Bank Failures: Protecting Your Firm and Your Clients

The news of bank failures has left many stakeholders concerned. The negative effects of failed banks often impact many individuals and businesses, including vendors, suppliers, and many other parties beyond just the depositors of the relevant banks. This widespread affect makes the concerns of those stakeholders justifiable.

By staying abreast of the issue and implementing both protective and mitigation strategies, you can protect your current interests and mitigate possible future losses for both your firm and clients.

Causes of the Bank Failures

Both Silicon Valley Bank (SVB) and Signature Bank held a series of risky and ill-focused investment portfolios. These investments included heavy ratios in bonds which were not performing as well in the current market. The banks failed to diversify their portfolios in a manner that adequately protected against negative financial fluctuations in the market.

SVB customers were predominantly small technology startups operating under increased pressure from inflated interest rates. Depositors liquidated their assets to cover costs in the face of increased rates and higher repayments. When the depositors liquidated assets, the bank realized an immediate loss of cash flow with little ability to supplement this loss with new, profitable investments.

Signature Bank had a heavy investment in Cryptocurrency and moved to announce that it would re-diversify its portfolio by paring back Cryptocurrency investments in the wake of the news of SVB’s failure. In an already risk-adverse market, depositors rushed to withdraw (protect) their assets from both institutions which left both banks unable to honor the withdrawals, causing the ultimate collapse of the banks in record time.

Given the market volatility in banking resulting from these bank failures, it is not prudent to assume that your deposits will remain unaffected from a future bank failure. A great deal of blame can be placed on the risky investment portfolios of the banking institutions, and this issue could affect any banking institution at any time if the same investment errors are realized, or if the institution participates in other poor practices.

Resulting Litigation and Investigatory Actions

Litigants filed complaints in Class actions against both SVB and Signature Bank to protect the affected depositors. The three (3) pending cases are:

  1. Snook v. SVB Financial Group et al, No. 23-01173 N.D. Cal, (filed March 15, 2023);
  2. Vanipenta v. SVB Financial Group et al, No. 23-01097 N.D. Cal, (filed March 13, 2023); and
  3. Matthew Schaeffer v. Signature Bank, et al, No. 23-01921 (E.D.N.Y), (filed March 14, 2023).

The premise of these complaints is materially the same, namely, that the Defendants’ actions arose to violations of the federal securities laws, and that the members of the class would like compensable damages for those violations.

In Snook, it is also alleged that one of the Defendants, Becker, was aware of the threat to the bank as evidenced by his sale of $3.6 million of SVB stock on February 27, 2023, 13 days before the collapse. Vanipenta and Shaeffer allege that the Defendant’s failed to include material information about the banks’ adverse market status in their reports. The complaints allege that this artificially inflated the security prices of the banks, and that the Class members would not have purchased the securities either at the advertised rate, or at all, if they were properly informed.
Both the Department of Justice and the Securities and Exchange Commission have commenced investigations into the collapse of SVB, though there are no formal updates on these investigations.

Protecting Your Firm and Your Clients

Current Protections

If your firm or your clients have been impacted by the bank failures, you may have exposure to contractual breaches, missed business opportunities, loss of reputation, inability to meet financial and contractual obligations (such as salaries, vendor invoices, loan payments), as well as the potential loss of assets beyond the FDIC’s $250,000 depositor insurance.

You and your clients should consider the following steps in risk mitigation:

  1. Review current financial and contractual obligations and proactively communicate with any affected party.
  2. Develop a liquidity or cash flow forecast to determine the ability to preserve cash and access to lines of credit.
  3. Determine and make claims against available FDIC insured coverage and develop a plan for recovering assets above the FDIC insured limit.
  4. Assess potential legal exposure resulting from the inability to fulfill immediate obligations.
  5. Ensure cybersecurity measures are in place as accounts are transitioned to a new bank.

Future Protections

Finally, your firm is well positioned to advise your clients on preventative measures to reduce the future risk of becoming affected by a bank failure. Your firm’s and your clients’ proactive measures to assess the health of any new bank may include the following considerations:

  1. Review SEC and FDIC regulatory reports and the FDIC credit rating of the institution.
  2. Review Federal Reserve bank stress tests, including most recent results.
  3. Review banking sector Analyst Reports which assess portfolio diversity, investment risk, lending risk, and loan to depositor ratios.
  4. Include the banks in all periodic investment reviews with financial advisors.
  5. Distribute deposit balances exceeding $250,000 among multiple, FDIC-insured accounts.

As banking market volatility continues, protecting your firm and your clients from business disruption and potential legal exposure will require proactive measures. Your clients will always look to you in times like this. Our objective is to provide you with helpful support for your legal practice.

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