Should Bank Directors’ Fiduciary Duties Be Expanded?

Should Bank Directors’ Fiduciary Duties Be Expanded?

 A recurring question is whether bank directors should be held to a more stringent fiduciary duty than are the directors of other kinds of companies. The question has been raised in the current wave of failed bank litigation, as the FDIC has tried to argue, for example, that bank directors are not entitled to the same protections of the business judgment rule as are directors of other companies. A recent speech by a Federal Reserve Board governor has once again raised the issue of whether bank boards should face “broadened” fiduciary duties, a suggestion that has provoked a sharp critical response.

In a lengthy June 9, 2014 speech (here), Federal Reserve Board Governor Daniel K. Tarullo raised the question whether the fiduciary duties of boards of regulated financial firms should be expanded because of the systemic risks embedded in banking sector.  Gov. Tarullo specifically referred to a “provocative recent paper” by Oxford University Law Professor John Armour and Columbia Law Professor Jeffrey N. Gordon  entitled “Systemic Harm and Shareholder Value” (here), in which the two professors propose board-level oversight responsibility for institutional risk-taking, in order to better align investor interest with societal interest in banking sector stability that could be disrupted by excessive risk-taking.  In their paper, the professors specifically propose that the directors be held liable for losses resulting from breaches of their risk management oversight.

As summarized by Gov. Tarullo, the professors argue that bank directors’ duties should be expanded “precisely because diversified shareholders have a strong interest avoiding risk decisions by these institutions that increase systemic risk.” The broadened fiduciary duties that the professors recommend would apply only to “systemically important financial institutions. “

These proposals were sharply criticized in an August 7, 2014 American Banker article by John Gorman of the Luse Gorman Pomerenk & Schick law firm entitled “Beware of Expanded Board Duties” (here). Among other things, Gorman notes that broadening bank directors’ fiduciary duties for institutional risk-management would “expose a board to liability for good faith judgments” and would “require boards to function in a management capacity.” These developments would be both “expensive and inefficient” and “would undoubtedly discourage capable persons from serving on bank boards.”

According to Gorman, altering bank boards’ fiduciary duties to require directors to take ownership for risk management issues “would merely provide a prima facie basis for the filing of a lawsuit against many boards.” Bank boards are “already significantly exposed to litigation and potential liability to both regulators and shareholders.” Any expansion of boards’ fiduciary duties with respect to risk management “would be a dangerous development for directors of all banks.”

The two professors’ recent article to which I linked above is hardly the first instance where it has been argued that, owing to their organizations’ unique roles in the financial system, bank directors should face a heightened standard of liability than do directors of other organizations. Indeed, in his recent speech Gov. Tarullo also cited to earlier academic articles where similar proposals had been suggested.

However, it is important to note that the idea that bank directors should face a different standard than directors of other companies has not been confined just to academic articles. Similar arguments have made their way into the current round of bank failure litigation, where, for example, the FDIC has argued that bank directors are not entitled to the same protection of the business judgment rule as are directors of other companies.

As noted here, Northern District of Georgia Judge Tom Thrash Jr. raised that very question in an FDIC lawsuit involving the failed Buckhead Community Bank. Among other things, Judge Thrash observed that “there is every reason to treat bank officers and directors differently from general corporate officers and directors.” Ultimately, rather than answer the question of whether bank directors are entitled to the same protection of the business judgment rule as other directors, Judge Thrash certified the question to the Georgia Supreme Court.

As discussed here, the Georgia Supreme Court’s answer was not exactly what the bank directors and officers had been hoping for; that is, the Court agreed in the end that the business judgment rule protects bank directors and officers and directors and officers of other corporations in the same way, but that in neither case are directors and officers entitled to absolute immunity from negligence claims. Just the same, Judge Thrash’s question show that it is not just academics and regulators that are struggling with the issue of whether or not different standards should apply to bank directors.

It should be emphasized that the academics’ proposal to hold bank directors to a higher standard was limited just to directors of systemically important financial institutions. I share the concerns John Gorman expressed in his American Banker article about this proposal. However, I have additional concerns, which is that there are already theories floating around that bank directors should be held to a different standard than directors of other companies, as shown by Judge Thrash’s remarks in the Buckhead Community Bank case. My concern is that if the idea were accepted that directors of systemically important banks should be held to have expanded fiduciary duties, the idea would quickly expand beyond just systemically important institutions and be applied to many , most, or even all bank directors, without regard to whether or not their institution is systemically important.

There undoubtedly are meritorious lawsuits filed against bank directors, particularly where there is evidence of self-dealing or complete abdication of responsibility. Just the same, the overall level of litigation aimed at bank directors is both excessive and socially inefficient, particularly with respect to the litigation that so often follows after banks’ failures. So often the failed bank lawsuit allegations consist of little more than scapegoating and hindsight second-guessing. Creating a liability regime that would encourage further litigation and expand the potential liabilities of bank directors would accomplish little except enlarging the litigation burden that prospective directors would have to consider before accepting a seat on a bank board.

I fully recognize that I am stepping into an issue on which there is already a spirited debate and I understand that reasonable minds could have a different view. I encourage those who see these issues differently to add their thoughts to this post using the blog’s comment feature.

Special thanks to a loyal reader for sending me a link to the American Banker article.

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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