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Board Report: 2014-SR-B-011 July 25, 2014

Enforcement Actions and Professional Liability Claims Against Institution-Affiliated Parties and Individuals Associated with Failed Institutions

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Results in Brief

Enforcement Actions. EAs against IAPs include removal/prohibition orders, civil money penalties (CMP), administrative restitution, and personal cease and desist orders. Removal/prohibition orders are the most severe actions and prohibit an IAP from participating in the affairs of any insured depository institution for life. Accordingly, the statutory criteria for sustaining a removal/prohibition order are rigorous and the Regulators must prove three grounds: misconduct, effect of the misconduct, and culpability for the misconduct. To prove culpability, the Regulators must show that the IAP exhibited personal dishonesty or a willful or continuing disregard for the safety or soundness of an institution. Proving willful or continuing disregard is particularly difficult, according to the Regulators.

The Regulators each have similar, formal processes to investigate and impose EAs on IAPs whose actions harmed institutions. These processes generally include an investigative period, agency review, an opportunity for the IAP to consent to the action, and a Notice of Charges if the IAP does not consent. A Notice of Charges triggers a review by an Administrative Law Judge (ALJ), followed by an agency decision, and potentially an IAP appeals process. Various divisions and offices within each agency coordinate with each other in pursuing EAs.

The Regulators issued 275 EAs against individuals associated with 87 failed institutions, or 19 percent of the 465 institutions that failed. The majority of these EAs were imposed against institution directors and officers. As of September 30, 2013, potential EAs against IAPs were in-process related to an additional 59 failed institutions. These EAs will ultimately be closed-out or imposed.

Of the total 275 EAs imposed, 128 were removal/prohibition orders against IAPs associated with 75 institutions (16 percent of the 465 failed institutions). This is an increase over the banking crisis of the 1980s and early 1990s where the Regulators imposed removal/prohibition orders against IAPs associated with about 6 percent of the institutions that failed from 1985 through 1995.

Removal/prohibition orders may be based on personal dishonesty or willful or continuing disregard for the safety or soundness of the institution. Most of the removal/prohibition orders issued by the Regulators included personal dishonesty as a basis for the action. The Regulators brought very few removal/prohibition orders based solely on willful or continuing disregard for safety or soundness. In this respect, we observed that most of our MLRs concluded that management did not operate institutions in a safe and sound manner, which contributed to institution failure. Most commonly, we reported that these failures were caused by the institutions' management strategy of aggressive growth that concentrated assets in commercial real estate loans, which was often coupled with inadequate risk management practices for loan underwriting, credit administration, and credit quality review.3

Several factors appeared to impact the Regulators' ability to pursue EAs against IAPs. Those factors included the rigorous statutory criteria for sustaining removal/prohibition orders; the extent to which each Regulator was willing to use certain EA tools, such as personal cease and desist orders; the Regulators' risk appetite for bringing EAs; EA statutes of limitation (SOL); and staff resources, among other things. In connection with these factors, we are making recommendations related to evaluating approaches and developing methodologies to support issuing EAs against IAPs where the Regulators can show that IAPs exhibited a willful or continuing disregard for safety or soundness and increasing the use of personal cease and desist orders.

We also identified other matters warranting the Regulators' attention. Specifically, the FDIC should issue guidance on the issuance and publication of letters to individuals who were convicted of certain crimes. In addition, the Regulators should address differences in how they notify each other when initiating EAs against IAPs and depository institutions.

Professional Liability Claims. The purpose of the professional liability program is to maximize recoveries to receiverships and hold accountable directors, officers, and other professionals that caused losses to failed depository institutions. The FDIC investigates PLCs pertaining to all failed depository institutions, regardless of whether the PFR was the FDIC, FRB, OCC, or OTS.

When an institution fails, the FDIC acquires a group of legal rights, titles, powers, and privileges, which include PLCs. The FDIC's Professional Liability Unit (PLU) is responsible for the FDIC's Professional Liability Program. PLU and the Investigations Department within the FDIC's Division of Resolutions and Receiverships (DRR) investigate 11 claim areas for each institution failure and pursue PLCs that are both meritorious and expected to be cost-effective. For a PLC to have merit, the FDIC must meet the burden of proof required by the federal or state law that applies to the claim. For a typical tort claim, the FDIC generally must show that the subject individual or entity owed a duty to the institution, breached that duty, and the breach caused a loss to the institution. Officials told us that the threshold for misconduct to sustain a PLC can be lower than that for a removal/prohibition order.

To collect on these claims, the FDIC typically must sue the professionals responsible for the losses resulting from their breaches of duty to the failed institution. Recovery sources include liability insurance policies, fidelity bond insurance policies, and the assets of the individuals or entities pursued.

The FDIC has a formal process for investigating and pursuing PLCs. During 2013, the FDIC made significant improvements in the coordination and sharing of PLC information between the PLU and Enforcement groups, other FDIC divisions and offices, and the other PFRs.

The FDIC completed 430 PLCs4 and had an additional 305 pending a final result based on litigation or negotiation as of September 30, 2013. In total, the 735 completed and pending PLCs were associated with 193 of the 465 failed institutions (42 percent).

Of the 735 completed and pending PLCs, 162 pertained to directors and officers associated with 154 of the 465 failed institutions (33 percent). During the banking crisis of the 1980s and early 1990s, the FDIC brought claims against directors and officers in 24 percent of the failed institutions.

A key factor impacting the pursuit of PLCs was an increasing number of exclusions that insurers inserted into insurance policies, which excluded or attempted to exclude coverage for claims made by the FDIC. Other factors include meeting applicable federal or state law standards in support of meritorious claims, limited recovery resources, and a court decision pertaining to another agency that resulted in the FDIC limiting its use of tolling agreements to extend the SOL on PLCs.

We are recommending that the FDIC research ways to make institutions more aware of, and mitigate the impact of, insurance policy exclusions. In addition, we are recommending that the OCC and FRB inform their regulated institutions about the risks related to insurance policy exclusions.

In evaluating the FDIC's PLC process, we noted improvements that could be made in the Corporation's tracking and reporting of PLC expense and recovery information. In that regard, our report includes a recommendation that the FDIC take steps to provide more institution-specific information to members of its Board of Directors (Board).

  • 3. Comprehensive Study on the Impact of the Failure of Insured Depository Institutions, Report EVAL-13-002, dated January 2013. Return to text
  • 4. Completed PLCs comprised settlements and court judgments to pay the FDIC and cases dismissed by the courts. Of the 430 completed PLCs, 379 resulted from settlements, 32 resulted from court judgments, and 19 were dismissed. Table 4 provides additional detail on the PLCs pertaining to the 465 failed institutions. Return to text