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As recently as this past Monday, commentators
were grumbling that the FDIC is moving too slowly in pursue claims against
former directors and officers of failed banks. The FDIC has responded in
dramatic fashion with a March 16, 2011 lawsuit filing in the Western District
of Washington against three former Washington Mutual executives, as
well as two of the executives' wives.
According to news reports (here),
the lawsuit seeks damages of as much as $900 million. The media stories also
suggest that there is an agreement by WaMu's outside directors to pay $125
million to settle claims by the FDIC is pending approval. A copy of the FDIC's
recent complaint against the WaMu executives and their wives can be found here.
WaMu's September 2008 failure (about which refer here),
represents by far the largest bank failure in U.S. history. The events
surrounding its failure have already been the subject of extensive litigation,
not the least of which is a pending securities class action lawsuit filed on
behalf of WaMu's shareholders, which, as noted here,
survived a renewed motion to dismiss after the lead plaintiffs amended their
The FDIC filed its recent lawsuit in its capacity as
WaMu's receiver. The lawsuit names as defendants WaMu's former CEO, Kerry Killinger, its
former President and COO, Stephen Rotella, and its chief of home lending, David
Schneider. In a rather unusual twist that shows just how aggressively the FDIC
may be prepared to get in pursuing these claims, the complaint also names
Killinger's wife, Linda Killinger, and Rotella's wife, Esther as explained
The complaint asserts claims against the three executives
for Gross Negligence, Ordinary Negligence and Breach of Fiduciary Duty.
The complaint alleges that the three defendants caused
the bank to take "extreme and historically unprecedented risks with WaMu's
held-for-investment loan portfolio." The three allegedly focused on short
term gains, to the disregard of the bank's long term safety and soundness. The
executives, lead by Killinger, allegedly developed an executed a strategy to
make billions of dollars of risky residential mortgages, increasing the risk
profile of the bank's held for investment mortgage portfolio.
The bank's business strategy dictated a lending approach
for which few lenders were turned away. The bank also layered multiple levels
of risk with particularly risk loan products such as option ARM mortgages, the
riskiness of which was further compounded by allowing stated income lending and
other questionable lending practices.
The complaint alleges further that these executives
continued to pursue their aggressive growth strategy even at a point when
housing prices "were unsustainably high" and while relying upon an
aging infrastructure that was inadequate to keep up with the enormous loan
volume. The complaint alleges that the three executives knew the strategy was
risky, knew the process weaknesses, and even knew there was a housing price
bubble. Yet, the complaint alleges, the three executives marginalized the
company's risk management department.
As a result, when the bubble collapsed, the bank
"was in an extremely vulnerable position" and, as a result of the
three executives "gross mismanagement" the bank suffered losses of
"billions of dollars."
The complaint also includes fraudulent conveyance claims
against Killinger and his wife Linda, and against Rotella and his wife Esther.
The complaint alleges that in August 2008, Killinger and
his wife transferred two residential properties to qualified personal residence
trusts and appointed themselves as trustees. The complaint alleges that these
transfers were made with the intent to hinder, delay or defraud Killinger's
The complaint contains similar allegations against
Rotella and his wife with respect to an April 2008 residential real estate
transfer and a September 2008 transfer from Rotella to his wife of $1 million.
In statements to the Wall Street Journal, here,
Killinger and Rotella said the FDIC's allegations are "baseless" and
"lack credibility" and that the lawsuit is "unworthy of the
government." I recommend that readers take a few minutes and read these
two individuals' statements. Whatever may be the merits of this and similar
cases brought by the FDIC, it is very clear from these statements that there
will be a personal price to pay for the individuals involved. The personal pain
these men are feeling is palpable, and there will be more of this kind of pain
for other former bank officials as more of these kinds of lawsuits are filed.
With the filing of this complaint, the FDIC has
unmistakably demonstrated that it will pursue claims against former directors
and officer of failed banks when it chooses to do so. Indeed, the claims
against the two executives' wives clearly show that the FDIC will proceed
Given that WaMu represented the largest bank failure in
U.S. history, it may come as no surprise that the FDIC is pursuing these kinds
of claims. What has been surprising to some, and what occasioned the criticism
I mentioned in my opening paragraph, is how deliberate the FDIC has been in
choosing to pursue claims. WaMu failed nearly two and one half years ago. If
the FDIC were to act with similar deliberation in pursing other claims, it
could well be some time before we know for sure how extensive the FDIC's
litigation activity ultimately will be in pursing claims as part of the current
It is, however, quite clear that the FDIC will be
pursuing more of these types of claims. The FDIC recently updated the
Professional Liability Lawsuits page on its website (here) to
show that the FDIC's board has approved lawsuits against 158 individual
directors and officers of failed banks. Since the six lawsuits the FDIC has
filed to date only amount to about 40 individual defendants in total, there are
many more lawsuits to come, just based on the actions that have been approved
One particularly interesting detail about the news
surrounding the FDIC's recent lawsuit is the report that WaMu's outside
directors have agreed to pay $125 million to settle claims. It is interesting
that the outside directors agreed to pay this amount without the intervening
step of a lawsuit against them. One question that immediately occurs to me is
whether and to what extent this $125 million payment is to be funded by D&O
WaMu's D&O insurance program was undoubtedly already
under pressure due to the significant presence of other claims already pending
against its former directors and officers. One possibility that occurs to me is
that the bank may have carried a significant layer of Side A DIC protection,
which may well have been triggered by the bank holding company's bankruptcy.
Because of the bankruptcy, all of the claims represent potential Side A losses,
suggesting that the bank's Excess Side A/DIC program could well have been
called in to contribute. All these are details that those of us on the outside
can only wonder about; however, comments from knowledgeable persons who are
closer to the situation are always welcome.
Whatever may be the case, it is clear that D&O
insurance may be playing a role of some kind in all of this. At least Stephen
Rotella thinks so. In his statement to the Wall Street Journal to which I
linked above, he speculated that the lawsuit itself "may be a way for the
FDIC to collect a payout from insurers who provided officers and directors
liability coverage for the time they worked at WaMu."
As noted, with this lawsuit, the total number of lawsuits
the FDIC has filed as part of the current wave of failed bank litigation is now
up to six. A list of the six lawsuits can be found here.
A March 17, 2011 Bloomberg article about the FDIC's
lawsuit can be found here.
A March 17, 2011 Seattle Post-Intelligencer article about the suit can be found
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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