Publications & Resources

October/November 2005
Focus: Directors Issues

Board membership: A serious commitment

By Mark C. Horton

There’s no doubt that serving on the board of directors for a financial institution is an important responsibility. Boards are receiving extra scrutiny these days given the recent spate of high-profile corporate fraud scandals. It’s definitely a commitment that shouldn’t be taken lightly. Directors are charged with the duty of supervision and control over the business affairs of the financial institution. That includes such items as selecting the institution’s executive management and determining the size and composition of the board. In addition, board members have an interest in protecting themselves from potential liability issues. As the saying goes, “You are at the helm of the ship, but you are not alone.” The board must set the strategic direction and policies of the company and monitor management’s execution of those direction and policies.

The recruitment and retention of competent directors is extremely important to the welfare of a financial institution. It is the responsibility of the board to hire and fire the management of a bank, while operating the institution efficiently through strategic planning, business development and policy formation. The board entrusts the day-to-day operations of the bank to management. However, a board member can’t delegate his or her responsibilities to management. The implementation of the policies and procedures prescribed by the board is delegated to management. The board must insist on open communication with management to ensure that management is adhering to the board’s overall direction and to circumvent any issues that may arise. It is important to receive a complete and accurate picture of the operations of the financial institution in order to make informed decisions.

The proper composition of the board is another responsibility a director will face. The “good ol’ boy” network is no longer acceptable. Men and women representing all facets of the community and those who are active in the community are serving on boards. Selecting a member who will add their own expertise is vital to the overall composition of the board. Potential members should be selected for their own ability to contribute to the operations of the corporation not for their prestige, wealth or social status. Remember, the board is in charge of policy formation, supervision of financial control, strategic planning and business development. In addition to the composition of the board, the number of members is an important consideration. There is no magic number but it’s usually an odd number. The Office of the Comptroller of the Currency allows a range of a minimum of five to a maximum of 25 and most state regulations require a minimum of five. The key is to have a number that is representative of the entire community the financial institution serves.

The search for the right board member is a demanding process which includes recruitment, screening and selection. It’s important to try to acquire the best mix of talent to improve the board’s bench strength. A plan should be in place prior to the search that clarifies the bank’s objectives and the challenges it faces in the future. In addition, the following questions should be answered before the search process begins: What type of person is the board seeking? What competencies and qualities are required of the candidate? What is the person’s character? The board should seek recommendations, conduct the interview process and ask for references. The ideal candidate should possess financial skills and background, and have had previous boardroom exposure. Once a candidate is selected, the board should provide him or her with the bank’s mission statement and organizational structure, a list of board committees, a copy of the by-laws and articles of incorporation, an annual report and policies and procedures that relate to conflict of interest and self-dealing.

Directors of financial institutions can be held personally liable, either criminally or civilly, for actions or lack of action taken while serving on the board. The newspapers are filled with articles about companies being sued over mergers and acquisitions, financial concerns and personal self-dealing. There are three areas of liability which can impact a director: statutory, common law and personal. Statutory law consists of bank regulations such as the National Bank Act and Federal Reserve Act. These laws regulate items such as the amount of interest a director can be charged on a bank deposit and other financial transactions. Common law liability involves civil and criminal matters and conflicts of interest. Civil matters include enforcement actions against a bank including a cease and desist order and a memo of understanding due to poor direction or no direction exhibited by the board. Criminal matters include embezzlement or misapplication of funds or receipt of a gift or commission after transacting business with a bank. An example of conflict of interest would be declaring payment of a dividend that would adversely impact the financial institution. Personal liability consists of a breach or failure to perform duties and self-dealing as well as willfulness and recklessness on the part of the director.

A violation of any of these liabilities can result in a lawsuit brought by shareholders, customers, and regulatory bodies. In many cases, these claims are resulting in large verdicts against financial institutions, as well as directors who thought they were “in the right.” No director is immune from such lawsuits. The board of a financial institution must protect the assets of the bank and each director must protect his or her personal assets. The best way to do this is to have an effective insurance plan in place. Directors and officers liability insurance protects individuals from the personal liability exposures they might face while performing the duties of a bank director or officer. The banking industry is heavily regulated so it is subjected to financial risk because of its legal indemnification obligations. This obligation, along with the Sarbanes-Oxley Act, has further increased the need for directors and officers to be protected by D&O insurance.

Board members of financial institutions should take care to develop an open communication relationship with bank management to assure that they have a complete grasp of the financial institution’s operations. Bank directors should not hesitate to ask the hard questions. In the end, it is the valuable information they gain from asking those questions and the sound judgment they exhibit in given situations that will make them valuable contributors to a bank’s success.

Mark C. Horton is national director, community banks for St. Paul Travelers in Saint Paul, Minn. He can be reached at (501) 223-6712 or mchorton@stpaultravelers.com.