The Federal Deposit Insurance Corporation has slowly startedfiling lawsuits against directors and officers of failed banks, butsuits—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 ofD&O insurance is the starting point for FDIC officials whenthey evaluate whether or not to file the suits.

Speaking at the D&O Symposium of theProfessional Liability Underwriting Society early this month, BrianMcCormally, a 20-year veteran of the Office of the Comptroller ofthe Currency and the Office of Thrift Supervision, also said theFDIC is likely to file several hundred suits in the next fiveyears—far more than the figure of just over a hundred beingadvanced by the agency itself.

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

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

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

“What is important to appreciate is this is just the tip of theiceberg,” 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 authorized119 suits, he noted that while 322 banking institutions had closedin the last three years (25 in 2008, 140 in 2009 and 157 in 2010),there are still 860 institutions currently on the FDIC's troubledbank list. In addition, the amount of distressed assets in those860 institutions is about $435 billion, he said.

“The damage claims that FDIC is proposing right now areminiscule,” Mr. McCormally said, comparing the FDIC's indicatedD&O damage claims (which stood at $2.5 billion at the time ofhis presentation) to funds the agency has already paidout—amounting to 16-times that figure.

The FDIC has incurred expenses now of about $40 billion, andthere 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. Theywill not,” but that's a tremendous number of banks yet to beresolved, he said.

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

“All the banking agencies are going to be bringing actionsagainst deep pockets,” Mr. McCormally said. “I fully expect theFDIC, in particular, to bring actions against law firms, and to alesser degree against accounting firms, on a variety of issues.” Hesaid the most obvious issue is that many financial institutions“could not have engaged in sophisticated lending apparatus withoutlegal advice which turned out to be wrong.”

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

Between 1985 and 1992, there were a fewhundred banks failing each year, Mr. Mattessich said, referring tofigures on a bar graph, which showed a peak coming in 1990—ataround 500 failures for that year. Subsequent bars showed figurestrailing off to minimal annual failure levels through the early2000s, until the pickup in 2007.

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

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

A RUNNING LAG

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

“When the FDIC goes in, they shut a bank, they marshal theassets, they get rid of the good portfolio, and then they startdealing with the bad portfolio. They are often left with just a lotof boxes and documents and no personnel around to explain whatanything is. And then that starts the forensic process, where theystart to target individuals—the directors and officers, and theaccountants where they can,” Mr. Mattessich said.

“It takes time for them to put casestogether,” he said, noting the FDIC itself estimates 18 monthstypically elapse from the time they go in to the time they finishtheir investigation and that case goes off for litigation reviewand filing.

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

The basis of the Integrity suit is that the directors andofficers “instituted and allowed a pattern of growth in high-riskcommercial and residential development loans—that that's what theypushed almost exclusively between 2000 and 2007—andcorrespondingly, they just simply didn't put in the amount ofcontrols that were necessary to check the growth, to check theindividual loans.”

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

The FDIC has said that filing suits against directors andofficers of such banks “is a priority,” he reported. “Withoutgetting into specifics, we certainly are aware that there have beena lot of notifications of potential claims under D&O andfidelity policies, and I think that's certainly a precursor toincreased activity and lawsuits,” he said.

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

Noting that at least two of the four suits already filed camenearly two years after the banks were shut down, Mr. LaCroix, whois 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 into2009.”

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

Mr. LaCroix, who started his legal career working on failed-bankcases during the S&L crisis, said bank regulators have “a postmortem process they go through” in every situation. “They don'twilly-nilly file lawsuits. They filed D&O cases in only 24percent of the failed banks in the S&L crisis,” he said, notingthat a straight application of the same percentage to 325credit-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 theS&L crisis in the 80s and early 90s,” Mr. McCormally said atPLUS. “It takes a while for the agencies to get going, but oncethey get going, it takes a while to get them stopped,” he said.

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

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

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

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

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

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

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

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

“An interesting phenomenon in the 1980s was the generic lossnotice on the D&O policies,” Mr. Mattessich said, explainingthat D&O carriers would get notices from the FDIC saying, “Weintend to sue your directors and officers.”

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

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

Related Articles:

• FDIC D&O Suits Likely Despite Lag In Activity In RecentYears, (Nov. 8, 2010 edition of National Underwritermagazine)

• Were Regulatory Exclusions Added In Time?