Bank Board Letter February 2014 : Page 2
Some banks also take weeks to respond to loan applications, but Southwest Capital Bank quickly informs customers of the decisions on their loan applications, Levenson said. As the bank gains customers, Levenson is careful to keep the focus on manag-ing growth in a way that allows it to maintain personal relation-ships; he believes communication is one of the keys to doing that. Prudent lending is also one of the reasons for stable, eﬃcient growth at Liberty State Bank in Powers Lake, N.D., with $80 million in assets. The bank does not sell its housing loans, said president and CEO Randy Streifel, a move that helps limit the bank’s interest rate risk. The bank balances that stability with ﬂexibility, he said. “I’ve been really fortunate that I’ve been able to keep and hire some of the best employees possible. We do not have a lot of turnover. We let our employees grow with our organization. We ﬁnd people who are self-starters and let them run with it.” Managers do not second-guess loan oﬃcers about lending decisions, he added, and employees can be proactive if they need something to improve their performances. “If they need some training, we set it up for them. If they need software to do their jobs, they don’t have to ask me. They can talk to purchasing and get it done.” That employee autonomy has paid oﬀ; over the past ﬁve years, the bank has had a zero Texas ratio, so it does not have a lot of risky loans, Streifel said. In the near future, the bank will look for opportunities to shorten the duration of its bond portfolio in case interest rates rise, but Streifel is conﬁdent 2014 will be a good year. His pro-jections, which account for various interest-rate scenarios, all show the bank will be able to accomplish its goals. He is also focusing on managing the bank’s growth and wisely investing the bank’s growing deposits. “We’ve more than doubled in the last ﬁve years,” he said. “That’s one of the hardest things to keep with when maintain-ing high performance.” Santa Cruz County Bank was only a few years old when the recession hit, but the $400 million bank, founded in 2004, did not let that dampen its growth. “As a community bank, when you start, you’re doing busi-ness with people you know,” said David V. Heald, president and CEO of the bank, which is based in Santa Cruz, Calif. “Our process was knowing the customer, working with them and providing them with the tools to be successful.” The bank also carefully monitored — and still monitors — performance metrics. Senior management and the board review the metrics every month, Heald said, which helps the bank eas-ily identify areas that need extra attention. Although Santa Cruz is a comfortable commute from San Jose and Silicon Valley, it is also surrounded by agri-culture. To be closer to that industry and the opportunity it presents, the bank relocated a lending executive to the southern part of the county. “That has proven to be an extremely good move for us. The lender has been there less than a year, and it has grown 50 per-cent,” Heald said. “The people there were very hungry for some-body like us. Identifying that opportunity, making a strategic plan around it and executing has been one area that has helped us be successful and increase our revenues.” Santa Cruz County Bank has also expanded its Small Business Administration loans, Heald said, a trend he expects to continue in the future. He also sees more opportunities to increase eﬃciency. Chesapeake Bank and Trust Co.’s future focus will also be eﬃciency and loan growth, said Anthony. “Ultimately, the proﬁtability of a bank is built on funda-mentals,” Anthony said. “And it’s been the same fundamentals forever and ever, and it’s a matter of focusing on those funda-mentals and getting them right.” Elizabeth Whalen is a contributing author based in Berkeley, Calif. DOES THE BUSINESS JUDGMENT RULE PROTECT BANK DIRECTORS? B BY HAROLD P. REICHWALD ank directors and oﬃcers may be held to a diﬀerent stan-dard of care from the directors and oﬃcers of other business corporations, leaving their actions without the protection of the business judgment rule, according to a recent and highly unusual decision from a federal court in Georgia. On Dec. 4, 2009, the Buckhead Community Bank failed. The FDIC took over as a receiver and subsequently ﬁled suit against NEXT MONTH: Disparate Impact: Fair Lending Risk to Banks Top-Down Stress Tests nine former directors and oﬃcers of the bank. In its complaint, the FDIC charged that the defendants were negligent and grossly negligent in their management of the bank’s loan port-folio, leading to the failure. According to the FDIC complaint, the bank’s loan committee “took unreasonable risks” and violated bank policy by approving speculative commercial real estate loans without adequate in-formation and participating in loan purchases from other banks without independently reviewing the loans, despite repeated warnings from regulators. In Georgia, the business judgment rule explicitly holds bank directors and oﬃcers to an ordinary negligence standard of care: “[d]irectors and oﬃcers of a bank or trust company shall dis-charge the duties of their respective positions in good faith and with that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions.”
DOES THE BUSINESS JUDGMENT RULE PROTECT BANK DIRECTORS?
Harold P. Reichwald
Bank directors and officers may be held to a different standard of care from the directors and officers of other business corporations, leaving their actions without the protection of the business judgment rule, according to a recent and highly unusual decision from a federal court in Georgia.
On Dec. 4, 2009, the Buckhead Community Bank failed. The FDIC took over as a receiver and subsequently filed suit against nine former directors and officers of the bank. In its complaint, the FDIC charged that the defendants were negligent and grossly negligent in their management of the bank’s loan portfolio, leading to the failure.
According to the FDIC complaint, the bank’s loan committee “took unreasonable risks” and violated bank policy by approving speculative commercial real estate loans without adequate information and participating in loan purchases from other banks without independently reviewing the loans, despite repeated warnings from regulators.
In Georgia, the business judgment rule explicitly holds bank directors and officers to an ordinary negligence standard of care: “[d]irectors and officers of a bank or trust company shall discharge the duties of their respective positions in good faith and with that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions.”
O.C.G.A. § 7-1-490(a). Other states with the business judgment rule, such as California, only protect directors, not officers, in this way.
The defendants filed a motion to dismiss the suit. Despite O.C.G.A. § 7-1- 490(a), they argued they could not be liable for ordinary negligence under the business judgment rule and their actions did not rise to the level of gross negligence.
U.S. District Court Judge Thomas W. Thrash Jr. acknowledged that Georgia federal courts have “uniformly applied the business judgment rule to protect bank officers and directors,” but reached a different conclusion.
“There is every reason to treat bank officers and directors differently from general corporate officers and directors,” he wrote. “In general, when a business corporation succeeds or fails, its stockholders bear the gains and losses. The business judgment rule is primarily applied in Georgia because ‘the right to control the affairs of a corporation is vested by law in its stockholders — those whose pecuniary gain is dependent upon its successful management.’ But when a bank, instead of a business corporation fails, the FDIC and ultimately the taxpayer bear the pecuniary loss. The lack of care of the officers and directors of banks can lead to bank closures, which echo throughout the local and national economy. To some extent, the failure of bank officers and directors to exercise ordinary diligence led to the very financial crisis that continues to affect the national economy.”
State courts in Georgia have generally applied the business judgment rule to preclude claims for ordinary negligence against the officers and directors of a corporation, the court said, but “no Georgia state court has explicitly extended the business judgment rule to protect the officers and directors of a bank being sued by the FDIC as a receiver.” With “no clear controlling precedents on this issue by the Supreme Court of Georgia,” and having reached a contrary conclusion from his fellow federal judges, Judge Thrash certified the question “of whether the business judgment rule should supplant the standard of care required of bank officers and directors by O.C.G.A. § 7-1-490 in a suit brought by the FDIC as receiver” to the state’s highest court.
Even lacking guidance from the state court, Judge Thrash declined to apply the business judgment rule to the FDIC’s ordinary negligence claim. The agency “has set forth numerous allegations indicating the defendants failed to exercise even slight diligence when acting as directors and officers of the bank,” he wrote, continuing to approve the questionable loans despite being aware of a decline in housing sales and in contravention of bank policy. “These risky assets led to the bank’s ultimate crash and led to the losses incurred by the FDIC.”
The Financial Institutions Reform, Recovery and Enforcement Act allows bank directors and officers to be liable for monetary damages based on gross negligence, the court noted, again denying the defendants’ motion to dismiss.
“The alleged facts show an ongoing tendency to ignore risks while taking on loans that were flagged by regulators. Similarly, the allegations suggest that the defendants invested the bank’s loan portfolio in a manner far more aggressive than banks in their peer group. Additionally, the defendants failed to adhere to procedures that would have identified the deficiencies in the loans, including internal policies concerning diversification and inspection,” Judge Thrash said. “The allegations of such disregard of care and procedures are sufficient for a reasonable jury to conclude that the defendants were grossly negligent in their management of the bank.”
Why it matters: The decision in Loudermilk may strike fear in the hearts of bank executives, particularly those located in the state of Georgia. Under the reasoning of the opinion, the protections of the business judgment rule for liability based on ordinary negligence would not apply to the directors and officers of banks because the Deposit Insurance Fund of the FDIC bears the impact of their actions, which the court said can “echo” nationwide. However, the court failed to recognize that the DIF (funded by bank assessments) bears the alleged losses, not the taxpayers. One possible light at the end of the tunnel, however, could be that Judge Thrash certified the question to the Georgia Supreme Court, which could reach a different conclusion.
Harold P. Reichwald is a partner at law firm Manatt, Phelps & Phillips, LLP in Los Angeles. Contact him at hreichwald@manatt. com or 310-312-4148.