FDIC Suits Against Execs May Spark M&A

The Federal Deposit Insurance Corp. is again making an example of Heritage Community Bank in Glenwood, Ill.

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Nearly two years after the regulator let a film crew tag along as it seized the $232 million-asset company in a segment for the news program “60 Minutes,” the FDIC is going after former officers and directors. In what is expected to be the first of many professional-liability lawsuits against individuals associated with failed banks, the FDIC wants to recoup some losses sustained by its Deposit Insurance Fund in the current economic cycle.

The litigation, or at least the threat of a lawsuit, could be enough to make leaders of other troubled banks squirm, with the broader potential of spurring more distressed sales, industry experts said. “If you are a director of a troubled community bank and you have had your head in the sand, this is your siren,” said Michael Iannaccone , the president of MDI Investments Inc. in Chicago. “It is time to cut a deal that gives you massive dilution or leaves you with nothing, rather than let your bank be taken over and have the FDIC hound you,” Iannaccone said.

That is if a bank can find a buyer. Some lawyers believe a fear of professional liability is hefty enough that some bankers might even pay an acquirer.

“In the late 70s, I remember a seriously troubled bank where the directors paid the buyer to take the bank over, thinking I would rather pay than for us to fail and for the FDIC to file suit,” said Jeffrey C. Gerrish , a partner at Gerrish McCreary Smith in Memphis, Tenn., who represented the FDIC in the 1970s. “It was unusual then, but we might see a few head in that direction again.”

The level of fear may hinge on what happens with Heritage or the other 70 former officers and directors that the FDIC has authorization from its board to seek claims against. While the lawsuit against Heritage is the first community bank claim so far, in July the FDIC sued four officers of the failed IndyMac Bank. (The number of banks that fall under that authorization remains undisclosed, but the FDIC can work under a three-year statute of limitation.)

On Nov. 1, the FDIC sued 11 former Heritage directors and officers for $20 million in the U.S. District Court for northern Illinois, pursuing about half of what the failure is expected to cost the insurance fund. In the complaint, the FDIC alleges gross negligence, negligence and breach of fidicuary duty. The officers and directors “failed to properly manage and supervise Heritage and its commercial real estate lending program,” the complaint said. “Defendants knew, or should have known, CRE lending is a specialized field with unique risks that require thorough understanding and close management.”

In the case of Heritage, the FDIC found that the bank lacked proper controls or foresight on its overexposure to commercial real estate. The lawsuit also claims that management continued to allow Heritage to make dividend payments even as the bank was falling apart.

The leaders of Heritage said they were blindsided like everyone else. “The FDIC’s action is both regrettable and wrong,” the defendants said in a press release. “With the advantage of 20-20 hindsight, the FDIC blames the former officers and directors of a small community bank for not anticipating the same market forces that also caught central bankers, national banks, economists, major Wall Street firms and the regulators themselves by surprise.”

The FDIC is not planning to file lawsuits against the directors and officers of every bank that fails. Greg Hernandez , an FDIC spokesman, said the regulator spends up to 18 months studying a failure to determine the role that management and the board played in the demise.

Gerrish said the FDIC will likely pursue cases where it knows that if proven right, the defendants will have the ability to pay either from their own pockets, or those whose directors’ and officers’ insurance covers such claims. In his estimation, about a fifth of policies have such coverage.

That’s dwindling, said David Baris , of BuckleySandler and executive director of the <org>American Association of Bank Directors. “Carriers are running away,” he said. “Most community banks can only get policies without regulatory coverage now.”

As troubled community banks take notice, so are insurers, said Stephen Fitzsimonds , a managing director of Arthur J. Gallagher Risk Management Services Inc. in Chicago. “The carriers have been pulling back for the last few years because they knew this was coming,” he said. “But now that we have this suit, I think we will see more pull back over the next 12 to 18 months.”