FDIC Legal Battles Over Financial Crisis Just Beginning

WASHINGTON — The financial crisis is over, but the Federal Deposit Insurance Corp.'s work to recoup losses related to bank failures through civil litigation is just starting — and likely to take far longer than the crisis itself.

Only one of the agency's 65 lawsuits against former bank directors and officers has produced an actual decision, while eight others have been settled out of court as of June 7. That leaves 56 cases still without an outcome, not to mention many new cases yet to come. Observers and FDIC officials agree the process is likely to play out for years.

"The pace is frustratingly slow," said Joseph Monteleone, a partner at Tressler LLP who specializes in D&O litigation issues. "We probably will see continuing high amounts of filings throughout 2013. Then we'll probably see an ebb in 2014. But the suits that are being filed now conceivably could take two or three years to run their course."

The pileup of unresolved cases is attributed to numerous factors. Pretrial phases in several FDIC lawsuits have been extended as defendants try to get cases thrown out and also win access to bank documents now under FDIC control. Battles over how much insurance policies, which directors and officers took out for covering damages, will actually pay following court decisions have also slowed the process.

"Justice is not always quick," said Catherine Galley, senior vice president at Cornerstone Research, which has tracked the progress of pending suits as well as the filing of new ones. "It's still early days."

But Monteleone noted that the longer some cases drag on, the more likely the FDIC is to face smaller paydays. The agency typically claims damages commensurate with how much insurance a former bank manager has to pay for litigation. But that amount can dwindle as defendants use it to pay for their legal defense and potentially the claims of other plaintiffs.

"In the most recent case I was involved in, before the FDIC even negotiated a settlement amount in principle, there were settlements with the holding company shareholders [and] with employees, plus there were ongoing investigations by various federal agencies, all dwindling down the amount of available insurance assets," Monteleone said. "The first claim that is settled is generally the first claim to get paid."

Richard Osterman Jr., the FDIC's acting general counsel, acknowledged that the agency faces the challenge of what is known as "wasting policies." But he said the agency has the option to seek damages from the personal assets of former bank managers as well.

Generally, Osterman said, the litigation "process is playing out pretty much along the lines that we expected."

"We're moving forward in a thoughtful and methodical way, reviewing the cases as the failures have come up," he said. "We're applying well-established FDIC policies to ensure that claims are meritorious and cost-effective. The process is playing out pretty much along the lines that we expected."

An April report by Cornerstone estimated that the FDIC is on pace to file about 40 lawsuits in 2013, the most in any year since the crisis began. (The agency so far has filed 21 this year.) With the FDIC typically subject to a statute of limitations requiring the agency to sue no more than three years after a failure, the recent escalation in filings corresponds with the period in 2010 when failures stemming from the crisis were at their height. Failures reached 157 that year, following a total of 140 in 2009.

The eight settlements to date have netted the FDIC more than $100 million, which does not include what the FDIC has collected from settlements in which the agency never filed a suit or civil actions against parties other than directors and officers. Since the beginning of 2011, the FDIC has collected roughly $600 million through all of its professional liability actions against individuals associated with failed institutions, including in out-of-court settlements.

Yet the only filed D&O case officially to enter a trial phase and actually produce a jury verdict is the first one the agency filed back in July 2010, which sought damages from three executives in a construction lending division of IndyMac Bank that the agency claimed had a role in the bank's 2008 failure. In December, a jury awarded $169 million to the FDIC. However, parties in the case are still sorting out issues related to the available coverage in the defendants' D&O insurance.

Other cases have remained mired in pretrial disputes. Several defendants have attempted motions urging judges to throw out cases before arguments are heard, claiming, for example, that state laws preclude the types of legal claims sought by the FDIC.

"Sometimes the motion to dismiss can sit there for what seems [like] forever. It can take months and months for the judge to make a decision," said David Baris, executive director of the American Association of Bank Directors and a partner at BuckleySandler LLP.

Once the case moves into the discovery phase, the opposing parties have butted heads over defendants' access to internal documents the FDIC controls as receiver of the failed bank.

A "cause of delay in many cases is the discovery disputes related to what documents the FDIC is required to produce, how the FDIC is required to produce them, and whether the FDIC is responsible for the cost associated with the production," said Mary Gill, a partner at Alston & Bird.

"These suits present the unusual circumstance of only one of the parties, the FDIC, having possession and control over the documents. The key bank documents have not been difficult to obtain from the FDIC in discovery. The disputed discovery issues generally pertain to email communications and other electronic files that the FDIC controls, as well as the supervisory files of the FDIC relating to the bank."

But Osterman said in some situations "the other side's requests for documents have been overbroad or are not relevant to the case."

"In that context, we might resist," he said.

Prolonged court battles are nothing new for the FDIC. It was just two years ago that the agency finally settled a well-publicized case against Grant Thornton for poor auditing practices related to the failure of First National Bank of Keystone in West Virginia. The bank had failed more than a decade earlier in 1999.

In some pending cases, the FDIC is also pursuing separate actions against the D&O insurance provider to force them to pay.

Perhaps the most contentious issue is over an exclusion in certain policies — known as the "insured versus insured" provision — that absolves the insurer from payout obligations if both parties in a case are covered under the policy. Some insurers have argued that since the FDIC steps into the shoes of the failed bank, which had previously taken out a policy, a suit brought by the agency triggers the exclusion. Some policies also exclude certain payments for claims tied specifically to loan losses at a financial institution.

"'Insured vs. insured' and loan loss provisions in these policies have been litigated quite a bit in this crisis," said Osterman.

Kevin LaCroix, an expert on director and officer liability cases, said in the wake of the savings and loan debacle the FDIC took to seeking settlements directly with the D&O insurance provider to cover claims in multiple failed-bank cases.

"The same dynamic could kick in," said LaCroix, who writes the D & O Diary blog and is executive vice president for RT ProExec, a specialty insurance brokerage division of R-T Specialty. "In the near term, though, these cases will slowly unfold and will likely be resolved one at a time."