The Federal Deposit Insurance Corporation has slowly started filing lawsuits against directors and officers of failed banks, but suits—and corresponding insurance claims—are likely to mushroom, according to banking and D&O liability insurance experts.

In fact, one former banking regulator said the existence of D&O insurance is the starting point for FDIC officials when they evaluate whether or not to file the suits.

Speaking at the D&O Symposium of the Professional Liability Underwriting Society early this month, Brian McCormally, a 20-year veteran of the Office of the Comptroller of the Currency and the Office of Thrift Supervision, also said the FDIC is likely to file several hundred suits in the next five years—far more than the figure of just over a hundred being advanced by the agency itself.

D&O insurance professionals and lawyers who spoke at PLUS in early February, and another group of experts who spoke during a separate webinar on D&O issues presented by New York-based Advisen in late January, cited FDIC statements indicating that just over 100 suits had been authorized by its board in late December, and that FDIC bumped the figure up to 119 suits in late January.

The latest official word from the government agency's website says that as of Feb. 7, 2011 “the FDIC has authorized suits against 130 individuals for D&O liability with damage claims of approximately $2.6 billion.”

The FDIC statement notes that the current figure includes four D&O suits it has already filed naming 35 individuals, adding that the FDIC has also authorized seven fidelity bond, attorney malpractice and appraiser malpractice lawsuits.

“What is important to appreciate is this is just the tip of the iceberg,” said Mr. McCormally, the former legal staffer of U.S. banking regulatory agencies who is now a partner at Arnold & Porter in Washington.

Speaking at the point in time when the FDIC board had authorized 119 suits, he noted that while 322 banking institutions had closed in the last three years (25 in 2008, 140 in 2009 and 157 in 2010), there are still 860 institutions currently on the FDIC's troubled bank list. In addition, the amount of distressed assets in those 860 institutions is about $435 billion, he said.

“The damage claims that FDIC is proposing right now are miniscule,” Mr. McCormally said, comparing the FDIC's indicated D&O damage claims (which stood at $2.5 billion at the time of his presentation) to funds the agency has already paid out—amounting to 16-times that figure.

The FDIC has incurred expenses now of about $40 billion, and there are an additional 860 banks yet to be dealt with, he said. “By no means am I suggesting that all 860 are going to fail. They will not,” but that's a tremendous number of banks yet to be resolved, he said.

“For the next five years, we will likely see [multiple] hundreds of lawsuits being filed by the FDIC,” Mr. McCormally concluded, referring not just to D&O suits but also to lawsuits against professionals involved with failing institutions.

“All the banking agencies are going to be bringing actions against deep pockets,” Mr. McCormally said. “I fully expect the FDIC, in particular, to bring actions against law firms, and to a lesser degree against accounting firms, on a variety of issues.” He said the most obvious issue is that many financial institutions “could not have engaged in sophisticated lending apparatus without legal advice which turned out to be wrong.”

Speaking during the Advisen webinar, Kevin Mattessich, managing partner in the New York office of Kaufman Dolowich Voluck & Gonzo, gave a historical perspective for FDIC litigation, drawing parallels between activity during the Savings & Loan crisis of the 1980s and 1990s and the current crisis precipitated by the subprime mortgage meltdown.

Between 1985 and 1992, there were a few hundred banks failing each year, Mr. Mattessich said, referring to figures on a bar graph, which showed a peak coming in 1990—at around 500 failures for that year. Subsequent bars showed figures trailing off to minimal annual failure levels through the early 2000s, until the pickup in 2007.

While he said that the structures and businesses of the community banks in trouble now are different from the S&Ls of the 1980s, he noted that the 20 percent failure rates have persisted over the years. In the 1980s, S&Ls numbered somewhere between 14,000 and 16,000, he added, noting that while there are only 2,000-3,000 comparable banks now, “we've got bigger dollars. When these [troubled] banks are failing, they seem to have a larger portfolio that goes under,” he said.

(See related article, “FDIC D&O Suits Likely Despite Lag In Activity In Recent Years,” by Trevor Howard, senior vice president of U.S. management liability with Liberty International Underwriters, for more about parallels to the S&L crisis.)

A RUNNING LAG

Noting that the FDIC projects that failure rates will drop off to minimal levels by 2015, Mr. Mattessich suggested that FDIC lawsuits against directors and officers will still be rolling in at that point. The agency is just getting started when it comes to filing these actions for the banks that have already failed, he said, going on to explain the reasons for the lag.

“When the FDIC goes in, they shut a bank, they marshal the assets, they get rid of the good portfolio, and then they start dealing with the bad portfolio. They are often left with just a lot of boxes and documents and no personnel around to explain what anything is. And then that starts the forensic process, where they start to target individuals—the directors and officers, and the accountants where they can,” Mr. Mattessich said.

“It takes time for them to put cases together,” he said, noting the FDIC itself estimates 18 months typically elapse from the time they go in to the time they finish their investigation and that case goes off for litigation review and filing.

He gave the example of a mid-January suit against officials of Integrity Bank in Georgia, which was closed down in August 2008, also noting that he believes the allegations in that case are likely to carry over to the next batch of suits.

The basis of the Integrity suit is that the directors and officers “instituted and allowed a pattern of growth in high-risk commercial and residential development loans—that that's what they pushed almost exclusively between 2000 and 2007—and correspondingly, they just simply didn't put in the amount of controls that were necessary to check the growth, to check the individual loans.”

“Significantly, what the suit also alleges is that this [activity] occurred at a time, in 2006 and 2007, when bank officers knew or should have known about the impending real estate downturn and debacle,” Mr. Mattessich said.

The FDIC has said that filing suits against directors and officers of such banks “is a priority,” he reported. “Without getting into specifics, we certainly are aware that there have been a lot of notifications of potential claims under D&O and fidelity policies, and I think that's certainly a precursor to increased activity and lawsuits,” he said.

Expanding on Mr. Mattessich's analysis, Kevin LaCroix, a broker with OakBridge Insurance Services in Beachwood, Ohio, noted that the FDIC within a two-week time period in January increased the level of authorized suits by 10—from 109 at year-end 2010 to 119 in mid-January.

Noting that at least two of the four suits already filed came nearly two years after the banks were shut down, Mr. LaCroix, who is also a lawyer and the author of the D&O diary blog (www.dandodiary.com), noted that “failures really started ramping up in late 2008 and going into 2009.”

“I think as we head through 2011, we're going to start seeing more and more of these lawsuits, [and] there will be further bank failures as we go forward as well, creating this running lag between failure and lawsuits,” he said.

Mr. LaCroix, who started his legal career working on failed-bank cases during the S&L crisis, said bank regulators have “a post mortem process they go through” in every situation. “They don't willy-nilly file lawsuits. They filed D&O cases in only 24 percent of the failed banks in the S&L crisis,” he said, noting that a straight application of the same percentage to 325 credit-crisis related failures (including three in 2011 so far) suggests at least 80 FDIC suits will be filed.

TAPPING COVERAGE

“This is following the same pattern that it followed in the S&L crisis in the 80s and early 90s,” Mr. McCormally said at PLUS. “It takes a while for the agencies to get going, but once they get going, it takes a while to get them stopped,” he said.

“There is every reasonable expectation that the FDIC will be filing a number of lawsuits, probably in the first quarter. This is just the first round, [and] they are specifically focusing on insurance proceeds unlike in the past,” he said, noting that bank regulators are applying lessons about D&O insurance coverage that they learned during the S&L crisis.

“The FDIC is taking a little bit of a different tack this time around,” he asserted. The regulators “are focusing specifically on institutions where there was D&O insurance, and they are evaluating whether sufficient facts exist from which they can make a claim against directors and officers quickly in order to secure as much of the insurance proceeds as possible.”

“We currently represent about two dozen directors and officers of failed banks, and in each of those cases [the FDIC] has followed the same pattern,” Mr. McCormally reported.

In the past, he said, “the FDIC would have just done a very quick investigation, filed suit, and then tried to work it out through the litigation process.”

Instead, “this time around they are taking a much more thoughtful approach….They are conducting extensive investigations. They are subjecting directors and officers to depositions. They are evaluating the availability of private funds from [these individuals], and they are having direct communications with the insurance carriers as to the availability of proceeds.”

He said an “obvious objective” for the FDIC is “to try to preserve as much of the insurance proceeds as possible, and to avoid those funds being utilized by defense counsel in eating up the policies.”

During the Advisen webinar, Keith Loges, a vice president of wholesaler broker Swett & Crawford in Atlanta, asked Mr. Mattessich for his take on how much consideration regulators give to D&O insurance programs. “Do they just automatically try to access those as they start litigating?” the broker asked.

“Yes, they have already tried to start doing that,” the lawyer replied.

“An interesting phenomenon in the 1980s was the generic loss notice on the D&O policies,” Mr. Mattessich said, explaining that D&O carriers would get notices from the FDIC saying, “We intend to sue your directors and officers.”

Similarly, he said that fidelity bond carriers would get employee dishonesty loss notifications with messages like, “We just took over the bank and discovered a loss due to employee dishonesty, [but] we don't know who did it or how it happened.”

In 2011, “we are definitely hearing anecdotally and directly that those kinds of generic notices are coming back out,” Mr. Mattessich reported.

• FDIC D&O Suits Likely Despite Lag In Activity In Recent Years, (Nov. 8, 2010 edition of National Underwriter magazine)

• Were Regulatory Exclusions Added In Time?

Special Reports /

D&O Insurers Getting Notices For FDIC Claims; Lawsuits Expected To Mushroom

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