1. Legal Issues for Directors of Financial Institutions in a Downturn Economy

2. General Board Responsibilities

• Your job is to:

• • Get competent management;

• • Establish goals and adopt policies to achieve those goals in a legal and sound manner;

• • Oversee operations to ensure that they are controlled adequately and are in compliance with laws and policies;

• • Oversee managements performance; and

• • Ensure that the institution helps to meet its communitys credit needs.

3. Fiduciary = Trust

• Directors and officers of financial institutions owe a fiduciary duty to:

• • Depositors

• • Shareholders

• • The Public

4. Financial Responsibility

• Directors are not personal guarantors that the institution will succeed, or that it will not have loan losses.

• They are obligated to act as prudent persons in supervising the institution. If they do not heed the warnings of regulators (even warnings that are general in nature), there is a potential claim that the directors failed to act in a manner consistent with their fiduciary duties.

• Directors of financial institutions are also susceptible to civil money penalties, which could be imposed for engaging in unsafe or unsound practices.

5. Safety and Soundness

• Federal regulators consider breaches of fiduciary duty to be per se safety and soundness violations.

• Zero tolerance environment.

6. Fiduciary Duties Defined

• • A director shall discharge his or her duties:

• • • in good faith;

• • • with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and

• • • in a manner the director reasonably believes to be in the best interests of the institution.

7. Business Judgment Rule

• If directors and officers act in good faith, and in a prudent, diligent and informed manner, they will be protected from liability under the business judgment rule for any decisions or actions that may later prove to be a mistake.

8. Independence

• Effective corporate governance requires a high level of cooperation between the board and management.

• The duty to oversee the conduct of the institutions business means that each director must exercise independent judgment in evaluating managements actions and competence.

• Directors who routinely approve management decisions without exercising their own informed judgment are not adequately serving their institutions, their stockholders, or their communities.

9. Duty of Care

• A director is charged with vigilance in the stewardship of the Bank, making him liable for what a prudent director should know, and imposing a duty to act on that knowledge.

10. Fulfilling the Duty of Care

• Directors are expected to attend board and committee meetings.

• Directors are expected to be prepared and to participate in board and committee meetings.

• Generally, a director may not vote by proxy at meetings.

• Directors and officers are expected to exercise independent judgment.

• Directors and officers must not willfully ignore problems.

11. What is a Director Supposed to Know?

• Income and expenses

• Capital adequacy

• Loans and investments

• Impaired assets (loans and securities)

• Performance in all of the above areas compared peers

12. Duty of Loyalty

• Directors and officers are not allowed to further their own interests at the expense of the institution.

• Directors and officers are expected to act in a manner consistent with the best interests of the institution as a whole, rather than representing a particular constituency.

13. Conflict of Interest Loans

• Greater responsibility in dealing with the loans to executive officers or directors.

• Decisions must preclude the possibility of partiality or favored treatment.

• Unwarranted loans to a banks directors or to Directors who become financially dependent on the institution should not continue to serve.

14. Reg O

• Extensions of credit must:

• • Be made on non-preferential terms ; and

• • Receive prior board approval .

• A bank must not pay an overdraft for an executive officer or director unless it is made in accordance with certain requirements.

• The extension of credit must also:

• • Not exceed the lending limit ; and

• • Comply with all procedural and reporting requirements .

15. Non-Preferential Terms

• To be made on non-preferential terms, an extension must:

• • Be made on substantially the same terms as comparable transactions ; and

• • Not involve more than the normal risk of repayment or present other unfavorable features.

16. Duty of Loyalty the 3 Cs

• C onflicts of interest between directors and officers and the interests of the institution;

• C orporate opportunities that become available to the institution; and

• C onfidentiality of non-public information.

17. Regulatory Responsibilities

• Responsible for requiring management to respond promptly to supervisory criticism.

• Open and honest communication between the board, management and the regulators is crucial.

18. Regulator Red Flags

• Gratuities or perks associated with the approval of financing arrangements or the use of particular services.

• The use of institutional monies to obtain or transact outside business.

• Transactions, especially loans involving conflicts of interest.

• • Full disclosure.

• • Abstain from voting on the matter.

• • Record the disclosure and abstention in the minutes.

19. Procedural Aspects of Responding to Regulatory Warnings

• How the Board reached a decision is critical when a regulatory authority questions past actions.

• Step #1 is knowing what should be taken to the Board. Although it is not necessary to take all regulatory warnings to the Board, strong warnings regarding a major function such as lending - should always be sent to the Board.

20. Board Minutes

• The minutes should reflect the information reviewed by the Board and the bases of its actions or conclusions.

• Without adequate minutes, it will be difficult to demonstrate how the Board made its decisions or why it took the actions in question.

21. Director Priorities in a Down Economy

• Problem loans, their present status and workout programs

• Allowance for possible loan loss

• Concentrations of credit

• Losses and recoveries on sales, collections, or other dispositions of assets

• Funding activities and the management of interest rate risk

22. Focus On.

• Any insider transactions that benefit, directly or indirectly, controlling shareholders, directors, officers, employees, or their related interests

• Activities undertaken to ensure compliance with applicable laws

• • lending limits

• • consumer requirements

• • Bank Secrecy Act

• • compliance problems

• Any extraordinary development likely to impact the integrity, safety, or profitability of the institution

23. 4 Most Common Personal Lawsuits

• Where the director or officer engaged in dishonest conduct or approved or condoned abusive transactions with insiders.

• Where a director or officer was responsible for the failure of an institution to adhere to applicable laws and regulations, its own policies or an agreement with a supervisory authority, or where the director or officer otherwise participated in a safety or soundness violation.

• Where directors failed to establish proper underwriting policies and to monitor adherence thereto, or approved loans that they knew or had reason to know were improperly underwritten

• Where the board failed to heed warnings from regulators or professional advisors, or where officers either failed to adhere to such policies or otherwise engaged in improper extensions of credit.

24. Protect Yourself

• DISCLOSURE

• RECUSAL

• DOCUMENTATION

• ADVANCE APPROVAL

• SEEK PROFESSIONAL HELP

• KEEP GOOD MINUTES

• INSURANCE

25. Addressing Credit Quality

• Are credit underwriting standards too loose or too tight?

• Does the loan policy reflect the standards used by lenders?

• Has there been any significant shift in loan categories that may indicate greater assumption of risk (for example, a significant decline in residential loans and an increase in loans to purchase raw land)?

• If entering a new area of lending, the Board needs to satisfy itself that the institution has qualified personnel to handle the new lending area, that the loan policy adequately addresses the new area, and that the reserve for loan losses will be sufficient to cover foreseeable potential losses from the new activity.

26. Credit Quality Questions

• Is loan review adequate and independent?

• Is the methodology used in calculating the loan loss reserve appropriate?

• Is the level of the Boards involvement in approving loans working?

27. Insufficient Capital- What Do We Do Now?

• Review and revise as necessary the business/operating plan for the next 12 to 24 months, using the most current data, with specific focus on liquidity and capital requirements and sources.

• Identify and implement cost reduction and other cash conservation measures.

• Closely monitor key performance indicators, material variances and their potential consequences.

28. What Do We Do Now?

• Stress test the business plan against downside scenarios.

• Pay particular attention to assumptions regarding projected income and expenses.

• Understand and take into account direct and indirect exposure to derivatives and risks around mark to market assets.

• Identify and evaluate risk issues related to the interconnected nature of the U.S. economy.

29. What Do We Do Now?

• Determine what capital expenditures are essential which can be deferred or are discretionary.

• Review sources of liquidity and capital, and assess whether and the extent to which they should be considered reliable going forward.

30. What Do We Do Now?

• Review debt agreements and other material contracts for potential compliance issues (collateral calls, financial covenant defaults, cross defaults and accelerations, put rights and joint venture governance rights).

• Make communications, internally and externally, a priority.

• • Be prepared to deal with misinformation and rumors.

• • Evaluate the appropriate frequency of board meetings in order to make sure the board is well informed and has the time necessary to deal with the issues facing the institution.

31. Corporate Governance

• Undertake a thorough corporate governance review

• • exculpatory charter provisions

• • scope and limits of liability insurance coverage

• • financial strength of insurance carriers

• Implement best practices with an emphasis on the boards good faith exercise of their responsibilities and reaffirming the right tone at the top

32. Contact Information

• Mary Neil Price Miller & Martin PLLC

• • [email_address]

• • (615) 744-8480

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