Analysis: Fed report on SVB collapse could buoy shareholder lawsuits

By Jack Queen

(Reuters) – A scathing Federal Reserve report on the collapse of Silicon Valley Bank released on Friday could be a boon to shareholders suing the defunct lender’s executives for allegedly hiding risks that led to its stunning downfall, legal experts said.

The Fed took its own share of the blame for SVB’s sudden collapse in March but also concluded that “foundational and widespread managerial weaknesses” at the bank left it “acutely exposed” to the one-two punch of rising interest rates and tech sector slowdown, which led to a run on deposits and subsequent government takeover.

“A report where the government is talking about all the problems it believed were present at SVB is icing on the cake for plaintiffs’ lawyers,” said Duke University School of Law professor James Cox.

SVB was shut down by state and federal banking regulators on March 10. The bank’s parent company, SVB Financial Group, entered bankruptcy on March 17. As a result, shareholders cannot press claims directly against the bank or its parent.

But the bank’s former executives face a bevy of proposed class action lawsuits by shareholders who allege they failed to disclose the bank’s exposure to rising rates, over-reliance on tech depositors and deficient risk-management practices, among other things.

Lawyers for the former executives did not immediately respond to requests for comment Friday.

The Fed’s report concluded that SVB did not adequately hedge against risk, failed its own liquidity stress tests, and chased short-term profits at the expense of long-term stability. Rather than address these risks, the bank changed how it measured them, the report found.

“What we’ve seen is consistent with what we alleged, which is that this is a failure of risk management at the bank,” said attorney Adam Polk, whose law firm has brought a case against SVB entities in California state court.

Polk said he and his team will use the report as a roadmap for discovery and likely incorporate its findings into any amended complaint they file.

SVB’s bankruptcy limits the available pot of money to the lender’s directors and officers liability insurance policy, a type of coverage that protects the personal assets of company leaders. 

Much bigger targets are the auditors, investment banks and other third parties that could be sued for allegedly aiding, abetting or breaching their duties to prevent SVB’s collapse.

“I see this (Fed) report as being extraordinarily useful evidence to dangle in front of a judge or jury on class action lawsuits against accounting firms,” Cox said.

In April, a group of SVB investors became the first to sue the lender’s accountants and underwriters, including accounting firm KPMG and investment banks Goldman Sachs (NYSE:), Bank of America (NYSE:) and Morgan Stanley (NYSE:).

Representatives for the companies did not immediately respond to requests for comment Friday.

The Fed report could also work in favor of defense lawyers, because the regulator fell on its sword and said that it neither fully appreciated SVB’s vulnerabilities nor ensured that its warnings about them were acted upon.

That could create an opening for defendants to argue that they cannot be held liable for not properly addressing risks that also slipped past SVB’s regulators, according to legal experts.

But the Fed repeatedly warned SVB about its weaknesses, even if those warnings lacked gusto: At the time of its failure, SVB had 31 unaddressed safe and soundness supervisory warnings, triple the number of its peers.

Plaintiffs could argue those were red flags that should have been swiftly addressed or at least disclosed by management, according to Columbia Law School professor Eric Talley.

“That’s going to hinge on how high up the warnings went up and how urgent they were, and those things will be tied to each other,” Talley said.