corporate officers.” Because the FDIC’s allegations against Perry in his capacity as an office, Judge Wright denied his motion to dismiss.

 

Discussion

Historically, courts in applying the business judgment rule have not always carefully examined whether or not the rule’s protection should apply to officers as well as to directors. Over time, some have argued rather vigorously that the rule should not apply to officers. Others have argued that officers should be entitled to rely on the business judgment rule. Certainly it would seem that in those jurisdictions where officers and directors are held to have the same duties then they should be entitled to the same protections.

 

In any event, the question of whether or not an officer is entitled to the same protection under the business judgment rule as a director is a question of state law on which state law will control. Judge Wright’s decision is clearly reflection of his analysis under California state law. But though it is limited on that basis, his conclusion nevertheless highlights the interesting question whether as a matter of public policy the decisions and actions of corporate officers should enjoy the same protection under the business judgment rule as directors.

 

Setting aside the question of whether or not officers are entitled to the protection of the business judgment rule is the question of whether or not questions involving the applicability of the protections should be addressed at the motion to dismiss stage. There is the further procedural question of whether the plaintiffs must be expected to plead around the defense in order for their case to go forward, or whether the protections are in their nature more in the form of an affirmative defense to be invoked and substantiated by the defendant as the case goes forward. Judge Wright’s analysis does not examine these issues in detail but they present and added level of inquiry beyond the issues Judge Wright does address.

In any event, special thanks to a loyal reader for providing me with a copy of Judge Wright’s decision.

 

More About the FDIC’s Settlement with WaMu Executives: As was widely reported yesterday, the FDIC has settled the action it brought as receiver for the failed Washington Mutual bank against three former WaMu executives and their wives.  The early reports did not specify the amount of the settlement, but a December 14, 2011 Wall Street Journal article (here) fills in some of the missing details.

 

The total amount of the settlement is $64 million, consisting of about $400,000 from the settling parties themselves, and the balance of the cash amount to be paid by insurance. The executives are also to forego a total of $24 million in retirement benefits and bonus claims.

 

The Journal article also makes a tantalizingly brief mention of a prior $125 million settlement that the FDIC previously reached “to release claims against other former outside directors and officers.” As I noted here, there had been some suggestion in the press when the FDIC first filed its action against the three executives that the agency had separately settled or reached an agreement with the failed bank’s outside directors, but the brief mention in the Journal article is the first affirmative substantiation I have seen since that time referencing this separate settlement. Any readers that can shed light on this separate settlement are encouraged to pass along whatever information they can.

 

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Whether the process is just winding down for the year or the process is actually winding down for good, the bank closure rate has recently fallen off dramatically. The FDIC has not taken over any banks for three weeks straight, with no bank closure at all so far during the month of December. And there were only five bank closures in November, after eleven in October.

 

With 90 bank failures so far in 2011, the total number of failed banks since January 1, 2008 stands at 412. The monthly high water mark during that four year period occured in July 2009, when the FDIC took control of 24 banks. More recently, the monthly numbers of bank failures has been well below the monthly high. But even if the rate of bank failures has more recently been down from those higher levels, the overall 2011 bank failure levels remain well above 2008 levels, when only 25 banks failed.

 

More than half of the bank failures so far this year have been concentrated in just four states, Georgia (which has had 23) and Florida (12), Illinois (9) and Colorado (6). The number of 2011 closures Colorado is a little bit unexpected, as during the preceding three years between 2008 and 2010, the state had a total of only three bank failures. The other three states, by contrast, have pretty much led the way throughout the current bank failure wave. Since 2008, Georgia has had a total of 74 bank failures; Florida has had 57; and Illinois has had 43. Bank closures in those three states, plus California (38) represent more than half (209) of the 412 bank failures between January 1, 2008 and today.

 

The number of lawsuits that the FDIC has filed so far against the former directors and officers of failed banks as part of the current bank failure wave currently stands at 17 (about which refer here, scroll down). The FDIC has maintained its very deliberate pace in initiating new lawsuits. However, this past week the agency did update the page on its website on which it discloses the number of lawsuits that has been authorized.

 

According to the FDIC’s site, as of December 8, 2011, the FDIC has authorized suits in connection with 41 failed institutions against 373 individuals for D&O liability for damage claims of at least $7.6 billion. These figures representing the authorized lawsuits contrast starkly with number of lawsuits that the agency has actually filed: So far, the agency has filed only 17 lawsuits against 135 former directors and officers of 16 failed financial institutions. Given the discrepancy between the number of suits authorized and the number of suits filed, there clearly are many more suits in the pipeline, with even more lawsuits likely to be authorized in the months ahead.

 

The FDIC’s website also mentions that that two of the 17 lawsuits it has filed so far already have settled. One of the two settlements occurred in the lawsuit the FDIC filed in connection with the failed First National Bank of Nevada. As discussed here, the FDIC and the defendants in that case settled for a stipulated judgment, the individual defendants’ assignment to the FDIC of their rights under the bank’s D&O insurance policy, a release of claims and the FDIC’s covenant not to execute the judgment against the individuals. The other of the other of the two settlements was entered in the lawsuits the FDIC had filed on connection with the failed Corn Belt Bank and Trust. In May 2011, the parties advised the court that they had settled the case, but the court file does not reflect the details of the settlement.

 

Though only two settlements have been announced, there are stories circulating that the FDIC has settled the lawsuit that the agency filed against three former directors and officers of failed Washington Mutual bank and their wives. Indeed, in an October 27, 2011 order in the case (here), Western District of Washington Marsha Pechman stayed all pending deadlines in the case, after noting that the parties had advised the court that the case had settled. (She gave the parties 60 days to complete their settlement and to file their settlement papers with the court.)

 

The amount of the purported WaMu settlement has not yet been disclosed, but there are a number of relevant data points that may suggest the likely settlement range. The recently announced $208.5 million settlement of the WaMu securities class action lawsuit included a $105 million settlement contribution on behalf of the individual director and officer defendants, to be funded entirely by D&O insurance.

 

In the settlement papers filed in connection with the WaMu securities class action settlement, it was disclosed that the $105 million in insurance proceeds were to be drawn from a D&O insurance tower (including both traditional and Excess Side A insurance) of $250 million. The $105 million contribution toward the WaMu securities class action settlement materially reduced the amount of insurance remaining in the tower, and it is likely the defense costs in the various actions pending against the former WaMu officers and directors further depleted the amount of insurance remaining.

 

The amount of the any settlement in the WaMu FDIC lawsuit remains to be seen and it also remains to be seen whether and to what extent the individuals might contribute toward the settlement out of their own assets. But the amount of insurance remaining is at this point likely to be under $100 million, so in the absence of any significant contribution from the individuals the amount of any cash settlement in the WaMu case is likely to be below $100 million. Given that the collapse of Washington Mutual was the largest bank failure in U.S. history, it will be interesting to see the amount of any settlement that ultimately does emerge.

 

The American Civil War Viewed from Other Shores: As detailed in Amanda Foreman’s massive book A World on Fire: Britain’s Crucial Role in the American Civil War, many individual Britons were so taken up with the apparently romantic appeal of the Confederacy that they enlisted in the Confederate Army. Many were convinced that the South would win its independence, and one Englishman was so certain that he converted “his entire savings into Confederate currency, while it was still cheap to buy.”

 

The British sympathies for the Southern Cause had many sources, but one of the most important was economic, as a significant part of the British mill industry was dependent on the import of cotton from the Southern States. But despite this obvious financial pull toward the Confederacy, the British Government remained officially neutral, in part because the government did not want to be drawn into the war, on either side. As the war progressed and the appalling numbers of casualties began to accumulate, a vocal peace party began to form in England, in the interests of stopping the carnage. Most of the supporters of this position believed (without any particular evidence) that the Confederacy would have to abandon slavery anyway, after the war ended.

 

It took two developments, both of which were agonizingly long in coming, for British sentiment to begin running in favor of the North and of the Union. The first was Lincoln’s Emancipation Proclamation, which allowed Northern supporters to contend that the purpose of the war was to end slavery. The real problem the supporters of the North faced was that for the first two years of the war, the North looked incapable of winning. Finally, after the tide finally turned at Gettysburg, the increasing likelihood of a Northern victory allowed the British political elites to begin to envision the possibility of a re-united country after the war concluded.

 

What Foreman does particularly well in this interesting and detailed book is to tell the tale of the battle for the hearts and minds of the British people while the actual war went forward back in the States. The British government’s official position may have been one of neutrality but it seems as if no one in Britain was personally neutral. After the surrender at Appomattox and shock of Lincoln’s assassination, the Britons rediscovered their natural affinities for their American cousins, and the groundwork was laid for a relationship that has ever since been described as “special.”

 

I heartily recommend this book, which the New York Times selected as one of the Ten Best Books of 2011.

 

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In a November 30, 2011 order (here), Central District of California Judge R. Gary Klausner has denied the motion of the FDIC as receiver of the failed IndyMac Bank to intervene in a declaratory judgment action involving IndyMac’s D&O insurance. The FDIC sought to intervene because of its interest in recovering under the policies in connection with two lawsuits it filed as IndyMac’s receiver against former IndyMac directors and officers. Judge Klausner’s denial of the FDIC’s intervention motion may be relevant in other failed bank coverage disputes where the FDIC is interested in preserving D&O insurance policy proceeds for its claims in competition with claims of claimants to the policy proceeds.

 

Background

IndyMac failed on July 11, 2008. The bank’s closure represented the second largest bank failure during the current banking crisis, behind only the massive WaMu failure. (IndyMac has assets of about $32 billion at the time of its closure).

 

As I detailed in a prior post (here), the bank’s collapse triggered a wave of litigation. The lawsuits include a securities class action lawsuit against certain former directors and officers of the bank; lawsuits brought by the FDIC and by the SEC against the bank’s former President; and a separate FDIC lawsuit against four former officers of Indy Mac’s homebuilders division. There are a total of twelve separate lawsuits pending. The underlying actions allege various improprieties, mostly centering around mortgage backed securities.

 

Prior to its collapse, IndyMac carried D&O insurance representing a total of $160 million of insurance coverage spread across two policy years. The insurance program in place for each of the two policy years consists of eight layers of insurance. Each layer has a $10 million limit of liability. The eight layers consist of a primary policy providing traditional ABC coverage, with three layers of excess insurance providing follow form ABC coverage, followed by four layers of Excess Side A insurance. The lineup of insurer involved changed slightly in second year.

 

As I also noted in a prior post (here), in early 2011, a unit of IndyMac had filed a declaratory judgment action seeking to establish coverage under the various policies in connection with claims that had been filed against the unit. In an August 2011 order, discussed in the prior blog post, Central District of California Judge R. Gary Klausner granted the defendants’ motion to dismiss the action as premature.

 

Separately, in March 2011, the four Side A carriers in the second of the two insurance towers filed their own separate declaratory judgment proceedings, against certain former IndyMac directors and officers, seeking to establish that terms in their policies preclude coverage for the various lawsuits. The directors and officers counterclaimed and also added as counter-defendants the four traditional ABC carriers in the second tower.

 

In October 2011, the FDIC, which in its capacity as IndyMac’s receiver has initiated two lawsuits against certain former IndyMac directors and officers of IndyMac, moved to intervene in the separate coverage action that the Side A carriers had initiated. The FDIC had moved to intervene on alternative grounds under the Federal Rules of Civil Procedure -- as of right; and alternatively under permissive intervention. The FDIC argued that because it is a plaintiff in the two underlying actions, it has an interest in seeing that the coverage dispute is resolved so that it can recover any eventual judgment in those actions out of the insurance proceeds.

 

The November 30 Ruling

In his November 30 opinion, Judge Klausner denied the FDIC’s motion to intervene. Judge Klausner held that the FDIC had not established its entitlement to intervene as of right because it “has not obtained a judgment against the Insured Defendants and may never do so,” and so presently it has at most “the hope of an eventual judgment.” Accordingly, he held, the FDIC has “no legally protected interest” in the coverage dispute.” He added that even if it had a legally protected interest, that interest is not related to the subject matter of the coverage lawsuit. Because the FDIC’s lawsuit against the former directors and officers and the separate insurance coverage action “involve different legal issues,” they are “not related for purposes of mandatory intervention.”

 

Judge Klausner held that FDIC’s alternative motion for permissive intervention also fails because the FDIC’s action against the former directors and officers, on the one hand, and the separate insurance coverage dispute, on the other hand,  do “not present common questions of law or fact.” He added that because the FDIC has not yet obtained a judgment against the Insured Defendants it “does not have an interest that it needs to protect” and its claims “are not yet ripe for adjudication” and therefore it does “not have standing as a permissive intervenor.”

 

Discussion

The FDIC’s interest in preserving its ability to collect the proceeds of a failed bank’s D&O insurance is not limited to this case. In connection with a host of other failed banks, the FDIC’s interest in the D&O insurance policy proceeds is in competition with the interests of a variety of other claimants, including in particular shareholders of the holding companies of the failed banks.  The various parties will be in a race to try to see who gets there first, and if they can get there before the insurance is substantially or entirely depleted by defense expenses. The FDIC’s interest in taking part in coverage litigation makes perfect sense.

 

But so too does Judge Klausner’s ruling here. It appears that until the FDIC has reduced its claims to a judgment it may have difficulty presenting its purported claims to the D&O insurance policy proceeds in a coverage action. The question of whether or not there is coverage under a D&O policy for a given claim scenario is different from the question whether or not the FDIC has any entitlement to the policy proceeds.

 

Special thanks to my friends at Bates Carey Nicolaides LLP for providing me with a copy of Judge Klausner’s opinion. Bates Carey represents one of the insurers in the pending coverage action.

 

ABA Journal Top 100  Blawgs: The D&O Diary is proud to have been selected as one of ABA Journal’s Blawg 100 for 2011, the Journal‘s fifth annual list of the best blogs about lawyers and the law. This year’s Top 100 designees were selected from over 1,300 nominees. It is a particular honor to be selected along with the other five business law designees, which include some of the best blogs on the Internet: Professor Jay Brown’s Race to the Bottom Blog; Broc Romanek’s The CorporateCounsel.net blog; Professor Stephen Bainbridge’s ProfessorBainbridge.com; the Truth on the Market blog, which is maintained by a number of academics; and Francis Pileggi’s Delaware Corporate and Commercial Litigation blog .

 

Between now and December 31, 2011, you can vote for your favorite among the top six business law blogs, by clicking on the ABA Journal Blawg 100 badge in the right hand column. Everyone here at The D&O Diary would appreciate your support. Thanks to the readers who make this blog possible and worthwhile.

 

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Guaranty Bank of Austin, Texas’s August 21, 2009 closure is the fourth-largest bank failure during the current wave of bank failures and the tenth largest bank failure in U.S. history. The bank’s failure, which came just 15 months after its publicly traded holding company spun out of Temple-Inland, Inc., was, the Treasury Department Office of Inspector General later concluded, due to the bank’s heavy investment in Option ARM mortgage-backed securities.

 

Though Guaranty Bank failed well over two years ago, and its holding company parent filed for bankruptcy an almost equally long time ago, its closure is only now giving rise to significant litigation based on the events surrounding the holding company’s December 2007 spin out from Temple-Inland and the bank’s August 2009 failure.

 

The latest of these recent lawsuits was filed on November 11, 2011, in the Northern District of Texas on behalf of the bank holding company’s shareholders who purchased their shares between December 12, 2007 and August 24, 2009 (that is, between the corporate spin out and the bankruptcy). The plaintiffs’ lawyers’ November 11, 2011 press release about the lawsuit can be found here.

 

The shareholders’ complaint, which can be found here, names Temple-Inland itself as a defendant, as well as five individuals: Kenneth Jastrow, who was Temple-Inland’s Chairman and CEO until December 28, 2007, and was also Chairman of both the bank and of the bank holding company until August 26, 2008; Randall Levy, Temple-Inland’s CFO; Kenneth Dubuque, who was the bank holding company’s and the bank’s CEO and director until November 19, 2008; Ronald Murff, the bank holding company’s CFO; and Craig Gifford, the holding company’s controller.

 

The complaint alleges that in the years prior to the holding company’s spin-off, the bank was required by a regulatory order to terminate its mortgage origination operations. In order to maintain its targeted rates of return, the bank “accumulated an unsafe and unsound concentration of higher yielding, but highly risky, homebuilder focused” Option ARM mortgage backed securities, largely originated in California.

 

The complaint alleges that Temple-Inland, which had previously wholly owned the bank holding company, recognized the threat that the bank posed to its own financial condition, and so devised the plan to spin off the bank holding company. The complaint alleges that during the period after the spin-out plan was devised and spin-out was completed, the defendants were aware that the real estate market’s conditions, particularly in California, were rapidly deteriorating and that delinquency rates there were “dramatically increasing.”

 

The defendants allegedly knew or recklessly ignored that the bank’s MBS portfolio was “materially impaired” and ignored questions asked prior to the spin-off about the adequacy of the bank’s capital. The complaint alleges that as of the date of the spin-off, the bank and its parent holding company were “insolvent and under-capitalized,” and that its financial statements did not reflect its true financial condition, largely as a result of its failure to properly value its impaired MBS assets.

 

The complaint alleges that the holding company did not fully recognize its losses on its MBS assets until later in 2009, shortly after which the bank was closed and put into FDIC receivership. The holding company’s bankruptcy followed within days thereafter.

 

The complaint alleges that the defendants’ misrepresented the holding company’s financial condition throughout the class period in violation of the Sections 10 and 20 of the Securities Exchange Act of 1934.

 

There are a number of interesting things about this lawsuit, the first of which is that it represents a late-arriving example of a basic subprime-related securities class action lawsuit. As I have documented on this site (refer here), there have been literally hundreds of subprime and credit crisis related securities class action lawsuits filed since the first of these cases was filed in February 2007. More recently, this wave of litigation seemingly has just about dwindled away. Yet here we are nearly five full years later, and subprime-related cases are still continuing to come in.

 

The belated arrival of this lawsuit raises yet another issue. Given that this lawsuit was filed well over two years after the bank’s failure and the holding company’s bankruptcy, it seems likely that the defendants will assert the statute of limitations as a defense. The complaint itself does not expressly address the possible statute of limitations issues, but the complaint does suggest at least a couple of factors on which the plaintiffs might try to rely in responding to statute of limitations issues.

 

That is, the complaint specifically cites two sources that only recently became available. These two sources are: the U.S. Treasury Department Office of Inspector General’s April 29, 2011 Material Loss Review of Guaranty Bank (here), which among other things, concluded that the bank failed because of its losses on its MBS portfolio; and the August 22, 2011 complaint filed in the Northern District of Texas by the trustee for the liquidation trust in the holding company’s bankruptcy (on behalf of the trust and as assignee of the FDIC) against Temple-Inland and five individual defendants, including  three of the individuals named as defendants in the recently filed shareholder suit. The complaint in the trustee’s lawsuit can be found here.

 

The trustee’s complaint makes for some interesting reading. Among other things, it accuses Temple-Inland of “fraudulently looting” the bank and the holding company of “assets exceeding one billion dollars,” and further alleges that “after fraudulently stripping” the bank and the holding company of assets “beyond the point of solvency and adequate capitalization,” the defendants came up with the plan of “spinning off the fatally crippled and doomed to fail” holding company.

 

The plaintiffs in the shareholder lawsuit may well contend that that until they were aware of the conclusions in the Inspector General’s report and of the allegations in the liquidation trustee’s complaint, they were not in a position to file their complaint, or were unaware of the allegations on which they based their complaint, and therefore that the statute of limitations should run from the disclosure of these allegations, rather than from the date of the bank failure. The defendants undoubtedly will contend that the circumstances that cause the bank’s demise were apparent at the time of its August 2009 failure and that the statute ought to run from that time.

 

Another interesting aspect of the shareholder’s complaint is the involvement corporate officials from the two separate companies, including one individual who is sued in dual capacities, as an officer and director of both companies. These allegations raise some potentially interesting questions about the extent to which each company’s respective D&O insurance programs are implicated by the claim. The liquidating trustee’s complaint presents the same issues. These issues are further complicated by the holding company’s August 2009 bankruptcy.

 

Temple-Inland likely has a current program of D&O insurance in force. The bank holding company’s D&O insurance likely lapsed some time shortly after the holding company’s bankruptcy. Unless there is some basis to relate the claim back to the holding company’s now lapsed policy, there may be no insurance available for the individuals defendants to defend themselves in their capacities as former directors and officers of the holding company – and given the bankruptcy, whatever limits there might even theoretically be available under the bankrupt holding company’s D&O program are likely to be significantly impaired.

 

With respect to Temple-Inland’s D&O insurance, there is an interesting question with respect to coverage for Temple-Inland itself. While most public company D&O insurance policies provide Securities Claim protection for corporate entity insureds -- and while the claims alleged against Temple-Inland in the shareholder lawsuit are asserted under the federal securities laws -- these allegations may or may not represent Securities Claims under the applicable insurance policy definition.

 

Many D&O insurance policies orient the definition of the term Securities Claim around allegations involving the securities of the insured corporate entity. The allegations in the recently filed shareholder lawsuit arguably pertain solely to the bank holding company’s securities, not to Temple-Inland’s securities (although the mechanics of the bank holding company’s spin-out from Temple-Inland fuzzies this up a little bit). There will be an interesting question as to whether or not the securities law allegations against Temple-Inland represent a Securities Claim within the meaning of the company’s D&O insurance policy. It is worth noting in that regard that the claims asserted against Temple-Inland in the trustee’s lawsuit are not based on alleged violations of the securities laws, and therefore also potentially might not trigger the entity coverage under the typical D&O insurance policy.

 

There obviously are many questions yet to come in these cases. At this point it may be sufficient to note that even after all this time, the litigation consequences of the subprime meltdown and of the bank failure wave are continuing to accumulate. Especially with respect to the failed banks, the litigation wave will continue to accumulate for years to come, and it will be an even longer time before all of the litigation has finally played out. Unfortunately it also looks like the economic consequences from the global financial crisis are also going to take many years finally to play out, as well.

 

Lehman Mortgage Backed Securities Lawsuit Settlement Depletes Remaining D&O Insurance Proceeds: Earlier this year, when the parties to the Lehman Brothers Equity and Debt Securitholders litigation announced that they had reached a $90 million, the amount of that settlement if approved appeared that it would deplete most but not all of the remaining limits under the Lehman Brothers’ D&O insurance program. As discussed at length here, I calculated that the $90 million settlement, together with other settlements and accumulated defense expenses, looked like it would leave about $25 million or so of insurance remaining in the $250 million program.

 

It now looks as there was slightly more left in the program than I had calculated. It also looks as if, based on the separate $40 million settlement of the Lehman Brothers Mortgage Backed Securities litigation, that whatever the amount of insurance that was remaining in the program, it has now been exhausted. According to a November 11, 2011 Reuters article (here), the D&O insurers will contribute a total of $31.7 million toward the$40 million settlement, an amount that should just about entirely deplete whatever was left in the program. Bankruptcy court approval is required.

 

I have added this Lehman Brothers Mortgage Backed Securities lawsuit settlement to my running tally of subprime and credit crisis securities class action lawsuit case resolutions, which can be accessed here.

 

MF Global’s D&O Insurance: I am sure many of you like me wondered which carriers were on the D&O insurance program for MF Global.  Judy Greenwald’s November 11, 2011 Business Insurance article (here), doesn’t list all of MF Global’ s D&O insurance carriers, but it does identify the primary carrier in the program, and it does reveal that MF Global carried a total of $250 million in D&O insurance. I am sure that a certain amount of the $250 million program is Excess Side A/DIC insurance, but given that MF Global has filed for bankruptcy even those Excess Side A/DIC layers would appear to be implicated by the claims arising from the company’s collapse.

 

Sometimes the World is a Very Strange Place: At least some of our country’s exports are succeeding in China, if this broadcast entitled “Lao Lai Qioa Gaga” from Hunan TV is representative. In this video, which really does have to be seen to be believed, a Chinese old folks choir belts out a spirited cover of Lady Gaga’s hit, “Bad Romance.” An unexpected interpretation of the work, I would say -- although arguably not any more bizarre than Lady Gaga's own video interpretataoin of the song.

 

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An inevitable part of the current wave of bank failures has been the FDIC’s filing of lawsuits against former directors and officers of the failed institutions. And though the FDIC’s initiation of this litigation has been gradual, the lawsuits have now started to accumulate in significant numbers. And just as this FDIC litigation was perhaps inevitable once the banks started to faile, so too it was also perhaps inevitable that the FDIC lawsuits would be accompanied by D&O insurance coverage litigation.

 

As discussed below, the failed bank insurance coverage lawsuits are now starting to arrive. If the initial cases are any indication, one of the main coverage battlegrounds will be the typical D&O insurance policy’s Insured vs. Insured exclusion. Specifically, the question will be whether the FDIC as receiver pursuing the failed bank’s claim against the bank’s former directors and officers is acting as an “insured” under the D&O policy so as to preclude coverage under the policy.

 

First up in this analysis is Michigan Heritage Bank of Farmington Hills, Michigan, which failed on August 29, 2009 (about which refer here). As discussed in greater detail here, on August 8, 2011, the FDIC, as the bank’s receiver, filed a lawsuits in the Eastern District of Michigan against a single former officer of the bank.

 

What followed next is that on November 1, 2011, Michigan Heritage’s D&O insurer filed an action in the Eastern District of Michigan seeking a judicial declaration that there is no coverage for the underlying lawsuit or for the bank officer’s defense expenses under the bank’s D&O policy. A copy of the insurer’s declaratory judgment complaint can be found here.

 

Among other things, the carrier seeks a judicial declaration that the policy’s Insured vs. Insured exclusion precludes coverage for the underlying lawsuit. The insurer’s argument is that as the bank’s receiver, the FDIC is asserting the bank’s own claims and is seeking to recover the bank’s losses. Therefore, the carrier contends, the FDIC’s lawsuit is a claim “by, on behalf of, or at the behest of” the bank, and as the bank and the defendant loan officer are both insureds under the policy, the policy’s Insured vs. Insured exclusion precludes coverage.

 

A very similar sequence has also followed with respect to Westernbank, of Mayaguez, Puerto Rico, which failed on April 30, 2010. As reflected here, on December 17, 2010, the FDIC, through its outside counsel, sent a letter to Westernbank’s D&O insurer asserting claims against the bank’s former directors and officers.

 

Westernbank’s directors and officers , in turn, on October 6, 2011, filed an action in local Puerto Rico court seeking judicial declaration that the FDIC’s claim is covered under the bank’s D&O policy. The complaint, which is in Spanish, can be found here. According to an October 14, 2011 press release from the direcrors and officers' counsel, the complaint seeks a judicial declaration with respect to “the controversial and critical question whether the FDIC-R can be deemed an insured under the Policy so as to excuse [the carrier] from providing coverage.”

 

Though these declaratory judgment actions have only just been filed, they are in many ways a vestige of an earlier time. As I discussed in a blog post way back in August 2008, when the current bank wave was only just starting to unfold, the question whether the Insured vs. Insured exclusion precluded coverage for claims by the FDIC as receiver against former directors and officers of failed banks was hotly contested during the S&L crisis. As I said in my earlier post, and as appears likely now, the Insured vs. Insured exclusion could be a critical part of the failed bank insurance coverage litigation during the current round of bank failures as well.  

 

During the S&L crisis, where the FDIC had its greatest success in overcoming the Insured vs. Insured exclusion was where it was able to argue successfully that the Insured vs. Insured exclusion precluded coverage only with respect to collusive lawsuits. Because it was able to show that its claims and lawsuits were fully adversarial, it was able to establish that the exclusion did not apply.

 

The FDIC was not uniformly successful in arguing that the exclusion only precluded collusive claims, and there has in fact been some intervening case law to the effect that the Insured vs. Insured exclusion applies even when the underlying claim is not collusive.

 

It will in any event be interesting to see how these coverage cases develop. The one thing that seems certain is that as the FDIC failed bank litigation continues to accumulate, so too will the related coverage litigations. Many of the related coverage suits likely will also involve these same Insured vs. Insured issues.

 

Another issue that is likely to be litigated in coverage cases arising out of FDIC failed bank litigation is the enforceabilty of the so-called Regulatory Exclusion, which when present in the D&O policy precludes coverage for claims brought by the FDIC and other regulators. Not all policies implicated in the bank failures have these exclusions, but where they are present they are likely to be relied upon by the carriers to contest coverage. It is probably worth noting that these issues were fully litigated during the S&L crisis and the courts generally found that the regulatory exclusion precluded coverge for FDIC claims. My prior blog post about the regulatory exclusion can be found here.

 

A good summary of the D&O insurance coverage issues involved in FDIC failed bank litigation can be found here.

 

Special thanks to the several loyal readers who sent me links to ths source documents referenced above.

 

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On October 25, 2011, the FDIC filed its latest failed bank lawsuit, in connection with events surrounding the July 2009 failure of Mutual Bank of Harvey, IL. The FDIC’s complaint, which was filed in the Northern District of Illinois, names as defendants eight former directors and two former officers of the bank. But in addition, the complaint also names as defendants the bank’s outside General Counsel, who was also a director of the bank, and well as the General Counsel’s law firm. There are a number of other interesting things about this complaint as well.

 

The FDIC’s complaint alleges that Mutual Bank’s failure has cost the FDIC’s deposit insurance fund an estimated $775 million in losses. In its lawsuit, the FDIC seeks to recover over $115 million in losses the bank suffered on twelve commercial real estate loans, $10.5 million in unlawful dividend payments and $1.09 million in wasted corporate assets.

 

The complaint asserts claims against the director defendants and the officer defendants for gross negligence, negligence, and breach of fiduciary duty. The complaint alleges that the directors and the officers approved high-risk loans to uncreditworthy borrowers. The complaint also asserts the directors failure to supervise the bank’s lending activities, approval of unlawful dividend payment and corporate waste.

 

The complaint also asserts claims against James Regas and his law firm, Regas Frezadas & Dallas, for legal malpractice, breach of fiduciary duty and aiding and abetting the director and officer defendants’ breaches of fiduciary duty. The lawyer and his firm are allege to have facilitated the unlawful payment of dividends; failed to counsel and prevent the bank’s board from making grossly imprudent loans; ignoring federal lending regulations; and facilitating bank transactions to entities in which one of the attorney defendants held an interest, despite the conflict of interest.

 

Interestingly, the roster of director defendants does not include Pethinaidu Velchamy, the bank’s former Chairman, or Parameswari Velchamy, the former Chairman’s wife, who was also a director of the bank. The complaint alleges that the two have each filed a petition under Chapter 7 of the bankruptcy code, and that “despite” their respective “culpability for the events described,” the stay in bankruptcy “precludes” naming them as a defendant “unless the stay is modified or lifted.”

 

Among other things, the Complaint alleges (in paragraph 34) that the former Chairman has filed a lawsuit against the bank’s former auditors, in which the Chairman supposedly alleges that “the Bank’s balance sheet contained hundreds of millions of dollars in loans that had been funded on the basis of substandard, if not reckless underwriting and … were not identified for corrective action because of critical failure in the Bank’s internal credit risk review function.”

 

Though the former Chairman and his wife are not named as defendants in the lawsuit, their son and daughter, both of whom served as members of the board of directors, were named as defendants.

 

These family connections are particularly interesting in relation to the FDIC’s waste allegations. Among other things, the FDIC alleges that board facilitated the payment of $250,000 in bank funds for the wedding of the Chairman’s daughter; authorized $495,000 in “bonuses” to pay the criminal defense costs of the bank President’s wife, who had been indicted for Medicaid fraud; and approving the use of $300,000 in bank funds to hold a board meeting in Monte Carlo.

 

Regas, the lawyer defendant, and his law firm, are alleged to have been aware that loans referenced in the complaint were “grossly deficient” but that despite the awareness of the “imprudence, and in some cases, unlawful nature of these transactions,” the lawyer and his firm failed to protect the bank from foreseeable injury inherent in these transactions. The law firm is alleged to have received over $3 million in fees between January 2007 and April 2009.

 

Regas is also alleged to have participated in a 2006 land loan transaction involving undeveloped real estate. The $28.5 million loan was originated by another bank for which Regas also served as director. The individual that sold the land to the borrower is described in the complaint as Regas’s “close friend and business colleague.” After the other bank made the loan, Regas allegedly arranged for Mutual Bank to acquire a $24.5 million participation in the loan. Regas allegedly steered the loan through the Mutual Bank approval process and did not abstain from voting to approve the loan. Regas is alleged to have abandoned his fiduciary duty to Mutual Bank in favor of the other bank and his friend. The loss to the bank from the loan is alleged to be approximately $24.5 million.

 

This latest complaint is the 16^th lawsuit that the FDIC has filed in connection with the current wave of bank failures, but so far as I am aware, it is the first in which the FDIC has named a failed bank’s outside lawyer and law firm as defendants. During the last round of bank failures in the S&L crisis, the FDIC pursued an aggressive litigation approach and often included failed bank’s lawyers or law firms as defendant. In many of those cases, as here, the lawyer defendants had served on the failed bank’s board and were alleged to have engaged in conflicts of interest. That prior history and the presence of those types of allegations here suggests that we are not about to see a comprehensive campaign against the outside law firms of failed banks. The firms or their lawyers are relatively unlikely to get drawn into the type of failed bank litigation if the firm did not have an attorney on the failed bank’s board or did not otherwise allegedly engage in conflicts of interest.

 

Out of the 16 failed bank lawsuits the FDIC has filed so far, this is the fourth involving an Illinois Bank (there have also been four lawsuits so far involving failed banks in California and Georgia, respectively). Like many of the lawsuit filed so far, this one was not filed until more than two years had elapsed since the bank’s closure. Given the fact that the bank closures did not really peak until late 2009 and early 2010, and allowing for that two year plus lag time, we could start to see increasing numbers of additional FDIC failed bank lawsuits in the months ahead.

 

Special thanks to a loyal reader for providing a copy of the Mutual Bank complaint.

 

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Early on during the current wave of bank failures, there were some pretty reckless predictions about how many banks might fail – indeed, some commentators suggested as many as 1,000 banks might ultimately fail, a prediction that I disputed at the time. But while it continues to seem highly unlikely that as many as 1,000 banks ultimately will fail, the failed banks are continuing to accumulate and we recently passed a significant failed bank milestone.

 

The total number of bank failures since January 1, 2008 now stands at 406. The 400^th bank failed without much fanfare a couple of weeks ago, on October 14, 2011. Regulators took control of four different banks on October 14, and four more the following Friday, October 21, 2011. With these latest bank failures, the total number of failed banks in 2011 now stands at 84. This year’s total seems highly unlikely to reach the 157 banks that failed in 2010 or the 140 that failed in 2009. But with about nine or ten weeks left to go in the year, it is possible that the total number of bank failures this year could reach as many as 100, particularly if the FDIC continues to take control of as many as four additional banks each Friday evening.

 

Many of the bank failures since January 1, 2008 have been concentrated in just a small number of states. Indeed just four states account for 214 of the failed banks or about 52% of the total: Georgia (73); Florida (57); Illinois (46) and California (38). Even during this fourth year of the failed bank wave, these same states continue to have the largest numbers of bank failures, particularly Georgia, which has had 22 bank failures this year alone. During 2011, Florida has had 12, Illinois has had 11 and California has three. Together these four states account for 45 of the 84 bank failures during 2011, or roughly 53%.

 

By interesting contrast to these states that have experienced such a high number of failed banks, eleven states have had not bank failures at all so far. The eleven states without any failed banks are Connecticut, Delaware, Hawaii, Iowa, Maine, Montana, New Hampshire, North Dakota, Rhode Island, Tennessee and Vermont. Among other things, this list suggests that the New England states have fared pretty well during the bank failure wave.

 

As the banks have failed, the failed bank litigation has also accumulated --  although the FDIC’s failed bank litigation has accumulated gradually. So far the FDIC has initiated 15 lawsuits against the directors and officers of 14 different institutions. As of October 24, 2011, the FDIC has authorized lawsuits involving 34 failed institutions and 308 officers and directors for D&O liability of at least $7.3 billion. As the total number of failed banks continues to accumulate, the authorized number of lawsuits will only grow.

 

The lag time between the date of bank closure and the date of the FDIC’s lawsuit filing seems to be running at least two years or more. As Jon Joseph points out in an October 24, 2011 post on his law firm blog (here), more than more than 335 of the 406 total bank failures occurred after July 2009, which seems to suggest that we are about to enter an extended period of active FDIC failed bank litigation. Joseph states in his blog post that now that time has elapsed since the wave of bank failures began to accumulate significantly,” the pace of lawsuits against former bank officers and directors will increase markedly.” Joseph also points out two thirds of the 15 FDIC failed bank lawsuits so far have involved failed banks in Georgia, California and Illinois (which is slightly more than the distribution of failed banks among those states but hardly surprising given the number of bank failures in those states.)

 

Of course, time will tell whether and to what extent we will see an uptick in FDIC failed bank litigation. But not only does significant litigation activity seem likely, it seems likely that the litigation will continue to accumulate for some time to come, given that banks are continuing to fail in significant numbers. Indeed, the recent closures would seem to suggest that the FDIC failed bank litigation will be continuing to arise well into 2014. As banks continue to fail in the weeks and months to come, this projected date could move into 2015.

 

Better get used to FDIC failed bank litigation, because it is going to be a big part of the landscape in the directors’ and officers’ liability arena for some time to come. In light of these issues, Jon Joseph has some practical suggestions for the boards of the surviving banks, in the blog post I linked to above.

 

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SciClone Settles FCPA Follow-on Derivative Suit : In a settlement that involves a company with significant Chinese operations -- and that also may represent something of a template for the settlement of FCPA enforcement follow-on civil lawsuits -- SciClone Pharmaceuticals and the individual defendant directors and officers have agreed to settle the consolidated derivative lawsuits that were filed following the company’s announcement that it was the target of SEC and DoJ investigations for possible FCPA violations.

 

According to the company’s October 12, 2011 press release (here), the parties have agreed, subject to court approval, to settle the consolidated cases based on the company’s agreement to adopt certain specified corporate governance reforms and the company’s agreement to pay $2.5 million in plaintiffs’ attorneys’ fees. The press release states that the payment of the plaintiffs’ attorneys’ fees is “to be paid by SciClone’s insurers under its director and officer insurance policy.” A copy of the parties’ stipulation of settlement can be found here.

 

The FCPA does not provide for a private right of action. However, as I have previously noted on this site, the advent of an FCPA investigation often triggers a follow-on civil lawsuit. In this case, multiple lawsuits were filed against the company, as nominal defendant, and certain of the company’s directors and officers, shortly after the company announced the existence of the investigation. The lawsuits, which were filed in San Mateo County (Calif.) Superior Court in September 2010, and which were later consolidated, alleged that “the Individual Defendants, by reason of their failure to implement and maintain internal controls and systems at the Company to assure compliance with the FCPA, breached their fiduciary duties and may be held liable for damages.”

 

As a result of mediation, the parties reached the settlement that the company announced in its press release. Among other thing, the settlement requires the company to adopt certain measures for three years, including the implementation of sanctions for employees violating the FCPA; the establishment of a compliance coordinator; the adoption of a compliance program and code; and the adoption of certain internal controls and compliance functions. The governance measures are described in detail in the parties’ settlement stipulation.

 

There are a number of interesting things to me about this settlement. The first is that it involves a company that, according to its own website, is a “China-centric” pharmaceutical company. Though the company has its headquarters in the U.S. its “strategy,” as described on the company’s website is to grow its sales in China.  The existence of the FCPA investigation underscores the challenges facing companies attempting to do business in China. Given the company’s business model, the compliance measures adopted in the settlement arguably are a good idea in any event, without regard to the fact that the company willingness to adopt the measures managed to resolve this consolidated litigation.

 

The D&O insurer’s payment of the plaintiffs’ attorneys’ fees shows how these kinds of lawsuits can contribute to insurers’ loss costs. Obviously, the D&O insurers also incurred the defense expenses as well, meaning that the total loss costs for this suit potentially represents a substantial figure. Moreover, depending on the nature and status of the government FCPA investigation, there could be additional covered loss costs as well. The company and certain of its directors and officers were also named as defendants in a related securities class action lawsuit (about which refer here), but that action was voluntarily dismissed without prejudice.

 

As antibribery enforcement activity is stepped up in this country and elsewhere, it seems likely that these types of lawsuits may become even more common. The likelihood is that this type of litigation could make a significant contribution toward insurers’ aggregate loss costs in the coming years. On the other hand, from an underwriting standpoint, it seems that companies that have already voluntarily adopted the kinds of compliance procedures that were the subject of this settlement should be view in a more favorable light, particularly with regard to those companies that might otherwise be viewed with caution owing to the countries in which they are doing business.

 

Dismissal Motion Denied in U.S.-Listed Chinese Company’s Securities Suit: In the second dismissal motion denial entered as part of the current wave of securities suits filed against U.S.-listed Chinese companies, on October 11, 2011, Central District of California Judge Christina Snyder denied the defendants’ motion to dismiss in the securities suit filed against China Education Alliance, Inc. (CEU) and  certain of its directors and officers. A copy of Judge Snyder’s opinion can be found here.

 

As discussed here, the plaintiffs first filed their action in December 2010. Among other things, the plaintiffs allege that the company overstated its revenue and profits by “exponential proportions.” The plaintiffs, in reliance on the report of an online securities analyst, alleged that the company maintained two sets of books, and that the revenue reported in the company’s Chinese regulatory filings was only a fraction of the revenue the company reported in its SEC filings. The complaint also alleges that the company’s educational website was not functional, and its education building allegedly is an empty building without classrooms.

 

The defendants moved to dismiss, arguing in part that the plaintiffs allegations, made in reliance on the online analyst report, merely repeated the unsubstantiated assertions of a professed short seller that was financially motivated to drive down the company’s share price. In rejecting the defendants’ argument in this regard, Judge Snyder relied on the earlier dismissal motion denial in the case involving another U.S.-listed Chinese company, Orient Paper (about which refer here). Judge Snyder found it was not appropriate to reject the allegations on that basis at this early stage.

 

Judge Snyder also found tat the plaintiffs had adequately alleged scienter, despite the absence of insider trading or other financially motivated conduct. Judge Snyder found that “additional facts” the plaintiff alleged “give rise to a strong inference of scienter.” Those alleged additional facts include the following:

 

That CEU has filed significantly disparate revenue figures in China and the United States: that plaintiffs’ own investigators toured CEU’s on-site “state of the art” facility in China only to find it an empty building; that witnesses told plaintiffs’ investigators that CEU was not the owner of the building; that CEU has had rapid turnover of its CFOs during the class period; and that many of the links on CEU’s website did not work properly despite its online segment purportedly deriving millions of dollars each year.

 

Judge Snyder said that “although each fact taken along might not give rise to an inference of fraudulent intent,” the allegations “taken together” establish that plaintiffs’ theory is at least as compelling as any opposing inference one could draw.

 

Judge Snyder’s dismissal motion denial suggests that in some cases at least the U.S.-listed Chinese companies draw into the wave of recent securities lawsuits may face difficulties evading these lawsuits, at least at the initial stages. Many of the cases, like this one, are based on the reports of financially motivated online analysts. Judge Snyder’s unwillingness to disregard the allegations based on the analyst’s report, notwithstanding the analysts admitted financial interest in driving down the value of the company’s stock, may represent a problem for the other companies tangled up in these cases as a result of negative reports by online analysts.

 

Moreover, Judge Snyder’s conclusion that the plaintiffs’ scienter allegations were sufficient, inter alia, on the discrepancies between the Chinese regulatory filings and SEC filings, may also suggest that a number of these cases could survive the initial pleading stages, as many of them are based on similar discrepancies between Chinese regulatory filings and SEC filings.

 

To be sure, some cases will nevertheless be dismissed, as was the case with the China North East Petroleum case, in which the dismissal motion was recently granted on loss causation grounds (about which refer here). But if Judge Snyder’s holding in the China Education Alliance case is any indication, other cases also will likely survive the initial dismissal motions.

 

Of course, it remains to be seen how valuable these cases ultimately prove to be for plaintiffs, even if they make it past the initial pleading hurdle. But the name of the game is making it past the dismissal motions, and at least in the China Education Alliance case, the plaintiffs have made it at least that far.

 

Special thanks to a loyal reader for providing me with a copy of Judge Snyder’s opinion.

 

Fed Officials Pursue Actions Against Failed Bank Officials: In a significant development in the current wave of bank failures, that involves a failed bank that had significant ties to and operations in China, on October 11, 2011, federal officials concurrently filed a regulatory enforcement action and a criminal prosecution against certain former officers of the failed United Commercial Bank.

 

San Francisco based United Commercial Bank failed on November 9, 2009 (about which refer here). The bank had offices throughout the United States, as well as China and Taiwan. The bank grew rapidly. According to the SEC, it was the first U.S. bank to acquire a bank in the People’s Republic of China. However, during the economic crisis in late 2008 and early 2009, the bank experience significant difficulties in its loan portfolio, which regulators allege led to the bank’s failure, which in turn triggered the recently filed actions involving the bank’s former officers.

 

First, in an October 11, 2011 complaint (here), the SEC filed a civil enforcement action against four former officers of the bank. According to the SEC’s October 11, 2011 litigation release, the complaint alleges that the defendants “concealed losses on loans and other assets from the bank’s auditors, causing the bank’s holding company UCBH Holdings, Inc. (UCBH) to understate its 2008 operating losses by at least $65 million.” The complaint alleges that the further loan losses ultimately caused the bank to fail. The SEC action seeks permanent injunctive relief, an officer bar, and civil money penalties.

 

In addition, as reflected in the FBI’s October 11, 2011 press release (here), a grand jury has indicted two of these same former bank officials, for conspiracy to commit securities fraud, securities fraud, falsifying corporate books and records and lying to auditors.

 

Both the SEC’s litigation release and the FBI’s press release specifically reference the assistance they received in preparing their actions from the FDIC. The FDIC’s role in these actions is a reminder that as part of its failed bank post mortem, the FDIC is not only attempting to determine whether or not it has a valuable civil suit on its own as receiver, but is also looking to see whether or not wrongdoing has occurred that warrants referral to other authorities.

 

Both the SEC action and the indictment refer to securities fraud, which serves as a reminder that, by contrast to the institutions caught up in the S&L crisis a few years ago, many of these failed financial institutions in the current bank failure wave are publicly traded, a circumstance that has many ramifications.

 

It remains to be seen whether or not the FDIC will also file its own separate civil action against the former directors and officers of this bank. The bank’s former investors have in any event already filed their own class action lawsuit. As discussed here, the defendants’ initial motion to dismiss the class action lawsuit was granted, albeit with leave to amend.

 

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Turns out that while some of us were wondering when the lawsuits arising out of the current bank wave would really start to accumulate, the FDIC itself was busy filing lawsuits -- they just didn’t tell anybody about it, at least not until now. Specifically, the FDIC filed three more lawsuits in August than had previously come to light. At a minimum, these lawsuits suggest the FDIC has been more active in pursuing its litigation strategy than may have been perceived. The suits also suggest that the FDIC’s declarations about its planned litigation strategy are very much in earnest.

 

The three newly publicized lawsuits, each of which were filed by the FDIC in its capacity as receiver of a failed bank, are as follows:

 

First, on August 8, 2011, the FDIC filed a lawsuit in the Eastern District of Michigan against a single former loan officer at Michigan Heritage Bank, of Farmington Hills, Michigan, which failed on April 24, 2009 (about which refer here). A copy of the complaint in this lawsuit can be found here. The complaint alleges that the individual, whom the complaint alleges had been CEO of a different Michigan bank that failed in 2002, caused the bank to incur losses in excess of $8.2 million. The complaint, which asserts claims of negligence, gross negligence and breach of fiduciary duty, alleges among other things that the lending officer “failed to conduct due diligence and analysis prior to originating and recommending approval of 11 commercial loans that resulted in losses” and “failed to adequately inform [the Bank’s] board of directors and senior management of deficiencies with respect to those loans.”

 

Second, on August 9, 2011, ,the FDIC filed a lawsuit in the District of Kansas against six former officers and directors of the Columbian Bank and Trust Company, of Topeka, Kansas, which failed on August 22, 2009 (about which refer here). The FDIC’s complaint in this lawsuit can be found here. The FDIC seeks to recover losses of at least $52 million the bank allegedly suffered because the defendants allegedly “negligently, grossly negligently, and in breach of their fiduciary duties originated and/or approved poorly underwritten large commercial and commercial real estate loans … and failed to properly supervise the Bank’s lending function.” The FDIC also alleges that the defendants (one of whom owned or controlled the bank’s holding company) “failed to heed the warnings of bank supervisory authorities.”

 

Third, on August 10, 2011, the FDIC filed a lawsuit in the Eastern District of North Carolina against nine former directors and officers of the Cooperative Bank, of Wilmington, North Carolina, which failed on June 19, 2009 (about which refer here). The FDIC’s complaint in this action can be found here. The complaint alleges that defendants “failed to manage the inherent risks associated with their aggressive growth strategy” and “permitted a lax loan approval process.” The complaint further alleges that through out the period 2005 through the bank’s failure, state and federal regulators “repeatedly warned” the bank’s management and board “about the risks associated with its high concentrations in speculative loans and weaknesses in lending functions,” yet the bank’s board “permitted and approved” the bank’s continued lending practices. The FDIC alleges that the defendants’ negligence, gross negligence and reckless conduct “ultimately led to the bank’s failure.”

 

There are a number of interesting things about these three new lawsuits, beyond the fact that they were filed on three successive days in August. For one thing, all three involved banks that failed more than two years before the complaints were filed. The timing of the filings relative to the earlier closures says something about the FDIC’s internal timetable for working up potential lawsuits. Another thing about these lawsuits are that the involve banks in states that have not been particularly hard hit during the current bank failure. By and large the bank failures have involved banks in just a few states, particularly Georgia, Illinois, California and Florida. Hard to know for sure what it signifies, but it is interesting that none of these suits involve banks from those hard hit states.

 

Another interesting thing about these suits is that all three involve relatively small banks. The Michigan Heritage bank lawsuit  involves a single mid-level lending officer and relatively modest losses on a relatively small number of loans. The implication seems to be that the FDIC intends to be very thorough and that there are not going to be cases that are too small to bother with. This is a salvage operation, pure and simple, and the FDIC is going to recover everything it can, no matter how small.

 

In any event, when these three additional lawsuits are taken into account, the total number of lawsuits that the FDIC has filed against former directors and officers of failed banks as part of the current bank failure wave is now up to fourteen, five of which were filed in August, and half of which were filed since June 30, 2011. The fact that these suits were filed in August and are just coming to light now suggests the possibility that there could be other FDIC lawsuits that have been filed but that have not yet surfaced.

 

Whether or not there are other filed but not yet publicized suits out there, it is clear there are many more lawsuits to come. On its website, the FDIC has said that as of September 13, 2011, the agency has approved lawsuits involving suits in connection with 32 failed institutions against 294 individuals with damage claims of at least $7.2 billion. The FDIC’s fourteen lawsuits to date involve only 103 directors and officers. The implication is that there are at least 18 more lawsuits yet to be filed – and that is only taking into account the lawsuits that have been approved as of September 13, 2011. There undoubtedly will be many lawsuits approved in the months ahead, with additional filings to follow after that.

 

Given the two year lag time between failure date and filing date that these three lawsuits described above demonstrate, and given the fact that the pace of bank failures only really accelerated during late 2009 and early 2010, it seems likely that the failed bank filings will not only continue well into at least 2012, but that over the next few months the pace of failed bank lawsuits could really take off. 

 

Indeed, one of the clear implications of the FDIC’s lawsuit filings during August of this year is that the agency’s declared litigation strategy is for real. The FDIC clearly does intend to pursue the active litigation strategy it has laid out on its website. And in light of these latest filings, the FDIC’s litigation approach clearly will not be limited just to the largest banks, but could well involve many smaller failures as well.

 

To be sure, the FDIC’s approach does not necessarily require an actual lawsuit in every case. Early on in connection with many of the bank failures, the FDIC has submitted notices of claim to the failed banks’ former directors and officers and to the failed bank’s D&O insurance carriers. In many cases, the FDIC may attempt to try to negotiate a settlement with the former directors and officers and the D&O carriers, without the actual filing of a civil action.

 

Reliable sources advise me that that is in fact exactly what happened in connection with one large failed bank in Florida. Apparently, the FDIC was able to negotiate a settlement in connection with the failed bank without actually filing a lawsuit against the failed bank’s former directors and officers. To the extent the FDIC pursues this approach in other cases and succeeds in negotiating settlements, there could ultimately be fewer complaints. In view of the fact that this approach would avert the erosion of the D&O insurance limits of liability by the payment of defense expenses, this approach could actually result in improved recoveries.

 

But though there may be cases where actual lawsuit filings are averted, the likelier scenario in many cases is that there will be an FDIC lawsuit. With the revelation of the FDIC’s August lawsuit filings, and the suggestion that the FDIC is now actively pursuing its litigation strategy, it is clear that the game is on. For months to come, one of the predominant stories on the directors and officers’ liability scene will be the FDIC’s pursuit of growing numbers of failed bank lawsuits against the former directors and offices of the failed institutions

.

One final note. The FDIC’s website makes it clear that its litigation strategy is not limited just to suits against former directors and officers. The site says that the agency has “also has authorized 20 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits. In addition, 175 residential malpractice and mortgage fraud lawsuits are pending, consisting of lawsuits filed and inherited.”

 

Active Self-Defense: As discussed in prior posts (refer for example here), the individuals dragged into the failed bank lawsuits will rely on a number of theories in order to try to defend themselves. Former Indy Mac Chairman and CEO Michael Perry is taking a different approach. He has launched a website called “Not Too Big to Fail” (here) on which he is attempting to defend himself against charges the FDIC has asserted against him and other former IndyMac executives.

 

As discussed here, in July 2011, the FDIC filed a lawsuit in the Central District of California against Perry. The FDIC alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses. Perry has also been named as a defendant in other lawsuits arising out of IndyMac’s July 2008 failure.

 

On his website, Perry asserts that “not one of the lawsuits against me has merit.” He says that “I and the management team and directors of IndyMac Bank made prudent and appropriate business decisions based on the facts available to us at the time and always with the primary goal being to keep IndyMac bank safe and sound.”

 

The name of the site is taken from Perry’s complaint that IndyMac did not receive government bailout funds that were made available to other banks. He asserts that this occurred because IndyMac was “not too big to fail.”

 

Though Perry’s website represents a rather impressive display of self-justification, it seems unlikely that his Internet-based public relations campaign will accomplish much. I suppose though for someone in Perry’s position there is some satisfaction involved with telling off the regulators, even if it is unlikely to change the outcome of any of the claims against him. The one thing that is clear is that Perry is both unrepentant and defiant.

 

Well, Maybe Next Year: For those who missed the allusion in the title of this blog post, the reference was to the lyrics of the song “Send in the Clowns,” from Stephen Sondheim’s Broadway musical A Little Night Music. The lyrics include these lines: “Sorry my dear/ But where are the clowns?/Quick, send in the clowns/Don’t Bother, they’re here.”  

 

Although many have sung this tune, it is has perhaps become most closely associated with Judy Collins. There are actually a surprising number of verions on You Tube of Judy Collings singing this song. Here's an audio only version:

 

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I am pleased to present below a guest post by Mike Hogan, Executive Vice President at U.S. Risk Financial Services. I would like to thank Mike for his willingness to publish his article on this site. I am interested in publishing guest posts from responsible commentators on topics of interest to readers of this blog. Please contact me directly if you are interested in submitting a guest post for consideration.

 

Here is Mike’s guest post:

 

The banking crisis of the 1980’s, resulted in the passage of the Financial Institutions Reform, Recovery and Endorsement Act by Congress, (FIRREA) that significantly increased the penalties for both banks, and individuals and broadened the applicability of Civil Money Penalties. These penalties may be assessed for the violation of any law, regulation, as well as for a violation of any condition imposed in writing by the appropriate Federal banking agency in connection with any written agreement between a depository institution and the agency.

 

Clearly, the banking industry has suffered through some of its most difficult times during the last three years as indicated by the 25 bank failures in 2008, 140 bank failures in 2009 and 157 failures in 2010. This year, thru September 2, 70 banks have failed with the expectation of considerably more before year end.  This year, on June 24, 2011, the FDIC announced  57 enforcement actions against problem banks that included 11 Civil Money Penalties, the majority of which were issued to individuals. 

 

As a result of these failures and the fact that over 800 banks are currently on the FDIC “Problem Bank List”, the agency has initiated a new trend to review directors and officer’s liability policies during their examinations. The intent of this review is to determine if there is a “regulatory exclusion” on the policy and to identify the potential limits of liability that might be available for recovery of losses the FDIC sustains when taking a bank into receivership.  

 

In the last few months the FDIC has also begun to review bank D&O Insurance  policies to determine if a “Civil Money Penalty” endorsement attached to the policy. If they find a Civil Money Penalty endorsement is attached to the policy, the agency is issuing citations to the bank along with a requirement that the endorsement be immediately deleted from the policy.

 

According to this author’s interview of an attorney in the FDIC’s legal division, the governing bank regulation is the Deposit Insurance Act (12 U.S.C. 1828(k)) Part 359.1(1)(2)  - Golden Parachute and Indemnification Payments. This regulation provides that a depository institution may not purchase an insurance policy that would be used “to pay or reimburse an IAP (institution affiliated party a.k.a Directors and Officers) for the cost of any judgment or Civil Money Penalty assessed against such person in an administrative proceeding or civil action commenced by any federal banking agency…”. Section 18(k) of the statute includes the same prohibitions. (See 12 U.S.C. 1828( k) (5)-(6) ). (Both Part 359 and Section 18 prohibit the bank from purchasing an insurance policy that includes Civil Money Penalties insurance coverage. 

 

The FDIC’s position with respect to insurance for Civil Money Penalties is made even more difficult by the period of time such coverage has been made available.  Over the last twenty years, most if not all of the principal insurers that offer directors and officers liability insurance to banks have also provided Civil Money Penalties coverage for bank officers and directors as long as the bank is performing well and have no current regulatory concerns. During this period, banks have been advised to retain photocopies of the Directors and Officers personal checks in the event the bank has to prove that these individuals had paid for the coverage personally. This was based on the assumption that if the bank could prove that the directors and officers paid for the coverage personally, that the FDIC wouldn’t object to the coverage. 

 

Insurance agents and brokers that have placed directors and officers liability insurance that include Civil Money Penalties coverage are potentially exposed to criticism for offering coverage that is contrary to FDIC rules and regulations,  and putting their client bank in a situation where the FDIC  cites the bank for violation of the FDIC regulations.   Equally, agents could be faced with competition from agents and other Insurers who are willing to offer the coverage in spite of these regulations.  Interestingly, many of the bank directors and officers liability insurers are continuing to offer bank management the choice of whether they want to purchase the coverage or not. 

 

These issues would lead most agents to believe that the most appropriate approach is to be proactive by advising their client bank management of the regulation and its intent so the directors and officers can make their own decision on whether to retain the current endorsements on the directors and officers liability policy or to remove it prior to the next FDIC exam. 

 

The FDIC attorney this author consulted further advised that the FDIC has no concerns or interest in policies where the bank is not named as an Insured on the policy. This could lead insurers to consider other options for providing Civil Money Penalties coverage. For example, the coverage could be offered through a stand alone policy where the bank is not named as an Insured. Alternatively, insurers may consider offering the coverage on a Side A Policy naming the Board and officers as Named Insureds or on an Individual D&O policy by endorsement. In either event,   directors and officers will have to pay for the coverage personally, as opposed to the bank purchasing it on their behalf. 

 

My New All-Time Favorite Headline: Our sincerest condolences to the family of the late Percy Foster. We mean no disrespect. But you have to admit, it is pretty hard to beat this headline from the September 14, 2011 issue of Perth Now: "Gordon Ramsay's Dwarf Porn Double Dies in Badger Den." (here)

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A recent negotiated resolution of an FDIC failed bank lawsuit suggests disputes over D&O insurance coverage may represent the real frontline in the failed bank litigation wars. The compromise was reached in the lawsuit the FDIC only recently filed in the District of Arizona involving the failed First National Bank of Nevada. As discussed below, the FDIC and the bank officer defendants have reached a settlement agreement that includes a stipulated judgment, assignment of insurance rights, release of claims against the individual defendants, and a covenant not to execute the judgment against the individual defendants.

 

First National Bank of Nevada failed on July 25, 2008 (as discussed here). First National Bank of Arizona was one of FNB Nevada’s sister banks until the two banks merged less than 30 days prior to FNB Nevada’s failure. As discussed here (scroll down), on August 23, 2011, the FDIC filed an action in the District of Arizona against Gary Dorris, who was CEO and Vice Chairman of the banks’ holding company as well as of both FNB Nevada and FNB Arizona, and Phillip Lamb, who was EVP of the banks’ holding company as well as of both FNB Nevada and FNB Arizona. The FDIC’s complaint alleged mismanagement and gross negligence at FNB Arizona that allegedly left FNB Arizona holding millions of dollars of bad loans.

 

On September 2, 2011, just days after the FDIC filed its complaint against the two individuals, the FDIC and the two defendants filed a joint motion for entry of judgment. A copy of the joint motion for entry of judgment can be found here. Though they had filed an answer denying liability, the defendants nevertheless consented to the entry of judgments “for purposes of compromising disputed claims.” Pursuant to the parties’ settlement agreement, the two individuals each consented to the entry against each of them of separate judgments in the amount of $20 million (plus post-judgment interest).

 

As part of the parties’ settlement agreement, upon the entry of the judgment the defendants will assign to the FDIC all of their rights and claims against the D&O insurer. The FDIC for its part agreed not to take any action to enforce the judgment against the individuals, except with respect to the individuals’ rights under the D&O policy. The joint motion alleged that the bank’s D&O insurer has “denied coverage, refused to defend, to advance defense costs, to indemnify, or to consider settlement of the claims brought against the defendants.”

 

Assuming for the sake of discussion that the court enters the consent judgment in the form the parties have requested, the FDIC’s obvious next move is to file a lawsuit against the bank’s D&O insurer, seeking to recover the amount of the judgments from the D&O insurer. The joint motion does identify the D&O insurer, but it does not specify the face amount of the D&O insurance policy, nor does it specify the basis on which the D&O insurer has denied coverage.

 

The fact that the consent judgment was submitted within days after the initial complaint was filed does seem to suggest that the lawsuit filing was itself part of a coordinated plan anticipating the consent judgments, as a way to shift the FDIC’s focus from the individuals themselves to the D&O insurer, the recovery of whose policy proceeds appears to have been the FDIC’s objective all along.

 

The problem with this approach is that it has not been established that the individuals in fact breached any duties or that they should be or could be held liable on the merits. Of course, the individuals would contend that when the D&O insurer failed to provide them with a defense, they were left on their own to take whatever steps they could to protect themselves from liability and to avert the accumulation of further defense expense. The FDIC, as the individuals’ successor in interest under the policy, now undoubtedly will argue that having disclaimed coverage and having declined to participate in the individuals’ defense, the carrier should not be heard to object to the basis on which the individuals compromised the lawsuit.

 

But merely because the FDIC will succeed to the individuals’ rights under the policy does not establish that there is coverage under the policy or that the D&O insurer has any liability for the amounts of the consent judgment. If it comes to that, the D&O insurer will undoubtedly attack the judgment on many bases. The D&O insurer will also likely maintain its assertion that there is no coverage under the policy for the claims against the individuals as well as for the judgment.

 

Given that this bank closed in mid-2008, which was very early in the current wave of bank failures, it is relatively unlikely that the operative policy had a regulatory exclusion (as those had only just started making their return to the D&O insurance marketplace at or about that time). The likelier possibility is that the coverage denial is based on some policy process issue, such as timely notice, claims made date, or the like.

 

As I previously noted, it could be argued that the D&O insurer, having denied coverage, should not be heard to object to the fact that the individuals have taken steps to protect themselves. However, the problem with these type of consent judgment/covenant not to execute type deals is that this approach can run the risk of slipping into a collusive arrangement, with the insured individual willingly agreeing to a settlement amount that has no relation to the his or her true liability exposure. In my prior life as an insurance company coverage attorney, I saw more than one deal that could only be described as abusive, and I have one particular deal   in mind that qualified as grotesque bad faith (it was so awful no court would touch it and it died a very ignominious death).

 

Whatever the merits or demerits of these types of deals, we undoubtedly will see many more of them before the current round of failed bank litigation finally plays itself out. FNB Nevada failed in the earliest days of this wave of failed banks, and the FDIC is just now getting around to pursuing claims and insurance coverage related to its closure. Many hundreds of banks have failed in the interim and over the coming months and years, the FDIC will be pursuing claims and insurance coverage in connection with many of those subsequent bank failures. In many of these cases, as apparently was the case here, the FDIC’s ultimate objective will be the recovery of D&O insurance proceeds.

 

As a result, there may well be many more occasions where, as here, individuals, in order to extricate from an FDIC lawsuit, similarly agree to a consent judgment and an assignment their rights to their D&O insurance policy in exchange for a covenant not to execute the judgment against them and their assets.

 

The larger message here is that as the FDIC ramps up its claims and lawsuits against the former directors and officers of failed banks, one of the consequences will be a rash of coverage lawsuits involving the failed institutions’ D&O insurance policies. All I can say is that it seems like old times to me. I expect that all across the country there are coverage attorneys getting their files from 20 years ago out of storage. 

 

As I said at the outset, D&O insurance coverage suits may represent the real frontlines of the failed bank litigation wars. (It is no coincidence that the lawsuit filed at the same time as the suit against the FNB Arizona defendants, the one filed against former directors and officers of Silverton bank, described here, apparently also is really a dispute about D&O insurance coverage; indeed in that case, the FDIC took the extraordinary step of naming the D&O insurers as defendants in the liability lawsuit.)

 

 In any event, it is clear that coverage lawsuits involving failed bank D&O policies will be one of predominant features of the D&O insurance scene for the next several years to come.

 

News coverage regarding the bank executives’ settlement with the FDIC can be found here. Special thanks to a loyal reader for sending me a copy of the parties’ joint motion for entry of judgment.

 

Court Rejects Failed Bank Directors and Officers Bid to Dismiss Claims Against Them: Meanwhile, in a case in the Northern District of Illinois involving the former directors and officers of the failed Heritage Community bank, the court has rejected the individual defendants’ motions to have the claims for negligence and breach of fiduciary duty against them dismissed, except to the extend the negligence claims are duplicative of the fiduciary duty claims.

 

As discussed here, in November 2010, the FDIC filed a lawsuit against certain former directors and officers of Heritage. The defendants moved to dismiss the FDIC’s negligence and breach of fiduciary duty allegations, arguing that the alleged misconduct that on which the negligence and breach of fiduciary duty claims are based are protected by the business judgment rule; that the FDIC had failed to sufficiently state claims for gross negligence, negligence or breach of fiduciary duty; and that the negligence and breach of fiduciary duty claims were duplicative.

 

In a September 1, 2011 order (here), Northern District of Illinois Judge Rebecca Pallmeyer denied the defendants’ motions, except that she granted the motions to the extent the negligence claims were duplicative of the fiduciary duty claims. In rejecting the defendants’ attempt to rely on the business judgment rule, she found that because these arguments represented affirmative defenses and held that the “appropriate mechanism for consideration” of the affirmative defenses is “a motion for judgment on the pleadings or for summary judgment.”

 

Judge Pallmeyer also found that the FDIC’s allegations “are sufficient to meet the liberal notice pleading requirements and to set for the duty, breach, causation and damage elements of claims for gross negligence, negligence and breach of fiduciary duty.”

 

For those involved in defending former directors and officers in FDIC litigation (and these individuals’ D&O insurers), Judge Pallmeyer’s ruling may be concerning. One of their principal defenses for individuals caught up in FDIC failed bank litigation will be that under FIRREA, they can only be held liable for gross negligence (refer here for an excellent discussion of these issues). This argument is most compelling with respect to outside directors, as  a judge in the Central District of California recently recognized in dismissing NCUA claims that had been brought against outside directors of the failed WesCorp credit union (as discussed at greater length here). Although Judge Pallmeyer did dismiss the negligence claims to the extent they were duplicative of the fiduciary duty claims, she did not reach the question whether or not under FIRREA the individuals can be held liable only for gross negligence.

 

Special thanks to a loyal reader for forwarding the Heritage bank ruling to me.

 

Annual Law Firm Survey of D&O Insurance Coverage Issues: On September 7, 2011, my good friends at the Troutman Sanders law firm issued their annual survey of coverage decisions involving D&O and professional liability insurance policies, which can be found here. The survey is very comprehensive and has the added virtue of being indexed by topic, which makes the survey a particularly useful resource for those involved with D&O insurance claims to keep at hand.

 

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I am pleased to present below a guest post from Mary C. Gill, Robert R. Long and Todd F. Chatham of the Officers & Directors of Distressed Financial Institutions team at the Alston & Bird law firm, in which they discuss the critical issues surrounding the defense of former directors and officers of failed banks who find themselves the target of an FDIC lawsuit.

 

My thanks to Mary, Robert and Todd for their willingness to publish their article here. This article will also be published in the October edition of The Review of Banking and Financial Services. Mary will also be presenting on these same topics in a September 14, 2011 webinar entitled "Bank Executives Under Heightened Scrutiny by the FDIC," about which refer here. I welcome guest posts from responsible commentators on topics of relevance to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Here is Mary, Robert and Todd's guest post.   

 

 

In the three years since the crush of the financial crisis, the number of banks that have been closed is roughly half the number of financial institutions that failed after the savings and loan crisis of the late 1980’s. [1] Although the number of problem institutions declined in the second quarter of 2011, there remain 865 institutions on the FDIC’s “problem bank list,” which indicates that bank closings will likely continue at a steady pace in the near term. [2] Whether the number of failed banks ultimately reaches the level of closings experienced in the post-savings and loan crisis remains to be seen.

 

 

The wave of litigation that has begun slowly and will continue in the wake of the bank closings also parallels the post-savings and loan crisis in many respects. [3] Significant developments in the law during the last decade, however, may yield strikingly different results in the claims that flow from the current financial crisis.

 

 

When a federally insured bank is closed, the Federal Deposit Insurance Corporation (“FDIC”) is appointed as conservator or receiver. The FDIC investigates every closed bank to determine whether there may be claims that can be pursued in an effort to recoup losses to the bank. [4] The investigation of a closed bank by the FDIC typically takes eighteen months with the focus on an array of professionals who provided services to the bank including accountants, lawyers, appraisers, and insurance brokers.  

 

 

The most intense scrutiny of the FDIC investigation, however, is on the former directors or officers of the failed financial institution. As a result, for an officer or director of a distressed financial institution, the risk of claims brought by the FDIC would appear to be high.    The FDIC has three years from the closing of a bank to bring claims against the former officers and directors. [5] At this point, the FDIC has authorized suits to be brought against 266 former directors and officers of 30 failed banks, seeking damages of $6.8 billion.   To date, however, only eleven lawsuits have been filed by the FDIC against former bank officers and directors. With the approach of the three year mark from the early bank closings, the pace of lawsuits filed against former bank officers and directors will undoubtedly increase.

 

 

FDIC Claims Against Bank Officers and Directors

 

According to its policy statement, the FDIC will only bring suit when there is a reasonable chance of establishing liability and the likelihood of recovery exceeds the cost of pursuing a claim. [6]   The current post-bank crisis litigation presents significant challenges to the FDIC in proving its case in court against the former officers and directors.   Under the federal statute that governs these claims, the FDIC must demonstrate that the officer or director conduct was grossly negligent, unless the applicable state law allows liability to be imposed based upon a stricter standard. [7] Simply stated, the FDIC must prove that the officers and directors made decisions that were in reckless disregard of the best interests of the bank.   In each case, the FDIC also must prove that the actions of the officers and directors caused actual losses to the bank.    In addition, the FDIC must rebut any affirmative defenses raised by the officers and directors to these claims. 

 

 

The first professional liability action brought by the FDIC in the current financial crisis was filed on July 2, 2010, against officers of the mortgage subsidiary of IndyMac, one of the earliest and largest bank failures. Since then, the FDIC has filed suit against the former officers and directors of ten other banks in Arizona, California, Illinois, Georgia and Washington. [8] The FDIC has asserted claims against these former officers and directors for negligence, gross negligence and breach of fiduciary duty. [9] In most of these cases, the claims relate to loans that were made by the bank. The FDIC also generally claims that the business plan executed by the officers and directors of the bank involved undue risk, overly aggressive growth strategy or unwarranted concentration in real estate based lending, particularly acquisition, development and construction. 

 

 

The FDIC has espoused the policy of pursuing claims against outside bank directors only for conduct that rises to the level of gross negligence or worse. [10] And, indeed, not all of the directors of these banks have been caught in the net of litigation. In many cases, only the outside directors who served on the loan committee and bore some responsibility for approving the particular loans were joined as defendants. In one instance, the FDIC sued outside directors for failure to supervise an allegedly faulty loan approval process.   Notwithstanding its stated policy, however, the FDIC has asserted claims of negligence against these outside directors.

 

 

In each of the pending lawsuits, the former officers and defendants have moved to dismiss the negligence claims on the grounds that FIRREA requires, at a minimum, a showing of gross negligence. [11] Thus, the threshold issue in these cases is whether claims of ordinary negligence will lie against the former officers and directors under the applicable state law.    Based upon well-established state law principles and decisions from the post-savings and loan litigation, courts should readily determine that the FDIC claims for negligence should be dismissed. In most states, directors are not subject to liability for negligence, either by statute or the application of the business judgment rule, which is generally viewed as protecting directors and officers from personal liability for ordinary negligence. Accordingly, in cases arising from the savings and loan crisis, courts rejected claims of negligence brought by the FDIC against bank officers and directors. For example, in a 1999 decision applying California law, the Ninth Circuit Court of Appeals held that directors are immune from claims of ordinary negligence brought by the FDIC when they have acted in good faith and on an informed basis. [12] Similarly, in the first court decision rendered in the recent wave of litigation, a federal court in California followed the same reasoning and held that the former directors of a credit union could not be held liable for negligence, which allegedly caused the failure of the financial institution. [13]

 

 

    

Although each case will be governed by the applicable state law governing the particular bank, the similarities in state law should lead to comparable results in most cases. Unless the state law governing the bank permits officers and directors to be held liable for ordinary negligence, the courts should dismiss the FDIC’s negligence claims.   The rulings in these initial cases will have a profound effect on the director and officer litigation that will continue in the years to come.

 

 

The Availability of Affirmative Defenses to FDIC Claims

 

The FDIC will also confront a variety of affirmative defenses raised by the former officers and directors in these cases. Many of these defenses were rejected by courts in the post-savings and loan crisis litigation.    The most common ground for striking affirmative defenses was the so-called “no duty” rule. A ruling by the United States Supreme Court near the end of the savings and loan litigation, however, has reopened the door to these defenses. As a result, there is a renewed viability to many of these affirmative defenses, which will level the playing field for officers and directors defending against FDIC claims.

 

 

The “no duty” rule was based upon “federal common law” and precluded former officers and directors from asserting certain defenses against the federally appointed receiver. The policy behind the “no duty” rule was “that any affirmative defense calling into question the pre-or post-bank closing action of the FDIC are [sic] insufficient as a matter of law because the FDIC owes no duty to the O&Ds of a failed bank either in its pre-failure regulation of a bank or in its post-failure liquidation of the same." FDIC v. Schreiner, 892 F. Supp. 848, 853 (W.D. Tex. 1985). Based upon this reasoning, the Resolution Trust Corporation (“RTC”), which served as receiver for many closed savings and loans, and the FDIC consistently relied on the “no duty” argument to block former officers and directors from asserting a variety of affirmative defenses to the receiver’s claims, including failure to mitigate damages, contributory or comparative negligence, estoppel and waiver. Prior to 1994, the RTC and the FDIC were generally successful in striking these defenses. As a result of the widespread acceptance by the courts of the “no duty” rule, bank officers and directors were handicapped in defending these lawsuits in the late 1980s and early 1990s.  

 

 

The litigation landscape was significantly altered near the end of the savings and loan litigation through a decision by the United States Supreme Court. As a result, former officers and directors of failed banks who face FDIC claims today may have an array of defenses that were not previously available. 

 

 

In the 1994 landmark decision, O’Melveny & Myers v. FDIC, 512 U.S. 79 (1994), the Supreme Court rejected the premise of “federal common law,” which afforded the FDIC unique protection from defenses. In doing so, the Supreme Court ruling swept away the basis for the “no duty” argument that had been applied by courts to reject an array of affirmative defenses raised by bank officers and directors to the FDIC claims.   In O’Melveny & Myers, the FDIC sued the former lawyers of a failed savings and loan institution. In their defense, the lawyers relied upon a defense that imputed the fraud of the former officers of the savings and loan to the institution itself and, as a result, to the FDIC, which as receiver stepped into the shoes of the institution.   The FDIC argued that public policy and federal common law barred the application of this defense against the FDIC.   Calling the FDIC’s premise “plainly wrong,” the Supreme Court unequivocally rejected the principle that there was a federal body of common law that afforded special defenses to the receiver. The Court held that neither federal policy, nor FIRREA itself, created a federal rule to protect the FDIC. Instead, “any defense good against the original party is good against the receiver.” [14]

 

 

 Thus, the FDIC’s previously successful argument that a federal “no duty” rule trumps otherwise available state law defenses is no longer available.   Moreover, because O’Melveny & Myers undermines the rationale upon which the prior pro-FDIC case law was based, these earlier decisions are no longer binding, nor should they be persuasive to courts in the current litigation environment.   In a number of decisions, courts have relied upon O’Melveny & Myers to reject the FDIC’s “no duty” argument and afford the director defendants state-law defenses that would have been denied them previously. [15] These decisions should pave the way for courts to allow the officer and director’s affirmative defenses to proceed on the merits, rather than stripping them of these arguments as a matter of federal policy. 

 

 

Conclusion

 

The wave of FDIC litigation against former officers and directors of banks will continue to build over the next few years. Not all officers and directors will face claims by the FDIC. For those who do, the burden of proof on the FDIC to establish liability is high.   Moreover, as a result of significant court decisions from the earlier savings and loan litigation, former bank officers and directors who face FDIC claims today have access to affirmative defenses that may bar or otherwise limit the receiver’s claims against them.   Bank directors and officers of distressed financial institutions may wish to seek counsel who can advise them and take steps now to prepare for potential FDIC claims.

 

__________________________________

 

[1]Between 1988 and 1992, there were 794 bank failures and 1,019 savings and loan failures. Recent Bank Failures and Regulatory Initiatives, Before The Committee on Banking and Financial Services, U.S. House Of Representatives (Testimony of Donna Tanoue, FDIC Chairman), February 8, 2000, available here.

 

[2] FDIC Quarterly Banking Profile, Second Quarter 2011, available here.

 

 

[3] The FDIC asserted professional liability claims against the former officers and directors of 24% of the banks that failed as a result of the savings and loan crisis from the late 1980s. Many of these claims were resolved, however, without litigation being filed by the FDIC.

 

[4] In an earlier article, the authors provided a full discussion of the FDIC investigation process, see Claims Against Bank Officers and Directors Arising from the Financial Crisis, The Review of Banking & Financial Services, Vol. 26 2010, available here.

 

[5] In some instances, the FDIC will seek to enter into tolling agreements with the former directors and officers in an effort to resolve the claims without filing a lawsuit and to afford the parties more time to do so.

 

[6} Fed. Deposit Ins. Corp., The FDIC and RTC Experience, Managing the Crisis, 266 (1998), available here.

 

[7] Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), 12 U.S.C. § 1821(k), refer here.

 

[8] FDIC v. Van Dellen, No. 2:10-cv-04915-DSF-SH (C.D. Ca.), July 2, 2010; FDIC v. Saphir, No. 1:10-cv-07009 (N.D. Ill.), Nov. 1, 2010; FDIC v. Appleton, No. 2:11-cv-00476-DDP-PLA (C.D. Ca.), Jan. 14, 2011; FDIC v. Skow, No. 1:11-cv-0111 (N.D. Ga.), Jan. 14, 2011; FDIC v. Stark, No. 3:11-cv-03060-JBM-BGC (C.D. Ill.), Mar. 1, 2011; FDIC v. Killinger, No. 2:11-cv-000459 (W.D. Wash.), Mar. 16, 2011; FDIC v. Spangler, No. 10-cv-4288 (N.D. Ill.), May 5, 2011; FDIC v. Perry, No. 11-cv-5561-ODW-MRWx (C.D. Cal.), July 6, 2011; FDIC v. Briscoe, No. 1:2011-cv-002303 (N.D. Ga.), July 14, 2011; FDIC v. Bryan, et al., No. 11-mi-99999-UNA (N.D. Ga.), August 22, 2011; FDIC v. Gary A. Dorris and Phillip A. Lamb, No. 11-cv-01652-GMS (D. Ariz.), August 23, 2011.

 

 

[9] In one of the cases, the spouses of the former officers were also sued for alleged fraudulent conveyance of assets.  FDIC v. Killinger, No. 2:11-cv-000459 (W.D. Wash.), Mar. 16, 2011.

 

[10] Managing the Crisis, supra, note 6, at 275.

 

[11] The difference between negligence and gross negligence is significant. Gross negligence requires a showing of reckless conduct in disregard of the best interests of the bank. Ordinary negligence may be established by showing a failure to act with ordinary care.

 

[12] FDIC v. Castetter, 184 F.3d 1040 (9^th Cir. 1999).

 

[13] National Credit Union Administration v. Siravo, No. 2:10-cv-01597-GW-MAN (C.D. Cal.), Mar. 3, 2010.

 

[14] O’Melveny & Myers, 512 U.S. at 86.

 

[15] See, e.g., RTC v. Mass. Mut. Life Ins. Co., 93 F. Supp. 2d 300, 306 (W.D.N.Y. 2000) (permitting the defense to assert the affirmative defenses of contributory negligence and failure to mitigate damages against the FDIC/RTC); FDIC v. Ornstein, 73 F. Supp. 2d 277, 282 (E.D.N.Y. 1999) (concluding that O’Melveny & Myers completely undermined the “no duty” rule and freed defendants to assert state law affirmative defenses, such as failure to mitigate damages, against the FDIC); FDIC v. Gladstone, 44 F. Supp. 2d 81, 89 (D. Mass. 1999); FDIC v. Haines, 3 F. Supp. 2d 155 (D. Conn. 1997); RTC v. Liebert, 871 F. Supp. 370 (C.D. Cal. 1994).   A few courts have reached contrary results and held that O’Melveny & Myers should be limited to its facts. See, e.g., FDIC v. Healey, 991 F. Supp. 53 (D. Conn. 1998); see also Grant Thornton, LLP v. FDIC, 535 F. Supp. 2d 676 (S.D. W. Va. 2007); FDIC v. Raffa, 935 F. Supp. 119 (D. Conn. 1995). These decisions are based upon the rationale that it is inappropriate to second-guess the conduct of federal banking agencies. See generally, Healey, 991 F. Supp. at 58-63. This reasoning, however, directly contradicts O’Melveny & Myers, which rejects the notion of federal common law used as a shield for affirmative defenses that would otherwise be available. O’Melveny & Myers, 512 U.S. at 86.

 

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On August 22, 2011, when the FDIC filed a lawsuit related to the collapse of Silverton Bank, which is Georgia’s largest failed bank, the named defendants included not only bank officers that the regulators allege are responsible for the bank’s failure, but also the bank’s former outside directors and even the bank’s D&O insurers. A copy of the FDIC’s complaint, which was filed in the Northern District of Georgia, can be found here. Scott Trubey’s August 22, 2011 Atlanta Journal Constitution article about the lawsuit can be found here.

 

In addition, and as discussed further below, on August 23, 2011, the FDIC separate filed an action in the District of Arizona against certain directors and officers of the failed First National Bank of Nevada.

 

When Silverton failed on May 1, 2009, it had assets of over $4 billion. Prior to its collapse, Silverton had done business as a “banker’s bank” and had been chartered to do serve the needs of community financial institutions, by providing correspondent and clearinghouse services. The bank eventually expanded into residential and commercial real estate acquisition and development loans, which it accomplished through “participations” in which the Bank shared funding and risk with other banks.

 

The FDIC’s complaint alleged that its case represents “a text book example of officer and directors of a financial institution being asleep at the wheel and robotically voting for approval of transactions without exercising any business judgment in doing go.” The complaint, which seeks recovery of damages of $71 million, asserts claims against the individual defendants for negligence, gross negligence, breaches of fiduciary duty and waste.

 

The individual defendants named in the lawsuit include not only the bank’s former President and CEO and two other former bank officers, but also 14 additional former outside board members. In naming the outside directors, the FDIC stressed that what makes this case “so unique and troubling” is that the bank’s board was not composed of “ordinary businessmen” but, rather, in view of the bank’s business as a banker’s bank, of individuals who were all CEOs or presidents of other community banks. These outside board members “by virtue of their elevated positions within their own banks, were more skillful and possessed superior attributes in relation to fulfilling their duties” than “others who may serve in this capacity.

 

The complaint alleges that the individual defendants allowed the bank to pursue a strategy of rapid expansion, particularly with respect to commercial real estate lending, just as the economy started to head south, and allowed the bank to continue to pursue this strategy even after the signs of economic problems began to mount. The complaint alleges that the bank’s “aggressive banking plan” was accompanied by weaknesses in loan underwriting, credit administration and a complete disregard of a declining economy, which “led to the failure of the Bank.”

 

The complaint also alleged that the individual defendants “directed the Bank on a course of expansive and extravagant spending on unnecessary items for the Bank after the economy began to decline.” The individual defendants are alleged to have “authorized the purchase of two new aircrafts, a new airplane hanger to house three large and expensive airplanes, and a large and lavish new office building.”

 

In addition to naming the former officials of the failed bank as defendants, the complaint somewhat unconventionally also names as defendants the bank’s two D&O insurers.

 

At the time the bank failed, it carried a total of $10 million of D&O insurance, arranged in two layers consisting of a primary layer of $5 million and an additional $5 million layer excess of the primary. The complaint relates that when the binder for the relevant primary policy was issued on March 3, 2009 (that is, less than two months before the bank failed), the binder listed ten endorsements, including an endorsement containing the so-called regulatory exclusion (for background about the regulatory exclusion, refer here). However, when the primary carrier issued the policy on April 1, 2009, only seven of the ten endorsements that had been listed on the binder were included on the D&O policy. Among the endorsements that were listed on the binder that were not included on the issued policy was the endorsement with the regulatory exclusion.

 

On the afternoon of May 1, 2009 (that is, the day Silverton was closed), a representative of the primary carrier sent an email message that he “had noticed that the Regulatory Endorsement was on the Binder but left off the policy in error,” and attached to the email an endorsement with the Regulatory Endorsement dated May 1, 2009 but with an effective date of March 9, 2009. The complaint characterizes this as a “last minute attempt to unilaterally change the terms of the Policy.” The complaint further alleges that policy issuance terminated the binder.

 

The FDIC’s complaint seeks a judicial declaration that the regulatory exclusion is not a part of the primary or excess policy, and that the Insured vs. Insured exclusion, on which the carriers also purport to rely to deny coverage, does not preclude coverage for the claim. (Refer here for a discussion of the issues surrounding the applicability of the Insured vs. Insured exclusion in connection with a claim involving the FDIC as receiver.)

 

Discussion

The FDIC’s lawsuit against the former Silverton directors and officers is not the first lawsuit filed as part of the current round of bank failures in which the FDIC has included outside directors as defendants. For example, the lawsuit the FDIC recently filed in connection with the collapse of Haven Trust included the failed bank’s former outside directors as defendants, as discussed here.  The FDIC seems to have particularly targeted the outside directors of this failed bank, owing to the unusual circumstance that former directors were all themselves also senior executives of other banking institutions. The FDIC clearly intends to try to bootstrap this fact in order to argue that these specific directors should be held to a higher standard of care. (My recent post on issues surrounding questions of bank director liability can be found here.)

 

Upon reflection of the unique circumstances by which these directors came to be on the Silverton board, it occurs to me that the FDIC may have certain additional motivations in pursuing claims against the former outside directors of the bank. The parrticular circumstance I have in mind is the fact that each of these outside directors of Silverton was also an officer of another banking institution. To the extent these individuals were serving on the Silverton board at the direction of the sponsoring institution, these individuals potentially could have coverge for claims in connection with their Silverton board service under the outside director liability provisions of their sponsoring bank's D&O insurance policies. I am expressing no views on whether or to what extent such coverage actually would be available, nor could I without further information about their sponsoring banks' D&O insurance policies and about the circustances by which they came to be on the Silverton board. My purpose in noting the observations here is simply to suggest this possible additional motivation that the FDIC might have in pursuing claims against these particular outside directors. In any event, the outside director liability coverage, if any, under the sponsoring company's D&O insurance may be limited to outside director service on nonprofit boards.

 

The FDIC’s inclusion of the D&O insurers as parties defendant in the liability lawsuit is unorthodox to say the least. One the one hand, as the complaint recites, the D&O insurers have denied liability for the FDIC’s claim, which might set the predicate for a more conventional (and separate) declaratory judgment action against the carrier. From reading the complaint, it seems that the primary carrier’s belated attempt to correct the omission of the regulatory exclusion from primary policy may explain the FDIC’s more aggressive approach here.

 

Whatever else may be said about the FDIC’s inclusion of the insurers as defendants in this lawsuit, the alleged facts provide a veritable parable about the importance of making sure that the issued policy matches the terms of the binder. It will be interested to see how the Court addresses what allegedly appears to be a policy issuance error, as the insurance arrangement to which the parties had agreed unquestionably was intended at the time of contract formation to include a regulatory exclusion.  For that matter, it will be interested to see whether the Court permits the coverage action to remain joined with the underlying liability action, and whether or not the Court will permit the two related actions to go forward at the same time.

 

FDIC Also Files Lawsuit Against Former Officials of First National Bank of Arizona: In addition to its new lawsuit against the Silverton officials, the FDIC also filed a separate lawsuit in August 23, 2011 in the District of Arizona  against two former directors and officers of First National Bank of Arizona,  which had been one of the sister banks of First National Bank of  Nevada until they merged shortly before FNB Nevada failed. FNB Nevada was among the first banks to fail as part of the current round of bank falures when it failed on July 25, 2008. A copy of the FDIC's complaint in the case can be found here.  

 

The complaint alleges breach of fiduciary duty, negligence and gross negligence against the former officers, asserting that they cause the bank to sustain "losses from the unsustainable business model they promoted for FNB Arizona's loan portfolio -- a model that depended on real estate values rising indefinitely and low defaule rate." The complaint alleges that "when the real estate market collapsed and default rates skyrocketed, FNB Arizona was left holding millions of dollars of bad loans it could not sell." The FDIC alleges that as a result of the defendants' conduct, the FDIC has sustained losses in excess of $193 million.

 

 

The Current FDIC Failed Bank Lawsuit Count: These complaints represent the tenth and eleventh that the FDIC has filed against former directors and officers of a failed bank as part of the current round of bank failures. The Silverton lawsuit represents the third so far in Georgia. There undoubtedly will be more lawsuits to come, as the FDIC has indicated on its website that as of August 4, 2011, it has authorized suits in connection with 30 failed institutions against 266 individuals for D&O liability with damage claims of at least $6.8 billion. With the Silverton Bank and FNB Nevada lawsuits, the FDIC has now filed suits in connection with eleven failed institutions against 77 individuals. Even just taking account of the lawsuits that have already been authorized, there are many more suits to come, and undoubtedly even more lawsuits will be authorized.

 

But with the back to back arrival of these two lawsuits in the space of two days, both involving banks the failed early on the the bank failure wave, there is a sense that the long lagtime associated with the FDIC's lawsuit filings may be over. For what it is worth, both of these new complaints both involve the same lawfirm on behalf of the FDIC, the Mullin Hoard & Brown law firm of Amarillo, Texas.

 

It is probably worth noting that the FDIC’s lawsuit is not the first to be filed against the former directors and officers of Silverton. As reflected here, the bank’s defunct parent company earlier this year filed suit against the bank’s former CEO and its former accountant and accounting firm, seeking about $65 million in damages.

 

Special thanks to the several readers who sent me copies of the Silverton complaint and related links. Special thanks also to the loyal reader who sent me a copy of the FNB Nevada lawsuit as well.

 

Number of Problem Banks Declines: According to the FDIC’s latest Quarterly Banking Profile, released on August 23, 2011 (refer here), the number of problem institutions during the second quarter of 2011 declined to 865, from 888 at the end of the first quarter of 2011. This reduction represents the first quarterly decline in the number of problem institutions in 19 quarters. (The FDIC identifies banks as problem institutions as those that are graded a 4 or a 5 on a 1-to-5 scale as a result of “financial, operational, or managerial weaknesses that threat their continued financial viability.” The FDIC does not release the names of the individual problem institutions.)

 

While the quarterly decline in the number of problem institutions is good news, the latest quarterly figure still represents a significant number and percentage of all banks. The 865 problem institutions represents about 11.5% of the 7513 of all reporting institutions. This is slightly lower than the 11.7% of all banks that were rated as problem institutions at the end of the first quarter.

 

With the continued weakness in the sector, the number of failed and troubled banks will continue to remain a concern for some time to come.

 

The FDIC’s August 23, 2011 press release regarding the latest Quarterly Banking Profile can be found here.

               

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In a settlement that apparently will be funded entirely by D&O insurance, the plaintiffs and 23 former executives of the failed Colonial Bank of Montgomery, Alabama have agreed to the settle the class action securities lawsuit that investors filed in connection with the bank’s 2009 collapse,  for $10.5 million. The settlement does not resolve the plaintiffs’ claims against the offering underwriter defendants nor does the settlement include the bank’s former auditor. The settlement is subject to court approval. A copy of the parties’ August 12, 2011 stipulation of settlement can be found here. The plaintiff’s August 12, 2011 motion for settlement approval can be found here.

 

When Colonial Bank failed in August 2009, it was the sixth largest U.S. bank failure of all time (as discussed here). The bank, which had assets of $26 billion, was brought down in part due to its involvement in the mortgage securities fraud scheme involving mortgage originator Taylor Bean, as discussed in a recent post. The bank’s holding company filed for bankruptcy shortly after the bank’s closure.

 

As discussed here, the plaintiffs had actually filed their securities lawsuit in February 2009, prior to the bank’s demise. The plaintiffs initially alleged that the defendants failed to disclose that "Colonial would be required to raise additional outside capital of $300 million before it could receive the $550 million in TARP funding." The complaint further alleges that Colonial "belatedly disclosed" this requirement, its share price plunged. The plaintiffs’ 334-page consolidated amended complaint (here) contains significantly broader allegations and contends that the defendants engaged in a broad, multipart fraudulent scheme that led to the bank’s collapse.

 

Given the bank’s size prior to its failure, and the high-profile nature of the allegations, including the bank’s association with the Taylor Bean fraud, the relatively modest $10.5 million settlement may seem low, especially by comparison to the string of nine-figure securities class action lawsuit settlements that recently have been announced (refer for example here). However, the dollar figure may also be reflective of the particularly challenging circumstances claimants may face when trying to pursue claims against the former officials of a defunct organization.

 

Without a solvent entity to fund claims settlements, the claimants may be left to try to salvage what they can from the remaining D&O insurance, which represents at best a declining fund that will only become smaller the longer the case continues and the more vigorously the parties contest the case, as defense expenses erode the limit of liability. The vulnerability of the insurance funds to claims cost erosion is a particular problem in a situation like this, where there are multiple proceedings and multiple parties.

 

Indeed, in their memorandum in support of their request for preliminary court approval of the settlement, the plaintiffs argue that the settlement represents n “outstanding result” given that they were facing a “significant risk of no or a much smaller recovery after protracted litigation.” The motion papers attribute this risk to the holding company’s bankruptcy and to “the limited resources of the primary Director and Officer defendants and the limited insurance policy proceed available.”

 

With respect to Colonial’s insurance, the plaintiff’s motion papers report that the bank had “a total of $35 million in liability insurance,” which were in the form of “wasting insurance policies.” At the time of the mediation “less that $32 million in funds remained available to satisfy all claims,” including not only the securities class action lawsuit but also a separate shareholder derivative suit filed on behalf of the company and the “claims of the FDIC-Receiver” as well as other matters.

 

In any event, this settlement is to be entirely funded by D&O insurance. Paragraph 6 of the settlement stipulation says that the Settling Defendants’ Insurance Carriers “shall pay the sum of $10,500,000 in cash into the Escrow Account.” (The carriers involved are identified in the definitions section, on page 13 of the stipulation.) The absence of any contribution to the settlement from the individual defendants is explained in the motion papers, which report that “during the mediation process, the plaintiffs acquired certain confidential financial information from certain selling Defendants that reflected an inability to contribute in any meaningful way to the settlement.”

 

Though this settlement may appear relatively modest, it may be worth noting that the settlement does not include the offering underwriter defendants or the bank’s former auditor, against whom the case will continue. Whether the plaintiffs ultimately will be able improve their overall recovery with settlements with these other defendants remains to be seen, but there is at least that possibility.

 

This settlement certainly reduces the insurance funds out of which the FDIC might have hoped to extract a recovery by pursuing claims against the bank’s former directors and officers. The reduction of the amount of insurance does underscore one problem the FDIC may face in pursuing claims against former directors and officers of some failed banks, which is that the FDIC may be a competition – or even in a race – with shareholder plaintiffs to try to capture remaining D&O insurance policy proceeds, before they are eroded by defense expense. That said, it does seem like an attempt was made as part of this settlement to preserve some remaining portions of the bank’s D&O insurance in order for them to defend or resolve the FDIC’s claims.

 

I have in any event added the Colonial Bank settlement to my running tally of subprime and credit crisis-related case resolutions, which can be accessed here.

 

Among the individual defendants party to this settlement is Colonial’s colorful and controversial former Chairman and CEO, Bobby Lowder. In addition to Colonial, Lowder has long been associated with Auburn University. I discussed Lowder’s Auburn connection in a prior post, which can be found here.

 

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In the wake of the current round of bank failures, the FDIC has filed a number of lawsuits against former directors and officers of failed banks, and has indicated that it intends to file more. Among the issues this litigation raises is the question of when the former directors of a failed bank can be held liable. As discussed in an August 10, 2011 memo from the Manatt, Phelps & Phillips law firm (here), a recent decision a case in the Central District of California involving a failed credit union may provide some insight into this question.

 

First, some background. Section 11(k) of the Federal Deposit Insurance Act provides that directors and officers of failed institutions can be held liable “for gross negligence.” in an action brought by the FDIC in its role as receiver.  As explained in the FDIC’s online materials about professional liability claims, case law interpreting this statute has established that “state law, not federal common law provides the liability standard for directors and officers, and that section 11(k) provided a gross negligence floor for the FDIC claims in states with insulating statutes.” (State insulating statutes allow corporations to amend their bylaws to limit the civil liability of the corporations’ directors.) As a result, even in states with insulating statutes, directors cannot protect themselves from FDIC claims based on gross negligence. 

 

The recent decision in the Central District of California involved a case brought by the National Credit Union Administration (NCUA) against 16 former directors and officers of Western Corporate Federal Credit Union (WesCorp). As discussed at greater length here, the NCUA alleged that the defendants had allowed WesCorp to purchase vast amounts of securities backed by Option ARM mortgages without appropriate analysis of the creditworthiness of the underlying securities or appropriate regard for the limits on concentrations in the company’ s portfolio.

 

In an August 1, 2011 order (here), Central District of California Judge George Wu granted the director defendants’ motion to dismiss the NCUA’s most recently amended complaint, for reasons discussed in the court’s July 7, 2011 minute order (here). In the July 7 minute order, Judge Wu noted that “the business judgment rule protects the director defendants,” adding that the director defendants “may have made choices—or not made choices – with which the NCUA disagrees, but that does not mean they failed in their responsibilities so severely that they lose the protection of the business judgment rule.”

 

Judge Wu drew a distinction between the officer defendants (whose dismissal motion he denied) and the director defendants, observing that “the question in assessing the director defendants’ liability vis a vis the Option ARMs and concentration levels is what the director defendants knew at the time that should have dictated to them that they do something more or different from all that they did do.” He concluded that the NCUA has “failed to present sufficient allegations in this regard, so as to fit within the exceptions to the business judgment rule.”

 

The law firm memo linked above observes that the holding in the WesCorp case is “equally applicable to actions brought by the FDIC against former directors of a failed bank.” In that regard, it is worth noting that the FDIC itself has said, in its online materials describing its approach to professional liability claims, that it is the FDIC’s “long-standing internal policy” of pursuing claims against outside directors only where “the facts show that the culpable conduct rises to the level of gross negligence or worse.” In other words, the FDIC itself has said that it is not its policy to pursue claims against directors based on mere negligence.  The law firm memo suggests, by reference to the WesCorp case, that conduct within the protection of the business judgment rule by definition is not grossly negligent, and therefore cannot serve as a basis for director liability.

 

In the law firm memo, the author notes that the misconduct that the FDIC has alleged in many of the cases it has filed as part of the current wave of bank failures arise in the context of the collapse of the residential real estate market and against the background of the global economic crisis. In light of those circumstances, the FDIC’s allegations may be susceptible to the argument that it is “attempting to substitute its after-the –fact judgment for that of the board made in real time.” The business judgment rule exists to “prevent a court from second guessing honest, if inept, business decisions.”

 

Directors’ protections under the business judgment rule may, however, be overcome where, for example, there is evidence that the directors’ “improper motives or undue influence, conflict of interest” or where the directors failed to be “fully informed before making decisions.”

 

The possibility of being drawn into an FDIC lawsuit is a recurring source of anxiety for outside directors of failed or troubled banks. Indeed, the FDIC has filed a number of these suits and clearly intends to file more. But directors concerned about the possibility of this type of litigation can be reassured, first, that it is the FDIC’s own policy only to pursue claims against outside directors where it believes there is evidence of gross negligence, and, second, that as a result of the protections of the business judgment rule, the directors cannot be held liable for actions that merely prove to have been mistaken or even inept. Judge Wu’s ruling in the Wescorp provides directors reassurance that defendant directors may even be able to get the claims against them dismissed -- even if claims against the officer defendants are not -- where the allegations presented are insufficient to meet these requirements.

 

The law firm memo concludes with a number of lessons for current bank directors from the current environment and from the FDIC’s allegations in the cases that it has filed so far. Among other things, the memo’s author notes the following: that board membership is a serious responsibility for which the individual directors must be willing to devote “substantial amounts of time” in order to perform their duties in accordance with the FDIC’s expectations;  that board members are “charged with holding management’s feet to the fire in addressing strategic challenges and operational problems”; that directors must act independently and must not “turn a blind eye to unsafe or unsound practices; and that directors “must be very sensitive to the appearance of a conflict of interest.”

 

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On July 14, 2011, the FDIC filed a lawsuit in the Northern District of Georgia against 15 former directors and officers of Haven Trust Bank of Duluth, Georgia. This suit is the ninth the FDIC has filed as part of the current bank failure wave and the second that the FDIC has filed in Georgia. A copy of the FDIC's complaint can be found here. Scott Trubey’s July 14, 2011 Atlanta Journal-Constitution article describing the lawsuit can be found here.  

 

Haven Trust was one of the earliest bank closures of the current wave when it failed on December 18, 2008. The bank’s failure has already been the subject of extensive litigation. In late December 2008, the bank’s investors filed a securities class action lawsuit against the former directors and officers of the bank. But as discussed here, on January 14, 2011, Northern District of Georgia Judge Charles A. Pannell, Jr. granted the defendants’ motion to dismiss the securities suit.

 

The FDIC’s suit filing against the Haven Trust officials may come as little surprise; indeed, as discussed here, the FDIC had previously sought to intervene in the investors’ securities suit. Among other considerations the FDIC cited as part of its bid to intervene was the FDIC’s own intention to assert claims against the individual defendants and the FDIC’s concomitant “interest” in the bank’s D&O insurance. On December 29, 2010, Judge Pannell denied the FDIC’s motion to intervene, as discussed here. He specifically rejected the argument that the FDIC has a “legally protectable interest” in the D&O insurance, as a mere prospective claimant.

 

In its lawsuit, the FDIC accuses the former directors and officers of gross negligence and alleges that they breached other duties. The complaint specifically alleges improper lending practices and seeks to recover over $40 million. Among other things, the FDIC alleges that the bank suffered losses of over $7 million on improper loans to family members of two bank insiders.

 

While this lawsuit is only the second that the FDIC has filed against former directors and officers of a failed Georgia bank as part of the current round of bank failures, there undoubtedly will be many more to come. Georgia, with 65 bank failures since mid-2008, has had more bank failures than any other state during that period. The prior FDIC lawsuit involving a Georgia bank failure was the lawsuit filed in January 2011 against former directors and officers of Integrity Bank, about which refer here. 

 

Though the FDIC has so far filed only nine lawsuits against failed bank officials, many more lawsuits will be coming. According to the professional liability lawsuit page on the FDIC’s website (which can be found here), the FDIC had as of July 7, 2011 authorized lawsuits against 248 individuals at 28 failed institutions. Even with the Haven Trust lawsuit, the FDIC has sued only 68 individuals in connection with nine failed institutions. Many more suits have been authorized, and it seems likely that even as the suits already authorized are filed, even more with be authorized in the months ahead.

 

Haven Trust was one of the first banks to fail back in late 2008, and the FDIC is just getting around to filling suit now. Since Haven Trust failed, well over 300 other banks have failed, and further bank failures seem likely. Given the lag time on the Haven Trust lawsuit, the FDIC lawsuits could continue to accumulate for at least another three years or more.

 

A Final Observation: The online registration form for Google+ provides the following choices for the registrant’s gender on a drop-down menu: “Male,” “Female,” and “Other.”

 

“Other”?

 

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The short week after the July 4^th holiday is usually quiet. There certainly did seem to be less traffic on the roads. But nevertheless, there was news of note this past week on several stories we have been following, as discussed below. The traffic on the roads may have slowed but the circulation on the information superhighway continued unabated.

 

Pace of Bank Failures Slows – But More Closures Loom: Earlier this year (refer here), I had noted that it seemed as if the pace of bank failures had finally started to decline. As discussed in a July 9, 2011 Wall Street Journal article (here), the pace of bank failures did indeed slow  in the first half of 2011, compared both to the equivalent period a year ago as well as to the second half of last year. There were 48 bank failures in the first half of 2011, compared to 74 in the second half of 2010 and 86 in the first half of 2010.

 

This slowdown is consistent with the FDIC’s projections. The agency had previously indicated that it believed 2010 would represent a high water mark for bank failures. But while the pace of bank closures has finally started to slow, the wave of bank failures is far from finished. As I noted here, the FDIC’s most recent Quarterly Banking Profile, released in May, showed that the number of “problem institutions” was a record levels, a situation that the Journal article characterized as representing a “backlog” of troubled banks. The FDIC reported that as of the end of March 31, 2011 there were 888 “problem institutions.”

 

And while the 48 bank failures in the year’s first half represents a decrease compared to recent periods, that figure still represents a sizeable number. By way of comparison, in 2008, when the financial crisis reached its crescendo, there were only 25 bank failures. Moreover, it is clear that bank failures will continue for the foreseeable future, even if at reduced levels from a year ago. Indeed, on Friday evening – the first Friday of the year’s second half – the FDIC took control of three more institutions.

 

The Journal article quotes one commentator as saying that historically about 19% of the banks on the FDIC’s problem list wind up failing, which implies about 169 bank failures after March 31, 2011. Since 22 banks failed in the second quarter of 2011, that would suggest that there may be about 147 bank failures yet to go. The completion of the current  bank closure process could, according to a source cited in the Journal article, take about two more years. As another commentator quoted in the article put it, the process is about in “the seventh inning” of the cycle of failures.

 

Though the bank closure process may now be slowing and will run its course in time, the mopping up process may only have just begun. Allowing for the extensive post-mortem that follows each failure, and the attendant lag time before the FDIC initiates litigation against the directors and officers of failed banks, the era of failed bank litigation may just be getting started. If the wave of bank failures is in the seventh inning, we are much earlier in the bank litigation wave ball game. Refer here for my recent review of the details surrounding the failed bank litigation.

 

U.S. Investors Are Not the Only Ones Concerned About Chinese Company Accounting Scandals: As various accounting scandals involving U.S.-listed Chinese companies have emerged, shareholders have launched a series of lawsuits in the U.S. against the companies and their senior officials, as I have previously noted on this blog. It turns out that U.S. investors are not the only ones upset about the problem involving Chinese companies.

 

A July 8, 2011 Bloomberg article (here) examines the concern that investors in Singapore have about Chinese companies, based on the various accounting issues that have come to light. Among other things, the article states that since 2008, more than ten percent of the Chinese companies listed on the Singapore stock exchange have been delisted or had trading in their shares suspended. The article also reviews investor concerns that executives of Chinese companies are outside the reach of Singapore enforcement authorities.

 

The crescendo of voices raising concerns about the Chinese companies may be being heard in China itself. News reports this past week (refer here) suggest that officials from the SEC and the PCAOB will be meeting with their Chinese counterparts this upcoming week to discuss the possibility of allowing the U.S. regulators to investigate Chinese companies and Chinese audit firms for the first time.

 

In the meantime, however, the wave of lawsuits in the U.S. involving U.S.-listed Chinese companies continues to mount. The latest lawsuit involves A-Power Energy Generation Company, which obtained its U.S. listing by way of a reverse merger with a U.S. listed publicly traded shell company. According to their July 5, 2011 press release (here), plaintiffs’ counsel have filed a securities class action lawsuit in the District of Nevada against the company and certain of its officers. The complaint (which can be found here), refers to published reports describing the company’s auditors concerns about weaknesses in the company’s internal controls and differences between financial figures the company reported to Chinese regulatory source compared to those reported in the company’s SEC filings. On June 28, 2011, the company announced (here) that its auditor had resigned because of the company’s failure to hire an independent forensic accountant to investigate certain business transactions.

 

With the arrival of this latest lawsuit, there have now been a total of 27 securities class action lawsuits filed against U.S. listed Chinese companies so far in 2011, representing about one-quarter of all 2011 securities lawsuit filings in the U.S.

 

One variation on this litigation theme has arisen in a separately filed securities suit that has been brought as an individual action rather than as a class action. As discussed in Jan Wolfe’s July 5, 2011 Am Law Litigation Daily article (here). Starr International has amended its securities suit against China MediaExpress Holdings and certain of its directors and officers to include as defendants three American businessmen who helped the company obtain its U.S. listing by way of reverse merger.

 

While there have been calls to reform the reverse merger process, particularly for foreign companies, if the functionaries that make the process possible are going to find themselves hauled into litigation involving the companies they help to go public, the reverse merger process may cease to exist as a means for non-U.S. companies to use in order to process the more conventional method of going public. In any event, in the current climate, it seems likely that there would be much investor interest in shares of foreign domiciled companies that obtained their U.S. listings by way of a reverse merger.

 

Variation on the Auction Rate Securities Concerns: There have been extensive developments recently involving financial companies involved with marketing or selling auction rate securities, as Tom Gorman summarized in a July 5, 2011 post on his SEC Actions blog. But a new adversary action filed in the Land American Financial Group bankruptcy proceeding shows an interesting variation on the usual auction rate securities litigation theme.

 

As discussed at length in the bankruptcy trustee’s June 24, 2011 complaint (here), Land America had a division (“LES”) whose purpose was to facilitate tax-advantaged land swaps. In essence, a property seller could “park” the proceeds of a land sale with LES until an appropriate land swap counterparty emerged, allowing the “exchange” to take place. The property sales proceeds were invested during the holding period. According to the complaint, beginning in about 2003, LES invested a substantial portion of the proceeds in auction rate securities. When the auction rate securities market froze up in 2008, 41% of LES’s assets were tied up in auction rate securities. The failure of the auction rate securities market eventually created a liquidity crisis for LES and for its parent company. The liquidity crisis, according to the complaint, was a substantial cause in the demise of the parent company.

 

According to the complaint, the parent company (LFG) “met its demise because the LFG and LES directors and officers failed to properly inform themselves and failed to consider and implement any timely action to mitigate the effects of the LES liquidity crisis. These failures caused LFG and its stakeholders to incur hundreds of millions of dollars in damages.”

 

As discussed in this July 8, 2011 Richmond Biz Sense article (here), the bankruptcy trustee is seeking damages of $365 million in the action , which names 21 former Land America directors and officers as defendants. The article quotes sources as saying that “the purpose of the suit is to trigger insurance policies that protect executives and directors in such instances.” 

 

Though the lawsuit itself may be an unremarkable bankruptcy-related effort to snare D&O insurance proceeds for the benefit of the bankruptcy estate, the allegations themselves represent an interesting variation from the usual action rate securities allegations. The typical auction rate securities lawsuit involves allegations by the securities buyer against the firm that sold the securities. Here the allegations are brought against the buyer’s own company officials in connection with the purchases.

 

These kinds of auction rate securities allegations are not unprecedented – as I have previously noted (for example, here), there have been prior lawsuits brought against the auction rate securities buyers rather than the sellers. The fact that these kinds of complaints are continuing to arise even critical events of the financial crisis continue to recede into the past suggests that while time may have passed, the critical effects of the crisis remain. And the lawsuits continue to mount.

 

Special thanks to a loyal reader for forwarding the news article about the Land America case.  

 

Second Circuit Rules out RICO Claims Against Securities Fraud Aiders and Abettors: One of the interesting questions is whether private claimants, foreclosed from pursuing claims against third parties for aiding and abetting securities law violation, could pursue their aiding and abetting claims against the third parties under RICO. In a July 7 decision (here), in a case captioned MLSMK Investment Company v. J.P. Morgan, the Second Circuit held that the aggrieved investors cannot pursue the aiding and abetting claims under RICO.

 

Alison Frankel has an excellent summary of the legal issues and of the holding in her July 8, 2011 article on Thompson Reuters News & Insight (here). As Frankel’s article discusses, the case has mostly drawn attention for its connection to the Madoff scandal and for its implications for the Madoff trustee’s pending claims against certain litigation targets. However, as she notes, the case does “far more” – it “forecloses the only possible route to recovery through federal court for securities investors suing defendants who help a company engage in securities fraud.” Frankel’s interesting article details the larger significance of the decision.

 

Special thanks to the several loyal readers who called this decision to my attention and for sending me a link to Frankel’s article.

 

Apologies: I would like to extend my regrets that on two occasions this part week there were duplicative email distributions in connection with a single new blog post publication. I am very sorry to have burdened anyone’s email box with duplicative email distributions. The duplicate emails were an unfortunate byproduct of an error I made in putting content up on my site for publication. It really was a rookie mistake, and even worse, I made the same mistake twice in the same week. Some readers may have found that they were unable to access the links in the initial email distributions.

 

The good news is that I know what caused the duplicate email distributions and I will take steps to try to ensure that the duplicate distributions do not recur.

 

I really feel bad about the duplicate email distributions. I really want to make it up to everyone. So what I have decided to do is to send everyone a bunch of roses. Wild roses. Please accept these flowers with my sincerest apologies.

 

 

Wild Roses

Shaker Heights, OH, Bicycle Path

July 6, 2011

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In the eighth lawsuit that the FDIC has filed so far as part of the current round of bank failures, on July 6, 2011, the FDIC filed suit in the Central District of California against former IndyMac CEO, Michael Perry. The FDIC’s complaint can be found here.  

IndyMac failed nearly three years ago, on July 11, 2008, as discussed here. The FDIC’s complaint against Perry alleges that he caused over $600 million in losses by causing the bank to purchase mortgage loans in 2007, just as the mortgage marketplace was destabilizing. The complaint alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses.

 

The news articles report that the Complaint alleges the “instead of enforcing credit standards, Perry chose to roll the dice in an aggressive gamble to increase market share while sacrificing credit standards.”

 

Even though its complaint against Perry is only the eighth so far during the current banking crisis, the lawsuit is the second that the FDIC has filed against former IndyMac executives. As discussed at length here, the first lawsuit the FDIC filed during the current round was filed in July 2010 against four former officers of IndyMac’s Homebuilder Division.

 

The FDIC’s concentration on IndyMac likely has something to do with the fact that the bank’s closure represented the second largest bank failure as part of the current banking crisis, following only the massive WaMu failure. (IndyMac has assets of about $32 billion at the time of its closure). IndyMac was also one of the earliest banks to fail – it was just the fifth bank to fail during 2008, while there have been well over 300 bank failures since then. So the FDIC’s post-mortem processes may be further along on IndyMac than with respect to the many other bank failures that have followed.

 

The FDIC’s lawsuit is far from the first legal imbroglio in which Perry has become involved. As discussed here, on February 11, 2011, the SEC filed a lawsuit against Perry and two other former IndyMac officers, accusing them of “misleading investors about the mortgage lender’s deteriorating financial condition.”

 

Perry is also one of the defendants named in the consolidated securities class action lawsuit first brought in the Central District of California in 2007 by IndyMac shareholders. The shareholder suit has a long and involved history, as discussed here. On March 29, 2010, Central District of California Judge George Wu denied the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint, while at the same time certifying the case for interlocutory appeal to the Ninth Circuit. Judge Wu’s order can be found here.

 

In any event, a list of the eight lawsuits that the FDIC has filed can be found on the FDIC’s website, here. As noted on the same page, as of July 7, 2011, the FDIC “has authorized suits in connection with 28 failed institutions against 248 individuals for D&O liability with damage claims of at least $6.8 billion.” Since the eight lawsuits filed so far involve only seven institutions and only 53 former directors and officers, there clearly are many more lawsuits (perhaps as many as 21 or more) the FDIC is preparing to file. In all likelihood, even further lawsuits will be approved in the future as well. All of which means that we could be heading into a period of very significant failed bank litigation.

 

Readers who scan the FDIC’s website closely will undoubtedly notice that one of the eight lawsuits has already settled. The settled case  is the lawsuit the agency filed in March 2011 in connection with Corn Belt Bank and Trust Company (about which here). As reflected in the FDIC’s May 10, 2011 motion (here), the parties settled the case. However, the court records do not reveal any of the details of the settlement.

 

The Name Game:  As far as I am aware, Michael Perry, the former Indy Mac CEO, is not related to Michael Dean Perry, who played football in the NFL, for the Cleveland Browns among others, during the 80s and 90s. According to Wikipedia (here), Michael Dean Perry had a McDonald’s hamburger sandwich named after him – the “MDP,” which was only served in Cleveland-area McDonald’s while Perry played for the Browns. As far as I am aware, the former IndyMac CEO did not have a sandwich named after him.

 

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According to FDIC’s Quarterly Banking Profile, released on May 24, 2011 (refer here), the pace of bank failures slowed during the first quarter. However, both the absolute and relative number of problem institutions continued to increase, albeit at a reduced pace compared to recent quarters. The FDIC’s May 24, 2011 press release about the Quarterly Banking Profile can be found here.

 

During the first quarter of 2011, 26 banking institutions failed, compared to 41 in the first quarter of 2010. The total of 26 bank failures in the first quarter is the smallest quarterly number of bank failures in seven quarters.  (My prior post on the declining pace of bank closures can be found here.) A total of 43 banks have failed year to date in 2011 as of May 25, 2011.

 

As of the end of the first quarter 2011, there were 888 “problem institutions,” compared to 884 at the end of 2010 and 775 at the end of the first quarter 2010. The increase in the number of problem institutions during the twelve month period ending March 31, 2011 is 113, or about 14.5%. (The FDIC identifies banks as problem institutions as those that are graded a 4 or a 5 on a 1-to-5 scale as a result of “financial, operational, or managerial weaknesses that threat their continued financial viability.” The FDIC does not release the names of the individual problem institutions.)

 

 The increase of only four additional problem institutions since year-end 2010 represents only a slight increase in the number of problem institutions. In its press release, the FDIC noted that this increase is “the smallest increase in three and a half years.” However, the 888 problem institutions as of March 31, 2011 represent the larges number of problem institutions since March 31, 1993, when there were 928.

 

The number of problem institutions as a percentage of all reporting institutions has continued to increase. This is not only due to the increase in the absolute number of problem institutions but also because of the declining number of reporting institutions. The decline in the number of reporting institutions is not only due to bank failures, but also due to mergers and acquisitions.

 

The 888 problem institutions as of March 31, 2011 represent about 11.7% of all 7574 reporting institutions. By way of comparison, the 775 problem institutions as the end of the first quarter 2010 represented only about 9.7% of all 7,934 reporting institutions as of that date. So both the absolute and relative numbers of problem institutions has increased substantially during the 12 months ending March 31, 2011.

 

Though the number of problem institutions has continued to increase, the aggregate assets those problem institutions represent has decreased. Thus the 775 problem institutions as of March 31, 2010 represented assets of $431 billion, whereas the 888 problem institutions as of March 31, 2011 represented assets of $387 billion.

 

With all of the remaining numbers of problem institutions, there are still a lot of challenges in the banking industry. There may yet be more bank failures yet to come, perhaps many more. However, the overall message of the Quarterly Banking Profile is guardedly upbeat. The press release quotes the FDIC Chairman Sheila Bair as saying that “the industry shows signs of improvement, “ and adding that “the process of repairing bank balance sheets is well along, but is not yet complete.”

 

As I have noted elsewhere, the numbers of bank failures overall may be slowing, but the lawsuits involving directors and officers of failed institutions may just be ramping up – slowly

 

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One of the ways in which the current wave of bank failures is different from the failures during the S&L crisis is that this time around, by comparison to that prior period, a number of the bank closures have been accompanied by shareholder lawsuits brought  against the former directors and officers of the failed institutions. Some of these shareholder suits have survived dismissal motions, as was the case, for example, with the lawsuit involving Corus Bankshares, the recent settlement of which is discussed below.

 

But there have also been a number of these failed bank shareholder suits that have not survived the preliminary motions, as was the case with the shareholder suit involving UCBH Holdings, as also described below. To be sure, the court’s grant of the UCBH defendants’ motion to dismiss is without prejudice. But in view of the nature of the factual allegations involved, the dismissal motion ruling is noteworthy. In particular the court’s consideration of the FDIC’s regulatory actions regarding the bank are particularly interesting.

 

UCBH was the holding company of United Commercial Bank of San Francisco. The FDIC took control of United Commercial Bank on November 6, 2009 (refer here). Shareholders filed a securities class action lawsuit in the Northern District of California against eight officer defendants and six director defendants, as discussed at greater length here. Their complaint originally named UCBH  as well, but following UCBH’s November 25, 2009 bankruptcy filing, the claims against UCBH itself were stayed.

 

The plaintiffs allege that during the class period  the defendants issued false and misleading statements concerning UCBH’s allowances and provisions for loan loss and falsely represented that the company’s financial reporting controls were effective. The complaint further alleges that on May 8, 2009, the company’s auditor, KPMG, met with the FDIC and state banking authorities to discuss the deterioration in asset quality and overall deterioration of UCBH’s financial condition.

 

On May 13, 2009, KPMG alerted UCBH’s audit committee that illegal acts may have occurred relating to the overvaluation of impaired and real estate owned loans. The audit committee investigated. On September 8, 2009, the company announced that as a result of the investigation UCBH was required to restate its financial statements and that UCBH had reached a consent agreement with FDIC relating to a cease and desist order concerning alleged improprieties. UCBH’s  stock value fell and the bank ultimately was closed.

 

The defendants moved to dismiss the plaintiffs’ complaint. In a May 17, 2011 order (here), Northern District of California Judge Jeffrey S. White granted the defendants’ motion to dismiss without prejudice, on the grounds, inter alia, that the plaintiffs had not adequately alleged scienter.

 

In concluding that the plaintiffs allegations were insufficient to create a strong inference scienter, Judge While found that the plaintiffs allegations based on UCBH’s statements about the efforts of “senior management” to monitor and evaluate the bank’s loan portfolio did “not contain sufficiently particularized allegations to give rise to a strong inference of scienter.” Similarly, Judge Whit found that the plaintiffs’ allegations that the senior officers were motivated to conceal UCBH’s financial condition in order to obtain TARP funds also failed to allege that the these defendants had information about the bank’s financial condition that was withheld or falsely reported.

 

The more interesting part of Judge White’s scienter analysis concerned the plaintiffs’ efforts to rely on the FDIC’s actions and findings. In particular the plaintiffs sought to rely on the findings in the FDIC’s “material loss review” (MLR) that “senior executives” engaged in deliberate misconduct to conceal the Bank’s deteriorating financial condition by delaying risk downgrades and minimizing the bank’s loan loss allowance. Judge White observed that these allegations do not support a strong inference of fraud “as to any one Defendant,” since the MLR does not name “any particular individual as responsible for the alleged misconduct.”

 

The plaintiffs also sought to rely on the FDIC’s report of examination in April 2009 and KPMG’s May 2009 report to the company’s audit committee to establish scienter, but Judge White found that the allegations do not establish when the defendants became aware of the alleged misconduct and which defendants became aware.

 

Finally Judge White rejected plaintiffs attempt to rely on the “core operations inference” to satisfy the scienter pleading requirement, essentially arguing that the matters alleged to be misrepresented were so essential  to the bank’s core operations as to establish that the defendants had access to the disputed information. Judge White rejected this suggestion, concluding that the plaintiffs had not sufficiently alleged that the loan loss allowances and provisions were part of the bank’s “core operations.”

 

Judge White’s ruling in the defendants’ favor on the dismissal was without prejudice, and the plaintiffs were given leave to replead. It may be that the plaintiffs will overcome the pleading deficiencies in their amended complaint – indeed, in many respects Judge White’s opinion provides a roadmap for repeading.

 

Nevertheless it is striking that the dismissal motion was denied in a case where the company’s own auditor reported that illegal acts may have occurred and where company’s own audit committee investigation preceded a restatement and an entry into a cease and desist order, and where the FDIC itself concluded that the “senior executives” engaged in deliberate misconduct to conceal the bank’s deteriorating financial condition. Judge White’s analysis represents  a very demanding application of the PSLRA’s specificity requirement. In particular, his unwillingness to accept the FDIC’s conclusions of misconduct involving “senior executives” as sufficient allegations against any one individual defendant is a very exacting application of the standard -- although certainly justified, from the defendants’ perspective.

 

It of course remains to be seen whether the plaintiffs will be able to cure the deficiencies on repleading.. But it is noteworthy that the UCBH is only one of several shareholder suits filed against directors and officers of failed banks that have faced difficulties overcoming the initial pleading hurdles. Motions to dismiss have been granted in a number of these cases, including for example the cases relating to Downey Financial (refer here), Fremont General (here) and Bank United (here -- without prejudice).  But as noted below, a number of survived the dismissal motions as well.

 

I have in any event added the UCBH ruling to my running tally of credit crisis dismissal motion rulings, which can be accessed here.

 

Corus Bankshares: Among the failed bank securities class action lawsuit is the one filed against the former directors and officers of Corus Bankshares, the parent company of Corus Bank, which closed on September 11, 2009 (about which refer here). As discussed here, in April 2010, Northern District of Illinois Judge Elaine Bucklo denied the defendants’ motion to dismiss (The opinion that stands in interesting contrast to Judge White’s opinion in the UCBH case.)

 

On May 17, 2011, the parties to the Corus Bankshares case filed a stipulation of settlement (here) indicating that the case has been settled for $10 million, all which is to be paid for by company’s D&O insurance. I have added the Corus settlement to my list of credit crisis securities lawsuit settlements, which can be accessed here.

 

As a result of its relatively modest size, the Corus settlement may not seem particularly noteworthy, which may be a fair assessment. What strikes me about the Corus settlements is that it represents something that still seems to be surprisingly rare, which is a settlement of credit crisis-related securities class action lawsuit.

 

Even though there were well over 230 credit crisis-related securities class action lawsuits filed, there still have only been 20 settlements of the credit crisis securities suits. To be sure, a fair number of these cases were dismissed, but a substantial number (like the Corus case) were not dismissed. Even though many of these cases are now several years old only a very small number have settled so far – indeed the Corus settlement is only the third such settlement this year.

 

It seems to me that there is a substantial backlog of these as-yet unresolved cases, many of which are moving – apparently very slowly -- toward settlement. Eventually these cases will settle in substantial numbers. Though many of the settlements will, like the Corus settlement, be relatively modest, some will not be so modest and in the aggregate the total settlements will likely represent a very large figure. Even though a large chunk of these settlements may not be insured, a big chunk will be insured. The collective cost to D&O insurers could represent an impressive total. Reasonable minds may question whether or not insurers are now fully reserved for this eventuality.

 

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The FDIC’s pursuit of litigation against directors and officers of banks that have failed as part of the current round of bank failures has been moving forward, albeit at a deliberate pace. The agency’s litigation efforts advanced a couple of steps in recent days, as the agency filed an additional lawsuit and publicly announced that even more are coming.

 

The FDIC filed its latest lawsuit on May 5, 2011 in the Northern District of Illinois. The lawsuit was filed against certain former directors and offices of Wheatland Bank of Napierville, Illinois, of which the FDIC took control on April 23, 2010 (about which refer here). The actual lawsuit in which the FDIC filed its complaint had begun as a shareholders’ derivative lawsuit in Cook County (Illinois) Circuit Court. The FDIC had removed the lawsuit to federal court (refer here) and on May 5, 2011, the federal court granted the FDIC’s motion to intervene as a party plaintiff and to filed its amended complaint.

 

In its complaint (a copy of which can be found here), the FDIC seeks to recover at least $22 million that the bank allegedly sustained in connection with commercial real estate loans (CRE). The complaint asserts claims for gross negligence, negligence, breach of the fiduciary duty of care, breach of the fiduciary duty of loyalty, and failure to supervise. The 6 individual defendants include four directors (two of whom who were also officers of the bank and two of whom were nonofficer directors who served on the loan committee), as well as the bank’s chief lending officer and its chief financial officer.  

 

The complaint alleges that:

 

Defendants recklessly implemented an unsustainable business model pursuing rapid asset growth concentrated in high-risk CRE loans without having adequate loan underwriting and credit administration practices to manage the risk. To make matters worse, the Bank routinely violated whatever loan policies it had in place and approved loans that had little chance of repayment. The Bank also made loans to favored shareholders and borrowers on terms that were preferential and abusive and then, after default, failed to pursue the borrowers and guarantors on these loans. Regulatory warnings about the Bank’s reckless lending practices were repeatedly ignored by Defendants. The out-of-control lending continued until the Bank was closed after only three years of operation.

 

With the filing of the Wheatland Bank complaint, the FDIC has now filed a total of seven lawsuits against former directors and officers of banks that have failed as part of the current round of bank failures. My running list of the FDIC’s lawsuits can be accessed here.

 

Interestingly, three of the seven have been filed against banks that had operated in Illinois. At one level, this not a surprise as Illinois has been of the leading states in terms of the number of failed banks. But there have been more in Georgia (which has only one lawsuit), and the over 360 bank failures since January 1, 2008 have involved banks in many different states. It isn’t clear if there is a reason why the litigation seems to be advancing in Illinois, as opposed to anywhere else.

 

While the FDIC has now filed a total of seven lawsuits against the former directors and officers of failed banks, it seems clear that there are more to come. On May 11, 2011, the FDIC updated its professional liability lawsuit page on its website to reflect that the FDIC has authorized suits against 208 individuals for D&O liability with damage claims of at least $3.86 billion. (The latest update increased the number to 208 from last month’s figure of 187.) Since the seven lawsuits the agency has filed includes only 52 individual lawsuits, there clear implication is that there are many more lawsuits yet to come against the remaining 156 defendants.

 

The FDIC’s website also discloses that the FDIC also has authorized 13 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits. In addition, 135 residential malpractice and mortgage fraud lawsuits are pending, consisting of lawsuits filed and inherited.

 

The number of directors and officers against whom the FDIC has authorized litigation has increased every month since the FDIC first began publishing the data in September 2010. The aggregate figure has increased much more quickly than the total number of individuals against whom lawsuits have actually been filed. The clear implication is that the FDIC is being very deliberate in preparing its claims. The suggestion is that the lawsuits will continue to come in slowly – and that the process of filing the lawsuits may go on for quite a while yet.

 

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When the FDIC released its Quarterly Banking Profile for the fourth quarter 2010, it included a statement from FDIC Chairman Sheila Bair that the agency believes “the number of failures peaked in 2010.” However, at least through the end of February 2011, the evidence was to the contrary, as the number of bank failures during the first two months of 2011 (23), exceed the number through the end of February 2010 (22).

 

However, since the end of February 2011, the number of bank failures has declined sharply. The FDIC closed only three banks during March 2011, and only one since March 11, 2011. As of April 1, 2011, there have been a total of 26 bank failures this year. By the same point in 2010, there had been a total of 41 failed banks.

 

The difference between the two year-to-date tallies is that during March 2010, the FDIC took control of 19 banks, compared to only three in March 2011. In addition, the first Friday in April 2011 also passed without any additional bank failures.

 

The 26 bank failures through the end of March would if annualized project to about 104 bank failures by year end 2001, which would be the lowest annual number of bank failures since 2008 (when there were 25). But if the bank failure pace that prevailed in March 2011 were to continue, the number of bank failures by year end could be well below that projected number.

 

One of the signs that will be interesting to watch is the number of problem institutions reported when the FDIC releases its next Quarterly Banking Profile for the quarter ended March 31, 2011. The Profile is due to be issued sometime later in May. The number of problem institutions has been increasing every quarter for several years now, although the rate of increase has slowed. In its last profile, the FDIC stated that 2010 was a “turnaround” year for the banking industry. If last year truly was a turnaround year, the reported number of problem institutions should finally start to decline -- which, if it were to happen, would tend to support the probability that the slower rate of bank failures could well continue as the year progresses.

 

With the 23 bank failures so far this year, the total number of bank failures since January 1, 2008 stands at 348. Even with this significant number of failed institutions and the amount of time that has passed since the beginning of the current bank failure wave, the FDIC has so far filed lawsuits against the directors and officers of only six failed banks. (Refer here to access a list of the FDIC lawsuits.)

 

On its website, the FDIC reports that as of March 15, 2011, it has authorized lawsuits against a total of 158 individuals. However, the six FDIC lawsuits so far collectively include only about  43 individual defendants, which suggest that there are a number of additional lawsuits being readied and likely to be filed in the near future. In addition, the number of individuals against whom lawsuits have been authorized has grown over recent months to its current level of 158, and since banks have continued to fail in the interim, it seems likely that the authorized number will continue to grow, which would imply an even greater number of lawsuits yet to come.

 

The number of lawsuits that ultimately will be filed remains to be seen. But while that part of the story unfolds, it is noteworthy that for the first time in quite a while, the story appears to be that the number of bank failures is declining. And that sure seems like a good thing to me.

 

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As recently as this past Monday, commentators were grumbling that the FDIC is moving too slowly in pursue claims against former directors and officers of failed banks. The FDIC has responded in dramatic fashion with a March 16, 2011 lawsuit filing in the Western District of Washington against three former Washington Mutual executives, as well as two of the executives’ wives.

 

According to news reports (here), the lawsuit seeks damages of as much as $900 million. The media stories also suggest that there is an agreement by WaMu’s outside directors to pay $125 million to settle claims by the FDIC is pending approval. A copy of the FDIC’s recent complaint against the WaMu executives and their wives can be found here.

 

WaMu’s September 2008 failure (about which refer here), represents by far the largest bank failure in U.S. history. The events surrounding its failure have already been the subject of extensive litigation, not the least of which is a pending securities class action lawsuit filed on behalf of WaMu’s shareholders, which, as noted here, survived a renewed motion to dismiss after the lead plaintiffs amended their complaint.

 

The FDIC filed its recent lawsuit in its capacity as WaMu’s receiver. The lawsuit names as defendants WaMu’s former CEO, Kerry Killinger, its former President and COO, Stephen Rotella, and its chief of home lending, David Schneider. In a rather unusual twist that shows just how aggressively the FDIC may be prepared to get in pursuing these claims, the complaint also names Killinger’s wife, Linda Killinger, and Rotella’s wife, Esther as explained below.

 

The complaint asserts claims against the three executives for Gross Negligence, Ordinary Negligence and Breach of Fiduciary Duty.

 

The complaint alleges that the three defendants caused the bank to take "extreme and historically unprecedented risks with WaMu’s held-for-investment loan portfolio." The three allegedly focused on short term gains, to the disregard of the bank’s long term safety and soundness. The executives, lead by Killinger, allegedly developed an executed a strategy to make billions of dollars of risky residential mortgages, increasing the risk profile of the bank’s held for investment mortgage portfolio.

 

The bank’s business strategy dictated a lending approach for which few lenders were turned away. The bank also layered multiple levels of risk with particularly risk loan products such as option ARM mortgages, the riskiness of which was further compounded by allowing stated income lending and other questionable lending practices.

 

The complaint alleges further that these executives continued to pursue their aggressive growth strategy even at a point when housing prices "were unsustainably high" and while relying upon an aging infrastructure that was inadequate to keep up with the enormous loan volume. The complaint alleges that the three executives knew the strategy was risky, knew the process weaknesses, and even knew there was a housing price bubble. Yet, the complaint alleges, the three executives marginalized the company’s risk management department.

 

As a result, when the bubble collapsed, the bank "was in an extremely vulnerable position" and, as a result of the three executives "gross mismanagement" the bank suffered losses of "billions of dollars."

 

The complaint also includes fraudulent conveyance claims against Killinger and his wife Linda, and against Rotella and his wife Esther.

 

The complaint alleges that in August 2008, Killinger and his wife transferred two residential properties to qualified personal residence trusts and appointed themselves as trustees. The complaint alleges that these transfers were made with the intent to hinder, delay or defraud Killinger’s future creditors.

 

The complaint contains similar allegations against Rotella and his wife with respect to an April 2008 residential real estate transfer and a September 2008 transfer from Rotella to his wife of $1 million.

 

In statements to the Wall Street Journal, here, Killinger and Rotella said the FDIC’s allegations are "baseless" and "lack credibility" and that the lawsuit is "unworthy of the government." I recommend that readers take a few minutes and read these two individuals' statements. Whatever may be the merits of this and similar cases brought by the FDIC, it is very clear from these statements that there will be a personal price to pay for the individuals involved. The personal pain these men are feeling is palpable, and there will be more of this kind of pain for other former bank officials as more of these kinds of lawsuits are filed.

 

With the filing of this complaint, the FDIC has unmistakably demonstrated that it will pursue claims against former directors and officer of failed banks when it chooses to do so. Indeed, the claims against the two executives’ wives clearly show that the FDIC will proceed aggressively.

 

Given that WaMu represented the largest bank failure in U.S. history, it may come as no surprise that the FDIC is pursuing these kinds of claims. What has been surprising to some, and what occasioned the criticism I mentioned in my opening paragraph, is how deliberate the FDIC has been in choosing to pursue claims. WaMu failed nearly two and one half years ago. If the FDIC were to act with similar deliberation in pursing other claims, it could well be some time before we know for sure how extensive the FDIC’s litigation activity ultimately will be in pursing claims as part of the current bank failure.

 

It is, however, quite clear that the FDIC will be pursuing more of these types of claims. The FDIC recently updated the Professional Liability Lawsuits page on its website (here) to show that the FDIC’s board has approved lawsuits against 158 individual directors and officers of failed banks. Since the six lawsuits the FDIC has filed to date only amount to about 40 individual defendants in total, there are many more lawsuits to come, just based on the actions that have been approved so far.

 

One particularly interesting detail about the news surrounding the FDIC’s recent lawsuit is the report that WaMu’s outside directors have agreed to pay $125 million to settle claims. It is interesting that the outside directors agreed to pay this amount without the intervening step of a lawsuit against them. One question that immediately occurs to me is whether and to what extent this $125 million payment is to be funded by D&O insurance.

 

WaMu’s D&O insurance program was undoubtedly already under pressure due to the significant presence of other claims already pending against its former directors and officers. One possibility that occurs to me is that the bank may have carried a significant layer of Side A DIC protection, which may well have been triggered by the bank holding company’s bankruptcy. Because of the bankruptcy, all of the claims represent potential Side A losses, suggesting that the bank’s Excess Side A/DIC program could well have been called in to contribute. All these are details that those of us on the outside can only wonder about; however, comments from knowledgeable persons who are closer to the situation are always welcome.

 

Whatever may be the case, it is clear that D&O insurance may be playing a role of some kind in all of this. At least Stephen Rotella thinks so. In his statement to the Wall Street Journal to which I linked above, he speculated that the lawsuit itself "may be a way for the FDIC to collect a payout from insurers who provided officers and directors liability coverage for the time they worked at WaMu."

 

As noted, with this lawsuit, the total number of lawsuits the FDIC has filed as part of the current wave of failed bank litigation is now up to six. A list of the six lawsuits can be found here.

 

A March 17, 2011 Bloomberg article about the FDIC’s lawsuit can be found here. A March 17, 2011 Seattle Post-Intelligencer article about the suit can be found here.

　

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In the fifth FDIC lawsuit against former directors and officers of failed banks as part of the current bank wave, on March 1, 2011, the FDIC as receiver for the failed Corn Belt Bank and Trust Company filed suit in the Central District of Illinois federal court against four former officer and directors of the bank, seeking to recover losses of at least $10.4 million.. A copy of the FDIC’s latest complaint can be found here.

 

According to the Complaint, examiners began criticizing the bank’s lending practices as early as 2003. The Complaint alleged that between 2003 and 2008 the bank "failed to address recurring criticisms by examiners regarding imprudent lending practices," and April 2, 2007, the bank entered a memorandum of understanding (MOU) with examiners. In November 2008, after the bank failed to comply with the MOU, the FDIC issued a cease and desist order. The bank ultimately failed on February 13, 2009.

 

The lawsuit itself is failed against the four members of the bank’s loan committee. These four individuals include the bank’s CEO, its chief lending officer and two outside directors. The complaint alleges that the four defendants "failed to adequately inform themselves of the relevant risks and acted recklessly in approving one or more of five high-risk commercial loans."

 

The five loans, all of which were made between 2005 and 2007 and all of which related to the long-haul trucking business, allegedly were "improperly underwritten and extended 100 percent financing to out of state, start-up businesses, and were primarily secured by rapidly depreciating semi-tractors." The complaint further alleges that the CEO and Chief Loan officer unilaterally funded the fifth of the five loans after the loan committee tabled its approval, and they failed to unsure that the loans were properly administered.

 

The complaint alleges that the defendants’ alleged conduct was "particularly egregious" because they approved one or more of the five loans "after Bank examiners repeatedly warned the Bank that it suffered from weak loan administration, and that it was facing risks posed by out of area lending, high loan-to-value ("LTV") loans, and excessive exposure to loan concentrations within its loan portfolio." All five of the loans at issue allegedly shared these characteristics.

 

The complaint alleges gross negligence under FIRREA and negligence under Illinois law against the four individuals for approving the loans. The complaint also specifically alleges gross negligence under FIRREA and negligence under Illinois law against the former CEO and the former chief lending officer in connection with the approval of the fifth of the five loans. Finally, the complaint alleges gross negligence under FIRREA and negligence under Illinois law against the former CEO and former chief lending officer for failing to properly administer the loans and for failing to protect the bank’s security interest in the collateral.

 

The FDIC’s complaint against the four former Corn Belt officials is just the fifth complaint filed so far as part of the current bank wave, and first since the FDIC filed two complaint’s the same day in January 2011. It is the second of the five to be filed against officials of a failed bank that had been based in Illinois. The complaint is interesting because it not only names the two bank officers as defendants, but it also names two outside directors who had served on the bank’s loan committee, as well.

 

Like the four prior lawsuits the FDIC filed as part of the current wave of bank failures, this lawsuit was filed over a year after the institution itself failed. Although the FDIC’s motivations can only be inferred, it appears that what may have provoked this suit is what the FDIC attempted to describe as the defendant’s "particularly egregious" conduct of having approved these particularly loans in the fact of examiners’ warning about loans sharing the characteristics of the five loans at issue.

 

In the Professional Liability Litigation page on the FDIC’s website (here), the FDIC has said, as of its last update, that it has approved lawsuits against a total of 130 individuals. The four previous lawsuits that had been filed named a total of 35 individuals as defendants. With the addition of the four individuals named as defendants on the Corn Belt lawsuit, a total of 39 individuals have now been named as defendants, suggesting that lawsuits to be filed against 91 additional individuals remain pending. Of court, the total number of individuals against who lawsuits have been authorized is likely to continue to grow as well.

 

My table of the lawsuits the FDIC has filed against former directors and officers of failed banks as part of the current failed bank wave can be accessed here.

 

Special thanks to a loyal reader for alerting me to the Corn Belt lawsuit.

　

　

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Though 2010 was a "turnaround" year for banks, the number of problem institutions continued to increase  during the year, according to the FDIC’s Quarterly Banking Profile for the fourth quarter of 2010. A copy of the FDIC’s February 23, 2011 press release about the report can be found here, and the Quarterly Banking Profile itself can be found here.

 

The FDIC defines a problem institution as one the agency has rated as a 4 or 5 on a 1 to 5 scale of ascending regulatory concern. Problems institutions are those with financial, managerial or operational weaknesses that threaten their continued viability. The FDIC does not publish the names of the institutions that it defines as problem institutions.

 

Of the 7,667 institutions that were federally insured as of December 31, 2010, the FDIC rated 884 as problem institutions, or about 11.5% -- or one out of nine -- of all banks in the country. These problems banks represented $390 billion in assets. These year end 2010 figures compare with the 702 banks rated as problem institutions at the end of 2009, representing $402 billion in assets.

 

The year-end 2010 tally of problem banks is not only up from the end of 2009, it is also up from the end of the third quarter of 2010. There were 860 problem institutions as of September 30, 2010, representing $379 billion in assets.

 

Though the number of problem institutions has continued to increase, the rate of increase has slowed. The FDIC noted in its press release that the rate of increases in the number of problem institutions has declined in each of the last four quarters.

 

The number of problem institutions as of the end of 2010 is the largest number of problem institutions since March 31, 1993, when there were 928.

 

The number of problems institutions has continued to grow even as the number of bank failures has continued to mount, which has the effect of reducing the number of institutions rated as problems. The 157 bank failures in 2010 were the highest number of bank failures since 1992 (when 181 banks failed.) Though the FDIC stated in its press release that it expects 2010 to be the high water mark of the current bank failure wave, 22 additional banks have failed already in 2011, putting this year’s bank closure pace ahead of last year’s.

 

Overall, however, the news in the Quarterly Banking Profile was relatively good. The FDIC characterized 2010 as a "turnaround" year, one in which the banking industry reported four consecutive quarters of positive income. The industry’s fourth quarter aggregate profit of $21.7 billion represented a $23.5 billion increase from the industry’s $1.8 billion loss in the year prior quarter. Almost two thirds of reporting institutions reported improvements in quarterly net income from a year ago. Much of the improvement in earnings is attributable to reductions in provisions for loan losses.

 

The DealBook blog’s summary of the FDIC’s report can be found here.

 

More Investors Opting Out?: Luke Green has an interesing February 23, 2011 post on his Risk Metrics Insights blog (here) about the number of large institutional investors that have opted out of the $624 million Countrwide securities class action settlement. As many as 33 large investors have opted out of the settlement, which has resulted in changes to the class action settlement, including the reduction of the settlement amount to $601.5 million. Many of the opt outs apparently have initiated separate litigation, as well. Green notes that there are a host of arguments against and in favor of opting out, but he nevetheless asks whether the willingness of large investors to opt out possibly represents a larger trend.

 

D&O Case Law Survey: The policyholder side coverage law firm Lowenstein & Sandler has published a "Review of 2010 Case Law on D&O Insurance Coverage," which can be found here. The memo provides brief reviews of critical D&O insurance coverage decisions from the past year.

 

 

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If the lawsuit filed on February 7, 2011 in the Northern District of Georgia is any indication, the FDIC’s efforts to pursue liability claims will not only include suits against the directors and officers of failed banks, but will also include in at least some instances the failed institutions’ outside law firms. The FDIC’s actions so far raise the question of how extensive the FDIC’s pursuit of these kinds of claims ultimately may prove to be.

 

As reflected in J. Scott Trubey’s February 8, 2010 Atlanta Journal Constitution article (here), the FDIC’s recent suit was filed against a Henry County, Georgia law firm, Smith Welch & Brittain, and J. Mark Brittain, in connection with the firm’s legal services on behalf of Neighborhood, Community Bank, a Newnan, Georgia bank that failed on June 26, 2009.

 

In its complaint, a copy of which can be found here, the FDIC as receiver for the failed bank seeks to recover damages "in excess of $6 million" plus legal fees, based on the defendants’ alleged legal malpractice in connection with the law firm’s handling of certain loans the bank made to a local real estate developer between 2005 and 2007. The complaint alleges that the bank hired the firm to process the documents for the bank’s loans to the developer, who allegedly was also a client of the law firm. The suit alleges the developer of obtaining loans based on inflated property values. The individual defendant allegedly facilitated this, among other things, by creating two sets of settlement statements.

 

The lawsuit filed Monday is the third liability suit filed in Georgia against a failed bank’s outside law firm. As reflected in press reports (here, scroll down), on October 19, 2010, the FDIC filed two separate lawsuits in the Northern District of Georgia against outside law firms for the failed Integrity Bank of Alpharetta, Georgia. (In January, the FDIC filed a separate suit against former directors and officers of Integrity Bank, as reflected here.) The defendants in one of these two lawsuits also include a title insurance company.

 

The FDIC has made no secret of the fact that it may pursue claims against the failed banks’ gatekeepers – not just banks’ former directors and officers, but also, according to the FDIC’s website, the banks’ "attorneys, accountants, appraisers, brokers, or others." The website also states that as of February 7, 2011, the FDIC has "authorized seven fidelity bond, attorney malpractice, and appraiser malpractice lawsuits." which presumably includes the suits described above. (As detailed here, the FDIC has to date filed four lawsuits against the directors and officers of failed banks as part of the current wave of bank failures.)

 

The FDIC’s pursuit of claims against lawyers and other outside professionals is entirely consistent with the actions the agency took during the FDIC crisis. According to NERA Economic Consulting’s August 2010 report about failed bank litigation, in connection with the 2,744 institutions that failed as part of the S&L crisis, the FDIC (or the Resolution Trust Corporation) filed a total of 205 legal malpractice claims and 139 accounting malpractice claims (about 7.5% and 5% of failed banks, respectively).

 

The outcome of the FDIC’s professional liability claims during the S&L crisis, more than anything else, explain the FDIC’s present actions to pursue these claims in connection with the current round of bank failures. According to the NERA report, as a result of the FDIC’s S&L crisis legal malpractice claims, the FDIC recovered $500 million, and as a result of its accounting malpractice claims, the FDIC recovered $1.1 billion. (By way of contrast, the FDIC’s S&L crisis related claims against the former directors and officers of failed banks resulted in recoveries of $1.3 billion). Given this track record, it is hardly surprising that the FDIC is pursing claims of the type described above now.

 

One question that all of this information raises is whether the FDIC will as part of the current round of bank failures pursue claims against the failed institutions’ accountants, as the FDIC did during the S&L crisis. The FDIC’s website does not specify whether or not the agency’s board has so far authorized any claims against accountants or accounting firms.

 

Thought the FDIC has not yet pursued (or indeed, apparently, authorized) claims against the accounting firms of failed banks, it may only be a matter of time until these claims emerge, at least according to a February 8, 2011 Legal Intelligencer article entitled "FDIC Professional Liability Group Set to Pursue Audit Firms" (here). The article lays out the legal theories on which the FDIC is likely to proceed in its claims against outside accounting firms, and also reviews the firms’ likely defenses.

 

Though there have only been a few legal malpractice claims to date and as yet no accounting malpractice claims, this process has really only just gotten started. The FDIC’s website describes an 18 month process that precedes the authorization for the filing of these types of claims. Indeed, the lawsuits discussed above were filed nearly two years after the failure of the related institution.. Given that the current bank failure wave really started to gain momentum in the second half of 2009, it seems likely that as this year progresses – and on into 2012 – we could be seeing a steadily growing number of these types of gatekeeper claims.

 

The fact that the first attorney malpractice claims were filed in Georgia may simply be a reflection of the fact that as part of the current found of bank failures, more banks have failed in Georgia than in any other state. Of the 336 banks that failed between January 1, 2008 and February 4, 2011, 51 have been located in Georgia (including four of the fourteen banks that have failed in 2011).

 

Special thanks to a loyal reader for providing a link to the Legal Intelligencer article.

 

Law Firm Memo Round Up: Among the long list of law firm memos that arrived in my inbox this past week were a number of noteworthy items. First, Jenner & Block attorney Lorelie Masters and her colleague Brian Scarbrough have a February 7, 2011 Law.com article entitled "5 Key Lessons from Stanford D&O Ruling" (here), which analyzes the implications of the Southern District of Texas’s October 13, 2010 ruling in the D&O insurance coverage case involving Allen Stanford. The article highlights the difficulties that that can arise from "in fact" wording in D&O insurance policy exclusions.

 

Second, the Lowenstein Sandler law firm has published a February 2011 memo entitled "Residential Mortgage-Backed Securities Litigation: 2010 Survey" (here), contains a helpful summary of the court rulings in securities lawsuits involving RMBS, and also includes a detailed description of a long list of significant cases.

 

Finally, the Simpson Thacher law firm’s January 2011 "Securities Law Alert" (here) contains a helpful review of recent significant securities law developments, including the district courts’ continuing application of the U.S. Supreme Court’s decision in Morrison v. National Australia Bank. The memo includes a detailed list of the cases to watch in 2011, including a description of the key cases currently before the U.S. Supreme Court.

　

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As detailed in the accompanying blog post, all signs are that the FDIC will be filing increasing numbers of civil actions against former officials of banks that have been closed as part of the current round of bank failures. With this possibility in mind, it seems like it is time for The D&O Diary to initiate yet another of its litigation tracking lists.

 

A list reflecting the civil lawsuits that the FDIC has filed in its capacity as receiver against former officials of failed banks can be found here.

 

 

 

I will be updating this list periodically as I become of aware of additional civil lawsuits that the FDIC has filed. This list is a community resource for readers of this blog, and I hope that readers will help maintain the value of this resource for the community by advising me of any new lawsuits that have been filed and of any omission from the list. As I update the list, I will indicate at the top of this blog post the last date on which the list was most recently updated.

 

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More banks have failed in Georgia than any other state as part of the current bank failure wave, but the FDIC had not yet filed a civil action against the former officials of a failed Georgia bank – that is, until now. On January 14, 2011, in what is the third FDIC lawsuit overall against former officials of a failed bank as part of the current round of bank failures, the FDIC filed a lawsuit against eight former officials of the failed Integrity Bank of Alpharetta, Georgia. The FDIC’s complaint can be found here.

 

UPDATE: As discussed further below, in addition to the Integrity Bank case, the FDIC also filed a separate lawsuit on January 14, 2011 in the Central District of California against former directors and officers of the failed 1st Centennial Bank of Redlands, California.

 

Including one bank closed already in 2011, there have been 52 bank failures in Georgia since January 1, 2008. Integrity Bank was one of the first in Georgia to fail when it was closed on August 28, 2008.  

 

 

In some ways, it may come as no surprise that the FDIC filed its first failed bank lawsuit in Georgia against officials from Integrity Bank. As noted here, the FDIC had successfully intervened in a derivative lawsuit brought by the trustee of the bank’s bankrupt holding company. In moving to intervene in the trustee’s lawsuit, the FDIC had said that it intended to file its own lawsuit against former Integrity bank officials.

 

 

In addition, two former Integrity officials have already drawn criminal charges involving activities at the bank, as discussed here. One of the two indicted Integrity officials, Douglas Ballard, is also named as a defendant in the FDIC’s civil lawsuit. As noted here, in July 2010, the two individuals entered criminal guilty pleas in the case.

 

 

As noted in Scott Trubey’s January 18, 2011 Atlanta Journal-Constitution article about the FDIC’s civil suit (here), among the former Integrity Bank officials names as defendants in the FDIC’s lawsuit is Georgia State Senator Jack S. Murphy,   who was only recently named as Chairman of the Georgia Senate Banking Committee. Another defendant, Clinton M. Day, a former bank chairman, previously was a state senator and was at one time the Republican Candidate for lieutenant governor, and also once served on the Senate Banking Committee

 

 

The FDIC, which filed the lawsuit in its capacity as Integrity Bank’s receiver, seeks to recover “over $70 million in losses” that the FDIC alleges the bank suffered on 21 commercial and residential acquisition, development and construction loans between February 4, 2005 and May 2, 2007.

 

 

The 56-page complaint, which names as defendants eight former directors of the company who also served on the bank’s director loan committee, alleges one count of negligence and gross negligence, and one count of breach of fiduciary duties.

 

 

The complaint alleges that the 21 loans at issue were “concentrated in a small number of preferred individual borrowers,” in violation both of the bank’s own lending policies and applicable statutory lending limits. The loans are alleged to have been made without appropriate documentation and with inadequate collateral. The complaint alleges that state and federal regulators “repeatedly warned” the bank about its heavily concentrated loan portfolio and lax oversight and control of its lending function.

 

 

The complaint concludes that “the years of excess risk taking and lack of oversight by the Defendants that fueled Integrity’s astronomical growth ultimately led to its failure on August 29, 2008.” The complaint also quotes the bank’s founder as admitting that “Our overwhelming success up to [mid-2006] became intoxicating and we shifted some of our focus from asset quality to earnings and growth which was a mistake …[t]his shift in our focus also created gaps in the enforcement of Bank policies and procedures. In other words, we became lax on having our checker checking the checker.”

 

 

Though a total of 325 banks have failed since January 1, 2008 (through Friday January 14, 2011), the Integrity Bank lawsuit is only the FDIC’s third lawsuit against former officials of failed banks filed as part of the current wave of bank failures. There undoubtedly are more lawsuits to come, as the FDIC’s website indicates (here) that through December 2010 the FDIC has authorized lawsuits against a total of 109 former bank officials. The website clearly shows that lawsuits against additional officials are being authorized each month.  

 

 

With the likelihood of many more lawsuits to come, I have started a list of the FDIC’s lawsuits, which can be accessed on accompanying blog post, here.

 

 

Special thanks to alert loyal readers who alerted me to this new lawsuit.

 

 

UPDATE: FDIC Also FIles Suit Against 1st Centennial Bank: After I first published this blog post, I learned that that in addition to the Integrity Bank lawsuit, the FDIC also filed a lawsuit on January 14, 2011 against 12 former directors and officers of the failed 1st Centennial Bank of Redlands, California. A copy of the FDIC's 1st Centennial complaint can be found here.

 

 

1st Centennial failed on January 23, 2009, so the FDIC's lawsuit arrived about two years after the bank first failed.

 

 

The complaint alleges that after a period of rapid growth, and at a time when it was apparent that the Southern California real estate market was already in decilne, the bank increased its exposure to the riskiest loans, in excess of regulatory limits. The complaint alleges that by concentrating the bank's activities in these riskiest loans, the bank suffered capital and liquidity problems. The complaint specifically alleges that the defendants 16 specific loans that caused the bank at least $26.8 million in losses. The complaint alleges that the bank's failure caused the FDIC insurance fund losses of about $163 million.

 

 

I have added the 1st Centennial bank complaint to my list of bank lawsuits, which as a result of this latest suit now shows that the FDIC has launched a total of four lawsuits so far as part of the current wave of bank failures.

 

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On January 14, 2011, in a ruling that could have implications for other failed bank investors’ securities class action lawsuits, Northern District of Georgia Judge Charles A. Pannell, Jr. granted defendants’ motions to dismiss the securities suit that had been brought by investors in the failed Haven Trust Bank of Duluth, Georgia. A copy of Judge Pannell’s order can be found here.

 

This case may be familiar to readers as I recently wrote about the FDIC’s failed bid to intervene in this case. As discussed here, Judge Pannell denied the FDIC’s motion to intervene.

 

Banking regulators closed Haven Truston December 12, 2008. As detailed here, on December 31, 2009, investors who purchased shares in the bank’s holding company filed suit in the Northern District of Georgia alleging that the company’s former officials had misled investors in connection with the share offering, in violation of federal and state securities laws.

 

In his January 14 order, Judge Pannell granted the defendants’ motion to dismiss, finding that the plaintiffs had not adequately alleged violations of either the state or federal securities laws. With respect to the plaintiffs’ federal securities laws allegations, Judge Pannell held that the plaintiffs had not adequately alleged scienter or loss causation.

 

In holding that the scienter allegations were insufficient, Judge Pannell said that "the amended complaint’s reliance on the defendants’ positions as directors and officers, their attendance at meetings, and access to internal documents and reports is insufficient to allege a strong inference of scienter." He also found that the defendants’ alleged motivation to maintain a dividend stream was also insufficient to allege scienter.

 

Finally, with respect to the plaintiffs’ allegations that there had been "excessively risky" loans to one of the defendant’s children "may be relevant to a shareholder derivative claim for corporate mismanagement" but were not relevant to determining scienter.

 

With respect to loss causation, the plaintiff’s allege that the FDIC announcement that it was taking over the bank caused the loss in value of the plaintiffs’ stock. Judge Pannell said that "this allegation does not establish that the defendants’ alleged misrepresentations and omissions caused the plaintiffs’ loss, but instead establishes that the loss was caused by the FDIC’s decision to close the Bank due to the effect of the subprime mortgage and financial crises on the Bank’s loan portfolio."

 

After quoting with approval from a Second Circuit decision holding that "when the plaintiff’s loss coincides with a marketwide phenomenon.. . the prospect that the plaintiff’s loss was caused by fraud decreases," Judge Pannell concluded by stating that "in this case, the plaintiffs have not offered any facts distinguishing between losses caused by the defendants’ alleged misrepresentations and the intervening events that wreaked havoc with the banking industry as a whole."

 

Discussion

Judge Pannell’s decision is interesting in an of itself, as it shows at a minimum in that investors in the many pending failed bank-related shareholder lawsuits will face difficult hurdles in surviving the initial pleading hurdles.

 

To be sure, it hardly comes as news that plaintiffs will be challenged in satisfying the scienter requirements under the federal securities laws, which is equally true in the failed bank investor suits as it is in securities class action cases in general.

 

On the other hand, Judge Pannell’s rulings with respect to loss causation may be particularly noteworthy, and may be particularly encouraging to defendants in the other failed bank-related securities cases. The plaintiffs in those other cases, like the plaintiffs in the Haven Trust case, may also face significant challenges showing that their alleged investment losses were caused by the alleged misrepresentations rather than the "intervening events that wreaked havoc with the banking industry as a whole."

 

Most defendants will be able to argue, as did the defendants in the Haven Trust case, that the plaintiffs’ investment lost value when the FDIC took over the now failed bank. Defendants in those cases will undoubtedly attempt to argue that since the investors’ loss "coincided with marketwide phenomena" the plaintiffs’ burden of pleading loss causation increases.

 

Many of the failed bank cases are just getting started and it may be some time before many of these cases have worked their way to the motion to dismiss stage. But Judge Pannell’s ruling in the Haven Trust case suggests that many of these cases could face uphill battle.

 

The defendants in these cases may still face separate claims brought by the FDIC as receiver, as may yet be the case for the defendants in the Haven Trust case (after all, the FDIC did seek to intervene in the securities case, in part based on the FDIC’s stated intent to assert its own claims against the defendants). But even if there are separate FDIC claims, at least the defendants are not facing a multi-front war.

　

Special thanks to a loyal reader for providing a copy of the dismissal motion ruling in the Haven Trust case.

　

More About Georgia Banks: At the same time as the lawsuit involving banks that failed some time ago are working their way through the system, other trouble banks in Georgia are continuing to fail. Just this past Friday night, regulators closed yet another bank in Georgia. Though this is the first bank to fail in Georgia in 2011, the bank is the 52^nd bank to fail in Georgia since January 1, 2008, the highest number of any state.

 

Highly reliable rumors also suggest that the FDIC is getting ready to initiate civil litigation, in its capacity as receiver of failed banks, against directors and officers of one or more failed Georgia banks, possibly as early as this week. Stay tuned.

　

More About China: Regular readers may recall prior posts (refer for example here), where I have written about increasing amounts of securities class action litigation involving Chinese-domiciled companies. Questions concerning Chinese companies listed in the U.S. are continuing to emerge, particularly with respect to Chinese companies that establish their U.S. listing by way of merger with a dormant publicly traded shell.

 

On January 13, 2011, Bloomberg Businessweek published another article raising questions about Chinese companies financial reporting. The article, entitled "Worthless Stock from China" (here), raises questions about a number of Chinese companies and their reporting practices. The article makes for interesting (albeit disturbing) reading.

　

　

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The year-end vacation days are over, the holiday decorations have been taken down, and last year’s wall calendars have been replaced. We are now into the Narnia season (at least here in Cleveland), where it is always winter but never Christmas. The New Year has entered with a bang, and that means more than just inexplicable piles of dead birds. It also means there are lots of newsworthy developments to report. Here’s the latest:

 

FDIC Increases Number of Authorized Lawsuits: Earlier this week, the FDIC updated the Professional Liability Lawsuits page on its website to reflect that the number of lawsuits that it has authorized has been increased. The FDIC has now authorized lawsuits against 109 directors and officers of failed financial institutions, up from 82 as of the end of November 2010. The website also reports that the claims against these individuals represent claimed damages of $2.5 billion.

 

The web page includes a monthly table at the end, showing how the number of individuals against whom lawsuits are authorized has increased since the end of the third quarter. The page also reports that the FDIC has authorized four fidelity bond and attorney malpractice lawsuits.

 

The page reflects a number of interesting details regarding the FDIC’s approach to litigation and litigation history. Among other things, the page reports that the investigation preceding the decision whether or not to bring a lawsuit is usually completed "within 18 months," which explains in part why there have been relatively few FDIC lawsuits against directors and officers of failed banks so far (only two lawsuits against 15 individuals).

 

The page also includes some general information about the legal theories on which the FDIC can seek to recover, the applicable statute of limitations, and the FDIC’s prior history of D&O litigation during the S&L crisis.

 

Many thanks to the several loyal readers who sent me links to the New York Times Dealbook blog’s January 5, 2010 post about the updated FDIC web page.

 

2011’s First Filed Securities Suit Continues 2010 Trend: As far as I can tell, 2011’s first filed securities class action lawsuit is the lawsuit filed on January 3, 2011 in the Eastern District of New York against Tongxin International, Inc. and certain of its directors and officers. The plaintiffs’ lawyers corrected press release describing the suit can be found here and a copy of the complaint can be found here.

 

The lawsuit alleges that the defendants misled investors with respect to its financial reports. The plaintiffs allege that the company initially withheld its financial statements, and then was forced to withdraw previously reported results as unreliable. The company later sued its former CEO and CFO for wrongfully transferring the Company’s funds.

 

As I noted in my analysis of 2010 securities class action lawsuits, one of last year’s noteworthy securities suit filing trends was the significant number of lawsuits involving Chinese companies. From a practical perspective (if not strictly as a formal matter), the new Tongxin lawsuit appears to represent a continuation of that filing trend.

 

Tongxin itself is incorporated in the British Virgin Islands. However, it was formed as subsidiary of a special purpose acquisition company (SPAC) that was formed to acquire an automotive manufacturing company in China. In April 2008, the SPAC acquired Hunan Enterprise Co., Ltd, a Chinese automotive supplier, and the SPAC merged into Tongxin. Tonxin’s operating company, and the events referenced in the complaint, all are or took place in China.

 

The litigation trend of new securities lawsuits involving Chinese companies seems to have carried over into the New Year.

 

Record Number of FCPA Enforcement Actions in 2010: According to the Gibson Dunn law firm’s January 3, 2010 memorandum entitled "2010 Year-End Update" (here), 2010 was a record setting year for FCPA enforcement activity. The memo reports that both the SEC’s and DoJ’s 2010 enforcement actions – which were essentially double the prior year’s record levels – "dwarfed the tally from any prior year in the statute’s 33-year history."

 

According to data reflected in the memo, during 2010 there were 48 DoJ FCPA enforcement actions (compared to 26 in 2009) and 26 SEC FCPA enforcement actions (compared to 14 in 2009). The memo also reports that "nearly every FCPA enforcement action from the past 12 months can be traced to multi-defendant, if not industry-wide investigation that involved numerous companies or persons engaged in coordinate or parallel schemes."

 

FCPA-related settlements in 2010 also were at record setting levels. According to a January 5, 2010 post on The FCPA Blog (here), eight of the top ten FCPA settlements of all time were reached in 2010. As it happens, eight of the top ten FCPA settlements involve non-U.S. companies as well.

 

As I have observed numerous times on this blog, FCPA enforcement activity increasingly is accompanied by follow-on civil litigation, a phenomenon that the Gibson Dunn memo notes "saw a marked increase in activity amongst the plaintiffs’ bar." The memo goes on to observe that "hardly an FCPA investigation or resolution was announced during the past year that was not followed in swift succession by a press release from any number of plaintiffs’ firms from any number of plaintiffs’ law firms that have creased a cottage industry for private FCPA enforcement."

 

Despite the absence of a private right of action under the FCPA, plaintiffs continue to "shoehorn" FCPA-related claims under a wide variety of theories, including securities fraud, breach of fiduciary duties, torts and breach of contract. The law firm memo sets out a long list of various cases that plaintiffs have pursued or are pursuing on FCPA-related allegations.

 

As I previously detailed (refer here), FCPA-related claims represent a growing area of D&O exposure, with important D&O insurance coverage implications.

　

Are Bylaw Forum Selection Clauses Unenforceable?: Many corporate litigants prefer the friendly confines of the Delaware Court system. It is not just that many companies are organized in Delaware and its courts are viewed as business friendly, but also the judges who serve on the Court of Chancery are viewed as both highly skilled and as experienced on complex business litigation issues.

 

Earlier this year, in the Revlon Shareholders’ Litigation, the Delaware Court of Chancery suggested that corporations organized under Delaware law are "free" to adopt "charter provisions selecting an exclusive forum or inter-entity disputes." In the wake of this suggestion, many lawyers began to recommend that their client companies adopt charter provisions designating the Delaware Court of Chancery as the preferred forum.

 

However, on January 3, 2011, Northern District of California Judge Richard Seeborg held, in a case of first impression, that a forum selection clause in Oracle’s bylaws was not enforceable, at least in the absence of shareholder approval. Significantly, Judge Seeborg did not reach issues of Delaware law; his ruling of unenforceability was reached as a matter of federal common law. A copy of Judge Seeborg’s opinion can be found here.

 

As might be expected, plaintiffs’ lawyers have welcomed Judge Seeborg’s ruling – refer for example to David Bario’s January 5, 2011 Am Law Litigation Daily article, here, quoting the plaintiffs’ lawyers in the case as saying that

 

The insertion of these forum selection clauses in bylaws, rather than by amending a company's charter with shareholder approval, has been increasing….I think this decision will help to pull the cover off the practice. It shows that passing a bylaw on normal company business is one thing, but when you're going to pass a bylaw that limits shareholders' rights, that's something much different, and I think that's at the core of the decision.

 

Others have been more critical of the decision. Rebecca Beyer’s January 5, 2010 Daily Journal article (here, registration required) about the decision quotes Stanford Law School Professor Joseph Grundfest as saying that "the distinction as to shareholders who hold shares prior to the bylaw amendment and after the bylaw amendment makes no sense….Every bylaw amendment has to bind all shareholders or it can't work."

 

Grundfest said when people buy shares in a company they agree to allow directors to amend bylaws. "If shareholders don't like the unilateral amendment, the shareholders can - by shareholder vote - overrule the board," he said. Grundfest also said that there likely will be further litigation on this issue, and that the issue could eventually make its way to the U.S. Supreme Court.

 

Time Out for A Couple of Technology Questions: What do you do when your Blackberry isn’t working? And why does the march of technological "progress" involve so many different kinds of fruit? (Special thanks to a loyal reader for a link to the video.)　

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2010 was an eventful year in the world of D&O liability. Congress passed massive financial reform legislation, the Supreme Court issued landmark decisions in important cases and numerous claims emerged as the litigation landscape continued to evolve. With so much going on, it is a challenge to narrow the year’s events down to just the ten most significant developments.

 

With appropriate humility about the limitations of all year-end inventories, here is my list of the top ten D&O developments of 2010.

 

1. Securities Suits Pick Up in Year’s Second Half: As I detailed in my 2010 securities litigation overview (here), after a filing downturn in the year’s first half, the number of securities lawsuit filing picked up in the last six months of the year. Among other things, as the year progressed, filing activity shifted away from credit crisis-related cases and toward a broader range of other types of cases.

 

Although at least some of the litigation activity in the year’s second half was driven by limited or short term events (as was the case, for example, in the rash of cases filed against for-profit education companies and against Chinese domiciled companies), the shift away from credit crisis cases could suggest that the heightened pace of securities suit filings may continue as we head into 2010.

 

2. The Changing Mix of Corporate and Securities Lawsuits: As insurance information firm Advisen has well documented, the mix of corporate and securities lawsuits has been evolving over the past several years. The most important feature of this changing mix of cases has been the decreasing prevalence of class action securities lawsuits as a percentage of all corporate and securities cases.

 

As the percentage of class action securities lawsuits has declined, other types of lawsuits, particularly breach of fiduciary duty cases, have grown in relative frequency. Many of these breach of fiduciary duty cases are related to mergers and acquisitions activity. Indeed, as I noted in my year-end review of 2010 securities lawsuit filings, even many of the cases that are categorized as securities class action lawsuits involve merger objection cases.

 

　

It is important to keep this changing mix of cases in mind when considering the various year end reports on securities litigation activity. These reports will show that overall 2010 securities class action lawsuit filings are down compared to post-PSLRA averages. However, it would be mistake to conclude that the relatively reduced number of securities class action lawsuits means that claims activity in general is down. To the contrary, overall claims activity is actually up. The mere fact that securities class action lawsuits are down does not mean that fewer companies are being sued or that overall claims exposure has diminished, either for companies or insurers. Rather, what is happening is that the claims exposure is changing, away from securities class action lawsuits and toward other types of claims.

 

This shift away from traditional securities class action lawsuits as a percentage of all claims activity has important implications for the insurance marketplace. The shift toward higher frequency, lower severity type of claims could have a significant impact both on primary and excess carriers. Primary carriers may experience an increase in overall claims frequency, with consequences for their loss experience. Excess carriers, particularly higher excess carriers, may experience relatively fewer claims piercing their layers, possibly producing a positive impact on the excess carriers’ results.

 

　

3. Banks Fail, Lawsuits Loom: 157 banks failed during 2010, the largest annual number of bank failures since 1992. The total number of bank closures since January 1, 2008 is 322. In addition, in the FDIC’s most recent Quarterly Banking Profile (refer here), the FDIC identified 860 banks, or about one out of nine of all banks, as "problem institutions."

 

Given the magnitude of these problems in the banking industry, it is hardly surprising that litigation involving failed and troubled banks is increasingly significant. Indeed, 13 of the 177 securities class action lawsuits filed in 2010 involved failed or troubled banks. In addition, aggrieved investors in failed or troubled privately held banks also filed a variety of other lawsuits, primarily in state courts.

 

It may be anticipated that the FDIC will also actively pursue claims against failed banks’ former directors and officers. However, to date, the FDIC has instituted only two D&O claims as part of the current round of failed banks (refer here and here).

 

It appears that it will only be a matter of time before the FDIC launches further suits against former officials of failed banks. Widely circulated news reports have quoted FDIC officials as saying that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks. In addition, the Wall Street Journal reported in November that the FDIC is conducting fifty criminal investigations against directors, officers and employees of failed banks.

 

While we may hope that the current round of bank failures may begin to wane as we head into 2011, it appears that the failed bank litigation may only just be getting started.

 

4. Credit Crisis Lawsuit Settlements: The Dog that Didn’t Bark This Year: The subprime and credit crisis-related litigation wave will be heading into its fifth year early in 2011. Since 2007, there have been over 230 subprime and credit crisis related securities lawsuits filed. Many of these cases continue to work their way through the system.

 

As some of these cases have survived the preliminary motions, they have moved toward settlement. There were several noteworthy credit crisis related securities class action lawsuit settlements during 2010, including Countrywide ($624 million, refer here), Schwab Yield Plus ($235 million , refer here), and New Century Financial ($124 million, refer here).

 

But while there have been a few noteworthy settlements of these cases this year, the more striking observation is how few of these cases have settled so far, particularly given how far along we are in the subprime and credit crisis litigation wave.

 

By my count, only 17 of the over 230 subprime and credit crisis-related securities class action lawsuit have settled, and only eight of these 17 settlements were announced in 2010. (My list of subprime and credit crisis-related lawsuit resolutions can be accessed here.)

 

NERA Economic Consulting stated in its year-end report on securities litigation that of the approximately 230 credit crisis securities suits, only 8% have settled, 29% have been dismissed, and 63% remain unresolved.

 

Of the 63% of unresolved cases, some of course will wind up being dismissed. But many more will settle, eventually. Given the now long duration of the credit crisis litigation wave, it can be anticipated that there may be many more settlements of these cases in 2011. The likelihood is that D&O insurers’ aggregate claims losses for these claims will mount, perhaps rapidly.

 

The question is whether the materialization of these losses will come as a surprise or has already been fully anticipated in the carriers’ prior years’ loss reserves. This answer to this question could have important implications for the D&O insurers’ 2011 calendar year results.

 

5. Megasettlements of Shareholders’ Derivative Lawsuits Surge: There was a time when the settlement of a shareholder derivative lawsuit involved the payment of little or no money, other than in connection with the payment of the plaintiffs’ attorneys’ fees. However, one of the more striking developments in recent years has been the emergence of jumbo settlements of shareholders derivative lawsuits, in which millions of dollars are paid to or on behalf of the company involved.

 

This emerging trend continued to develop in 2010, with at least two huge shareholder derivative lawsuit settlements: the $90 million AIG/Greenberg settlement (about which refer here) and the $75 million Pfizer settlement (refer here).

 

These 2010 settlements join a growing list of other jumbo derivative settlements in recent years, including the UnitedHealth Group settlement ($900 million, refer here); Oracle ($122 million, refer here); Broadcom ($118 million, refer here); and the first AIG derivative settlement (refer here).

 

The striking thing about these settlements is not only their size, but also the fact that in each case the company involved is solvent. The significance of this fact is that these settlements represent instances in which the companies’ D&O insurance potentially could have been called upon to fund an A Side loss outside of the insolvency context. These kinds of settlements provide concrete evidence of the value to policyholders of Side A insurance protection even outside of the insolvency context, and underscore the importance of added Side A protection in a well-designed D&O insurance program.

 

From the carriers’ perspective, these settlements suggest that Side A losses can mount outside of insolvency. Only the carriers themselves can answer the question whether or not they are actually pricing their Side A products for this loss exposure.

 

One final note about the Pfizer derivative lawsuit settlement concerns the unusual funding mechanism the settlement implemented. In many derivative lawsuit settlements the companies involved agree to institute corporate governance reforms. What was unusual about the Pfizer settlement is that the settlement agreement created a dedicated fund intended to finance the company’s agreed upon governance reforms. If the advance funding of corporate governance reforms were to become a standard feature of derivative lawsuit settlements, the cash cost of derivative settlements could increase substantially. This is a potential development worth watching closely.

 

6. Rare Securities Lawsuit Trials Result in Plaintiffs’ Verdicts: Very few securities class action lawsuits actually go trial. Most are settled or dismissed. But in 2010, two cases made it all the way through to jury verdicts. In January, the jurors in the Vivendi case entered a verdict on behalf of the plaintiffs against the company (about which refer here), and in November, the jurors entered a verdict for the plaintiffs in the BankAtlantic subprime-related securities suit (refer here).

 

In addition to these jury verdicts, in June 2010, the Ninth Circuit issued an opinion overturning the trial court’s post trial ruling in the Apollo Group case, a ruling that had set aside the jury’s $277.5 million jury verdict in that case. Refer here regarding the Ninth Circuit’s opinion in the Apollo Group case.

 

All three of these cases remain subject to further proceedings. The Vivendi case in particular is the subject of significant post-trial motions having to do with the composition of the plaintiffs’ class in the wake of the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case (about which refer to these prior guest blog posts, here and here. See also item 10, below).

 

The defendants in the Apollo Group case have filed a petition with the U.S. Supreme Court for a writ of certiorari (about which refer here). And the BankAtlantic case has now moved on to post-trial motions, and depending on the motions’ outcome, possible appeal.

 

But while the ultimate outcome of these cases remains to be determined, it is striking that all three of these cases not only involve rare trials, but all three resulted in jury verdicts for the plaintiffs. To be sure, there have also been recent securities lawsuit trials that have resulted in defense verdicts, as was the case for example in the JDS Uniphase trial (about which refer here).

 

According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, there have now been ten securities class action lawsuit trial post-PSLRA and involving post-PSLRA facts. The scoreboard currently reads: Plaintiffs 6, Defendants 4. The scoreboard is of course subject to revision pending further proceedings. Nevertheless, the juries themselves seem to have been favoring the plaintiffs, a phenomenon that may make plaintiffs’ threats to push a case to trial represent a particularly threatening tactic.

 

7. Assessing Coverage for "Bump Up" Claims: As noted above, a significant and growing number of corporate and securities lawsuits arise out of merger and acquisition activity. Often, the goal of this litigation is to try to increase the transaction consideration. One recurring question is the availability of D&O insurance coverage for amounts paid in settlement of so-called "bump up" claims.

 

In October 2010, the First Circuit entered an opinion in coverage litigation involving Genzyme Corporation, discussing the question of the preclusive effect of a D&O policy’s "bump up" exclusion. The First Circuit overturned the lower court’s decision that had held that the company’s D&O insurance policy did not provide coverage for additional amounts paid to claimants who asserted they did not received adequate consideration in a share exchange.

 

Though the First Circuit reversed the lower court’s holding of noncoverage, the First Circuit did not invalidate the bump up exclusion and agreed that the exclusion precluded entity coverage for bump up amounts.

 

The First Circuit remanded the case to the lower court for further allocation proceedings (that is, because the First Circuit held that the bump up exclusion precluded coverage only under the policy’s entity coverage provision, further proceedings are required to determine whet portion if any of the underlying settlement is allocable to settlement of liabilities of persons insured under other insuring provisions of the policy).

 

Of critical importance is that the First Circuit found that exclusion is enforceable and is effective to preclude coverage according to its terms. The holding clearly will be relevant to questions of coverage in future cases involving settlements of "bump up" claims, at least where the implicated D&O insurance policies include bump up exclusions.

 

8. D&O Insurance Coverage for Informal SEC and Internal Investigations: Among the perennial D&O insurance issues are the questions of coverage for informal SEC investigations and for internal investigations. In either case, the question is whether or not there is a "claim" as required to trigger coverage under the policy.

 

In one of the year’s most noteworthy D&O insurance coverage decisions, Southern District of Florida Judge Kenneth Marra, applying Florida law in a summary judgment ruling in coverage litigation involving Office Depot, held there is no coverage under the company’s D&O insurance policies for either of these categories of expenses.

 

Though the holding in the Office Depot case is direct reflection both of the specific policy language involved and the facts presented, the decision nevertheless could be influential in future claims involving questions of coverage for informal SEC investigations and internal investigations. The Office Depot decision suggests that policy definitions of the terms "Securities Claim" and "Claim" are critical, particularly with respect to the definitional references to "investigations" and "proceedings." Refer here for a more detailed discussion of the case and the decision.

 

The Office Depot ruling is hardly the final word on these issues, but it clearly will loom large in future consideration of questions of coverage for these kinds of expenses. Insurers undoubtedly will seek to rely on the decision to try to preclude coverage for costs incurred in connection with informal SEC investigations and internal investigations.

 

On a related note, a separate court held in the MBIA coverage case that there is coverage under the D&O insurance policy at issue for special litigation committee expenses, as discussed here.　

 

9. Is a Whistle the Sound of the Future?: The massive Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 enacted in July will affect virtually every aspect of our financial system, in ways that may only become clear over time. But among the Act’s innovations that seem likeliest to have a significant litigation impact are the Act’s new whistleblower provisions.

 

The whistleblower provisions include the creation of a new whistleblower bounty pursuant to which persons who first bring securities law violations to the attention of the SEC will receive between 10 percent and 20 percent of any recovery in excess of $1 million.

 

Give the magnitude of the fines paid in many recent SEC enforcement actions, particularly those involving Foreign Corrupt Practices Act violations (about which refer here), the prospective size of potential bounties is enormous. These bounty provisions seem likely to encourage a flood of whistleblower reports to the SEC. This could create an administrative nightmare for the SEC, and the agency is already struggling with funding limitations that may constrain its ability to implement the whistleblower requirements. On the other hand, the SEC, under pressure to rehabilitate its regulatory credentials after its failure to detect the Madoff scheme, will face significant pressure to pursue whistleblower claims.

 

Another 2010 development that seems likely to encourage an entirely different sort of whistleblower activity is the series of WikiLeaks disclosures. The extensive media attention give to the disclosures, as well as the suggestions of WikiLeaks founder Julian Assange that future disclosures will expose corporate misconduct, raise the possibility of that other self-appointed corporate scourges will launch similar guerilla campaigns involving the disclosure of internal corporate communications.

 

These two types of prospective whistleblower risks arguably represent an entirely new level of corporate exposure that could leave companies and their senior officials susceptible to claims of wrongdoing based on public or regulatory disclosures by persons inside the company with access to sensitive information. Indeed, companies and their senior officials could even be susceptible to claims for the alleged failure to implement and maintain sufficient controls to prevent embarrassing or harmful disclosures. Regardless, companies could face the prospect of significant risks involving person inside (or with access to) their own operations.

 

10. Foreign Companies, U.S. Courts: In June 2010, the U.S. Supreme Court issued its long-awaited decision in the Morrison v. National Australia Bank case, holding that Section 10(b) of the Securities Exchange Act of 1934 applies only to transactions taking place on the U.S. securities exchanges, or domestic transactions in other securities.

 

Among other things, the Morrison decision seems to represent the end of so-called "f-cubed" claims, involving foreign claimants who bought their shares in foreign companies on foreign exchanges.

 

Lower courts are now wrestling with Morrison’s implications, including, for example, the question of whether or not Morrison precludes claims under the U.S. securities laws against companies whose American Depositary Receipts trade on U.S. exchanges. (Surprisingly, at least one court has held that case has that effect, as discussed here.) Other courts have struggled to determine what falls within Morrison’s second prong relating to "domestic transactions in other securities." Clearly, there will be much further lower court activity as these kinds of issues are sorted out.

 

In the meantime, one consequence that seemed likely in the wake of Morrison is that there might be fewer (or at least only narrower) cases filed in U.S. courts involving non-U.S. companies. Contrary to expectations, however, there were quite a number of securities cases filed in U.S. courts involving foreign-domiciled companies in 2010, including many filed after the Supreme Court issued its Morrison opinion.

 

As reflected in my recent year-end analysis of 2010 securities lawsuit filings, there were 19 new securities class action lawsuits filed in 2010 involving foreign domiciled companies, representing 10.7% of all 2010 securities lawsuit filings. Of these 19 cases, 12 were filed after the Supreme Court issued its opinion in Morrison.

 

One possibly temporary factor driving many of these filings is the rash of new cases filed against Chinese- domiciled companies. There were ten new lawsuits against Chinese companies in 2010, eight of which were filed post-Morrison. It should be noted that the shares of many of these Chinese companies trade on U.S. exchanges and in fact many of the cases directly relate to the companies’ securities offerings in the U.S., facts which made these companies susceptible to securities lawsuits in this country even under Morrison.

 

The lower courts will continue to interpret and apply Morrison in the months ahead. In the meantime, it seems that lawsuits involving non-U.S. companies will continue to arise, at least where the companies’ shares trade on U.S. exchanges.

 

A Final Note: Readers of this blog post may also be interested in my September 2010 post entitled "What to Watch Now in the World of D&O," which can be found here.

　

Ten Top Ten Lists: Top ten surveys proliferated at year end, and so it seems like a list of ten top ten lists would be the appropriate accompaniment to The D&O Diary’s own top ten list:

The Year’s Top Ten Insurance Coverage Decisions

Top Ten YouTube Videos of 2010

Top Ten Annoying Things British Men Do While Abroad

Top Ten New Species (International Institute for Species Exploration)

Top Ten Goals from the 2010 World Cup

Top Ten TV Commercials of 2010

Top Ten Encyclopedia Britannica Queries 2010

Top Ten Must-Reads in the Law, 2010

Princeton Review Top College Ranking 2010-2011

Time Magazine’s Top Ten of Everything List

　

　

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The FDIC as receiver of the failed Haven Trust Bank may not intervene in a securities lawsuit brought by the aggrieved investors of the Bank’s holding company, according to Northern District of Georgia Judge Charles A. Pannell, Jr.’s December 29, 2010 order in the case. Judge Pannell’s ruling, a copy of which can be found here, could have important implications for other failed bank investor cases in which the FDIC has or may seek to intervene.

 

Background

Banking regulators closed Haven Trust, located in Duluth, Ga., on December 12, 2008. As detailed here, on December 31, 2009, investors who purchased shares in the bank’s holding company filed suit in the Northern District of Georgia alleging that the company’s former officials had misled investors in connection with the share offering, in violation of federal and state securities laws. The individual defendants had served as directors both of the holding company and of the operating bank.

 

On October 4, 2010, the FDIC as the failed bank’s receiver moved to intervene in the investor action. As detailed at greater length here, the FDIC alleged that the investor action was essentially just a "derivative lawsuit in disguise," and, under FIRREA, as receiver, the FDIC succeeded to all of the bank’s rights, including its rights to control actions brought on the company’s behalf.

 

The FDIC also asserted that it had an "interest" in the case sufficient to support intervention because of its interests in preserving the D&O insurance policy for potential recoveries in connection with future claims the FDIC as receiver might assert against the former directors and officers of the bank.

 

The December 29 Ruling

In his December 29 ruling, Judge Pannell rejected both of the bases on which the FDIC had sought to intervene.

 

First, Judge Pannell rejected the FDIC’s argument that the investors’ claims were essentially just derivative claims over which the FDIC had priority rights under FIREEA. Judge Pannell said

 

These claims are not derivative claims against the Bank but are instead direct claims against the defendants …. While the FDIC controls derivative claims against the Bank’s former officers, it does not control claims against the holding company’s officers …. In this case, the plaintiffs assert their claims not as stockholders of the failed Bank, but instead as shareholders of the holding company.

 

Second Judge Pannell rejected the FDIC’s argument that it was entitled to intervene because of its prospective interest in the Company’s D&O insurance policy. Judge Pannell found that the FDIC does not have a "legally protectable interest" because the FDIC "has no rights with respect to this insurance policy except as a potential claimant against certain of the policy’s insured parties," and the FDIC’s "potential future rights" are "insufficient to establish that the FDIC has an interest in this case that justifies intervention as of right."

 

Finally, Judge Pannell denied the FDIC’s request for "permissive intervention" because the FDIC’s intervention "would needlessly delay the current proceedings while the FDIC investigates to determine whether it has any legitimate claims against the defendants."

 

Discussion

As NERA Economic Consulting noted in its August 2010 study of failed bank litigation (here), private investor securities suits were "not a notable feature of the S&L crisis," because few of the institutions that failed during that era had conducted securities offerings. By contrast, private litigation against directors and officers of failed banks during the current wave have been "widespread." As a result, the FDIC is in a position of competing with investor claimants for dwindling D&O insurance policy proceeds, as the Haven Trust case demonstrates.

 

As I discussed in my prior post about the FDIC’s bid to intervene in the Haven Trust case, the claimants who may be competing with the FDIC for the D&O insurance policy proceeds include not only aggrieved investors, but in instances where the bank holding company is in bankruptcy, may also include the bankruptcy trustee.

 

In both of these kinds of cases, the claims against the individual defendants will be direct claims aimed against them in their capacities as directors and officers of the holding company. At least according to the logic of Judge Pannell’s decisions in the Haven Trust case, the FDIC’s rights as receiver may not be sufficient to allow the FDIC to control or otherwise take priority over these direct claims targeted at the holding company level.

 

The essential problem at the heart of all of these kinds of disputes is that the parties left aggrieved in the wake of a bank failure are set against one another in a scramble for the D&O insurance (or whatever might be left of it after defense expenses have eroded the limits). Meanwhile, the former directors and officers are put squarely in the crossfire, with heightened exposure to multiple conflicting claims. Whatever else might be the merits of Judge Pannell’s holding, the practical effect of his ruling is to exacerbate all of these forces.

 

From the FDIC’s perspective, Judge Pannell’s ruling, if followed by other courts, could put the FDIC in a quite a dilemma. On the one hand, the FDIC has been proceeding quite deliberately as part of its process of investigating bank failures and deciding whether to bring claims. (Indeed, even though 322 banks have failed since January 1, 2008, the FDIC has filed only two lawsuits against former directors and officers of failed banks).

 

On the other hand, however, if by proceeding deliberately the FDIC is to be disadvantaged in the scramble for D&O insurance policy proceeds, and if the FDIC is unable to intervene in and stay investor and trustee actions against former bank officials, it may find itself compelled to move more quickly to file suit, simply to try to preserve a part of the dwindling policy proceeds before the other claimants get there.

 

Whether or not the FDIC will now accelerate its investigative and litigious processes remains to be seen. But at a minimum, Judge Pannell’s ruling suggests that the FDIC does not have priority rights over the direct claims of bank holding company investors, which is a principle that could prove important in the numerous other failed bank-related proceedings.

 

Special thanks to the several loyal readers who sent me a copy of Judge Pannell’s ruling.

 

Editorial Note: In my January 3, 2011 post, I mentioned that I would be publishing a list of the top ten D&O stories of 2010 today (January 4, 2011). However, because of the several time sensitive developments (including the above), I will postpone the publication of the top ten list until later in the week. Sorry for any confusion.

　

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Even after two years, the Madoff scandal continues to fascinate. Following close on the heels of last week’s news of Mark Madoff’s tragic suicide is the absolutely arresting news of Jeffry Picower’s estate’s $7.2 billion settlement with the U.S. government – to be specific, the precise amount of the settlement is $7,206,157,717, according to the Southern District of New York U.S. Attorney’s December 17, 2010 press release.

 

 

According to the press release, the settlement amount represents “all the profits Picower withdrew over the years.” Picower apparently first invested with Madoff in the late 70’s, and withdrew billions over time. After Madoff’s scheme was exposed “it became clear” that Picower had “profited at the expense of more recent [Madoff] investors.”

 

 

 

One aspect of the settlement, and apparently a critical condition on which Picower’s widow had insisted, is the provision that “neither Picower nor any of the related entities participating in the settlement had any involvement in, or knowledge of, Madoff’s fraud.”

 

 

 

This settlement will not leave Picower’s widow destitute. Most of this money had been intended for a philanthropic foundation, not for Picower’s heirs. According to the Washington Post (here), Picower’s widow will retain $200 million and his daughter will retain $25 million, the funds for all of which reportedly derived from sources other than Madoff-related profits.

 

 

 

Those readers who are curious to know exactly how a $7.2 billion civil forfeiture works will want to take a look at the U.S. Attorney’s December 17, 2010 forfeiture complaint. The complaint, which can be found here, is styled as an action by the United States against the “Defendant in rem” – specifically, “$7,206,157,717 on Deposit at J.P. Morgan Chase Bank, N.A..”

 

 

 

Among other interesting tidbits, the complaint reveals that, in order to generate those $7.2 billion in profits, the total amount that Picower had invested with Madoff’s investment advisory services was $617,456,578 – which by my calculation means that Picower’s investment with Madoff had supposedly generated lifetime returns of over 1,100%)

 

 

 

The estate’s December 17, 2010 stipulation of settlement with the government, which can be found here, represents in effect the estate’s agreement to forfeit the Defendant in rem to the government, to be effected, the stipulation recites, by the Clerk of Court’s issuance of “a warrant for the arrest of the Defendant in rem.”

 

 

 

Southern District of New York Judge Thomas Greisa approved the forfeiture case settlement. The settlement remains subject to the bankruptcy court’s approval.

 

 

 

This dual judicial approval is required because the settlement actually represents two different funds to be paid in settlement of two different matters. One fund, in the amount of $5 billion, is to be paid in settlement of the adversary proceeding the SIPC Trustee Irving Picard had filed against Picower in the bankruptcy court. The remaining $2.2 billion is actually in settlement of the civil forfeiture proceeding itself. Picard is to administer both funds for the benefit of the Madoff victims according to the detailed procedural specifications in the settlement stipulation.

 

 

 

 

The New York Times speculates that as a result of this and other recoveries, those who lost the amount of their principal investment by investing with Madoff may recover as much as 50 percent of their losses.

 

 

 

Special thanks to a loyal reader for providing the Picower settlement documents.

 

 

 

The Next Act of this Icelandic Saga Will Not be Staged in New York: Many readers may recall my May 2010 post about the events surrounding the failure of Iceland’s Glitnir Bank and the subsequent lawsuit filed in New York state court against the bank’s controlling shareholder and his wife, certain former bank directors and officers, and the Bank’s auditor.

 

 

 

At the time, I noted that “the obvious question about this case is what the heck is it doing in state court in New York?”

 

 

 

Apparently, the New York state court judge in charge of the case had exactly the same question. As reflected in Julie Triedman’s December 17, 2010 Am Law Litigation Daily article (here), on December 15, 2010, Judge Charles Ramos has thrown out the lawsuit on forum non conveniens grounds.

 

 

 

According to the article, among other issues with which Ramos was concerned was the practical problem associated with language translation. Judge Ramos seemed to accept the argument of counsel for one of the defendants, who had asked the Judge to “imagine the burden of trying to translate that all? We can’t even pronounce the names, much less translate this all.” (In that regard, I note that in typing my prior post about this case, I was unable to accurately reproduce the individual defendants’ names, as the requisite typographic symbols are simply unavailable.)

 

 

 

Judge Ramos also seemed annoyed by the very idea that this case could be added to his judicial burdens. The article reports that Judge Ramos said “you know something, we don’t need extra work. How many cases does the average judge in Iceland have in their inventory?...I’ve got 350.”

 

 

 

Demonstrating the true New Yorker’s perception of geography, Ramos added that “what I see unfolding is a case that is going to show me that the conspiracy was hatched in Iceland or Denmark or some place, but not necessarily New York.”

 

 

 

Ramos conditioned his dismissal on the defendants’ acceptance of jurisdiction in Icelandic courts. He advised the plaintiffs’ counsel to “get yourself a plane ticket.”

 

 

 

And Speaking of Failed Banks: Meanwhile, while everyone was distracted with other things, the FDIC quietly closed six more banks this past Friday night, bringing the 2010 YTD total to 157. There could be more bank failures yet to come this year, but given that next Friday is Christmas Eve and the following Friday is New Year’s Eve, the FDIC might be done closing banks, for this year at least.

 

 

 

Though the monthly totals fluctuated throughout the year from a monthly low of seven failed banks in February 2010 to a monthly high of 23 in April 2010, it definitely seems as if the bank closure pace slowed as the year progressed. There have been only 71 bank failures in the second half of 2010, compared with 86 in the first half. Moreover, after the FDIC closed 22 banks in July 2010, the agency closed only 49 banks over the following give months (an average of just under 10 banks a month).

 

 

 

The six bank closures this past Friday included three more bank in Georgia. There have been 51 bank failures total in Georgia since January 1, 2008, the highest total for any state during that period.

 

 

 

But the state with the highest number of bank closures in 2010 is Florida, which with one more bank closure this past Friday now has had 29 bank failures this year. (Georgia is second in 2010 bank failures with 21.) Florida also has the second highest number of bank failures since 2010, with 45.

 

 

 

Since January 1, 2010, there have now been a total of 322 bank failures. With 860 banks ranked as “problem institutions” in the agency’s most recent Quarterly Banking Profile, it seems likely that bank failure will likely continue as we head into 2010.

 

 

 

A Spectral Italian Vintner, Perhaps?: Novelist Jay McInerney’s wine column in this Saturday’s Wall Street Journal (here) contained this sentence: “When the elder brother died, he returned to Italy to run the family business.” In fairness, the surrounding context makes some sense out of this otherwise incomprehesible sentence. Nevertheless, The D&O Diary feels compelled to throw a flag on this sentence for unnecessary roughness in the use of the English language.

 

 

 

And Finally: If you have not yet had someone send you a link to the marvelous December 16, 2010  “Let it Dough!” illustrations on Christoph Niemann’s Abstract City blog on the New York Times website, give yourself a treat and take a few minutes to check them out here. (The “Hot Toddies” illustration alone justifies the time to visit the site.)

 

 

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Our beat here at The D&O Diary is basically restricted the world of directors’ and officers’ liability. So, regrettably, we don’t often have the occasion to write about college football. But a story making the rounds on the Internet manages to connect Colonial Bank (the third largest bank to fail during the current bank failure wave) and the evolving pay-to-play scandal surrounding Auburn University quarterback and Heisman candidate Cam Newton. So we felt empowered to write a post about it.

 

From the moment the Montgomery, Alabama bank closed in August 2009, observers have been asking what the bank failure might mean for Auburn football. As noted at the time on Time Magazine’s Curious Capitalist blog (here), Colonial’s founder, CEO and Chairman, Bobby Louder was also "the dominant force at Auburn University since George Wallace appointed him to [Auburn’s] board of trustees in 1983." ESPN.com called Louder "The Most Powerful Booster in College Football."

 

Many readers undoubtedly are aware that the news wires have been buzzing recently with stories about how Cam Newton’s father allegedly demanded payment from Mississippi State in order for Cam Newton to play there coming out of junior college. Since Newton did not wind up attending Mississippi State, but does play for Auburn, many have questioned whether or not there may have been similar payment demands at Auburn.

 

The lines of the Colonial Bank and the Cam Newton stories have started to cross, at least on the Internet. At least according to stories making the rounds online, the government authority’s investigation of circumstances surrounding the collapse of Colonial Bank has led to the discovery of information suggesting the possibility of payments made in order for Newton to play at Auburn.

 

I have linked in the next paragraph to a site that contains an exhaustive summary of the various details of this story that are available on the Internet. I would like to emphasize that in linking to this site, I am in no way indicating that I necessarily think any of the information on the site is true. The web site’s host himself indicates that he has not verified any of the information. The newsworthiness of these unproven allegations consists of the fact that these allegations are being raised, in that they suggest how far reaching the investigation into a bank’s failure potentially may spread. (Besides, as I noted at the outset, they involve college football, which is another reason I am writing about them here)

 

With all disclaimers duly noted, the site, which can be found here, makes for some awfully interested reading and I would suggest making some time to read all the way through the page. The page is assembled rather awkwardly and you will have to scroll down multiple times. Special thanks to a loyal reader for forwarding me the link to the site.

 

While we cannot now know what among the various things asserted on this site are factual, I would have to say that it would hardly come as a surprise that there might be some sort of a governmental investigation in connection with the collapse of Colonial Bank. Colonial Bank had assets of $25 billion, making its closure the third largest failure in the current wave of failed banks. Its failure caused a $2.8 billion loss to the FDIC insurance fund. Given the numbers involved, an investigation seems probable.

 

In addition, one of the former directors of Colonial, Milton McGregor, also a prominent casino owner and a prominent Auburn football booster, was recently arrested in Alabama in connection with a vote buying scandal that followed FBI wiretaps. The inflammatory question is whether or not the wiretaps divulged anything about payments to Cam Newton. There are news articles denying that the wire taps revealed anything about Cam Newton. However, it does seem clear that for whatever reason the FBI is involved in investigating the Cam Newton allegations.

 

A couple of observations, one D&O related and one not. On the D&O side, the information on the linked site (even if ultimately unproven) potentially could implicate at least two D&O insurance policies, the policy for Colonial and the policy of the Auburn University Board of Trustees. (Please note that I am not expressing an opinion here whether or not anything on the Internet constitutes a claim under any policy or even constitutes circumstances that might give rise to a claim)

 

Because of the significant overlap in membership between the two boards, there are at least a couple of complicated insurance questions. One has to do with the capacity in which the various individuals were acting in connection with the various misconduct alleged, as the capacities seemed to have overlapped in many important ways.

 

The other insurance problem is, well, an other insurance problem. The "other insurance" clause in each of the policies could lead to some roundabout analysis between the two policies.

 

I will reserve for another day (and perhaps another blog site entirely) my views about the insanity of a system in which college football players, who risk potentially crippling injuries and whose athletic displays produce billions of dollars of economic activity, are deprived of any financial benefit for their efforts. This grotesque system inevitably leads to scandals like the current one involving Cam Newton.

 

And Now From Our Vietnam Bureau: Under the heading of things we did not really expect to find ourselves writing about, we also note that Bloomberg news reports (here) that regulators in Vietnam have brought there first securities enforcement action, accusing a pharmaceutical company official of stock price manipulation. Apparently regulators and market participants around the world recognize the need to maintain marketplace integrity.

 

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While the condition of commercial banks continues to improve overall, the number of "problems institutions" also continues to grow, in both absolute and percentage terms, according to the FDIC’s latest report on the banking industry. The FDIC’s Quarterly Banking Profile, dated November 23, 2010 and reporting figures through September 30, 2010, showed that the FDIC now rates 860 banks as problem institutions, up 829 at the end of the second quarter.

 

The increased numbers of problem banks stands in contrast to the overall tenor of the report. Tthe FDIC said that during the thing quarter the banking industry was characterized by "resilient revenues and improving asset quality." Year over year earnings improved for the fifth consecutive quarter. Indeed almost two out of three institutions reported higher net income than a year earlier.

 

Other signs are also positive. Quarterly provisions for loan losses were at the lowest quarterly amount since the fourth quarter of 2008, net charge-offs were lower than both the previous quarter and the year-earlier quarter, and industry assets continued to improve.

 

However, within this good news, some evidence of continuing difficulties also emerged. One in five banks continues to be unprofitable. The 860 institutions reported as problem institutions represent more than 11 percent of all 7,780 insured institutions. In other words, the FDIC ranks about one our of nine of all banks in the country as problem institutions.

 

(The FDIC considers a bank a "problem institution" if it is ranked as either a "4" or a "5" on the agency’s 1 to 5 scale of supervisory concern. Problem institutions are "those institutions with financial, operational, or managerial weaknesses that threaten their continued financial viability." The FDIC does not publish the names of the banks it considers to be problem institutions.)

　

The 860 problem institutions at the end of the third quarter represent an increase of 308 problem institutions during the twelve months since September 30, 2009, or about 56%. This increase is all the more noteworthy given that 172 banks closed during that period and so fell off of the problem list.

　

The number of problem institutions at the end of the third quarter is the largest number of problem institutions since March 31, 1993, when there were 928.

 

One positive note is that while the number of problem institutions continues to increase, the aggregate assets represented by these problem institutions declined in the third quarter, to $379.2 billion, from $403.2 at the end of the second quarter. This is the second quarter in a row that the assets of problem banks have declined. The fact that aggregate assets are declining even as the total number of problem banks is increasing suggests that many of the newly added problem banks are smaller institutions.

 

A total of 314 banks have failed since January 1, 2008, with 149 during 2010 alone (so far). Yet the number of problem institutions continues to grow, which suggests that there could be more, possibly many more, bank failures yet to come. Although there had been some hope that the number of bank failures might have peaked and would now begin to taper off, the FDIC’s latest report suggests that we could continue to see bank closures well into 2011 and possible beyond.

 

In the meantime, as I recently noted, the FDIC reportedly is gearing up to pursue both civil and criminal proceedings against former directors and officers of the failed banks, while at the same time investors have also been pursuing their own separate claims. It seems highly probable that these claim-related activities will escalate in the months ahead.

 

A November 23, 2010 New York Times article about the FDIC’s report can be found here.

　

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The lead article in the November 17, 2010 Wall Street Journal reported that the FDIC is conducting 50 criminal investigations of directors, officers and employees of failed banks. Given that (as of November 19, 2010) 314 banks have failed since January 1, 2008, this report suggests that the FDIC is investigating possible criminal charges in connection with a pretty hefty percentage of the bank failures -- about 16%, if each of the 50 investigations relates to a separate bank.

　

These reports of as many as 50 criminal investigations are all the more striking because up to this point, the FDIC has not conspicuously pursued criminal charges. The most prominent criminal charges filed as part of the current wave of bank failures related to the May 2010 indictment of two former officials from Integrity Bank in Alpharetta, Georgia. Integrity Bank failed in August 2008, which was fairly early in the current failed bank wave. Many more banks have failed since then, and so the FDIC may just now be completing its investigations of many of the later bank failures.

 

In the meantime, banks are continuing to fail. Just this last Friday night, the FDIC closed three more banks, bringing the 2010 YTD total number of bank failures to 149. (The Journal article does note that FDIC officials "expect the failure wave to peak this year.")

 

Obviously, the FDIC has not even had an opportunity to investigate the most recent bank failures, which suggests that the figure of investigations could grow.

 

The Journal article quotes one FDIC official, speaking of possible civil actions to be brought against former officials of failed banks, "these numbers will continue to grow as time goes on." (The Journal article repeats the information, now widely circulated, that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks.) The Journal article also reports that it takes up to 18 months for the FDIC to determine whether to bring an action, meaning that "the surge in scrutiny is likely to continue for years."

 

One particularly noteworthy step the FDIC has taken as it readies itself to pursue actions in connection with the failed banks is that it has begun to try to recover documents from outside law firms that were advising the directors and officers of failed institutions before they were closed.

 

As detailed in a November 20, 2010 Bloomberg story (here) the FDIC has sued one law firm and threatened to sue another in order to recover documents bank executives gave the lawyers before the institutions failed.

 

A copy of the November 9, 2010 complaint filed against the Bryan Cave law firm can be found here; a copy of the November 10, 2010 consent order attempting to resolve the matter can be found here. A November 12, 2010 Am Law Daily article about the dispute can be found here. .

 

In the dispute involving the second law firm, the law firm itself initiated an action, in the form of a November 17, 2010 declaratory judgment action. The law firm had received a letter from the FDIC demanding the immediate return of the documents their clients had supplied them.

 

It may be, as suggested in the Journal article, that the wave of bank failures will peak this year. But the FDIC’s recent actions seem to be preliminary to an onslaught of litigation activity (both civil and criminal) and suggest that the FDIC claims-related activities have only just begun but will be accelerating for some time to come.

 

Special thanks to a loyal reader for copies of the pleadings in the FDIC’s law firm related litigation.

　

Meanwhile, Investors Pursue Securities Suits Against Banks: While the FDIC’s moves toward litigation involving failed banks has been a long time coming, investors in failed and troubled banks have much more assertive. As I have previously observed, a noteworthy feature of the current round of bank failures has been the significant numbers of investor suits involving failed and troubled banks.

 

The numbers of investor related suits involving failed or troubled banks continues to mount. Just in the last week, investors filed two more securities class action lawsuits involving failed banks.

 

First, as reflected in their November 18, 2010 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the District of Delaware against Wilmington Trust Corporation and certain of its directors and officers. A copy of the complaint can be found here.

 

Second, in a separate November 18, 2010 press release (here), another plaintiffs’ firm announced that they had filed a securities class action lawsuit in the Eastern District of Tennessee against Green Bankshares and certain of its directors and officers. A copy of the complaint can be found here.

 

With the addition of these two latest lawsuits, as many as thirteen of the approximately 154 new securities class action lawsuit filed during 2010 have involved commercial banks, or roughly 8.5% of all 2010 securities class action lawsuits. The banking related securities suit activity has been one of the most significant factors in 2010 securities filing activity (not even taking into account the claims that have arisen involving banking companies that were not publicly traded).

 

Perhaps the only other group of companies that has been so specifically targeted in lawsuits this year is the for-profit education sector, which has been hit with nine separate securities class action lawsuits this year, or about 6 percent of all 2010 securities suits.

 

Schwab YieldPlus Settlement Back On?: As I reported in an earlier post, the Charles Schwab Corporation had announced its decision to withdraw from the $235 Schwab YieldPlus Fund subprime-related securities class action settlement, due to a dispute about whether or not the settlement stipulation released the California state law claims of non-California class members.

 

However, according to November 18, 2010 news reports (here), the parties to the YieldPlus case have reached a revised settlement The revised settlement is intended to make it clear that all of the claims of the class are released, including the California state law claims of non-California residents.

 

A copy of the parties’ November 17, 2010 amendment to their settlement stipulation, reflecting the revised understanding, can be found here. A copy of the parties’ joint motion regarding the revised settlement stipulation can be found here. The parties’ amended settlement stipulation is subject to the approval of Northern District of California Judge William Alsup.

 

QE II: Here at The D&O Diary we have followed with interest the debate about the Federal Reserve’s latest round of "quantitative easing." Because we feel unqualified to comment on the Fed’s actions, we express no views of our own here about the wisdom of the Fed’s approach.

 

Others have not been as restrained.

 

In that vein, a video critical of the Fed’s actions has been making the rounds and I have attached it below. I want to stress that this video does not necessarily reflect my views, and I am linking to it here only because I think it is pretty amusing and because it has been a while since I have had occasion to link to a video on this site. Special thanks to a loyal reader for the link to the video. 

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If the lawsuit filed on Monday is any indication, the long-anticipated FDIC litigation against failed banks may have arrived. On November 1, 2010, the FDIC filed a lawsuit in the Northern District of Illinois against eleven former directors and officers of Heritage Community Bank, a lending institution in Glenwood, Illinois that failed in February 2009. A copy of the FDIC’s complaint can be found here.

 

Because 304 banks have failed since January 1, 2008, there has been widespread speculation that the FDIC might pursue claims against the former directors and officers of the failed institutions. Until now, the FDIC has filed just one lawsuit against former executives of a failed bank, involving former officers of IndyMac bank (about which refer here). More recently, there had been reports that the FDIC’s board had authorized numerous lawsuits to proceed – and now the lawsuits apparently have begun.

 

The Heritage Community Bank lawsuit, filed by the FDIC in its capacity as the bank’s receiver, seeks to "recover losses of at least $20 million" that the FDIC alleges the bank suffered because the defendants "failed to properly manage and supervise Heritage and its commercial real estate lending program." The complaint alleges claims of negligence, gross negligence and breach of fiduciary duty.

 

Essentially, the complaint alleges that the defendants made imprudent or improper commercial loans while "making millions of dollars of dividend payments to Heritage’s holding company and paying generous incentive awards to senior management." The complaint also alleges that by December 2006, the defendants knew the bank was in trouble, but instead of curtailing lending, the defendants "tried to mask the Bank’s mounting problems" by lending troubled borrowers more to pay down earlier loans.

 

The defendants in the case include not only the bank’s CEO, CFO and various lending officers, but also five outside directors.

 

The defendants are alleged to have extended or approved commercial real estate without appropriate expertise, processes or supervision, allowing loans in excess of prudent loan to value rations. The bank allegedly also lacked appropriate loan monitoring processes. The bank allegedly failed to post appropriate loan loss reserves, and even inappropriately recognized income as subsequent loans were used to pay off interest on prior loans.

 

The inappropriately recognized income allowed the allegedly improper holding company dividends and incentive compensation payments. (The allegedly improper incentive compensation payments in 2007 totaled $825,000.) The FDIC alleges that the total amounts of the improper dividends and inventive compensation payments were over $11 million.

 

Counsel for the defendants issued a press release on the defendants’ behalf that stated among other things:

 

The FDIC has now filed a lawsuit against the Bank’s former officers and directors for failing to foresee the recent unprecedented collapse in real estate values. The FDIC’s action is both regrettable and wrong. With the advantage of 20-20 hindsight, the FDIC blames the former officers and directors of a small community bank for not anticipating the same market forces that also caught central bankers, national banks, economists, major Wall Street firms, and the regulators themselves by surprise.

 

From my perspective, this case seems like an unexpected place for the FDIC to have started. The allegedly improper compensation seems relatively modest and there are otherwise no allegations of self-dealing or other egregious conduct. Similarly, there are no allegations that the bank operated in violation of any regulatory orders or consents.

 

Even taking the FDIC’s complaint on its own terms, it looks as if this bank (like so many others) got caught up in the real estate bubble and then failed to recognize the collapse until it was too late. In the aftermath, it seems easy to say the bank should have been more prudent than it was. The bank has a lot of company in that regard, starting with the Federal Reserve and going from there.

 

I will say this (in quotation of a comment from one of my readers) this complaint is a hell of a lot more compact than the 300-page behemoth the FDIC filed in the Indy Mac case.

 

It is perhaps not much of a surprise that this suit involves an Illinois failed bank. There have been 38 bank failures in Illinois since January 1, 2008, the third highest number of any state, behind only Georgia (46) and Floriday (43).

 

Earlier news reports had suggested that the FDIC had authorized lawsuits against as many as 50 former directors and officers of failed banks, but news reports concerning the new Heritage Community Bank lawsuit report that the FDIC has now authorized lawsuits against "more than 70" former directors and officers. Reliable sources tell me that the FDIC has also filed a lawsuit against the former directors and officers of a specific failed bank in a Western state although I have been unable to independently verify that.

 

But in any event, it appears the FDIC failed bank D&O litigation has now begun. It seems probable that may more lawsuits will follow. Stay tuned.

 

Special thanks to John M. George, Jr. of the Katten & Temple law firm for providing copies of the complaint and of the defense counsel press release. George's firm is of counsel in connection with the defense of one of the indidivudal defendants.

 

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As has now become a familiar routine, this past Friday night the FDIC took control of several more commercial banks. The seven additional banks seized on Friday bring the year to date total number of failed banks to 139, and the total since January 1, 2008 to 304. At the same time, lawsuits involving failed and troubled banks are also accumulating, and on Friday, investors filed two more banking-related securities class action lawsuits. And as noted below, the jury trial in another banking related-securities class action lawsuit continues to go forward in federal court in Florida.

 

Recent Banking-Related Securities Suits

The first of the new lawsuits was filed on October 22, 2010 in the Northern District of Illinois against PrivateBancorp and certain of its directors and officers. As reflected in the plaintiffs’ lawyers’ October 22 press release (here), the Complaint alleges material misrepresentations in connection with the company’s June 4, 2008 and May 11, 2009 securities offerings. The complaint (which can be found here) alleges that the company’s share price fell over 37% in October 2009 after it announced that it held nearly $400 million in nonperforming loans.

 

The other recently filed banking-related suit was filed on October 22, 2010 in the Northern District of Iowa against Meta Financial Group and certain of its directors and offices. According to their October 22, 2010 press release (here), the Complaint (which can be found here) relates to the company’s October 12, 2010 announcement that the Office of Thrift Supervision was investigating the company in connection with its iAdvance credit origination program. The complaint alleges that the company’s shares declined over 40% on the news.

 

Statistical Review of Recent Banking-Related Litigation

Securities class action activity involving commercial banks represents a significant part of 2010 securities class action lawsuit filings. By my count, there have been at least ten securities class action lawsuits so far this year involving banking institutions, representing about seven percent of the approximately 143 securities suits filed year to date.

 

As noted in NERA’s August 2010 report on failed bank litigation, investor lawsuits involving failed and troubled banks have been a significant accompaniment of the current round of banking problems. According to the NERA report, private investor litigation "was not a notable feature of the S&L crisis litigation," but this time around "private litigation against D&Os has been widespread."

 

Among other statistics, the NERA report notes that of the 240 securities class action lawsuits filed against financial sector firms in 2008 and 2009, there were 45 against depositary firms. The report further notes that of the 20 largest failed banks prior to 2010, 13 involved publicly traded institutions, and eight were involved in securities class action litigation through the end of 2009.

 

Updated Overview of Bank Failures

Meanwhile the number of failed banks continues to mount. The 139 banks closed in 2010 through October 22 is nearly equal to the 140 banks closed in all of 2009. The seven banks closed this past Friday night includes two more failed banks in Georgia and Florida, respectively, as well as one more in Illinois. There three states – Georgia, Florida and Illinois – are the states with the highest numbers of failed banks, both this year and since January 1, 2008.

 

So far this year, Florida has the highest number of failed banks, with 27, followed by Georgia (16), Illinois (16) and California (10). These four states alone have combined for 69 bank failures this year, or just under 50% of all 2010 bank failures.

 

Though 39 states and Puerto Rico have each had at least on bank failure since January 1, 2010, the bank failures have predominately been concentrated in just a handful of states, again led by the same four states – with Georgia leading the way with 46 failed banks, followed by Florida (43), Illinois (38) and California (32). These four states together have had 159 bank failures, or about 52% of all failed banks since January 1, 2008. Other states with high numbers of failed banks during that period include Minnesota (14), Washington (13), Missouri (11) and Nevada (10).

 

The 2010 bank failures have largely been concentrated among smaller banks. 116 of the 139 bank failures, or about 83%, have involved institutions with less than $1 billion in assets. 32 (or about 29%) of the 2010 bank failures have involved banks with less than $100 million in assets. Of course, given that there are many more smaller banking institutions in the U.S. than there are larger banks, it may be unsurprising that there are so many bank closures involving smaller banks.

 

Discussion

While the bank closure statistics are striking, it is worth noting that the lawsuits described above, as well as much of the banking-related securities litigation, involves banks that remain in operation. In other words, the current level of banking-related securities litigation represents more than just the direct fallout from the high level of bank failures. Rather the litigation reflects the pressures and stresses more widely distributed throughout the entire U.S. banking industry in the wake of the credit crisis.

 

Even though we are well past the depths of the financial crisis (at least temporally), many banks remain under pressure, as reflected in the FDIC’s most recent quarterly banking profile (about which refer here). In many instances, this pressure has, among other things, led to litigation.

 

So while we continue to wait and see the extent to which the FDIC will, as a result of the current round of bank failures, become an active claimant against former directors and officers of failed bank, investors have pressed ahead with their own claims. Many of these investor claims have come in the form of securities class action lawsuits, the targets of which include a range of banking-related defendants, beyond just the failed institutions. The most recent filings suggest that we may continue to see more commercial banking-related securities litigation in the months ahead.

　

Meanwhile, BankAtlantic Securities Trial Continues: Among the banking-related securities cases filed in recent years is the securities class action lawsuit filed against BankAtlantic Bancorp and certain of its directors and officers, which recently became one of the very rare securities class action lawsuits to actually go to trial (about which refer here). The jury trial in the case is going forward in federal court in Miami, and as reflected in the October 22, 2010 post in the Southern Florida Business Journal Blog (here), the trial has among other things involved the plaintiffs’ introduction of inflammatory internal emails highly critical of the bank’s lending practices and processes.

 

According to informed sources, the plaintiffs are likely to conclude the presentation of their case some time during the upcoming week, and it will then be the defendants’ turn to present evidence and to introduce testimony.

 

Plaintiffs in the case are represented by Matthew Mustokoff and Andrew Zivitz of the Barroway Topaz firm and Mark Arisohn of Labaton Sucharow. The defendants are represented by Eugene Stearns of the Stearns Weaver Miller law firm.

 

Anatomy of a Failure: Those readers wondering how in the world we got into this current banking mess may want to take a look at the article entitled "Death of a Small Town Bank" in November 1, 2010 issue of Time Magazine (link currently unavailable) The article tells the story of Community Bank & Trust (CBT) of Cornelia, Georgia, which the FDIC closed on January 29, 2010.

 

Though CBT is just one of the 139 banks that have failed this year, its tale encompasses so many of the problems underlying the current crisis. All of the usual details are present, as a small town institution got caught up in the speculative fever caused by rapidly escalating real estate prices, compounded by administrative and procedural shortcomings (and possibly worse) that led to faulty and some improper loans. The sudden collapse of prices that accompanied the financial crisis left lenders unable to repay and the bank saddled with a portfolio of bad loans that ultimately caused the bank’s failure and left the town with a challenging future. The article makes for interesting, if sobering, reading.

 

For Those Looking for Something to Feel Good About: Those readers who have had just about enough of depressing stories about failed banks may want to take a look at the cover article from the October 24, 2010 issue of The New York Times Magazine entitled "The D.I.Y. Foreign-Aid Revolution." The article reports the stories of several individuals who have made it their personal responsibility to try to make the world a better place, and who actually have each found a way to actually do things that can make a difference. A really inspirational article about some really interesting and impressive people.

 

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The FDIC has authorized more than 50 lawsuits against former directors and officers of failed banks, according to an October 8, 2010 Bloomberg article. But merely because the lawsuits have been authorized does not necessarily mean we will see 50 lawsuits, as it appears that the FDIC approval was calculated in part to encourage pre-litigation settlements.

 

Since January 1, 2008, the FDIC has taken control of 294 banking institutions, as detailed here. The FDIC has been a very active litigant seeking to assert its rights of priority over other litigants’ claims against the directors and officers of failed banks, but the FDIC itself has filed only one lawsuit against the senior officials at a failed bank.

 

Though the FDIC has to date pursued relatively little litigation itself, it has asserted claims against individuals at failed banks. These claims have come in the form of demand letters nominally addressed to the individuals but also with copies to the failed institution’s D&O insurers.

 

For example, as discussed here, the FDIC filed a November 24, 2009 motion in the BankUnited Holding Company bankruptcy proceeding asserting its rights of priority to assert claims against Company’s bank unit’s directors and officer. Attached to the motion was a copy of a November 5, 2009 letter the FDIC’s attorneys sent to former directors and officers of BankUnited, in which the FDIC presented a demand for civil damages and losses. Copies of the letter were sent to the company’s primary and first level excess D&O insurers.

 

With its recent litigation authorization, the FDIC may now proceed to file more lawsuits against directors and officers of failed banks. However, the authorization (and surrounding publicity) may have been calculated to try to avoid litigation and encourage pre-litigation settlement in connection with some of the claims the FDIC has previously asserted in the form of demand letters like the one in BankUnited.

 

Along those lines, the Bloomberg article quotes an FDIC spokesman as saying that "the goal is to reach as many settlements as possible," adding further that "it’s both in our interest and theirs to try and settle this matter before it gets into court and we get into expensive litigation." Thus, it appears that the authorization and surrounding publicity is designed in part to encourage settlements before available funds have been reduced by defense expenses.

 

The article cites the FDIC’s estimate that the 50 authorized lawsuits would represent an effort to try to recoup more than $1 billion in losses. By way of comparison, and according to the NERA’ August 2010 report on failed bank litigation (about which refer here), during the S&L crisis, the FDIC recovered about $1.3 billion in D&O claims.

 

In terms of the number of lawsuits filed, the 50 currently authorized lawsuits would represent about 17% of the 294 banks that have failed since January 1, 2008. During the S&L crisis, the FDIC filed lawsuits in connection with about 24% of the 1.813 failed financial institutions -- meaning roughly 435 lawsuits. Because the institutions failing during the current banking crisis are larger than the institutions that failed during the S&L crisis, the potential litigation recoveries in connection with many of the current failed institutions are proportionately larger.

 

Even though the FDIC want to try to settle cases if it can, it seems probable that it soon will be filing lawsuits, perhaps many of them in the days ahead. The Bloomberg article quotes the FDIC’s spokesman as saying that "we’re ready to go," adding that "we could walk into court tomorrow and file the lawsuits."

 

As a loyal reader said, commenting on the reports of the FDIC’s litigation authorization, "Game on." Indeed.

 

UPDATE: In picking up this story, various news sources have clarified that the FDIC did not authorize 50 lawsuits but rather authorized lawsuits against 50 individuals. Refer for example here. At least one knowledgeable source I consulted confirmed that what the FDIC authorzied was not 50 separate lawsuits, but rather lawsuits against 50 indiviudals. The expectation then is that there might be 5 to 10 lawsuits, which is quite a bit different than 50 lawsuits. Hard to see how the FDIC plans to get to $1 billion in recoveries from that level of litigation activity.

 

Special thanks to the several readers who sent me copies of the Bloomberg article.

 

Morgan Keegan Funds ’33 Act Subprime-Related Claims Survive Dismissal: In a September 30, 2010 order (here), Middle District of Tennessee Judge Samuel H. Mays, Jr. granted the defendants’ motions to dismiss the ’34 Act claims but denied the motions to dismiss the ’33 Act claims in the Regions Morgan Keegan Open-End Mutual Fund securities class action litigation.

 

Plaintiffs are investors in three Morgan Keegan select mutual funds. The defendants are the funds themselves, their corporately affiliated asset manager, related corporate entities, as well as their corporate parent. The defendants include individual officers and directors of the funds and related entities.

 

The plaintiffs’ allegation is basically that the funds invested in CDOs and other illiquid subprime mortgage-backed investments in excess of stated restrictions on the funds’ investments. The plaintiffs contend that their investment losses are not the result of normal market factors, but rather are due to the funds investment in lower-priority tranches of asset-backed securities. When the market for the instruments began to decline in 2007, the funds found themselves holding assets that quickly declined in value and which they could not readily sell because of the limited market for such investments. Two of the funds declined in value over 70 percent, the third declined over 20 percent.

 

In reviewing the motions to dismiss, Judge Mays noted that the plaintiffs’ amended complaint "exceeds four hundred pages, comprising 766 paragraphs and six appendices." This extraordinary length may in the end have weighed against the plaintiffs. Judge Mays observed that "when it is possible to ask legitimately, after reading a four-hundred page Complaint, who is being sued for what on a particular count, Plaintiffs have not met the PSLRA’s pleading standards," adding that "it is not for the Court or for Defendants to ask who is ‘relevant’ to a particular count. It is the plaintiffs’ duty to state clearly against whom they seek damages." Judge Mays found that dismissal of the ’34 Act claims on this basis alone is sufficient.

 

Judge Mays went on, assuming for the sake of analysis that the plaintiffs claims had been pled with sufficient particularity, to hold that the plaintiffs had not sufficiently pled scienter. In attempting to establish scienter, the plaintiffs had relied on the "group pleading" doctrine. Judge Mays assumed for purposes of his opinion that group pleading had survived the PSLRA, but nevertheless concluded that "plaintiffs have failed to demonstrate that the inference of scienter is at least as compelling as any opposing inference of nonfraudulent intent."

 

But while Judge Mays granted the defendants’ motion to dismiss the plaintiffs’ ’34 Act claims, he denied the defendants motions to dismiss the plaintiffs’ ’33 Act claims, finding that the plaintiffs had adequately identified the allegedly misleading statements in order to state a claim.

 

I have added the Morgan Keegan ruling to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

 

Indian Summer: Wikipedia’s various supposed explanations for the origins of the phrase "Indian Summer" seem equally implausible and lack the ring of truth. Whatever the origin of the expression, the weather to which it refers is a delight and a balm in our weary world. In a few short weeks, the winds will howl and the snows will blow. But for now, a beneficent sun shines in an azure sky arching over the changing leaves' brilliant colors. It is enough to make your heart glad.

 

 

 

Horseshoe Lake, Shaker Heights, Ohio, October 9, 2010

　

　

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With one lone exception, the FDIC has not yet itself pursued litigation against the directors and officers of a failed financial institution. However, the FDIC has already made it clear that it intends to assert its rights under FIRREA as the receiver of failed banks to take control of shareholders’ derivative lawsuits.

 

More recently, and perhaps more aggressively, the FDIC is now attempting to intervene in two direct shareholder actions where failed institutions’ aggrieved investors are asserting their own claims, rather than derivatively asserting those of the failed institution. These more recent moves may represent efforts not just to assert but to extend the FDIC’s litigation preclusion rights. The FDIC’s actions are interesting in and of themselves, but also for what the FDIC has claimed in asserting its rights.

 

The FDIC’s most recent move in this direction is its October 4, 2010 motion to intervene in the Haven Trust Bancorp securities class action litigation pending in the Northern District of Georgia. A copy of the FDIC’s memorandum in support of its motion to intervene can be found here. Haven Trust Bancorp was the parent corporation for Haven Trust Bank, a Duluth, Georgia failed bank of which the FDIC took control on December 12, 2008.

 

The FDIC has previously moved to intervene in the negligent misrepresentation lawsuit that individual investors had filed in Fulton County (Georgia) State Court against certain former directors and officers of Georgian Bancorp. A copy of the FDIC’s September 23, 2010 motion to intervene, and accompanying motion to remove the case to federal court upon grant of the intervention, can be found here. Georgian Bancorp was the corporate parent of Georgian Bank, of which the FDIC took control on September 25, 2010. My prior post about the Georgian Bancorp case can be found here.

 

Both of these lawsuits are direct, not derivative, actions. In each case the plaintiffs seek to recover damages in the form of their own lost investment interests. In asserting that it nevertheless has the right to intervene, the FDIC raises a number of interesting arguments.

 

First, in both cases, the FDIC asserts that both cases are basically just derivative lawsuits in disguise. Thus, for example, in the Haven Trust case, the FDIC asserts that "although Plaintiffs have attempted to frame their allegations of wrongdoing and damages in terms of securities fraud and misrepresentations …Plaintiffs’ alleged losses clearly emanate from the fact that the Bank, as sole asset of the Holding Company, became worthless upon the appointment of the FDIC as receiver for the Bank." In the Georgian case, the FDIC asserts that the plaintiffs’ claim is "in substance a derivative claim." The FDIC asserts, the shareholders’ claims are, in effect, "double derivative" claims.

 

Second, the FDIC asserts that as receiver of the respective banks, under 12 U.S.C. Section 1821 it has succeeded to "all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder … of such institution with respect to the institution and the assets of the institution." In reliance on this provision, the FDIC asserts as an initial matter that it has priority rights to assert the claims presented in the respective plaintiffs’ complaints, because they are essentially derivative complaints.

 

The FDIC’s further argument in reliance on this statutory provision is with reference to the respective institutions’ D&O insurance policies. Thus, for example, the FDIC asserts in the Georgian case that among the assets with respect to which it assumed priority upon being appointed receiver was Georgian’s D&O insurance policy, which "provides limited and finite monies for claims covered by the Policy and may be the only source of recovery against the Defendants in this or any subsequent lawsuit."

 

The FDIC points out further that the D&O policy is a "wasting asset" that would be reduced by defending the plaintiffs’ claims. The FDIC has the right to intervene, it therefore asserts, because "its ability to recover in a subsequent lawsuit will be affected by any judgment in this action or protracted litigation."

 

The FDIC is even more explicit about the possibility of its pursuing claims in its intervention motion in the Haven Trust case. There the FDIC explicitly stated that its investigation includes examination of the "acts and/or omissions of the Bank’s former officers and directors in connection with their management of the Bank’s affairs." The FDIC states that after completing its investigation it will determine "whether claims should be brought against any individual or entity," noting that "several of the defendants in this case, as former officers and/or directors of the Bank, are potential targets."

 

There are a number of concerns with the grounds on which the FDIC is moving to intervene. First, the FDIC completely disregards the investors’ own legal right to assert their own claims for their own alleged financial injuries. Second, and perhaps more to the point, the investors are asserting their claims as shareholders of the parent holding companies of the failed banks, not of the failed banks themselves. The FDIC’s priority rights extend to its rights as receiver of the failed bank. Whether the FDIC can assert rights on behalf of the parent holding company of the failed bank is a potentially contentious proposition.

 

Section 1821 (d)(2)(A)(i), on which the FDIC relies to assert its priority rights, refers to the rights, titles, etc., of the "insured depositary institution, and of any shareholder …of such institution." However, the plaintiffs’ in this shareholder suits are not asserting rights as shareholders of the institution, but of the parent holding company. The FDIC may or may not be able to persuade a court to make the leap from its rights as receiver of the failed bank to the rights of the shareholders of the bank’s parent company, but the argument seems to strain the language of the provision.

 

Finally, the FDIC may indeed be interested in preserving the D&O policies, but there is nothing about Section 1821 that gives the FDIC priority to the proceeds of the policy, in preference to other prospective claimants. The insurance proceeds are not a cash fund like an investment account: rather, the proceeds are available only for payment of certain kinds of loss arising from claims. The policy itself may be an asset of the estate, but the proceeds are available only pursuant to the terms and conditions of the policy, only for payment of claims, and the rights of the insureds and the claimants to the proceeds of the policy are determined by the policy’s own terms.

 

Whatever else may be said about the FDIC’s actions in moving to intervene in these case, they do show both that the FDIC is actively considering pursuing its own lawsuits, and that it is will to move aggressively to preserve its own recovery prospects in the event it subsequently decides to pursue lawsuits. The pretty clear message is that the FDIC does intend to pursue lawsuits, too.

 

As if the prospect of competing lawsuits from both investors and regulators were not daunting enough for directors and officers of failed institutions (and their insurers), a lawsuit recently filed in South Carolina suggests yet another type of prospective claimant that may be asserting claims against failed banks’ directors and officers.

 

On September 29, 2010, the trustee for the estate of Beach First National Bankshares filed a lawsuit in the Bankruptcy Court for the District of South Carolina against certain directors and officers of the bankrupt company. A copy of the complaint can be found here. The company’s wholly owned subsidiary, First National Bank of Myrtle Beach, was closed on April 9, 2010 The Trustee’s complaint asserts claims for breach of fiduciary duty and negligence.

 

While the Trustee may have seized the initiative in this case, there would seem to be the possibility that the FDIC might yet seek to intervene in the Trustee’s case just as it did in the cases described above. Disappointed shareholders might also seek to assert their own claims for harm to their own investment interests, particularly since the First National holding company is a publicly traded company.

 

The possibility of claims asserted by these various prospective and active claimants underscores how one of the consequences of a bank failure may be a scramble for the proceeds of the insurance policy. The FDIC may well contend that under FIRREA it has certain priorities but other claimants are also highly motivated to circumvent the FDIC’s asserted rights.

 

Of course in the end the FDIC may establish its priority. But in the meantime, the scramble for the D&O insurance could become quite a circus. And in the center ring could be the directors and officers of the failed institutions – and their insurers – against whom the competing claimants will assert their claims. The likelihood for further D&O litigation involving failed banks’ directors and officers seems high.

 

One final thought about the FDIC's interventions in the two case discussed above -- there have been a fair number of shareholder class actions brought by investors in failed financial institutions. It will be interesting to see how far the FDIC goes with thie intervention tactic and whether it will seek to intervene in other cases involving larger financial institutions. Perhaps its initiatives in the two Georgia lawsuits are test cases that will determine whether it will seek to intervene elsewhere.

 

Many thanks to a loyal reader for providing copies of the various pleadings to which I linked above.

 

A copy of an October 3, 2010 Myrtle Beach Sun News article about the Beach First Trustee’s lawsuit can be found here. (Full disclosure, I was interviewed in connection with the article.)

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News reports about the September 22, 2010 Senate Banking Committee hearing regarding the SEC have focused on the provocative statements by SEC Inspector General H. David Katz. Among other things, Katz suggested that a Texas-based SEC official quashed the investigation of allegations regarding Stanford Financial Group, allowing the Stanford-related Ponzi scheme to continue. Katz also suggested that the SEC times its initiation of its enforcement action against Goldman Sachs to draw attention away from the Inspector General’s report critical of its Stanford-related failures. (Katz’s written testimony, which focuses primarily on the Stanford-related issues, can be found here.)

 

But along with the headline-grabbing commentary on the SEC’s processes, there was also other commentary and information at the Hearing suggesting the possibility of future regulatory and enforcement actions against corporate and banking figures in response to the global financial crisis.

 

First, at least according to press reports, the hearing seemed to reflect political expectations, in the wake of the financial crisis, for regulators to pursue actions against corporate officials. For example, the September 23, 2010 Wall Street Journal quotes Delaware Senator Edward Kaufman as having observed at the hearing that "we have seen very little in the way of senior officers or boardroom-level prosecutions of the people on Wall Street who brought this country to the brink of financial ruin. Why is that?"

 

Second, the same Journal article quotes the deputy inspector general of the FDIC as saying that the FDIC is investigating 227 banks.

 

There undoubtedly will be further fallout from the SEC Inspector General’s report about the SEC’s handling of the Stanford investigation. But amid those details, the larger picture should not be overlooked. That is, we remain in an atmosphere of recrimination that includes a political expectation that government officials should pursue action against corporate executives in connection with the financial crisis. In this atmosphere, because of the political pressures, it seems probable that government officials will feel obliged to bring claims and pursue actions.

 

And while these government actions might take any number of forms, one area where regulatory and enforcement action seems probably is in the banking arena. Just as during the S&L crisis, the FDIC pursued numerous claims in response to political pressure, the FDIC may well feel the same kind of pressure in the current circumstances, and may pursue claims as a result.

 

All of which is a reminder that larger forces may drive claims against corporate and banking officials, possibly for years to come.

 

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Many observers have been waiting to see whether and to what extent the FDIC will pursue claims against former directors and officers of banks that have failed during the current bank failure wave. So far, the FDIC has filed just a single suit, against former officers of a subsidiary of IndyMac.

 

However, on August 31, 2010, federal regulators filed a complaint in the Central District of California against 16 officer and directors of a failed financial institution – but the agency filing the lawsuit was not the FDIC and the failed institution was not a bank. Rather, the agency filing suit was the National Credit Union Administration, and the failed institution was a credit union, Western Corporate Federal Credit Union (or WesCorp) of San Dimas, California.

 

A copy of the NCUA’s complaint can be found here. A copy of the NCUA’s August 31, 2010 press release can be found here.

 

Prior to its closure, WesCorp had operated as a wholesale or corporate credit union, providing back office services to other credit unions. As reflected in the agency’s press release at the time, on March 20, 2009, the NCUA placed WesCorp in conservatorship. At the time, WesCorp had $23 billion in assets and 1,100 retail credit union members.

 

As reported in the Agency’s August 31 press release, the former directors and officers were originally sued in November 2009 in Los Angeles County Superior Court in action brought by seven WesCorp member credit unions. The NCUA intervened in that suit and sought leave to substitute the NCUA as the proper party plaintiff. The court granted the NCUA’s motion and to file an amended complaint by August 31. The NCUA’s complaint supersedes the initial complaint filed by the member credit unions.

 

The NCUA’s complaint alleges beginning in 2002, after Robert Siravo became the institution’s CEO, WesCorp embarked "an aggressive campaign" to grow, which was successful due to the institution’s reliance on borrowed funds to make investments in mortgage backed securities. While WesCorp grew, so did its borrowings, which eventually equaled over 30% of the institution’s assets. As the firm grew, so too did its exposure to exotic mortgage backed assets, particularly securities backed by Option ARM mortgages.

 

In 2009, WesCorp was forced to record $6.9 billion in losses, rendering the institution insolvent. About two-thirds of the losses were from Option ARM securities WesCorp purchased in 2006 and 2007.

 

In addition to allegations against all defendants alleging negligence and breach of fiduciary duty, the NCUA complaint also allege that Siravo and the former head of Human Resources manipulated their retirement accounts to make them more lucrative, resulting in over $4.4 million in overpayments, including an extra $2.3 million to Siravo.

 

One of the defendants in the case is William Cheney, who was a member of WesCorp’s board from May 2002 to February 2006. Cheney is currently the President of the National Credit Union Association, which is the credit union industry’s national trade association.

 

At the time that the NCUA took control of WesCorp, the institution was the largest of the corporate credit union. The credit union industry, along with the rest of the financial sector, had been suffering some turbulence over the last several years. The NCUA has closed 14 retail credit unions in 2010, and closed 12 retail credit unions in 2009. There were 7,554 federally insured credit unions as of December 31, 2009.

　

The Wall Street Journal’s September 2, 2010 article about the NCUA’s lawsuit can be found here.

　

Be Excellent to Each Other: San Dimas is not only the pre-conservatorship home of WesCorp. It is also the home of San Dimas High School, which is of course where Bill and Ted went to school in the most excellent 1989 movie, Bill and Ted’s Excellent Adventure. (I wonder if Bill and Ted went on to work at WesCorp after their high school graduation. Perhaps in the investment division.) I am sure that when Bill and Ted learned that WesCorp had been put into conservatorship, they said something like "Bogus. Heinous. Most non-triumphant."

 

In honor of San Dimas High School and the school’s two most famous alums, here’s a video tribute to Bill and Ted, showing their history report at a San Dimas high school assembly:　

　

 

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According to the FDIC’s Second Quarter 2010 Quarterly Banking Profile, which the agency released on August 31, 2010, aggregate indicators of banking institutions’ financial health are improving, but at the same time the number of "problem institutions" also continues to increase. The FDIC’s August 31, 2010 press release about the Quarterly Banking Profile can be found here.

 

The positive news is that the industry’s 2Q10 earnings of $21.6 billion are the highest since the third quarter of 2008. Almost two-thirds of the banks reported higher year-over-year quarterly net income. However, 20 percent of institutions did report quarterly net losses (compared to 29 percent 2Q09).

 

The quarterly report also reflects that provisions for loan losses, while "still high by historic standards," represented the smallest total since the first quarter of 2008. Fewer borrowers are falling behind on their loan payments. With respect to just about every type of loan, troubled loans declined for the first time in more than four years. The only exception was commercial real estate loans, which continued to show increased weakness.

 

Despite this relatively good news, the number of problem institutions increased in the second quarter, to 829, up about 7% from the 775 problem institutions at the end of 1Q10, up 18% from the 702 problem institutions at the end of 2009, and up almost 100% from the 416 at June 30, 2009. (The FDIC defines a "problem institution" as those it rates as "4" or a "5" on its one-to-five scale of rating banks’ financial and operating criteria. The FDIC does not disclose the names of the problem institutions.)

 

The number of problem institutions is the highest since March 31, 1993, when there were 928.

 

To put the latest number of problem institutions into perspective, at the end of the second quarter, there were a total of 7,830 insured institutions. So the 829 problem banks represent about 10.6% of all insured institutions.

 

Or to put it a different way, one out of every ten banks in the United States is a problem institution. (And that’s after the 283 banks that have failed since January 1, 2008 have been taken out of the equation).

 

Though the number of problem institutions increased in the quarter, the assets associated with these banks did decrease. The 829 problem institutions at the end of the second quarter represented assets of about $403 billion, down slightly from the $431 billion that represented by the 775 problem institutions at the end of 1Q10.

 

To put the assets associated with the problem institutions into perspective, the collective assets of all insured institutions totals $13.2 trillion. The $403 billion in assets associated with the problem institutions represents about 3.1% of the industry’s total assets.

 

One other sign that the banking industry as a whole may not yet be in the clear, notwithstanding the relatively positive industry news overall, is that during the second quarter and for the first time in the 38 years for which data is available, there were no new insured institutions.

 

Since January 1, 2008, 283 banks have failed, 118 in 2010 alone. But even with the growing numbers of failures (each one of which presumably reduces the number of problem institutions by a count of one), the number of problem institutions continues to grow. The likelihood seems to be that the number of failed banks will continue to grow for some time to come.

 

Eric Dash’s August 31, 2010 New York Times article about the report can be found here.

 

Ain't Too Proud to Beg: The D&O Diary has been selected as a nominee candidate for the LexisNexis Top 25 Business Law Blogs of 2010. The ultimate list of the Top 25 blogs will be chosen based on comment submited by members of either of two LexisNexis business law communities, the Corporate & Securities Law Community and the UCC, Commercial Contracts and Business Law Community. If you are a registered member of either of these communities, I would appreciate your comment in support. Members of the Corporate & Securities Law Community can submit comments here, and members of the UCC, Commercial Contracts and Business Law Community can submit comments here. The deadline for comments is October 8, 2010.

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In recent months, I have documented on this blog the rising tide of failed banks as well as the ensuing failed bank related litigation. An August 16, 2010 report by Paul Hinton of NERA Economic Consulting entitled "Failed Bank Litigation" (here) takes a comprehensive view of the economics and causes of recent bank failures, compares the recent bank failure wave to the S&L crisis, and analyses the implications for litigation against the directors and offices of the failed institutions. The report contains a wide variety of different kind of information that readers will find interesting and useful.

 

Bank Failures to Date

The report begins with an analysis of the causes of the bank failures to date. The report notes that the earliest failures in the current wave derived from "losses in residential real estate and their structured finance businesses," but more recently the bank failures have been "characterized by smaller institutions that are more specialized in financing local businesses, commercial mortgages and real-estate development."

 

The report specifically notes that banks that went on to fail were held worse performing loans in each loan category than banks overall. These banks were also "less well prepared to deal with expected losses," since their allowance for loan losses at the beginning of the credit crisis were "not correspondingly higher," but instead were "lower than for all other banks."

 

Possible Future Bank Failures

Looking ahead, though the economy has improved and banks overall are showing signs of recover, the number of problem banks continues to rise and loan performance has yet to turn around. Many community banks may be burdened as a result of their issuance of trust preferred securities, the holders of which have priority rights in the event of bank failure, which could deter prospective investors. A wider concern for community banks is "the risk posed by continuing financial distress in commercial real estate markets," an issue I explored at length in a prior report here.

 

The report notes that one group of banks particularly at risk are "community banks with high [construction and development, or C&D] loan concentrations and the smallest allowances for loan losses compared to their level of non-performing loans." Another high-risk group of institutions are banks that are "under-provisioned and that have relatively high levels of non-performing loans."

 

Comparison to the S&L Crisis

Though the number of failed banks so far in the current wave is lower than the number that failed during the S&L crisis, "the losses incurred in 2009 are larger than all but one year of losses during the S&L crisis (expressed in 2010 dollars)," because the average size of banking institutions and savings institutions has increased since the time of the S&L Crisis. The average per failed bank loss in the current crisis ($303 million) is more than three times larger in 2010 dollars than for banks in the S&L crisis and were attributable to banks that were about two and a half times as big.

 

The factors contributing to bank failures in the current failed bank wave appear similar to the factors the FDIC identified as having caused bank failures during the S&L crisis. That is, economic conditions were "secondary to poor management and other internal problems."

 

Many readers will find the reports analyses of the banking regulators’ S&L crisis-related litigation track record particularly interesting. Among other things, the report documents (in Figure 14) that the FDIC pursued D&O claims with respect to about one-quarter of failed institutions. The report also shows (in Figure 15) that the FDIC’s peak recoveries lagged peak bank failures by about three years, which may be suggestive of the likely recovery track for the current bank failures.

 

Of particular interest is the detail (in Figure 16) regarding the FDIC’s professional liability claims recoveries during the period 1990-1995 (when most, but not all, of the FDIC’s S&L Crisis-related recoveries took place.). The chart shows that overall, excluding recoveries related to Drexel Burnham and excluding further criminal restitutions, the FDIC recovered $3.2 billion, $1.3 billion of which was from D&O claims, $1.15 billion of which was from accounting claims, and $500 million of which was from attorney malpractice claims. Another $300 million was from fidelity bond claims.

 

Failed Bank Litigation

The report details the FDIC’s special litigation authority under FIREEA (about which refer here), while noting that the FDIC’s special standing may not entirely preclude the claims of private litigants. Though the FDIC has to date filed only one action against former directors and officers of failed banks, all signs are that the FDIC is readying itself to bring more claims, as the report details.

 

Among other things, the report notes that many of the failed and troubled banks in the current wave are publicly traded, by comparison to the S&L crisis, when almost none of the failed institutions are publicly traded. As a result, there is much more investor related litigation this time around than there was during the prior crisis.

 

The report notes that of the roughly 240 credit crisis-related securities class action lawsuits, there were 45 against depository institutions (after excluding auction-rate securities cases). Eleven were filed against failed banks. Of the 20 banks that failed prior to 2010 and that produced the largest losses. 13 were publicly traded, of which eight have been sued in securities class action lawsuits as of the end of 2009.

 

The report notes that the private litigants will compete with the FDIC for D&O insurance, and while the FDIC is generally first in line to recover assets, private litigants may be able to recover against insurance assets even when the FDIC is not (for example, where the D&O policy has a regulatory exclusion that would preclude coverage for the FDIC’s claim but not for the investors’ claims).

 

Though there is already extensive litigation and more seems likely to come, all claimants, including even the FDIC, will face a basic causation problem; as the report concludes, "distinguishing the effects of underwriting practices from the effects of a deteriorating economy will be one of the important elements of this litigation." These cases "will require careful case-by-case economic analysis."

 

Conclusion

Overall, this report is useful and informative. Readers will undoubtedly find the report’s distillation of important background information and analysis in a single source to be particularly helpful.

 

Many D&O insurance professionals in particular will find this report to be helpful, particularly those involved with either the placement of D&O insurance for banking institutions or those involved in claims arising under those policies. Underwriters and brokers will find the report’s analysis of the causes of bank failures and the likely causes of future failures informative. Those involved in claims and claims administration will find the aggregate date from the S&L crisis claims particularly useful.

 

Special thanks to the report’s author, Paul Hinton, for providing me with a copy of the report. I would also like to thank Paul for his numerous citations to this blog in his report.

 

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The FDIC closed took control of eight more banks this past Friday night, bringing the 2010 total of failed banks to 118. The eight closures is the largest single day total since April 16, 2010. The pace of closures remains well ahead of last year’s closure rate – the FDIC did not reach its 118^th closure in 2009 until November. The FDIC is on pace for 180 bank closures this year, compared to 140 in 2009.

 

There have now been 283 bank failures since January 1, 2008. The state with the largest number of closures during that period is Georgia, with 41. However, during 2010, the state with the highest number of bank closures is Florida, with 22 bank failures this year and 38 since January 2008 (which ranks second overall). Two of the banks that closed this past Friday night were based in Florida.

 

One of the banks closed on Friday was in Illinois, which has the second highest number of bank closures in 2010 (15), and is the third highest since 2008 with 37. Four of the banks that closed this past Friday were based in California, which now has 10 bank closures in 2010, and 32 overall.

 

Those four states – Georgia, Florida, Illinois and California – account for 148 (52%) of the banks that have closed since January 1, 2008, and 58 (49%) of the 2010 bank closures.

 

Of the 118 bank closures in 2010, 97 (82%) had assets of less than $1 billion. 27 (23%) had assets under $100 million. Overall, since January 1, 2008, 225 (79.5%) of the failed banks have had assets under $1billion, with 56 (19.7%) under $100 million. There have already been more closures of banks with assets of under $100 million in 2010 (27) than in all of 2009 (24).

 

39 States and Puerto Rico have all had at least one bank closed in since January 1, 2008. The states that have not had any banks closed during that period are: Alaska, Delaware, Connecticut, Hawaii, Maine, Montana, New Hampshire, North Dakota, Rhode Island, Tennessee, and Vermont. So – small states, new states, northeastern and upper plains states, and, inexplicably, Tennessee.

 

Morgan Stanley Subprime Mortgage-Related Lawsuit Dismissed: On August 17, 2010, Southern District of New York Judge Laura Taylor Swain granted the defendants’ motion to dismiss a securities class action lawsuit filed on behalf of purchasers of mortgage pass-through certificates sold by 31 Morgan Stanley trusts. In her opinion, Judge Swain held that lead plaintiff, which had bought shares in only one of the trusts, lacked standing to assert claims in connection with the other thirty, and that the claims in connection with the trust certificates it had purchased were time barred.

 

Judge Swain’s dismissal as the 30 trusts in which the lead plaintiff had not bought shares was with prejudice; however, the dismissal as to the trust in which the plaintiff had purchased shares was without prejudice, as plaintiffs were given leave to replead as to those allegations.

 

Andrew Longstreth’s August 20, 2010 Am Law Litigation Daily article about the decision can be found here. I have added the ruling to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be found here.

 

All the World’s a Stage: Michael Maslanka, a Dallas-based labor lawyer wrote an interesting August 20, 2010 Texas Lawyer column entitled "What Can Lawyers Learn From ‘Othello’" (here), in which he examines the lessons for lawyers exemplified in the play’s two lead male characters, Othello and Iago.

 

For those readers unfamiliar with the play, Iago manipulates Othello into believing that his wife, Desdemona, has been false with him by having an affair with Cassio. In a jealous rage, Othello kills Desdemona, though it is a heart-breaking scene for the audience, not only because Desdemona has been falsely accused, but also because Othello clearly still loves her.

 

Maslanka’s analysis extracts some important lessons from the play. From Iago’s character, Maslanka draws lessons about the pitfalls of manipulation, and from Othello, he draws lessons about rationalization.

 

Though Maslanka’s analysis is perceptive, there is another character in the play whose role may have yet another and perhaps more important lesson. The character is Iago’s wife, Emilia, who is Desdemona’s attendant and friend. In a peculiarly modern twist, Amelia plays the role of whistleblower, by revealing – at hazard to her own life -- Iago’s falsity and proving Desdemona’s innocence.

 

Emilia’s role, though relatively small, is crucial, for without her brave willingness to protect Desdemona’s innocence and reveal Iago’s perfidy, Iago’s nefarious scheme might have gone undetected.

 

Emilia has a special role in Shakespearean literature for the speech she delivers at the end of Act IV, Scene iii, in which she recognizes the centrality of the struggle between men and women, a struggle for which she places the responsibility squarely on the men – "I do think it is their husbands’ fault." Her observations seem particularly apt in a play where both male leads murder their wives, both of whom are innocent, in the play’s final act.

 

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Though we are in the midst of the dog days of summer (at least in the northern hemisphere), the federal courts, at least, have been busy. In the last several days alone, several courts have issued dismissal motion rulings in lawsuits arising out of the subprime meltdown and the credit crisis.

 

As noted below, several of these decisions involve failed or troubled banks, and therefore may be of particular interest in relation to the many banks have failed in recent months or that are continuing to struggle now. Though investor plaintiffs in other cases involving failed or troubled banks have sometimes struggled to survive the initial pleading stages, in the cases discussed below, the plaintiffs managed to survive the dismissal motions, at least in part.

 

PFF Bancorp: In an August 9, 2010 opinion (here), Central District of California Judge Andrew Guilford denied the defendants’ motions to dismiss in the securities class action lawsuit against two former directors and officers of PFF Bancorp, the corporate parent for PFF Bank & Trust, which failed on November 21, 2008.

 

As reflected here, in January 2009, shareholders of the holding company filed a securities lawsuit alleging that the company’s President and CEO and its CFO contending that they concealed the Bank’s unsafe lending practices and made misleading statements about the bank’s loan loss reserves and capital levels.

 

In his August 9 order, Judge Guilford found that while the plaintiffs’ allegations that defendants made misleading statements about the banks’ "cautious" and "conservative" lending practices were insufficient to state a claim, the plaintiffs’ allegations that defendants had falsely characterized the bank’s loan loss reserves as "adequate" were sufficient to state a claim.

 

Judge Guilford also found that plaintiffs had adequately alleged scienter, finding that plaintiffs’ allegations "permit the inference that Defendants knew PFF’s loan practices were risky and that PFF had inadequate loan loss reserves, yet told investors that the loan loss reserves were adequate."

 

Interestingly, Judge Guilford found plaintiffs’ scienter allegations to be adequate despite the defendants’ contention that they had actually purchased PFF shares at the supposedly inflated prices. Judge Guilford declined, at the motion to dismiss state, to take judicial notice of the SEC forms on which defendants sought to rely in order to establish their share purchases.

 

Popular, Inc. (Securities Claim): In an August 2, 2010 order (here), District of Puerto Rico Judge Gustavo Gelpí granted in part and denied in part the defendants motion to dismiss the securities class action lawsuit that had been filed against Popular, Inc., certain of its directors and officers, its auditor and its offering underwriters.

 

The plaintiffs’ complaint focused on the company’s accounting for a deferred tax asset. In the three years preceding the beginning of the class period (which went from January 24, 2009 to February 2009), the company had recorded tax loss carry forwards that totaled over $1 billion, largely as a result of the company’s U.S. subprime and other lending operations. The benefit of these deferred tax assets could only be realized if the company experienced sufficient U.S.-based gains within 20 years.

 

To offset the possibility the company might not fully realize the value of the deferred tax assets, accounting rules required reporting companies to take a valuation allowance, but the company recorded no material valuation allowance of this asset until late 2008. The company ultimately recorded an allowance for the full value of the asset. Following the announcement of this action, the company’s share price fell substantially.

 

The plaintiffs allege that the increasing, multiyear U.S.-based operating losses prevented it from anticipating sufficient taxable income to realize the full value of the deferred tax asset prior to the expiration of the 20-year period, yet failed to take a valuation reserve because doing so would have lowered the bank’s risk-based capital ratio below regulatory requirements. The financial picture the company’s treatment of the asset portrayed allowed the company to raise over $300 million in a May 2008 offering.

 

The Court found that the plaintiffs allegations adequately alleged material misrepresentations, given that "Popular’s three-year cumulative loss position, combined with the Company’s significant downsizing of its U.S. mainland operations and the worsening market conditions, constituted strong evidence that at the beginning of the class period it was more likely than not that the Company would not be able to realize the benefit of its [deferred tax asset] in full."

 

The Court also concluded that the complaint adequately alleged scienter, concluding that the defendants’ decision "not to take an earlier valuation allowance was ‘highly unreasonable’ and an ‘extreme departure from the standards of ordinary care’ to the extend that the danger was either know to the defendants or so obvious that they must have been aware of it."

 

The Court also concluded that the ’33 Act allegations against the officer defendants were also sufficient. However, because the Court found that the amended complaint in which the plaintiffs added as defendants the outside directors, the company’s auditor and its offering underwriters had been filed more than a year after there were sufficient "storm warnings" to put the plaintiffs on inquiry notice, the ’33 Act claims against those defendants were untimely and were therefore dismissed.

 

Popular, Inc. (Derivative Suit): In an August 11, 2010 opinion (here), applying Puerto Rico law, in the shareholders’ derivative lawsuit filed against Popular, Inc, as nominal defendant, certain of its directors and officers, and its outside auditor, Judge Jay Garcia-Gregory denied in part and granted in part the defendants’ motions to dismiss. The allegations in the derivative suit largely mirror those alleged in the securities class action lawsuit.

 

The officer and director defendants had moved to dismiss on the ground that the plaintiff had not presented a demand to the company’s board to pursue the lawsuit. The plaintiff argued that demand was futile, and the Court agreed. The Court found that the plaintiffs’ allegations and of the requirements of SFAS 109 "provide ‘reason to doubt’ the legality of declining to record a valuation allowance until 2009" and therefore "demand is excused" because the presumption that the board took a valid business judgment had been rebutted by the alleged lack of "legal fidelity."

 

The Court did, however, dismiss the plaintiff’s gross mismanagement claim as duplicative of the breach of fiduciary duty claim. The Court also found that the plaintiff had not adequately alleged corporate waste. Finally, the Court found that the plaintiff’s claim against the company’s auditor should also be dismissed, on the grounds that the plaintiff had not made a demand on the company’s board to pursue the claim and had not established demand futility.

 

Discussion

Plaintiffs have had some difficult surviving initial dismissal motions in many of the securities class action lawsuits that have been filed against the directors and officers of banks that have failed during the current failed bank wave. For example, the securities class action lawsuit arising out the failure of Downey Financial Corp. (whose operating bank failed the same day as PFF Bank & Trust) was dismissed with prejudice.

 

Similarly, the motion to dismiss in the Fremont General case was also ultimately dismissed with prejudice. Similarly, the motion to dismiss was granted in the BankUnited securities case, albeit without prejudice.

 

More recently, however, the motion to dismiss was denied in the securities class action lawsuit arising out of the failure of Corus Bankshares. With the above decisions, it seems as if the plaintiffs in these cases have managed to overcome the initial pleading hurdle at least in several cases now.

　

To be sure, the reasoning the Popular case is based on circumstances that may be unique to that case. The allegations in the PFF Bancorp case, however, arguably are more typical. But while the PFF Bancorp case survived the dismissal motions, it remains to be seen whether the case will survive additional proceedings in the case, if defendants are able to establish that the purchased company shares at the allegedly inflated prices.

 

Ultimately, the fundamental question about the failed banks is whether the FDIC will lower the litigation boom on directors and officers of the failed banks. So far, the FDIC’s litigation activity has been limited to a single lawsuit it filed against officers of a subsidiary of IndyMac (about which refer here). Whether and to what extent the FDIC will pursue other claims will be revealed in the weeks and months ahead.

 

In any event, I have added these decisions to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.

 

Very special thanks to the loyal readers who provided me with copies of these decisions.

　

Another Banking Institution Dismissal Motion Ruling: Though the financial institution involved has neither failed nor is seriously troubled, it should be noted here at least briefly that in an August 10, 2010 order (here), Southern District of Ohio Judge Sandra Beckwith denied in part and granted in part the defendants’ motion to dismiss in the securities class action lawsuit that had been filed against Fifth Third Bancorp and certain of its directors by former shareholders of First Charter, which Fifth Third acquired in a deal announced in August 2007.

 

As discussed here, the former First Charter shareholders alleged that in connection with the merger, Fifth Third and certain of its directors and officers had materially misrepresented Fifth Third’s exposure to poorly performing residential real estate markets, and had not fully represented how seriously its mortgage portfolio was deteriorating.

 

Judge Beckwith’s detailed and painstaking August 10 opinion denied the motion to dismiss as to the claims of certain classes of First Charter shareholders, but granted the motion to dismiss as to all other claims and claimants.

 

Another Credit-Crisis Related Securities Suit Dismissal Motion Ruling: In an August 13, 2010 order (here), District of Maryland Judge Catherine Blake denied in part and granted in part defendants’ motions to dismiss the securities class action lawsuit that had been filed against Constellation Energy.

 

As discussed here, Constellation Energy was one of the many nonfinancial companies that suffered credit crisis related financial reverses in late 2008 and early 2009 and attracted securities litigation arising out the companies’ financial woes.

 

In September 2008, Constellation shareholders and subordinated debenture holders filed a securities class action lawsuit against the company, certain of its directors and officers and offering underwriters. Their complaint asserts claims under Section 11, 12(a)(2) and 15 of the ’33 Act and under Section 10(b) of the ’34 Act.

 

Essentially, the plaintiffs alleged that the defendants had misrepresented the additional collateral the company would have to post in connection with its merchant energy business in the event of a company credit downgrade. (As the company itself later disclosed, the collateral requirements for a one-notch credit downgrade were less than had been disclosed; the collateral requirements for a two or three notch downgrade were significantly greater than disclosed.)

 

The plaintiffs also alleged that the defendants had not sufficiently disclosed the company’s exposure to Lehman Brothers. The plaintiffs also alleged that the defendants’ misrepresented the company’s future earnings, business outlook, risk management and internal controls.

 

In fall 2008, after the company suffered a several notch ratings downgrade and after Lehman collapsed, the company’s share price fell and investors’ sued. The company ultimately sold a substantial portion of its assets.

 

In her August 13 order, Judge Blake found that the plaintiffs’ ’33 Act allegations regarding the company’s downgrade collateral obligations were sufficient to state a claim. Interestingly, Judge Blake reached her conclusion even though the company’s debenture prices dropped only slightly immediately after the disclosure of the company’s revised collateral obligation and in fact rose thereafter for several weeks. These facts "ultimately may counsel against materiality" but are "not dispositive at this stage of the litigation.

 

Judge Blake found that the plaintiffs’ remaining ’33 Act allegations were insufficient to state a claim.

 

As for plaintiffs ’34 Act allegations, Judge Blake found that the plaintiffs had not adequately alleged scienter in connection with the downgrade collateral obligations. She noted that "without additional factual allegations that the defendants were somehow aware that the downgrade collateral requirements were miscalculated …neither Constellation nor its officers can be presumed to have known of a faulty computer calculation."

 

Judge Blake also found that the plaintiffs’ remaining ’34 Act allegations were inadequate.

 

I have also added the Fifth Third and Constellation Energy rulings to my running tally of credit crisis lawsuit dismissal motion rulings, which again can be accessed here.

 

Special thanks to a loyal reader for providing a copy of the Constellation Energy decision.

　

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Though 268 banks have failed since January 1, 2008, there has been relatively little litigation related to the failed banks, as least so far. For example, the FDIC only recently filed its first action against former directors and officers of a failed bank (as discussed here). There have also been relatively few suits brought by private investors as well, though that could change. The failed bank lawsuits do continue accumulate, however, including an investor lawsuit recently filed in state court in Georgia that both has some interesting features and that may present some interesting potential D&O insurance coverage issues.

 

The case in question was initiated on July 22, 2010 in Fulton County (Georgia) State Court by three investors in Georgian Bankcorporation. The company operated Georgian Bank in Atlanta, which was taken over by regulators on September 25, 2009. The defendants are two of the company’s former directors and officers, one of whom was the company’s Chairman and CEO for several years, and the other of whom was the successor Chairman and CEO. A copy of the complaint can be found here.

 

All three of the plaintiffs were investors in the bank holding company. Two of the three plaintiffs served as company directors until 2003. All of the parties are residents of Georgia.

 

The complaint seeks damages for negligent misrepresentation. The plaintiffs allege that the defendants negligently misrepresented the negative effects of the economic slowdown was having on the bank; negligently failed to timely and fully report to plaintiffs various adverse regulatory actions taken against the bank and related regulatory findings; and negligently failed to inform plaintiffs that a key depositor was withdrawing its more than $200 million in deposits.

 

The complaint is emphatic that it is asserting claims only for negligent misrepresentation. Paragraph 11 of the complaint states that the plaintiffs "exclude and disclaim" any allegations under the federal and state securities laws; common law fraud; intentional, reckless or knowing misconduct; breach of fiduciary duty or mismanagement. In addition, in paragraph 12 the complaint emphasizes that the claims of it asserts are direct, on behalf of plaintiffs, and not derivative, on behalf of the company.

 

There are a number of interesting things about this complaint, beyond just the fact that it represents an example of a recent bank failure that resulted in a D&O lawsuit.

 

First, the complaint’s insistence that the plaintiffs are "disclaiming" a number of kinds of allegations suggests the narrow line the plaintiffs are trying to walk. Their disavowal of all securities law claims seemingly is calculated to try to avoid the initial pleading hurdles and defenses to which securities claims are vulnerable, as well as to avoid any possible federal question jurisdiction that might facilitate the case’s removal to federal court.

 

The other claims plaintiffs disavow, particularly the fraud and intentional misconduct allegations, may reflect a desire to avoid the conduct exclusions typically found in D&O insurance policies.

 

The plaintiffs’ insistence that they are asserting only direct not derivative claims is clearly an effort to fend off the FDIC, which might otherwise (and who knows, may yet) intervene to assert its rights as receiver under FIRREA to control litigation asserted in the right of the failed bank itself. (For more about the FDIC’s rights under FIRREA, refer here). The plaintiffs’ wariness about the FDIC’s interest in the lawsuit is apparently well founded, because, as I discussed in a prior post, the FDIC has sent letters to former officials at the failed bank detailed potential claims the FDIC may assert against them.

 

The complaint also raises a number of potential D&O insurance coverage issues.

 

The first has to do with the fact that two of the plaintiffs are former directors of the company. The typical D&O insurance policy has an "insured vs. insured" exclusion precluding coverage for claims brought by one insured against another insured. The two former directors would be insureds under most D&O policies, and so all else equal, their claim would involve an insured vs. insured claim. The exclusion potentially might preclude coverage for this claim.

 

However, the typical insured vs. insured exclusion also usually has multiple exceptions that carve back coverage for certain kinds of claims (derivative action, for example). In recent years, among the coverage carve backs found in many D&O policies is a carve back for claims brought by former directors and officers more than four year (sometimes three years) after they left their position. This new lawsuit presents an interesting example of a case where the inclusion of this coverage carve back could be crucial to preserving coverage.

 

A second interesting thing about this case from an insurance standpoint relates to the plaintiffs’ insistence that they are asserting only claims for negligent misrepresentation. The reason this is interesting is though the plaintiffs are asserting harm to their investment interests, they are not asserting claims base on the securities laws. Rather they are quite deliberately asserting claims solely under the common law.

 

The reason this is interesting is in connection with the definition of the term "securities claim" found in the typical public company D&O insurance policy. Many policy forms do not include within the definition claims asserted under common law, and so carriers are often requested to amend the definition of the term to include common law claims. Some carriers resist this change, arguing either that the change is unnecessary or that claimants will not assert claims on that basis.

 

The deliberately narrowed way the plaintiffs have framed their claims in this case both illustrates why the inclusion of common law claims in the definition of "securities claims" is appropriate and provides and example of a case in which the change could be critical.

 

The deliberately narrow way the plaintiffs framed their complaint also underscores the challenges claimants may face in trying to assert claims against former directors and officers of failed banks. Between worries that the FDIC will sweep in and try to take over the claim and concerns that D&O insurance coverage issues could eliminate possible insurance recoveries, prospective claimants face some formidable obstacles. Indeed these considerations may be among the reasons why there has been relatively little D&O litigation (so far) as a result of the current round of bank failures.

 

A July 27, 2010 Atlanta Journal Constitution article about the lawsuit can be found here.

 

Special thanks to Henry Turner, counsel for plaintiffs in the case, for providing a copy of the complaint.

　

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On July 2, 2010, in what is as far as I am aware the first suit by the FDIC against former directors and officers of a failed bank as part of the current wave of bank failures, the FDIC as receiver of IndyMac filed a lawsuit in the Central District of California against four former officers of IndyMac’s Homebuilder Division (HBD). 

 

Very special thanks to Peter Christensen of the Appraiser Law blog for providing links to the complaint.

 

The FDIC took control of IndyMac on July 11, 2008. At the time, the outstanding balance on HBD’s portfolio of homebuilder loans was nearly $900 million. The FDIC alleges in its complaint that IndyMac’s losses "are estimated to exceed $500 million."

 

The lawsuit is filed against Scott Van Dellen, HBD’s former President and CEO, who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved at least 40 of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved at least 57 of the loans at issue; ;and William Rothman, who served as HBD’s Chief Lending Officer from mid-2006 and who is alleged to have approved at least 34 of the loans at issue.

 

The lawsuit seeks to recover damages from the four individual defendants for "negligence and breach of fiduciary duties." The lawsuit alleges "two significant departures from safe and sound banking practices."

 

First, the complaint alleges that HBD’s management "repeatedly disregarded HBD’s credit policies and approved loans to borrowers who were not creditworthy and/or for projects that provided insufficient collateral." The complaint further alleges that HBD’s compensation plans encouraged HBD’s management to "push for growth in loan production volume with little regard for credit quality."

 

Second, HBD’s management is alleged to have "continued to follow a strategy for growth at the tail-end of the longest appreciating real estate market in over four decades," despite management’s alleged "awareness that a significant downturn in the market was imminent and despite warnings from IndyMac’s upper management about the likelihood of a market decline." HBD’s management allegedly "unwisely continued operations in homebuilder lending in deteriorating markets even after becoming aware of the market decline.

 

The FDIC’s complaint, which sprawls to some 309 pages, details a litany of allegedly negligent lending practices, including approving loans where repayment sources were not likely to be sufficient; where the loans violated applicable laws and the Bank’s own internal policies; where the loans were made to borrowers who "were or should have been known to be not creditworthy and/or in financial distress; based on inadequate or inaccurate financial information; without taking proper and reasonable steps to insure that the loan proceeds would be used in accordance with the loan application.

 

The complaint is very detailed and reflects painstaking preparation. A lot of time and effort went into the preparation of this complaint, which may in and of itself explain why the FDIC has not up until this point filed other complaints against directors and officers of failed banks. If the FDIC is taking similar measures in connection with other claims that it might be considering, it is little wonder that there have been no claims up until this point. Complaints containing this level of specificity and painstaking detail will take a significant amount of time to prepare.

 

There are some particular reason why IndyMac attracted one of the first claims. First, the FDIC took control of IndyMac relatively early in the current round of bank failures – it has been almost exactly two years since IndyMac closed, meaning the FDIC has had a greater amount of time to review the circumstances that led up to IndyMac’s failure and consider potential claims. When the FDIC took control of IndyMac, it was only the fifth bank failure that year, meaning that IndyMac was among the earliest of the current bank failures.

 

But perhaps even more important that its timing was the sheer size of IndyMac’s failure. At the time of its closure, IndyMac had assets of about $32 billion, making its closure the second largest bank failure during the current wave of bank failures (exceeded only by the closure of Washington Mutual, which had assets of $307 billion).

 

More to the point, IndyMac’s failure triggered losses to the FDIC’s insurance fund of $8 billion, by far the largest amount of any bank failure during the current round. The magnitude of these losses suggests possible motivations for the FDIC to give priority to claims relating to IndyMac.

 

While the recently filed IndyMac claim may be the first claim the FDIC has filed against former directors and officers of a failed bank as part of the current bank failure wave, it is surely not the last. (Indeed, it may not even be the last filed against former IndyMac officials.) Statistics reported by the Alston & Bird firm suggest that during the last wave of bank failures in the S&L crisis, the FDIC filed claims in connection with about 24% of all bank failures.

 

The fact that the FDIC appears poised to pursue many additional claims against bank officials represents a threat both to the individuals themselves and to the bank’s D&O liability insurers. The extent to which the FDIC’s efforts result in significant recoveries will depend on a wide variety of factors, the most important of which is the extent to which the FDIC can successfully allege individual liability. But beyond that, the FDIC’s ability to actually recover money will depend on identifying and accessing funding sources.

 

The extent to which the FDIC will succeed in recovering substantial amounts of D&O insurance will depend on a host of factors, including in particular the terms and conditions of the applicable policies. Claims made and notice of claims issues will be highly relevant, as will potential policy exclusions, such as, for example, the regulatory exclusion, which insurers added to many policies in recent years. These insurance coverage questions suggest the likelihood that in addition to a round of claims against former officials of failed banks, we are also likely to see a parallel round of insurance coverage litigation.

 

In addition to the FDIC’s recent action, there has also been extensive litigation involving IndyMac’s shareholders, as detailed here. Most recently, on March 29, 2010, Central District of California Judge George Wu certified an interlocutory appeal to the Ninth Circuit of his denial of the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint.

 

Bank Failure Wave Continues: Meanwhile, while the FDIC cranks up its litigation efforts, it is continuing to take control of additional banking institutions. This past Friday evening, July 9, 2010, the FDIC took control of four additional banks, bringing the 2010 total number of failed banks to 90.

 

Through June 30, 2010, the FDIC had closed 86 banks, which put the FDIC on pace to close 172 banks this year, compared to 140 in 2009 and only 25 in 2008. Indeed, by way of comparison, as of June 30, 2009, the FDIC had closed only 40 banks, as the pace of bank failures quickened substantially in the second half of 2009 and continued into 2010.

 

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The FDIC in its status as receiver of a failed bank may not avoid rescission of a fidelity bond procured by material misrepresentation, notwithstanding the FDIC’s statutory receiver rights, according to a June 7, 2010 Second Circuit decision. This decision represents an important interpretation of the FDIC’s statutory rights as receiver, and could prove to be an important precedent in future insurance-related litigation arising out to the current round of failed banks. The Second Circuit’s June 7 opinion can be found here.

 

Background

In 1999, Connecticut Bank of Commerce (CBC) entered an agreement to acquire MTB Bank. The transaction closed March 30, 2000. Prior to the deal’s closing, two things happened of relevance to the subsequent insurance dispute.

 

First, MTB discovered that its agents had advanced $950,000 based on fraudulent invoices in connection a business deal involving Harmony Designs. MTB noticed its fidelity bond carrier regarding the Harmony Designs matter, although MTB ultimately reduced its loss below the amount of the deductible.

 

Second, in March 2000, before the CBC deal closed, MTB’s president and other officers were indicted in an alleged conspiracy involving the imposition of Argentinean minerals. MTB also noticed its fidelity bond insurer regarding the indictments.

 

After the CBC deal closed, CBC was added to MTB’s fidelity bond. As the bond’s June 30, 2000 expiration approached, CBC sought to renew it. The insurer declined to renew unless CBC came to London to provide additional information in connection with the renewal. The insurer also refused to extend the bond period 30 days.

 

CBC declined to visit London as the fidelity bond insurer had requested. Instead, CBC obtained replacement fidelity bond coverage from a different insurer. In order to secure this replacement coverage, CBC completed and submitted a policy application that required CBC, among other things, to disclose losses sustained during the preceding three years; whether there were additional circumstances relevant to the application; and whether insurance had been declined or canceled during the past three years. Post-binding, CBC completed the replacement insurer’s separate application form, which also asked questions related to past losses and whether CBC had had insurance declined or canceled.

 

CBC answered "None" or "No" to these application questions. CBC did not disclose or identify the Harmony Designs loss, the indictments, or the predecessor insurer’s actions in connection with the fidelity bond insurance renewal application.

 

CBC went into receivership in June 2002. In 2006, the FDIC as receiver sued CBC’s fidelity bond insurer alleging breach of contract for dishonoring claims under the bond for CBC’s losses related to a loan scheme used to fund MTB’s acquisition.

 

The district court granted the fidelity bond insurer’s motion for summary judgment on the ground that it properly rescinded the bond based on CBC’s application misrepresentations and omissions. The FDIC appealed.

 

The June 7, 2010 Opinion

In a June 7, 2010 opinion by Southern District of New York Judge John Keenan (sitting by designation on the Second Circuit), the Second Circuit affirmed the district court’s entry of summary judgment on behalf of the fidelity bond insurer.

 

In seeking to overturn the district court’s opinion, the FDIC had sought to rely on its rights under 12 U.S.C. Section 1823(e), which protects the FDIC from defenses not apparent on the face of an asset it acquires as a receiver of a failed bank. The FDIC argued that this provision bars the fidelity bond insurer’s misrepresentation defense.

 

The Second Circuit held (contrary to a prior holding in the Sixth Circuit) that a fidelity bond is in fact an "asset" to which this provision applies. However, the Second Circuit rejected the FDIC’s argument that this provision bars the fidelity bond insurer’s policy defenses.

 

The Second Circuit said that the provision is intended to "bar ‘secret’ defenses which would diminish the FDIC’s interests in a failed bank’s assets," but that "defenses raised by the bond itself may prevent recovery by the FDIC."

 

The Second Circuit found that "as the grounds for rescission were plainly stated on the face of the bond, there is nothing secret about [the fidelity bond insurer’s] misrepresentation defense." To recognize the FDIC’s position, the Second Circuit said, would be to "strike the rescission clause from the bond."

 

In the final portion of its opinion, the Second Circuit went on to hold that each of the three alleged misrepresentations separately provided sufficient ground to support rescission. The Second Circuit found that the omission of the information about the Harmony Designs loss, about the indictments, and about the prior insurer’s refusal to renew or extend each separately representing sufficient grounds for rescission.

 

The Second Circuit’s holdings about the sufficiency of the fidelity bond insurer’s basis for rescission are quite broad. Among other things, the Second Circuit said that "information about previous losses is presumptively material," and "the determination of risk is one properly left to the insurer, not the insured, and the insurer cannot make an accurate risk assessment without full disclosure from the applicant."

 

Discussion

It seems probable that in connection with the current wave of bank failures that the FDIC as receiver to the failed banks will attempt to recover under the failed banks’ insurance policies. The Second Circuit’s holding in the CBC case underscores the fact that notwithstanding the FDIC’s receivership status, and the statutory rights that status may entail, the FDIC’s ability to enforce the failed bank’s insurance coverage is subject to the defenses the insurer may have that appear in the relevant policies.

 

To that extent, at least, the Second Circuit’s opinion could be relevant to may arise in the wake of the FDIC’s attempt as receiver to recover under the failed banks’ insurance policies.

 

The CBC opinion is relevant for another reason that arguably is completely independent of the FDIC’s involvement in this dispute. That is, the opinion starkly demonstrates the critical importance of the policy application process and the extent of the insurer’s rights, under certain circumstances, to seek rescission. The Second Circuit’s view of the applicant’s obligation to provide responsive information is broad and encompassing.

 

The Second Circuit’s rescission holding seems to reflect a perception that CBC knew that if it disclosed the prior losses it would be unable to secure replacement fidelity bond coverage. To that extent, the rescission holding may reflect the somewhat distinct circumstances of the case. However, the Second Circuit’s rhetoric is broad and is not delimited to the referenced circumstances. The breadth of the ruling rescission ruling could well prove helpful to insurers in other rescission cases, even those lacking the distinctive characteristics of this case.

 

Financial Reform Impact on the Insurance Industry: In a prior post (here), I noted that the Senate’s version of the financial reform bill includes a number of specific reforms that particularly impact the insurance industry.

 

In a June 7, 2010 memo entitled "The Impact on the Insurance Industry of the Financial Regulatory Reform Bills: A Legislative Update" (here), the Simpson Thacher law firm examines and compares the various insurance industry reforms proposed in the House and Senate versions of the reform legislation.

 

The memo details the numerous insurance industry measures that are substantially similar in the two bills, suggesting that the provisions are likely to survive the current conference process. Among other things, the provisions intended to streamline the regulation of reinsurance and nonadmitted insurance are "substantially identical in both bills, and are therefore likely be enacted into law, as are a number of other measures.

 

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According to the FDIC’s Quarterly Banking Profile for the 1^st Quarter of 2010, released on May 20, 2010 (here), results for reporting banks "contained positive signs of recovery for the industry," reflecting "clear improvement in certain performance indicators." Nevertheless, the number of "problem" institutions at quarter end increased to 775, up from 702 at the end of 2009 and representing 10% of all reporting institutions.

　

The positive signs include such things as lower provisions for loan loss reserves and reduced expenses for goodwill impairment. These and other factors contributed to reported earnings at FDIC-insured institutions of $18 billion, the highest quarterly total since the first quarter of 2008.

 

However, some of these positive sign look somewhat less reassuring on closer scrutiny. Thus, for example, though the reporting institutions reported $10.2 less in loan loss reserve increases than they had in the first quarter of 2009, only about one-third of all institutions reported year-over-year declines, with most of the overall reduction concentrated among a few of the largest banks.

 

In addition, there are indicators that some concerns have not yet started to improve. For example, the total number of loans at least three months past due climbed for the 16th consecutive quarter. The Wall Street Journal quotes FDIC chairman Sheila Bair as saying that "The banking system still has many problems to work through, and we cannot ignore the possibility of more financial market volatility,"

 

This uneven distribution of the positive signs and the continuing concerns in some areas helps explain at least in part how the number of "problem" institutions continues to grow despite the positive signs in the industry.

 

The FDIC defines "problem" institutions as those with "financial, operations or managerial weaknesses that threaten continued financial viability." These institutions are rated as "4" or "5" on the FDIC’s 1-to-5 scale of financial and operational criteria.

 

As of March 31, 2010, there were 725 "problem" institutions, which is the highest number since 1993. The 775 institutions represent total assets of $431,189 million. These figures also represent increases in the number of "problem" institutions and total assets of 154% and 96% respectively over the equivalent figures as of March 31, 2009, when there were 305 "problem" institutions representing $220,047 million in assets.

 

This increase over that period is all the more striking given that during the same 12 month period, the number of "problem" institutions was being reduced as some of those institutions changed their status from "problem" to "failed." During the period March 31, 2009 to March 31, 2010, the FDIC took control of 160 banks, which makes the growth in the number of "problem" institutions during that period all the more striking.

 

The March 31, 2010 "problem" institution figures also represent increases of 10% and 7%, respectively, in the number of institutions and total assets since December 31, 2009, when there were 702 "problem institutions" representing $402,782 in total assets.

 

Though the number of "problem" institutions continues to grow, the pressure on the FDIC may be beginning to ease. According to a May 19, 2010 New York Times article (here), the growing willingness of private investors to step in with financial investments in some trouble institutions is a positive sign that may mean fewer failed banks.

 

Interestingly, among the specific institutions the Times article mentions as having attracted private investment capital are banks that have also recently attracted securities class action lawsuits, including Synovus Financial, Sterling Financial, and Pacific Capital Corporation. (Perhaps the investment explains in part why the class action plaintiffs voluntarily dismissed their suit against Pacific Capital Bancorp, about which refer here.)

 

Once consequence of the improving banking industry conditions and the increasing willingness of private investors to step in is that there may be few total number of bank failures than some observers had previously projected. Thus, even those who had predicted 1,000 bank failures (a figure I questioned at the time they were first pronounced), now, according to the Times article, "foresee perhaps 500 to 750 bank failures."

 

If the continued pace of bank failures continues unabated through the end of 2011, we could perhaps reach a total number of bank failures of as many as 500 to 750 banks. (There have been 357 bank failures since January 1, 2008.) However, the positive signs indicating improvements in the banking sector and the return of private investors offers some hope that at some point the number of bank failures may begin to decline. Indeed, the Journal article quotes FDIC officials as saying that the bank failures will probably peak in 2010.

 

But for now, with the most current FDIC figures indicating an increase in the number of "problem" institutions, signs are that bank failures will continue to accumulate, at least for the near term.

 

"Beyond Tone Deaf": Though the $250 million punitive damages award in the Novartis class action gender discrimination case is outside of The D&O Diary’s usual bailiwick, it still caught our attention. There undoubtedly will be further proceedings in the case, but for eye-popping jury verdict is attracting scrutiny.

 

Those interested in trying to understand what the company may have done to get his with a punitive damages award of that magnitude will want to read Susan Beck’s scathing May 19, 2010 Am Law Litigation Daily column (here).

 

According to Beck, referring to the company’s trial counsel Richard Schnadig of the Vedder Price firm, "this was a company – and a lawyer – that simply didn’t know how to deal with the plaintiffs’ accusations. Their response to the women’s testimony was beyond tone deaf. It was, to put it bluntly, insulting and stupid."

 

As support for this statement, Beck cites Schnadig’s characterization in his closing arguments of the testimony of one the named plaintiffs, who testified that her manager had pressured her not to have children. Schnadig dismissed the plaintiff as hysterical, stating "I’ve never seen anybody cry so much on the witness stand in my life…She didn’t have very much to cry about…It’s like she had been knifed. Honestly, what’s wrong with this woman? She was so fragile." Her manager, Schnadig argued, was more credible because according to Schnadig, he was "a nice Southern guy."

 

Beck cites numerous other statements in closing arguments very much in the same vein.

 

Novartis may have had many other things to say in its defense, but these kinds of statements apparently did not play well with the jury. Jurors are scary enough as it is, but trying to convince a jury that the plaintiffs are just a bunch of crazy hysterics seems like a particularly ill-advised strategy.

 

　

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In prior posts (most recently here), I have noted the growing numbers of lawsuits brought against the former directors and officers of failed or troubled banks. If the complaint recently filed in New York state court is any indication, the "dead bank" lawsuits apparently will also include claims against the directors and offices of failed banks from outside the U.S., too. As it turns out, the fallout from the Icelandic banking explosion includes claims filed in New York against former directors and officers of one of the largest Icelandic bank failures.

 

On May 11, 2010, the U.S. representative of the resolution committee of Glitnir Bank filed an action in New York (New York County) Supreme Court seeking to recover $2 billion in damages from Glintir’s controlling shareholder and his wife; two former directors and the former CEO of Glitnir; several of the controlling shareholder’s business associates, and the bank’s auditor, the Icelandic affiliate of PricewaterhouseCoopers. A copy of the complaint can be found here.

 

Though based in tiny Iceland (total population substantially smaller than that of Cleveland), Glitnir, which ultimately was one of Iceland’s three largest banks, grew to have over 1,900 employees in ten countries, with a market capitalization of over $7 billion and total assets of over $40 billion.

 

In October 2008, in the midst of the global financial crisis, Iceland’s Financial Services Authority took control of Glitner. Glitner ultimately filed a petition for bankruptcy in the U.S. under Chapter 15 of the Bankruptcy Code. According to the May 11 complaint, creditors have filed claims exceeding $26 billion.

 

Michael Lewis’s outstanding April 2009 Vanity Fair article, "Wall Street on the Tundra" (here) chronicles the astonishing and even inexplicable rise and spectacular collapse of the Icelandic banking bubble. ("Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’ In the end, Icelanders amassed debts amounting to 850 percent of their GDP.")

 

The May 11 complaint alleges that Jon Asgeir Johannesson (typographical markings omitted) and his wife, Ingibjorg Stefania Palmadottir (typographical markings omitted), and businesses they owned or controlled, used improper means to "wrest control" of Glitnir and to "fraudulently drain over $2 billion out of the Bank to fill their pockets and prop up their own failing companies."

 

According to the complaint, beginning in 2006, Johannesson "engaged in a scheme" using his "web of companies" to take control of Glitnir in violation of Icelandic law. By April 2007, Johannesson and his companies owned about 39% of Glitnir’s stock. As a result, Johanneson was able to "stack" Glitnir’s board "with individuals who had connections with companies he controlled," and he also "had his inexperienced hand-selected candidate" replace the existing CEO.

 

Having taken control of the Bank, its board and its management, Johannesson and the other individual defendants "used their control over the Bank and funds raised in U.S. financial markets to issue massive ‘loans’ to, and a series of equity transactions with, companies Johannesson controlled, in an effort to stave off their eventual collapse," which "placed the Bank in extreme financial peril."

 

The complaint specifically alleges that the defendants "concealed the truth about their risk they had created for Glitnir when they turned to the United States markets to raise funds." The complaint specifically references a September 2007 transaction in which Glitnir issued $1 billion in medium term notes (MTN), alleging that the offering documents "understated Glitnir’s exposure to related and connected parties by $800 million."

 

The complaint also alleges that the individual defendants "could not have succeeded in their conspiracy to loot Glitnir without the complicity of Glitnir’s outside auditors at PricewaterhouseCoopers." (Jim Peterson has a particularly interesting commentary on the Glitnir bank claims against PwC on his Re:Balance blog, here.)

 

The complaint asserts nine separate claims against the individual defendants alleging violation of Icelandic statutory laws governing corporations. The complaint also asserts common law claims against the individual defendants for tort, conversion, and unjust enrichment. In addition, the complaint asserts negligence and breach of contract claims against PwC. The complaint seeks damages of $2 billion against the individual defendants and $1 billion against PwC.

 

The complaint’s allegations are fascinating, in the way that it is interesting to find out what events and actions preceded a train wreck or plane crash. In many critical ways, the events (allegedly) preceding Glitnir’s collapse precisely recapitulate the sequence Micheal Lewis described in summarizing what happened in Iceland; Lewis wrote in his Vanity Fair article that "a handful of guys in Iceland, who had no experience in finance, were taking out billions of dollars in short-term loans from abroad. They were then re-lending this money to themselves and their friends to buy assets – the banks, soccer teams, etc."

 

Though this lawsuit has its own peculiar Icelandic flavor, the lawsuit resembles in many ways any lawsuit that might be filed in the wake of a U.S. bank’s collapse. The specific U.S. variety of lawsuit this case most resembles is a claim brought by a bankruptcy trustee, as opposed to an investor lawsuit or a lawsuit brought by regulators.

 

But the resemblance to a variety of U.S. lawsuit notwithstanding, the obvious question about this case is: what the heck is it doing in state court in New York? We’ve got an Icelandic bank, Icelandic defendants, and even claims under Icelandic statutory law. The plaintiffs knew you were going to ask that question. The complaint helpfully points out that Johannesson and his wife reside in New York; that many of the acts in furtherance of the conspiracy took place in New York (including the September 2007 MTN financing); many of the transaction documents had New York choice of law provisions; and the bank and its key officials "had substantial interaction with New York."

 

The plaintiffs do their earnest best to justify their resort to a New York court for this case. They even try to exploit New York’s vain self-regard, asserting that the case belongs in New York because it is "the financial center of the world," and it not only has "a general interest in maintaining and fostering its undisputed status as the preeminent commercial and financial nerve center" but it also has "a keen interest in making sure its financial markets are not abused to facilitate massive illegal activity."

 

The plaintiffs do not mention, but we can assume, that they prefer New York over Iceland because U.S. courts offer a host of advantages over the courts of just about any other jurisdiction, including jury trials, pre-trial discovery, and contingent attorneys’ fees.

 

For all of the reasons the plaintiffs acknowledge, and perhaps even more so for the reasons the plaintiffs don’t explicitly mention, litigants from around the world may seek to access U.S. courts for redress of grievances in the wake of bank failures. I have long felt that the current wave of U.S. bank failures is going to produce a wave of lawsuits. The Glitnir case suggests that the litigation wave may well encompass claims relating to failed banks from around the world, not just failed U.S. banks.

 

One question I wondered while reading this complaint is whether or not Glitnir carried D&O insurance. The reckless way business was conducted in Iceland (at least as portrayed in Lewis’s Vanity Fair article) suggests the Icelandic financiers might not have slowed down long enough to consider any type of risk mitigation, much less anything as conventional as insurance. And even if Glitnir had insurance, it has likely long since lapsed, and so unless this new complaint relates back to some timely filed claim or notice, insurance might not be available anyway.

 

But whether or not there is D&O insurance available, this complaint, for all of its peculiar Icelandic features (including typographical symbols I am unable to reproduce here), in many ways represents the classic type of D&O claim that can follow a bank’s collapse, at least to extent it names two former directors and the former CEO as defendants. I had not anticipated that claims involving Icelandic banks would corroborate my position, but I will say that this case is at least consistent with my long-standing projection for litigation arising from the growing number of failed banks.

 

There are of course many more conventional cases also corroborating my position, including the investor lawsuit filed on May 7, 2010 involving First Regional Bancorp (about which refer here) and the lawsuit filed on May 12, 2010 involving BancorpSouth (refer here) – both of which involving U.S.-based banks.

 

The bottom line is that it is no longer quite accurate for me to continue to say that failed bank litigation is coming – it is here.

 

A Literary Interlude: The reference above to Michael Lewis’s Vanity Fair article reminded me that a copy of his latest book, The Big Short, is languishing unread on my bookshelf. Rather than reading yet another account of our dysfunctional financial system, I have been distracted by Maurice Lever’s excellent biography of Pierre-Augustin Caron de Beaumarchais.

 

Beaumarchais is now remembered mostly for having written The Barber of Seville and The Marriage of Figaro, though ironically he wrote those works essentially as a diversion from his many other hyperkinetic activities. Beaumarchais was a watchmaker’s son who managed to leverage music lessons provided to the French King’s daughters into court contacts and business opportunities from which he achieved wealth, notoriety and a life so full it almost can’t be summarized.

 

Variously an entrepreneur, inventor, author, royal agent, diplomat, spy, labor organizer, publisher and printer, arms merchant, and revolutionary, and throughout it all a tireless and effective self-promoter and compulsive litigant, Beaumarchais was at the center of many of the critical events in the events leading up to the French Revolution.

 

The vast sweep of Beaumarchais’s life encompasses enough to have filled several lifetimes. If we now remember him most for his plays, we should at least recognize how provocative and even seditious his plays were at the time. One excerpt from Figaro is particularly illustrative in that regard, and worth reproducing here. Though Figaro speaks the words, it is not too hard to imagine these same sentiments come from the mouth of one as talented and ambitious as Beaumarchais, chaffing against the unfairness of a system of aristocracy that delimited the upward range of his achievement:

 

Just because you’re a great nobleman, you think you’re a great genius! Being an aristocrat, having money, a position in society, holding public office – all that makes a man so arrogant! What have you ever done for all this wealth? You took the trouble to be born and nothing else! Apart from that you’re rather an ordinary man. And me, God damn it, a nobody, one of the crowd, and I’ve had to use more skill and ingenuity simply to stay alive than they’ve expended in a hundred years governing the whole of Spain! And you dare challenge me!

 

　

　

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It remains to be seen whether the FDIC will pursue civil actions against former directors and officers of failed banks, but it has made it clear that it will file criminal actions in cases where it suspects fraud. According to news reports, on May 7, 2010, the U.S. Attorney of the Northern District of Georgia unsealed indictments against two former officers of the failed Integrity Bank as well as against a real estate developer whom the officials said obtained $80 million in improper loans from the bank.

 

Douglas Ballard, the bank’s former Executive Vice President in charge of client relationships and a member of the bank’s board of directors, and Joseph Todd Foster, the bank’s former Executive Vice President for Risk Management, are charged with conspiracy, insider trading and bank fraud. The developer, Guy Mitchell, is charged with conspiracy and bribery.

 

The indictment alleges that Mitchell and companies he controlled obtained more than $80 million in business loans from Integrity Bank. He allegedly obtained the loans under false pretenses and deposited nearly $20 million in a checking account used for personal expenses, included over $1.5 million spent on a private island in the Bahamas. Later loans were used to pay interest on earlier loans.

 

The indictment also alleges that Mitchell paid Ballard, who authorized the loans, over $290,000 over a nine month period (half in cash and half in a cashier’s check) as a reward for Ballard’s assistance.

 

Ballard and Foster are also alleged to have committed securities fraud by engaging in insider trading. They are alleged to have sold all of their shares based on inside information (specifically, with knowledge of the bank’s problems with Mitchell’s loans).

 

Many of the news reports about the indictment have highlighted the fact that Integrity Bank had been founded with a faith-based theme. According to the Atlanta Journal Constitution (here), bank employees regularly prayed before meetings and in bank lobbies with customers.

 

The FDIC took control of the bank in August 2008. The Atlanta Journal Constitution article quotes the U.S. Attorney for the Northern District of Georgia as saying that the alleged fraud "was substantial contributing factor to the collapse," adding that "more than $80 million was given away from a dirty insider who was taking payoffs from the developer. That’s more that the average bank has had to deal with."

 

The Wall Street Journal (here) also quotes the U.S. Attorney as saying that "We are continuing to investigate and potentially other officials could be charged."

 

Statements by agency officials suggest that this prosecution may not be an isolated event. The indictment reportedly was the result of an interagency collaboration that included the FDIC’s Office of Inspector General. News reports quote the FDIC’s Inspector General as saying that "we are particularly concerned when senior bank officials, who are in positions of trust within their institutions, are alleged to be involved in unlawful activity. Prosecutions of individuals and entities involved in criminal misconduct maintain the safety and soundness of the Nation’s financial institutions."

 

The FDIC had already demonstrated substantial interest in claims involving Integrity Bank. As I discussed in a prior post (here), the FDIC intervened in the derivative lawsuit that had been brought by the bankruptcy trustee of the bank’s holding company against four former directors and officers of the holding company and the bank. The court granted the FDIC’s motion to intervene and also granted the FDIC’s motion to have the trustee’s claims dismissed, holding that under FIRREA the agency had the exclusive right to pursue claims on behalf of the bank. Basically, the FDIC made it clear that if anybody is going to pursue claims against the former officers, it is going to be the FDIC.

 

I had interpreted the FDIC’s moves in the bankruptcy trustee’s lawsuit as evidence that the FDIC intended to pursue its own claims against the former officials of Integrity Bank. But I was expecting civil claims; I certainly did not forsee this criminal prosecution. The FDIC may yet pursue civil claims as well. But it is nevertheless interesting that the FDIC is going ahead with criminal prosecutions but not yet pursuing its own civil actions, either in connection with Integrity or really any other failed banks.

 

Special thanks to the several readers who sent me links to news articles about the Integrity indictment.

　

Meanwhile the Investor Lawsuits Continue to Emerge: While we all wait to see that whether the FDIC will unleash a flood of failed bank claims as it did during the S&L crisis, the failed banks’ aggrieved investors are continuing to file their own claims against the directors and officers of the failed institutions.

 

The latest of these investor lawsuits is the securities class action lawsuit filed on May 7, 2010 in the Central District of California against certain former directors and officers of First Regional Bancorp, the holding company for First Regional Bank, a Los Angeles based bank that regulators closed on January 29, 2010. According the plaintiffs’ attorneys’ May 7 press release (here), the defendants "caused the Company to disseminate financial statements that were not fairly presented in conformity with Generally Accepted Accounting Principles and were materially false and misleading, and failed to make complete and timely disclosures concerning certain actions taken by regulators."

 

The First Regional lawsuit follows several other recent securities lawsuits that have involved failed banks. For example, on April 15, 2010, investors filed a securities lawsuit in the Western District of Washington against Frontier Financial Corp., the holding company of Frontier Bank, and certain of its directors and officers. Regulators closed Frontier Bank on April 30, 2010.

 

There have also been a number of securities lawsuits filed against other troubled banks, including Sterling Financial, Smithtown Bancorp and Haven Trust Bancorp.

 

In addition to securities class action lawsuits, investors are pursuing a variety of other kinds of claims against former directors and officers of failed banks, as illustrated, for example, by the recent action for negligent misrepresentation filed against the former officials of the failed Alpha Bank and Trust, about which refer here.

 

At this point, it seems well-established that failed bank investors intend to pursue these kinds of claims, although whether they will succeed and produce value for the claimants remains to be seen. My recent post discussing plaintiffs’ dismissal motion record in these kinds of cases can be found here.

 

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The FDIC’s closure of troubled financial institutions has recently taken on a state-based theme. Last week, on April 23, 2010, the FDIC closed seven banks, all of which were in the state of Illinois. This past Friday night, on April 30, 2010, when the FDIC again closed seven banks, the list included three from Puerto Rico, as well as two from Missouri. The FDIC’s Failed Bank List can be found here.

 

With the closure of seven banks on two successive Friday nights, the pace of bank failures has definitely picked up. The most recent round of closures brings the 2010 year to date number of bank failures to 64. The 2010 closure rate is well ahead of last year’s pace, when the FDIC closed a total of 140 banks. The FDIC did not close its 64^th bank during 2009 until July 24^th. There have been 229 bank failures since January 1, 2008.

 

The 23 banks closed in April 2010 is the second highest monthly total during the current round of bank failures, exceeded only by the 24 banks closed in July 2009. (By way of comparison, there were only 25 banks closed in all of 2008.)

 

The seven Illinois banks closed on April 23 brings the total number of Illinois bank failures to ten, the highest number for any state during 2010. The other states with the highest numbers of bank failures during 2010 are Florida (9), Georgia (7) and Washington State (6).

 

Though Illinois leads the 2010 bank failure tables, the state with the highest numbers of bank closures since January 1, 2008 is Georgia with 37 failed banks, followed by Illinois (32), California (26), Florida (25), and Minnesota (11).

 

There has definitely been a concentration of bank failures in certain states. However, the woes besetting banks are surprisingly widespread. 38 states (as well as Puerto Rico) have each had at least one bank failure since January 1, 2008.

 

The states without any bank failures since January 1, 2008 are: Alaska, Connecticut, Delaware, Hawaii, Iowa, Maine, Mississippi, Montana, New Hampshire, North Carolina, North Dakota, Rhode Island, Tennessee, Vermont, and West Virginia. There have been no failed banks in the District of Columbia either. (Readers who think they can discern the unifying factor that explains why these states have no failed banks are invited to add their explanations using the blog’s comment feature.)

 

The costs to the FDIC from these bank failures have been enormous. The cost to the FDIC’s Depositors Insurance Fund (DIF) from the April 2010 bank closures alone was $9.4 billion, the highest monthly total so far during the current bank failure wave.

 

The April 30 closure of Westernbank in Puerto Rico cost the DIF fund $3.31 billion, the third most costly closure in the current round. Only the July 11, 2008 closure of IndyMac ($8.0 billion) and the May 21, 2009 closure of BankUnited ($4.9 billion) were more costly to the fund.

 

Roughly three quarters of the banks that have failed so far this year have involved banks with assets under $1 billion. The 2010 failed banks involve a slightly higher proportion of larger banks; in 2010, about 26% of bank failures (17 out of 64) have involved banks with assets over $1 billion, compared to about 20% in 2009 (28 out of 140).

 

The 2010 bank closures have also involved a slightly greater proportion of the smallest banks. Thus, about 23% of the 2010 bank closures (15 out of 64) have involved banks with assets under $100 million, compared to about 17% of failed banks in 2009 (24 out of 140).

 

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As the number of failed banks has mounted in the last couple of years, the question that has arisen is whether the FDIC will pursue claims against the directors and officers of the failed institutions. While we are still waiting to see what the FDIC will do, private litigants have been moving forward. In particular, in many cases the investors have pursued securities lawsuits against the directors and officers of the failed banks.

 

Unfortunately for some of these plaintiffs, however, a number of these cases have resulted in dismissals. By way of example, dismissal motions were granted in the BankUnited case, and Downey Financial case. However, a recent decision in the securities lawsuit surrounding the collapse of Corus Bankshares went the other way, in an opinion that is largely favorable to plaintiffs.

 

Until the bank was closed on September 11, 2009, Corus Bankshares operated as the holding company for Corus Bank, a depositary institution that concentrated its lending activities in commercial construction loans, particularly condominium construction and conversion loans. Investors sued Corus and two of its former officers alleging that Corus misrepresented its lending practices, capital position and loan loss reserves. As the court later stated "the complaint alleges that Corus misrepresented the nature and extent of its financial troubles and its ability to survive the downturn affecting the economy at the time." The defendants moved to dismiss.

 

In an order dated April 6, 2010 (here), Northern District of Illinois Judge Elaine Bucklo denied the motions to dismiss as to Corus and its former CEO, but granted the motion as to its former CFO.

 

In their dismissal motions, the defendants had argued that the plaintiff’s allegations represented nothing more than "fraud by hindsight," particularly with respect to plaintiff’s allegations about the inadequacy of the loan loss reserves. Judge Bucklo rejected these arguments, finding that "plaintiff here has alleged specific, concrete reasons for his contention that Corus should have known that its reserves were inadequate and needed to be increased, and that Corus’s statements about the adequacy of its reserves were misleading." Judge Bucklo also found that plaintiff’s allegations about other aspects of Corus’s financial condition were also sufficient.

 

Judge Bucklo also concluded that the plaintiff’s scienter allegations were sufficient, at least as to Corus and its former CEO. She said that "an inference of scienter is supported, first of all, by Corus’s awareness of the discrepancy between its public statements about its finances and the corporation’s true financial condition." The inference, she said, was "buttressed by many other allegations," including the company’s undisclosed use of special purpose entities.

 

The defendant had argued that the plaintiff’s scienter theory was undercut by the "frankness" of some of the company’s disclosures. Judge Bucklo said that

 

The argument is not without force, but it does not carry the day. Plaintiff does not contend that Corus sought to pull the wool over the public’s eyes by claiming that it would pass through the recession entirely unscathed. Instead, according to plaintiff, Corus’s fraud consisted largely in concealing the full extent of its financial difficulties. Thus, the fact that Corus disclosed certain of its difficulties during the class period does not necessarily negate any inference of scienter, for Corus’s statements may still have been intended to conceal the fact that its condition was substantially worse than it statements suggested.

 

Judge Bucklo also concluded that the scienter allegations were sufficient as to the company’s former CEO, largely in reliance on plaintiff’s allegations that the CEO was "deeply involved in every major aspect of the lending process." She concluded that plaintiff’s scienter allegations against the CFO were not sufficient, particularly where there were no allegations that the CFO was deeply involved in the lending process.

 

HomeBanc Corporation Securities Suit Dismissed: In a ruling that came out completely opposite from Corus case, on April 13, 2010, Northern District of Georgia Judge Timothy C. Batten, Sr. entered an order (here) granting with prejudice the defendants’ motions to dismiss the securities lawsuit pending against two former officers of HomeBanc Corporation.

 

HomeBanc was an Atlanta-based real estate investment trust in the business of investing in and originating residential mortgage loans. The plaintiffs alleged that prior to the company’s August 9, 2007 bankruptcy the defendants portrayed"overly rosy picture" of the company’s finances, and misrepresented the company’s underwriting practices, loan loss reserve model, and other aspects of the company’s lending and mortgage investment operations. The plaintiffs alleged that the company "loosened its underwriting standards and policies in response to slowing loan originations and shifted from its stated focus on conservative risk management to attempting to profit by selling poor quality loans." The defendants moved to dismiss.

 

In his April 13 order, Judge Batten agreed with the Defendants’ position that "the bulk of the statements upon which Plaintiff relies fail to satisfy the ...standards for materiality." Among other things he found that the complaint "makes conclusory allegations of falsity without establishing contrary true facts." He also said that the complaint is "rife with forward-looking statements made by HomeBanc that were accompanies by meaningful risk disclosures."

 

Judge Batten also concluded that the plaintiff "has failed to allege sufficient facts to demonstrate a cogent and compelling inference of scienter," noting that "the complaint cites differences of opinion, conjecture and innuendo in an attempt to make the Defendants’ behavior look suspicious, but it conspicuously omits any facts that would require one to rule out an innocent explanation for the alleged behavior." Judge Batten also held that the plaintiff had not sufficiently pled loss causation.

 

Discussion

These are two completely different cases involving two completely different sets of parties and two completely different sets of allegations. But it is very hard to read them back to back and not come away with a strong impression of how different the two judges’ approaches were and how the difference of those approaches seemed to lead directly to the outcome. To be sure, the difference of the approach may be nothing more than a reflection of the relative merits of the two cases. On the other hand, it is hard to shake the impression that there were two different outcomes simply because there were two different judges involved.

 

Some might argue that I am being naïve to believe that merits outcomes ought not to turn simply of the luck of the judicial draw. And yet others might say that judicial draw has nothing to do with the difference in outcome of these two rulings, but rather the outcomes reflect the cases. And I suppose it could be said that the system requires only uniform principles not uniform outcomes. But all of that said, it really does seem sometimes that the most significant factor in determining the outcome of a case is the identity (and predisposition) of the judge.

 

At the risk of starting something, I do think it is interesting to note that Judge Bucklo, who denied the motion to dismiss in the Corus case, is a Clinton appointee, and Judge Batten, who granted the motion to dismiss, is a Bush (W) appointee. Not that that has anything to do with the outcomes, of course.

 

I have in any event added these rulings to my running tally of subprime and credit crisis related case resolutions, which can be accessed here.

 

Special thanks to the several readers who sent me copies of the Corus decision and to the loyal reader who sent me the HomeBanc decision.

 

PLUS Webinar: On April 22, 2010, at 2:00 P.M. EDT, I will be participating in a webinar sponsored by the Professional Liability Underwriting Society (PLUS) entitled "D&O Insurance and the Outcome and Timing of Securities Class Action Resolution: What New Data Shows." The purpose of the webinar is to discuss recent research completed by Stanford Law School Professor Michael Klausner on the impact of D&O insurance on securities class action resolutions. Professor Klausner’s research also addresses the timing of case resolution and factors affecting the eventual outcomes.

 

Joining me on the discussion panel, in addition to Professor Klausner, will be Steve Anderson of Beecher Carlson and Todd Greeley of C N A. The session will be moderated by Paul Lavelle of LVL Claims Services.

 

Information and Registration for this free webinar can be found here.

 

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In the largest weekly collection of bank failure so far this year, the FDIC took control of seven banks this past Friday evening, bringing the 2010 year to date total of failed banks to 37. The YTD total already far exceeds the 2008 annual total of 25 failed banks and the pace of the 2010 closures is well ahead of last year’s pace, when a total of 140 banks closed by year end.

 

The closures this past Friday night included three more banks in Georgia, bringing the 2010 year to date total in that state to five, and the total since January 1, 2008 to 35, by far the highest number for any state during that period.

 

The only other state with as many as 2010 closures as Georgia is Florida, which also has five failed banks in 2010. Since January 1, 2008, Florida has had a total of 21 failed banks, which ranks the state fourth overall during that period, behind Georgia, Illinois (25), and California (24). During 2010, Illinois has three failed banks and California has two.

 

Two other states that have significant numbers of 2010 bank closures are Minnesota and Washington State. Minnesota has four 2010 YTD bank failures and eleven total since January 1, 2008, Washington has four failed banks this year and seven total since January 1, 2008.

 

Overall 17 states have had at least one bank failure in 2010. Although there is a perceptible concentration of bank failures in Georgia and Florida, the 2010 failed banks have been widely dispersed geographically.

 

This overall geographic spread has characterized the current wave of bank failures since its beginning. Indeed, since January 1, 2008, 36 different states have each had at least one failed bank. There has, however, been some concentration in certain states, particularly Georgia, Illinois, California and Florida.

 

The pace of bank closures so far in 2010 is well ahead of the pace during 2009. At this same point a year ago, there had only been 20 failed banks, compare to 37 so far this year. The 37^th bank closure last year did not take place until June 5, 2009.

 

The pace of bank failures definitely has quickened in recent months. During the 27 month period since January 1, 2008, here have been 202 bank closures. However, of those 202, 132 (or roughly two-thirds) have failed just in the nine months since July 1, 2009.

 

Although there has been no single month that has come close to the July 2009 total of 24 failed banks, the 15 so far this month is tied with the third highest monthly total since the early 90’s.

 

The 2010 bank closures continue to be concentrated among the smaller banks. 29 of the 37 bank failures so far this year have involved institutions with assets under $1 billion. (Of course, there are many more institutions with assets under $1 billion, so in that sense this distribution may not be surprising.)

 

The pace of bank failures has remained at elevated levels over the past nine months. Given that in its last Quarterly Banking Profile, the FDIC identified 702 banks as "problem institutions" as of December 31, 2009, the heightened pace of bank failures seems likely to continue for some time to come.

 

But while the number of failed banks continues to grow, there has not yet been an equivalent wave of failed bank litigation. Indeed, at least one lawsuit brought by a failed bank’s investors has been withdrawn.

 

As I noted in an earlier post (here), in December 2009, nearly 60 investors in New Frontier Bank had brought suit against certain former directors and officers of the failed bank. However, the Greeley (Colo.) Tribune reported on March 17, 2010 (here), that the investors are withdrawing their lawsuit out of concerns about insurance coverage and out of recognition of the FDIC’s priority rights as receiver to the bank’s claims. Based on the article, I am no entirely sure what the investors’ insurance coverage concerns are, but I have previously written about the FDIC’s priority rights here.

 

The New Frontier Bank’s investors’ expectation is that the FDIC will pursue claims against the former directors and officers of that bank. Indeed, the expectation in general has been that the FDIC will pursue these kinds of claims with respect to many of the banks that have failed during the current round of bank closures. Certainly during the S&L crisis, the FDIC pursued claims against former directors and officers of roughly a quarter of the banks that failed (as detailed here). There no reason to assume that the FDIC will not be similarly litigious this time around. But at least so far lawsuits brought by the FDIC as receiver against the directors and officers of failed banks have yet to materialize in significant number.

 

Travel Hell: On Saturday March 13, 2010, I was scheduled to catch a flight from Cleveland to Newark at 5:55 pm, where I was to catch an 8:45 pm flight to London. At around 3 pm on Saturday, I received an email from Continental Airlines advising me that my flight to Newark was delayed due to weather and that it would not arrive in Newark until 8:30 pm.

 

Because of concern that I would miss my connection in Newark, I called Continental. They advised me that the 2:00 pm flight from Cleveland to Newark was also delayed and had not yet left Cleveland, and perhaps I could catch that flight and still make my connection.

 

I sprinted to the airport and managed to get a seat on the delayed 2:00 pm flight. However, as the afternoon turned into evening, all of the Newark bound flights were pushed back further and further. (There were huge storms in the New York area that night.) Eventually, the delayed flights were scheduled to leave Cleveland after the scheduled departure time of the London flight. I threw in the towel and booked myself on the first flight to Newark in the morning, and then I went home.

 

The 8:45 am flight from Newark to London, meanwhile, left Newark right on time. I suspect it was the only flight that entire weekend that was on schedule.

 

The next morning, I was up at 4:00 am (which felt like 3:00, due to the daylight savings time change), and I went to the Cleveland airport to start all over again. My 6:25 am flight to Newark was also delayed somewhat, but I made it to Newark by about 8:30 am, in plenty of time for the 10:00 am connection to London.

 

However, the airplane that was to be used for the London flight had been delayed coming out of Lima, Peru the prior evening, and it did not actually arrive in London until about 11:30 am.

 

After the plane from Peru arrived, there was a long delay, and finally about 12:45 pm, there was an announcement that while en route from Lima, the plane had been hit by lightening, and it was being taken out of service. A new plane would have to be brought to the gate.

 

We finally started to board the new plane at around 2:00 pm. The plane was entirely full and the boarding process took a long time. Finally, after everyone had boarded, the captain came on the P.A. and announced that the crew had timed out, and there would have to be a delay while the crew rested. So – everyone off the plane. The new departure time announced was 12:45 am.

 

After several lonely lifetimes haunting the concourse at Newark, we finally boarded the plane at 2:00 am. After everyone had boarded, the captain came on the P.A. and announced that the plane had a flat tire, and so we would have to get a new plane. So—everyone off the plane.

 

After everyone was off the plane, it was discovered that everyone’s boarding passes had expired. So everyone had to get new boarding passes.

 

After everyone had their new boarding passes, we boarded yet another new plane at around 4 am. Astonishingly, at about 4:45 am, the plane finally departed.

 

About three hours later, while the plane was approximately over the middle of the Atlantic Ocean, a flight attendant came on the P.A. and said, "If there is a doctor on the plane, could you please ring your flight attendant call button." About ten minutes later, the flight attendant came back on the P.A. again and said, "If there is anyone on the plane who is qualified to read vital signs, could you please ring your flight attendant call button."

 

For the rest of the flight, the flight attendants rushed back and forth with worried faces. When we finally reached the gate at Heathrow, a crew of EMTs boarded the plane and they removed a very grave looking older man from the plane.

 

After I took a taxi into London, I finally arrived at my hotel around 5 pm local time on Monday – about 46 hours after I first left my house on Saturday. I had missed all of my Monday meetings.

 

I left my hotel to return home at about 5 am on Wednesday morning, about 36 hours after I had finally arrived. In other words, I spent ten hours less in London than I had spent trying to get there.

 

On the other hand, though it was pretty bad for me, it was worse for the guy they carried off the plane on stretcher.

 

Service Announcement: Readers may have experienced a variety of different problems with the email notifications for this blog. There have been duplicate notifications, late notifications, missing notifications -- and the problems have been getting worse.

 

As a result of these problems, I will be switching to a different service provider for delivery of email notifications. I am still not 100% sure when the switchover will take place, but probably some time in the next few days.

 

When the change does occur, every current email subscriber will receive an email requiring them to confirm their subscription. This is important – if you wish to continue to receive email notifications, you will need to reconfirm in order to reactive your subscription, so that you will receive email notifications from the new service provider.

 

I apologize for any inconvenience this change may cause, but in light of the recurring problems with my existing email notification service, I had to take corrective action. Please let me know if you have any difficulties with the change.

 

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As of year-end 2009, the FDIC identified 702 banks as "problem institutions," representing about 9% of all institutions reporting to the FDIC and the highest number of problem banks since 1993, according to the FDIC’s latest banking report.

 

On February 23, 2010, the FDIC released its Quarterly Banking Profile for the fourth quarter 2009, which can be found here. The FDIC’s February 23, 2010 press release describing the report can be found here.

 

The FDIC defines "problem institutions" as those with "financial, operational or managerial weaknesses that threaten their continued financial viability." Problem institutions are ranked as either 4 or 5 on the FDIC’s 1 to 5 scale of "risk and supervisory concerns." The FDIC does not publicly identify the problem institutions by name.

 

The 702 problem institutions at year end (out of 8,012 reporting institutions) represent the largest number of problem institutions since 1993. The 702 institutions also represented combined assets of $402.8 billion. The year end number of problem institutions is 27 percent greater than the 552 problem institutions as of the end of 3Q09. The 2009 year end figures compare to the 252 problem institutions, representing $159 billion in assets as of the end of 2008.

 

Given that the "problem institution" category tracks banks with "financial viability" concerns, it is hardly surprising that the increase in the number of problem institutions has been accompanied by a growing number of failed financial institutions. There were 140 bank failures in 2009, and there have already been 20 bank failures already in just the first seven weeks of 2010. The number of bank failures so far this year suggests that we may have at least as many if not slightly more bank failures this year compared to last year.

 

The FDIC’s report comes on the heels of the recent report of the Congressional Oversight Panel (about which refer here), in which the watchdog committee warned that coming commercial mortgage woes could further damage many lending institutions.

 

But not all of the banking news is bad. FDIC Chairman Sheila Bair is quoted in the FDIC’s press release as saying that the FDIC sees "signs of improving performance in the industry, " although basically that means that the pace of deterioration has slowed, not necessarily that the negative trends have been reversed.

 

Whatever else that might be said, the continued increase in the number of problem institutions as 2009 progressed suggests that we can expect to continue to see growing numbers of failed financial institutions as 2010 unfolds.

 

A Business Week article about the FDIC’s report can be found here, and a New York Times report can be found here.

 

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As the number of failed banks has surged over the past couple of years, one anticipated byproduct has been a corresponding wave of litigation against the failed institutions’ former directors and officers. The thing is, the anticipated wave really has not yet materialized. But nevertheless some suits are coming in, as demonstrated most recently in a new lawsuit filed this past week against certain former directors and officers of a failed Georgia bank.

 

On February 18, 2010, seventeen individual plaintiffs (including one trust) filed a Verified Complaint (here) in Cobb County (Ga.) Superior Court against three former directors of Alpha Bank and Trust, an Alpharetta, Ga. bank that failed on October 24, 2008. A February 18, 2010 Atlanta Journal-Constitution article about the filing can be found here.

 

The bank, according to press reports, was "one of the quickest bank failures in the nation in recent years, losing almost half of its assets after only 29 months in business."

 

The plaintiffs’ complaint seeks recovery for negligent misrepresentation and alleges that the three defendants had possession of material information about the bank that they failed to disclose to the plaintiffs, who owned shares in the bank.

 

There are a number of interesting things about this complaint. The first is that in paragraph 10, the complaint expressly purports to "exclude and disclaim any allegations whatsoever that could be construed as alleging or sounding in" the federal securities laws; common law fraud; intentional, knowing or reckless misconduct; breach of fiduciary duty, or mismanagement.

 

Clearly, the plaintiffs are not only aiming to avert procedural hurdles and potential defenses, but, as discussed below, they are also trying to circumvent the FDIC’s priority rights under FIRREA to claims the FDIC acquired as the bank’s receiver.

 

Second, the specific misrepresentations alleged – that the bank experienced undisclosed regulatory difficulties almost from its very beginning, that the bank submitted an undisclosed revised business plan to regulators, that the bank’s board dismissed the bank’s CEO for undisclosed reasons, among other things – all took place after the bank was launched and apparently after the plaintiffs’ acquired their shares.

 

As a result, plaintiffs’ claim is not that the they were misled into investing in the bank in the first place, but rather that as a result of a series of allegedly wrongful omissions, they "continued to hold their substantial respective investments," as the complaint puts it. A "continued to hold" assertion is a more challenging claim that an "induced to buy" argument.

 

Third, as suggested above, the plaintiffs clearly tried to shape their allegations in order to avert the FDIC’s rights as receiver to priority over all of the failed institution’s claims. (Refer here for my prior post discussing the FDIC’s right under FIRREA.) The plaintiffs have very carefully alleged that they seek to "recover individualized damages," as well as explicitly asserting that they are not alleging breach of fiduciary duty or mismanagement, which are claims to which the FDIC’s priorities would be clearest.

 

The FDIC may yet of course attempt to assert its right to priority over the claims the plaintiffs have asserted, and even assert its own claims, based on its status as the bank’s receiver. A recent memo from the Alston & Bird firm (here), citing the FDIC’s own statistics, reports that "of the financial institutions that failed in the period between 1985 and 1992, the FDIC initiated claims against the former directors and officers of 24 percent of those institutions."

 

There is absolutely no reason to expect that the FDIC will prove to be less litigious now than it was during the S&L crisis. So there would seem to be a considerable possibility the FDIC could yet assert its own claims, as receiver, against the former Alpha Bank officials.

 

Whether the existing investor claim or any future FDIC claim might succeed remains to be seen. However, were the FDIC to pursue a claim as receiver, and if it were unable to assert its priority under FIRREA over the investors’ claim, there could be a race to capture assets from which to recover – the most obvious asset being the D&O policy. A potential barrier under the D&O policy to any recovery by the FDIC would arise if the applicable policy has a regulatory exclusion.

 

Whether any successful claimant would be able to recover under the D&O policy will depend further on whether or not anything is remaining when the time arrives. If there were to be litigation free-for-all, defense costs alone could substantially erode the available insurance.

 

Finally, in terms of the anticiapted litigation wave, it is worth noting that approximately 16 months elapsed between the time Alpha Bank failed and the date the investors filed their suit against the former bank officials. Most of the closures of the most of the banks that have failed as part of the current banking crisis have failed more recently than Alpha Bank. The litigation may yet arrive, it may just follow more slowly than might have been anticiapted.

 

Special thanks to the several loyal readers who forwarded copies of the Alpha Bank complaint to me.

 

Belated Securities Suit Filings (Extreme Edition): In a number of recent posts (most recently here), I have noted the curious phenomenon of securities class action lawsuits that are filed well after the proposed class period cut off date. In some cases, the filing has come well over a year after the alleged stock price drop. However, a recent filing seems to set some kind of a belatedness record, as the complaint was filed nearly four and a half years after the proposed class period cutoff date.

 

In a complaint filed on February 18, 2010 against certain former directors and officers of the bankrupt Dana Corporation (here), the proposed class period runs from February 23, 2005 to October 7, 2005. The class period starting date is just short of five years, which is represents the period of the statute of repose for ’34 Act claims.

 

A great deal of context is necessary just to try to start to make sense of what might be going on here. First, there already is an existing securities class action lawsuit pending against other former directors and officers of Dana. The prior case, about which refer here, was first filed in the Northern District of Ohio in October 2005 and was dismissed with prejudice in August 2009 (here). The appeal of the dismissal is currently pending in the Sixth Circuit.

 

A knowledgeable observer suggested to me that the plaintiffs’ lawyers may think they have uncovered new facts implicating the four lower level defendants that are named in the new case. The speculation is that the plaintiffs’ lawyers filed the new case against the four new defendants to preserve the statute of limitations while the "main case" is on appeal. Because of the prior dismissal, the plaintiffs’ lawyers couldn’t just amend the previously existing complaint.

 

Where all of this might lead remains to be seen, but in the meantime the new complaint sets a new standard in superannuated securities lawsuit filings.

 

Special thanks to a loyal reader for sending along a copy of the new Dana complaint.

 

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After an initial flurry of bank failures in January, the pace of bank closures more recently has slowed. There has been only one failed bank so far in February, and there were none at all this past Friday night, the first failure-free Friday in several weeks. The apparent bank closure slowdown does not, however, mean that the worst is past; indeed, if a recent Congressional watchdog committee report is accurate, there may be many, many more bank failures ahead.

 

The Congressional Oversight Panel was created to oversee the expenditure of TARP funds and provide recommendations on regulatory reform. The Panel is chaired by Harvard Law Professor Elizabeth Warren.

 

On February 10, 2010, the Panel released its 190-page February Oversight Report, entitled "Commercial Real Estate Losses and the Risk to Financial Stability." The Report can be found here, and the Panel’s February 11, 2010 press release about the Report can be found here.

 

The Report paints a dire picture of the current and likely future performance of outstanding commercial real estate loans. The Report begins by observing that the Panel is "deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as damage spreads beyond smaller banks that it will contribute to prolonged weakness throughout the economy."

 

The fundamental problem is that between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are "underwater," meaning that the borrower owes more than the property is currently worth.

 

The commercial real estate borrowers’ problems are two-fold. The weakened economy means that the borrowers are having problems realizing sufficient cash from the properties to cover their principal and interest obligations (or, to give the problems its technical name, to maintain their "debt service coverage ratio"). The deeper problem is that when their debt obligation matures, they won’t be able to refinance the loan due to tougher bank underwriting standards or property value decreases.

 

Figure 31 on page 72 of the Report graphically illustrates the problem. The bar graph shows that commercial mortgage maturities will hit their highest levels between 2010 and 2014, with the peak coming during 2012 and 2013.

 

The timing of the debt maturities is all the more unfortunate, because they arise as signs point to continued (and perhaps progressively worse) deterioration of real estate market fundamentals. As the Report notes, "commercial real estate metrics tend to lag overall economic performance." For the last several quarters vacancy rates have risen and average rental prices have fallen for all major commercial property types.

 

Unless the nascent economic recovery picks up sufficient momentum to reverse these negative trends, the likelihood is that many of the maturing real estate loans will fail. Which means trouble for many smaller banks.

 

According to the Report, 2,988 of the roughly 8,100 U.S banks have a "CRE Concentration," meaning that such loans represent at least 300% of total capital or that construction and land loans exceed 100% of capital.

 

The danger is not just to the banks, according to the Report; rather, because of the downward spiral that defaults trigger, "a significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American."

 

The Report is neutral on the possibility whether an economic recovery could avert the worst of these concerns, saying only that "there is no way to predict with assurance whether an economic recovery of sufficient strength will occur to reduce these risks before the large-scale need for commercial mortgage refinancing is expected to begin in 2012-2013." The Report urges the Treasury and the banking regulators to "take coordinated action to address forthrightly and transparently the state of the commercial real estate markets."

 

Although the Report itself does not address this issue, an accompanying problem that is exacerbating these issues for many smaller banks is the banks’ past issuance of "trust preferred securities" to raise capital and fund loans. As I discussed at greater length here, these hybrid debt-equity instruments were a popular way in recent years for many banks to raise funds. Between 2000 and 2008, more than 1,500 small and regional banks issued about $50 billion in trust preferred securities, according to a February 12, 2010 Wall Street Journal article (here).
 

 

But as the current banking crisis has unfolded, certain features of these securities have operated to magnify many banks’ woes. The first is that the buyers of these instruments were in many cases other banks. As the issuing banks’ finances have deteriorated, the value of the instruments to the investor banks has also declined. Indeed, the deteriorating value has contributed to the demise of at least some of investor banks (about which refer here).

 

As the Journal article itself notes, these instruments give the buyers certain preferences. However, the existence of these preferences, which ensure that the holders of the instruments would be first in line to recover losses, means that other prospective investors now are wary of making any further investments, for fear that their investments would be subordinated to the trust preferred securities holders. These circumstances leave some banks unable to raise additional capital, "increasing the possibility that some of the weakest banks could fail."

 

Many banks are trying to repurchase their trust preferred securities at steep discounts, in a bid to circumvent these problems, but many of the holders (in many cases, other banks with their own problems) are reluctant to sell and be forced to recognize and absorb their losses. As the Journal article notes, "the standoff is particularly perilous for banks that are reeling from deteriorating real-estate portfolios."

 

The bottom line is that many banks will face daunting circumstance possibly for several years to come. These concerns in turn present a challenge for D&O insurance underwriters as they struggle to assess the risk exposures associated with these financial institutions. Whatever else might be said, it does seem likely that the current unsettled D&O insurance marketplace for lending institutions will continue.

 

As one time, and for many years, I was responsible for managing a team of D&O underwriters. If I were managing D&O underwriters today, particularly if our portfolio of risks included lending institutions, I would require all of my underwriters to read the Congressional Oversight Panel’s latest Report. It makes for some sobering reading.

 

Other Important Information: How to tell if your cat is plotting to kill you. Read it here.

　

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Last year’s wave of bank failures had clearly carried over into the New Year. On Friday, January 22, 2010, the FDIC closed five more banks, already bringing the year to date number of bank closures to nine. (At this same point last year, the FDIC had only closed three banks, before eventually closing 140 banks for the entire calendar years.).

 

The nine banks that have failed so far this year are a surprisingly diverse bunch. The closures are distributed across eight different states. While three of the failed banks were tiny, with assets of under $70 million, three of then nine were pretty good sized, with assets of over $1 billion. Perhaps the most noteworthy discernable trait of the group is that three of them were located in the Pacific Northwest, two in Washington, one in Oregon. Bank failures are not unknown to that part of the country – including, of course, the Washington Mutual closure, the largest bank failure of all time.

 

But though the bank failures have continued to flood in, litigation involving the directors and officers of the failed institutions has – at least so far— been relatively light. Nevertheless, I continue to believe that it will only be a matter of time before the FDIC begins to file significant numbers of lawsuits. My expectation in this regard is largely driven by the fact that during the S&L crisis in the 80s and early 90s litigation was such an important component of the FDIC’s efforts to recoup its losses. The FDIC has filed a number of notices of claims with some bank officials and their D&O carriers, but so far it has not filed lawsuits in significant numbers.

 

While we all wait to see what the FDIC will do, investors in some failed banks are moving ahead with their own claims. For example, as reported in the January 15, 2010 Greeley (Colo.) Tribune (here), almost 60 investors filed a lawsuit on December 15, 2009 in Weld County (Colo.) District Court former directors and officers of New Frontier Bank. The bank, which was located in Greely, Colorado, was taken over by regulators in April 2009. Prior to its closing, the bank had assets of over $2 billion.

 

The circumstances surrounding New Frontier’s demise were the subject of a June 16, 2009 Wall Street Journal article entitled "Town’s Friendly Bank Left Nasty Mess" (here). Among other things, the article reports that the bank’s failure "is expected to set off a cascade of bankruptcies and foreclosures across several counties" and that companies that relied on the bank for financing "are cutting staff and curtailing payments to suppliers."

 

At least as depicted in the Journal article, New Frontier’s failure represents something of a modern day morality tale reflecting the excesses that can cause a banking crisis. New Frontier was particularly dependent on so-called "hot money" – that is, brokered deposits on behalf of investors seeking higher rates of return on their deposits. The flood of hot money facilitated the bank’s business lending, "leading to meteoric growth and favorable press." But, according to comments by the bank’s competitors quoted in the article, the bank "had looser credit requirements that virtually any other bank in town." The other banks reportedly used New Frontier as a safety valve, by urging their own customers that had fallen behind on their payments to refinance their loans at New Frontier.

 

One factor that proved particularly dangerous for the bank was its heavy concentration in agricultural loans, particularly for local dairies. A number of the borrowers fell behind or defaulted after prices for milk and other products fell. Many of the defaulting borrowers themselves now face ruin. The Journal’s photo essay about the bank’s failure, here, reflects the community and many of the individuals hit by the bank’s closure.

 

A flood of public accusations have followed in the wake of the bank’s failure. For example, the December 30, 2009 Denver Post had an article (here), reporting supposedly improper practices at the bank and also that the bank’s practices are the subject of a Department of Justice investigation.

 

According to the Greely Tribune article, the investors allege in their lawsuit that senior bank officials engaged in a host of improprieties including reckless lending activities without regard to loan quality, insider deals that improperly benefited board members and many instances of conflicts of interest among board members. Among other things, the complaint alleges that insiders received huge loans on preferred terms, and that the bank’s headquarter building was built by the construction company owned by one board member and that rather than owing the building outright, the bank leased it from a company owned by other board members, on terms that were heavily favorable to the leasing company.

 

The New Frontier circumstances may be unusual because of the nature of the concerns. But the level of scrutiny the bank is now facing in the wake of its closure is not uncommon. In many instances, the questions will eventually take the form of accusations presented in the form of a lawsuit. Before all is said and done, there will be many more lawsuits like that filed by the New Frontier investors. And that does not even take into account the lawsuits we are likely to see from the FDIC. I continue to believe that the arrival of failed bank lawsuits will be one of the top litigation stories of 2010.

 

None of this has been lost on the D&O insurance carriers. D&O insurance for many commercial banks has become a much more expensive proposition, and for some banks an outright challenge. As reflected in a January 15, 2010 article in the Atlanta Business Chronicle (here, registration required), banks’ D&O insurance costs have begun to "skyrocket across the board" and terms and conditions have narrowed substantially. The insurance marketplace is particularly difficult for banks operating under regulatory orders. In light of the continued wave of bank failures and the anticipated arrival of claims, the insurance marketplace conditions seem unlikely to improve anytime soon.

 

Special thanks to the several loyal readers who sent me many of the various items to which I linked in this post. I am always grateful when readers send me material, it helps me and it helps other readers as well.

 

Reflections on the Citizens United Case: The Internet is awash with instant analysis from the commentariat about the U.S. Supreme Court’s 5-4 decision in the Citizens United case. I will leave it to the pundits to sound off about the case’s outcome. For myself, I was struck by the heated rhetoric of the majority opinion and the vehemence of the dissent. (Justice Stevens took the extraordinary step of reading his dissent from the bench, in a special session apparently scheduled for the purpose of allowing him to do so.)

 

The narrowness of the margin of decision is nothing new, since 5-4 opinions have been an unfortunate staple of the divided court for the last several years. But the tone of the language used in the opinions in the Citizens United case suggest that the Court’s proceedings have taken on a deeply personal character, with emotional overtones that have become all too public. It does kind of make you wonder what the heck is going on up there.

 

I have to admit that I am a sucker for the genre of popular literature in which the Court’s inner workings are "revealed." I devour books like Jeffrey Toobin’s The Nine: Inside the Secret World of the Supreme Courtand Supreme Conflict: The Inside Story of the Struggle for Control of the United States Supreme Court by Jan Crawford Greenburg. Among other things, these books underscore the fact that one of any President’s most enduring legacies is the identity of the justices he has named to the Court. The books also make clear that the shifting currents in Presidential politics in recent years have dramatically shaped the current Court’s composition. (For those interested in a casual but entertaining read about the Court, I particularly commend Toobin’s book.)

 

Because the Court is called on to decide some of our country’s most difficult and divisive issues, it is hardly surprising that the Court sometimes expresses itself in multiple voices. But even when issues are of paramount importance, a divided court is not inevitable.

 

I recently stumbled across the excellent biography of Earl Warren by journalist Jim Newton, entitled Justice for All: Earl Warren and the Nation He Made. Newton’s entertaining and readable book convincingly argues that Warren was one of the most important Americans of the 20^th Century. Warren’s career prior to ascending to the Court is itself fascinating, and his three terms as California’s governor transformed the state (although I couldn’t help but thinking that the Warren’s terms as governor may also have planted the seeds of many of California’s current financial woes.) Warren could easily have become President in 1948 or even 1952 (he was the Republican vice presidential candidate in 1948), if the Republicans could have overcome their East Coast bias.

 

Warren’s tenure on the court of course continues to be highly controversial, and there are many who will always carry virtual "Impeach Earl Warren" billboards around in the foremost part of their conscious brain. In many quarters, the Warren Court is a byword for reckless judicial activism. But it is almost impossible to imagine what our country would have been like were it not for the civil rights decisions of the Warren Court.

 

At the time Eisenhower nominated Warren to the bench, the Court had already heard oral argument on the Brown vs. Board of Education case, involving the racial segregation of Topeka’s public schools. However, under Warren’s predecessor, Fred Vinson, the justices had been unable to reach even a majority opinion on any of the issues presented and the case was put over to the following term for reargument. In the interim, Vinson died from a heart attack, and Warren came onto the bench.

 

After Warren joined the Court, the case was reargued. Newton shows how under Warren’s leadership and as a result of Warren’s formidable political skills, the Court was able to reach agreement on a single, unanimous opinion, reversing Plessy v. Ferguson and holding that "separate but equal is inherently unequal."

 

No one ever accused Warren of being the most intellectual justice. But his leadership skills and his ability to unite powerful personalities with strongly divergent views proved to be indispensible. Warren’s incomparable abilities allowed the Court to speak with a united, single voice. The moral authority this unanimity gave the Court finally allowed the country to move purposefully to try to start removing the shameful legacies of legalized racial segregation.

 

It all too easy to forget now, but it was only ten short years from the Supreme Court’s opinion in Brown v. Board of Education to Congress’s enactment of the Civil Rights Act of 1964. Can you imagine what this country would have been like if the Court had not spoken forcefully and with a unified voice during the civil rights era? I grew up in Virginia in the 60’s and I can still remember the "Coloreds Only" counter at the soda fountain inside the local drug store. How long would absolutely appalling conditions like that have continued if the Court had dithered?

 

The Warren Court was of course not always unanimous and many of its legacies remain highly controversial. But at its finest, the Warren Court showed how powerful the Court can be when it is strong and united.

 

For some time and for many reasons, the Supreme Court has been much more prone to speaking with multiple, deeply disparate voices. 5-4 opinions that overturn recent cases (which include opinions both by the Court’s liberal wing and its conservative wing) risk undermining the authority with which the court speaks, because voting majorities can shift so easily. If such slight variations are sufficient for the Court to cast aside even its most recent decisions, then its work becomes of little more enduring value than yesterday’s newspapers. The Court’s haphazard demolition of its own precedents not only begets inconsistency and unpredictability but it risks breeding a disrespect of the authority of the law.

 

It may be that the Court’s divisions are simply are reflection of divisions within our country, and of the way those divisions have driven the outcomes of Presidential elections in recent years. But I wonder if part of the problem might not be the kind of person that all recent Presidents have preferred for the Court. Because of certain explicit and implicit litmus tests, recent Presidents have overwhelmingly preferred to nominate to the court only judges with long judicial track records, on the theory that the judicial record provides some reassurance of the nominee’s ideology.

 

I wonder if the Court might shed some of its venomous division if there were more justices nominated whose qualifying experience was not limited to service in the judiciary. After all, the circuit courts are more than just a farm team for the highest bench, and the Supreme Court would benefit from the judgment of men and women whose world views reflected more than what can be gleaned on the inside of an appellate courtroom. I wonder whether a President would have the courage to nominate persons of intelligence and integrity whose experience includes more than just prior judicial service and who would bring with them more than mere ideological reliability.

 

In any event, it is worth remembering that the Supreme Court is not inevitably divided. Perhaps the most important legacy of the Warren Court is the reminder that at a critical moment in the country’s history, the Court was united. For those of us of moderate views who recoil instinctively from ideological extremism, the Court’s inability to command greater moral authority by speaking with a more consistent, more unified voice, and in particular its willingness to exploit a fragile majority to run roughshod over its own recent decisions, is deeply distressing.　

　

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The FDIC has picked up where it left off at the end of 2009, with its first bank closure of the New Year. On Friday, January 8, 2010, the FDIC took control of Horizon Bank of Bellingham, Washington, for the first bank closure of 2010. While the FDIC’s continuation of its regulatory actions regarding troubled banks seems likely in the near term, what remains to be seen is whether the FDIC’s actions will include litigation against the former directors and officers of the failed banks.

 

Though the FDIC has yet to launch D&O litigation, the lawsuits may be just ahead. The FDIC is taking a series of steps clearly designed to prepare for litigation.

 

First, as reported in a January 10, 2010 article in FinCri Advisor (here), the FDIC is "subpoenaing bank officials and workers, hoping to gather evidence to use in potential litigation." By way of illustration, a recent motion filed by bank officials in connection with the bankruptcy proceedings involving Haven Trust Bancorp, the holding company for a Duluth, Georgia bank that failed in December 2008, states that certain of the officials "received subpoenas…issued by counsel to the [FDIC] regarding the FDIC’s investigation of certain matters relating to the failure of Haven Trust Bank." (The former officials’ motion sought access to the D&O insurance policy proceeds in order for the officials to be able to defend themselves.)

 

Second, as I noted in a prior post, the FDIC is sending civil demand letters to former directors and officers of failed banks. According to the FinCri Advisor article, former directors in Florida, California, Illinois, Texas and Georgia have received FDIC claims letters. According to a commentator in the article, one obvious trigger for a demand letter is the approaching expiration date of the D&O insurance policy.

 

An example of one of these demand letters is described in a January 8, 2010 Atlanta Business Chronicle article, here (registration required). The article describes a September 28, 2009 letter sent to the D&O liability insurer for Georgian Bank, an Atlanta bank that the FDIC closed on September 25, 2009. According to the article, the letter details the potential claims the FDIC might make against the bank’s former directors and officers, including allegations of "unsafe and unsound banking practices."

 

Industry experts quoted in the Atlanta Business Chronicle article say that "such letters likely have been filed with insurers by all 30 banks that have failed in Georgia since August 2008."

 

But while the FDIC is clearly pursing investigations and taking steps to try to preserve the right to try to recover D&O insurance proceeds, it "has not filed any D&O lawsuits in connection with the bank failures since the crisis began in 2008," according to an FDIC spokesman quoted in the article.

 

According to the FinCri Advisor article, "the FDIC spends about a year conducting an investigation into a failed bank before deciding whether it can pursue a claim against former directors and officers."

 

Because of the FDIC’s many continuing investigations, 2010, according to an attorney quoted in the FinCri Advisor article, "will be the year of investigation and tolling agreements." One reason for the FDIC to proceed carefully is that it doesn’t want to push cases early that may set bad precedents, which could "doom subsequent cases."

 

But though the FDIC is now proceeding cautiously, when the litigation ultimately comes, there is likely to be a lot of it. The FinCri Advisor article quotes the FDIC’s former head of litigation as saying that "about half" of the bank failures will "see some director litigation." Before all is said and done, the coming litigation "could rival the litigation that occurred in the 80s and 90s as a result of the many thrift failures."

 

Special thanks to loyal reader Henry Turner for providing me with a copy of the Haven Trust pleading and the Atlanta Business Chronicle article.

 

Another Perspective: As a continuation of my early post in which I linked to a variety of Top Ten lists, I note here the recent post on the Corporate Disclosure Alert blog (written by my law school classmate and investor advocate, Sanford Lewis) about "10 Questions of Risk Management for the New Decade" (here). Lewis contends that "far more must be done to turn the patchwork of risk management approaches into viable public policy and corporate governance solutions." The list of issues that Lewis contends should be addressed is interesting and provocative.

 

We Aren’t What We Watch – Are We?: On New Year’s Day, my hyperkinetic eldest daughter -- collegiate swimmer, rugby player – who rarely sits still long enough to watch TV, announced "I think I’ll watch some college football" and she plopped herself down beside me on the couch. Unfortunately for the nascent possibility of a little father-daughter bonding, the game broadcast at that moment was in the middle of the Flomax halftime report, and the commercial had just reached the point where it advised that Flomax’s adverse side effect may include a "reduction in semen."

 

As she was leaving the room, my daughter offered the observation that at least on TV college football is clearly meant for a "different demographic."

 

Indeed. But what exactly is the intended demographic?

 

The commercials themselves suggest that the target audience consists of people who are basically worried. They are not only worried just because they have to go pee all the time. They are worried about their credit scores. They are worried that their nest eggs have shrunk. They are worried about figuring out their taxes. They are worried because their computers are too slow and because their 3G network’s coverage areas are too small.

 

So many things to worry about. Too bad for you if all you want to do is watch a little football.

 

But in the midst of all of this apprehension and fear, there is cause for hope. For the overweight, for example, Taco Bell would like to communicate the optimistic message that you can lose weight by eating fast food. (I am not making this up.)

 

If playing time alone is any measure, the most important message for our society seems to be that Taco Bell now has a five-layer burrito for 89 cents. For those of you thinking, "No Way!" -- you have to understand that they are not offering to pay you 89 cents to eat that thing. They are expecting you to pay them. Seriously. As my son said, "Is that supposed to be food?"

 

Perhaps (I can hope optimistically) we are all in the wrong demographic. How much more fortunate are the viewers of the UK premier league soccer games. Since the game clock never stops, there are no commercial interruptions – which obviously is the reason that soccer has never been allowed to catch on commercially in the U.S. Of course, the soccer games do have halftimes, which does hold open the theoretical possibility for Flomax halftime reports.

　

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Since the sole remaining Friday in December is also Christmas Day, the seven banks the FDIC closed last Friday night may represent the last bank failures of 2009. Of course, there is no legal requirement that Friday is the only day of the week on which the FDIC can close a bank. The FDIC could close additional banks on any of the few remaining business days left this year. But given the holiday season, the 140 year-to-date number of bank failures seems likely to be where we will end the year.

 

The 140 bank closures were both widely dispersed and narrowly concentrated. The FDIC took control of banks in 32 different states, but the closures were particularly clustered in four states: Georgia (with 25 closures), Illinois (21), California (17), and Florida (14). These four states alone account for 77 of the bank failures this year, more than half of the year to date total. Indeed, no other state had double digit numbers of bank failures. The next closest states were Minnesota (6), Texas (5) and Arizona (5).

 

Though the bank closures have been geographically dispersed, certain regions have been spared. For example, there were no 2009 bank failures in the New England states of Maine, Vermont, New Hampshire, Massachusetts, Connecticut or Rhode Island, and only one each in New York and Pennsylvania. And though Georgia and Florida have seen high numbers of bank failures, much of the rest of the South has been relatively untouched – there were no 2009 bank failures in West Virginia, South Carolina, Tennessee, Mississippi, Arkansas and Louisiana, and only one each in Virginia, Kentucky and Oklahoma.

 

Among the banks that failed in 2009 were some of the country’s largest, including Colonial Bank (with assets of $25 billion), Guaranty Bank ($13 billion), and BankUnited ($12.8 billion). However, these banks all are smaller than two of the larger banks that failed in 2008, Washington Mutual ($307 billion) and IndyMac ($32 billion).

 

But though there the list of failed banks includes these larger banks, the list of bank closures really has been predominated by smaller banks. Of the 140 banks that failed in 2009, 112 (80%) involved institutions with less than $1 billion in assets. Indeed, 97 of the 140, or about 69%, had assets of under $500 million. 21 of the 2009 failed banks, or 15%, has assets of under $100 million.

 

Lest anyone might optimistically hope that with the end of 2009 we have put these sad tidings in the past, the 2009 bank closure timeline seems to suggest to the contrary. Of the 140 banks that closed in 2009, 95 (or about 68%) closed in the second half of the year, compared to 45 in the first half of the year. Though the highest monthly total was in July (when 24 banks were closed, nearly as many as the 25 banks that failed in all of 2008), there were significant numbers of closures in October (20) and December (16).

 

The FDIC’s latest Quarterly Banking Profile stated that as of September 30, 2009, it graded 552 banks as "problem" institutions (about which refer here), which suggests there could be many bank closures yet to come – which helps explain why FDIC Chairman Sheila Bair last week proposed to increase the agency’s budget and staff, in order for the agency to be able to deal with the anticipated increasing numbers of banking failures in 2010.

 

I have previously commented the high numbers of bank failures in Georgia, which has been referred to as the "bank failure capital of the world." In that regard, it is noteworthy that there were as many 2009 bank failures in Georgia (25) as there were in the entire country in 2008. In the two year period, Georgia has a total of 30 failed banks, as detailed here.

 

Who Might Sue When Banks Fail: In prior posts (for example, here), I have noted developments in claims being asserted against directors and officers of failed financial institutions by disappointed investors and by banking regulators. But in addition to these two groups that potentially might assert claims against the directors and officers of failed banks, another group of potential claimants also has recently emerged – the employees of the failed banks.

 

For example, as reflected in their December 17, 2009 press release, plaintiffs’ attorneys filed a class action lawsuit in the Western District of Washington against Venture Financial Group, the parent of Venture Bank, which regulators closed on September 11, 2009. The lawsuit is filed on behalf of the participants in the bank’s retirement plans. The defendants include the holding company’s directors and officers, some of whom also served on the bank’s board, as well as the individual members of the plans’ administrative committees.

 

The complaint, which can be found here, alleges that the bank engaged in "a number of large, high-risk and inappropriate investment practices." These practices, "combined with its hazardous lending practices produced more than $200 million losses" and "exposed the retirement plans," which included investments in the holding company’s stock, and which allegedly sustained more than $12 million in losses. The complaint seeks to recover damages on behalf of the plan participants under ERISA.

 

On December 16, 2009, the same plaintiffs’ firm also announced (here) that it is investigating the possibility of a similar ERISA class action behalf of participants in the benefits plans of Sterling Financial Corporation, which, though it is not among the banks that the FDIC has closed,  was also recently hit with a securities class action lawsuit.

 

This new lawsuit and the plaintiffs’ lawyers’ investigation announcement underscore that in the wake of a bank failure there are a variety of constituencies might consider initiating claims against the failed institution’s directors and officers. This is all just one more reason I think that one of the key litigation trends we will see in 2010 is an upsurge in litigation against the directors and officers of failed banks.

 

The Receiver’s Right to Stay Failed Bank Litigation and Require Exhaustion of Administrative Remedies: Though other constituencies may seek to assert claims, the FDIC has rights to seek a stay of the other claimants’ lawsuits under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA), as reflected in a December 10, 2009 order in the Northern District of Texas lawsuit involving Millennium State Bank. Millennium failed on July 2, 2009 (refer here). Investors who had purchased Millennium stock filed a state court action against the bank, its directors, its auditors and its offering underwriter. The investors claimed they had been provided incomplete and inaccurate information about the bank. The investors alleged violations of Texas securities law and common law, and they sought to rescind their investment traction and/or damages.

 

The FDIC moved to intervene in the state court suit and then removed the case to the Northern District of Texas. The FDIC then filed a motion under FIRREA, arguing that the investors’ case should be stayed and that the plaintiffs’ and intervenors’ claims must be "exhausted under the administrative claim procedure of FIRREA."

 

The court granted the motion, holding that the FDIC was entitled to the stay, saying that "the law is well established that a stay is mandatory for any claim subject to FIRREA, if the receiver requests one." The court rejected the investors’ argument that the FDIC was not entitled to a stay because they had not named the bank as a party. The court found that "the mandatory stay applies to all claims against the bank and any related third parties" and found further that under FIRREA the "stay is required as to all parties."

 

The court quoted case authority from the prior era of failed banks to the effect that refusing to grant a stay "would largely defeat FIRREA’s purpose of allowing the agency to evaluate claims in a streamlined administrative procedure."

 

The court granted the stay until the earlier of the date on which the FDIC as receiver disallows the claims or until the 180-day administrative review period has expired.

 

In other words, though there may be many constituencies that may seek to pursue claims in the wake of a bank’s failure, the FDIC has rights under FIRREA to sort out which claims will go forward. It seems likely one consideration that might affect whether the FDIC will allow a claimant’s case to go forward would be whether the FDIC intends to pursue its own claims as receiver against the defendants (and, it should probably be added, to try to maximize its own recovery from D&O insurance proceeds). As I previously noted (here), the FDIC has already established that it is going to be aggressive in asserting its priority rights to assert claims against the directors and officers of failed financial institutions.

 

So if, as I expect, there will be an upsurge in failed bank litigation in 2010, the FDIC is going to call the shots.

 

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Though the year-to-date tally of failed banks is, as of Friday night, now up to 133, the much-anticipated wave of FDIC litigation against the directors and officers of the failed institutions has been slower to emerge. As I recently noted, however, the signs are that the FDIC is now starting to assert itself. Along those lines, a demand letter from the FDIC to the former directors and officers of BankUnited FSB, filed in the bankruptcy proceedings of BankUnited’s corporate parent company, shows that the FDIC is prepared to assert claims and demonstrates what those claims will look like.

 

On May 21, 2009, in a rare Thursday night action, the FDIC took over BankUnited, about which refer here. At the time of its closure, BankUnited has assets of over $12 billion, but as a result of the loss share arrangement the FDIC reached with the investors that purchased BankUnited’s assets, the FDIC estimated that the bank’s failure would cost the FDIC $4.9 billion.

 

On May 22, 2009, BankUnited’s parent company, BankUnited Financial Corporation, and related entities filed a petition for bankruptcy in the bankruptcy court for the Southern District of Florida.

 

According to court filings in the bankruptcy proceedings, BankUnited carried $50 million in directors’ and officers’ liability insurance, arranged in four layers. The program’s extended reporting period had a November 10, 2009 expiration date.

 

On November 24, 2009, the FDIC filed a motion with the bankruptcy court regarding the FDIC’s rights to assert claims against the BankUnited’s former directors and officers. A copy of the motion can be found here. In essence, the FDIC’s motion sought to establish the FDIC’s right to assert its claims in priority over the claims against the bank’s former directors and offices that committee on unsecured creditors and others sought to assert.

 

As part of its motion, the FDIC attached a copy of a November 5, 2009 letter that the FDIC, as BankUnited’s receiver, had sent to fifteen former directors and officers of the bank, in which the FDIC presented its "demand for civil damages arising out of losses suffered as a result of wrongful acts and omissions committed by the named Directors and Officers." The letter explains that the demand for civil damages is "based on the breach of duty, failure to supervise, negligence, and/or gross negligence of the named Directors and Officers."

 

Though the letter is nominally addressed to the fifteen individuals, copies of the letters also were sent directly to the bank’s primary and first level excess D&O insurers. The FDIC’s motion papers explain, in footnote 4, that the FDIC sent the letter to the bank’s primary and first level excess D&O insurers, but not to the second and third level excess D&O insurers, because the second and third level excess insurer’s policies "contain a regulatory exclusion."

 

In its November 5 letter, the FDIC states that its demand is based on damages "arising out of losses suffered due to wrongful acts committed in connection with the origination and administration of unsafe and unsound residential real estate loans." The letter cites in particular the individuals’ alleged wrongful acts in connection with "pursuing an overly aggressive grown strategy focused primarily on the controversial Payment Option ARM product (the ‘Option ARM’)." The letter asserts that by the end of 2007, Option ARM mortgages represented 70% of the bank’s residential loan portfolio and 60% of its total loan portfolio, and by 2008 represented 575% of the bank’s capital.

 

The letter asserts that individuals failed "to implement adequate credit administration and risk management controls failed to heed warnings and/or recommendations of bank supervisory authorities and bank consultants." The letter also states that the "inherent risk" of Option ARM loans was "coupled with deficiencies in the Bank’s underwriting, appraisal process and credit administration."

 

As the FDIC summarized in its November 24, 2009 motion, the letter asserts that the bank’s directors and officers:

 

(i) adopted an overly aggressive and reckless growth strategy by investing most of the Bank's assets in "Option ARM" lending products;

(ii) failed to provide the Bank with adequate reserves for potential loan losses resulting from its investments in Option ARM lending products;

(iii) engaged in reckless, high-risk, and limited scrutiny lending;

(iv) failed to oversee the Bank's affairs, including the failure to monitor the rising volume of loan delinquencies and to establish lending policies that would adequately protect the Bank; and

(v) failed to provide adequate personnel and administrative capacity to appropriately monitor loan appraisals and to carry out diligent underwriting reviews.

 

Among the FDIC’s more colorful allegations, the letter accuses the directors and offices of "encouraging an extremely liberal and aggressive lending mentality to 'make the loan as long as the borrower has a pulse.'" The letter also accuses the individuals of "engaging in reckless, high-risk, and limited-scrutiny lending to fuel the bank's aggressive and rapid growth — in direct contradiction to public representations of the bank's conservative lending and strict underwriting policies."

 

In addition, the letter accuses the individuals of "approving and putting in place a compensation structure that drove the bank's directors and officers to pursue recklessly risky lending and business practices."

 

The letter asserts that these "breaches of their fiduciary duties" caused the bank to suffer loan losses between January 1, 2006 and May 21, 2009 of over $227 million. In addition to these losses, the FDIC recognized a $4 billion loss to pay off liabilities the Bank used to fund its lending activities. The FDIC’s letter concludes with the note that its investigation is continuing and that it will supplement its demand as appropriate as its investigation progresses.

 

The FDIC’s demand letter demonstrates not only its willingness and intent to assert claims against the former officials of failed lending institutions, but also show that it is highly aware of the D&O insurance requirements relating to those claims. The timing of the FDIC’s November 5 demand letter (sent just prior to the insurance program’s expiration), coupled with the fact that no demand was sent to the excess carriers whose policies contain regulatory exclusions, shows that the FDIC claims approach is keyed to the failed financial institutions’ D&O insurance program.

 

So the signs are that the claims against the directors and officers of failed banks are coming, and that one of the principal purposes of the exercise is to try extract recoveries from the banks’ D&O insurance policies. Seems just like old times…

 

A December 11, 2009 Palm Beach Post article about the FDIC’s demand letter can be found here. Special thanks to a loyal reader for providing a copy of the Palm Beach Post article.

 

More Troubled Bank Litigation: In yet another sign that litigation involving troubled banks could be an increasingly important part of D&O claims activity in the weeks and months ahead, on December 11, 2009, plaintiffs filed a purported securities class action lawsuit in the Eastern District of Washington against Sterling Financial Corporation and two of its officers.

 

As reflected in the plaintiffs’ lawyers’ December 11 press release, the complaint, which can be found here, alleges that the defendants failed "to disclose the extent of seriously delinquent commercial real estate loans and construction and land loans" and that the defendants "failed to adequately and timely record losses for its impaired loans, causing its financial results and its Tier 1 capital ratio to be materially false."

 

According to the press release, the complaint further alleges that:

 

(a) defendants’ assets contained hundreds of millions of dollars worth of impaired and risky securities, many of which were backed by real estate that was rapidly dropping in value and for which Sterling had failed to record adequate loan loss reserves; (b) defendants failed to properly account for Sterling’s commercial real estate loans and construction and land development loans, failing to reflect impairment in the loans; (c) Sterling had not adequately reserved for loan losses such that its financial statements were presented in violation of Generally Accepted Accounting Principles ("GAAP"); (d) Sterling had not adequately accounted for its goodwill or its deferred tax assets such that its financial statements were presented in violation of GAAP; (e) Sterling had not adequately reserved for loan losses such that its Tier 1 capital was presented in violation of banking regulations; and (f) the Company’s capital base was not adequate enough to withstand the significant deterioration in the real estate markets and, as a result, Sterling would be forced to consent to a cease and desist order from the Federal Deposit Insurance Corporation directing it to raise $300 million in capital.

 

What makes the FDIC’s demand letter to the BankUnited officials and the shareholders’ complaint against Sterling Financial noteworthy is not that the banking activities to which the allegations relate are unique; to the contrary, it seems particularly important to note that during the period of the these banks’ alleged misconduct, many other banks were involved in the same or similar banking activities. This fact together with the growing number of failed banks and the significant additional numbers of troubled banks suggests that in the weeks and months ahead there could be many more demands and lawsuits along the lines of the ones described above.

 

I don’t think I am going out on a limb to say that litigation involving failed and troubled banks could be one of the most important litigation trends in 2010.

 

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With 124 failed banks so far in 2009, and more likely to come in the weeks and months ahead, one recurring question has been whether the FDIC will be as aggressive in pursuing claims against directors and officers of failed lenders as it was during the S&L crisis. While we are awaiting the arrival of the seemingly inevitable regulator lawsuits, it is worth reviewing what the FDIC’s receivership litigation rights look like.

 

A recent decision out of the Northern District of Georgia arising from the 2008 failure of Integrity Bank and citing the body of case law the FDIC developed during the last failed bank era examines the FDIC’s litigation rights and also strongly reinforces the impression that the FDIC has D&O claims on its agenda.

 

Background

Integrity Bancshares is the parent holding company of Integrity Bank of Alpharetta, Georgia. On August 29, 2008, Georgia banking regulators closed Integrity Bank and the FDIC was appointed as receiver. On October 13, 2008, the holding company filed for Chapter 7 bankruptcy.

 

In February 2009, the bankruptcy trustee filed a damages action against four individual directors and officers for breach of fiduciary duties and negligence. Though some of the individual defendants were directors and officers of both the holding company and of the bank, the trustee’s claims are based solely on the individual defendants’ capacities as officers of the holding company and the bank. The trustee also filed an action against the bank’s D&O insurer seeking a judicial declaration of coverage for the damages action.

 

The trustee’s damages action alleges that the individual defendants harmed the now-bankrupt holding company and imperiled the capital that the holding company raised for and provided to the bank, by negligently managing the bank’s operations. Among other things, the trustee alleges that the bank’s lending practices, for which the individual defendants were responsible, were deeply flawed and were characterized by loans to speculative developments made at substantial variance to the bank’s putative lending requirements.

 

The FDIC intervened in the trustee’s damages action to assert that the trustee lacks standing to bring the damages claims, because the essentially derivative claims the trustee has brought belong to the FDIC as receiver of Integrity Bank. The individual defendants and their D&O insurer also moved to dismiss the declaratory judgment action based on the absence of an actual case or controversy.

 

The Court’s Opinion

In a November 30, 2009 opinion (here), Judge Richard W. Story granted the FDIC’s motion to dismiss, holding that under the Financial Institution Reform, Recovery and Enforcement Act of 1989 (FIRREA) all derivative claims against the officers and directors of Integrity Bank belong to the FDIC.

 

Judge Story observed that to have standing, the trustee would have to allege that the defendants caused direct and unique harm to the bankrupt holding company. But, Judge Story found, all of the alleged misconduct took place at the bank level. The allegations relate "only to actions taken in the Defendants’ roles as Bank officers." The harm to the holding company alleged is in its capacity "as a shareholder to the Bank," and the alleged harm is "secondary and predicated upon injury to the Bank."

 

Judge Story found that

 

Once the FDIC-R became the receiver of the Bank, the Debtor [i.e, the bank’s parent holding company] no longer had the ability to bring derivative claims against the officers of the Bank, because the FDIC-R succeeded to those claims. The fact that the Debtor subsequently declared bankruptcy did not create in the Trustee any standing that the Debtor did not already possess. Therefore, the Trustee does not have standing to bring the derivative claims alleged in the Damages Complaint.

 

Judge Story also found that though the complaint stated that the Trustee alleged "direct and unique harm," these allegations represent mere conclusory allegations insufficient to satisfy threshold pleading requirements under Iqbal.

 

Finally, Judge Story granted the motion to dismiss the declaratory judgment action as moot, essentially ruling that the court cannot rule on coverage issues until the underlying claims have been addressed.

 

Discussion

I literally have not had occasion to write or type the acronym "FIRREA" for over 15 years. Reading Judge Story’s opinion really is like déjà vu all over again. All of the key cases Judge Story cites are over 15 years old. This all has an uncannily familiar feel.

 

But there’s no nostalgia here.

 

No one should miss the obvious implication from the FDIC’s intervention in the Integrity case that if anybody is going to sue the directors and officers, it is going to be the FDIC. The FDIC’s assertion of its successor rights to derivative claims is not a mere academic exercise. The FDIC’s intervention looks like a blocking tactic calculated to preserve its ability to pursue its own claims as receiver.

 

All of this makes me feel like Harry Potter revealing the awful truth to his fellow students at Hogwarts – Voldemort is back, after a 14 year absence. (We still bear the scars from our last encounter, which quite nearly killed us, too.)

 

So it may be time to retrieve all those old files out of storage, because it looks like its dead bank litigation time again. Indeed, with the return of the regulatory exclusion on many financial institutions D&O policies, this may well and truly be déjà vu all over again.

 

To end where I began, with 124 failed banks this year, I think it is only a matter of time before we see the FDIC pursuing many claims against the directors and officers of failed financial institutions. As the Integrity Bank case makes clear, the FDIC as receiver has rights under FIRREA to pursue derivative claims against the Ds and Os of the failed banks.

 

Strap on your helmets.

Very special thanks to Henry Turner of the Turner Law Offices for providing me with a copy of Judge Story’s opinion.

 

More About Iqbal: Judge Story's reference to Iqbal reminds me to advise readers that the Senate Judiciary Committee held a hearing today on Senator Specter's bill to set aside Iqbal. The Witness Testimony and Members' Statements can be found on the Committee's Hearings page, here. The Blog of the Legal Times has a short summary of the hearings, here. The short version is that the Democrat members ot the Committee think Iqbal is bad.

 

Those readers interested in the intellectual debate over the merits of Iqbal will want to refer to the Drug and Device Law blog, where the authors have agreed to engage in a point/counterpoint on the Iqbal decision with Univesity of Pennsylvania Law Professor Stephen Burbank. The first volley in the exchage can be found here.

 

Vanity Fair on Goldman: If you have not yet seen it, you will want to take a look at the article about Goldman Sachs by Bethany McLean in the January 2010 issue of Vanity Fair, entitled "The Bank Job" (here). The article reviews Goldman's perspective on the its role in the global financial crisis and its aftermath. It also does a good job capturing the widespread outrage regarding Goldman's compensation, as well as the conspiracy theories about Goldman's various connections to official Washington. Basic theme: storied but aggressive bunch of capitalists has managed to draw a huge target on its own back.

 

Bethany McLean is an old hand at reporting on arrogant corporations, having co-authored Enron: The Smartest Guys in the Room.

 

Speakers' Corner: On Thursday December 3, 2009, I will be presenting at Skadden's Annual Securities Litigation and Enforcement Seminar.

 

 

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The FDIC’s latest Quarterly Banking Profile (here) shows that as of September 30, 2009, the country’s commercial banks are continuing to struggle, and that as a result of the banks’ woes the FDIC’s Deposit Insurance Fund (DIF) is $8.2 billion in the red. The rising numbers of "problem" institutions suggests both that the number of failed banks could continue to grow and that the DIF could remain under pressure – although as discussed below, the DIF situation may not be quite as dire as the headline details might otherwise suggest.

 

The FDIC report states that the number of banks on the FDIC’s "problem" institution list rose during the third quarter to 552 from 416 at the end of 2Q09, and that the total assets of "problem" institutions increased from $299.8 billion to $345.9 billion. If assets at "problem" institutions of a third of a trillion dollars sound bad, that’s because it is. The FDIC reports that both the numbers and assets of "problem" institutions are "now at the highest level since the end of 1993."

 

The FDIC defines "problem" institutions as "those with financial, operational or managerial weaknesses that threaten their continued financial viability." To be classified as a "problem," an institution would have to be ranked as either a "4" or a "5" on the FDIC’s "scale of 1 to 5 in ascending order of supervisory concern." The FDIC does not provide the names of the "problem" institutions, nor does it specify how many of them are rated "4" and how many are rated "5."

 

To put the number (552) and assets ($345.9 billion) of the third quarter-end "problem" institutions into some perspective, there were "only" 171 "problem" institutions as of the end of 3Q08. In twelve months, the number of "problem" institutions more than tripled, and the assets at "problem" institutions more than doubled.

 

Along with the growing numbers of "problem" institutions have come an escalating number of bank failures. During the third quarter of 2009, "fifty insured institutions with combined assets of $68.8 billion failed," which represents "the largest number [of bank failures] since the second quarter of 1990 when 65 insured institutions failed." As of the September 30, 2009, 95 banks had failed, and as of November 20, 2009, the 2009 YTD total number of bank failures stood at 124.

 

This wave of bank failures has taken its toll on the Deposit Insurance Fund (DIF). During the third quarter, the DIF decreased by $18.6 billion, to negative $8.2 billion, "primarily because of $21.7 billion in additional provision for bank failures."

 

Although these DIF figures sound disastrous, there is more to the story than just the reported negative figure. The FDIC’s November 24, 2009 press release accompanying the report (here) explains that the negative balance reflects a $38.9 billion "contingent loss reserve that has been set aside to cover estimated losses over the next year." In addition, the DIF balance is not the same as the FDIC’s cash resources, which stood at $23.2 billion as of the end of the third quarter.

 

To further bolster the FDIC’s cash position, on November 12, 2009, the FDIC’s board voted to required insured institutions to prepay three years’ of deposit insurance premiums – worth about $45 billion – at the end of 2009. The press release on the prepayment assessment can be found here.

 

With the increase in the number of "problem" institutions and the obvious relationship between rising numbers of "problems and the likely number of future bank failures, signs are that we could continue to see significant numbers of bank failures as we head into 2010. While I still don’t think we are going to see 1,000 failed banks by the end of 2010, we are clearly going to be seeing a lot more failed banks.

 

As bad as all of this is, the Quarterly Banking Profile hints at the possibility that all of the bad news might not even be out in the open yet. Among any other details, the Quarterly Banking Profile also reports that "growth in [loan loss] reserved continued to lag the rise in noncurrent loans, and the industry’s ratio of reserves to noncurrent loans declined for a 14^th quarter, from 63.6 percent to 60 percent."

 

In terms of what all of this means for the economy, perhaps the most significant detail in the document is its report that "loan balances declined by the largest percentage since quarterly reporting began in 1984." The FDIC’s press release quotes FDIC Chairman Sheila Bair as saying that "there is no question that credit availability is an important issue for economic recovery. We need to see banks making more loans to their business customers."

 

Europeans Worried About Proposed U.S. Investor Protection Law: According to a November 23, 2009 Financial Times article (here), the European Commission is worried about legislation currently before Congress that would specify the circumstances under which investors could sue foreign domiciled companies in U.S. courts.

 

As I discussed in a prior post (here), Section 215 the Investor Protection Act of 2009 is addressed to "Extraterritorial Jurisdiction" which would amend the ’33 Act, the ’34 Act and the Investment Advisors Act of 1940 to specify that U.S. courts could properly exercise jurisdiction in any action involving "conduct with the United States that constitutes significant steps in furtherance of violation, even if the securities transaction occurs outside the United States and involves only foreign investors," as well "conduct outside the United States that has a foreseeable substantial effect in the United States."

 

Under the first of these two prongs, U.S. based conduct alone would be sufficient jurisdictional basis, even with respect to foreign purchasers of who purchased their shares of foreign-domiciled companies on foreign exchanges (so-called "f-cubed claimants").

 

The article quotes the former director of litigation for Bank of America as saying that "if this legislation passes, there will be greater opportunity for foreign companies to be hauled into U.S. courts." The article also reports that Charlie McCreevy, the European Union Commission for Internal Markets as having "expressed concern over the measure."

 

All-Time Worst E-Mail Faux Pas?: The title of the Clusterstock’s post (here) pretty much says it all: "Cornell Business School Employees Accidentally Email Everyone with Their Dirty Email Love Notes." Clusterstock observes that the "this might set some kind of record for the worst email mistake anyone has ever made."

 

Due to the family-oriented nature of this blog, The D&O Diary will not reproduce any examples of the couple’s inadvertently forwarded emails.

 

The good news is that the two employees involved are married. The bad news is that they are not married to each other.

 

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The onslaught of bank closures continues. The FDIC’s closure of five more banks this past Friday night brings the 2009 YTD total number of bank failures to 120 – including twenty-one in just the last three weeks alone. There are a variety of reasons for the growing number of bank failures, but clearly one important reason is the continuing deterioration of commercial real estate loans.

 

As I noted in a prior post (here), there may be further bank failures ahead as commercial real estate mortgages come due or default. A November 5, 2009 BusinessWeek article entitled "The Commercial Loan Nightmare Facing U.S. Banks" (here) suggests that banks’ commercial real estate loan problems may be worse even than may be currently apparent.

 

According to the article, "many banks have been forestalling the day of reckoning" by using an approach the article described as "extend and pretend," which consists of allowing "temporary extensions to trouble borrowers on maturing commercial loans to give them, and the bank, some breathing room."

 

The problem for the banks is that "surging delinquencies and defaults will eventually catch up with them." Many banks are currently showing no charge-offs, but as much as $500 billion in commercial real estate loans will mature within in coming months, while commercial real estate values have declined as much as 40 percent since the beginning of 2007. As these issues catch up with the banks, according to the article, more banks could fail.

 

The article includes a list of the 30 publicly traded banks that may have the most exposure to commercial real estate. The 30 banks have more than 50 percent of their loan portfolios in commercial real estate loans. To be sure, the banks’ heavy concentration in real estate loans is not the same as being burdened with bad loans, but it does mean that the listed banks "have more exposure to the commercial real estate sector."

 

Among the bank closed this past Friday night was the California-based United Commercial Bank, as reflected in this November 6, 2009 FDIC Press Release (here). The bank's parent holding company, UCBH, and certain of its directors and officers, were already the subject of a securities class action lawsuit, as I discussed in a prior post, here. The UCBH lawsuit and the failure of the bank operating company may represent examples of the ways in which the growing numbers of troubled banks could lead to an increased amount of litigation arising from the banks' woes.

 

Another Subprime Securities Suit Dismissal: In an October 6, 2009 order (here), District of Massachusetts Judge Nathaniel Gorton granted the defendants’ motion to dismiss the complaint that had been filed against the commercial construction firm, Perini Corporation and certain of its directors and officers. Judge Gorton’s dismissal ruling granted the plaintiffs leave to amend, but he warned that if the amended complaint is deficient, "dismissal will be with prejudice."

 

As reflected here, the plaintiffs had alleged that Perini had failed to disclose that the developer on a major Las Vegas construction project was experiencing financial difficulties, including difficulties in obtaining project financing for the Las Vegas project. The complaint further alleged that as a result of these difficulties the Las Vegas project faced possible delays and that the developer faced a risk of default. The complaint further alleged that the Las Vegas project represented as much as 20% of the Perini company’s construction backlog and that as a result of the difficulties the company’s ability to maintain its profit margins was in doubt.

 

As Judge Gorton later summarized, the "crux" of the plaintiffs’ complaint is that the company knew about the developer’s financial troubles, "which rendered statement that, in essence, all was well at Perini, false and misleading."

 

In his October 6 ruling, Judge Gorton found that the plaintiffs had failed to adequately allege scienter. He said that even assuming the defendants were aware of the developer’s financial difficulties "the complaint fails to attribute the requisite high level of culpability to them. To the contrary, the complaint sets forth facts showing that the defendants were actively and ultimately successfully, working to ensure that any difficulties of [the developer] did not impact Perini."

 

The court found that the non-fraudulent inferences from the defendants’ conduct and statements to be "more compelling that any inferences of culpable scienter." Moreover, Judge Gorton found further that the plaintiffs had failed to "plead adequately that the defendants were even ‘aware of’ [the developer’s] financing difficulties in the first instance."

 

Finally, Judge Gorton found that even if the plaintiffs had adequately alleged scienter, the allegedly fraudulent statements do not provide a basis of liability. He found that most of the statements came within the safe harbor for forward looking statements and that the few remaining statements that were not forward looking were not otherwise actionable

 

I have added the Perini decision to my running tally of subprime and credit crisis-related dismissal motion resolutions. The tally can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing copies of the Perini ruling.

 

Another FCPA-Related Civil Lawsuit Settlement: Regular readers know I have written frequently about civil litigation that can follow in the wake of Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions. (Refer for example here.) In the latest resolution of this kind of follow on civil action, on November 6, 2009, Nature’s Sunshine Products announced (here) that the court had preliminarily approved the settlement of the lawsuit in which the company had agreed to pay $6 million.

 

As reflected here, the plaintiffs in the securities lawsuit had alleged in connection with the improper payments that the company lacked appropriate internal controls and that the company’s books and records did not reflect the foreign transactions. As noted here, the court had denied the defendants’ motions to dismiss.

 

The company’s FCPA-related problems received additional attention earlier this year when (as noted here), the SEC brought control person liability charges against the company’s CEO and CFO, even though the individuals were not alleged to have had any involvement in or even awareness of the company’s allegedly improper payments.

 

The company’s $6 million securities class action settlement is just the latest in a line of settlements in securities cases following in the wake of FCPA-related investigations and enforcement actions. My prior overview of FCPA-related follow-on civil litigation can be found here.

 

The Financial Crisis and D&O Insurance: A wide variety of litigation has arisen out of the global financial crisis, much of which has implicated the D&O insurance of the defendant companies. The involvement of the companies’ D&O coverage in turn has underscored the importance of the applicable policies’ coverage and in particular the sufficiency of the policies’ terms and conditions.

 

A recent memo entitled "Directors’ and Officers’ Coverage Priorities in the Financial Crisis: A Seven-Point Inspection for Your D&O Policy" (here) by Ernest Martin Jr. and Micah Skidmore of the Haynes and Boone law firm presents a comprehensive overview of the critical D&O insurance issues arising from the current financial crisis. The article is thorough and timely.

 

Apologies: Due to a massive spambot attack directed at the "Comment" function of blog sites hosted by the LexBlog network (on which The D&O Diary is hosted), there have been a variety of service and performance disruptions on this site over the last several days. Among other things, the comment function has been disabled and the email notification system was interrupted. I have also had intermittent difficulties just adding new content.

 

I apologize to readers for any difficulties you may have had accessing this site, posting comments, or receiving email notifications. I am hopeful that the problems are now or will soon be completely resolved.

 

My special thanks to everyone at LexBlog for the courteous and attentive service while managing this crisis.

 

This Week: The D&O Diary’s publication schedule during the week of November 9 will be disrupted because I will be in Chicago for the annual PLUS International Conference. I know many readers will also be there and I hope readers who see me there will be sure to say hello and, if we have not met before, to introduce themselves. I look forward to seeing everyone in Chicago.

 

Upcoming Conference: On November 30-December 1, 2009, I will be co-Chairing the American Conference Institute’s Fifteenth Annual Advanced Forum on D&O Liability in New York. This event will include presentations from the leading figures in the D&O insurance field, and the program will address the most critical issues facing the D&O insurance industry today. The program agenda, including registration information, can be found here.

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In what is the largest number of banks closed on a single day in years, this past Friday night the FDIC seized nine related lending institutions. The nine banks, based in California, Illinois, Texas and Arizona, had been owned by FBOP Corp., a privately held Illinois-based bank holding company. U.S. Bancorp agreed to assume all of the combined banks assets of $19.4 billion and deposits of $15.4 billion.

 

The latest round of closures brings the 2009 YTD total number of bank closures to 115, already the highest annual total since 1992, when 181 lending institutions failed during the S&L crisis. 31 banks failed just in September and October 2009 alone, more than the 25 banks that failed during all of 2008. Indeed, the FDIC has closed 16 banks just in the last two weeks. The FDIC’s complete list of failed banks can be found here.

 

Though certain states have seen higher numbers of bank failures this year, the current banking woes are not contained to just one state or region. The failed banks are quite dispersed geographically. 31 different states have had at least one bank closed this year. The states with the highest numbers of bank failures are Illinois (20), Georgia (19), California (13), Texas (5) and Minnesota (5). The Wall Street Journal has a nifty interactive map of the U.S. showing the location of the bank failures, with scaled markers indicated the relative size of each failed bank.

 

One of the banks closed this past Friday night was California National Bank. With assets of $7.8 billion and $6.2 billion in deposits, CNB is the fourth largest bank to fail this year, according to the Los Angeles Times (here).

 

The FBOP banks had their share of troubled loans, but the collapse of FBOP’s banks was, according to the Chicago Tribune (here), the result of "an abrupt reversal of fortune last year when the government takeover of Fannie Mae and Freddie Mac exposed the holding company’s large concentration of Fannie and Freddie preferred stock." According to the Los Angeles Times article linked above, the holding company had owned $855 million in preferred Fannie and Freddie shares that became worthless when the government placed the companies in receivership in September 2008.

 

U.S. Bankcorp’s acquisition of the nine banks’ deposits and assets seems to be a pretty sweet deal. U.S. Bancorp acquired the assets under a loan-sharing plan with the FDIC, which will absorb 80% of the first $3.5 billion in losses and 95 percent of any additional losses.

 

The swelling numbers of failed banks is certainly worrisome, particularly as the pace of bank closures seems to have quickened recently. This year’s aggregate numbers are starting to rival those for the later years of the S&L crisis.

 

There are, however, important differences between the current circumstances and the earlier era. The first is the geographic dispersion of the bank failures. During the S&L crisis, many of the failed institutions initially were concentrated in the southeastern part of the country, although as the bank crisis evolved, the bank closures moved up the coast to the northeastern states. By and large, the rest of the country experienced relatively few bank failures.

 

Another significant difference is the cause of many of the current bank failures. During the S&L crisis, bad loans caused most of the bank failures. Bad loans are clearly a significant factor in many of the current closures as well. But a significant contributing cause of many of the current closures is the presence of troubled assets in the failed banks’ investment portfolios. FBOP’s problems from its soured investments in Fannie and Freddie represent one example where troubled investment assets triggered a bank closure. Similarly, as discussed at length here and here, some banks that have failed this year were weighed down by their investment in other banks’ trust preferred securities.

 

Another difference is that this time around – at least so far – there does not seem to have been the same surge of FDIC-led failed bank litigation. Of course, it remains to be seen whether the FDIC will once again unleash a wave lawsuits against the former directors and officers of the failed institutions. There has been a certain amount of investor driven involving banks that have failed (refer for example here), but so far at least the FDIC has not been prominently pursuing litigation.

 

The one thing that seems for certain is that, particularly in light of the recent acceleration of the pace of bank closures, the number of failed banks seems likely to grow as this year ends and we head into next year.

 

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This past Friday night, San Joaquin Bank of Bakersfield, California became the 99^th bank the FDIC closed this year (refer here) The growing wave of bank failures has been a troubling story all year, and one that unquestionably will get worse before it gets better. But now that the 100^th bank failure of the year is approaching, the mainstream media have noticed and have taken up the story.

 

The approaching bank failure century mark certainly is noteworthy, but not all of the reporting is appropriately balanced. Some of the media reports have gotten a little overexcited about the whole thing.

 

Among the recent news reports observing the approaching 100^th bank failure of the year are the October 11, 2009 New York Times article entitled "Failures of Small Banks Grow, Straining FDIC" (here) and Time Magazine’s article, in its October 26^th issue, entitle "Spotlight: Bank Failures" (here). The Cleveland Plain Dealer’s lead article on Sunday October 18, 2009 was devoted to the topic, as well as to the threat that local banks face from souring commercial real estate loans.

 

The growing number of failed banks is unquestionably an important story and one that rightly deserves the media attention it is getting. But apparently not content with the presently available facts, some media sources have felt compelled to try and sensationalize the story.

 

Both the Time Magazine and New York Times article linked above repeat the alarmist (and as I detailed here, arguably suspect) forecast that as many as 1,000 banks – approximately one eighth of all the banks in the country – will fail by the end of next year. The Time Magazine article goes even further by reciting without question or comment an unsubstantiated projection that "soured commercial real estate loans may generate a fresh $600 billion of losses by 2013."

 

Not only is this projection out of proportion to other published commercial real estate loan loss projections – the highest number generally circulating is $100 billion – but it is self-evidently questionable. The total amount of commercial real estate and construction loans held by banks is $1.8 trillion (a figure recited, among other places, in the Times article linked above). How likely is it that one third of all of these loans will become total losses by the end of 2013? To put this question into context, the current commercial loan default rate that has everyone so alarmed is 3.8%.

 

In the current economy, we have more than enough real challenges to deal with without the media conjuring up projections to try to make things seem even scarier than they already are.

 

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As the number of failed and troubled banks has surged, one recurring question has been whether the banks woes would lead to a new round of banking-related litigation. While a few lawsuits had emerged in connection with earlier bank failures (refer here), there really has been nowhere near the number of suits as might be expected from the number of trouble banks – until now, perhaps. The arrival of a couple of bank loan loss reserve lawsuits this past week, as well as other banking-related developments, raises the question whether the conjectured round of bank related lawsuits may now have begun.

 

First, on September 8, 2009, plaintiffs filed a securities class action lawsuit in the Central District of California against Pacific Capital Bancorp and certain of its directors and officers, as well as a stock analyst that follows the bank’s stock. According to the plaintiff’s counsel’s September 8, 2009 press release (here), the complaint alleges that the defendants misled investors by representing that:

 

that the Company was maintaining a strong allowance for loan losses which would enable it to absorb losses in its portfolio. As alleged in the complaint, defendants’ misstatements and omissions relating to Pacific Capital’s loan loss provision caused the Company’s common stock to trade at artificially inflated levels between April 30, 2009, when the Company reported that it maintained its loan loss provision at a very high level, through July 30, 2009, when the Company admitted that it had not adequately reserved for loan losses, had not applied a conservative reserve methodology, and needed to record an additional loan loss provision of $117 million. The "buy" rating issued by the analyst defendants on the Company’s common stock also contributed, as alleged, at certain times during the Class Period to the artificial inflation in the price of Pacific Capital stock.

 

Second, on September 11, 2009, plaintiffs filed a securities class action lawsuit in the Northern District of California against UCBH Holding and certain of its directors and officers. (UCBH Holding is a bank holding company for United Commercial Bank, a California-state chartered bank with its headquarters in San Francisco, refer here.) According to the plaintiffs’ lawyers’ September 11, 2009 press release (here), the complaint alleges:

 

UCBH knowingly falsified its financial statements by concealing the rising level of loan losses and non-performing loans through a series of improper accounting tricks and outright deception of regulators and auditors. On September 8, 2009, UCBH announced that its Chairman and CEO, Thomas Wu, and its Chief Credit Officer, Ebrahim Shabudin, were resigning following the results of an investigation of the improper loan accounting. As a result of the accounting improprieties, UCBH must restate its financial statements for each quarter and the full fiscal year of 2008. News of the accounting fraud and the pending restatement caused UCBH's stock price to fall significantly, damaging investors.

 

The complaint can be found here.

 

The final related development this past week took place on Friday night after the close of business, when the FDIC closed Corus Bank, N.A. about which refer here. (The FDIC actually closed three banks on Friday, refer here, bringing the 2009 year to date total number of bank failures to 92.) Though Corus only just now failed, the bank’s holding company and certain of its directors and officers had already been sued earlier this year (refer here) in a securities class action lawsuits in the Northern District of Illinois alleging that:

 

(i) that Corus was failing to recognize losses on its condominium loans in accordance with generally accepted accounting principles ("GAAP"); (ii) that Corus and/or its affiliates was purchasing condominiums in developments Corus had financed in an attempt to: (a) inflate the appraised values of condominiums to delay having to recognize losses on financing for such condominiums; (b) inflate developers’ sales figures to increase the likelihood of successful future sales; and (c) create the illusion of successful sales histories in order to inflate appraisal values for the condominiums to ensure inflated future prices for the condominiums; and (iii) that Corus was involved in detailed and in-depth negotiations with the Federal Reserve Bank of Chicago and the Office of the Comptroller of Currency regarding its deteriorating pool of condominium loans.

 

The arrival of the new lawsuits and the development involving Corus all in this past week may well have been coincidental. It remains to be seen whether there will in fact be a significant number of additional lawsuits involving failed or troubled banks.

 

That said, there is definitely a familiar tone to these recent cases. The allegations regarding the various banks’ alleged loan loss reserve deficiencies and alleged failure to recognize failing loans will be quite familiar to anyone who was involving in any way in the wave of failed bank litigation that accompanied the last round of failed banks during the S&L crisis. Though the future is uncertain, it is difficult no to speculate that we will see many more of these kinds of loan loss reserve inadequacy cases in the months ahead.

 

Of course, even if the cases do arrive in significant numbers, that does not necessarily mean that they will succeed. Some cases previously filed in connection with banks that failed in 2008 have already been dismissed. For example, the Fremont General lawsuit (refer here) and the Downey Financial lawsuit (refer here) have both been dismissed, and in Downey Financial’s case, the dismissal is with prejudice.

 

Nevertheless, the most recent filings seem to suggest that plaintiffs’ lawyers are not deterred by the prior dismissals. Given the depth of the current difficulties in the banking sector (about which refer here), there may yet be more, perhaps much more, banking-related litigation to come.

 

Citigroup Auction Rate Securities Lawsuit Dismissed: On September 11, 2009, Southern District of New York Judge Laura Taylor Swain dismissed the auction rate securities lawsuit that had been filed Citigroup. A copy of the September 11 opinion can be found here.

 

This action follows the earlier dismissals of the auction rate securities lawsuits that had been filed against UBS (refer here) and Northern Trust (refer here). However, this dismissal represents its own separate development, because unlike many of the other auction rate securities lawsuits, which were based on alleged misrepresentations in connection with the sale of the securities, the Citigroup auction rate securities lawsuit was based on a market manipulation theory.

 

As reflected in greater detail here, the plaintiff in the Citigroup auction rate securities lawsuit had alleged "defendants manipulated the market for Citigroup ARS by fostering the illusion that a valid market existed where buyers and sellers came together, with supply and demand in balance, allowing for the successful completion of auctions of Citigroup ARS. In fact, no such balance existed." The defendants moved to dismiss.

 

In her September 11 order granting the defendants’ motion to dismiss, Judge Swain held with respect to the plaintiff’s market manipulation claim under Section 10(b) of the ’34 Act that the plaintiffs had insufficiently alleged fraud; scienter; reliance; and loss causation. She also dismissed the plaintiffs’ claims under the Investment Advisers Act for lack of subject matter jurisdiction and the plaintiffs’ state law claims because they were preempted by SLUSA.

 

With respect to the plaintiffs’ market manipulation claim, she found the plaintiff’s fraud allegations insufficient because the complaint "does not include specific allegations as to which Defendants performed what manipulative acts at what times and with what effect" but instead that the complaint "relies on general and conclusory allegations regarding Defendants’ practices" regarding the ARS auctions. She concluded that "absent particularized allegations regarding Defendants’ alleged manipulative conduct, Plaintiff cannot state a claim for market manipulation."

 

With regard the plaintiff’s scienter allegations, Judge Swain found that the plaintiff has not sufficiently alleged motive and opportunity, holding that "Plaintiff’s conclusory allegations regarding Defendants’ motive for the alleged manipulation focus principally on Defendants’ desire to sell Citigroup ARS to offset subprime losses and to obtain fees for services in connection with the auctions." She found these allegations "too generalized to meet the scienter pleading requirement."

 

She also found that plaintiff had failed to allege particularize facts giving rise to a strong inference of scienter based on circumstantial evidence of conscious misbehavior or recklessness. She found that "the very market conditions – specifically the ‘subprime crisis’ – that Plaintiffs cites in his Complaint…give rise to an opposing and compelling inference that Defendants engaged only in bad (in hindsight) business judgments in connection with the ARS, and did not engage in the alleged conduct with an intent to deceive."

 

Judge Swain found further that the plaintiff had not adequately alleged reliance. In reaching this conclusion, Judge Swain specifically reference an SEC report that preceded the class period in which many of the practices of which the plaintiff complains regarding the ARS market auction process. These materials "disclosed that the ARS market was not necessarily set by the ‘natural interplay of supply and demand’" and therefore Plaintiff has not identified any basis on which the class reasonably could have relied on "the market ‘integrity’ assumption."

 

Finally, Judge Swain found that the market manipulation claim also fails because the plaintiff’s loss causation allegations are insufficient. In reaching this conclusion, she observed that "Plaintiff does not specifically allege that he tried to sell his ARS, nor does he allege that the interest rates set through Defendants’ manipulative conduct were lower than they would have been absent such conduct."

 

The dismissal granted in Judge Swain’s September 11 ruling is without prejudice; the plaintiff has until October 1, 2009 to file an amended complaint.

 

I have in any event added the Citigroup auction rate securities dismissal to my table of subprime and credit crisis-related lawsuit dismissal motion ruling, which can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing me with a copy of Judge Swain’s ruling.

 

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The FDIC’s August 27, 2009 announcement in its latest Quarterly Banking Profile (here) that during the second quarter of 2009 it had increased the number of financial institutions on its "Problem List" from 305 to 416 (a 36% increase) caused quite a stir. The Wall Street Journal’s lead article the next day referred to the FDIC’s "sick list" and other media sources also buzzed with the news.

 

And well they might. As I noted in the prior issue of InSights (here), the number of banks on the FDIC’s "Problem List" and the assets they represent have both grown rapidly. The 416 institutions on the list at the end of the second quarter of 2009, representing assets of $299.8 billion, contrasts dramatically with the end of the second quarter of 2008, when there were "only" 117 institutions on the list representing $78.3 billion in assets. This nearly 300 percent increase in the number of problem banks in just one year, along with the nearly 400 percent increase in the assets the problem banks represent, are both deeply troublesome developments.

 

The FDIC itself noted in its Quarterly Banking Profile that the current number of problem banks is the highest such count since June 30, 1994, and the assets they represent are at the highest level since December 31, 1993.

 

It is hardly surprising that these disturbing developments and the trends they represent have triggered some daunting projections about what the future may hold. Among the most alarmist, and the one that has garnered the most media attention, is the statement on CNBC by banking veteran and investor John Kanas that the number of failed banks could reach 1,000 by the end of next year. Other commentators have made other pessimistic albeit less dire projections (refer for example here.)

 

It may not be possible simply to write off the question whether 1,000 bank failures over the next year and a half is a possibility. Certainly, banks failed at a tremendous rate during the S&L crisis. During the dark days of 1989, banking regulators took control of 534 banking institutions. Overall, during the S&L crisis, over 1,000 financial institutions failed.

 

In addition, other details in the FDIC’s latest Quarterly Banking Profile certainly underscore the deteriorating conditions facing many banks. Among other things, the banks’ loan portfolios are weakening faster than the banks can set aside loss reserves. At the end of the second quarter, the industry’s ratio of reserves to bad loans stood at just 63.5%, its lowest level since 1991.

 

The data in the FDIC’s report also highlights how problems are spreading beyond just the real-estate sector where the problems in the current economic crisis first emerged. Credit card losses are increasing and the banks find themselves collectively holding billions of dollars worth repossessed real estate. Persistent high levels of unemployment raise the risk that even low-risk borrowers could fall behind or default on their loan payments. For further details about reasons why banks are failing now, refer to my recent post here.

 

Though we are still a very long way from 1,000 failed banks, the number of failed banks has continued to surge. With the addition of three more bank closures this past Friday night, the number of 2009 year to date bank failures now stands at 84. Since January 1, 2008, 109 banks in 29 states have failed. These bank failures have ranged from the smallest banks with assets under $15 million, to Washington Mutual's failure, which with assets of $307 billion was the largest bank falure in U.S history. The FDIC’s complete list of failed banks since October 2000 can be found here.

 

All of that said, it is still a very long way from 84 bank failures – in and of itself a significant number – to 1,000 bank failures by the end of 2010. This truly pessimistic prediction presumes that more than double the number of current problem banks will fail in the next 14 months. This despite the fact that while both the number of problem banks and the number of failed banks have climbed dramatically in the past year, the number of failed banks has remained well below the number of problems banks.

 

Because of the historical example of the S&L crisis, it is hard to say that 1,000 bank failures couldn’t happen. It happened before and it could happen again. However, in the range of possible outcomes, the likelihood of 1,000 bank failures has to rank among the remote possibilities. Among other things, the prediction of 1,000 bank failures seems to reckon without the possibility that eventually the effects of the economic recovery might start to alleviate the harsher trends of the economic downturn.

 

Unfortunately, the current trends do seem to suggest that things will continue to get worse before they get better. But one of the lessons we were all supposed to have learned from the events that preceded the credit crisis is the fallacy of projecting from current conditions and presuming current conditions will continue indefinitely into the future.

 

Just as it was a mistake in the late stages of the housing bubble to assume, for example, that housing prices would continue to rise indefinitely, so too it could be a mistake to presume that current adverse banking conditions will continue unabated into the future. Yes, circumstances are difficult and there undoubtedly will be further bank failures, perhaps many more bank failures. The possibility of as many as 1,000 bank failures seems remote and unlikely, even given current adverse and deteriorating conditions. Securities Analyst Meredith Whitney’s projection of 300 bank failures (refer here), although also arguably pessimistic, by comparison seems less radical.

 

Among other questions raised when discussing these issues on recent days is whether the rising tide of bank failures, no matter how large it ultimately proves to be, will lead to a wave of lawsuits against the former directors and officers of the failed institutions, as happened during and following the S&L crisis.

 

As I have noted previously, most recently here, there have been some lawsuits filed by shareholders of failed banks, who claim that their investment losses were the fault of the banks’ former directors and officers. There have also been a number of securities class action lawsuits filed by shareholders of publicly traded failed banks. Indeed, of the 25 banks that failed in 2008, six were sued in securities class action lawsuits, even though just eleven of the 25 were publicly traded.

 

These seems to have been less of this shareholder litigation in connection with the 2009 bank failures so far, perhaps in part due to the fact that fewer of the 2009 bank closures involve publicly traded financial institutions.

 

Prospective litigants are not likely to be encouraged by the recent developments in one of the 2008 securities class action lawsuits involving a failed bank. That is, on August 21, 2009, the court granted with prejudice the defendants’ renewed motion to dismiss the amended complaint plaintiffs had filed to try to cure the defects noted in the earlier dismissal motion rulings in the subprime-related securities class action lawsuit involving Downey Financial. A copy of the court’s ruling can be found here. This development underscores the pleading obstacles plaintiffs may face in trying to survive dismissal motions in any case involving a failed bank, particularly against the larger background of the global economic crisis and wave of bank failures.

 

One recurring question I am asked is whether the FDIC will, as it did during the S&L crisis, pursue liability claims against the former directors and officers of failed financial institutions. These kinds of lawsuits were a major part of the FDIC’s efforts to try to recoup its losses during the last banking crisis. There would seem to be every reason to expect the FDIC to attempt to do the same thing this time around as well.

 

However, at least so far, the FDIC does not seem to have actually filed these kinds of claims, at least as far as I am aware. I have been informed by reliable sources that the FDIC has presented written notices of potential claims in certain instances (perhaps in an effort to preserve a possible later recovery from D&O insurance policy proceeds before the policy’s lapse). However, so far, the FDIC does not seem to have actually pursued these claims.

 

One thing that seems certain is that if there really were to be as many as 1,000 failed banks, or any number remotely in that neighborhood, the latent prospect for litigation involving the former directors and officers of the failed banks would potentially be enormous.

 

Special thanks to the many readers who sent me links, comments and questions about the FDIC's latest Quarterly Banking Profile and related media developments.

 

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It might well be asked why anyone should bother reading both the Wall Street Journal and the New York Times business pages. After all, both usually cover the same stories. Indeed, on Friday, both ran stories discussing the fact that year-to-date bank failures are at the highest level since 1992.

 

However these same-day articles about the number of bank failures in fact were a great illustration of the value of reading both publications, because the two newspapers presented very different explanations for the run of failed banks, particularly with respect to the latest round of bank closures. Each article has its points, though, and both raise interesting questions.

 

First, the context for the two articles. With the addition of four bank closures this past Friday night, there have now been 81 bank failures this year, compared to 25 during all of 2008, and just three in 2007. Not since June 12 has there been a Friday without a bank closure (Friday being the FDIC’s preferred day to take control of banks.) The FDIC’s complete list of banks that have failed since October 2000 can be found here.

 

The addition of two more failed banks in Georgia among this Friday’s round of bank closures brings that state’s nation-leading year to date total number of failed banks to 18. Friday’s closures also included Austin, Texas-based Guaranty Bank, the tenth largest bank failure in U.S. history. For more about Guaranty’s closure, refer here.

 

Though this year’s round of bank failures includes behemoths like Guaranty, and Colonial Bank of Birmingham, Alabama which closed last Friday, the bank failures generally involve much smaller banks, many of them so-called community banks having assets of less than $1 billion. Of the 81 year-to-date bank failures, 68 of them have involved community banks.

 

Now – why are the banks failing? The Journal and the Times disagree on that point, particularly with respect to the most recent closures.

 

In an August 21, 2009 article written by Floyd Norris, the Times reported (here) that "banks are now losing money and going broke the old-fashioned way: They made loans that will never be repaid." The Times article notes further with respect to the bank failures that "it has become clear that most of them had nothing to do with the strange financial products that seemed to dominate the news when the big banks were nearing collapse and being bailed out by the government."

 

There were, Norris writes, "no C.D.O’s or S.I.V.’s or AAA-rated ‘super-senior tranches.’" He added that "certainly, there were not ‘C.D.O.’s-squared.’"

 

The WSJ sees things quite differently. In a front-page article (published the same day as the Times article) entitled "In New Phase of Crisis, Securities Sink Banks" (here), the Journal asserts that "the banking crisis is entering a new stage, as lenders succumb to large amounts of toxic loans and securities they bought from other banks." Guaranty’s woes and ultimate failure were, for example, due to its "investment portfolio, stuffed with deteriorating securities created from pools of mortgages originated by some of the nation’s worse lenders."

 

The Journal article notes that Guaranty "is one of the thousands of banks that invested in such securities, which were often highly rated but ultimately hinged on the health of the mortgage industry." The securities fell into two categories, those "carved out of loans originated by mortgage companies, packaged by Wall Street firms, and then sold to investors," and "trust preferred securities" which are hybrid securities banks issue through special purpose trusts and that have certain advantages for purposes of measuring regulatory capital (for further background regarding trust preferred securities and the problems they are causing banks, refer here).

 

Banks themselves issued trust preferred securities, which "Wall Street brokerage firms bought" and packaged into "so-called collateralized-debt obligations" for which "many of the buyers were small and regional banks." The outcome of what one commentator called "this wonderful chain of stupidity" is that the "consequences are cascading down on the banks that bought these securities." Indeed, trust preferred securities holdings "doomed six family-controlled Illinois banks that collapsed last month." (My post about these six banks’ failure can be found here.)

 

It hardly seems as if the two newspapers were discussing the same topic, with the Times saying the bank failures had nothing to do with these exotic investment securities, and the Journal directly pinning the blame for numerous recent bank failures on the banks’ investment in precisely these kinds of investment instruments. Certainly, the examples the Journal cites suggest that the structured investments has had a lot more to do with at least some of the most recent banks failures than the Times article implies.

 

But as different as the two articles’ analyses may appear, the articles do agree that the fundamental problem for banks is that too many loans are not performing. The Journal article specifically notes that "delinquency rates and losses are at all-time highs," and the investment portfolio problems are hitting banks "already weakened by losses on home mortgages, credit cards, commercial real-estate and other assets imperiled by the recession."

 

The one topic on which the two articles unquestionably agree is that the banks’ problems are likely to continue to get worse for some time to come. The Times article specifically notes that "the losses on current failures stem mostly from construction loans," but that commercial real estate could be "the next problem area." Commercial real estate loans typically must be refinanced every few years, and with rents down and vacancies up, "some owners are just walking away from their buildings."

 

Finally, an August 23, 2009 New York Times article entitled "What the Stress Tests Didn’t Predict" (here) confirms, based on a comprehensive review of over 7,000 banks (but excluding the 19 money center banks), that there was "more stress in the banking industry in the second quarter of 2009 than in the immediately preceding periods" and that "even the best run banks are having trouble escaping the impact of a sluggish economy and high unemployment."

 

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