In mid-November 2011, the FDIC filed a complaint against eleven former directors and officers of Westsound Bank (Bremerton, WA), which was closed in May 2009.  The lawsuit is the FDIC’s seventeenth action against former D&Os of failed banking institutions since the advent of the Great Recession. A copy of the FDIC’s complaint is available here.

The FDIC’s core allegations resemble those asserted in its prior D&O lawsuits.  Specifically, it alleges that the Westsound board embarked on a “reckless” business strategy focused on high-risk ADC and CRE lending.  The FDIC further contends that the board and the Directors Loan Committee (“DLC”): (i) failed to properly manage and supervise the bank’s lending function; (ii) approved loans in violation of and without regard to the bank’s loan policy; (iii) ignored regulators’ warnings about excessive loan concentrations and lax oversight of the lending function; and (iv) approved additional loans and loan renewals and advances to mask non-performing credits.

The FDIC seeks to recover damages in excess of $15 million on claims for gross negligence (under FIRREA), and state law claims for negligence and breach of fiduciary duty.  Its alleged damages are tied to 35 specific credits, including seven ADC/CRE loans, and seven other loans to insiders allegedly made without board approval in violation of Reg. O.

The most interesting loan losses arise from 21 loans made to members of the local Russian/Ukranian community.  These loans were among 142 “fraudulent” loans originated by a single loan officer, who the FDIC alleges colluded with a non-bank employee, Aleksandr Kravchenko, to bring loans to the bank.  According to the complaint, Mr. Kravchenko frequently purchased properties, and then would find a straw buyer to obtain the loan to buy the property and fund construction of a spec home.  Mr. Kravchenko, through his construction company, often received a “development fee” of $10,000 – $15,000 from the loan proceeds, although no work was performed for the fee.

The FDIC contends that, under the bank’s loan policy, these loans should have been considered by the Directors’ Loan Committee (“DLC”).  Instead, these loans were approved through an automated (and easily manipulated) process reserved for loans intended to be sold into the secondary market.   Most of the loans provided 100% financing, and many were based on stated-income or incomplete and questionable financial information.  Additionally, the appraisals used to support automated approval were based upon an “as-built” valuation, even where the proposed borrower had not submitted building plans.  Furthermore, the loan officer who originated the loans earned more than $1 million in commissions alone, including commissions on renewals of non-performing loans, in less than two years.  The FDIC alleges that regulators warned the board that the bank’s lending function, and specifically the protocol that allowed the loan officer to obtain approval of the questionable credits, was “malfunctioning.”  It further alleges that the board did not address the problem in a timely fashion, allowing the loan officer to extend credit on the 21 “fraudulent” loans for which the FDIC is now seeking to recover damages.