L. William Seidman Courage Award: Community Bancshares, Blountsville, Alabama

And the winner is…Community Bancshares of Blountsville, AL

Final confirmation of long-held suspicions landed with a resounding thud on a January morning in 2003. For more than two years, the four outside directors who served on the audit committee of Community Bancshares in Blountsville, Alabama believed that the company’s longtime CEO, Kennon Patterson, had been treating the institution as his own personal piggybanku00e2u20ac”but they lacked a smoking gun. When attorneys for Patterson notified directors at an Atlanta meeting that the CEO had filed for bankruptcyu00e2u20ac”a day before he had a second mortgage on his house released without board approvalu00e2u20ac”directors moved quickly to remove him.

Patterson could not be reached for comment. His Birmingham-based attorney, William Clark of Redden, Mills & Clark, declines much comment currently, citing pending litigation, but he does say Patterson “adamantly” denies any wrongdoing. The former CEO filed suit last year charging the bank, its holding company, and five directors with breach of contract and conspiracy in connection with his firing and claims not to have been paid $2.4 million allegedly accrued prior to his termination. Patterson “was improperly removed,” Clark says, adding that directors “are trying to justify themselves and their roles” in the company’s recent troubles.

The status of these charges and a confusing array of other suits and countersuitsu00e2u20ac”involving former management, the board, shareholders, accounting and law firms, and even the company’s employee stock ownership programu00e2u20ac”are in flux. But Patterson, along with former vice president Larry Bishop, was set to go on trial in January, facing a 25-count criminal indictment by the Justice Department alleging he employed the company’s funds for his own use. Patterson was removed from the board last June.

Community’s board members have watched the ongoing legal machinations with modest trepidation, though at this point, little fazes them. Over the past four years, they’ve endured lawsuits and paid $10,000 in civil money penalties to the Federal Deposit Insurance Corp. for breaching their fiduciary responsibilities and participating in “unsafe and unsound banking practices.” They also have seen a once-prosperous bank become a smaller, money-losing enterprise on their watchu00e2u20ac”all the while enduring a raft of small-town whispers about their perceived roles in the saga.

“This is the environment they’ve had to work in,” says Scott Sorrels, a partner with Powell Goldstein LLP in Atlanta, the audit committee’s outside counsel. “Everything has been second-guessed, and they’ve been threatened, or hit, with litigation when they didn’t agree with the actions being taken.”

All in all, it’s far more than this collection of community leaders with no previous banking experience bargained for when they joined the board, and few would have blamed them for simply walking away. Instead, the outside directors have persevered, forming an unusually close bond. Some three years ago, as the storm clouds gathered, the directors made a pact that reflected their outrage and determination. “We looked at each other and made a commitment that we were going to fight together,” recalls Glynn Debter, a nine-year director who raises bulls on his central Alabama ranch. “We said we were going to be honest and find the truth; let the hatchet fall where it may.”

Although some contentious issues linger, the four core directorsu00e2u20ac”Debter; John (Jay) Lewis, a production manager at the local Tyson Foods plant; Roy Jackson, a retired owner of a farm and garden store; and Jimmie Trotter, a retired high school principalu00e2u20ac”have emerged from Community’s darkest days for the better. They have hired a new chairman and CEOu00e2u20ac”Patrick Frawley, a former director of regulatory affairs for Bank of America and, before that, director of bank supervision for the Office of the Comptroller of the Currency’s Atlanta office. Together they have helped steer the $544 million banking company back toward profitability. In the first half of 2004, Community reported net income of $285,000, after losing $13 million in 2003.

It hasn’t been easy, or cheap. Frawley says the legal tab for all the litigation has exceeded $5 million. Problem loans have exacerbated the losses. Community sold off $15 million in troubled assets in 2003 and, in total, has taken about $30 million in chargeoffs since 2000. Board members, intent on preventing a replay, have worked overtime, updating company and board policies and procedures and overhauling committee charters and governance rules. In 2003 alone, Frawley estimates, they held about 110 board and committee meetings. “It’s taken a tremendous amount of time and effort on their parts, but they’ve held up well,” he says.

Community got its start in 1923 as the Bank of Blountsville and maintained a relatively sleepy existence until Patterson took the reins. In 1985, he opened a second branch in nearby Oneonta, Alabama and changed the name to Community. Over the next 15 years, the institution expanded rapidly, adding a consumer finance operation and an insurance agency. By 2000, Community boasted 32 branches and $720 million in assets.

When Debter and Lewis joined the board in the mid-1990s, there was no apparent reason for concern. Community, with a network of branches in rural Alabama and Tennessee and a balanced portfolio of mortgage, consumer, and commercial loans, was growing fast. The stock price was appreciating, and Patterson looked like a genius. “Everything was going so well, and his leadership and vision seemed to be so strong, that we didn’t really think about something going wrong,” recalls Lewis, a director since 1996.

Somewhere along the lineu00e2u20ac”no one’s exactly sure when, or whyu00e2u20ac”things changed. In July 2000, two employee directors alleged that a contractor building a new branch had overcharged the company, diverting some of the funds to subsidize the construction of Patterson’s new 17,000-square-foot house. Although most directors didn’t initially believe the charges, the board quickly set up a special committee to investigate them. Two days later, three shareholders filed suit claiming that Patterson and 12 directors had knowingly permitted the overcharges. In September, a former director and key shareholder filed a similar suit. Another suitu00e2u20ac”this one by the two employee directors, claiming they had been fired for whistle-blowingu00e2u20ac”followed.

The committee’s investigation came up empty, hindered, directors say, by Patterson’s denials and the seizure of key documents by law enforcement agencies, including the FBI, that also were interested. “We looked in a lot of places, but couldn’t find many answers,” recalls Lewis, who served on the committee. But directors did see enough in the reports to raise suspicions about Patterson, as well as concerns about the quality of information they were receiving from the bank’s law firm. (Government investigators eventually concluded Community had paid subcontractors about $2 million for work done at the CEO’s residenceu00e2u20ac”a finding Patterson disputes.)

For directors, the budding controversy carried a personal sting. As word of the allegations spread, community membersu00e2u20ac”many of whom were among the company’s 2,600 shareholdersu00e2u20ac””questioned our loyalty to the bank,” Lewis says. One day, an extensive story featured in a local newspaper painted a picture of a board in legion with the CEO. Debter showed the story to Lewis. “I said, ‘Jay, if you didn’t know any of us and read this, what would you think of us?’” Debter recalls. Lewis’s response: “I’d think we were a bunch of crooks.”

“I guess it hurt me a little bit. My family’s had a good name around here for a long time,” Debter adds. “But we decided to stick through it and do the right thing, and then at the end, not to be ashamed of anythingu00e2u20ac”to search for the truth and be proud of what we had done.”

In retrospect, the board clearly missed some signals. When Frawley joined the company in 2002 “there were red flags all over the place,” he says, which the board was either missing or failing to comprehend. The CEO was paid $1 millionu00e2u20ac”all in a lump sum at the beginning of the year, he notes, and the next-highest paid employee was his brother. Patterson’s wife was on the payroll as the bank’s interior decorator, and the largest single loan on the books belonged to the boss. “There were inadequate controls,” Frawley says. “The board was oblivious … naive to a degree. But they also were kept in the dark.”

Worse was the information flow. Community’s CEO pretty much spoon-fed a complacent board all the information he felt it needed and little more, according to board members. Both internal and external audit reports, as well as loan review reports and other financial documents, were filtered through Patterson, directors say. While Patterson never actually lied, they add, he left things out in presentations that supported his agenda. “You want to be skeptical, or at least impartial, but you trust people, too,” Lewis says. “This person was a master of giving pieces of information, and not the whole story, to help get what he wanted.” Clark, Patterson’s attorney, denies the assertion.

Things began to change in December 2002, when the audit committee hired Powell Goldstein as its own counsel. “For the first time, they had someone who was providing them with straight-up advice and representing them as a board, not the CEO,” Frawley says. Among the firm’s first moves was to advise a realignment of the seven-member audit committee to include only truly independent directors, cutting the number to four. The committee also replaced the auditors, and began getting its own unfiltered reports, directors say. As for Patterson, the board stood firm: Despite appearances of wrongdoing, an ambiguously worded employment contract made it almost impossible to force him out.

Then came January 2003. On Martin Luther King Day, the CEO had, unbeknownst to the board, filed for bankruptcy protection. The next day, Tuesday, he tried to convince directors to release a $5.3 million second mortgage secured by his company stock, Frawley says. Board members agreed to explore the idea, but didn’t give approval. Patterson had the mortgage released anyway. That Wednesday, as directors gathered in Atlanta for a meeting with regulators, Patterson’s attorney notified them that the CEO had filed for bankruptcy.

“We felt like we had been deceived,” Lewis recalls. “He was no longer the victim of allegations. He was looking out for himself and had shown he didn’t care what happened to the bank.” A testy, nine-hour board meeting followed.

Patterson, his son, the bank president, and a close ally voted to retain him. The four audit committee members, joined by a former president, voted to oust the CEO. Frawley was named as his replacement.

Today, Community’s board remains a work in progress, but one that, bolstered by years on the front lines of controversy, is much more knowledgeable and professional than in the past. Frawley has witnessed a lot of boards in action, including the high-powered group at BofA. “For most boards, things like civil money penalties and shareholder lawsuits are theories, concepts,” he says. For Community’s band of four, Frawley says, it’s all too real. “These guys have learned the hard way. As a result, they’re better directors than the people I’ve seen in much larger companies.”

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