On October 10, 2013, the Federal Deposit Insurance Corporation (FDIC) advised regulated financial institutions to be wary of “an increase in exclusionary terms or provisions” in insurance policies covering directors and officers liability (D&O). While this advice was directed to financial institutions regulated by the FDIC, much of it is good advice to follow for all corporations and their board of directors.
This unusual advisory came in the form of a Financial Institution Letter.i In the Letter, the FDIC recommended specific questions that directors and officers of regulated financial institutions should address both as to existing D&O policies and when considering renewals or amendments of such policies. The Letter also provided guidance on the legality of insurance for civil money penalties (CMP).
The FDIC made clear its concern that the increasing frequency of exclusions in D&O policies may result in directors and officers not having insurance coverage for “damages arising out of civil suits relating to their decisions and actions.” In such cases, the agency warned, directors and officers may be “personally liable” for damages and legal fees. As a result, such exclusions “may adversely affect the recruitment and retention of well-qualified individuals” to financial institutions’ top leadership positions.
Due to such threats, the FDIC cautioned that it is “vital” that each board member and executive officer ensure that they and their financial institution have adequate D&O coverage. In particular, the FDIC suggested answering the following questions:
- What protections do I want from my institution’s D&O policy?
- What exclusions exist in my institution’s D&O policy?
- In a proposed renewal policy, are any of the exclusions new, and if so, how do they change my coverage?
- What is my potential personal financial exposure arising from each policy exclusion?
The Letter itself does not explain the FDIC’s motive for issuing this unusual warning, but it is most likely practical. Since the recent financial crisis, the FDIC has taken numerous failed financial institutions into receivership. When doing so, in many instances the FDIC has looked to coverage under that financial institution’s D&O policies in order to recoup losses the FDIC absorbed. However, the FDIC’s pursuit of such coverage often has been stymied by so-called “regulatory agency exclusions” – exclusions that purport to preclude coverage for claims brought against directors and officers or insured entities by regulatory agencies such as the FDIC. The Letter then can be viewed as a wakeup call to financial institutions and their boards to pay careful attention to exclusionary provisions in their D&O policies and do their utmost to remove or narrow such exclusions lest they be left uninsured.
On another topic, the FDIC Letter contained a “reminder” that federal law prohibits insured depository institutions and their holding companies from buying insurance coverage for CMP. Cited in support were the Federal Deposit Insurance Act and FDIC regulations.ii These laws state that covered institutions may not buy insurance for a CMP assessed by a federal banking agency against an institution’s directors or officers or other individuals.iii For example, federal banking agencies can impose such penalties against directors and officers when they violate the agencies’ final orders, conditions imposed by agencies, or written agreements with the agency.iv
Reading these laws, some may have thought they permitted institutions to buy coverage for CMP if the directors and officers reimbursed the institutions for such coverage. But in the Letter, the FDIC made clear its view that such practice is not permitted by federal law. Financial institutions and their directors and officers subject to such federal law should carefully review whether they are in compliance with the FDIC’s interpretation on this issue and whether there are alternative insurance protections that could be put in place for CMP.