Bank Director | Dando Liability Archives

Lessons Learned from FDIC Lawsuits

Posted on May 25, 2012 at 7:03 pm.

As bank failures went on the rise after the crisis of 2008, so did lawsuits from the Federal Deposit Insurance Corp. The target of many of these lawsuits has been both the management of banks, but also independent directors, which can be a scary thought for anyone serving on a bank board today. So what can we learn from this moving forward? Based on the responses Bank Director received from lawyers across the country, the “best practices” today can still be summarized by the same timeless instructions: make sure your board is engaged, get a good directors and officers (D&O) insurance policy, and document, document, document!

What is the most important lesson that bank boards should learn from the surge in FDIC lawsuits, and how should this be institutionalized in the form of a best practice?

Some things never change, and it’s never too late to re-learn old lessons. Directors must remain independent, informed and involved in their institution’s affairs. It’s not enough to simply attend board meetings. Directors need to read materials provided by management, ask questions and actively participate in board discussions. And they should make sure their participation is accurately reflected in the minutes. Special care should be taken when considering transactions with insiders and affiliates, and directors should always require detailed presentations from management regarding steps to address regulatory criticisms raised in examinations or otherwise. In addition, professional advice and expertise should be sought when addressing complex issues or other out of the ordinary course matters, and fully documented when appropriate.

—William Stern, Goodwin Procter

Given that the FDIC has authorized lawsuits in a significant number of failed bank cases, directors are appropriately concerned about liability. I continue to believe that ensuring fulfillment of the two underpinnings of the business judgment rule—the duty of loyalty and the duty of care—remain a director’s best defense against such actions. The bank can help institutionalize that as a best practice by providing full board packages in a timely manner, strongly encouraging attendance at meetings, and making internal and external experts and counsel available to board members.

—Gregory Lyons, Debevoise & Plimpton

There has been a surge in FDIC lawsuits because there has been a surge in bank failures and FDIC losses due to the financial market meltdown and the great recession. Perhaps the most important lessons for bank boards are that 1) capital is KING and 2) process is KING. Moreover, a board has to be diligent and honest in terms of assessing management performance and replacing management as needed. Finally, and as discussed above, a board’s fiduciary obligations require that adequate systems be in place to monitor compliance with laws, regulations and policies and that boards be informed and engaged and take action as necessary when red flags indicate issues or problems in certain areas. A cardinal sin in banking, which mirrors this fiduciary obligation, is to have regulatory violations repeated, i.e., uncorrected. Uncorrected violations are probably the single most cause of civil money penalties against banks and their boards.

—John Gorman, Luse Gorman

From a legal standpoint, a best practice is threefold. First, maintain capital levels substantially higher than the minimum levels necessary to qualify as well-capitalized, even if it causes the bank’s return on equity (ROE) to suffer. Second, make sure that the bank’s charter and by-laws provide the maximum legal indemnification protection permitted under the applicable law, including providing for advancement of funds during litigation to defend the directors. And third, be sure to maintain an adequate directors and officers liability policy with no regulatory exclusion, so the insurance company has an obligation to defend FDIC claims. The only good protection from a storm surge such as this is a good wall of defenses and a plan of retreat!

—Doug McClintock, Alston + Bird

Excessive concentration of credit risk is a recurring theme in FDIC lawsuits. Boards need to monitor on an ongoing basis significant credit risk concentrations, whether it be in type of loan, type of borrower, geographical concentration, etc. Management reports to the board should address these and other concentration risks inherent in the institution’s loan portfolio.

—Victor Cangelosi, Kilpatrick Townsend

Directors should pay attention to their D&O insurance. All policies are not equal and the insurance markets are constantly evolving. Banks and their boards should consider involving experts in the negotiation of the policy terms and cost. Independent directors may want special counsel to be involved. Beyond paying attention to D&O insurance, directors need to pay more attention—pure and simple. The recent case brought by the FDIC against directors of Chicago-based defunct Broadway Bank criticizes the directors for not digging into lending policies or the details of lending relationships and deferring entirely to management. Documenting involvement is almost as important as the involvement itself.

—Mark Nuccio, Ropes & Gray

Trends in FDIC Lawsuits Against Directors and Officers

Posted on May 4, 2012 at 1:09 pm.

Written by Cornerstone Research Group

This is the second in a series of articles that examines statistics and offers commentary on the characteristics of professional liability lawsuits filed to date by the Federal Deposit Insurance Corporation (FDIC) against directors and officers of failed financial institutions. Here is a summary of some of our findings. For a full report with charts, click here.

Overview

Seizures of banks and thrifts by regulatory authorities have subsided in 2012 relative to the levels in 2011 and 2010. From January through late April 2012, 22 financial institutions have been seized. If the current pace of seizures continues throughout the year, 69 financial institutions will be seized in 2012, compared to 92 seizures in 2011 and 157 seizures in 2010. In contrast, the FDIC has been intensifying its litigation activity associated with failed financial institutions, filing 11 lawsuits through late April 2012, compared with 16 lawsuits in all of 2011. If filings continue at the current pace, an additional 24 lawsuits will be filed this year.

Overall, from July 2, 2010, through April 20, 2012, the FDIC filed 29 lawsuits against directors and officers of 28 failed institutions. As we observed previously, these lawsuits continued to target the officers and directors of financial institutions that had a large asset base and a high estimated cost of failure. Aggregate damages claimed in the complaints totaled $2.4 billion and were typically based on losses related to commercial real estate (CRE) lending, and acquisition, development and construction (ADC) lending.

Summary of Findings

To date, 6 percent of financial institutions that have failed since 2007 have been the subject of FDIC lawsuits. The 28 financial institutions targeted in lawsuits had median total assets of $973 million, compared with median total assets of approximately $241 million for all failed institutions. Six of these institutions had total assets of more than $3 billion. An additional seven had total assets between $1 billion and $3 billion. None had assets less than $100 million.

Geographically, the largest concentration of financial institution failures between 2007 and April 2012 occurred in Georgia, Florida, Illinois and California. The percentage of FDIC lawsuits targeting failed institutions in Georgia, Illinois and California is similarly high and in fact, slightly higher than the percentage of failed institutions in these states. Florida is currently the exception, with only one FDIC lawsuit related to the failure of a Florida institution.

Defendants named in the 29 filed lawsuits included 239 former directors and officers. In nine of these cases, only inside directors and officers were named as defendants. Outside directors were named as defendants in addition to inside directors and officers in the remaining 20 lawsuits. CEOs were named as defendants in 26 cases. Other officers commonly named as defendants included CFOs (five cases), chief loan officers (nine cases), chief credit officers (nine cases), chief operating officers (six cases), and chief banking officers (two cases). In addition, three lawsuits named insurance companies as defendants, and one case identified a law firm as a defendant. Three cases also included spouses of the directors and officers as named defendants. Although we do not address separate suits that may be brought only against other associated parties, such as accountants, appraisers or brokers, these parties are also potentially subject to litigation by the FDIC.Allegations of negligence, gross negligence, and breach of fiduciary duty were made in 26, 26 and 23 of the lawsuits, respectively.

Losses on CRE and ADC loans were the most common bases for alleged damages. Seventeen of the complaints identified CRE loans as a basis for the damages claim and fifteen identified ADC loans as a basis. Despite the widespread problems in residential lending and residential real estate markets, fewer lawsuits focused on those types of lending.

As of April 27, 2012, three of the 29 lawsuits have settled:

FDIC as Receiver of Corn Belt Bank and Trust Company v. Stark et al. settled on May 24, 2011, with settlement details remaining undisclosed.

FDIC as Receiver for First National Bank of Nevada v. Dorris and Lamb, which claimed damages of $193 million, settled on October 13, 2011, with the two officers and director defendants each agreeing to pay $20 million. The defendants assigned their rights to collect from the insurer to the FDIC. The FDIC’s success in collecting from the insurer is unknown.

FDIC as Receiver for Washington Mutual Bank v. Killinger et al. agreed to settle in late-2011 with three former executives agreeing to pay $64 million in total. The case was dismissed by the court on April 26, 2012.

About the Authors

Abe Chernin is a senior manager in the San Francisco office of Cornerstone Research; Catherine J. Galley is a senior vice president of Cornerstone Research in the firm’s Los Angeles office; Yesim C. Richardson is a vice president in the firm’s Boston office; and Joseph T. Schertler is a senior consultant in the firm’s Menlo Park office.

Characteristics of FDIC Lawsuits against Directors & Officers of Failed Financial Institutions

Posted on February 1, 2012 at 4:20 pm.

Written by Cornerstone Research Group

As widely reported in the press, seizures of banks and thrifts by regulatory authorities began to subside in 2011. Throughout the year, 92 institutions were seized compared with 157 in 2010 and 140 in 2009. In contrast, Federal Deposit Insurance Corporation professional liability lawsuits targeting failed financial institutions began to increase in 2011. These are lawsuits in which the FDIC, as receiver for failed financial institutions, brings professional liability claims against directors and officers of those institutions and against other related parties, such as accounting firms, law firms, appraisal firms or mortgage brokers.

Overview

From July 2, 2010, through January 27, 2012, the FDIC filed 21 lawsuits related to 20 failed institutions (two of the 21 lawsuits were associated with IndyMac Bank, F.S.B). Of the 21 lawsuits, two were filed in 2010, 16 in 2011, and three in January 2012. Aggregate damages claimed in the complaints totaled $1.98 billion.

On average, the FDIC waited 2.2 years to file a lawsuit related to a failed financial institution, although the majority of recent FDIC lawsuits were filed more quickly.

To date, only 4.7 percent of financial institutions that failed since 2007 have been the subject of FDIC lawsuits (20 out of a total of 424 bank failures). These lawsuits have tended to target larger failed institutions. The 20 banks named in lawsuits had median total assets of $882 million compared with median total assets of $241 million for all failed institutions. Furthermore, the 20 bank failures had a median estimated cost to the FDIC of $179 million at the time of seizure. This compares with the median estimated cost of failure of $60 million for all failed banks.

The FDIC lawsuits to date have included those related to the two largest failed institutions (Washington Mutual and IndyMac). However, there are many other large or costly failures that have not yet been the target of FDIC lawsuits. In particular, many of the most costly failures that occurred in 2008 and 2009 have not yet resulted in FDIC lawsuits. Given statute of limitations restrictions, these would seem to be the most likely candidates for FDIC lawsuits in the near future.

Each federal banking regulator was the primary supervisor for at least one of the institutions targeted by an FDIC lawsuit. Among the 20 sued institutions, two were savings associations regulated by the former Office of Thrift Supervision (OTS), two were nationally chartered commercial banks regulated by the Office of the Comptroller of the Currency (OCC), 14 were state-chartered nonmember banks supervised by the FDIC, and two were state-chartered member banks supervised by the Federal Reserve Board.

The geographic mix of lawsuits has paralleled the location of failed institutions, with the largest concentrations in Georgia, Illinois and California. One exception is Florida, where a large percentage of failed financial institutions were located (60 banks or 14 percent of all failures since 2007), but where no FDIC lawsuits have been filed to date.

Defendants and Claims

Defendants named in the 21 filed lawsuits included 178 former directors and officers. In six of these cases, only inside directors and officers were named as defendants. Outside directors were named as defendants in addition to inside directors and officers in the remaining 15 lawsuits. CEOs were named as defendants in 18 cases. Other officers commonly named as defendants included CFOs (four cases), chief loan officers (eight cases), chief credit officers (six cases), chief operating officers (four cases), and a chief banking officer (one case). In addition, three lawsuits named insurance companies as defendants, and one case identified a law firm as a defendant. Three cases also included spouses of the directors and officers as named defendants.

Allegations of negligence, gross negligence, and breach of fiduciary duty were made in 19, 18, and 18 of the lawsuits, respectively.

Damages Claimed

In 19 of the 21 complaints, the FDIC explicitly claimed damages amounts ranging from $20,000 to over $600 million. The average and median damages claims were $104 million and $40 million, respectively.

Losses on commercial real estate (CRE) loans and acquisition, development and construction (ADC) loans were the most common bases for alleged damages. Twelve of the complaints identified CRE loans as a basis for the damages claim and nine identified ADC loans as a basis. Despite the widespread problems in residential lending and residential real estate markets, fewer lawsuits focused on those types of lending.

Settlements

As of January 27, 2012, three of the 21 lawsuits have settled. FDIC as Receiver of Corn Belt Bank and Trust Company v. Stark et al. settled on May 24, 2011, with settlement details remaining undisclosed. FDIC as Receiver for First National Bank of Nevada v. Dorris and Lamb, which claimed damages of $193 million, settled on October 13, 2011, with the two officer and director defendants each agreeing to pay $20 million. Most recently, FDIC as Receiver for Washington Mutual Bank v. Killinger et al. agreed to settle with three former executives agreeing to pay $64 million in total.

Final Note

These findings do not include the many negotiations and mediation discussions the FDIC has undertaken with officers and directors of failed institutions. Statistics for these activities are unavailable. The number of lawsuits filed has yet to approach the numbers authorized by the FDIC. As of January 18, 2012, the FDIC has authorized lawsuits in connection with 44 failed institutions against 391 individuals, claiming damages of at least $7.7 billion. The difference suggests that more lawsuits may be filed before long.

Download all exhibits in PDF format.

How is Your Bank Perceived by the D&O Underwriter?

Posted on December 20, 2011 at 7:21 pm.

Written by Dennis Gustafson

Whether you are an executive preparing for the upcoming directors & officers (D&O) liability insurance renewal or a board member preparing for the D&O discussion at the next meeting, there is one person you should be trying to impress. That’s the underwriter who is analyzing your bank and determining the D&O renewal terms and conditions.

The perceptions of this individual are going to determine whether the insurance policy that protects the personal assets of the directors and officers and the corporate balance sheet is comprehensive enough to include the most up-to-date coverage enhancements, or is so restrictive as to include a regulatory exclusion. Now before getting into what steps you can take to improve that perception, it is important to understand the claims and litigation trends that these underwriters are talking about before they start to take a look at your bank.

The top two claims leaders in the banking D&O marketplace continue to be regulatory exposures and M&A. With regards to regulatory concerns, the data provides an interesting dichotomy. While we see a decrease in 2011 for both class action claims relating to the credit crisis and to the number of failed banks (figure 1), we continue to see a very large spike in the number of FDIC D&O defendants (figure 2).

This is consistent with the fact that the FDIC reports that “most investigations are completed within 18 months from the time the institution is closed” (www.fdic.gov). And it is not just failed banks that concerns underwriters. Most underwriters would categorize a bank as a regulatory risk if any of the following exist:

Any open regulatory agreement
Consent order
Cease and desist order
MOU (memorandum of understanding relating to asset quality, earnings, or capital, but not so much for safety and soundness or the Bank Secrecy Act)
Severe degradation of asset quality following a regulatory exam or audit where the expectation would be a regulatory restriction on the following exam (Texas ratio close to 100 percent or Tier 1 capital/total loan ratio of <2 percent)

And once a bank is perceived as a regulatory risk, there is a good chance that the D&O liability terms would include the very restrictive regulatory exclusion.

As mentioned, the second significant risk exposure is M&A (mergers and acquisitions), which also demonstrates compelling data points. In 2010, M&A filings represented the largest broken out category with 40 such filings representing out of 167 filings or 24 percent. That percentage jumps to 30 percent in the first half of 2011. So if your institution has any regulatory exposures or is anticipating some type of M&A, you can expect a lot of questions during the upcoming renewal process.

And while there are many ways to address those questions, we believe that coordinating some type of underwriter meeting or call is the best way to improve underwriter perceptions and generate the most comprehensive D&O renewal with regards to terms, conditions and pricing. The process usually entails coordinating a meeting with the management team, the incumbent underwriter and all competing underwriters either at the bank’s office or a centrally located site. In order to make the meeting as productive as possible, your broker should obtain any questions the underwriters would have and present that to the management team prior to the meeting. The benefits of such a meeting are four-fold:

1. Unlike insurance lines such as property/casualty or workers’ compensation, where actuaries are able to somewhat predict the likelihood of a claim based on past trends, there has been no reliable model to mathematically predict when the next securities class action or next suit against a director/officer will be. So when an underwriter has an opportunity to meet or listen to the management team, this provides a gut feeling as to the quality of the management.

2. Having all of the underwriters in a room or on a call at the same time goes a very long way in fostering the competitive influences in the marketplace. One comment I hear is that it is unfair to include the incumbent underwriter in the same meeting as all of his/her competitors What we recommend instead is to then have a one-on-one lunch or dinner meeting with the incumbent underwriter(s) to further develop that existing relationship.

3. By meeting with the underwriter, you have now developed more of a personal relationship with the underwriter, which can be helpful in the future is in the event of there is a claim or a service request.

4. One of the frustrations I hear a lot from bankers is that the process to finally bind up the renewal often incorporates a lot of last minute questions or requests. At this meeting with the underwriters, you are basically saying, “speak now or forever hold your peace.” We find that once the meeting is completed, the remainder of the renewal process becomes very streamlined.

So as you prepare for that D&O renewal or discussion, don’t forget to think about that underwriter and what you can do to improve the perception of the bank.

What Directors and Officers at Failed Banks Should Know

Posted on July 24, 2011 at 7:41 pm.

Written by jveta

The law firm Covington & Burling’s involvement in defending financial institutions and their directors and officers dates back to the representation of clients in the savings and loan crisis of the 1980s and is as current as the ongoing representation of the CEO of the former IndyMac Bank. Some of the lawyers have served in high-ranking government positions, such as former Comptroller of the Currency John Dugan. Bank Director magazine talked to Covington & Burling partner Jean Veta recently about what steps officers and directors should take if they are sued and what trends she sees in liability cases.

What are some of the first steps officers and directors should take if their bank fails?

As soon as the bank fails, they should get legal counsel—in fact, they should get counsel when they see the bank is headed toward receivership. The bank’s counsel cannot represent the individuals because the bank counsel’s client is the bank, not the individuals. Counsel for the individual officers and directors can assess the probability of getting sued and assist these individuals in preparing for potential lawsuits. In addition, counsel can help the individuals determine whether they have directors and officers (D&O) liability insurance and, if so, how to seek coverage under those policies.

What kinds of claims does the FDIC make in its lawsuits against officers and directors?

The FDIC brings suits against officers and directors for damages caused by the loss to the deposit insurance fund when the FDIC put the bank into receivership. Although each case is different, the FDIC typically will allege that the officers and directors were negligent or breached their fiduciary duty with respect to some activity that purportedly resulted in the bank’s failure. These claims often focus on such areas as the underwriting for residential mortgage loans, commercial real estate lending practices or insider transactions.

What other kinds of legal exposure do officers and directors face?

In addition to suits by the FDIC, the officers and directors can face other types of lawsuits, including those filed by private plaintiffs, a holding company’s bankruptcy trustee or the bank’s primary regulator. If the bank was publicly held, the individuals may also risk lawsuits by shareholders and the Securities and Exchange Commission. In the worst cases, the Department of Justice or local U.S. attorney’s office may open a criminal investigation.

Because the officers and directors can face a number of different lawsuits, it is important to develop a legal strategy that deals with all the potential areas of exposure. You need to make sure, for example, that the individuals’ defense theory in an FDIC case doesn’t adversely affect the individuals’ defense against claims being asserted by the holding company’s bankruptcy trustee or the bank’s primary regulator.

You made reference to the bank’s primary regulator. What role do they play?

It is now becoming apparent that in addition to the traditional suits by the FDIC, the bank’s primary regulator may also seek to go after individual officers and directors if the regulator believes the individual’s conduct was especially problematic. In those circumstances, the bank’s primary regulator typically will seek civil money penalties and/or prohibition orders that would bar the individual from participating in the banking industry.

What should an officer or director know about D&O insurance?

The availability and amount of D&O insurance is often important in determining whether the individuals have adequate resources available to mount a defense against the various threatened claims. Although most financial institutions have D&O insurance, the insurance carriers may seek to limit the amount of coverage available, so the individuals need to know how to respond to the carrier’s position. D&O insurance also is an important factor in the FDIC’s decision to sue the officers and directors. Unless the individuals were really bad actors, the FDIC typically is not interested in suing an individual with modest personal assets and little or no D&O coverage. In contrast, the primary bank regulator may well go after an officer and director—regardless of the level of personal assets or D&O insurance—if the regulator believes the individual’s conduct was especially bad. In these circumstances, the primary regulator is not looking for substantial monetary damages (as is the case in an FDIC lawsuit), but rather a prohibition order or civil money penalty that comes out of the individual’s own pocket.

D&O insurance: hope for the best, prepare for the worst

Posted on February 14, 2011 at 11:56 am.

Written by ssinadmin

On day three of our annual Acquire or Be Acquired event, a major snowstorm was hitting the mid-west and shutting down many airports leaving attendees either stranded or dashing off to catch a flight. The possibility of being stuck in Arizona didn’t concern the many remaining bankers who joined the breakout session on D&O insurance, led by Dennis Gustafson, SVP & Financial Institutions Practice Leader of AH&T Insurance, as he explored how changes at an institution can impact its risk profile as perceived by the underwriters.

While there are a variety of activities that will impact the underwriters’ risk assessment process, by understanding what they look for, directors and officers can better communicate their story to the insurance carrier. Gustafson shared the following key factors that today’s underwriter considers when identifying a financial institution’s risk profile:

Regulatory Exposures
Given the condition of the financial services industry, regulatory exposure is still the single largest risk to bank boards. With the increase in bank failures reflective of the increased number of lawsuits authorized by the FDIC, it’s become the government’s standard practice to contact the insurance carriers of a failed bank to recoup their losses and therefore gain access to the policy whether the board did their job or not.

However, as Gustafson pointed out to the audience, when a bank is considered a regulatory risk, the D&O carrier can file a regulatory exclusion which allows the insurance agency to deny claims filed by FDIC based on asset quality and capital.

Mergers & Acquisitions
Any director and/or officer of an institution in an acquisition is considered an increased risk as they are more likely to be sued. The insurance policy might need a mid-term acquisition’s threshold for acquirers, discovery provisions for sellers, change of control provisions, cancellation and M&A exclusion. Directors should conduct an in-depth conversation about the specific M&A goals of the institution with the carrier before renewing the policy.

Loan & Asset Quality
For many reasons, loan and asset quality directly affects the risk profile of any director or officer. AH&T utilizes an underwriting risk spreadsheet that includes benchmark figures and calculates the risk associated with each policy. For instance, a loan portfolio with 1-4 family mortgages carries less risk than an institution with a higher commercial real estate profile. Deposits, positive ROA and ROE, along with capital, give the underwriter a good sense of the overall risk profile.

Peer Benchmarking
By reviewing what a bank’s peers are doing, insurance carriers can help measure what type of policy a board member should be getting and how much they can expect to spend. As an industry, financial services saw the highest premium rate for $5 million in coverage during their last renewals

Securities Litigation filings by Industry
Another method carriers will use as consideration is the number of securities class action lawsuits filed in the financial industry as compared to the rest of the universe. In 2009, the financial industry had 38.2 percentage of market capitalization subject to new filings which made for a riskier profile.

Gustafson strongly recommends that before your next D&O renewal, you set up a meeting with all the bidding underwriters to accurately present the financial institution’s goals and objectives over the term of the policy. With a face-to-face conversation, the underwriters are able to ask and answer questions in order to get a better sense of the bank’s risks. By engaging in these conversations, insurance carriers can prepare the most appropriate language for a policy, therefore better protecting a director’s personal assets.

What Keeps Directors Up at Night

Posted on January 4, 2011 at 12:43 pm.

Written by jgeiringer

During the S&L crisis of the late 80’s and early 90’s, the Federal Deposit Insurance Corporation sued or settled claims against bank officers and/or directors on nearly a quarter of the institutions that failed during that time. If the past is any indication of the future, then there is a significant risk that directors of failed banks from the recent financial crisis may see some type of action taken against them by the FDIC.

In addition to lawsuits against senior executives of IndyMac Bank, and also senior officers and directors of Heritage Community Bank in Illinois, the FDIC has authorized actions against more than 109* insiders at failed banks to recover over $2.5* billion in losses to the deposit insurance fund resulting from this wave of bank failures.

Based on their work with a number of banks as well as individuals who are the targets of recent FDIC cases in various stages of development, John Geiringer and Scott Porterfield from the Chicago-based law firm of Barack Ferrazzano answer some questions about what could be keeping bank directors up at night.

What are the steps taken by the FDIC after the closure of a bank?

The FDIC begins a preliminary investigation when it believes that a bank may fail and will interview bank employees, officers and directors promptly after the bank’s closure.It is common for the FDIC to send a demand letter to the bank’s officers and directors demanding payment, usually in the tens or hundreds of millions of dollars, shortly before the expiration date of the bank’s D&O insurance policy.The FDIC sends that letter in an apparent attempt to preserve the D&O insurance for any litigation claims that it may later assert.

The FDIC may then subpoena officers and directors for documents and depositions. After conducting depositions, the FDIC will decide whether to initiate litigation against any officer or director. If the agency decides to litigate, it will initiate settlement discussions before actually filing its lawsuit. Because of the many evolving issues in these situations, such as whether insiders may copy documents for defense purposes before their banks fail, potential targets of these actions should ensure that they are being advised by counsel through every step of this process, even before their banks have failed.

What are the legal standards by which the FDIC may sue directors?

The FDIC bases its lawsuits on general legal principles that govern director and officer conduct and also considers the cost effectiveness of any potential lawsuit when making its decision. Federal law allows the FDIC to sue directors and officers for gross negligence and even simple negligence in certain states. What those standards mean as they relate to the conduct of bank insiders during this unprecedented economic cycle is difficult to predict at this time, although we are getting a clearer picture.

In the Heritage case, for example, the FDIC alleges that the defendants did not sufficiently mitigate the risks in the Bank’s commercial real estate portfolio and made inappropriate decisions regarding dividend and incentive compensation payments.

Will the FDIC differentiate between inside and outside directors?

Whether someone is an inside or outside director is one of the factors that the FDIC considers in determining whether to sue a director of a failed bank. According to the FDIC’s Statement Concerning the Responsibilities of Bank Directors and Officers, the most common lawsuits likely to be brought against outside directors will probably involve insider abuse or situations in which directors failed to respond to warnings from regulators and bank advisors relating to significant problems that required corrective actions.

Will D&O insurance cover any liability to the FDIC?

That depends on the amount and terms of the D&O policy. Directors should work with their insurance broker and bank counsel to review their D&O policies and to help them to make this determination. They should determine whether their policy amount is sufficient, whether their policy has certain exclusions (such as regulatory and insured vs. insured exclusions), whether proper notices are being made and under what conditions their policy can be cancelled.

What can directors do to mitigate their risk in the event that their bank fails?

In its Policy Statement, the FDIC states that it will not bring civil suits against directors and officers who fulfill their responsibilities, including the duties of loyalty and care, and who make reasonable and fully informed business judgments after proper deliberation. The FDIC generally requires bank directors to: (i) maintain independence; (ii) keep informed; (iii) hire and supervise qualified management; and (iv) avoid preferential transactions.

Directors should ensure that their bank’s counsel and other advisors are discussing these crucial issues with them. If their bank is in troubled condition, directors should seriously consider the need to hire personal legal counsel and to understand their ability to obtain indemnification.

* Figures updated as of 1/4/11 based on latest reportings.