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1997 Annual Report

Signature Court Cases

Matters in litigation covered a broad spectrum including issues relating to the supervision of insured institutions, the resolution of failed banks and savings associations, the liquidation of assets and the pursuit of liability claims against failed institution officers, directors and professionals. The FDIC’s litigation caseload declined 23 percent, from about 12,300 matters at year-end 1996 to approximately 9,500 at year-end 1997. The Legal Division and the Division of Resolutions and Receiverships recovered nearly $156.8 million during 1997 from professional liability settlements or judgments. At year-end, the FDIC’s professional liability caseload included investigations, lawsuits and settlement collections involving more than 180 institutions. This caseload includes the cases the FDIC assumed from the former Resolution Trust Corporation (RTC) on January 1, 1996. The Legal Division, working closely with other divisions and offices, was involved in several noteworthy court cases in 1997, as described below. (For more information about professional liability settlements and judgment (click here).

Goodwill

As a result of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), the Office of Thrift Supervision (OTS) changed the regulations governing the capital requirements for thrift institutions to make them conform to those for commercial banks. Consequently, certain forms of intangible capital, such as supervisory goodwill, were no longer allowed to be counted as part of a thrift’s capital. A number of acquirers of thrift institutions sued the government, alleging that they had purchased failed or failing thrifts prior to the passage of FIRREA based on a promise that they could count certain intangibles toward their capital requirements. They said FIRREA’s changes resulted in a breach of contract or a taking of their property without just compensation.

Three of the cases were consolidated and heard by the U.S. Supreme Court in a case known as Winstar Corporation v. United States (Winstar). The Court issued a decision in July 1996, finding the United States liable for a breach of contract based on FIRREA’s change in capital standards. As a result of that decision, more than 120 of these cases are pending in the U.S. Court of Federal Claims, with the lead case, Glendale v. United States, in its seventh month of trial at year-end. A second case was set for trial in April 1998; trial dates have not been set for remaining cases. A small number of the Winstar cases, known as the Guarini cases, involve challenges to legislation passed after FIRREA that changed the method for computing certain tax benefits given to acquirers of failed or failing thrifts.

The FDIC as successor to the rights of failed institutions is a co-plaintiff or plaintiff in more than 40 goodwill cases.

Entitlement to Deposit Insurance

In 1993, recipients of a new bank charter in Michigan filed an application with the FDIC for deposit insurance. On June 21,1994, and on two subsequent occasions, the FDIC Board of Directors denied the group’s application for deposit insurance because of concerns about one of the proposed bank officials. In a previous banking position, this person mixed the bank’s assets with his personal assets and demonstrated a continuing inability to identify and understand conflicts of interest.

In November 1996, in the case of Anderson v. FDIC, the U.S. District Court for the Eastern District of Michigan granted the FDIC’s request for a summary judgment and dismissed the case. The organizers filed an appeal with the U.S. Court of Appeals for the Sixth Circuit in Cincinnati, Ohio, and a decision upholding the FDIC’s action was issued on August 19,1997. The Appeals Court concluded that the FDIC’s concerns were appropriate and that its decisions denying the applications were not arbitrary or capricious. The organizers’ petition for rehearing was denied by the Court on November 14, 1997. This case is significant because it upheld the FDIC’s discretion to grant or deny applications for deposit insurance.

Removal and Prohibition

An individual who worked for a coin and precious metals business made more than $1 million in cash sales to one customer as part of a money-laundering scheme in 1993. The seller later was convicted of failing to file a Form 8300 (Currency Transaction Report), which a business must file with the Internal Revenue Service (IRS) when it receives more than $10,000 in a cash transaction. He also was convicted of creating a false Form 8300 to deceive IRS compliance auditors. While the criminal proceedings were progressing, however, the local bank where he had been previously employed hired him as its president. In 1996, the FDIC Board removed him from banking due to his conduct at the coin business, citing Section 8(e)(1) of the Federal Deposit Insurance Act.

In a Section 8(e)(1) proceeding, the FDIC must demonstrate misconduct, culpability and effect due to the person’s activities at a business or financial institution. In Hendrickson v. Federal Deposit Insurance Corporation, the U.S. Court of Appeals for the Seventh Circuit in Chicago, Illinois, affirmed the FDIC’s decision to remove the individual from banking. The case is significant to the FDIC because it involved an order of prohibition against a person for misconduct when he was not in banking, and did not involve a bank. The case also is sig-nificant because the "benefit" to the individual was not an immediate gain in the form of cash or property, but instead the continued employment by his family's coin business.

Directors’ and Officers’ Standard of Liability

During the 1980s, even as many financial institutions were failing, a number of states relaxed the traditional negligence standard of director and officer liability. These states provided for liability based on gross negligence or even intentional wrongdoing instead of the simple negligence standard. In addition, many states enacted "insulating statutes" allowing, for example, corporations to eliminate the civil liability of their directors for even gross breaches of the traditional duties of care and diligence. When enacting FIRREA in 1989, Congress included a new statute in the Federal Deposit Insurance Act demonstrating concern about states protecting directors and officers from liability for breach of traditional duties to federally insured depository institutions. The new federal statute, while allowing for "gross negligence" liability in FDIC civil action against directors and officers of failed depository institutions, does not impair FDIC rights "under other applicable law." Litigation immediately ensued over the meaning of this statute.

Lower and appellate courts around the country issued widely conflicting opinions concerning the basic standard of care for which bank and thrift officials may be held personally liable for monetary damages. The U.S. Supreme Court's decision in Atherton v. FDIC, issued on January 14,1997, resolved this long-standing conflict. The Court agreed with the FDIC's position that FIRREA's "gross negligence" standard "provides only a floor - a guarantee that officers and directors must meet at least a gross negligence standard. It does not stand in the way of a stricter standard (such as ordinary negligence)."

However, the Court disagreed with the FDIC on whether federal or state law supplied the standard of pre-insolvency and receivership liability for officers of federally chartered institutions. The Court explained that state law applies when the institution is in receivership, although subject to the limitation of FIRREA’s gross negligence standard. The lower federal courts have been in considerable disagreement on this issue. Because of this confusion, the Court's decision represents a needed clarification of the law.

The Atherton decision is expected to streamline litigation against bank officers and reduce litigation costs because it removes one of the principal uncertainties of the law. The FDIC will continue to follow its long-standing practice of bringing claims against outside directors where investigation shows them to have been grossly negligent or worse. However, where applicable state law provides an ordinary care standard, the FDIC still will sue outside directors believed to be guilty of gross negligence but will allege only what is required under the law.

D’Oench Duhme

In 1942, the Supreme Court in D’Oench, Duhme & Co. v. FDIC established a broad rule protecting the FDIC against any arrangements, including oral or secret agreements, that are likely to mislead bank examiners in their review of a bank’s records. Then, in 1950, Congress established strict approval and recording requirements that, if not met, barred any claim attempting to diminish the interest of the FDIC in assets acquired from a failed bank.

Motorcity of Jacksonville v. Southeast Bank remains one of the most important cases in the FDIC’s efforts to preserve the D’Oench doctrine’s protection from unwritten agreements or arrangements. On August 20,1997, the U.S. Court of Appeals for the Eleventh Circuit in Atlanta, Georgia, sitting en banc (with all active judges participating), held in Motorcity that the D’Oench doctrine was intended by Congress to survive the passage of FIRREA and remains a viable protection for the FDIC. However, that decision disagreed with a 1995 opinion by the U.S. Court of Appeals for the District of Columbia.

The plaintiff in Motorcity appealed to the U.S. Supreme Court, arguing that the "split" between the two circuits needed to be resolved. Following its decision in Atherton v. FDIC, which involved federal common law in a different context, the U.S. Supreme Court instructed the Eleventh Circuit to reconsider its decision and determine whether Atherton affected the outcome. The Eleventh Circuit on August 20,1997, held that nothing in Atherton altered the outcome of its earlier decision and in an even stronger opinion, reinstated its previous decision that the D’Oench doctrine is not limited by a specific asset requirement, that the freestanding tort exception to D’Oench does not apply to Atherton and that Motorcity does not have a viable state law claim. According to the Eleventh Circuit, the Atherton decision recognized the continuing availability of federal common law for circumstances involving uniquely federal interests requiring a special rule. The Eleventh Circuit held that D’Oench recognized those special needs and that the special rule was still required. In the absence of clear congressional intent to displace the D’Oench doctrine, it survives as an effective protection for the FDIC. The Motorcity plaintiff filed its second appeal to the U.S. Supreme Court on December 18, 1997.

Enforcement Powers

In December 1997, the Supreme Court issued a favorable decision in a case affecting the FDIC’s enforcement powers. In Hudson v. United States, the Court decided that criminal prosecution of bank officers after the Office of the Comptroller of the Currency (OCC) had imposed civil money penalties for the same conduct does not violate the Constitution’s Double Jeopardy Clause. Hudson effectively overruled a 1989 Supreme Court decision that created doubt as to whether the FDIC or any other bank regulator could impose civil penalties in cases that might also give rise to criminal prosecution. Hudson holds that only additional criminal penalties are unconstitutional and that the sanctions imposed by the OCC were civil in nature.

Although the case arose from OCC actions, the decision imposes the same kind of civil money penalties that could be used by the FDIC. Hudson effectively removes the doubt created by the 1989 decision and should result in smoother coordination with the U.S. Department of Justice in cases with the potential for criminal prosecution.

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