On January 15, the OCC announced its 2014 schedule of workshops for directors of national community banks and federal savings associations. The workshops, which are led by OCC examiners and are meant to provide practical training and guidance to directors, include (i) Mastering the Basics: A Director’s Challenge; (ii) Risk Assessment for Directors: Where is the Risk in Your Institution?; (iii) Compliance Risk: What Directors Need to Know; and (iv) Credit Risk: A Director’s Focus.
Comptroller Curry Addresses Senior Management’s AML Compliance Responsibilities, Criticizes “De-Risking”
On March 17, Comptroller of the Currency Thomas Curry reaffirmed his agency’s views with regard to BSA/AML compliance and the responsibilities of senior bank managers and boards of directors. Mr. Curry asserted that BSA infractions “can almost always be traced back to decisions and actions of the institution’s Board and senior management” and that the deficiencies underlying those infractions tend to involve failures in four areas: (i) the culture of compliance at the organization; (ii) the resources committed to BSA compliance; (iii) the strength of information technology and monitoring process; and (iv) the quality of risk management. Mr. Curry reported a recent positive trend, particularly at OCC-regulated large banks, which have increased spending and added BSA/AML compliance staff. He stated that such actions are one aspect of banks’ efforts to align “good compliance practices and the bank’s system of compensation and incentives.” The Comptroller criticized a separate trend of “de-risking”, in which banks avoid or end relationships with types of businesses deemed too risky. He warned that any business can be used for illicit purposes and “de-risking” is not a shortcut to circumvent a bank’s obligation to evaluate risk on an individual basis. He encouraged banks not to avoid high-risk businesses, but rather to apply stronger risk management and controls as necessary.
On January 3, the U.S. District Court for the Northern District of Illinois held that a relator failed to support allegations that the outside directors of a failed bank misrepresented to the FDIC the quality of the bank’s collateral on real estate loans, and dismissed those claims. U.S. v. Veluchamy, No. 11-4458, 2014 WL 51398 (N.D. Ill. Jan. 3, 2014). The relator alleges that the outside directors, as well as bank managers and employees and the bank’s appraisal company, violated the False Claims Act by engaging in a scheme to defraud the FDIC by misrepresenting the loan-to-value ratios for real estate lending and submitting fraudulent Call Reports based on overvalued appraisals. The court held that the bank’s outside directors were not shown to be involved in the day-to-day operations of the bank, and that the relator failed to demonstrate the directors had knowledge of or contributed to the alleged scheme. The court denied motions to dismiss filed by the other defendants. The court also held that the relator’s claims were not barred by prior public disclosure of the allegations. The court explained that a Material Loss Review issued by the FDIC’s inspector general following the bank’s failure did not include “critical elements” of the relator’s fraud claims, and that a prior state court employment case filed against the bank by the relator also did not reveal essential elements of the current claims.
On December 30, the FDIC responded to a recent joint letter from the AABD and ICBA expressing concern with the lack of new bank charters and proposing policy reforms to encourage more de novo applications. As the trade groups pointed out, the FDIC has only approved deposit insurance for one de novo bank since 2011, a dramatic shift from many years of de novo bank formation averaging over 170 per year. FDIC Director Doreen Eberley acknowledged the concern, but defended FDIC policy and cited cyclical conditions as a potential explanation for the current situation rather than any FDIC policy change. Ms. Eberley reasserted the FDIC’s commitment to assisting with potential de novo community bank formations.
On January 8, in a Daily Show interview, CFPB Director Richard Cordray discussed with host Jon Stewart some of the Bureau’s efforts to date, including implementation of the CFPB’s mortgage rules and the Bureau’s credit card add-on product enforcement actions. Director Cordray added that the Bureau will continue to take enforcement actions against individual officers and employees responsible for company wrongdoing, including by imposing officer-director bans, seeking disgorgement, and referring matters for criminal investigation. “There’s always officials and people in the company that make the decisions. So going after them for money, making them feel at risk, sometimes going after them to take them out of the business for a period of time, or referring them criminally if that is appropriate, that’s part of what we’re doing,” Cordray stated.
These comments mirror statements Director Cordray made last year, in which he cautioned that “[i]ndividuals need to know they’re at risk when they do bad things under the umbrella of a company.” The agency has already pursued individuals in several enforcement actions, and Director Cordray’s remarks suggest the Bureau will continue to devote resources toward investigating individual involvement in alleged company misconduct, along with the entities themselves.
Eleventh Circuit Certifies Questions On Georgia Business Judgment Rule In Bank Officer Case, Declines To Apply “No Duty” Rule To Bar Affirmative Defenses
On December 23, the U.S. Court of Appeals for the 11th Circuit certified questions to the Georgia Supreme Court regarding whether bank directors and officers can be subject to claims for ordinary negligence under the state banking code. FDIC v. Skow, No.12-15878, 2013 WL 6726918 (11th Cir. Dec. 23, 2013). In this case, former directors and officers of a failed Georgia bank moved to dismiss a suit brought against them by the FDIC as receiver for the failed bank, asserting that the state’s business judgment rule blocked the FDIC’s ordinary negligence allegations. Specifically, the FDIC claimed that the former directors and officers were negligent in pursuing an unsustainable growth strategy that included approving high risk loans that resulted in substantial losses and contributed to the bank’s failure. The appeals court explained that state law appears to provide that a bank director or officer who acts in good faith might still be subject to a claim for ordinary negligence if he failed to act with ordinary diligence. However, given that its reading of the state statute conflicts with state intermediate appellate court holdings, the Eleventh Circuit asked the Supreme Court of Georgia to determine (i) whether a bank director or officer violates the standard of care established by state statute when he acts in good faith but fails to act with “ordinary diligence;” and (ii) whether, in a case applying Georgia’s business judgment rule, the bank officer or director defendants can be held individually liable if they are shown to have been ordinarily negligent or to have breached a fiduciary duty, based on ordinary negligence in performing professional duties. The court also affirmed the district court’s denial of the FDIC’s motion to strike certain affirmative defenses, rejecting the FDIC’s argument that under federal common law it owes “no duty” to bank officers or directors and it therefore is exempt from defenses under state law.
Governor Yellen Addresses Bank Director Removal Over Foreclosure Practices; Lawmakers Press Regulators On Independent Foreclosure Review Details
On November 18, Federal Reserve Chair nominee Janet Yellen responded to a recent inquiry by Senator Elizabeth Warren (D-MA) seeking more details about the Federal Reserve Board’s process for determining whether bank officers or directors should be removed because they directly or indirectly participated in the alleged violations that have resulted in various mortgage servicer settlements. Governor Yellen stated that the Federal Reserve Board “has not, to date, taken any actions removing or prohibiting insiders of the mortgage servicing organizations that were subject to the 2011 and 2012 mortgage servicing enforcement actions for their conduct in connection with servicing or foreclosure activities”, but “[the Federal Reserve Board is], however, continuing to investigate whether such removal or prohibition actions are appropriate.” In addition, on November 15, Senator Warren, joined by Representatives Elijah Cummings (D-MD) and Maxine Waters (D-CA), again pressed the Federal Reserve Board and the OCC to release a public report on the Independent Foreclosure Review process. This latest request follows other similar requests made earlier this year.
On November 14, the U.S. District Court for the Southern District of West Virginia denied motions to dismiss filed by former officers and directors of a failed federal thrift who allegedly contributed to the bank’s collapse by failing to exercise due diligence and monitor the bank’s relationship with a third party mortgage loan originator. FDIC v. Baldini, No. 12-0750, 2013 WL 6044412 (S.D. W.Va. Nov. 14, 2013). The former bank officers and directors moved to dismiss the FDIC’s negligence claims, filed as conservators for the failed thrift, arguing that the business judgment rule operates as a substantive rule of law that immunizes the directors and officers from liability for the alleged ordinary negligence. The court held that it is too early in the case to decide whether the officers and directors are entitled to business judgment rule protection. The court reasoned that determining whether the rule applies requires a fact-intensive investigation that is not appropriate for resolution on a 12(b)(6) motion to dismiss. The court noted that even if the rule applies, the FDIC should be permitted an opportunity to rebut that presumption. The court also held that the FDIC’s claims satisfy Twombly and Iqbal pleading requirements by sufficiently alleging that the directors and officers “essentially abdicated oversight completely” in the context of the thrift’s relationship with the third-party broker, which the court held was enough to support claims of not only ordinary, but gross negligence.
On October 10, the FDIC released Financial Institution Letter FIL-47-2013 to caution financial institutions about an increase in exclusionary terms or provisions in director and officer (D&O) liability insurance policies purchased by financial institutions. The FDIC reports that insurers are increasingly adding exclusionary language to D&O policies that has the potential to limit coverage and leave officers and directors personally responsible for claims not covered by those policies. Such exclusions may adversely affect financial institutions’ ability to recruit and retain qualified directors and officers. The FDIC advises institutions to thoroughly review the risks associated with coverage exclusions contained in D&O policies. The letter also reminds institutions that FDIC regulations prohibit an insured depository institution or depository institution holding company from purchasing insurance that would be used to pay or reimburse an institution-affiliated party for the cost of any civil money penalties assessed in an administrative proceeding or civil action commenced by any federal banking agency.
On September 16, an economic and financial analysis and consulting firm issued a report that indicates the FDIC already has filed more suits against bank directors and officers in 2013 than it has in any year since the start of the financial crisis. The report states that through August 2013, the FDIC has seized 20 institutions and filed at least 32 lawsuits against officers and directors. Notably, the report finds that the pace of filings in the second and third quarters of 2013 has exceeded the rate of new filings in any equivalent period in the past three years. Over that three year period, the FDIC has filed a total of 76 suits against the directors and officers of failed institutions, 10 of which have settled, and one of which resulted in a jury verdict.
On June 19, the U.K. Parliamentary Commission on Banking Standards published a report titled “Changing Banking for Good.” The Commission, established in July 2012 after the alleged rigging of LIBOR was revealed, was tasked “to conduct an inquiry into professional standards and culture in the U.K. banking sector and to make recommendations for legislative and other action.” The report covers a broad range of banking sector issues, but focuses on the impacts of a perceived misalignment of incentives in banking. Some of the key recommendations include: (i) establishing a new regime to ensure that the most important responsibilities within banks are assigned to specific, senior individuals so they can be held fully accountable for their decisions and the standards of their banks ; (ii) creating a new licensing regime underpinned by Banking Standards Rules; (iii) creating a new criminal offense of reckless misconduct in the management of a bank for senior bank officers; (iv) adopting a new remuneration code to better align risks taken and rewards received that would also defer more remuneration for a longer period of time; and (v) giving the bank regulator a new power to cancel all outstanding deferred remuneration for senior bank employees in the event their banks require taxpayer support.
On April 3, the FDIC released the first in a series of videos to provide technical assistance to bank directors, officers, and employees on areas of supervisory focus and proposed regulatory changes. The initial set of videos cover (i) director responsibilities, (ii) fiduciary duties, (iii) acting in the best interest of the bank, (iv) the FDIC examination process, (v) risk management examinations, and (vi) compliance and community reinvestment act examinations. The FDIC plans to release by June 30, 2013 a second set of videos that will consist of six modules covering (i) interest rate risk, (ii) third party relationships, (iii) corporate governance, (iv) the Community Reinvestment Act, (v) information technology, and (vi) the Bank Secrecy Act. A third installment will follow later in the year and will provide technical assistance regarding (i) fair lending, (ii) appraisals and evaluations, (iii) interest rate risk, (iv) troubled debt restructurings, (v) the allowance for loan and lease losses, (vi) evaluation of municipal securities, and (vii) flood insurance. The FDIC also plans to continue the model introduced as part of prior rulemaking processes and provide overviews and instructions on more complex rulemakings.
On January 29, the U.S. Court of Appeals for the D.C. Circuit held that the OCC and the Federal Reserve Board (FRB) improperly prohibited a bank director from participating in future banking activities of several institutions based on an agreement the director made to avoid state-level prosecution on perjury charges. DeNaples v. OCC, No. 12-1162, 2013 WL 322531 (D.C. Cir. Jan. 29, 2013). Under Section 19 of the Federal Deposit Insurance Act, banking regulators can prohibit an individual from participating in the affairs of an insured depository institution if the individual has been convicted of certain criminal offenses, or if the individual has entered into a “pretrial diversion or similar program” related to those criminal charges. In this case, the OCC and the FRB determined that a bank director could not participate in the affairs of several institutions with which he was affiliated because the director entered an agreement with state prosecutors by which the prosecutors withdrew perjury charges in exchange for certain actions taken by the bank director. The agencies determined the agreement constituted a “pretrial diversion or similar program.” When the bank director refused to halt his participation, the OCC and the FRB issued cease and desist orders requiring the director to terminate his relationship with the institutions. On appeal, the court held that the regulators applied an improper definition of “pretrial diversion or similar program” when they reasoned that the ordinary meaning of the phrase extends to any conditional agreement to withdraw charges. The court held that the definition must require more than any quid pro quo, and that the regulators should consider whether an agreement to avoid charges includes a voluntary agreement for treatment, rehabilitation, restitution or other noncriminal or nonpunitive alternatives. The court vacated the agencies’ orders and directed the agencies to determine on remand whether the conditions required by the state-level agreement fit within the parameters of a “pretrial diversion or similar program,” as established by the court.
Fourth Circuit Holds Bankruptcy Trustee Cannot Pursue Former Directors of Bankrupt Holding Company for Alleged Mismanagement of Subsidiary Bank
On December 28, the U.S. Court of Appeals for the Fourth Circuit affirmed a district court holding that a bankruptcy trustee lacked standing to sue former directors of an insolvent bank holding company for alleged mismanagement of a failed subsidiary bank. In re Beach First Nat’l Bancshares, Inc., No. 11-2019, 2012 WL 6720911 (4th Cir. Jan. 2, 2013). The district court determined previously that the directors and officers of the holding company and the subsidiary bank were one and the same, and that the harm caused to the bankrupt holding company was the direct result of the failure of the subsidiary bank. As such, the district court held that the trustee’s claims on behalf of the holding company are derivative claims that can only be pursued by the FDIC as receiver for the failed subsidiary. On appeal, the trustee argued that the claims are direct, not derivative, claims that fall outside of the FDIC’s purview, and, in the alterative, the claims are proper even if derivative because the FDIC has declined to act. The appeals court agreed with the district court and held that the trustee pled mainly claims deriving from defalcations at the subsidiary bank level, and not a distinct and separate harm specific to the holding company. Further, the appeals court held that the FDIC retains its statutory authority to act, and, in any event, has no statutory authority to transfer to another party its right to act on behalf of the failed subsidiary. The appeals court reversed the district court with regard to one of the trustee’s claims, holding that the trustee’s claim that the directors caused the holding company to improperly subordinate its equity interest in a company that owned real property could proceed on remand as a direct claim against the directors because the alleged actions caused damages unique to the holding company.
On November 19, the U.S. District Court for the Northern District of Illinois held that the FDIC, as receiver for a failed bank, is not entitled to memoranda prepared by a law firm in connection with the firm’s representation of two directors of the failed bank. FDIC v. Belongia Shapiro & Franklin, LLP, No. 12-2889, 2012 WL 5877559 (N.D. Ill. Nov. 19, 2012). The FDIC petitioned the court to enforce an administrative subpoena seeking legal opinions the firm provided to the bank in which the firm counseled the bank to pay the legal fees of bank personnel in three lawsuits. The court held that even though the FDIC stands in the shoes of the bank and generally holds any privilege the firm may assert, the firm was not required to turn over its legal advice provided to two of the bank’s directors who faced an administrative enforcement action by the FDIC. The court reasoned that because the firm was providing advice to the directors and not to the bank, the FDIC does not hold the attorney-client privilege. Further, the court explained that even though the firm provided advice to the bank before it represented the individual directors, such representation does not establish a joint-client or common interest exception to the privilege. Moreover, the bank’s payment of the firm’s fees does not entitle the bank to be privy to the firm’s communications with the directors. The court did require the firm to produce materials regarding two other matters in which the firm provided advice to the bank.