On top of everything else bank board members must think about these days, they must also consider and avoid their own exposure to personal liability for actions taken (or not taken) in connection with their board duties. What can you do to avoid personal liability?
Good corporate governance is the first line of defense for a board of directors. With today’s demanding regulatory climate, bank boards are being held more accountable than ever. Directors need to go back to the basics. Understanding the duties of care and loyalty are the foundation of corporate governance and properly documenting actions taken at the board meetings provides evidence that directors exercised their fiduciary duties.
Beyond this, regulators are asking, “Was the board informed?” and “Did the board approve this?” The key to avoiding personal liability is to stay informed of important decisions by management. There are legal protections in most states for boards that make judgments in the course of business. The board can show it exercised business judgment by documenting the decision-making process with full disclosure, including any discussions fully disclosed in the minutes. Each individual director is obligated to speak up and challenge management.
Engaged independent, outside directors can strengthen a board’s exercise of its fiduciary duties. Though most Federal Deposit Insurance Corp. lawsuits against bank directors have come out of bank failures, with the creation of the Consumer Financial Protection Bureau and the increasing role of shareholder activists, we may see heightened scrutiny on boards with an eye towards damages should the bank sell, falter, or fail. Engaged, independent directors have an important role to play in protecting the board. They should hold regular executive sessions without management, and these sessions also should be documented. In keeping with this concept, it is effective for the board to name a lead independent director who will guide executive sessions and secure the minutes. The lead outside director should also communicate with management.
A knowledgeable director is a good director. Having an appropriately educated board is good for the bank, good for the individual director, and looked on favorably by the regulators. Directors would be wise to undertake risk management education, with content appropriate for the size and scope of the bank. The test applied by the regulators is whether the board is knowledgeable enough to understand the risks attendant to the bank’s operations and product lines (existing and planned), and to challenge management’s analysis of such risks and the proposed action plans to mitigate or take advantage of them. This is not to suggest that directors need to be experts in, for example, designing a capital or liquidity stress test model, but directors are expected to understand management’s analysis of the output in order to effectively guide the bank’s decision-making process.
A best practice is to develop and adopt a director education policy/program that includes, at a minimum, the following:
- general description of subject matter expected to be covered and updated annually;
- number of hours/days of education expected for the year;
acceptable forms of education—external, internal, self-study, trade association seminars, etc.
- who pays the cost (including travel);
- whether attendance/completion will be included in annual director evaluations; and
- assignment of responsibility for documenting, monitoring and reporting on compliance with the policy.
Paying attention to and engaging with your regulators will reduce your risk of serving on a bank board. A bank director’s primary responsibilities vis-a-vis the bank’s regulators are:
- to review and understand regulatory reports and other correspondence from the regulator;
- to formulate corrective action to address issues/deficiencies identified in regulatory reports;
- to assign responsibility to appropriate bank management or staff for implementation of corrective action;
- to monitor and manage the progress of corrective action to its timely and effective completion; and
- to maintain an open line of communication with the bank’s examiner in charge and others within the regulatory agency, as appropriate.
These responsibilities apply whether your bank is well managed, highly profitable, and well capitalized or subject to a formal enforcement action. If your bank finds itself in the latter category, the risk of personal liability is significantly higher. The federal regulatory agencies have little patience for boards that do not take seriously their responsibility to “fix the problems” and are quick to threaten and impose civil money penalties where timely, effective and complete corrective action is not taken. Timely and open communication with the regulators is also important, especially where corrective action deadlines will not be met. Regulators are human too, and like most of us, they hate bad news surprises.
Bank board members need to keep personal liability top of mind. These four practices may not be complete safe harbors, but they will go a long way to helping protect personal assets.