The Federal Deposit Insurance Corp. and the Resolution Trust Corp. deserve our applause. While public attention has focused on legislative wrangling over how to pay for the savings and loan debacle, these agencies have quietly done a remarkable job of protecting depositors, recapitalizing failed institutions, and returning assets to private hands.

While extending our congratulations, we must caution the agencies not to tarnish a good record by prosecuting the wrong people for the wrong reasons.

No one quibbles with the efforts to identify the real culprits. Fraud, criminal activity, self-dealing, and insider abuse are rightfully punished. But we should be wary of the recent surge in "bad loan" or "risky business activity" cases being filed against directors.

And we should also take care not to make scapegoats of those outside attorneys, auditors, and appraisers who bear little responsibility for the thrift disaster, but are being targeted in the belief they have "deep pockets."

20-20 Hindsight

Let's talk about the directors.

Six or seven years ago, directors were faced with decisions about complicated real estate loans, investments, or other activities. Decisions were made based on recommendations of management, statements by loan officers, and other material or information available at the time.

Unfortunately, the loans did not get repaid, the investments went sour, and - worst of all - institutions ultimately failed.

Now the regulators, with the perfect vision that comes with hindsight, accuse the directors of negligence and seek recovery for the losses that ensued.

It is unfair to the director, who is a fiduciary rightfully expected to exercise judgment in the best interest of the institution. Indeed, many of the cases being brought today do not focus on the nature of judgment exercised at the time. They focus on the results of that judgment. But had results do not equal misconduct or wrongdoing.

It is doubtly unfair when many of the losses were caused or exacerbated by actions taken by the government itself. There is no question that the Tax Reform Act of 1986 took billions of dollars of value from the real estate market.

Three years later, the Financial Institutions Reform, Recovery, and Enforcement Act essentially took thrifts out of commercial real estate lending and forced them to divest real estate assets, high-yield securities, and other assets - dumping them into illiquid markets at very inopportune times.

Risk-based capital standards further promote "safe" loans and investments over commercial real estate and added to the problems of an illiquid market hampered by a credit crunch.

High-Priced Penalties

While the governmental actions may promote the long-run health of our economy, each has had a significant impact on the value of the loans and other assets in the portfolios of financial institutions.

The regulators' actions are unfair in another way, too. The director bears the brunt of significant financial penalties as soon as a lawsuit is filed, incurring expenses that overwhelm the modest financial benefits of directorship. Many directors of financial institutions served without pay; others received only modest payments of a few hundred dollars per meeting.

The cost of defending a director liability suit can easily exceed $200,000. Even if the director is able to share that expense with other directors, the penalty is significant.

There is, of course, no indemnification, because the institution has failed. Further, the insurance companies vigorously resist providing coverage, citing the common regulatory exclusions that preclude coverage for suits brought by the government regulatory agencies.

A Threat to the Nation

The regulators' policy is unfair to all of us, in another way: For if this litigation trend continues unchecked, it has the distinct possibility of depriving the financial system of talented outside directors.

The benefits of being an outside director of a financial institution are marginal at best, and are probably now limited to the satisfaction of helping support a vital component of our financial system. When measured against the risk to one's net worth, potential directors must carefully consider the risk/reward ratio.

When asked by clients or friends whether they should accept a proffered directorship of a bank or thrift, we discuss the financial condition of the institution, the regulatory environment, the strengths and weaknesses of management, the other members of the board, and the benefits to the candidate that would flow from service.

These factors must be measured against the substantial time commitment required to be a productive board member and the risks to a director's personal net worth by the acceptance of contingent liability.

On Saying |No'

Our financial system needs these individuals and many others like them. They are successful in their businesses, with keen insights into how business operates and how local and regional economies function, and they have important contacts that may be beneficial to the institution.

Sadly, declining the directorship is most often the wisest choice in the present environment. As long as regulators persist in making scapegoats of directors whose sole failing was an honest error of judgment, it is the only thing a prudent person can do.

Mr Douglas is a partner in the Atlanta law firm of Alston & Bird. He was general counsel to the Federal Deposit Insurance Corp. from 1987 to 1989.

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.