Directors: It's Long Past Time To Check The Liability Policy

An article in The Las Vegas Review-Journal that discusses the recent settlement by the former CEO and the former EVP (both also directors) of First National Bank of Arizona, which failed in 2008 as a result of a business plan that focused on Alt-A residential mortgage loans, also known as "liar loans," is noteworthy not so much for its content, but for the fact that most of the online commenters to the story don't bash the defendants but, rather, the US government and big banks that were bailed out while little banks like this one were allowed to sink. One commenter who calls herself "BarbVe" must have inside knowledge. FNB had received the highest asset quality ratio possible from its regulators as late as 2006. The mortgage market crashed in 2007. Virtually every mortgage company went out of business during that time frame (the exceptions are those that received govt support–e.g., BofA, Wells Fargo, etc…). While bankers should take some responsibility for the crash, it should be shared with regulators, policy makers (e.g., the Fed's low interest rates, numerous incentives to promote home ownership), and yes, homeowners themselves. These mortgages went bad because the borrowers stopped paying. Those of us who represent officers and directors of distressed community banks, as well as the banks themselves, have been struck by how common it was for many of the banks to have been highly rated, with a composite CAMELS rating of 1 or 2, right up until the year the market crashed. Then, suddenly, these geniuses were converted into idiots, and "grossly negligent" idiots at that. The FDIC argues that the bank's examiners expressed concerns and "warned" the bank of the dangers of the bank's lending strategy in reports of examination years in advance of the market crash, but it seems that those "warnings" never resulted in directives to "stop what you're doing" or even affected the high ratings given the bank. I don't know what the facts involved in the ANB case might have been, since all I've read is the FDIC's complaint;however, the bottom line, however, is that whether or not the defendants actually thought they bore responsibility for the bank's failure, the FDIC sued them for $193 million and settled for $20 million from each of them. To make matters more painful, the D&O liability insurance carrier denied coverage, although, since the defendants assigned their claims against the insurer to the FDIC, it's likely the denial will not go unchallenged. On a related note, McDermott Will & Emery published a newsletter yesterday that contains some timely advice concerning the wave of D&O litigation that's rolling (and will continue to roll) as a result of the hundreds of failures of banks so far and the additional failures that are coming down the pike. As the article points out, "[a]s of August 2011, the FDIC had initiated suits in connection with 11 failed institutions against 77 individuals. Other suits have been authorized but not yet filed, involving a total of 30 failed institutions against 266 individuals." That's just the tip of the iceberg. With respect to D&O liability insurance coverage, the firm notes that directors and officers of community banks are well advised to understand what's covered and what's not. Specifically, the "insured vs. insured exclusion" and the "regulatory exclusion" found in many of these policies can cause substantial heartburn. It's better to focus on ways to address these potential landmines while the bank is doing well rather than getting a sinking feeling in the pit of you stomach when realize at the most inopportune moment that you're "uncovered" and the FDIC is breathing down your neck.

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