Directors and Officers Insurance Coverage--Important Developments

“Boring” dull and uninteresting: causing boredom.  Merriam-Webster Dictionary

The FDIC has suddenly become active about issues in Directors and Officer Insurance coverage.  The FDIC’s sudden interest in this boring subject caught a wide spectrum of the banking associations, insurance industry and bank legal experts by surprise.   But this is important stuff.

On February 12, 2012 the American Association of Bank Directors wrote the General Counsel of the FDIC to complain “ F.D.I.C. examiners cited at least two nonmember banks in Louisiana for violations of 12 C.F.R. § 359 for having an endorsement in their D&O policy that would indemnify directors for Civil Money Penalties (“CMP”) assessed against them. The policies were issued to the banks, but the banks did not pay for the coverage; the directors did.”  The AABD stated that it had been a practice since 1996—the year 12 C.F.R. § 359 was adopted-- for insurance carriers to issue D&O policies with an endorsement that covered Civil Money Penalties as long as the director paid or reimbursed the bank for the endorsement cost.  The reimbursement was minimal.    On February 27, 2012 the FDIC General Counsel replied.   He rejected AABD’s CMP reimbursement argument.  He stated that allowing CMP coverage endorsements of directors, even if repaid by the directors, would damage the deterrent effect of the regulation.  He did not explain why the FDIC had waited 16 years to make this determination. 

For reasons that may be  clearer in the following D&O coverage statement by the FDIC, the CMP is a wholly different form of regulatory legal action than the agency’s legal actions against former directors or officers of failed banks for alleged losses borne by the FDIC as insurer and receiver for failed institutions.  Such actions can be covered by D&O liability insurance.

 CMPs may be assessed by a variety of federal regulatory agencies, including the FDIC, OCC, Federal Reserve, FinCEN and others. One cannot easily determine the total number of CMPs issued by the agencies although CMPs are public records.  However, the regulatory agencies have a potent enforcement action if they seek such relief—made far more potent if it cannot be covered by D&O insurance.  The type of director or officer conduct that may bring a CMP action is beyond the scope of this article.  However, one of the common grounds for the FDIC’s seeking a CMP is a violation of a cease and desist order, violation of law or similar circumstance.  In CMP proceedings there are various levels of alleged wrongdoing and there are three tiers of penalty ranging from $5000 per day to over $ 1 million per day. A survey of recent CMPs shows one for $3500 against a North Dakota bank director (Cease and Desist Order), 37.5 million against TD Bank of Wilmington, Delaware (failure to file SARs in Ponzi scheme and other misconduct) and a rare CMP against a credit union by NCUA  (no money penalty).

All was quiet on the insurance front for a time, but on October 13, 2013 the FDIC issued a “Financial Institutions Letter” which contained a strange mix of guidance on D&O insurance coverage.  Firstly, the Letter advises banks to carefully examine their D&O policies for exclusions of coverage. The Letter stated “[t]hese exclusions may limit insurance coverage under certain circumstances, thereby increasing the potential personal exposure of board members and bank officers in civil lawsuits.” And secondly, the Letter went further.  It reminded banks that a bank could not purchase an endorsement covering CMP for directors and officers, even if the director or officer paid the cost of the CMP endorsement.  FDIC voiced no similar concern about potential personal exposure of board members and bank officers about the CMP exposure.

The FDIC’s advice concerning D&O coverage exclusions is not disinterested.  D&O insurance for directors and officers is a major source of recovery by settlement in the FDIC ‘s actions as receiver of failed banking institutions. The FDIC is concerned that insurance companies will insert a “regulatory” exclusion in a bank’s D&O policy—usually on renewal.  The exclusion will block or impede FDIC, as receiver for failed banks, in recovery in its lawsuits against former directors. On the other hand, CMPs are used as punishment for the wayward director or officer. 

The FDIC’s prohibition of CMP endorsement appeared on my radar when I learned of the OCC’s citation of a New Mexico community bank for its D&O coverage for CMP by endorsement. Unfortunately, for now, the law on directors and officers bearing the cost of a separate CMP endorsement is clear.  A bank may not purchase CMP endorsement coverage, even if the director or officer reimburses the cost.  One insurance blog suggests that director and officers could purchase stand-alone CMP coverage or add CMP coverage to homeowner policies. 

Frank Carroll, of the Dallas law firm Cox Smith, is an expert in FDIC litigation.  He observes “we know of no insurer in this market that offers standalone CMP policies to Ds or Os – the pricing for such coverage would be prohibitively high…” Carroll added that such policies would require state insurance regulator’s approval, which might be unlikely in view of the FDIC position that such coverage is contrary to public policy.   Given the size of the New Mexico market the odds of such standalone coverage are even more remote.  

One bright spot: the FDIC regulation clearly allows a bank to purchase insurance for the cost of the defense of director and officer CMP claims  (12 CFR s 359.1(l)(2)(i)) Directors and officers do not have to reimburse the bank for such coverage. Carroll warns that some OCC and FDIC examiners do not know the rule and may cite the bank. 

 Larry Lujan and Jim Rhodes of Hub International (formerly the Lujan Agency) confirm that the cost of defense coverage is available in New Mexico.  CMP coverage is not available--standalone or as an endorsement.  In some policies cost of defense may be included in the general cost of defense for all D&O coverage.  However, that is not true of all D&O policies.  Rhodes reported one insurance broker termed the cost of defense market as "evolving".  

Sorry to burden you with what is a  legalistic topic. Nonetheless, the subject of D&O insurance is critical to your bank, its officers and directors.  Critical steps to take:

• You should carefully review your D&O policy for exclusions with an attorney who knows D&O insurance coverage for banks.   No matter how healthy your bank is, this review should occur yearly--preferably at renewal.   
• You should insure that your policy does not have the forbidden CMP endorsement. 
• If so, replace it with cost of defense coverage (for which the bank can pay).  This is essential to your directors since expert legal assistance in CMP proceedings may save them money. It may be included in your present D&O policy but make sure it is. 

 As an aside, the regulators want experienced, diligent, smart directors.  However, the regulators do almost everything they can do to discourage that type of director from serving. The FDIC's change in position on CMP coverage is all too typical.

Friday is June 6—D Day.  If one every questions the day’s meaning I suggest that you visit Omaha Beach in Normandy and the U.S. Cemetery which looks down on Omaha.  The almost endless white burial crosses and other stone religious symbols cause you to wonder about those fallen.  When you look down on Omaha Beach, from the site where the German Wehrmacht had heavy weapons and machine guns, you wonder how our troops ever got up the steep bluff.  Many did not and rest beneath the white stones.  But enough did.

Do Good, 

MARSHALL G MARTIN

(505) 228-8506

mgm@marshallgmartin

mmartin@tinninlawfirm.com