THEY were the pillars of the community: a judge, a congressman, a dairy farmer, a manufacturer of airplane parts, a leading restaurateur. But suddenly they found themselves being sued for $50 million by the federal government because they were among the 19 members of the board of directors of Knox Federal, a failed Knoxville, Tenn., thrift. According to the government, the men should have detected questionable activity that lead to the bank's downfall. ``They breached their fiduciary duty. They were on the board to supervise the running of the bank and they failed to do that,'' says Dennis Klein, a lawyer with Hopkins & Sutter, a law firm that represented the government. Government pursues lawsuits
But restaurant owner and former board member Bill Regas calls the government suit, ``Ridiculous, a ripoff.''
Mr. Regas served on the board, which settled with the government on September 1988, because he felt he was serving the community. ``I wanted to help make things grow,'' he says.
Increasingly, the government is bringing lawsuits against people like Regas. Today, it has 250 suits pending against directors, officers, and other professionals at failed banks and thrifts. The federal government's legal department that pursues these cases has increased from 24 lawyers in 1989 to 80 this year.
There are hundreds of investigations to determine if more suits should be brought. One of those investigations involves Neil Bush, President Bush's son. The younger Bush was on the board of Silverado Banking, Savings, and Loan Association, a Colorado thrift that regulators sold to another bank.
There is big money involved in the cases. In one suit, filed against the directors and officers of the Lincoln Savings Bank in California, the government is suing for $1.1 billion.
Although the government sues directors for large sums, most businessmen don't end up paying the money out of their pocket. They have directors' and officers' liability insurance to protect themselves from lawsuits. The directors of Lincoln, for example, are covered by less than $10 million in insurance.
``The government sees this as a way to recoup some of the money paid out to failed banks and put some of the expense on the backs of the insurance companies,'' says Ronald Glancz, who used to be an attorney at the Federal Deposit Insurance Corporation (FDIC), which insures banks. He is now in private practice representing insurance companies and directors.
However, John Thomas, associate general counsel for the FDIC, says the agency's role as receiver or liquidator ``is to pursue all viable claims including claims based on negligence by officers or directors. When insurance companies have insured officers and directors against whom we have claims, the FDIC will, of course, seek to recover from those insurance companies.''
Rarely do any of these cases go to trial. According to lawyers familiar with the practice, only about 5 percent do. Most are settled out of court by either the defendants or their insurance companies. This is in large part because the government has been extremely successful at winning cases.
Most of the decisions to settle are made during the process of discovery when lawyers question potential witnesses before the actual trial. During discovery, the government's lawyers question the board members at length about every loan that went bad. Trials are costly
Since many loans have gone bad, a pattern of neglect will appear. This type of evidence has helped the government develop an enviable litigation track record: The FDIC has lost only one case that went to trial; the Federal Savings and Loan Insurance Corporation (FSLIC) has not lost any cases.
The government too is under pressure. Trials are expensive and the cost of the defense's lawyers is usually deducted from the insurance coverage. The longer a case takes, the less money the government may get.
In 1988, the FSLIC brought 55 lawsuits, netting $110 million while the FDIC netted $92 million on 110 lawsuits. The government does not disclose how much money it settles individual cases for.
Since the government does not have enough lawyers to pursue the cases, it hires local litigators. Two years ago, FSLIC spent $49 million on outside legal fees. The government is such a good customer, in fact, lawyers give Uncle Sam a volume discount, lowering fees to a top rate of about $200 an hour.
Another reason insurance companies are more prone to settle is because the damages can be high when a defendant loses. A New Orleans jury on Dec. 9, 1988, awarded the government $35 million in a case against John Mmahat, a Louisiana lawyer who was also the chairman of the board of Gulf Federal Savings Bank.
In the future, however, many lawyers believe there will be more trials. ``It may change as the FDIC becomes more vigorous and the [insurance] carriers dig in their heels,'' says Mr. Glancz, whose law firm is Drinker Biddle & Reath.
Savings and loan specialist Bert Ely believes the issue of government ineptitude will become more important in future cases. ``If the government did not delay closing down ailing thrifts, it could have cut the losses,'' says Mr. Ely who runs his own consulting business in Alexandria, Va.
Ely has been hired as an outside expert in half a dozen cases. ``When you get a chance to do a detailed pathology of a dead thrift, it's incredible to see the regulatory bungling,'' says Ely. Government lawyers would not comment.
Last March, US District Judge Jack B. Weinstein in Brooklyn, N.Y., blamed the government when he dismissed criminal charges against Carl Cardascia, the president of Flushing Federal, a failed thrift.
However, the insurance company representing the directors and many of the officers of Flushing Federal recently settled a civil lawsuit asking for $70 million. The amount of the settlement was not made public.
The case was hotly contested, recalls Thomas Demski, a lawyer with the Newark, N.J., firm of Sills Cummis which represented the directors.
``Most of the members of the board found the suit very embarrassing and lost a lot of sleep over it,'' Mr. Demski says.
This was also the case in Knoxville. Knox Federal had been bought by C. H. Butcher, then a leading Tennessee banker. The directors did not know that Mr. Butcher, faced with his own banking woes, started dumping bad loans into the thrift's portfolio. It took only a short time for the bad loans to drag the thrift down. The FSLIC maintained the board erred by not setting up a system to catch Butcher.
Bruce Anderson, a Knoxville lawyer representing the board, recalls that the members were ``shocked and outraged when FSLIC brought suit. The directors all felt they had done everything that a normal director should do.''
For the government, it's a tough decision to sue because the suits can discourage good businessmen from serving on boards. ``Thrifts are encountering problems getting board members in smaller communities,'' says Phil Gasteyer, general counsel for the US League of Savings Institutions.