Relying Reasonably on Management May No Longer Be Good Enough

A fundamental legal principle underlying the development of the modern American corporation has been the ability of the directors to reasonably delegate duties to subordinate officers and employees without the fear of personal liability. This principle is reflected in state statutes and case law as well as the Model Business Corporation Act. That Act allows directors to rely reasonably upon the performance of officers and employees of duties delegated to them by the Board unless the director has knowledge that makes such reliance unwarranted.

A recent speech by Comptroller of the Currency Dugan, however, puts into question whether bank directors can continue to rely reasonably on officers to whom the board has delegated duties.

In a speech delivered to the American Bankers Association on November 1, 2005, Comptroller Dugan addressed the role of board members in overseeing BSA compliance. He emphasized that directors have an oversight responsibility, not a management responsibility. He pointed out that OCC enforcement documents regarding both BSA and other matters have long used standard language requiring directors to ensure that corrective action is taken. hid He then stated:

This language does not prevent directors, however, from delegating this responsibility to appropriate management officials within the bank. In fact, our documents typically contain standard language making it clear that such delegation is entirely appropriate. Of course, the ultimate accountability for ensuring that management follows through remains with the board.

Emphasis added.

The speech read well until the last sentence. The last sentence suggests that a board that relies reasonably on the performance of management to whom the board delegated certain responsibilities to management may still be held ultimately accountable for mistakes that management may have made. This position undermines the fundamental premise upon which delegation rests; that board members can reasonably rely on management to perform the tasks assigned to management without fear of personal liability even if management does not properly perform the duties delegated to them.

That is not to say that the board should not monitor what management does and react appropriately if management does not accomplish what the board had delegated management to do. Once the board is on notice that management is not doing its job, it needs to address management's shortcomings. But that is different from saying that "the ultimate accountability for ensuring that management follows through remains with the board."

The Model Business Corporation Act, in Section 8.30(d) (Standards of Conduct for Directors) provides that:

…In discharging board or committee duties a director who does not have knowledge that makes reliance unwarranted is entitled to rely on the performance by any of the persons specified in subsection (f)(1) or subsection (f)(3) to whom the board may have delegated, formally or informally by course of conduct, the authority or duty to perform one or more of the board functions that are delegable under applicable law.

Subsection (f)(1) refers to officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided. Subsection (f)(3) refers to a committee of the board of directors of which the director is not a member if the director reasonably believes the committee merits confidence.

Section 8.30(e) of the Model Business Corporation Act provides that in discharging board or committee duties a director who does not have knowledge that makes reliance unwarranted is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, prepared or presented by any of the persons specified in subsection (f). This includes those mentioned in the previous paragraph and legal counsel, public accountants, or other persons retained by the corporation who the director reasonably believes are competent to perform the duties assigned to them.

The prefatory material to Section 8.30 points out that within the authorization in Section 8.30(d) and ((e), "the right to rely applies to the entire range of matters for which the board of directors is responsible." It goes on to state that a director so relying must be without knowledge that would cause that reliance to be unwarranted. A director cannot "hide his or her head in the sand." A director cannot rely on the delegation of board functions, or on information, opinions, reports, or statements, when the director has actual knowledge that makes reliance unwarranted.

Over ten years ago, AABD questioned whether the OCC should hold national bank directors ultimately accountable for the actions of their bank's management even though the directors reasonably relied on management. In 1995, the OCC proposed Interpretive Ruling 7.2010, which stated in part that "The board may delegate the day-to-day operations of the bank to the management of the bank, but the board remains responsible for overseeing the affairs of the bank and the conduct of the management of the bank." We objected to this language because it failed to state that for nearly all board functions, directors are entitled to rely reasonably on management, officers, and professionals. The OCC ultimately decided to withdraw the proposal, but never went on record to accept the basic corporate law principle that corporate directors may reasonably rely on others to whom they legally delegate responsibilities.

The predecessor interpretative ruling, which the OCC rescinded in 1995, was even more flawed. 12 CFR 7.4425 denied the existence of any right by a national bank's board to delegate "responsibility for its duties" even those that they may legally delegate. One of the effects of this interpretative ruling was to mislead some bank examiners into believing that directors were legally responsible for anything that went wrong in a national bank.

Unfortunately, this may be the place to which we have returned. We believe that Comptroller Dugan should clarify his remarks to the public and to national bank examiners to assure both bank directors and examiners that bank directors are entitled to rely reasonably on the performance of persons to whom they have delegated responsibilities without fear of personal liability, even if those persons do not fully and properly perform their delegated responsibilities.