The pace of bank failures might be peaking, but for the directors and officers of failed institutions, the pain and suffering is far from over.
The Federal Deposit Insurance Corp. has begun laying the groundwork for potentially years of lawsuits against senior executives and directors it claims may have been responsible for their bank's collapse—a process that netted the agency $2.5 billion in the aftermath of the last banking crisis. The FDIC has sent hundreds of demand letters warning officers and directors of possible civil charges, announced formal investigations of individuals and subpoenaed directors' financial statements and other documents.
The agency says the actions are necessary first steps in both assessing accountability for the heavy failures and replenishing the Deposit Insurance Fund. They set the stage for monetary settlements and civil lawsuits, though sometimes they will result in no further action.
But some industry representatives wonder if the FDIC is targeting individuals with the financial means—including hefty insurance policies—to pay the damages more so than those it believes were responsible for a failure. In some cases, observers say, the amount of damages the FDIC asks for mirrors what is covered in an insurance policy.
If there's insurance, "and there's money to go after, I believe that the inclination of the FDIC is to try to go after it, whether there is a good case or not," says David Baris, a partner at Buckley Sandler LLP and the executive director of the American Association of Bank Directors.
Senior FDIC officials strongly refute that claim, saying directors will not receive a demand letter without cause, and the bluntly worded letters-which include the amount of potential damages-are required by the insurance carrier to begin the claims process. Typically the letters must be issued before an insurance policy expires, which can be right after the failure.
"Everybody thinks that they're being pursued because they have money or there is some other reason," but "in reviewing the claims, we're looking at whether we have a meritorious and a cost-effective claim," says Richard Osterman, a deputy general counsel at the agency. "How far we go will depend on the facts and circumstances in each case. We send in investigators and attorneys to look at the facts. If they find on the face of it there's nothing there, then we close out the investigation."
The FDIC typically begins gathering information that can be used in a suit as soon as it takes over a failed bank.
After it has determined an insurance policy exists, and there is reasonable suspicion someone was responsible for the failure, the agency will issue a demand letter as the first step in the process. The letters, often sent by outside counsel it hires, outline all the possible allegations a board member or officer could face.
"It's a starting point for targeting them down the line for eventual lawsuits," says Joseph Lynyak, a partner at Venable.
For example, a March 26 letter to board members of BankFirst in Sioux Falls, S.D., which failed in July 2009, listed everything from poor risk management to violating loan approval policies. The letter demanded payment of over $77 million for "Director and Officer Wrongful Acts." Later, if the agency decides to pursue the case further, a director or officer may settle or face civil litigation.
The FDIC filed a $300 million lawsuit on July 2 against four former executives of a homebuilding division of IndyMac in federal court in California, but have not done so against officers or directors of an entire bank — yet. Observers say that will likely change soon. The FDIC, which has projected that failures will peak this year, has a three-year statute of limitations from the date of failure to sue management and board members.
In the thrift debacle of the 1980s and 1990s, the FDIC brought "professional-liability cases"—meaning it filed lawsuits or reached settlements—in about 30 percent of the more than 2,000 failures that occurred. Since the start of 2008, more than 250 banks and thrifts have failed and experts predict that figure could double in the next year or two.
Kip Weissman, a partner at Luse, Gorman, Pomerenk & Schick, says the FDIC is likely to file some suits next year and even more in 2012.
Still, despite the FDIC's ability to pursue directors and officers, the agency often faces numerous obstacles in actually collecting damages. Various state laws require different standards for proving culpability, and as failures have persisted many insurance carriers have excluded payment of civil damages tied to a failure from their policies.
"Many of the insurers purposefully put that clause in to stop the FDIC from just generally going after boards to get the insurance payout," said William Longbrake, a former chief financial officer at the FDIC and now an executive in residence at the University of Maryland.
To bolster a case against a bank's management, the FDIC will issue other actions early in the process besides the demand letters. These include a "Notice of Investigation," which announces a formal probe by the agency into particular individuals, and subpoenas for documents related to a case. Documents revealing an officer's or director's personal wealth also could be sought.
Baris says that just receiving an early demand letter can be "a disaster" for some bank directors.
"Most of these people are from small banks in small towns and probably have never gotten sued in their life, and they get a letter from a perceived all-powerful federal government with seemingly limitless resources demanding money that is in far excess of any amounts they ever dreamed of having," he says.
But the FDIC stresses that the letters must be issued if the agency is to collect an insurance payout down the road. Moreover, officials say that while the agency is not likely to pursue individuals unable to pay damages, it will still send demand letters if it has reason to suspect negligence.
"The purpose here is simply to preserve insurance. A lot of these letters go out shortly after a bank failure if the policy is expiring then," says Rob Robinson, a senior counsel at the FDIC. "The claim must be made during the policy period so if the policy is about to expire ... then we're required to get a notice out the door before the policy expires."
"We're not just sending letters and making up claims," he adds. "We try to make enough of a preliminary investigation to make sure that when we send the letter we're sending it to the right people and we have a basis for the claim."