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Originally published Friday, June 17, 2011 at 9:43 AM

Settlement may be near in federal lawsuit against Killinger, other WaMu execs

A settlement is being negotiated in the lawsuit by federal regulators against three top Washington Mutual officials, according to court papers filed Thursday.

Seattle Times business reporter

WaMu execs sued by FDIC

Kerry Killinger: Became CEO in April 1990 and chairman in 1991; led WaMu in national expansion; forced out less than three weeks before WaMu failed.

WaMu compensation 2005-08, according to FDIC: More than $65.9 million

Stephen Rotella: Hired in January 2005 from JPMorgan Chase as president and chief operating officer, in charge of WaMu's day-to-day management; left WaMu days after it failed.

WaMu compensation 2005-08: $23.4 million

David Schneider: Joined WaMu in 2005 as head of home lending; after JPMorgan Chase took over, stayed on as head of retail banking for the WaMu segment.

WaMu compensation 2005-08: $5.9 million

Sources: FDIC lawsuit, Seattle Times archives

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The top Washington Mutual executives who were sued by federal regulators over the mortgage giant's 2008 collapse are in talks to settle the lawsuit, an attorney for two of them confirmed.

But attorney Barry Ostrager cautioned that the discussions, conducted "intermittently" for a "relatively short time," may not lead to a deal for the two executives he represents or for WaMu's longtime chairman and CEO Kerry Killinger.

The suit accuses Killinger, former WaMu chief operating officer Stephen Rotella, and former home-loans president David Schneider of recklessly pushing WaMu into making billions in high-risk home loans, despite knowing the nation was in the midst of an unprecedented housing bubble and being warned the company was unprepared to handle so much risk.

Killinger's wife, Linda, and Rotella's wife, Esther, also are named in the complaint, for allegedly helping their husbands transfer homes and cash into trusts to keep them out of creditors' hands.

According to court papers, the two sides have been working with a mediator to strike a deal. Additional mediation sessions are set for June 29 and 30, assuming they haven't reached agreement by then.

Friday had been the deadline for the executives to formally respond to the suit, filed in March by the Federal Deposit Insurance Corp.

2008 takeover

The FDIC took over Washington Mutual Bank, WaMu's main operating subsidiary, in September 2008, after it had accumulated billions of dollars in losses and all but exhausted possible sources of new capital.

But late Thursday the two sides agreed to a two-week delay, saying in a joint court filing that they had "exchanged settlement term sheets reflective of a potential settlement" and were "diligently working to resolve their remaining disputes."

Ostrager, who represents the Rotellas and Schneider, declined to comment on how advanced the talks were or how close the parties might be to a deal.

"The FDIC is prepared to talk, so why not?" he said.

David Aufhauser, the Killingers' attorney, did not respond to a request for comment.

Some terms of any potential settlement would need consent of "certain third parties," the two sides said in their filing, without being more specific.

The FDIC's suit, filed in federal court in Seattle, lays the demise of WaMu squarely at the feet of Killinger, Rotella and Schneider.

Killinger, the agency alleges, devised the "higher risk lending strategy" in June 2004, in an effort to boost WaMu's size and profitability.

The executives responsible for carrying out Killinger's plan were Rotella, hired as chief operating officer in January 2005, and Schneider, who came in eight months later to run the home-loans division.

WaMu quickly ramped up lending in the highest-risk categories: subprime mortgages, pay-option adjustable-rate mortgages, and home-equity loans and lines of credit.

The company's culture shifted to emphasize loan volume over prudent risk-taking: Both Killinger and Rotella, according to the complaint, "were heard to deride risk managers as 'checkers checking checkers.' "

All three men knew or should have known WaMu was taking on more far risk than it could reasonably handle, the FDIC alleges, and their actions constituted gross negligence and a violation of their duties to the company.

Execs' earnings

The suit says that from 2005 to 2008, Killinger earned $65.9 million from WaMu, Rotella earned $23.4 million and Schneider earned $5.9 million. It doesn't say how much in damages the FDIC seeks to collect.

The WaMu suit is one of just seven similar suits, naming 52 former officers and directors of failed banks, that the FDIC has filed since the financial crisis hit. However, the agency says it has authorized suits against 186 more individuals, with total damage claims of at least $6.8 billion.

Only one of the seven suits, against Corn Belt Bank and Trust in Illinois, has been settled. In that case, the FDIC sought $10.4 million from four former Corn Belt directors and officers; the final settlement terms weren't made public.

In October, Angelo Mozilo, the co-founder and former head of Countrywide — WaMu's archrival in the mortgage-lending business — settled civil fraud charges brought by the Securities and Exchange Commission by paying a $22.5 million penalty and giving up $45 million in so-called "ill-gotten gains." Two other top Countrywide executives also settled charges against them for lesser amounts.

In February, federal prosecutors quietly dropped their criminal investigation of Mozilo and other Countrywide executives without indicting anyone.

Civil litigation

John Coffee, an expert on corporate fraud and securities law at Columbia Law School, said the FDIC's decision to pursue civil litigation against Killinger and the other executives likely means regulators have decided against filing criminal charges.

Civil cases often can be based on documents, such as the scores of emails and memos to and from Killinger, Rotella and Schneider that the FDIC suit cites. But prosecuting a criminal case usually requires an inside source willing to testify about the defendants' intentions, Coffee said.

"Bank cases like this, mismanagement cases, are much more difficult to frame as a criminal prosecution," he said. "The burden of proof is 'beyond a reasonable doubt,' and you have to show willful intent. Very few people willfully wanted to cause the failure of their bank."

Just weeks after WaMu's failure in 2008, an investigation was announced by the U.S. Attorney at the time, Jeffrey Sullivan, who said law enforcement was "examining activities at the bank to determine if any federal laws were violated."

Spokeswoman Emily Langlie had no comment Friday on whether a criminal case is still being explored.

Kevin LaCroix, an attorney in suburban Cleveland who is an expert on directors' and officers' liability insurance, said nearly all cases brought by regulators against bank executives eventually are settled rather than going to trial.

"The longer it drags out, the more it will cost the executives to defend themselves and reduce the amount of insurance available for a settlement," LaCroix said.

A settlement could, however, specify that some portion of any penalty be paid directly by the person involved rather than through insurance, he said.

Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com

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