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FDIC Cracks Down on Insurance for Civil Money Penalties

For the last 20 years, directors and officers (D&O) liability insurers have been including endorsements on their policies that also provide directors and officers with indemnification against civil money penalties assessed by a court or regulatory agency as a punishment for wrong doing. Seemingly, the only requirement was that the directors or officers paid for the cost of the endorsement out of their own pockets, even though the D&O policy itself had been obtained by the company.

Recently, however, it appears that the Federal Deposit Insurance Corp. (FDIC) has begun to enforce a provision of the Federal Deposit Insurance Act-known as Part 359-that prohibits banks from including coverage for civil money penalties in their D&O policies even if the covered individuals reimburse the bank for this additional cost. Of late, the agency’s examiners have been scrutinizing bank D&O policies to see whether the forbidden coverage has been provided.

From the FDIC’s perspective, there is no doubt a compelling public policy motivation behind the prohibition against insurance coverage for civil money penalties. These are generally assessed when the director’s or executive’s behavior has been especially egregious, and denying such behavior the protection of third-part indemnification theoretically provides a significant incentive to walk the straight and narrow.

And yet the FDIC’s aggressive pursuit of D&O insurance proceeds in recent years-the agency has authorized 1,058 lawsuits against the directors or officers at failed banks since 2009, including 316 through early December of 2013-gives board members good reason for concern. “For individuals serving as officers or directors of banks, civil money assessments represent a potential risk to personal assets,” says Ken Achenbach, an associate with the law firm Bryan Cave LLP in Atlanta. Of course, this unwelcome development occurs when the compensation for bank directors hasn’t kept pace with an increasing work load due in large part to heightened regulation.

It is possible that D&O underwriters might eventually offer separate coverage for civil money penalties that directors and officers would be able to purchase on their own, although no D&O carrier is currently offering this coverage. It is also unclear whether the FDIC would allow directors to purchase a stand-alone policy that offers indemnification protection against civil money penalties.

Jack Milligan

Regulators Eye Bitcoin

Bitcoin may be a great step forward or a facilitator of illegal activity, or both. At its heart, Bitcoin operates as a peer-to-peer payment system with no middleman and no governing body.

Adam Shapiro, director at consulting firm Promontory Financial Group, thinks bankers should think of Bitcoin less as a currency and more as the next step forward in bank technology. Bitcoin allows users to more cheaply and quickly send money throughout the world, he says. “That has incredible power, if it can be made safe and convenient for the mass market.”

However, Jennifer Shasky Calvery, director at the Financial Crimes Enforcement Network (FinCen), a bureau of the U.S. Department of Treasury, says she is watching to see if it lasts. “It’s in its infancy though, and there’s a lot of infrastructure that needs to rise around it.”

Digital currency isn’t without its problems. Bitcoin’s value can be volatile. The U.S. government is concerned with the potential for Bitcoin to facilitate illegal activities such as money laundering, as users are anonymous and the currency is transferred without the use of banks or other regulated entities. This was highlighted most recently in the Silk Road bust, referring to a black market website for drug deals, in which 144,000 Bitcoins, valued at the time at $28 million, were confiscated by the Federal Bureau of Investigation. In November, a 4-month-old online wallet, essentially a Bitcoin bank operated by an Australian man known online as TradeFortress, was hacked. The theft of 4,100 Bitcoins left him unable to pay back depositors. It’s something that could happen in the U.S., as Bitcoin investments are not insured.

Cue the regulators.

A letter published in September 2013 by then-Federal Reserve Board Chairman Ben Bernanke indicated that the Fed would only have the authority to regulate digital currency “if it is issued by, or cleared or settled through, a banking organization that we supervise,” adding that currency like Bitcoin holds promise, “particularly if the innovations promote a faster, more secure and more efficient payment system.”

Calvery heads one of the chief federal agencies in charge of enforcing the Bank Secrecy Act and provisions against money laundering. She testified before a hearing of the Senate Committee on Homeland Security and Governmental Affairs last November and feels that, for now, current regulations are enough. Much of FinCen’s focus falls on Bitcoin exchangers who buy and sell the currency, and these businesses are regulated by the agency. “We don’t know how it’s going to develop, so we’ll see over time whether we need to make any changes but right now we feel pretty comfortable,” she says. Patrick Murck, general counsel of The Bitcoin Foundation, a non-profit organization serving the Bitcoin community, agrees. “Over-regulation risks stifling innovation and driving Bitcoin-based businesses and venture capital overseas,” he says.

While Sen. Heidi Heitkamp of North Dakota and others at the hearing agreed that it’s perhaps best to leave Bitcoin alone, some state regulators have concerns. The New York Department of Financial Services plans to take a closer look, which may lead the state to issue a BitLicense to businesses that want to use the digital currency. Regulators in Virginia and California are also keeping tabs on Bitcoin.

In his Senate testimony, Murck stressed the importance of banker involvement in furthering the legitimacy of Bitcoin. “Established banks could provide expert counsel and cultivate customer relationships with these companies, and we think they should,” he said.

“Banks have been dealing with difficult AML [anti-money laundering] issues for a lot longer than Bitcoin companies, whose management generally come from tech roots and don’t have exposure to financial services risk and compliance,” says Shapiro. They “would benefit from the expertise that banks have developed over the years. Banks with strong AML programs that see opportunity in Bitcoin have a strong case to make to their regulators that banking these companies-and subjecting them to rigorous AML oversight-will help reduce anti-money laundering risk.”

Perhaps with some trepidation, it looks like banks are beginning to come around to Bitcoin. Bank of America Corp. initiated analyst coverage of the digital currency in December 2013, saying in a report that Bitcoin “may emerge as a serious competitor to traditional money transfer providers. As a medium of exchange, Bitcoin has clear potential for growth.” Other major financial institutions likely won’t be far behind.

For banks interested in working with Bitcoin exchanges, Calvery recommends looking at the firm’s integrity and transparency. “There have been some issues around some folks absconding with the money,” says Calvery. But she says that doesn’t mean banks shouldn’t do business with Bitcoin. “There appear to be a lot of legitimate business folks who are interested in trying to develop this product, and we’ll see where it goes.”

Emily McCormick

The Financial Crisis and Its Costs

Question: What is green, opaque and bigger than what the big banks earned in all of 2012? Answer: The legal costs and settlements associated with the financial crisis. The six largest U.S. banks have spent more than $103 billion in legal costs, according to a Bloomberg tally in August 2013. Since then, JPMorgan Chase & Co. settled with state and federal regulators for $13 billion over mortgage-related lawsuits. It settled the following November with 21 institutional investors for an additional $4.5 billion over the sale of mortgage-backed securities. Worldwide, in the third quarter last year alone, 13 global investment banks reported $13.8 billion in legal costs, according to investment bank Keefe, Bruyette & Woods. KBW estimates that just three cases could cost global investment banks another $96 billion and take a decade to resolve-the mortgage-related claims from the Federal Housing Finance Agency on behalf of Fannie Mae and Freddie Mac, the LIBOR [London Interbank Offered Rate] scandal, where it appeared traders had manipulated the LIBOR, and the foreign currency exchange (FX) affair. The latter is very similar to the LIBOR case in that traders at global banks are accused of getting together in a group called “the cartel” to manipulate benchmark exchange rates.

So what does that mean for the biggest banks? There is a lot of money going into the hands of plaintiffs and their attorneys and not in the hands of shareholders. “Investors are finding it difficult to quantify all of the different cases and allocate a cost to each issue, which is already dragging on the valuation of the affected stocks,” says Andrew Stimpson, a London analyst for KBW. Once investors feel more comfortable with the costs, those bank stocks will look like good value, he says. Fannie Mae just filed a LIBOR lawsuit last fall, more than a year after the scandal broke. The average time to resolve a case is three and a half years, but other claimants haven’t even filed their cases yet, he says. The biggest banks in the world may have survived the financial crisis, but they, and their shareholders, haven’t got off scot-free.

Naomi Snyder

Bank Director Staff Writer

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