Looking for Someone to Blame

When a federally insured bank is closed, the FDIC is appointed as conservator or receiver. The FDIC may then pursue a claim against directors or officers of the failed institution in an effort to recoup losses to the BIF. Between1985- 1992 (the last financial crisis), the FDIC initiated claims against the former officers and directors in approximately 24% of the failed institutions it investigated.

On July 2, 2010, FDIC filed its first lawsuit in the current financial crisis against officers and directors of a failed financial institution (Indy Mac Bank) two years after failure. Since then, FDIC has filed 9 additional civil complaints against 96 officers and directors seeking to recover losses to the BIF caused by their banks' failure. As of August 2011, FDIC has authorized civil lawsuits against 30 additional failed banks and 266 individuals for D&O liability with damage claims of at least $6-8 billion. Since 2008, 434 banks have failed. As of June 2011, there are 865 banks on the FDIC Problem Bank List.

According to an FDIC Policy Statement, claims will not be brought against officers and directors "who fulfill their responsibilities, including the duties of loyalty and care, and who make reasonable business judgments on a fully informed basis and after proper deliberation." Actions will be brought against officers and directors in instances when the FDIC believes that there is evidence of:

• Dishonest conduct or abusive insider transactions,

• Violations of internal policies, law or regulations that resulted in a safety or soundness violation, or

• Failure to establish, monitor or follow proper underwriting procedures or heed warnings from regulators or advisors.

Director Duties and Responsibilities

Bank directors are accountable to shareholders, depositors and regulators. Directors must exercise independent judgment and actively participate in decision-making and are individually responsible for knowing the condition of the bank (e.g., cannot rely on the ROE to inform them). Directors have two basic fiduciary duties and FDIC lawsuits against directors generally allege intentional or negligent violations of one or both of them.

The Duty of Care

Directors are required to exercise the same level of care in making decisions for the bank that ordinary persons would use in making their own personal or business decisions.

Common Breaches of the Duty of Care

• Failure to adopt and/or follow adequate policies and procedures

• Permitting violations of law

• Failure to hold regular board and committee meetings

• Failure to attend board and committee meetings

• Failure to properly supervise management

• FAILURE TO ACT ON THE RECOMMENDATIONS OF REGULATORY AUTHORITIES

The Duty of Loyalty

Directors are required to administer the affairs of the bank with candor, personal honesty and integrity. Directors cannot use inside information for stock trades or otherwise; must conduct all transactions with the bank at arm’s length; and must maintain confidentiality of all information provided to the board or committees.

Common Breaches of the Duty of Loyalty

• Unauthorized disclosure of confidential information

• Use of confidential information for personal benefit

• Failure to disclose conflicts of interest

• Violations of the bank’s code of ethics policy

Federal Minimum Standard of Liability

The federal minimum standard of liability is 'gross negligence', but FDIC may rely on a lesser 'simple negligence' standard if established by state law.

Potential Defenses

All of the following defenses have been (or will be) raised by defense counsel at one time or another in defending actions against directors for breach of fiduciary duties.

• FDIC's failure to establish proof of negligence (gross or simple)

• Reliance on management expertise

• Reliance on retained experts

• Reliance on committee due diligence

• Business Judgment Rule

  • Decisions made

    • In good faith

    • After reasonable efforts to inform

    • On rational belief that action taken was in the best interest of the bank

• Reliance on regulators' satisfactory reviews of bank condition

• Statute of limitations

D&O Insurance- Key Provisions

When the FDIC brings actions against bank directors following bank failure, it hopes to be able to reach the directors' D&O insurance policy benefits. On this issue, the interests of the FDIC and bank directors are aligned. Thus, it is important for directors to understand the terms and limitations of their D&O insurance coverage.

Basic Coverages

• Side A: covers claims against officers and directors to the extent the bank or holding company is not permitted or is unable to indemnify them.

• Side B: reimburses the company for its obligation to indemnify officers and directors for claims against them.

• Side C: covers the liability of the bank or holding company for securities claims.

Key Definitions/ Key Clauses

• Claim – Should be defined to include informal investigations, subpoenas and criminal matters.

• Cancellation – Reasons should be limited to nonpayment.

• Rescission – Side A coverage should be non-rescindable.

• Claim Reporting:

  • Timing – As soon as practicable.

• Allocation / Order of Payments:

  • One aggregate limit of liability is shared for Side A, B and C coverage and among all directors and officers.

  • Order of payments provisions that are most advantageous for directors and officers make payments first under Side A coverage to protect directors and officers

  • Consider a stand alone Side A policy

Key Exclusions

• Fraud/Dishonesty:

  • No coverage for fraud, dishonesty or criminal acts

Insured v. Insured:

•  
  • Claims by officers/directors against one another
  • Does not apply to FDIC as receiver in actions v. directors and officers
    • But still being raised as a defense by insurers

The "Regulatory Exclusion", in one form or another, expressly excludes coverage for claims brought by FDIC as receiver against a failed bank's officers and directors.

However, it may be possible to negotiate retaining coverage for defense costs.

In Anticipation of Bank Failure -- How To Prepare

• Record all informal meetings participated in and correspondence received regarding the institution.

  • Log all telephone calls

  • Retain copies of emails and letters exchanges with management, regulators and counsel.

• Engage Special Counsel to the board. Regular bank counsel cannot represent directors.

• Review D&O insurance policies and obtain additional coverage if possible

• AGGRESSIVELY TAKE ALL REASONABLE STEPS TO SAVE THE BANK

  • Raise capital

  • Sell assets

  • Market the bank to potential buyers/merger partners

• DOCUMENT ALL ACTIONS

If the FDIC seizes your bank…

• The FDIC will file a claim for 100% of the available coverage under the bank’s D&O policy.

• Place D&O carriers on notice of claims and seek coverage determinations.

• Engage legal counsel for the Board (should have been done earlier)

• Consult with your new legal counsel before talking to the FDIC.

  • As of the moment the FDIC seizes the bank, all communication with the FDIC and its representatives should be deemed to be adversarial and made in anticipation of litigation.

• If your bank has a holding company, consider engaging bankruptcy counsel for the holding company.

When the FDIC Takes Over

• FDIC steps into the shoes of the institution, its shareholders, and its management.

• Statutorily required to investigate why failure occurred.

• All documents pertaining to the failed institution become the property of the FDIC, and the FDIC may refuse to provide copies to former directors.

• Bank counsel now reports to the FDIC.

  • May not be permitted to communicate with former directors.

  • May be prohibited from providing documents to former directors.

  • No more attorney/client privilege with Bank counsel. Communications now owned by the FDIC.

Final Thoughts

1. Adopt adequate policies and procedures (revise, if necessary)

   • Follow them

   • Document actions

2. Promptly correct any cited violations of law

   • Document actions

3. Attend all Board meetings

   • In person or via teleconference

   • Document actions

4. Act independently of management

   • Review management reports

   • Document actions

5. Promptly resolve all recommendations of regulators

   • Document actions

6. Comply with all requirements of regulatory enforcement actions---or explain why not

   • Document actions

7. Actively search for capital and/or merger partner

   • Document actions

8. Engage Special Counsel to the Board

9. Document everything. If it isn't written, it didn’t happen

For more information on this subject, contact Len Rubin at len.rubin@nelsonmullins.com.