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

In recent months, I have documented on this blog the rising tide of failed banks as well as the ensuing failed bank related litigation. An August 16, 2010 report by Paul Hinton of NERA Economic Consulting entitled "Failed Bank Litigation" (here) takes a comprehensive view of the economics and causes of recent bank failures, compares the recent bank failure wave to the S&L crisis, and analyses the implications for litigation against the directors and offices of the failed institutions. The report contains a wide variety of different kind of information that readers will find interesting and useful.

Bank Failures to Date

The report begins with an analysis of the causes of the bank failures to date. The report notes that the earliest failures in the current wave derived from "losses in residential real estate and their structured finance businesses," but more recently the bank failures have been "characterized by smaller institutions that are more specialized in financing local businesses, commercial mortgages and real-estate development."

The report specifically notes that banks that went on to fail were held worse performing loans in each loan category than banks overall. These banks were also "less well prepared to deal with expected losses," since their allowance for loan losses at the beginning of the credit crisis were "not correspondingly higher," but instead were "lower than for all other banks."

Possible Future Bank Failures

Looking ahead, though the economy has improved and banks overall are showing signs of recover, the number of problem banks continues to rise and loan performance has yet to turn around. Many community banks may be burdened as a result of their issuance of trust preferred securities, the holders of which have priority rights in the event of bank failure, which could deter prospective investors. A wider concern for community banks is "the risk posed by continuing financial distress in commercial real estate markets," an issue I explored at length in a prior report here.

The report notes that one group of banks particularly at risk are "community banks with high [construction and development, or C&D] loan concentrations and the smallest allowances for loan losses compared to their level of non-performing loans." Another high-risk group of institutions are banks that are "under-provisioned and that have relatively high levels of non-performing loans."

Comparison to the S&L Crisis

Though the number of failed banks so far in the current wave is lower than the number that failed during the S&L crisis, "the losses incurred in 2009 are larger than all but one year of losses during the S&L crisis (expressed in 2010 dollars)," because the average size of banking institutions and savings institutions has increased since the time of the S&L Crisis. The average per failed bank loss in the current crisis ($303 million) is more than three times larger in 2010 dollars than for banks in the S&L crisis and were attributable to banks that were about two and a half times as big.

The factors contributing to bank failures in the current failed bank wave appear similar to the factors the FDIC identified as having caused bank failures during the S&L crisis. That is, economic conditions were "secondary to poor management and other internal problems."

Many readers will find the reports analyses of the banking regulators’ S&L crisis-related litigation track record particularly interesting. Among other things, the report documents (in Figure 14) that the FDIC pursued D&O claims with respect to about one-quarter of failed institutions. The report also shows (in Figure 15) that the FDIC’s peak recoveries lagged peak bank failures by about three years, which may be suggestive of the likely recovery track for the current bank failures.

Of particular interest is the detail (in Figure 16) regarding the FDIC’s professional liability claims recoveries during the period 1990-1995 (when most, but not all, of the FDIC’s S&L Crisis-related recoveries took place.). The chart shows that overall, excluding recoveries related to Drexel Burnham and excluding further criminal restitutions, the FDIC recovered $3.2 billion, $1.3 billion of which was from D&O claims, $1.15 billion of which was from accounting claims, and $500 million of which was from attorney malpractice claims. Another $300 million was from fidelity bond claims.

Failed Bank Litigation

The report details the FDIC’s special litigation authority under FIREEA (about which refer here), while noting that the FDIC’s special standing may not entirely preclude the claims of private litigants. Though the FDIC has to date filed only one action against former directors and officers of failed banks, all signs are that the FDIC is readying itself to bring more claims, as the report details.

Among other things, the report notes that many of the failed and troubled banks in the current wave are publicly traded, by comparison to the S&L crisis, when almost none of the failed institutions are publicly traded. As a result, there is much more investor related litigation this time around than there was during the prior crisis.

The report notes that of the roughly 240 credit crisis-related securities class action lawsuits, there were 45 against depository institutions (after excluding auction-rate securities cases). Eleven were filed against failed banks. Of the 20 banks that failed prior to 2010 and that produced the largest losses. 13 were publicly traded, of which eight have been sued in securities class action lawsuits as of the end of 2009.

The report notes that the private litigants will compete with the FDIC for D&O insurance, and while the FDIC is generally first in line to recover assets, private litigants may be able to recover against insurance assets even when the FDIC is not (for example, where the D&O policy has a regulatory exclusion that would preclude coverage for the FDIC’s claim but not for the investors’ claims).

Though there is already extensive litigation and more seems likely to come, all claimants, including even the FDIC, will face a basic causation problem; as the report concludes, "distinguishing the effects of underwriting practices from the effects of a deteriorating economy will be one of the important elements of this litigation." These cases "will require careful case-by-case economic analysis."

Conclusion

Overall, this report is useful and informative. Readers will undoubtedly find the report’s distillation of important background information and analysis in a single source to be particularly helpful.

Many D&O insurance professionals in particular will find this report to be helpful, particularly those involved with either the placement of D&O insurance for banking institutions or those involved in claims arising under those policies. Underwriters and brokers will find the report’s analysis of the causes of bank failures and the likely causes of future failures informative. Those involved in claims and claims administration will find the aggregate date from the S&L crisis claims particularly useful.

Special thanks to the report’s author, Paul Hinton, for providing me with a copy of the report. I would also like to thank Paul for his numerous citations to this blog in his report.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Though we are in the midst of the dog days of summer (at least in the northern hemisphere), the federal courts, at least, have been busy. In the last several days alone, several courts have issued dismissal motion rulings in lawsuits arising out of the subprime meltdown and the credit crisis.

As noted below, several of these decisions involve failed or troubled banks, and therefore may be of particular interest in relation to the many banks have failed in recent months or that are continuing to struggle now. Though investor plaintiffs in other cases involving failed or troubled banks have sometimes struggled to survive the initial pleading stages, in the cases discussed below, the plaintiffs managed to survive the dismissal motions, at least in part.

PFF Bancorp: In an August 9, 2010 opinion (here), Central District of California Judge Andrew Guilford denied the defendants’ motions to dismiss in the securities class action lawsuit against two former directors and officers of PFF Bancorp, the corporate parent for PFF Bank & Trust, which failed on November 21, 2008.

As reflected here, in January 2009, shareholders of the holding company filed a securities lawsuit alleging that the company’s President and CEO and its CFO contending that they concealed the Bank’s unsafe lending practices and made misleading statements about the bank’s loan loss reserves and capital levels.

In his August 9 order, Judge Guilford found that while the plaintiffs’ allegations that defendants made misleading statements about the banks’ "cautious" and "conservative" lending practices were insufficient to state a claim, the plaintiffs’ allegations that defendants had falsely characterized the bank’s loan loss reserves as "adequate" were sufficient to state a claim.

Judge Guilford also found that plaintiffs had adequately alleged scienter, finding that plaintiffs’ allegations "permit the inference that Defendants knew PFF’s loan practices were risky and that PFF had inadequate loan loss reserves, yet told investors that the loan loss reserves were adequate."

Interestingly, Judge Guilford found plaintiffs’ scienter allegations to be adequate despite the defendants’ contention that they had actually purchased PFF shares at the supposedly inflated prices. Judge Guilford declined, at the motion to dismiss state, to take judicial notice of the SEC forms on which defendants sought to rely in order to establish their share purchases.

Popular, Inc. (Securities Claim): In an August 2, 2010 order (here), District of Puerto Rico Judge Gustavo Gelpí granted in part and denied in part the defendants motion to dismiss the securities class action lawsuit that had been filed against Popular, Inc., certain of its directors and officers, its auditor and its offering underwriters.

The plaintiffs’ complaint focused on the company’s accounting for a deferred tax asset. In the three years preceding the beginning of the class period (which went from January 24, 2009 to February 2009), the company had recorded tax loss carry forwards that totaled over $1 billion, largely as a result of the company’s U.S. subprime and other lending operations. The benefit of these deferred tax assets could only be realized if the company experienced sufficient U.S.-based gains within 20 years.

To offset the possibility the company might not fully realize the value of the deferred tax assets, accounting rules required reporting companies to take a valuation allowance, but the company recorded no material valuation allowance of this asset until late 2008. The company ultimately recorded an allowance for the full value of the asset. Following the announcement of this action, the company’s share price fell substantially.

The plaintiffs allege that the increasing, multiyear U.S.-based operating losses prevented it from anticipating sufficient taxable income to realize the full value of the deferred tax asset prior to the expiration of the 20-year period, yet failed to take a valuation reserve because doing so would have lowered the bank’s risk-based capital ratio below regulatory requirements. The financial picture the company’s treatment of the asset portrayed allowed the company to raise over $300 million in a May 2008 offering.

The Court found that the plaintiffs allegations adequately alleged material misrepresentations, given that "Popular’s three-year cumulative loss position, combined with the Company’s significant downsizing of its U.S. mainland operations and the worsening market conditions, constituted strong evidence that at the beginning of the class period it was more likely than not that the Company would not be able to realize the benefit of its [deferred tax asset] in full."

The Court also concluded that the complaint adequately alleged scienter, concluding that the defendants’ decision "not to take an earlier valuation allowance was ‘highly unreasonable’ and an ‘extreme departure from the standards of ordinary care’ to the extend that the danger was either know to the defendants or so obvious that they must have been aware of it."

The Court also concluded that the ’33 Act allegations against the officer defendants were also sufficient. However, because the Court found that the amended complaint in which the plaintiffs added as defendants the outside directors, the company’s auditor and its offering underwriters had been filed more than a year after there were sufficient "storm warnings" to put the plaintiffs on inquiry notice, the ’33 Act claims against those defendants were untimely and were therefore dismissed.

Popular, Inc. (Derivative Suit): In an August 11, 2010 opinion (here), applying Puerto Rico law, in the shareholders’ derivative lawsuit filed against Popular, Inc, as nominal defendant, certain of its directors and officers, and its outside auditor, Judge Jay Garcia-Gregory denied in part and granted in part the defendants’ motions to dismiss. The allegations in the derivative suit largely mirror those alleged in the securities class action lawsuit.

The officer and director defendants had moved to dismiss on the ground that the plaintiff had not presented a demand to the company’s board to pursue the lawsuit. The plaintiff argued that demand was futile, and the Court agreed. The Court found that the plaintiffs’ allegations and of the requirements of SFAS 109 "provide ‘reason to doubt’ the legality of declining to record a valuation allowance until 2009" and therefore "demand is excused" because the presumption that the board took a valid business judgment had been rebutted by the alleged lack of "legal fidelity."

The Court did, however, dismiss the plaintiff’s gross mismanagement claim as duplicative of the breach of fiduciary duty claim. The Court also found that the plaintiff had not adequately alleged corporate waste. Finally, the Court found that the plaintiff’s claim against the company’s auditor should also be dismissed, on the grounds that the plaintiff had not made a demand on the company’s board to pursue the claim and had not established demand futility.

Discussion

Plaintiffs have had some difficult surviving initial dismissal motions in many of the securities class action lawsuits that have been filed against the directors and officers of banks that have failed during the current failed bank wave. For example, the securities class action lawsuit arising out the failure of Downey Financial Corp. (whose operating bank failed the same day as PFF Bank & Trust) was dismissed with prejudice.

Similarly, the motion to dismiss in the Fremont General case was also ultimately dismissed with prejudice. Similarly, the motion to dismiss was granted in the BankUnited securities case, albeit without prejudice.

More recently, however, the motion to dismiss was denied in the securities class action lawsuit arising out of the failure of Corus Bankshares. With the above decisions, it seems as if the plaintiffs in these cases have managed to overcome the initial pleading hurdle at least in several cases now.

To be sure, the reasoning the Popular case is based on circumstances that may be unique to that case. The allegations in the PFF Bancorp case, however, arguably are more typical. But while the PFF Bancorp case survived the dismissal motions, it remains to be seen whether the case will survive additional proceedings in the case, if defendants are able to establish that the purchased company shares at the allegedly inflated prices.

Ultimately, the fundamental question about the failed banks is whether the FDIC will lower the litigation boom on directors and officers of the failed banks. So far, the FDIC’s litigation activity has been limited to a single lawsuit it filed against officers of a subsidiary of IndyMac (about which refer here). Whether and to what extent the FDIC will pursue other claims will be revealed in the weeks and months ahead.

In any event, I have added these decisions to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.

Very special thanks to the loyal readers who provided me with copies of these decisions.

Another Banking Institution Dismissal Motion Ruling: Though the financial institution involved has neither failed nor is seriously troubled, it should be noted here at least briefly that in an August 10, 2010 order (here), Southern District of Ohio Judge Sandra Beckwith denied in part and granted in part the defendants’ motion to dismiss in the securities class action lawsuit that had been filed against Fifth Third Bancorp and certain of its directors by former shareholders of First Charter, which Fifth Third acquired in a deal announced in August 2007.

As discussed here, the former First Charter shareholders alleged that in connection with the merger, Fifth Third and certain of its directors and officers had materially misrepresented Fifth Third’s exposure to poorly performing residential real estate markets, and had not fully represented how seriously its mortgage portfolio was deteriorating.

Judge Beckwith’s detailed and painstaking August 10 opinion denied the motion to dismiss as to the claims of certain classes of First Charter shareholders, but granted the motion to dismiss as to all other claims and claimants.

Another Credit-Crisis Related Securities Suit Dismissal Motion Ruling: In an August 13, 2010 order (here), District of Maryland Judge Catherine Blake denied in part and granted in part defendants’ motions to dismiss the securities class action lawsuit that had been filed against Constellation Energy.

As discussed here, Constellation Energy was one of the many nonfinancial companies that suffered credit crisis related financial reverses in late 2008 and early 2009 and attracted securities litigation arising out the companies’ financial woes.

In September 2008, Constellation shareholders and subordinated debenture holders filed a securities class action lawsuit against the company, certain of its directors and officers and offering underwriters. Their complaint asserts claims under Section 11, 12(a)(2) and 15 of the ’33 Act and under Section 10(b) of the ’34 Act.

Essentially, the plaintiffs alleged that the defendants had misrepresented the additional collateral the company would have to post in connection with its merchant energy business in the event of a company credit downgrade. (As the company itself later disclosed, the collateral requirements for a one-notch credit downgrade were less than had been disclosed; the collateral requirements for a two or three notch downgrade were significantly greater than disclosed.)

The plaintiffs also alleged that the defendants had not sufficiently disclosed the company’s exposure to Lehman Brothers. The plaintiffs also alleged that the defendants’ misrepresented the company’s future earnings, business outlook, risk management and internal controls.

In fall 2008, after the company suffered a several notch ratings downgrade and after Lehman collapsed, the company’s share price fell and investors’ sued. The company ultimately sold a substantial portion of its assets.

In her August 13 order, Judge Blake found that the plaintiffs’ ’33 Act allegations regarding the company’s downgrade collateral obligations were sufficient to state a claim. Interestingly, Judge Blake reached her conclusion even though the company’s debenture prices dropped only slightly immediately after the disclosure of the company’s revised collateral obligation and in fact rose thereafter for several weeks. These facts "ultimately may counsel against materiality" but are "not dispositive at this stage of the litigation.

Judge Blake found that the plaintiffs’ remaining ’33 Act allegations were insufficient to state a claim.

As for plaintiffs ’34 Act allegations, Judge Blake found that the plaintiffs had not adequately alleged scienter in connection with the downgrade collateral obligations. She noted that "without additional factual allegations that the defendants were somehow aware that the downgrade collateral requirements were miscalculated …neither Constellation nor its officers can be presumed to have known of a faulty computer calculation."

Judge Blake also found that the plaintiffs’ remaining ’34 Act allegations were inadequate.

I have also added the Fifth Third and Constellation Energy rulings to my running tally of credit crisis lawsuit dismissal motion rulings, which again can be accessed here.

Special thanks to a loyal reader for providing a copy of the Constellation Energy decision.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Though 268 banks have failed since January 1, 2008, there has been relatively little litigation related to the failed banks, as least so far. For example, the FDIC only recently filed its first action against former directors and officers of a failed bank (as discussed here). There have also been relatively few suits brought by private investors as well, though that could change. The failed bank lawsuits do continue accumulate, however, including an investor lawsuit recently filed in state court in Georgia that both has some interesting features and that may present some interesting potential D&O insurance coverage issues.

The case in question was initiated on July 22, 2010 in Fulton County (Georgia) State Court by three investors in Georgian Bankcorporation. The company operated Georgian Bank in Atlanta, which was taken over by regulators on September 25, 2009. The defendants are two of the company’s former directors and officers, one of whom was the company’s Chairman and CEO for several years, and the other of whom was the successor Chairman and CEO. A copy of the complaint can be found here.

All three of the plaintiffs were investors in the bank holding company. Two of the three plaintiffs served as company directors until 2003. All of the parties are residents of Georgia.

The complaint seeks damages for negligent misrepresentation. The plaintiffs allege that the defendants negligently misrepresented the negative effects of the economic slowdown was having on the bank; negligently failed to timely and fully report to plaintiffs various adverse regulatory actions taken against the bank and related regulatory findings; and negligently failed to inform plaintiffs that a key depositor was withdrawing its more than $200 million in deposits.

The complaint is emphatic that it is asserting claims only for negligent misrepresentation. Paragraph 11 of the complaint states that the plaintiffs "exclude and disclaim" any allegations under the federal and state securities laws; common law fraud; intentional, reckless or knowing misconduct; breach of fiduciary duty or mismanagement. In addition, in paragraph 12 the complaint emphasizes that the claims of it asserts are direct, on behalf of plaintiffs, and not derivative, on behalf of the company.

There are a number of interesting things about this complaint, beyond just the fact that it represents an example of a recent bank failure that resulted in a D&O lawsuit.

First, the complaint’s insistence that the plaintiffs are "disclaiming" a number of kinds of allegations suggests the narrow line the plaintiffs are trying to walk. Their disavowal of all securities law claims seemingly is calculated to try to avoid the initial pleading hurdles and defenses to which securities claims are vulnerable, as well as to avoid any possible federal question jurisdiction that might facilitate the case’s removal to federal court.

The other claims plaintiffs disavow, particularly the fraud and intentional misconduct allegations, may reflect a desire to avoid the conduct exclusions typically found in D&O insurance policies.

The plaintiffs’ insistence that they are asserting only direct not derivative claims is clearly an effort to fend off the FDIC, which might otherwise (and who knows, may yet) intervene to assert its rights as receiver under FIRREA to control litigation asserted in the right of the failed bank itself. (For more about the FDIC’s rights under FIRREA, refer here). The plaintiffs’ wariness about the FDIC’s interest in the lawsuit is apparently well founded, because, as I discussed in a prior post, the FDIC has sent letters to former officials at the failed bank detailed potential claims the FDIC may assert against them.

The complaint also raises a number of potential D&O insurance coverage issues.

The first has to do with the fact that two of the plaintiffs are former directors of the company. The typical D&O insurance policy has an "insured vs. insured" exclusion precluding coverage for claims brought by one insured against another insured. The two former directors would be insureds under most D&O policies, and so all else equal, their claim would involve an insured vs. insured claim. The exclusion potentially might preclude coverage for this claim.

However, the typical insured vs. insured exclusion also usually has multiple exceptions that carve back coverage for certain kinds of claims (derivative action, for example). In recent years, among the coverage carve backs found in many D&O policies is a carve back for claims brought by former directors and officers more than four year (sometimes three years) after they left their position. This new lawsuit presents an interesting example of a case where the inclusion of this coverage carve back could be crucial to preserving coverage.

A second interesting thing about this case from an insurance standpoint relates to the plaintiffs’ insistence that they are asserting only claims for negligent misrepresentation. The reason this is interesting is though the plaintiffs are asserting harm to their investment interests, they are not asserting claims base on the securities laws. Rather they are quite deliberately asserting claims solely under the common law.

The reason this is interesting is in connection with the definition of the term "securities claim" found in the typical public company D&O insurance policy. Many policy forms do not include within the definition claims asserted under common law, and so carriers are often requested to amend the definition of the term to include common law claims. Some carriers resist this change, arguing either that the change is unnecessary or that claimants will not assert claims on that basis.

The deliberately narrowed way the plaintiffs have framed their claims in this case both illustrates why the inclusion of common law claims in the definition of "securities claims" is appropriate and provides and example of a case in which the change could be critical.

The deliberately narrow way the plaintiffs framed their complaint also underscores the challenges claimants may face in trying to assert claims against former directors and officers of failed banks. Between worries that the FDIC will sweep in and try to take over the claim and concerns that D&O insurance coverage issues could eliminate possible insurance recoveries, prospective claimants face some formidable obstacles. Indeed these considerations may be among the reasons why there has been relatively little D&O litigation (so far) as a result of the current round of bank failures.

A July 27, 2010 Atlanta Journal Constitution article about the lawsuit can be found here.

Special thanks to Henry Turner, counsel for plaintiffs in the case, for providing a copy of the complaint.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On July 2, 2010, in what is as far as I am aware the first suit by the FDIC against former directors and officers of a failed bank as part of the current wave of bank failures, the FDIC as receiver of IndyMac filed a lawsuit in the Central District of California against four former officers of IndyMac’s Homebuilder Division (HBD). 

Very special thanks to Peter Christensen of the Appraiser Law blog for providing links to the complaint.

The FDIC took control of IndyMac on July 11, 2008. At the time, the outstanding balance on HBD’s portfolio of homebuilder loans was nearly $900 million. The FDIC alleges in its complaint that IndyMac’s losses "are estimated to exceed $500 million."

The lawsuit is filed against Scott Van Dellen, HBD’s former President and CEO, who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved at least 40 of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved at least 57 of the loans at issue; ;and William Rothman, who served as HBD’s Chief Lending Officer from mid-2006 and who is alleged to have approved at least 34 of the loans at issue.

The lawsuit seeks to recover damages from the four individual defendants for "negligence and breach of fiduciary duties." The lawsuit alleges "two significant departures from safe and sound banking practices."

First, the complaint alleges that HBD’s management "repeatedly disregarded HBD’s credit policies and approved loans to borrowers who were not creditworthy and/or for projects that provided insufficient collateral." The complaint further alleges that HBD’s compensation plans encouraged HBD’s management to "push for growth in loan production volume with little regard for credit quality."

Second, HBD’s management is alleged to have "continued to follow a strategy for growth at the tail-end of the longest appreciating real estate market in over four decades," despite management’s alleged "awareness that a significant downturn in the market was imminent and despite warnings from IndyMac’s upper management about the likelihood of a market decline." HBD’s management allegedly "unwisely continued operations in homebuilder lending in deteriorating markets even after becoming aware of the market decline.

The FDIC’s complaint, which sprawls to some 309 pages, details a litany of allegedly negligent lending practices, including approving loans where repayment sources were not likely to be sufficient; where the loans violated applicable laws and the Bank’s own internal policies; where the loans were made to borrowers who "were or should have been known to be not creditworthy and/or in financial distress; based on inadequate or inaccurate financial information; without taking proper and reasonable steps to insure that the loan proceeds would be used in accordance with the loan application.

The complaint is very detailed and reflects painstaking preparation. A lot of time and effort went into the preparation of this complaint, which may in and of itself explain why the FDIC has not up until this point filed other complaints against directors and officers of failed banks. If the FDIC is taking similar measures in connection with other claims that it might be considering, it is little wonder that there have been no claims up until this point. Complaints containing this level of specificity and painstaking detail will take a significant amount of time to prepare.

There are some particular reason why IndyMac attracted one of the first claims. First, the FDIC took control of IndyMac relatively early in the current round of bank failures – it has been almost exactly two years since IndyMac closed, meaning the FDIC has had a greater amount of time to review the circumstances that led up to IndyMac’s failure and consider potential claims. When the FDIC took control of IndyMac, it was only the fifth bank failure that year, meaning that IndyMac was among the earliest of the current bank failures.

But perhaps even more important that its timing was the sheer size of IndyMac’s failure. At the time of its closure, IndyMac had assets of about $32 billion, making its closure the second largest bank failure during the current wave of bank failures (exceeded only by the closure of Washington Mutual, which had assets of $307 billion).

More to the point, IndyMac’s failure triggered losses to the FDIC’s insurance fund of $8 billion, by far the largest amount of any bank failure during the current round. The magnitude of these losses suggests possible motivations for the FDIC to give priority to claims relating to IndyMac.

While the recently filed IndyMac claim may be the first claim the FDIC has filed against former directors and officers of a failed bank as part of the current bank failure wave, it is surely not the last. (Indeed, it may not even be the last filed against former IndyMac officials.) Statistics reported by the Alston & Bird firm suggest that during the last wave of bank failures in the S&L crisis, the FDIC filed claims in connection with about 24% of all bank failures.

The fact that the FDIC appears poised to pursue many additional claims against bank officials represents a threat both to the individuals themselves and to the bank’s D&O liability insurers. The extent to which the FDIC’s efforts result in significant recoveries will depend on a wide variety of factors, the most important of which is the extent to which the FDIC can successfully allege individual liability. But beyond that, the FDIC’s ability to actually recover money will depend on identifying and accessing funding sources.

The extent to which the FDIC will succeed in recovering substantial amounts of D&O insurance will depend on a host of factors, including in particular the terms and conditions of the applicable policies. Claims made and notice of claims issues will be highly relevant, as will potential policy exclusions, such as, for example, the regulatory exclusion, which insurers added to many policies in recent years. These insurance coverage questions suggest the likelihood that in addition to a round of claims against former officials of failed banks, we are also likely to see a parallel round of insurance coverage litigation.

In addition to the FDIC’s recent action, there has also been extensive litigation involving IndyMac’s shareholders, as detailed here. Most recently, on March 29, 2010, Central District of California Judge George Wu certified an interlocutory appeal to the Ninth Circuit of his denial of the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint.

Bank Failure Wave Continues: Meanwhile, while the FDIC cranks up its litigation efforts, it is continuing to take control of additional banking institutions. This past Friday evening, July 9, 2010, the FDIC took control of four additional banks, bringing the 2010 total number of failed banks to 90.

Through June 30, 2010, the FDIC had closed 86 banks, which put the FDIC on pace to close 172 banks this year, compared to 140 in 2009 and only 25 in 2008. Indeed, by way of comparison, as of June 30, 2009, the FDIC had closed only 40 banks, as the pace of bank failures quickened substantially in the second half of 2009 and continued into 2010.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The FDIC in its status as receiver of a failed bank may not avoid rescission of a fidelity bond procured by material misrepresentation, notwithstanding the FDIC’s statutory receiver rights, according to a June 7, 2010 Second Circuit decision. This decision represents an important interpretation of the FDIC’s statutory rights as receiver, and could prove to be an important precedent in future insurance-related litigation arising out to the current round of failed banks. The Second Circuit’s June 7 opinion can be found here.

Background

In 1999, Connecticut Bank of Commerce (CBC) entered an agreement to acquire MTB Bank. The transaction closed March 30, 2000. Prior to the deal’s closing, two things happened of relevance to the subsequent insurance dispute.

First, MTB discovered that its agents had advanced $950,000 based on fraudulent invoices in connection a business deal involving Harmony Designs. MTB noticed its fidelity bond carrier regarding the Harmony Designs matter, although MTB ultimately reduced its loss below the amount of the deductible.

Second, in March 2000, before the CBC deal closed, MTB’s president and other officers were indicted in an alleged conspiracy involving the imposition of Argentinean minerals. MTB also noticed its fidelity bond insurer regarding the indictments.

After the CBC deal closed, CBC was added to MTB’s fidelity bond. As the bond’s June 30, 2000 expiration approached, CBC sought to renew it. The insurer declined to renew unless CBC came to London to provide additional information in connection with the renewal. The insurer also refused to extend the bond period 30 days.

CBC declined to visit London as the fidelity bond insurer had requested. Instead, CBC obtained replacement fidelity bond coverage from a different insurer. In order to secure this replacement coverage, CBC completed and submitted a policy application that required CBC, among other things, to disclose losses sustained during the preceding three years; whether there were additional circumstances relevant to the application; and whether insurance had been declined or canceled during the past three years. Post-binding, CBC completed the replacement insurer’s separate application form, which also asked questions related to past losses and whether CBC had had insurance declined or canceled.

CBC answered "None" or "No" to these application questions. CBC did not disclose or identify the Harmony Designs loss, the indictments, or the predecessor insurer’s actions in connection with the fidelity bond insurance renewal application.

CBC went into receivership in June 2002. In 2006, the FDIC as receiver sued CBC’s fidelity bond insurer alleging breach of contract for dishonoring claims under the bond for CBC’s losses related to a loan scheme used to fund MTB’s acquisition.

The district court granted the fidelity bond insurer’s motion for summary judgment on the ground that it properly rescinded the bond based on CBC’s application misrepresentations and omissions. The FDIC appealed.

The June 7, 2010 Opinion

In a June 7, 2010 opinion by Southern District of New York Judge John Keenan (sitting by designation on the Second Circuit), the Second Circuit affirmed the district court’s entry of summary judgment on behalf of the fidelity bond insurer.

In seeking to overturn the district court’s opinion, the FDIC had sought to rely on its rights under 12 U.S.C. Section 1823(e), which protects the FDIC from defenses not apparent on the face of an asset it acquires as a receiver of a failed bank. The FDIC argued that this provision bars the fidelity bond insurer’s misrepresentation defense.

The Second Circuit held (contrary to a prior holding in the Sixth Circuit) that a fidelity bond is in fact an "asset" to which this provision applies. However, the Second Circuit rejected the FDIC’s argument that this provision bars the fidelity bond insurer’s policy defenses.

The Second Circuit said that the provision is intended to "bar ‘secret’ defenses which would diminish the FDIC’s interests in a failed bank’s assets," but that "defenses raised by the bond itself may prevent recovery by the FDIC."

The Second Circuit found that "as the grounds for rescission were plainly stated on the face of the bond, there is nothing secret about [the fidelity bond insurer’s] misrepresentation defense." To recognize the FDIC’s position, the Second Circuit said, would be to "strike the rescission clause from the bond."

In the final portion of its opinion, the Second Circuit went on to hold that each of the three alleged misrepresentations separately provided sufficient ground to support rescission. The Second Circuit found that the omission of the information about the Harmony Designs loss, about the indictments, and about the prior insurer’s refusal to renew or extend each separately representing sufficient grounds for rescission.

The Second Circuit’s holdings about the sufficiency of the fidelity bond insurer’s basis for rescission are quite broad. Among other things, the Second Circuit said that "information about previous losses is presumptively material," and "the determination of risk is one properly left to the insurer, not the insured, and the insurer cannot make an accurate risk assessment without full disclosure from the applicant."

Discussion

It seems probable that in connection with the current wave of bank failures that the FDIC as receiver to the failed banks will attempt to recover under the failed banks’ insurance policies. The Second Circuit’s holding in the CBC case underscores the fact that notwithstanding the FDIC’s receivership status, and the statutory rights that status may entail, the FDIC’s ability to enforce the failed bank’s insurance coverage is subject to the defenses the insurer may have that appear in the relevant policies.

To that extent, at least, the Second Circuit’s opinion could be relevant to may arise in the wake of the FDIC’s attempt as receiver to recover under the failed banks’ insurance policies.

The CBC opinion is relevant for another reason that arguably is completely independent of the FDIC’s involvement in this dispute. That is, the opinion starkly demonstrates the critical importance of the policy application process and the extent of the insurer’s rights, under certain circumstances, to seek rescission. The Second Circuit’s view of the applicant’s obligation to provide responsive information is broad and encompassing.

The Second Circuit’s rescission holding seems to reflect a perception that CBC knew that if it disclosed the prior losses it would be unable to secure replacement fidelity bond coverage. To that extent, the rescission holding may reflect the somewhat distinct circumstances of the case. However, the Second Circuit’s rhetoric is broad and is not delimited to the referenced circumstances. The breadth of the ruling rescission ruling could well prove helpful to insurers in other rescission cases, even those lacking the distinctive characteristics of this case.

Financial Reform Impact on the Insurance Industry: In a prior post (here), I noted that the Senate’s version of the financial reform bill includes a number of specific reforms that particularly impact the insurance industry.

In a June 7, 2010 memo entitled "The Impact on the Insurance Industry of the Financial Regulatory Reform Bills: A Legislative Update" (here), the Simpson Thacher law firm examines and compares the various insurance industry reforms proposed in the House and Senate versions of the reform legislation.

The memo details the numerous insurance industry measures that are substantially similar in the two bills, suggesting that the provisions are likely to survive the current conference process. Among other things, the provisions intended to streamline the regulation of reinsurance and nonadmitted insurance are "substantially identical in both bills, and are therefore likely be enacted into law, as are a number of other measures.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In prior posts (most recently here), I have noted the growing numbers of lawsuits brought against the former directors and officers of failed or troubled banks. If the complaint recently filed in New York state court is any indication, the "dead bank" lawsuits apparently will also include claims against the directors and offices of failed banks from outside the U.S., too. As it turns out, the fallout from the Icelandic banking explosion includes claims filed in New York against former directors and officers of one of the largest Icelandic bank failures.

On May 11, 2010, the U.S. representative of the resolution committee of Glitnir Bank filed an action in New York (New York County) Supreme Court seeking to recover $2 billion in damages from Glintir’s controlling shareholder and his wife; two former directors and the former CEO of Glitnir; several of the controlling shareholder’s business associates, and the bank’s auditor, the Icelandic affiliate of PricewaterhouseCoopers. A copy of the complaint can be found here.

Though based in tiny Iceland (total population substantially smaller than that of Cleveland), Glitnir, which ultimately was one of Iceland’s three largest banks, grew to have over 1,900 employees in ten countries, with a market capitalization of over $7 billion and total assets of over $40 billion.

In October 2008, in the midst of the global financial crisis, Iceland’s Financial Services Authority took control of Glitner. Glitner ultimately filed a petition for bankruptcy in the U.S. under Chapter 15 of the Bankruptcy Code. According to the May 11 complaint, creditors have filed claims exceeding $26 billion.

Michael Lewis’s outstanding April 2009 Vanity Fair article, "Wall Street on the Tundra" (here) chronicles the astonishing and even inexplicable rise and spectacular collapse of the Icelandic banking bubble. ("Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’ In the end, Icelanders amassed debts amounting to 850 percent of their GDP.")

The May 11 complaint alleges that Jon Asgeir Johannesson (typographical markings omitted) and his wife, Ingibjorg Stefania Palmadottir (typographical markings omitted), and businesses they owned or controlled, used improper means to "wrest control" of Glitnir and to "fraudulently drain over $2 billion out of the Bank to fill their pockets and prop up their own failing companies."

According to the complaint, beginning in 2006, Johannesson "engaged in a scheme" using his "web of companies" to take control of Glitnir in violation of Icelandic law. By April 2007, Johannesson and his companies owned about 39% of Glitnir’s stock. As a result, Johanneson was able to "stack" Glitnir’s board "with individuals who had connections with companies he controlled," and he also "had his inexperienced hand-selected candidate" replace the existing CEO.

Having taken control of the Bank, its board and its management, Johannesson and the other individual defendants "used their control over the Bank and funds raised in U.S. financial markets to issue massive ‘loans’ to, and a series of equity transactions with, companies Johannesson controlled, in an effort to stave off their eventual collapse," which "placed the Bank in extreme financial peril."

The complaint specifically alleges that the defendants "concealed the truth about their risk they had created for Glitnir when they turned to the United States markets to raise funds." The complaint specifically references a September 2007 transaction in which Glitnir issued $1 billion in medium term notes (MTN), alleging that the offering documents "understated Glitnir’s exposure to related and connected parties by $800 million."

The complaint also alleges that the individual defendants "could not have succeeded in their conspiracy to loot Glitnir without the complicity of Glitnir’s outside auditors at PricewaterhouseCoopers." (Jim Peterson has a particularly interesting commentary on the Glitnir bank claims against PwC on his Re:Balance blog, here.)

The complaint asserts nine separate claims against the individual defendants alleging violation of Icelandic statutory laws governing corporations. The complaint also asserts common law claims against the individual defendants for tort, conversion, and unjust enrichment. In addition, the complaint asserts negligence and breach of contract claims against PwC. The complaint seeks damages of $2 billion against the individual defendants and $1 billion against PwC.

The complaint’s allegations are fascinating, in the way that it is interesting to find out what events and actions preceded a train wreck or plane crash. In many critical ways, the events (allegedly) preceding Glitnir’s collapse precisely recapitulate the sequence Micheal Lewis described in summarizing what happened in Iceland; Lewis wrote in his Vanity Fair article that "a handful of guys in Iceland, who had no experience in finance, were taking out billions of dollars in short-term loans from abroad. They were then re-lending this money to themselves and their friends to buy assets – the banks, soccer teams, etc."

Though this lawsuit has its own peculiar Icelandic flavor, the lawsuit resembles in many ways any lawsuit that might be filed in the wake of a U.S. bank’s collapse. The specific U.S. variety of lawsuit this case most resembles is a claim brought by a bankruptcy trustee, as opposed to an investor lawsuit or a lawsuit brought by regulators.

But the resemblance to a variety of U.S. lawsuit notwithstanding, the obvious question about this case is: what the heck is it doing in state court in New York? We’ve got an Icelandic bank, Icelandic defendants, and even claims under Icelandic statutory law. The plaintiffs knew you were going to ask that question. The complaint helpfully points out that Johannesson and his wife reside in New York; that many of the acts in furtherance of the conspiracy took place in New York (including the September 2007 MTN financing); many of the transaction documents had New York choice of law provisions; and the bank and its key officials "had substantial interaction with New York."

The plaintiffs do their earnest best to justify their resort to a New York court for this case. They even try to exploit New York’s vain self-regard, asserting that the case belongs in New York because it is "the financial center of the world," and it not only has "a general interest in maintaining and fostering its undisputed status as the preeminent commercial and financial nerve center" but it also has "a keen interest in making sure its financial markets are not abused to facilitate massive illegal activity."

The plaintiffs do not mention, but we can assume, that they prefer New York over Iceland because U.S. courts offer a host of advantages over the courts of just about any other jurisdiction, including jury trials, pre-trial discovery, and contingent attorneys’ fees.

For all of the reasons the plaintiffs acknowledge, and perhaps even more so for the reasons the plaintiffs don’t explicitly mention, litigants from around the world may seek to access U.S. courts for redress of grievances in the wake of bank failures. I have long felt that the current wave of U.S. bank failures is going to produce a wave of lawsuits. The Glitnir case suggests that the litigation wave may well encompass claims relating to failed banks from around the world, not just failed U.S. banks.

One question I wondered while reading this complaint is whether or not Glitnir carried D&O insurance. The reckless way business was conducted in Iceland (at least as portrayed in Lewis’s Vanity Fair article) suggests the Icelandic financiers might not have slowed down long enough to consider any type of risk mitigation, much less anything as conventional as insurance. And even if Glitnir had insurance, it has likely long since lapsed, and so unless this new complaint relates back to some timely filed claim or notice, insurance might not be available anyway.

But whether or not there is D&O insurance available, this complaint, for all of its peculiar Icelandic features (including typographical symbols I am unable to reproduce here), in many ways represents the classic type of D&O claim that can follow a bank’s collapse, at least to extent it names two former directors and the former CEO as defendants. I had not anticipated that claims involving Icelandic banks would corroborate my position, but I will say that this case is at least consistent with my long-standing projection for litigation arising from the growing number of failed banks.

There are of course many more conventional cases also corroborating my position, including the investor lawsuit filed on May 7, 2010 involving First Regional Bancorp (about which refer here) and the lawsuit filed on May 12, 2010 involving BancorpSouth (refer here) – both of which involving U.S.-based banks.

The bottom line is that it is no longer quite accurate for me to continue to say that failed bank litigation is coming – it is here.

A Literary Interlude: The reference above to Michael Lewis’s Vanity Fair article reminded me that a copy of his latest book, The Big Short, is languishing unread on my bookshelf. Rather than reading yet another account of our dysfunctional financial system, I have been distracted by Maurice Lever’s excellent biography of Pierre-Augustin Caron de Beaumarchais.

Beaumarchais is now remembered mostly for having written The Barber of Seville and The Marriage of Figaro, though ironically he wrote those works essentially as a diversion from his many other hyperkinetic activities. Beaumarchais was a watchmaker’s son who managed to leverage music lessons provided to the French King’s daughters into court contacts and business opportunities from which he achieved wealth, notoriety and a life so full it almost can’t be summarized.

Variously an entrepreneur, inventor, author, royal agent, diplomat, spy, labor organizer, publisher and printer, arms merchant, and revolutionary, and throughout it all a tireless and effective self-promoter and compulsive litigant, Beaumarchais was at the center of many of the critical events in the events leading up to the French Revolution.

The vast sweep of Beaumarchais’s life encompasses enough to have filled several lifetimes. If we now remember him most for his plays, we should at least recognize how provocative and even seditious his plays were at the time. One excerpt from Figaro is particularly illustrative in that regard, and worth reproducing here. Though Figaro speaks the words, it is not too hard to imagine these same sentiments come from the mouth of one as talented and ambitious as Beaumarchais, chaffing against the unfairness of a system of aristocracy that delimited the upward range of his achievement:

Just because you’re a great nobleman, you think you’re a great genius! Being an aristocrat, having money, a position in society, holding public office – all that makes a man so arrogant! What have you ever done for all this wealth? You took the trouble to be born and nothing else! Apart from that you’re rather an ordinary man. And me, God damn it, a nobody, one of the crowd, and I’ve had to use more skill and ingenuity simply to stay alive than they’ve expended in a hundred years governing the whole of Spain! And you dare challenge me!

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

It remains to be seen whether the FDIC will pursue civil actions against former directors and officers of failed banks, but it has made it clear that it will file criminal actions in cases where it suspects fraud. According to news reports, on May 7, 2010, the U.S. Attorney of the Northern District of Georgia unsealed indictments against two former officers of the failed Integrity Bank as well as against a real estate developer whom the officials said obtained $80 million in improper loans from the bank.

Douglas Ballard, the bank’s former Executive Vice President in charge of client relationships and a member of the bank’s board of directors, and Joseph Todd Foster, the bank’s former Executive Vice President for Risk Management, are charged with conspiracy, insider trading and bank fraud. The developer, Guy Mitchell, is charged with conspiracy and bribery.

The indictment alleges that Mitchell and companies he controlled obtained more than $80 million in business loans from Integrity Bank. He allegedly obtained the loans under false pretenses and deposited nearly $20 million in a checking account used for personal expenses, included over $1.5 million spent on a private island in the Bahamas. Later loans were used to pay interest on earlier loans.

The indictment also alleges that Mitchell paid Ballard, who authorized the loans, over $290,000 over a nine month period (half in cash and half in a cashier’s check) as a reward for Ballard’s assistance.

Ballard and Foster are also alleged to have committed securities fraud by engaging in insider trading. They are alleged to have sold all of their shares based on inside information (specifically, with knowledge of the bank’s problems with Mitchell’s loans).

Many of the news reports about the indictment have highlighted the fact that Integrity Bank had been founded with a faith-based theme. According to the Atlanta Journal Constitution (here), bank employees regularly prayed before meetings and in bank lobbies with customers.

The FDIC took control of the bank in August 2008. The Atlanta Journal Constitution article quotes the U.S. Attorney for the Northern District of Georgia as saying that the alleged fraud "was substantial contributing factor to the collapse," adding that "more than $80 million was given away from a dirty insider who was taking payoffs from the developer. That’s more that the average bank has had to deal with."

The Wall Street Journal (here) also quotes the U.S. Attorney as saying that "We are continuing to investigate and potentially other officials could be charged."

Statements by agency officials suggest that this prosecution may not be an isolated event. The indictment reportedly was the result of an interagency collaboration that included the FDIC’s Office of Inspector General. News reports quote the FDIC’s Inspector General as saying that "we are particularly concerned when senior bank officials, who are in positions of trust within their institutions, are alleged to be involved in unlawful activity. Prosecutions of individuals and entities involved in criminal misconduct maintain the safety and soundness of the Nation’s financial institutions."

The FDIC had already demonstrated substantial interest in claims involving Integrity Bank. As I discussed in a prior post (here), the FDIC intervened in the derivative lawsuit that had been brought by the bankruptcy trustee of the bank’s holding company against four former directors and officers of the holding company and the bank. The court granted the FDIC’s motion to intervene and also granted the FDIC’s motion to have the trustee’s claims dismissed, holding that under FIRREA the agency had the exclusive right to pursue claims on behalf of the bank. Basically, the FDIC made it clear that if anybody is going to pursue claims against the former officers, it is going to be the FDIC.

I had interpreted the FDIC’s moves in the bankruptcy trustee’s lawsuit as evidence that the FDIC intended to pursue its own claims against the former officials of Integrity Bank. But I was expecting civil claims; I certainly did not forsee this criminal prosecution. The FDIC may yet pursue civil claims as well. But it is nevertheless interesting that the FDIC is going ahead with criminal prosecutions but not yet pursuing its own civil actions, either in connection with Integrity or really any other failed banks.

Special thanks to the several readers who sent me links to news articles about the Integrity indictment.

Meanwhile the Investor Lawsuits Continue to Emerge: While we all wait to see that whether the FDIC will unleash a flood of failed bank claims as it did during the S&L crisis, the failed banks’ aggrieved investors are continuing to file their own claims against the directors and officers of the failed institutions.

The latest of these investor lawsuits is the securities class action lawsuit filed on May 7, 2010 in the Central District of California against certain former directors and officers of First Regional Bancorp, the holding company for First Regional Bank, a Los Angeles based bank that regulators closed on January 29, 2010. According the plaintiffs’ attorneys’ May 7 press release (here), the defendants "caused the Company to disseminate financial statements that were not fairly presented in conformity with Generally Accepted Accounting Principles and were materially false and misleading, and failed to make complete and timely disclosures concerning certain actions taken by regulators."

The First Regional lawsuit follows several other recent securities lawsuits that have involved failed banks. For example, on April 15, 2010, investors filed a securities lawsuit in the Western District of Washington against Frontier Financial Corp., the holding company of Frontier Bank, and certain of its directors and officers. Regulators closed Frontier Bank on April 30, 2010.

There have also been a number of securities lawsuits filed against other troubled banks, including Sterling Financial, Smithtown Bancorp and Haven Trust Bancorp.

In addition to securities class action lawsuits, investors are pursuing a variety of other kinds of claims against former directors and officers of failed banks, as illustrated, for example, by the recent action for negligent misrepresentation filed against the former officials of the failed Alpha Bank and Trust, about which refer here.

At this point, it seems well-established that failed bank investors intend to pursue these kinds of claims, although whether they will succeed and produce value for the claimants remains to be seen. My recent post discussing plaintiffs’ dismissal motion record in these kinds of cases can be found here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

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.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Last year’s wave of bank failures had clearly carried over into the New Year. On Friday, January 22, 2010, the FDIC closed five more banks, already bringing the year to date number of bank closures to nine. (At this same point last year, the FDIC had only closed three banks, before eventually closing 140 banks for the entire calendar years.).

The nine banks that have failed so far this year are a surprisingly diverse bunch. The closures are distributed across eight different states. While three of the failed banks were tiny, with assets of under $70 million, three of then nine were pretty good sized, with assets of over $1 billion. Perhaps the most noteworthy discernable trait of the group is that three of them were located in the Pacific Northwest, two in Washington, one in Oregon. Bank failures are not unknown to that part of the country – including, of course, the Washington Mutual closure, the largest bank failure of all time.

But though the bank failures have continued to flood in, litigation involving the directors and officers of the failed institutions has – at least so far— been relatively light. Nevertheless, I continue to believe that it will only be a matter of time before the FDIC begins to file significant numbers of lawsuits. My expectation in this regard is largely driven by the fact that during the S&L crisis in the 80s and early 90s litigation was such an important component of the FDIC’s efforts to recoup its losses. The FDIC has filed a number of notices of claims with some bank officials and their D&O carriers, but so far it has not filed lawsuits in significant numbers.

While we all wait to see what the FDIC will do, investors in some failed banks are moving ahead with their own claims. For example, as reported in the January 15, 2010 Greeley (Colo.) Tribune (here), almost 60 investors filed a lawsuit on December 15, 2009 in Weld County (Colo.) District Court former directors and officers of New Frontier Bank. The bank, which was located in Greely, Colorado, was taken over by regulators in April 2009. Prior to its closing, the bank had assets of over $2 billion.

The circumstances surrounding New Frontier’s demise were the subject of a June 16, 2009 Wall Street Journal article entitled "Town’s Friendly Bank Left Nasty Mess" (here). Among other things, the article reports that the bank’s failure "is expected to set off a cascade of bankruptcies and foreclosures across several counties" and that companies that relied on the bank for financing "are cutting staff and curtailing payments to suppliers."

At least as depicted in the Journal article, New Frontier’s failure represents something of a modern day morality tale reflecting the excesses that can cause a banking crisis. New Frontier was particularly dependent on so-called "hot money" – that is, brokered deposits on behalf of investors seeking higher rates of return on their deposits. The flood of hot money facilitated the bank’s business lending, "leading to meteoric growth and favorable press." But, according to comments by the bank’s competitors quoted in the article, the bank "had looser credit requirements that virtually any other bank in town." The other banks reportedly used New Frontier as a safety valve, by urging their own customers that had fallen behind on their payments to refinance their loans at New Frontier.

One factor that proved particularly dangerous for the bank was its heavy concentration in agricultural loans, particularly for local dairies. A number of the borrowers fell behind or defaulted after prices for milk and other products fell. Many of the defaulting borrowers themselves now face ruin. The Journal’s photo essay about the bank’s failure, here, reflects the community and many of the individuals hit by the bank’s closure.

A flood of public accusations have followed in the wake of the bank’s failure. For example, the December 30, 2009 Denver Post had an article (here), reporting supposedly improper practices at the bank and also that the bank’s practices are the subject of a Department of Justice investigation.

According to the Greely Tribune article, the investors allege in their lawsuit that senior bank officials engaged in a host of improprieties including reckless lending activities without regard to loan quality, insider deals that improperly benefited board members and many instances of conflicts of interest among board members. Among other things, the complaint alleges that insiders received huge loans on preferred terms, and that the bank’s headquarter building was built by the construction company owned by one board member and that rather than owing the building outright, the bank leased it from a company owned by other board members, on terms that were heavily favorable to the leasing company.

The New Frontier circumstances may be unusual because of the nature of the concerns. But the level of scrutiny the bank is now facing in the wake of its closure is not uncommon. In many instances, the questions will eventually take the form of accusations presented in the form of a lawsuit. Before all is said and done, there will be many more lawsuits like that filed by the New Frontier investors. And that does not even take into account the lawsuits we are likely to see from the FDIC. I continue to believe that the arrival of failed bank lawsuits will be one of the top litigation stories of 2010.

None of this has been lost on the D&O insurance carriers. D&O insurance for many commercial banks has become a much more expensive proposition, and for some banks an outright challenge. As reflected in a January 15, 2010 article in the Atlanta Business Chronicle (here, registration required), banks’ D&O insurance costs have begun to "skyrocket across the board" and terms and conditions have narrowed substantially. The insurance marketplace is particularly difficult for banks operating under regulatory orders. In light of the continued wave of bank failures and the anticipated arrival of claims, the insurance marketplace conditions seem unlikely to improve anytime soon.

Special thanks to the several loyal readers who sent me many of the various items to which I linked in this post. I am always grateful when readers send me material, it helps me and it helps other readers as well.

Reflections on the Citizens United Case: The Internet is awash with instant analysis from the commentariat about the U.S. Supreme Court’s 5-4 decision in the Citizens United case. I will leave it to the pundits to sound off about the case’s outcome. For myself, I was struck by the heated rhetoric of the majority opinion and the vehemence of the dissent. (Justice Stevens took the extraordinary step of reading his dissent from the bench, in a special session apparently scheduled for the purpose of allowing him to do so.)

The narrowness of the margin of decision is nothing new, since 5-4 opinions have been an unfortunate staple of the divided court for the last several years. But the tone of the language used in the opinions in the Citizens United case suggest that the Court’s proceedings have taken on a deeply personal character, with emotional overtones that have become all too public. It does kind of make you wonder what the heck is going on up there.

I have to admit that I am a sucker for the genre of popular literature in which the Court’s inner workings are "revealed." I devour books like Jeffrey Toobin’s The Nine: Inside the Secret World of the Supreme Courtand Supreme Conflict: The Inside Story of the Struggle for Control of the United States Supreme Court by Jan Crawford Greenburg. Among other things, these books underscore the fact that one of any President’s most enduring legacies is the identity of the justices he has named to the Court. The books also make clear that the shifting currents in Presidential politics in recent years have dramatically shaped the current Court’s composition. (For those interested in a casual but entertaining read about the Court, I particularly commend Toobin’s book.)

Because the Court is called on to decide some of our country’s most difficult and divisive issues, it is hardly surprising that the Court sometimes expresses itself in multiple voices. But even when issues are of paramount importance, a divided court is not inevitable.

I recently stumbled across the excellent biography of Earl Warren by journalist Jim Newton, entitled Justice for All: Earl Warren and the Nation He Made. Newton’s entertaining and readable book convincingly argues that Warren was one of the most important Americans of the 20^th Century. Warren’s career prior to ascending to the Court is itself fascinating, and his three terms as California’s governor transformed the state (although I couldn’t help but thinking that the Warren’s terms as governor may also have planted the seeds of many of California’s current financial woes.) Warren could easily have become President in 1948 or even 1952 (he was the Republican vice presidential candidate in 1948), if the Republicans could have overcome their East Coast bias.

Warren’s tenure on the court of course continues to be highly controversial, and there are many who will always carry virtual "Impeach Earl Warren" billboards around in the foremost part of their conscious brain. In many quarters, the Warren Court is a byword for reckless judicial activism. But it is almost impossible to imagine what our country would have been like were it not for the civil rights decisions of the Warren Court.

At the time Eisenhower nominated Warren to the bench, the Court had already heard oral argument on the Brown vs. Board of Education case, involving the racial segregation of Topeka’s public schools. However, under Warren’s predecessor, Fred Vinson, the justices had been unable to reach even a majority opinion on any of the issues presented and the case was put over to the following term for reargument. In the interim, Vinson died from a heart attack, and Warren came onto the bench.

After Warren joined the Court, the case was reargued. Newton shows how under Warren’s leadership and as a result of Warren’s formidable political skills, the Court was able to reach agreement on a single, unanimous opinion, reversing Plessy v. Ferguson and holding that "separate but equal is inherently unequal."

No one ever accused Warren of being the most intellectual justice. But his leadership skills and his ability to unite powerful personalities with strongly divergent views proved to be indispensible. Warren’s incomparable abilities allowed the Court to speak with a united, single voice. The moral authority this unanimity gave the Court finally allowed the country to move purposefully to try to start removing the shameful legacies of legalized racial segregation.

It all too easy to forget now, but it was only ten short years from the Supreme Court’s opinion in Brown v. Board of Education to Congress’s enactment of the Civil Rights Act of 1964. Can you imagine what this country would have been like if the Court had not spoken forcefully and with a unified voice during the civil rights era? I grew up in Virginia in the 60’s and I can still remember the "Coloreds Only" counter at the soda fountain inside the local drug store. How long would absolutely appalling conditions like that have continued if the Court had dithered?

The Warren Court was of course not always unanimous and many of its legacies remain highly controversial. But at its finest, the Warren Court showed how powerful the Court can be when it is strong and united.

For some time and for many reasons, the Supreme Court has been much more prone to speaking with multiple, deeply disparate voices. 5-4 opinions that overturn recent cases (which include opinions both by the Court’s liberal wing and its conservative wing) risk undermining the authority with which the court speaks, because voting majorities can shift so easily. If such slight variations are sufficient for the Court to cast aside even its most recent decisions, then its work becomes of little more enduring value than yesterday’s newspapers. The Court’s haphazard demolition of its own precedents not only begets inconsistency and unpredictability but it risks breeding a disrespect of the authority of the law.

It may be that the Court’s divisions are simply are reflection of divisions within our country, and of the way those divisions have driven the outcomes of Presidential elections in recent years. But I wonder if part of the problem might not be the kind of person that all recent Presidents have preferred for the Court. Because of certain explicit and implicit litmus tests, recent Presidents have overwhelmingly preferred to nominate to the court only judges with long judicial track records, on the theory that the judicial record provides some reassurance of the nominee’s ideology.

I wonder if the Court might shed some of its venomous division if there were more justices nominated whose qualifying experience was not limited to service in the judiciary. After all, the circuit courts are more than just a farm team for the highest bench, and the Supreme Court would benefit from the judgment of men and women whose world views reflected more than what can be gleaned on the inside of an appellate courtroom. I wonder whether a President would have the courage to nominate persons of intelligence and integrity whose experience includes more than just prior judicial service and who would bring with them more than mere ideological reliability.

In any event, it is worth remembering that the Supreme Court is not inevitably divided. Perhaps the most important legacy of the Warren Court is the reminder that at a critical moment in the country’s history, the Court was united. For those of us of moderate views who recoil instinctively from ideological extremism, the Court’s inability to command greater moral authority by speaking with a more consistent, more unified voice, and in particular its willingness to exploit a fragile majority to run roughshod over its own recent decisions, is deeply distressing.　

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

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.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Though the year-to-date tally of failed banks is, as of Friday night, now up to 133, the much-anticipated wave of FDIC litigation against the directors and officers of the failed institutions has been slower to emerge. As I recently noted, however, the signs are that the FDIC is now starting to assert itself. Along those lines, a demand letter from the FDIC to the former directors and officers of BankUnited FSB, filed in the bankruptcy proceedings of BankUnited’s corporate parent company, shows that the FDIC is prepared to assert claims and demonstrates what those claims will look like.

On May 21, 2009, in a rare Thursday night action, the FDIC took over BankUnited, about which refer here. At the time of its closure, BankUnited has assets of over $12 billion, but as a result of the loss share arrangement the FDIC reached with the investors that purchased BankUnited’s assets, the FDIC estimated that the bank’s failure would cost the FDIC $4.9 billion.

On May 22, 2009, BankUnited’s parent company, BankUnited Financial Corporation, and related entities filed a petition for bankruptcy in the bankruptcy court for the Southern District of Florida.

According to court filings in the bankruptcy proceedings, BankUnited carried $50 million in directors’ and officers’ liability insurance, arranged in four layers. The program’s extended reporting period had a November 10, 2009 expiration date.

On November 24, 2009, the FDIC filed a motion with the bankruptcy court regarding the FDIC’s rights to assert claims against the BankUnited’s former directors and officers. A copy of the motion can be found here. In essence, the FDIC’s motion sought to establish the FDIC’s right to assert its claims in priority over the claims against the bank’s former directors and offices that committee on unsecured creditors and others sought to assert.

As part of its motion, the FDIC attached a copy of a November 5, 2009 letter that the FDIC, as BankUnited’s receiver, had sent to fifteen former directors and officers of the bank, in which the FDIC presented its "demand for civil damages arising out of losses suffered as a result of wrongful acts and omissions committed by the named Directors and Officers." The letter explains that the demand for civil damages is "based on the breach of duty, failure to supervise, negligence, and/or gross negligence of the named Directors and Officers."

Though the letter is nominally addressed to the fifteen individuals, copies of the letters also were sent directly to the bank’s primary and first level excess D&O insurers. The FDIC’s motion papers explain, in footnote 4, that the FDIC sent the letter to the bank’s primary and first level excess D&O insurers, but not to the second and third level excess D&O insurers, because the second and third level excess insurer’s policies "contain a regulatory exclusion."

In its November 5 letter, the FDIC states that its demand is based on damages "arising out of losses suffered due to wrongful acts committed in connection with the origination and administration of unsafe and unsound residential real estate loans." The letter cites in particular the individuals’ alleged wrongful acts in connection with "pursuing an overly aggressive grown strategy focused primarily on the controversial Payment Option ARM product (the ‘Option ARM’)." The letter asserts that by the end of 2007, Option ARM mortgages represented 70% of the bank’s residential loan portfolio and 60% of its total loan portfolio, and by 2008 represented 575% of the bank’s capital.

The letter asserts that individuals failed "to implement adequate credit administration and risk management controls failed to heed warnings and/or recommendations of bank supervisory authorities and bank consultants." The letter also states that the "inherent risk" of Option ARM loans was "coupled with deficiencies in the Bank’s underwriting, appraisal process and credit administration."

As the FDIC summarized in its November 24, 2009 motion, the letter asserts that the bank’s directors and officers:

(i) adopted an overly aggressive and reckless growth strategy by investing most of the Bank's assets in "Option ARM" lending products;

(ii) failed to provide the Bank with adequate reserves for potential loan losses resulting from its investments in Option ARM lending products;

(iii) engaged in reckless, high-risk, and limited scrutiny lending;

(iv) failed to oversee the Bank's affairs, including the failure to monitor the rising volume of loan delinquencies and to establish lending policies that would adequately protect the Bank; and

(v) failed to provide adequate personnel and administrative capacity to appropriately monitor loan appraisals and to carry out diligent underwriting reviews.

Among the FDIC’s more colorful allegations, the letter accuses the directors and offices of "encouraging an extremely liberal and aggressive lending mentality to 'make the loan as long as the borrower has a pulse.'" The letter also accuses the individuals of "engaging in reckless, high-risk, and limited-scrutiny lending to fuel the bank's aggressive and rapid growth — in direct contradiction to public representations of the bank's conservative lending and strict underwriting policies."

In addition, the letter accuses the individuals of "approving and putting in place a compensation structure that drove the bank's directors and officers to pursue recklessly risky lending and business practices."

The letter asserts that these "breaches of their fiduciary duties" caused the bank to suffer loan losses between January 1, 2006 and May 21, 2009 of over $227 million. In addition to these losses, the FDIC recognized a $4 billion loss to pay off liabilities the Bank used to fund its lending activities. The FDIC’s letter concludes with the note that its investigation is continuing and that it will supplement its demand as appropriate as its investigation progresses.

The FDIC’s demand letter demonstrates not only its willingness and intent to assert claims against the former officials of failed lending institutions, but also show that it is highly aware of the D&O insurance requirements relating to those claims. The timing of the FDIC’s November 5 demand letter (sent just prior to the insurance program’s expiration), coupled with the fact that no demand was sent to the excess carriers whose policies contain regulatory exclusions, shows that the FDIC claims approach is keyed to the failed financial institutions’ D&O insurance program.

So the signs are that the claims against the directors and officers of failed banks are coming, and that one of the principal purposes of the exercise is to try extract recoveries from the banks’ D&O insurance policies. Seems just like old times…

A December 11, 2009 Palm Beach Post article about the FDIC’s demand letter can be found here. Special thanks to a loyal reader for providing a copy of the Palm Beach Post article.

More Troubled Bank Litigation: In yet another sign that litigation involving troubled banks could be an increasingly important part of D&O claims activity in the weeks and months ahead, on December 11, 2009, plaintiffs filed a purported securities class action lawsuit in the Eastern District of Washington against Sterling Financial Corporation and two of its officers.

As reflected in the plaintiffs’ lawyers’ December 11 press release, the complaint, which can be found here, alleges that the defendants failed "to disclose the extent of seriously delinquent commercial real estate loans and construction and land loans" and that the defendants "failed to adequately and timely record losses for its impaired loans, causing its financial results and its Tier 1 capital ratio to be materially false."

According to the press release, the complaint further alleges that:

(a) defendants’ assets contained hundreds of millions of dollars worth of impaired and risky securities, many of which were backed by real estate that was rapidly dropping in value and for which Sterling had failed to record adequate loan loss reserves; (b) defendants failed to properly account for Sterling’s commercial real estate loans and construction and land development loans, failing to reflect impairment in the loans; (c) Sterling had not adequately reserved for loan losses such that its financial statements were presented in violation of Generally Accepted Accounting Principles ("GAAP"); (d) Sterling had not adequately accounted for its goodwill or its deferred tax assets such that its financial statements were presented in violation of GAAP; (e) Sterling had not adequately reserved for loan losses such that its Tier 1 capital was presented in violation of banking regulations; and (f) the Company’s capital base was not adequate enough to withstand the significant deterioration in the real estate markets and, as a result, Sterling would be forced to consent to a cease and desist order from the Federal Deposit Insurance Corporation directing it to raise $300 million in capital.

What makes the FDIC’s demand letter to the BankUnited officials and the shareholders’ complaint against Sterling Financial noteworthy is not that the banking activities to which the allegations relate are unique; to the contrary, it seems particularly important to note that during the period of the these banks’ alleged misconduct, many other banks were involved in the same or similar banking activities. This fact together with the growing number of failed banks and the significant additional numbers of troubled banks suggests that in the weeks and months ahead there could be many more demands and lawsuits along the lines of the ones described above.

I don’t think I am going out on a limb to say that litigation involving failed and troubled banks could be one of the most important litigation trends in 2010.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

With 124 failed banks so far in 2009, and more likely to come in the weeks and months ahead, one recurring question has been whether the FDIC will be as aggressive in pursuing claims against directors and officers of failed lenders as it was during the S&L crisis. While we are awaiting the arrival of the seemingly inevitable regulator lawsuits, it is worth reviewing what the FDIC’s receivership litigation rights look like.

A recent decision out of the Northern District of Georgia arising from the 2008 failure of Integrity Bank and citing the body of case law the FDIC developed during the last failed bank era examines the FDIC’s litigation rights and also strongly reinforces the impression that the FDIC has D&O claims on its agenda.

Background

Integrity Bancshares is the parent holding company of Integrity Bank of Alpharetta, Georgia. On August 29, 2008, Georgia banking regulators closed Integrity Bank and the FDIC was appointed as receiver. On October 13, 2008, the holding company filed for Chapter 7 bankruptcy.

In February 2009, the bankruptcy trustee filed a damages action against four individual directors and officers for breach of fiduciary duties and negligence. Though some of the individual defendants were directors and officers of both the holding company and of the bank, the trustee’s claims are based solely on the individual defendants’ capacities as officers of the holding company and the bank. The trustee also filed an action against the bank’s D&O insurer seeking a judicial declaration of coverage for the damages action.

The trustee’s damages action alleges that the individual defendants harmed the now-bankrupt holding company and imperiled the capital that the holding company raised for and provided to the bank, by negligently managing the bank’s operations. Among other things, the trustee alleges that the bank’s lending practices, for which the individual defendants were responsible, were deeply flawed and were characterized by loans to speculative developments made at substantial variance to the bank’s putative lending requirements.

The FDIC intervened in the trustee’s damages action to assert that the trustee lacks standing to bring the damages claims, because the essentially derivative claims the trustee has brought belong to the FDIC as receiver of Integrity Bank. The individual defendants and their D&O insurer also moved to dismiss the declaratory judgment action based on the absence of an actual case or controversy.

The Court’s Opinion

In a November 30, 2009 opinion (here), Judge Richard W. Story granted the FDIC’s motion to dismiss, holding that under the Financial Institution Reform, Recovery and Enforcement Act of 1989 (FIRREA) all derivative claims against the officers and directors of Integrity Bank belong to the FDIC.

Judge Story observed that to have standing, the trustee would have to allege that the defendants caused direct and unique harm to the bankrupt holding company. But, Judge Story found, all of the alleged misconduct took place at the bank level. The allegations relate "only to actions taken in the Defendants’ roles as Bank officers." The harm to the holding company alleged is in its capacity "as a shareholder to the Bank," and the alleged harm is "secondary and predicated upon injury to the Bank."

Judge Story found that

Once the FDIC-R became the receiver of the Bank, the Debtor [i.e, the bank’s parent holding company] no longer had the ability to bring derivative claims against the officers of the Bank, because the FDIC-R succeeded to those claims. The fact that the Debtor subsequently declared bankruptcy did not create in the Trustee any standing that the Debtor did not already possess. Therefore, the Trustee does not have standing to bring the derivative claims alleged in the Damages Complaint.

Judge Story also found that though the complaint stated that the Trustee alleged "direct and unique harm," these allegations represent mere conclusory allegations insufficient to satisfy threshold pleading requirements under Iqbal.

Finally, Judge Story granted the motion to dismiss the declaratory judgment action as moot, essentially ruling that the court cannot rule on coverage issues until the underlying claims have been addressed.

Discussion

I literally have not had occasion to write or type the acronym "FIRREA" for over 15 years. Reading Judge Story’s opinion really is like déjà vu all over again. All of the key cases Judge Story cites are over 15 years old. This all has an uncannily familiar feel.

But there’s no nostalgia here.

No one should miss the obvious implication from the FDIC’s intervention in the Integrity case that if anybody is going to sue the directors and officers, it is going to be the FDIC. The FDIC’s assertion of its successor rights to derivative claims is not a mere academic exercise. The FDIC’s intervention looks like a blocking tactic calculated to preserve its ability to pursue its own claims as receiver.

All of this makes me feel like Harry Potter revealing the awful truth to his fellow students at Hogwarts – Voldemort is back, after a 14 year absence. (We still bear the scars from our last encounter, which quite nearly killed us, too.)

So it may be time to retrieve all those old files out of storage, because it looks like its dead bank litigation time again. Indeed, with the return of the regulatory exclusion on many financial institutions D&O policies, this may well and truly be déjà vu all over again.

To end where I began, with 124 failed banks this year, I think it is only a matter of time before we see the FDIC pursuing many claims against the directors and officers of failed financial institutions. As the Integrity Bank case makes clear, the FDIC as receiver has rights under FIRREA to pursue derivative claims against the Ds and Os of the failed banks.

Strap on your helmets.

Very special thanks to Henry Turner of the Turner Law Offices for providing me with a copy of Judge Story’s opinion.

More About Iqbal: Judge Story's reference to Iqbal reminds me to advise readers that the Senate Judiciary Committee held a hearing today on Senator Specter's bill to set aside Iqbal. The Witness Testimony and Members' Statements can be found on the Committee's Hearings page, here. The Blog of the Legal Times has a short summary of the hearings, here. The short version is that the Democrat members ot the Committee think Iqbal is bad.

Those readers interested in the intellectual debate over the merits of Iqbal will want to refer to the Drug and Device Law blog, where the authors have agreed to engage in a point/counterpoint on the Iqbal decision with Univesity of Pennsylvania Law Professor Stephen Burbank. The first volley in the exchage can be found here.

Vanity Fair on Goldman: If you have not yet seen it, you will want to take a look at the article about Goldman Sachs by Bethany McLean in the January 2010 issue of Vanity Fair, entitled "The Bank Job" (here). The article reviews Goldman's perspective on the its role in the global financial crisis and its aftermath. It also does a good job capturing the widespread outrage regarding Goldman's compensation, as well as the conspiracy theories about Goldman's various connections to official Washington. Basic theme: storied but aggressive bunch of capitalists has managed to draw a huge target on its own back.

Bethany McLean is an old hand at reporting on arrogant corporations, having co-authored Enron: The Smartest Guys in the Room.

Speakers' Corner: On Thursday December 3, 2009, I will be presenting at Skadden's Annual Securities Litigation and Enforcement Seminar.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

As the number of failed and troubled banks has surged, one recurring question has been whether the banks woes would lead to a new round of banking-related litigation. While a few lawsuits had emerged in connection with earlier bank failures (refer here), there really has been nowhere near the number of suits as might be expected from the number of trouble banks – until now, perhaps. The arrival of a couple of bank loan loss reserve lawsuits this past week, as well as other banking-related developments, raises the question whether the conjectured round of bank related lawsuits may now have begun.

First, on September 8, 2009, plaintiffs filed a securities class action lawsuit in the Central District of California against Pacific Capital Bancorp and certain of its directors and officers, as well as a stock analyst that follows the bank’s stock. According to the plaintiff’s counsel’s September 8, 2009 press release (here), the complaint alleges that the defendants misled investors by representing that:

that the Company was maintaining a strong allowance for loan losses which would enable it to absorb losses in its portfolio. As alleged in the complaint, defendants’ misstatements and omissions relating to Pacific Capital’s loan loss provision caused the Company’s common stock to trade at artificially inflated levels between April 30, 2009, when the Company reported that it maintained its loan loss provision at a very high level, through July 30, 2009, when the Company admitted that it had not adequately reserved for loan losses, had not applied a conservative reserve methodology, and needed to record an additional loan loss provision of $117 million. The "buy" rating issued by the analyst defendants on the Company’s common stock also contributed, as alleged, at certain times during the Class Period to the artificial inflation in the price of Pacific Capital stock.

Second, on September 11, 2009, plaintiffs filed a securities class action lawsuit in the Northern District of California against UCBH Holding and certain of its directors and officers. (UCBH Holding is a bank holding company for United Commercial Bank, a California-state chartered bank with its headquarters in San Francisco, refer here.) According to the plaintiffs’ lawyers’ September 11, 2009 press release (here), the complaint alleges:

UCBH knowingly falsified its financial statements by concealing the rising level of loan losses and non-performing loans through a series of improper accounting tricks and outright deception of regulators and auditors. On September 8, 2009, UCBH announced that its Chairman and CEO, Thomas Wu, and its Chief Credit Officer, Ebrahim Shabudin, were resigning following the results of an investigation of the improper loan accounting. As a result of the accounting improprieties, UCBH must restate its financial statements for each quarter and the full fiscal year of 2008. News of the accounting fraud and the pending restatement caused UCBH's stock price to fall significantly, damaging investors.

The complaint can be found here.

The final related development this past week took place on Friday night after the close of business, when the FDIC closed Corus Bank, N.A. about which refer here. (The FDIC actually closed three banks on Friday, refer here, bringing the 2009 year to date total number of bank failures to 92.) Though Corus only just now failed, the bank’s holding company and certain of its directors and officers had already been sued earlier this year (refer here) in a securities class action lawsuits in the Northern District of Illinois alleging that:

(i) that Corus was failing to recognize losses on its condominium loans in accordance with generally accepted accounting principles ("GAAP"); (ii) that Corus and/or its affiliates was purchasing condominiums in developments Corus had financed in an attempt to: (a) inflate the appraised values of condominiums to delay having to recognize losses on financing for such condominiums; (b) inflate developers’ sales figures to increase the likelihood of successful future sales; and (c) create the illusion of successful sales histories in order to inflate appraisal values for the condominiums to ensure inflated future prices for the condominiums; and (iii) that Corus was involved in detailed and in-depth negotiations with the Federal Reserve Bank of Chicago and the Office of the Comptroller of Currency regarding its deteriorating pool of condominium loans.

The arrival of the new lawsuits and the development involving Corus all in this past week may well have been coincidental. It remains to be seen whether there will in fact be a significant number of additional lawsuits involving failed or troubled banks.

That said, there is definitely a familiar tone to these recent cases. The allegations regarding the various banks’ alleged loan loss reserve deficiencies and alleged failure to recognize failing loans will be quite familiar to anyone who was involving in any way in the wave of failed bank litigation that accompanied the last round of failed banks during the S&L crisis. Though the future is uncertain, it is difficult no to speculate that we will see many more of these kinds of loan loss reserve inadequacy cases in the months ahead.

Of course, even if the cases do arrive in significant numbers, that does not necessarily mean that they will succeed. Some cases previously filed in connection with banks that failed in 2008 have already been dismissed. For example, the Fremont General lawsuit (refer here) and the Downey Financial lawsuit (refer here) have both been dismissed, and in Downey Financial’s case, the dismissal is with prejudice.

Nevertheless, the most recent filings seem to suggest that plaintiffs’ lawyers are not deterred by the prior dismissals. Given the depth of the current difficulties in the banking sector (about which refer here), there may yet be more, perhaps much more, banking-related litigation to come.

Citigroup Auction Rate Securities Lawsuit Dismissed: On September 11, 2009, Southern District of New York Judge Laura Taylor Swain dismissed the auction rate securities lawsuit that had been filed Citigroup. A copy of the September 11 opinion can be found here.

This action follows the earlier dismissals of the auction rate securities lawsuits that had been filed against UBS (refer here) and Northern Trust (refer here). However, this dismissal represents its own separate development, because unlike many of the other auction rate securities lawsuits, which were based on alleged misrepresentations in connection with the sale of the securities, the Citigroup auction rate securities lawsuit was based on a market manipulation theory.

As reflected in greater detail here, the plaintiff in the Citigroup auction rate securities lawsuit had alleged "defendants manipulated the market for Citigroup ARS by fostering the illusion that a valid market existed where buyers and sellers came together, with supply and demand in balance, allowing for the successful completion of auctions of Citigroup ARS. In fact, no such balance existed." The defendants moved to dismiss.

In her September 11 order granting the defendants’ motion to dismiss, Judge Swain held with respect to the plaintiff’s market manipulation claim under Section 10(b) of the ’34 Act that the plaintiffs had insufficiently alleged fraud; scienter; reliance; and loss causation. She also dismissed the plaintiffs’ claims under the Investment Advisers Act for lack of subject matter jurisdiction and the plaintiffs’ state law claims because they were preempted by SLUSA.

With respect to the plaintiffs’ market manipulation claim, she found the plaintiff’s fraud allegations insufficient because the complaint "does not include specific allegations as to which Defendants performed what manipulative acts at what times and with what effect" but instead that the complaint "relies on general and conclusory allegations regarding Defendants’ practices" regarding the ARS auctions. She concluded that "absent particularized allegations regarding Defendants’ alleged manipulative conduct, Plaintiff cannot state a claim for market manipulation."

With regard the plaintiff’s scienter allegations, Judge Swain found that the plaintiff has not sufficiently alleged motive and opportunity, holding that "Plaintiff’s conclusory allegations regarding Defendants’ motive for the alleged manipulation focus principally on Defendants’ desire to sell Citigroup ARS to offset subprime losses and to obtain fees for services in connection with the auctions." She found these allegations "too generalized to meet the scienter pleading requirement."

She also found that plaintiff had failed to allege particularize facts giving rise to a strong inference of scienter based on circumstantial evidence of conscious misbehavior or recklessness. She found that "the very market conditions – specifically the ‘subprime crisis’ – that Plaintiffs cites in his Complaint…give rise to an opposing and compelling inference that Defendants engaged only in bad (in hindsight) business judgments in connection with the ARS, and did not engage in the alleged conduct with an intent to deceive."

Judge Swain found further that the plaintiff had not adequately alleged reliance. In reaching this conclusion, Judge Swain specifically reference an SEC report that preceded the class period in which many of the practices of which the plaintiff complains regarding the ARS market auction process. These materials "disclosed that the ARS market was not necessarily set by the ‘natural interplay of supply and demand’" and therefore Plaintiff has not identified any basis on which the class reasonably could have relied on "the market ‘integrity’ assumption."

Finally, Judge Swain found that the market manipulation claim also fails because the plaintiff’s loss causation allegations are insufficient. In reaching this conclusion, she observed that "Plaintiff does not specifically allege that he tried to sell his ARS, nor does he allege that the interest rates set through Defendants’ manipulative conduct were lower than they would have been absent such conduct."

The dismissal granted in Judge Swain’s September 11 ruling is without prejudice; the plaintiff has until October 1, 2009 to file an amended complaint.

I have in any event added the Citigroup auction rate securities dismissal to my table of subprime and credit crisis-related lawsuit dismissal motion ruling, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing me with a copy of Judge Swain’s ruling.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The FDIC’s August 27, 2009 announcement in its latest Quarterly Banking Profile (here) that during the second quarter of 2009 it had increased the number of financial institutions on its "Problem List" from 305 to 416 (a 36% increase) caused quite a stir. The Wall Street Journal’s lead article the next day referred to the FDIC’s "sick list" and other media sources also buzzed with the news.

And well they might. As I noted in the prior issue of InSights (here), the number of banks on the FDIC’s "Problem List" and the assets they represent have both grown rapidly. The 416 institutions on the list at the end of the second quarter of 2009, representing assets of $299.8 billion, contrasts dramatically with the end of the second quarter of 2008, when there were "only" 117 institutions on the list representing $78.3 billion in assets. This nearly 300 percent increase in the number of problem banks in just one year, along with the nearly 400 percent increase in the assets the problem banks represent, are both deeply troublesome developments.

The FDIC itself noted in its Quarterly Banking Profile that the current number of problem banks is the highest such count since June 30, 1994, and the assets they represent are at the highest level since December 31, 1993.

It is hardly surprising that these disturbing developments and the trends they represent have triggered some daunting projections about what the future may hold. Among the most alarmist, and the one that has garnered the most media attention, is the statement on CNBC by banking veteran and investor John Kanas that the number of failed banks could reach 1,000 by the end of next year. Other commentators have made other pessimistic albeit less dire projections (refer for example here.)

It may not be possible simply to write off the question whether 1,000 bank failures over the next year and a half is a possibility. Certainly, banks failed at a tremendous rate during the S&L crisis. During the dark days of 1989, banking regulators took control of 534 banking institutions. Overall, during the S&L crisis, over 1,000 financial institutions failed.

In addition, other details in the FDIC’s latest Quarterly Banking Profile certainly underscore the deteriorating conditions facing many banks. Among other things, the banks’ loan portfolios are weakening faster than the banks can set aside loss reserves. At the end of the second quarter, the industry’s ratio of reserves to bad loans stood at just 63.5%, its lowest level since 1991.

The data in the FDIC’s report also highlights how problems are spreading beyond just the real-estate sector where the problems in the current economic crisis first emerged. Credit card losses are increasing and the banks find themselves collectively holding billions of dollars worth repossessed real estate. Persistent high levels of unemployment raise the risk that even low-risk borrowers could fall behind or default on their loan payments. For further details about reasons why banks are failing now, refer to my recent post here.

Though we are still a very long way from 1,000 failed banks, the number of failed banks has continued to surge. With the addition of three more bank closures this past Friday night, the number of 2009 year to date bank failures now stands at 84. Since January 1, 2008, 109 banks in 29 states have failed. These bank failures have ranged from the smallest banks with assets under $15 million, to Washington Mutual's failure, which with assets of $307 billion was the largest bank falure in U.S history. The FDIC’s complete list of failed banks since October 2000 can be found here.

All of that said, it is still a very long way from 84 bank failures – in and of itself a significant number – to 1,000 bank failures by the end of 2010. This truly pessimistic prediction presumes that more than double the number of current problem banks will fail in the next 14 months. This despite the fact that while both the number of problem banks and the number of failed banks have climbed dramatically in the past year, the number of failed banks has remained well below the number of problems banks.

Because of the historical example of the S&L crisis, it is hard to say that 1,000 bank failures couldn’t happen. It happened before and it could happen again. However, in the range of possible outcomes, the likelihood of 1,000 bank failures has to rank among the remote possibilities. Among other things, the prediction of 1,000 bank failures seems to reckon without the possibility that eventually the effects of the economic recovery might start to alleviate the harsher trends of the economic downturn.

Unfortunately, the current trends do seem to suggest that things will continue to get worse before they get better. But one of the lessons we were all supposed to have learned from the events that preceded the credit crisis is the fallacy of projecting from current conditions and presuming current conditions will continue indefinitely into the future.

Just as it was a mistake in the late stages of the housing bubble to assume, for example, that housing prices would continue to rise indefinitely, so too it could be a mistake to presume that current adverse banking conditions will continue unabated into the future. Yes, circumstances are difficult and there undoubtedly will be further bank failures, perhaps many more bank failures. The possibility of as many as 1,000 bank failures seems remote and unlikely, even given current adverse and deteriorating conditions. Securities Analyst Meredith Whitney’s projection of 300 bank failures (refer here), although also arguably pessimistic, by comparison seems less radical.

Among other questions raised when discussing these issues on recent days is whether the rising tide of bank failures, no matter how large it ultimately proves to be, will lead to a wave of lawsuits against the former directors and officers of the failed institutions, as happened during and following the S&L crisis.

As I have noted previously, most recently here, there have been some lawsuits filed by shareholders of failed banks, who claim that their investment losses were the fault of the banks’ former directors and officers. There have also been a number of securities class action lawsuits filed by shareholders of publicly traded failed banks. Indeed, of the 25 banks that failed in 2008, six were sued in securities class action lawsuits, even though just eleven of the 25 were publicly traded.

These seems to have been less of this shareholder litigation in connection with the 2009 bank failures so far, perhaps in part due to the fact that fewer of the 2009 bank closures involve publicly traded financial institutions.

Prospective litigants are not likely to be encouraged by the recent developments in one of the 2008 securities class action lawsuits involving a failed bank. That is, on August 21, 2009, the court granted with prejudice the defendants’ renewed motion to dismiss the amended complaint plaintiffs had filed to try to cure the defects noted in the earlier dismissal motion rulings in the subprime-related securities class action lawsuit involving Downey Financial. A copy of the court’s ruling can be found here. This development underscores the pleading obstacles plaintiffs may face in trying to survive dismissal motions in any case involving a failed bank, particularly against the larger background of the global economic crisis and wave of bank failures.

One recurring question I am asked is whether the FDIC will, as it did during the S&L crisis, pursue liability claims against the former directors and officers of failed financial institutions. These kinds of lawsuits were a major part of the FDIC’s efforts to try to recoup its losses during the last banking crisis. There would seem to be every reason to expect the FDIC to attempt to do the same thing this time around as well.

However, at least so far, the FDIC does not seem to have actually filed these kinds of claims, at least as far as I am aware. I have been informed by reliable sources that the FDIC has presented written notices of potential claims in certain instances (perhaps in an effort to preserve a possible later recovery from D&O insurance policy proceeds before the policy’s lapse). However, so far, the FDIC does not seem to have actually pursued these claims.

One thing that seems certain is that if there really were to be as many as 1,000 failed banks, or any number remotely in that neighborhood, the latent prospect for litigation involving the former directors and officers of the failed banks would potentially be enormous.

Special thanks to the many readers who sent me links, comments and questions about the FDIC's latest Quarterly Banking Profile and related media developments.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

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.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

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.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In recent posts discussing year-end trends, my observations included predictions that credit crisis related lawsuits would continue in 2009 and that increased levels of bank failures could lead to further "dead bank" litigation. As it turns out, 2009’s first-filed securities class action lawsuit appears to reflect both of these projected trends.

According to the plaintiffs’ attorneys’ January 6, 2009 press release (here), they have filed a securities class action lawsuit in the Central District of California alleging that PFF Bancorp and certain of its directors and officers issued false and misleading statements about the company’s financial condition and business practices in violation of the federal securities laws. Until the bank’s closure, PFF operated a community bank located in Pomona, California.

As the FDIC reported (here), on November 21, 2008, banking regulators closed PFF and its assets were transferred to U.S. Bankcorp. PFF is one of the twenty-five U.S. banks that failed during 2008. (The FDIC’s complete list of the failed banks can be found here.)

The only defendants named in the complaint (which can be found here) are the company’s former CEO and former CFO. According to the press release, the Complaint alleges that the defendants "concealed" the bank’s "improper lending to borrowers with little ability to repay the amount loaned and failed to inform investors of the impact of changes in the real estate market in San Bernardino and Riverside Counties."

Specifically, and according to the press release, the Complaint alleges that the defendants concealed that:

(a) PFF's assets contained hundreds of millions of dollars worth of impaired and risky securities, many of which were backed by real estate that was rapidly dropping in value; (b) prior to and during the Class Period, PFF had been extremely aggressive in generating loans, including being heavily involved in offering Home Equity Lines of Credit ("HELOCs"), which would be enormously problematic if the value of residential real estate did not continue to increase; (c) defendants failed to properly account for PFF's real estate loans, failing to reflect impairment in the loans; (d) PFF's business prospects were much worse than represented due to problems in the Inland Empire market, which was a key focus of PFF's business; and (e) PFF had not adequately reserved for loan losses on HELOCs and on other real estate-related assets.

In prior posts, I have speculated (most recently here) that the growing number of failed banks could lead to a wave of failed bank litigation. I also recently projected (here) the likelihood that credit crisis related litigation wave will continue in 2009. One case is obviously no basis from which to generalize, but it does at least indicate that the forces on which I based my speculations are at least at work.

The likely operation of these factors, as well as the Madoff litigation and the general turbulent conditions in the financial marketplace, are among the reasons that that 2009 could be a very active year for securities litigation.

The year has barely begun and the horizon is still wide open, but from my perspective we seemed to have picked up right where we left off.

In any event, I have added the PFF Bancorp case to my running tally of the subprime and credit crisis-related lawsuits, which can be accessed here. With the addition of the first-filed case of 2009 to the list, the number of subprime and credit crisis-related lawsuit filed during the period 2007 through 2009 now stands at 142.

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

All litigants face the challenge of managing lawsuit expenses and exposures. The Reserve Primary Fund investor litigation defendants have crafted a novel approach to addressing these challenges – they apparently intend to finance their defense as well as any indemnity out of funds due to investors -- that is, the funds of the very people on whose behalf the claims are being asserted.

Background

In September, the Reserve Primary Fund ("the fund") gained notoriety when the money market fund "broke the buck," as massive redemptions and the fund’s exposure to Lehman Brothers’ securities drove the fund’s per share net asset value below one dollar. Due to the magnitude of the redemption requests, the fund’s trustees voted to liquidate the fund and distribute the assets to investors.On December 8, 2008, the Wall Street Journal ran a front page article (here) detailing the events behind the fund's woes.

Meanwhile, investors initiated a number of securities lawsuits against the fund, its directors and officers, its investment advisor and related parties. (Refer here for background regarding the lawsuits.) The lawsuits allege, among other things, that the defendants’ selective or inaccurate disclosure regarding the fund’s troubled assets enabled certain institutional investors to avoid losses to the detriment of other investors. The lawsuits also alleged that the fund failed to disclose its vulnerability due to its alleged overexposure to Lehman. The lawsuits also allege that the Lehman Brothers investments were inappropriate for a money market fund, and that the fund deviated from its stated investment approach.

The Liquidation Plan

On December 3, 2008, the fund’s trustees issued a "Plan of Liquidation and Distribution of Assets" (here). Among other things, the Liquidation Plan provides a plan for distribution of fund assets through "interim payments." The interim payments are to include distribution amounts "up to the amount of a special reserve, which would include amounts that would be required to satisfy disputed claims."

As the Liquidation Plan explains, this special reserve will be used to finance "costs and expenses of the Fund, its officers and Trustees"; "pending and threatened claims against the Fund"; and claims, "including but not limited to claims of indemnification that could be made against plan assets." Were the fund to distribute its assets without the special reserve, investors could expect about 98.5 cents per share. However, the special reserve, the amount of which has yet to be determined, will reduce this per share distribution.

As a December 5, 2008 New York Times article entitled "Embattled, Fund Shifts Costs to Investors" (here), put it, investors might hope to get 98.5 cents on the dollar, but "if they continue to wage legal battles against the fund managers, the company will use investors’ own money to defend itself against allegations or mismanagement and deception." Moreover, the Liquidation Plan makes it clear that the special reserve is not just for litigation expense, but also to "satisfy disputed claims." The December 8 Journal article cited above states that the fund has told investors "the fund will use some if its assets to fight suits investors have filed, which could reduce the money available to return to them."

Insurance and Indemnification

Readers who like me wonder whether there isn’t D&O liability insurance available to pay these amounts will be interested to learn that there is insurance, just not very much. According to the Liquidation Plan, the fund has a directors’ and officers’ liability insurance policy with a $10 million aggregate limit of liability.

Not only does the fund only have a $10 million D&O policy, but it is a "joint" policy, insuring not just the fund and its directors, officers and trustees, but also its investment advisor, its corporate parent, and other affiliated parties and person, many of whom are co-defendants with the fund and its directors and officers in the mass of investor lawsuits that have been filed.

In other words, though the fund has D&O insurance, its limits are, well, limited, and are also subject to erosion or depletion due to competing interests of multiple parties in the policy proceeds. It should be emphasized that under most D&O policies, defense expense reduces the amount of insurance remaining under the policy, meaning that there could be little or no insurance available to satisfy investors’ claims if the various cases are actively litigated.

The rights of the fund’s individual officers, directors and trustees to indemnification are not eliminated merely because of the allegations raised in the lawsuits (indeed, the outbreak of litigation is precisely the circumstances that trigger the operation of indemnification rights). Angered investors who may want to contend that the individual’s supposed misconduct should forfeit their rights to indemnification can try to argue based on Section 17(h) of the Investment Company Act that the fund cannot indemnify the individuals for "willful malfeasance, bad faith, gross negligence, or reckless disregard."

The problem for any investor inclined to make that argument is that the only way to establish that the statutory indemnification prohibitions have been triggered is to litigate the issue – which, as the Times article notes, is "the very act that could reduce the return to investors." In order to establish that the disqualifying conduct occurred, investors would have to pursue their case all the way to verdict, and arguably through appeal as well, a process that would be as uncertain as it would be costly and protracted.

Discussion

So basically the message seems to be, you want to litigate, investors? Fine, knock yourselves out. It’s your money. As the Times article puts it, the choice offered investors under the Liquidation Plan "struck some legal experts as brazen."

The fund’s insurance limits are also worthy of comment. The fund had assets of approximately $64 billion. In that light, some may find the fund’s $10 million D&O insurance limits, well, surprising, particularly given that the limits insure not just the fund and its directors, officers and trustees, but also the fund’s investment advisor and other affiliated parties and person. Reasonable minds might well question the fund’s limits selection.

These circumstances also highlight the risks associated with widely shared limits. The number and diversity of entities and person who will be depending on the limits, along with the apparent seriousness and extent of the litigation involved, raises the probability that the litigation expense will quickly erode if not altogether deplete the available limits. The risk of limits erosion associated with these kinds of shared limits further underscores the fact that reasonable minds might well question the fund’s insurance limits selection.

In any event, the circumstances, particularly the Liquidation Plan, present investors with some difficult decisions. It will be interesting to see their next move, and whether they try to challenge the Liquidation Plan.

Special thanks to Kelly Rehyer for the link to the Times article.

And Speaking of Threats to Litigating Investors: As I noted in a prior post (here), investors have sued the Bank of America, challenging the loan modifications to which the bank agreed in connection with mortgages issued by Countrywide. The litigation has apparently caught the attention of FDIC chairman Sheila Bair.

As reported in a December 4, 2008 Los Angeles Times article (here), Bair told a consumer group gathering that "there is an obligation to modify mortgages," and that "investors should take a hard look at what they are advocating." She also said that "the harder investors push, the more there’s going to be a backlash here." She suggested that Congress may step in and change the legal obligations of mortgage services toward investors.

Interestingly, Bair did not state that the investors’ opposition to the mortgage makeovers is illegitimate or unmeritorious, only that their assertion of their interests represents an obstruction to policy goals she advocates. It certainly can be inconvenient when concerned parties insist on asserting their rights, but the threat of a Congressional backlash could strike some as heavy-handed.

Call it a hunch, but Bair’s remarks seem likelier to embolden rather than to discourage investors, as her remarks suggest that she recognizes the potential significance of their claims. In any event, whether or not Congress has the power or political will to set aside the agreements on which the investors are relying, if Congress were to take such a step it would do little to restore investor confidence in mortgage marketplace mechanisms, which would seem to be an indispensible part to restoring stability to the mortgage lending industry.

And Speaking of the FDIC: In yet another Friday-night special, on December 5, 2008, First Georgia Community Bank of Jackson, Georgia became the twenty third U.S. bank failure this year, after state regulators closed the bank and the FDIC was named receiver. The closure is Georgia’s fourth bank failure this year.

The FDIC’s December 5, 2008 press release can be found here. The FDIC’s updated list of bank failures can be found here. My prior post about the significance of the accumulating bank failures can be found here, and my prior post about the prospects for a new wave of "dead bank" litigation can be found here.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link