UPDATE 3-FDIC sues ex-WaMu execs, wives over bank's failure

Thu Mar 17, 2011 5:35pm EDT

* Three top WaMu execs sued for role in bank failure

* Lawsuit alleges gross negligence, fraudulent conveyance

* Alleges asset transfers to wives to avoid creditors (Adds details from complaint, background on Washington Mutual and FDIC lawsuits, comments from Rotella letter)

By Tom Hals

WILMINGTON, Del., March 17 (Reuters) - A U.S. government regulator sued Kerry Killinger and two other Washington Mutual Bank executives accused of pioneering reckless home loans that led to biggest bank failure in U.S. history.

The three "gambled billions of dollars of WaMu's money" by rewarding employees and themselves for pushing risky, low-teaser rates loans while ignoring warnings about the housing bubble, the Federal Deposit Insurance Corp said in its lawsuit.

When the bubble began to burst, Killinger and former Chief Operating Officer Stephen Rotella were alleged to have quietly transferred their wealth to their wives, in an attempt to put it beyond the reach of creditors.

The lawsuit also named their spouses as defendants, which one attorney who specializes in banking regulatory matters called "really aggressive."

The third former executive was David Schneider, the former president of the company's home loans division.

U.S. banking regulators have authorized lawsuits against 158 bank officials so far as they seek to recover at least $3.6 billion in losses from bank failures related to the 2007-2009 financial crisis.

Founded in Seattle in 1889, Washington Mutual was the largest U.S. savings and loan, with more than 2,000 branches, $300 billion of assets and $188 billion of deposits when it was seized at the height of the 2008 financial panic.

The bank was immediately sold to JPMorgan Chase & Co for $1.88 billion, and the parent company Washington Mutual Inc WAMUQ.PK landed in bankruptcy the next day.

The regulator said the executives had a "fixation on short-term profits" and a desire to gobble up market share in risky loans, such as mortgages with an option to make minimal initial payments, despite loud warnings from risk managers.

The lawsuit accused the three, who collected $95 million in compensation between 2005 and 2008, of gross negligence and breach of fiduciary duty.

Killinger has accused regulators of jumping the gun in shutting down the bank.

"It was with great shock and sadness that I read of the seizure," he told a congressional panel last year.

In the weeks leading up to the seizure, the FDIC said Killinger and Rotella were transferring assets to their wives to avoid creditors.

Killinger transferred his ownership interest in his Palm Desert, California, and Shoreline, Washington, homes to his wife Linda, while Rotella transferred more than $1 million to his wife Esther.

Both women are being sued for fraudulent conveyance.

"I really haven't seen that," said James Rockett, an attorney with Bingham McCutcheon in San Francisco, of the naming the wives as defendants. "It's really aggressive."

The FDIC has not brought many lawsuits to date in the current cycle of bank failures, and Rockett said there may have been some reluctance to sue after the agency's experience in the 1990s following a previous wave of bank failures.

Rockett noted that in general, the recoveries from the lawsuits brought against directors in the previous cycle were considered to be on the light side, given the costs.

"That's why they may be somewhat reluctant to move in this cycle," he said.

Joe Garrett, of Garrett Watts & Co which provides risk management for banks, noted that regulators were sometimes seen as abusive of their powers in their past pursuits.

Rotella may have had that on his mind in a letter sent to the media.

He called the lawsuit "unfair and an abuse of power. I believe this may be a way for the FDIC to collect a payout from insurers who provided officers and directors liability coverage for the time they worked at WaMu," said the letter.

He also noted it was unfair for the FDIC to blame executives for not seeing the coming housing bust, which he said the agency also did not anticipate.

Washington Mutual Inc declined to comment. Attorneys for Killinger and Schneider did not immediately return a call seeking comment.

The FDIC said it does not comment on specific litigation.

The case is The Federal Deposit Insurance Corp as receiver of Washington Mutual Bank, v Kerry K Killinger, Stephen J Rotella, David C Schneider, Linda C Killinger and Esther T Rotella, U.S. District Court, Western District of Washington, No. 11-459. (Additional reporting by David Clarke in Washington; Editing by Bernard Orr)