In 1982, in the height of the first savings and loan crisis, the Federal Savings and Loan Insurance Corporation announced a new policy that would seek to hold those responsible — particularly directors and officers — for losses ultimately suffered by the FSLIC in resolving their failed institutions.
The policy was simple, if actions taken or authorized by D&Os, management, accountants, attorneys, appraisers or other institution affiliated parties demonstrably contributed to the failure of the bank, they would be held responsible for their actions. The theory was that a healthy dose of market discipline would counterbalance the "heads I win tails you lose" impact of deposit insurance. The FDIC followed with a similar policy statement in 1992.
Since the adoption of these policies, the FSLIC, Resolution Trust Corporation and Federal Deposit Insurance Corporation have brought suits (or settled claims) against thousands of former directors and officers, and recovered billions in claims against them. And in the wake of the latest financial crisis, the FDIC has authorized suits in connection with more than 30 failed banks against approximately 300 individuals to recoup damages of more than $7 billion. Many more suits are likely to come.
The defense that this is an unprecedented financial crisis that impacted a wide range of financial companies' will be argued, but there is no reason to believe that the FDIC will not investigate and bring cases exactly as it has in the past against parties that they believe have wrongfully contributed to the financial distress at their banks. It makes sense, therefore, to revisit the question most asked by bank directors in these times: "how do I avoid being sued by the FDIC?"
First, directors should study the indemnification provisions in the bank's and the holding company's bylaws to determine under what circumstances they are covered, and most importantly, how automatic the advancement of fees are if a claim is brought against them. Final indemnification for a judgment levied against a director is important, but it may be only half the loaf if the bylaws limit the advancement of fees during the prosecution of a claim. Few directors have the personal resources to mount a multi-year defense against one or more government agencies with the hope that if they are ultimately successful and their bank is still in existence, their costs will be reimbursed.
Because indemnification from a director's bank will not always be available, particularly after it fails, it is critical to have comprehensive D&O liability insurance coverage which has adequate limits of liability and does not have exclusions or endorsements which limit the coverages that are most needed. All too often, directors may be lulled into a sense of false security by the existence of policies that fall short in one or more of these areas. The time to resolve these issues is before the bank gets into financial trouble, or finds itself in the zone of a possible receivership.
Many boards of directors of troubled banks engage independent advisors to represent their interests. In a context where directors may ultimately be sued, a second set of eyes can be helpful in dealing with difficult regulatory and business issues. Even more importantly, the board's engagement of independent advisors often will be viewed as a positive step by regulators and may earn credibility that may be used to improve the bank’s regulatory posture
As a former regulator, it is axiomatic that if something is not in the minutes, it didn't happen. All too often, a client will say that he or she voiced strong opposition to a loan or related party transaction, a fact that would normally be exculpatory, but there is no mention of it in the minutes. The benefits of getting along in the board room and demonstrating unanimity are well understood, but they are not beneficial when it comes to defending a director who tried to do the right thing.
Document retention is an increasingly complex area since liability can attach whether documents are retained or discarded. Sarbanes-Oxley significantly criminalized a range of document destruction scenarios, while the FDIC has recently sued lawyers representing directors because they had retained copies of a large number of bank documents after the bank failed. Both federal and state civil and criminal laws affect the rights of directors to copy, destroy and retain bank documents, so consultation with counsel is critical before any action is taken.
Most banks have holding companies and often the board of directors of both companies are identical or nearly identical. In those circumstance, when a bank gets into financial difficulty, conflicts of interest tend to appear. For example, if the holding company has an obligation to replenish the capital of its subsidiary bank, the bank's board, understanding the responsibilities that the regulators will espouse, will want that capital to be injected into the bank. The board of the holding company, however, having a slightly different set of fiduciary concerns, may decide not to contribute the capital, opting instead to preserve assets for shareholders or creditors. Because of such conflicting interests, directors often find themselves deciding which potential plaintiff — the FDIC, shareholders or creditors — they are less willing to be sued by. The time to deal with these types of conflicts is before they ripen into full blown problems.
Financial stress creates significant challenges for bank directors. The extent to which liability follows is one that is manageable, if the issues are dealt with openly and early enough.
Thomas P. Vartanian is a partner in the global law firm, Dechert LLP and heads the firm's financial institutions practice. He is a former general counsel of the Federal Home Loan Bank Board and the FSLIC. This article is derived from a speech he delivered to the New York State Bankers Association.