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TheStreet Open House

FDIC Readies Lawsuit Onslaught Against Bank Execs

Stocks in this article: BBT UMPQ

WASHINGTON ( TheStreet) -- The U.S. government has already filed lawsuits for billions in damages against bank executives following mortgage crisis and the resulting bank failures.

However, many industry professionals say this only represents the tip of the iceberg of possible damage claims from Federal Deposit Insurance Corp. against directors and officers of failed banks.

"Many directors still don't understand the extent of their liability or that the FDIC can and will pursue them in the event of a bank failure," says Jonathan Hullick, a former senior policy specialist for the FDIC.

As of December 14, the FDIC had authorized lawsuits against 109 individuals for directors and officers (D&O) liability claiming $2.5 billion in damages, according to a report by the agency. The FDIC has also authorized four fidelity bond and attorney malpractice lawsuits and over 190 malpractice and mortgage fraud suits, some of which were inherited from failed institutions.

But as the receiver for failed banks and thrifts, the FDIC has three years to file tort claims and six years for breach-of-contract claims unless the failed institution's home state has a longer statute of limitations.

Given that there have been 322 bank and thrift failures since the current wave began in 2008 -- and none of the failures have passed the three-year mark yet -- the FDIC still has plenty of time to press lawsuits for most of the closures.

Frank Mayer -- a partner with Pepper Hamilton LLP of Philadelphia and a former senior attorney with the FDIC and senior counsel for the Resolution Trust Corporation -- told TheStreet that "it takes on average 18 to 24 months from the time FDIC is appointed receiver to investigate a D&O situation," and if the failed institution was held by a publicly traded company, "there can be a shareholder class action lawsuit going, also pursuing the D&O policy proceeds."

Hullick, also a former bank executive who is currently consulting for several troubled banks, added that "being a bank director is much more than showing up for a monthly meeting. Too many boards fail to exercise sufficient governance over the CEO and executive team."

The FDIC said that between 1985 and 2009 it had brought lawsuits against directors and officers in 24 percent of bank failures, collecting $6.2 billion in professional liability claims, while spending "$1.5 billion to fund all professional liability claims and investigations."

But now the agency is under pressure to speed-up the process.

The FDIC's proposed 2011 operating budget includes an additional 263 permanent staff, an increase of 5% from 2010.

Mayer explained the FDIC has "been staffing-up over the last nine months or so," including "outside counsel, some of whom they used back in the day," following the savings and loan crisis of the late 80's and early 90's. The agency has historically spent about 23 cents for every dollar it collects and is "constantly doing cost-benefit analyses," he said, adding that "based on my current experience the FDIC is acting in an equally prudent manner."

JUDGE RULES AGAINST THE FDIC

Mayer said the FDIC was left scratching its head on how to best "get their fair share of the D&O policy" after being "bounced out of court" on December 29, when U.S. Northern District of Georgia Judge Charles A. Pannell, Jr. denied the agency's motion to intervene in a class action suit brought by shareholders of Haven Trust Bancorp, which was the holding company for Haven Trust Bank of Duluth, Ga. The bank failed in December 2008, costing the FDIC's insurance fund $207 million. The FDIC sold Haven Trust Bank's deposits to BB&T (BBT - Get Report).

Haven Trust Bancorp's shareholders filed suit in December 2009 alleging that the holding company's directors had mislead investors. The FDIC in October 2010 filed a motion to intervene, saying that the agency had assumed all of the failed bank's rights and had an interest in preserving the holding company's D&O policy. The FDIC argued that the plaintiff's claims were "derivative" and belonged solely to the agency.

The court agreed with the plaintiffs and the defendants in the class action suit "that the FDIC does not have an interest in this case," adding that the claims "are not derivative claims against the Bank but are instead direct claims against the defendants regarding the marketing and selling of the holding company's stock."

FDIC Spokesman David Barr said the agency was "still studying the order, and will not be commenting."

A GOOD DEFENSE.

When asked about how directors and officers of banks can best protect themselves against claims in the event their bank fails, Mayer explained that it is essential to "detail in the minutes board decision making," adding that "in hindsight, the decision didn't have to be correct, but had to be prudent that appropriate business judgment was exercised." Mayer said that it is also essential for the directors to have previously appointed a special counsel who was provided with copies of all board documents ahead of time, since "once the FDIC becomes the receiver it is very difficult to get the documents."

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