Current Topics in Bank Governance and Recommended Practices

Banking is one of the most heavily regulated industries in the United States. In recent years, that regulatory burden has grown, as has the complexity of the risks faced by the industry. As a result, it may come as no surprise that it is becoming increasingly difficult for bank boards to continue to be effective.

A multi-year review of bank board practices by the Federal Reserve identified the following challenges:

• Supervisory expectations of boards and senior management have become increasingly difficult to distinguish.
• Boards are often devoting significant time towards satisfying supervisory expectations that do not directly relate to their core responsibilities, which are:
  • Guiding the development of strategy and the types and levels of risk a bank is willing to take;
  • Overseeing senior management and holding them accountable;
  • Supporting the stature and independence of independent risk management and internal audit functions; and
  • Adopting effective governance practices.
• Boards face significant information flow challenges, especially in preparing for and participating in board meetings (and are inherently disadvantaged given their dependence on management for the quality and availability of information).

And the stakes are getting higher for boards.  Incoming Federal Reserve Chairman Jerome Powell stated in an August 2017 speech that across a range of responsibilities, the Federal Reserve expects much more of boards of directors than ever before, and there is no reason to expect that to change.  In February 2018, the Federal Reserve signed a consent order with Wells Fargo in further response to sales practice issues that were first identified in 2016.  The consent order, along with letters sent to the Wells Fargo Board, Lead Director and Chairman, specifically addressed the Board’s failure to meet supervisory expectations.  In addition to abiding by the terms of the consent order, Wells Fargo will replace four additional members of its 16-member board.  Previously, it had already replaced half of its board after low shareholder support at its annual shareholder meeting.

In line with the tenor of its communications surrounding the Wells Fargo consent order, in 2017 the Federal Reserve proposed new board effectiveness guidance (FR Doc. 2018–00294).  The guidance is expected to be finalized in the first half of 2018 although the Federal Reserve points out that the guidance will consolidate and replace 170 existing board supervisory expectations that currently reside in 27 separate Federal Reserve Board Supervisory and Regulation letters (“SR Letters”).

For large financial institutions with total consolidated assets of $50 billion or more, the proposal includes specific guidance for board effectiveness, describing the five attributes of effective boards of directors:

• Setting clear direction for the firm;
• Actively managing information and board discussions;
• Holding senior management accountable;
• Supporting independent risk management and internal audit; and
• Maintaining a capable board composition and governance structure.

Finally, in order to keep the board properly focused on their core responsibilities, most matters requiring attention (MRAs) and matters requiring immediate attention (MRIAs) will be directed to senior management, instead of the board, for remediation.  

As this proposal moves towards adoption, bank directors may need to re-examine their role, as it has been established over time in charter documents, board policies, meeting agendas and governance practices and expectations, and whether their role fulfills the core responsibilities articulated by the Federal Reserve or other regulators.  Where the board role has expanded beyond the core responsibilities, and at the expense of fulfilling those responsibilities, a realignment of board versus management roles may be overdue.

The legal obligations for bank directors are complex, because they are governed by a voluminous body of laws and regulations that can vary depending on whether a bank is state or nationally chartered.  Fiduciary duties owed by directors in principle are similar to those owed by directors at other companies, including the duty of loyalty, which requires them to put the interests of the company and its stockholders over their own personal interests in making decisions and evaluating opportunities for the company, and the duty of care, which requires them to exercise care in making decisions, on an informed basis and with a good faith belief that their decisions are in the best interest of the company and its stockholders.  Regulatory agencies such as the FDIC may have their own articulations of these duties.

The standard for liability for bank directors in case of a bank failure can be found in Section 1821(k) of FIRREA, which stipulates that directors and officers may be personally liable for loss or damage caused by their “gross negligence,” as defined by state law.  Under Gimbel v. Signal Companies, Inc., 316 A.2d 599 (Del.Ch. 1974), gross negligence involves a reckless indifference or a deliberate disregard of the interests of the company and its stakeholders, or actions that are not within the bounds of reason.  However, a savings clause in section 1821(k) provides that the FDIC may pursue claims based on “simple negligence” (a mere failure to exercise reasonable care) if state law permits liability under a lower standard.  See Atherton v. FDIC, 519 U.S. 213 (1997).