The Federal Deposit Insurance Corporation (FDIC) may decide to appeal a recent decision to dismiss its lawsuit against the officers and directors of failed Cooperative Bank, several banking experts say.
Earlier this month, U.S. District Court judge Terrence W. Boyle issued a summary judgment in the case, finding inadequate evidence for the FDIC’s charges against the bank leaders of “negligence, gross negligence, and breaches of fiduciary duty” in connection with the bank’s approval of 86 loans between Jan. 5, 2007 and April 10, 2008.
FDIC spokeswoman Juan Williams-Young, reached by phone Tuesday morning, said the agency did not have any comment at this time about its intentions in the case.
The suit was filed more than a year after the N.C. Commissioner of Banks designated the FDIC as Cooperative Bank’s receiver when the bank was declared insolvent in June 2009. By the time the suit was filed, First Bank of Troy, North Carolina had purchased most of Cooperative’s assets. The suit claimed many instances of ill-advised real estate loans made by Cooperative’s officers and directors without following the bank’s own loan approval protocol, and in some cases based on inflated appraisals.
In his ruling, Boyle pointed to the fact that the FDIC’s own examiners consistently gave Cooperative Bank a passing grade of “2” in terms of the bank’s CAMELS ratings (Capital, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk) before the bank failed.
“Therefore, the facts show that the process that defendants used to make the challenged loans were expressly reviewed, addressed and graded by FDIC regulators . . .” Boyle wrote in his judgment. “The regulators assigned defendants a passing grade of “2” in the CAMELS system and to now argue that the process behind the loans is irrational is absurd.”
“I can’t imagine that the [FDIC] won’t appeal the verdict here,” Tony Plath, associate professor of finance at University of North Carolina at Charlotte, said Tuesday.
“I don't think the FDIC will allow this to happen without some sort of challenge to the Boyle ruling," he wrote in an email, "but it’s incumbent on the regulators to do a much better job in court explaining just why they’d grant a satisfactory CAMELS rating to a clearly troubled bank shortly before the institution collapsed into a taxpayer bailout.”
William Sackley, professor of finance at University of North Carolina Wilmington, had a similar observation.
Sackley, referring to a statement by former Federal Reserve chairman Ben Bernanke that the financial crisis of 2008 was a “perfect storm” that regulators could not have anticipated, said that “if the regulators were regularly assessing the quality of the bank’s management and assigning a ‘2’ ... coupled with my interpretation of the [N.C. statute] Business Judgment Rule, it could make it difficult for the FDIC to prevail in an appeal.
“Having said that, I might expect the FDIC to aggressively appeal this ruling, to remove precedents for future cases,” Sackley said in an email.
Under the state’s Business Judgment Rule, Boyle wrote, there can be no liability for officers and directors even when “a judge or jury considering the matter after the fact believes a decision substantively wrong or degrees of wrong ... so long as the court determines that the process employed was either rational or employed in a good faith effort to advance the corporate interests.”
UNCW professor of finance Ed Graham believes evidence points to the fact that Cooperative’s leadership was acting in good faith.
“The management and board of Cooperative were not guilty of theft or fraud, and as such were not held liable for Cooperative’s insured losses,” Graham said in an email. “I know of at least one bank in North Florida – First Guarantee Bank and Trust – that had a healthy balance sheet with generous amounts of equity capital in 2004 or 2005, but which like Cooperative was overwhelmed by rapidly falling real estate values and business failures in the late 2000’s.
“While it might be politically attractive to 'claw back' management earnings after insured business failures, it is generally impractical to do so, and is often unfair,” Graham added.
Plath, however, emphasized the importance of setting a precedent.
“The FDIC is just getting around to prosecution of individual board and management members connected with failed banks during the Great Recession, and I imagine they have a number of cases similar to Cooperative waiting in the pipeline,” he said. “Like Cooperative, many of these other banks in which former officers and directors face individual prosecution from the FDIC for their role in various taxpayer-assisted bailouts from the recession years were rated as CAMELS 2 or 3 banks in the months prior to their failure, so if Judge Boyle's ruling is allow to stand unchallenged, it basically provides a get-out-of-jail-for-free card to officers and directors at other failed banks that the FDIC would otherwise charge with breach over the course of the next few years.”
Plath believes the FDIC will appeal, build a better case and ultimately be successful in prosecuting its case.
“The Agency likely has a good case against Cooperative; they just failed to do the work necessary to make it a good, winnable case when they presented it in court,” he said. “Thus, Judge Boyle is telling the FDIC to do a better job of building and presenting its cases in court, rather than suggesting that the officers and directors at Cooperative have no legal liability in connection with the Cooperative failure.
“The general public is anxious to see the government hold individuals accountable for their actions in connection with financial wrongdoing associated with the recession, and so far, anyway, the government has been really lax in going after individual managers and directors of failed banks."
“In addition, the FDIC is anxious to reduce the overall taxpayer cost of bailing out failed banks, and a guilty verdict against bank officers and directors in court will lead to a damage assessment against these people, helping to reduce the FDIC's bailout expense,” Plath added.
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