Darnell J Parker | Failed Banks Cast Long Shadows: FDIC Targets Insiders, Other Professionals

Published On September 16, 2013 » 1153 Views» By parker » Uncategorized

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In the wake of the global financial crisis, the FDIC has commenced a wave of lawsuits against and criminal investigations of the officers and directors of failed banks, and those who did business with them. What can senior executives, companies, and their counsel expect?

In addition to the increased general activity, they will have to be aware of how FDIC matters differ from more traditional areas. This is because the FDIC has powers that are broad in scope and reach, which it is now signaling it will use. In civil litigation, the FDIC has the power to hold officers and directors of failed banks personally liable for bank losses caused by their negligence or other misfeasance. The standard of care can vary by jurisdiction and, in New York, bank directors are not protected by the business judgment rule.

The FDIC also benefits from extended statutes of limitations in tort and fraud actions. On the criminal side, investigations and prosecutions stemming from bank failures involve a broad range of charged offenses and a wide variety of underlying conduct.

Senior bank executives, directors, companies, and their counsel must monitor developments over the coming months and years. As the various investigations develop, there will likely be systemwide effects caused by the FDIC’s expanded enforcement activities.

Background

In 2005 and 2006, there were no bank failures.In 2007, three banks insured by the FDIC became insolvent.

In 2008, as the subprime crisis beganto make itself felt, 25 banks failed. As the crisis deepened, in 2009, there were 140 bank failures.

And in 2010, the number was 157—the worst yearfor bank failures since 1992. These statistics donot include the hundreds of banks that the FDICcurrently deems “at-risk”—some of which willalso probably fail.

A significant number of failed banks are inIllinois, California, Florida, Minnesota, Washington,and Georgia. But failures have occurred throughoutthe country, including at least five in New Yorkand four in New Jersey.

The country has not seen so many bank failuressince the savings-and-loan crisis of the 1980s, whenmore than 1,000 banks collapsed, at a cost to thegovernment of over $100 billion. In response to thatcrisis, Congress passed the Financial InstitutionsReform, Recovery & Enforcement Act of 1989(FIRREA). The supervision and enforcement toolscreated by FIRREA have been and will be usedby the FDIC and other government agencies torespond to the current crisis

Lawsuits Against Executives

Personal Liability.

As the receiver for failed banks, the FDIC has authority to recover lossescaused by unsound practices by bank officersand directors. The bank officers and directorsare personally liable for such losses. See 12 U.S.C.§1821(k) (a “director or officer of an insureddepository institution may be held personallyliable for monetary damages in any civil actionby…the FDIC as receiver”).

According to The Wall Street Journal, the

FDIC has sent hundreds of “demand” letters

notifying former bank employees of potential civil

claims.

Lawsuits against 109 bank officers anddirectors seeking at least $2.5 billion were recentlyauthorized.

“These numbers will continue toincrease as time goes on,” according to RichardOsterman, the FDIC’s acting general counsel.

Standard of Care.

The applicable standardof care depends on state law. And 12 U.S.C.1821(k) provides that recovery may be basedon “gross negligence.” However, the SupremeCourt has held that the phrase “gross negligence”does not immunize directors and officers fromliability for less culpable conduct—such asordinary negligence—but rather “provides only a floor,” with states free to enact more stringent requirements.

Atherton v. FDIC , 519 U.S. 213, 227-28 (1997). Thus, no uniform standard of care applies to bank officers and directors, though the banks are federally insured, regulated and supervised.Atherton , 519 U.S. at 214. The Business Judgment Rule May Not Apply.

Although many states provide some protection to bank directors through the business judgment rule, New York does not. New York Banking Law §7015(1) provides that bank directors must act “in good faith” and exercise the “degree of diligence, care and skill” that an ordinarily prudent person would exercise under similar circumstances. Courts have interpreted this statute to mean that the business judgment rule does not apply in suits by the FDIC alleging misconduct. See

FDIC v. Bober , 2002 WL 1929486, at 2, No. 95 Civ. 9529 (JSM) (SDNY Aug. 19, 2002) (Martin, J.) (interpreting the statute to mean that New York bank directors are denied the protection of the business judgment rule and are subject to a more stringent standard); FDIC v. Ornstein , 73 F.Supp.2d 277, 280 (EDNY 1999) (Gleeson, J.); Resolution Trust Corp. v. Gregor , 872 F.Supp. 1140, 1151 (EDNY 1994) (Ross, J.) (noting that defendants admitted they could not find any New York authority applying the business judgment rule to bank directors). Thus, New York bank directors facing personal liability in FDIC suits based on alleged negligence will have difficulty obtaining pretrial dismissals.

Even in states where the business judgment rule applies, bank directors have had limited success using the rule to their advantage. See, e.g., FDIC v. Schreiner , 892 F.Supp. 869, 875-84 (W.D. Tex. 1995) (denying bank directors’ motion for summary judgment under Texas business judgment rule because the directors failed to thoroughly evaluate borrower’s creditworthiness); FDIC v. Gonzalez- Gorrondona , 833 F.Supp. 1545, 1561 (S.D. Fla. 1993) (denying directors’ motion to dismiss based on Florida business judgment rule where “bad faith and management,” “failure to establish proper monitoring procedures,” “failure to supervise” staff, and “abandonment of responsibility” were alleged); FDIC v. Miller , 781 F.Supp. 1271, 1277-78 (N.D. Ill. 1991) (denying motion to dismiss under Illinois business judgment rule where FDIC alleged that bank director “did not perform her duties with care and diligence”).

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