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Home > News & Events > Speeches and Testimony |
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Speeches and Testimony |
Ricki Helfer Chairman Federal Deposit Insurance Corporation before the Assembly for Bank Directors San Diego, CA May 2, 1997
It is a great pleasure to be with you today at the Centennial
Assembly for Bank Directors -- when anything lasts for 100 years,
it must be good.
There is a widespread belief that Abraham Lincoln
encapsulated his belief in democracy during his historic debates
with Stephen A. Douglas with the words: "You can fool all the
people some of the time and some of the people all the time, but
you can not fool all the people all the time." This quotation
endures, despite the fact that historians and other writers have
found no evidence that Abraham Lincoln ever said the words.
It is an example of a myth -- a story people believe that has
no basis in truth.
I am here today to talk about another myth -- one that is
less positive -- a myth that could cause a great deal of harm to
banks by discouraging capable and dedicated people from serving
on a bank's board of directors. That myth is that federal regulators
in general and the Federal Deposit Insurance Corporation in
particular hold bank directors to standards that go well beyond
those normally applicable to corporate directors.
The truth is that the general standards that we, and other
bank regulators, expect bank directors to follow are substantially
the same as the standards for directors of all companies. Today I
will describe the standards for corporate directors and discuss how
our standards are applications of those accepted standards. I will
also sketch a brief history of our actions against bank directors
when institutions fail and why those actions have made sense in
light of accepted standards for the responsibilities of bank
directors.
Our laws have long held that all corporate directors and
officers have duties to the corporations they serve. These duties
are generally known as the duty of care and the duty of loyalty.
They embody the expectation that a director will pay attention to
the operations of the organization and will put the organization's
interests above his or her personal interests in doing the job.
The duty of care dates back at least to the early 1800s when
the courts ruled that directors are required to use the same care and
diligence that an ordinary person would exercise under similar
circumstances. The U.S. Supreme Court applied virtually the same
standard to bank directors more than a century ago when it ruled
that the director of a financial institution is expected to act as a
reasonably prudent person would. The Supreme Court also
stressed that bank directors, like their corporate counterparts, are
not expected to guarantee the success of every business venture
and bank directors are not liable for mere errors of judgment. No
one expects bank directors to be liable when reasonable business
decisions go wrong -- but all corporate directors are expected to
take an active role in overseeing the management of the
organization and to avoid self-interest and self-dealing in
performing that function.
Historically, state common law defined the fundamental
duties of corporate governance. It included the concept of
"business judgment" -- a recognition that, while directors are
required to oversee management, they must be entitled reasonably
to rely on management, board committees, and the reports they
generate in order to make decisions and authorize business risks
without fear of personal liability.
In recent years, most state legislatures have enacted
statutory standards of care applicable to corporations and, at least
in a number of instances relating to bank failures, to insured
financial institutions. Forty-four states in recent years have relaxed
common law standards from "ordinary negligence" to gross
negligence or, in some of the more extreme instances, to some
form of recklessness or intentional behavior. Unfortunately, in the
case of the extreme instances, states went too far beyond long
accepted standards of conduct in their efforts to insulate directors
from liability. In states that insulated directors from recklessness
or intentional misconduct, it began to look as though directors
could rarely be held accountable for any of their actions or
inactions no matter how egregious.
Accordingly in 1989, at the height of the savings and loan
crisis, Congress enacted a law to preserve lawsuits brought by the
FDIC as receiver of failed financial institutions against directors
and officers to the extent state law sought to insulate bank directors
for conduct constituting gross negligence or worse. This federal
attempt to modify by statute the liability of directors of failed
banks left a lot of confusion and caused significant litigation over
exactly what Congress intended.
The question was finally settled by the Supreme Court
earlier this year. The Supreme Court decided that state law
standards of conduct should continue to apply to all insured
financial institutions regardless of charter but only so long as state
law provides a minimum standard no worse than "gross
negligence." Thus, if a state were to pass legislation insulating
bank directors from all suits brought by the FDIC as receiver of a
failed institution except for cases involving, for example,
intentional misconduct, the FDIC as receiver would still be
allowed to bring suits for gross negligence.
Coming full circle, gross negligence is precisely the
standard the FDIC always applies in determining whether to sue
outside directors for breaching their duty of care.
Let's look more closely at the duties of corporate directors
in general and compare them to the expectations for bank directors.
A corporate director must be independent. A director
should also be diligent, investing significant amounts of time and
energy in monitoring management's conduct of the business and
compliance with the corporation's operating and administrative
procedures. Those are exactly the expectations that bank
regulators have for bank directors. To meet those expectations,
directors should regularly attend board meetings, obtain and read
relevant materials, participate in discussions, ask questions, and
require management to make timely and accurate reports to the
board.
In meeting his or her duties, a corporate director is entitled
to rely on reports, opinions, information, and statements of the
corporation's officers, legal counsel, accountants, employees, and
committees of the board, when under the circumstances it is
reasonable to do so. Whether reliance is reasonable depends on
the facts in a specific situation. Outside directors are not required
to replicate the work of management, experts, or committees, but
bank directors should question the source, timeliness, and accuracy
of the information that management and others provide. In these
ways, outside directors exercise oversight.
In the case of banks, a bank examination serves as an
additional source of information on the accuracy of information
provided by the institution's officers to the board. Let me be clear,
however, that bank examinations are not audits, they are one way
that we at the FDIC assess risks to the insurance funds and that all
bank supervisors assess the safety and soundness of banks. They
are not intended to replace audits. Directors have the responsibility
to set up their own mechanisms to monitor compliance with
policies and law. A bank examination does not take the place of a
good system of internal controls. While no bank director wants to
be in the position of having examiners point out that the bank's
systems for reporting and internal controls have deficiencies, if
such problems are revealed in an examination report, the director
has the responsibility not to ignore them.
I was told by an examiner that the first thing he does when
examining a problem institution is to ask the institution's officers
for their copies of the last examination report. If the top has not
been creased or folded, it is evidence that the officers did not take
the time to find out what the examiners had to say the last time --
and it raises doubts about the seriousness of efforts to solve the
problems.
Corporate directors have the responsibility for establishing
policies for carrying out the major operations and functions of the
business. In addition, directors have the responsibility to monitor
compliance with those policies -- as well as compliance with laws
and regulations -- and to take action to correct the deficiencies that
are uncovered. In short, the duty of care requires members of the
board to monitor the activities of management and not to act
merely as a rubber stamp for management's actions.
I would stress that the FDIC does not require or expect that
responses by directors to problems will invariably succeed in
completely eliminating problems. We do, however, expect that
directors will take reasonable steps to address material problems
identified by management; examiners; and legal, accounting, and
other advisors.
As I noted earlier, the duty of loyalty -- the second duty that
applies to corporate directors, including bank directors -- simply
means that a director must never put his own interests above those
of the corporation, including any financial institution, he or she
serves. The duty of loyalty requires that a director not use the
position as director for personal benefit at the expense of the
corporation. Our FDIC guidelines for bank directors clearly mirror
this requirement. Under our guidelines, the duty of loyalty
requires directors and officers to administer the affairs of the bank
with candor, personal honesty, and integrity. Bank directors are
prohibited from advancing their personal business interests, or
those of others, at the expense of the bank.
Among businesses, banks are special because banks lend
other people's money. The common law of corporations tells
directors to question insider transactions closely so that positions
of authority are not abused by officials of the corporation. In the
case of banks, insider transactions are subject to regulatory
limitations because insider abuse is frequently found when banks
fail. We regulators expect a proper credit evaluation to be made
each time an extension of credit is made, regardless of whether
there are personal relationships between the credit applicant and
bank officers or directors. We also expect the extension of credit
to be made on an arms length basis -- that means on the same terms
offered other customers of an institution.
If our expectations for bank directors are essentially the
same as the long-standing expectations for corporate directors, how
did the myth that we have significantly higher standards arise?
The answer lies in recent history. The FDIC's statutory
responsibility to the insurance funds requires us to conduct an
investigation of whether there are potential claims against the
directors of every bank that has failed.
When the number of bank failures began to rise in the mid-1980s,
the number of investigations necessarily began to rise also.
These investigations, however, resulted in fewer lawsuits against
directors than the myth suggests. All professional liability claims
brought by the FDIC -- including claims against directors -- must
meet a two-part test: One, is the case meritorious? And, two, is it
likely to be cost effective? If a potential claim does not meet both
parts of the test, a lawsuit is not initiated against a bank director,
and settlements of potential claims are not sought. Since the mid-1980s,
the FDIC has brought suit -- or settled claims without suit --
against directors and officers in only approximately 20 percent of
more than 1,000 bank failures. Moreover, even when the FDIC
brings suit, it is not always against all directors and officers of a
failed institution. Each suit against each director must meet the
two-part test.
The two-part test has served us very well. By focusing our
resources on only the cases we believe are meritorious and likely to
be cost-effective, the FDIC has avoided costly, full-scale litigation
in numerous instances while successfully recovering substantial
amounts for the insurance fund. We used the same two-part test in
reviewing all of the claims we inherited from the RTC at its sunset
on December 31, 1995. Fortunately, a majority of the RTC claims
we reviewed met the test. There were some cases, however, that
simply were not cost-effective or displayed significant weaknesses
on the merits. Where we found claims that lacked merit, the
claims were withdrawn entirely by the FDIC. In one instance the
FDIC refused to bring a case that had been authorized, but not
filed, by the RTC, and decided to forego a $200,000 settlement
offer that was on the table because the case lacked merit. All FDIC
suits are reviewed on a semi-annual basis in order to ensure that the
two-part test continues to be met.
The court decisions have generally found standards for
bank directors applied by bank regulators, including the FDIC, to
be appropriate. Let me give you two examples.
In a case from the late 1980s, a court found three outside
directors of a thrift institution, who were members of an executive
loan committee, liable for failing to oversee the management of the
institution. In particular, the court faulted the directors for failing
to correct the problems identified in a Cease and Desist Order
issued by the Federal Home Loan Bank Board.
The directors had access to information on the problems in
the savings and loan association from four sources: examination
reports, the Cease and Desist Order, a court order enforcing the
Cease and Desist Order, and the regulations that governed the
institution. The court found the directors liable because the board
had not followed up to ensure that the institution's problems were
addressed after the board instructed management to comply with
the cease and desist order.
In another example, the facts are that in 1981 the FDIC
warned a bank that it must improve the quality of its loans and that
the directors must "adequately monitor the lending function." The
next year, the FDIC and the state banking department entered into
a Memorandum of Understanding with the bank requiring a 50
percent reduction in substandard loans within 360 days. Despite
these actions, the condition of the institution continued to
deteriorate. In 1983, a second Memorandum of Understanding was
entered into requiring a written loan policy and a reduction of
substandard assets. The bank did not fulfill its agreement, its
condition worsened, and the bank was declared insolvent in 1985.
The FDIC suit against outside directors was based on bad loans put
on the books after the regulators brought the bank's lending
problems to the directors' attention. The court held bank directors
liable for approving improvident loan transactions after repeated
warnings from the bank regulator about the failure of the
institution to monitor and correct deficiencies in the lending
process.
These are just two of the many cases where the regulators,
including the FDIC, have been upheld in court, but I think they
show how reasonable our expectations are.
John F. Kennedy once said -- in a statement documented in
his presidential papers -- that "the great enemy of truth is very
often not the lie -- deliberate, contrived, and dishonest -- but the
myth -- persistent, persuasive and unrealistic."
The myth is the great enemy of truth because it is accepted
all too often without reflection. I came here today to challenge the
mythology that the FDIC's expectations have been extraordinary
and to confirm that our expectations for bank directors are
essentially the same as those for a director on the board of any
business corporation. I hope that I have reassured you -- and also
reassured other people who may be considering service on a bank
board.
The job that you do is critical. In thousands of
communities across America, the bank links farmers and factories,
local governments and merchants, consumers and builders to the
global financial marketplace. In fulfilling your responsibilities as a
bank director, you serve not only the bank, but your neighbors and
your community as well. Indeed, when capable and dedicated
people serve on a bank's board of directors, the bank benefits, its
customers benefit, the community benefits, and the financial
system benefits. We, and our fellow regulators, recognize the
contribution that capable and dedicated bank directors make -- and
we want to work with bank directors to achieve our common
interest of assuring the safety and soundness of an insured bank.
Our goal is to keep banks open and serving their communities
safety and soundly. Bank failures benefit no one.
It is a challenging time for banks. Many of the old
restraints and certainties are fading -- or are already gone. From
the largest banks in the country to the smallest, new technology is
transforming what the business of banking means. Given these and
other considerable challenges, banks need the talents, expertise,
and insight of capable, dedicated directors more than ever. There
are responsibilities in serving on a bank's board of directors. There
are also opportunities for real service. Never has there been more
of an opportunity to shape a better future for banks and their
customers.
Thank you.
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Last Updated 6/25/99
communications@fdic.gov
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