While addressing my class recently, a guest speaker brought up a problem community banks often face: how the interests of banks and lawyers can conflict.

The speaker is CEO of a regional investment banking house that specializes in mergers and acquisitions involving community banks. His comment pointedly described the conflicts of interest he has encountered.

"One of the biggest roadblocks in our work is when there is a lawyer on the board," he told my students. "For he is usually the recipient of the majority of the bank's legal business. And he knows that if the bank sells out, it is highly improbable that he will continue to have this source of income. So he is against all structural change."

Community banks must confront this question: Are its board members favoring the bank's best interests - or their own?

I have seen boards turn down attractive offers simply because the directors enjoy going to the annual convention at a ritzy resort. They know that if they sell and become advisory board members, the tax-free trips are likely to end-so why rock the boat?

Bankers admit that the main reason advisory boards are formed is to give ex-board members a chance to get together with former colleagues and be paid for it.

But lawyers are special because they function both as board members and paid legal advisers. And their legal fees can be substantial.

One Florida thrift that was going public stated in the prospectus that 1% of gross income went, and would continue to go, to the thrift's law firm- which just happened to be owned by the thrift's CEO.

Lawyers on the board can be extremely valuable. They can determine whether proposals are legal and whether fees of other lawyers used by the bank are fair.

And many community bankers say that their close relationships with lawyers and accountants is an excellent marketing weapon. Referrals by legal or accounting professionals are the surest way to generate new accounts.

Lawyers who are deeply involved in the bank's best interests also can accomplish a great deal more than what is standard operating procedure. When I was on the board of an REIT that filed for Chapter 11 bankruptcy, the party that had the strongest, most obstinate lawyers got the best deal in the reorganization.

The threat these lawyers posed was serious: "You give my client what I want, or I will throw the entire proceeding into a more radical Chapter 10, and you will get nothing." And it works.

However, as an outside director, I was sad to see that the lawyers got every dollar they billed, though the REIT was bankrupt. And when I went to the annual meeting I heard those with smaller investments ask: "When will you start the dividend again?"

In cases like the merger situations discussed above, it is the unpleasant task of the CEO to remind the lawyer-director and the rest of the board that the best interests of the bank must come first.

If this is difficult or unpleasant, the trauma could be avoided by barring from the board anyone with a possible conflict of interest. Mr. Nadler, an American Banker contributing editor, is professor of finance at Rutgers University Graduate School of Management.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.