According to the FDIC’s Second Quarter 2010 Quarterly Banking Profile, which the agency released on August 31, 2010, aggregate indicators of banking institutions’ financial health are improving, but at the same time the number of "problem institutions" also continues to increase. The FDIC’s August 31, 2010 press release about the Quarterly Banking Profile can be found here.
The positive news is that the industry’s 2Q10 earnings of $21.6 billion are the highest since the third quarter of 2008. Almost two-thirds of the banks reported higher year-over-year quarterly net income. However, 20 percent of institutions did report quarterly net losses (compared to 29 percent 2Q09).
The quarterly report also reflects that provisions for loan losses, while "still high by historic standards," represented the smallest total since the first quarter of 2008. Fewer borrowers are falling behind on their loan payments. With respect to just about every type of loan, troubled loans declined for the first time in more than four years. The only exception was commercial real estate loans, which continued to show increased weakness.
Despite this relatively good news, the number of problem institutions increased in the second quarter, to 829, up about 7% from the 775 problem institutions at the end of 1Q10, up 18% from the 702 problem institutions at the end of 2009, and up almost 100% from the 416 at June 30, 2009. (The FDIC defines a "problem institution" as those it rates as "4" or a "5" on its one-to-five scale of rating banks’ financial and operating criteria. The FDIC does not disclose the names of the problem institutions.)
The number of problem institutions is the highest since March 31, 1993, when there were 928.
To put the latest number of problem institutions into perspective, at the end of the second quarter, there were a total of 7,830 insured institutions. So the 829 problem banks represent about 10.6% of all insured institutions.
Or to put it a different way, one out of every ten banks in the United States is a problem institution. (And that’s after the 283 banks that have failed since January 1, 2008 have been taken out of the equation).
Though the number of problem institutions increased in the quarter, the assets associated with these banks did decrease. The 829 problem institutions at the end of the second quarter represented assets of about $403 billion, down slightly from the $431 billion that represented by the 775 problem institutions at the end of 1Q10.
To put the assets associated with the problem institutions into perspective, the collective assets of all insured institutions totals $13.2 trillion. The $403 billion in assets associated with the problem institutions represents about 3.1% of the industry’s total assets.
One other sign that the banking industry as a whole may not yet be in the clear, notwithstanding the relatively positive industry news overall, is that during the second quarter and for the first time in the 38 years for which data is available, there were no new insured institutions.
Since January 1, 2008, 283 banks have failed, 118 in 2010 alone. But even with the growing numbers of failures (each one of which presumably reduces the number of problem institutions by a count of one), the number of problem institutions continues to grow. The likelihood seems to be that the number of failed banks will continue to grow for some time to come.
Eric Dash’s August 31, 2010 New York Times article about the report can be found here.
Ain't Too Proud to Beg: The D&O Diary has been selected as a nominee candidate for the LexisNexis Top 25 Business Law Blogs of 2010. The ultimate list of the Top 25 blogs will be chosen based on comment submited by members of either of two LexisNexis business law communities, the Corporate & Securities Law Community and the UCC, Commercial Contracts and Business Law Community. If you are a registered member of either of these communities, I would appreciate your comment in support. Members of the Corporate & Securities Law Community can submit comments here, and members of the UCC, Commercial Contracts and Business Law Community can submit comments here. The deadline for comments is October 8, 2010.
It remains to be seen whether the FDIC will pursue civil actions against former directors and officers of failed banks, but it has made it clear that it will file criminal actions in cases where it suspects fraud. According to news reports, on May 7, 2010, the U.S. Attorney of the Northern District of Georgia unsealed indictments against two former officers of the failed Integrity Bank as well as against a real estate developer whom the officials said obtained $80 million in improper loans from the bank.
Douglas Ballard, the bank’s former Executive Vice President in charge of client relationships and a member of the bank’s board of directors, and Joseph Todd Foster, the bank’s former Executive Vice President for Risk Management, are charged with conspiracy, insider trading and bank fraud. The developer, Guy Mitchell, is charged with conspiracy and bribery.
The indictment alleges that Mitchell and companies he controlled obtained more than $80 million in business loans from Integrity Bank. He allegedly obtained the loans under false pretenses and deposited nearly $20 million in a checking account used for personal expenses, included over $1.5 million spent on a private island in the Bahamas. Later loans were used to pay interest on earlier loans.
The indictment also alleges that Mitchell paid Ballard, who authorized the loans, over $290,000 over a nine month period (half in cash and half in a cashier’s check) as a reward for Ballard’s assistance.
Ballard and Foster are also alleged to have committed securities fraud by engaging in insider trading. They are alleged to have sold all of their shares based on inside information (specifically, with knowledge of the bank’s problems with Mitchell’s loans).
Many of the news reports about the indictment have highlighted the fact that Integrity Bank had been founded with a faith-based theme. According to the Atlanta Journal Constitution (here), bank employees regularly prayed before meetings and in bank lobbies with customers.
The FDIC took control of the bank in August 2008. The Atlanta Journal Constitution article quotes the U.S. Attorney for the Northern District of Georgia as saying that the alleged fraud "was substantial contributing factor to the collapse," adding that "more than $80 million was given away from a dirty insider who was taking payoffs from the developer. That’s more that the average bank has had to deal with."
The Wall Street Journal (here) also quotes the U.S. Attorney as saying that "We are continuing to investigate and potentially other officials could be charged."
Statements by agency officials suggest that this prosecution may not be an isolated event. The indictment reportedly was the result of an interagency collaboration that included the FDIC’s Office of Inspector General. News reports quote the FDIC’s Inspector General as saying that "we are particularly concerned when senior bank officials, who are in positions of trust within their institutions, are alleged to be involved in unlawful activity. Prosecutions of individuals and entities involved in criminal misconduct maintain the safety and soundness of the Nation’s financial institutions."
The FDIC had already demonstrated substantial interest in claims involving Integrity Bank. As I discussed in a prior post (here), the FDIC intervened in the derivative lawsuit that had been brought by the bankruptcy trustee of the bank’s holding company against four former directors and officers of the holding company and the bank. The court granted the FDIC’s motion to intervene and also granted the FDIC’s motion to have the trustee’s claims dismissed, holding that under FIRREA the agency had the exclusive right to pursue claims on behalf of the bank. Basically, the FDIC made it clear that if anybody is going to pursue claims against the former officers, it is going to be the FDIC.
I had interpreted the FDIC’s moves in the bankruptcy trustee’s lawsuit as evidence that the FDIC intended to pursue its own claims against the former officials of Integrity Bank. But I was expecting civil claims; I certainly did not forsee this criminal prosecution. The FDIC may yet pursue civil claims as well. But it is nevertheless interesting that the FDIC is going ahead with criminal prosecutions but not yet pursuing its own civil actions, either in connection with Integrity or really any other failed banks.
Special thanks to the several readers who sent me links to news articles about the Integrity indictment.
Meanwhile the Investor Lawsuits Continue to Emerge: While we all wait to see that whether the FDIC will unleash a flood of failed bank claims as it did during the S&L crisis, the failed banks’ aggrieved investors are continuing to file their own claims against the directors and officers of the failed institutions.
The latest of these investor lawsuits is the securities class action lawsuit filed on May 7, 2010 in the Central District of California against certain former directors and officers of First Regional Bancorp, the holding company for First Regional Bank, a Los Angeles based bank that regulators closed on January 29, 2010. According the plaintiffs’ attorneys’ May 7 press release (here), the defendants "caused the Company to disseminate financial statements that were not fairly presented in conformity with Generally Accepted Accounting Principles and were materially false and misleading, and failed to make complete and timely disclosures concerning certain actions taken by regulators."
The First Regional lawsuit follows several other recent securities lawsuits that have involved failed banks. For example, on April 15, 2010, investors filed a securities lawsuit in the Western District of Washington against Frontier Financial Corp., the holding company of Frontier Bank, and certain of its directors and officers. Regulators closed Frontier Bank on April 30, 2010.
In addition to securities class action lawsuits, investors are pursuing a variety of other kinds of claims against former directors and officers of failed banks, as illustrated, for example, by the recent action for negligent misrepresentation filed against the former officials of the failed Alpha Bank and Trust, about which refer here.
At this point, it seems well-established that failed bank investors intend to pursue these kinds of claims, although whether they will succeed and produce value for the claimants remains to be seen. My recent post discussing plaintiffs’ dismissal motion record in these kinds of cases can be found here.
The FDIC has picked up where it left off at the end of 2009, with its first bank closure of the New Year. On Friday, January 8, 2010, the FDIC took control of Horizon Bank of Bellingham, Washington, for the first bank closure of 2010. While the FDIC’s continuation of its regulatory actions regarding troubled banks seems likely in the near term, what remains to be seen is whether the FDIC’s actions will include litigation against the former directors and officers of the failed banks.
Though the FDIC has yet to launch D&O litigation, the lawsuits may be just ahead. The FDIC is taking a series of steps clearly designed to prepare for litigation.
First, as reported in a January 10, 2010 article in FinCri Advisor (here), the FDIC is "subpoenaing bank officials and workers, hoping to gather evidence to use in potential litigation." By way of illustration, a recent motion filed by bank officials in connection with the bankruptcy proceedings involving Haven Trust Bancorp, the holding company for a Duluth, Georgia bank that failed in December 2008, states that certain of the officials "received subpoenas…issued by counsel to the [FDIC] regarding the FDIC’s investigation of certain matters relating to the failure of Haven Trust Bank." (The former officials’ motion sought access to the D&O insurance policy proceeds in order for the officials to be able to defend themselves.)
Second, as I noted in a prior post, the FDIC is sending civil demand letters to former directors and officers of failed banks. According to the FinCri Advisor article, former directors in Florida, California, Illinois, Texas and Georgia have received FDIC claims letters. According to a commentator in the article, one obvious trigger for a demand letter is the approaching expiration date of the D&O insurance policy.
An example of one of these demand letters is described in a January 8, 2010 Atlanta Business Chronicle article, here (registration required). The article describes a September 28, 2009 letter sent to the D&O liability insurer for Georgian Bank, an Atlanta bank that the FDIC closed on September 25, 2009. According to the article, the letter details the potential claims the FDIC might make against the bank’s former directors and officers, including allegations of "unsafe and unsound banking practices."
Industry experts quoted in the Atlanta Business Chronicle article say that "such letters likely have been filed with insurers by all 30 banks that have failed in Georgia since August 2008."
But while the FDIC is clearly pursing investigations and taking steps to try to preserve the right to try to recover D&O insurance proceeds, it "has not filed any D&O lawsuits in connection with the bank failures since the crisis began in 2008," according to an FDIC spokesman quoted in the article.
According to the FinCri Advisor article, "the FDIC spends about a year conducting an investigation into a failed bank before deciding whether it can pursue a claim against former directors and officers."
Because of the FDIC’s many continuing investigations, 2010, according to an attorney quoted in the FinCri Advisor article, "will be the year of investigation and tolling agreements." One reason for the FDIC to proceed carefully is that it doesn’t want to push cases early that may set bad precedents, which could "doom subsequent cases."
But though the FDIC is now proceeding cautiously, when the litigation ultimately comes, there is likely to be a lot of it. The FinCri Advisor article quotes the FDIC’s former head of litigation as saying that "about half" of the bank failures will "see some director litigation." Before all is said and done, the coming litigation "could rival the litigation that occurred in the 80s and 90s as a result of the many thrift failures."
Special thanks to loyal reader Henry Turner for providing me with a copy of the Haven Trust pleading and the Atlanta Business Chronicle article.
Another Perspective: As a continuation of my early post in which I linked to a variety of Top Ten lists, I note here the recent post on the Corporate Disclosure Alert blog (written by my law school classmate and investor advocate, Sanford Lewis) about "10 Questions of Risk Management for the New Decade" (here). Lewis contends that "far more must be done to turn the patchwork of risk management approaches into viable public policy and corporate governance solutions." The list of issues that Lewis contends should be addressed is interesting and provocative.
We Aren’t What We Watch – Are We?: On New Year’s Day, my hyperkinetic eldest daughter -- collegiate swimmer, rugby player – who rarely sits still long enough to watch TV, announced "I think I’ll watch some college football" and she plopped herself down beside me on the couch. Unfortunately for the nascent possibility of a little father-daughter bonding, the game broadcast at that moment was in the middle of the Flomax halftime report, and the commercial had just reached the point where it advised that Flomax’s adverse side effect may include a "reduction in semen."
As she was leaving the room, my daughter offered the observation that at least on TV college football is clearly meant for a "different demographic."
Indeed. But what exactly is the intended demographic?
The commercials themselves suggest that the target audience consists of people who are basically worried. They are not only worried just because they have to go pee all the time. They are worried about their credit scores. They are worried that their nest eggs have shrunk. They are worried about figuring out their taxes. They are worried because their computers are too slow and because their 3G network’s coverage areas are too small.
So many things to worry about. Too bad for you if all you want to do is watch a little football.
But in the midst of all of this apprehension and fear, there is cause for hope. For the overweight, for example, Taco Bell would like to communicate the optimistic message that you can lose weight by eating fast food. (I am not making this up.)
If playing time alone is any measure, the most important message for our society seems to be that Taco Bell now has a five-layer burrito for 89 cents. For those of you thinking, "No Way!" -- you have to understand that they are not offering to pay you 89 cents to eat that thing. They are expecting you to pay them. Seriously. As my son said, "Is that supposed to be food?"
Perhaps (I can hope optimistically) we are all in the wrong demographic. How much more fortunate are the viewers of the UK premier league soccer games. Since the game clock never stops, there are no commercial interruptions – which obviously is the reason that soccer has never been allowed to catch on commercially in the U.S. Of course, the soccer games do have halftimes, which does hold open the theoretical possibility for Flomax halftime reports.
Even though Madoff victims previously filed a securities class action lawsuit against Banco Santander and other parties in the Southern District of Florida (as discussed here), a different group of claimants has now filed a separate lawsuit in the Southern District of New York against substantially the same set of defendants. However, the new lawsuit purports to represent a different approach, and also presents specific allegations pertaining to Banco Santander’s public offer (here) to compromise the Madoff-related claims.
On February 4, 2009, plaintiffs filed a purported class action lawsuit in the Southern District of New York "on behalf of all persons or entities who owned shares of Optimal Strategic U.S. Equity Ltd. on December 10, 2008." The defendants include Banco Santander S.A. and related entities; Optimal Investment Services; PricewaterhouseCoopers; several HSBC-related entities; and several individual defendants. A copy of the complaint can be found here.
Both the purported class and cast of defendants named in this new lawsuit are similar to the class and defendants named in the previously filed Southern District of Florida lawsuit (about which refer here). However, unlike the prior lawsuit, the most recent lawsuit does not assert any claims under the federal securities laws.
Even though the new lawsuit purports to involve a class action, it asserts, rather than alleged violations of the federal securities laws, common law claims against all defendants for negligent misrepresentation, breach of fiduciary duty, and unjust enrichment. The complaint also asserts a claim for aiding and abetting a breach of fiduciary duty claim against PricewaterhouseCoopers. In addition, the complaint asserts a claim against all defendants under Section 349 of the New York General Business Law.
What makes this class action complaint’s lack of securities law allegations noteworthy is that it was filed by one of the leading plaintiffs’ securities class action law firms. A number of possibilities suggest themselves as to the reasons for the omission of a claim based on the firm’s area of specialty.
The first is the possibility that the firm hopes to maintain its own lawsuit separately and without consolidation with the previously filed lawsuits.
Another more interesting possibility is that the law firm wants to avoid the discovery stay under the PSLRA. Indeed, press reports (here) relating to the lawsuit expressly noted that "unlike other Madoff-related cases, the suit does not contain a securities claim, meaning plaintiffs can receive relevant information about the case before any trial that could bring to light previously unknown details on the case."
A leading plaintiffs’ securities firm’s use common law claims as a tactical way to insert a discovery tentacle, possibly to support later amended securities claims, is a disturbing possibility that would represent a circumvention of the PSLRA’s intended protections. Of course, there is always the possibility that the plaintiff lawyers in fact intend to pursue the common law claims without later adding securities claims, which would represent an interesting development in and of itself.
Yet another reason the plaintiffs’ lawyers may have dispensed with a federal securities claim is suggested in the claim asserted against PricewaterhouseCoopers. Under Stoneridge, the plaintiffs have no aiding and abetting claim against the audit firm under the securities laws. The complaint nevertheless asserts an aiding and abetting claim against the audit firm, but for fiduciary duty violations, not Securities law violations, suggesting an attempt to avoid Stoneridge’s limitations.
The new complaint in any event expressly references Banco Santander’s public offer to compromise the Madoff-related claims (about which refer here). Among other things, the complaint describes Santander’s offer as "woefully inadequate," citing the fact that the offer "does not compensate Class members for any interest or gain their money would have earned," and asserting that the preferred stock Banco Santander is offering would be substantially discounted in the open market.
For their part, the plaintiffs in the action previously filed in the Southern District of Florida have filed an "emergency motion" to enjoin Banco Santander from contacting putative class members to try to secure a release from them of their claims. In the memorandum filed in support of the motion (a copy of which can be found here), the plaintiffs allege that Santander "has launched a misleading and coercive campaign to pick off class members one by one, by pressuring them to release their claims based on incomplete and misleading information."
The memorandum cites Santander’s supposed use of closed door meetings, in which class members are presented with "onerous conditions and take-it-or-leave-it terms with quick expiration dates." The memorandum also references Santander’s "failure" to inform the putative class members of the existence of the lawsuit that "seeks recovery in excess of the compensation proposed."
The motion seeks to enjoin Santander from contacting class members, in order to prevent an "end-run around the Court’s jurisdiction and power to preside over this Class Action."
Whatever else may be said about the multidirectional litigation, it seems fairly certain that Banco Santander is getting a quick indoctrination into the battlefield tactics of the U.S. plaintiffs’ bar.
I have in any event added the new lawsuit to my running tally of the Madoff-related litigation, which can be accessed here. The new lawsuit appears in Table IV, in which I have identified "additional lawsuits against related defendants" and that are distinct from the federal securities class action lawsuits separately listed in the document.
Special thanks to Adam Savett of the Securities Litigation Watch blog for a copy of the complaint of the new lawsuit.
More Bank Closures: The expanding wave of bank failures swelled again this past Friday night when the FDIC announced the closure of three more banks, bringing the number of 2009 year-to-date closures to nine.
The three latest bank closures are Alliance Bank, previously a $1.14 billion asset bank in Culver City, CA (about which refer here); County Bank, previously a $1.3 billion bank in Merced, California (refer here); and First Bank Financial, previously a $279 million asset bank in McDonough, Georgia (refer here). The FDIC’s complete list of failed banks can be found here.
The closure of nine banks already in 2009, including in particular the closure of six banks in just the last two weeks, is extraordinary in and of itself. It is also noteworthy in context, as the number of bank closures just in the opening weeks of this year already exceeds the total number of all bank closures during the four years between January 1, 2003 and January 1, 2007. Indeed, during the period January 1, 2000 to January 1, 2008, only one year (2002, with 11 closures) had more bank closures than the nine already in the first six weeks of the year.
As I recently noted (here), the increasing number of bank closures is a difficult and disturbing trend, Unfortunately, all signs are that the number of bank closures will continue to grow as the year progresses.
Event Registration Update: If you are planning on attending the PLUS D&O Symposium on February 25 and 26, 2009 at the Marriott Marquis hotel in New York but you have not yet registered, you may want to get your registration in at your earliest opportunity. Event registration is rapidly filling, and so you may want to register now before it is too late. Registration information can be found here.
This year’s conference promises to be particularly interesting and informative. I am co-Chairing this year’s Symposium with my good friends, Chris Duca of Navigators Pro and Tony Galban of Chubb. The key note speakers include former Secretary of States Madeline Albright and New York Insurance Superintendent Eric Dinallo. Other panelists and speakers include a number of noteworthy individuals, including Stanford Law Professor Joseph Grundfest, Wilson Sonsini partner Boris Feldman and many others.
The Symposium will also feature a reprise of the excellent video, first shown at the PLUS International Conference in November, of "The Life and Times of Bill Lerach." The Securities Docket recently featured a trailer of the video, here.
All litigants face the challenge of managing lawsuit expenses and exposures. The Reserve Primary Fund investor litigation defendants have crafted a novel approach to addressing these challenges – they apparently intend to finance their defense as well as any indemnity out of funds due to investors -- that is, the funds of the very people on whose behalf the claims are being asserted.
Background
In September, the Reserve Primary Fund ("the fund") gained notoriety when the money market fund "broke the buck," as massive redemptions and the fund’s exposure to Lehman Brothers’ securities drove the fund’s per share net asset value below one dollar. Due to the magnitude of the redemption requests, the fund’s trustees voted to liquidate the fund and distribute the assets to investors.On December 8, 2008, the Wall Street Journal ran a front page article (here) detailing the events behind the fund's woes.
Meanwhile, investors initiated a number of securities lawsuits against the fund, its directors and officers, its investment advisor and related parties. (Refer here for background regarding the lawsuits.) The lawsuits allege, among other things, that the defendants’ selective or inaccurate disclosure regarding the fund’s troubled assets enabled certain institutional investors to avoid losses to the detriment of other investors. The lawsuits also alleged that the fund failed to disclose its vulnerability due to its alleged overexposure to Lehman. The lawsuits also allege that the Lehman Brothers investments were inappropriate for a money market fund, and that the fund deviated from its stated investment approach.
The Liquidation Plan
On December 3, 2008, the fund’s trustees issued a "Plan of Liquidation and Distribution of Assets" (here). Among other things, the Liquidation Plan provides a plan for distribution of fund assets through "interim payments." The interim payments are to include distribution amounts "up to the amount of a special reserve, which would include amounts that would be required to satisfy disputed claims."
As the Liquidation Plan explains, this special reserve will be used to finance "costs and expenses of the Fund, its officers and Trustees"; "pending and threatened claims against the Fund"; and claims, "including but not limited to claims of indemnification that could be made against plan assets." Were the fund to distribute its assets without the special reserve, investors could expect about 98.5 cents per share. However, the special reserve, the amount of which has yet to be determined, will reduce this per share distribution.
As a December 5, 2008 New York Times article entitled "Embattled, Fund Shifts Costs to Investors" (here), put it, investors might hope to get 98.5 cents on the dollar, but "if they continue to wage legal battles against the fund managers, the company will use investors’ own money to defend itself against allegations or mismanagement and deception." Moreover, the Liquidation Plan makes it clear that the special reserve is not just for litigation expense, but also to "satisfy disputed claims." The December 8 Journal article cited above states that the fund has told investors "the fund will use some if its assets to fight suits investors have filed, which could reduce the money available to return to them."
Insurance and Indemnification
Readers who like me wonder whether there isn’t D&O liability insurance available to pay these amounts will be interested to learn that there is insurance, just not very much. According to the Liquidation Plan, the fund has a directors’ and officers’ liability insurance policy with a $10 million aggregate limit of liability.
Not only does the fund only have a $10 million D&O policy, but it is a "joint" policy, insuring not just the fund and its directors, officers and trustees, but also its investment advisor, its corporate parent, and other affiliated parties and person, many of whom are co-defendants with the fund and its directors and officers in the mass of investor lawsuits that have been filed.
In other words, though the fund has D&O insurance, its limits are, well, limited, and are also subject to erosion or depletion due to competing interests of multiple parties in the policy proceeds. It should be emphasized that under most D&O policies, defense expense reduces the amount of insurance remaining under the policy, meaning that there could be little or no insurance available to satisfy investors’ claims if the various cases are actively litigated.
The rights of the fund’s individual officers, directors and trustees to indemnification are not eliminated merely because of the allegations raised in the lawsuits (indeed, the outbreak of litigation is precisely the circumstances that trigger the operation of indemnification rights). Angered investors who may want to contend that the individual’s supposed misconduct should forfeit their rights to indemnification can try to argue based on Section 17(h) of the Investment Company Act that the fund cannot indemnify the individuals for "willful malfeasance, bad faith, gross negligence, or reckless disregard."
The problem for any investor inclined to make that argument is that the only way to establish that the statutory indemnification prohibitions have been triggered is to litigate the issue – which, as the Times article notes, is "the very act that could reduce the return to investors." In order to establish that the disqualifying conduct occurred, investors would have to pursue their case all the way to verdict, and arguably through appeal as well, a process that would be as uncertain as it would be costly and protracted.
Discussion
So basically the message seems to be, you want to litigate, investors? Fine, knock yourselves out. It’s your money. As the Times article puts it, the choice offered investors under the Liquidation Plan "struck some legal experts as brazen."
The fund’s insurance limits are also worthy of comment. The fund had assets of approximately $64 billion. In that light, some may find the fund’s $10 million D&O insurance limits, well, surprising, particularly given that the limits insure not just the fund and its directors, officers and trustees, but also the fund’s investment advisor and other affiliated parties and person. Reasonable minds might well question the fund’s limits selection.
These circumstances also highlight the risks associated with widely shared limits. The number and diversity of entities and person who will be depending on the limits, along with the apparent seriousness and extent of the litigation involved, raises the probability that the litigation expense will quickly erode if not altogether deplete the available limits. The risk of limits erosion associated with these kinds of shared limits further underscores the fact that reasonable minds might well question the fund’s insurance limits selection.
In any event, the circumstances, particularly the Liquidation Plan, present investors with some difficult decisions. It will be interesting to see their next move, and whether they try to challenge the Liquidation Plan.
Special thanks to Kelly Rehyer for the link to the Times article.
And Speaking of Threats to Litigating Investors: As I noted in a prior post (here), investors have sued the Bank of America, challenging the loan modifications to which the bank agreed in connection with mortgages issued by Countrywide. The litigation has apparently caught the attention of FDIC chairman Sheila Bair.
As reported in a December 4, 2008 Los Angeles Times article (here), Bair told a consumer group gathering that "there is an obligation to modify mortgages," and that "investors should take a hard look at what they are advocating." She also said that "the harder investors push, the more there’s going to be a backlash here." She suggested that Congress may step in and change the legal obligations of mortgage services toward investors.
Interestingly, Bair did not state that the investors’ opposition to the mortgage makeovers is illegitimate or unmeritorious, only that their assertion of their interests represents an obstruction to policy goals she advocates. It certainly can be inconvenient when concerned parties insist on asserting their rights, but the threat of a Congressional backlash could strike some as heavy-handed.
Call it a hunch, but Bair’s remarks seem likelier to embolden rather than to discourage investors, as her remarks suggest that she recognizes the potential significance of their claims. In any event, whether or not Congress has the power or political will to set aside the agreements on which the investors are relying, if Congress were to take such a step it would do little to restore investor confidence in mortgage marketplace mechanisms, which would seem to be an indispensible part to restoring stability to the mortgage lending industry.
And Speaking of the FDIC: In yet another Friday-night special, on December 5, 2008, First Georgia Community Bank of Jackson, Georgia became the twenty third U.S. bank failure this year, after state regulators closed the bank and the FDIC was named receiver. The closure is Georgia’s fourth bank failure this year.
The FDIC’s December 5, 2008 press release can be found here. The FDIC’s updated list of bank failures can be found here. My prior post about the significance of the accumulating bank failures can be found here, and my prior post about the prospects for a new wave of "dead bank" litigation can be found here.
FDIC Report: More Bank Failures Coming?: The FDIC’s Quarterly Banking Profile for the third quarter 2008 (here), released on November 25, 2008, paints a dismal picture of the banking industry.
Among other things, the Report notes that during the third quarter the number of insured institutions on the FDIC’s "Problem List" increased from 117 to 171, and the net assets of "problem" institutions rose from $78.3 billion to $115.6 billion. This represents the first time since the middle of 1994 that assets of "problem" institutions have exceeded $100 billion.
These grim statistics suggest further bank failures ahead. A November 25, 2008 CFO.com article discussing the FDIC’s report (here) quotes FDIC chairperson Sheila Bair as saying "we expect more banks to fail."
In its November 25 press release (here), the FDIC also notes that "community banks – those with total assets of under $1 billion – are beginning to exhibit stresses similar to those facing the industry as a whole." However, the press release also comments that "capital levels and reliance on retail deposits remain higher at those banks than the industry average."
My recent post detailing the latest bank failures and possible implications can be found here. My earlier post addressing the possibility of a new wave of "dead bank" litigation can be found here.
Big FCPA Penalties Ahead: According to statements reported in a November 25, 2008 Law.com article (here), the SEC’s deputy enforcement division director expects the imposition in the next two to six months of Foreign Corrupt Practices Act (FCPA) penalties that will "dwarf the disgorgement and penalty amounts that have been obtained in prior cases."
The biggest FCPA penalty to date is the $44.1 million settlement Baker Hughes paid last year to settle charges of bribery and other improper conduct in six countries (about which refer here).
One probe attracting particularly attention is the investigation involving Siemens, which in 2006 disclosed that it had uncovered more than $1 billion in bribes paid in over a dozen countries in order to win contracts. The potential magnitude of this fines and penalties Siemens could be facing may be inferred from Siemens’ recent 1 billion euro provision for the expected settlement with U.S. and German authorities of bribery allegations (about which refer here).
A "twist" noted with respect to the forthcoming cases is that a "significant" number involve violations that were not self-reported by the companies. In the recent past, many of the FCPA enforcement cases have arisen when companies themselves discovered and reported violations. However, many of the newer cases "were generated by other leads," such as the SEC’s own investigatory work or whisteblowers.
As I have noted in prior posts (most recently here), one of the risks increasingly associated with FCPA enforcement actions is the threat of follow-on civil litigation. For example, Siemens itself is the subject of a purported shareholders’ derivative suit in the U.S. related to its ongoing bribery investigations. As the scale of FCPA enforcement activity grows, the threat of FCPA-related civil litigation will also increase.
Litigation Funding Developments: In a November 2008 report on Transatlantic Trends in Business and Litigation (here), the Lloyd’s insurance market, among other things, examines the growing prevalence of third-party litigation funding, whereby investors financially support a claimant in return for a share of the damages. (My recent post discussing the role of litigation funding in the Australian class action against Centro Properties can be found here.)
The Lloyd’s report concludes that businesses on both sides of the Atlantic "should expect third party litigation funding to rise," and that "current economic conditions may actually accelerate the growth."
Meanwhile, a start-up venture is planning to try to launch an IPO in what may be one of the more creative attempts to try to fund litigation. According to a November 18, 2008 Pensions & Investments article (here), VR Holdings, Inc. is planning the offering to try to "provide liquidity" for the suit’s 2,500 claimants, 2,000 of whom are older than 65 and concerned that they may not live to see the suit settled. (For reasons specified below, these concerns may be well founded.)
According to the company’s President, the IPO will "give the claimants a vehicle to hopefully generate some funds for themselves." The offering is a "way to sell stakes in the eventual payout," in that the shares will be "like an option that sells for around $1 but has a potential upside of $12 or $14." (I guess this fellow believes the company is not yet in the quiet period.)
The suit, which has been filed against several investment firms, alleges that the defendants conspired to "take over, liquidate, and bankrupt" (I presume not necessarily in that order) a concert T-shirt maker.
In addition to possible legal objections to this litigation funding arrangement, the prospective IPO may face a more immediate practical obstacle. That is, the case, which was pending in the Northern District of Illinois, has already been dismissed with prejudice. It is unclear from the article whether a timely notice of appeal was filed. (No, I am not making any of this up.)
The prospective IPO sponsors may want to reconcile themselves to the possibility that investors may not exactly fall all over themselves to get a piece of this action.
And Finally: The Securities Docket blog has an interesting interview (here) with trailblazing blogger Mike O’Sullivan of the Munger, Tolles & Olson law firm, whose trendsetting Corp Law Blog showed the way for many blogs that followed, including The D&O Diary. After running his blog for some time, O’Sullivan ultimately stopped adding new posts in 2004.
In discussing the reasons why he discontinued the blog, O’Sullivan notes that he was facing "existential doubts" of the kind that will be familiar to any blogger, including yours truly: "Why am I doing this? What do I really have to say? Why are you reading this?"
In commenting on the current crop of corporate and securities blogs, O’Sullivan mentions that one blog he "slavishly" follows is Broc Romanek’s (and now Dave Lynn’s) Corporate Counsel blog (here), which I mention here because it is a blog that I read every day as well.
Hats off to Bruce Carton for the interview and for his new Securities Docket site (here) which has quickly also become a daily (or even several times daily) must-read.
Blogging Off: The D&O Diary likely not be adding any new posts for the next few days. We will resume our "normal" publication schedule after December 1.
The closure of three more banks this past Friday night underscores the difficult environment now facing many banks and also suggests that the pace of bank failures is accelerating. These developments may also have important implications for the D&O insurance placement market banks may have to confront in the months ahead.
On November 21, 2008, the FDIC announced (here) that state bank regulators had closed The Community Bank of Loganville, Georgia and that the FDIC has been named as a receiver.
The FDIC also announced on November 21, 2008 (here) that as part of an FDIC-brokered deal, U.S. Bank had acquired the banking operations of Downey Savings and Loan Association of Newport Beach, California and PFF Bank and Trust of Pomona, California.
With the addition of these three banks, the total number of 2008 bank closures now stands at 22. The FDIC’s complete list of all bank failures since October 2000 can be found here. The 2008 year-to-date total represents the highest annual total since 1993 and is already double the highest annual number of bank failures for any year reflected on the FDIC table. (There were 11 bank failures in 2002).
Moreover, the pace of bank failures has accelerated as the year has progressed. 18 of the 22 bank failures in 2008 have taken place since July 1, 2008, and nine have occurred just since October 1, 2008. The November 2008 month-to-date total of five bank failures is already the highest number of failures for any month reflected on the FDIC table.
In addition, as noted in a November 22, 2008 Washington Post article (here), the most recent bank failures expanded "what is by far the most expensive crop of bank failures in modern American history." Downey, which had $12.6 billion in assets is the third largest bank failure this year (after Washington Mutual and IndyMac). The FDIC projects that it will spend $2.3 billion as a result of the three most recent closures. The FDIC also projects that it will spend almost $15 billion total on the year-to-date 2008 closures. The Post article notes that this 2008 annual amount is "more than twice the total of any previous year."
The states with the highest number of 2008 closures so far are California (4), Georgia (3), Nevada (3), and Florida (2), which may be expected due to the well-chronicled trouble in the housing markets in those regions. But banks in states outside these more notoriously troubled areas are also failing, including, for example, banks in Missouri, Minnesota, Kansas and Illinois. In other words, while the banks in the states with the most significant housing trouble are faring poorly, banks in other states may also face challenges.
At this point, the reasonable presumption is that there will be further bank failures to come. It seems unlikely that there will be hundreds of failures as occurred during the S&L crisis, but the number of failures yet to come could be substantial. The slowing economy and the likelihood of continued deterioration in the residential and commercial real estate sectors suggest that the pace of bank failures could continue well into 2009 and even beyond.
One of the possible consequences from a wave of bank failures could be surge of related claims. I have previously noted (here) the possibility that we could be headed toward a new era of "dead bank" litigation. It is hardly surprising then that D&O underwriters’ concerns regarding banks and other traditional lending institutions are increasing, even with respect to those, such as community banks, that have seemingly avoided many of the problems of the current financial crisis.
Very recently, it has become apparent that the D&O underwriting industry has taken a much more defensive approach to banking institutions, again even including in some instances institutions such as community banks. To be sure, financial institutions in general have faced greater underwriting scrutiny for some months now as the credit crisis has unfolded. Recently, the level of scrutiny has increased and the scope of the scrutiny has widened. The carriers that are active in this space are taking a much harder line, and have shown an unaccustomed willingness to walk away even from long-standing relationships.
These carriers’ apparently altered underwriting stance has changed the insurance environment for many banking institutions. Some smaller banks that have for years enjoyed significant competition among D&O underwriters may now find that they face a changed situation. Banks that are facing operational or financial challenges may now find insurance placement difficult.
The changed insurance underwriting environment for banks and other financial institutions is part of the evidence some commentators have cited to support their view that a harder D&O insurance market may be approaching (refer, for example, here). Whether the overall D&O insurance market will harden remains to be seen. But it seems likely that the D&O insurance market for financial institutions, at least, could become challenging as we head into 2009.
Court Rejects Starr Foundation Lawsuit Against Former AIG CEO, CFO: According to a Bloomberg article (here), on November 17, 2008, New York Supreme Court Justice Charles Ramos dismissed a lawsuit that the Starr Foundation had filed against former AIG Chairman and CEO Martin Sullivan and former AIG CFO Steven Bensinger, calling the case a "waste of time."
Starr’s May 2008 lawsuit contended that the defendants had "fraudulently reassured" Starr in August 2007 that AIG’s "risk of loss from its credit-default swap portfolio was remote." Starr alleged that it would have sold its entire portfolio of AIG stock if it had known the extent of the company’s subprime exposure.
Starr’s President, Florence Davis, testified that the foundation had been "reassured" by the defendants’ August 2007 remarks. However, in an affidavit, Davis acknowledged that the foundation sold more than 12 million AIG shares, worth almost $1 billion, between August and October 2007, and only stopped because the company’s share price fell below $65 a share.
Judge Ramos questioned Davis at the November 17 hearing, seeking to clarify this seeming inconsistency in Davis’s comments. Judge Ramos apparently found Davis’s answers less than satisfying. The Bloomberg article reports that Judge Ramos told Davis "You are being more than difficult. You are being contemptuous, and you are very, very close to contempt of court and I’m talking criminal contempt. Now answer my question."
According to the Bloomberg article, following this barrage, Davis asked for a break to get an asthma inhaler.
Under questioning from the defendants’ counsel, Davis also testified that the foundation did not sell its remaining shares in February 2008, even after AIG had disclosed its subprime woes, because the price was "too low." Defense counsel argued that this showed that the foundation based its decisions to sell or to hold on its own criteria, and not based on the defendants’ disclosures.
Just an aside, but do you suppose that the Starr Foundation’s Chairman, Hank Greenberg, who was also Sullivan’s predecessor as AIG’s Chairman and CEO, had anything to do with the foundation’s pursuit of this litigation against the defendants? Nah….
And Finally: Speaking of AIG, the Delaware Corporate and Commercial Litigation Blog (here) has posted links to video clips of portions of the recent Delaware Chancery Court hearing regarding the AIG derivative litigation about the government’s bailout of the company. The footage is a reminder that the expression "courtroom drama" does not apply to everything that happens in a courtroom.
At first glance, poultry producer and processor Pilgrim’s Pride and shopping center REIT General Growth Properties would seem to have little in common. But while they may be in different business sectors they share a remarkable number of common woes.
Both are laboring under crushing debt obligations associated with recent acquisitions, and both face potentially insurmountable problems servicing or restructuring their debt. The problems facing both companies are further exacerbated by the economic downturn. In each case, the founding families may lose control of the companies, or perhaps even their entire investment. Both companies have also seen their share prices plummet.
And now, both companies have been hit with securities class action lawsuits.
While these two new lawsuits at one level are the result of these two companies’ particular challenges, the underlying debt issues and complications arising from the current credit crisis could affect legions of other companies, and possible spark even further securities litigation.
Pilgrim’s Pride: As detailed in a front-page October 17, 2008 Wall Street Journal article entitled "Debt Woes, Feed Costs Come Home to Roost at Pilgrim’s" (here), Pilgrim’s Pride is struggling under the burden of debt associated with its 2007 acquisition of rival Gold Kist, making Pilgrim’s Pride the "world’s largest chicken company."
As noted in a subsequent Journal article (here), in addition to an "increasingly untenable debt load," the company has been "hammered by rising prices for feed, bad bets in the grain market, [and] falling prices for chicken." The October 17 Journal article details an ill-timed hedge the company had entered, fixing its grain feed costs when prices had peaked, locking the company into a costly contract just before prices began to decline.
Pilgrim Pride’s financial challenges have been "exacerbated" by the economic downturn, as a result of which fewer consumers are dining out, reducing demand for chicken.
Due to these circumstances, Pilgrim Pride’s share price has declined 97 percent this year. On October 30, 2008, press reports (here) speculated that the company, which faces pending interest payments it may not be able to fulfill, is a "likely" candidate for bankruptcy.
In addition, and also on October 30, 2008, plaintiffs’ lawyers issued a press release (here), announcing that they have filed a securities lawsuit in the Eastern District of Texas against Pilgrim’s Pride and certain of its directors and officers. A copy of the complaint can be found here.
According to the press release, the complaint alleges that the defendants "misrepresented the Company’s financial condition and concealed the impact of the Company’s capital problems on its business and prospects." The Complaint specifically references the company’s September 24, 2008 press release (here), in which it announced that it had "notified its lenders that it expected to report a significant loss" in its fiscal period ending September 27, "due to high feed-ingredient costs, continued weak pricing and demand for breast meat, and the significant impact of hedged grain positions during the quarter."
According to the press release, the complaint alleges that the defendants failed to disclose that:
(a) the Company’s hedges to protect it from adverse changes in costs were not working and in fact were harming the Company’s results more than helping; (b) the Company’s inability to continue to use illegal workers would adversely affect its margins; (c) the Company’s financial results were continuing to deteriorate rather than improve, such that the Company’s capital structure was threatened; (d) the Company was in a much worse position than its competitors due to its inability to raise prices for customers sufficient to offset cost increases, whereas its competitors were able to raise prices to offset higher costs affecting the industry; and (e) the Company had not made sufficient changes to its business model to succeed in the more difficult industry conditions.
General Growth Properties: As detailed in Wall Street Journal articles dated October 20, 2008 (here), and October 28, 2008 (here), the "aggressive mortgage financed acquisition strategy" of General Growth Properties, the second-largest U.S. mall owner, "has left the company with little ability to pay debt coming due amid the credit crisis."
As detailed in an October 27, 2008 Bloomberg article (here), General Growth’s shares have declined over 95 percent this year "on concern that the company won’t be able to refinance about $1.2 billion of debt this year." The debt stems in part form the company’s 2004 $11.3 billion acquisition of Rouse companies.
Compounding the company’s difficulties are the departures of three of the company’s senior executives (refer here), on reports that the executives had obtained loans from a trust associated with the company’s founding family, in order to pay of margin debt the executives had incurred to acquire stock in the company.
The company had earlier sought to raise capital through the sale of preferred stock, but these efforts "fizzled", as reported in the October 28 Journal article. The company is now seeking to sell three massive Las Vegas luxury malls, to try to address the company’s "most pressing problem," which is $900 million in mortgage acquisition costs coming due on November 28. The October 28 Journal article reports that "without an extension or new funding, General Growth doesn’t have cash on hand to pay the debt."
General Growth is burdened not only with the heavy load of debt that financed its acquisition strategy and difficulty in obtaining credit or additional capital, but it is also challenged by falling real estate values and increasing vacancy rates, driven by the declining economy.
On October 31, 2008, plaintiffs’ counsel issued a press release (here) announcing that they had initiated a securities class action lawsuit in the Northern District of Illinois against General Growth and certain of its directors and officers. A copy of the complaint can be found here.
According to the press release, the Complaint alleges that the defendants "made false and misleading statements about General Growth’s access to financing," in particular that the company "had the ability to refinance billions of dollars of debt that was coming due in the fall of 2008 and the spring of 2009, on acceptable terms." The complaint further alleges that the company failed to disclose that "the Company’s President/Chief Operating Officer had received loans from the Chief Executive Officer’s family trust in violation of the Company’s own Code of Business Conduct and Ethics."
Discussion: Pilgrim’s Pride and General Growth are far from the only companies burdened with debt incurred as a result of acquisitions fueled by the easy credit during an earlier era. Nor are they the only companies laden with debt they may not be able to refinance or repay while also facing the adverse effects of the general economic downturn.
Just this past week, the U.S.’s second largest ethanol producer, VeraSun, filed for bankruptcy; VeriSun also fell victim of wrong way hedges on corn supplies (refer here). Well-known retailers Mervyn’s, Linens ‘N Things, and Shoe Pavilion are already in liquidation (refer here). The financial difficulties have also spread to some unexpected places, as described, for example in the October 29, 2008 Wall Street Journal article entitled " Cash-Poor Biotech Firms Cut Research, Seek Aid" (here).
One particular area of concern involves the numerous companies acquired as part of debt-financed leverage buyout. As detailed in a November 2, 2008 New York Times article entitled "Debt Linked to Buyout Tighten the Economic Vise" (here), "many of the loans used to finance the deal are coming due at the worst possible time." The article quotes a Harvard Business School professor as saying that "The big question is how apocalyptic it will be."
In the weeks and months ahead, there will be other companies – perhaps many other companies – faced with precisely the same dismal circumstances as these two companies. In the current economic downturn, all companies will suffer, and weaker companies will struggle. Highly leveraged companies may not survive.
As other companies toil with these challenges amid the difficult financial conditions, many of them may also become the target of securities litigation. Indeed, as I noted in recent posts (here and here), the "bad economic vibe" could result in further securities litigation.
While the arrival of additional securities lawsuits seems likely, it remains to be seen how many of these cases succeed. As I noted in a recent post discussing the subprime-related securities litigation (here), courts increasingly appear skeptical of allegations that a company’s collapse in the current challenging economic circumstances, even if the result of aggressive or even sloppy business practices, is the result of fraud.
An additional question these cases present is whether they are sufficiently credit-crisis related to be included in my running tally of subprime and credit crisis-related securities litigation (which can be accessed here). While I could certainly come up with arguments for including these cases, in the end I don’t think they belong on the list. These cases are more the result of generalized business conditions rather than the specific phenomenon I have been trying to capture in my lawsuit tracking. But regardless of how they are categorized, these cases certainly do suggest we are and will remain in a period of heightened litigation activity.
One final note about these cases is that they involved companies outside of the residential real estate and financial services industries. Whether or not these cases are credit crisis related for purposes of categorization and tracking, they are definitely indicative of the way in which deteriorating financial and economic conditions -- that originated in the subprime arena but quickly spread more broadly -- threaten to extend the current litigation wave beyond the financial sector to the general marketplace.
The subprime and credit crisis litigation wave may well have been contained to a relatively narrow segment of industries, but as economic conditions continue to deteriorate, the litigation thread will become more generalized and widespread.
Another Failed Bank: After the close of business on Friday October 31, 2008, state banking regulators closed Freedom Bank of Bradenton, Florida, and the FDIC was named as a received. An FDIC press release describing the closure can be found here. According to the FDIC’s Failed Bank List (here), the closure of Freedom Bank is the 17th U.S. bank seized by regulators so far in 2008.
As reflected in a November 1, 2008 Bloomberg article (here) reporting about Freedom Bank, the number of bank closures in 2008 year-to-date represents the highest number of bank failures since 1993, which was of course at the tail and of the last significant era of failed banks.
The Bloomberg article also reports that Freedom Bank had lost $258 million in the last two quarters from rising losses on real estate loans. Freedom is the second bank failure in Bradenton this year; in August, regulators closed First Priority Bank of Bradenton (about which refer here).
Contagion: The November 1, 2008 New York Times article entitled "From Midwest to M.T.A., Pain from Global Gamble" (here) describes how market place participants as diverse as Wisconsin school systems and New York’s Metropolitan Transit Authority were ensnared in the financial difficulties of formerly high-flying Irish bank Depfa, which in October 2007 merged into German bank Hypo Real Estate. The consequences for Hypo have proved to be dire, as the company recently required a massive bailout from the German government.
The consequences for the Wisconsin schools have also been calamitous, as detailed in the article. The article does not mention that the Wisconsin schools have already launched a lawsuit against the broker/dealer and investment bank responsible for the schools’ CDO investment. My prior post discussing the Wisconsin schools’ lawsuit can be found here.
PLUS Week: This upcoming week, I will be in San Francisco attending the PLUS International Conference. As a result, The D&O Diary will likely not maintain its usual publication schedule. If you see me at the conference, I hope you will take a moment to introduce yourself, particularly if we have not previously met. See you in San Francisco.
The credit crisis recently entered a dark new phase, and this new darker phase has also already produced its own distinctive round of lawsuits. Like the ominous economic circumstances, the new litigation phase also seems darker and more threatening.
In the latest issue of InSights (here) -- entitled "Has the Credit Crisis Litigation Wave Reached an Inflection Point?" – I briefly review the subprime litigation wave as it developed over the past two years and then examine the dramatic events that occurred in the financial marketplace beginning in September 2008. The article then examines the recent wave of litigation surrounding these events and concludes with an assessment of what these developments may signify going forward.
No Avalanche After All?: Following the U.S. Supreme Court’s February 2008 decision in the LaRue case (about which I wrote here), in which the court recognized an individual’s right to pursue a breach of fiduciary duty claims for mismanagement of their 401(k) plan, there was significant speculation that the decision could unleash an avalanche of lawsuits. The avalanche may yet materialize. But in the meantime it is worth noting that despite his victory in the Supreme Court, LaRue himself has voluntarily dismissed his case in the district court, where the case was on remand after the Supreme Court’s decision.
As reflected in the October 21, 2008 Consent Order of Dismissal in the case (here),LaRue withdrew his complaint after he "decided that it is not financially feasible to continue to pursue his claim."
As Professor Paul Secunda noted on the Workplace Law Prof Blog (here), LaRue’s withdrawal of his case shows that "these types of claims are still extremely difficult for plaintiffs to prevail upon" and "all the doomsday prognostications to the contrary seem just a tad off."
Just In Case Those Bank Lawsuits Do Materialize: In a recent post (here), I speculated that we may be entering a new phase of litigation involving failed banks. Apparently I am not the only one who anticipates that we may be seeing more failed bank litigation. In an October 23, 2008 memorandum entitled "Failed Financial Institution Litigation: Remember When" (here), the Willkie Farr & Gallagher law firm observes that the recent dramatic financial institution failures "are likely to fan the flames for myriad government agencies to pursue litigation against all parties associated with the financial institutions."
The Willkie Farr memorandum takes a comprehensive look at the potential failed financial institution litigation that may emerge, referring to the litigation that unfolded during the S&L crisis as a guide. The memo examines likely litigants, including in particular the probable defendants. The memo also reviews the factual and legal issues that are likely to arise, including some issues that may be different in the current era than previously– for example, with respect to circumstances involving credit default swaps.
The memorandum also briefly reviews the D&O insurance issues that are likely to arise in connection with claims against the directors and officers of the failed financial institutions. Among other issues, the memorandum review issues in connection with the regulatory exclusion (about which I previously wrote here), and in connection with the insured vs. insured exclusion (which I wrote about here).
The Willkie Farr memorandum is thorough and comprehensive, and is a good resource to keep at hand in the event the "dead bank" litigation does in fact materialize.
An Insurance Professional Takes A Look Back: It may surprise those outside the industry, but the insurance business really is full of a wide assortment of interesting, amusing and entertaining people. Many of their stories are humorously retold by industry veteran Larry Goanos in his new book Claims Made and Reported: A Journey Through D&O, E&O and Other Lines of Insurance (here). Larry’s book examines the careers of some of the luminaries of professional lines insurance industry and provides valuable insights for business success.
While writing the book, Larry apparently interviewed over 400 people, some of whom started in the industry back in the 1940s and 1950s. Many of the stories Larry recounts have become legendary in the industry, such as the tale of the broker whose suit was seemingly in flames during a meeting while he continued to talk or the mid-level executive who bought a Rolls Royce as his company car --on his lunch hour. The book is written with in the same spirit of friendship and good humor that characterizes the best side of our industry, and will be enjoyable for anyone who is a part of or is interested in the industry.
Congrats to Larry on his book. He obviously had a lot of fun writing it, and a lot of people are going to have fun reading it. It is worth noting that Larry intends to split the proceeds from the book’s sales among four charities, including the PLUS Foundation and Grateful Nation Montana.
What the Hell is the Point of 36 Watches -- Or, For That Matter, Three Mirrored Disco Balls?: In an October 29, 2008 Wall Street Journal article (here) describing unexpected challenges facing lenders that foreclosed on properties, the article details issues arising in connection with Indianapolis developer Christopher T. White and his business, Premier Properties USA:
Indianapolis prosecutors charged Mr. White in June with theft and fraud for writing a $500,000 check to Premier for payroll purposes on a nearly empty account. Mr. White's defense attorney counters that the developer believed money was arriving to cover the check. A lender seized Mr. White's personal property and in August auctioned items including five Vespa scooters, 15 flat-panel televisions, 36 watches and three mirrored disco balls.
"Where the Hell is Matt?": If you have not yet seen this latest viral Internet video, you have to take four minutes and watch it right now. Absolutely guaranteed to make you smile. Matt really does seem to have visited (and danced in) all the places depicted, which kind of makes you wonder how long it took to make this video. While he was dancing, the rest of us were sitting at our desks doing much more productive things...
After the close of business on Friday, October 10, 2008, the FDIC announced (here and here) that state regulators had closed two banks, Meridian Bank of Eldred, Illinois, and Main Street Bank of Northville, Michigan. The closure of these two banks brings the 2008 total number of bank closures to 15.
By way of comparison, there were only three bank closured during all of 2007. Indeed, there were none at all between June 25, 2004 and February 2, 2007. (An FDIC table showing all bank closures since 2000 can be found here.) According to an October 11, 2008 Bloomberg article (here), the 15 bank closures during 2008 already represents the highest annual total since 1993, which of course was the tail end of the last era of failed banks.
Nor is this current wave of bank failures over. Conditions in the housing market continue to deteriorate, and job losses associated with the anticipated recession could only accelerate this process. A slumping economy will challenge borrowers across all lines of credit. This June 30, 2008 FDIC chart (here) graphically illustrates the dramatic growth in troubled loans over recent periods, and both trendlines and headlines suggest that this will only continue.
Moreover, the balance sheets of many banks are already under pressure because of the banks’ extensive holdings in securities of Fannie Mae and Freddie Mac, and, to a lesser extent, Washington Mutual, AIG, and Lehman Brothers. Banks dependent on short term interbank loans may also be experiencing liquidity issues as a result of the current disruption in the credit markets.
As of the end of the second quarter 2008, the FDIC listed (refer here) 117 banks on its "Problem List," which represents a 30 percent jump since the end of the first quarter. The "Problem List" numbers through the end of the third quarter are not yet available, but significant further deterioration seem probable given third quarter events, and developments already in the first two weeks of the fourth quarter certainly have not helped.
UPDATE: Consistent the hyperspeed circumstances that have come to characterize recent events, the announcement this evening after the close of the market that the U.S. will buy stakes in the Nation's largest banks (refer to WSJ article here), along with related disclosures, potentially impacts the foregoing analysis as well as much that follows. In particular, the Journal is reporting that "one central plank of these new efforts is a plan for the Treasury to take approximately $250 billion in equity stakes in potentially thousands of banks." This obviously could impact the issue whether or not or to what extent other banks will fail. As these details are only now emerging (after I wrote this entire blog post, wouldn't you know it), and as it will take some time before the details become clear, much less that the government acts, the discussion in this post may remain relevant. How relevant remains to be seen, depending on the specifics of the government's plan and its implementation.
A significant part of the last era of failed banks was the appearance of a flotilla of lawsuits, in which investors and regulators sought to assign blame and recover losses. There already has been extensive litigation filed in connection with the two most prominent bank failures of 2008, IndyMac (refer here and here) and Washington Mutual (refer here).
The follow-on failed bank litigation has started to emerge in connection even with the lower profile failures, as illustrated by the recent lawsuit filed in connection with the failure of Integrity Bank of Alphretta, Ga.
State banking regulators closed Integrity on August 29, 2008, and the FDIC was appointed as its receiver (about which refer here). The bank’s deposit liabilities and some of its assets were sold to Regions Financial Corp. Prior to a March 2008 delisting, shares of Integrity’s holding company, Integrity Bancshares, traded on Nasdaq.
On September 12, 2008, Integrity shareholders filed a purported class action in Georgia (Fulton County) Superior Court against the holding company and four Integrity officers. On October 7, 2008, the defendants removed the case to the Northern District of Georgia. A copy of the removal petition, to which the state court complaint is attached, can be found here.
The plaintiffs’ complaint alleges that the defendants misled investors about the bank holding company’s health during 2006 and 2007, as a result of which the plaintiffs allege violation of state securities laws, common law fraud, and negligent misrepresentation. The complaint specifically alleges that the defendants understated or failed to disclose "the nature and degree of risk associated with the following conditions":
(i) a loan portfolio comprised almost entirely on real estate acquisition, development and construction, which risk was further by an unreasonable concentration of such toasts its borrower relationship (the "Related Loans"), (ii) a loan portfolio principally collateralized by real estate, (iii) operating with a Board of Directors that failed to provide adequate supervision over and direction to Bank management (iv) operating with inadequate management not sufficiently experienced in or Knowledgeable of good lending practices, (v) operating with inadequate equity capital and reserves in relation to the volume and quality of assets held by the operating with a large volume of poor quality loans, (vii) operating with inadequate allowance for loan and lease basses, (viii) operating with hazardous loan and administration practices, (ix) banking regulations concerning safe lending practices, (x) the potential for cross-defaults with respect to some or all of the Related Loans, (xi) potential difficulty in and realizing on loan collateral in market conditions, (xii) the potential and severity of losses from deteriorating market affecting borrowers, and (xiii) the adverse affect of losses from such loan defaults on the Bank’s liquidity, capital resources and operations.
The Integrity lawsuit is not the only complaint to be filed in connection with the current wave of bank failures. In addition to the Washington Mutual and IndyMac lawsuits cited above, investors also filed a securities class action lawsuit in connection with the failure of NetBank, about which refer here. The FDIC’s press release about the September 28, 2007 closure of NetBank, which coincidentally was also based in Alphretta, Georgia, can be found here.
The failure of additional banks, while not inevitable, seems more likely than not. (I doubt there are many informed observers now who would assert that there will be no further bank failures.) To the extent more banks fail, there undoubtedly will also be further related litigation. And to the extent the pace of bank closures quickens, which certainly is within the range of possibilities, there could be a surge of "dead bank" litigation comparable to the flood of lawsuits that kept so many lawyers employed during the late 80s and early 90s (including, it should be noted, your humble correspondent).
If the earlier era is any guide, the lawsuits that may arise will include not just investor lawsuits like the one involving Integrity, but also actions by regulators as well. And again, if the earlier era is any guide, the defendants will include not only the financial institutions’ directors and officers, but also the financial institutions’ outside professionals, particularly the auditors and attorneys.
During the competitive D&O insurance marketplace conditions that have prevailed in recent years, many financial institutions were able to procure D&O insurance policies without a so-called regulatory exclusion (for further background about which refer here). It may be that in light of current conditions in the banking industry, the regulatory exclusion could be poised for a comeback.
In any event, community banks and other small to medium-sized banks, which have enjoyed a competitive D&O insurance marketplace for several years may now face rapidly changing and less advantageous conditions. Certainly, the D&O insurance underwriters will undoubtedly approach these kinds of accounts with a great deal more caution than in recent years.
Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Integrity removal petition.
That Goes for Subordinated Investors Too: In a prior post, here, I suggested that the dramatic failure of several prominent companies was drawing preferred shareholders into securities class action litigation. It appears that these events may be having the same effect on investors in subordinated securities as well.
According to the plaintiffs’ October 10, 2008 press release (here), a purported class action lawsuit has been filed in the Southern District of New York on behalf of person who purchased securities in the December 11, 2007 offering of 7.70% Series A5 Junior Subordinated Debentures of AIG, against certain AIG directors and officers, as well as the offering underwriters. The complaint alleges that the offering documents did not accurately represent AIG’s financial condition, and in particular misrepresented the company’s exposure to loss associated with credit default swaps.
As I noted in my earlier post, the massive investment losses associated with the collapse of these prominent financial companies is drawing many new classes of litigants who previously would not have become involved in securities litigation.
Run the Numbers: With the addition of the Integrity and the AIG subordinated debenture lawsuits, my current tally of the subprime and credit crisis-related securities lawsuits now stands at 124, of which 84 have been filed in 2008. The lawsuit tally can be accessed here.
When They Are Done in Reykjavik, Would They Be Willing to Come to Wall Street?: An October 13, 2008 Financial Times article entitled "Icelandic Women to Clean Up 'Male Mess'" (here) reports that two women, Elín Sigfúsdóttir and Birna Einarsdóttir, are set to become chief executives of two nationalized banks the Icelandic government created in the wake of the recent banking crisis. A government official quoted in the ariticle said that these appointments were "an attempt to signal a new culture within the banking system"
The article quotes a banker who blames the Icelandic banking system's collapse on "young and predominately male bankers" whose "eyes were bigger than their stomachs." A government official is quoted as saying that "now the women are taking over. It's typical, the men make the mess and the women come in to clean it up."
Meanwhile, Iceland may run out of food, or at least imported food. Bloomberg reports (here) that due to the unwillingness of banks outside the country to trade in Iceland's currency, the krona, the country's foreign trade has come to a standstill. As a result, the country's food shelves are being stripped bare, and they may not soon be replenished.
Amidst all of the tumult over the Fed bailout and the Presidential debates, not to mention a host of other events large and small, news about WaMu’s collapse has already slipped from the front pages of the nation’s newspapers. Astonishingly, in one short weekend, events have superseded the largest bank failure in U.S. history.
The problem with treating this extraordinary development as just another item in the news cycle is that it could be possible, notwithstanding the magnitude of the event, to overlook its significance. Make no mistake, however; the consequences of Washington Mutual’s failure, and the specific way the J.P. Morgan buyout went down, are enormously significant, and the implications of these developments are laden with portent.
Takeover/Buyout/Bankruptcy
On September 25, 2008, the Office of Thrift Supervision announced (here) that it closed Washington Mutual and appointed the FDIC as the institution’s received. The FDIC announced that same day (here) that as a result of an auction process J.P. Morgan Chase had acquired Washington Mutual’s banking assets.
J.P. Morgan’s September 25, 2008 press release (here) provides further detail regarding this transaction. J.P. Morgan’s press release explains that in exchange for the payment of $1.9 billion, the company had acquired "all deposits, assets, and certain liabilities of Washington Mutual’s banking operations." The press release also states that the transaction excluded "senior unsecured debt, subordinated debt, and preferred stock" of WaMu’s banks as well as any assets or liabilities of the parent holding company or the parent holding company’s nonbank subsidiaries.
J.P. Morgan also announced that as a result of this acquisition, it "will be marking down the acquired loan portfolio by approximately $31 billion," which it said "represents our estimate of remaining credit losses related to the impaired loans."
The final step of this process followed on September 26, 2008, when the parent holding company filed a bankruptcy petition in U.S. Bankruptcy Court in Delaware, about which refer here.
As NYU economics professor Lawrence White noted in a September 26, 2008 Forbes column (here), for its $1.9 billion investment, J.P. Morgan acquires net assets with a nominal value of $240 billion and deposit liabilities of $188 billion, suggesting a nominal acquisition value of approximately $52 billion. Of course, the planned write-downs diminish –but do not eliminate --this nominal value. Nevertheless J.P Morgan’s $1.9 billion offer was the best bid that the FDIC received.
Clearly, asset valuation uncertainty explains this apparent disparity. J.P. Morgan’s announcement of an immediate $31 billion write-down underscores the magnitude of the valuation uncertainty. But both the extent of this disparity and the magnitude of the write-downs have major implications, as discussed below.
One aspect of J.P. Morgan’s acquisition that was widely emphasized in the press reports was the FDIC’s success in completing this transaction without any losses to the deposit insurance fund. Indeed, there were reports that the FDIC’s chairman’s highest priority in the sequence of events was protecting the fund. Had the deposit insurance been called into play, the impact on the fund would have been enormous, and impact on depositors whose deposits exceeded the insurance limits also would have been significant. Nevertheless, the particular way in which the fund was protected, which left debtholders and bond investors exposed, presents its own set of issues.
Consequences and Implications
1. Valuation Issues: The massive discount on WaMu’s asset valuations implied in J.P. Morgan’s acquisition price has great significance for other institutions holding similar assets. While mortgage assets are not uniform, and the distinct characteristics are highly relevant to valuation issues, the obvious implication of the price and of J.P. Morgan’s announced $31 billion write-down is that similar assets on other institutions’ balance sheets may be overvalued.
Professor White, in the Forbes article cited above, states that these developments are "strong reinforcement for the view that lots of other institutions’ mortgages and mortgage-backed securities are also overvalued."
Indeed, the September 27, 2008 "Heard on the Street" column in the Wall Street Journal notes that "applying J.P. Morgan’s projections on other large banks implies higher losses for those with WaMu-like assets." The Journal column specifically suggests that these concerns may explain why Wachovia’s shares plunged on Friday and that rumors of Wachovia’s possible sale also immediately began circulating. Wachovia, it should be noted, like WaMu, has a significant concentration in Option ARM loans, which undoubtedly reinforce the concerns about possible future write-downs on Wachovia's loan portfolio.
Professor White notes with respect to these valuation concerns that "most of these assets are held outside the banking system," as they are held in "investment banking firms, finance companies, insurance companies, hedge funds, mutual funds, pension funds, etc." All of these institutions will face valuation pressures in the wake of the WaMu takeover.
In any event, along with the possibility that other institutions’ assets may be overvalued is the consequent possibility that investors in those institutions may later claim that they have been misled about the true financial condition of those institutions. (Indeed, WaMu itself previously had been hit with a securities lawsuit in which investors claim that they were misled about the company’s exposure to Option ARM loans, as noted here.) All of which may suggest the possibility of significant additional litigation, as discussed further below.
2. The Insurance Fund is Safe. Bond Investors? Not So Much: J.P. Morgan’s September 25 press release carefully isolated the liabilities it was not acquiring as part of the transaction. While the company cheerfully acquired WaMu’s bank deposit liabilities, other liabilities were left behind.
As detailed in a September 25, 2008 Seattle Times article (here), J.P. Morgan’s $1.9 billion payment will go into a fund for WaMu’s creditors. The only creditors likely to get anything out of the fund are the holders of WaMu’s $7 billion senior unsecured debt, who possible will get not more than 27 cents on the dollar. Holders of over $11 billion of WaMu subordinated debt and preferred stock will get nothing, as will other WaMu debtholders. The total amount of WaMu’s debt outstanding may be as much as $28 billion.
Among others that will be left out in the cold is the private equity fund TPG (formerly known as the Texas Pacific Group), which pumped $1.3 billion into WaMu as one of several investors that invested $7 billion into WaMu just five months ago. As the Wall Street Journal noted in its September 27, 2008 article entitled "WaMu Fall Crushes TPG" (here), these "losses illustrate the peril of investing in distressed banks and financial companies."
These losses are significant in two particular ways. First, WaMu’s collapse has thrown off significant losses for bond investors, many of whom are already reeling from earlier collapses of Bear Stearns, Lehman Brothers, Fannie Mae and Freddie Mac. As these losses continue to filter out into the investment community and the larger economy, the cumulative effect potentially could be staggering (especially in combination with equity investment losses, discussed below).
These losses may also have important implications for other troubled banks’ capital raising prospects. The FDIC may well have succeeded in protecting the insurance fund in this instance. However, the incentives for any investors to consider pumping additional capital into banking institutions have been undermined. Certainly, the likelihood of another TPG-like capital infusion for another troubled bank would seem increasingly improbable in light of these developments.
By its unwillingness to liquidate WaMu now, a move that might have salvaged something for bond investors, the FDIC potentially could have set up further problems down the road. If investors are unwilling to risk investments in floundering financial institutions, additional bank failures could follow. The losses to the insurance fund potentially could be even greater.
3. "I awoke last night to the sound of thunder/ How far off I sat and wondered": The reverberations from the WaMu collapse will ripple through the economy, with many effects near and far, for months to come. Some, like the ones described above, may be readily apparent. Others will be more remote and will take longer to emerge.
Take, for example, the recondite world of collateralized debt obligations, already the subject of much scrutiny due to CDO investment in subprime mortgages. According to a September 26, 2008 Bloomberg article (here), WaMu’s collapse could also have a "significant" impact on CDOs.
According to the Bloomberg article, 1,526 synthetic CDOs sold default protection on WaMu. The CDOs sold notes to investors that are repaid using proceeds of credit default swap premiums. As a credit default swap seller, the CDOs must pay the buyers face value in exchange for the underlying securities or the cash equivalent after a bankruptcy filing.
In other words, as a result of WaMu’s collapse, the CDOs are likely to sustain enormous losses. CDO investors and noteholders, whose investments were already hit by the Lehman Brothers bankruptcy, will see the value of their investments fall even further.
The realization and assessment of these and other more remote consequences of WaMu’s failure, as well as other tumultuous events in the financial marketplace, may take time to emerge. It will likely be a considerable time before all of these consequences have surfaced.
4. A Billion Here, A Billion There: In the last year, WaMu’s market capitalization declined over $80 billion. In isolation, this is significant. Taken collectively with other market losses, the aggregate impact is staggering. Collectively, the failures of WaMu, Lehman Brothers, Bear Stearns, Fannie Mae and Freddie Mac represent roughly a $230 billion loss in market capitalization from a year ago.
Nor is that all. If you add in the market capitalization loss in the last year at AIG, Merrill Lynch, Goldman Sachs, Bank of American and Citigroup, the aggregate market capitalization decline in the last year is nearly $700 billion (just about the size of the Treasury bailout, by coincidence).
These stocks were largely held by institutional investors. The aggregate losses on these investments significantly affect the value of these institutions’ holdings, with significant implications for these institutions’ beneficiaries, investors and other stakeholders.
5. Knock-on Effects: One consequence of these circumstances in our blame-centric culture is that as these losses surface and become more apparent, litigation seems virtually inevitable. I have already noted (here and here) how Lehman Brothers’ failure has been significant factor in recent litigation against other companies. Similar litigation consequences from WaMu’s collapse seem likely. The wide dispersion of the consequences from WaMu’s failure raises the significant possibility that the litigation effects will not be limited to the financial sector alone.
Commercial Irony: Although ironic now with the benefit of hindsight, Washington Mutual consciously built its identity on its willingness to lend to those unable to borrow from others. The thrift built this identity with a series of commercials that remain amusing, although for some reasons now perhaps different than at the time the commercials were first created. I have linked a particularly amusing example below, which I commend for its entertainment value. (Hat tip to the Wall Street Fighter blog, here, for the video link.) Note the ironic symbolism of the disfavored borrower popping a balloon at the start of the commercial.
Kevin M. LaCroix is an attorney and a Partner in OakBridge Insurance Services, Beachwood, Ohio. OakBridge is an insurance intermediary focused exclusively on management liabilityMore...
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The credit crisis recently entered a dark new phase, and this new darker phase has also already produced its own distinctive round of lawsuits. Like the ominous economic circumstances, the new litigation phase also seems darker and more threatening.
After the close of business on Friday, October 10, 2008, the FDIC announced (
Amidst all of the tumult over the Fed bailout and the Presidential debates, not to mention a host of other events large and small, news about WaMu’s collapse has already slipped from the front pages of the nation’s newspapers. Astonishingly, in one short weekend, events have superseded the largest bank failure in U.S. history.
