Bank Directors and Officers Face Increased Scrutiny from Regulatory Lawsuits and Criminal Investigations Brought by Federal Regulatory and Law Enforcement Agencies.
CHICAGO May 8, 2014 – After recent court rulings and criminal investigations, the directors and officers of banks may not be sleeping so soundly. Seemingly gone are the days where courts and regulators reflexively deferred to the business judgment of a bank’s officers and directors. Banks and their directors and officers are now being targeted for corporate misconduct in lawsuits brought not only by traditional bank stakeholders, but also the Federal Deposit Insurance Company (FDIC) and the U.S. Justice Department. On May 5, 2014 in a video message posted on the Justice Department’s Web site (http://www.justice.gov/agwa.php) U.S. Attorney General Eric Holder stated that “[N]o individual or entity that does harm to our economy is ever above the law. There is no such thing as ‘too big to jail.’”
In many states bank officers and directors have, until recently, received immunity from prosecution for corporate mismanagement through the use of a legal defense known as the “business judgment rule.” The business judgment rule is a longstanding doctrine that protects a corporation’s directors and officers from legal liability arising from allegations that their mismanagement of the company adversely impacted the company’s value. The business judgment rule is a concept advocated by the judiciary and legislatures of many states who believe that the critical decisions made by companies on a daily basis are inherently risky, thus, directors and officers should be permitted to make decisions without fear of liability. “Put simply, the business judgment rule allows officers and directors to conduct their management and oversight duties without fear that a risky, controversial or ultimately unwise business decision will subject them to legal second-guessing by courts who have the benefit of hindsight[,]” according to Tracy A. Campbell, Founder and CEO of Cynosure Risk Advisors LLC (CRA, www.cynosurerisk.com).
Recently, a court has ruled that the business judgment rule should not apply to the directors and officers of banks. In November 2013, a Georgia federal court in the case of FDIC v. Loudermilk, No. 1:12-cv-4156-TWT, 2013 WL 6178463 (N.D. Ga. Nov. 25, 2013) ruled that the business judgment defense did not apply in a lawsuit brought by the FDIC against the directors and officers of a bank and that those defendants could be found liable for simple negligence. The Court reasoned that negligent banking practices extend past the particular organization engaging in such acts and can affect the overall economy. Id. at *5 The Court opined that, given the distinctions, the business judgment rule should not be applied in cases of bank mismanagement as it does in other industries. Id.
In addition, this week’s Justice Department video message reaffirms its intention to more aggressively pursue criminal investigations of banks and their directors and officers. This development is of great concern to banks, not only because of the potential regulatory fallout of a criminal conviction, but also because some of their institutional clients might refrain from conducting business with a convicted felon.
If the Georgia federal court ruling begins a national trend then one of the likely consequences could be the elimination of the business judgment rule not only for banks, but also for financial institutions of which banks may be just subsidiaries. Since one of the Georgia court’s arguments for eliminating the defense of the business judgment rule for banks is the impact bank failures could have on the overall economy, investment companies and other “too big to fail” financial institutions, such as the former AIG, may also be in danger of losing the protection of the business judgment rule. Moreover, in states such as California the business judgment rule is state law that applies only to directors and not officers. Officers are seen to have more influence on the day to day operations of companies and have access to critical information that outside directors may not have, while directors focus on the long-term strategic direction of the company. The rule may very well morph in other states to an immunity that is only enjoyed by outside directors.
In the event other states follow the reasoning of the Georgia federal court, the FDIC may feel emboldened and seek expanded authority from Congress to hold directors and officers of banks liable for simple negligence. Given the public’s continued displeasure with both financial institutions and the government for the financial crisis bailouts at taxpayer’s expense, banks should pay close attention in the coming months to these legal and regulatory developments. In addition, prudent bank directors and officers should investigate their bank’s management liability (or D&O) insurance coverage to ensure there is sufficient coverage for them in case formerly disallowed lawsuits naming them as individual defendants arise and they do not become personally liable should their bank’s insurance coverage run out.
CRA is a national consulting firm specializing in crisis management, risk management, regulatory compliance, corporate insurance coverage and health care reform counseling. For more information visit www.cynosurerisk.com.
Tracy A. Campbell, J.D.
Founder and CEO
Cynosure Risk Advisors LLC
- 8 May, 2014
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