Publications & Resources

October/November 2006
Focus: Directors Issues

Directors’ Obligation to Establish a Well-Functioning Board

By Brent Faye

Yearly, boards of directors recommend slates of director nominees to their shareholders. How many directors recognize that they have an obligation to shareholders to assure that the nominees for election are qualified for the job? Maybe one of the nominees has proven ineffectual or does not attend board or committee meetings on a regular basis. Can a director in good faith recommend such a person to the shareholders? How does the board handle unqualified members? What qualifications should a director possess? Should there be an age limit? What sort of education and training should be provided to assure directors have sufficient knowledge to serve on a bank board? These are questions that all bank directors should ask themselves. This article will provide guidance to directors the next time they prepare a slate of director nominees for consideration by their shareholders.

The Duty to Recommend Qualified Nominees

When the board of directors prepares its slate of director nominees for election, it is recommending that slate to the shareholders. In essence the board is representing that each of the nominees is qualified to serve as a director. Recommending a nominee who the board knows is unqualified constitutes a breach of the directors’ fiduciary duty to act in the best interests of the bank and its shareholders. Also keep in mind that the nomination procedure is, in general, the only way to remove an unqualified director. During a director’s term of office, a director can only be removed for cause (insanity or conviction of a felony) or by a vote of the shareholders.

Directors Must Be Active Participants

Directors who consistently miss board meetings cannot knowledgeably participate in board activities or adequately represent the bank’s shareholders. Likewise, directors who come to board meetings unprepared or demonstrate an inability to handle, or a lack of interest in, matters coming before the board cannot be said to be active participants in the board’s affairs.

Establish Minimum Requirements for Directors

To prevent any misunderstanding amongst board members, it is good practice to establish a policy or charter setting out the bank’s minimum requirements for directors. Basic requirements might include board attendance and the willingness to commit the time necessary to prepare for meetings; the ability to generate business for the bank; demonstrated analytical ability; the ability to read and understand financial statements; and the ability to exercise sound independent judgment. Each bank might also establish additional criteria to meet the specific requirements of the bank, such as technological expertise or knowledge of specific industries. Banks with securities listed on stock exchanges have additional requirements, such as having a financial expert on the audit committee.

The Need For Independent Directors

Additionally, the board will want to assure that at least a majority of the directors are independent. At a minimum, independence would entail directors who are not officers or employees of the bank. For a bank whose securities are registered under the Securities Exchange Act of 1934, as amended, additional criteria apply.

Considerations in Establishing Age Limitations For Directors

Directors who are not employees of the bank are not subject to federal and state age discrimination statutes. However, there are sound reasons for not establishing a maximum age for directors. For instance, once an age limit is established, it must be applied uniformly. Exception could not be made for the one 70 year old director who the bank would want to retain. Also such a restriction could send the message that the bank does not value senior citizens. (Think of your retired customers).

The Need For Continuing Director Education

Most bank boards conscientiously assure that officers and employees are properly educated. What about the directors themselves? Orientation programs should be established for new directors, especially directors with no prior financial institution experience. Matters presented could include the duties and responsibilities of the directors, an overview of the banking industry and the bank regulatory process, including insider transactions, and the operations of the bank. But education cannot stop there. Education must be on ongoing. Directors must be kept abreast of new issues as they arise. In recent years bank directors have become responsible for administering such complex issues as BSA compliance, privacy, and technology security. A continuing education program for directors should be established, including advising directors of the availability of programs put on by various trade organizations such as WIB.

Brent Faye is a partner on the Regulated Financial Institution (RFI)Team of Nixon Peabody LLP, Attorneys At Law. He can be reached at 415-984-8365 or rfaye@nixonpeabody.com.