The recent news (here) that federal regulators had seized IndyMac Bank in one of the largest bank failures in history brought back memories from the late 80’s and early 90’s, when numerous financial institutions around the country met a similar fate. The litigation surrounding the financial institutions’ collapse kept legions of lawyers profitably employed for years, including your humble correspondent.

 

Among the many types of cases litigated in that era were D&O insurance coverage disputes, and in particular, disputes involving the applicability of the so-called “regulatory exclusion.” The regulatory exclusion typically precludes coverage for claims brought by any governmental, quasi-governmental, or self-regulatory agency.

 

In the competitive underwriting environment that has prevailed in recent years, the regulatory exclusions has become an infrequent part of financial institutions’ D&O insurance policies, a development that has seemed unremarkable as the prior failed bank era has receded into the past. However, with the dramatic news of IndyMac’s regulatory seizure, and the consequent concern that further financial institutions failures may lie ahead (refer here), the issues surrounding the regulatory exclusion could once again become relevant.

 

Undoubtedly in response to these very issues, on July 21, 2008, the Latham & Watkins law firm issues a memorandum entitled “D&O Policies – Regulatory Exclusions” (here). The memorandum briefly reviews the issues that were debated concerning the regulatory exclusion in the last era of failed banks.

 

Among other things, the memorandum correctly recollects that it was not just the insured persons who disputed the regulatory exclusion’s applicability, but it was the governmental agencies as well. The agencies “fought regulatory exclusions clauses using mainly public policy arguments” because the exclusions “impair the ability of the government to seek redress in the situation of a failed bank.”

 

The memorandum notes that the courts found that the “freedom to contract overrode the government agency’s right” to bring claims against individuals. The courts also found that it would not have been against public policy for banks to purchase no D&O insurance at all, so therefore “excluding optional coverage in certain situations would clearly not fall against public policy.”

 

The government also tried to argue that the exclusions were ambiguous. But the courts read the exclusions broadly and in the context of the policy as a whole, and on the basis did not find them to be ambiguous. The courts found that the exclusions applied whether the government was pursuing claims as a regulator or as a liquidator, and regardless whether then government actually brought or was merely maintaining the claims.

 

It remains to be seen whether or not there will in fact be further financial institution failures, and if there are, whether the regulators will pursue claims against the failed institutions’ former management. Even if the government does pursue these kinds of claims, it is relatively unlikely that many of the institutions current policies contain a regulatory exclusion that would preclude coverage for these claims.

 

But the spate of bad news that banks have reported in recent days is a vivid reminder of the challenging circumstances that banks face. D&O underwriters are monitoring these developments with mounting anxiety. As conditions continue to deteriorate, and in particular if there are any further significant financial institution failures, D&O insurers relatively benign approach to the regulatory exclusion could change. The regulatory exclusion could once again become a more common part of D&O coverage for some financial institutions.

 

Of course, all of these things will be revealed in the fullness of time. But the IndyMac bank failure sure does have a familiar ring to it. As Mark Twain famously said, “History doesn’t repeat itself, but it does rhyme.” Along those lines, the current circumstances could start to sound more and more like the prior era of failed banks, and it could involve many of same endings.

 

Oy, Canada: The subprime litigation wave has been sweeping the U.S. for now well over a year. But now the wave finally seems to have spread to our neighbors to the north.

 

On July 23, 2008, a Canadian law firm announced (here) that it had launched a securities class action lawsuit in the Ontario Court of Justice against the Canadian Imperial Bank of Commerce and certain of its directors and officers.

 

According to the press release, the Complaint alleges that:

CIBC misrepresented the magnitude and level of risk associated with its U.S. subprime residential mortgage investments. In particular, CIBC represented during the class period that its total exposure in USSRMM investments, including both hedged and unhedged investments, was "not a major issue" when, in fact, the bank had exposure to billions of dollars of losses, as was only subsequently disclosed.

Further, CIBC failed to disclose that one of its principal hedge counterparties, ACA Financial, was woefully undercapitalized with an asset to guarantee ratio of "1-180" and was far from able to provide any meaningful hedge protection to the bank’s USSRMM investments

CIBC had previously been named as a defendant in a U.S. securities class action lawsuit (as detailed here), but that prior lawsuit involved investments and disclosures by CIBC’s MFS family of mutual funds, and did not relate to CIBC’s own disclosures or activities.

 

In addition to CIBC, another Canadian company, the Royal Bank of Canada (RBC), was also previously named as a defendant in a U.S.-based securities class action lawsuit (refer here), but that lawsuit relates to the sales of auction rate securities by RBC’s affiliate, RBC Dain Rauscher, and does not relate to RBS’s own disclosures or activities.

 

So far as I am aware, the recent lawsuit filed against CIBC in the Ontario Court of Justice represents the first subprime-related securities class action lawsuit to be filed against a Canadian company for the company’s own disclosures or activities.

 

A July 23, 2008 Bloomberg article describing the CIBC lawsuit can be found here.

 

UPDATE: In response to my comment above about Canadian subprime litigation, Ari Karoly of NERA Economic Consulting sent along the following observation: "I wanted to point out that the FMF capital class action which settled last year (refer here) was a class action brought against a US company in Canadian courts with respect to alleged misrepresentations made by FMF regarding subprime exposure and risks. You were technically correct because FMF was a US company which traded on the Toronto Stock Exchange, but I still wanted to bring that case to your attention."

Now We Know Where the Airline Industry Found Its Service Model:  According to a complaint filed on July 18, 2008 in the Hamilton County (Tenn.) Circuit Court (here), when a resident of the Shallowford Trace luxury apartment homes complained of being unable to find a parking place, an employee of the apartment company put a gun between the resident’s eyes and stated “You f***ing b**ch, I’ll blow your f***ing brains all over this concrete” and also “Please give me a reason. I’ve got a permit. I’ll blow your brains out.”

The permit makes everything nice and legal. You wouldn’t want someone without a permit putting a gun between your eyes.

Hat tip to Courthouse News (here) for the Shallowford complaint.