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.
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 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.
On October 31, the Federal Financial Institutions Examination Council (FFIEC) issued a revised Supervision of Technology Service Providers Booklet (TSP Booklet). The revised TSP Booklet, which is part of the FFIEC Information Technology Examination Handbook, provides guidance for examiners and financial institutions on the supervision of technology service providers by describing the federal banking regulators’ statutory authority to supervise third-party service providers, outlining the regulators’ risk-based supervision program, and providing the Uniform Rating System for examinations. The TSP Booklet clarifies that outsourced activities should be subject to the same risk management, security, privacy, and other internal controls and compliance policies as if such functions were performed internally, and that a financial institution’s board of directors and management have the responsibility for ensuring that outsourced activities are conducted in a safe and sound manner and in compliance with applicable laws and regulations.
Concurrent with the release of the updated TSP Booklet, the Federal Reserve Board, the FDIC, and the OCC issued new Administrative Guidelines for the Implementation of Interagency Programs for the Supervision of Technology Service Providers. The Guidelines are separate from the FFIEC IT Examination Handbook and describe how the agencies implement their interagency supervisory programs. The Guidelines are primarily a resource for examiners and include the reporting templates used by examiners.
Puerto Rico Federal District Court Denies Motions to Dismiss FDIC Suit Against Former Bank Officers and Directors
On October 23, the U.S. District Court for the District of Puerto Rico denied motions to dismiss gross negligence claims against former directors and officers brought by the FDIC as receiver for a failed bank. The court further held that the FDIC as receiver is not precluded from recovering under the directors and officers’ insurance policies. W Holding Co. v. Chartis Ins. Co.-Puerto Rico, No. 11-2271, slip op. (D. Puerto Rico Oct. 23, 2012). The FDIC sued former officers and directors of the bank, alleging that they were grossly negligent in approving and administering commercial real estate, construction, and asset-based loans and transactions and seeking over $176 million in damages. The court concluded that the FDIC could not maintain claims for ordinary negligence against the former officers and directors because of the business judgment rule, but that the FDIC had stated sufficient facts to allege a plausible claim for gross negligence. The court held that (i) the FDIC’s complaint adequately specified which alleged misconduct was attributable to each director or officer, (ii) the claims should not be dismissed on statute of limitations grounds, and (iii) separate claims against certain former officers and directors concerning fraudulent conveyances should not be dismissed. In addition, the court denied the insurers’ motions to dismiss the FDIC’s claims for coverage under the directors and officers’ liability policies. The court held that the policies’ “insured versus insured” exclusion did not apply to an action by the FDIC as receiver because the FDIC was suing on behalf of depositors, account holders, and a depleted insurance fund.
On October 5, the U.S. District Court for the Central District of California dismissed several affirmative defenses invoked by a group of former bank officers sued by the FDIC as receiver for a failed bank, including their claim of protection from personal liability for business decisions. FDIC v. Van Dellen, No. 10-4915, 2012 WL 4815159 (C.D. Cal. Oct. 5, 2012). The FDIC sued the former officers, alleging that, in pursuit of bonuses for high loan origination volumes, the officers approved homebuilder loans to unqualified borrowers. As part of their defense, the officers claimed that the court should apply the law of the state of Delaware where the bank was incorporated, and not California law where the bank had its principle place of business. The officers sought to invoke Delaware law protecting officers from personal liability for business decisions. The court disagreed and held that (i) California law applies under any choice of law test and (ii) California’s business judgment rule, both as codified and its common law element, immunizes directors from personal liability but not officers. With regard to the officers’ defense that the FDIC claims were time barred as allegations of professional negligence, the court held that the gravamen of the complaint actually is breach of fiduciary duty, which has a longer statute of limitations. The court also reiterated a previous ruling that the officers could not invoke any defenses that would rely on imputing the bank’s pre-receivership conduct to the FDIC as receiver. The court did agree with the officers that any recoveries made by the FDIC in another case should be considered when assessing damages in this case, and that claims regarding certain loans approved by the bank’s federal regulator should be reviewed by a jury.
On July 11, four former bank officers and two of their former customers were indicted in the U.S. District Court for the Eastern District of Virginia on eighteen counts of fraud. Indictment, United States v. Woodard, No. 12-105 (E.D. Va.). The indictment alleges that in the run-up to the financial crisis, the bank more than doubled its assets primarily through brokered deposits, while the directors administered a lending program that violated industry standards and the bank’s internal controls. In connection with the financial crisis, the indictment states, the bank’s loan portfolio deteriorated and the directors conspired to conceal the institution’s financial condition. Ultimately, the bank failed, leaving the federal government insurance fund to cover approximately $260 million in deposits, the indictment claims. In addition to the criminal charges, the U.S. Attorney is seeking forfeiture of the defendants’ assets. Other bank officers, employees, and customers already have pled guilty to related charges.
On June 29, the U.S. Court of Appeals for the Seventh Circuit directed a D&O insurance provider to cover certain claims against defendants insured under the same policy as some plaintiffs despite an “insured vs. insured” exclusion from coverage under the insurance arrangement. Miller v. St. Paul Mercury Ins. Co., No. 10-3839 (7th Cir. June 29, 2012). The dispute began when five plaintiffs sued Strategic Capital Bancorp, Inc. (“SCBI”) for fraud and other state law claims flowing from SCBI’s alleged material misstatements relating to the company’s financial condition. Three of the plaintiffs were directors or officers covered under SCBI’s policy; the other two plaintiffs were not insureds under the policy. When SCBI notified its insurance carrier and requested indemnity and defense coverage under the insurance agreement, the carrier refused, citing the policy’s “insured vs. insured” provision. All parties to that initial lawsuit then filed a new action against the carrier in an effort to force it to provide coverage. The Seventh Circuit reversed the district court’s dismissal of those claims brought by the two non-insured plaintiffs. In a lawsuit involving both insured and non-insured plaintiffs, the court ruled, the insurance carrier must “provide indemnity for losses on claims by non-insured plaintiffs but not for losses on claims by insured plaintiffs.” The court reasoned that such a holding conforms to the parties’ expectations, minimizes the risk of arbitrary results, and discourages efforts to manipulate the result through strategic party joinder or case consolidation.