1 Legal Issues Legal Issues for for Directors of Directors of Financial Financial Institutions Institutions in a Downturn in a Downturn Economy Economy
Guidelines for Bank Directors in a Troubled Economy
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1. Legal Issues for Directors of Financial Institutions in a
Downturn Economy
2. General Board Responsibilities
Your job is to:
Get competent management;
Establish goals and adopt policies to achieve those goals in a
legal and sound manner;
Oversee operations to ensure that they are controlled
adequately and are in compliance with laws and policies;
Oversee managements performance; and
Ensure that the institution helps to meet its communitys credit
needs.
3. Fiduciary = Trust
Directors and officers of financial institutions owe a
fiduciary duty to:
Depositors
Shareholders
The Public
4. Financial Responsibility
Directors are not personal guarantors that the institution will
succeed, or that it will not have loan losses.
They are obligated to act as prudent persons in supervising the
institution. If they do not heed the warnings of regulators (even
warnings that are general in nature), there is a potential claim
that the directors failed to act in a manner consistent with their
fiduciary duties.
Directors of financial institutions are also susceptible to
civil money penalties, which could be imposed for engaging in
unsafe or unsound practices.
5. Safety and Soundness
Federal regulators consider breaches of fiduciary duty to be
per se safety and soundness violations.
Zero tolerance environment.
6. Fiduciary Duties Defined
A director shall discharge his or her duties:
in good faith;
with the care an ordinarily prudent person in a like position
would exercise under similar circumstances; and
in a manner the director reasonably believes to be in the best
interests of the institution.
7. Business Judgment Rule
If directors and officers act in good faith, and in a prudent,
diligent and informed manner, they will be protected from liability
under the business judgment rule for any decisions or actions that
may later prove to be a mistake.
8. Independence
Effective corporate governance requires a high level of
cooperation between the board and management.
The duty to oversee the conduct of the institutions business
means that each director must exercise independent judgment in
evaluating managements actions and competence.
Directors who routinely approve management decisions without
exercising their own informed judgment are not adequately serving
their institutions, their stockholders, or their communities.
9. Duty of Care
A director is charged with vigilance in the stewardship of the
Bank, making him liable for what a prudent director should know,
and imposing a duty to act on that knowledge.
10. Fulfilling the Duty of Care
Directors are expected to attend board and committee
meetings.
Directors are expected to be prepared and to participate in
board and committee meetings.
Generally, a director may not vote by proxy at meetings.
Directors and officers are expected to exercise independent
judgment.
Directors and officers must not willfully ignore problems.
11. What is a Director Supposed to Know?
Income and expenses
Capital adequacy
Loans and investments
Impaired assets (loans and securities)
Performance in all of the above areas compared peers
12. Duty of Loyalty
Directors and officers are not allowed to further their own
interests at the expense of the institution.
Directors and officers are expected to act in a manner
consistent with the best interests of the institution as a whole,
rather than representing a particular constituency.
13. Conflict of Interest Loans
Greater responsibility in dealing with the loans to executive
officers or directors.
Decisions must preclude the possibility of partiality or
favored treatment.
Unwarranted loans to a banks directors or to Directors who
become financially dependent on the institution should not continue
to serve.
14. Reg O
Extensions of credit must:
Be made on non-preferential terms ; and
Receive prior board approval .
A bank must not pay an overdraft for an executive officer or
director unless it is made in accordance with certain
requirements.
The extension of credit must also:
Not exceed the lending limit ; and
Comply with all procedural and reporting requirements .
15. Non-Preferential Terms
To be made on non-preferential terms, an extension must:
Be made on substantially the same terms as comparable
transactions ; and
Not involve more than the normal risk of repayment or present
other unfavorable features.
16. Duty of Loyalty the 3 Cs
C onflicts of interest between directors and officers and the
interests of the institution;
C orporate opportunities that become available to the
institution; and
C onfidentiality of non-public information.
17. Regulatory Responsibilities
Responsible for requiring management to respond promptly to
supervisory criticism.
Open and honest communication between the board, management and
the regulators is crucial.
18. Regulator Red Flags
Gratuities or perks associated with the approval of financing
arrangements or the use of particular services.
The use of institutional monies to obtain or transact outside
business.
Transactions, especially loans involving conflicts of
interest.
Full disclosure.
Abstain from voting on the matter.
Record the disclosure and abstention in the minutes.
19. Procedural Aspects of Responding to Regulatory Warnings
How the Board reached a decision is critical when a regulatory
authority questions past actions.
Step #1 is knowing what should be taken to the Board. Although
it is not necessary to take all regulatory warnings to the Board,
strong warnings regarding a major function such as lending - should
always be sent to the Board.
20. Board Minutes
The minutes should reflect the information reviewed by the
Board and the bases of its actions or conclusions.
Without adequate minutes, it will be difficult to demonstrate
how the Board made its decisions or why it took the actions in
question.
21. Director Priorities in a Down Economy
Problem loans, their present status and workout programs
Allowance for possible loan loss
Concentrations of credit
Losses and recoveries on sales, collections, or other
dispositions of assets
Funding activities and the management of interest rate
risk
22. Focus On.
Any insider transactions that benefit, directly or indirectly,
controlling shareholders, directors, officers, employees, or their
related interests
Activities undertaken to ensure compliance with applicable
laws
lending limits
consumer requirements
Bank Secrecy Act
compliance problems
Any extraordinary development likely to impact the integrity,
safety, or profitability of the institution
23. 4 Most Common Personal Lawsuits
Where the director or officer engaged in dishonest conduct or
approved or condoned abusive transactions with insiders.
Where a director or officer was responsible for the failure of
an institution to adhere to applicable laws and regulations, its
own policies or an agreement with a supervisory authority, or where
the director or officer otherwise participated in a safety or
soundness violation.
Where directors failed to establish proper underwriting
policies and to monitor adherence thereto, or approved loans that
they knew or had reason to know were improperly underwritten
Where the board failed to heed warnings from regulators or
professional advisors, or where officers either failed to adhere to
such policies or otherwise engaged in improper extensions of
credit.
24. Protect Yourself
DISCLOSURE
RECUSAL
DOCUMENTATION
ADVANCE APPROVAL
SEEK PROFESSIONAL HELP
KEEP GOOD MINUTES
INSURANCE
25. Addressing Credit Quality
Are credit underwriting standards too loose or too tight?
Does the loan policy reflect the standards used by
lenders?
Has there been any significant shift in loan categories that
may indicate greater assumption of risk (for example, a significant
decline in residential loans and an increase in loans to purchase
raw land)?
If entering a new area of lending, the Board needs to satisfy
itself that the institution has qualified personnel to handle the
new lending area, that the loan policy adequately addresses the new
area, and that the reserve for loan losses will be sufficient to
cover foreseeable potential losses from the new activity.
26. Credit Quality Questions
Is loan review adequate and independent?
Is the methodology used in calculating the loan loss reserve
appropriate?
Is the level of the Boards involvement in approving loans
working?
27. Insufficient Capital- What Do We Do Now?
Review and revise as necessary the business/operating plan for
the next 12 to 24 months, using the most current data, with
specific focus on liquidity and capital requirements and
sources.
Identify and implement cost reduction and other cash
conservation measures.
Closely monitor key performance indicators, material variances
and their potential consequences.
28. What Do We Do Now?
Stress test the business plan against downside scenarios.
Pay particular attention to assumptions regarding projected
income and expenses.
Understand and take into account direct and indirect exposure
to derivatives and risks around mark to market assets.
Identify and evaluate risk issues related to the interconnected
nature of the U.S. economy.
29. What Do We Do Now?
Determine what capital expenditures are essential which can be
deferred or are discretionary.
Review sources of liquidity and capital, and assess whether and
the extent to which they should be considered reliable going
forward.
30. What Do We Do Now?
Review debt agreements and other material contracts for
potential compliance issues (collateral calls, financial covenant
defaults, cross defaults and accelerations, put rights and joint
venture governance rights).
Make communications, internally and externally, a
priority.
Be prepared to deal with misinformation and rumors.
Evaluate the appropriate frequency of board meetings in order
to make sure the board is well informed and has the time necessary
to deal with the issues facing the institution.
31. Corporate Governance
Undertake a thorough corporate governance review
exculpatory charter provisions
scope and limits of liability insurance coverage
financial strength of insurance carriers
Implement best practices with an emphasis on the boards good
faith exercise of their responsibilities and reaffirming the right
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