Bank D&O Defense Manual

PREFACE

The recent financial crisis has resulted in the largest number of bank failures since the savings and loan crisis in the late 1980s and early 1990s ("S&L Crisis"). In March 1982, as the General Counsel to both the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corporation (which was later merged into the Federal Deposit Insurance Corporation ("FDIC")), I introduced the policies and standards upon which directors and officers of failed banks would be held responsible for any misconduct. Those policies were followed by a similar statement issued in 1992 by the FDIC.

During the S&L Crisis, directors, officers, attorneys, accountants and other professionals became the prime targets of litigation conducted by the FDIC and the Resolution Trust Corporation ("RTC") seeking to recover losses sustained by failed banks. In the aftermath of the S&L Crisis, the FDIC and the RTC brought suit or settled claims against hundreds of former directors and officers of failed banks and recovered approximately $1.3 billion in claims against former directors and officers. The FDIC is now again initiating an aggressive litigation strategy against the former directors and officers of recently failed banks.

In preparation for this latest wave of litigation, the FDIC has been increasing its internal legal staff and engaging outside law firms to perform professional liability investigations and to prosecute claims. To date, the FDIC has commenced twenty-nine lawsuits as of April 25, 2012 against former directors or officers of recently failed banks. In addition, the FDIC has announced that it has authorized lawsuits against 493 individuals for D&O liability in connection with recently failed banks in an effort to recoup over $8 billion in losses.

While seeking to recover from those responsible for a bank's failure is a fundamental part of any system that includes a federal safety net (such as FDIC deposit insurance), the FDIC's decision to commence failed bank litigation should not be influenced by a desire simply to collect damages from anyone who happened to be at the scene of the accident when the bank failed, whether or not they were responsible for the bank's failure or its losses. Any decision by the FDIC to sue the former directors and officers of a failed bank should only be made in compliance with the highest standards expected of a federal agency when it mounts an attack on an individual.

This guide has been prepared to assist directors and officers who may potentially find themselves opposite the FDIC in a lawsuit to understand how to avoid an investigation or to respond as effectively as possible.

Thomas P. Vartanian Washington, D.C.

FDIC PROFESSIONAL LIABILITY INVESTIGATIONS

An insured depository institution ("bank") fails when it is seized by its primary banking regulator and its charter is terminated. The bank's primary regulator immediately appoints the FDIC as receiver for the bank (or, in rare circumstances, as conservator for the institution). By operation of law, the FDIC, as receiver, succeeds to all rights, titles, powers and privileges of the insured depository institution, and of any stockholder, member, accountholder, depositor, officer or director of such institution with respect to the institution and the assets of the institution.

It is important to note that the FDIC wears several hats: (i) in its capacity as a regulator, the FDIC has back-up supervisory responsibility for all insured depository institutions and is the primary federal regulator of state non-member banks; (ii) in its corporate capacity, the FDIC is responsible for maintaining the Deposit Insurance Fund ("DIF"); and (iii) in its capacity as receiver or conservator, the FDIC has responsibility for resolving or rehabilitating failed insured depository institutions. As a result of these distinct roles, an action commenced by the FDIC in its capacity as receiver of a failed bank is not a claim by the FDIC in its corporate capacity as a regulatory agency.

Among the most important assets acquired by the FDIC, as receiver, is the right to bring professional liability claims against a failed bank's former directors and officers and its accountants, attorneys, appraisers and other professionals. Professional liability claims are claims brought by the FDIC to recover losses sustained by a failed bank as a result of the acts or omissions of the bank's former directors and officers and other professionals, and such claims may ultimately result in civil claims.

Following the closure of an insured depository institution, the FDIC's professional liability division will conduct an investigation to determine, among other things, whether the failed institution's former directors, officers or third-party professionals were responsible for the institution's losses and, if so, how to hold them accountable. The FDIC's professional liability section generally opens as many as eleven different types of professional liability investigations with respect to each failed institution, including, but not limited to, investigations of directors, officers, attorneys, accountants, fidelity bond carriers, appraisers and perpetrators of mortgage fraud. The extent to which the FDIC will investigate the circumstances surrounding the failure of an insured depository institution will depend upon several factors, including the extent of any losses suffered by the institution. If the institution has suffered relatively few losses, the FDIC may take the view that any investigation or lawsuit conducted to recoup such small losses would not be cost effective. Whether the FDIC initiates an investigation or ultimately brings a lawsuit does not ensure that the primary state or federal bank regulators will not begin their own administrative enforcement proceedings, or that the Department of Justice ("DOJ"), which has jurisdiction with regard to criminal liability and concurrent jurisdiction with regard to civil liability, will not also jump into action. Thus, there may be multiple fronts to be concerned about after a financial institution fails.

During the course of a professional liability investigation, the FDIC may make a pre-litigation demand on the former directors or officers of the failed bank for the payment of civil money damages and may send a copy of the demand letter to the appropriate insurance carrier(s). The purpose of such demand letters is to put the director or officer on notice of a potential lawsuit and to provide the requisite notice to the appropriate insurance carrier(s) of a "claim" made against the insured director and officer under the applicable insurance policy, in order to preserve insurance coverage as a potential source of recovery in the event that litigation is commenced and liability is established.

The FDIC reportedly has already sent hundreds of "demand" letters to former officers, directors and other employees of failed banks, as well as to their professional liability insurers, putting them on notice of potential claims. While the FDIC generally does not publicly release its demand letters, they may become public through disclosure in court proceedings, among other avenues. For instance, the demand letter sent by attorneys representing the FDIC to fifteen directors and officers of BankUnited, FSB, which was closed by the Office of Thrift Supervision in May 2009, was attached to a motion filed in a bankruptcy court. In addition to sending demand letters, the FDIC may issue subpoenas to the former directors and officers of a failed bank requiring them to testify at a deposition or produce documents relating to their personal financial affairs, including a personal financial statement showing their net worth. Such subpoenas may be issued prior to the FDIC actually initiating a lawsuit.

The FDIC's Office of Inspector General ("FDIC OIG") also may conduct an independent investigation into the reasons for an institution's failure. The FDIC OIG's Office of Material Loss Reviews is statutorily required to complete a "material loss review" with respect to the failure of insured institutions that cause material losses to the DIF. A material loss review consists of an investigation of the FDIC's supervision of the institution, including the implementation of prompt corrective action, a determination as to why the institution's problems resulted in a material loss to the DIF and recommendations to prevent future losses. The FDIC-OIG's material loss reports may also identify the actions or omissions of the institution's former directors and officers as a major cause for the institution's failure. As such, these reports may act as a road map for the FDIC and other potential plaintiffs to follow in seeking to bring professional liability claims against those allegedly responsible for the institution's failure, including directors and officers.

An FDIC professional liability investigation may take an extended period of time to complete. The FDIC has a stated goal of seeking to make a decision whether or not to pursue professional liability claims against a failed institution's former directors, officers and other professionals within 18 months of the institution's failure. The FDIC does not always complete its investigation within 18 months, however, and there may be a significant time lag between the date of an institution's failure and the date on which any litigation is actually commenced by the FDIC. In that regard, the FDIC generally has three years from the date a bank fails and the receivership begins to bring a breach of fiduciary duty case against the former directors and officers of a failed depository institution. As part of the investigation process, however, the FDIC may seek to enter into tolling agreements with potential defendants to allow settlement discussions to proceed without the need for the FDIC to file a lawsuit within the otherwise applicable statute of limitations.

In addition to conducting an...