2.02.2016, 10:12:00 AM

Does the FDIC only sue bankers who have D&O insurance?

No. At least, that is the conclusion put forward in Why does the FDIC sue? by Christoffer Koch (Federal Reserve Bank of Dallas) and Ken Okamura (Said Business School,  University of Oxford), which was recently posted on SSRN.

This paper is the first which empirically investigates the litigation strategy of the FDIC with regards to failed commercial banks. 

Anyone familiar with litigation and regulatory action can see there are two competing hypotheses:  either (1) the FDIC is primarily motivated in replenishing governmental coffers and thus seeks out "deep pocket" defendants who are backed up by ample directors & officers insurance or (2) the FDIC is motivated primarily by regulatory concerns and litigates to shape bank executive behavior and  correct poor governance.

The answer to this question is important to anyone buying, selling, or advising on the purchase of directors & officers insurance coverage, especially in the bank and non-insurance financial sector. The conventional wisdom and anecdotal evidence both point towards D&O insurance being the pot of gold at the end of the litigation rainbow.  Or, as the authors report, "one former banking regulator [who] said the existence of D&O insurance is the starting point for FDIC officials when they evaluate whether or not to file the suits . . . all the banking agencies are going to be bringing actions against deep pockets."  And certainly, banks often carry substantial amounts of D&O coverage.  Immediately after the financial crisis, Towers Watson reported that in 2009 the financial services sector (excluding insurance) had median coverage of $30 million and mean coverage of $81.7 million, the 25th percentile being $20 million and the 75th percentile being $100 million.

This paper, and its underlying research, was based on 161 civil tort cases against individual directors & officers litigated by the FDIC arising from 408 failures which occurred prior to June 2012.  These FDIC lawsuits have been characterized by the American Association of Bank Directors as being largely brought against former directors of community banks and based on the approval by the board or board committee of a handful of large loans that caused losses contributing to the bank's failure.

The authors found that "regardless of the recovery potential, that there is no "too-small-to-get-sued."   

Instead, the authors found evidence that FDIC litigation is largely correlated with, and directed against, bank executives who are "gambling for resurrection" (to borrow a term from game theory and international politics).  That is, bank executives who are "more optimistic, underprovisioning for losses, and more aggressively pursuing asset growth with riskier funding sources."  The authors characterize this as the FDIC "imposing a retroactive duty of care to deposit holders and a requirement that the directors and officers focus on the safety and stability of the financial institution."  As a result, bank executives who seek to "accelerate asset growth reliant on riskier funding sources" are more likely to be targets of FDIC litigation, rather than simply those who were prudent enough to purchase bountiful amounts of directors & officers insurance. 

These findings, if borne out through further research, also have interesting implications for the intersection of D&O insurance and moral hazard. 

Labels:

0 Comments:

Post a Comment

<< Home

back to top