The first time I sat on a bank board was in 1984, and I remember the board packet being around 50 to 60 pages. I recently saw a board packet for a bank that was over 600 pages, and on top of that was another 300 pages for the holding company. Considering that most banks have monthly board meetings, it’s like having to read War and Peace or Moby Dick each month.
People like to say that these monstrous board packets are really for the regulators, and while it might be largely true, it’s not entirely true. The true purpose is to help the board provide proper oversight, and even if regulators never saw the monthly board packets, directors still need to know what’s going on at the bank. And as regulations keep multiplying, so must board packets keep getting bigger to show directors that the bank is, in fact, complying with all the new rules and regulations.
One issue is how much of these 500 to 1,000 pages a director should read. I’ve never conducted a survey, but I’m pretty certain that very few directors read the whole thing. The truth is that each board member picks and chooses what he or she thinks are the most important pages to read. This might not be ideal, but I think it’s realistic.
What about the beginning of the board packet, which often contains the minutes of the previous meeting? I’ve always believed that the minutes are a director’s one best defense against being accused of negligence in a possible Federal Deposit Insurance Corp. (FDIC) lawsuit. I have heard many people over the years say, “You’re never going to get in trouble if the minutes show you asking questions, challenging management, and generally being a prudent overseer of the bank and the risk it takes.” I accepted this as truth, but I’m not certain anymore. I know someone who was on the board of a $12 billion asset California thrift that failed in 2008. The thrift had done loads of option adjustable rate mortgages, teaser rates and all, and this one director kept questioning the wisdom of these loans. It got to the point that the chairman/CEO found his skepticism so irritating that he tried to get him off the board.
With this director’s questions and doubts about the lending strategy splashed all over the board minutes, I’m sure he felt immune from any problems when the thrift failed. Apparently, none of this mattered. He was named with everyone else in the FDIC lawsuit, and seven years later, when he tried to start a new bank, he was told his application wouldn’t be approved because he was on the board of a failed thrift.
Regardless of how big board packets have gotten, it’s important that directors get them as much in advance as possible. What I really don’t get are those banks where the directors get the board packet the day they show up for the board meeting. I know two such banks. The owner of one of the banks is also the chairman, and the other directors don’t own any stock, so maybe they feel as if they have no real power. What I’d wonder about, though, is what happens if things fall apart. If either bank were to fail, I suspect it would come out that directors didn’t get their packets in advance. And I suspect that would be deemed unsafe and unsound in any FDIC lawsuit.
Is there anything to be done about this monthly tidal wave of pages to read? Aside from asking to receive board packets a few days in advance, a table of contents could help. That way, a director could know exactly where to go to choose those areas he really wants to read in depth. A second idea is executive summaries for each section. Another solution is for a board to pick a different topic each month to put greater emphasis on. If the board members knew that this month there would be an emphasis on, say, mortgage lending, they could read the pages covering that topic in depth before the meeting. Over the course of a year, they might read those parts of the packet they otherwise might not read.
A third possible solution is to have one page at the front with 20-30 of the most important ratios. They could be shown for the current month as well as the previous 12 months so that directors could easily spot trends and see where things might be deteriorating. Each metric could also have a maximum or minimum, and if any of them are exceeded, they could be highlighted in red. That way, even a director who didn’t read the other 499 ages could read this one page and see where the bank had serious problems that needed to be discussed. It shouldn’t be hard to figure out what those key ratios should be. Capital ratios and levels of non-performing loans would be two of the most important, and obvious, ones. A side benefit to this key metrics page is that it would make it impossible for management to steer the board away from difficult issues. Instead of the bad news being buried in the third paragraph on page 423, it would be right there, a bright red flag on page 1.
I will say that we’ve made great progress in going electronic. The days of lugging around thick binders seems mostly a thing of the past. But electronic board packets don’t make the packet shorter. Quite the opposite. It just makes it easier to put loads of information in there because there is less paper to photocopy.
Reading a 1,000-page board packet will never be as enjoyable as, say, reading Moby Dick or War and Peace. But we all do the best we can, reading as much as we have time for, skimming some parts and probably skipping some sections entirely. And with some of the improvements suggested here, perhaps it can work even better.
Some things never change, and it’s never too late to re-learn old lessons. Directors must remain independent, informed and involved in their institution’s affairs. It’s not enough to simply attend board meetings. Directors need to read materials provided by management, ask questions and actively participate in board discussions. And they should make sure their participation is accurately reflected in the minutes. Special care should be taken when considering transactions with insiders and affiliates, and directors should always require detailed presentations from management regarding steps to address regulatory criticisms raised in examinations or otherwise. In addition, professional advice and expertise should be sought when addressing complex issues or other out of the ordinary course matters, and fully documented when appropriate. 
Given that the FDIC has authorized lawsuits in a significant number of failed bank cases, directors are appropriately concerned about liability. I continue to believe that ensuring fulfillment of the two underpinnings of the business judgment rule—the duty of loyalty and the duty of care—remain a director’s best defense against such actions. The bank can help institutionalize that as a best practice by providing full board packages in a timely manner, strongly encouraging attendance at meetings, and making internal and external experts and counsel available to board members.
There has been a surge in FDIC lawsuits because there has been a surge in bank failures and FDIC losses due to the financial market meltdown and the great recession. Perhaps the most important lessons for bank boards are that 1) capital is KING and 2) process is KING. Moreover, a board has to be diligent and honest in terms of assessing management performance and replacing management as needed. Finally, and as discussed above, a board’s fiduciary obligations require that adequate systems be in place to monitor compliance with laws, regulations and policies and that boards be informed and engaged and take action as necessary when red flags indicate issues or problems in certain areas. A cardinal sin in banking, which mirrors this fiduciary obligation, is to have regulatory violations repeated, i.e., uncorrected. Uncorrected violations are probably the single most cause of civil money penalties against banks and their boards.
From a legal standpoint, a best practice is threefold. First, maintain capital levels substantially higher than the minimum levels necessary to qualify as well-capitalized, even if it causes the bank’s return on equity (ROE) to suffer. Second, make sure that the bank’s charter and by-laws provide the maximum legal indemnification protection permitted under the applicable law, including providing for advancement of funds during litigation to defend the directors. And third, be sure to maintain an adequate directors and officers liability policy with no regulatory exclusion, so the insurance company has an obligation to defend FDIC claims. The only good protection from a storm surge such as this is a good wall of defenses and a plan of retreat!
Excessive concentration of credit risk is a recurring theme in FDIC lawsuits. Boards need to monitor on an ongoing basis significant credit risk concentrations, whether it be in type of loan, type of borrower, geographical concentration, etc. Management reports to the board should address these and other concentration risks inherent in the institution’s loan portfolio.
Directors should pay attention to their D&O insurance. All policies are not equal and the insurance markets are constantly evolving. Banks and their boards should consider involving experts in the negotiation of the policy terms and cost. Independent directors may want special counsel to be involved. Beyond paying attention to D&O insurance, directors need to pay more attention—pure and simple. The recent case brought by the FDIC against directors of Chicago-based defunct Broadway Bank criticizes the directors for not digging into lending policies or the details of lending relationships and deferring entirely to management. Documenting involvement is almost as important as the involvement itself.
On average, the FDIC waited 2.2 years to file a lawsuit related to a failed financial institution, although the majority of recent FDIC lawsuits were filed more quickly.
Settlements
What banks have paid the piper from securities fraud lawsuits following the financial crisis?