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

As the number of failed banks has surged over the past couple of years, one anticipated byproduct has been a corresponding wave of litigation against the failed institutions’ former directors and officers. The thing is, the anticipated wave really has not yet materialized. But nevertheless some suits are coming in, as demonstrated most recently in a new lawsuit filed this past week against certain former directors and officers of a failed Georgia bank.

On February 18, 2010, seventeen individual plaintiffs (including one trust) filed a Verified Complaint (here) in Cobb County (Ga.) Superior Court against three former directors of Alpha Bank and Trust, an Alpharetta, Ga. bank that failed on October 24, 2008. A February 18, 2010 Atlanta Journal-Constitution article about the filing can be found here.

The bank, according to press reports, was "one of the quickest bank failures in the nation in recent years, losing almost half of its assets after only 29 months in business."

The plaintiffs’ complaint seeks recovery for negligent misrepresentation and alleges that the three defendants had possession of material information about the bank that they failed to disclose to the plaintiffs, who owned shares in the bank.

There are a number of interesting things about this complaint. The first is that in paragraph 10, the complaint expressly purports to "exclude and disclaim any allegations whatsoever that could be construed as alleging or sounding in" the federal securities laws; common law fraud; intentional, knowing or reckless misconduct; breach of fiduciary duty, or mismanagement.

Clearly, the plaintiffs are not only aiming to avert procedural hurdles and potential defenses, but, as discussed below, they are also trying to circumvent the FDIC’s priority rights under FIRREA to claims the FDIC acquired as the bank’s receiver.

Second, the specific misrepresentations alleged – that the bank experienced undisclosed regulatory difficulties almost from its very beginning, that the bank submitted an undisclosed revised business plan to regulators, that the bank’s board dismissed the bank’s CEO for undisclosed reasons, among other things – all took place after the bank was launched and apparently after the plaintiffs’ acquired their shares.

As a result, plaintiffs’ claim is not that the they were misled into investing in the bank in the first place, but rather that as a result of a series of allegedly wrongful omissions, they "continued to hold their substantial respective investments," as the complaint puts it. A "continued to hold" assertion is a more challenging claim that an "induced to buy" argument.

Third, as suggested above, the plaintiffs clearly tried to shape their allegations in order to avert the FDIC’s rights as receiver to priority over all of the failed institution’s claims. (Refer here for my prior post discussing the FDIC’s right under FIRREA.) The plaintiffs have very carefully alleged that they seek to "recover individualized damages," as well as explicitly asserting that they are not alleging breach of fiduciary duty or mismanagement, which are claims to which the FDIC’s priorities would be clearest.

The FDIC may yet of course attempt to assert its right to priority over the claims the plaintiffs have asserted, and even assert its own claims, based on its status as the bank’s receiver. A recent memo from the Alston & Bird firm (here), citing the FDIC’s own statistics, reports that "of the financial institutions that failed in the period between 1985 and 1992, the FDIC initiated claims against the former directors and officers of 24 percent of those institutions."

There is absolutely no reason to expect that the FDIC will prove to be less litigious now than it was during the S&L crisis. So there would seem to be a considerable possibility the FDIC could yet assert its own claims, as receiver, against the former Alpha Bank officials.

Whether the existing investor claim or any future FDIC claim might succeed remains to be seen. However, were the FDIC to pursue a claim as receiver, and if it were unable to assert its priority under FIRREA over the investors’ claim, there could be a race to capture assets from which to recover – the most obvious asset being the D&O policy. A potential barrier under the D&O policy to any recovery by the FDIC would arise if the applicable policy has a regulatory exclusion.

Whether any successful claimant would be able to recover under the D&O policy will depend further on whether or not anything is remaining when the time arrives. If there were to be litigation free-for-all, defense costs alone could substantially erode the available insurance.

Finally, in terms of the anticiapted litigation wave, it is worth noting that approximately 16 months elapsed between the time Alpha Bank failed and the date the investors filed their suit against the former bank officials. Most of the closures of the most of the banks that have failed as part of the current banking crisis have failed more recently than Alpha Bank. The litigation may yet arrive, it may just follow more slowly than might have been anticiapted.

Special thanks to the several loyal readers who forwarded copies of the Alpha Bank complaint to me.

Belated Securities Suit Filings (Extreme Edition): In a number of recent posts (most recently here), I have noted the curious phenomenon of securities class action lawsuits that are filed well after the proposed class period cut off date. In some cases, the filing has come well over a year after the alleged stock price drop. However, a recent filing seems to set some kind of a belatedness record, as the complaint was filed nearly four and a half years after the proposed class period cutoff date.

In a complaint filed on February 18, 2010 against certain former directors and officers of the bankrupt Dana Corporation (here), the proposed class period runs from February 23, 2005 to October 7, 2005. The class period starting date is just short of five years, which is represents the period of the statute of repose for ’34 Act claims.

A great deal of context is necessary just to try to start to make sense of what might be going on here. First, there already is an existing securities class action lawsuit pending against other former directors and officers of Dana. The prior case, about which refer here, was first filed in the Northern District of Ohio in October 2005 and was dismissed with prejudice in August 2009 (here). The appeal of the dismissal is currently pending in the Sixth Circuit.

A knowledgeable observer suggested to me that the plaintiffs’ lawyers may think they have uncovered new facts implicating the four lower level defendants that are named in the new case. The speculation is that the plaintiffs’ lawyers filed the new case against the four new defendants to preserve the statute of limitations while the "main case" is on appeal. Because of the prior dismissal, the plaintiffs’ lawyers couldn’t just amend the previously existing complaint.

Where all of this might lead remains to be seen, but in the meantime the new complaint sets a new standard in superannuated securities lawsuit filings.

Special thanks to a loyal reader for sending along a copy of the new Dana complaint.

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The problems facing many banks in the current economic environment are well-documented. For troubled banks’ directors and officers, the banks’ D&O insurance may represent a last line of protection. But what if the insurers could just cancel the policies? Surprisingly, many bank D&O insurers have that right under their policies, and while cancellation is rare, it is not unprecedented, and some insurers are now invoking that right to shed the risks associated with failing or problem institutions.

As reflected in a January 24, 2010 FinCri Advisor article entitled "Your D&O Insurer Might Be Scouring Your Call Report Looking to Cancel Coverage" (here), the policy forms of many bank D&O insurers have cancellation clauses that permit the insurer to cancel the policies mid-term, either because there is a "material change in the risk" or for any reason at all.

Many of these clauses are found only in policies that were issued on a multiyear basis, but even some single-year bank D&O insurance policies contain cancellation clauses. While many policies also specify that the insurer must give the policyholder 60 days (or more) notice so that the policyholder can try to replace coverage, the fact is that if something serious enough to cause the insurer to cancel coverage has occurred, it likely will be a very difficult time for the policyholder to try to find replacement coverage.

For D&O insurance practitioners who don’t venture into the Financial Institutions arena (or FI as it is known), the very existence of these clauses in bank D&O policies may come as a surprise, since these clauses do not appear in most mainstream commercial D&O insurance policies.

The obvious question is how did a cancellation clause get into bank D&O policies when it is rarely if ever seen in other kinds of D&O insurance policies? Part of the answer is that, particularly with respect to community banks, the D&O insurance marketplace has over the years become both very specialized and intensely competitive.

Before the current troubled bank era began, D&O insurance for community banks became increasingly less expensive. But as buyers became increasingly (or even exclusively) focused on price, some carriers looked for ways to trim coverage. And so a term such as the cancellation clause that isn’t seen in other D&O insurance policies found its way into the basic forms of several community bank D&O insurance carriers.

A neutral observer might question the value of a contract that one party can simply cancel unilaterally. The promise to provide insurance seems tenuous indeed if the insurer can walk away because problems have emerged – which is of course the very circumstance for which buyers purchase insurance in the first place.

All of this does raise the question of why any buyer would agree in the first place to accept a policy that has a cancellation clause. The answer is either that the buyer is unaware the clause is there or the buyer has no other choice.

Given the number of bank D&O insurers that have cancellation clauses in the policy forms, there undoubtedly are many banks whose policies have these clauses. I am guessing only a very small number of these banks (many of whom may have purchased their insurance on a direct basis) have any idea the clauses are there.

The problem is that the market for D&O insurance for banking institutions is in turmoil now due to the number of failed and troubled banks. For banks that are struggling, it may be challenging in the current environment to obtain a policy without a cancellation clause. Or, if they can a policy without a cancellation clause, the coverage afforded may otherwise be restricted (as for example, by the inclusion of a regulatory exclusion or the absence of past acts coverage).

Healthy financial institutions in many instances can still get coverage on a relatively attractive basis. Healthier banks should not have to accept a policy with a cancellation clause. However, even the healthy banks can only avoid the cancellation clause and other undesirable policy features if their advisor is well-informed and knows what to look and ask for.

One added note is that even some bank D&O policies that do not have cancellation clauses have other undesirable features that are almost as bad. For example, the policy form of at least one D&O insurer that is active with community banks does not allow the policyholder the option of purchasing extended reporting period coverage, even in the event of nonrenewal, which could have a similarly negative impact on a bank whose D&O insurance is not renewed. Again the presence or absence of an extended reporting period option is a term that the bank’s D&O insurance advisor will, if well-informed and knowledgeable, be looking for.

For the banks whose D&O insurers hit them with a notice of cancellation, the only recourse may be for the banks to provide their insurers with a "laundry list" notice of circumstances that may give rise to a claim – always a challenging proposition because of the uncertainty of knowing what claims may arise later. But the laundry list may be the only chance the bank has to lock in coverage before it is unilaterally taken away.

All of this underscores the critical importance for banks and for all insurance buyers of involving a knowledgeable and experience advisor in the acquisition of D&O insurance. Without informed advice, policyholders can be left with inadequate insurance protection when problems arise.

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Since the sole remaining Friday in December is also Christmas Day, the seven banks the FDIC closed last Friday night may represent the last bank failures of 2009. Of course, there is no legal requirement that Friday is the only day of the week on which the FDIC can close a bank. The FDIC could close additional banks on any of the few remaining business days left this year. But given the holiday season, the 140 year-to-date number of bank failures seems likely to be where we will end the year.

The 140 bank closures were both widely dispersed and narrowly concentrated. The FDIC took control of banks in 32 different states, but the closures were particularly clustered in four states: Georgia (with 25 closures), Illinois (21), California (17), and Florida (14). These four states alone account for 77 of the bank failures this year, more than half of the year to date total. Indeed, no other state had double digit numbers of bank failures. The next closest states were Minnesota (6), Texas (5) and Arizona (5).

Though the bank closures have been geographically dispersed, certain regions have been spared. For example, there were no 2009 bank failures in the New England states of Maine, Vermont, New Hampshire, Massachusetts, Connecticut or Rhode Island, and only one each in New York and Pennsylvania. And though Georgia and Florida have seen high numbers of bank failures, much of the rest of the South has been relatively untouched – there were no 2009 bank failures in West Virginia, South Carolina, Tennessee, Mississippi, Arkansas and Louisiana, and only one each in Virginia, Kentucky and Oklahoma.

Among the banks that failed in 2009 were some of the country’s largest, including Colonial Bank (with assets of $25 billion), Guaranty Bank ($13 billion), and BankUnited ($12.8 billion). However, these banks all are smaller than two of the larger banks that failed in 2008, Washington Mutual ($307 billion) and IndyMac ($32 billion).

But though there the list of failed banks includes these larger banks, the list of bank closures really has been predominated by smaller banks. Of the 140 banks that failed in 2009, 112 (80%) involved institutions with less than $1 billion in assets. Indeed, 97 of the 140, or about 69%, had assets of under $500 million. 21 of the 2009 failed banks, or 15%, has assets of under $100 million.

Lest anyone might optimistically hope that with the end of 2009 we have put these sad tidings in the past, the 2009 bank closure timeline seems to suggest to the contrary. Of the 140 banks that closed in 2009, 95 (or about 68%) closed in the second half of the year, compared to 45 in the first half of the year. Though the highest monthly total was in July (when 24 banks were closed, nearly as many as the 25 banks that failed in all of 2008), there were significant numbers of closures in October (20) and December (16).

The FDIC’s latest Quarterly Banking Profile stated that as of September 30, 2009, it graded 552 banks as "problem" institutions (about which refer here), which suggests there could be many bank closures yet to come – which helps explain why FDIC Chairman Sheila Bair last week proposed to increase the agency’s budget and staff, in order for the agency to be able to deal with the anticipated increasing numbers of banking failures in 2010.

I have previously commented the high numbers of bank failures in Georgia, which has been referred to as the "bank failure capital of the world." In that regard, it is noteworthy that there were as many 2009 bank failures in Georgia (25) as there were in the entire country in 2008. In the two year period, Georgia has a total of 30 failed banks, as detailed here.

Who Might Sue When Banks Fail: In prior posts (for example, here), I have noted developments in claims being asserted against directors and officers of failed financial institutions by disappointed investors and by banking regulators. But in addition to these two groups that potentially might assert claims against the directors and officers of failed banks, another group of potential claimants also has recently emerged – the employees of the failed banks.

For example, as reflected in their December 17, 2009 press release, plaintiffs’ attorneys filed a class action lawsuit in the Western District of Washington against Venture Financial Group, the parent of Venture Bank, which regulators closed on September 11, 2009. The lawsuit is filed on behalf of the participants in the bank’s retirement plans. The defendants include the holding company’s directors and officers, some of whom also served on the bank’s board, as well as the individual members of the plans’ administrative committees.

The complaint, which can be found here, alleges that the bank engaged in "a number of large, high-risk and inappropriate investment practices." These practices, "combined with its hazardous lending practices produced more than $200 million losses" and "exposed the retirement plans," which included investments in the holding company’s stock, and which allegedly sustained more than $12 million in losses. The complaint seeks to recover damages on behalf of the plan participants under ERISA.

On December 16, 2009, the same plaintiffs’ firm also announced (here) that it is investigating the possibility of a similar ERISA class action behalf of participants in the benefits plans of Sterling Financial Corporation, which, though it is not among the banks that the FDIC has closed,  was also recently hit with a securities class action lawsuit.

This new lawsuit and the plaintiffs’ lawyers’ investigation announcement underscore that in the wake of a bank failure there are a variety of constituencies might consider initiating claims against the failed institution’s directors and officers. This is all just one more reason I think that one of the key litigation trends we will see in 2010 is an upsurge in litigation against the directors and officers of failed banks.

The Receiver’s Right to Stay Failed Bank Litigation and Require Exhaustion of Administrative Remedies: Though other constituencies may seek to assert claims, the FDIC has rights to seek a stay of the other claimants’ lawsuits under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA), as reflected in a December 10, 2009 order in the Northern District of Texas lawsuit involving Millennium State Bank. Millennium failed on July 2, 2009 (refer here). Investors who had purchased Millennium stock filed a state court action against the bank, its directors, its auditors and its offering underwriter. The investors claimed they had been provided incomplete and inaccurate information about the bank. The investors alleged violations of Texas securities law and common law, and they sought to rescind their investment traction and/or damages.

The FDIC moved to intervene in the state court suit and then removed the case to the Northern District of Texas. The FDIC then filed a motion under FIRREA, arguing that the investors’ case should be stayed and that the plaintiffs’ and intervenors’ claims must be "exhausted under the administrative claim procedure of FIRREA."

The court granted the motion, holding that the FDIC was entitled to the stay, saying that "the law is well established that a stay is mandatory for any claim subject to FIRREA, if the receiver requests one." The court rejected the investors’ argument that the FDIC was not entitled to a stay because they had not named the bank as a party. The court found that "the mandatory stay applies to all claims against the bank and any related third parties" and found further that under FIRREA the "stay is required as to all parties."

The court quoted case authority from the prior era of failed banks to the effect that refusing to grant a stay "would largely defeat FIRREA’s purpose of allowing the agency to evaluate claims in a streamlined administrative procedure."

The court granted the stay until the earlier of the date on which the FDIC as receiver disallows the claims or until the 180-day administrative review period has expired.

In other words, though there may be many constituencies that may seek to pursue claims in the wake of a bank’s failure, the FDIC has rights under FIRREA to sort out which claims will go forward. It seems likely one consideration that might affect whether the FDIC will allow a claimant’s case to go forward would be whether the FDIC intends to pursue its own claims as receiver against the defendants (and, it should probably be added, to try to maximize its own recovery from D&O insurance proceeds). As I previously noted (here), the FDIC has already established that it is going to be aggressive in asserting its priority rights to assert claims against the directors and officers of failed financial institutions.

So if, as I expect, there will be an upsurge in failed bank litigation in 2010, the FDIC is going to call the shots.

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The FDIC’s latest Quarterly Banking Profile (here) shows that as of September 30, 2009, the country’s commercial banks are continuing to struggle, and that as a result of the banks’ woes the FDIC’s Deposit Insurance Fund (DIF) is $8.2 billion in the red. The rising numbers of "problem" institutions suggests both that the number of failed banks could continue to grow and that the DIF could remain under pressure – although as discussed below, the DIF situation may not be quite as dire as the headline details might otherwise suggest.

The FDIC report states that the number of banks on the FDIC’s "problem" institution list rose during the third quarter to 552 from 416 at the end of 2Q09, and that the total assets of "problem" institutions increased from $299.8 billion to $345.9 billion. If assets at "problem" institutions of a third of a trillion dollars sound bad, that’s because it is. The FDIC reports that both the numbers and assets of "problem" institutions are "now at the highest level since the end of 1993."

The FDIC defines "problem" institutions as "those with financial, operational or managerial weaknesses that threaten their continued financial viability." To be classified as a "problem," an institution would have to be ranked as either a "4" or a "5" on the FDIC’s "scale of 1 to 5 in ascending order of supervisory concern." The FDIC does not provide the names of the "problem" institutions, nor does it specify how many of them are rated "4" and how many are rated "5."

To put the number (552) and assets ($345.9 billion) of the third quarter-end "problem" institutions into some perspective, there were "only" 171 "problem" institutions as of the end of 3Q08. In twelve months, the number of "problem" institutions more than tripled, and the assets at "problem" institutions more than doubled.

Along with the growing numbers of "problem" institutions have come an escalating number of bank failures. During the third quarter of 2009, "fifty insured institutions with combined assets of $68.8 billion failed," which represents "the largest number [of bank failures] since the second quarter of 1990 when 65 insured institutions failed." As of the September 30, 2009, 95 banks had failed, and as of November 20, 2009, the 2009 YTD total number of bank failures stood at 124.

This wave of bank failures has taken its toll on the Deposit Insurance Fund (DIF). During the third quarter, the DIF decreased by $18.6 billion, to negative $8.2 billion, "primarily because of $21.7 billion in additional provision for bank failures."

Although these DIF figures sound disastrous, there is more to the story than just the reported negative figure. The FDIC’s November 24, 2009 press release accompanying the report (here) explains that the negative balance reflects a $38.9 billion "contingent loss reserve that has been set aside to cover estimated losses over the next year." In addition, the DIF balance is not the same as the FDIC’s cash resources, which stood at $23.2 billion as of the end of the third quarter.

To further bolster the FDIC’s cash position, on November 12, 2009, the FDIC’s board voted to required insured institutions to prepay three years’ of deposit insurance premiums – worth about $45 billion – at the end of 2009. The press release on the prepayment assessment can be found here.

With the increase in the number of "problem" institutions and the obvious relationship between rising numbers of "problems and the likely number of future bank failures, signs are that we could continue to see significant numbers of bank failures as we head into 2010. While I still don’t think we are going to see 1,000 failed banks by the end of 2010, we are clearly going to be seeing a lot more failed banks.

As bad as all of this is, the Quarterly Banking Profile hints at the possibility that all of the bad news might not even be out in the open yet. Among any other details, the Quarterly Banking Profile also reports that "growth in [loan loss] reserved continued to lag the rise in noncurrent loans, and the industry’s ratio of reserves to noncurrent loans declined for a 14^th quarter, from 63.6 percent to 60 percent."

In terms of what all of this means for the economy, perhaps the most significant detail in the document is its report that "loan balances declined by the largest percentage since quarterly reporting began in 1984." The FDIC’s press release quotes FDIC Chairman Sheila Bair as saying that "there is no question that credit availability is an important issue for economic recovery. We need to see banks making more loans to their business customers."

Europeans Worried About Proposed U.S. Investor Protection Law: According to a November 23, 2009 Financial Times article (here), the European Commission is worried about legislation currently before Congress that would specify the circumstances under which investors could sue foreign domiciled companies in U.S. courts.

As I discussed in a prior post (here), Section 215 the Investor Protection Act of 2009 is addressed to "Extraterritorial Jurisdiction" which would amend the ’33 Act, the ’34 Act and the Investment Advisors Act of 1940 to specify that U.S. courts could properly exercise jurisdiction in any action involving "conduct with the United States that constitutes significant steps in furtherance of violation, even if the securities transaction occurs outside the United States and involves only foreign investors," as well "conduct outside the United States that has a foreseeable substantial effect in the United States."

Under the first of these two prongs, U.S. based conduct alone would be sufficient jurisdictional basis, even with respect to foreign purchasers of who purchased their shares of foreign-domiciled companies on foreign exchanges (so-called "f-cubed claimants").

The article quotes the former director of litigation for Bank of America as saying that "if this legislation passes, there will be greater opportunity for foreign companies to be hauled into U.S. courts." The article also reports that Charlie McCreevy, the European Union Commission for Internal Markets as having "expressed concern over the measure."

All-Time Worst E-Mail Faux Pas?: The title of the Clusterstock’s post (here) pretty much says it all: "Cornell Business School Employees Accidentally Email Everyone with Their Dirty Email Love Notes." Clusterstock observes that the "this might set some kind of record for the worst email mistake anyone has ever made."

Due to the family-oriented nature of this blog, The D&O Diary will not reproduce any examples of the couple’s inadvertently forwarded emails.

The good news is that the two employees involved are married. The bad news is that they are not married to each other.

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In what is the largest number of banks closed on a single day in years, this past Friday night the FDIC seized nine related lending institutions. The nine banks, based in California, Illinois, Texas and Arizona, had been owned by FBOP Corp., a privately held Illinois-based bank holding company. U.S. Bancorp agreed to assume all of the combined banks assets of $19.4 billion and deposits of $15.4 billion.

The latest round of closures brings the 2009 YTD total number of bank closures to 115, already the highest annual total since 1992, when 181 lending institutions failed during the S&L crisis. 31 banks failed just in September and October 2009 alone, more than the 25 banks that failed during all of 2008. Indeed, the FDIC has closed 16 banks just in the last two weeks. The FDIC’s complete list of failed banks can be found here.

Though certain states have seen higher numbers of bank failures this year, the current banking woes are not contained to just one state or region. The failed banks are quite dispersed geographically. 31 different states have had at least one bank closed this year. The states with the highest numbers of bank failures are Illinois (20), Georgia (19), California (13), Texas (5) and Minnesota (5). The Wall Street Journal has a nifty interactive map of the U.S. showing the location of the bank failures, with scaled markers indicated the relative size of each failed bank.

One of the banks closed this past Friday night was California National Bank. With assets of $7.8 billion and $6.2 billion in deposits, CNB is the fourth largest bank to fail this year, according to the Los Angeles Times (here).

The FBOP banks had their share of troubled loans, but the collapse of FBOP’s banks was, according to the Chicago Tribune (here), the result of "an abrupt reversal of fortune last year when the government takeover of Fannie Mae and Freddie Mac exposed the holding company’s large concentration of Fannie and Freddie preferred stock." According to the Los Angeles Times article linked above, the holding company had owned $855 million in preferred Fannie and Freddie shares that became worthless when the government placed the companies in receivership in September 2008.

U.S. Bankcorp’s acquisition of the nine banks’ deposits and assets seems to be a pretty sweet deal. U.S. Bancorp acquired the assets under a loan-sharing plan with the FDIC, which will absorb 80% of the first $3.5 billion in losses and 95 percent of any additional losses.

The swelling numbers of failed banks is certainly worrisome, particularly as the pace of bank closures seems to have quickened recently. This year’s aggregate numbers are starting to rival those for the later years of the S&L crisis.

There are, however, important differences between the current circumstances and the earlier era. The first is the geographic dispersion of the bank failures. During the S&L crisis, many of the failed institutions initially were concentrated in the southeastern part of the country, although as the bank crisis evolved, the bank closures moved up the coast to the northeastern states. By and large, the rest of the country experienced relatively few bank failures.

Another significant difference is the cause of many of the current bank failures. During the S&L crisis, bad loans caused most of the bank failures. Bad loans are clearly a significant factor in many of the current closures as well. But a significant contributing cause of many of the current closures is the presence of troubled assets in the failed banks’ investment portfolios. FBOP’s problems from its soured investments in Fannie and Freddie represent one example where troubled investment assets triggered a bank closure. Similarly, as discussed at length here and here, some banks that have failed this year were weighed down by their investment in other banks’ trust preferred securities.

Another difference is that this time around – at least so far – there does not seem to have been the same surge of FDIC-led failed bank litigation. Of course, it remains to be seen whether the FDIC will once again unleash a wave lawsuits against the former directors and officers of the failed institutions. There has been a certain amount of investor driven involving banks that have failed (refer for example here), but so far at least the FDIC has not been prominently pursuing litigation.

The one thing that seems for certain is that, particularly in light of the recent acceleration of the pace of bank closures, the number of failed banks seems likely to grow as this year ends and we head into next year.

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It might well be asked why anyone should bother reading both the Wall Street Journal and the New York Times business pages. After all, both usually cover the same stories. Indeed, on Friday, both ran stories discussing the fact that year-to-date bank failures are at the highest level since 1992.

However these same-day articles about the number of bank failures in fact were a great illustration of the value of reading both publications, because the two newspapers presented very different explanations for the run of failed banks, particularly with respect to the latest round of bank closures. Each article has its points, though, and both raise interesting questions.

First, the context for the two articles. With the addition of four bank closures this past Friday night, there have now been 81 bank failures this year, compared to 25 during all of 2008, and just three in 2007. Not since June 12 has there been a Friday without a bank closure (Friday being the FDIC’s preferred day to take control of banks.) The FDIC’s complete list of banks that have failed since October 2000 can be found here.

The addition of two more failed banks in Georgia among this Friday’s round of bank closures brings that state’s nation-leading year to date total number of failed banks to 18. Friday’s closures also included Austin, Texas-based Guaranty Bank, the tenth largest bank failure in U.S. history. For more about Guaranty’s closure, refer here.

Though this year’s round of bank failures includes behemoths like Guaranty, and Colonial Bank of Birmingham, Alabama which closed last Friday, the bank failures generally involve much smaller banks, many of them so-called community banks having assets of less than $1 billion. Of the 81 year-to-date bank failures, 68 of them have involved community banks.

Now – why are the banks failing? The Journal and the Times disagree on that point, particularly with respect to the most recent closures.

In an August 21, 2009 article written by Floyd Norris, the Times reported (here) that "banks are now losing money and going broke the old-fashioned way: They made loans that will never be repaid." The Times article notes further with respect to the bank failures that "it has become clear that most of them had nothing to do with the strange financial products that seemed to dominate the news when the big banks were nearing collapse and being bailed out by the government."

There were, Norris writes, "no C.D.O’s or S.I.V.’s or AAA-rated ‘super-senior tranches.’" He added that "certainly, there were not ‘C.D.O.’s-squared.’"

The WSJ sees things quite differently. In a front-page article (published the same day as the Times article) entitled "In New Phase of Crisis, Securities Sink Banks" (here), the Journal asserts that "the banking crisis is entering a new stage, as lenders succumb to large amounts of toxic loans and securities they bought from other banks." Guaranty’s woes and ultimate failure were, for example, due to its "investment portfolio, stuffed with deteriorating securities created from pools of mortgages originated by some of the nation’s worse lenders."

The Journal article notes that Guaranty "is one of the thousands of banks that invested in such securities, which were often highly rated but ultimately hinged on the health of the mortgage industry." The securities fell into two categories, those "carved out of loans originated by mortgage companies, packaged by Wall Street firms, and then sold to investors," and "trust preferred securities" which are hybrid securities banks issue through special purpose trusts and that have certain advantages for purposes of measuring regulatory capital (for further background regarding trust preferred securities and the problems they are causing banks, refer here).

Banks themselves issued trust preferred securities, which "Wall Street brokerage firms bought" and packaged into "so-called collateralized-debt obligations" for which "many of the buyers were small and regional banks." The outcome of what one commentator called "this wonderful chain of stupidity" is that the "consequences are cascading down on the banks that bought these securities." Indeed, trust preferred securities holdings "doomed six family-controlled Illinois banks that collapsed last month." (My post about these six banks’ failure can be found here.)

It hardly seems as if the two newspapers were discussing the same topic, with the Times saying the bank failures had nothing to do with these exotic investment securities, and the Journal directly pinning the blame for numerous recent bank failures on the banks’ investment in precisely these kinds of investment instruments. Certainly, the examples the Journal cites suggest that the structured investments has had a lot more to do with at least some of the most recent banks failures than the Times article implies.

But as different as the two articles’ analyses may appear, the articles do agree that the fundamental problem for banks is that too many loans are not performing. The Journal article specifically notes that "delinquency rates and losses are at all-time highs," and the investment portfolio problems are hitting banks "already weakened by losses on home mortgages, credit cards, commercial real-estate and other assets imperiled by the recession."

The one topic on which the two articles unquestionably agree is that the banks’ problems are likely to continue to get worse for some time to come. The Times article specifically notes that "the losses on current failures stem mostly from construction loans," but that commercial real estate could be "the next problem area." Commercial real estate loans typically must be refinanced every few years, and with rents down and vacancies up, "some owners are just walking away from their buildings."

Finally, an August 23, 2009 New York Times article entitled "What the Stress Tests Didn’t Predict" (here) confirms, based on a comprehensive review of over 7,000 banks (but excluding the 19 money center banks), that there was "more stress in the banking industry in the second quarter of 2009 than in the immediately preceding periods" and that "even the best run banks are having trouble escaping the impact of a sluggish economy and high unemployment."

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Another Subprime-Related Securities Lawsuit Dismissal: In yet another subprime-related securities class action lawsuit decision in defendants’ favor, on July 29, 2009, District of Connecticut Judge Stefan Underhill granted the defendants’ motion to dismiss in the securities lawsuit pending against CBRE Realty Finance and certain of its directors and officers. A copy of the opinion can be found here. Background regarding the case can be found here.

As reflected in Alison Frankel’s July 30, 2009 article about the decision in The American Lawyer Daily (here), the court’s order in the CBRE Realty case may be particularly noteworthy because the plaintiffs’ complaint asserts claims under the ’33 Act, in connection with which the plaintiffs would not have to plead scienter or even loss causation in order to survive a motion to dismiss -- they only need to plead a material misrepresentation or omission.

In his July 29 order, Judge Underhill found that the plaintiffs had not adequately pled that the alleged misrepresentations or omissions were material. The plaintiffs had alleged that in connection with company’s IPO, the company’s offering documents had not adequately disclosed the risk of default in connection with two Maryland condominium conversion projects known as Triton. Judge Underhilll concluded that plaintiffs had failed to allege that there was not sufficient collateral to back the $51 million loan to Triton.

Judge Underhill’s ruling does not indicate whether or not it is with or without prejudice; however, he did order the court clerk to close the file.

I have added the CBRE decision to my register of subprime and credit crisis-related lawsuit dismissal motion outcomes, which can be accessed here.

Still More Bank Failures: In case you missed it, this past Friday night, the FDIC closed five more banks, bringing the year to date total number of bank failures to 69. The FDIC has taken control of 32 banks just since June 19, 2009. An August 1, 2009 Bloomberg article detailing the latest bank closures can be found here.

The most recent round of bank closures continues the trend concentration of recent bank closures within the community banks. Four of the five latest bank closures involved institutions that had assets of under $1 billion. Of the 69 banks that have closed this year, 59 have had assets under $1 billion.

The signs are that the bank closures will continue for some time to come. The July 31, 2009 Wall Street Journal reported (here) that banking regulators have already entered at least 285 memoranda of understanding with banking institutions this year, on pace for nearly 600 by year end, compared with 399 for the full year last year. While the MOUs are designed to try to direct the institutions away from closure, the sheer number of agreements is a reflection of the difficult circumstances that many banking institutions are facing.

The FDIC’s complete list of banking institutions that have failed since October 2000 can be found here.

Another Madoff-Related Insurance Coverage Action: In an earlier post (here), I noted the arrival of the Madoff-related insurance coverage litigation and suggested there would be much more similar coverage litigation ahead. Another Madoff-related coverage lawsuit has now arrived.

On July 20, 2009, Blezak Black filed an action (here) in New Jersey (Camden County) Superior Court against its crime insurers. The plaintiff alleges to have invested over $13 million with Madoff, which it lost. The plaintiffs’ crime insurers have denied coverage for the claim. The plaintiff’s complaint alleges breach of contract and seeks a judicial declaration of coverage.

I have added this lawsuit to my register of Madoff-related insurance coverage litigation, which can be found in Table V of my register of Madoff lawsuits. The register can be accessed here.

Special thanks to a loyal reader for providing a copy of the latest Madoff-related insurance coverage lawsuit complaint.

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With the closure of a group of six interrelated Georgia banks this past Friday night, the state has now reclaimed the dubious distinction of as having the most failed banks of any state this year. With the addition of the most recent closures, there have now been 16 failed banks in Georgia this year, compared to 12 in Illinois, which had previously and for a brief period (refer here) led Georgia in the number of failed banks.

There were a total of seven bank closures on July 24, 2009, which brings the year to date total number of closures to 64. The pace of bank failures has definitely picked up in the last several weeks. There have been 27 bank closures just in the five-week period since June 19, which is more that the number of banks (25) that failed in all of 2008.

The six Georgia banks that filed Friday were all subsidiaries of Security Bank Corp., which had been Georgia’s fourth-largest lender. The six units were technically six separate banks, although according to the Atlanta Business Chronicle (here), "the banks essentially operated as the same institution."

The Atlanta Journal-Constitution described the rise and fall of the holding company (here) as "a stark symbol of the state’s banks woes." The bank made a "fatal push" into the Atlanta residential market in 2005 and 2006. The bank "tripled in size" between 2005 and 2009. The bank lost $243 million last year, and at the end of the first quarter of 2009 reported $277 in "severely delinquent loans that bank had given up hope of collecting on."

There have now been 22 different states that have had at least one bank failure this year. Beyond Georgia and Illinois, the other states with high numbers of bank failures include California (8) and Florida (3). Generally, the banks that have failed so far this year have been smaller banks; of the 64 banks that have failed so far this year, 55 have had assets under $1 billion. The FDIC’s complete list of all banks that have failed since October 2000 can be found here.

Relatively few of the bank failures involve publicly traded institutions. In its recent mid-year report on securities litigation (here), Cornerstone Research noted that of the 45 banks that had failed through June 30, 2009, only 21 involved publicly traded companies, and only one failed banks had been involved in securities class action lawsuits this year.

My earlier post analyzing the number of failed banks in Georgia can be found here.

Break in the Action: The D&O Diary will be on an intermittent publication schedule for the next few days. The "normal" publication schedule will resume the week of August 10.

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On Friday June 26, 2009, in the highest number of bank closures on a single day since 1992, the FDIC assumed control of five more banks, bringing the YTD total number of failed banks to 45, compared to 25 for all of 2008. In addition, at the same time as bank closures surge, there are growing signs that both private litigants and the FDIC intend to pursue claims against the former directors and officers of the failed institutions.

The five banks closed on Friday are Mirae Bank of Los Angeles, California, which prior to its closure had assets of $456 million (and about which refer here); MetroPacific Bank of Irvine, California, which prior to its closure had assets of $80 million (refer here); Horizon Bank of Pine City, Minnesota, which had assets of $87.6 million (refer here); Neighborhood Community Bank, of Newnan, Georgia, which had assets of $221,6 million (refer here); and Community Bank of West Georgia, Villa Rica, Georgia, which has assets of $199.4 million (refer here).

The closure of the two Georgia banks continues the pattern of a high concentration of bank failures in that state. With the addition of these two latest closures, the number of bank failures in Georgia since January 1, 2008 now stands at 14, the highest number of any state. There have been nine bank closures in Georgia already so far in 2009. My prior post discussing the Georgia bank failures at greater length can be found here.

The closure of the two California banks brings the total number of failed banks in California since January 1, 2008 to eleven. There have been seven bank failures in Illinois and four in Florida since the beginning of 2008. The FDIC’s complete list of all banks that have failed since October 2000 can be found here.

The relatively small size of all five of the banks closed this past Friday night continues the concentration of bank failures in the community banking sector. Of the 45 bank failures so far this year, 39 have involved institutions with assets under $1 billion. Only eleven of the 45 had assets over $500 million.

Some litigation against the directors and officers of these failed banks has already begun to emerge. As I previously noted (here), from among the six of the 25 banks that failed in 2008 have become involved in securities class action litigation, even though only eleven of the 25 were publicly traded.

Shareholders of failed banks are also starting to file shareholders’ derivative and individual litigation against the directors and officers of failed banks. For example, on May 28, 2009, a shareholder of Meridian Bank of Madison County, Illinois, which regulators closed on October 10, 2008 (refer here), filed a complaint (here) in Madison County (Illinois) Circuit Court against the former President of the bank and two former directors. The complaint combines derivative and individual claims. Among other things, the complaint alleges that the directors engaged in self-interested transactions and that the bank’s practices and procedures were detrimental, resulting in the bank’s closure by federal regulators and in damages to the bank’s shareholders.

In addition, according to a June 14, 2009 article in the FinCri Advisor (here, registration required), the FDIC is currently assessing whether to pursue claims against the former directors and officers of failed financial institutions. According to the article, the FDIC has begun the process of potentially suing directors and officers, by sending claims letters to ousted officials advising them of the FDIC’s intent to pursue claims.

Because the FDIC typically assumes control of failed banking institutions after the close of business on Friday evenings, it seems relatively unlikely that there were be any further bank closures in June 2009. However, the 45 closures in the first half of the year alone already represent an 80% increase over the total number of closures during all of 2008.

With the continued stress in the general economy, the deteriorating condition of the commercial real estate sector, and the elevated levels of unemployment, the likelihood is that the number of bank closures will continue to grow as the year progresses. Indeed, In the FDIC’s most recent Quarterly Banking Profile (as of March 31, 2009), the FDICcounted 305 institutions with assets of $220 billion on its Problem List. The Problem List is up from 252 institutions with $118 billion in assets at the end of the third quarter of 2008, which in turn was up from 117 institutions with $78.3 billion in assets as of the end of the second quarter. (The FDIC does not identify the problem banks by name.)

At the same time, there would appear to be a growing likelihood of claims against the former directors and officers of at least some of the failed banks. As I have previously noted (here), these developments have already registered in the D&O insurance marketplace for community banks, which has quickly become characterized by rising prices and narrowing terms and conditions.

Hat tip to the Courthouse News Service (here) for the Meridian Bank complaint.

Children’s Place Settles Securities Suit: In a June 26, 2009 filing on Form 8-K (here), The Children’s Place Retail Stores announced the settlement of the consolidated securities class action litigation that had first been filed against the company and certain of its directors and officers in the Southern District of New York in September 2007. Background regarding the securities lawsuit can be found here.

According to the 8-K, in the settlement, the company agreed to pay $12 million for a release of all claims. The cost of the settlement, according to the 8-K, “is covered by the Company’s insurance.”

Securities Suit Against FX Energy Dismissed: In an order dated June 25, 2009 (here), District of Utah Judge Clark Waddoups granted the defendants’ motion to dismiss the securities class action lawsuit that had been filed against FX Energy Corporation and certain of its directors and officers. Background regarding the case can be found here.

As summarized in the June 25 opinion, the plaintiffs alleged that the defendants had made two essential sets of misrepresentations. First, the plaintiffs alleged that in press releases and in a slide presentation the defendants had falsely represented that the decision to drill for gas at two sites was “based on well-established scientific and geological data,” while the defendants had in fact (the plaintiffs alleged) used only two-dimensional (2D) seismic data while suggesting that they had used three-dimensional (3D) data. Second, the plaintiffs alleged that the defendants had touted the proximity of the Sroda-5 and Lugi-1 sites to other successful wells as a significant factor indicating that gas could be located at one of the two sites, knowing that this representation was untrue.

With respect to the allegedly misleading statements regarding the type of seismic data used, the court found that reading all of the allegedly misleading statements, it “cannot find any statements that reasonably imply that FX Energy was using 3D seismic data.” To the contrary, the court found “the non-specific references to 2D and 3D in these documents give one the impression that FX Energy was generally using 2D but had plans to use 3D at some future time.” Accordingly, the court found with respect to the first set of allegations that the plaintiffs had not sufficiently pleaded fraudulent statements or omissions.

With the second set of alleged misrepresentations, the court found that the plaintiffs had adequately alleged that the defendants’ statements implied that the Lugi-1 and Sroda-5 wells would have a higher chance of success given the success of other wells in the vicinity. However, the court found plaintiffs allegations were still insufficient to establish a claim for securities fraud due to the complaint’s failure to properly plead scienter.

Specifically, the court found that there was a plausible opposing explanation for defendants’ statements, which is “that the Defendants actually believed that they were true.” The court found that it did not believe that a reasonable person would conclude that that the plaintiffs’ allegations that the defendants acted with scienter was at least as compelling as the opposing inference.

As the court said, “to accept Plaintiffs’ allegations, one would have to believe that Defendants knew that their information on Lugi-1 or Sroda-5 was unreliable and actually had strong information that those wells were dry, but nonetheless planned to drill there, repeatedly publicized those plans, and they expended significant resources to actually drill there, all on the chance that taking these actions might artificially inflated stock prices.” The court also found that the plaintiffs’ reliance on the testimony of confidential witnesses and on the defendants’ trading in their share in company stock were unavailing.

Accordingly the court granted the defendants’ motion to dismiss the plaintiffs’ complaint.

Hat tip to Adam Savett of the Securities Litigation Watch (here) for the link to the Children’s Place 8-K and to the June 25 opinion in the FX Energy case.

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As discussed in a prior post (here), at an April 1, 2009 hearing, Southern District of New York Judge Jed Rakoff had raised concerns that a proposed lead plaintiff’s law firm may have a "blatant, shocking conflict of interest," as a result of free portfolio monitoring services the firm performed for its client, the Iron Workers Local No. 25 Pension Fund. On April 25, 2009, Judge Rakoff entered an order (here) naming the Public Employees’ Retirement System of Mississippi (MissPERS) as lead plaintiff, stating that he would explain his reasons in a forthcoming opinion.

On May 26, 2009, Judge Rakoff entered his opinion (here) explaining his lead plaintiff selection in the case, which involves consolidated lawsuits relating to Merrill Lynch mortgage pass-through certificates. The opinion contains some interesting comments and observations about the two competing plaintiffs and their relations to their counsel

In his opinion, Judge Rakoff explained that because of "problematic relationships" between plaintiffs and their counsel, he was faced with a choice between "two less-than-perfect plaintiffs." He was particularly concerned with the relationship between the Iron Workers Fund and its counsel, because of testimony at the April 1 hearing showing that the Fund had a contractual arrangement with counsel whereby the law firm provided "free monitoring" of the Fund’s portfolio, in exchange for which if the firm recommended that the Fund pursue securities litigation, the firm would be retained on a contingency fee basis.

Judge Rakoff said that this arrangement goes "far beyond any traditional contingency arrangement" and creates a "clear incentive" for the firm to "discover fraud" and to recommend litigation, a practice that "fosters the very tendencies toward lawyer-driven litigation that the PSLRA was designed to curtail."

As the April 1 hearing, Judge Rakoff had questioned whether this arrangement was ethical. Following the hearing, the concerned law firm filed an affidavit from distinguished scholar Geoffrey Hazard, who opined that the arrangement did not create an improper conflict of interest. Among other things, Professor Hazard based his opinion on the conviction (speaking with respect to securities litigation) that plaintiffs’ lawyers had every incentive to proceed only if the claim is reasonably viable. He also noted that in contemporary practice, most plaintiffs are sophisticated and have access to sophisticated advisors.

Judge Rakoff noted that while he has "the very greatest respect" for Professor Hazard, he was not persuaded. First, the Professor’s statements about plaintiffs’ counsel’s incentives to pursue only viable claims are contrary to the concerns of Congress in enacting the PSLRA "regarding abusive lawyer-driven litigation."

And with respect to the supposed sophistication of plaintiffs and their access to sophisticated advisors, Judge Rakoff noted that the Iron Worker’s Fund’s administrator "was not particularly sophisticated in evaluating securities actions" and "only had a rough idea what this lawsuit was all about," and the "sophisticated advisors" on whom the Fund was relying were "the very lawyers who would be bringing suit."

Judge Rakoff concluded that he "need not determine whether there here exists a conflict of interest that violates ethical rules," since it is clear that the Iron Workers Fund is "in no position to adequately monitor the conduct of this complex litigation."

Which is not to say that MissPERS, the lead plaintiff he selected, is "without blemish," since it too relies on portfolio monitors and has very regularly served as a lead plaintiff. However, Judge Rakoff found that MissPERS relies on twelve different monitors, rather than a single monitor, and it employs a group of lawyers to evaluate litigation recommendations and "plainly had a sophisticated knowledge of such matters."

As for the objection that MissPERS was a "professional plaintiff" of the kind the PSLRA disfavors, Judge Rakoff noted that when the alternative plaintiff had little expertise, "the accumulated experience of MissPERS in pursuing multiple securities fraud actions seems a benefit more than a detriment."

In a final footnote, Judge Rakoff raised, but did not address, concerns about Pay-to-Play arrangements that could affect relations between plaintiffs’ firms and elected officials, but he declined to address the issue, which he said was not "presently before the Court in this case."

It is probably worth noting that the strong language Judge Rakoff used at the April 1 hearing has drawn considerable attention in other forums. For example, in a May 5, 2009 hearing before Central District of California Judge Andrew Guilford to determine the lead plaintiff in a case pending there, Judge Guilford noted (here) that because the same law firm was involved in the case before him as in the case before Judge Rakoff, he was "concerned" by Judge Rakoff’s observations at the April 1 hearing, and he noted further that his lead plaintiff "determination will benefit" from the analysis Judge Rakoff was to provide in his then-forthcoming opinion. Clearly, Judge Rakoff’s various statements and rulings could have significance outside the confines of the specific case in which they were delivered. Special thanks to a loyal reader for a copy of the May 5 opinon

On the other hand, it is relevant to note that in another recent lead plaintiff decision by a judge in same courthouse as Judge Rakoff did not consider the monitoring services this particular law firm provided to the lead plaintiff to even be a relevant consideration. In a  May 22, 2009 opinion (here), Southern District of New York Judge Barbara S. Jones rejected arguments that the law firm had a conflict of interest due to the portfolio monitoring servicves it provided to the proposed lead plaintiff. Judge Jones said that "the Court has been shown no reason why this monitoring system causes any issues or impediments to teh firm's representation," noting that the firm "has substantial experience in representing shareholders in securiteis class actions" and that she "believes the firm will serve the class adequately." Special thanks to a loyal reader for a copy of the May 22 opinion.

Andrew Longstreath’s May 27, 2009 Law.com article about Judge Rakoff’s opinion can be found here.

More Problem Banks: In prior posts (most recently here), I noted concerns regarding the increasing number of failed banks, and conjectured that banking closures were likely to continue to accumulate for the foreseeable future, citing the FDIC’s estimates of the number of "problem banks."

In its latest Quarterly Banking Profile, released on May 26, 2009 for the first quarter of 2009 (here), the FDIC increased the number of banks on its "Problem List" from 252 at year end 2008 to 305 as of March 31, 2009, and increased the total assets at problem institutions from $159 billion to $220 billion. (The FDIC does not identify the banks it has designated as "problems" by name.)

To put this increase in context, the number of banks on the Problem List as of the end of the third quarter of 2008 was only 171, and at the end of the second quarter of 2008, the count was only 117. In other words, the number of banks on the Problem List not only increased 21% from year end 2008 to the end of the first quarter 2009, but it has increased 160% in just nine months between the middle of 2008 and the end of the first quarter.

As I have said before, all signs are that the current banking woes are likely to continue for the foreseeable future.

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In an earlier post (here) in which I raised the question whether lawyers would find themselves the targets of gatekeeper blame from the subprime meltdown, I discussed a malpractice action that had been brought against the Cadwalader law firm by Nomura Securities, in connection with a commercial mortgage securitization transaction in which Cadwalader had acted as counsel.

According to Susan Beck’s May 21, 2009 Law.com article (here), Nomura’s lawsuit has survived Cadwalader’s motion to dismiss. As the article notes, the "backstory" on this case "is complicated." Cadwalader had been Nomura’s counsel in connection with the securitization. After one of the underlying commercial mortgages defaulted, LaSalle National Bank, the loan servicer, had sued Nomura. Nomura settled the LaSalle case for $67.5 million and then sued Cadwalader for malpractice in connection with the securitization documentation.

In his April 28, 2009 opinion (here) denying Cadwalader’s motion to dismiss, New York Superior Court Judge Melvin L. Schweitzer ruled that Nomura’s position in the LaSalle case that Cadwalader’s actions were proper did not preclude Nomura’s claims in the malpractice action, and that Cadwalader’s reliance on standard language from a Standard & Poor’s publication did not create a defense for a motion to dismiss.

Though the underlying securitization is from an era long ago (the transaction took place in 1997), the attempt to impose gatekeeper liability on the law firm raises the possibility that lawyers may find themselves among the targets in connection with more recent securitization transactions. The Nomura lawsuit’s survival of the initial motion to dismiss, though for reasons very specific to the particular case, may motivate other erstwhile plaintiffs to consider the possibility of targeting the transaction attorneys involved in the many securitizations now the subject of extensive litigation.

If the Nomura case is any indication, aggrieved parties may well attempt to seize on purported defects in the securitization documents to attempt to target the law firms that drafted the documents. To the extent law firms' clients and former clients are compelled to pay investor losses on securities they sold to investors, the clients and former clients may attempt to shift those losses to the lawyers that drafted the securitization documents.

Interestingly, according to the Law.com article, the attorney that initiated the Nomura lawsuit was none other than Marc Dreier, who recently pled guilty to a series of criminal actions that may be even harder to believe than they are to summarize. The Nomura case is being carried forward by two attorneys from Drier’s former law firm.

Florda Bank Becomes Larges Bank to Fail This Year:  In a rare Thurday night regulatory action, on May 21, 2009, BankUnited FSB became the thirty-fourth bank failure so far this year when regulators took control of the bank and sold its assets to a group of investors. According to news reports (here), the BankUnited closure is also the biggest bank failure so far this year. The failed bank had assets of $12.80 billion.

According to the Wall Street Journal (here), BankUnited's woes were due in part to its significant exposure to "nonresident alien" mortigage, which foreign domiciled individuals (primarily in Latin America) used the loans to acquire Flordia residential properties.

The DealBook blog has a lengthy description (here) of the private equity process that resulted in the transfer of BankUnited's assets.

In connection with prior bank closures this year, the FDIC had waited until after the close of business at the end of the week on Friday afternoon to announce its regulatory action. The FDIC’s Thursday afternoon action on BankUnited breaks this otherwise consistent pattern. Perhaps the banking regulators wanted to get ahead to allow them to get an early start on the upcoming holiday weekend.

The FDIC’s press release regarding the closure can be found here and additional background information from the FDIC can be found here. The FDIC’s complete list of failed banks can be found here. A helpful Wall Street Journal table regarding the recent bank closures can be found here.

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As the subprime meltdown has become a more generalized economic crisis, the adverse consequences have moved far beyond the residential real estate sector where the trouble first began. Until recently, however, the worst effects were concentrated in the financial sector. But as Chrysler’s recent bankruptcy filing shows, the turmoil is no longer limited to the finance sector alone. The infiltration of the credit crisis into the larger economy not only threatens a rise in bankruptcies, but could also include increased bankruptcy-related securities litigation, much of which may be outside the financial sector.

An indication of how these developments might arise can be seen in the securities class action lawsuit filed in the Northern District of Texas on April 30, 2009, against certain former officers of Idearc, Inc. A copy of the complaint can be found here. Idearc "manages and delivers print, online and wireless publishing and advertising services on multiple platforms," including yellow and white pages, online directories and search services. Idearc itself filed for protection under the U.S. bankruptcy laws on March 3, 2009, and so is not named as a defendant in the securities lawsuit.

The complaint alleges that in 2006 and 2007, the company had "touted" its credit and collection policies and procedures, which it claimed had resulted in a steady decline in its bad debts. However, the complaint alleges, during 2007, the company "relaxed" its credit policies "in order to increase the dollar amount" of reported revenue.

The complaint further alleges that the company, "by selling to non-creditworthy customers, effectively reported tens of millions of dollars of sales that it otherwise would not have reported while accumulated tens of million of dollars of uncollectible receivables." However, the complaint alleges, in mid-2008, the company admitted that it had relaxed its credit policies in 2007, and "began to write off these uncollectible receivables in a piecemeal fashion over several quarters."

The complaint alleges that by year end 2008, the company had written off $47 million of receivables, which among other things "materially contributed to the company’s need to file for bankruptcy protection." The complaint alleges that investors were misled by the company’s disclosures regarding its credit and collection policies and procedures as well as by the piecemeal revelation of its company’s growing problems with receivables collections and reserve for bad debts.

As the economy sours, many companies – including companies outside the financial sector, like Idearc – are likely to experience increasing difficulties realizing the anticipated benefits from customer, vendor or counterparty obligations. By the same token, reduced economic activity may render many companies unable to meet their own obligations to their creditors, suppliers and others.

As these problems accumulate, other companies will find it necessary to seek protection under the bankruptcy laws. The officers and directors of many of these bankrupt companies, like those at Idearc, may find themselves the target of a post-filing securities class action lawsuit. Another recent example of a post-filing bankruptcy lawsuit involves former directors and officers of MRU Holdings, about which I previously wrote here.

The increase of these kinds of bankruptcy related lawsuits may be the means by which the current wave of subprime and credit crisis-related litigation spreads outside the financial sector. In its recent quarterly report on securities litigation (here), Advisen suggested that "it is likely that the wave of subprime-related suits, and in particular suits filed against financial services companies, will crest in 2009." The report goes on to suggest that "as bankruptcies rise through the economy, hitting all sectors, and securities suits are filed as a consequence, suits filed will become more dispersed …broadly affecting all sectors."

More Failed Banks: In what is now a standard weekend ritual, this past Friday evening the FDIC closed three more banks, bringing the year to date total number of failed banks to 32. The three banks closed this Friday night were: Silverton Bank of Atlanta, Georgia, which prior to its closure had assets of $4.1 billion, making it the fifth largest bank to fail since the beginning of 2008 (further details about the bank can be found here); Citizens Community Bank of Ridgewood, N.J. , which had assets of $45.1 million (refer here); and America West Bank of Layton, Utah, which had assets of $299.4 million (refer here).

Silverton is the sixth Georgia bank to be closed this year and the eleventh since January 1, 2008, the highest total for any state during either of those two periods.

In light of their relatively small size, both Citizens Community Bank and America West Bank qualify as community banks. As I recently noted (here), the 2009 bank failures have largely involved these kinds of smaller community banks. Indeed, 27 of the 32 banks that have failed so far this year have involved financial institutions below $1 billion in assets, which is one standard measure of community banks.

Silverton was quite a bit larger than these community banks, and it is also somewhat unusual in that Silverton did not take deposits from the general public or make loans to consumers. Silverton was a wholesale bank, providing services, according to the Wall Street Journal (here), to one in every five banks in the country. Silverton was known as the Bankers Bank until last year. Its customers, depositors and investors are all banks. Banks that had invested in Silverton will incur losses as a result of its failure, which could pose problems other banks.

The FDIC’s complete list of failed banks since October 2008 can be found here. The Wall Street Journal has a nifty interactive table of all the failed banks here, which can be sorted by name, closure date, asset and deposit size, and other factors. (The Journal’s list does not yet include Citizens Community Bank and America West Bank.)

Speakers’ Corner: On Monday, May 4, 2009, I will be in New Orleans at the spring meeting of the Casualty Actuarial Society, participating on a panel entitled "An Update on the Credit Crisis and Related Issues for D&O Insurers." The panel will be chaired by Joe Lebens of the Towers Perrin firm, and will include Stephanie Plancich from NERA Economic Consulting and David Bradford from Advisen. More information about the session and the conference can be found here.

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With the addition of four more bank closures this past Friday night, the YTD number of bank failures now stands at 29, which already exceeds 2008’s total of 25 and is the highest annual total since 1993, at the end of the last era of failed banks. All signs are that the number of bank failures will continue to grow in the months ahead, a prospect that is already affecting the D&O insurance marketplace, even for smaller community banks. 

The four banks that closed this past week were: American Southern Bank of Kennesaw, Georgia, which prior to its closure had assets of $112.3 million (for further details about its closing, refer here); Michigan Heritage Bank in Farmington Hills, Michigan, which previously had assets of $184.6 million (refer here); First Bank of Beverly Hills in Calabasas, California, which previously had assets of $1.5 billion (refer here); and First Bank of Idaho in Ketchum, Idaho, which has assets of $488.9 million (refer here). 

Although the assets of three of the banks were sold to other financial institutions, the FDIC was unable to find a buyer for First Bank of Beverly Hills, forcing the FDIC to assume the financial institutions assets. 

The closure of American Southern Bank adds to the growing list of failed banks in Georgia, which, as I noted at length here, leads the nation in number of bank failures. With the addition of American Southern, there have been ten bank failures in Georgia since January 1, 2008, including five already in 2009. California is a close second behind Georgia in number of failed banks, and the failure of First Bank of Beverly Hills brings the number of California bank closures since January 1, 2008 to nine. 

But the overall geographic distribution of the latest four banks to fail, and indeed of the banks closed so far in 2009, highlights the fact that the bank woes are not concentrated in any one geographic area. Rather, the banking troubles seem to be distributed around the country. Banks have failed in 16 different states already this year, sprinkled across the national map. The FDIC’s complete list of failed banks since October 1, 2000 can be found here. 

These latest four closures also highlight the fact that the banking woes are not limited just to the largest banks; to the contrary, the bank failures increasingly seem to involve the smaller community banks. Three of the four most recently closed banks had assets below $500 million, and many of the other banks closed this year also were similarly smaller banks.

One generally accepted definition of a community bank is a banking institution with assets below $1.0 billion (refer here). By this definition, 25 of the 29 banking institutions that have failed this year are community banks, as only four the failed banks had assets over $1 billion. Indeed, most of the failed banks are very small; only seven of the 29 banks that have failed in 2009 had assets over $500 million. 

For many years, and even throughout the recent financial turmoil, community banks have been viewed as relatively safe. Their lack of involvement both in commercial lending and in subprime loans seemingly spared them the most significant problems that have characterized the current crisis – until now. The growing problems in residential real estate and rising unemployment levels are raising problems even in the community banking sector, as the bank closures described above demonstrate. Based on the 2009 bank closures, the community banking sector may now have become the leading edge for problems in the banking sector. 

Unfortunately, all signs are that these difficulties will continue in the months ahead. In the FDIC’s most recent Quarterly Banking Profile (as of December 31, 2008), the FDIC counted 252 institutions with assets of $159 billion on its “Problem List,” up from 171 institutions with $116 billion in assets at the end of the third quarter of 2008. (The FDIC does not identify the problem banks by name.) With unemployment growing and the number of troubled loans increasing, the number of banks on the “Problem List” undoubtedly will have grown when the FDIC releases its Quarterly Banking Profile for the first quarter of 2009 in a few weeks. And the bank closures are likely to continue to accumulate. 

The D&O insurance marketplace for the community banking sector had been a placid, quiet area where many insurers were willing to offer broad terms at low prices. However, as a result of the recent deterioration in the sector, the D&O insurance marketplace has very recently begun to change. There are still a number of carriers active in this space, but a number of players have recently started to take more conservative positions, even nonrenewing insureds in certain geographic areas or with certain characteristics. 

More restrictive terms that had largely disappeared, such as the regulatory exclusion, are suddenly reappearing in coverage proposals for some accounts. And banks that have been declined by several carriers may find they can only place their coverage at significantly increased premiums. The D&O insurance marketplace for community banks is placid no more. 

Perhaps the most noteworthy thing about these changes is how quickly they have taken place. This heretofore quiet corner of the D&O marketplace has very quickly become characterized by rapid chance. Although I have been and remain skeptical of some of the predictions about when we may see a hard insurance market, the speed of the changes in community banking sector represents the type and velocity of change that can occur in a market turn. It is still premature to say definitively that we are headed into a hard market anytime soon, even just for community banks, but there is some evidence to suggest that a harder market could well lie ahead.

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The current financial crisis involves a potent witches’ brew of bankruptcies, mortgage bailouts, failed banks, blame assignment, and liquidity issues. Because every one of these ingredients contributes in some important way to the total mix of current woe, this post briefly references each one of these issues and concludes with a video that manages to find humor despite the current dismal circumstances.

Bankruptcies Double: Though it is early yet, one of 2009’s stories of the year has to be the surge in corporate bankruptcies. According to recently published data (here), bankruptcies this year by publicly traded companies are running at more than twice their 2008 pace. Bankruptcies of companies with assets over $1 million are fueling the surge.

According to the data, there have been 46 bankruptcy filings (under Chapter 11 or Chapter 7) by public companies in 2009, with total combined assets of $74 million. As this point last year, there were only 21 bankruptcies totaling $11 billion.

Some context is required for these numbers, however. This year’s bankruptcy pace is still below that of 2002, a "record-breaking" year in which there were 60 bankruptcies by early March.

The financial market turmoil is producing numerous casualties. Indeed, Blackstone Chairman Stephen Schwarzman was quoted today (here) as saying that "between 40 and 45 percent of the world’s wealth has been destroyed in little less than a year and a half." Give the staggering scale of market losses, even optimists will recognize that further bankruptcies undoubtedly lie ahead.

My recent post discussing D&O insurance issues arising from bankruptcy can be found here.

A Successful Mortgage Bailout: As depressing as the current circumstances are, a sucessful bailout from an earlier era may provide reason to hope that it may be possible to manage our way out of the current mortgage crisis.

A March 6, 2009 post in the Harvard Business Review Editors’ Blog entitled "The Mortgage Bailout That Worked (here) describes a "remarkably similar catastrophe" that "happened during the real estate boom of the 1920s." In that earlier time, an investment frenzy developed over "guaranteed mortgage certificates" that were issues, in denominations as small as $100, for shares in residential mortgages and groups of mortgages. The certificates were issued by guaranty companies and backed by the state of New York.

Investor demand for the certificates soon outstripped the supply of mortgages, in turn fueling a demand for even more mortgages, whether or not the mortgages were compliant with regulatory requirements. The frenzy to supply investors with more certificates also encouraged the guaranty companies to assume borrowers’ loan fees and offer bonuses to brokers for mortgages. Ultimately, to protect their own investments, the guaranty companies swapped good mortgages out of customers’ certificates and transferred them to their own certificates. (Sound familiar?)

Eventually, the scheme collapsed and the state of New York stepped in and "amazingly, managed to clean up the bulk of the mess in just four years of hard, hard work." The state formed a Commission, which eventually had over 1,000 employees, to "take over the guaranty companies and sort out the certificates." What they did was to "preserve the value of the certificates by preserving the value of the underlying real-estate assets."

The process the Commission followed, which was designed to work out the mortgage or dispose of the property in some productive way, could be a useful model for today. The lesson for the current circumstances from the prior effort, according to the HBR post, seems to be to "hire a sufficiently large group of people to track down and preserve the value of the assets underlying all of our current toxic real-estate securities" in a similar manner. It certainly worked in the earlier era; the Commission "recouped 84% of the value of the certificates" and brought "order out of chaos."

Are Bank Failures a Necessary Recovery Prerequisite?: Some readers may have noted that this past Friday night, the FDIC took control of yet another bank, Freedom Bank of Georgia (as noted here). Prior to its closure, the bank, which was located in Commerce, Georgia, had assets of $173 million. This latest bank closure brings the year to date total of failed banks to 17, and the number of banks that have failed just since July 1, 2008 to 39. The FDIC’s complete list of banks that have failed since October 2000 can be found here.

While bank failures are one among the more disturbing parts of the current economic turmoil, they may also be a necessary part of the recovery as well. A March 7, 2009 Washington Post article entitled "Every Bank Failure is Also a Beginning" (here) states that the increase in bank closures is "a sign of the nation’s economic distress," but it is also a "first step toward revival." According to the article, "in wiping away problem loans and brining in new investors, the government is creating the necessary conditions for new lending."

The Post article explains the FDIC’s bank closure process, including its efforts to transfer the bank’s existing banking relationships to a healthier institution. The process is not without its pitfalls, but it is, according to the article, essential to ensuring that a community has banking resources available despite the closed bank’s failure.

The Post article focuses on the events surrounding the closure of the Community Bank of Loganville, Ga., which failed in November 2008 (refer here). Last Friday’s bank closure involved yet another bank from Georgia, the seventh bank in Georgia to fail since October 2007. Many of the failed banks were located in or around Alphretta, Georgia, which earlier this year the Wall Street Journal referred to (here) as "Bank-Failure Central."

Among other things, commentators cited in the Journal article ascribed the rash of bank failures in Georgia to "overabundant home building, years of risky lending and one of the most relaxed environments in the U.S. for starting new banks." The Journal article also states that the failures "reflect an unusually dense concentration of go-go optimism run amok."

Credit Agency Focus: When assigning blame for the current crisis, many commentators often cite the credit rating agencies. Indeed, Time Magazine’s list of the 25 people to blame for the current financial debacle included Kathleen Corbet, who ran S&P for most of the last decade. Whether or not the credit rating agencies are blameworthy is one question; whether they can be held liable for it is yet another, as this blog has previously noted (here).

A recent memorandum by the Jenner & Block firm entitled "Credit Rating Agencies in the Spotlight: A New Casualty of the Mortgage Meltdown" (here) admirably summarizes the legal issues that investor litigation against the credit rating agencies might present. One noteworthy observation in the memo is the possibility federal preemption of state regulatory action under the Credit Rating Agency Reform Act of 2006. In addition to discussing other defenses that may be available to the credit rating agencies, the article also helpfully cites a lists a number of cases currently pending against the firms.

A recent post in which I discussed the partial denial of the motion to dismiss in the securities lawsuit that Moody’s shareholders filed against the company, and the ruling’s possible implications for the rating agencies’ potential liability for their ratings activities, can be found here.

Liquidity Issues Affect Everything: A company’s inability to access cash when needed can raise a host of complications, including even with respect to pending securities class action lawsuit settlements. As reflected in its March 10, 2009 press release (here), due to liquidity constraints, Korean semiconductor company Pixelplus is unable to fund its agreed $1 million cash contribution to the settlement of the securities class action lawsuit that had been filed against the company.

According to the press release, the court has approved an addendum to the parties’ settlement stipulation with respect to the company’s agreed settlement contribution. The press release states that the company could not make its contribution "due to the economic turmoil in Asia arising from the global financial crisis and the world-wide recession, which continues to have a severe negative impact on the financial position and business operations of the company."

In lieu of the company’s contribution, its insurance carrier is paying about $331,000 (at current exchange rates). The company will make up the difference "if and when such funds become available."

There may be implications here for the growing wave of subprime and credit crisis-related litigation. A cause of action is not worth much if the target company can’t even fund an eventual settlement. There may be more than a few target companies that might eventually prove unable to fund their portion of any eventual settlements.

Citi of the Future: Citigroup’s shares were up today on relatively positive news. However, according to an article in today’s Wall Street Journal (here), "barely a week after the third rescue of Citigroup," U.S officials are weighing "what fresh steps they might need to take if its problems mount." The bank’s continuing problems have, among other things, fueled rampant speculation that the government eventually will be forced to nationalize Citigroup.

The prospect of a nationalized Citigroup might have been unimaginable even a short time ago, but now some at least some folks apparently have no trouble imaging what a government-owned Citibank might be like, as reflected in the following video. (Sensitive readers should be forewarned that this video makes rather promiscuous use of the F-bomb and may otherwise be offensive. On the other hand, it is also very funny.)

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Even after Merrill Lynch’s recent $550 million settlement of the subprime-related securities and ERISA lawsuits pending against the company (about which refer here), the consolidated subprime-related derivative lawsuit against the company’s directors and officers remained pending. By contrast to the massive settlements in those other lawsuits, the derivative litigation was recently dismissed, because of the company’s January 2009 acquisition by Bank of America.

In a February 17, 2009 opinion (here), Judge Jed Rakoff of the Southern District of New York granted the defendants’ motion to dismiss the derivative action. The defendants had argued that as a result of the Bank of America’s acquisition of Merrill in a stock-for-stock transaction, the plaintiffs are no longer Merrill shareholders and therefore lack standing to pursue the derivative actions as filed. Judge Rakoff granted the motion in light of the requirement under Delaware law for a derivative plaintiff to show "continuing ownership."

In his opinion, Judge Rakoff expressly noted that the dismissal "is without prejudice to plaintiffs’ filing with this Court, if and when they have standing, a renewed action, recast as a derivative action against Bank of America, or as a so-called ‘double derivative action, or otherwise, but based on the same underlying allegations as the actions here dismissed." (As reflected here, a "double derivative action" is a lawsuit in which a shareholder of a parent corporation brings an action on behalf of a wholly owned subsidiary for alleged wrongs to a subsidiary.)

The subprime-related derivative litigation involving Countrywide was also dismissed, following Bank of America’s acquisition of Countrywide, based on the requirement that derivative plaintiffs must demonstrated continuing ownership in order to have standing to assert the derivative claim, as reflected here and here.

Bank of America’s acquisition of Merrill is itself now the subject of extensive securities litigation, as discussed here.

A February 20, 2009 Law.com article discussing the dismissal in the Merrill subprime-related derivative litigation can be found here.

Second Stanford Financial Lawsuit Alleges Madoff Connection: As noted in a prior post (here), the same day as the SEC announced that it had launched a civil enforcement proceeding against R. Allen Stanford, the Stanford Financial Group and related entities and individuals, aggrieved investors also launched a securities lawsuit against many of the same entities and individuals in the Southern District of Texas.

A second lawsuit has now been commenced in the Southern District of Texas against the Stanford International Bank and related Stanford entities. Among other things, the second complaint expressly alleges a connection between the Madoff scandal and the new Stanford Financial scandal.

As reflected in the plaintiff’ lawyers February 19, 2009 press release (here), the action is brought "on behalf of purchasers of Stanford International Bank Ltd. ("SIB") certificates of deposit ("CDs") or shares in SIB’s Stanford Allocation Strategy proprietary mutual fund wrap program ("SAS") between February 19, 2004 and February 17, 2009."

According to the press release, the Complaint (which can be found here), alleges that the defendants

fraudulently peddled CDs that promised rates of return far above those available from other banks. Defendants claimed that these superior returns were possible because SIB invested its deposits rather than loaning them. To ensure that depositors could redeem their CDs, defendants assured them that SIB’s investments were liquid and diversified. In fact, nearly 80% of SIB’s investments were concentrated in just two high-risk, illiquid categories: private equity and real estate. Now that the real estate and private equity markets are in free fall, many of those who purchased SIB’s CDs have recently been informed that they cannot redeem them.

The complaint also alleges with respect to the defendants mislead investors about the SAS program. The complaint alleges that the defendants

picked a handful of mutual funds that had performed extremely well in 1999-2004 and claimed the returns of those high-performing funds as the historical returns of the SAS program. Defendants also inflated the claimed returns of the SAS program in 2006 and 2007. Investors, misled by defendants’ claims of historic returns, have fared very poorly in the SAS program.

The complaint also alleges that the defendants misled investors about SIB’s exposure to the Madoff scandal. The complaint alleges that the bank sent investors a letter

unequivocally stating that "Stanford International Bank did not have any exposure to the Madoff Fund." Just two days before this letter was sent, an SIB analyst informed all three of the individual defendants, including R. Allen Stanford ("Stanford"), that SIB had invested in Meridian, a New York-based hedge fund that used Tremont Partners as its asset manager. Tremont, in turn, had invested a portion of Meridian’s – and SIB’s – money with Madoff.

The two fraud schemes seem to have come together as if they were subatomic particles drawn by some unwritten law of physics.

The Sox First blog has an interesting post here on the parallels between the Madoff and Stanford scandal.

Yet Another Bank Closure: By contrast to the last several Friday nights in a row, the FDIC did not assume control of multiple banks following their closure by regulatory authorities. Rather than multiple banks, this Friday the FDIC announced that it had assumed control of just a single bank.

As reflected in its February 20, 2009 press release (here), the FDIC assumed control of Silver Falls Bank of Silverton, Oregon. Prior to its closure, the bank had assets of approximately $131.4 million.

The closure of the Oregon bank already brings the 2009 year to date total of bank failures to 14 (by contrast to the 25 banks that failed during all of 2008). As I have recently noted (here), the surging bank failure levels has some very troublesome implications, and the now standard Friday bank closure announcement is one more reflection of the current challenging financial circumstances.

Auction Rate Securities: Balance Sheet Valuation Concerns: With all the long-standing publicity surrounding the difficulties in the auction rate securities markets, and the extensive related litigation, you might expect that companies with balance sheet exposure to auction rate securities had long since adjusted the securities’ carrying values to reflect the current market conditions. But according to a recent study, many companies with auction rate securities exposure have yet to make any accounting adjustments.

As reported in a February 20, 2009 CFO.com article (here), a recent study of 625 corporate auction rate securities holders found that 186 of them, or nearly 30 percent, continue to report them at par value. The study’s author is quoted as saying that "there’s still an awful lot of companies out there that are not properly accounting for [the auction rate securities]."

These companies failure to recognize their balance sheet exposure to auction rate securities could represent a significant litigaton risk factor. There have already been at least one securities lawsuits against a nonfinancial company that included allegations based on the company’s alleged failure to disclose its exposure to auction rate securities (refer, for example here). Companies delaying their recognition of this exposure could be exacerbating an already serious concern. The delay potentially could represent a heightened litigation risk.

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The pace of bank failures is accelerating. This past Friday night the FDIC took control of four more banks, representing the largest number of bank closures yet on a single date and bringing the year to date total to 13 -- including ten just in the last three weeks alone.

On February 13, 2008, the FDIC announced that it had taken control of Riverside Bank of the Gulf Coast, of Cape Coral, Florida, which previously had assets of $539 million (about which refer here); Sherman County Bank of Loup City, Nebraska, which previously had assets of $129.8 million (refer here); Corn Belt Bank and Trust Co. of Pittsfield, Illinois, which had assets of $271.8 million (refer here); and Pinnacle Bank of Beverly, Oregon, which had assets of $73 million (refer here).

The geographic distribution of these banks, including the presence of three banks outside the most challenged real estate markets in California and Florida, together with the fact that these are smaller community banks, are both particularly troublesome notes.

The FDIC has now taken control of 34 banks just since July 1, 2008. (The FDIC’s failed bank list can be found here.) The accumulated effect of these regulatory actions is starting to strain the agency, as detailed in a February 14, 2009 New York Times article entitled "Failed Banks Pose Test for Regulators" (here). The article states that the agency is in the midst of a "military-style buildup as it undertakes one of the greatest fire sales of all times." The FDIC is, according to the article, "struggling to deal with a miserable stew of failed real estate projects, vacant land, boarded-up houses and loans to defunct or bankrupt businesses."

In all likelihood, the situation will only get worse for some time to come. To be sure, we are a long way from the dark days of 1989, when regulators took control of 534 lenders (including 327 savings and loans). But we could be headed in that direction.

According to a February 9, 2009 Bloomberg article (here), an RBC Capital Markets analyst has predicted that as many as 1,000 U.S. banks may fail in the next three to five years. The analyst said that most of the failures will probably occur at banks with less than $2 billion in assets as their commercial loans default.

Both the analyst’s emphasis on smaller banks and on the banks’ exposure to commercial loans are particularly disturbing observations. By and large, the worst (or at least the most public) consequences from the credit crisis have been concentrated among the largest banks and have arisen from problems involving residential real estate lending. The expansion of the meltdown’s ill effects to a wider variety of financial institutions and other types of credit could have serious implications – and not just for the threatened banking institutions, but for the economy as a whole.

In any event, the four bank closures this past Friday night is the most yet on a single day as part of the current wave of bank failures. The seven banks closed so far in February already represent the highest monthly total yet. Unfortunately it appears that many of these kinds of records will be established and broken in the weeks and months ahead.

Motley Fool, commenting (here) on the FDIC’s practice of announcing bank closures on Friday evening, observed that "evidently the U.S. head-in-sand department has decreed that all such unpleasant announcements should be made when the least people will read them." The Fool might be right; the FDIC could in fact be worried about what might happen if people were to focus too closely on the accumulating number of bank failures. It may or may not be a real concern (yet) that depositors might lose confidence in the banking system, but the FDIC might well have that possibility in mind.

Conduct Unbecoming of a Gentleman: As described in a February 13, 2009 Las Vegas Sun article (here), Station Casino bondholders have sued the company and certain of its directors and officers, as well as certain related entities, alleging that the company’s debt-reduction plan is unfair to some of the company’s bondholders.

While the claims themselves may seem commonplace, the bondholders’ complaint (here) displays a rather unusual literary flair. Among other things, in what is effectively a prologue, the complaint quotes Count Leo Tolstoy as having said: "A gentlemen is a man who will pay his gambling debts even when he knows he has been cheated." Perhaps even more flamboyantly, the complaint then goes on to state that the defendants are "not acting Gentlemanly."

Shocking bevior, indeed.

Hat tip to Courthouse News Service for the Station Casino complaint.

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As detailed in a recent post (here), one of the more worrisome trends in an economic environment full of thing to worry about is the increasing number of bank failures involving community banks. This trend continued this past Friday night when the FDIC closed three more banks, brining the 2009 bank closure tally up to six.

The three banks closed on Friday were MagnetBank of Salt Lake City, Utah, which has assets of $292.9 million (and the details about which can be found here); the Suburban Federal Savings Bank of Crofton, Maryland, with assets of $360 million (refer here); and Ocala National Bank of Ocala, Florida, with assets of $223.5 million (refer here).

A particularly troublesome note regarding the Utah bank’s closure is that the FDIC was unable to find a buyer for the bank’s assets or deposits, which the Wall Street Journal described (here) as a “rare event and an ominous sign for regulators.” According to news reports (here), this is the first time in over five years that the FDIC has been unable to find a buyer for a failed bank’s assets. In the absence of a buyer, the FDIC will issue checks to the bank’s depositors, increasing the impact on the FDIC insurance fund.

The failure of the Suburban Federal Savings Bank was the first bank failure in Maryland since 1992. As detailed in the Washington Post (here), the bank’s failure was precipitated by mounting losses in the bank’s mortgage loan portfolio.

Perhaps even more noteworthy than the fact that the total number of bank failures in 2009 is already up to six banks is the fact that the total number of bank failures in the seven month period between July 1, 2008 and January 31, 2009 is 27. (The FDIC’s complete list of failed banks for the period October 2000 through the present can be found here.) That is a huge number and all signs are that these numbers will continue to grow as 2009 progresses. The Journal article specifically observed that regulators are “bracing for dozens of more lenders to collapse in the coming months.”

Along those lines, it is worth noting that in the FDIC’s Quarterly Banking Profile for the Third Quarter of 2008 (here), which is the FDIC’s most recent quarterly profile, the number of institutions on the FDIC’s problem list increased from 117 to 171, and the assets of the “problem institutions” rose from $78.3 billion to $115.6 billion. This is the first time since 1994 that assets from problem institutions have exceeded $100 billion.

The FDIC’s next quarterly banking profile, for the quarter ending December 31, 2008, will not be released until later in February (the reports are issued 55 days after each quarter end). It will be interesting to see how significant the deterioration was in the fourth quarter.

As I detailed in my prior post, both historically and more recently, an increase in the number of failed banks has meant an increase in failed bank litigation. As the bank failures continue to mount, the threat of increased bank related litigation will also continue to grow.

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In recent days, all eyes have been on two of the world’s largest banks. Commentators have questioned, for example, whether Citigroup should be nationalized (refer here) or if the Merrill Lynch-related losses might cost Bank of America CEO Kenneth Lewis his job (refer here). These institutions’ enormous size makes their problems predominant.

But while the woes of the financial titans are undeniably deeply troublesome, I have found myself increasingly concerned about the problems involving three much smaller banks: First Centennial Bank of Redlands, California; Bank of Clark County of Vancouver, Washington; and National Bank of Commerce of Berkley, Illinois.

My concerns about these banks are not about their business prospects – it is too late for that, as these three banks have already failed. Regulators closed First Centennial after the close of business this past Friday, January 23, 2009 (about which refer here), and Bank of Clark County and the National Bank of Commerce were closed the preceding Friday, on January 16, 2009 (refer here and here).

My concerns relating to these banks have to do with the facts and circumstances surrounding their closures, as well what the closures may portend.

1. The Number and Pace of Bank Failures: The closure of three banks on two successive Fridays in just the first few weeks of the New Year shows that the pace of bank failures, which accelerated as 2008 progressed, has continued unabated as we have headed into 2009. In 2008, there were a total of 25 bank closures (complete list here), of which 21 were in the second half of the year. With three closures already this year, signs suggest the heightened level of bank closures at year’s end has carried forward into 2009.

2. Community Banks are Not Immune After All: All three of these banks fall within a standard definition of "community banks" – that is, they had assets below $1 billion. National Bank of Commerce had assets of $430.9 million; Bank of Clark County had assets of $446.5 million; and First Centennial Bank had assets of $803.3 million. The community bank sector has largely been viewed as less affected by the worst of the current credit crisis. However, these three banks’ failures, and their geographic dispersion, suggest that the problems in the community bank sector could be more widespread than previously perceived.

3. Is the Worst Yet to Come?: These three bank failures are likely only the first of many yet to come in 2009. A January 23, 2009 Wall Street Journal article entitled "Banks Die Too Fast for Regulators" (here) reports that "federal regulators are bracing for more than 20 bank failures in the first quarter of this year," which were it to happen would mean nearly as many bank failures in the first quarter as during all of 2008 (which in turn was the most active year for bank failures since 1994).

Moreover, the Journal article specifically noted that the banks "are failing with accelerating speed, exposing holes in the regulatory infrastructure designed to catch collapsing institutions."

A vexing related issue is the apparent intervention of politicians on behalf of troubled banks. A January 24, 2009 Wall Street Journal article entitled "Politicians Asked Feds to Prop Up Failing Banks" (here) describes the efforts of two Illinois politicians on behalf of the National Bank of Commerce prior to its failure. As the article notes, politicians’ efforts "recall the savings and loan turmoil of the late 1980s, when members of Congress pressured the government to go easy on struggling thrift institutions." As one commentator cited in the article stated, these kinds of things "made the saving-and-loan debacle into a political scandal as well as a financial scandal."

4. Dead Banks Mean More Dead Bank Litigation: Both historically and more recently, failing banks have meant failed bank litigation. The Cornerstone Research Report on the 2008 securities litigation activity specifically observed that "five of the 25 banks that failed in 2008 were named in federal securities class actions filed in 2008," even though "only 11 of the 25 banks that failed were publicly traded."

Indeed, already in 2009, another one of the 25 banks that failed in 2008 has been sued in a securities class action lawsuit. As noted here, on January 5, 2009, plaintiffs initiated a securities lawsuit against PFF Bancorp and certain of its directors and officers, whose banking subsidiary was closed on November 21, 2008 (about which refer here). This 2009 lawsuit suggests the likelihood of even further "dead bank" litigation ahead, especially of the heightened level of bank closures persists.

5. Will Asset Woes Afflict More Banks – And Other Kinds of Companies?: There is a specific aspect of the National Bank of Commerce failure that I find particularly troublesome. As noted in much greater detail in a January 23, 2009 American Banker article entitled "Failure Over Securities Losses Sets Off Alarm" (here, registration required), the National Bank of Commerce failed not because of liquidity issues (the usual reason for bank failures) but "because it suffered such massive losses on its investments in Fannie Mae and Freddie Mac stock that it had negative capital levels." As the article notes, the bank’s failure "heightens concern about the fate of some other banking companies that had heavy securities losses."

The American Banker article also specifically notes that similar problems indirectly led to the failure of PFF Bancorp, the banking company noted above as having been sued in 2009. PFF apparently had agreed in June 2008 to sell itself to FBOP Corp. of Oak Park, Illinois, but after FBOP wrote down at the end of the third quarter $936 million of investment securities, the $17-billion asset bank found itself undercapitalized and regulators refused to approve the pending deal. Undoubtedly other banks face similar challenges in their investment portfolios.

Concerns about banks’ troubled asset portfolios were the original basis for TARP, but the American Banker article noted that TARP money wouldn’t have been sufficient to save the National Bank of Commerce, as "the bank would have been eligible for a maximum of $12 million but needed at least $26 million to become well-capitalized again."

Financial institutions’ exposures to troubled assets could be widespread and could become significantly worse as the credit crisis continues to spread. In particular, the number of assets that are troubled continues to grow. They included not only all of the toxic mortgage-backed assets, but also securities and other assets related to Fannie Mae and Freddie Mac, and also assets related to a growing list of other institutions, including Lehman Brothers, Washington Mutual, American International Group, and the Icelandic banks.

More recent financial turmoil has made this list even longer. For example, just in the past few days, Aflac’s share price fluctuated sharply and the company’s financial strength rating was downgraded because to the company’s exposure to debt securities issued by the Royal Bank of Scotland, Barclays and other troubled European banks.

The Aflac example shows that the asset issues that capsized the National Bank of Commerce stretch far beyond the banking sector. Indeed, a January 24, 2009 Washington Post article entitled "Life Insurers Take a Hit" (here) cites Aflac and states, among other things, that "financial markets downward spiral has drawn the nation’s life insurers into its vortex, reducing the already depressed value of its stock by a third since early this month." The article specifically notes concerns that life insurance companies’ balance sheets and financial statements might not "fully reflect the reduced value of the investments they hold."

Nor are these concerns limited just to the banking and life insurance sectors. The Wall Street Journal’s January 24, 2009 Heard on the Street column (here) notes balance sheet concerns involving reinsurer Swiss Re.

The various companies’ balance sheet vulnerabilities arising from their exposure to the securities of other failed or failing financial institutions is precisely the circumstance to which I was referring when I asserted (here) that the credit crisis and its related litigation wave had reached an "inflection point" – that is, companies are getting punished in the financial marketplace (and also getting sued) not necessarily because of their own direct credit crisis-related problems but rather because of their exposure through their investment portfolios to other companies’ credit crisis woes.

Whether or not a revitalized TARP program would be sufficient to remediate these problems for troubled banks is a question our political leaders must decide. But in the interim, the widespread balance sheet exposure to trouble assets will continue to burden a wide variety of companies, including but not limited to banks.

Moreover as the list of companies whose related assets are toxic continues to grow (now including Royal Bank of Scotland with others yet to come), the number of companies struggling with toxic balance sheet assets will also grow. One inevitable consequence undoubtedly will be further litigation, both in the banking sector and elsewhere as well.

A Case of Earlier Indigestion: Concerns surround the most recent financial institution mergers, such as the Bank of America’s acquisitions of Merrill Lynch and Countrywide; Wells Fargo’s acquisition of Wachovia; and PNC Banking Corporation’s merger with National City Corporation.

But a recently filed lawsuit is concerned not with these recent deals, but rather a transaction froman earlier era – Wachovia’s ill-fated $25 billion acquisition of Golden West, which at the time was the nation’s second largest savings and loan.

The new lawsuit was filed in California (Alameda County) Superior Court on January 21, 2009. The complaint, which can be found here, alleges that as a result of the Golden West acquisition, Wachovia acquired a $120 billion portfolio of Option ARM (or "Pick-A-Pay" loans as they were called) which the complaint alleges were not properly underwritten, inadequately capitalized, and became delinquent at very high rates. Within two years of the Golden West transaction, the complaint alleges, Wachovia "ultimately collapsed under the delinquencies and defaults on the Pick-A-Pay loans."

The complaint alleges that Wachovia, certain of its directors and officers, and its offering underwriters failed to disclose these risks to investors who purchased Wachovia’s shares in various securities offerings between 2006 and 2008. The compliant alleges that when the concerns were "ultimately revealed" the company was "forced into a fire sale by the FDIC that finally revealed to investors what had been misrepresented for months, if not years, as a result of its toxic subprime assets, Wachovia was a shell of a corporation that could not exist independently."

The plaintiffs’ lawyers have chosen to file their lawsuit in state court in express reliance on the concurrent jurisdiction provisions of Section 22 of the ’33 Act. I have previously discussed the plaintiffs’ lawyers’ possible forum selection (shopping?) motivations for filing federal securities lawsuits in federal court, here. As I also discussed in a recent post (here), the federal courts are split on whether SLUSA or CAFA preempted the concurrent jurisdiction provisions in the ’33 Act, although the law is most favorable to a finding of state court jurisdiction in the Ninth Circuit.

In any event, I have added the new securities suit to my list of subprime and credit crisis-related cases, which can be accessed here. With the addition of this case, there have now been a total of 147 subprime and credit crisis-related securities cases filed during the period 2007 through 2009, of which seven have been filed already in 2009. A spreadsheet of the 2009 cases can be accessed here.

A Word to the Wise: Those of you who may be planning on attending the 2009 PLUS D&O Symposium, to be held February 25 and 26 at the Marriott Marquis in New York, will want to know that the early registration discount is about to expire. The registration fee for those registering prior to January 30, 2009 is $845 for PLUS members and $1,045 for nonmembers. For after January 30, the fee will rise to $975 for members, and $1,175 for nonmembers. Registration and agenda 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.

And Finally: On January 28, 2009, the Securities Docket will be sponsoring the latest in its series of free webinars on securities related topics. The upcoming webinar is entitled "FCPA Enforcement: The Paradigm Shift" and will feature F. Joseph Warin of the Gibson Dunn law firm. Further information can be found here.

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From this week’s news, it almost appears as if there had been some kind of an unannounced competition for most outrageously fraudulent or corrupt scheme. First, there was Marc Dreier’s incredibly brazen plot to peddle bogus notes to hedge funds using assumed identities. Then there was Illinois Governor Rod Blagojevich’s apparent attempt to flog Barrack Obama’s vacant Senate seat for personal enrichment. And finally there was New York financier Bernard Madoff’s massive Ponzi scheme, which may have taken investors for as much as $50 billion.  

The scale of the corruption and deception involved in these schemes is almost incomprehensible. It could be said of the three perpetrators of each of these scandals, as Time Magazine said (here) of Blagojevich, he is “either delusional, stupid or some combination of both.” But as astonishing as these developments may all be, they really don’t represent anything new.

Buried underneath the week’s headlines were the latest developments in an older but equally unsavory tale, which may serve as a reminder that there is, regrettably, nothing new about massive schemes of deception and corruption.

According to a December 12, 2008 Bloomberg article entitled “Siemens Agrees to Pay Fine to Settle Bribery Charges” (here), Siemens AG has agreed to plead guilty to Foreign Corrupt Practices Act violations and pay $800 million to settle U.S. charges that it paid $1.36 billion in bribes to government officials in at least a dozen countries.

The FCPA Blog (here) has an extensive review of the charges against Siemens, as well as links to the supporting documents, including the criminal information filed against Siemens and the DoJ’s sentencing memorandum. As the FCPA Blog puts it, the criminal charging documents detail “years of systematic and intentional violations of the internal controls and books and records provisions. It's a story of fraud, deceit and concealment -- filled with phony contracts, fake invoices, slush funds, and a boardroom feigning ignorance. “

A hearing on the deal under which Siemens would pay a $450 million fine and forfeit $350 million in profits will take place on December 15. If accepted, the penalty would be by far the largest FCPA penalty ever, far eclipsing the prior record payment of $44 million in the Baker Hughes case (about which refer here).

The Siemens case is a reminder that, as startling as this past week’s revelations have been, there is nothing new about fraudulent schemes or deceptive behavior. In the timeless words of the Book of Ecclesiastes (here), “What has been will be again, what has been done will be done again; there is nothing new under the sun.”

Next Up: The Litigation: One inevitable byproduct of the developments like those of the past week is litigation, and so it comes as no surprise that a lawsuit against Bernard Madoff and his firm has already emerged.

On December 12, 2008, an investor initiated a purported securities class action lawsuit in the Eastern District of New York against Madoff and his firm (BMIS), on behalf of “all persons and entities who purchased securities sold by or through” Madoff and his firm, “from the early formation of BMIS in the 1960s until December 12, 2008.” Refer here for news coverage of the lawsuit.

The complaint (reproduced below) alleges that its claims arise “from one of the most damaging Ponzi schemes in the history of Wall Street and the United States,” and that the defendants “swindled investors out of monies estimated to exceed $50 billion.” The complaint alleges breaches of the federal securities laws, civil RICO violations, and related state and common law violations.

Meanwhile, other plaintiffs’ firms have announced (for example, here) that they are investigating the alleged “massive fraud.” UPDATE: Please refer here to access my regularly updated list of all Madoff investor litigation, including in particular "feeder fund" lawsuits.

The filing of this lawsuit may not be surprising, and there may be further litigation yet to come. As detailed in the lead story in the December 13, 2008 Wall Street Journal (here), the victims of Madoff’s scheme include a host of institutional investors, hedge funds, and funds of funds. It may well be that these entities’ investors, eager to recoup losses as well as to assign blame, will also file lawsuits in a daisy-chain of litigation based on the Madoff firm’s collapse.

Hat tip to the Dealbook blog (here) for the text of the Madoff class action complaint, which can be viewed here:

Class Action Lawsuit Against Madoff

Another Friday Night Special: December 12, 2008 was a Friday, and that can only mean one thing – after the close of business, the FDIC announced another round of bank closures.

First, the FDIC announced (here) that state banking regulators had closed, and the FDIC had been appointed receiver of, Haven Trust Bank of Duluth, Georgia. Next, the FDIC announced (here) that state regulators had closed, and the FDIC had been appointed receiver of, Sanderson State Bank of Sanderson, Texas.

These two closures represent, respectively, the twenty-fourth and twenty-fifth bank failures so far this year. The FDIC’s complete list of failed banks during the period October 2000 to the present can be found here. Haven Trust is the fifth Georgia bank to close this year, which represents the highest total for any one state. The Sanderson bank’s closure is the second in Texas this year.

As I have noted before (here), the pace of bank closures has accelerated as the year has progressed. Of the 25 bank closures in 2008, 21 have taken place since July 1, eight of them just since November 1. The trend certainly suggests that there will be further bank closures in the weeks and months to come. And, pertinent to the preceding discussion, there likely will also be further bank-related litigation (refer here).

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