Expert Article Library
The Role Of Banks' Outside Directors: Suggestions For Change (1)
REGULATORS have increased their attacks. It is not surprising that newspapers refer to bank directors as an endangered species.
This article is intended to discuss the conflicting pressures being applied to a bank or savings and loan ("Bank") outside director ("Director") from new regulations, legal threats, shareholder activism, and the change in non-Bank corporate governance practices. Recommendations regarding Bank board ("Board") composition, restructuring, activities and compensation will be offered.
Recently there have been disturbing changes in the attitudes of shareholders, Bank regulators ("Regulators") and the courts relative to Bank management and the role of Directors. Major pension and mutual funds have begun acquiring substantial blocks of Bank securities, bringing with them the influence of the emerging changes in non-Bank corporate governance rules. Regulators have increased their legal attacks on Directors of failed Banks, and appear to have an unlimited legal budget and the support of Congress and the Administration. Congress is currently considering lengthening the statute of limitations on thrift Director suits to five years and reducing the federal culpability standard from gross negligence to ordinary negligence. These actions have resulted in Directors experiencing "paranoia" and, appropriately, requiring changes in Bank Board organization and activities.
Investigators customarily hired by the Regulators have indicated that they routinely recommend suing failed Banks' Directors in cases where: (1) the Directors have substantial personal net worths, (2) the Board minutes are sufficiently general and non-descriptive to create a prima facie case for Director inactivity or omission, or (3) the Directors have director's and officer's professional liability insurance ("D & O") coverage. They candidly admitted they obtained further investigatory assignments by participating in regulatory agency recoveries while ignoring the costs expended. Their personal rationale for these actions was to create vivid public "examples" which would send clear messages to Bank Directors and discourage future inappropriate conduct. With such a strong show of force by Regulators it is not surprising that newspapers are replete with articles referring to Bank Directors as an "endangered species."
In an attempt to assuage potential Bank Directors' fears and to provide "clear" guidelines for Director conduct, the Office of Thrift Supervision ("OTS") and FDIC each issued its own official statement concerning the responsibilities of "Bank Directors and Officers." Although the OTS and FDIC "Statements" and accompanying press releases were not identical, they were surprisingly similar for these diverse organizations. Careful analysis of these "Statements" reveals the need for most Bank's Boards to undergo a major overhaul of their activities, composition and structure. Both the FDIC and OTS require the following conduct:
"This means that directors are responsible for selecting, monitoring, and evaluating competent management; establishing business strategies and policies; monitoring and assessing the progress of business operations; establishing and monitoring adherence to policies and procedures required by statute, regulation, and principles of safety and soundness; and for making business decisions on the basis of fully informed and meaningful deliberation."
Bank management's responsibilities are stated as follows:
"Officers are responsible for implementing the policies and business objectives set by the board; for running the day-to-day operations of the institution consistent with those policies and objectives and in compliance with applicable laws, rules, regulations and the principles of safety and soundness. Directors must require and management must provide the directors with timely and ample information to discharge board responsibilities."
The clearest interpretation of these regulatory guidelines is that Bank Directors can no longer safely rely upon senior management as their sole source of information and advice regarding the Bank's operations and activities. Bank Directors are apparently required to go beyond observing only the information which management typically provides. Instead, it appears that now Directors are being held to a higher standard, thereby requiring them to develop independent sources of information and analysis. Directors now appear to have an increased affirmative duty to: (1) be fully aware of the Bank's actual operations, including the Bank's products and services, (2) initiate appropriate business strategies and policies, and (3) monitor and evaluate management through personal involvement, experience, expertise and advice from professional advisors.
It would be tempting for Bank professionals to disregard these apparent regulatory "messages" because they believe these guidelines may be replaced with others more attuned to the present actual Bank governance process. However, it may be naive to take lightly the rules created by any organization with a reputedly unlimited legal budget and the support of Congress and the Administration.
Sophisticated "Wall Street" investors/advisors have recently initiated drastic changes in the corporate governance rules and practices of many non-Bank corporations.9 With the recent shift in Bank securities ownership concentrations to major pension and mutual funds, these non-Bank corporate governance reforms are increasingly being applied to Banks. Recent surveys have asserted that shareholder activism has substantially increased earnings, thus providing further justification for this trend.10 The goal of Bank Directors and management now appears to be to maximize shareholder value consistent with safe and sound practices.
Banks that are public companies are subject to all of the new changes in shareholder activism, non-Bank corporate board governance and shareholder discontent pressures. They are also preemptively controlled by Regulators who have recently issued influential new guidelines. In response to this seemingly overwhelming shift in pressures placed upon the banking industry, the following recommendations are offered. They are intended as a new vision for the composition, structure and activities of Bank Boards. They present a synthesis of the recent non-Bank corporate governance changes and suggestions previously described and the Bank Board experiences of this writer.
I. Board Composition:
1. Bank boards should be composed of no more than nine members of which at least eight are outside independent Directors. Any greater number would prove inefficient for accomplishing Board goals within appropriate time frames because full airing of strong opinions could not occur. Much larger Boards could result in largely ceremonial Directors controlled by management. An even mix among the following categories of Directors is suggested:
A. Professional bankers, from both the local area and other parts of the country, who have recently left banking, are involved in Bank consulting or non-Bank companies, and have recently been involved in various highly complex Bank and non-Bank issues. These individuals may provide ideas from other Banks, and other parts of the country, where similar problems had been encountered or new opportunities had been developed. They may, in hindsight, be more capable of identifying danger signs or trends in this Bank's local area.
B. Assertive business-persons divided into those who have local experience and knowledge of the market and those that operate nationally. Particularly desirable are business-persons who have reorganized real estate and/or manufacturing, service and sales entities in coordination with institutional lenders. They are accustomed to questioning an unsuccessful status quo and can contribute to the Board's understanding both loan adjustment and lending activities.
C. Financial persons who have the ability to command capital on a local and national scale. They can provide new ideas for products, services and structuring that will make the Bank more attractive to investors needed for the growth of the Bank or to make it more desirable to potential merger candidates.
D. An attorney and an accountant familiar with Bank regulations, legislation, regulatory relations and audit. They should not presently be with any firm that can compete for the Bank's business and must be the kind that know how to say "yes" as well as "no." They can provide regulatory and analytical guidance and can help control outside professionals' fees.
A subsequent article will discuss Board structuring, activities and compensation.