The FDIC: It’s Back, It’s Busy and It’s More Powerful Than Ever

What corporate counsel needs to know about the FDIC in 2009

An interview with Megan Kraai by Teresa Zink

Megan Kraai is a partner in the Litigation and Regulatory practice group at DLA Piper, LLP (US). She practices in the areas of commercial litigation, regulatory and compliance matters and government controversies. Ms. Kraai was formerly Head of Compliance for Fannie Mae in Washington, D.C. and before that was Senior Vice President for Global Anti-Money Laundering Operations and Compliance at Bank of America. She will speak further on this topic at Mealey’s Litigation Conferences program “The FDIC & The Banking Crisis: Litigation Challenges Past, Present & Future” being held Jan. 15 and 16 at the Westin Grand in Washington, D.C.

Wachovia, IndyMac, Washington Mutual…these and other bank failures have rocked the financial world and should be a wakeup call for corporate counsel and others who represent banks or companies that do business with banks. So far in 2008, there have been 24 bank failures, with ten of those in the last quarter alone, notes DLA Piper partner Megan Kraai. Compare that to three bank failures in 2007 and none in 2005 or 2006 and it is easy to understand why the number and speed of recent bank failures have caught many by surprise.

“I would encourage lawyers to talk with their clients and make sure their clients understand the nature of their relationship with the bank, even when the bank is healthy,” Kraai advises. “2008 has shown us is that these bank failures can happen quickly.” It is important to understand what your position is in the event of a bank failure, and it is equally important to understand the role the Federal Deposit Insurance Corporation (FDIC) plays in addressing the problems of failed banks.

Because there were few bank failures in recent years, there are not as many practitioners as there were in the 1980s who understand what the FDIC does when a bank becomes troubled. But they should. “When the FDIC takes over a bank, it has what are sometimes called superpowers in the event of a receivership,” Kraai warns, and the situation is not all that similar to a business bankruptcy. Lessons learned from the recent wave of consolidations in the banking industry won’t help much either, she says. “A bank acquisition is much different than a receivership by the FDIC.”

Acknowledging that “we are all reluctant to admit what we don’t know,” Kraai offers a primer on the FDIC for 2009.

The FDIC is Busy, And Getting Busier
As a response to the sheer numbers of bank failures, Kraai notes, the FDIC has taken steps to bolster its ability to respond. For example, she says, in an effort to find people with relevant experience, the FDIC in August began hiring back some of its retirees who had experience in the savings and loan crisis of the 1980s. In October, the FDIC increased the amount of the deposit insurance on accounts to $250,000, in part to preempt runs on banks and in part reacting to the reactions of WaMu depositors as the bank was failing, according to Kraai.

The FDIC maintains what is called a Troubled Bank List and while the names of the banks are confidential in order to prevent runs on the banks, the size of the list is important, Kraai says. “Currently there are 171 troubled banks on the list, which is up 46 percent since just the second quarter and it is the highest number since 1995,” according to Kraai. Historically approximately 13 percent of the banks on the list have failed.

However, Kraai warns, “although it is an important list, no list is perfect.” For example, she points out, “IndyMac, which was an historic failure, was not on the troubled bank list six months before it failed. WaMu never went on it. So, I think it is interesting to note that the list is large and growing larger, but I think it also indicates that the speed of some of these recent failures has taken many by surprise.”

New Territory For Many
Kraai thinks that, “because it has been a fairly long time, thankfully, since we have seen bank failures on this scale,” it is worth thinking about what happened and how to advise clients who “haven’t experienced this type of economic environment or bank failure environment.” Whether the clients are banks, companies that have service contracts with the banks or large depositors, it is worth taking the time to understand what their rights and responsibilities are if a bank should fail.

“I think an important thing to recognize is, to the extent that you look at a traditional business bankruptcy as an analogy, it is not all that useful.” Kraai warns. “In a regular business bankruptcy, the goal is to keep the business operating as a going concern and try to find a private sector resolution.” However when a bank fails and the FDIC comes in, it has “significant powers and wide latitude in what it can do and the goal is to resolve the failed bank’s problems and its commitments at the least cost possible to the FDIC and therefore the consumer.” That is a very different goal.

The other often surprising thing is how quickly the banks operations can be wound up. “The FDIC is efficient, which might surprise some people in a government agency,” says Kraai. She notes that companies can operate in Chapter 11 for years, but a bank failure is generally resolved within 90 to 100 days, and sometimes more quickly than that. So even if a bank your client does business with is on sound financial footing, it is still a good idea to take the time to understand what their rights and responsibilities are should something happen to the bank.

What Happens When A Bank Fails?
When a bank fails, the FDIC is appointed either receiver or conservator in order to wind up the bank’s business in the way that will minimize the cost to the FDIC deposit insurance fund or to operate the bank as a going concern. Generally, that means drawing up a menu of the assets and the liabilities of the troubled bank and offering it for sale to other financial institutions, according to Kraai.

According to Kraai, “There are different ways that the FDIC can dispose of the assets and liabilities of a failed bank when the FDIC is acting as a receiver, but the most commonly used approach is a purchase and assumption (P&A) transaction.” In a P&A transaction, the FDIC acts as broker and finds a healthy bank to take over part or all of the failed bank.

“There are certain things that you should know if you are advising someone who has a relationship to a failed bank, if you are advising the bank that is having problems or if you are advising a bank that is thinking of acquiring a failed bank,” Kraai says. For example, there are types of claims that never go to the acquiring bank, but stay with the FDIC. These include: claims or lawsuits against the directors and officers of the failed bank, any claims under directors and officers insurance policies and employee benefit plans. Real estate and subsidiaries of the failed bank usually don’t go to the acquiring bank, according to Kraai, however in the case of WaMu, JPMorgan Chase acquired WaMu’s real estate.

Most of the time when a bank fails, the FDIC is appointed as receiver. However, occasionally, the FDIC operates the bank in a conservatorship proceeding. IndyMac, is one conservatorship in the news right now, according to Kraai. When that bank failed it had assets of $32 billion and deposits of $19 billion. According to Kraai, “a conservatorship is more akin to a regular bankruptcy because the FDIC is trying to conserve the resources of the bank and operate the bank, whereas the goal of receivership is to liquidate the bank, wind it up, sell its assets and move on.”

“Though each bank failure is different, there are broad parameters: if a bank fails, the FDIC will either act as conservator or receiver, almost always a receiver. If it is a receivership, most of the time the FDIC disposes of the failed bank’s assets and liabilities through the mechanism of a purchase and assumption agreement. If it is a purchase and assumption agreement, most of the time these claims don’t pass, they stay with the FDIC.” However, she warns “other than those broad parameters, every single failure is different.”

In addition, Kraai emphasizes that, “When assessing the bids for the bank’s assets the FDIC is required to accept the bid that will be least costly to the FDIC deposit insurance fund,” known as the “least cost rule.” If the FDIC believes that a particular failure poses systemic risk, it can waive the least cost rule, but doing so is rare.

Kraai points to the Wachovia transaction as a special situation. At the end of September the FDIC seized Wachovia and brokered a transaction with Citigroup for Citigroup to buy Wachovia on an “open bank basis,” which means that the FDIC was going to advance funds to help make the purchase. Then on October 5, Wells Fargo, “which had been at the table with Citigroup and had walked away from the transaction,” according to Kraai, came back in and bought Wachovia in a private transaction. “It seems as though the FDIC was willing to entertain that because it fit with the least cost resolution since federal government did not have to put forth any funds to make that transaction happen,” Kraai speculates.

FDIC ‘Superpowers’
The FDIC has extensive powers as the receiver of a failed bank which are designed to help the agency achieve its mission very quickly. These powers include the authority to: merge the bank with another bank, transfer any asset of the failed bank, issue subpoenas,
hire private sector services (like law firms) if it is cost effective, repudiate leases or contracts, and sue directors and officers personally for gross negligence. Further, when the FDIC acquires bank assets in the receivership it can defeat claims against those assets, according to Kraai.

Something that surprises many companies that do business with a bank that goes into receivership is that during first 90 days of the receivership, you cannot terminate a contract with the failed bank, says Kraai. “No matter what the contract says, you cannot exercise your right to terminate the contract or declare a default or accelerate any of the remedies. You have to keep performing under the contract.”

In addition, the FDIC has the power to repudiate any contract with the failed bank that it finds “burdensome” and, unlike in other areas of the law where there are certain standards for termination of a contract “the FDIC has sole discretion for determining what it finds burdensome,” Kraai says. “The FDIC does not need to explain, or write down, why it found the contract to be burdensome.” In addition, the FDIC has the power to assign any contract with a failed bank, even if the terms of the contract specifically prohibit assignment.

However, Kraai says, “although the FDIC can chose what contracts to accept or repudiate, it can’t cherry pick within those contracts. So if you have a contract with a failed bank, the FDIC either has to accept that contract in whole or repudiate it in whole.”

Something else to keep in mind, says Kraai, is that if your client is a depositor with money in a foreign branch of a bank that fails, that deposit is not insured, even if it is a domestic bank.

Where are the Failing Banks?
Briefly examining the demographics of recent bank failures, Kraai notes that this year they have been spread around the country, including California, Georgia, Texas, Michigan, Minnesota, Illinois, North Carolina, West Virginia, Ohio, Nevada, and it is fairly obvious that the failures can be tied to banks that were heavily involved in mortgages.

In addition to making sure clients understand the nature of their relationships with banks, it is also important to for people to understand that “if you have a relationship with a bank that has gone into receivership there are priorities of how people are going to get paid out, just like in a business bankruptcy.” Administrative expenses of the receivership are paid first (which can sometimes work to the advantage of entities that have a contract with a failed bank), then the deposits, other senior liabilities, subordinated debt and finally shareholders.

Talk To The FDIC
Also, she says, don’t be shy about going to the FDIC and asking questions. “I think it can be a natural tendency to not want to go in and ask ‘What’s my status, where am I?’” Kraai notes. Although anyone with an agreement with a failed bank is required to keep performing under any contracts for the first 90 days, “there may be things you can do and it is wise to talk with the FDIC.” She notes that the FDIC maintains a website with information on all of the failed banks and telephone numbers to call “and they are very responsive, even with the volume of work they are doing.” Because every P&A agreement is different, “it can be confusing for someone who has an agreement with the bank to know where it is residing and what is going to happen to it,” according to Kraai.

“So I think that it makes sense to spend some time talking with your clients and understanding ‘this is what my agreement means and this is what happens if the bank goes under or is taken over.’ Then if the bank fails, avail yourself and your client of the resources the FDIC provides.”

Teresa Zink is a freelance writer living in the suburbs of Philadelphia. She is former legal news editor at Mealey Publications . She is a frequent contributor to HB Litigation Conferences, formerly Mealey’s Litigation Conferences. You can email Teresa at tkz@verizon.net.

BVR Editorial Staff: Case May Mark Start of Securities Litigation Boom

Written by BVR Editorial Staff

In what may be the first reported case to emerge from the ongoing financial crisis, the North Carolina Superior Court considered a shareholder’s challenge to the proposed merger between Wachovia and Wells Fargo banks. In Ehrenhaus v. Baker (Nov. 3, 2008), a Wachovia shareholder claims that the merger price and other particulars of the deal are unfair, constituting a breach of the directors’ fiduciary duties. In particular, the merger permits:

• A stock-for-stock exchange, 0.1991 shares of Wells Fargo common stock for each share of Wachovia common stock, valued at $7.00 per share;
• A share exchange agreement, whereby Wells Fargo gains nearly 40% aggregate voting rights;
• A “fiduciary out” provision, which prohibits the Wachovia board from walking away from the Wells Fargo deal should a better offer come along; and,
• Three Wachovia board members to join the Wells Fargo board.

In considering the plaintiff’s motion to enjoin the merger and expedite discovery, the court began with a dire assessment of the current U.S. economy:

For several months, this nation has been engulfed by a financial storm the likes of which have not been seen since the Great Depression. Venerable financial institutions thought to be permanent pillars of both Wall Street and Main Street have been sold at the equivalent of a federal fire sale, nationalized, or put into bankruptcy or receivership.

Although the court denied the plaintiff’s request for speedy discovery, under the circumstances it did agree to expedite the injunction proceedings, asking the parties to file briefs in time for a November 24, 2008 hearing. Look for a complete abstract of the court’s decision in the January 2009 Business Valuation Update™, and additional reports of case proceedings in the BVWire™.

Former Fannie Mae Compliance Lead to Speak at Banking Litigation Conference in January

From Tom Hagy

To the Customers of Mealey’s Litigation Conferences

 

Megan Kraai, DLA Piper

We at Mealey’s Litigation Conferences are pleased to announce that former Fannie Mae compliance lead Megan Kraai has agreed to join the faculty of The FDIC & the Banking Crisis: Litigation Challenges Past, Present & Future.  

 

This fully accredited program is being held at the Westin Grand in Washington, DC, Jan. 15-16, 2009.

 

Kraai is now partner with DLA Piper in that global law firm’s litigation and regulatory practice group.  While with Fannie Mae, Kraai created, implemented and led a risk-based compliance program; developed company-wide policies; developed the company’s corporate privacy program; started the company’s first OFAC program for compliance with US trade sanctions regulations; and developed and delivered the company’s first online courses for privacy, code of conduct and insider trading.

 

Kraai will join nearly two dozen other speakers at the FDIC & the Banking Crisis program, chaired by attorneys at another leading law firm, Hughes Hubbard & Reed LLP.  Scott H. Christensen and Dennis S. Klein, both Hughes Hubbard partners, are putting together a unique program on this urgent issue. 

 

We are thrilled to be working with such top legal industry talent, something we strive for with all of our events.  

 

For more information, click here or contact me at tom.hagy@bvresources.com or 484-324-2755 x207, or Sharon Boothe, vice president, at sharon.boothe@bvresources.com or 484-324-2755 x208.

Tom Hagy

November 22, 2008

 

Willkie’s James Dugan on Professional Experts & Expert Professionals

By Tom Hagy

 

When selecting a financial expert, you first want to make sure you need one and, if so, why type.  Speaking for Mealey Conferences, James C. Dugan, partner with Willkie Farr & Gallagher LLP, said not all cases require a financial expert.  The attorney needs to ask:  will an expert genuinely help inform the judge or jury?   “In some cases an expert will be cumulative and not additive,” he said – you don’t want an expert when the other side’s case is clearly weak otherwise you risk dignifying your adversary’s position. 

 

Once you’ve made the decision that a financial expert is what you need, another question is whether you want a “professional expert” or an “expert professional.”  Professional experts, whose primary source of income is testifying, and professionals who rarely if ever testify, both have advantages and disadvantages for different situations.  “It’s important to get this [choice] right early on,” Dugan said.  The advantages of a professional expert are his ability to testify across disciplines and their experience in the courtroom.  They are less likely to become flustered and are used to analyzing large amounts of data.  “However, professional experts have a huge public record that can be used by an adversary in cross-examination,” Dugan cautioned.  “It’s very hard to be completely consistent on every issue you are tapped to opine on.  The larger the record, the more likely your adversary will find something.”

 

Another downside to the professional expert is that the jury or judge may infer a lack of credibility to someone who testifies for a living, Dugan said, especially if they have only taken one side of an issue in their testifying career.  Counsel must scrutinize the expert’s record thoroughly during the vetting process, Dugan said, just as their adversary will do later on.

 

In practice attorneys do not always get the choice between types of experts, he said, and sometimes a subject is so esoteric that it simply cannot be addressed by an “arm-chair practitioner.”   Sometimes you need someone who acted in the relevant role, such as an investment advisor, to have more credibility with a jury.   The disadvantages in this situation are that the witness will not be familiar with the litigation process.  “It’s pretty hard to withstand cross examinations if you haven’t done it before,” Dugan said.  Or, the expert professional may not be a good communicator to a jury.  The advantage of a professional expert is that they will have been in front of juries before and the attorney will have some idea of how the witness will come across.   Dugan added that some professional experts – despite deep technical knowledge – also know how to come off folksy, which is a winning combination.

 

This is adapted from audio recordings and materials available on CD by Mealey’s Litigation Conferences and Business Valuation Resources.  These audio packages — “Effective Timing & Use of Financial Experts” and “Compelling Statistical Evidence: Mining, Modeling, and Presenting Quantitative Financial Evidence to Juries” –contain presentation materials and full transcripts.  For more info, write to me directly at tom.hagy@bvresources.com.  

 

CFA Weighs in on Financial Crisis & FAS 157

It’s no secret that many think FAS 157 helped fan the flames of the current financial crisis (see: More blame for FAS 157 in current economic crisis?) while others assert that it confuses many valuation issues without sufficient guidance, especially on its seemingly counterintuitive valuation requirements. Indeed, just this week, in a letter to SEC Chairman Christopher Cox, The American Bankers Association asked that the “SEC use its statutory authority to step in and override the guidance issued by FASB.”  Another take:  In a letter recently sent to Congressional leaders and the Securities and Exchange Commission (SEC), the CFA Institute Centre reinstated its position for an end to the calls for rolling back fair value reporting.

 

In brief, the letter notes that:

 

1) Ending fair value reporting will only serve to undermine the confidence of investors in our financial institutions and lead to a further crisis of confidence in our government and the regulatory bodies overseeing those institutions.

2) The process of stabilizing the global financial markets and reinvigorating liquidity starts with improving the transparency of financial institutions.

3) The causes of the massive asset write-downs we have observed have nothing to do with financial reporting, but everything to do with the need for effective stewardship.

4) Complaints about fair value arise largely in the context of their impact on capital adequacy. Rather than suspending fair value and thereby the transparency and relevance of financial information, perhaps the focus should instead be on flexibility in capital adequacy requirements in times of distress.

 

 

 

Countrywide’s $8.4B Settlement: Must Holders of Its Securitizations Foot the Bill?

Written by J. Bruce Boisture

Managing Partner

Grais & Ellsworth LLP

 

To settle allegations of predatory lending made by the Attorneys General of California, Illinois, and nine other states, Countrywide Financial Corporation proposes to modify the mortgage loans of some 400,000 borrowers, a proposal estimated to be worth some $8.4 billion to those borrowers. But even though it is Countrywide’s own conduct (or misconduct) and the resulting liabilities that make it prudent to offer so large a  settlement, Countrywide plans to pay not a cent of its own (or, rather, of its parent Bank of America) toward the $8.4 billion. Instead, it plans to impose the cost of its settlement on the trusts into which the to-be-modified loans were securitized, and thereby onto holders of certificates in those trusts. In our view, Countrywide’s plan will violate the agreements that govern those trusts.

 

Only a hopeless conflict of interest enables Countrywide even to think of passing the cost of its settlement to certificate holders. Wearing one hat, Countrywide originated predatory loans and sold them to securitization trusts. Wearing another, Countrywide services the loans in the trusts on behalf of the trustees and certificate holders. Countrywide as servicer now plans to modify 50,000+ loans so as to extinguish the liabilities of Countrywide as predatory lender. Countrywide as servicer says these modifications will increase revenue into the trusts by avoiding the expense of foreclosure, etc. This assertion is laughable, for two reasons. First, if it were true, then Countrywide as servicer would be modifying those loans anyway, and the settlement between the Attorneys General and Countrywide as predatory lender would convey no incremental value at all to borrowers in distress. Second, Countrywide as servicer could say nothing else without betraying the plan of Countrywide as predatory lender to shift the cost of its misconduct to certificate holders.

 

Securitizations are governed by pooling and servicing agreements, and the PSAs that govern Countrywide’s many securitizations are all very similar. Three provisions of those PSAs are pertinent.

 

First, Countrywide as lender represents and warrants that “[e]ach Mortgage Loan …complied in all material respects with applicable local, state, and federal laws, including, but not limited to, all predatory and abusive lending laws.” (Emphasis added.) [§ 2.03(b)(68).†] The proposed settlement makes clear that Countrywide breached this representation and warranty wholesale. Countrywide must repurchase from the trusts each loan that was not made in compliance with “all predatory and abusive lending laws,” and must pay the trusts 100% of unpaid principal and interest, plus “any costs, expenses and damages incurred by the Trust Fund resulting from any violation of any predatory or abusive lending law in connection with [the] Mortgage Loan [being repurchased].” [§§ 2.03(g); 1.01 (definition of “Purchase Price”).]

 

Second, Countrywide as servicer must “service and administer the Mortgage Loans in accordance with customary and usual standards of practice of prudent mortgage loan lenders.” [§ 3.01.] Prudent lenders do not make predatory loans or spend their money to discharge the liabilities of others. In servicing and administering the loans, Countrywide “shall take no action that is inconsistent with or prejudices the interests of the Trustee or the Certificateholders.” [§3.01.] Thus, Countrywide as servicer must act in the interests of the certificate holders, not in the interests of Countrywide as predatory lender.

 

Third, Countrywide as servicer may modify mortgage loans, but only five percent of them by principal amount and, more important, only if Countrywide as lender then repurchases each modified loan from the trust. [§ 3.12(a).] Countrywide as lender would argue that the unpaid principal and interest that it must pay for each loan are the reduced amounts after the modification.  But no matter.  As noted above, Countrywide as lender must also pay “any costs, expenses and damages incurred by the Trust Fund resulting from any violation of any predatory or abusive lending law in connection with [the] Mortgage Loan [being repurchased].” [§ 1.01 (definition of “Purchase Price”).]  Those “costs, expenses and damages” are precisely the difference between what Countrywide as lender pays each trust for a modified loan and the unpaid principal and interest on the loan unmodified. Those “costs, expenses and damages”, according to B of A, will be at least $8.4 billion.

 

Countrywide’s PSAs try to make it difficult for certificate holders to enforce their rights.

 

Countrywide and B of A must be assuming that the $8.4 billion will be spread over enough certificate holders that none will think it worth the trouble to protest. By working together for their mutual protection, certificate holders can disabuse Countrywide and B of A of this unfortunate assumption.

 

† Citations are to the sections of a typical PSA, dated September 1, 2006, and available at

http://tinyurl.com/4kpb5k.

 

The opinions expressed in this article are not necessarily those of BVR Legal or Business Valuation Resources LLC.

 

EVENT ALERT: Financial Crisis in the Banking Industry Conference – Litigating For & Against the FDIC will be held January 15-16 at the Westin Grand in Washington, DC.   Watch www.bvrlegal.com’s “Live Conferences” section for details.

 

 

DLA Piper Among Large Firms ‘Publishing’ Frequent News, Views on Financial Tsunami

Law firms are increasingly going straight to the Web with their own brand of updates and perspectives, creating a motherlode of free legal insights.  The urgency of the credit markets crisis has put many firms into high gear with fresh content going up daily.  DLA Piper is no exception.  Below are some recent observations provided by the firm.  More info at www.dlapiper.com.

 

September 21, 2008, Implications of the Global Credit Crisis and the US Government’s Response

1.    “Participants in the global financial services industry have witnessed developments this past week unprecedented since the late 1920’s: within the span of several days, a major investment bank (Lehman Brothers) was forced to file bankruptcy, one of the premier retail and institutional broker/dealers in the United States (Merrill Lynch) was induced to be sold to Bank of America amid concerns of its own solvency and survival, and a major insurance conglomerate (American International Group (AIG)) was rescued by a direct loan and guarantee program that effectively provides for this entity to be owned and operated by the United States government.  These developments occurred within weeks of the federal rescue of two crucial government sponsored enterprises (Fannie Mae and Freddie Mac), and only months after the near collapse and government-guaranteed acquisition by JP Morgan of another prominent investment bank (Bear Sterns).”

 

2.   “The Treasury has been encouraging its counterpart agencies overseas to develop and implement comparable asset purchase programs.  The ability to extend the availability of the US purchase program to additional foreign entities having a significant presence in the US may, in turn, depend on the extent to which comparable programs are established overseas.”

 

3.   “In light of the broad ranging and dramatic nature of the proposals promulgated by the regulators and contemplated for passage by the Congress, the impact on individual businesses and their counterparties will be significant…”

 

4.   “By allowing hedge funds or other investors to hold amounts greater than 25 percent of the total contributions to the capital of a banking entity, without becoming subject to regulation as a bank holding company, banking regulators may create the potential of opening a significant amount of new sources of capital for investment in the banking industry.”

September 22, 2008, SEC Attacks Short Selling on Regulatory and Enforcement Front

1.    “With the issuance of a formal order of investigation, the Enforcement Division now has the power to subpoena documents and testimony relevant to its investigation into manipulative and ‘abusive’ short selling practices and illegal ‘rumor mongering.’”

 

2.   “According to the SEC’s press release, hedge fund managers, broker-dealers and institutional investors with significant trading activity in certain financial issuers or positions in credit default swaps will be required to disclose these positions, under oath, to the Commission.”

September 24, 2008, Update: The Global Credit Crisis and the US Government’s Response

1.   “Today the financial markets received the welcome news that investor Warren Buffett, acting through Berkshire Hathaway, Inc., is planning to invest $5 billion in Goldman Sachs.  The proposal, coupled with an additional capital raise by Goldman Sachs announced today, is being seen as a favorable indication of faith in the viability of the country’s financial system.”

 

2.   “This CDS [credit default swaps] market has been the fastest growing derivatives market worldwide in the last two years.  The sellers of CDS protection are often Insurance companies, and the risk of loss to sellers (in the event reference indebtedness is not repaid in accordance with its terms) increases exponentially.  This arguably increases systemic risk to the financial markets.”

September 29, 2008, Update: The Global Credit Crisis and the US Government’s Response

1.    “…concerns of Main Street bankers in smaller communities who are expressing anxiety at recent market turmoil, and communicating to their legislative representatives the fear that the Wall Street upheaval may result in contagion by smaller market participants in communities and industries throughout the US.  Indeed, legitimate fears exist, given European market developments, that such systemic breakdowns will accelerate beyond the shores of America to Europe and Asia, as well.”

 

2.   “Only one certainty remains: both the regulatory and the market landscape will be a radically different one in the months to come.  While once-hallowed institutions meet their demise by restructuring, liquidation, acquisition or bankruptcy, governmental authorities across the globe are calling for a new system of financial regulation amidst frank acknowledgements….that the old regulatory regimes are obsolete.”

October 1, 1008, The Global Credit Crisis and the Global Response

1.    “In the regulatory area, the Securities and Exchange Commission announced additional guidance on market-to-market accounting standards, in an effort to address concerns about the implementation of this regime and its impact on the financial services industry.  It is expected that this topic will be one of extended debate in weeks to come, as the goals advanced by such accounting treatment, providing for greater clarity and transparency in the valuation of assets, are outweighed by the difficulties of determining accurate values at times when market prices for such assets may be impossible to obtain in a deteriorating market.”

 

Court Approves Valuation Expert’s $18.6M Diminished Value Tag in S&L Case

WASHINGTON, D.C. – In a case that begins at the dawn of the 1980s S&L crisis, the U.S. Court of Federal Claims has found “fair and reasonable” the opinion of an expert witness for S&L owners that the Government’s breach of their assistance agreements caused by the enactment of FIRREA cost them $18.6 million in economic value.  Claims for future lost profits did not survive, however.

 

Publisher’s Note:  You can comment on this story and see the complete case summary where the Court addresses a number of valuation methods and the defense expert’s testimony elsewhere on this blog.  

 

Plaintiffs Holland and Ross purchased all of the shares in Rock Falls Savings & Loan Association in 1986, about the time that S&Ls were collapsing across the country.  The FSLIC, which insured the thrift deposits, tried to get healthy thrifts to acquire insolvent ones.  The plaintiffs entered into an assistance agreement with the FSLIC to purchase some S&Ls.  The agreement included language that cash contribution from the FSLIC, the subordinated debenture and preferred stock purchased by the FSLIC could all be counted as regulatory capital on River Valley’s books – a provision that was wiped out with the enactment of FIRREA in1989.   To purchase another thrift called San Antonio Federal Savings Bank, the pair had to find other investors and form a new entity.  They acquired the bank.  Its assets were sold at a significantly gain for the investors.  First Bank acquired River Valley in 1995. 

 

Holland, Ross and First Bank sued the Government for breach of contract.  The court ruled in an earlier decision that the Government’s enactment of FIRREA did breach the contracts. 

 

Losing on Future Lost Profits

 

In calculating damages, the Court reviewed the plaintiffs’ theories, starting with the claim that they suffered lost opportunity to purchase SAFSB; therefore losing  potential profits or dividends.  Rejecting this claim, the Court said that when seeking damages from future income generating property, the market value of the asset at the time of the breach must be considered, not lost actual profits that could have been produced in the future had a different set of circumstances occurred.  Lost potential future income and dividends are not recoverable for the loss of the acquisition opportunity, the Court determined.

 

Hughes Hubbard Critical Player in Distressed Debt Arena

Hughes Hubbard partner James Giddens, was appointed by the U.S. District Court for the Southern District of New York to be the Trustee for the liquidation of Lehman Brothers Inc. under the Securities Investor Protection Act of 1970.  Giddens is a partner with the firm, specializing in bankruptcy and reorganization.  Past service includes trusteeship of SIPC brokerage firm liquidations and administrator of the SEC Restitution Fund.

 

Giddens’ colleague, Hughes Hubbard partner Dennis S. Klein is chairing BVR Legal’s October 7 teleconference:  The Financial Crisis in the Banking Industries.    Joining Klein is Scott Christensen, also with the firm.

 

Giddens, along with Hughes Hubbard colleagues Jeffrey S. Margolin and Anson B. Frelinghuysen, recently posted an article “Avoiding Rough Seas in the Distressed-Debt & Bankruptcy Morass,” where they commented on two recent cases that highlight the exposure professionals face when offering services to distressed companies.  “As unsecured creditors face reduced recoveries in the recent wave of bankruptcies,” the attorneys warned, “they are increasingly targeting the bankrupt’s financial advisors, investment banks, and accounting firms with lawsuits to attempt to mitigate their losses.” 

 

As outlined in the article, available for free from the Hughes Hubbard site: In American Business Financial Services, Inc. Noteholder Litigation, the court refused to dismiss fraud claims brought by ABFS’ noteholders against the company’s auditors.  The court said the noteholders sufficiently allege the accounting firm failed to maintain its independence and ignored certain red flags.  In In re Oakwood Homes, a federal court in Delaware dismissed the liquidation trustee’s damage claims against the financial advisor on the grounds that the doctrine of equal fault, or in pari delicto,  protected the financial advisor from liability where the company retained final say in decisions.