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We've been through this before: Corporate governance ratings don't work

February 25th, 2011 |

Following the S&L crisis twenty years ago, a number of banking trade organizations, usually in association with a directors and officers liability (D&O) insurance company, trotted out the idea that directors should be accredited. Banks were told that if they sent their boards to special programs on corporate governance, the directors would be accredited and this would save the bank money on D&O policies. The organizations then offered the accreditation programs and made money on them. And if the D&O was placed with the preferred insurance company, the association made a finder’s fee.

However, D&O insurance is a hand written policy, so a discount on your policy is not transparent. It is like getting a discount on a house or a used car. In a negotiated process, how would you be able to tell what kind of discount you actually got?

D&O prices are determined by an underwriter who tries to anticipate how likely it is that you or your bank will be sued. If your bank recently merged, had its CAMELS rating take a beating or saw an ugly drop in the value of its shares, the underwriter either will not write it or charge a great deal of money to cover you. The board’s accreditation won’t affect the price.

The accreditation and corporate governance rating concept was recycled right after Sarbanes Oxley passed in 2002 when Institutional Shareholder Services (ISS, which is now part of MSCI) created a corporate governance rating for publicly traded companies.  ISS then asked the same companies to pay them a consulting fee through its RiskMetrics brand to figure out how to improve their corporate governance. Since ISS voted a great number of shares for institutional investors, companies paid more often than they would publicly admit.

MSCI is changing this business model because it failed to have predictive value in the latest crisis. In fact, as reported by the Huffington Post: “Exactly fourteen days before Lehman Brothers Holding[s], Inc. filed for bankruptcy in September 2008, ISS gave Lehman a corporate governance rating of 87.6 percent, meaning that Lehman's corporate governance in ISS' view was better than 87.6% of other diversified financial companies. ISS also doled out generous ratings to other ailing financial companies such as Washington Mutual, which was rated by ISS as being ‘better than 44.3% of S&P 500 companies and 95.6% of [b]ank companies’  just weeks before it's [sic] undoing. And if that was not enough, a few days before AIG scurried to put together an emergency loan, ISS rated AIG as being ‘better than 97.9% of S&P 500 companies and 99.2% of [i]nsurance companies.’"

Our partner Bill Seidman used to say: “When the tide goes out you get to see who was swimming without their shorts on.” The tide went out and corporate governance ratings took a beating.

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There is a big difference between accreditation and education. Educated boards are stronger boards.

Right now, if I were serving on a bank board I would be drilling into the issues that really affect the health of the bank. I would be asking about our strategic plan around the coming wave of M&A and if we had a firm idea of what the bank was worth. I’d want to hear what the regulators are saying about our bank and how the Dodd-Frank Act might affect our institution. I would focus on how we pay our people, especially the CEO and the top five key leaders, and how we are developing our bench. I would want to hear about pockets of opportunity for lending and how much we know about our customers. I would attend highly focused programs, talk to my director peers and talk to auditors, lawyers and consultants that work with banks regularly to identify the coming challenges and opportunities. And of course I would read Bank Director. (Yes, that is a plug for our magazine).

I think that a toolbox of information for a board is far better that a one-time, one-size-fits-all accreditation process that focuses on corporate governance in a traditional sense.

 

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Joan Susie is the CEO of Bank Director, an information resource for directors and officers of financial companies. Connect with her on LinkedIn or follow @BankDrector on Twitter. You can also get additional updates by visiting www.BankDirector.com.

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