FDIC files suit against Sonoma Valley Bank officers

Three officers of the failed Sonoma Valley Bank are the target of a new Federal Deposit Insurance Corporation lawsuit seeking to collect more than $12 million for losses brought about by a series of risky real estate loans that led to the bank's 2010 collapse.

The lawsuit filed in U.S. District Court in San Francisco names the bank's president and chief executive officer, Sean Cutting, former CEO and director Mel Switzer and vice president and chief loan officer Brian Melland, accusing them each of gross negligence and breach of fiduciary duty for their roles in the institution's failure.

The suit threatens to undo a $2 million settlement reached this summer in a separate Sonoma County Superior Court lawsuit initiated by shareholders against Switzer, Cutting and other bank officers. FDIC lawyers are asking Judge Elliot Daum for permission to intervene in the settlement, arguing that receivership terms dictate the money should go first to depositors, who were insured by the FDIC.

Next in line would be general trade creditors, bond holders and then shareholders, said FDIC spokesman David Barr.

"Shareholders are last in line to get any proceeds from a failed bank," Barr said. "That's the way receivership rules work."

Anne Marie Murphy, a lawyer for the shareholders, which include many Sonoma Valley residents, contends banking regulators have no legal grounds to derail the settlement. The money would come from an insurance policy that covers bank officers, she said.

"The plaintiffs plan to vigorously oppose the FDIC motion, which comes at the eleventh hour," Murphy said. "They sat on the sidelines for nearly two years."

It's uncertain whether shareholders will succeed at an upcoming Nov. 6 hearing. Before the settlement was reached, Daum dismissed two shareholders' suits, finding the group lacked legal standing.

The shareholders had blamed the bank's top officials, including directors of its holding company, Sonoma Valley Bancorp, for reckless lending. Investors saw the value of their stock fall from $31 a share in 2007 to less than a penny after the bank's seizure. The three-year slide wiped out $69 million in wealth, according to the shareholders' 2011 lawsuit.

They pointed to $55 million in loans to Marin County developer Bijan Madjlessi, who later defaulted on a majority of the notes.

Regulators shut the institution in 2010 and the U.S. Attorney's Office opened a criminal investigation into lending practices, sources said. Earlier this year, Cutting and Melland were banned by the FDIC from working in the banking industry.

So far, none of the bank officers have been charged with any crime, according to court records. Lillian Ara?zHaase, a spokeswoman for the U.S. Attorney in San Francisco, wouldn't comment on the case. Switzer, Cutting and Melland did not return calls Friday seeking comment.

At the time of the seizure, the bank's top leaders, including Cutting and Switzer, issued a public statement blaming the sharp real estate downturn for their troubled loans. They said the bank had been profitable in its most recent quarter and would have returned to financial health.

The FDIC lawsuit, filed Aug. 19, seeks to recover millions in losses the bank suffered on 10 commercial real estate loans and one commercial line of credit from December 2006 to December 2008.

In addition to naming Switzer, Cutting and Melland as defendants, it makes a general reference to seven members of the bank's board of directors, although it does not name them.

The eleven transactions included loans made to entities affiliated with Madjlessi, who is not named in the FDIC lawsuit. The suit identifies the developer only as "Borrower A."

The suit contends the defendants approved the loans in disregard of prudent lending practices. It alleges they knew or should have known they were lending to one borrower in excess of banking or legal limits, that the transactions were based on stale or inadequate appraisals and that the borrowers were debt-laden and had little or no equity invested.

It also argues the projects were outside the bank's primary service area in the Sonoma Valley, among other claims.

One group of loans involved the refinancing of a 228-unit condominium complex in Santa Rosa called Park Lane Villas, the lawsuit said. Another, called the Petaluma Greenbriar Loans, involved paying off existing mortgages on low-income apartments and a condominium conversion project. Yet another was a personal loan to Borrower A and another involved the purchase of land adjacent to Park Lane Villas, the lawsuit said.

In each case, the lawsuit alleges the bank's leaders took unnecessary risks or allowed multiple extensions, despite warning signs that the loans were unsound.

All of the transactions required the approval of the bank's lending committee, which included seven bank directors, the lawsuit said.

None of the directors are named in the FDIC lawsuit but they could be included in future legal actions, said Sonoma resident Ralph Hutchinson, a former federal bank regulator and critic of the bank's lending practices.

Hutchinson said banks are unique in that directors can be sued personally for losses sustained by their institutions. He said the lawsuit's mention of seven directors sitting on the lending committee — a group that includes some prominent Sonoma Valley business leaders — could be a sign the FDIC will go after them next.

"This is opening up another avenue," Hutchinson said. "They want to get to the deep pockets."

Sonoma Valley Bank opened for business in 1988. Its holding company, Sonoma Valley Bancorp, was publicly traded before the bank closed in 2010. At the time, it had $337 million in assets.