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

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

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

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

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

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

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

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

Discussion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I look forward to seeing everyone in New York.

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

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

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

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

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

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

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

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

DEFENSE COUNSEL: Yes, I did, your honor.

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

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

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

DEFENSE COUNSEL: Yes, your Honor.

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

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

Judge Fischer denied the defendants’ motion.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Background

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

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

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

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

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

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

The November 30 Ruling

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

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

Discussion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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In an opinion that provides an interesting glimpse of a complex D&O insurance program, on August 24, 2011, Central District of California Judge R. Gary Klausner granted the motions to dismiss of the insurance company defendants in an action that had been brought by a subsidiary of IndyMac bank, which was trying to establish its rights to coverage under the failed bank’s D&O insurance policies. A copy of the August 24 opinion can be found here.

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

As I detailed in a prior post (here), the bank’s collapse triggered a wave of litigation.  The lawsuits include a securities class action lawsuit against certain former directors and officers of the bank; lawsuits brought by the  FDIC and by the SEC against the bank’s former President; and a separate FDIC lawsuit against four former officers of Indy Mac’s homebuilders division.  According to Judge Klausner’s August 24 opinion, there are a total of twelve separate lawsuits pending (referred to in the opinion as the “underlying actions”). Judge Klausner describes the litigation generally as alleging “various improprieties, mostly centering around mortgage backed securities.”

IndyMac MBS was a subsidiary of IndyMac Bank, and is now wholly owned by the IndyMac federal receivership. IndyMac MBS is a defendant in a number of the lawsuits that have been filed in the wake of the bank’s collapse. Earlier this year, IndyMac MBS filed an action seeking a judicial declaration of coverage on its behalf under the bank’s D&O insurance policies.

The insurance policies at issue represent a total of $160 million of insurance coverage spread across two policy years. (Judge Klausner’s opinion does not explain why two policy year’s policies are potentially implicated, rather than only one.) The coverage in the 2007-2008 policy year, providing coverage during the year from March 1, 2007 to March 1, 2008, consists of eight layers of insurance. Each layer has a $10 million limit of liability. The eight layers consist of a primary policy providing traditional ABC coverage, with three layers of excess insurance providing follow form ABC coverage, followed by four layers of Excess Side A insurance.

The coverage for the policy year March 1, 2008 to March 1, 2009 is arranged similarly, except that the lineup of insurer involved changed slightly in the 2008-2009 program. Judge Klausner’s opinion names all of the carriers involved and their respective roles in the two programs.

In its declaratory judgment action, IndyMac MBS sought to have the court determine that each of the underlying actions is covered under one or the other of the two insurance coverage towers. Moreover, because the two programs are each subject to a “priority of payments” provision giving the individual defendants in the underlying actions priority to coverage under the policies, IndyMac MBS sought to have the court make a determination of coverage for the individual defendants in the underlying actions, so as to allow the court to ascertain whether IndyMac MBS  may be eligible to receive coverage under the policies. The defendant insurance companies moved to dismiss.

In his August 24 order, Judge Klausner granted the insurance companies’ motions to dismiss, holding that IndyMac MBS’s request for declaratory relief is “too remote to constitute a case or controversy” because any insurance coverage that may ultimately be owed “can only be determined after the underlying actions involving the Individual Defendants have been concluded.” Accordingly, IndyMac MBS “does not yet have an adequate injury that would make this case justiciable.”

In addition, Judge Klausner found with respect to the excess layers of insurance had not even been triggered because the underlying insurance has not yet been exhausted, and whether the excess layers “will ever be triggered in the underlying action is too speculative to give rise to a valid request for standing in the current case.” Indeed, even under the primary policy, IndyMac’s alleged injury is “too speculative” as IndyMac MBS has not yet met the $2.5 million deductible.

Finally, Judge Klausner separately granted the Excess Side A insurers’ motion to dismiss. Because the insurance coverage under the Excess Side A policies is only available, if at all, for the benefit of the individual defendants, IndyMac “lacks standing to request declaratory relief” because it “cannot adequately allege that it has a legal interest” in the Excess Side A policies, given that the Excess Side A policies “provide coverage only for the Individual Insured Defendants.”

Discussion

There is nothing surprising about the outcome of this ruling. It clearly is too early for the court or anyone else to try to sort out who is going to be entitled to what under the various policies. Nevertheless, it certainly is understandable that IndyMac MBS would want to know how much insurance it is going to have as it faces the various lawsuits in which it is involved.

This is a classic situation of too many claims, too many defendants and possibly not enough insurance. Even though IndyMac carried annual limits of liability of $80 million (and I note as an aside, there is nothing that says that both of the two $80 million towers of insurance will actually be available; it is entirely possible that all claims will relate back to the date of the initial filing of the first claim, in which case only a single $80 million tower would actually be available to pay the various insured persons’ losses), that may prove to be an insufficient amount to pay the defense fees and to pay settlements and judgments in order to resolve all of the various underlying actions.

The larger concern for IndyMac MBS is that owing to the priority of payments provision in the traditional ABC policies, and owing to the limitation of coverage in the Excess Side A policies to the individuals only, it is entirely possible that payment of the individual insureds’ defense expenses and settlement amounts will entirely exhaust all insurance. The Excess Side A insurance of course is not available at all for IndyMac MBS. IndyMac’s declaratory judgment action seems like an attempt to try to do something before all of the insurance is gone.

Of course, I am assuming for the sake of argument that there actually is coverage available under these policies for the benefit of the individual insured persons. Whether or to what extent there are policy terms and conditions that preclude coverage in whole or in part for the individual insureds is another question. That is of course one of the questions that IndyMac MBS wanted answered in the declaratory judgment action, because knowing the answer to the question of how much insurance is available to the individuals is a necessary predicate to knowing the answer to how much insurance might be available to IndyMac MBS.

The structure of IndyMac’s insurance was somewhat unusual, as it is not common for companies to carry equal amounts of traditional ABC insurance and of Excess Side A insurance, or to carry $40 million of Excess Side A, as IndyMac did here. However, from the perspective of the individuals, the unusually large amount of Excess Side A insurance that the bank carried is turning out to be a good thing from there perspective, as it is looking like they are going to need it, and it is only going to be available to them and for their benefit, without having to share with other entities.

Anyway, while I don’t think the outcome of this decision is particularly surprising, it is still an interesting situation. The circumstances provide insight into the ways that the various parts of a D&O insurance program operate, particularly the priority of payments provision and the Excess Side A insurance structure.

One final observation has to do with the fact that a lot of insureds, like IndyMac MBS, become frustrated when they are unable to find out with clarity at the outset of a claim how much insurance is going to be available. The problem is, as this case demonstrates, until the underlying litigation has played itself out, it is not possible to know how all of the various rights and interests under the policy are going to be addressed. When this type of frustration arises in the course of a claim, the insured persons often translate their frustration into anger at the carriers involved. But as this case also shows, even taking as active a step as suing the carriers to try to force a determination of coverage cannot eliminate the unavoidable constraint that requires the underlying claim to be resolved (or at least sufficiently advanced) before coverage can finally be determined.

I do wonder sometimes whether it is a sad commentary that I find all of this interesting.

Special thanks to a dedicated reader for sending me a copy of the IndyMac order.

Las Vegas Sands Credit Crisis-Related Securities Suit Survives Dismissal Motion: Like a lot of companies during the economic turmoil in late 2008, the Las Vegas Sands Corp. experienced serious liquidity problems that put it in breach of various covenants it has with its lenders. These disruptions affected the company’s ability to proceed with expansion plans in Las Vegas and Macao. As these events unfolded the company’s share price lost much of its value.

As I discussed in an earlier post, somewhat belatedly, in May 2010, a plaintiff shareholder filed a securities class action lawsuit in the District of Nevada, alleging that the company and certain of its directors and officers had made misleading statements about the company, its development plans, its liquidity and its financial condition. The defendants moved to dismiss.

In an August 24, 2011 order (here), District of Nevada Judge Kent Dawson denied the defendants’ motion to dismiss. He concluded that the plaintiffs “have adequately pled facts asserting that investors were misled by statements that liquidity was not an issue and that development was steadily progressing.” He also concluded that the plaintiffs have “adequately pled that Defendants knew that the statements they were making were false.”  He also found that the allegations in the complaint “show a series of public statements on material issues that were inconsistent with what was known internally.” He did conclude that certain forward-looking statements were not actionable, because they came within the safe harbor for forward looking statements.

I have added the Las Vegas Sands case to my running tally of credit crisis-related dismissal motion rulings, which can be accessed here.

Here’s A Real Shocker: Merger Objection Lawsuits Are Worthless: If the hurricane blew away your Saturday newspapers, you may not have seen the August 27, 2011 article in the Wall Street Journal entitled “Why Merger Lawsuits Don’t Pay” (here). According to the article, “legal experts” warn prospective claimants with respect to merger objection lawsuits that “the chances that you will succeed in stopping a deal or receiving a payday are minimal.”

The article reports data from Advisen that in 2010, there were 353 merger objection lawsuits, which represents a 58% increase from 2009. There have already been 352 merger objection lawsuits so far this year. The number of these lawsuits keeps increasing even though these suits “rarely result in a tangible award,” and the best outcomes are usually limited to “a delay in the merger or slightly improved disclosures about the deal’s terms.”

The answer to the question about why these cases are filed if they produce so little is that they make money for the lawyers. As the article puts it, “in many cases the biggest beneficiaries are the law firms,” which collect fees “from roughly $400,000 for typical cases to several million for bigger cases.” The article quotes a statement from Delaware Chancellor J. Travis Laster that the specific merger objection case before him was “a bunch of movement for nothing.”

Yes, it’s a great country, isn’t it?

Video Tribute: As a parting salute to Irene as she heads north and back out to sea, here's a video tribute -- The Scorpions "Rock You Like A Hurricane." (sorry about the commercial at the beginning, it is short).

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

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

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

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

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

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

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

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

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

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

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

Discussion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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One of the many distinctive traits of the litigation that surrounded the S&L crisis in the late 80s and early 90s was the plethora of lawsuits  between the FDIC (and other federal banking regulators), on the one hand,  and the failed banks’ insurers, on the other hand,  over the interpretation of the banks’ management liability insurance policies. Among the questions surrounding the current bank failure wave has been whether or not we will see a similar round of insurance coverage litigation. If a lawsuit filed last week in the Middle District of Alabama is any indication, the anticipated insurance coverage litigation may be on its way.

The coverage lawsuit arises out of the massive failure of Colonial Bancorp, which closed its doors on August 14, 2009. The bank’s holding company filed for bankruptcy on August 25, 2009. Among the factors contributing to Colonial’s failure was the criminal conspiracy relating to the failed mortgage lender, Taylor Bean & Whitaker. In April 2011, Lee Farkas, Taylor Bean’s ex-Chairman, was convicted of wire fraud and securities fraud.

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

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

At the time of the bank’s failure, the bank carried three financial institution bonds. At or about the time that Colonial failed, the bank submitted notices of claim under the financial institutions bonds in connection with the activities and actions that ultimately were the topic of the criminal guilty pleas of the bank employees.

In a complaint filed on July 29 in the Southern District of Alabama (a copy of which can be found here), the FDIC as receiver for Colonial Bank, as well as the bankrupt bank holding company on its own behalf, filed an action against the bank’s bond insurer. Among other things, the complaint alleges that the losses caused by the misconduct “constitute recoverable losses under the Bonds up to the full aggregate limits of liability of the Bonds.” 

The complaint states that the bond insurer “has neither accepted nor denied the Plaintiffs’ claims under the Bonds.” The complaint alleges  that the insurer “has failed to investigate the claims and losses in a reasonable and appropriate manner.” After cataloging the back and forth between the FDIC and the insurer on their respective efforts to enter a confidentiality agreement, the complaint alleges that the insurer “has declined to enter into any of the proposed confidentiality agreements or offer appropriate confidentiality agreements of its own,” and “hence” the FDIC is unable to produce the confidential information that the insurer has requested. The complaint asserts a single claim for breach of contract.

Interestingly, the complaint does not specify whether or not the FDIC or the bankrupt holding company is entitled to recover under the bonds, but rather says that the amount of any recovery under the bonds is to be deposited in a bankruptcy court escrow account, where the issue of entitlement to the proceeds will be determined.

There are a number of arguably unusual features of this dispute. First, it is filed in connection with the failed bank’s financial institutions bonds, rather than in connection with the failed bank’s D&O insurance policy. To be sure, given the circumstances surrounding the bank employees’ guilty pleas, the implication of the bonds is hardly surprising. But the typical bank closure during the current round of bank failures will not implicate the failed bank’s financial institution bonds. The relevant insurance issues will more likely arise, if at all, under the failed bank’s D&O policy.

Another interesting thing about this dispute is that the parties are in coverage litigation even though the carrier has not even denied coverage. It looks as if the parties’ so-far unsuccessful attempts to hammer out a confidentiality agreement have gotten a little bit out of hand. It is mercifully uncommon for parties in similar circumstances to be unable to come up with a mutually acceptable confidentiality agreement. It may be that once the parties in this circumstance can finally manage to come up with a confidentiality agreement that this whole dispute will resolve itself without the need for further litigation (whether or not there was ever really any need for litigation in the first place.)

But the fact that the FDIC has not hesitated to file this suit in the first place certainly does evince a willingness to use the court to pursue its claims, as receiver, in connection with failed banks’ insurance policies. And while this case may not on its face present any significant coverage issues of more general significance, the likelihood is that as the FDIC presses claims for insurance recovery, that some of these claims will find their way into court with significant implications for questions of coverage under the applicable policies.

As I have said before, so many aspects of the current bank failure wave provide a feeling of déjà vu for those of us who lived through the S&L crisis. If the feeling is not necessarily one of nostalgia, it at least has a certain familiarity. Of course, it remains to be seen whether or not there will be any where near the amount of coverage litigation this time around. It just looks to me from this recent lawsuit that just like last time, the FDIC is not messing around, and it is not going to hesitate to use the courts to pursue claims against failed banks’ insurers.

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

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

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

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

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

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

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

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

“Other”?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The complaint alleges that:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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In today’s global economy, business increasingly is conducted cross-jurisdictionally. Company officials and their advisors increasingly must grapple with liability issues arising under the laws of multiple jurisdictions. These liability issues in turn can present complex indemnification and insurance questions. Simply identifying the operative legal considerations can present a significant challenge.

A newly updated legal resource may afford valuable information for those struggling with these issues. Information about the new volume, entitled Directors’ Liability and Indemnification: A Global Guide, Second Edition, can be accessed here. This new edition was edited by UK Insurance maven, Ed Smerdon of the Sedgwick Detert law firm.

The book’s separate chapters describe the essential legal principles in 38 different countries. This latest edition includes new chapters on China, the Czech Republic, Kazakhstan, South Korea and the United Arab Emirates, among others. Each chapter has been written by a leading law firm in the relevant jurisdiction. For example, the chapter on the United States was written by Dan Bailey and Darius Kandawalla of the Bailey Cavalieri law firm.

Each chapter provides a country-specific overview of the legal principles governing directors’ duties and obligations. The text also contains a description of the claims environment in each country, including the relevant considerations regarding criminal and regulatory liability. The information also includes the principles governing the availability of indemnification and insurance in each country, as well.

The information for each country is presented succinctly and provides more of an introduction to the critical legal considerations than it does a comprehensive dissertation. This volume will be most useful to those looking for a quick impression of the legal environment. For those looking for a deeper understanding, this volume at least provides some starting points.

It seems likely that legal challenges arising from the cross-jurisdictional conduct of business will only increase in the months and years ahead. This volume will likely prove a valuable resource for insurance advisors and others called upon to counsel companies in connection with the associated liability exposures and related insurance considerations. We can only hope that this book’s editors and authors will continue to update and expand this volume in the years ahead.

Many thanks to Ed Smerdon for providing me with an opportunity to review an advance copy of the book.

D&O Insurance Implications of Dodd-Frank: The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 introduced sweeping reforms to every aspect of the country’s financial system. In addition, many of the Act’s provisions – including in particular its new whistleblower bounty sections -- seem likely to lead to increased SEC enforcement activity. The enforcement activity could in turn lead to follow on civil litigation.

The Act’s potential enforcement and litigation implications also carry important D&O insurance implications. These considerations and implications are reviewed in detail in a February 2011 article entitled "Dodd-Frank, SEC Enforcement Activity, Whistleblowers and D&O Insurance" (here) by my friend Priya Cherian Huskins and her colleague Carolyn Polikoff of the Woodruff Sawyer firm. Among other things, the authors discuss particular problems that may arise in connection with the Dodd-Frank’s executive compensation clawback provisions, as well as D&O insurance concerns arising from the new whistleblower provisions. The article concludes with a list of eight D&O insurance recommendations.

My thanks to Priya for reaching out to me to include a link to the article on this site.

Failed Bank Litigation Resources: Most readers who are following the events surrounding the current failed bank litigation wave likely are already familiar with the FDIC’s Failed Bank List, which is updated every Friday evening to reflect the latest banks of which the FDIC has taken control.

Another page on the FDIC website of which readers may want to be aware is the FDIC’s Professional Liability Lawsuits page. I have previously linked to this page in prior blog posts, but the FDIC has been updating the page and it now has a number of additional useful features.

First, for some time now, the FDIC has been updating the page to reflect the latest number of former directors and officers of failed banks against whom civil actions have been authorized. The page has recently been updated to show that the FDIC has now authorized civil actions against 130 directors and officers. More importantly, it is clear that the FDIC will be regularly updating this page with new information as additional actions are authorized.

In addition, in the new feature that readers may find most useful, the FDIC has now provided specific details regarding each of the four civil actions it has filed so far against former directors and officers of failed banks. From the way the information is presented (at the bottom of the page), it appears that the FDIC intends to update this information as additional actions are filed. Accordingly, this page could prove to be a valuable resource over time as the number of FDIC actions grows.

I intend to continue to track -- and link to --the FDIC litigation on my own as it is filed, as reflected here. At least for now, the FDIC itself also seems to be committed to tracking and providing this information as well. Many readers may find the FDIC’s page to be a highly credible and (we can hope) timely resource on these issues. I will continue to provide links to the lawsuits.

And speaking of failed banks, the FDIC did take control of four additional banks this past Friday night, as is reflected on the agency’s Failed Bank List. These four new closures bring the 2011 year to date number of failed banks to 18.

The 18 bank failures have been spread across 12 different states, though the largest number of closures this year has been in Georgia (4), which has led the way with the largest number of bank failures since the current wave began. The 18 failures so far in 2011 bring the total number of failed banks since January 1, 2008 to 340.

It is interesting to note that the pace of bank closure so far this year is running slightly ahead of the pace in 2010, when the FDIC closed more banks than it had in a single year since 1992. The FDIC did not close its 18^th bank in 2010 until February 19.

Living in America: On Friday, the determination of peaceful demonstrators in Egypt resulted in the historic overthrow of their oppressive government, but the lead story in Saturday’s Cleveland Plain Dealer was that the Cleveland Cavaliers’ ended their 26-game losing streak on Friday night. The Cavs’ first victory since December also apparently merited a headline in larger type as well.

As a letter to the editor in Sunday's edition put it, "Your newspaper failed to explain why all those Egyptians were so excited about the Cavs game."  

Web Animation Video Phenomenon Even Reaches the Insurance Industry: I know that many of you were as interested as I was in the February 11, 2011 Wall Street Journal article about the increasing numbers of customized computer-generated animated videos, which anyone can make on web sites such as Xtranormal.

One sure sign of how widespread this new phenomenon has become is the animated Xtranormal video now circulating that takes a light-hearted look at the perennial conversation about business between brokers and underwriters. For those of you who have not already seen it, here is the "I Need New Business" video. (The views, attitudes and opinions expressed in the video do not necessarily reflect those of The D&O Diary or its author.)

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

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

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

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

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

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

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

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

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

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

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

Discussion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Background

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

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

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

The December 29 Ruling

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

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

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

Second Judge Pannell rejected the FDIC’s argument that it was entitled to intervene because of its prospective interest in the Company’s D&O insurance policy. Judge Pannell found that the FDIC does not have a "legally protectable interest" because the FDIC "has no rights with respect to this insurance policy except as a potential claimant against certain of the policy’s insured parties," and the FDIC’s "potential future rights" are "insufficient to establish that the FDIC has an interest in this case that justifies intervention as of right."

Finally, Judge Pannell denied the FDIC’s request for "permissive intervention" because the FDIC’s intervention "would needlessly delay the current proceedings while the FDIC investigates to determine whether it has any legitimate claims against the defendants."

Discussion

As NERA Economic Consulting noted in its August 2010 study of failed bank litigation (here), private investor securities suits were "not a notable feature of the S&L crisis," because few of the institutions that failed during that era had conducted securities offerings. By contrast, private litigation against directors and officers of failed banks during the current wave have been "widespread." As a result, the FDIC is in a position of competing with investor claimants for dwindling D&O insurance policy proceeds, as the Haven Trust case demonstrates.

As I discussed in my prior post about the FDIC’s bid to intervene in the Haven Trust case, the claimants who may be competing with the FDIC for the D&O insurance policy proceeds include not only aggrieved investors, but in instances where the bank holding company is in bankruptcy, may also include the bankruptcy trustee.

In both of these kinds of cases, the claims against the individual defendants will be direct claims aimed against them in their capacities as directors and officers of the holding company. At least according to the logic of Judge Pannell’s decisions in the Haven Trust case, the FDIC’s rights as receiver may not be sufficient to allow the FDIC to control or otherwise take priority over these direct claims targeted at the holding company level.

The essential problem at the heart of all of these kinds of disputes is that the parties left aggrieved in the wake of a bank failure are set against one another in a scramble for the D&O insurance (or whatever might be left of it after defense expenses have eroded the limits). Meanwhile, the former directors and officers are put squarely in the crossfire, with heightened exposure to multiple conflicting claims. Whatever else might be the merits of Judge Pannell’s holding, the practical effect of his ruling is to exacerbate all of these forces.

From the FDIC’s perspective, Judge Pannell’s ruling, if followed by other courts, could put the FDIC in a quite a dilemma. On the one hand, the FDIC has been proceeding quite deliberately as part of its process of investigating bank failures and deciding whether to bring claims. (Indeed, even though 322 banks have failed since January 1, 2008, the FDIC has filed only two lawsuits against former directors and officers of failed banks).

On the other hand, however, if by proceeding deliberately the FDIC is to be disadvantaged in the scramble for D&O insurance policy proceeds, and if the FDIC is unable to intervene in and stay investor and trustee actions against former bank officials, it may find itself compelled to move more quickly to file suit, simply to try to preserve a part of the dwindling policy proceeds before the other claimants get there.

Whether or not the FDIC will now accelerate its investigative and litigious processes remains to be seen. But at a minimum, Judge Pannell’s ruling suggests that the FDIC does not have priority rights over the direct claims of bank holding company investors, which is a principle that could prove important in the numerous other failed bank-related proceedings.

Special thanks to the several loyal readers who sent me a copy of Judge Pannell’s ruling.

Editorial Note: In my January 3, 2011 post, I mentioned that I would be publishing a list of the top ten D&O stories of 2010 today (January 4, 2011). However, because of the several time sensitive developments (including the above), I will postpone the publication of the top ten list until later in the week. Sorry for any confusion.

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The FDIC has authorized more than 50 lawsuits against former directors and officers of failed banks, according to an October 8, 2010 Bloomberg article. But merely because the lawsuits have been authorized does not necessarily mean we will see 50 lawsuits, as it appears that the FDIC approval was calculated in part to encourage pre-litigation settlements.

Since January 1, 2008, the FDIC has taken control of 294 banking institutions, as detailed here. The FDIC has been a very active litigant seeking to assert its rights of priority over other litigants’ claims against the directors and officers of failed banks, but the FDIC itself has filed only one lawsuit against the senior officials at a failed bank.

Though the FDIC has to date pursued relatively little litigation itself, it has asserted claims against individuals at failed banks. These claims have come in the form of demand letters nominally addressed to the individuals but also with copies to the failed institution’s D&O insurers.

For example, as discussed here, the FDIC filed a November 24, 2009 motion in the BankUnited Holding Company bankruptcy proceeding asserting its rights of priority to assert claims against Company’s bank unit’s directors and officer. Attached to the motion was a copy of a November 5, 2009 letter the FDIC’s attorneys sent to former directors and officers of BankUnited, in which the FDIC presented a demand for civil damages and losses. Copies of the letter were sent to the company’s primary and first level excess D&O insurers.

With its recent litigation authorization, the FDIC may now proceed to file more lawsuits against directors and officers of failed banks. However, the authorization (and surrounding publicity) may have been calculated to try to avoid litigation and encourage pre-litigation settlement in connection with some of the claims the FDIC has previously asserted in the form of demand letters like the one in BankUnited.

Along those lines, the Bloomberg article quotes an FDIC spokesman as saying that "the goal is to reach as many settlements as possible," adding further that "it’s both in our interest and theirs to try and settle this matter before it gets into court and we get into expensive litigation." Thus, it appears that the authorization and surrounding publicity is designed in part to encourage settlements before available funds have been reduced by defense expenses.

The article cites the FDIC’s estimate that the 50 authorized lawsuits would represent an effort to try to recoup more than $1 billion in losses. By way of comparison, and according to the NERA’ August 2010 report on failed bank litigation (about which refer here), during the S&L crisis, the FDIC recovered about $1.3 billion in D&O claims.

In terms of the number of lawsuits filed, the 50 currently authorized lawsuits would represent about 17% of the 294 banks that have failed since January 1, 2008. During the S&L crisis, the FDIC filed lawsuits in connection with about 24% of the 1.813 failed financial institutions -- meaning roughly 435 lawsuits. Because the institutions failing during the current banking crisis are larger than the institutions that failed during the S&L crisis, the potential litigation recoveries in connection with many of the current failed institutions are proportionately larger.

Even though the FDIC want to try to settle cases if it can, it seems probable that it soon will be filing lawsuits, perhaps many of them in the days ahead. The Bloomberg article quotes the FDIC’s spokesman as saying that "we’re ready to go," adding that "we could walk into court tomorrow and file the lawsuits."

As a loyal reader said, commenting on the reports of the FDIC’s litigation authorization, "Game on." Indeed.

UPDATE: In picking up this story, various news sources have clarified that the FDIC did not authorize 50 lawsuits but rather authorized lawsuits against 50 individuals. Refer for example here. At least one knowledgeable source I consulted confirmed that what the FDIC authorzied was not 50 separate lawsuits, but rather lawsuits against 50 indiviudals. The expectation then is that there might be 5 to 10 lawsuits, which is quite a bit different than 50 lawsuits. Hard to see how the FDIC plans to get to $1 billion in recoveries from that level of litigation activity.

Special thanks to the several readers who sent me copies of the Bloomberg article.

Morgan Keegan Funds ’33 Act Subprime-Related Claims Survive Dismissal: In a September 30, 2010 order (here), Middle District of Tennessee Judge Samuel H. Mays, Jr. granted the defendants’ motions to dismiss the ’34 Act claims but denied the motions to dismiss the ’33 Act claims in the Regions Morgan Keegan Open-End Mutual Fund securities class action litigation.

Plaintiffs are investors in three Morgan Keegan select mutual funds. The defendants are the funds themselves, their corporately affiliated asset manager, related corporate entities, as well as their corporate parent. The defendants include individual officers and directors of the funds and related entities.

The plaintiffs’ allegation is basically that the funds invested in CDOs and other illiquid subprime mortgage-backed investments in excess of stated restrictions on the funds’ investments. The plaintiffs contend that their investment losses are not the result of normal market factors, but rather are due to the funds investment in lower-priority tranches of asset-backed securities. When the market for the instruments began to decline in 2007, the funds found themselves holding assets that quickly declined in value and which they could not readily sell because of the limited market for such investments. Two of the funds declined in value over 70 percent, the third declined over 20 percent.

In reviewing the motions to dismiss, Judge Mays noted that the plaintiffs’ amended complaint "exceeds four hundred pages, comprising 766 paragraphs and six appendices." This extraordinary length may in the end have weighed against the plaintiffs. Judge Mays observed that "when it is possible to ask legitimately, after reading a four-hundred page Complaint, who is being sued for what on a particular count, Plaintiffs have not met the PSLRA’s pleading standards," adding that "it is not for the Court or for Defendants to ask who is ‘relevant’ to a particular count. It is the plaintiffs’ duty to state clearly against whom they seek damages." Judge Mays found that dismissal of the ’34 Act claims on this basis alone is sufficient.

Judge Mays went on, assuming for the sake of analysis that the plaintiffs claims had been pled with sufficient particularity, to hold that the plaintiffs had not sufficiently pled scienter. In attempting to establish scienter, the plaintiffs had relied on the "group pleading" doctrine. Judge Mays assumed for purposes of his opinion that group pleading had survived the PSLRA, but nevertheless concluded that "plaintiffs have failed to demonstrate that the inference of scienter is at least as compelling as any opposing inference of nonfraudulent intent."

But while Judge Mays granted the defendants’ motion to dismiss the plaintiffs’ ’34 Act claims, he denied the defendants motions to dismiss the plaintiffs’ ’33 Act claims, finding that the plaintiffs had adequately identified the allegedly misleading statements in order to state a claim.

I have added the Morgan Keegan ruling to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Indian Summer: Wikipedia’s various supposed explanations for the origins of the phrase "Indian Summer" seem equally implausible and lack the ring of truth. Whatever the origin of the expression, the weather to which it refers is a delight and a balm in our weary world. In a few short weeks, the winds will howl and the snows will blow. But for now, a beneficent sun shines in an azure sky arching over the changing leaves' brilliant colors. It is enough to make your heart glad.

Horseshoe Lake, Shaker Heights, Ohio, October 9, 2010

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With one lone exception, the FDIC has not yet itself pursued litigation against the directors and officers of a failed financial institution. However, the FDIC has already made it clear that it intends to assert its rights under FIRREA as the receiver of failed banks to take control of shareholders’ derivative lawsuits.

More recently, and perhaps more aggressively, the FDIC is now attempting to intervene in two direct shareholder actions where failed institutions’ aggrieved investors are asserting their own claims, rather than derivatively asserting those of the failed institution. These more recent moves may represent efforts not just to assert but to extend the FDIC’s litigation preclusion rights. The FDIC’s actions are interesting in and of themselves, but also for what the FDIC has claimed in asserting its rights.

The FDIC’s most recent move in this direction is its October 4, 2010 motion to intervene in the Haven Trust Bancorp securities class action litigation pending in the Northern District of Georgia. A copy of the FDIC’s memorandum in support of its motion to intervene can be found here. Haven Trust Bancorp was the parent corporation for Haven Trust Bank, a Duluth, Georgia failed bank of which the FDIC took control on December 12, 2008.

The FDIC has previously moved to intervene in the negligent misrepresentation lawsuit that individual investors had filed in Fulton County (Georgia) State Court against certain former directors and officers of Georgian Bancorp. A copy of the FDIC’s September 23, 2010 motion to intervene, and accompanying motion to remove the case to federal court upon grant of the intervention, can be found here. Georgian Bancorp was the corporate parent of Georgian Bank, of which the FDIC took control on September 25, 2010. My prior post about the Georgian Bancorp case can be found here.

Both of these lawsuits are direct, not derivative, actions. In each case the plaintiffs seek to recover damages in the form of their own lost investment interests. In asserting that it nevertheless has the right to intervene, the FDIC raises a number of interesting arguments.

First, in both cases, the FDIC asserts that both cases are basically just derivative lawsuits in disguise. Thus, for example, in the Haven Trust case, the FDIC asserts that "although Plaintiffs have attempted to frame their allegations of wrongdoing and damages in terms of securities fraud and misrepresentations …Plaintiffs’ alleged losses clearly emanate from the fact that the Bank, as sole asset of the Holding Company, became worthless upon the appointment of the FDIC as receiver for the Bank." In the Georgian case, the FDIC asserts that the plaintiffs’ claim is "in substance a derivative claim." The FDIC asserts, the shareholders’ claims are, in effect, "double derivative" claims.

Second, the FDIC asserts that as receiver of the respective banks, under 12 U.S.C. Section 1821 it has succeeded to "all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder … of such institution with respect to the institution and the assets of the institution." In reliance on this provision, the FDIC asserts as an initial matter that it has priority rights to assert the claims presented in the respective plaintiffs’ complaints, because they are essentially derivative complaints.

The FDIC’s further argument in reliance on this statutory provision is with reference to the respective institutions’ D&O insurance policies. Thus, for example, the FDIC asserts in the Georgian case that among the assets with respect to which it assumed priority upon being appointed receiver was Georgian’s D&O insurance policy, which "provides limited and finite monies for claims covered by the Policy and may be the only source of recovery against the Defendants in this or any subsequent lawsuit."

The FDIC points out further that the D&O policy is a "wasting asset" that would be reduced by defending the plaintiffs’ claims. The FDIC has the right to intervene, it therefore asserts, because "its ability to recover in a subsequent lawsuit will be affected by any judgment in this action or protracted litigation."

The FDIC is even more explicit about the possibility of its pursuing claims in its intervention motion in the Haven Trust case. There the FDIC explicitly stated that its investigation includes examination of the "acts and/or omissions of the Bank’s former officers and directors in connection with their management of the Bank’s affairs." The FDIC states that after completing its investigation it will determine "whether claims should be brought against any individual or entity," noting that "several of the defendants in this case, as former officers and/or directors of the Bank, are potential targets."

There are a number of concerns with the grounds on which the FDIC is moving to intervene. First, the FDIC completely disregards the investors’ own legal right to assert their own claims for their own alleged financial injuries. Second, and perhaps more to the point, the investors are asserting their claims as shareholders of the parent holding companies of the failed banks, not of the failed banks themselves. The FDIC’s priority rights extend to its rights as receiver of the failed bank. Whether the FDIC can assert rights on behalf of the parent holding company of the failed bank is a potentially contentious proposition.

Section 1821 (d)(2)(A)(i), on which the FDIC relies to assert its priority rights, refers to the rights, titles, etc., of the "insured depositary institution, and of any shareholder …of such institution." However, the plaintiffs’ in this shareholder suits are not asserting rights as shareholders of the institution, but of the parent holding company. The FDIC may or may not be able to persuade a court to make the leap from its rights as receiver of the failed bank to the rights of the shareholders of the bank’s parent company, but the argument seems to strain the language of the provision.

Finally, the FDIC may indeed be interested in preserving the D&O policies, but there is nothing about Section 1821 that gives the FDIC priority to the proceeds of the policy, in preference to other prospective claimants. The insurance proceeds are not a cash fund like an investment account: rather, the proceeds are available only for payment of certain kinds of loss arising from claims. The policy itself may be an asset of the estate, but the proceeds are available only pursuant to the terms and conditions of the policy, only for payment of claims, and the rights of the insureds and the claimants to the proceeds of the policy are determined by the policy’s own terms.

Whatever else may be said about the FDIC’s actions in moving to intervene in these case, they do show both that the FDIC is actively considering pursuing its own lawsuits, and that it is will to move aggressively to preserve its own recovery prospects in the event it subsequently decides to pursue lawsuits. The pretty clear message is that the FDIC does intend to pursue lawsuits, too.

As if the prospect of competing lawsuits from both investors and regulators were not daunting enough for directors and officers of failed institutions (and their insurers), a lawsuit recently filed in South Carolina suggests yet another type of prospective claimant that may be asserting claims against failed banks’ directors and officers.

On September 29, 2010, the trustee for the estate of Beach First National Bankshares filed a lawsuit in the Bankruptcy Court for the District of South Carolina against certain directors and officers of the bankrupt company. A copy of the complaint can be found here. The company’s wholly owned subsidiary, First National Bank of Myrtle Beach, was closed on April 9, 2010 The Trustee’s complaint asserts claims for breach of fiduciary duty and negligence.

While the Trustee may have seized the initiative in this case, there would seem to be the possibility that the FDIC might yet seek to intervene in the Trustee’s case just as it did in the cases described above. Disappointed shareholders might also seek to assert their own claims for harm to their own investment interests, particularly since the First National holding company is a publicly traded company.

The possibility of claims asserted by these various prospective and active claimants underscores how one of the consequences of a bank failure may be a scramble for the proceeds of the insurance policy. The FDIC may well contend that under FIRREA it has certain priorities but other claimants are also highly motivated to circumvent the FDIC’s asserted rights.

Of course in the end the FDIC may establish its priority. But in the meantime, the scramble for the D&O insurance could become quite a circus. And in the center ring could be the directors and officers of the failed institutions – and their insurers – against whom the competing claimants will assert their claims. The likelihood for further D&O litigation involving failed banks’ directors and officers seems high.

One final thought about the FDIC's interventions in the two case discussed above -- there have been a fair number of shareholder class actions brought by investors in failed financial institutions. It will be interesting to see how far the FDIC goes with thie intervention tactic and whether it will seek to intervene in other cases involving larger financial institutions. Perhaps its initiatives in the two Georgia lawsuits are test cases that will determine whether it will seek to intervene elsewhere.

Many thanks to a loyal reader for providing copies of the various pleadings to which I linked above.

A copy of an October 3, 2010 Myrtle Beach Sun News article about the Beach First Trustee’s lawsuit can be found here. (Full disclosure, I was interviewed in connection with the article.)

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

Bank Failures to Date

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

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

Possible Future Bank Failures

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

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

Comparison to the S&L Crisis

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

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

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

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

Failed Bank Litigation

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

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

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

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

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

Conclusion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Discussion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Background

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

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

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

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

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

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

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

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

The June 7, 2010 Opinion

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

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

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

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

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

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

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

Discussion

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Background

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

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

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

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

The Court’s Opinion

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

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

Judge Story found that

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

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

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

Discussion

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

But there’s no nostalgia here.

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

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

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

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

Strap on your helmets.

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

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

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

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

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

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

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

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

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

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

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

The complaint can be found here.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

This year’s conference promises to be particularly interesting and informative. I am co-Chairing this year’s Symposium with my good friends, Chris Duca of Navigators Pro and Tony Galban of Chubb. The key note speakers include former Secretary of States Madeline Albright and New York Insurance Superintendent Eric Dinallo. Other panelists and speakers include a number of noteworthy individuals, including Stanford Law Professor Joseph Grundfest, Wilson Sonsini partner Boris Feldman and many others.

The Symposium will also feature a reprise of the excellent video, first shown at the PLUS International Conference in November, of "The Life and Times of Bill Lerach." The Securities Docket recently featured a trailer of the video, here.

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

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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.

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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.

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