Publications & Resources

December 2002/January 2003
Focus: Corporate Governance

10 Commandments For Community Bank Corporate Governance

By Jeffrey C. Gerrish

Corporate governance for large or small institutions, while always important, has recently been thrust into the headlines. Corporate governance is simply a fancy way to refer to the inter-workings of the bank or bank holding company at its highest levels including the board of directors, board committees and senior management. Because of the recent scrutiny applied to corporate governance issues, a review and analysis, or in many cases an overhaul, of the corporate governance processes in our community banks is likely necessary. The following 10 commandments will provide food for thought on the key areas where our attention should begin to focus.

Thou shalt realize, the times, they are a changin’!
Corporate governance for most banks and bank holding companies, other than the largest, has been a non-issue for the last decade at least. Times are changing even for the smallest bank which now will require certain corporate governance restructuring. Thanks to the apparent lack of integrity and values in the operation of large corporations such as WorldCom and Enron, all of us large and small have to play.
Thou shalt establish an effective, capable and reliable board of directors
Every community bank or bank holding company should have an effective, reliable and capable board of directors. This means having individuals with integrity who are qualified and successful in their own fields and who have the capacity, understanding and interest to focus on the financial services industry. That means that a majority of your board of directors should be truly outside, independent directors. Outside independent directors will have some stock ownership (you really don’t want somebody running the company who has no financial interest) but would otherwise be independent; being “independent” typically implies that the individual does not work for the company, does not have a material business relationship with the company, and is otherwise able to provide independent advice. The board must be effective and should meet in executive session at least monthly without the CEO, even if the CEO is a member of the board. The board also should set the long-term strategy, policy and values for the organization. However, the board should not micro manage the institution.
Thou shalt establish a corporate code of ethics for the bank or bank holding company
As Yogi Berra said, “if you don’t know where you are going, you will wind up someplace else.” If corporate ethics, values and the like are not established at the top, at the board level, and used to govern the operations of the company, both from a long-term strategy and a daily basis through executive management, then executive management certainly cannot anticipate that the rank and file employees will follow such a code on their own. Establish a workable, reliable and realistic corporate code of ethics for the way the company will conduct business internally and externally and review the code of ethics annually and have board members and executive officers assist in the development of the code of ethics.
Thou shalt consider establishing an office of the chairman of the board
Many large organizations are considering establishing an Office of the Chairman of the Board. This will be a paid, full-time position. It will be compensated only by salary and not subject to any type of supervisory authority by the executive management of the company. A full-time Chairman of the Board will report only to the board and will be the board’s eyes and ears on a daily basis in connection with the workings of the company. While this certainly may not be feasible for many smaller community banks, it is still a concept worth exploring with respect to having a truly independent board chairman.
Thou shalt have an effective and operating audit committee, compensation committee and nominating/corporate governance committee
The audit committee, compensation committee and nominating committee should be composed of all independent, outside directors of the company who operate independently. These committees should have access to attorneys and consultants, paid for by the company other than the corporation’s customary counsel and consultants. Clearly, under the new Sarbanes-Oxley Act, for SEC reporting companies, the audit committee is entitled to such independent counsel and representation. The audit committee should directly retain the auditors and set the scope of the engagement. The committee also should monitor outside, non-audit work performed for the company by the auditors.

The independent nature of the compensation committee and nominating committee is also critical. The compensation committee should not be a rubber stamp for management. The nominating committee should consider establishing an evaluation system for board members. Simply because you are a board member elected at the last election, you should not automatically be re-elected at the current annual meeting, unless you bring some value to the institution.
Thou shalt consider effective board compensation
Directors, particularly with their new duties, responsibilities and liabilities, should be fairly compensated. However, admittedly, directors never will be truly compensated for the risk inherent in the position. Appropriate questions to consider are as follows. Should directors receive additional compensation for serving on some of the critical committees, such as audit, compensation and nominating? Probably so. Should directors receive stock options? Many do, as a way of keeping directors focused on the value of the company. If the bank or bank holding company’s goal is to attract and retain the highest quality employees, it also should attract, retain and maintain the highest quality directors.
Thou Shalt Require Continuing Education For Directors
The financial services industry is moving rapidly in a number of different directions. It is critical, even for the smallest institution, that directors be educated about the options and opportunities for the institution. Only then can they make wise choices with respect to its effective long-term strategies. Many state associations and other trade groups are now offering educational programs targeted specifically for directors. Your directors should take advantage of these options.
Thou shalt establish procedures for board succession
A critical issue of corporate governance is to make sure qualified board members are available. This involves issues of succession. Does the holding company have a mandatory retirement age that is actually enforced? Does a board self-evaluation process exist to rid the board of non-productive directors? Does the company have a plan to maintain a fully staffed board of directors with capable people, no matter what the ages, as it moves forward for the next several years? All of these must be addressed under the umbrella of corporate governance.
Thou shalt disclose, disclose, disclose
Publicly held banks and bank holding companies (greater than 500 shareholders) will find that disclosure will be quicker and more onerous than in the past. Even for private companies and banks, those with less than 500 shareholders, disclosure needs to be stepped up. This may be through quarterly letters to your shareholders or other types of communication. But some means of communication, though not legally required, will go a long way toward furthering the confidence of your shareholders in your institution.
Thou shalt recognize that your duty is to establish corporate governance procedures that will serve to enhance shareholder value
The primary job of the board of directors is to enhance the value of the shares held by its shareholders. This is generally done through growing earnings, providing an adequate return on equity, providing liquidity in the shares and some type of cash flow off the shares. All of that is contemplated within an overall strategy established by the board. Corporate governance procedures now should be part of that strategy and should be designed to enhance the long-term value for the shareholders.

Jeffrey C. Gerrish is chairman of Gerrish & McCreary Consultants L.L.C. and a member of the Memphis based law firm of Gerrish & McCreary, P.C., Attorneys. The two firms have assisted over 900 community banks in 47 states with mergers and acquisitions, bank holding company formations and use, acquisition and ownership planning for boards of directors, strategic planning for boards of directors, regulatory matters, ESOPs and other matters of importance to community banks. He can be reached at (901) 767-0900.