On March 16, 2011, the Federal Deposit Insurance Corporation (“FDIC”) filed suit against three former high ranking Washington Mutual (“WaMu”) executives, alleging that they recklessly managed the company’s held-for-investment loan portfolio by focusing “on short term gains to increase their own compensation, with reckless disregard for WaMu’s longer term safety and soundness.”
According to the complaint, the “unprecedented” risks taken by WaMu’s former CEO, Kerry Killinger, its former President and COO, Stephen Rotella, and its President of Home Loans, David Schneider, led to billions of dollars in company losses, and the largest bank failure in U.S. history.
However, once news of the government’s lawsuit broke, the initial response from many was: “What took so long?”
This article explores: (1) the reasons behind the speed (or lack thereof) with which the FDIC’s suit was filed; (2) whether the FDIC will become more aggressive in bringing cases against failed bank executives in the future, and (3) where any monetary recovery obtained by the government will come from.
A Deliberate Pace
The Office of Thrift Supervision closed WaMu on September 25, 2008, and the FDIC was appointed as the bank’s receiver almost immediately thereafter. Yet the FDIC took nearly two and one half years to file its case against the bank’s senior officers – just shy of the three-year statute of limitations under federal law. Just days before the WaMu filing, the centre of Public Integrity blasted the FDIC in the Washington Post for taking action against executives at less than two per cent of the 345 banks which had failed since 2008. To the casual observer, the FDIC has proceeded at a slow, leisurely pace.
A closer look, however, reveals that the 30-month period between WaMu’s demise and the FDIC’s lawsuit is not uncommon. Indeed, the five lawsuits previously filed by the FDIC against directors and officers of failed banks came an average of two years and three days after each bank’s closing. Taken in this context, the two and one half years between WaMu’s closure and the FDIC’s suit is not unreasonable.
Private litigants often file securities class action complaints in a matter of days based on little more than allegedly misleading statements of senior officers, combined with a precipitous decline in the company’s stock price. In contrast, the FDIC has the authority to issue administrative subpoenas in order to compel testimony and the production of documents before any suit is filed. This is one reason why it takes the FDIC approximately eighteen months to complete any investigation of a failed bank.
More Lawsuits to Come?
All signs point to the FDIC’s suit against WaMu as one of the first in a large wave of lawsuits against failed bank executives that have yet to be filed. As of March 15, 2011, the FDIC has already authorised suits against 158 individual executives, with a potential recovery of at least $3.57 billion. Next, while nearly 350 banks have failed since 2008, only 25 of those failed in the 2008 calendar year.
In contrast, the number of bank failures in the U.S. rose to 140 in 2009, with another 157 in 2010. If the FDIC stays true to its average of bringing suit just over two years after a bank’s closure, an even sharper uptick in the number of lawsuits filed is inevitable. Finally, consider this: in 2010, the FDIC hired 1,500 new employees and received a 55% budget increase. In the midst of a recession, that is an unmistakable sign.
Who Will Pay?
With so much anger publicly directed at well-paid bank executives, people may be surprised to learn that the FDIC isn’t interested in punishing wrongdoers. Its goal is to recover as much money as possible to offset its own losses through guaranteeing money lost by depositors of failed banks. If litigation is not cost-effective, the FDIC will do nothing.
Towards that end, WaMu’s outside directors are rumoured to have already agreed to a $125 million settlement with the FDIC – even though no suit was filed against them. Rotella speculated that the lawsuit itself is merely “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.” The extent of WaMu’s insurance to cover lawsuits brought against its directors and officers is not publicly known – but it would seem very likely that a significant portion of any funds won by the government will be coming from WaMu’s insurers, and not the executives.
Still, WaMu’s executives may not escape scot-free. The FDIC’s lawsuit also names Killinger and Rotella’s wives as defendants, alleging that they took part in fraudulent conveyances designed to hide their husbands’ assets from creditors. Allegations like these usually indicate that regardless of insurance, the government will be seeking stiff damages from the defendants personally.