'Business judgment' defense used in WaMu case
For many people, one of the most maddening things about the financial crisis is the fact that so few of the bankers, lenders and brokers involved have been held legally responsible.
A recent federal case out of California sheds light on why that is, and also suggests that the Federal Deposit Insurance Corp. (FDIC) may have a tough time making its case against three former top officers of Washington Mutual.
First, the California case. Western Corporate Federal Credit Union (or WesCorp) was a $32.5 billion institution that served retail credit unions throughout the West. During the housing bubble WesCorp invested heavily in option ARMs, collateralized debt obligations (CDOs) and other soon-to-be-notorious products of financial wizardry. After the bubble burst and those securities lost most of their value, WesCorp was taken over and eventually liquidated by the National Credit Union Administration (NCUA).
The NCUA sued WesCorp's top executives and its directors (including board Chairman Robert Harvey, who headed Seattle Metropolitan Credit Union before retiring earlier this year) for plunging into mortgage securities they barely understood — and borrowing heavily to do so — without adequately considering the risks involved.
But last month the judge dismissed the case against the directors, saying they were protected by the "business judgment" rule. This is a well-established legal doctrine that aims to keep courts from second-guessing legitimate, good-faith business decisions, even if those decisions turn out to be grievously wrong.
While the WesCorp directors "may have made choices — or not made other choices — with which the NCUA disagrees ... that does not mean they failed in their responsibilities so severely that they lose the protection of the business judgment rule," the judge wrote.
What does this have to do with WaMu (which was based in Seattle before it collapsed in 2008)? Ex-CEO Kerry Killinger, ex-COO Stephen Rotella and ex-mortgage chief David Schneider have all cited the business judgment rule in seeking to have the FDIC suit tossed.
The FDIC's allegations against Killinger, Rotella and Schneider — that they took "extreme and historically unprecedented risks" with WaMu's home-loans business, despite knowing that "the real estate market was in a 'bubble' that could not support such a risky strategy over the long term, that WaMu did not have the technology to adequately manage and evaluate the higher risks associated with the (loan) portfolio, and in the face of continuing warnings from WaMu's internal risk managers" — are strikingly similar to the NCUA's allegations against WesCorp's officers and directors.
The WesCorp ruling didn't help the credit union's former executives; the case was decided under California law, which excludes corporate officers from the business judgment rule. But since WaMu was incorporated in Washington, the FDIC case presumably will be decided under Washington law, which does include corporate officers under the rule.
The business judgment rule is a strong but not absolute defense. Back in 2003, for instance, officers of Bainbridge Island-based Znetix cited the rule to try to dismiss suits against them, but the judge refused, saying they had "acted in bad faith and in self-interest at the expense of the corporation and its shareholders" by ignoring rampant evidence that Znetix was a Ponzi scheme.
The judge in that case: Marsha Pechman, who's also presiding over the FDIC suit.
seattletimes.nwsource.com |
