WASHINGTON — As directors and officers of failed banks brace for Federal Deposit Insurance Corp. lawsuits, an intense legal battle is developing over accessing files at their former institutions.
Before regulators locked the doors, board members and senior officers at numerous troubled banks made copies of their institution's internal documents, which included sensitive customer information, and fed them to outside defense teams to prepare for potential litigation.
But now, as the FDIC prepares to seek billions from executives, the agency is demanding the documents back, calling their release a significant security breach. The former bankers and their lawyers, meanwhile, argue the FDIC is trying to restrict their access to evidence that could exonerate them.
"You have a tug-of-war over whether or not the bank's records are solely the property of the bank, and therefore property of the FDIC as the party taking it over, or whether those individuals have a right of access to those records, even though they are not technically their records," said Kirby Behre, a partner at Paul, Hastings, Janofsky & Walker LLP.
Three pending court cases may decide the issue. Two filed in the northern U.S. District Court of Georgia involve law firms — Bryan Cave LLP and McKenna Long & Aldridge LLP — that were hired to advise directors and officers before their banks' closures, and were privy to extensive internal records, including loan files.
The third targets a banking company, Liberty Financial Group Inc. in Eugene, Ore., that, according to court papers, fed records to its outside counsel just before its LibertyBank subsidiary was closed.
Attorneys said that possessing copies of such records — as opposed to original bank documents — is legally justified, and that the FDIC's argument that it violates privacy policies cloaks the agency's desire to gain an upper hand in upcoming litigation. They said firms have taken steps to ensure confidentiality of the material. "It's a chilling situation for directors to be put in a situation where they don't have any access to information that can be used to defend themselves in these blunderbuss claims that are being made by the FDIC," said James Rockett, a partner at Bingham McCutchen. "Directors should be entitled to make use of that kind of information in their defense. Once the FDIC gets ahold of that, getting access to it in the future is going to be almost impossible."
But the FDIC argued the data collection poses risks beyond the lawsuits, threatening the protection of information that was not meant to see the light of day, including confidential customer information, exam reports and suspicious activity reports. Agency officials said defense lawyers could enter agreements with the FDIC over controlled use of the data, rather than simply keeping material that is not theirs. "There is a right way to go about doing this in terms of getting the documents to these folks. But what's happening here is indiscriminate copying of documents and taking them out before the bank fails," said Richard Osterman Jr., a deputy general counsel at the FDIC.
"Most of the time we don't bring an action" against an officer or director, Osterman added. "Imagine with over 300 failures, and everybody making copies of all these documents before a bank fails and taking them outside the bank what that means in terms of opening and exposing all of that confidential information to a non-accountable entity where it might be shared further."
The three cases are a prelude to what many expect will be a flurry of FDIC court action starting this year. The agency has filed only two official suits claiming monetary damages against former managers for alleged roles in the downfall of their banks.
But that is only the beginning. On Jan. 4 the FDIC announced it had authorized suits against 109 defendants the agency believes were negligent, seeking nearly $2.5 billion. Both numbers could increase over time as investigations continue. Many cases will likely be settled out of court.
Supporters of officers and directors said defendants had difficulty accessing information in litigation after the savings and loan crisis, and are trying to be proactive this time. While records are more readily available once a lawsuit has been filed, through the discovery process, the question is how soon before a trial should defendants gain access. Typically, a director or officer's defense begins upon receiving an FDIC letter warning of civil action that often does not result in an actual suit.
David Baris, an attorney who advises potential defendants as the executive director of the American Association of Bank Directors, said former officers and directors need full access to copies of bank documents to have the opportunity to convince the FDIC that a suit is unwarranted.
"If the directors don't have a full opportunity to discuss with FDIC representatives that there is no merit to the lawsuit, then there's a greater chance that the FDIC will bring a suit that doesn't have merit," said Baris, a partner at BuckleySandler.
Twenty years ago, Baris added, defendants who had lacked access to internal records had trouble responding to FDIC questions in cases recalling decisions they had made several years before.
"They couldn't respond to questions because some of the questions related to loans that had been approved 10 years before," he said. "They didn't remember those loans, or if they did they had a very faint memory. They weren't able to get access to and review the documents."
In December, Baris submitted a letter on behalf of the AABD to FDIC Chairman Sheila Bair saying that "bank directors have the absolute right to access bank records during their tenure on a bank's board, and that right should not be impeded when the decisions those directors made are called into question after the fact."
But FDIC officials said they are not intending to monopolize evidence, and there are other ways to share information. "The argument on the other side is the directors need the information to defend themselves," Osterman said. "We understand that, and in fact we will provide them with the documents that they need. But there are ways to do that under appropriate legal mechanisms, for example entering into a confidentiality agreement where control is in place and the documents are clearly identified and held in a safe way, or getting a protective order from a court.
When outside counsel can have unsanctioned access, however, that threatens the success of a receivership, officials said.
"The issue is that these documents are not theirs," said Michael Krimminger, the agency's acting general counsel. "These are bank records that belong to the bank. The director has no personal right to hold the records, period. Since we take over for the bank as receiver, we have complete rights to take the records. It is fundamental to what we do in resolving banks."
FDIC officials said executives have copied confidential data before the failure of several banks, but the lawsuits have only been filed where the parties involved refused to return them.
The cases involving the two law firms have been partially resolved.
The FDIC had asked the Georgia court to combine the Bryan Cave and McKenna Long cases, both filed in November, but a judge denied the request. (Both law firms declined requests for comment.)
The lawsuit brought by the FDIC against Liberty, meanwhile, is similar to the other two but appears to have been brought at the request of the defendant who wanted a judge to confirm the FDIC's right to reclaim data.
The agency had sued Bryan Cave alleging the St. Louis firm's possession of copied records from Hillcrest Bank of Overland Park, Kan., which failed in October, was "improper and unlawful." A judge in the case issued a consent order agreed to by both parties that ordered the law firm to return copies of bank documents to the FDIC.
The senior executives at Hillcrest who had hired Bryan Cave are no longer its clients, according to court records. But the lawsuit said the firm had initially declined to return the documents to the FDIC, arguing they were justified in holding them.
Instead, the firm had returned them to the former Hillcrest officials, and began destroying its own electronic copies, according to the suit. The suit sought for the documents to be returned, asked that Bryan Cave stop destroying its copies, and sought for the firm to give up the legal fees paid by the Hillcrest clients.
Bryan Cave, under the consent order, must not only cease utilizing or destroying any records but must also provide information regarding the "chain of custody" of the records.
Meanwhile, McKenna Long is the plaintiff in its suit, seeking protection from the court for its possession of documents related to four different failures. The law firm states its pledge to keep the documents safeguarded, even winning an order from the court to deposit the records into court protection pending the suit's outcome. "The FDIC has provided no authority, and MLA has found none, for the proposition that once collected, copies of corporate documents must be returned to a corporation, or to the FDIC as receiver of a failed bank, as a matter of course or because a bank was placed into receivership," the suit says.
But the agency said the partial orders in the two cases do not resolve the issue.
The FDIC's motion to combine the two cases had sought a more formal declaration criticizing the data collection. "Bryan Cave and MLA continue to engage in the same conduct with respect to the records of other failed or failing banks," the FDIC's motion said. "The fact that one set of such records has now, after the expenditure of much time and effort, apparently been recovered, does not make the central issue moot, nor does it alleviate the danger."
Some legal experts find merit in the argument that officers and directors relinquished their claims to internal data when their banks failed. While not commenting specifically on the cases, Heidi Mandanis Schooner, a law professor at Catholic University, said the FDIC has a strong basis to argue for the return of documents that are the property of a receivership.
"At least on its surface, I would tend to agree with the FDIC that" the former directors and officers "didn't have the right to take those documents and give them to their private lawyers just because they had access to them. It's almost like a theft. It's not their documents," she said. "Why is this different from any other defendant of another agency action that doesn't have the ability to grab documents before a suit?"
But others said the documents are central to the issue of litigating against former managers, and restricting their access means the FDIC will have an unfair advantage. "It only stands to reason that on the eve of a takeover, and on the eve proverbially of a suit that will name these individuals, … that those individuals want to mount their defense," Behre said. "How do you do that? You show your meticulous records. You show that that loan that went belly-up couldn't have been reviewed any better if you had tried."