Over the past few weeks many articles have been published about the damage that has been caused by lawsuits the FDIC has filed against bank directors and officers. I know there were some things going on in a few banks that weren’t always done appropriately or legally, but the problem is that much of this activity had been occurring for years. As Warren Buffet once said, “Only when the tide goes out do you discover who’s been swimming naked.”
As we all know, the tide went out on the banking industry. If that wasn’t bad enough, the regulators (the same people that go into almost all the banks in the country once a year to do their “safe and soundness” reviews) decided they should start filing lawsuits. Most banks have D&O insurance and the FDIC saw that as easy pickings.
The FDIC’s website discusses what they do in their annual bank examinations: www.fdic.gov. It states “Financial performance ratios and other quantitative measures are only part of the comprehensive process that supervisors use to evaluate an institution’s overall condition.”
If the FDIC was really doing a “comprehensive” review of all these banks, why didn’t they find all the problems in the years before they shut these banks down?
Many of the directors and officers who have been sued, received a CAMELS rating of 1 or 2 the year before the regulators decided it was time to shut the bank down. In fairness to the regulators, they did give these banks an opportunity to save themselves. Basically they needed to raise capital after the regulators made them write off those real estate loans. Some of the first banks did raise capital only to see it depleted immediately by the regulators. Investors then became few and far between.
The FDIC publicizes these lawsuits and how much money they are collecting, but what they are not telling everyone is that these suits are causing long-term damage to the financial industry.
A recent article titled “As FDIC targets executives of failed banks, healthy banks feel pain” mentions that the cost of D&O insurance has doubled since these lawsuits began. These costs put additional pressure on community banks’ profit margins.
As I mentioned in an earlier post, one of the biggest problems that this article failed to mention is that in the future it will be hard to find experienced, successful businesspeople to serve on bank boards, and you can’t start a new bank without directors. The FDIC is bragging about all the money they are getting from these directors, but most of it is coming from the insurance companies. So naturally the insurance companies are going to raise their rates, putting even more pressure on bank profits. The good news for the community banks is that there will be less competition in the future, since most smart businesspeople won’t have an interest in starting a bank.
In another post I recommended steps that directors and officers should take to be better prepared for a lawsuit from the FDIC. Working with banks all over the country, here are a few things I recommend:
1. Directors and officers need to keep copies of everything they are given in board meetings, especially the Regulator’s Examination Reports, Internal and External Auditor Reports, Board Minutes and Loan Committee Notes. When regulators shut down a bank it is extremely difficult to obtain copies of those reports. Even though a bank might have received a CAMELS rating of 1, when the directors and officers are sued, the small 8 pt. copy on page 32 of the examination report where the bank was warned about making “risky” real estate loans, will become a major act of gross negligence. You’ll need to get legal advice on where to keep these documents, because the regulators could claim you took sensitive, personal and confidential information out of the bank. Or when the lawsuit is filed, they could claim that you stole it. And if you’re on the loan committee, make sure to get the documents a couple of days before the loan committee meeting so you’ll have time to study them. If not, the lawsuit will claim that you just rubber-stamped the loans without even reading them. You’ll want to keep these in case a loan is made that doesn’t match what was presented to the loan committee. Also make notations such as “I asked about the bank’s legal lending limit and attorneys in attendance assured me that we were legal.”
2. Another important fact to remember is that the attorney present at the board meeting who told everyone that the loans were within the bank’s legal lending limits won’t be available when the lawsuit is filed. They now belong to the FDIC, and with “attorney–client privileges” they won’t even remember your name. Occasionally directors should invest a little of their own money for an outside attorney to make sure all their processes are legal. Consider it an insurance policy and the price of doing business.
3. Which brings up another important item. Make sure you keep copies of your D&O policy in a safe and secure place. When the lawsuit is filed and you contact the insurance company they develop amnesia very quickly. They are not in the business of paying out on policies. They’ll claim they’ve never heard of you or your bank until you are able to give them the policy number.
And most attorneys won’t even talk to you until you show them the money.
Make sure you spend a lot of time at the next board meeting having an expert explain the small type in your D&O policy. I wouldn’t recommend having your D&O Insurance Company explain it, because they’re making changes to your policy as you read this.