Corporate Governance: Evolving Expectations for Community Bank Boards
By: KAREN L. GRANDSTRAND
September 2004
The Sarbanes-Oxley Act of 2002 (“SOX”) was passed by Congress following several widely-publicized financial scandals and represents one of the most significant changes in the regulation of corporate activity since the 1930s. While SOX directly applies only to public companies, it has affected community banks. It has raised the bar in terms of regulator and marketplace expectations on corporate behavior and governance.
Given this climate, a number of new best practices are emerging related to the structure of community bank boards of directors:
Board Independence
Community banks are reassessing the composition of their boards and determining whether they should add additional independent directors. In my experience, most banks are not mandating that a board have more independent than inside directors. Rather, banks are moving in that direction. To further ensure effective oversight, banks are considering whether an independent director should chair the board.
Director Qualifications
The emphasis on independence must not cause banks or regulators to lose sight of an equally, if not more, important factor – competence. A board must have individuals who can contribute. In choosing new board members, it is important to determine what additional skills would be useful given the current composition of the board. Also, the individual board members must work well together as a group. The bank additionally needs to comply with the Depository Institution Management Interlocks Act, which establishes certain prohibitions on an individual simultaneously serving as a management official of two unaffiliated depository institutions. Further, the bank should consider whether an individual’s service on the board raises other potential conflicts of interest.
Committee Structure
Many community banks have had the same committee structure in place for some time. Banks are evaluating whether the structure continues to meet the bank’s needs. In some cases, banking organizations have grown and now consist of several banks within a bank holding company structure. In a multi-bank organization, the individual bank boards may choose to rely on centralized audit, credit and other committees.
Audit Committee
Increasingly, either the entire committee or a majority of the committee is comprised of independent directors. The audit committee is taking a more active role in hiring the outside auditor, determining the scope of the external and internal audit, and following up on audit and examination findings.
Credit Committee
Bank regulators are urging banks with credit quality issues to have independent directors on the credit committee. Some de novo banks have also been strongly encouraged to consider such a structure.
Conflicts of Interest
Historically, conflict of interest policies have focused largely on the Bank Bribery Act. These old policies are being updated to address the potential conflicts that can arise from outside employment, outside investments, hiring vendors who are related to bank staff, and the like.
Governance Charters/ Bylaws/Articles
Many large organizations have governance charters for their boards of directors and committees. Community banks may find charters an effective tool to modify an organization’s governance structure and culture. Depending on the types of structural changes contemplated by an organization, the bank or bank holding company’s bylaws and articles may need to be amended.
We will likely see more developments in the area of corporate governance, not only with respect to board structure, but related to policies, planning, management, audits, controls and systems. In a May 17, 2004 presentation, Federal Reserve Governor Susan Bies stated that “the Federal Reserve has a number of initiatives underway.” This sounds like a “heads-up” that more is coming from the regulators.