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The Fear of a Bank Director

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In the movie Pat Garrett and Billy the Kid, Pat, played by James Coburn, is hired by a group of wealthy landowners to track down his old friend Billy the Kid. Pat takes the local sheriff to find Billy, only for the sheriff to lose his life in a gun battle. As the sheriff stumbles toward the water, his last breath is gasped while the now famous Bob Dylan song Knockin on Heavens Door plays in the background.

Sometimes I feel like the directors are the sheriff. The regulators are Billy the Kid. And in hopes to protect our self from Billy the Kid, we have hired consultants to be Pat Garrett. Sure it’s a little dramatic, but what a great song and movie.

Being the president of a local independent insurance agency and founding member and current director of a community bank, the risk associated with board membership is all too familiar.

We all know we have a fiduciary duty of care and loyalty to the shareholders of the institution we serve. But after the financial crisis, watching one of the largest banking failures in the country happen right down the street, and attending seminar after seminar regarding important regulatory issues surrounding directors, I am beginning to question my sanity.

As I was preparing this piece, I came across a recent AP article entitled "Directors of Failed Atlanta Bank Sues, Accused of Lavish Spending."  My first reaction was, “I’ve been a director for almost six years and haven’t received one penny in director fees. I shouldn’t have a problem here.” Then I read another article about corporate governance, legislation, and regulatory oversights. My confidence quickly vanished.

What is a director to do?

Any seminar you attend will talk about communication. Form committees, attend meetings, stay informed, solve problems, and monitor management, etc. Clearly this is sound advice.

But the question is “How can an outsider grasp and stay current on all the regulatory, accounting and financial issues?” The answer is you can’t, not very well at least.

If this is not the best solution, what is?

Simple risk management says you retain, transfer, or eliminate risk. The later is not an option. Transfer of the risk to a third party/insurance company is the most obvious and effective risk strategy for banks. What does this contract do; what should I look for as a director?

As a director, there are seven key elements you should be looking for in your bank’s insurance policy.

1. Pay- On Behalf vs Indemnity – Will the contract pay ongoing legal bills as they accrue or will insurance companies wait until final resolution to reimburse/indemnify the corporation? The bank is required to indemnify the directors, but the financial strain placed on the banks could make this difficult. Legal fees alone can run into the millions.
2. Severability – How does the policy treat the “innocent director” in the event of application fraud, inaccurate financial information, or apparent conflicts of interest? If I am not guilty, will the policy respond if I am personally sued?
3. Side A Coverage – How does the policy treat the directors and officers in the event the policy limit is exhausted? What is the priority of payments between directors, company, employees, etc? As directors do we have a separate limit for us in the event the limits are exhausted?
4. Allocation – How does the policy respond if the suit involves covered and uncovered claims? Almost all suits allege fraud which is not insurable by law. Who defends me for the covered and uncovered allegations?
5. Mutual Choice of Counsel – A local attorney, a long time ago, told me an individual needs God and a good attorney. While this is a stretch, does the policy allow the board to select the lawyer or does the insurance company get to choose? If insurance company decides, who are they?
6. Consent to Settle – What rights do we have in the settlement of a claim? Must the insurance company secure our blessing to settle? What happens if we refuse the try and protect our professional reputation?
7. Definitions and Exclusions – My insurance professor always told me to read the definitions and exclusions of any insurance contract to try to understand its true meaning. Does the definition of named insured include my spouse? Does the definition of damages include punitive? How does the policy exclude claims brought by one insured against another insured? Are there exceptions? Is there a regulatory exclusion, if so, what does it say? I would not want to wake up one morning, like the directors of the Atlanta bank, only to find my policy does not cover me for a regulatory action by FDIC.

When you have taken the time to review your bank’s insurance policies, you can breathe easier. But this won’t be the end. You will need to continue to be wise. Continue to ask the tough questions.

In summary, Directors and Officers policies are especially important given the state of our industry. We as Board members accept a personal financial risk with our directorships. We need to take that role seriously, communicate with our management and use outside tools, like insurance, to minimize the risk. Don’t depend on the consultants entirely or you will end up like the sheriff, your finances shot and gasping for air.

About the Author
Bolling “Trey” P. Starke, III is president of Starke Agency, Inc., a third generation insurance brokerage and risk management company. He is also a founding member of River Bank & Trust, a community bank with branches in Central Alabama. Trey can be contacted at 334.263.5535 or tstarke@starkeagency.com.