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

Failed bank lawsuit this year area on pace to total the largest annual number of lawsuits yet during the current bank failure wave, according to an April 2013 report from Cornerstone Research entitled “Characteristics of FDIC Lawsuits Against Directors and Officers” (here). The report identifies several factors – including the FDIC’s recently published settlement data – that the authors believe that “together suggest that substantially more FDIC cases may be filed in upcoming months.”

 

The report notes that as of April 22, 2013, the FDIC has filed twelve lawsuits against former directors and officers of failed banks during 2013. (I am aware of at least two additional suits that have been filed since that time; refer here, second item for the most recent). That brings the total number of lawsuits that the FDIC has filed since 2012, as of that date, to 56. The authors project that at the current filing rate, 2013 filings could total as many as 39.

 

Given the three year lag that generally follows after a bank fails before the FDIC files suit, and given that the peak number bank failures took place between the third quarter of 2009 and the third quarter of 2010, “this year will likely be a peak period for new filings.”

 

Though lawsuits have continued to emerge this year, bank failures themselves have slowed considerably during 2013, with only eight for the year so far compared to 51 during all of 2012. Since the beginning of 2007, 476 banks have failed. The authors project that as many as 26 banks total could fail this year.

 

To date, 12 percent of bank failures have resulted in D&O lawsuits. The lawsuits generally have targeted larger institutions and those whose failures produced larger costs. To date the FDIC has filed lawsuits against 21 percent of the banks that failed in 2009 and against 10 percent of banks that failed in 2010.

 

As I noted in an earlier post, the FDIC recently began publishing on its website information regarding settlements the agency has reached in connection with bank failure claims and lawsuits. The authors of this report have done the hard work of going through all of the settlements that agency has posted on its website.

 

Among other things, the authors report that the FDIC has obtained aggregate settlements of $601 million -- $115 million attributable to filed D&O lawsuits; $216 million attributable to 33 claims involving directors and officers of failed banks that did not result in a complaint; and $270 million attributable to claims against professional firms and non-D&O individuals. As many as 17 of the settlement agreements required out-of-pocket payment by individual directors and officers. The out-of-pocket payments totaled $8 million.

 

The report is interesting and worth reading in full. The authors merit our gratitude for working through and summarizing the settlement information on the FDIC’s website. The report contains a number of interesting insights, such as, for example, the authors’ observation about the number of settlements in which directors and officers were required to make out-of-pocket contributions to the settlements.

 

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The fallout from the ongoing banking crisis continues to emerge, with the arrival in recent days of still more bank failures and of even more FDIC lawsuits involving failed banks. Unfortunately, the hopes that that all of the bank failures might be safely behind us, or, as I recently suggested on this blog, the hopes that we might be in a “lull” in the failing of failed bank lawsuits, have been dashed. As developments this past week show, banks continue to fail and the FDIC is continuing to actively pursue litigation against the directors and officers of failed banks – and even against the failed bank’s outside professionals.

 

With respect to the bank failures, the FDIC announced on its website this past Friday night the closure of three more banks, two in Florida and one in Kentucky. The two Florida banks are the Chipola Community Bank of Marianna, Florida and the Heritage Bank of Northern Florida of Orange Park, Florida. The Kentucky bank is the First Federal Bank of Lexington, Kentucky. Prior to the closure of these three banks on Friday, there had only been a total of five bank closures so far during all of 2013, and only two since February 1, 2013. It really did seem as if the bank failure wave might finally have played itself out and that the banking crisis of the past few years had safely moved into the moping up phase. These three latest bank failures suggest that the banking failure wave may yet have further to go and that we could continue to see still more bank closures as the year unfolds.

 

With respect to the failed bank lawsuits, just this past Tuesday I had noted that pace of the FDIC’s new lawsuit filings seemed to have slowed. In the preceding month, the FDIC had filed just one new lawsuit and the agency had filed only four new lawsuits since February 1, 2013. However, I did also note that late April 2010 had been a particularly busy period for bank failures and that during late April 2013 nearly two dozen banks would be reaching the third anniversary of their closure date. (The FDIC typically files its failed bank lawsuits close to the third anniversary owing to statute of limitations considerations.)

 

As I anticipated might happen given the number of bank closures in April 2010, this past week the FDIC filed at least two new failed bank lawsuits in connection with two banks whose third year anniversary date fell just after the date on which the FDIC filed its complaints.

 

First, on April 15, 2013, the FDIC filed a lawsuit in its capacity as a receiver for the failed City Bank of Lynwood, Washington filed a complaint against the bank’s founder and former CEO and against a loan officer in the bank’s real estate department. City Bank failed on April 16, 2010, so the FDIC filed its complaint the day before the third anniversary of the bank’s closure. In its complaint, a copy of which can be found here, the FDIC asserted claims against the two defendants for negligence, gross negligence and for breaches of fiduciary duties for “approving, in violation of the City Bank Loan Policy and prudent, safe and sound lending practices, at least 26 loans between May 2005 ad October 2008.” The FDIC’s complaint seeks damages of “not less than $41 million.” An April 16, 2013 Seattle Times article about the lawsuit can be found here.

 

Second, and also on April 15, 2013, the FDIC in its capacity as receiver of the failed Riverside National Bank of Ft. Pierce, Florida, filed a complaint in the Southern District of Florida against eight former directors and officers of the failed bank. Riverside National Bank also failed on April 16, 2010, so again the FDIC took it right down to the wire, filing its complaint the day before the three year statute of limitations period expired. In its complaint, a copy of which can be found here, the FDIC seeks to recover “in excess of $8 million” in damages caused by the defendants’ alleged breaches of duties, gross negligence and negligence “based on defendants’ permitting an excessive number of poorly underwritten loans to be made that were secured solely or largely by the stock of [affiliates of the bank’s holding company].” Owing to the familiarity with the circumstances involving these affiliates, the defendants “had personal knowledge of the dangers inherent in such stock loans.” An April 17, 2013 South Florida Business Journal article about the lawsuit can be found here.

 

So after filing only two lawsuits between March 1, 2013 and April 12, 2013, the FDIC filed two new lawsuits in a single day on April 15, 2013. As I noted in my recent post, there were 22 bank failures during the period between April 16, 2010 and April 30, 2010. I speculated that this large group of bank failures in a compressed period in late April 2010 might produce a flurry of new lawsuit filings during the last two weeks of April 2013; the arrival of these two latest lawsuit bears out this supposition and suggests that we may see further suits in the next few days as the third anniversary of these various April 2010 bank closures approaches. In any event, the arrival of these two new suits puts to rest any suggestion of a “lull” in the filing of new failed bank lawsuits.

 

In addition to these two latest lawsuits against former directors and officers of failed banks, the FDIC has also recently filed a lawsuit against the outside law firm of a failed bank. On March 15, 2013, the FDIC, in its capacity as receiver for the failed Orion Bank of Naples Florida, filed a lawsuit in the Middle District of Florida against the Nason Yeager Gerson White & Lioce law firm, and against two partners of the firm, Alan I. Armour II and Ryan P. Aiello. Orion Bank failed in November 2009. In its complaint, a copy of which can be found here, the FDIC alleges that the defendants “inexcusably failed to recognize a slew of glaring red flags.”

 

The complaint alleges that the bank had retained the firm in connection with certain loans to entities controlled by a local businessman, Francesco Mileto, a borrower who already owed the bank $43 million. The complaint alleges that by June 29, 2009, the date the new loans closed, the defendants “should have known that these loans were in fact the center of a conspiracy among the Bank’s officers to manipulate the Bank’s accounting, deceive the Bank’s Board of Directors … and illegally finance the purchase of stock in the Bank’s own holding company.” The “obvious red flags” did not dissuade the defendants from disbursing $26.5 million in violation of the terms and conditions of the loans and in violation of the law. The defendants’ allegedly “turned a blind eye to the Bank’s officers’ brazen disregard for the internal and legal constraints on their lending.” As a result, the bank allegedly sustained losses in excess of $31 million. The complaint asserts claims of legal malpractice, professional negligence and breach of fiduciary duty.

 

According to a April 17, 2013 South Florida Business Journal article about the lawsuit, here, Mileto and Orion Bank’s former CEO have both previously been sentenced to prison for inflating the bank’s capital levels through a scheme to purchase bank stock using  the proceeds of loans from the bank. 

 

The arrival of this lawsuit against the failed bank’s outside law firm is interesting. In many ways, the FDIC’s litigation approach during the current bank failure wave has been quite similar to the approach that the FDIC and the other banking regulatory agencies followed during the S&L Crisis. The one way the FDIC’s approach this time seemed to differ is that the last time around, the banking regulators had aggressively pursued the outside professionals that had advised the failed banks and the failed banks’ boards of directors. From my perspective, the FDIC has not been as aggressive in pursuing the FDIC’s outside professionals.

 

To be sure, there have been some noteworthy cases where the FDIC has filed claims against failed banks’ outside professionals. For example, as discussed here, in November 2012, the FDIC filed an action against PwC and Crowe Horvath, the former accountants for the failed Colonial Bank of Montgomery, Alabama. In addition, as discussed here, in the October 2011 lawsuit that the FDIC filed its capacity as receiver of the failed Mutual Bank of Harvey, Illinois, the FDIC’s complaint named as defendants not only certain former directors and officers of the bank, but also the bank’s outside General Counsel, who was also a director of the bank, and the General Counsel’s law firm.

 

But even though as these cases show there have been instances where the agency has pursued claims against failed banks’ former accountants or former lawyers, the FDIC has not as actively pursued claims against outside professionals as it did during the S&L crisis. The FDIC states on the professional liability lawsuit page on its website that, other than lawsuits involving the former directors and officers of failed banks, the agency has authorized an additional 51 lawsuits for “fidelity bond, insurance, attorney malpractice, appraiser malpractice, accounting malpractice, and RMBS claims.” The website does not specify from among these 51 additional authorized lawsuits how many relate specifically to attorney or accountant malpractice. The FDIC’s recent filing against the former outside law firm for the failed Orion Bank, as well as the prior two cases cited above, does show that at least in certain instances the FDIC does intend to pursue claims against failed banks’ outside attorneys and accountants.

 

In any event, with the FDIC’s filing of the latest two failed bank D&O lawsuits described above, the FDIC has now filed a total of 56 lawsuits against the former directors and officers of failed banks during the current bank failure wave, including 12 so far during 2013. The professional liability lawsuit page on the FDIC’s website states that as of April 12, 2013, the agency has authorized lawsuits against former directors and officers of in connection with 109 failed institutions, inclusive of the now 56 lawsuits involving 55 failed institutions that have already been filed. The gap between the number of suits authorized and the number filed suggests the possibility of as many as 53 additional lawsuits are yet to come. In addition, each month for the past several months, the FDIC has increased the number of lawsuits it has authorized, so the number of potential lawsuits in the pipeline likely is even greater than the current gap between the numbers of authorized and filed lawsuits suggests. In other words, it seems likely that we will continue to see the arrival of additional failed bank lawsuits in the weeks and months to come.

 

One final note. As I previously noted, in response to media pressure, the FDIC recently has added a new page to its website on which the agency has linked to settlement agreements that the agency has reached in connection with claims and lawsuits that agency has failed or asserted as part of the current bank failure wave. There is a lot of information in the settlement agreements to which the agency has linked on the page. As Joe Montelone notes in an interesting April 19, 2013 post on his blog, The D&O and E&O Monitor, the agency’s publication of these agreements on its website raises a number of interesting issues and presents some potential challenges for defendants and D&O insurers in other claims and lawsuits.

 

A Note to Readers: This past Wednesday, I added a new post about the $500 million settlement agreement that the parties reached in the Countrywide mortgage backed securities litigation. I composed and published the post while sitting in the boarding area at the Cleveland airport, waiting to board a delayed flight to Chicago (I spent quite a bit of time this past week sitting in airports waiting for various delayed flights). In my haste to publish the post before boarding the flight, I put the post up on my site with a typo in the blog post title – I referred to “Countrywide” as “Countywide.” I am grateful to a number of readers who caught the typo and who sent me notes about it. However, I have not corrected the error, for a very simple reason. If I were to make the change, the software running my blog would think I had added a new blog post, and would send out emails to all of my readers as if I had added a new post.

 

We all get too many emails. I don’t want to add to the burden by having a bunch of potentially confusing emails going out to all of my readers. Because I don’t want to burden everyone with a completely unnecessary email, I am just going to have to live with the typo. So – my apologies for the error, it is just one of the side effects of the way in which this blog is created, developed and maintained. I hope that readers can look at the typo and recognize that I am living with the embarrassment of the error rather than contributing to email pollution. My thanks to everyone who sent me notes about the typo. I always appreciate it when people help me out by spotting possible errors. In this instance, the error will have to stand uncorrected.

 

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As it has been doing on a monthly basis during the current banking crisis, the FDIC has once again updated the page on its website describing the failed bank litigation that the agency has initiated. According to the latest update, as of April 12, 2013, the agency has now filed a total of 54 failed bank lawsuits during the current bank failure wave. But though the new suits continue to come in, the agency’s filing pace appears to have slowed, at least for now. In the month since its last web update, the agency has only filed one additional lawsuit, and only four overall since February 1, 2013, even though the significant numbers of institutions reached the third anniversary of their closure during that period (Due to statute of limitations concerns, the agency typically files its failed banks suits shortly before the a failed bank’s third anniversary.)

 

Since its last update last month, the FDIC did initiate one lawsuit in its capacity as receiver for New Century Bank of Chicago, Illinois, which failed April 23, 2010. On March 26, 2013 (that is, just a few weeks before the third anniversary of the bank’s failure), the agency filed a complaint in the Northern District of Illinois alleging that the six former directors and officers named as defendants “acted negligently and grossly negligently and breached their fiduciary duties by disregarding the Bank’s loan policy, prudent lending practices, and regulatory warnings in connection with numerous commercial real estate and other loans during the period April 2005 through July 2008.” The FDIC seeks to recover “more than $33 million in losses.”

 

With the addition of just this one lawsuit, the FDIC has filed only two new complaints against former directors and officers of failed banks since March 1, 2013 and only four new complaints since February 1, 2013. By contrast, during January 2013, the FDIC filed five new complaints, just in that one month alone. In the two month period including December 2012 and January 2013, the FDIC filed a total of nine new lawsuits.

 

This relative slowdown since February 1, 2013 is all the more noteworthy given the number of banks that failed during the corresponding period three years ago. During the period February-April 2010, there were a total of 49 bank closures. By way of comparison, there were only 51 bank closures during all of calendar year 2012, and there have only been five so far during 2013. Early 2010 was a very active period for bank closures, and so given that the FDIC tends to file its suits, if at all, as the third anniversary approaches, it seemed that 2013 was going to be an active period of new lawsuit filing.

 

In addition, each month the agency updates its website to show the increased numbers of lawsuits that have been authorized. At its most recent update, the agency indicated that the number of lawsuits authorized has once again increased during the past month. As of April 12, 2013, the FDIC has now authorized suits in connection with 109 failed institutions against 888 individuals for D&O liability. This figure of 109 authorized lawsuits is inclusive of the 54 filed D&O lawsuits naming 407 former directors and officers that have already been filed. These figures suggest that there is a backlog of 55 cases that have been approved and not yet filed. The backlog seems to be growing. Given the monthly increase in the number of authorized lawsuits, you would really expect to see the agency’s new lawsuit pace moving along an active clip, not as seems to be the case, entering some sort of a lull.

 

There are a number of possible reasons for the apparent slowdown in the number of failed bank lawsuit filings. The first is just timing. I mentioned above that during the period February to April 2010, 49 banks closed, but of those 49 bank failures, 23 occurred in April 2010 alone (a very busy month for bank failures). Of the 23 bank closures in April 2010, 22 took place on or after April 16, 2010. In other words a very large percentage of the banks that failed during this period failed in late April 2010, and thus still have not yet reached the third anniversary of their closure. The third anniversary is coming up, but we are not quite there yet. There could be a flurry of new failed bank lawsuit filings in the next few days.

 

Another possible explanation for the apparent lull of new failed bank lawsuit filings over the last few weeks is that the agency may have entered tolling agreements with the failed banks directors and officers to see if they agency can reach a negotiated settlement with the directors and officers and with their bank’s D&O insurer. If the parties have entered tolling agreements, lawsuits involving some of the banks still could be filed later.

 

Finally, there are a number of cases in which the agency has reached a negotiated settlement with the directors and officers and with the D&O insurer without the agency actually filing the lawsuit. If the agency was able to reach a settlement agreement of this type in a number of cases, that too might account for the apparent filing slowdown over the past several weeks. (The agency has posted the settlement agreements in a number of these kinds of settlements on its website.)

 

Nevertheless, given the number of banks that failed in the first half of 2010 and given the growing number of lawsuits the agency has filed, it seems as if the failed bank lawsuit filing pace should be picking up again soon. As I have previously noted, there have previously been lulls in the FDIC's failed bank lawsuit filing activity (refer here, for example, wiht respect to the two month lull during mid-year 2012). But the prior lulls have in most instances been quicly followed by a period of quickened filing actiivity (as discussed, for example, here).. Circumstances may be poised for the same filing pattern again now.

 

Another FCPA Civil Lawsuit: There is no private right of action in the FCPA. Nevertheless, civil litigation has followed in the wake of the proliferation in the number of governmental enforcement actions alleging violations of the FCPA, as investors allege that company management have violated their corporate duties in allowing the bribery to take place or that, by failing to disclose the briber, management has misrepresented the company’s internal controls or financial condition.

 

The latest example of these kinds of civil suits is interesting because at least so far there is no formal enforcement action against the company involved or its senior officials, although the bribery allegations have been the subject of very high-profile publicity.

 

According to their April 12, 2013 press release, plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Wal-Mart de Mexico SAB (“Walmex”) and Ernesto Vega, the Chairman of Walmex’s board of directors and Chairman of the Board’s audit and corporate practices committee. The complaint, a copy of which can be found here, purports to be filed on behalf of investors who purchased ADRs of Walmex between February 21, 2012 and April 22, 2012. The complaint alleges seeks damages under the ’34 Act.

 

The investors’ complaint alleges that during the class period the defendants made false and misleading statements about Walmex’s business practices with respect to unlawful or unethical bribery conduct. Specifically, according to the plaintiffs’ lawyers press release, the complaint alleges that Walmex “failed to disclose that it had been involved in a bribery scheme,” and that as a result of the defendants’ misleading statements the company’s ADRs traded at inflated prices during the class period.

 

Unlike many of these kinds of civil actions, the plaintiffs do not base their assertions on allegations derived from a prior regulatory enforcement action; so far, there has been no formal regulatory enforcement action taken against the company. Rather, the plaintiffs’ allegations rely heavily on information in an April 22, 2012 New York Times article entitled “Wal-Mart Hushed Up a Vast Mexican Bribery Case” (here). The lengthy article detailed the extensive payment program that executives at Walmex allegedly had pursued in order to obtain Mexican zoning approvals, reductions in environmental impact fees and the allegiance of neighborhood leaders. According to the article, an internal Wal-Mart investigation not only found evidence of the payments, but also that Walmex executives knew about the payments and took steps to conceal the payments from Wal-Mart’s headquarters. The lead investigator recommended that Wal-Mart expand the investigation, but instead, according to the article, Wal-Mart’s leaders shut it down.

 

The new compliant quotes extensively from the New York Times article; parts of the complaint are nothing more than lengthy block quotes from the article. Among other things, the Times article notes that in December 2011, after learning of the Times’s reporting in Mexico, Wal-Mart informed the Justice department that it had begun an internal investigation into possible FCPA violations. In subsequent regulatory filings, the company has stated that it is investigating possible improper payments in other countries. To date, there have been (so far as I am aware) no formal regulatory actions taken against Wal-Mart or its officials.

 

Nevertheless, though there had to date been no enforcement action, the Walmex investors have initiated a securities class action lawsuit based on the information provided in the Times article. The case is not the first civil action seeking damages in connection with alleged FCPA violations in the absence of a formal regulatory action. However, it does provide a high-profile example of the way in which FCPA allegations can lead to private civil litigation.

 

One other interesting feature of the Walmex situation is that the alleged bribery allegations first came to light in September 2005 when a whistleblower contacted a senior Wal-Mart lawyer. It is an interesting question of what might happen in similar circumstances today, given the potentially rich whistleblower bounty payments potentially available under the Dodd-Frank whistleblower provisions. The bounty provisions provide a significant incentive for a whistleblower of the kind involved here to go straight to the SEC. These circumstances provide a powerful illustration of the kinds of circumstances that could make the Dodd-Frank whistleblower provisions so significant and could lead to increased regulatory and enforcement activity.

 

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Possibly as a result of a barrage of recent press criticism for its nonpublic settlements, the FDIC has launched a page on its website to publish details regarding the settlements it has reached in failed bank claims. The page, which can be found here, acknowledges that it is not yet complete. Even in its incomplete state it does reflect information about at least three settlements that as far as I am aware had not previously been publicly available.

 

First, the background about the questions surrounding the FDIC’s nonpublic settlements. In a March 11, 2013 Los Angeles Times article entitled “In a Major Policy Shift, Scores of FDIC Settlements Go Unannounced” (here) critical of the agency, E. Scott Rickard noted that the FDIC has “opted to settle cases while helping banks avoid bad press, rather than trumpeting punitive actions as a deterrent to others.” The article notes the agency’s willingness to agree, in connection with claims settlements, that the details of the settlements would not be disclosed except in response to a specific inquiry. As a result, claims defendants were able to avoid having settlement details made public.

 

Indeed, there have been settlements in FDIC failed bank lawsuits that are not publicly available. In report on FDIC litigation as of December 31, 2012, Cornerstone Research noted in connection with failed bank lawsuits that have settled so far, the details of at least two of the six settled cases had not been made publicly available.  In addition, I have been advised by many participants in the failed bank claim process that there have been other settlements in which the parties resolved failed bank claims without the FDIC actually filing suit. Details regarding these pre-suit settlements have also not been publicly disclosed.

 

Perhaps as a reaction to the adverse publicity following the Los Angeles Times article, the FDIC has now added to its website a page on which it has listed at least some settlements with the apparent intention of having the page complete by the end of this month. The page (here) lists only three settlement agreements, all from the state of Florida. As far as I am aware, the details regarding these three settlements previously were not publicly available. At least one of the settlements directly involves the thee settling defendants D&O insurer. None of the three settlements listed relate to the two cases for which Cornerstone Research had been unable to obtain settlement information.

 

The first of the three settlement agreements posted on the site involves a July 2012 settlement between the FDIC as receiver for the failed BankUnited of Coral Gables, Florida and Michael Orlando. BankUnited failed in May 2009. In May 2012, the FDIC in its capacity as BankUnited’s Receiver filed an action against Orlando and others in the Northern District of California alleging fraud and other misconduct in connection with certain loan transactions. According to the settlement agreement posted on the FDIC’s website, Orlando agreed to settle the FDIC’s claim for payments totaling $1 million. The settlement agreement does not specify whether or not Orlando served as a director or officer of the bank, but certain details of the settlement suggest that he was not. The settlement agreement does not mention D&O insurance.

 

The second settlement agreement that the FDIC has posted on its website involves the failed First Priority Bank of Bradenton, Florida. First Priority, which closed in April 2008, was one of the first bank’s to fail as part of the current bank failure wave. The settlement agreement, which is dated in April 2012, states that the FDIC as First Priority’s receiver asserted claims against certain former directors and officers of First Priority in connection with certain of the bank’s loans. It does not appear that the agency actually filed a lawsuit against the individuals; rather, it appears that the settlement was negotiated without a suit being filed. In a detail that will be of interest to readers of this blog, it appears that First Priority’s D&O insurer is a party to the settlement agreement and that the insurer, despite apparently disputing whether there was coverage under its policy for the FDIC’s claim, agreed to fund the settlement in the amount of $1,750,000. The insurer apparently received a policy release for its payment, subject to certain specified reservations.

 

The third settlement agreement list on the FDIC’s website involves the failed Ocala National Bank of Ocala, Florida, which failed in January 2009. The agreement is between the FDIC in its capacity as the bank’s receiver and an entity identified only as The Willoughby Corporation. The FDIC apparently filed a lawsuit against Willoughby, which Willoughby apparently agreed to settle for its payment of $40,000. The settlement agreement does not identify the nature of the FDIC’s claims against Willoughby.

 

It isn’t clear from the FDIC’s website why all three of the matters referenced on t he website page involve failed Florida banks, nor is it clear why these three particular matters are the ones included on the site – frankly, the three seem like a rather odd assortment, and the absence of information relating to the settlements of the litigated cases seems odd. An optimistic assessment of the information would be that this page is still under construction and the obviously missing information to be added in order to complete the page.

 

Indeed, the page itself says that the “initial posting of past settlements will occur on a rolling basis as they are processed with the goal to have recent settlement agreements posted by March 31, 2013.” The page also says that “will publish the terms and conditions of all settlements as they become available and the material will be updated on a monthly basis.” It will be interesting to monitor the page as the agency updates it in the coming days, in particular to see whether the agency posts the previously unavailable information about the litigates case settlements, and to see the extent to which the agency includes information regarding pre-litigation settlements.

 

The agency’s apparently new found interest in settlement transparency could pose some challenges. The agency could face certain constraints in disclosing past settlements to the extent the parties to the settlements had reached understandings that the settlement would remain confidential. Future settlement negotiations could be complicated to the extent that parties to the negotiations want to try to make confidentiality a condition of any possible settlement. Negotiations could also be complicated as information becomes more readily available that might serve as settlement benchmarks or at least reference points. On the other hand, greater transparency will allow a more accurate assessment of what the FDIC’s claims have accomplished and could even afford some insight into the impact of the settlements on D&O insurers. Some observers may also contend that greater settlement transparency will provide deterrent effects as well.

 

Special thanks to a loyal reader for providing a link to the settlement page on the FDIC’s website.

 

NERA Releases 2012 Wage and Hour Settlements Report: On March 12, 2013, NERA Economic Consulting released its 2012 report on settlements of wage and hour cases. The report, which is entitled “Trends in Wage and Hour Settlements: 2012 Update,” can be found here.

 

The report contains a number of interesting observations about wage and hour settlements. Among other things, the report notes that on average, companies paid $4.8 million to resolve wage and hour cases in 2012, up slightly from the $4.6 million observed in 2011, but lower than the overall average of $7.5 million for the 2007 to 2012 period. The median settlement value for 2012 of $1.7 million was also slightly higher than the $1.6 million median in 2011. (Although it is not expressly stated in the report, it appears that the settlement analysis is solely with respect to class action wage and hour litigation, not individual actions.)

 

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The improving trend that the banking industry has shown for the last three years accelerated in 2012, according the FDIC’s Quarterly Banking Profile for the final quarter of 2012, which was released on February 26, 2013. Overall, the industry reported 2012 earnings of $141.3 billion, which represents a 19.3 percent improvement over 2011 and the second-highest annual earnings ever reported for the industry (behind only the $153.billion earned in 2006, before the credit crisis emerged.). The FDIC”s latest Quarterly Banking Profile can be found here.

 

The agency’s February 26, 2013 press release about the report (here) quotes FDIC Chairman Martin Gruenberg as saying that “the improving trend that began more than three years ago gained further ground in the fourth quarter,” and that “balances of troubled loans declined, earnings rose from a year ago, and more institutions of all sizes showed improvement.

 

Sixty percent of all institutions reported improvements in their quarterly net income from a year ago. Asset quality indicators continued to improve as insured banks and thrifts charged off $18.6 billion in uncollectable loans during the quarter, down $7.0 billion (27.4 percent) from a year earlier.

 

In another positive sign, the number of failed institutions is also declining. Eight institutions failed in the fourth quarter of 2012, which is the lowest quarterly total since 2008, when two institutions failed. (So far during the first quarter of 2013, three banks have failed.) For all of 2012, there were a total of 51 bank failures, down from 92 in 2011 and 157 in 2010. The 2012 total of 51 bank failures represents the lowest annual number of bank failures since 2008, when 25 banks failed.

 

One thing that is clear is that the U.S. banking industry has been through a massive winnowing effect over the last several years. The FDIC’s quarterly reports shows that as of the end of 2012, there were only 7,083 reporting financial institutions, by comparison to the 8.534 reporting institutions at the end of the 2007. The 1,451 decline in the number of reporting institutions during that period represents a decline of 17%. The number of reporting institutions has declined steadily during that intervening five year period. Indeed, the number of reporting institutions decline from 7,357 at the end of 2011 to the 2012 year end number of 7,083, a decline of 274 institutions (3.72%).

 

During the fourth quarter 2012, the number of reporting institutions declined by 98 banks (1.31%), from 7,181 at the end of the third quarter of 2012 to the year end number of 7,083. The FDIC’s report states that most of this decline (88 out of 98 institutions) was attributable to the merger of institutions into other banks. The remainder is due to failures and closures. The unstated inference seems to be that the industry is improving as the weaker banks are merged out of existence.

 

Not all of the news in the FDIC’s quarterly report is positive. Among other things, the report notes that for the sixth quarter in a row, no new reporting institutions were added. The year 2012 is the first in FDIC history in which no new reporting institutions were added, and the second year in a row with no new start-up charters (the three new reporting institutions added in 2011 were all charters created to absorb failed banks).

 

And though the overall banking industry continues to improve, the number of “problem institutions” remains stubbornly high. (A “problem institution” is an insured depositary institution that is ranked either a “4” or a “5” on the agency’s 1-to-5 scale of risk and supervisory concern. The agency does not release the names of the banks on its “problem” list.) Though the number of institutions on the FDIC’s problem list declined for the seventh consecutive quarter in the fourth quarter of 2012, from 694 to 651 representing a decline of 6.2% in the number of problem institutions), the number of problem institutions remains high relative to the number of reporting institutions, which, as noted above, is also declining.

 

The 651 problem institutions at the end of 2012 represent a significant drop in the number of problem institutions from the end of 2011, when there were 813 problem institutions, and from the end of 2010, when there were 884 problem institutions. The 162 drop in the number of problem institutions between the end of 2011 and 2012 – a decline of nearly 20% in the number of problem institutions – represents a substantial drop in one year.

 

But the number of problem institutions as a percentage of reporting institutions remains stubbornly high. This is in part due to the fact that as the number of problem institutions declines, the number of reporting institutions is also declining. The 651 problem institutions as of the end of 2012 still represent 9.19% of all reporting institutions. Though this is down from the equivalent percentage as of the end of 2011 (when it was 11.01%), the 2012 year end percentage of problem institutions means that as of year end, nearly one out of every ten reporting institutions is a problem institution. By way of contrast, as of the end of 2007, the FDIC ranked only 76 institutions as problem institutions. Though subsequent events suggest that the 2007 year end number was artificially low, the 2007 number does show what the percentage of problem looks like when the industry is not under stress.

 

Though the industry as a whole remains on the road to recovery, the problems from the credit crisis continue to haunt the industry and the number of problem institutions persists at an elevated level.

 

As the numbers of failed banks have decline, the number of failed bank lawsuits has continued to grow, as I detailed in a recent post (here).

 

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The pace of bank closures has slowed to a trickle. There have only been three bank failures so far in 2013 (including one this past Friday evening, involving the Covenant Bank of Chicago, Illinois). But while bank failures have dwindled, the number of failed bank lawsuit filings has surged. On February 15, 2013, the FDIC updated its website to reflect a cluster of new failed bank lawsuit filings as well as an increased number of lawsuit authorizations. With the latest lawsuit authorizations, the FDIC is now approaching an authorized level of lawsuit filings comparable to the lawsuit filing level during the S&L Crisis.

 

With the three bank closures this year, there have now been a total of 471 bank failures since January 1, 2007. The FDIC’s latest litigation update shows that  during the current wave of bank failures the agency has now filed 51 lawsuits against the former directors and officers of 50 failed banks, meaning that the FDIC has already filed lawsuits in connection with just under 11% of all bank failures. But, as reflected in the updated information on the FDIC’s website, the agency has also authorized more lawsuits. The number of authorized lawsuits has continued to increase each month, as well.

 

As of February 15, 2013, the FDIC has authorized suits in connection with 102 failed institutions against 836 individuals for D&O liability. This includes the 51 filed lawsuits naming 396 former directors and officers at 50 institutions. In other words, there could be as many as 52 as-yet-to-be-filed lawsuits based just on the authorizations to date. Some of these authorized lawsuits may not ultimately be filed, as pre-litigation negotiations sometimes results in settlements that avert the need for a lawsuit to be filed. But were the FDIC to file lawsuit in connection with as many as 102 failed institutions, that would mean that the FDIC would have initiated lawsuits in connection with nearly 22% of all bank failures, a percentage that would approach the 24% rate during the S&L crisis. To the extent the agency authorizes even more lawsuits in coming months, the litigation rate could meet or even exceed the S&L crisis litigation rate.

 

The updated information on the FDIC’s website includes information relating to four additional filed bank lawsuits that I had not previously tracked. With the addition of these four latest suits, the FDIC has now filed a total of seven failed bank lawsuits so far in 2013, after having filed 26 during 2012. I briefly discuss each of the four latest lawsuits below. One interesting note about these four new suits is that none of them involve failed Georgia banks. As I have previously noted on this blog (most recently here, see second item), the failed bank lawsuits had been disproportionately concentrated in Georgia. These latest filings, none of which involve Georgia banks, might suggest that this imbalance may start to level out.

 

Here is brief description of the four latest failed bank lawsuit filings.

 

First, on January 18, 2013, the FDIC in its capacity as receiver for the failed Columbia River Bank of The Dalles, Oregon filed an action in the District of Oregon against seven former officer and three former directors of the bank. The bank failed on January 22, 2010, so the FDIC filed the suit just ahead of the third year anniversary of the bank’s closure. The FDIC’s complaint (a copy of which can be found here) asserts claims against the former directors and officers for gross negligence, negligence and breach of fiduciary duties. The complaint alleges that the defendants “took unreasonable risks with the Bank’s loan portfolio, allowed irresponsible and unsustainable rapid asset growth concentrated in high-risk and speculative” loans, “disregarded regulator warnings,” and violated the Bank’s loan policies and procedures. The defendants allegedly caused damages to the bank of no less than $39 million.

 

Interestingly, though the Columbia River Bank was not closed until January 2010, all but one of the specific loans cited in the complaint were originated in 2006 and 2007 (the one exception was originated in early 2008). As time goes by, the loan originations cited in the FDIC’s complaint start to seem more and more like ancient history.

 

Second, on January 29, 2013, the FDIC filed an action in the Middle District of Florida in its capacity as receiver for the failed Orion Bank of Naples, Florida. The FDIC’s complaint can be found here. The FDIC’s complaint seeks to recover damages of in excess of $58 million. The lineup of defendants is interesting, as the four individuals named as defendants are all former directors; none of the bank’s former officers are named as defendants.

 

The complaint, which asserts claims for gross negligence and breach of fiduciary duties, alleges that the bank “collapsed under the weight of the unsustainable growth strategy that the Defendants permitted Chief Executive Officer Jerry Williams to pursue.” Williams, the former CEO, is not named as a defendant in the case. The complaint alleges that as Williams pursued his “reckless growth strategy” he was “unrestrained” by the defendants who engaged in a “pattern of unconsidered acquiescence.” The Defendants are alleged to have approved loans “without meaningful deliberation or discussion.” The complaint alleges that the director defendants even continued to “ignore” their duties even after the bank had entered an August 25, 2008 written agreement with the federal banking authorities that was specifically concerned with the directors’ oversight responsibilities. 

 

The Orion Bank failed on November 13, 2009, which suggests that the parties may have entered some sort of a tolling agreement. The naming of only four former directors as defendants, and the absence of any officer defendants, is not explained in the complaint. One possibility is that as a result of negotiations while the tolling agreement was in place resulted in settlements on behalf of the former officers (this, I should add is sheer speculation on my part).

 

Third, on January 31, 2013, the FDIC in its capacity as receiver of the failed Security Savings Bank of Henderson, Nevada, filed an action in the District of Nevada against three former director and officers of the bank. The FDIC’s complaint (a copy of which can be found here) seeks to recover damages in excess of $13.1 million from the three defendants who allegedly “underwrote, recommended and/or voted to approve at least seven high-risk commercial real estate and acquisition and development and construction loans in violation of the Bank’s lending policies and clear principles of safety and soundness.”

 

The bank was closed and the FDIC appointed as receiver on February 27, 2009, which suggests that the parties had entered some sort of tolling agreement. The three defendants had resigned before the bank failed; two of them, the former CEO and the former Chief Credit Officer, had resigned in September 2008, and the third had resigned all the way back in December 2006. The three individual defendants have long since scattered, with two now living in Texas and a third living in Virginia. All of the specific loans mentioned in the FDIC’s complaint were originated in 2005 and 2006, which really does seem like ancient history.

 

Fourth, on February 13, 2013, the FDIC, in its capacity as receiver of the failed LaJolla Bank of LaJolla, California filed an action in the Southern District of California against two former officers of the bank and against the bank’s former board Chairman. The complaint (here) asserts claims for negligence, gross negligence and breach of fiduciary duty and seeks to recover damages in excess of $57 million. The complaint alleges that the defendants violated the bank’s loan policy and “safe and sound lending practices” by “recommending or approving speculative commercial real estate loans despite known adverse economic conditions,” as well as recommending or approving loans to borrowers who were not creditworthy, or without requiring sufficient underwriting and without sufficient information.

 

Regulators closed the LaJolla Bank on February 19, 2010, so the FDIC filed its complaint just prior to the third anniversary of the bank’s closure. The specific loans referenced in the complaint were originated between March 2007 and March 2009.

 

Reading these four complaints in quick succession was an interesting experience. Though there are noteworthy variations between the complaints (for example, with the Orion Bank complaint, which names only director defendants), there is also a certain sameness to the complaints, as well – so much so that some of the allegations and even phraseology seem to be lifted verbatim from other complaints. It is, after all, a familiar story. The banks grew quickly during a period of rapid economic expansion and then were slow to recognize the seriousness of the downturn. In the aftermath, it appears that many of the loans extended during the go-go days had not always been made with full procedural compliance. It does beg the question whether the losses were the result of the failure to follow procedures or of the suddenness and severity of the downturn.

 

Another unmistakable impression from reading these complaints in quick succession is that as time goes by, the events on which the FDIC is going to be trying to base its current and any future lawsuits are receding further and further into the past. As noted above with respect to the Security Saving Bank complaint, the defendants are scattering. As time goes by, the FDIC’s burden is going to become increasingly archeological.

 

This Just In From Our Istanbul Bureau -- D&O Liability and Insurance in Turkey: As is the case in many countries, the use of D&O insurance is still relatively new in Turkey. However, as discussed in an interesting January 29, 2013 article by Naşe Taşdemir Önder and Pelin Baysal of the Mehmet Gün & Partners law firm entitled “Turkey: Directors’ and Officers’ Liability Insurance in View of the New Turkey Commercial Code” (here), new standards on corporate governance incorporated into the new Turkish Commercial Code are “expected” to “lead to increase in demand for D&O policies.”

 

According to the authors, the new Code introduces new requirements for “universal accounting and auditing standards and rules for increased transparency” which the authors expect will support the “operability” of “liability provisions.” According to the authors, the Code introduces a “heavier level of duty of care” for directors and officers. Among other things, the new Code provisions introduce certain specific types of liability provisions, including in particular liability for misrepresentations in documents and declaration and misrepresentations on capital subscription. The Code introduces many other new provisions, including new provisions allowing for claims by shareholders for losses incurred by the company.

 

With respect to insurance, the new Code specifies that third party liability insurance will be consider “occurrence based” unless otherwise indicated in the policy. The new Code also prohibits coverage for losses arising as a result of willful acts. The author’s very thorough examination of the new Code’s insurance-related provisions detail the many other specific insurance issues that the new Code addresses.

 

For anyone interested in the D&O liability and D&O insurance issues in Turkey, the authors’ memo is a valuable resource.

 

And Now, From Our Singapore Bureau: Regular readers of this blog may recall my post about my April 2012 visit to Singapore, which I found to be an interesting and impressive place. But Singapore’s transformation into a gleaming metropolis is relatively recent. As shown in this photo montage from Business Insider, Singapore had to become what it is today and relatively recently it was a very different place. I found these photographs, and the history they embody, to be fascinating.

 

And Finally: Kalefa Sanneh’s excellent and interesting article in the February 11 & 18 issue of The New Yorker entitled “Sprit Guide” (here), about whisky distiller Bruichladdich, contains the following sentence, written with reference to the whisky sampling  techniques of the whisky maker’s master distiller, Jim McEwan: “It’s a simple process, but consumers hoping to reproduce McEwan’s results at home will find, no doubt, that some variant of the uncertainty principle applies: the more research you conduct, the less reliable your data become.” I tip my hat to the article’s author; the sentence has its own humor, in that conducting whisky research undoubtedly involves certain limits owing to the properties of the subject matter.  But it is the sly side reference to Heisenberg’s uncertainty principle that I admire.

 

Though I could never hope to write with such sophisticated humor, I can certainly admire the writing, including also the following sentence from the same article:  “The first part of the distillate, known as the foreshot, contains methanol, which can be toxic in large quantities – although the same could be said of whisky.” (Side note: In Scotland, there’s no “e” in whisky.)

 

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In order to try to defend themselves from claims asserted against them by the FDIC as receiver for a failed bank, the failed bank’s directors and officers often raise affirmative defenses, either based on pre-receivership conduct (as for example, in connection with pre-failure examinations) or post-receivership conduct (as for example in connection with the agency’s management of the liquidation process). Whether or not these defenses can be asserted against the FDIC was litigated extensively in the failed bank litigation arising in the S&L crisis era. These questions were raised again in one of the FDIC’s current bank cases. In a February 12, 2013 order (here), Northern District of Illinois Judge Virginia Kendall granted the FDIC’s motion to strike the directors and officers affirmative defenses.

 

On July 31, 2009, regulators closed the Mutual Bank of Harvey, Illinois and the FDIC was appointed as receiver.  As discussed here, on October 25, 2011, the FDIC initiated a lawsuit in the Northern District of Illinois. The complaint was noteworthy at the time because the bank not only named as defendants eight former directors and two former officers of the bank but also included 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.

The defendants asserted a number of affirmative defenses, including the defenses of failure to mitigate, comparative fault, superseding/intervening cause, lack of proximate cause and waiver and estoppel. The FDIC moved to strike the affirmative defenses.

In her February 12 order, Judge Kendall first addressed the defendants’ defenses that were based on the FDIC’s alleged conduct during the regulatory and investigatory of the FDIC’s examination of the bank (that is, its pre-receivership conduct).  Judge Kendall granted the FDIC’s motion to strike these defenses because the conduct of the FDIC during the pre-receivership regulation of the bank falls into the “discretionary conduct” exception to the Federal Tort Claims Act. Discretionary agency conduct cannot be the basis of a claim against the U.S. or one of its agencies. Judge Kendall said the same reasoning “applies with equal force to affirmative defenses pleaded against a government agency because of that agency’s discretionary acts.”

The defendants also asserted affirmative defenses of failure to mitigate, superseding/intervening cause, comparative fault, which related to the agency’s post-receivership conduct. These defenses relied primarily upon the agency’s alleged post-receivership failure to collect on the bank’s accounts and improperly disposed of the bank’s assets, among other things. After an extensive review of the case law developed during the S&L crisis, Judge Kendall concluded that all of the conduct on which the defendants sought to rely was within the agency’s discretionary functions. Judge Kendall granted the FDIC’s motion to strike these defenses “because they improperly challenge the discretionary power of the FDIC to maintain and dispose of the Bank’s assets post-receivership.”

The defendants also raise affirmative defenses related to causation, such as lack of proximate cause and intervening/superseding causes, based on the general market conditions during the financial downturn. Judge Kendall noted that proximate cause is an element of the FDIC’s case in chief and is not properly pleaded as an affirmative defense. However, she noted, “striking the affirmative defenses related to lack of proximate cause and/or presence of intervening cause by no means bars the defense from asserting that the FDIC has not carried its burden with respect to the element of causation.”

Finally, Judge Kendall also struck the defendants attempt to reserve the right to assert affirmative defenses at a later date. Judge Kendall found that this attempted reservation is an “improper reservation under the Federal Rules.”

Discussion

The FDIC generally argues that when it takes over as receiver, it “stands in the shoes” of the failed bank. That does not seem entirely to be the case, however, at least with respect to some of the affirmative defenses these defendants sought to assert here. Certainly, if the bank were still viable and asserted the claims against the directors and officers of the kind that the FDIC is asserting, the individual defendants would have the right to assert affirmative defenses (or at least to argue that they had that right under applicable state law). However, the agency argued that it is not susceptible to these defenses because of its discretionary agency functions. Clearly, if the agency has the right to make that argument, its receivership status involves something other than just standing in the shoes of the failed bank.

During the current bank failure wave, other failed banks’ directors and officers  have also sought to assert affirmative defenses against the FDIC, and in at least some instances, they have done so with somewhat greater success that the defendants here. For example, as discussed here, in a February 2012 ruling, Northern District of Georgia Judge Steve C. Jones granted in part and denied in part the FDIC’s motion to strike the affirmative defenses of the former directors and officers of the failed Integrity Bank.

Judge Jones granted the FDIC’s motion to strike the directors and officers affirmative defenses based on the agency’s pre-receivership conduct. 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’s rulings in the Integrity Bank case are now before the Eleventh Circuit on interlocutory appeal, although the principal issue before the appellate court is whether r not under Georgia law the FDIC can assert claims of ordinary negligence against the failed bank’s directors and officers. Interestingly, Judge Kendall’s opinion does not refer to Judge Jones’ s rulings in the Integrity Bank case (perhaps because Judge Jones’s rulings relied to a certain extent on Georgia law).

Whether or not the former directors and officers of a failed bank can assert affirmative defenses against the FDIC represents a significant issue, and one on which the courts appear to be differing conclusions. It remains to be seen whether one or the other line of analysis will control these issues. It should be noted that in both of the two district court opinions, the district court judges did agree that even if the defendants could not argue causation issues as an affirmative defense that the defendants could argue that the FDIC had not carried its burden to establish causation in its case in chief.

Many thanks to a loyal reader for sending me a copy of Judge Kendall’s opinion.

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A shareholder of the holding company for a failed Virginia bank, the Bank of the Commonwealth, has filed a securities class action lawsuit in the Eastern District of Virginia against the holding company and certain of the company’s directors and officers. The lawsuit, filed on January 22, 2013, follows after the July 2012 indictment of four of the bank’s officers, and the SEC’s January 9, 2013 filing of a civil enforcement action against three of the bank’s former officers. A copy of the shareholder’s securities class action complaint can be found here.

 

The Bank of the Commonwealth of Norfolk, Virginia failed on September 23, 2011. As discussed in a prior post (here, second item), on July 11, 2012, a grand jury returned an indictment (here) against the bank’s former Chairman and CEO, Edward Woodard, Jr.,  for conspiracy to commit bank fraud, bank fraud, false entry in a bank record, multiple counts of unlawful participation in a loan, multiple counts of false statement to a financial institution, and multiple counts of misapplication of bank funds. Three other former officers of the bank and two of its customers are charged with a variety of related charges. The FBI’s July 12, 2012 press release regarding the indictment can be found here.

 

As described in its January 9, 2013 press release (here), the SEC filed a civil enforcement action against Woodard, Cynthia Sabol, the bank’s CFO, and Stephen Fields, the bank’s former executive vice president. The SEC’s complaint, which can be found here, asserts claims for securities fraud against the three defendants for alleged “misrepresentations to investors by the bank’s parent company.” The SEC charged the three “for understating millions of dollars of losses and masking the true health of the bank’s loan portfolio at the height of the financial crisis.” The SEC alleges that Woodard “knew the true state” of the bank’s “rapidly deteriorating loan portfolio,” yet he “worked to hide the problems and engineer the misleading public statements.” Sabol also allegedly knew of the efforts to mask the problems yet signed the disclosures and certified the bank’s financial statements. Fields allegedly oversaw the bank’s construction loans and helped mask the problems.

 

Following just days after the SEC filed its enforcement action, a holding company investor filed a securities class action complaint in the Eastern District of Virginia on January 22, 2013. The complaint names as defendants the holding company itself, six of its former officers and seven directors. The complaint alleges that the defendants “concealed” the holding company’s and the bank’s “true financial condition in a number of ways,” including “fraudulently underreporting the Company’s allowance for loan and lease losses (‘ALLL’) and provision for loan and lease losses … in an effort to overstate the quality and nature of the Bank’s loan portfolio.”

 

The complaint further alleges that “the truth of the Company’s true financial condition emerged through partial disclosures,” and while the company announced increases in ALLL and the provision for loan and lease losses during the class period “it fraudulently attempted to do so with a ‘soft landing’ by failed to increase ALLL and the Provision to the full extent required, and at the same time issuing false reassurances to investors.”

 

The complaint alleges that the holding company, Woodard, Sabol, and Woodard’s successor as CEO, Chris Beisel, violated Section 10(b) of the Exchange Act. In a separate count, the complaint alleges that the remaining individual defendants are liable to the plaintiff class as Control Persons under Section 20 of the Exchange Act.

 

Among the individual defendants named in the complaint is Thomas W. Moss, Jr, a former director of the bank and presently the Norfolk City Treasure and a former speaker of the Virginia House of Delegates. A January 24, 2013 Virginian-Pilot article about the new lawsuit quotes Moss as saying that “the board is clean on this” and saying with respect to the plaintiff that “he doesn’t know what he’s talking about,” adding that “the feds haven’t found a thing wrong with the board.”

 

The named plaintiff in the complaint, Robert Bogatitus, accompanied his complaint with a certification stating among other things that he had purchased a total of 2000 shares in the bank holding company four separate transactions between May and September 2011. Interestingly, all four of the purchase transactions took place after the company filed its 2010 10-K on April 15, 2011. In the 10-K, the company revealed that “[a] federal grand jury is investigating the Bank and certain of its former and current officers regarding lending and reporting practices of the Bank and the manner in which certain loans and loan renewals were considered and approved.” In addition, the plaintiff purchased half of his 2,000 shares of holding company stock on September 26, 2011 – three days after the September 23, 2011 closure of the bank. The patterns of the plaintiff’s purchases seem to undercut the suggestion that he made his purchases in reliance on representations about the bank’s loan quality and financial condition.

 

In the wake of current wave of bank failures, much of the focus (including on this blog) has been concentrated on the lawsuits that the FDIC has been filing against former directors and officers of the failed banks. But as the circumstances involving this failed bank show, the post-failure legal proceedings can and sometimes do include a host of other kinds of actions, both civil and criminal. Indeed, at least as of today, the FDIC itself has not filed an action in its capacity as receiver for the failed bank against this bank’s former directors and officers.

 

The proliferation of legal proceedings here underscores the range of exposures that bank directors and officers can face following a bank’s failure, beyond just the risk of an FDIC D&O action. These proceedings also show the diversity of demands that can be put on a failed bank’s D&O insurance program. It is of course impossible to discern from the outside whether and to what extent this bank carried D&O insurance at the time it failed, and whether or not any insurance remained in place when these various actions have commenced. But to the extent the bank had D&O insurance in place that remained in effect as these various actions have arisen, the attorneys’ fees and costs from the various actions are likely to quickly erode the remaining limits of liability.

 

If nothing else, the various proceedings also underscore the range of exposures that face bank directors and officers. For those advising banks with respect to their D&O insurance – particularly with respect to publicly traded banks – the sequence of events here represents something of a cautionary example. The proceedings that have followed this bank’s failure provide a substantial example of the kinds of risks that the program should be designed to address.

 

Special thanks to a loyal reader for sending me a link to the Virginian-Pilot article linked to above.

 

The Beginning of Another Epic Journey for a Familiar Company? : As reflected in detail here, on June 18, 2002, plaintiff shareholders filed a securities class action lawsuit against Tellabs and certain of its directors and officers. The case would eventually makes its way all the way up to the U.S. Supreme Court, where in 2007 the Court would enter a landmark opinion decision defining the standards to be applied at the dismissal motion stage in a securities class action. The decision is widely viewed as a setback for securities class action plaintiff. After the Supreme Court decision, the case returned to the lower court for extensive further proceedings (including an important interlude in the Seventh Circuit). Finally in April 2011, nearly nine years after the case began, the parties settled the case for $7.375 million.

 

Whether or not the ultimate outcome was worth it after that tortuous journey, another set of plaintiffs are back at it again. As reflected in the plaintiffs’ lawyers’ January 23, 2013 press release (here), plaintiff investors filed a new securities class action lawsuit in the Northern District of Illinois against Tellabs and certain of its directors and officers. According to the press release, the Complaint alleges that:

 

the defendants failed to disclose, among others: (1) that in the fourth quarter of 2010, the Company was changing its distribution arrangement with a customer; (2) that this change to the distribution arrangement masked that Tellabs’ business was declining substantially faster than the Company had represented to the public; (3) that the Company's North American business was slowing at a greater rate than the Company had represented to the public; and (4) that, as a result of the above, the defendants' positive statements about the Company's business, operations and prospects lacked a reasonable basis.

 

It is always hard to know at the outset of a securities suit where it is going to lead, but I suspect that these plaintiffs do not expect another nine year marathon and certainly are hoping that they will not have to make another foray to the Supreme Court. In any event, when the company files its inevitable motion to dismiss, it will be able to rely heavily on the principles established in a Supreme Court decision with the company’s own name on it.

 

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Picking up where it left off at the end of the year, the FDIC has filed its first failed bank D&O lawsuit of 2013. The lawsuit, which the agency filed on January 17, 2013 in the District of New Mexico, names as defendants ten former directors and officers of the failed Charter Bank, New Mexico. The complaint, which the FDIC filed in its capacity as receiver for the failed bank, alleges claims for negligence, gross negligence and breach of fiduciary duty, can be found here.

 

Charter Bank failed on January 22, 2010, so the FDIC filed the complaint just before the third anniversary of the bank’s closure (and just before a long holiday weekend as well.) The complaint alleges that prior to its failure the bank committed 72% of the bank’s core capital to a “highly speculative and risky” subprime lending operation in Denver, Colorado in late 2006, when the defendants “knew or should have known” there was no secondary market for subprime mortgage loans. The operation made loans that “no reasonable institution” would have made at the time, and relaxed underwriting standards to do so. Unable to sell the mortgages into the secondary market, the bank had to take the loans onto its own balance sheet, which cause the bank to suffer financial losses.

 

The lawsuit, the first that the FDIC has filed in 2013, is also the first that the agency has filed in New Mexico as part of the current failed bank litigation wave. This latest lawsuit is the 45^th that the agency has filed as during the current banking crisis, 26 of which were filed in 2012. (These figures, both overall and for 2012, include the lawsuit filed just before the holidays in the Central District of California in connection with the failed Alliance Bank of Culver City, California. The FDIC’s complaint, filed on December 21, 2012, in its capacity as receiver for the failed bank against X former directors and officer of the bank can be found here.)

 

There undoubtedly are more lawsuits to come. On January 22, 2013, the FDIC updated the page on its website on which the agency indicates the current number of lawsuits that the agency has authorized. According to the latest update, as of January 15, 2013, the FDIC has authorized suits in connection with 95 failed institutions against 788 individuals for D&O liability. This includes 45 filed D&O lawsuits naming 355 former directors and officers. The 45 lawsuits filed involve 44 failed institutions, so the implication is that there are lawsuits involving some 51 failed institutions yet to come – based on the number of lawsuits that have been authorized so far. Since the FDIC has increased the number of authorized lawsuits each month for several months in a row now, the likelihood seems to be that there are at least 51 more lawsuits – and possibly many more – to come in the months ahead.

 

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As the current wave of bank failure litigation has unfolded, the directors and officers of banking institutions rightly have become more concerned about the own potential liability exposures and interested in learning more about how they might be able to reduce their risks and exposures. In the following guest post, Joseph T. Lynyak III and Rodney R. Peck of the Pillsbury law firm take a look at the current litigation environment facing directors and officers of financial institutions and provide some practical steps that these officials can take to try to mitigate their risks

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I would like to thank Joe and Rob for their willingness to publish their articcle on this site. 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 Joe's and Rod’s guest post.

 

 

 

In this article, we analyze the steps that officers and directors of bank and non-bank financial companies and their holding companies and affiliates can take to address personal liability for alleged breaches of duty to manage and supervise a financial company’s operations, allegations which are being made in an increasing number by federal and state regulatory agencies, including the federal banking agencies and the U.S. Consumer Financial Protection Bureau (CFPB).

 

On December 10, 2012, a California jury returned a verdict of $169 million in a case brought by the FDIC against three former IndyMac Bancorp Inc. executives after determining that those officers were negligent in making loans to homebuilders by continuing to push for growth in loan production without proper regard for creditworthiness and market conditions. Soon thereafter, the former CEO of IndyMac Bank agreed to pay $1 million from his personal assets in addition to available insurance proceeds to settle another FDIC claim related to the failure of IndyMac Bank. In an unrelated yet problematic series of developments, the newly formed CFPB recently assessed civil money penalties against three holding companies for aggressive marketing practices in an aggregate amount exceeding $500 million.

 

Approximately 25 lawsuits were filed in 2012 by the FDIC against former officers and directors of failed institutions, up from 16 in 2011. In total, more than 40 lawsuits have been filed against officers and directors of failed institutions since 2010. Since the beginning of 2007, approximately 467 financial institutions have failed. The FDIC has indicated that it is continuing its investigation of many bank failures and additional actions can be expected. Outside directors, in addition to inside directors and senior officers, were named in 30 of the cases. (See, Cornerstone Research, “Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions,” December 2012.)

 

These and similar administrative and civil enforcement actions brought by governmental entities have caused considerable concern among officers and directors of financial services companies. Specifically, many individuals have raised questions whether—and in what circumstances—management or members of a board of directors might be held personally liable for similar penalties or damages, and if so, what prudent actions could be taken to mitigate that risk.

 

Although these issues are complex and the risk will vary based upon differences between the corporate laws of state jurisdictions and the possible applicability of several banking and securities laws (among others), this article presents an overview and proposed approach to analyzing the risk of personal liability. It also includes a methodology to evaluate protections that might be available under current corporate governance provisions.

 

What follows is a summary of pertinent legal issues relating to the risk of personal liability, distinctions to be drawn between liability arising in the bank and non-bank context, and steps that directors and officers might take to minimize personal liability risk, as well as a methodology for taking an inventory of existing protections available to a board and management.

 

Overview and Summary—State Corporate Laws

From a traditional corporate law perspective, both officers and directors of a corporation owe a duty to the corporation to avoid self-dealing and conflicts of interest (the “duty of loyalty”) and an affirmative obligation to use reasonable efforts to properly manage and supervise the business of the company (the “duty of care”). The degree or standard by which an officer or director must comply with his or her duty of care is generally governed by the corporate law of the state in which the company is incorporated. That standard can range from an obligation to act in a reasonable manner and avoid negligent actions or decisions, to a diminished level of care that creates personal liability only in the case in which one acts in a grossly negligent fashion.

 

Because most state legislatures have considered these questions, each state’s Corporations Code has its own version of the duty of care, and in many jurisdictions the courts have further refined that standard by judicial interpretation. For example, in several states, liability for breaching the duty of care can only be actionable when a director or officer is grossly negligent, while in other states the standard of gross negligence protects only outside directors while management is held to the higher standard of mere negligence. Further, in many jurisdictions there is recognition—either by statute, case law or common law—that directors and/or officers may rely upon the so-called “business judgment rule” that protects them against personal liability provided that the officer or director took reasonable steps to come to a decision even when the decision is proven to be wrong.

 

In addition, several states have authorized limitations of liability for corporate misfeasance by permitting a corporation to adopt provisions in its articles or bylaws that further limit liability for board members or management. Importantly, in recent years, several states have adopted expanded indemnification rights for corporate stakeholders by permitting a corporation to adopt in its articles and bylaws very broad rights to indemnify officers and directors against individual damage claims brought against them in their individual capacities.

 

The lesson to be learned is that concerned officers and directors should establish a baseline to identify by what state law standard they will be measured when being judged regarding compliance with the duty of care, as well as related state law limitations regarding liability.

 

Additional Concerns for FDIC-Insured Institutions, Subsidiaries and Holding Companies

In addition to the state law standards regarding a director or officer complying with his/her duty of care, there are several other significant considerations that require attention for an officer or director of an FDIC-insured institution or a bank or savings and loan holding company.

 

First, an important U.S. Supreme Court decision, Atherton v. FDIC, confirms that there is no federal common law regarding the duty of care for a national bank or a federal savings association. Accordingly, based upon the Atherton decision (which interpreted a provision of the Federal Deposit Insurance Act, or the “FDI Act”, for receivership claims brought by the FDIC following a failure of a bank or thrift), the standard for national bank and federal association officers and directors generally follows state law, except that state law cannot impose a standard lower than gross negligence. Of course, for banks and bank holding companies organized under state corporate laws, the duties of care on the part of officers and directors are governed by such laws (subject to the partial preemption under the Atherton decision).

 

Second, applicable regulations for national banks and federal savings associations provide a useful alternative that permits a national bank or federal savings association to adopt for corporate governance purposes the Corporations Code of the state in which the institution is located, the Model Business Corporations Act or the Delaware General Corporations Code. This is a potentially valuable option that should be carefully considered. For example, in states in which liability for bank officers is based upon the higher standard of mere negligence, adopting the corporate law of Delaware not only lowers the standard for breach of the duty of care to gross negligence, but may also provide enhanced protection in regard to indemnification and the availability of the Delaware version of the business judgment rule.

 

However, it should be noted that Section 18(k) of the FDI Act (and thus, FDIC’s regulations) severely (and unfairly) limits indemnification rights of officers and directors of FDIC-insured institutions, their subsidiaries and their holding companies in instances in which civil money penalties and other regulatory enforcement orders are assessed against an “institution affiliated party,” which includes officers and directors of an FDIC-insured institution, its subsidiaries and any parent holding company. Even though defense costs may be paid or advanced by an institution (and commercial insurance may be purchased to pay such expenses), the proceeds of the insurance cannot be used to pay for penalties assessed.

 

Mitigation Considerations for Officers and Directors

If there is a key conclusion that can be drawn from this discussion, it should be that individuals acting as officers and directors of financial intermediaries should engage in advance planning and clearly understand the nature of their rights in regard to administrative enforcement actions that might be brought by one of the federal banking agencies or the CFPB. Importantly, when complying with his or her duty of care, an officer or director should ensure that the record reflects reasonable steps to comply with that standard.

 

In that regard, an officer or director should be provided with legal advice as to what degree of diligence and review should be incorporated into the decision-making process, as well as how that process is reflected in the records of the institution. Particularly in the case in which the business judgment rule is available, the business records of the entity should reflect that all appropriate steps were taken prior to decisions being made.

 

It should be noted, however, that a distinction should be drawn between an FDIC receivership claim and assessment of civil money penalties by the CFPB or one of the federal banking agencies. In the case of a receivership claim following a bank failure, the above-referenced duty of care for personal liability purposes (e.g., negligence, gross negligence, etc.) is most often a determinative factor. However, in the administrative context in which civil money penalties are being assessed, culpability need not be based upon the failure to comply with a duty of care, but rather, can be based upon an institution’s compliance or non-compliance with an enforcement order previously issued in which officers and directors are ordered to take specific remedial steps to achieve compliance.

 

A Methodology for Determining and Achieving Reasonable Risk Mitigation to Avoid Personal Liability

As even the casual observer can see, being an officer or director for a financial institution—whether FDIC-insured or otherwise—presents a range of challenges. Complicating the situation is the nature of legal representation of companies, in that counsel for a company is usually not deemed to be providing individual legal advice to officers or directors, and hence the use of in-house counsel or a company’s outside lawyers to provide personal advice may not be appropriate or available in all cases.

 

We suggest that several steps be considered to address the concerns discussed by this article.

 

First, as noted above, officers and board members should obtain an overview of the rules governing compliance with the duty of care applicable to the company, including how courts and agencies have interpreted those rules. Among other things, identifying process issues and evidencing development of policies and procedures is essential, as well as ensuring that business records reflect robust discussion and reasonable reliance on experts (i.e., to be able to take advantage of the business judgment rule).

 

Second, a corporate governance review should take place to determine whether corporate documents such as articles and bylaws include the most favorable indemnification rights permitted under applicable law. (In that regard, it is important to note that in most cases such protections are optional under state corporate law and must be affirmatively adopted by a company’s board of directors.)

 

Third, employment agreements and indemnification agreements should be reviewed and updated on an annual basis to maximize contractual rights for designated officers and directors.

 

Fourth, extreme care should be exercised when transactions or other matters arise in which the director or officer may be seen as having a conflict of interest. All corporate processes should be followed, including full disclosure of the nature of the conflict, approval of the matter by a majority of disinterested directors, advice of counsel, etc.

 

Fifth, directors should work with management to establish internal tracking systems on matters requiring attention (“MRA”) arising out of regulatory examinations. Repeat violations of law or failure to remediate troublesome conditions by the next examination can be seen as a lack of proper board oversight. Careful attention should be given to the regulators’ evaluation of management and appropriate action taken when poor ratings are given. However, reliance on the regulators’ evaluations of management alone may not be sufficient because it appears that regulatory evaluations of management in many cases of failed banks have not been significantly downgraded by the regulators until a year or two before the bank’s failure. (Cornerstone Research, supra.)

 

Finally, a legal review of a company’s directors’ and officers’ liability insurance policies should be conducted and benchmarked against similar institutions in similar circumstances. It should also be noted that the contractual terms of directors’ and officers’ liability policies are frequently negotiable, and can result in valuable additional liability protection.

 

Other Standards of Liability Impacting Officers and Directors of a Financial Company

Although this article focuses on corporate and banking liability standards applicable to officers and directors of a financial intermediary, other standards of care arise in particular circumstances as part of the performance of the activities of an officer or director of a financial company. For example, in several instances under the federal securities laws, a corporate officer for a registered company can be held liable in civil or SEC actions for material misstatements in offering materials unless the director has engaged in a “due diligence” review. In regard to companies and “institution affiliated parties” that are subject to Section 8 of the FDI Act, liability might be viewed as a strict liability standard if a federal banking agency views the actions of an officer or director as having engaged in a violation of a federal law, regulation, or unsafe or unsound banking practice. Similarly, the newly established CFPB may also directly access civil money penalties and other remedial measures if an officer or director has participated in the violation of a covered federal consumer protection law.

 

Please note that this article summarizes several complex liability topics and by its nature is a starting point for further inquiry by officers and directors of banks and non-banks participating in the financial services industry.

 

Joseph T. Lynyak III is a partner in the Finance practice at Pillsbury Winthrop Shaw Pittman LLP in Washington, D.C., and Los Angeles. He can be reached at (213) 488-7265 or joseph.lynyak@pillsburylaw.com.

 

Rodney R. Peck is a partner in the Corporate & Securities practice at Pillsbury in San Francisco. He can be reached at (415) 983-1516 or rodney.peck@pillsburylaw.com.

 

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One of the most vexing problems that can arise in the D&O claims context is when the amount of insurance available proves to be insufficient to resolve the pending claims. Although this problem can arise in many claims contexts, one particular context in which the problem can arise is in the context of claims by the FDIC as receiver of a failed bank against the bank’s former directors and officers.

 

In the following guest post, John F. McCarrick takes a look at these issues in the failed bank context and proposes a solution. John is a partner in the New York offices of the law firm White and Williams LLP, and focuses his practice on director and officer liability and related insurance coverage issues. The comments in this article are those of the author and do not represent the views of White and Williams LLP or any of its clients.

 

I would like to thank John for his willingness to publish his guest post on this site. 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 John’s guest post. 

 

            It’s a point of increasing discussion – and heated debate – in FDIC claims against the directors and officers of failed banks: the available D&O insurance limits of liability are insufficient to meet the FDIC’s settlement expectations, Who bears responsibility for purchasing adequate bank D&O insurance limits? And who should be blamed if the available D&O insurance coverage proves to be insufficient? To make matters worse, quantifying adequate D&O insurance is akin to aiming at a moving target. D&O insurance is a wasting asset; amounts spent on defense costs and on resolving non-FDIC claims reduce – on a dollar-for-dollar basis – the limits of liability left to settle an FDIC claim made during that same policy period. Should defendant directors and officers of a failed bank be expected to contribute to settlements out of their own, now-thinner wallets. Is this a fair outcome? On a more practical level, isn’t there a better way to avoid this outcome?

 

The Scorecard to Date

Since January 1, 2007, 467 U.S. financial institutions have failed. Of this total, the FDIC thus far has sued the directors and officers of 40 failed banks, and has reported agency authorization to file an additional 49 lawsuits. According to Cornerstone Research, the failures of the 40 institutions that are the subject of FDIC-initiated D&O lawsuits had a median estimated cost to the FDIC of $134 million.   Only six of these lawsuits had settled as of December 2012.

 

One FDIC case has gone to trial. On December 7, 2012 a jury in federal court in Los Angeles awarded $169 million to the FDIC in its suit against three former officers of IndyMac. Given the absence of significant personal assets of the three former IndyMac officers to satisfy this judgment, the FDIC is seeking to intervene in pending coverage litigation in an effort to recover some or all of the remaining D&O limits from IndyMac’s 2007 and 2008 D&O insurance towers. However, even a complete win by the FDIC in the D&O coverage litigation would allow the FDIC to recover just a percentage of the awarded jury verdict.

 

            The FDIC’s track record in settlement recoveries is not significantly better. The chart below shows reported settlement amounts compared to FDIC estimated losses.

Name of Institution	FDIC Est’d Cost of Failure	Claimed Damages in Complaint	Settlement Amount
	(Millions)	(Millions)	(Millions)
Westsound Bank	$108	$15	$2
County Bank	$135	$42	TBD
Heritage Community Bank	$42	$20	Not Reported
Washington Mutual Bank	$0	TBD at Trial	$64[1]
First National Bank of Nevada	$862	$193	$40
Corn Belt Bank & Trust Co.	$100	$10	Not Reported

Source: Cornerstone Research,Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions (December 2012)

 

 

Shortly after the above Cornerstone Research report was issued, former IndyMac CEO Michael Perry reportedly reached an agreement with the FDIC to settle the FDIC’s lawsuit against him for a payment by Perry of $1 million out of his own assets plus an additional $11 million in potential insurance funds through an assignment of Perry’s rights under his D&O policies.

 

With respect to the FDIC D&O cases still pending, the insured deposit losses paid by the FDIC in each case generally far outstrip the available D&O insurance proceeds. Moreover, because each failed bank’s D&O policies must respond to not only FDIC claims, but also other potential sources of D&O claims, including for example, shareholder and derivative claims, debtor claims brought by or on behalf of the bank holding company and claims brought by creditors of the failed bank, the FDIC is often faced with a materially-depleted insurance asset when it comes time to settle FDIC litigation against the directors and offices of a failed bank. To make matters worse (for the FDIC), the available limits of liability under D&O policies are eroded on a dollar-for-dollar basis by defense costs incurred prior to any settlement across all of these categories of claims and in defending collateral regulatory investigations. 

 

A Solution That is Not Novel

If the perceived inadequacy of D&O insurance limits is an issue of real concern for the FDIC, there is a simple solution to this problem: use the FDIC’s regulatory authority to require the purchase of D&O insurance limits in an amount proportional to the amount of risk created for the FDIC by aggregate insured deposits. This approach is by no means novel or creative: in fact, the FDIC already mandates that banks purchase fidelity bond insurance coverage.

 

By statute, the Federal Deposit Insurance Company can require insured financial institutions to maintain fidelity bonds to insure against such losses, and the FDIC has chosen to mandate that requirement. Other federal banking regulators, as well as most state regulators, also require universal fidelity coverage. For instance, the Comptroller of the Currency requires national banks to have "adequate fidelity coverage."

 

Similar mandatory purchases of fidelity bond coverage are detailed in the Employee Retirement Security Act of 1974, as amended (“ERISA”). ERISA Section 412(a) requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of the plan must be bonded, with limited exceptions.

 

The amount of the ERISA fidelity bond is fixed at the beginning of each plan year and cannot be less than 10 percent of the amount of the funds handled. The amount of funds handled is determined by the amount of funds handled by the person, group, or class to be covered by the bond and by their predecessor(s), if any, during the previous reporting year.[2]

 

The FDIC also presumably has the authority to specify the kinds of D&O products most directly accessible for primarily FDIC recovery purposes. The following chart shows some of the obstacles faced by the FDIC, and the D&O insurance market solutions that have developed in response to similar concerns raised by other kinds of D&O insureds.

 

Types of Available D&O Insurance

FDIC Perceived Concern	Available D&O market solution	Comments
Inadequate insurance limits	Ample D&O limits capacity through U.S., Bermuda and Lloyd’s markets	Limits could be tied to FDIC exposure for insured deposits, as a correlated percentage of those deposits
Dilution of available limits	Side-A D&O insurance	Side A limits are preserved for claims against D&Os when advancement or indemnification from the bank is unavailable due to its insolvency, and provides no coverage for the bank’s own liability
Preserved limits for potential FDIC claims	Side-A insurance potentially sitting excess of a traditional ABC D&O tower	Underlying limits would be used for defending and resolving competing D&O claims, including by shareholders and creditors, preserving limits for a more limited set of liability exposures above the standard D&O limits
Denial of coverage by underlying D&O insurers	Side A DIC insurance	DIC (Difference-in-conditions) contains, as one coverage trigger, a denial of coverage by an underlying D&O insurer

So why are these D&O market solutions available now, and why weren’t they available in the late 1980s during the last significant wave of bank failures?

 

The Changed Landscape for Bank D&O Liability -- and for D&O Insurance

The battleground over available D&O insurance for regulatory claims over failed banks bears little resemblance to that of the so-called S&L crisis of the late 1980s. Although D&O insurance had been available for 30-odd years before the wave of FDIC/RTC litigation against failed banks and S&Ls, D&O insurance was still, in the late 1980s, a relatively immature insurance product -- one that had been designed primarily for public companies and their directors and officers facing shareholder class actions and derivative litigation exposures.

 

The S&L crisis and accompanying D&O litigation brought by banking regulators arguably comprised the first systemic loss event for the financial institutions sector of the D&O insurance industry, and the industry’s arsenal of defensive weaponry -- in the form of “insured v. insured” exclusions, regulatory exclusions, aggregation of losses and multiple deductibles -- were tested, to varying outcomes, in state and federal courts throughout the United States. The experience was both difficult and instructive for D&O insurers and bank policyholders. As a result of that experience, D&O underwriters became more aware of the size and scope of potential claims involving bank insureds, and began underwriting to a fuller set of potential exposures. Buyers of D&O bank policies obtained more certainty about how the policies would respond in the event of a bank failure.

 

In the intervening years since the S&L crisis, there have been two major developments impacting bank D&O insurance. The first is that a series of lengthy competitive (or “soft”) underwriting market cycles (punctuated by short “hard” markets) has led to a material broadening of D&O policy terms across all underwriting segments, such that the typical D&O policy of today is materially broader in scope than the typical D&O policy of 1987. Expanded insuring agreements, key definitions and liberalizing endorsements, coupled with narrower exclusions and exclusion triggers, have collectively resulted in a materially broader D&O insurance contract, covering a wide range of entity and individual insureds. 

 

A related development has been an increase in the number of insurers willing to sell D&O policies. This increase in competition, coupled with broader D&O policy terms, has meant that D&O buyers could purchase materially broader coverage from a larger number of insurers, at lower prices.   D&O insurers also now offer a number of other related D&O insurance products, such as Side-A only coverage, independent director liability coverage, and investigations coverage to D&O insurance buyers.

 

The foregoing is an overly-abbreviated list of significant changes relating to D&O insurance that have had the intended effect of making D&O insurance available to buyers on materially better (and broader) terms, and at lower prices. Banks have benefitted from these insurance market developments, and D&O insurance is a routine – albeit voluntary -- purchase for large and small banks in the United States.

 

 The second significant development relating to bank D&O liability insurance since the late 1980s is that banks have materially changed the way they operate and make money. There are numerous reasons why banks have changed their business models since the late 1980s but here are a few of the most significant reasons:

 

1.      The repeal of Sections 20 and 32 the Glass-Steagall Act in 1999 allowed larger banks to engage in commercial activity outside traditional bank deposit and lending activities, including investment banking, securities underwriting and insurance, and even smaller banks were forced to adapt their business models;

2.      The rise of mortgage securitizations encouraged banks to sell off their mortgage portfolios, and focus on earning money primarily through loan initiation fees; and

3.      Proprietary trading allowed banks to make money by trading for their own accounts.

 

Of course, not all banks engaged in all of these activities; however, market competition among banks is being increasingly driven by their success in business activities outside traditional bank deposit and lending activities. In the wake of the credit crisis, it is clear that these non-banking activities have the ability to generate – and indeed, have generated -- significant D&O and professional liability claims activity from shareholders, customers, creditors and non-banking regulators, posing significant competition for the very D&O insurance limits the FDIC targets as its primary source of recovery in failed bank D&O litigation.  

 

These two significant developments -- broader D&O polices sold for lower premiums and a potentially broad range of business activities carried out under a bank banner -- set the stage for a drastically different test for the next wave of bank failures.

 

That next wave of bank failures arrived beginning in 2008 courtesy of the so-called subprime crisis. Falling house prices undermined the packaged securities holding residential mortgages, leading to a near collapse in credit availability, choking off cash flow for banks and their customers.

 

Of the banks most significantly impaired by the credit crisis, some banks were acquired by larger, more stable banks – with some unfortunate results. Other banks simply failed, requiring the FDIC to compensate depositors for their insured deposits, and place the failed banks into an unduly liquidation process. Litigation inevitably followed -- not just by the FDIC, but also by shareholders of bank holding companies, bank employees whose 401(K) retirement savings were held in the bank’s now worthless stock, and bank creditors too.

 

The FDIC does not appear to have kept up with the collateral liability and D&O insurance developments impacting the financial institutions whose customer deposits the FDIC insures. But, as discussed above, there appear to be some relatively simple fixes available.

 

For example, the FDIC could require that a bank purchase a minimum level of insurance limits of Side-A D&O coverage, under the reasoning that the FDIC would not want its regulated limits of liability impaired by defense costs, settlements or judgments payable to other claimants by, for example, the insured entity or non-officer employees. Such a required purchase would not prohibit a bank or bank holding company from purchasing broader types of D&O policies including, for example, conventional D&O policies that insure the named entity for securities related claims and other non-FDIC claims.

 

It is not the ordinary preference of bank managers (or the bank’s shareholders) to allocate substantial additional monies each year to D&O insurance premiums. Moreover, bank D&O insurance rates increase across the board when – as was the case in 2007-2010 -- the entire industry sector is financially weakened. Nevertheless, it seems apparent that a scenario in which defendant directors and officers of failed banks must make personal settlement contributions to facilitate the settlement of an FDIC claim in light of impaired or otherwise inadequate D&O insurance limits proves the point that current models used in estimating and purchasing appropriate bank D&O limits are flawed, and negatively impact the FDIC’s ability to obtain a reasonable recovery for taxpayers -- while placing bank managers’ personal assets at great risk.

 

This type of solution probably would not have been feasible in the late 1980s, when fewer than 10 insurers regularly underwrote D&O insurance. Today, there are more than 60 insurers selling D&O insurance for U.S. risks, enhancing the ability of banks to secure necessary additional limits of liability from numerous well-capitalized D&O insurers. Of this number, 26 carriers also actively underwrite Side A D&O insurance, suggesting that there are numerous purchasing choices for D&O insurance in general, and Side A insurance, in particular.

 

Conclusion

Neither policyholders nor D&O insurers favor unnecessarily outsized settlements of bank D&O claims, and there is always a legitimate concern that policyholders could be waste money unnecessarily on overly large or complex D&O insurance programs. On the other hand, absent some compelling reasons -- such as fraud, self-dealing and the like – it is a questionable rationale for the FDIC to demand personal settlement contributions from directors and officers of failed banks based primarily on allegations of simple negligence and for failing to procure sufficient D&O insurance to meet the FDIC’s resolution expectations. If indeed a key driver of demands for personal contributions by the FDIC is inadequate amounts of D&O insurance, there is an easy fix to that problem.

 

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The FDIC’s filing of lawsuits against former directors and officers of failed banks increased “markedly” during the fourth quarter of 2012 after a “lull” during the second and third quarters of the year, according to a new study from Cornerstone Research. The study, released December 18, 2012 and entitled “Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions” can be found here. Cornerstone Research’s December 18 press release about the study can be found here.

 

As of December 7, 2012, the FDIC has filed a total of 23 lawsuits this year, compared to 18 total filed during 2010 and 2011. The FDIC filed nine lawsuits (so far) during the fourth quarter, the same as during the fist quarter, compared to two during the second quarter and three during the third quarter. The 41 lawsuits overall relate to 40 different financial institutions, meaning that so far the FDIC has filed lawsuits in connection with nine percent of the 467 financial institutions that have failed since January 1, 2007.  

 

(Since the December 7 closing date for the Cornerstone Research report, the FDIC has filed one additional lawsuit {refer here, second item} , bringing the quarter to date total to ten, the total this year to 24, and the total overall to 42. For clarity’s sake, throughout this post I have referenced the data used and analyzed in the Cornerstone Research study, rather than attempting to update it to reflect the additional lawsuit.)

 

The FDIC’s D&O lawsuits generally have targeted larger failed institutions and those with a higher estimated cost of failure, though the lawsuits the FDIC filed during he second half of 2012 have involved smaller and less costly failures. Overall the failed banks that have been targeted had median total assets of $647 million, compared to $225 million total assets for all failed banks. However, the failed banks targeted during the third and fourth quarters had median total assets of $136 million and $154 million respectively. The median estimated cost to the FDIC for the failed banks that the FDIC has targeted in D&O litigation has been $134 million, compared to a median estimated cost for all failed banks of $55 million. However, during the third and fourth quarters of 2012, the median total costs of failed banks that the FDIC has targeted in D&O litigation was $27.3 million and $58 million, respectively.

 

Most of the FDIC’s D&O lawsuits have included both officer and directors defendants. Only 11 of the 41 lawsuit the FDIC has filed have involved only officer defendants. 30 of the lawsuits have also involved director defendants, including seven of the nine lawsuits filed so far during the fourth quarter.

 

One particularly interesting observation in the report relates the failed institutions’ CAMELS ratings in the period preceding the banks’ closures. The CAMELS rating ranks the institutions on a scale of 1 to 5, with 1 being the best score and 5 the lowest. (The CAMELS ratings are not public, but in the agency’s loss review of failed institutions includes a short history of the failed bank’s examination ratings.) The study reports that 86 percent of the institutions subject to FDIC lawsuits had composition ratings of 1 or 2 two years prior to their closure. Not until one to two years prior to failure did any of the institutions have a composite rating of 4 or 5, and 36 percent of the institutions still had a rating of 2 one year prior to closure. The report concludes that “Weak ratings were not a persistent historical problem for this group of institutions. The decline in ratings occurred near the end of their independent existence.”

 

The study also includes a helpful summary of all of the FDIC lawsuits that have settled so far, although readers should note that the recent settlement of IndyMac CEO Michael Perry (about which refer here) is not reflected on the settlement table on page 11 of the study. The Perry settlement is referenced in the text of the study.

 

The report notes that the number of lawsuits that the FDIC has filed lags the number of lawsuits that the FDIC has authorized. (The updated number of authorized lawsuits can be found on the FDIC’s website, here.) The report notes that the difference between the number of lawsuits authorized and the number filed increased during 2012. The report comments that “this backlog of authorized lawsuits, the FDIC”s recent success in the IndyMac trial, and the approaching end of the statute of limitations for making a claim against the numerous institutions that filed in 2009 and 2010 suggest that substantially more FDIC cases may be filed in upcoming months.”

 

Discussion

The Cornerstone Research report’s statement that the FDIC has initiated lawsuits in connection with nine percent of the banks that have failed since 2007 is interesting. Just to put that into perspective, during the S&L crisis, the FDIC (and other federal banking regulators) filed D&O lawsuits in connection with 24% of all failed institutions. If the FDIC were to file D&O lawsuit in connection with 24% of all failed institutions this time around, that would imply that the FDIC would ultimately file about 112 lawsuits (based on the number of banks that have failed so far since 2007).

 

 As it turns out, the final number of FDIC lawsuits might well get into that range, as the FDIC’s most recent update indicates that the agency has authorized lawsuit in connection with 89 institutions (or about 19% of the banks that have failed so far). The FDIC has increased the number of authorized lawsuits each month this year, so the authorized number of suits could quickly get reach as high as the implied 112 number of suits.

 

The study’s report that the more recently filed lawsuits involve smaller institutions than the earlier lawsuits had targeted is really not a surprise. The very largest banks that failed during the current banking crisis failed early on. For example, the two largest failures this time around, WaMu and IndyMac, both failed in 2008, and were among the first failed banks that the FDIC targeted in failed bank litigation. It may not be so much that the FDIC is targeting smaller institutions as such now, it may simply be that there are larger failures were the first to work their way through the system.

 

The analysis of the failed banks’ CAMELS ratings is also interesting. The implication of the analysis is that the banks that failed deteriorated rapidly. The failed institutions’ relatively high ratings until just prior to their closure seems consistent with the argument that many of the individual defendants are raising in their defense – that is, that the failure of their bank wasn’t the result of anybody’s fault; rather it was the outcome of problems that no one, including the FDIC itself, saw coming.

 

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IndyMac CEO Michael Perry has reached an agreement with the FDIC to settle the lawsuit the agency filed against him in the Central District of California in July 2011 in its capacity as receiver of the failed bank. In the settlement agreement, filed with the court on December 14, 2012,  Perry agreed to pay $1 million out of his own assets plus an additional $11 million in insurance funds. However, the insurers are not parties to the agreement; rather, the FDIC has accepted Perry’s assignment of his rights under the insurance policies, which the FDIC apparently will now seek to assert against the insurers. The parties’ stipulation of dismissal, to which their settlement agreement is attached, can be found here.

 

Perry’s settlement comes just a week after a jury entered a $168.8 million verdict in the separate case the FDIC filed against three other IndyMac officers. The agency filed the two lawsuits separately as part of an apparent strategy in the separate case against the three officers to recover under a second $80 million tower of D&O insurance. As noted here, in July 2012, Judge Gary Klausner held in a related insurance coverage action that all of the various IndyMac lawsuits relate back to the first lawsuit to be filed, and therefore only trigger a single tower of insurance. Klausner’s ruling is on appeal.

 

Just as the FDIC’s separate lawsuit against the three officers appears to be a part of an insurance-oriented strategy, the FDIC’s settlement with Perry also appears in large measure to be about the D&O insurance. (To be sure, Perry will also be paying $1 million out of his own pocket, but the remainder of the agreement pertains to the insurance issues.)

 

The settlement agreement specifies that the Insurers shall pay the $11 million insurance portion of the settlement within 30 days. However, the insurers are not parties to the agreement, and the agreement appears to fully anticipate that the insurers will not in fact fund the $11 million insurance portion. The settlement agreement includes detailed provisions for the assignment of Perry’s rights against the insurers, including his rights for alleged “breach of the covenant of good faith and fair dealing.” (Perry expressly reserves his rights to try to recover from the insurers his past and future attorneys’ fees.) The agreement specifies that Perry is not personally liable of the $11 million insurance portion of the settlement.

 

The settlement agreement recites that on July 20, 2012, certain of IndyMac’s D&O insurers (that is, insurers in the so-called first tower of insurance) filed an interpleader action in the Central District of California. As I previously noted on this blog in connection with the insurance issues in this case, IndyMac’s collapse has led to multiple lawsuits involving multiple parties, creating competition among the various claimants for the dwindling amounts of insurance available as accumulating defense expenses erode the available limits. Brian Zabcik’s December 14, 2012 Am Law Litigation Daily article about Perry’s settlement with the FDIC  (here) quotes Perry’s counsel as saying that “Perry decided to settle the FDIC’s lawsuit in large part because the insurance funds available to fund his defense had been exhausted by all the various lawsuits brought against former IndyMac officers and directors,"

 

Perry’s settlement agreement with the FDIC specifies that the FDIC “agrees that, in its capacity as Mr. Perry’s assignee, it shall take no position in the Interpleader Action inconsistent with Mr. Perry’s position that the Insurers are obligated to fund other settlements to which Mr. Perry is a party.” (Among the other settlements identified in Perry’s settlement agreement with the FDIC is the $5.5 million settlement in IndyMac securities class action lawsuit known as the Tripp litigation, about which refer here.)

 

In other words, it appears that the $11 million insurance portion of Perry’s settlement with the FDIC basically represents a claim check for the agency to try to redeem in the interpleader action. Because there are numerous other claimants each attempting to assert their own claims to the insurance proceeds, it will remain to be seen how much of the $11 million insurance portion of its settlement with Perry the FDIC will ultimately collect.

 

As discussed here, the FDIC filed its lawsuit against Perry, in its capacity as receiver for Indy Mac bank, in July 2011. The FDIC’s complaint against Perry alleged that he caused over $600 million in losses by having the bank 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.

 

Interestingly, in its settlement stipulation with Perry, the FDIC expressly acknowledges that the FDIC’s complaint “does not allege that Mr. Perry caused the Bank to fail or that he caused a loss to the FDIC insurance fund.” Nevertheless, on December 14, 2012, the FDIC entered – apparently with Perry’s consent – an Order of Prohibition from Further Participation (here) reciting that Perry “engaged or participated in unsafe or unsound banking practices” at IndyMac; that these practices "demonstrate [his] unfitness" to serve as a director or officer at any FDIC-insured institution; and prohibiting him from involvement in any financial institution. The Am Law Litigation Daily article quotes Perry’s counsel as saying with respect to this order, to which Perry consented, that “the FDIC extracted this condition at the eleventh hour because they could,” and that “the FDIC knew Perry was out of insurance funds, and they took advantage of the situation."

 

Yet Another FDIC Lawsuit Involving a Failed Georgia Bank: For whatever reason, the FDIC’s lawsuits against former directors and officers of failed banks have been disproportionately concentrated in Georgia. On December 13, 2012, the FDIC filed yet another failed lawsuit in connection with a failed Georgia bank. A copy of the FDIC’s complaint, filed in the Northern District of Georgia against three former officers and four former directors of the failed RockBridge Commercial Bank of Sandy Spring, Georgia, can be found here.

 

RockBridge was closed by regulators on December 18, 2009. The complaint asserts claims against the seven individual defendants for negligence, gross negligence, and breach of fiduciary duty. In connection with the defendants alleged “numerous, repeated and obvious breaches and violations of the Bank’s Loan Policy and procedures, underwriting requirements, banking regulations, and prudent and sound banking practices,” as “exemplified” by 16 loans made between February 14, 2007 and November 12, 2008, which allegedly caused the bank losses of in excess of $27 million.

 

Interestingly, one of the defendants, Arnold Tillman, who has filed for Chapter 7 bankruptcy, was sued with leave of the bankruptcy court and “nominally to the extent of insurance coverage only.” (The FDIC proceeded in the same fashion against several individual defendants in the lawsuit it filed in November 2012 in its capacity as receiver of the failed Community Bank of West Georgia, of Villa Rica, Georgia, as I discussed in a prior post, here – second item in the blog post.)

 

The FDIC’s assertion of claims for ordinary negligence against the former directors and officers of RockBridge is interesting in light of the now several district court decisions holding that under Georgia law officers cannot be held liable for claims of ordinary negligence, as was discussed in a recent guest blog post on this site (This issue is now on an interlocutory appeal to the 11^th Circuit in the Integrity Bank case.) The FDIC anticipated this argument, and specifically alleges in paragraph 58 of the complaint that the defendants are not entitled to rely on the business judgment rule and therefore liable for ordinary negligence.

 

The FDIC’s complaint against the former Rockbridge directors and officers is the 14^th that the agency has filed in connection with a failed Georgia bank and the 42^nd that the agency had filed overall, meaning that the FDIC’s D&O lawsuits involving failed Georgia banks represent one-third of all of the D&O lawsuits the agency has filed. The FDIC’s lawsuits against the failed Georgia banks represents a disproportionately high percentage of D&O suits; even though Georgia has had more bank failures than any other state, closed bank in Georgia still represent only about 18% of all bank failures. For whatever reason, the FDIC seems to be concentrating its litigation activity in Georgia. Indeed, the last four suits the agency has filed have involved failed Georgia banks.

 

Readers that follow the failed bank litigation closely will be interested to note that on December 11, 2012, the FDIC updated the page on its website that reports statistics and information on the agency’s failed bank litigation. In the latest update, the agency reports that it has authorized suits in connection with 89 failed institutions against 742 individuals for D&O liability. This includes 42 filed D&O lawsuits involving 41 institutions and naming 331 former directors and officers, inclusive of the latest suit against the former RockBridge directors and officers. The agency clearly will be filing many more lawsuits in the weeks and months ahead.

 

Special thanks to a loyal reader for providing a copy of the RockBridge complaint. Scott Trubey’s December 14, 2012 Atlanta Journal Constitution article about the FDIC’s latest lawsuit can be found here.

 

More About Securities Class Action Opt-Outs: In a recent post, I noted that the incidence of securities class action opt-outs seemed to be on the increase. In the prior post, I referred specifically to the high profile institutional investors that had chosen to opt out of the Pfizer securities litigation. Now it appears that there have been significant opt outs from the Citigroup subprime-related securities class action lawsuit settlement, as well.

 

As discussed here, in late August 2012, the parties to the high-profile Citigroup subprime-related securities class action lawsuit agreed to settle the case for $590 million, subject to court approval. However, as discussed in Nate Raymond’s December 13, 2012 On the Case blog post (here), several significant institutional investors have elected to opt out of the more than half a billion dollar settlement and are pursuing their own separate actions. The article, which notes that “opt-outs have become a regular feature fixture in any big securities class action,” reports that a total of 134 investors have chosen to opt out of the Citigroup settlement, including some institutional investors that had filed separate individual actions as long as two years ago.

 

The article notes that institutional investors choose to opt out where they think they can improve their recoveries by proceeding separately from the class. The article notes that this approach is “not without its risks,” including the exposure of the opting-out party to full discovery, depositions and document discovery.” Given these concerns, the allure for institutional investors in opting out will only be there, according to one commentator quoted in the article, if “the losses are substantial enough to grab the defendants’ attention.” The rise in class action opt-outs carries risks for defendants as well, as they are unable to ensure “global peace” through the class settlement, and even run the risk of the opt-outs triggering the “blow up” provision in the class settlement agreement.

 

As I noted in my recent post about opt-outs, class action lawsuits have for many years been a favored whipping boy for conservative commentators. But for all of the ills that the class action process can sometimes involve, the prospect of a litigation process in which mass group claims are fragmented and can only be resolved in a piecemeal fashion is no improvement. Given the apparently increasing institutional investor interest in pursuing claims separate from the larger investor class, we could very quickly be getting to the point where resolution of class litigation is only one part of a multistep process, at least in the class action lawsuits where larger losses are at issue.

 

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As I noted in a post earlier this week, last Friday a jury in the Central District of California returned a $168.8 million verdict in the lawsuit the FDIC filed in its capacity as receiver of the failed IndyMac bank against three former officers of the bank. The verdict has occasioned a great deal of commentary. A particularly interesting review of the D&O insurance issues involved can be found in a December 11, 2012 post on Alison Frankel’s On the Case blog (here).

 

I am pleased to present below a guest post from Mary C. Gill and Austin Hall of the Officers & Directors of Distressed Financial Institutions team at the Alston & Bird law firm, in which they discuss their views regarding the verdict and the verdict’s potential relevance for other pending FDIC failed bank cases – or lack thereof.

 

 

My thanks to Mary and Austin for their willingness to publish their guest post  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 and Austin’s guest post.  

 

 

In the first trial of a case brought by the FDIC against former bank officers during this financial crisis, a California jury concluded that three former officers of a division of IndyMac Bank, F.S.B. (“IndyMac”) are liable under California law for negligence and breach of fiduciary duty to the FDIC. FDIC v. Van Dellen,Case No. 2:10-cv-04915-DSF-SH (C.D. Cal.)(“Van Dellen”). On December 7, 2012, the jury in Van Dellen awarded the FDIC damages of $168.8 million following sixteen days of trial.  There are important distinctions, however, between the Van Dellen case and FDIC actions brought in other jurisdictions against former bank officers and directors. In the majority of these cases, the FDIC will be required to demonstrate that the former bank officers and directors committed gross negligence, which is far more difficult to prove than simple negligence or breach of fiduciary duty.

 

 

IndyMac was among the earliest and largest of the bank failures when it was closed on July 11, 2008. The Van Dellen complaint, which was filed in June 2010, was the first action brought by the FDIC against former bank officers, none of whom were directors, during this financial crisis. The FDIC filed a separate action in July 2011 against IndyMac’s former CEO, Michael Perry, which remains pending. FDIC v. Perry, Case No. 2:11-cv-5561 (C.D. Cal.).

 

 

The trial in Van Dellen involved the President and CEO of the IndyMac Home Builder Division, and its Chief Lending Officer and the Chief Credit Officer. The complaint focused upon twenty-three loans, which the FDIC contended were approved without adequate information and in violation of bank policies. With respect to each of these twenty-three loans, the jury concluded that one or more of the former officers were negligent and breached their fiduciary duties in approving the loan.

 

 

Under the federal statute that governs claims by the FDIC, 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. Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), 12 U.S.C. § 1821(k).  In many states, officers and directors are not subject to liability for negligence, either by statute or application of the business judgment rule, which generally protects officers and directors from personal liability for ordinary negligence. Thus, for example, FDIC claims for ordinary negligence brought against former bank officers and directors in Georgia have been dismissed.  FDIC v. Skow, Case No. 1:11-cv-0111 (N.D. Ga. Feb. 27, 2012), reconsideration denied (N.D. Ga. Aug. 14, 2012); FDIC v. Blackwell, Case No. 1:11-cv-03423 (N.D. Ga. Aug. 3, 2012); FDIC v. Briscoe, Case No. 1:11-cv-02303 (N.D. Ga. Aug. 14, 2012); FDIC v. Whitley, Case No. 2:12-cv-00170 (N.D. Ga. Dec. 10, 2012).  The Eleventh Circuit recently accepted an appeal in FDIC v. Skow, in which the FDIC seeks review of this issue under Georgia law. FDIC v. Skow, Case No. 1:11-cv-00111 (N.D. Ga. Nov. 19, 2012).   

 

 

The FDIC claims in Van Dellen were based upon California law, which affords directors, but arguably not officers, the protection of the business judgment rule from claims of ordinary negligence.   Prior to trial, the Van Dellen court held that the officers could not rely upon the business judgment rule under California law. This ruling was consistent with the earlier ruling in the action against IndyMac’s CEO, FDIC v. Perry.  In contrast, a 1999 decision from the Ninth Circuit Court of Appeals, which remains as binding precedent, held that under California law bank directors are protected by the business judgment rule from claims of ordinary negligence.  FDIC v. Castetter, 184 F. 3d 1040 (9th Cir. 1999)

 

 

Accordingly, the Van Dellen verdict cannot be viewed as a predictor of potential results in other cases, particularly those in which officers and directors are afforded the protection of the business judgment rule and the FDIC is required to demonstrate gross negligence.  

 

 

Alston & Bird’s Distressed Financial Institutions Team represents and counsels over 200 current and former directors and officers in over 40 distressed or closed financial institutions across the country. The team offers expertise and experience regarding regulatory enforcement actions and the unique fiduciary roles of bank directors in distressed bank situations, as well as providing advice on insurance coverage for bank directors and officers. The team also represents former bank directors and officers in over 80 claims by the FDIC for civil money damages. 

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On December 7, 2012, in a comprehensive victory for the FDIC in its capacity as receiver of the failed IndyMac bank, a jury in the Central District of California entered a verdict of $168.8 million in the FDIC’s lawsuit against three former officers of the bank. As reflected in the verdict form (a copy of which can be found here), the jury found that the defendants had been negligent and had breached their fiduciary duties with respect to each of the 23 loans at issue in this phase of the FDIC’s case against the three individuals

 

At the time its July 11, 2008 closure, IndyMac had assets of about $32 billion, making its failure the fifth largest bank failure in U.S. history. But though there have been a few larger bank failures, none have been costlier to the FDIC’s deposit fund. IndyMac’s collapse has cost the fund nearly $13 billion.

 

In June 2010, the FDIC filed against a lawsuit several former officers of the bank’s homebuilder division, in what was the first D&O lawsuit the agency filed during the current bank failure wave, as discussed here. The FDIC’s lawsuit sought to recover damages from the individual defendants for “negligence and breach of fiduciary duties” and alleged “significant departures from safe and sound banking practices.” As discussed here, in July 2011, the FDIC filed a separate lawsuit against IndyMac’s former CEO, Michael Perry.

 

As discussed here, trial in the FDIC’s case against the former homebuilder division officers began on November 6, 2012. The three individual defendants in the case that went to trial are: Scott Van Dellen, the former President and CEO of IndyMac’s Homebuilders Division (HBD), who was 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 was alleged to have approved a number of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is also alleged to have approved many of the loans. (The FDIC’s original complaint had named a fourth individual, William Rothman, as a defendant as well. According to pleadings filed in the case, Rothman settled with the FDIC in exchange for Rothman’s assignment to the FDIC of Rothman’s rights against IndyMac’s D&O insurers.)

 

According to news reports, the jury reached its verdict after 16 days of trial. During the trial, the defendants attempted to argue that they and the bank were victims of an unanticipated downturn in the housing market. The FDIC in turn argued that the bank officials disregarded danger signals about the housing market and continued to approve loans in order to meet production goals and obtain bonus compensation.

 

The jury verdict form reflects separate verdicts as to each of the 23 loans that were at issue in this phase of the trial of the case. With respect to each of the loans, the jury separately found that the specific defendants who were named as to each of the loans had been negligent and had breached their fiduciary duties. The jury assigned separate damages as to each of the loans as well. The separate damage awards total $168.8 million. However, each of the three defendants was held liable for differing amounts. All three of the defendants were named only with respect to 14 of the 23 loans. With respect to five of the 23 loans, only Van Dellen and Shellem were named, and as to four of the loans, Van Dellen alone was named. Thus the jury found Van Dellen liable as to all 23 of the loans, but found Shellem liable only as to 18 of the loams and found Koon liable only as to 14 of the loans.

 

The just completed trial apparently represents only the first trial phase of this matter. There apparently will be a separate trial phase that will address the FDIC’s allegations as to scores of other loans as well as allegations with respect to the bank’s loan portfolio as a whole. The FDIC apparently is seeking total damages of more than $350 million. In addition, the FDIC’s separate case against Perry, the bank’s former CEO, will continue to go forward as well.

 

Given the magnitude of the jury’s verdict, there undoubtedly will be post-trial motions and, after the conclusion of all remaining trial phases, appeals as well. One issue that likely will be subject of an appeal will be Central District of California Judge Dale Fischer’s October 2012 determination under California law that the three defendants, as former officers (but not former directors), could not rely on the business judgment rule and therefore could be held liable for mere negligence. (The potential appeal value of this issue for the defendants may be diminished somewhat due to the fact that the jury specifically found that the defendants had not only been negligent, but had also violated their fiduciary duty, suggesting that the defendants would still have been found liable even if they couldn’t be held liable for negligence).

 

While the jury verdict unquestionably represents a victory for the FDIC, the FDIC may face considerable challenges attempting to collect on the verdict. There may be little or no remaining D&O insurance out of which the FDIC might try to recover. As discussed at length here, in July 2012, Central District of California Judge Gary Klausner held in a related D&O insurance coverage case that all of the various lawsuits related to Indy Mac’s collapse (including the case that in which the jury verdict was just entered) were interrelated to the first-filed lawsuit, and thus triggered only the D&O insurance that was in force when the first suit was filed. Because all of the later-filed lawsuits related back to the first lawsuit, the later lawsuits – including the lawsuit in which the jury verdict was entered -- did not trigger a second $80 million insurance program that was in force when the later suits were filed. (The FDIC has filed an appeal of Judge Klausner’s ruling.)

 

In other words, unless Judge Klausner’s insurance coverage ruling is reversed on appeal, the only insurance available out of which the FDIC might be able to try to realize the amount of the jury verdict is whatever is left under the first tower of insurance. However, as I noted in a prior post, in pleadings that they filed in July 2012, the defendants represented to the court that defense fees incurred in all of the various IndyMac-related lawsuits, as well as settlements that had been reached in some of the suits, had exhausted or would soon exhaust the first tower of insurance.

 

Pleadings that the three individuals filed in the case state that “the FDIC specifically structured this lawsuit in order to reach the Tower 2 Policy.” Judge Klausner’s ruling in the insurance coverage case obviously upset the FDIC’s strategy in this case. The outcome of the appeal in the insurance coverage case may well determine whether or not the massive verdict the FDIC just won results in any significant monetary benefits for the agency.

 

This case was not only the first case the FDIC filed against the former directors and officers of a failed bank as part of the current bank failure wave, but it is also the first case to go to trial. Since the FDIC filed this suit back in July 2010, the agency has filed forty more cases against the directors and officers of failed banks. There undoubtedly will be more lawsuits yet to come. Many of the individual defendants named in these cases vigorously dispute the FDIC’s allegations. However, the jury verdict in the IndyMac case may communicate a sobering message about what it might mean to force a case all the way to trial. Given this verdict, it may now be even more unlikely that one of these cases would go to trial.

 

Scott Recard’s December 8, 2012 Los Angeles Times article about the jury verdict can be found here.

 

Special thanks to Thomas Long of the Nossaman law firm for sending me the jury verdict form. The Nossaman firm represented the FDIC at the IndyMac trial.

 

D&O Insurer, FDIC Settle Claims Against Former BankUnited Officials: The FDIC’s efforts to try to recover under failed banks’ D&O insurance do not always involve a lawsuit. Sometimes the FDIC asserts its claims in a demand letter that it presents to the former directors and officers of a failed bank, with a copy of the letter also send to the failed bank’s D&O insurers. Sometimes these kinds of letter demands result in a settlement without a lawsuit ever being filed. That apparently is what has happened in connection with the FDIC’s claims against former directors and officers of BankUnited, a Coral Gables, Florida bank that failed in May 2009, at least according to a December 6, 2012 article in the South Florida Business Journal.

 

As reflected here, on November 5, 2009, the FDIC, in its capacity as BankUnited’s receiver, sent a letter 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, a copy of which can be found here, 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.

 

In addition to the FDIC’s claims against former directors and officers of the failed bank, shareholders of the failed bank’s holding company (which is now bankrupt) filed a lawsuit against certain former bank directors and officers. The bankruptcy trustee asserted claims against the individuals as well.

 

According to the newspaper article, these various parties have reached a settlement agreement, subject to bankruptcy court approval, to divide the bank’s $10 million primary D&O insurance policy four ways: $3.5 million to the class action plaintiff; $2.5 million to the FDIC; $1.65 to the bankruptcy trustee; and the balance going to pay legal defense fees and other costs. The settlement agreement also allows the FDIC to attempt to pursue a recovery from the carrier that issued the bank’s $10 million first level excess D&O insurance carrier, which has refused to pay under its policy.

 

This settlement is interesting because it reflects the tensions that can arise when multiple claims have been asserted against the former directors and officers of a failed bank. When there are multiple claims and only limited insurance, the various claimants are put in competition with each other, as they each race to try to capture as much of the insurance as they can while at the same time accumulating defense fees erodes what little insurance there may be. The division here of the $10 million primary D&O policy reflects an effort between and among the various claimants to try to work out a split of the insurance  so that each of the various sets of claimants at least gets a part of the policy proceeds. The challenge for other claimants trying to work out similar deals in other cases is to try and get a deal done before defense fees exhaust the insurance fund.

 

Special thanks to a loyal reader for sending me a link to the article about the BankUnited settlement.

 

Civic Duty: I will be on jury duty this week. We'll see if anybody has the guts to allow me to remain in the jury box. If I am called, it may be a few days before I am able to resume normal blogging activities.  

 

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Insured depositary institutions continued to improve during the third quarter of 2012, while at the same time the number and percentage of “problems institutions” declined, according to the FDIC’s latest quarterly banking profile. The quarterly report for the quarter ending September 30, 2012, which the agency released on December 4, 2012, can be found here. The FDIC’s December 4, 2012 press release about the report can be found here.

 

According to the report, reduced expenses from loan losses and rising noninterest income helped the insured institutions’ earnings reach $37.6 billion in the third quarter, the highest quarterly earnings posted since the third quarter of 2006. The FDIC’s press release quotes FDIC Chairman Martin Gruenberg as saying that “this was another quarter of gradual bur steady recovery for FDIC-insured institutions.”

 

The FDIC also reported a decline in the number of “problem institutions” during the quarter, from 732 at the end of the second quarter of 2012 to 694 at the end of the third quarter. (A “problem institution” is an insured depositary institution that is ranked either a “4” or a “5” on the agency’s 1-to-5 scale of risk and supervisory concern. The agency does not release the names of the banks on its “problem” list.) The quarterly decline represented the sixth consecutive quarter that the number of “problem” banks has fallen, and it is the first time in three years that there have been fewer than 700 banks on the list.

 

The number of reporting institutions declined during the quarter, from 7245 at the end of the second quarter 2012 to 7181 at the end of the third quarter. The 694 problem institutions at the end of the third quarter 2012represented 9.66% of all reporting institutions, whereas the 714 problem banks at the end of the second quarter 2012 represented 10.10% of all reporting institutions. By way of comparison, at the end of the third quarter of 2011, there were 844 problem institutions, representing 11.35% of the 7436 institutions reporting as of September 30, 2011. At year end 2010, there were 884 problem institutions, representing 11.39% of all reporting institutions at the time.

 

The assets of the “problem banks” as of the end of the third quarter 2012 stood at $262.2 billion, down from $282.2 billion as of the end of the second quarter 2012. The problem institutions as of the end of the third quarter of 2011 represented assets of $339 billion. At the end of 2009, the 702 problem institutions at that time represented assets of $402 million.

 

Twelve institutions failed during the third quarter of 2012, the smallest number of failures in a quarter since the fourth quarter of 2008, when there were also 12. There were a total of 43 bank failures in 2012 through September 30, 2012. There have been seven more bank failures since that date, brining the 2012 YTD total as of December 4, 2012 to 50. Through December 4, 2011, there had been 90 YTD bank failures. At this point it appears that there will be fewer bank failures this year than during any year since 2008, when there were 25. Since January 1, 2008, there have been a total of 457 bank failures. The high water mark for bank failures was in 2012, when there were 157 – the highest annual number of bank failures since 18 years prior.

 

Still Another Failed Bank Lawsuit in Georgia: While the bank failure wave finally seems to be winding down, the follow-on litigation is still just ramping up. With the third year anniversaries of bank failures that occurred during the period with the most bank closures approaching, the FDIC clearly seems to be ramping up its failed bank litigation. On December 3, 2012, the FDIC filed yet another lawsuit against the former directors and officers of a failed Georgia bank. The FDIC’s complaint, filed in the Northern District of Georgia in its capacity as receiver for the failed First Security National Bank (FNSB) of Norcross, Georgia, can be found here.

 

FNSB failed on December 4, 2009, so the FDIC really went down to the three year statute of limitations wire on its FNSB filing. The FDIC’s complaint names seven former directors and officers as defendants. The FDIC asserts claims for both negligence and gross negligence, citing the defendants’ “numerous, repeated, and obvious breaches and violations of the Bank’s loan policy and procedures, underwriting requirements, banking regulations and sound bank practices” as “exemplified” by 17 loans made between December 20, 2995 and February 19, 2008, for which the agency seeks damages of no “less than $7.596 million.”

 

This latest complaint is the 41^st that the FDIC has filed against the former directors and officers of a failed bank as part of the current bank failure wave. It is also the 13^th the agency has filed involving a failed Georgia bank, meaning that over 31% of all failed bank D&O lawsuits have targeted failed Georgia banks. While Georgia has had more bank failures during the current bank failure wave than any other state, its approximately 80 bank failures represents only about 17.5 percent of all bank failures, meaning that the FDIC is pursuing a disproportionally high number of lawsuits in connection with failed Georgia banks, as I noted in greater detail in a recent post (here).  

 

Special thanks to a loyal reader for providing me with a copy of the FSNB complaint.

 

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Though the FDIC has filed failed bank lawsuits in a number of states during the current bank failure wave, the agency has filed a disproportionally large number of suits against former directors and officers of failed Georgia banks. On November 30, 2012, the FDIC filed yet another D&O lawsuit involving a failed Georgia bank, the twelfth the agency has filed involving a failed Georgia bank, out of 40 total lawsuits overall that it has filed.

 

On November 30, 2012, the FDIC as receiver of The Buckhead Community Bank filed a complaint in the Northern District of Georgia nine former directors and officers of the failed bank. Six of the individual defendants served only as directors, two served as both directors and officers, and one seved only as an officer. The FDIC’s complaint can be found here.

 

The individual defendants include the bank’s former Chairman, R. Charles Loudermilk, Sr. In addition to serving as the bank’s Chairman, Loudermilk was, according to the complaint, also the largest shareholder of the bank’s holding company. Loudermilk is the 85-year old founder of the rent-to-own company, Aaron’s Inc. Loudermilk was also the founder of Buckhead Community Bank as well.

 

The bank, which was located in the Buckhead neighborhood of Atlanta, failed on December 4, 2009. The FDIC’s complaint asserts claims against the defendants for negligence and for gross negligence and alleges that the defendants engaged in “numerous, repeated, and obvious breaches and violations of the Bank’s Loan Policy, underwriting requirements and banking regulations, and prudent and sound banking practices” as “exemplified” by thirteen loans and loan participations the defendants approved that cause the bank damages “in excess of $21.8 million.”

 

An interesting feature of the lawsuit is that the FDIC has included allegations of ordinary negligence. This is interesting because of the recent decision in the Northern District of Georgia in the Integrity Bank case, applying Georgia law and holding that because of their protection under the business judgment rule, directors cannot be held liable of ordinary negligence. In light of that earlier decision, it would seem that the defendants in the new lawsuit have a basis on which to seek to have the negligence claims against them dismissed.

 

The FDIC, in anticipation of this argument, has alleged (at paragraph 84 of the complaint), that the individual defendants are not entitled to rely on the business judgment rule because “none of the Defendants’ actions or inactions, which are the basis of the this negligence claim, was taken in good faith, nor were Defendants reasonably well-informed in taking such actions or inactions.”

 

 It should also be noted that the FDIC is pursuing an interlocutory appeal of the court’s order in the Integrity Bank On November 19, 2012, the Eleventh Circuit granted the FDIC’s request for leave to pursue an  interlocutory appeal, so there will likely be much more to be heard on this issue in the months ahead.

 

The FDIC’s lawsuit against the former directors and officers of The Buckhead Community Bank is the 40^th failed bank lawsuit the agency has filed as part of the current bank wave. Of these 40 lawsuit, 12 (including this latest suit) have been filed against former directors and officers of failed Georgia banks, or about 30 percent of all of the failed bank D&O suits that agency has filed so far. Georgia has had more bank failures than any other state, but with about 80 failed banks out of the more than 440 failed banks total, Georgia’s bank failures represented only about 18 percent of all failed banks. For whatever reason, Georgia’s failed banks are disproportionately represented among the bank failures that have led to FDIC failed bank litigation.

 

One final note about this case is that it was filed just days before the third anniversary of the bank’s failure. Because so many banks failure in the fourth quarter of 2009 and the first two quarters of 2010, it seems likely there will be many more suits just ahead. The FDIC has made it clear that further lawsuits are coming. On its website (here), the agency states that as of November 15, 2012, it has authorized suits in connection with 84 failed institutions against 700 individuals for D&O liability. This includes 40 filed D&O lawsuits naming 317 former directors and officers (these figures take this latest lawsuit into account). In other words, the agency has authorized as many as 44 additional lawsuits. For many months now, each time that the agency updates its website, the number of authorized lawsuits increases, so even more lawsuits likely lie ahead.

 

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The FDIC has been more actively filing failed bank lawsuits than may have been apparent. With the November 20, 2012 update to its online list of failed bank lawsuits, the FDIC made known that it has in recent weeks filed a number of lawsuits that had not previously hit our radar screens. In addition to the agency’s recently filed lawsuit in Georgia (which I discussed in a recent post, here, second item), the agency has also recently filed three additional lawsuits in West Virginia, California and Florida, bringing the total number of failed bank lawsuits the FDIC has filed during the current bank failure wave to 39.

 

The FDIC filed the first of these three additional lawsuits on October 26, 2012 in the Southern District of West Virginia. Acting in its capacity as receiver of the failed Ameribank, of Northfork, West Virginia, the agency has sued five of the bank’s former officers for the defendants alleged negligence, gross negligence and breach of fiduciary duty in allegedly improperly delegating their duties and for failing to properly supervise a third-party mortgage broker and originator, Bristol Home Mortgage Lending. A copy of the FDIC’s complaint in the Ameribank case can be found here.

 

The second of these three lawsuits was filed November 6, 2012 in the Central District of California. The FDIC filed its complaint in its capacity as receiver for the failed Pacific Coast National Bank of San Clemente California. The complaint, which can be found here, asserts claims against six former officers and directors of the bank for negligence, gross negligence and breaches of fiduciary duty in operating and managing the lending function of the Bank.

 

The FDIC filed the third of these three lawsuits on November 9, 2012 in the Middle District of Florida. The FDIC filed its lawsuit in its capacity as receiver of the failed Century Bank of Sarasota, Florida. The agency’s complaint, which can be found here, asserts claims against five former directors (one of whom was also an officer) of the failed Bank for negligence and gross negligence in connection with ten “speculative and high risk transactions.”

 

The new California and Florida lawsuits were both filed as the third-year anniversary of the failures of the banks in question approached. Both of the banks involved had failed on November 13, 2009, and so the FDIC filed those complaints just prior to the third-year anniversary. Interestingly, the West Virginia lawsuit was filed well after the third-year anniversary had passed; the bank involved had failed on September 18, 2008, yet the lawsuit was not filed until October 23, 2012. In the absence of other considerations, the defendants in the West Virginia lawsuit could have significant statute of limitation. It seems likely that some sort of tolling agreement was in place although the complaint says nothing about any agreement.

 

With these three new lawsuits and the others that have recently been filed and noted on this blog, the FDIC has now filed a total of 39 D&O lawsuit as part of the current bank failure wave, 21 of which have been filed in 2012. There had been a period during the mid-part of this year when it seemed as if the agency had entered some sort of a filing lull; as noted here, between the beginning of May and the end of September, the agency filed only two new lawsuits, after a flurry of filing activity earlier in the year. However, since October 1, 2012, the agency has now filed seven new failed bank lawsuits, and the seeming lull during the summer appears to have ended.

 

The high water market in terms of numbers of bank failures was during late 2009 and early 2010, so during the coming months the third anniversaries of the failures of an increasing number of banks will be coming up, which suggests there could be even further filings ahead. Indeed, with the latest update to the FDIC’s litigation page (here), the agency disclosed that as of November 15, 2012, the FDIC has authorized suits in connection with 84 failed institutions against 700 individuals for D&O liability. These figures are inclusive of the 39 filed D&O lawsuits naming 308 former directors and officers that the agency has already filed. Given the number of authorized suits, it seems likely that the new failed bank lawsuit filings will mount in the months ahead.

 

With the addition of the lawsuits filed above, the FDIC has now filed failed bank suits in eleven different states as well as the in Puerto Rico. The states with the largest number of lawsuits are Georgia (11), California (7) and Illinois (6), which is not surprising as these states are also among the leaders in terms of numbers of failed banks. However, Florida is also among the states with the highest numbers of bank failures but even with the new lawsuit described above, the state still has had only two failed bank lawsuits.

 

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According to a November 13, 2012 press release from their defense counsel (here), the five bank officer defendants in an action the FDIC filed against them as the failed bank’s receiver have settled the case for an assignment to the agency of their rights under the bank’s D&O insurance policy.

 

The case involves the former County Bank of Merced, California, which failed on February 6, 2009, when the FDIC was appointed as its receiver. As discussed here, in January 2012, the FDIC filed an action in the Eastern District of California 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 that the FDIC says caused the bank losses in excess of $42 million.

 

In August 2012, the five individuals filed their own separate lawsuit in the Eastern District of California against the bank’s D&O insurer. A copy of their complaint can be found here. The individuals contend that the carrier has wrongfully denied coverage under the policy and wrongfully refused to defend them. The individuals seek a judicial declaration that the claim against them is covered under the policy and also asserts claims for breach of contract and for bad faith.

 

From the individuals’ complaint, it appears that the carrier is denying coverage based on the insured vs. insured exclusion (about which refer here). The individuals contend that the policy’s base form had a regulatory exclusion, which had it remained in the policy would have precluded coverage for the FDIC’s action against them. The individuals allege further that the bank had purchased an endorsement to the policy that removed the regulatory exclusion from the policy. The individuals essentially contend that the point of the endorsement to remove the regulatory exclusion was to ensure that the policy provided coverage for claims brought by the FDIC, and the carrier therefore should not be able to rely on a different exclusion to try to deny coverage for an FDIC claim.

 

According to defense counsel’s press release, in their settlement with the FDIC, the five individuals assigned their claim for bad faith and breach of contract to the FDIC, while retaining their right to try recover from the D&O insurer their defense fees incurred prior to the settlement The parties also exchanged covenants not to bring any further actions against each other, and the settlement also included a covenant by the FDIC not to assert any claims against the five individuals’ property or assets. The FDIC will control and prosecute the assigned claims against the insurer at the agency’s own cost and expense. The officers maintained their right to continue their own retained claims.

 

As I have previously noted (here), questions of D&O insurance coverage may represent the real battle ground in the current wave of FDIC failed bank litigation, and as I also noted in that same post, one of the critical coverage issues of contention may be whether or not the insured vs. insured policy precludes coverage for the FDIC’s claims against the former officers and directors of the failed bank.

 

Perhaps of greater interest in this context, in the case that I discussed in the prior post to which I linked in the preceding paragraph, the former bank officials involved in the case were also able to settle the FDIC’s claim against them for their agreement to the entry of a judgment against them together with an assignment of their rights under their D&O insurance and a covenant by the FDIC not to execute the judgment against them.

 

It remains to be seen whether or not the FDIC’s willingness to resolve these cases against the former bank officers and directors on this basis will work for the agency. They will still have to succeed in establishing that the D&O insurers’ policies provide coverage for the claims (as well as fight off the carriers’ likely procedural objections to the validity of the agreed judgment and assignment). But it is in any event interesting to see that the FDIC is willing to resolve cases on this basis, at least in certain circumstances (perhaps only when particular coverage issues are involved as well).

 

There may well be legitimate arguments about the merits or demerits of these types of deals. Of course, it certainly 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. Without meaning to suggest anything one way or another about this particular deal, I will say that in my prior life as an insurer-side coverage attorney, I did see deals that were questionable.

 

All of that said, however, these types of deals have undeniable attractions for the individual defendants involved, and I would expect that other defendants in other failed bank cases will undoubtedly be looking to see if they can reach settlements with the FDIC on a similar basis. 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.

 

Special thanks to a loyal reader for seding me a copy of the defense counsel's press release.

 

Management Liability Insurance and the Potential Liabilities of Law Firm Managers: Attorneys are well aware of their need to procure and maintain errors and omissions insurance – or what they typically think of as malpractice insurance. But while they understand their need to have insurance in the event of claims against them asserting that they erred in the delivery of client services, attorneys, or at least some of them, can be reluctant to accept their need to also maintain insurance protecting their firm’s managers against claims for wrongful acts committed in the management of their firm.

 

Attorneys resistant to the need for this type of insurance (or advisors who have to try to persuade them of the need) will want to take a look at the November 14, 2012 Wall Street Journal article entitled “Creditors Seek to Sue Dewey’s Ex-Leader” (here). The article describes a motion that the unsecured creditors of the failed Dewey & LeBouef firm have filed in the firm’s bankruptcy proceedings. The unsecured creditors seek the leave of the bankruptcy court to file an action against the firm’s former Chairman, its former executive director, and its former chief financial officer, seeking to hold the three individuals liable for alleged misconduct the unsecured creditors contend led to the firm’s demise.

 

The unsecured creditors bid to pursue claims against the former law firm managers illustrates a point I have often made when discussing management liability insurance for law firms, which is that law firm managers face the possibility of potential claims for an wide variety of potential claimants. Indeed, as I think this situation illustrates, the law firm managers at least potentially face potential claims from the same general range of claimants as does any privately held business and therefore the need for management liability insurance is the same.

 

Lawyers are of course nothing if not argumentative and I can anticipate the likely lawyer reaction (being a recovering attorney myself) to the attempt to draw these kinds of conclusion from this situation. First, some lawyers might argue that the lawsuit the unsecured creditors want to file is solely about the insurance that the law firm maintained, and in the absence of the insurance, the unsecured creditors would not be pursuing the claim. I would object to this argument on two grounds; first, it is speculative (as it requires us to make assumptions about the claimants’ motivations) and also it assumes facts not in evidence (that is, that the claimants would not be pursuing the claims in absence of the insurance).

 

But the real problem with this argument is that is presumes that prospective defendants would be better off without the insurance. That strikes me as a dicey proposition and not one that personally I would not want to have to test. Most self-interested persons faced with the prospects of angry creditors asserting millions of dollars of claims would be very grateful to have a D&O insurance policy to defend and indemnify them.

 

Special thanks to a loyal reader for drawing my attention to the Journal article.

 

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Trial in the FDIC’s failed bank lawsuit against three former officers of IndyBank commenced on November 6, 2012 in the federal court in Los Angeles. According Scott Reckard’s November 9, 2012 Los Angeles Times article (here), the parties’ counsel have delivered their opening statements. The case, which was the first failed bank lawsuit the FDIC filed as part of the current bank failure wave, is also the first to go to trial.

 

As detailed here, the FDIC first filed the lawsuit against the former IndyMac officers in June 2010. The FDIC’s lawsuit seeks to recover damages from the individual defendants for "negligence and breach of fiduciary duties." The lawsuit alleges "significant departures from safe and sound banking practices."  As discussed here, in July 2011, the FDIC filed a separate lawsuit against IndyMac’s former CEO, Michael Perry.

 

There are three individual defendants in the case that is now in trial:  Scott Van Dellen, the former President and CEO of IndyMac’s Homebuilders Division (HBD), 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 a number 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 many of the loans at issue.

 

The case against the three former IndyMac officers has been very vigorously litigated; I detailed the particularly memorable hearing regarding one discovery dispute that arose in the case here. (While writing this article, I reread the article about the discovery dispute; Central District of California Judge Dale Fischer’s comments during the hearing make for very interesting reading, and I commend the article to readers looking for a little diversion.) Among other significant pretrial rulings, in October 2012, Judge Fischer also held that under California law the individuals were not entitled to rely on the business judgment rule, as discussed here.

 

And in June 2012, as discussed here, in a significant ruling in a related D&O insurance coverage case, Central District of California Judge Gary Klausner held that all of the various IndyMac lawsuits (including the one the FDIC filed against the three former IndyMac officers) were interrelated to the first filed lawsuit, and thus triggered only a single tower of D&O insurance. This holding was of particular significance both to the former IndyMac officers and to the FDIC, as the FDIC’s lawsuit was filed during the policy period of the second insurance tower. The ruling that the subsequent lawsuit are all interrelated to the first filed lawsuit means that the only insurance available for the individuals (and out of which the FDIC might recover from the insurers) is whatever is left under the first tower of insurance.

 

According to their July 2012 motion to stay the FDIC’s lawsuit against them, the three defendants represented to the court that defense fees in various IndyMac-related lawsuits as well as the costs associated with settlements that had been reached in several of the cases will deplete or threaten to deplete all of the remaining proceeds under the first tower of insurance.  (The motion asserts that defense fees in excess of $50 million and settlements totaling $29 million would deplete the $80 million insurance tower.) The defendants sought to stay the FDIC’s lawsuit against them so that they could pursue their appeal of Judge Klausner’s insurance coverage ruling. The defendants’ motion can be found here. Judge Fischer denied the defendants’ motion to stay the proceedings.

 

The upshot of the unavailability of the second tower of insurance and the apparent exhaustion of the first tower is that the three individual defendants face the prospect of that there might not be any insurance available to protect them in the event that the trial results in an award of damages against them (subject of course to the outcome of the pending appeals of Judge Klausner’s insurance coverage ruling).

 

The FDIC’s original complaint had named a fourth individual, William Rothman, as a defendant as well. According to a footnote in the motion to stay referenced above, Rothman had settled with the FDIC in exchange for Rothman’s assignment to the FDIC of Rothman’s rights under the second tower of insurance.  The separate suit against IndyMac’s former CEO, Michael Perry, remains pending.

 

In any event, it will be very interesting to see how this case proceeds. It is highly unusual for a case like this to proceed to trial, particularly where there may be limited or even no insurance out of which the FDIC may be able to recover any judgment. (Interestingly, in the defendants’ motion to stay referenced above, counsel for the defendants asserts that “the FDIC specifically structured this lawsuit in order to reach the Tower 2 Policy,” in which case Judge Klausner’s insurance coverage ruling upset a part of the FDIC’s strategy in their case against the three individual defendants.) Obviously, the outcome of the appeal in the insurance coverage case is of keen interest to the FDIC as well as to the individual defendants.

 

I am sure that there are many readers who will be following this trial closely and who may be able to monitor the case more closely than I can. I would be grateful if readers would be willing to keep me informed about the case.

 

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On November 1, 2012, in what is the first lawsuit the FDIC has filed as part of the current bank failure wave against a failed bank’s accountants, the FDIC, as receiver for the failed Colonial Bank, has filed an action in the Middle District of Alabama against Pricewaterhouse Coopers and Crowe Horwath. PwC served as the bank’s external auditor and Crowe provided internal audit services to the Bank. A copy of the FDIC’s complaint can be found here. (Very special thanks to Francine McKenna of the re: The Auditors blog for providing me with a copy of the FDIC’s complaint.).

 

When Colonial Bank failed in August 2009, it was the sixth largest U.S. bank failure of all time (as discussed here). In is complaint against the accountants, the FDIC alleges Colonial’s failure was triggered by the massive, multi-year fraud against the bank by the bank’s largest mortgage banking customer, Taylor Bean & Whitaker.

 

As I detailed in a prior post, here, In April 2011, Lee Farkas, Taylor Bean’s ex-Chairman, was convicted of wire fraud and securities fraud. Prior to Farkas’s conviction, two Colonial Bank employees pled guilty in connection with the Taylor Bean scheme. As reflected here, on March 2, 2011, Catherine Kissick, a former senior vice president of Colonial Bank and head of its Mortgage Warehouse Lending Division, pleaded guilty to conspiracy to commit bank, wire and securities fraud for participating in the Taylor Bean scheme. As reflected here, on March 16, 2011, Teresa Kelly, the bank’s Operations Supervisor and Collateral Analyst, pled guilty on similar charges.

 

In the criminal cases against the bank employees, the government alleged that the two bank employees caused the bank to purchase from Taylor Bean and hold $400 million in mortgage assets that had no value. The employees also allegedly engaged in fraudulent actions to cover up overdrafts of Taylor Bean at the bank. The employees are also alleged to have had the bank engage in the fictitious trades with Taylor Bean that had no value.

 

The complaint alleges that while Taylor Bean was carrying out its “increasingly brazen” fraud, PwC “repeatedly issued unqualified opinions” for Colonial’s financial statements, and Crowe “consistently overlooked serious internal control issues” – and, more the point, both failed to detect the fraud. The complaint alleges that if the firms had detected the fraud earlier, it would have prevented losses or additional losses that the bank suffered at the hands of Taylor Bean. The complaint asserts claims against the firms for professional negligence, breach of contract, and negligent misrepresentation. The complaint alleges that in the absence of the firm’s wrongful acts, the Taylor Bean fraud would have been discovered by 2007 or early 2008, and “losses currently estimated to exceed $1 billion could have been avoided.”

 

The FDIC does have one problem in asserting these claims. In its role as receiver, the FDIC stands in the shoes of the failed bank, and is subject to all of the defenses that could have been asserted against the bank. As Alison Frankel discusses in her On the Case blog (here), the accounting firms are likely to raise the in pari delicto defense, “which holds that one wrongdoer can't sue another for the proceeds of their joint misconduct” The FDIC has anticipated this defense in its complaint, alleging that the two bank employees that facilitated the Taylor Bean fraud were “rogue employees” who acted our of their own self-interest and not at the direction of or to the benefit of the bank, but rather to the detriment of the bank. 

 

In the wake of the current bank failure wave, the FDIC has filed a number of lawsuits against the directors and officers of failed banks. As of my latest tally (refer here, scroll down to second item), the FDIC has filed 35 suits against failed bank directors and officers. However, until now, the FDIC has not filed any actions against the former auditors of a failed bank. The Colonial bank suit is particularly interesting because it not only names the failed bank’s former outside auditor, but it also names the accounting firm that was performing the bank’s internal audit functions. There may be more accounting malpractice actions to come; on its website, the FDIC reports that the agency has “authorized 46 other lawsuits for fidelity bond, insurance, attorney malpractice, appraiser malpractice, accounting malpractice, and RMBS claims.”

 

Readers of this blog may recall that in August 2012, certain former Colonial Bank directors and officers agreed to settle the securities class action lawsuit that had been filed against them in connection with allegations surrounding the bank’s collapse. The $10.5 million settlement was to be funded entirely by D&O insurance. The securities suit settlement is discussed here. Significantly, the settlement did not include the bank’s offering underwriters or its outside auditors. Among the individual defendants party to the securities suit settlement was 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.

 

As I also noted in a prior post (here), in July 2012, the FDIC as receiver for Colonial Bank, as well as the bankrupt bank holding company on its own behalf, filed an action against the bank’s bond insurer. Among other things, the complaint alleges that the losses caused by the misconduct “constitute recoverable losses under the Bonds up to the full aggregate limits of liability of the Bonds.” The complaint states that the bond insurer “has neither accepted nor denied the Plaintiffs’ claims under the Bonds.” The complaint alleges that the insurer “has failed to investigate the claims and losses in a reasonable and appropriate manner.” In September 2012, the parties jointly moved the court to revise the schedule in the case to permit them to engage in settlement discussion.  

 

Speaking of Failed Banks: Shareholders of yet another failed bank holding company have now initiated a securities class action lawsuit. On November 2, 2012, the shareholders of Tennessee Commerce Bancorp filed a securities class action lawsuit in the Middle District of Tennessee against the holding company and certain of its directors and officers. A copy of the complaint can be found here.

 

Tennessee Commerce Bank failed on January 27, 2012. According to the plaintiff’s lawyers’ November 2 press release (here), the defendant directors and officers and the holding company violated the federal securities laws by “issuing false and misleading information to investors about the Company's financial and business condition.”  The lawsuit asserts that “defendants misrepresented and failed to disclose that the Company had serious internal control deficiencies causing it to be unable to monitor its loan portfolio; obtain up to date and current appraisals of collateral; follow bank rules of procedures relating to the Company's allowance for loan losses; and remediate internal control deficiencies..” The lawsuit is filed on behalf of investors who purchased shares in the holding company during the period from April 18, 2008 through September 13, 2012.

 

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After a nearly three-month period in which the FDIC filed no new lawsuits against the former directors and officers of a failed bank, the agency has in recent days filed two new suits, both involving banks that were approaching the third anniversary of their closure. The FDIC’s latest lawsuit, filed in the Northern District of Georgia on October 17, 2012, against certain former directors and officers of the failed American United Bank of Lawrenceville, Georgia, which was closed by regulators on October 23, 2009. A copy of the FDIC’s complaint can be found here.

 

The FDIC’s complain, which it filed in its capacity as American United’s receiver, names as defendants two former officers of American United – T. Glenn Thompson, the bank’s former CEO, and Joel C. Taylor, the bank’s former Chief Lending Officer – as well as six individual members of the bank’s board of directors. The complaint asserts claims against the individuals for negligence and for gross negligence.

 

The complaint alleges that “rather than manage the Bank’s lending function in a sound and responsible manner, the Defendants took unreasonable risks with the Bank’s loan portfolio, allowed irresponsible and unsustainable rapid asset growth concentrated in high-risk and speculative acquisition development and construction and commercial real estate loans and loan participations, disregarded regulator warnings about lending activities, violated the Bank’s loan policies and procedures, and knowingly permitted poor underwriting in contravention of the Bank’s policies and reasonable industry standards.” The FDIC alleges that these actions caused damages to the bank “in excess of $7.3 million.”

 

The FDIC’s complaint against the former American United officials is the 34^th lawsuit that the FDIC has filed as part of the current failed bank wave and the 16^th that the agency has filed so far in 2012. The FDIC filed a considerable number of complaints in the first few months of this year, filing 12 new lawsuits in the first five months of the year. But then for two months, until mid –July, the agency filed no new lawsuits, and then after filing two on July 13, filed no further lawsuits until November.

 

The apparent slowdown in the FDIC’s new lawsuit filings during the period between May and October 2012 was surprising not only because of the more rapid pace of filings in the first five months of the year, but also as 2012 progressed, the third anniversaries of the closures of an increasing number of banks has been approaching. Given that the number of bank failures ramped up as 2009 progressed, it seemed likely that the number of new lawsuits would have increased during the year, as the three-year statute of limitations for increasing numbers of failed banks approached.

 

The slowdown is surprising for another reason as well, which is that while there have been a couple of very large gaps this year (together stretching over nearly a five month period) during which only a small number of lawsuits were filed, the agency has continued each month to update its website to show that an increasingly larger number of lawsuits have been filed. As the latest update on October 9, 2012, the agency has authorized suits in connection with 80 failed institutions against 665 individuals for D&O liability. These figures are inclusive of the now 34 lawsuits involving 33 institutions and  naming 280 former directors and officers that have been filed so far – suggesting an increasingly large backlog of as yet unfiled complaints.

 

As I have previously noted on this blog, knowledgeable persons have advised me that at least part of the explanation for the apparent filing slowdown is that the FDIC and the prospective defendants (and their insurers) have in some instances been involved in negotiations. In some instances, the FDIC has requested that the indivudals agree to a tolling agreement which stays the running of the statute of limitations while the negotiations continue. These negotiations have in at least some cases permitted matters that might otherwise have resulted in litigation to be resolved without a complaint being filed. While that might well account for some of the slowdown, the increase in the numbers of authorized lawsuits does suggest that there is still a backlog of cases to be filed. It still seems likely that as the third anniversary of bank failures from late 2009 and early 2010 approaches (which period was the high water mark of the current bank failure wave) we should be seeing an upsurge in new FDIC lawsuits, especially given the extent to which the number of authorized lawsuits exceeds the number of lawsuits filed

 

The FDIC’s suit against the former American United officers is the ninth lawsuit so far involving a failed Georgia bank, meaning that lawsuits involving banks from Georgia account for more that a quarter of failed bank lawsuits so far. At one level, this is not a surprise, since there have been many more bank failures in Georgia as part of the current bank failure wave than any other state. But the over 80 Georgia banks that have failed since August 2008 represent only about 18 percent of the over 440 banks that have failed during that period, meaning that the failed Georgia banks have been targeted at a disproportionately higher rate. By way of contrast, Florida, which also has experienced a very high bank failure rate so far, has only had one failed bank lawsuit. Georgia banks were very heavily represented in the earliest part of the current bank failure wave, so it  may be that these apparent mismatches will even out over time as more suits are filed.

 

There is one other interesting feature of the new American United case, which is that the FDIC has included allegations of ordinary negligence. This is interesting because of the recent decision in the Northern District of Georgia in the Integrity Bank case, applying Georgia law and holding that because of their protection under the business judgment rule, directors cannot be held liable of ordinary negligence. More recently (as discussed here), in the FDIC’s lawsuit against former directors and officers of the failed Haven Trust bank, Northern District of Georgia Judge Steve C. Jones affirmed that Georgia’s business judgment rule is applicable to the actions of bank directors and officers. Based on that determination, Judge Jones dismissed the FDIC’s claims against the directors and officers for ordinary negligence and breach of fiduciary duty. In light of that earlier decision, it would seem that the defendants in the new American United case have a basis on which to seek to have the negligence claims against them dismissed. (The FDIC, undoubtedly anticipating this argument, included in its complaint specific allegations asserting that the defendants are not entitled to rely on the business judgment rule, at paragraph 55 and following.) 

 

Very special thanks to a loyal reader for providing me with a copy of the FDIC’s American United complaint.

 

Welcome to the Blogosphere: The D&O Diary is very happy to welcome D&O Discourse, a new blog from the securities litigation group of the Lane Powell law firm. The new blog, which can be found here, will, according to the firm, “discuss select securities and corporate governance litigation developments of interest to public companies and their directors and officers, D&O liability insurance carriers and brokers, plaintiffs' and defense lawyers, and economists, forensic accountants and other professionals whose practices involve securities and corporate governance litigation.” The new site looks good, and based on its early entries it will represent a welcome addition to the blogosphere. Everyone here at The D&O Diary looks forward to following the site in the future.

 

Regulatory ADD? : Francine McKenna, the author of the re: The Auditors blog, has an interesting October 18, 2012 article in Forbes Magazine entitled “Is the SEC’s Ponzi Crusade Enabling Companies to Cook the Books, Enron-Style?” (here). In the article, McKenna suggests that the SEC, eager to make up for its failure to catch Madoff, is disproportionately devoting resources to Ponzi-scheme prosecution and also to FCPA enforcement activities, to the detriment of its efforts to root out “fraudulent or misleading accounting and disclosures by public companies.” McKenna questions whether “a stretched SEC” might be “neglecting accounting fraud.” McKenna’s article looks at whether the reduced accounting fraud enforcement activity in recent years is the result of decreased fraud or a reduced emphasis on the issue from the regulatory agency.

 

In a concluding section that will be of interest to readers of this blog, McKenna’s article closes with a seven-point checklist to use to test for accounting risk at any particular company.  

 

More About Opt-Outs: I have written frequently about class-action opt-outs on this site (most recently here) In an October 18, 2012 Metropolitan Corporate Counsel article entitled “The Securities Class Action Opt-Out Plaintiffs: By the Numbers” (here), Neal Troum of the Stradley Ronon Stevens & Young law firm takes a closer look at class action opt-outs recoveries. Troum concludes that “institutional investors with significant losses on account of securities fraud may recover more as opt-out plaintiffs than class members in securities fraud actions.” He suggests that “institutional investors have their options and, with increasing frequency, they are choosing a different path.”

 

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An overabundance of airplane time and a shortage of Internet access (not the mention my day job’s unrelenting requirements) have kept The D&O Diary on the blogging sidelines despite a host of noteworthy events in recent days. The march of events moves ever onward, but before the sands of time envelop recent notable events altogether, we note them briefly here.

 

Alcoa Settles Bribery Suit With Alba: On October 9, 2012, Alcoa announced (here) that it had agreed to pay Aluminum Bahrain B.S.C. (better known as “Alba”) $85 million to settle the long-running RICO action that the state-owned Bahraini aluminum smelter had filed against the company in the Western District of Pennsylvania. The settlement is noteworthy in a number of respects, not the least of which the settlement’s size. The settlement is also noteworthy given the identity of the claimant, as discussed below.

 

As discussed here, in February 2008, Alba had sued Alcoa, one of its affiliates, and two individuals (one of whom was an officer of an Alcoa affiliate), alleging that the defendants had engaged in a 15-year conspiracy involving overcharging, fraud and bribery of Bahraini officials. The complaint alleges that one of the individual defendants, Victor Daladeh, funneled payments to one or more (unnamed) Bahraini officials as part of an alleged conspiracy to cause Alba to cede a portion of its equity to Alcoa, to pay Alcoa inflated prices for alumina, and to corrupt the integrity of senior Bahraini officials. Alba’s complaint sought to recover damages from the defendants based on the alleged violations of the Racketeer Influenced and Corrupt Organizations Act (RICO), conspiracy to violate RICO, and for fraud.

 

The case was stayed for several years while related U.S. government investigations continued. (The government investigations are continuing.) However, in November last year, Alcoa’s lawyers persuaded the Western District of Pennsylvania Judge Donetta Ambrose to lift the stay so that the defendants could file a motion to dismiss. Among other things, the defendants argued, in reliance on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, that the court should dismiss the case because the alleged wronging on which Alba relied in support of its claim took place entirely outside the U.S. and therefore not appropriately the subject of a lawsuit in the U.S. under U.S. laws. As discussed in Victor Li’s August 1, 2012 Corporate Counsel article (here), Judge Ambrose rejected defendants’ motion, finding that Alcoa’s Pittsburgh headquarters was the “nerve center” of the alleged scheme, because the control and decision-making of the alleged conspiratorial enterprise came from Pittsburgh.  

 

According to its October 9 press release, Alcoa will pay the $85 million settlement amount in two installments, with half to be made at the time of the settlement and the other half to be paid one year later. The press release also states that Alcoa and Alba have “resumed a commercial relationship” and entered into a long-term supply agreement, “demonstrating a mutual desire to work together going forward.” The settlement does not resolve Alba’s claims against Daladeh, who according to news reports, has been arrested in October 2011 by British officials and charged with bribing officials at Alba.

 

As I have previously noted on this blog, one of phenomena associated with the recent upsurge in FCPA enforcement activity has been related growth in follow-on shareholder litigation. However, by contrast to these more common types of follow-on civil suits, this action was not brought by Alcoa’s shareholders; rather, this lawsuit was brought by the alleged victims of the corrupt activity (and indeed, the suit was initiated before there had been any separate governmental enforcement action; the government action followed after the civil suit).

 

As anti-bribery enforcement activity has increased, the prospect for follow-on civil litigation has also grown. In that regard, the size of the settlement in this case and the claimant’s relative success in bringing its claim will not go unnoticed. The likelihood is that companies that become enmeshed in bribery allegations could also face related civil litigation, and in light of this sizeable settlement, the threat of civil litigation will include not only the possibility of claims from shareholders, but also possible claims from the purported victims of the alleged corrupt activity.

 

Pfizer Settles Celebrex-Related Securities Suit for $164 Million: According to papers filed with the Court, Pfizer has settled the long-running securities suit alleging that Pharmacia (which Pfizer acquired in 2003) had misrepresented the safety of its anti-inflammatory drug, Celebrex, for $164 million. A copy of the parties’ October 5, 2012 stipulation of settlement can be found here. 

 

As discussed here, shareholders first sued Pharmacia and certain of its directors and officers in 2003, alleging that the company had released only part of a long-term clinical study the company had commissioned on the side effects of the drug. The complaint also alleged that scientists affiliated with the company had used the partial data to write an article in the Journal of t he American Medical Association, while failing to reveal that only part of the data was used. When Pharmacia later sought to the FDA’s approval to market the drug without certain warning labels, the agency declined based on questions concerning the completeness of the study results, following which the company’s share price declined.

 

This case had a long and complex procedural history. District of New Jersey Anne Thompson had initially dismissed the case on statute of limitations ground. But as discussed here, in 2009, the Third Circuit reversed the district court, and the case returned to the District Court. The settlement comes as an October 22, 2012 trial date loomed. 

 

Nate Raymond and Ransdell Pierson’s October 9, 2012 Reuters article about the settlement can be found here.

 

This settlement is noteworthy in many respects, not least of which because of its size. However, in a world of class action securities lawsuit settlements measured in the billions, even a settlement of this size does not attract as much attention as it might have at one time. Indeed, according to my research, this $164 million settlement does not even break the top 50 of all time securities lawsuit settlements. It is not even the largest securities suit settlement, having been exceeded, among others, by Bristol Myers Squibb’s $300 million securities lawsuit settlement (about which refer here).  The settlement amount alone does not take into account the defense fees incurred, which, given the case’s long and complicated procedural history, also likely were substantial (particularly given the approaching trial date). 

 

It is not an original observation, but the total economic cost of this kind of litigation is truly astonishing. 

 

Breaking Lull, FDIC Files Latest Failed Bank Lawsuit: On October 2, 2012, in the first lawsuit the FDIC has filed since July in its capacity as receiver of a failed bank against the bank’s former directors and officers, the FDIC filed a lawsuit in the Northern District of Illinois against six former directors and officers of the failed Benchmark Bank of Aurora, Illinois. The FDIC’s complaint can be found here.

 

Benchmark Bank failed on December 4, 2009 (about which refer here). In its complaint, the FDIC alleges that the defendants breached their duties of care by approving certain high-risk acquisition, development and construction loans. The FDIC seeks to recover losses “of at least $13.3 million” allegedly caused by the defendants gross negligence, negligence and breaches of fiduciary duties.

 

The Benchmark Bank lawsuit is the fifteenth failed bank lawsuit the FDIC has filed during 2012 and the 33^rd overall that the FDIC has filed as part of the current bank failure wave. However, it is the first the FDIC has filed since mid-July and only the third the FDIC has filed since late May. The slow filing pace is all the more surprising as comes three years after what had been the period when bank closures were ramping up in earnest. All is equal, it seems as if there would have been more lawsuits filed like this one as the three year closure anniversary approached.

 

The slowdown is all the more surprising because the lull has come even though the FDIC has continued to indicate on its website (here) on a monthly basis that the number of lawsuits the agency has authorized has increased. Indeed, in its latest update (dated October 9. 2012), the FDIC indicated that it has authorized suits in connection with 80 failed institutions against 665 individuals for D&O liability. These figures are inclusive of the 33 filed D&O lawsuits involving 32 institutions, naming 272 former directors and officers. filed so far. 

 

As the number of authorized lawsuits has continued to accumulate and as the three year closure anniversary of an increasingly large number of banks has approached, it has seemed as if we would be seeing increasing numbers of lawsuits filed. Yet in the last five months there have only been three new suits filed, and this latest complaint is the first in three months. Knowledgeable participants in this process have advised me that part of the reason for the slowdown is that in a number of instances the FDIC is engaged in negotiations to see if the matters can be resolved without litigation. But as the number of lawsuits authorized continues to increase it does seem likely that sooner or later we will be seeing an upsurge in new complaints. It just hasn’t happened yet.

 

In the meantime, it is reassuring to note that the number of new bank closures has dwindled. There have been no new bank closures so far during October 2012, after only three in September 2012 and only one in August 2012. It certainly can be hoped that now, more than four years after the depths of the financial crisis, perhaps the wave of bank closures is finally about to come to an end.

 

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On October 5, 2012, in the latest in a series of decisions addressing the question whether or not corporate officers (as differentiated from corporate directors) are entitled under California law to rely on the protections of the business judgment rule, Central District of California Judge Dale Fischer held that former officers of the failed IndyMac bank cannot assert an affirmative defense based on the business judgment rule in the FDIC’s failed bank lawsuit pending against them. Judge Fischer also addressed the question whether the individual officer could assert a number of other affirmative defenses against the FDIC. A copy of Judge Fischer’s memorandum opinion can be found here.

 

Background

IndyMac Bank failed on July 11, 2008. As discussed in detail here, On July 2, 2010, in the first lawsuit against former directors and officers of a failed bank it filed 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). 

 

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." 

 

In their answers to the FDIC’s complaint, the officer defendants asserted a number of affirmative defenses, including a defense based on their assertion that their actions were protected by the business judgment rule. The parties filed cross-motions for partial summary judgment on a number of issues, including the question of whether or not the defendants were entitled to rely on the protections of the business judgment rule, as well as the defendants’ other affirmative defenses.  

 

The October 5 Ruling

Judge Fischer began her October 5 opinion with a detailed choice of law analysis. The defendants had argued, in reliance on the holding company’s Delaware incorporation, that Delaware law applied. The FDIC argued that because the bank was locating in and conducted its operations in California, California law governed. Judge Fischer found that regardless of which choice of law principles were used to determine the question, California law governed.

 

Having determined that California law applied, Judge Fischer then turned to the question of the applicability of California’s Business Judgment Rule (BJR). Judge Fischer noted that under California law, the BJR has two components, an “immunization from liability” codified in Corporations Code Section 309, and a “judicial policy of deference to the exercise of good faith business judgment in management decisions.”

 

The officer defendants conceded that the protections codified in Section 309 were not available (undoubtedly because Section 309 refers only to “directors”). So the question for Judge Fischer was whether the common law element of the BJR applies to officers.

 

After reviewing California case law and also the work of the California Law Revision Commission, Judge Fischer determined that “the Court is left with only one reasonable conclusion” – that is, that “the state’s business judgment rule does not protect officers” and therefore the individual officer defendants “may not use the business judgment rule as an affirmative defense.” Judge Fischer granted the FDIC’s motion for partial summary judgment in that respect.

 

Judge Fischer then went on and considered several of the individual defendants’ other affirmative defenses. Among other things, Judge Fischer concluded that California’s four-year statute of limitations applied to the FDIC’s claims against the four individuals for breach of fiduciary duty, rather than either FIRREA’s three-year statute of limitations or other shorter California statutes of limitation on which the individual defendants sought to rely.

 

Judge Fischer also concluded that the defendants are barred from asserting against the FDIC (as Indy Mac’s receiver) affirmative defenses for failure to mitigate, unclean hands and ratification, based on the FDIC’s pre- and post-receivership conduct, because, as Judge Fischer concluded, under California law, equitable defenses that would have been good against the Bank could not be raised against the FDIC as receiver.

 

Discussion

In several instances, individual defendants have successfully argued that their conduct is protected by the business judgment rule and accordingly, that they cannot be held liable for ordinary negligence. The most significant holding is the August 14, 2012 decision in the Northern District of Georgia in the Haven Trust case, in which Judge Steve C. Jones dismissed the claims against both the director and officer defendants, because of his determination that under Georgia law the directors’ and officers’ conduct is protected by the business judgment rule. The Haven Trust case is discussed here. Earlier in August, a judge in the Middle District of Florida, ruled in the FDIC’s failed bank lawsuit relating to the failed Florida Community Bank of Immokalee, Florida, that under Florida law directors cannot be held liable for ordinary negligence, as discussed here. The ruling in that case did not reach the question of whether or not officers can be held liable for ordinary negligence under Florida law.

 

However, as California attorney Jon Joseph wrote in his April 11, 2012 guest post on this blog (here), courts applying California law on the issue and considering whether corporate officers as well as directors can rely on the business judgment rule have split on the issue. Most recently, on June 7, 2012, Eastern District of California Judge Lawrence O’Neill held that the defendant officers cannot rely on the statutorily codified business judgment rule under California Corporations Code Section 309, because the statute by its terms refers only to officers not directors. Judge O’Neill’s ruling is discussed here (second item).

 

The significance of Judge Fischer’s ruling in the Indy Mac case is that it was, by contrast to Judge O’Neill’s June 2012 decision, not solely with relationship to provisions of Section 309, which by its terms refers only to directors (a point conceded by the defendants in the Indy Mac case). Judge Fischer went on to hold that corporate officers may not rely on the protections of the common law business judgment rule, either.

 

Although Judge Fischer’s analysis in connection with her rulings regarding the defendants’ other affirmative defenses is not early as detailed as with respect to the business judgment rule, it is nevertheless significant that she determined as a matter of California law that the defendants cannot assert against the FDIC the affirmative defenses for failure to mitigate, unclean hands and ratification. As noted below, other courts, applying the laws of other jurisdictions, have reached contrary conclusions on the question of whether or not former Bank officers and directors can assert equitable defenses against the FDIC asserting claims as receiver as a failed bank.

 

Special thanks to a loyal reader for providing me with a copy of Judge Fischer’s October 5 opinion.

 

Under North Carolina Law, Failed Bank’s Former Directors and Officers Can Assert Equitable Defenses Against the FDIC: An October 2, 2012 ruling, applying North Carolina law, reached a different conclusion that Judge Fischer on the question of whether or not former directors and officers of a failed bank can assert equitable defenses against the FDIC. A copy of the October 2 opinion can be found here.

 

As discussed here, the FDIC had brought an action against nine former directors and officers of the failed Cooperative Bank of Wilmington, North Carolina. As detailed in the October 2 order, Eastern District of North Carolina Judge Terrence Boyle denied the defendants’ motion to dismiss.

 

The FDIC had also separately moved to strike the individual defendants’ affirmative defenses for avoidable consequence/failure to mitigate damages. The defendants contend that the terms of the loss-share agreement entered between the FDIC and Cooperative’s acquiring bank did not provide the acquiring bank with incentive to lessen the loan losses, which aggravated the losses or even cause the losses in connection with some loans. The FDIC moved to strike the defense, on the ground that it had “no duty” to the defendants.

 

The defendants argued in reliance on the U.S. Supreme Court’s 1994 ruling on O’Melveny & Myers v. FDIC that when the FDIC brings an action as receiver, it “steps into the shoes” of the failed bank and state common law governs questions of tort liability.

 

Judge Boyle noted that the courts are split on the question whether the “no duty” rule (on which the FDIC relied in its motion to strike) still applies after the O’Melveny decision. Citing an unpublished Fourth Circuit opinion, Judge Boyle concluded that state law governs what defenses are available against the FDIC. Judge Boyle found that under basic principles of North Carolina law, a plaintiff must take reasonable steps to mitigate damages. Accordingly Judge Boyle denied the FDIC’s motion to strike, allowing the defendants to assert the equitable defenses against the FDIC.

 

Although Judge Fischer reached a different conclusion in the Indy Mac case on the ability of individual defendants to assert equitable defenses against the FDIC as receiver of a failed bank, the difference in outcome in the two cases at least arguably can be explained by the difference in the two jurisdictions’ law that was applied. The two cases did at least conclude that the question of the availability of affirmative defenses is a question of state law.

 

Judge Boyle’s opinion not only ruled that the defendants can assert the equitable defenses but also implicitly rejected the FDIC’s “no duty” argument, one of several defendants to reach this conclusion.

 

For a detailed discussion of the issues surrounding the FDIC’s “no duty” argument, please refer to August 31, 2011 guest post, here.

 

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

 

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As I have previously noted (most recently here), the pace of filing of FDIC actions against directors and officers of failed banks has slowed considerably as 2012 has progressed. Indeed, there have only been two new FDIC failed bank lawsuits filed since May, and none at all since mid-July (even though the FDIC has each month continued to increase the number of authorized lawsuits, as reflected on the agency’s website, here).

 

While the FDIC has not filed any new failed bank lawsuits recently, that is not to say that the regulatory authorities have not been active. Specifically, on September 25, 2011, the SEC filed enforcement actions in the District of Nebraska against three former officers of the failed TierOne Bank of Lincoln, Nebraska, as well as against the son of one of the three officers. The SEC’s September 25, 2012 press release regarding the enforcement actions can be found here, and the SEC’s two complaints can be found here and here.

 

Banking regulators closed TierOne Bank on June 4, 2012 (refer here). The SEC alleges that prior to the closure, TierOne understated its loan losses  and misstated the value real estate the bank had repossessed. The SEC alleges that as a result of the bank’s expansion into “riskier types” of lending in Las Vegas and other high growth areas, and the resulting increase in problems loans, the Office of Thrift Supervision directed the bank to maintain higher capital ratios. The SEC alleges that in order to comply with these requirements, three TierOne officials – Gilbert Lundstrom, the bank’s Chairman and CEO; James Laphen, the bank’s President and COO; and Don Langford, the bank’s chief credit officer – disregarded information that collateral securing the bank’s loans and real estate the bank had repossessed were significantly overvalued. The SEC alleges that as a result the bank’s losses were understated by millions of dollars in multiple SEC filings.

 

The SEC further alleges that after the OTS required the bank to obtain new appraisals for the collateral and repossessed real estate, the bank disclosed more than $130 million in loan losses. The SEC alleges that had these losses been booked in the appropriate quarters, the bank would have missed the required capital ratios several quarters earlier. Following the announcement of the loan losses, its stock price dropped more than 70%

 

The SEC alleges that Lundstrom communicated inside information to his son about the bank’s intention to sell certain assets. With the benefit of this information, Lundstrom’s son was able to purchase TierOne stock and then later sell it at a profit.

 

The SEC has reached settlements with Lundstrom and with his son, and with Laphen. Lundstrom has agreed to pay a $500,921 penalty. Laphen has agreed to pay a $225,000 penalty. Lundstrom’s son has agreed to pay a $225,921 disgorgement plus a $225,921 penalty. The sole remaining defendant, Langfor, has not settled the charges and the case against him remains pending.

 

The SEC’s press release quotes SEC Enforcement Director Robert Khuzami as saying that the bank’s understatement of its loan losses had the effect of “concealing the bank’s deterioration from shareholders and regulators alike.” The SEC’s press release also expressly acknowledges the “cooperation” of the Office of the Comptroller of the Currency.

 

The SEC enforcement actions relating to TierOne Bank are not the first that the SEC has brought against in the wake of a bank closure as part of the current wave of bank failures. As noted here, in April 2012, the SEC filed a civil enforcement action against two former officers of the publicly traded holding company of the failed Franklin Bank. In addition, 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.

 

The SEC action against the former TierOne officials 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 even a securities class action lawsuit. Even though the penalty amounts the SEC sought in the enforcement actions 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 erode the limits of liability of any applicable insurance, reducing the amount of insurance available for any other pending claims. 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.

 

Summary Judgment Denied in Failed Bank Coverage Suit: Readers may recall that in a prior post (here), I described an action that a D&O insurer had filed in the Eastern District of Michigan, seeking a judicial declaration that the policy the insurer had issued to the failed Michigan Heritage Bank did not provide coverage for the claims that the FDIC, as receiver for the failed bank, had filed against a former officer of the bank. The defendants in the insurer’s declaratory judgment action include both the FDIC and the former bank official that the FDIC has separately sued.

 

In its declaratory judgment action, the insurer contends that there is no coverage under its policy for the FDIC’s claim against the former bank officer, arguing that coverage is barred by the “insured vs. insured” exclusion” and that the financial loss alleged in the underling claim does not constitute loss under the policy. The insurer moved for summary judgment.

 

In a September 24, 2012 opinion and order (here), Eastern District of Michigan Judge Bernard Freidman denied without prejudice the insurer’s summary judgment motion. In opposing the summary judgment motion, the FDIC has argued that the motion was premature because the terms on which the carrier seeks to rely are ambiguous and because discovery is required to determine the meaning of the terms.

 

In denying the insurer’s motion, Judge Friedman said that “the FDIC has shown that some ambiguity exists in the insured vs. insured exemption [sic] due to the ‘security holder exception,’ the omission of a regulatory exclusion, and statements by plaintiff that regulatory suits, which might include the instant action are covered.”

 

Judge Friedman also found “the FDIC has shown that some ambiguity exists in the definition of ‘loss’ because the so-called ‘loan loss carve out’ does not clearly exemption tortious conduct.” Judge Friedman also cited the insurer’s marketing materials “which indicated that charged-off loan losses are covered not excluded.” Judge Friedman denied the summary judgment motion to permit discovery on specified issues.

 

Judge Friedman’s ruling in this case does not represent a determination on the merits. It does not represent a determination that the Insured vs. Insured exclusion does not apply to a claim by the FDIC as receiver of a failed bank against the former officials of the bank.

 

However, there may still be some significance to the fact that Judge Friedman did find “some ambiguity” in the provisions on which the insurer sought to rely to contest coverage. His determination in the regard depended in part on specific factual issues, pertaining in particular to the insurer’s marketing materials. Nevertheless, the ruling does represent to some extent a determination that the question of whether or not the Insured vs. Insured exclusion applies to an FDIC failed bank lawsuit may not be a strictly legal issue but could involve factual issues on which discovery is required. If this coverage question is a factual issue – if there is “some ambiguity” regarding the insured vs. insured exclusion -- it could complicate insurer’s efforts to rely on the exclusion in order to contest coverage for FDIC failed bank claims.

 

To be sure, there will likely be another round on the issue of the exclusion’s applicability following discovery. But having to go on to that later round at a minimum could mean that obtaining  the coverage determination might turn out to be more involved than might have initially seemed like it would be.

 

FDIC, Bank Officials Settle Failed Bank Lawsuit: According to press reports, the FDIC and certain former directors and officers of Heritage Community Bank of Glenwood, Illinois have reached a settlement of the failed bank litigation that the FDIC, as receiver for the bank, had filed against the former bank officials. Background regarding the FDIC's 2012 lawsuit can be found here. The press reports do not disclose the amount or terms of the settlement. The September 10, 2012 settlement stipulation that the parties filed with the court (a copy of which can be found here) does not disclose the terms or amount of the settlement.

 

A March 2012 memo by the Jones Day law firm  discussing the Heritage Community Bank case (among other things) can be found here.

 

FDIC Settles Failed Bank Insurance Coverage Action: A week after the parties to the Heritage Community Bank case filed their settlement stipulation, the parties tothe D&O insurance lawsuit pending in the DIstirct of Puerto Rico involving the failed Westernbank. also filed a stipulation of settlement. As discussed here (refer to the "Update" section in the body of the blog post), in January 2012, the FDIC intervened in an action that the holding company for Westernbank had filed against the bank's D&O insurance carriers. According to the parties' September 17, 2012 stipulation  (here), the FDIC and the carriers have reached a settlement. The terms of the settlement are not disclosed in the stipulation. UPDATE: A knowledgeable reader who wishes to remain anonymous advises as follow with respect to the Westerbank settlement: "That action actually hasn't settled. The parties to a parallel proceeding involving fidelity bonds issues by [two insurers] (who also are parties to the Westernbank/FDIC D&O coverage action) did apparently settle, and was confirmed by the motion to dismiss referenced in  your blog post. Very similiar parties, and they involve some of the same underlying loans that assertedly led to the failure of the bank. But the fight goes on in the D&O coverage litigation." 

 

 

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In an August 14, 2012 opinion in the FDIC’s lawsuit against former directors and officers of the failed Haven Trust bank, Northern District of Georgia Judge Steve C. Jones affirmed that Georgia’s business judgment rule is applicable to the actions of bank directors and officers. Based on that determination, Judge Jones dismissed the FDIC’s claims against the directors and officers for ordinary negligence and breach of fiduciary duty. Judge Jones also ruled that the FDIC must replead its gross negligence claims against the former directors and officers to provide specific allegations as to each defendant’s alleged involvement in or responsibility for the alleged wrongdoing.

 

A copy of the August 14 opinion can be found here. An August 15, 2012 memo from the Alston & Bird law firm describing the August 14 ruling can be found here.

 

Haven Trust Bank of Duluth, Georgia was one of the first banks to fail as part of the current bank failure wave. Regulators closed the bank on December 18, 2008. As described in greater detail here, on July 14, 2001, the FDIC as receiver for the bank filed a lawsuit against 15 of the bank’s former directors and officers. The FDIC’s 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. In its complaint, the FDIC asserts claims for negligence, breach of fiduciary duty, and gross negligence.

 

The defendants moved to dismiss, arguing that Georgia’s business judgment rule protects bank directors and officers from personal liability for ordinary negligence and from liability for breach of fiduciary duty in the absence of allegations of bad faith, fraud or abuse of discretion. The defendants also contended that the FDIC had not pled a valid claim for gross negligence.

 

In his August 14, 2012 opinion, Judge Jones granted the defendants’ motions to dismiss the FDIC”s claims for negligence of for breach of fiduciary duty. He determined first that, contrary to the arguments of the FDIC, t was appropriate to consider the business judgment rule at the motion to dismiss stage. Judge Jones then went on to conclude that “when Georgia’s business judgment rule is applied to claims for ordinary negligence, Georgia courts hold that such claims are not viable.” He also specifically confirmed that the business judgment rule is applicable in the banking context. Based on these determinations, Judge Jones dismissed the FDIC’s claims for ordinary negligence and breach of fiduciary duty (based on ordinary negligence).

 

Judge Jones denied the defendants’ motion to dismiss the gross negligence count, finding that “the complaint has alleged in a collective/group manner sufficient facts for which a jury might reasonably conclude that Defendants were ‘grossly negligent’ as defined by Georgia law.” However, noting that the “factual allegations must give each defendant ‘fair notice’ of the nature of the claim” against them, Judge Jones ordered the FDIC to replead its gross negligence claim “to provide specific allegations as to each Defendant’s involvement or responsibility for the alleged wrongs, decisions, approvals, transactions and loans referenced in the original Complaint.”

 

Judge Jones’s rulings in the Haven Trust Bank case are consistent with his earlier rulings in the FDIC’s action against certain former directors and officers of Integrity Bank, another failed Georgia banking institution. As discussed here, in February 2012, Judge Jones ruled in the Integrity Bank case that Georgia’s business judgment rule protects the directors and officers of banks from claims for ordinary negligence and for breach of fiduciary duty based on negligence. In a footnote in this August 14 opinion in the Haven Trust case, Judge Jones expressly stated that he “adheres to and incorporates by reference into [the August 14 opinion], the Court’s prior holdings (in the context of a motion to dismiss, motion for judgment on the pleadings and motion for reconsideration) on the business judgment rule” in the Integrity Bank case.

 

Coincidentally, and also on August 14, 2012, Judge Jones entered a 52-page opinion in the Integrity Bank case denying the FDIC’s motion for reconsideration of the prior ruling in that case on the applicability of the business judgment rule and certifying the entire order for interlocutory appeal. A copy of the August 14 opinion denying the FDIC’s motion for reconsideration in the Integrity Bank case can be found here.

 

These rulings in the Georgia cases are significant for a number of reasons. First and foremost, more banks have failed in Georgia during the current wave of bank failure than in any other state. The determination of the issues regarding director and officer liability under Georgia law potentially could affect the FDIC’s potential claims against the directors and officers of many other failed Georgia banks. In addition, because Georgia banks were heavily represented among the earliest failures during the bank failure wave, the FDIC’s claims against Georgia banks have moved further along than claims the FDIC later filed elsewhere.

 

The determinations in the cases that have advanced further inevitably will have an effect on the cases that were filed later – and indeed, may have an impact on whether or not the FDIC’s even files a complaint in connection with banks that failed later. Certainly, if the FDIC cannot pursue claims for ordinary negligence in Georgia (and perhaps elsewhere), that could cause the FDIC to forebear from filing suit in at least some situations. For that reason, it will be important to see whether the Eleventh Circuit elects to take up the interlocutory appeal in the Integrity Bank case. A opinion from the Eleventh Circuit would obviously not only prove determinative in existing and potential future failed bank suits in Georgia, but could prove influential in suits and potential suits elsewhere in the Eleventh Circuit, and perhaps even outside the Circuit.

 

Along those lines, and in terms of what is happening on these issues elsewhere, earlier this month a judge in the Middle District of Florida, ruled in the FDIC’s failed bank lawsuit relating to the failed Florida Community Bank of Immokalee, Florida, that under Florida law directors cannot be held liable for ordinary negligence, as discussed in a prior post, here. The ruling in that case did not reach the question of whether or not officers can be held liable for ordinary negligence under Florida law.

 

Very special thanks to a loyal reader for providing me with a copy of the two August 14 orders in the Haven Trust and Integrity Bank cases.

 

More About Libor Scandal-Related Litigation: In an earlier post (here), I took a closer look at the Libor scandal, including in particularly the litigation that has arisen in the wake of the scandal. Since I added that post, there have been other lawsuits filed (refer here and here). It is clear that the Libor scandal litigation will be an important part of the litigation landscape for months and years to come.

 

An August 4, 2012 Economist article entitled “Suing the Banks: Blood in the Water” (here) takes its own look at the Libor-scandal litigation. The article notes that many law firms are looking at the Libor scandal as a potentially lucrative source of business. The article states that “so far, at least 28 serious lawsuits have been filed.” All of these cases, the article notes, are “either assigned or likely to be assigned” to Southern District of New York Judge Naomi Buchwald.

 

The Economist article notes that “if there is a hesitation” it is because, notwithstanding Barclays’s massive regulatory settlements “a case will not be easy to make.” Establishing culpability “will not be straightforward.” Among other things, “no one is forced to use [Libor], and those who do often add further costs (such as a credit spread).” In addition, “it will not be easy to determine what the rate should have been” since that will require determining “what the rate should have been each trading day, minus any potential benefit.” Working this out will be “mind-wrenchingly complex for many.”

 

Just the same, as the article notes in conclusion, other legal action tied to Libor is “percolating” in Japan, Canada and Singapore, and “it would not be a shock if there were not more cases in America as well.”

 

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A federal court has ruled in the only FDIC failed bank lawsuit pending in Florida that directors cannot be liable for ordinary negligence under Florida law. On August 8, 2012, Middle District of Florida Judge Gregory Presnell granted the motion of the director defendants to dismiss the FDIC’s claim against them for ordinary negligence. A copy of Judge Presnell’s order can be found here.

 

As discussed here, in March 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 director defendants (except for one director who has filed for personal bankruptcy and with respect to whom the FDIC’s action as been stayed) moved to dismiss, arguing that Florida law allows recovery for bank directors only for gross negligence and therefore the claim against them for ordinary negligence should be dismissed; and also arguing that the FDIC’s allegations in the claim against them for gross negligence failed to rise to the level of gross negligence.

 

In his August 8 order, Judge Presnell granted the director defendants motion to dismiss the FDIC’s claim for ordinary negligence. He found first that Florida Statutes Section 607.830(1) imposes an ordinary standard of care on directors. However, the liability of directors is governed by Section 607.831, which provides that directors can be held liable only of one of five conditions were met. Judge Presnelll found that the only section that “conceivably “could apply is the provision requiring in order to impose liability on directors a showing that the directors’ failure constituted “conscious disregard for the best interests of the corporation or willful negligence.”

 

Judge Presnell found that the statute “conditions directorial liability on something beyond ordinary neglilgence,” and so the count in the FDIC complaint asserting a claim for ordinary negligence “must therefore be dismissed.”

 

Judge Presnell denied the directors’ motion to have the FDIC’s claim against them for gross negligence dismissed, finding that the FDIC’s allegations “are sufficient at this stage of the proceedings to state a claim for gross negligence.”

 

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 has so far only filed this one failed bank lawsuit in Florida. There undoubtedly are other lawsuits involving other failed Florida banks yet to come. To the extent the FDIC does filed further actions in Florida and to the extent those other action involve former directors of the failed banks, the directors defendant will argue in reliance on this case that they cannot be held liable under Florida law for ordinary negligence.

 

Judge Presnell’s decision pertains only to the director defendants, and the statutes on which he relied in reaching this decision relate only to the liabilities of directors. Accordingly his decision doesn’t reach the question  whether officers (as opposed to directors) may also argue that they can only be held liable for gross negligence., or whether officers otherwise have other protections from liability for ordinary negligence.

 

Special thanks to a loyal reader for sending me a copy of Judge Presnell’s decision.

 

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On July 13, 2012, after a lull of nearly two months during which the FDIC did not file any new failed bank lawsuits, the FDIC filed two new lawsuits against former directors and officers of failed banks. The FDIC also updated the number of authorized failed bank lawsuits as well.

 

The first of the two lawsuits was filed in the Northern District of Georgia against six former directors, one of whom was also an officer, of the First Piedmont Bank of Winder, Georgia, which failed on July 17, 2009. The FDIC’s complaint, which can be found here, asserts claims for negligence and for negligence in connection with “nine speculative and high risk acquisition, development and construction (ADC) transactions” that the defendants approved between October 18, 2005 and July 24, 2007. The complaint alleges that the defendants approved the loans “on an uninformed basis,” and “allowed irresponsible and unsustainable rapid asset growth concentrations in high-risk ADC transactions, without implementing and adhering to adequate underwriting and credit administration policies and practices.”

 

The second of the two July 13 lawsuits was filed in the District of Arizona against seven former directors and officers of the Community Bank of Arizona, of Phoenix, Arizona, which failed on August 14, 2009. Three of the seven defendants were both officers and directors of the failed bank; the remaining four were directors only. The complaint, which can be found here, asserts claims against all defendants for gross negligence and for breach of fiduciary duty and asserts claims of ordinary negligence against the officer and director defendants as well. The FDIC alleges that the defendants improperly “rubber stamping” the purchase of interests in numerous loans that had been originated at the bank’ “sister bank” – the Community Bank of Nevada, which also failed on August 14, 2009 – without the Arizona bank conducting its own underwriting of the loans and in reliance on the sister bank’s “outdated or inadequate” underwriting. The FDIC seeks to recover damages of at least $11 million.

 

In addition to the fact that both of these complaints were filed on July 13, 2012, these complaints also have in common the fact that they were both filed as the end of the three year statute of limitations period approached. In the case of the First Piedmont Bank lawsuit, the FDIC filed its complaint almost at the very end of the three year period. Given how many banks failed in the second half of 2009, there could be a host of other bank failures that in the coming months will be approaching the end of the three year period following their closure.

 

Indeed the high number of 2009 bank failures had been one of the reasons that some commentators (including me) had predicted that this would be a very active year for FDIC lawsuit filings. Indeed, through about the middle of April of this year, the FDIC had been very active. But since mid-April, the FDIC had only filed one additional lawsuit before it filed these two complaints on July 13. It is hard to tell from here whether or not the filing of these two lawsuits means the short lull is over.

 

There are further lawsuits to come at some point, that much is clear. The FDIC has updated its website to indicate that the number of authorized lawsuits has increased. As of July 17, 2012, the FDIC has authorized suits in connection with 68 failed institutions against 576 individuals for D&O liability. This figure is inclusive of the 32 D&O lawsuits that the agency has already filed naming 266 former directors and officers. In other words, there are as many as 36 further lawsuits in the pipeline, involving an additional 310 individuals. There are going to be a lot more lawsuits before all is said and done.

 

One interesting difference between the two July 13 lawsuits is that the Arizona lawsuit seems to have been crafted so as to avoid asserting ordinary negligence claims against the director defendants, while the Georgia lawsuit actively asserts ordinary negligence claims against the director defendants. This is interesting because of the recent decision in the Northern District of Georgia in the Integrity Bank case, applying Georgia law and holding that because of their protection under the business judgment rule, directors cannot be held liable of ordinary negligence. In light of that earlier decision, it would seem that the director defendants in the new Georgia case have a basis on which to seek to have the negligence claims against them dismissed.

 

Despite the recent lull, there have still been a total of 14 FDIC failed bank lawsuits filed this year, and 32 overall as part of the current bank failure wave. Eight of the 32 total lawsuits, or a quarter of all lawsuits, have involved failed Georgia banks, the highest number for any state, which is hardly surprising since Georgia has had the highest number of bank failures of any state. However, the 80 Georgia banks that have failed since August 2008 represent substantially less than a quarter of the approximately 440 bank failures during that same period, so the Georgia bank failures seem to be attracting litigation at an unexpectedly elevated rate, at least so far.

 

Scott Trubey's July 18, 2012 Atlanta Journal Constitution article about the new Georgia lawsuit can be found here.

 

Advisen Webinar on Securities Litigation Developments: On Thursday, July 19, 2012 at 11:00 am EDT, I will be participating in free, one-hour webinar sponsored by Advisen and entitled “Second Quarter Securities Litigation Review.” The webinar will be chaired by Advisen’s Jim Blinn and will also include Terence Healy of the Reed Smith law firm. Further information and registration instructions for the webinar can be found here. I hope all blog readers will listen in, this should be a lively webinar. There is a lot to talk about.

 

Advisen’s quarterly report on 2Q12 corporate and securities litigation can be found here.

 

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In a May 31, 2012 study of the FDIC failed bank litigation that contains a number of interesting observations and projections, NERA Economic Consulting projects at the current filing rate, the FDIC’s failed bank litigation ultimately could total 86 lawsuits, or much as 20% of all banks that have failed as part of the current round of bank failures. The study, which is entitled “Trends in FDIC Professional Liability Litigation,” can be found here.

 

The NERA study is based on its analysis of all failed bank lawsuits through the end of the first quarter of 2012, at which time there were 27 lawsuits involving 26 failed banks. (Through May 30, 2012, there have been a total of 30 lawsuits involving 29 institutions.)

 

Based on lawsuit filing patterns through March 31, 2012, NERA projects that ultimately the FDIC will file 86 lawsuits in total, representing about 20% of all bank failures. Through the end of the first quarter, the FDIC had authorized lawsuit against 54 institutions, suggesting that the FDIC had authorized about 60% of the number of lawsuits that NERA projects the FDIC will file. (After the end of 1Q12, the FDIC increased the number of authorized lawsuits; through May 15, 2012, the FDIC had authorized lawsuits involving 63 failed institutions, or about 73% of the number of lawsuits that NERA projects ultimately will be filed.)

 

The 20% filing rate that NERA projects is slightly less than the 24% filing rate following the S&L crisis. However, despite this lower projected filing rate, NERA projects that the FDIC’s aggregate recoveries could approach recoveries during the S&L crisis. The recoveries following the S&L crisis totaled $1.3 billion, or $2.3 billion in inflation adjusted terms, while NERA projects aggregate recoveries from the current round of bank failure litigation of about $1.9 billion.

 

The NERA report notes that the banks failures that produced the largest losses to the deposit insurance fund are more likely to be the subject of litigation. Bank failures that caused losses to the deposit insurance fund of greater than $200 million have filing rates of 62%, while bank failures that produced losses to the deposit insurance fund of under $50 million have a filing rate of only about 3% For bank failures that produced deposit insurance fund losses of between $50 million and $200 million, the filing rate has been about 19%.

 

The lower filing rate with respect to banks whose failure caused deposit insurance fund losses under $50 million could impact the number of future filings, Since the third quarter of 2010, the average deposit insurance fund losses per failed institution has dropped significantly, and for many of the banks that have failed most recently, the losses were below $50 million, suggesting a much lower likelihood that many of the most recent bank failures ultimately will involve litigation.

 

On the other hand, NERA’s analysis suggests that litigation involving some of the largest bank failures to date has yet to be filed, especially when the aggregate losses claimed in lawsuits already filed is compared to the FDIC’s projection of aggregate losses involved in all authorized lawsuits. NERA reckons claims involving some of the largest failed losses may be about to be filed. In terms of losses to the deposit insurance fund, the four largest bank failures that have not yet seen litigation are BankUnited ($5.8 billion in deposit insurance fund losses); Colonial Bank ($4.2 billion); Amtrust Bank ($2,5 billion); and United Commercial ($2.5 billion).

 

Comparing the bank failures by state to the lawsuits filed so far by state, the NERA report suggests that there have been relatively high litigation levels in Illinois, Nevada, North Carolina, and Puerto Rico, while filings in California and Florida are fewer than the number of bank failures in those states would suggest. In Minnesota, Missouri and Arizona, there have not yet been any lawsuits filed even though those states are among the top ten in terms of bank failures. However, the study notes based on the date of bank failures in those states that litigation involving failed banks in those states is not projected until after the end of the first quarter of 2012.

 

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According to the FDIC’s Quarterly Banking Profile for the first quarter of 2012, which can be found here and which was released on May 24, 2012, the banking industry generally continues to show improvement. The industry’s aggregate profits are up, and the industry is shedding bad loans, bolstering net worth, and increasing profitability. In addition, the number of banks that the FDIC ranks as “problem institutions” continues to decline. The FDIC’s May 24, 2012 press release about its Quarterly Banking Profile can be found here.

 

According to the report, as of March 31, 2012, there were 772 problem institutions, compared to 813 as of the year-end 2011, and 888 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 FDIC does not identify the problem institutions by name.) The quarterly decline in the number of problem institutions represents about a 5% drop, and the decline during since March 31, 2011 represents about a 13% drop.

 

According to the FDIC, the 1Q12 decline in the number of problem institutions represents the fourth consecutive quarterly decline. The number of problem institutions is now at its lowest level since year-end 2009.  The assets of “problem” banks fell during the first quarter from $319 billion to $292 billion. As recently as the end of 2009, the problems institutions assets’ were as much as $402 billion.

 

Though the total number of problem institutions has declined, the number of reporting institutions has also continued to decline (due to mergers and closures). The 772 problem institutions represent about 10.5% of all reporting institutions as of March 31, 2012. Even though that is the lowest absolute number of problem institutions since year-end 2009, the 702 problem institutions as of year-end 2009 represented only about 8.5% of all reporting institutions at that time. Thus, though the total number of problems institutions has declined, as a percentage of all institutions the number of problem institutions remains at elevated levels.

 

In other words, the declining number of problem institutions does not necessarily mean that the number is declining because of improvement among problem institutions. In larger measure, the number of problem institutions is declining because many of the institutions formerly assessed as problems simply no longer exist, whether as a result of mergers or closures.

 

On a more positive note, the 16 bank failures during the first quarter of 2012 represents the smallest quarterly number of bank closures since the fourth quarter of 2008, when there were 12 bank failures. The 16 bank failures in 1Q12 compares to the 26 bank failures in the first quarter of 2011. (As of today, there have been a total of 24 bank failures so far during 2012, compared with 43 YTD bank failures on the same date in 2011).

 

The decline in the number of banking institutions during the current banking crisis really has been remarkable. As recently as year-end 2007, there were 8,649 reporting institutions. The 7,307 institution remaining as of March 31, 2012 represents a decline of 1,342 banking institutions, or a decline of about 15.5% during that period.

 

The remaining 7,307 banking institutions are largely concentrated in the community banking space. As of March 31, 2012, 6,643 (or about 90.9%) of the 7,307 remaining banks had assets less than $1 billion. Only about 107 institutions (or 1.5% of all institutions) had assets of $10 billion or greater.

 

While the number of problem institutions and failed institutions has been declining, the FDIC has been increasing the number of lawsuits it has authorized against the former directors and officers of failed institutions. As of the FDIC’s latest update on May 15, 2012, the FDIC has authorized suits in connection with 63 failed institutions against 549 individuals for D&O liability. This includes the 29 lawsuits involving 28 institutions that the FDIC has already filed, naming 239 former directors and officers. The implication is that there are many more lawsuits in the pipeline – although interestingly, the FDIC has not filed any new lawsuits in over a month. The last lawsuit that the FDIC filed was filed on April 20, 2012.

 

“The Most Serious Natural Resources Shortage You’ve Never Heard Of”: We can live without oil, but we can’t live without food. For decades, the world has been able to feed a growing population by using phosphorus-rich fertilizer to increase crop yields. The problem is, we are running out of phosphorous.

 

My research biologist brother-in-law has been telling me for years about the dwindling supplies of phosphorus. The looming phosphorus shortage is the subject of an April 20, 2012 article in Foreign Affairs entitled “Peak Phosphorus” (here), which warns that there “will not be sufficient phosphorus supplies from mining to meet agricultural demand within 30 to 40 years.” The consequences of the looming shortage will be felt long before the supplies finally run out. Even in the short run, increased demand and decreasing supplies “will result in higher prices, significantly affecting millions of farmers in the developing world who already live on the brink of bankruptcy and starvation.”

 

Tensions about control over phosphorus supplies have already been the source of significant issues involving Morocco (where the largest number of phosphorus mines are located) and Western Sahara, a disputed independent territory that is Morocco currently occupies. China, the country with the second largest reserves, has already once resorted to trade tariffs that effectively eliminated exports in 2008, which was a contributing factor to dramatically rising food prices that year. While the U.S. historically has been a leading source of phosphorus, the supplies from its most productive mines have been declining rapidly. As a result, the country, which has been a phosphorus exporter for decades, is now imports as much as 10% of its supply.

 

As the article notes “establishing a reliable phosphorus supply is essential for assuring long-term food security.” The most important step is to reduce the demand for phosphorus by “eliminating wasteful practices” – phosphorus can be used over and over, and effective conservation techniques could significantly expand the usefulness of remaining supplies. In addition, there is a significant promise in the development of new, phosphorus-efficient foods.

 

If we fail to respond to the challenge, however, “humanity faces a Malthusian trap of widespread famine on a scale that we have not yet experienced. The geopolitical impacts o such disruptions will be severe, as an increasing number of states fail to provide their citizens with sufficient food.” This “dark scenario” is not inevitable, but in order to avoid this destiny, the threats involved with the looming phosphorus shortage must be addressed.

 

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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 in