Bolstered regulation expected after banks collapse

Lawyer compares sheer size of the implosion to the Enron scandal

Bolstered regulation expected after banks collapse

Bank failure fallout continued with the recent filings of a class action lawsuit alleging securities violations by Signature Bank – among the initial steps one seasoned attorney predicts will ultimately lead to bolstered regulatory oversight over the industry.

In a press release, Robbins Geller Rudman & Dowd LLP notified of the litigation naming the bank and certain of its top executives with violations of the Securities Exchange Act of 1934. “Shareholders and certain unsecured debtholders will not be protected,” officials wrote. “Senior management has also been removed. Any losses to the Deposit Insurance Fund to support depositors will be recovered by a special assessment on banks, as required by law.”

A similar class action suit was also filed against the parent company of Silicon Valley Bank (SVB), its CEO and chief financial officer, as the Associated Press and other media outlets reported. The suit seeks unspecified damages to those who invested in SVB between June 16, 2021, and March 10, 2023. Plaintiffs claim the banking company failed to disclose the risks that future interest rate increases would have on its business, the AP reported.

Don Hayden, partner at Miami-based boutique law firm Mark Migdal & Hayden, spoke to Mortgage Professional America about the possible implications of the litigation. Hayden has more than three decades of experience handling cases against and on behalf of board directors in similar circumstances, trade secret infringements and defamation litigation.

“You would have thought there would be a lot more claims but given that the government came in and agreed to cover the accounts of the depositors, what you have are the remaining claims by the investors of the bank itself,” he said.

He described what led to the downfall of Silicon Valley Bank: “It’s a unique bank in that its primary focus was on venture capitalists in the tech space. They kind of found themselves in a liquidity crisis with the interest rate going up and unable to cash in on long-term Treasury notes they had in place,” he said.

“There was a run on the bank, if you will, caused in large part by social media,” Hayden added. “Things move a lot faster now these days with social media and so you had both Silicon Valley Bank and Signature Bank, Credit Suisse had issues.”

Further contagion was avoided thanks to quick regulatory action, he suggested: “It looked like this could blow up as a global crisis; I think it’s been contained, but I think we’re going to see more of this primarily with regional, mid-sized banks that probably haven’t been smart about corporate governance and risk management and taking some risks.

“Usually, the banks in their investment portfolios are very conservative, and may have gone out on a limb – especially the banks that have gotten involved in some of the more risky investments like the crypto craze that some of the newer banks have gotten involved in we may see some of that. But for the most part, what it did show is that our banking system is sound and was able to respond.”

Parallels drawn with Enron

Given the sheer scale of the implosions, Hayden compares the turmoil to that of the Enron scandal of 2001, when accounting loopholes, special purpose entities and opaque financial reporting led to shareholders filing a $40 billion lawsuit. As a result of that scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies.

Collapsing within days of each other earlier this month, Silicon Valley Bank of Santa Clara, Calif., and Signature Bank of New York City represented the second- and third-largest bank failures in US history, respectively.

What banking law changes could arrive in 2023?

Hayden expects to see new regulation emerging as a result of the banks’ collapse: “There will definitely be investigations undertaken into what happened and how it happened,” he said. “I anticipate there will be new banking regulation put in place to try to address some of the concerns.”

Some of that bolstered oversight has already begun. On Wednesday, a bipartisan group of senators drafted legislation that would empower the Federal Deposit Insurance Corp. (FDIC) to confiscate executive compensation in taking over a failed bank, according to multiple media reports. The legislation would allow regulators to claw back executive pay in a five-year period leading up to a banking collapse.

“Americans are sick and tired of fat cat bankers paying themselves handsomely while risking other people's hard-earned money,” Democratic Sen. Elizabeth Warren of Massachusetts said in a prepared statement.  “It's time for Congress to step up and strengthen the law so bank executives bear the cost of failure, not line their pockets and walk away scot-free."

Republican Sen. Josh Hawley of Missouri echoed the sentiment in his statement: “Bank executives who make risky investments with customers’ money shouldn’t be permitted to profit in the good times, and then avoid financial consequences when things go south,” he said. “This legislation puts the executives’ own profits on the line, and that’s exactly as it should be.”

Notwithstanding the bipartisan nature of the proposed legislation, already the recriminations have begun: “There are a lot of claims as to why this happened,” Hayden said, “and a lot of finger-pointing on both sides of the aisle whether the loosening of regulations with regard to small- and intermediate-sized banks during the Trump administration was the cause or whether it was a failure of present regulators to be on top of the situation with banks like Silicon Valley and Signature that were involved in the tech space.”