A federal appeals court last week gave regulators a powerful weapon for prosecuting the directors and officers of failed institutions.

The court affirmed that the Federal Deposit Insurance Corp. need prove only simple negligence when suing bank officials, rather than meet the tougher standard of gross negligence.

Impact on Bank Boards

The decision by the U.S. Court of Appeals for the 10th Circuit in Denver was a setback for banking trade associations. They contended that such a ruling would make it difficult to recruit and retain competent directors.

The decision, handed down last Tuesday, overturned a lower court ruling. Because all the judges of the 10th Circuit participated, the only hope for overriding the simple-negligence standard would be a petition to the Supreme Court.

There was no [unreadable words omitted] end of last [unreadable words omitted] the FDIC case - former directors of the failed Tracy Collins Bank and Trust Co. of Salt Lake City - would appeal. Their lawyer, Robert Campbell of Campbell, Maack & Sessions in Salt Lake City, was not available for comment.

The appeals court judges, splitting 7 to 2, "supported our arguments almost completely," said Alfred J.T. Byrne, the FDIC's general counsel. He said he was "absolutely delighted" with the outcome. He pointed out that a decision by a full complement of appellate judges carries great weight.

But Don Allen, a lawyer who filed a friend-of-the-court brief on behalf of the Utah Bankers Association, called the ruling "a disaster."

"It will have a chilling effect on the ability of banks to recruit qualified directors," he said.

Mr. Byrne dismissed such complaints, saying he has seen no proof that recruiting directors would be a significant problem.

The Tracy Collins case, formally FDIC v. Charles R. Canfield [the bank's former chairman] et al., has run a twisted course since the FDIC filed charges of negligence and breach of fiduciary duty against the former officials in 1990, more than a year after their bank was closed.

The FDIC based its case on enforcement powers it had gained in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. The lawsuit sought more than $7 million in damages.

The U.S. District Court in Utah ruled against the FDIC's argument that the 1989 law did not require it to prove gross negligence. This court's opinion supported the Tracy Collins officials, who argued in part that a simple-negligence standard would discourage them from fulfilling their oversight obligations.

But the FDIC's simple-negligence interpretation prevailed in U.S. district courts in California, Colorado, Illinois, Oklahoma and Texas, according to Nicholas M. De Feis, a lawyer at Milbank, Tweed, Hadley & McCloy in New York.

An initial 10th Circuit appellate ruling in favor of the FDIC, by a three-judge panel last February, was vacated when all the circuit judges agree to hear the case as a group.

The majority opinion last week, written by Circuit Judge Stephanie K. Seymour, said the Tracy Collins officers and directors had addressed their gross-negligence argument "to the wrong forum," since "Congress left it to the states to decide the propriety of a simple-negligence standard." Utah has no law that would override the FDIC's interpretation, the court said.

The dissenting judges, Wade Brorby and John P. Moore, offered a different interpretation of the disputed section in the 1989 law. Judge Moore said that if Congress had wanted to set a simple-negligence standard, "it would have said so unequivocally."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.