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Business Reorganization & Financial Restructuring Expert Witnessing & Litigation Consulting Group Board of Directors Membership, Advisory & Corporate Governance
The Andela
Consulting Group, Inc. |
"A
Season for Change" What are some of these changes? 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 has lengthened the statute of limitations on thrift director suits to five years and reduced the federal culpability standard from gross negligence to ordinary negligence. These actions have turned up the heat on directors’ responsibilities, thus requiring the banks’ boards to effect changes in their organization and activities. Sitting ducks Banking industry analysts observe that law firms representing regulators have no incentive to analyze carefully or settle cases against failed banks’ directors because they have a virtually unlimited legal budget. Investigators customarily hired by the regulators indicate 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 nondescriptive to create a prima facie case for director inactivity or omission, or (3) the directors have D&O liability insurance coverage. They candidly admit they have obtained further investigatory assignments by participating in regulatory agency recoveries while ignoring the costs expended. Both attorneys and investigators acknowledge that their personal rationale for these actions has been 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 there is a general reluctance to serve as a bank director. Directors have the responsibility to make careful decisions. Historically, bank directors have been satisfied with choosing apparently competent management and responding appropriately to management’s information and reports. In many cases, bank management have slapped the hands of directors who become too involved in management decisions, charging that the directors are “micromanaging.” With that attitude, it doesn’t take long for directors to back off. Recent lawsuits have demonstrated that regulators do not seem to share the historical perspective that those benign activities by directors of failed banks are sufficient. To most bank directors the mere threat of a regulatory lawsuit is sufficient to cause them to avoid becoming directors or to be overly conservative in their policies and public postures. The agencies speak out 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.” • (Office of Thrift Supervision, Department of the Treasury: “Statement Concerning the Responsibilities of directors and Officers of Insured Depository Institutions,” November 16, 1992. Federal Deposit Insurance Corporation: “Statement Concerning the Responsibilities of bank directors and Officers,” December 4, 1992.) Both of these regulatory agencies further state that most director lawsuits involve situations where directors failed to take reasonable steps to respond to either criticisms from regulators, or problems which the board become aware of based upon the advice of outside professional advisors. At their peril, directors must now analyze these regulatory guidelines in light of their wording, the current political climate and the realities of regulatory enforcement procedures, personnel and organizations. Onus on directors 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 that management typically provides. Instead, it appears now that directors are being held to a higher standard, which requiring them to develop independent sources of information and analysis. Directors now appear to have an increased affirmative duty to: • be fully aware of the bank’s actual operations, including the bank’s products and services • initiate appropriate business strategies and policies • monitor and evaluate management through personal involvement, experience, expertise and advice from professional advisors. It would be tempting for bank professionals to disregard these regulatory messages because they believe that the guidelines may be replaced with others more attuned to the present actual bank governance process. However, it would 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. Wall Street investors/advisors have recently initiated drastic changes in the corporate governance rules and practices of many nonbank corporations. With the recent shift in bank securities ownership concentrations to major pension and mutual funds, these nonbank 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. The goal of bank directors and management now appears to be to maximize shareholder value consistent with safe and sound practices. In their Business Lawyer magazine article, “A Modest Proposal for Improved Corporate Governance” (November, 1992), attorneys Martin Lipton and Jay W. Lorsch provide cogent, strong and creative suggestions for changing nonbank boards’ structures and activities. Basically, they recommend that management should have daily responsibility for operations while directors should be responsible for carefully and creatively evaluate management’s plans and results. While this is similar to the FDIC and OTS statements, it is interesting that to note that their suggestions for nonbank board structuring and management involvement are substantially different from those that presently exist in banks. Banks that are public companies are subject to all of the new changes in shareholder activism, nonbank 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 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. Furthermore, these recommendations present a synthesis of the recent nonbank corporate governance changes and suggestions previously described, as well as the bank board experiences of this writer. Recommendations for board composition 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: • Professional bankers, who are both local and from other regions, who have recently left banking, who are involved in bank consulting or nonbank companies, and have recently been involved in various highly complex bank and nonbank issues. These individuals can provide ideas from other banks and other geographic regions, where similar problems may have been encountered or new opportunities developed. They may, in hindsight, be more capable of identifying danger signs or trends in this bank’s local area. • Assertive businesspersons with local experience and knowledge of the market and others that operate nationally. Particularly desirable are persons who have reorganized real estate and/or manufacturing, service, and sales entities in coordination with institutional lenders. They will be accustomed to questioning an unsuccessful status quo and can contribute to the board’s understanding both loan adjustment and lending activities. • Financial professionals 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 or to make it more desirable to potential merger candidates. • 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 of person who can say “yes” as well as “no.” They can provide regulatory and analytical guidance and can help control outside professionals’ fees. Board Structuring and Activities Bank boards and management should strive to maintain a high level of synergy. Under any possible scenario, boards should be structured to deal quickly with unsuccessful policies, practices, personnel, and board members. The following structure is suggested: • The board should have a chairperson who is not a member of management, and whose responsibilities are to set meeting agendas; ensure timely, appropriate, and adequate information to directors; and coordinate the supervision, choice and evaluation of both management and directors. (This is similar to the new bylaws recently adopted by General Motors.) • The vice-chairperson should be the bank’s chief executive officer who manages the daily operations of the bank, coordinates the information flow and employee availability to directors and represents the bank at public functions. • Individual directors should be assigned to relate to management in the specific areas where those directors have expertise. To the extent possible, board subcommittees should consist of outside directors who have related expertise in the subcommittees’ specialized area. These subcommittees should meet monthly and require line management to present pertinent information. • Highly descriptive, but summarized and analyzed, subcommittee information should be provided to all directors in advance of the full board meeting. • At monthly board meetings, the outside directors should meet first, with line management possibly being required to present reports at such a meeting. The full board meeting’s agenda may then be revised. • No outside director should be a member of the board for more than five years, whether consecutive or otherwise. • Annual offsite retreats or weekends should be organized and should include all directors, both senior and some junior management, and a limited number of the separate consultants to directors and management. These weekends are intended to establish professional personal relationships and an opportunity for candid conversations between directors and management. • A nominating and evaluating board subcommittee, composed of only outside directors, should be established. This subcommittee should meet at least every six months. Its purpose would be to evaluate each director’s contribution and effectiveness and senior management’s attainment of agreed upon strategic goals. It should first suggest remedial activities and provide warnings. If directors have been inactive or ineffective, then they should not be recommended for re-election. However, this should not be allowed to become a popularity contest. This subcommittee should be the primary source and forum for any suggestions to improve or replace senior management. • The board calendar should allocate a portion of each meeting for a revolving evaluation of the bank’s functional areas. These areas include: selection, evaluation, and compensation of senior management; corporate strategy and strategic planning; legal and regulatory compliance; (iv) capital allocation; staffing; special or classified assets; asset and liability management; and marketing and business development. • Directors should be compensated primarily through stock options and reasonably low fee payments. Executive compensation should be primarily through incentives awarded for: profitability; market position; productivity; product leadership; personnel development; employee attitudes; compliance with public responsibility and regulations; investor and customer relations; and achievement of strategic goals (which are agreed to each six months by the CEO and the directors). • The directors should be advised by independent consultants and attorneys. These professionals will: evaluate management’s reports; do independent research to reveal issues and problems; and suggest alternatives used by other banks or required by regulators. Those professionals should report directly to the directors; however, generally, their reports should be shared with senior management. • Outside directors and senior management, supported by professional advisors, should jointly prepare reports for public dissemination. (This one is a little unclear...reports for what and disseminate how and to whom, shareholders, the general public?) • Special annual full board meetings should be held with the 10 largest shareholders who are given the opportunity to critique, and suggest alternatives to, directors and senior management. Reports of these suggestions should be disseminated to all shareholders. Defining roles In the past, there has been a distant relationship between a bank’s management and its directors. Management has been unable to take advantage of directors’ experience and overview because they feared directors becoming overly involved in management’s decisions. We are now in a new era of heightened shareholder awareness, regulatory dominance, and consumer and customer dissatisfaction. Bankers must now compete aggressively, yet retain their traditional conservatism. The best way to harmonize these apparently inconsistent goals is for management and directors to forge a working partnership to better achieve the preeminent goal of increasing shareholder value in keeping with safe and sound practices. Only through the creation of such a mutually respectful partnership can directors truly represent the interests of the bank’s owners, effectively evaluate management’s activities, and monitor and supervise the creation of assertive, yet conservative, products, activities and restructuring. Through an operative partnership with directors, management can best utilize directors’ skills to enhance management’s successes. By capitalizing on this synergy, bankers can anticipate receiving both compliments and financial remuneration for their achievements. [Business Reorganization & Financial Restructuring ] [Expert Witnessing & Litigation Consulting Group] [Board of Directors Membership, Advisory & Corporate Governance] [Download Articles]
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Andela Consulting, Inc. |