On October 10, 2013, the Federal Deposit Insurance Corporation (“FDIC”) issued Financial Institution Letter 47-2013 to warn insured depository institutions of two areas of concern for director and officer insurance policies. First, the FDIC has noted an increase in exclusionary terms or provisions contained in institutions’ D&O insurance policies “that may adversely affect the recruitment and retention of well-qualified individuals.” The FDIC also suggests that directors and officers “may not be fully aware of the addition or significance of such exclusionary language.” In order to address this area of concern, an institution should conduct a review of all of its insurance policies, including D&O policies, on a periodic basis. It is not enough that directors and officers are provided with an overview of the institution’s D&O coverage when the director or officer is on-boarded. Rather, as the institution’s risk profile changes, so must the institution’s self-assessment of its insurance policies in place to hedge against that risk.
The second key concern expressed by the FDIC is insurance coverage for civil money penalties (“CMPs”). CMPs can be assessed against a director or officer in his or her personal capacity for a variety of reasons, including violations of laws, rules, agency orders, or conditions imposed in writing; participating in unsafe or unsound practices; committing breaches of fiduciary duty; or willful misconduct. 12 U.S.C. § 1818(i). Such CMPs can be assessed against an individual either on the basis of the individual’s own acts or omissions, or because the individual caused the institution itself to commit a violation, practice, or breach. The Federal Deposit Insurance Act provides for CMPs ranging from $5,000 per day for unintentional violations, to $25,000 per day for reckless conduct. 12 U.S.C. § 1818(i)(2). Additionally, for “knowing” violations, unsafe or unsound practices, or breaches of fiduciary duty, the federal regulators can assess a CMP against an individual of up to $1 million, and against an institution of up to the lesser of $1 million or 1 percent of the institution’s assets. Id.
Unlike most areas of potential director and officer exposure – where the ability of a director or officer to be covered by the institution’s D&O liability policy is left to the contract between the institution and the insurer – federal law prohibits an institution from indemnifying a director or officer against a CMP. 12 C.F.R. Part 359. Not only does this prevent an institution from directly indemnifying a director or officer for a CMP, but it also prevents institutions from paying insurance premiums on a D&O policy to cover a director’s or officer’s personal CMP. Some institutions have attempted to provide an accommodation for directors and officers by purchasing a rider policy for CMPs as to a specific director or officer, with the director or officer reimbursing the institution for the cost of the additional coverage. The FDIC has advised that the prohibition on indemnifying a director or officer for a CMP does “not include an exemption for cases in which the [director or officer] reimburses the depository institution for the designated cost of the CMP coverage.” The FDIC’s reasoning behind this is that by utilizing the institution’s insurance purchasing and negotiating power, the director or officer is receiving the benefit of lower premium pricing than the director or officer would otherwise be able to obtain had he or she sought insurance coverage independent of the institution.
While the FDIC’s recent guidance on CMP insurance is clearly applicable to state-chartered banks with the FDIC as their primary regulator, its applicability to state-chartered banks supervised by the Federal Reserve and to institutions supervised by the Office of the Comptroller of the Currency is less certain. In discussions with one attorney at a federal bank regulatory agency, in response to the question as to whether a bank could provide a CMP rider for its director or officer so long as the insured director or officer pays for the additional coverage, the agency official said that so long as the director or officer is paying the premium, “there would not be a problem.” This leaves institutions with the somewhat awkward dilemma of, on the one side complying with the apparent plain language of the regulation in a manner common in the industry – and with at least the tacit approval of federal bank examiners – while on the other side, the agency that authored the rule (the FDIC) comes to a contrary view in published agency guidance. Institutions facing such a dilemma should consult with regulatory counsel for guidance.
Similar to the first issue, institutions can address this supervisory concern by evaluating their insurance policies to ensure that there are no add-ons to cover individual directors or officers. Notably, the prohibition on making improper indemnification payments is phrased as a prohibition on the institution. Therefore, an improper indemnification, including the payment of a prohibited premium by an institution subject to FDIC oversight, can result in the institution committing a violation. See 12 C.F.R. § 359.3.