[authors: Harold P. Reichwald and John F. Libby]
Last week, a jury in Los Angeles federal court in a case entitled FDIC v. Van Dellen, et al. found three former officers of the failed IndyMac Bank liable for $168 million in losses in construction loans suffered by the bank's Homebuilder Division. After the verdict was announced, some of the jurors commented that the greed of the defendants, built into their performance-based compensation based on production, was partly responsible for the losses that led to the verdict.
However, there are other lessons to be learned from the jury's quick verdict after a sixteen-day trial that was, in the words of one juror, "mind-numbingly repetitive." These lessons are of interest not only to former officers who have found themselves in the FDIC crosshairs but also to D&O insurance carriers who already are funding the defense of cases brought by the FDIC and others who are engaged or may in the future engage in negotiations with the FDIC over possible settlement of claims before litigation.
If given the chance, jurors are loath to blame the housing crisis that gave rise to the Great Recession and bank losses on economic factors and would much rather blame bankers for acting negligently.
Performance-based compensation will be viewed askance if it can be shown that the officers acted with bonuses in mind, rather than what was good for the institution in question. In other words, proper underwriting of potential loans is essential no matter the pressures for increased production and expected revenues.
Officers are likely to be held to a higher standard than directors if they actually approved the loans in question rather than for merely doing the preparatory work for final approval by a directors' loan committee or other supervening authority in the bank. This is especially true in California, where the courts have consistently refused so far to extend the business judgment rule to others beyond directors.
Officers who ignored warnings of impending problems in the market generally, particularly if those warnings came from senior officials in the bank, run the risk of having such arrogance being held against them.
The FDIC is not responsible for a failure to warn bankers of impending problems, whether generally or in their own institutions.
These are sobering reflections on the first FDIC-initiated case to come to trial since the housing crisis arose over four years ago. In all likelihood, the FDIC will feel emboldened by this trial court victory, and it will have an immediate effect on potential settlements in a number of cases. The case undoubtedly will be appealed on a number of issues, including the question of the applicability of the business judgment rule to officers in California. Still, it offers lessons for those dealing with the FDIC in other pending cases and those yet to be brought.