Good Corporate Governance Starts With the Articles and Bylaws

governance-11-14-16.pngJust as a good diet and regular exercise contribute to a healthy lifestyle, good corporate governance and board oversight often serve as the foundation for the health and stability of any corporate organization. Corporate governance is often a difficult concept to nail down. In the highly regulated banking industry, the importance of good corporate governance practices is significantly amplified due to the additional layer of regulatory risk that may not affect businesses in other industries.

Although good corporate governance is often associated with maintaining certain policies and procedures, such as guidelines, codes of conduct, committee charters, shareholder agreements and intercompany and tax sharing agreements, we routinely encounter financial institutions that ignore or overlook one of the most fundamental aspects of corporate governance: the articles of incorporation and bylaws. In fact, we experience many situations in which financial institutions have articles and bylaws that are significantly outdated and have not been revised to comply with current laws, regulations and other corporate best practices. Failure to keep these governing documents current can not only raises legal and regulatory concerns, but oftentimes compromises the ability of the management team to protect and preserve the interests of its shareholders.

A comprehensive review of the articles and bylaws is recommended, particularly if you have not conducted such a review in the past. Set forth below is a summary of certain terms and provisions that may be of particular interest to your management and board of directors.

Compliance With State Corporate Laws
State corporate laws provide the basic foundation for the conduct of business of most banks and bank holding companies. Over time, these state corporate laws are revised or replaced with more modern corporate statutes. Although the corporate laws may evolve over time, many financial institutions fail to adapt their articles and bylaws to conform to these changes. In many cases, we encounter articles and bylaws that reference outdated and repealed laws and statutes that could lead to questionable legal interpretations and uncertainty in many critical situations.

Limitation of Personal Liability and Indemnification of Directors and Officers
Most state corporate laws have provisions that permit a corporation to limit the personal liability of, and/or provide indemnification to, directors and officers pursuant to provisions in its articles or bylaws. Typically, the ability to limit liability and provide indemnification to directors and officers is eliminated in certain situations such as a breach of fiduciary duty or intentional misconduct. However, we routinely experience situations in which the limitation of liability and indemnification are either not addressed by the articles or bylaws or contain provisions that may not fully protect the interests of the management team.

Electronic Communications
As technology continues to evolve, many state corporate statutes have been revised to permit certain shareholder and director communications, such as notices of shareholder and director meetings, to be delivered in electronic format. Despite these statutory revisions, if your institution’s articles and bylaws require physical delivery of these notices, you might not be able to take advantage of these newer and less costly forms of communication.

Uncertificated Shares
As financial institutions continue to consolidate and increase their shareholder base, the use of third-party transfer agents is becoming more prevalent for the management of stock transfer records. Most transfer agents have implemented uncertificated book-entry systems as a means of recording stock ownership, which eliminates the need for physical stock certificates. However, it is not uncommon for the articles and bylaws to specifically require the issuance of physical stock certificates to their shareholders. Obviously, these provisions must be revised before implementing an uncertificated stock program.

In addition to the specific matters addressed above, some other important areas to consider when reviewing your articles and bylaws include the shareholders’ ability to call special meetings, the process for including shareholder proposals at annual or special meetings, the implementation of a classified board of directors, the process for the removal of directors, mandatory retirement age for directors, shareholder vote by written consent and a supermajority vote standard for certain article and bylaw amendments, such as limitation of liability and indemnification.

A review of your institution’s articles and bylaws is only one component of the broader corporate governance umbrella, but it is one of the more important and fundamental aspects of your board’s corporate governance responsibilities. Routine maintenance of these fundamental corporate documents will be a good start towards enhancing your institution’s overall corporate governance structure.

Four Ways Board Members Can Avoid Personal Liability

9-24-14-Dinsmore.pngOn 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?

  1. 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.

  2. 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.
  3. 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.
  4. 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.