federal depositFollowing the recent bank failure wave, the FDIC filed liability actions against the former directors and offices of many of the failed banks, as detailed here. But the FDIC did not sue the former executives of every failed bank. Why did the FDIC sue the executives of some failed banks but not others? Was it because the failed banks the agency targeted had engaged in qualitatively different conduct? Or was it merely because the ones the FDIC sued had D&O insurance in force from which the agency could extract a monetary recovery?


According to a December 31, 2015 paper by Christoffer Koch of the Federal Reserve Bank and Ken Koamura of the Saïd Business School at the University of Oxford entitled “Why Does the FDIC Sue?” (here), it was the banks’ behavior, not the banks’ insurance, that drew the lawsuits. The banks whose former directors and officers the agency targeted had significantly different “balance sheet dynamics” during the three year period prior to their failure than banks that failed but that whose executives were not sued. From this, the authors in turn concluded that the agency does not merely target bank executives with insurance to pay claims, but rather seeks to set corporate governance standards by suing the executives at banks that were pursuing riskier strategies.


The authors’ paper is the subject of a February 2, 2016 memo by Jonathan Reich of the Womble Carlyle firm entitled “Does the FDIC Only Sue Bankers Who Have D&O Insurance?” (here).



Because the FDIC’s failed bank litigation efforts often are viewed as a salvage operation, there has long been a suspicion that the agency only targets those from whom it believes it can extract a monetary recovery, and in particular that the agency targets executives from banks that have D&O insurance in place. The authors quote a statement attributed to an unnamed former banking regulator who is supposed to have said that “the existence of D&O insurance is the starting point for FDIC officials when they evaluate whether or not to file the suits.” The agency, another commentator is quoted as saying, is “looking at D&O insurance as a resource for replenishing at least a portion of the government’s losses.”


The alternative theory to this “deep pockets” explanation for the FDIC’s litigation approach is that, because the FDIC sees value in improving banks’ governance, it pursues directors “in a systematic fashion reflecting poor governance.” Under this alternative theory, the FDIC targets those banks that were (as described in a phrase from academic literature) “gambling for resurrection” – that is, the banks that were “more optimistic, underprovisioning for losses, and more aggressively pursuing asset growth with riskier funding resources.”


The Authors’ Analysis and Conclusions

In order to try to determine which of these two alternative theories actually represent the FDIC’s litigation approach, the authors reviewed the track records of the 408 banks that failed prior to June 2012. (The authors looked only at banks that failed prior to that time because of the three year statute of limitations within which the FDIC may file liability actions.) The FDIC filed liability lawsuits against the former directors and officers of 161 of these 408 banks, or roughly 35% of the banks that filed during that period. The authors looked at twelve balance sheet measures for all of the failed banks using data from the banks’ Call Reports in the periods preceding their failure, to see if there were differences between the failed banks whose officers and directors were sued and the failed banks whose directors and officers were not sued.


For example, the authors looked at the differences in the banks’ risk-taking behaviors, through such actions as reliance on non-deposit funding (such as commercial paper and borrowing) and the impact such actions had on the banks’ performance. Among other things, the authors found that the banks that depended more significantly on non-deposit funding experienced a deterioration of the return on assets, and that these patterns were more predominant among the banks that failed. The banks that were sued also appeared to be “overly optimistic,” in that among the banks that were sued, there was a dramatic uptick in the provisioning for loan losses in the quarters immediately prior to failure by comparison to the banks that failed but that were not sued.


These and other aspects of the authors’ analysis led them to conclude (through results the authors called “univariate” – which I think means consistent) that “the FDIC is indeed pursuing the ‘right’ directors and officers insofar as the banks being sued likely have been following a riskier strategy.” Their analysis suggests “some degree of over-optimism in sued banks’ directors about the state of their assets as well as signs of gambling for resurrection by accelerating asset growth reliance on riskier funding sources.” In other words, the authors conclude, the agency is not merely pursuing a “deep pockets” litigation theory but in fact seems to be targeting the bank that did in fact engage in riskier behavior.


Final Observations

The authors provide a useful additional observation with respect to the factors the measure in order to assess the banks’ behaviors. That is, the authors note, it “might be helpful if each bank’s board of directors was to receive a report showing how their institution compared to similar institutions on spatial proximity and size,” particularly with respect to the twelve factors the authors used for their analysis and comparison.


Finally, it should be noted that what the authors concluded about the bank directors is also true with respect to D&O insurance underwriters. By using the kinds of comparative factors the authors’ used here, underwriters could identify banks that are deviating toward riskier behaviors. This analysis might or might not help identify which banks are likelier to fail, but it could help identify that banks whose executives are likelier to be sued if the banks were to fail.


My thanks to the several readers who send me a copy of the authors’ article.


Cliffs Natural Resources Settles Securities and Derivative Litigation: A news item caught my eye over the weekend having to do with the settlement of litigation involving Cliffs Natural Resources. According to the company’s February 7, 2016 press release (here), the company has reached a settlement in principle to settle the securities class action litigation pending against the company and certain of its directors and officers, as well as the parallel shareholder derivative litigation, for $85 million, as well as the company’s agreement to adopt certain corporate governance reforms. The company also agreed to pay the derivative litigation plaintiffs’ counsel attorneys’ fees of $775,000. The settlement is subject to court approval.


As discussed here, plaintiff shareholders first filed a securities lawsuit against the company in the Northern District of Ohio in May 2014. The plaintiffs had alleged that the defendants had misrepresented its ability to increase production and reduce production costs at its most important iron ore mining facility, as well as its ability to sustain its dividend payments to investors.


In a November 6, 2015 order (here), Northern District of Ohio Judge Dan A. Polster denied defendants’ motion to dismiss the plaintiffs’ second amended complaint. In his November 6 order, Judge Polster also directed the parties to continue their ongoing mediation efforts. Apparently those efforts culminated in the recently announced settlement.


As massive as this settlement is, it does not even crack the list of the top 100 all-time securities class action lawsuit settlements (here). But while it is not a top 100 settlement, it is still sizeable. While the settlement is interesting in and of itself, what makes it particularly interesting to me is the notation in the company’s announcement that the “totality” of the $84 million settlement will be funded by the company’s “third party insurance carriers.”



This settlement will hit the results of several D&O insurers. Because the settlement amount will be spread among a number of different insurers, this loss alone will not seriously undermine the results for any single insurer. But just the same, it is undoubtedly an unwelcome development for the insurers involved, particularly those on the excess layers of the company’s insurance program.


It may be a competitive D&O insurance marketplace and there may be plenty of D&O insurance available out there, at pricing and with terms and conditions that are attractive for insurance buyers. But it is still a dangerous world out there. In particular, the D&O insurers that concentrate on excess placements – a part of the marketplace where pricing is under particular pressure – the dangers are particularly noteworthy.