On a daily basis, we are learning about fraudulent or irresponsible activities in some of America’s largest companies. And, we are learning that, in many cases, the banks are accused of being a part of the frauds and accounting tricks that were committed. At a minimum, they are accused of turning a blind eye to unethical or crooked activities.
The reports of wrongdoing probably make every bank director wonder why he or she agreed to assume the risk of becoming a board member. Having second thoughts about accepting a board seat is more likely if a director is serving on the board’s audit committee. The personal liability exposure for bank directors continues to escalate. Regulators and the plaintiffs bar accuse board members of negligenceu00e2u20ac”oru00e2u20ac”worse for failing to dig out and stop corporate accounting problems before they caused huge financial damages.
Board members nervously wonder whether their directors and officers liability insurance, provided by most banks, will adequately protect them. And very few banks regularly have an independent audit of their D&O insurance to ensure they have adequate coverage.
Even the most well-meaning director cannot perform well if the information that he or she receives does not provide the “facts.” In the alleged Enron frauds, one of the accusations is that financial institutions were part of the “sham” transactions that were designed to make loans look like “forward sales.” If these accusations are true, how could directors of the banks have known of this activity? In these cases, very large amounts of money were involvedu00e2u20ac”more than a billion dollars in some transactions. The banks have denied being involved in the “sham,” but government prosecutors are trying to put the corporate employees in jail for their participation in the alleged schemes. If the government succeeds, the plaintiffs bar will have a field day attempting to hold the banks, and their directors, liable for the losses incurred as a result of phony deals.
On another front, banks are taking huge hits from loans to telecommunication companies and the losses are still increasing. Directors will be called to explain their failure to curb this lending.
How is a bank director supposed to protect himself and the bank from this kind of fraud or reckless lending?
I’d like to give you a nice, neat, bulletproof answer, but such an answer escapes me. The fact is, directors are pretty helpless if the information they receive is inaccurateu00e2u20ac”or worse.
The new corporate governance law requires audit committees to have a qualified financial expert as a memberu00e2u20ac”generally interpreted to be an ex-CPA, a CFO, or an equivalent. I guess I’d qualify, as I’m an ex-CPA and ex-CFO, but I don’t know what I could do if the information the audit committee received was not adequate.
The first line of defense for a director is to be able to rely on the management the board appoints to be honest and to keep the board fully informed. Every director at every board meeting should make a judgment on the honesty and forthrightness of the management.
The second line of defense is the professional advice received from CPAs, attorneys, and other experts. Are these professionals acting in an independent manner that shows that they see their primary allegiance to the board and the shareholders?
The new law requiring separation of audit and consulting services by auditing firms will help make them more independent. But the issue of control over “independent” auditors remains unanswered as long as the companies they audit are the ones footing the bill.
Beyond that, the development of a series of red-flag tests for fraud could be of some help. Red-flag lists are available from your auditor. Software is also available that analyzes financial results and explains in pretty clear language what it finds (for example, “cash flow is inadequate to support the income figures report,” “inventories are increasing at an unsustainable rate.”)
But it boils down to this: No matter how good a job a bank director tries to do, the risk to his pocketbook exceeds the reward. So why be a bank director?
Because without good directors, the U.S. banking system could not function and neither could your company. So, my fellow directors, (I’m a director of three small banks) though you have a lot to lose and little to gain, it’s really a great public service we must perform.
Just don’t hold your breath waiting for the public to give you credit for it.