How Directors Can Avoid Liability in Today's Climate
Once upon a time - before the thrift bailout law - being asked to join a bank board of directors was among the greatest honors bestowed upon a business leader. But for the men and women now working as bank directors, the fairy tale fantasy falls way short of the truth.
Times have changed for banking and for bank directors. The regulators, including the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision, are pushing for tougher penalties for infractions of the law.
What is more, although close to three-quarters of all bank directors are covered by directors and officers insurance, such policies frequently exclude suits brought by government regulators.
Fines Can Be Hefty
Under the Financial Institutions Reform, Recovery, and Enforcement Act, directors can be socked with fines of $5,000 a day for violating any law or regulation.
"The tax code used to be the abomination of business," said John J. Gorman, a partner with Muldoon, Murphy & Faucette, a Washington-based law firm that frequently counsels bankers and bank directors.
"Now it's the banking regulations. It's practically impossible not to violate the code - there's too many i's to dot and t's to cross."
"It's ironic - regulators are the most feared plaintiff, yet most D&O insurance excludes those suits," he continued. "The power granted to bank regulators would be the perfect model for a Fascist government. They have the authority to shoot first and ask questions later. Their charge from Congress is to find people to blame."
Most Worried over Liability
In a survey of bank directors, conducted this past summer, 90% of the respondents expressed concern about their liability; 27% said they did not have the authority to reduce liability; and 20% said the bank had no clear policies for directors.
Nevertheless, when asked "If you had to do it over again, would you agree to serve on your bank board?" three-quarters of the respondents said yes.
"The survey confirmed what I had expected," said Thomas P. Phelps, founder and partner of Manatt, Phelps & Philips, the Los Angeles-based law firm that conducted the study.
"Although bank directors are very concerned about liability exposure, they obviously feel the benefits to themselves and the community are well worth it."
Banks Most Vulnerable
But the problems continue to mount. Of all the industries monitored by Wyatt Co., a Chicago-based human resource consulting firm, banks are sued most often. Suits are pressed by shareholders, employees, customers, and, especially in banking, government regulators.
But there are a number of steps management can take to alleviate risk. Written documentation of loan decisions - both approvals and denials - is extremely important.
"That's where regulators will slam you," said Mr. Gorman. "You have to have loan policies and you have to have them in writing."
Most lawyers who advise bank directors suggest that the bank adapt a policy of no loans to directors. If that's too strict, "make the standards for loans to directors very tough, very rigorous," said Mr. Phelps, the architect of the bank director survey.
Bank directors should also keep accurate records of the discussions at board meetings - again, in writing.
"Get rid of the one-page nutshell summary of a three-hour meeting," said Mr. Gorman. "Keep records of the exchanges to prove that [the board] is not just a rubber stamp. Boards have to be able to prove that they asked questions; that they have turned down bad loans."
Another suggestion: know and address the examiner's criticisms. "The board has to get more involved and know what's going on," said Mr. Gorman.
"They should not rest until [the problems] have been fixed and the examiners are satisfied. That's the cardinal rule of dealing with examiners: never let them see the same problem twice."
Education Is Important
Of course, for directors to be effective, they must be educated in the banking business. "Our bank sent us to a banking seminar where we had the opportunity to meet with other directors and discuss mutual concerns," said William H. Overfelt, who sits on the board of directors of Tokai Bank of California.
Unfortunately, too many outside directors (those not employed by the bank) do not have banking-specific knowledge, and are not given a chance to get it.
The Manatt, Phelps & Phillips survey of 49 bank directors from Western states who attended an educational forum sponsored by the law firm in June found:
* Almost four out of five said their banks had not conducted in-house education on lessening liability risks.
* A total of 73% said their banks have no job descriptions for directors.
* Seven out of eight said their banks do not have an orientation program for directors.
* Nearly 20% said they are not receiving sufficient information to fulfill director responsibilities.
"A lot of managements are reluctant to discuss these issues with the board because they don't want to scare them," said Mr. Gorman. But management does have a responsibility to reduce liability risk, he added.
"Directors have to spend a lot of time - attending meetings, reading reports," said Mr. Phelps. "It's not a country club. It takes a lot of hard work. I think it's a good idea for management to take steps to reduce the risks."
PHOTO : Directors' Concerns Source: Manatt, Phelps & Phillips bank director survey