March 17, 2011
By ERIC DASH
The Federal Deposit Insurance Corporation sued the former chief executive of Washington Mutual and two of his top lieutenants, accusing them of reckless lending before the 2008 collapse of what was the nation’s largest savings bank.
The civil lawsuit, seeking to recover $900 million, is the first against a major bank chief executive by the regulator and follows escalating public pressure to hold bankers accountable for actions leading up to the financial crisis.
Kerry K. Killinger, Washington Mutual’s longtime chief executive, led the bank on a “lending spree” knowing that the housing market was in a bubble and failed to put in place the proper risk management systems and internal controls, according to a complaint filed on Thursday in federal court in Seattle.
David C. Schneider, WaMu’s president of home lending, and Stephen J. Rotella, its chief operation officer, were also accused of negligence for their roles in developing and leading the bank’s aggressive growth strategy.
“They focused on short-term gains to increase their own compensation, with reckless disregard for WaMu’s long-term safety and soundness,” the agency said in the 63-page complaint. “The F.D.I.C. brings this complaint to hold these highly paid senior executives, who were chiefly responsible for WaMu’s higher-risk home lending program, accountable for the resulting losses.”
In addition, the complaint says that Mr. Killinger and his wife, Linda, set up two trusts in August 2008 to keep his homes in California and Washington out of the reach of the bank’s creditors. Months earlier, in the spring of 2008, Mr. Rotella and his wife, Esther, made similar arrangements. The F.D.I.C. is seeking to freeze the assets of both couples and named the wives as defendants in the lawsuit.
In unusually vigorous denials, Mr. Killinger and Mr. Rotella came out swinging against the F.D.I.C. Mr. Killinger said the agency’s claims were “baseless and unworthy of the government” and its legal conclusions were “political theater.” Mr. Rotella said the action “runs counter to the facts about my relatively short time at the company,” calling it “unfair and an abuse of power.” He said the trust was for normal estate planning purposes and was set up before the bank’s downfall. Mr. Schneider, who is represented by the same lawyer as Mr. Rotella, did not release a public statement.
Although the F.D.I.C. is mainly known for its role in shuttering failed lenders, the agency has a legal obligation to bring lawsuits against former directors and officers when it finds evidence of wrongdoing.
So far, the F.D.I.C. has brought claims against 158 individuals at about 20 small banks that failed during the recent crisis. The agency is seeking a total of more than $2.6 billion in damages. But the $900 million case against the former WaMu officials is its biggest and most prominent action to date.
Federal regulators have come under fire for failing to hold executives responsible for their involvement in the worst financial crisis since the Great Depression. Last fall, the Securities and Exchange Commission reached a settlement with Angelo R. Mozilo, the former chief executive of Countrywide Financial, to pay a $22.5 million penalty over misleading investors about the financial condition of the giant mortgage lender.
The New York attorney general’s office has brought a civil suit against Kenneth D. Lewis over improper disclosures related to the 2008 rescue of Merrill Lynch by Bank of America, of which he was chief executive.
But several investigations into the actions of executives at the American International Group, Lehman Brothers and other financial firms have stalled — especially criminal cases, which have a much higher burden of proof.
The F.D.I.C., meanwhile, has been under intense pressure to recoup as much money as possible on behalf of Washington Mutual bondholders, who were outraged over its sale in September 2008. Critics said the agency moved too quickly to seize the troubled bank, and then allowed JPMorgan Chase to snap up its assets and branches for a mere $1.8 billion. Ever since, they have unleashed a wave of litigation and asked lawmakers to hold hearings about the controversial rescue.
In his statement, Mr. Rotella suggested the lawsuit was a way for the F.D.I.C. to extract a windfall from directors’ and officers’ insurers, which would want to settle any claims.
The F.D.I.C. complaint says that Mr. Killinger and his top lieutenants took “extreme and historically unprecedented risks” as the savings bank plunged headlong into risky mortgage lending near the height of the housing boom. As experienced bankers, they should have tempered this growth strategy and improved risk management systems to reduce potential losses if the real estate market fell, according to the complaint.
Instead, according to the complaint, they ignored the warnings of the bank’s risk managers and sank deeper into the risky subprime lending and hot real estate markets, like Florida and California. Indeed, the complaint lists more than 26 areas in which they acted recklessly, including a failure to put adequate limits on the concentration of mortgages and employee compensation programs that encouraged high loan volume at the expense of loan quality. The complaint quotes Washington Mutual’s own chief risk officer as telling Mr. Killinger, just weeks before it was seized, that the “risk chromosome” was missing from the bank’s DNA.
In lengthy statements, Mr. Killinger and Mr. Rotella disputed the basic thrust of the F.D.I.C.’s case and reiterated their belief that Washington Mutual was prematurely and unfairly seized. They also insisted that they behaved prudently, acted with constant oversight of banking regulators and took strong action to shore up the bank’s finances when market conditions worsened in late 2007 and early 2008.
“Those initiatives — once applauded by the regulators as diligent and responsible management — have, through the alchemy of Washington, D.C., politics been turned into allegations of gross negligence,” Mr. Killinger said in a statement.
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