Comment: Directors' Best Defense Is Good Record

Two years ago I resigned my position as a director of a failing $500 million-asset New England mutual thrift. Within 30 days regulatory proceedings began in earnest against the institution; within 60 days the thrift was, without assistance, sold; and within 90 days the chief executive officer of two decades resigned.

The regional director of the Federal Deposit Insurance Corp. sent me a letter accepting my resignation and complimented me on my tenure - a rarity in regulatory etiquette and policy. Until the call accepting my resignation and announcing the letter, I had never talked to a regulator outside the boardroom.

I was not a whistle-blower. I was a director for nine years who fulfilled his fiduciary obligation. Both my attorney and regulators told me the letter was a safe haven. It was obvious to me that regulators create safe havens, but that attorneys only sell hope.

Indeed, in my opinion it is a serious mistake to assume that lawyers can create a safe haven for directors.

Our bank spent hundreds of thousands of dollars with two national law firms and two national consultants creating what was supposed to be a safe haven, and it proved meaningless.

The reality is that the FDIC's goal is "to protect the fund." When the fund is threatened, the FDIC becomes nasty. We all know that.

When the non-earnings shoot up like a rocket and the bank's capital sinks like a stone, all directors become suspect and potential for a claim against them grows.

The FDIC, or the applicable regulator, will look at all the expensive policies and reports done by impressively credentialed consultants and simply say they were wrong, and, what's worse, wonder if there was an attempt to obfuscate what was really happening.

The vast majority of directors at troubled or failing banks have no real idea what happened. They saw manifestations of difficulties first, but were told they were aberrations in the market. Common sense must tell a director if a problem is more than an aberration.

Even the regulators often do not go beyond that type of assessment. Once an institution is under a regulatory agreement, any prior positive assessments are forgotten. Directors at good banks, the vast majority, will never have the problem and need not concern themselves.

If a bank loses 50% of its capital in two years, there are a lot of unanswerable questions.

But, despite what many people think, regulators are not just going into a crowded theater and opening fire.

It has taken years to prosecute or settle with a handful of the most egregious offenders in bank failures. You hear about bystanders who got caught in the whirlpool but, in reality, very few have.

It serves the financial interests of lawyers and consultants well to stoke the fires of fear and, if that is the only way to spur directors to action, God bless them.

Directors do have the power to make a difference. Remember, if you are a director who has never opposed management proposals and the bank goes belly up, costing the fund millions, you clearly have a liability problem unless you can prove mental incapacity.

The flaw in the safe-haven approach is not in the theory but in the application. If the bank is simply creating a defense to paper over gravity-defying decision-making, then somebody is taking advantage of somebody. You be the judge of whom.

In the worst cases it is the chief executive officer taking advantage of the directors. The vast majority of failing banks have weak management and board members who would make Voltaire's Dr. Pangloss look like Socrates.

When we became directors, it was because we had good relations with the chief executive officer and some other directors. Maybe we had some talent for the position, but probably not.

Recently I discussed hypothetically opposing a chief executive officer with an individual who has served as a director of two multibillion-dollar banks. The individual admitted having trouble separating the personal relationship from the director relationship. This is a problem endemic with boards, not with banking. For proof, just read "Barbarians at the Gate: The Fall of RJR Nabisco."

Twenty-five years ago, friends let friends drive drunk. Today they don't. It still takes guts to tell a friend he's drunk. It takes guts to tell a CEO his strategy is wrong or that he can't make a loan. For six years, I may have been more outspoken than my peers, but I fell in line. When non-earning assets hit 8% and poor judgment continued, I started voting against insider loans, high-risk situations, and expansion into businesses in which we had no experience.

I voted against loans equivalent to 50% of our capital, 100% of which went bad. No other director voted against management during my tenure. Our CEO had only one friend, and neither he nor the board recognized that fact. The FDIC recognized it simply from the voting record.

As non-earnings rose and capital dropped, the CEO brought in partners from a major law firm and a national bank consulting firm. They pronounced that he was doing an excellent job.

Even though their declarations flew in the face of common sense, the board happily accepted them. The regulators ignored them and looked at weak and deteriorating numbers. The CEO developed an adversarial relationship between me and the rest of the board by tabbing me a dissident.

In the general sense of the word a dissident is an obstructionist. Directors must use common sense. If the supposed dissident is right 100% of the time, maybe he is a visionary. I often respect the opinions of people I don't like. However, if the dissident is only right 10% of the time, then he's an obstructionist and deserves the boot.

As an executive search consultant for the financial services industry for the last 20 years, I have used common sense. I look for top-quartile performers and base my work on what they tell me. I want to know how those doing it right have succeeded.

Here's my definition of common sense for bank directors: As long as the bank meets regulatory ratios and non-earning assets are below 7%, you can be the kind of friend every CEO wants. Once those facts aren't true, you can't. At that point become the kind of friend he needs: Say no when appropriate.

My three cardinal rules for creating a safe haven: Don't trust anyone whose check you don't sign; document your independent positions; and don't fear becoming proactive.

I was the only director to oppose a national consultant's report. The FDIC rejected it twice. Two of us kept our own record of meetings, and we later had credibility. I worked for 14 months to interest a neighboring bank in a buyout. It worked. If you protect "the fund," you protect yourself in the process and create the safe haven everyone wants.

I have seen a number of CEOs drive their institutions into the ground, and the boards have been willing partners. Since many boards have a hard time firing a failing CEO, I recommend that they simply force the failing CEO to conform to some basic values.

Don't be bullied by some director who has better credentials than you but hasn't made a good call in three years. Once the bank goes under regulatory agreement, if you don't understand it's every man for himself, then you had best resign fast. If you don't follow this advice, then you are putting your own net worth at risk and deserve whatever happens.

Just as sending a televangelist $10,000 will not get you into heaven, hiring a lawyer or consultant will not relinquish your fiduciary responsibility. Safe havens are not bought, they are earned by showing some common sense and intestinal fortitude.

Mr. Cosgrove formed the executive search firm Cosgrove, Nocton & Co. of Bristol, Conn., which specializes in searches for the financial services and banking industries. He was a director of Bristol Savings Bank for nine years.

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