Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, May 16, 1993 TAG: 9305160065
SECTION: BUSINESS PAGE: D1 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
But now, thanks to new laws and court decisions, that place of honor has become a hot seat.
The changes are designed to force directors to accept more responsibility for the health of their banks. It makes service on a bank board more onerous - and more of a lightning rod for lawsuits - than a seat on any other type of corporate board.
Consider some recent headlines in American Banker, the industry's main trade paper:
"For some directors, '91 law is last straw."
"Guidelines fail to protect directors."
"Director liability: a truly frightening decision."
"Directors face an impossible situation."
Yet banks in Western Virginia say there have been no resignations of their board members, at least so far.
"Most of them don't have a clue as to what's going on," said Vittorio Bonomo, associate professor of finance, insurance and business law at Virginia Tech and an expert on banking.
He has been talking to boards of small banks, informing directors about their new liabilities.
Yet he foresees no trouble getting new recruits to serve on bank boards. "Most people are happy to serve," because not even a hospital board can equal the prestige.
Nor does Bonomo believe the new rules are too burdensome.
Bank board seats always were an "honorific," or a means of obtaining additional accounts, Bonomo said.
This was good business for the bank. The new director enjoyed prestige, the opportunity to form relationships with other businessmen on the board and, in the old days, smoother dealings with the bank.
"It's a good thing to feel like they're under the gun a little more," Bonomo said.
The change in the world of banking began in 1989 with the Financial Institutions Reform, Recovery and Enforcement Act, which made it easier to prove wrongdoing by bank officers and directors.
That act said that a "director or officer of an insured depository institution may be held personally liable for monetary damages in any civil action by . . . [the FDIC] for gross negligence."
That means that, if an institution should fail, the directors' personal assets are directly at risk.
Then came the FDIC Improvement Act of 1991, which further increased directors' workloads, especially those who served on bank audit committees. It became effective this year.
FDIC's proposed guidelines under the act require that all banks with more than $150 million in assets have audit committees composed entirely of so-called outside directors, or people not employed by the bank. That excludes most small community banks - which most banks are.
At banks with more than $500 million in assets, at least two audit committee members must have financial experience. All of Virginia's statewide banks have assets of at least several billion dollars and, thus, are covered by the new rules.
And none can have a "significant relationship" with the bank. That is defined by a pending proposal as a large customer whose borrowings total 1.25 percent of the institution's total assets or have a relationship that accounts for more than 1 percent of its income. That seldom would be a problem except at a small bank.
Those outside audit committee members must approve the annual audits of the bank, in effect becoming virtual bank examiners themselves. They must certify the bank's safety and soundness and its compliance with internal controls.
And all directors must be "fully informed" with "ample information" before they act on bank business.
All of these vague and largely undefined terms are a virtual invitation for a lawsuit, either by regulators and creditors in case of a failure or by disgruntled stockholders in case of disappointing results.
The grounds don't have to be anything as serious as outright fraud. Poor business judgment, such as approving a loan that turned sour, is sufficient reason.
In cases in which the government alleges fraud, however, the recent Crime Control Act would seem to bar the bank from indemnifying (or reimbursing) directors for any fines and defense costs. In such an extreme situation, a director's assets could be frozen pending outcome of a trial.
Courts, meanwhile, have continued to be severe in their handling of bank officers and directors.
A recent federal case, decided in Utah, shook the industry.
In that case, a court ruled that a director could be held personally liable for a civil fine - meaning his assets would be at stake - to the Federal Deposit Insurance Corp. even if the evidence showed neglect of duty rather than fraud.
The court said regulators must prove that directors were guilty only of simple negligence in handling bank problems, rather than the higher legal standard of gross negligence.
All of these factors mean that directors must become more actively involved in the day-to-day operations of the bank or thrift.
At Western Virginia banks, board members have maintained their equanimity. There have been no resignations and, so far, no problem filling the few vacancies up for grabs.
That's probably due to the sound condition of virtually all banks in this area, ruling out attacks by the FDIC and keeping stockholders content and out of court.
"It doesn't worry me," said William R. Battle of Roanoke, who is a director of Richmond-based Crestar Financial Corp. and a member of its audit committee.
There's a real obligation to stay well-informed about Crestar's business, he said, and the board must pay attention to the activities of the staff running the bank on a day-to-day basis.
Directors, he said, must work hard and take the job seriously.
Battle, former chairman of the board at Roanoke's Shenandoah Life Insurance Co., said he feels confident about Crestar's quality.
"It takes more work," Battle said of a director's new duties. He spends more time at the task and tries to inform himself. "You do your job."
"It's not a major concern to our board members," reported Cheryl Jenkins, a spokeswoman for Crestar Bank.
"The [Crestar] board hasn't raised it as an issue," Jenkins said.
But, "certainly you think of it very carefully," said James McComas, president of Virginia Tech in Blacksburg, who recently accepted an appointment to the board of First Union Corp. of Charlotte, N.C. The potential liability was just as high when he was a director for Dominion Bankshares Corp. prior to its acquisition in March by First Union, he said.
Court cases now seem to be going in both directions, McComas said, and the banking system has many safeguards.
The potential liability is there, McComas said, but he believes the risks have been reduced as long as board members are conservative in their approach to decisions.
Every position carries potential liability, McComas pointed out, particularly his own career as president of Virginia Tech.
"It's no great problem," said Brenton Halsey, who joined the First Union board in April with McComas.
Halsey, chairman emeritus of James River Corp. in Richmond, said bank directors in particular must be "extremely diligent," keep abreast of the bank's business and act quickly in case a problem arises.
He called First Union a very healthy organization that is well-run and conservatively managed.
Andrew T. "Kip" Moore Jr., senior vice president and corporate secretary at Signet Banking Corp. in Richmond, said banks greeted the new obligations calmly because they already are accustomed to heavy government regulation.
"We've learned how to adjust and deal with reporting responsibilities," he said.
The FDIC "overreacted," he said, but that's understandable because of the number of banks and thrifts that have failed.
In a few years, Moore said, he hopes the rules will be amended and relaxed.
Signet has worked for many months on compliance with the new rules, Moore said, but Signet is large enough to spend money and employ staff to meet the regulations. They include extensive new reporting to regulators on such items as internal controls, loan documentation, assets and even employee compensation as well as director responsibility.
"The people hurt the most are small community banks," Moore said.
Yet Clark Owen, president of Salem Bank and Trust in Salem, said the bank is too small to feel much of the burden. With assets of $105 million, it falls below the $150 million threshold for the most recent regulations.
Even so, he said, the bank faces "a lot of rules that are ever-changing" and constantly expanding.
The way to avoid problems, he said, is to get qualified people on the board who "make the right decisions."
"I think if they use their minds and have their hearts in the right place," Owen added, "they don't have a lot to fear."
Bill Stoyko, legal counsel to Central Fidelity Bank in Richmond, said the rules cover lending policies, investment policies and audit committee procedures.
The regulations require board members to play a more active role in management of the bank, Stoyko said.
It's the threat of personal liability for directors that is "the biggest inhibiting factor," he said.
"People have to consider that fact when they agree to go on" the board, Stoyko said. Even so, Central Fidelity directors are sticking with the job.
Ben Jenkins, president of First Union National Bank of Virginia in Roanoke, said directors have no difficulty about service because of the company's "performance, financial condition, safety and soundness issues."
The bank has experienced no problem at all in recruiting for the board, he said.
First Union also looks at its board committees every year, Jenkins said, and the audit committee membership already met the new standards for expertise and conflict of interest.
But Charles O. Meiburg, professor of business administration at the University of Virginia's Darden graduate business school, believes that "it is going to be harder" to find bank directors in the future.
Banks will face more difficulty convincing qualified people, Meiburg said, because it's no longer a matter of just attending meetings.
"The liability is getting larger," Meiburg said. "There are all sorts of potholes out there."
That's especially true for the audit committee, he said, because it's at the mercy of the auditors but now held responsible for the result. Even auditors can't guarantee that no fraud is occurring.
"You just hope nothing happens," Meiburg said of the board's plight.
Offsetting this problem, Meiburg said, is the fact that a bank board seat "will probably continue to be a prestigious position."
Moore of Signet agreed that banks could face trouble ahead as the rules weigh down on directors.
Board members, he said, are "sitting out" the change in their responsibilities and liabilities. "In a year or two," Moore said, "this may be a better story."
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