In March, the Federal Deposit Insurance Corp. named the football star-turned-bank-director as a defendant in a lawsuit that soon will be followed, the agency says, by a surge of legal actions aimed at officials of banks that failed after the 2008 financial crisis.
The FDIC alleges that McMahon, who became one of Broadway’s directors in 2003, is personally responsible along with other bank officials for bringing down the bank by approving bad loans. Among 437 banks failing in the wake of the 2008 financial crisis, Broadway was 25th to be the focus of such suits, which seek to recover from bank officials the FDIC’s costs of shutting them down.
FDIC Deputy General Counsel Richard Osterman said the agency plans to increase the pace of such legal actions against former directors and officers, and that they will probably peak at “the end of this year, early next year.”
Osterman declined to specify how many officials will be sued: “We don’t have quotas. It’s not like we’re giving out traffic tickets.”
The usual delay between a bank’s collapse and the regulator’s filing of a director-and-officer liability suit -- 2.2 years, as measured by consulting firm Cornerstone Research - - means banks that failed in the peak year of 2010 will now begin to see court action. In 2011, the FDIC board authorized lawsuits against 264 defendants; in just the first four months of this year, suits against 120 defendants were authorized.
Many authorized suits will be settled before they are filed. Since the 2008 crisis, the board has approved suits involving 58 firms and has so far filed 29.
Few of the FDIC legal actions have targeted major U.S. banks. The exceptions have included suits against officials at Pasadena, California-based IndyMac Bancorp Inc. and Seattle, Washington-based Washington Mutual Inc., the largest bank failure in U.S. history.
“What you’re seeing in this crisis, overwhelmingly, is smaller banks,” said William K. Black, who teaches economics and law at the University of Missouri at Kansas City’s law school and was a former litigation director of the Federal Home Loan Bank Board. Most of the largest banks won’t be sued by the FDIC because, as beneficiaries of other government help, they didn’t fail, he said. “The big baddies don’t go through receivership.”
Ronald R. Glancz, a former FDIC assistant general counsel who heads Venable LLP’s financial-services group, said the FDIC is using a low bar for deciding which cases to pursue. He is helping defend directors and officers of Wilmington, North Carolina-based Cooperative Bank, which failed in June 2009 and is the subject of an FDIC suit.
“We may be going back to the FDIC’s very aggressive ways, back in the ‘80s,” Glancz said, referring to the savings and loan crisis, which he said was very different from the 2008 crisis. “This was a worldwide recession. Are you saying directors ought to have more foresight? Are they responsible for predicting something that the rest of the world didn’t?”
After savings and loans collapsed in the 1980s, the FDIC went after officials at about one in four of the 1,813 failed firms. In the wake of the 2008 crisis, the ratio of failures pursued by the agency has been building to a current rate of about one in eight.
‘Should Be Screaming’
The FDIC “should be screaming to the Justice Department to bring criminal actions and investigations,” said Black, adding that on the civil side, “the percentage of folks who did things worthy of suit is much higher this time around.”
That was especially true in the commercial real estate market, he said, in which bankers were “massively increasing” their investments “as the glut and the vacancy rate skyrocketed.”
In the Broadway Bank case, the FDIC accused McMahon of helping approve a $28 million interest-only loan to Normandy Shores LLC for a Miami Beach, Florida, condominium development that lost the bank $19.5 million, according to the March 7 complaint in federal court. No application was submitted for the loan; there was no demonstration of ability to pay it back; construction was already millions over budget; and the guarantor had lived in Brazil for five years, the FDIC said.
In a statement issued through his lawyer, McMahon said he and his colleagues on the bank’s board could not have foreseen the coming crisis. “Broadway was unable to withstand the greatest market decline since the Great Depression,” McMahon said in the statement. “With the advantage of 20-20 hindsight, the FDIC now blames Broadway’s former officers and directors for not anticipating the same unprecedented market forces that also surprised central bankers, national banks, economists, major Wall Street firms, and the regulators themselves.”
The former quarterback joined the bank’s board in 2003, at about the same time that a Northbrook, Illinois restaurant that bore his name, McMahon’s Arena, was failing. McMahon, now living in Scottsdale, Arizona, is among a group of former players who sued the National Football League Inc. last year for its policies on concussions, claiming they suffer health problems from repeated head injuries.
McMahon, who is said in the FDIC lawsuit to have missed multiple meetings during his five-year stretch on the board, is accused of being so inattentive to the bank’s business that it constituted “gross negligence.”
Degree of Negligence
The generally understood difference between negligence and gross negligence is in the degrees between failing to use reasonable care in protecting the bank’s interests and recklessly dodging those duties. Many states don’t allow the regulators to go after simple negligence.
“I suspect that the FDIC now, even in the screening process, may be basically going ahead and deciding that they’re going to sue for ordinary negligence,” Glancz said, adding that the agency seems to be suing “even in cases where there were just mistakes in judgment.”
The FDIC, which acts as the receiver of failed banks and also maintains the fund that protects customers from losses, has three years from each failure to file a suit. It recovered $231.9 million in such professional liability cases last year, spending $139.5 million, Osterman said.
“I don’t see the FDIC going after fairly small losses,” said Tariq Mirza, a managing director at Grant Thornton LLP who previously worked as a senior adviser to former FDIC Chairman Sheila Bair. “It has to be material. It also has to be worthwhile regarding the probability of success.”
1992 Policy Applies
A 1992 policy statement spelled out the approach the FDIC still uses. The agency isn’t interested in going after directors who are doing their jobs based on informed judgments, it says. It also won’t go after claims it can’t readily prove in court and for which there’s no available cash to collect -- either from an insurance policy or a defendants’ own wealth.
“Our worry is where you start to criminalize business judgment,” said Wayne Abernathy, an executive vice president at the American Bankers Association. He said punishing bank officials for business decisions “dampens the willingness of banks to take prudent risks.”