FDIC Launches Full-Scale Attack on Bank Directors

As financial institutions fail, government seeks money from former management

With bank failures piling up, the FDIC has initiated vigorous legal attacks on bank directors and officers. Reflecting the same tactics that yielded about $2.5 billion in settlements from directors and officers following the savings and loan crisis of the late 1980s, bank regulators are undertaking a full-court press against bank management.

However, if bank directors and officers take a few basic precautionary measures, the risks and the damages can be substantially mitigated.

First the Earthquake, Then the Tidal Wave

The tremors from the financial crisis triggered the collapse of 311 institutions and the official declaration that nearly 800 more could come tumbling down soon.

Among the debris of the latest wave of bank failures is the following:

• · The FDIC announced in November that it was considering lawsuits against 80 officers and directors, and working on 50 possible criminal claims.
• · The law firm of Bryan Cave was sued by the FDIC to produce documents they were holding in connection with five failed banks.
• · The FDIC has sent hundreds of letters to banks notifying them of possible claims and advising these institutions to notify their liability insurers.
• · The FDIC filed the first lawsuit in the nation against directors and officers of a recently closed Illinois bank.

This “rolling thunder” of FDIC actions duplicates the tactics from 20 years ago. Then, as now, the FDIC notified banks as they were being closed to prompt the filing of insurance claims. However, the lawsuits did not begin to fly until two or three years following the closing of the bank or savings and loan, hence creating a backlog of bank director and officer litigation well into the 1990s. Expect the same. The first lawsuit against a failed bank was filed this fall — nearly two years following the closing of the bank. Based on this schedule, directors and officers of failed banks should prepare for legal battles that will not be concluded until 2015 or later.

Director Checklist — Troubled Banks

For a “troubled” bank, directors should begin putting plywood over the glass windows of their management style as hurricane FDIC comes ashore. The troubled bank is one that is effectively on probation by the FDIC — usually the subject of a cease and desist order or memorandum of understanding. These regulatory orders often direct the bank to rapidly improve the management and finances of the institution. Also, the bank may show significant losses due to loan write-offs, and does not have much capital to absorb another dropping shoe of a non-accrual loan.

Directors and officers should take the following steps, among others:

Work overtime to address as many of the criticisms as possible in the memorandum of understanding or cease and desist order. These days, safety and soundness is king — which means addressing problems in making and managing loans. Have the files reviewed, organized and completed. Frequently a troubled bank has a troubled history of documenting loans. Staff will need to stay late to organize loans and complete missing documents. If the regulators demand new management, look for ways to supplement or shift management responsibilities. If regulators demand higher capital ratios, adjust the balance sheet and solicit more investors. Failure to substantially address criticisms will provide great ammunition to the FDIC as it tells a judge that the directors repeatedly demonstrated a fatal nonchalance toward regulatory orders.

Update and complete policies and procedures. All policies should be vetted to ensure that they are at least as good as those of similar banks, if not better. Since a court will subject management practices to unrealistic scrutiny, the policies and procedures should likely be more complete than those of bank peers.

Create committees of independent directors. Banks should demonstrate a willingness to separate oversight of the board from the daily management of the institution. Frequently, banks encounter problems when the owner is the president and the dominant director. If the board is more of a rubber stamp than an independent overseer, the FDIC will more likely sue the directors individually. The bank should empower outside directors, even if this requires establishing independent committees to review loans and prior procedures.

Document personal effort. FDIC lawsuits are personal attacks, and therefore the director needs a personal defense. This requires that the director document the effort to persuade the board to take actions requested by the regulators; if the other board members balk at addressing the problems, the minority squeaky-wheel director should send emails and memoranda that demonstrate an effort to convince the board to address problems.

Review the directors’ and officers’ insurance policy. Notify the carrier if a claim is imminent. Be aware of actions that would trigger an exclusion.

Director Checklist — Failed Banks

Once the FDIC has closed the bank, the game changes dramatically. For the bank director, everything is history — which may be written by a hostile judge. The time for hard work and conscientious documentation is over. The FDIC becomes the “receiver”; the brain and body of the private sector bank becomes inhabited by the government. Internally, the FDIC will initiate a formal inquiry into the actions of the bank’s officers and directors, including a dragnet-like review of the bank’s records, interviews of bank employees and subpoenas of former management. The process culminates with a lawsuit, the first of which was filed this fall, and more will likely follow.

Therefore, after the failure, directors (or rather, former directors) should quickly undertake the following:

Hire a personal lawyer with experience with FDIC litigation. The moment the bank is seized, the counsel to the bank is beholden to the government receiver. The director’s relationship has been completely and permanently severed. Rights to advice, documents and confidentiality cease. Ironically, the attorney to whom management confided in the days before the closing becomes the legal warrior for the FDIC the day after the closing. Anything said to the lawyer can, and probably will, be used against the director.

Limit discussion with other directors. Unfortunately, the rules of the game require that each individual director and officer may be sued for different reasons. Outside directors with ownership stakes of less than ten percent of the bank will be at odds with senior management or a controlling owner. The FDIC lawsuit will be a zero-sum game — the defense of one individual will come at the expense of the defense of another.

Review the directors’ and officers’ insurance policy — again. Now that the bank has closed and the facts have been established, a professional experienced with insurance should review the policy to determine limits, deductibles, and coverage exclusions.

Gather documents. The FDIC will almost certainly demand a copy of all records and correspondence of the director regarding the bank. Therefore, the director should work with his personal counsel to gather and organize documents. In addition, a professional can review the documents to determine the basis for a possible claim by the FDIC.

With the surprisingly severe downturn in the economy in general, and real estate market in particular, banks and their directors have suffered disproportionately. For the directors especially, the hundreds or thousands of hours sacrificed to assist the bank and the community will be rewarded with only an accusatory lawsuit. However, if directors undertake some early actions, and avoid mistakes that compound the legal problems, they should be able to weather the storm and continue their successful business careers.

Craig McCrohon and Aaron Stanton are partners who represent directors subject to FDIC scrutiny, including defending the first FDIC lawsuit filed nationally.

McCrohon is a banking, acquisitions and securities partner. He began his bank regulatory and corporate legal career working with the legal staff of the United States Senate Banking Committee during the passage of laws regarding the savings and loan crisis; he is past chairman of the Consumer Financial Services Committee of the Chicago Bar Association; and he served as lead legal instructor for the Illinois Bankers Association new bank directors school. You may contact Craig McCrohon at 312/840-7006 or cmccrohon@burkelaw.com.

Stanton is a litigation partner who was named one of the top “40 under Forty” attorneys in Illinois (attorneys under the age of 40) by the Chicago Law Bulletin in 2009. Stanton has experience representing officers and directors in breach of fiduciary cases and in securing insurance coverage for his clients. You may contact Aaron Stanton at 312/840-7078 or astanton@burkelaw.com.