Although doubts persist about whether federal banking regulators will ever really employ new powers to seize a large nonbank financial company, a new insurance product may signal the market's belief that such authority will one day be used.
The insurance broker Marsh USA Inc. recently unveiled protection for the prospect that the Federal Deposit Insurance Corp. — authorized by the Dodd-Frank Act to resolve firms too big for bankruptcy — could someday try to punish officers of a failed company by reclaiming their salaries.
Observers said the coverage, offered by two carriers, reflects market views that the FDIC's powers are more than just abstract, and that directors and officers of systemically important holding companies, equity funds and other firms could face similar risks of FDIC action that already haunt scores of failed banks.
"The bottom line is any insurance company that sees a need and sees a void is going to come up with a product to deal with that eventuality," said Kirby Behre, a partner at Paul, Hastings, Janofsky & Walker LLP. "This is speculating, but it very well could be that they're predicting some sort of uptick in these types of takeovers."
Under Dodd-Frank, the FDIC is responsible for resolving certain failed companies deemed systemically risky. When it takes over failed banks, the agency can now pursue civil damages against those accused of having a role in the failure, and in some cases it has sought compensation. Since the recent crisis, the FDIC board has authorized lawsuits against more than 180 defendants — although only six suits have been filed — seeking $3.8 billion in claims.
The new law makes such lawsuits possible for directors and officers at seized nonbanks as well. It also expressly allows the FDIC to cancel compensation agreements for managers at such firms or claw back their compensation earned over a prior two-year span.
While a nonbank's general D&O policy — meant now for proceedings such as shareholder lawsuits — could likely be used to cover future FDIC litigation, the products that Marsh is marketing target the risk of lost compensation, which are not typically covered. The new products also enhance coverage for defense costs.
"This is something that is meant to be a supplement to a professional liability policy," said Mark Cuoco, a managing director at Marsh.
Nevertheless, he said, the new resolution system may force companies that never considered D&O insurance of any kind to change course, even those not sure they would be big enough to be considered systemically risky.
"What we might see is more hedge funds and other financial companies purchasing professional liability that never purchased it before," Cuoco said. In an April 21 press release announcing the new coverage, Cuoco said the FDIC's "dramatically expanded authority" poses "significant personal risks to executives, directors and partners of financial companies."
Kevin LaCroix, an attorney and executive vice president for OakBridge Insurance Services, a D&O provider in Beachwood, Ohio, said boards and officers at nonbanks are likely not as familiar as they should be about the risks from FDIC actions. "Chances are they're not fully informed about these concerns. Dodd-Frank is such a monster, and" the sections on potential FDIC claims are "buried pretty deeply," he said. "They probably need to pay more attention to the liability provisions in the statute."
Yet many said companies could be taking a risk of purchasing a policy if they do not ultimately need it. Some companies may not even know if they are considered systemic, and then there are the questions of whether the government would order a special resolution rather than just let the company declare bankruptcy, and of whether the FDIC would find it necessary to pursue a claim after the seizure. "Because it's a highly unlikely contingency, it will be priced accordingly, i.e., it will be less expensive than more generic D&O insurance," Behre said.
Sam Buffone, a partner at BuckleySandler LLP, said the FDIC, which is already investigating failed-bank directors and officers and has yet to exercise the new authority, may not view D&O claims for nonbanks as a priority.
"It's hard to imagine that without some additional resources that the agency would be able to take on this kind of new responsibility," he said.
LaCroix, who writes the "D&O Diary" blog, said the threat of a government takeover, which never existed before Dodd-Frank, may be a motivation for troubled firms to right themselves.
"We're looking into the future because this is all new," he said. "It's a legitimate question: How many companies are truly within the range of potentially being found to present systemic risk? Even if you decide, 'Maybe I am one of those companies,' how likely is it that you will face the kind of determination described in the statute that would result in the triggering of the liquidation authority? If those two things have happened, how likely is it that the FDIC … will elect to pursue these remedies?"
LaCroix added that insurers could possibly add "regulatory exclusions" for policies of large nonbanks, which they have used lately in light of all the bank failures to avoid payouts for troubled depository institutions.
"What we need to see is whether the marketplace will in some circumstances allow nonbank financial companies that are in financial trouble only to get a D&O policy with a regulatory exclusion," he said. "What's happening in the banking sector now, given its problems, is financially troubled banks are having difficulty getting D&O insurance without a regulatory exclusion. Financially stable banks have not had a problem. That might exactly be where we wind up going with nonbank financial companies."
Still, observers said nonbank directors and officers should seriously consider the risk of FDIC action. Behre pointed out that while directors and officers at nonbank companies are not strangers to liability claims, including actions from shareholders and the Securities and Exchange Commission, they may not be used to certain elements of FDIC proceedings. For example, he said, the FDIC usually tries to prove in a civil case that an individual's actions were "negligent," helping to cause a failure.
"What we're talking about in these other government investigations is typically a higher standard," Behre said.
Ultimately, some said, having D&O protection at nonbanks could make the difference in attracting strong management.
"Eventually there's going to have to be a resolution that if you want a former Fed chairman to sit on the board of directors of your unregulated entity, and it falls under the purview of the Dodd-Frank Act as a potentially systemic unregulated entity, what are you going to tell him when he says, 'How much D&O coverage do you have?' and the response is, 'None'?" said Robert Novak, an attorney at Jennings, Strouss & Salmon. "That just simply won't work."
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