Aon | Financial Services Group
Release Date: March 2023
Management Liability Implications of Bank Collapses
On March 10, 2023, the U.S. Federal Deposit Insurance Corporation (FDIC) took control of the assets of Silicon Valley Bank (SVB), the 16th largest bank in the U.S. The collapse has been dominating headlines.
Shortly after, a joint statement was released by the Secretary of the Treasury, Federal Reserve Board Chair and FDIC Chairman that all SVB depositors would have access to their SVB deposits starting on Monday, March 13, 2023. The federal government has apparently mollified SVB depositors’ concerns for now, but SVB’s collapse spotlights myriad risks and highlights numerous noteworthy potential ramifications, including substantial exposures for failed banks and their respective directors and officers (D&Os), as well as third parties.
Shareholder Litigation Risks for Failed Financial Institutions and Their D&Os
While the collapse of a large financial institution such as SVB is extraordinary, it is not unprecedented. Similar risks were highlighted during the Savings and Loan crisis and the 2007-2008 financial crisis when Washington Mutual collapsed after aggressively pursuing a business strategy focused on subprime mortgage lending. Washington Mutual and its D&Os (and certain of their spouses) were targeted in shareholder litigation, including securities class actions, derivative claims and claims asserted by the FDIC in its capacity as Washington Mutual’s receiver. The litigation alleged mismanagement and breaches of fiduciary duties tied to the bank’s overexposure to the subprime market.
Just one business day after the announcement of SVB’s receivership, the bank and certain senior officers were sued in California federal court for securities fraud based on the company’s alleged failure to adequately disclose its exposure to rising interest rates. It is possible that more complaints will be filed against SVB and other financial institutions that may have similar issues. Such claims may also be disclosure-based and/or based on alleged defects in the institution’s internal governance: alleged mismanagement of assets and failure to appropriately hedge; pursuit of a customer base overly concentrated with loan-averse start-ups; inadequate board oversight by an inexperienced board; defective or insufficient internal controls (e.g., SVB allegedly operated without a chief risk officer in the year leading up to its collapse) and alleged insider trading.
SVB’s most senior officers are under scrutiny for having sold substantial amounts of SVB stock just one week before SVB’s collapse, pursuant to U.S. Securities and Exchange Commission (SEC) Rule 10b5-1 trading plans that they had entered into mere weeks before SVB’s collapse. These are precisely the type of suspiciously-timed 10b5-1 sales made without a sufficient cooling off period that the SEC has sought to stamp out, including through its new amendments to Rule 10b5-1. Such claims may, depending on the policy, generally have at least some coverage under D&O policies. It is reasonable to expect that management liability insurance underwriters will probe whether and how other financial institutions have addressed the types of governance issues discussed above.
Shareholder Litigation Risks for Companies with Exposure to Failed Financial Institutions
Shareholder claims against other companies and their D&Os are possible if the companies incur losses related to their exposures to failed banks. For example, the D&Os of major insurers were sued by shareholders for allegedly overexposing their companies to the 2007-2008 financial crisis subprime mortgage-related losses, even though the insurers were not mortgage originators. Failed banks’ counterparties and/or their D&Os could likewise possibly be targeted by their own shareholders if these companies incur losses tied to an alleged overconcentration of exposure to a failed bank.
It is possible to expect that some private companies reliant on collapsed financial institutions will incur (or already have incurred) losses tied to inadequate liquidity, deteriorating valuations and funding levels and business disruptions arising from their banking partners’ collapse. This may make these companies and their D&Os targets for shareholder litigation. Again, these claims may, depending on the policy, generally have at least some coverage under D&O insurance programs and it is reasonable to expect that D&O underwriters will inquire about whether insureds are overly exposed to any particular financial institution.
Litigation over an eventual merger or acquisition of a compromised or failed bank is another source of potential shareholder litigation for which there may be D&O coverage. In the event of any M&A transaction involving a distressed or collapsed bank, shareholders of that bank and/or the acquiror may seek to challenge the deal by asserting, among other things, that the target’s D&Os breached their fiduciary duties to stockholders (e.g., by allegedly failing to secure an adequate price though an adequate sale process), that the acquiror’s board committed corporate waste by overpaying, and/or that the acquiror aided and abetted the target’s directors’ alleged malfeasance. These types of M&A allegations are not uncommon and may trigger coverage under the target’s or the acquiror’s insurance programs.
In any insolvency or liquidation, it is important to review key policy provisions including the Order of Payments provision, Insured vs. Insured exclusion exceptions and language in respect of policy proceeds being for the benefit of individuals.
Regulatory Risks for SVB and its D&Os, and Other Financial Institutions
It is possible that state and federal regulators, including, among others, the federal Office of the Comptroller of the Currency (OCC), the SEC, and the U.S. Department of Justice, will investigate, and even potentially bring a claim against, failed banks such as SVB and/or their D&Os for malfeasance. Such investigations and enforcement actions could trigger a failed bank’s D&O insurance program.
Moreover, as a general matter, Side A coverage for non-indemnifiable loss may be important to D&Os if they are facing a claim from a regulator given that company indemnification in such enforcement actions may be prohibited under federal regulations.
Aside from the regulatory investigation and litigation-related exposures that failed banks face, the recent collapse of SVB may also prompt the government to introduce or reintroduce requirements that create additional regulatory exposures for financial institutions, including, for example, stress tests and capital requirements.
Employee-Related Risks for SVB Customers
Although the recent joint announcement of the Secretary of the Treasury, Federal Reserve Board Chair, and FDIC Chairman may have quelled concerns for companies reliant on deposits with SVB to make payroll, some companies might already have missed payroll. In such circumstances, given the potential personal exposure of individual D&Os, the need for adequate insurance is particularly acute. For example, certain states, including California, Illinois, Massachusetts, New York, and Texas, have laws that could potentially impose civil and, in some cases, possibly even criminal, personal liability on D&Os and/or large shareholders for unpaid wages.
Under the federal Fair Labor Standards Act, in certain circumstances corporate D&Os could potentially be held personally liable for minimum wage and overtime violations. Such wage-related liabilities may be covered under management liability insurance programs, such as employment practices liability (EPL), wage and hour, or even D&O insurance.
Beyond wage-related exposures, some start-up employers have already announced staff reductions in the wake of the SVB collapse and others may conduct reductions in force or layoffs in the event of further economic disruption. Such employment-related actions may make employers targets for wrongful termination lawsuits, underscoring the importance of having adequate EPL insurance in place.
Commercial Crime Insurance Implications
Fidelity Bond or commercial crime insurance is typically purchased by banks to insure loss of bank assets due to the malfeasance of its employees. Although neither insolvency nor the liquidation of a bank such as SVB is generally a trigger to such insurance, to the extent that it is determined in the liquidation process that assets of the failed bank’s estate are missing due to employee dishonesty or theft, such insurance could also become an asset of the estate, further supplementing funds available to be returned to depositors and creditors.
Additional Depositor-Protective Insurance
Aside from the liability, regulatory, and crime-related risks discussed above, the SVB collapse also brings to light two noteworthy types of insurance designed to protect bank depositors.
First, while somewhat obscure and with generally low bank take-up rates, the commercial insurance market offers a surety product to banks to cover deposit losses above the $250,000 FDIC protection amount. Such coverage would have to be secured before a bank failure and is underwritten based on the creditworthiness of the bank by several prominent surety carriers. In the event of a bank liquidation, the product is intended to pay customers that have not been made whole by the FDIC.
Second, separate and apart from FDIC protection, which is only available for member banks, Securities Investor Protection Corporation (SIPC) protection is afforded to SIPC-member brokerage firms to provide certain protection for cash (up to $250,000) and securities (up to $500,000) and can be supplemented on a firm-aggregate basis in the insurance market subject to underwriting review.
Read about the cyber implications of the collapse in Cyber Solutions at Aon’s Cyber Risk Related to SVB Collapse.
If you have questions about your coverage or are interested in obtaining coverage, please contact your Aon broker. Discuss this article with Financial Services Group professional Nicholas Reider.
Senior Vice President, Deputy D&O Product Leader – West
All descriptions, summaries or highlights of coverage are for general informational purposes only and do not amend, alter or modify the actual terms or conditions of any insurance policy. Coverage is governed only by the terms and conditions of the relevant policy.