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T t________________________ w a rn V N EW S R ELEASE FEDERAL DEPOSIT INSURANCE CORPORATION FOR IMMEDIATE RELEASE PR-42-74 (7-15-74) | V \ <9 T| a c, à \ dtn üio$ \?<x^ K A d d r e ss By G eorge A. °L e M X â istr e D ir e c to r F e d e r a l D e p o sit In su ra n ce C orporation ( V B e fo r e the A nnual Bank D ir e c t o r s ’ C o n feren ce L o u is v ille , K entucky, \ Ju ly 14, 1974. J ^Cy3 <nN w<5>V %\ .FEDERAL DEPOSIT INSURANCE CORPORATION, 550 Seventeenth St. N.W ., W ashington, D. C. 20429 • 202-389-4221 Address by George A. LeMaistre, Director Federal Deposit. Insurance Corporation July 14, 1974 Dr. D ob son and M r. M o rem a n in d ica ted that I m ig h t in te r p r e t the t it le , " R e s p o n s ib ilitie s and F u n c tio n s of Bank D i r e c t o r s ,11 so m ew h a t b ro a d ly . I w ould lik e to tak e th at lic e n s e and d is c u s s a s p e c ific p r o b le m fa c e d by bank d ir e c to r and r e g u la to r a lik e - - t h e m a tte r o f how b e s t to curb a b u se in tr a n s a c tio n s b e tw e e n a bank and in s id e r s or th eir in t e r e s t s . B efo re p r o c e e d in g w ith that d is c u s s io n , it is w e ll to r e v ie w th e b a s ic p r in c ip le s w h ich d e fin e th e r e s p o n s ib ilit ie s and fu n ctio n s of bank d ir e c t o r s . The F D IC 's M anual o f E xam in a tio n P o l i c i e s , w h ich p r o v id e s gu id an ce to our ex am in ation fo r c e , s ta te s : "In th e fin a l a n a ly s is , the b oard o f d ir e c t o r s is c h a r g ed w ith th e r e s p o n s ib ilit y o f th e condu ct o f the bank. It is not e x p e c te d to c a r r y on th e d e ta ils of the b an k's b u s in e s s ; the d e ta ils m a y be d e le g a te d to th e b an k 's o ffic e r s - -but not d e le g a te d and fo rg o tten . The p ow er to m a n a g e and a d m in is te r c a r r ie s w ith it th e duty to s u p e r v is e . Thus d ir e c t o r s m u st p e r io d ic a lly e x a m in e the s y s te m o f a d m in istr a tio n w h ic h th ey e s ta b lis h e d to s e e that it fu n ctio n s; should it b e c o m e o b s o le te , it sh ou ld be m o d er n iz e d ; should the bank's o ff ic e r s fa il to fu n ctio n a s in ten d ed , th ey sh ou ld be rep la ce d ; and la s t but not le a s t , th e d ir e c t o r s m u s t s u p e r v is e th e conduct o f the b u s in e s s o f th e bank. " This p a r a lle ls th e ad m o n itio n of a K en tu ck y c o u r t in a c a s e , S o c ie ty v . U nderw ood, d ecid ed e a r ly in th e 19th c en tu r y . The c o u r t stated; "It is th e duty o f th e b oard to e x e r c is e a g e n e r a l s u p e r v isio n o v e r th e a ffa ir s o f th e bank, and to d ir e c t and co n tr o l its su b o rd in a te o f f ic e r s . The co m m u n ity h a s a rig h t to a s s u m e that the board d o e s its duty. T hey in v ite the p u blic to d ea l w ith the c o rp o ra tio n , and w h en an yon e a c c e p ts the in v ita tio n he h as a r ig h t to e x p e c t r e a s o n a b le d ilig e n c e and good fa ith at th e ir h an d s, and, if th ey fa il in e ith e r , th ey a r e r e s p o n s ib ile for the r e s u lt . " In e s s e n c e , a d ir e c to r h as a duty to s u p e r v is e the b u s in e s s o f h is bank d ilig e n tly and in good fa ith . S h a r e h o ld e r s , d e p o s ito r s and c r e d ito r s h ave the rig h t to exp ect no l e s s . By ex a m in in g a s p e c if ic p r o b le m a r e a , it is p o s s ib le to s e e in c o n c r e te te r m s the m ea n in g o f t h e s e r a th e r broad and a b s tr a c t s ta te m e n ts . I h ave a ls o c h o se n to c o n c e n tr a te on the m a tte r o f in s id e r tr a n s a c tio n s b e c a u s e the su b je c t is lik e ly to b e th e fo c u s o f r e g u la to r y and C o n g r e ss io n a l a tten tio n in th e co m in g m onths and b e c a u s e th e r e a r e , in m y opin ion, su b sta n tia l r e a s o n s w hy su ch tr a n s a c tio n s sh ou ld be su b je c t to m o r e r ig o r o u s board and r e g u la to r y d is c ip lin e . As you m a y be a w a r e , th e C o m p tro ller h a s p u b lish e d for c o m m e n t a p r o p o se d reg u la tio n r eq u ir in g th at r e c o r d s be k ep t o f in s id e r s ' in t e r e s t s and d e a lin g s with th e ir bank. A t th e F D IC , a c o m m itte e of s e n io r s ta ff is a c tiv e ly w o rk in g - 2 - on the d e v e lo p m e n t o f to o ls to cu rb a b u se s in th is a r e a . The m o s t d r a m a tic im p e tu s fo r o ff ic ia l c o n c e r n and a c tio n h a s b e e n , o f course, the r o le p la y e d by s e lf - d e a lin g in th e fa ilu r e o f U . S. N a tio n a l Bank in San Diego la s t O c to b e r . O pening h e a r in g s on the p r o p o se d F in a n c ia l In stitu tio n s A ct of 1973, la s t N o v e m b e r , S en ator M cIn ty re sta ted : R e c e n t e v e n ts h a v e b rou gh t into fo c u s a n u m b er o f d e f ic ie n c ie s e x is tin g in our p r e s e n t s y s t e m . One can w e ll a sk how in our p r e s e n t r e g u la to r y s c h e m e th e 83 rd la r g e s t c o m m e r c ia l bank in th e co u n try can su d d en ly be p la c e d in r e c e iv e r s h ip . "W ith a ll th e in t r ic a te c h e c k s and b a la n c e s that h a v e b een d e v e lo p e d o v e r th e y e a r s , w e h ave s t i l l e x p e r ie n c e d th e la r g e s t s in g le bank fa ilu r e in the h is to r y o f th is c o u n try . " The q u e s tio n p o s e d by S en a to r M cIn ty re can b e s e p a r a te d into two q u estio n s: W hat c a u s e d a r e s p e c t e d b illio n d o lla r bank to b e c o m e in so lv e n t? And why w e r e th e b an k 's d if fic u lt ie s not d is c o v e r e d and a d d r e s s e d m o r e q u ick ly by F e d e r a l r e g u la to r s o r th e b an k 's board? It s e e m s to m e th at w e a s ban kers and r e g u la to r s m u s t be p r e p a r e d to a n sw e r th e s e q u e s tio n s and, in addition, fa c e c e r ta in u n d e rly in g i s s u e s illu m in a te d by the fa ilu r e . Why USNB b e c a m e in s o lv e n t i s r e la t iv e ly s im p le . U S N B 's in s o lv e n c y resu lted fr o m the w h o le s a le and unsound e x te n s io n o f c r e d it to p e r s o n s and e n titie s c o n tr o lle d by or a s s o c ia t e d w ith the c o n tr o llin g sto c k h o ld e r and fo r m e r board c h a ir m a n . O r, in the w o r d s o f C o m p tr o lle r o f the C u rren cy J im Sm ith, in s o lv e n c y w a s la r g e ly th e r e s u lt o f a " . . . r io t o f s e lf - d e a lin g . " In e ffe c t , U. S. N a tio n a l Bank w a s n ot o n e , but tw o b a n k s. One, an apparently sound and e ffic ie n t in s titu tio n , s e r v e d th e San D ieg o p u b lic . The sec o n d provided c r e d it to e n t e r p r is e s r e la te d to o r a ffilia te d w ith th e d om in an t sto c k h o ld er , ig n o r in g both sound banking p r a c t ic e s and r e g u la to r y r e q u ir e m e n ts . Involving 2 0 0 -3 0 0 c o r p o r a te e n t it ie s , th e s e tr a n s a c tio n s in v o lv ed b e tw e en $400 and $450 m illio n . T h ey often w e r e not h an dled in th e o r d in a r y c o u r s e o f the bank's b u s in e s s , but, in s te a d , w e r e p r o c e s s e d by c e r ta in in s id e r s . If U. S. N a tio n a l w e r e th e o n ly in d ic a tio n that s e lf - d e a lin g c o n s titu te s a serious p r o b le m , it m ig h t b e d is m is s e d a s an a b e r r a tio n . T h is, h o w e v e r , is not the c a s e . On Jan u ary 2 5, 1971, the S h a rp sto w n S ta te Bank in H ou ston , T ex a s, w ith a s s e t s am ou ntin g to a p p r o x im a te ly $81 m illio n w a s c lo s e d . It w a s then th e se c o n d la r g e s t fa ilu r e in FD IC h is to r y . The p r im a r y c a u s e w a s the s e lf s e r v in g a c t iv it ie s o f a d om in an t s h a r e h o ld e r . T h r ee w e e k s la te r it w a s d ropp ed to th ird p la c e by th e fa ilu r e o f B irm in gh am B lo o m fie ld , u n til U SN B, the la r g e s t fa ilu r e o f an F D I C -in s u r e d bank. H ere, - 3 s e lf-d e a lin g w a s co m b in ed w ith an u n sa fe and unsound in v e s tm e n t policyd ictated by th e d om in an t sh a r e h o ld e r . U nder the e ffe c tiv e c o n tr o l o f the sa m e ind ividu al, D e tr o it's Bank o f th e C om m on w ealth, w ith co m b in ed d e p o s its o f just o v e r $1 b illio n and to ta l a s s e t s o f $ 1 . 26 b illio n , w ould have fa ile d in 1972 for the s a m e r e a s o n s , had the FDIC not p ro v id ed a s s is t a n c e in the fo r m o f a $35. 5 m illio n in fu sio n o f c a p ita l. W hile the b illio n d o lla r Bank of the C om m on w ealth w a s not a llo w e d to fa il, its p lig h t u n d e r s c o r e d the le s s o n s o f Sh arp stow n and B ir m in g h a m -B lo o m fie ld and s e r v e d as a w a rn in g that a r e s p e c te d b illio n dollar bank m ig h t b e c o m e in s o lv e n t. A r e v ie w of our L iq u id ation s t a t is t ic s r e v e a ls that s e lf -d e a lin g is not lim ite d to the s p e c ta c u la r bank fa ilu r e a s an im p o rta n t c a u s a tiv e fa c to r . S in ce January 1, I9 6 0 , 63 banks have fa ile d . A m ong th e s e , s e lf - s e r v in g t r a n s action s w e r e a sig n ific a n t fa c to r in 37, or 58. 8%, of the c a s e s . D e fa lc a tio n s , e m b e z z le m e n ts and m a n ip u la tio n s c a u se d 20, or 31.7% , of the fa ilu r e s , w hile m a n a g e r ia l w e a k n e s s in loan p o r tfo lio m a n a g em en t a cco u n ted for only 6, or 9. 5%. A q u ick r e v ie w o f our " P r o b le m Bank" f il e s r e v e a ls m u ch the sam e p a tte rn . A s o f la s t w e e k , 60% o f the c a s e s c la s s if ie d " S erio u s P r o b le m P o ten tia l Payout" and 63% of th o se c la s s if ie d " S erio u s P ro b lem " r e f le c t s e lf - s e r v in g p r a c t ic e s on the p a r t o f m a n a g em en t or c o n tr o llin g in t e r e s t s . Standing a lo n e , e v id e n c e that in s id e r tr a n s a c tio n s a r e a p r im a r y fa c to r in failed and p r o b le m banks in d ic a te s the n eed fo r s p e c ia l s c r u tin y o f su ch t r a n s action s by b o a r d s o f d ir e c t o r s and for in n ovation in the a g e n c ie s ' ap p roach to the a b u se s o f s e lf - d e a lin g . C au se fo r c o n c e r n d o e s not end h e r e , h o w e v e r. The c o n se q u e n c e of s e lf - d e a lin g in h ea lth y banks is s im ila r ly p e r n ic io u s . A bank is n e c e s s a r ily a d v e r s e ly a ffe c te d w hen an in s id e r e x a c ts te r m s not a v a ila b le to m e m b e r s o f the p u b lic . T his is tru e w h eth er th e d e a l r e f le c t s a c o n s c io u s in ten t to m ilk th e bank or is m e r e ly the r e s u lt o f ta in ted ju d gm en t. In e ith e r e v en t, the bank is h a r m e d , s in c e the e c o n o m ic b e n e fit w h ich red ound s to the in s id e r r e p r e s e n t s a c o s t or lo s s o f e a r n in g s w h ich is b orn e by n o n b en efitin g s h a r e h o ld e r s a n d /o r in so m e w ay p a s s e d through to the b an k's c u s to m e r s . For th is r e a s o n , any tr a n s a c tio n b etw een an in s id e r or h is in t e r e s t s and a bank w h ich i s s ig n ific a n tly m o r e fa v o r a b le to th e in s id e r than a c o m p a r a b le tr a n sa c tio n w ith a n o n -in s id e r is not a sound banking p r a c tic e and sh ou ld not be to le r a te d by a b an k 's b oard o f d ir e c t o r s . M o r e o v e r , in m y v ie w , w h e r e such con d u ct is to le r a te d by a b an k 's b o a rd , it sh ou ld be th e su b je c t o f fir m su p e r v iso r y a c tio n . To fo llo w any oth er p o lic y is to a llo w banks to s u b s id iz e the n on -b an k in g fin a n c ia l a c tiv ity of p r e fe r r e d in s id e r s at the u ltim a te e x p e n s e of m in o r ity or n o n -in t e r e s t e d s h a r e h o ld e r s and, in the c a s e of bank fa ilu r e , at the e x p e n s e o f m an y c r e d it o r s and d e p o s ito r s a s w e ll. - 4 W h ile it is d iffic u lt to e v a lu a te its im p a c t, a sec o n d c o n se q u e n c e flo w s from a llo w in g a b an k 's f id u c ia r ie s to e x em p t th e m s e lv e s fr o m th e d is c ip lin e of the m a r k e t. N ot on ly a r e a b an k 's a s s e t s o ften w a s te d , but the a llo c a tio n of a c o m m u n ity 's r e s o u r c e s a s r e p r e s e n te d by the b an k 's d e p o s its can be misallocati or a llo c a te d ir r a tio n a lly . T he c o n s tr u c tio n and o p e r a tio n o f the W estg a te Plaza H o te l, sa id by m an y to be on e o f the fin e s t h o te ls in the w o r ld , is illu stra tiv e. C ap ital c o s t s p er r o o m h a v e b een e s tim a te d at m o r e than $ 1 0 0 , 000 and the o p e r a tio n w a s la v is h to s a y th e le a s t . F o r e x a m p le , a f r e s h p in ea p p le was p la c e d in th e r o o m o f e a c h g u e s t a t a c o s t to th e h o te l o f n e a r ly $10 p er p in e a p p le . It i s , I a s s u r e you, a v e r y fin e h o te l. It w a s , h o w e v e r , not a sound b u s in e s s e n t e r p r is e , and it is h ig h ly doubtful that it w ou ld h a v e been b u ilt or run a s it w a s if USNB and o th er e n te r p r is e s r e la te d to th e in te r e sts o f th e d om in an t sh a r e h o ld e r had n ot sto o d r e a d y to , and did, s u b s id iz e the o p e r a tio n o f th e h o te l. F in a lly , it s e e m s to m e that o v e r r e a c h in g o f the s o r t s e e n at U SN B, at S h a rp sto w n , and at B ir m in g h a m -B lo o m fie ld a r e m a n ife s ta tio n s o f the malady w h ich tr o u b le s th e p r e s e n t A d m in is tr a tio n and b u s in e s s in g e n e r a l. In financial and p o lit ic a l a r e n a s , p o w e r fu l and r e s p e c te d in d iv id u a ls h a v e ig n o r e d legal, in s titu tio n a l and e th ic a l r e s t r a in t s in th e ir d r iv e s fo r p o w er or p r o fit. F u n d am en tal in s titu tio n a l c o n s id e r a tio n s a r e a t sta k e - - c o n s id e r a tio n s which I m a y h a v e b een la id a s id e for th e m o m e n t's e x p e d ie n c y . C o m m e r c ia l banks a r e c h a r te r e d to s e r v e a s p e c if ic banking fu n ctio n in th e eco n o m y . In the c o m p e titiv e f r e e e n t e r p r is e s y s t e m , p r o fit and c o m p e n sa tio n sh ou ld flow to b a n k ers a s a r e s u lt o f th e ir e ffe c t iv e ly c a r r y in g on th e b u s in e s s o f banking and not fr o m th e ir u s e o f the in s titu tio n to ga in e c o n o m ic ad van tage w hich cou ld not be g a in ed in d ep en d en tly . A s w e h a v e s e e n , w h e r e le g a l and in s titu tio n a l a r r a n g e m e n ts a r e a v o id e d , d is to r tio n s o ccu r w h ich m a y range fr o m th e fa ilu r e o f a b illio n d o lla r bank to a s lig h t lo s s o f e a r n in g s in a small ; co u n try bank. W hether th e c o n s e q u e n c e i s la r g e or r e la t iv e ly s m a ll, there is a str o n g s o c ie t a l in t e r e s t in in s is tin g th at b a n k ers a s w e ll a s p o litic ia n s p la y by th e r u le s of th e g a m e . W hat m o r e , th en , m ig h t be done by bank s u p e r v is o r s to p r o te c t th is interest? And, w h at a r e the r e s p o n s ib ilit ie s and fu n ctio n s o f bank d ir e c t o r s w ith respect to d e a lin g s b e tw e en a bank and it s fid u c ia r ie s ? Two g e n e r a l a p p ro a c h e s m ig h t be taken by the banking a g e n c ie s . On one hand, in s id e r tr a n s a c tio n s o f a c e r ta in kind or m a g n itu d e m ig h t be forb id d en or s ig n ific a n tly lim ite d . T h is w ou ld n ot o n ly e lim in a te the in s id e r 's advantage v i s - a - v i s th e p u b lic , but a ls o p la c e h im at a d isa d v a n ta g e . T he seco n d a p p ro a ch w ou ld s e e k to in s u r e that in s id e r s d e r iv e no b e n e fit n ot a v a ila b le to n o n - in s id e r s . In e s s e n c e , th is is the a p p ro a ch p r e s e n t ly fo llo w e d at the F D IC , and it is th e on e w h ich I fa v o r . H o w e v er , s u p e r v is io n m ig h t be m a d e - 5 m o r e r ig o r o u s . The C o m p tr o lle r ’s O ffice h a s is s u e d fo r co m m en t a p r o p o se d r e g u la tio n w h ich w ould r e q u ir e a ll n a tio n a l bank d ir e c t o r s and p r in c ip a l o ff ic e r s to k e e p on file at the bank a w r itte n sta te m e n t o f th eir o u tsid e b u s in e s s in t e r e s t s and of any e x te n s io n o f c r e d it or oth er tr a n sa c tio n b etw een th o se in t e r e s t s and the bank. T h e se s ta te m e n ts o f in t e r e s t w ould be a v a ila b le fo r r e v ie w by the n ation al bank e x a m in e r s , the b an k 's b oard o f d ir e c t o r s , m a n a g em en t, len d in g o f f ic e r s , a u d ito r s and a tto r n e y s . A c co r d in g to th e C o m p tr o lle r ’s ’’N o tic e o f P r o p o se d R u le M aking": "T he p u r p o se o f th is R eg u la tio n is to e s ta b lis h an in fo rm a tio n a l b a s e upon w h ich bank m a n a g em en t and the C o m p tr o lle r 's O ffice m a y a s s e s s m o r e a c c u r a te ly the ex ten t and m an n er by w h ich a n a tio n a l bank m a y be en gagin g in tr a n s a c tio n s w ith its own d ir e c t o r s and s e n io r o f f ic e r s . " To in s u r e e ffe c t iv e r e g u la tio n , d is c lo s u r e r e q u ir e m e n ts m ig h t go s t ill fu rth e r. For e x a m p le , su c h d is c lo s u r e r e q u ir e m e n ts m ig h t in clu d e: (1) the r e q u ir e m e n t that in fo r m a tio n d e m o n str a tin g th e fa ir n e s s o f in s id e r tr a n s a c tio n s be rep o rted ; (2) the in c lu s io n o f d om in an t or su b sta n tia l s h a r e h o ld e r s am ong th o se r e q u ir e d to m ak e d is c lo s u r e s ; (3) the r e q u ir e m e n t that s e lf -d e a lin g d is c lo s u r e s be m ad e a v a ila b le to a ll sto c k h o ld e r s ; and (4) the r e q u ir e m e n t that a ll or a c e r ta in c la s s o f su c h tr a n s a c tio n s be d is c lo s e d in c a ll r e p o r ts or along w ith oth er d is c lo s u r e s m a d e under th e S e c u r itie s L a w s. The a g e n c ie s m ig h t r e q u ir e board a p p ro v a l o f a ll or c e r ta in in s id e r tr a n s a c tio n s p r io r to co n su m m a tio n . To in s u r e th e e f f e c t iv e n e s s of su ch r e q u ir e m e n ts , the a g e n c ie s m u st d e m o n str a te the c le a r c u t in ten tio n to im p o s e c r im in a l and c iv il sa n c tio n s w hen th e s e r e q u ir e m en ts a r e n ot c o m p lie d w ith . In a d d ition to th e im p o sitio n and e n fo r c e m e n t o f d is c lo s u r e r e q u ir e m e n ts , the s u p e r v is o r y a g e n c ie s sh ou ld m ak e p la in through in te r p r e tiv e r e g u la tio n s that c o r r e c tiv e a c tio n w ill be tak en w h e r e in s id e r s or th e ir in t e r e s t s r e c e iv e b e n e fits fr o m th e ir d e a lin g s w ith banks that a r e not g e n e r a lly a v a ila b le . The FDIC B oard p r e s e n t ly ta k e s su ch c o r r e c tiv e a c tio n w hen p r e s e n te d in s ta n c e s of o v e r r e a c h in g in a p p lic a tio n s of th e v a r io u s s o r t s . W ith c o m p r e h e n s iv e d is c lo s u r e r e q u ir e m e n ts , su ch a s th o se I have m e n tio n e d , th is p o lic y m ig h t be a p p lied m o r e s y s t e m a t ic a lly . In c a s e s w h e r e v o lu n ta r y c o m p lia n c e is not fo r th c o m in g , p ro m p t e n fo r c e m e n t a c tio n is n e c e s s a r y . A C e a se and D e s is t O rder under S e c tio n 8(b) of the C o rp o ra tio n 's A ct i s an e ffe c tiv e v e h ic le fo r e n fo r c e m e n t. Such r e g u la tio n w ou ld go far to curb o v e r r e a c h in g and co u ld , I b e lie v e , be a c c o m p lis h e d w ith a m in im u m o f in te r fe r e n c e w ith th e con d u ct o f a b a n k 's b u s in e s s . U ltim a te ly , h o w e v e r , th e m o s t e ffe c tiv e c h e ck on a b u se s by in s id e r s is a B oard o f D ir e c to r s w ith s u ffic ie n t in fo r m a tio n , in q u is it iv e n e s s , and in d ep en d e n c e to c r it ic a lly s c r u t in iz e and p a s s upon a ban k’s d e a lin g s w ith in s id e r s and th e ir in t e r e s t s . W hile ju d ic ia l p r o n o u n c em en ts reg a rd in g d ir e c t o r s ’ r e s p o n s ib ilit ie s and lia b ilit ie s , su ch a s m y e a r lie r q u otation from S o c ie ty v. U nd erw ood, do not d e s c r ib e a m o d e o f con d u ct w h ich w ill apply to a ll c ir c u m s t a n c e s , it i s p o s s ib le , I b e lie v e , to a r tic u la te c e r ta in g u id elin es w h ic h s u r e ly c o n stitu te good fa ith and r e a s o n a b le d ilig e n c e in th e trea tm en t o f in s id e r tr a n s a c tio n s . F i r s t , a d ir e c to r sh ou ld i n s i s t that he h a v e ad eq u ate in fo r m a tio n to evaluate th e so u n d n e ss o f the b an k 's d e a lin g s w ith in s id e r s . W hether s u p e r v is o r y a u th o r itie s r e q u ir e it or n ot, it s e e m s to m e that th e ban k ’s b oard should: (1) R e q u ir e th e r e p o r tin g o f a ll s ig n ific a n t in t e r e s t s o f d ir e c t o r s , o f f ic e r s , oth er k ey e m p lo y e e s and s u b s ta n tia l s h a r e h o ld e r s w ho a r e not m e m b e r s o f th e board; (2) R e q u ir e the r e p o r tin g o f a ll s ig n ific a n t tr a n s a c tio n s b etw een su c h in d iv id u a ls and th e bank, in clu d in g s u ffic ie n t in fo r m a tio n on w h ic h to b a s e an in d ep en d en t ju d g m en t w ith r e s p e c t to th e fa ir n e s s o f the tr a n s a c tio n v i s - a - v i s th e bank; and (3) R e q u ir e b oard a p p ro v a l o f a ll or c e r ta in in s id e r tr a n s a c tio n s and th e e s ta b lis h m e n t o f p r o c e d u r e s to in s u r e the p r o p e r tr e a tm e n t o f th o se fo r w h ich a p p ro v a l is n ot r e q u ir e d . S eco n d , in a s s e s s i n g a tr a n s a c tio n b etw een a bank and an in s id e r , ea ch d ire c to r sh ou ld s a t is f y h im s e lf that the tr a n s a c tio n is a fa ir on e and th at the in sid e r has n ot d e r iv e d b e n e fit at the b an k 's e x p e n s e by v ir tu e o f h is r e la tio n s h ip to the bank. In m ak in g th is ju d g m en t, it is w e ll to r e c a ll the s ta te m e n t o f the S u p rem e C ourt in th e c a s e o f P e p p e r v . L itto n . T h e r e , th e C ourt a d d ressed th e m a tte r o f w ho m u s t b e a r the p r o o f in a c o u r t o f la w w h e r e an in s id e r tr a n s a c tio n w a s c h a lle n g e d . It s e e m s to m e th at a d ir e c to r sh ou ld engage h i m u ch th e s a m e c r it ic a l e x e r c is e in h is own r e v ie w o f an in s id e r t r a n s a c tio n . The C ourt stated : "A d ir e c to r is a fid u c ia r y . . . . So is a dom in an t or c o n tr o llin g s to c k h o ld e r o r group o f s to c k h o ld e r s . . . . T h eir p o w e r s a r e p o w e r s in tr u s t. . . . T h eir d e a lin g s w ith th e c o r p o r a tio n a r e s u b je c te d to r ig o r o u s s c r u tin y and w h e r e any o f th e ir c o n tr a c ts or e n g a g e m e n ts w ith the c o r p o r a tio n is c h a lle n g e d th e burden is on th e d ir e c to r or sto c k h o ld e r not o n ly to p r o v e th e good fa ith o f th e tr a n s a c tio n but a ls o to show it s in h e r e n t f a ir n e s s fr o m the v ie w p o in t o f th e c o r p o r a tio n and th o s e in t e r e s t e d t h e r e i n .. . . The e s s e n c e o f the t e s t is w h e th e r o r n o t under a ll the c ir c u m s t a n c e s the tr a n s a c tio n c a r r ie s the e a r m a r k s o f an a r m ’s len g th b a r g a in . " - 7 I am a w a r e th at p r e fe r e n tia l c r e d it te r m s or a p r e m iu m paid for a s s e t s a r e often v ie w e d a s a m e a n s o f su p p lem en tin g th e c o m p e n sa tio n o f an in s id e r or as on e o f th e b e n e fits o f a s s o c ia tio n w ith a bank. H o w ev er, the stan d ard to be a p p lied sh ou ld b e th at of th e m a r k e t and, w h e r e the p a rty on th e oth er sid e o f a d e a l i s an in s id e r , a d ir e c to r sh ou ld tak e s p e c ia l c a r e to s a tis fy h im s e lf th at th e te r m s and co n d itio n s o f th e tr a n s a c tio n a r e at le a s t a s fa v o r a b le to th e bank a s th ey w ould h a v e b een had th e d ea l b een n e g o tia ted w ith a n o n -in s id e r . A p p lica tio n o f a l e s s r ig o r o u s sta n d a rd i s , in e ffe c t, to a llo w a w a stin g o f bank a s s e t s . F in a lly , it is im p o rta n t to e m p h a s iz e th e n e c e s s it y o f e a ch b o a rd m e m b e r 's e x e r c is in g and e x p r e s s in g h is ow n in d ep en d en t ju d g m en t. W h en ever a bank d ir e c to r fu n c tio n s a s a ru b b er stam p fo r m a n a g em en t o r c o n tr o llin g in t e r e s t s , or m e r e ly g o e s alo n g w ith th e m a jo r ity a s a r e s u lt o f r e t ic e n c e or ig n o r a n c e , he h as c e a s e d to s e r v e h is in s titu tio n a l fu n ctio n and h a s th e r e b y a b d ica ted h is le g a l r e s p o n s ib ilit y . It h a s b een sa id and I a g r e e that th e r e a r e tim e s when a " d ir e c to r sh ou ld r is k h is p o s itio n to th e e x te n t o f b rin k m a n sh ip if he is to c o n tr ib u te to th e w e lfa r e o f the bank and to d is c h a r g e h is tr u s t. " W here d e a lin g s b e tw e en a bank and in s id e r s a r e in v o lv e d , th e n e e d for su ch in d ep en d en ce is com p ou n d ed . It is w e ll to r e c a ll th at a co m m o n e le m e n t in m any m a jo r bank fa ilu r e s o f r e c e n t y e a r s h a s b een a s in g le in d iv id u a l w ho d om inated h is b oard . To s u m m a r iz e , it s e e m s to m e th at th e r e a r e th r e e k e y e le m e n ts in v o lv e d in a d ir e c t o r 's a d e q u a te ly fu lfillin g h is in s titu tio n a l r o le and s a tis fy in g h is le g a l r e s p o n s ib ilit ie s . T h e se app ly n o t o n ly to th e ev a lu a tio n o f in s id e r tr a n s a c tio n s but to a ll d e c is io n s m a d e in the s u p e r v is io n o f a b an k 's b u s in e s s . - - h e sh ou ld i n s i s t upon s u ffic ie n t in fo rm a tio n to m a k e a c o n s id e r e d d e c is io n ; - - h e sh ou ld a n a ly z e and q u e s tio n c r it ic a lly th e in fo r m a tio n p r o v id e d u n til s a t is f ie d that a g iv e n tr a n s a c tio n or p o lic y i s in the b an k 's b e s t in te r e s t; - - and he sh ou ld e x e r c is e and e x p r e s s in d ep en d en t ju d g m en t, not fe a r in g to go on r e c o r d a s a d is s e n t e r . In c o n c lu s io n , I sh ou ld e m p h a s iz e th at I do not m e a n to be a d o o m sd a y p ro p h et nor to s u g g e s t th at in s id e r tr a n s a c tio n s a r e bad p e r s e . On th e c o n tr a r y the v a st m a jo r ity o f su ch r e la tio n s h ip s a r e m o r e than fa ir to th e bank c o n c e r n e d . Indeed, in m a n y c o m m u n itie s , d e a lin g s b e tw e en a bank and it s d ir e c to r a te a re th e lif e b lood o f th e in s titu tio n . At th e sa m e tim e , w e m u st r e c o g n iz e that o v e r r e a c h in g d o e s o c c u r , w h e th e r th e r e s u lt o f ta in te d ju d g m en t or d is h o n e s ty , and that it s im p a c t can be s e v e r e , a s it w a s in San D ie g o . As I h a v e o u tlin e d , w e do h ave th e to o ls , w h ich can be em p lo y ed w ith o u t undue b u rd en , to b e tte r in s u r e th at a b u se is m in im iz e d and th at th e p u b lic - 8 - d o e s not c o m e to b e lie v e th at condu ct su ch a s that w h ich o c c u r r e d at USNB i s stan d ard o p e r a tin g p r o c e d u r e fo r b a n k e r s. It s e e m s to m e that th e resu lt o f th e im p o sitio n of th e s e c o n s tr a in ts w ill n e c e s s a r ily en h a n ce p u b lic ■ ‘<&bnfid'eh'Ce in m o r e e ffic ie n t fin a n c ia l in s titu tio n s . In lig h t o f th e atten tion fo c u s e d at San D ieg o and e c o n o m ic u n c e r ta in ty g e n e r a lly , it s e e m s to m e that the tim e is r ip e to e m p lo y th e s e t o o ls . B e c a u s e w e at th e FD IC a r e a c tiv e ly c o n s id e r in g th e s e i s s u e s , I w ould g r e a tly a p p r e c ia te th oughts w h ich you m a y have on the su b je c t. I thank you fo r in v itin g m e to sh a r e m y thoughts w ith you. ##############
