06/03/2011

Effective Strategies to Support Board Deliberations


Meaningful boardroom deliberation indicates that directors of banks and their holding companies are fulfilling fiduciary obligations and meeting regulatory expectations. Robust discussion of complex topics often requires officers to play a critical “assist” role by gathering and providing complex information to directors in a clear and comprehensible format. Thus, successful presentations by officers can be the foundation for well-informed decisions. In this article, we suggest a toolkit of five practical techniques for directors and officers to consider when gathering information and considering complex issues. For each technique, we give an example by using a hypothetical involving a recommendation to increase a bank’s provision for loan losses. We begin this article with an overview of relevant fiduciary duties and regulatory expectations regarding corporate governance.

Overview of Fiduciary Duties

The corporate laws of most U.S. states provide that the principal fiduciary duties of directors are the duty of care and the duty of loyalty. The duty of care requires directors to exercise the level of care that a normally prudent person would exercise under similar circumstances. Directors fulfill the duty of care by becoming well informed prior to making a business decision, engaging in deliberations during meetings, and considering the advice of experts when appropriate. The duty of loyalty requires directors to act in good faith and in the best interests of the corporation and its shareholders. Directors fulfill this duty by disclosing any conflict of interest and taking actions that permit the disinterested directors to make a well-informed decision without regard to the conflict. In some states, directors also have a duty to ensure that a company implements adequate information reporting mechanisms.

Officers of Delaware corporations owe the same duties of care and loyalty as directors. State corporate statutes following the Model Business Corporation Act (“MBCA”) define virtually identical general standards of conduct for directors and officers. In addition, the MBCA requires an officer to report up the chain of command any known material information regarding a corporation’s affairs.

A breach of a fiduciary duty can result in personal liability. In extreme circumstances, a court may also overturn a board’s decision based on a violation of fiduciary duty. While directors and officers generally owe their duties to the corporation, both a corporation and its stockholders may file a legal action regarding a breach of duty. The class of potential plaintiffs expands to include creditors once management or the board becomes concerned about the financial viability of the corporation and its ability to pay debts as they come due.

Regulators’ Expectations Regarding Corporate Governance

Bank regulators’ expectations regarding corporate governance often generally align with state law fiduciary duties. Sound board oversight is a crucial element in meeting regulatory expectations regarding corporate governance. For example, the FDIC expects directors to make business decisions on the basis of fully informed and meaningful deliberation. The FDIC has stated that it will not bring civil suits against directors or officers who fulfill their fiduciary duties and make reasonable business judgments “on a fully informed basis and after proper deliberation.” Similarly, the following excerpt from a recent enforcement action provides a detailed illustration of the FDIC’s expectations regarding corporate governance:

“[T]he Board shall … assum[e] full responsibility for the approval of sound policies and objectives and for the supervision of Bank management and all of the Bank’s activities, consistent with the role and expertise commonly expected for trustees/directors of banks of comparable size. This participation shall include meetings to be held no less frequently than monthly at which, at a minimum, the following areas shall be reviewed and approved: reports of income and expenses; new, overdue, renewed, insider, charged off, delinquent, noncurrent and recovered loans; investment activity; adoption or modification of operating policies; liquidity and funds management; individual committee reports; audit reports; internal control reviews including managements’ responses; reconciliation of general ledger accounts …. The Board shall maintain adequate and complete minutes of all Board meetings, approve such minutes and retain them for supervisory review.”

In some cases, regulatory expectations exceed fiduciary duty standards. For example, the Federal Reserve expects boards to: “oversee bank management to ensure it operates in the best interest of the shareholders and other stakeholders (e.g., employees, customers and community).” Accordingly, the Federal Reserve expects the boards it supervises to consider the interests of constituencies other than just shareholders and creditors when establishing policies. Accordingly, a board deliberating on a complex issue will also want to consider the impact of the proposed action on these stakeholders. Directors should seek legal advice in situations where the interests of other stakeholders may be directly opposed to the interests of shareholders and, in insolvency or near-insolvency contexts, creditors.

Toolkit to Support Board Deliberations on Decisions Involving Complex Information

We suggest directors and officers consider using some of the following techniques to support robust board deliberations of complex issues. For each technique, we give an implementation example based on a hypothetical situation in which a bank’s Chief Credit Officer (“CCO”) learns that the bank’s loan portfolio has weakened at a rapid pace and together with the Chief Financial Officer (“CFO”) seeks board approval of a significant increase in the provision for loan loss expense.

1. Develop a Roadmap

Technique. When a director or officer identifies the need to make a decision involving highly important, complex information, she could develop a roadmap for the decision making process together with the board chair, lead independent director, or other appropriate director. We recommend that a roadmap provide for multiple opportunities to expose the board to complex information, allowing directors to develop the well-rounded understanding of the subject matter necessary for well-informed deliberations and decision making. Here are some examples of questions to ask when developing a roadmap:

  • Who has the authority to make this decision?
  • By when does the decision need to be made?
  • What meetings and/or calls do we need to schedule?
  • What resources will we need?

This practice provides a disciplined approach for developing strategy and marshalling resources in what could very well be a crisis situation.

Hypothetical example. During their first discussion of the loan loss expense issue, the bank’s CEO, CFO, and board chair develop a roadmap for decision making that:

  • Identifies the full board as the decision maker;
  • Provides a schedule of weekly conference calls for the board during which the issue will be discussed;
  • States specific action items to be delegated to the loan committee;
  • Specifies deliverables to the board to provide background information;
  • Indicates a deadline for developing a communications plan for this issue; and
  • Indicates a deadline for approving the amount of the loan loss provision expense.

2. Explain Why the Decision Is Difficult

Technique. A well-informed board understands not only why it needs to make a decision but also why the decision may be difficult. In preparing board presentations on complex issues, officers should avoid presenting a seemingly “easy” decision. An officer may want to consider the following (or other similar) questions when preparing a board presentation regarding a complex issue:

  • Does this presentation clearly explain the benefits and risks of the proposed action?
  • Does it provide an apples-to-apples comparison of alternative courses of action?
  • Does it identify any reasons for not approving the proposed action?
  • Does it describe the likely impact of the proposed action on the bank’s various stakeholders?

Additionally, if a there is a significant range of internal opinions on the issue, the presenting officer should consider sharing this with the board as well.

Hypothetical example. During the board meeting presentation, the bank’s CFO explains that:

  • The amount of the loan loss expense provision has a direct impact on reported earnings;
  • An overstatement of earnings can result in a violation of law;
  • An understatement of earnings would unduly have a negative impact on depositor confidence and the price of the bank’s stock; and
  • The proposed action could have an impact on the bank’s capital, employee morale and depositor confidence.

The CCO provides a brief overview of the range of internal opinions regarding the outlook for the local economy, the strengths and weaknesses of borrowers, and the resulting alternative loan loss projections.

3. Use the Power of the Question

Technique. By asking thoughtful questions, a board can explore many aspects and viewpoints concerning a complex topic and can shape a dynamic information-gathering process. Questions can also be used to remind a presenter to not rely on acronyms or industry jargon during a presentation about a complex topic.

The presenting officer should gather and present the information in a way that will permit the board members to learn enough about the topic to be able to ask thoughtful questions. In doing so, officers should be sensitive to the knowledge base of their board members as well as their possibly different learning styles. An officer may want to consider the following (or other similar) questions and whether the presentation answers them adequately:

  • Am I providing the information clearly enough at this stage to allow my board to ask thoughtful questions that could shape the discussion of this topic?
  • What questions would a director ask who knew everything that I know?
  • What else will the directors want to know?

Hypothetical example. After management’s presentation regarding projected loan losses, directors asked questions regarding the bank’s methodology for projecting loan losses and determining suitable reserve amounts, including:

  • What benchmarks will our regulators use to determine the adequacy of reserves and capital?
  • Has the regulators’ guidance in this area changed recently?
  • What developments in our local economies have you observed and documented that will impact our loan losses?
  • What is the process by which the performance of large loans is analyzed and how robust is that process?

4. Engage Outside Advisors

Technique. Outside advisors provide particular value when an organization has not developed a significant expertise regarding the relevant subject matter. Additionally, independent outside advisors can assess quality of the resources that management has applied to addressing a complex matter. Furthermore, independent outside advisors may be required when there is a management conflict. When deciding whether to engage outside advisors, a board can consider asking the following questions:

  • Would these advisors provide resources or expertise that we do not have in-house?
  • Is there any reason the outside advisor needs to be independent of management?
  • Does the proposed outside advisor have appropriate experience and credentials?

Unless it is important for the advisor to be independent of management, officers may want to consider recommending advisors and offer to assist in the evaluation of their credentials.

Hypothetical example. At the board meeting, the CCO explains to the board that a key factor in determining the amount of the bank’s projected loan losses is the accuracy of risk ratings for the bank’s loans in its commercial real estate loan portfolio. During the board’s executive session, it decides to engage an independent outside expert to review and rate those loans and to report on whether the bank’s ratings methodology should be revised. After considering the proposals of several firms that provide this type of service, the board approves the engagement of one of these firms. The team leader provides progress reports during the board’s weekly conference calls and attends the next board meeting to explain the firm’s findings and recommendations.

5. Use Committees Effectively

Technique. Highly important complex matters often merit both committee involvement to assess the matter and develop a recommendation and board involvement to deliberate and decide on a course of action. Appropriate roles for a committee in dealing with a highly important complex matter include:

  • Identifying important issues;
  • Questioning the assumptions and conclusions of management and its advisors;
  • Recommending independent experts or advisors;
  • Formulating recommendations; and

Assisting in the selection of read-ahead materials to frame issues for discussion.

For example, a committee can assist a board with a complex strategy decision by developing subject matter expertise to facilitate active deliberations at the board level and arranging for outside experts to provide an educational presentation to the board.

Hypothetical example. Provisions for loan losses are developed within a particular context, taking into account many factors, including but not limited to historical loan losses, lending practices, current level of nonperforming loans, and local economic conditions. Directors need to understand all of these factors to make a well-informed decision. To address this information need, the board delegates the following tasks to its loan committee:

  • Identify resources and develop expertise on each relevant factor;
  • Work with an independent outside expert to evaluate management’s assessments of these factors; and
  • Develop a list of issues and questions for the next board meeting.

Conclusion

The toolkit for promoting better understanding of complex issues is designed to facilitate robust deliberations and sound decision making. These practices will likely be most effective in organizations where directors are intellectually honest about their level of understanding, and where officers feel comfortable sharing with the board their candid perceptions of risks and uncertainties. We suggest directors and senior management consider which practices could be useful for their organization and agree to apply them. We encourage directors and officers to annually evaluate the quality of board presentations and deliberations. Based on these evaluations, directors and senior management can agree to implement additional steps to improve presentations and deliberations. This approach assists directors and officers in their efforts to fulfill their fiduciary duties and meet regulatory expectations.

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