Directors Can Be Held Personally Liable

MANAGEMENT - Includes both the Board (elected by shareholders), and executive officers (appointed to positions by the Board). - Directors can be held personally liable - Board is source of all authority and responsibility - Board responsible for the formulation of policies and objectives - Executive management responsible for implementation of Board policies and objectives in the bank’s day-to-day operations Directors Selection and Qualifications of Directors - Statutory or regulatory qualifications can included: - Taking oath of office - Unencumbered ownership of a specific amount of the bank’s capital stock - Residential and citizenship requirements - All Directors must posses: - personal integrity - Knowledge of the duties and responsibilities of the office - Genuine interest - Capability of recognizing/avoiding conflicts of interest (also appearance of independence) - Sound business judgement - Familiarity with the community/trade area - Independence Powers, Duties, and Responsibilities Regulating the affairs of the bank - Board must establish policies and objectives which executive management must operate within. Established policies should include: - Investments - Loans - Asset, liability, and funds management - Profit planning and budgeting - Capital planning - Internal routine and controls - Personnel - Part 364 – sets specific guidelines for the safe operation of banks in the following areas: - Internal controls and information systems - Internal audit system - Loan documentation - Credit underwriting - Interest rate exposure - Asset growth - Asset quality - Earnings - Compensation, fees, and benefits - These standards establish objectives of proper operations and management - Polices should be written and reviewed periodically - Bank may obtain written policies from outside sources, however, management must ensure that policies are suited to the bank - Best way to ensure Directors are properly supervising the affairs of the bank is to ascertain their involvement in devising, enforcing, and modifying the institution’s written guidelines Corporate Planning Sets the future direction of the bank - Three fundamental dimensions of management: - Planning - Organizing - Controlling - Planning must be dynamic, carefully attended to, and well supported - Projections should be reviewed and periodically revised to meet changing circumstances - Plans should be: - Formal planning process - Board participation in development - Realistic assumptions (present and future) - Monitor actual performance to projections - Take into consideration changing conditions - Focus for examiners is to evaluate the process of planning; however, if plan/projections are inappropriate or may result in significant financial harm, examiners should identify deficiencies in the plan and attempt to effect necessary changes Appointing, Dismissing at Pleasure, and Defining the Duties of Officers - Board primary duty is to appoint executive officers and dismiss executive officers who are unable to meet the needs of the institution Personnel Administration - Features of a good personnel administration: - Designated organization structure - Detailed position descriptions - Carefully planned recruiting - Appropriate training and development activities - Performance appraisal system - Quality salary administration - Effective communication system Honestly and Diligently Administering the Affairs of the Ban - Board is responsible for conducting the affairs of the bank - Board may delegate responsibility to executive officers for carrying out the details of the bank’s business, HOWEVER, duties may not be delegated and forgotten - Directors must periodically examine the bank to ensure it is functioning properly Observance of Laws to Which the Bank is Subject - Board should develop a system to monitor compliance with policies and laws and regulations - When violations do occur correction should be made as quickly as possible - Violations should not be committed knowingly Avoiding Self-Servicing Practices - Directors should place performance of their duties above personal concerns - Directors must never abuse for personal advantage their influence with respect to the bank’s management - Same principals apply to bank management Divisions - Board has responsibility of maintaining adequate capital Internal Control System and Auditing Program Management Information System (MIS) - Management responsible for developing system that provides timely and accurate information Supervision By Directors - Board should see that policies are being implemented and adhered to and its objectives achieved - Procedures should be established that bring to the Board’s attention relevant and accurate information about the bank in a consistent format and at regular intervals - Directors should keep abreast of basic facts such as: - Growth (asset, capital), loan to deposit ratios, deposit mix, liquidity position, portfolio composition, loan limits, loan losses, recoveries, delinquencies, etc. - Directors should insist on receiving pertinent information about the bank in concise, meaningful and written form, and executive management should ensure that Directors are kept fully informed on all important matters - Board meetings should: - Conducted in businesslike and orderly manner - Regular attendance is required (record should denote attendance at each meeting) - Director dissent from the majority should be recorded and maintained - Agenda should be prepared and include: - Reports on income and expenses - New, overdue, renewed, insider, charged-off and recovered loans - Investment activity - Personnel - Individual committee actions (review of minutes) - Board may appoint and authorize committees to perform specific tasks and supervise certain phases of operations (loans, investment, etc.) However, this delegation does not relieve the Board of its fundamental responsibilities for actions taken by those groups Legal Liabilities of Directors - Directors and other officers of a bank may be held personally liable for: - Breach of trust - Negligence which is the proximate cause of loss to the bank - Ultra vires acts or acts in excess of powers - Fraud - Misappropriation or conversion of the bank’s assets - (Difficulties usually arise in cases involving negligence (or breach of duty) which fall short of breach of trust or fraud) - Negligent acts are premised on common law for failure to exercise the degree of care prudent individuals would exercise under similar circumstances, and/or noncompliance with applicable statutory law - The following actions or inactions have been found to constitute negligence on the part of directors - Attitude of general indifference to the affairs of the bank (failure to hold meetings, obtain statements of the bank’s financial condition, or examine and audit the books and records) - Failure to heed warnings of mismanagement - Failure to adopt practices and follow procedures - Turning over virtually unsupervised control of the bank to officers and employees relying upon their supposed fidelity and skill - Failure to acquaint themselves with examination reports - Assenting to loans in excess of applicable statutory limitations - Permitting large overdrafts in excess of policies and to insiders in violation of law - Representing certain assets as good in a report of condition when such assets were called Loss by examiners (and should have been removed from the books) Federal Banking Law Part 359 Golden Parachutes and Indemnification Payments - Prohibits or limits, by regulation, golden parachute payments or indemnification payments Section 39 (c) FDI Act – Compensation Standards - Requires FDIC to prohibit excessive compensation to executive officers, employees, directors, and principal shareholders as an unsafe and unsound practice (Also Part 364) Section 32 FDI Act - Troubled insured depository institution (including holding companies) may not add any individuals to the Board or employ any individual as a senior executive officer if the appropriate banking regulatory agency issues a notice of disapproval of such addition or employment before the end of the 30-day period beginning on the date the agency receives the required notice Section 19 FDI Act - Prohibits, without the prior written consent of the FDIC, a person convicted of any criminal offenses involving dishonesty or breach of trust or money laundering, or who has entered into a pretrial diversion or similar program in connection with a prosecution for such offenses, from becoming or continuing as an institution affiliated party (IAP), owning or controlling, directly or indirectly, an insured institution, or otherwise participating, directly or indirectly, in the conduct of the affairs of an insured institution - The intent is not punitive, but the purpose is to demonstrate that the applicant/person is fit to participate in the affairs of the bank without creating a risk to the bank or impairing the publics confidence Part 349 - Prohibits: - Preferential lending by a bank to executive officers, directors, principal shareholders of another bank, or any related interest of such person, when there is a correspondent account relationship between the banks OR - Opening a correspondent account with a bank when there is preferential extension of credit by one of the banks to an executive officer, director, or principal shareholder of the other bank, or any related interest of such person - Also imposes annual reporting requirements Regulation O - Pertains to loans and extensions of credit to executive officers, directors, principal shareholders and their related interest. Aimed at prevention and detection of insider abuse - Regulation O requires that extensions of credit to executive officers, directors, principal shareholders or their related interest be made on the same terms as those prevailing at the time for comparable transactions with persons not covered by the regulation - Payment of overdrafts of directors or executive officers is prohibited unless part of a written preauthorized interest bearing, extension of credit plan - Aggregate lending limits are imposed (total capital???) Part 337 - Establishes criteria for approval of extensions of credit to insiders - Prior approval of the bank’s Board is necessary when the extension will exceed the amount specified in the regulation when aggregated with the amount of all other extensions of credit or LOC to that person. - Approval must be granted by a majority of the Board and the interest party(ies) must abstain from voting - Any violator of Regulation may be assessed a CMP Part 348 - Prohibits management official of one bank or holding company from also serving in a similar capacity in another bank or holding company if: - The two organizations are not affiliated and are located in the same area OR - The two organizations are not affiliated and are very large - FDIC may serve written notice of intention to remove a director or officer from office whenever, in its opinion, such director or officer is in violation of this regulation Change in Bank Control Act - Prohibits any person, acting directly or indirectly or through or in concert with one or more individuals, from acquiring control of any insured bank unless the appropriate Federal banking agency has been given 60 days prior written notice of the proposed acquisition. - An acquisition may be made prior to the expiration of the disapproval period if the agency issues written notice of its intent not to disapprove the action - Controls is: - The power, directly or indirectly, to direct management or policies of an insured bank or - Vote 25% or more of any class of voting stock of the insured bank Gramm-Leach Bliley Act - Precludes persons from serving both as an officer or director of a public utility and a bank except when: - The individual does not participate in any deliberations involved in choosing a bank to underwrite or market the securities of the utility - The bank is chosen by competitive pressures - The issuance of securities by the public utility have been approved by all appropriate regulatory agencies Other Issues Indebtedness of Directors, Officers, and Related Interest - Loans to directors, officers, and related interest must be made on the same terms as those prevailing at the time for comparable transactions with regular bank customers Conflicts of Interest At times loans are advanced to business associates where an insider benefits. Examiners through the first day letter or fax should ask if any of the following situations exist: - Loans or other transactions where an insider (or related interest) of the bank holds a beneficial interest - Loans or other transactions where an insider (or related interest) of another bank holds a beneficial interest - Loans or other transactions at any bank where an insider (or related interest) holds a beneficial interest direct, or indirect - Loans or other transactions where an insider (or related interest) has no direct interest but involves parties with whom an insider has other partnership or business association - Loans extended personally by insiders (or related interest) to parties who are also borrowers from the bank or loans extended personally by any borrowing customers to an insider or principal stockholder Any deficiencies in credit quality or other aspects of the transaction should receive critical comment in asset quality and management rating - If a Director has a personal financial interest in a loan or other transaction subject to adverse classification, the Board should be urged to require that Director to strengthen the credit sufficiently to remove the adverse classification within a reasonable time frame or resign from the Board - When an officer or principal shareholder (not a director) is involved in an adversely classified loan or other transaction, the Board should be urged to assume special oversight over the loan or activity, either directly or through a committee of outside directors, with a view towards limiting any further exposure and moving aggressively to secure or collect any exposed balances as the circumstances may permit Non Banking Activities Conducted on Bank Premises - When non-banking activities are conducted on bank premises either by bank personnel or others and when the benefit and profit does not flow directly to the bank, certain disclosures, approvals, and reimbursements must be made: - Bank’s directors and shareholders should be informed on the non-banking activity conducted on premises - Operation should be approved by shareholders - Expenses incurred by the bank in connection with these operations formally approved by the Board annually - Bank should be adequately compensated for any expenses it incurs for providing: - Personnel - Equipment - Space - These activities should be reported to the bank’s bonding company Directors of One Man Banks and Advisory Directors - When the bank’s principal officer or stockholder dominates virtually all phases of the bank’s policies and operations - Two potential dangers: - Incapacitation of the dominate individual may deprive the bank of competent management and create the need to immediately fill the position, which may render the bank vulnerable to dishonest or incompetent replacement leadership - Problem situations resulting from mismanagement attributed to the dominate individual - Honorary Director – attends Board meetings and offers advice on a limited participation basis, but has no formal voice or vote in proceedings, nor the responsibilities or liabilities of the office Golden Parachute Payments - Part 359 limits and/or prohibits banks from agreeing to make or making golden parachute payments when the bank making the payment is troubled - Rule does not restrict the payments by healthy banks, except - Holding companies are prohibited from making payments to IAP of troubled subsidiary banks and savings associations - Exceptions to the prohibition: - Bona fide deferred compensation plans - Nondiscriminatory severance payment plans (for personnel reductions in force) - Qualified pension or retirement plans - Payments pursuant to employee welfare benefit plan - Payments made by reason of termination caused by death or disability - Payments required by state statute or foreign law *Final three listed exceptions require the approval of the FDIC and appropriate Federal banking agency - Troubled institution hiring new management (White Knight) - Severance payment in the event of an unassisted change in control - Any others on a case by case basis with the regulators approval Indemnification Payments - Circumstances when indemnification may be permitted: - Banks Board determines in writing that these four criteria are satisfied: - IAP acted in good faith - Payment will not materially adversely affect the bank - Payment is limited to expenses incurred in an administrative proceeding or civil action instituted by a Federal financial bank’s regulator - IAP agrees to reimburse the bank if he/she is found to have acted improperly - Insurance policy or fidelity bond may pay the cost of defending an administrative proceeding or civil action. It may not pay a penalty or judgement. - Partial payment may be allowed when charges are found in favor of the IAP : - The payment of administrative or civil action expenses are NOT allowed when cases end in a settlement. (Can pay when charges are dropped) - Partial payment is allowed for the dropped charges when several significant items have been charged (during the process a settlement is reached where only some of the infractions are admitted) - Partial payment is not allowed with the IAP has been removed from office and/or prohibited from participating in the affairs of the bank - Golden parachute is prohibited to an individual leaving the bank, it is prohibited forever, even if the bank returns to health (after the individual has left the bank) - (Exceptions for individuals who leave a troubled bank to avoid the prohibition if that individual has not contributed significantly to the demise of the bank) - Troubled banks cannot apply for an exception to offer White Knight parachutes to their current officers to not leave the bank. White Knight incentives are to entice new management to join the bank by compensating for the uncertainty of joining a troubled bank - Approval is required for a severance payment in the event of an unassisted change in control - A maximum payment of 12 months salary is permitted under this exception - Request for payments in excess of this amount would have to be considered for approval Excessive Compensation Part 364 - Prohibits the payment of excessive compensation, as well as compensation that could lead to material financial loss to a bank, as an unsafe and unsound practice - Also, urges banks to maintain safeguards that prevent excessive compensation or compensation that could subject the bank to material financial loss - Excessive compensation – amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal shareholder. Factors to consider: - Combined value of all cash and non cash benefits - Compensation history of individual and other individuals with similar experience - Financial condition of the bank - Compensation practices at similar banks (size, location, risk profile) - Projected total cost and benefit to the bank for post employment benefits - Connection between the individual and any instance of fraud or insider abuse - Any other factor - Section 39 FDI Act – prohibits agencies from establishing guidelines that set specific level or range of compensation for bank insiders Appraisal of Management Should be based on: - Banks performance - Decisions made by management and directors - Banks condition should not be sole determinate especially when external factors influenced/caused problems - Higher rating for management when problems are caused by external factors rather than internal factors, especially when sound decisions have been made - Whether or not insider abuse is present - Management’s past record of performance - Whether loan losses and other weaknesses are recognized in a timely manner - Past compliance with agreements, commitments, orders - Capability of management - Rating should be consistent with any recommended supervisory actions