ADVISORY BOARDS - ARE THEY FOR YOUR BANK?

Introduction

As bank boards of directors begin to decide who will be nominated for Board seats next year, what thought is being put into the idea of an advisory board?

Some bankers and bank directors think that advisory boards are for big banks, not community organizations. At least that is what the results of the 1998 Survey of Bank and Savings Institution Directors conducted by the American Association of Bank Directors suggest. According to the Survey, 50% of those banks over $5 billion, but less than 20% of banks under $500 million in assets, have advisory boards.

This article does not advocate that your banks should have an advisory board. Rather, it urges Boards of Directors to evaluate whether having an advisory board makes sense for their bank. The article also addresses the role of advisory boards and ways in which the potential liability of advisory board members may be minimized or eliminated.

What do you call an advisory board member?

Advisory board members go by different names. They are also known as associate directors, honorary directors, and directors emeriti. Sometimes, there is no advisory board, just an individual who has been given a title and function of an advisory director.

What does an advisory board member do?

Let's first point out what advisory board members are not. They are not the Board of Directors elected by the bank's shareholders and they are not officers or employees of the bank. They do not vote as part of the Board of Directors. They do not have policy-making powers, and do not have management authority in the bank.

If they did have such authority, they would run some risk of liability if they did something to cause the bank to suffer losses or to fail. The RTC and FDIC, as receivers of failed institutions in the late 1980's and early 1990's, did sue some advisory board members for allegedly functioning as if they were elected Board members or members of management.

Our 1998 Survey results indicate that advisory boards of bank respondents focus primarily on business development (marketing, sales, loan/deposit growth, etc.). Typically, respondents described their advisory boards as "the eyes and ears into the community" or "bank emissaries to the local community."

Why have an advisory board?

Whether or not to have an advisory board is a strategic decision. What value will an advisory board add to the bank? How does an advisory board fit into the strategic vision of the bank? How can an advisory board be structured so that it meets a strategic objective?There are a variety of strategic purposes served by an advisory board. I will describe some of them in this article. Some or none may fit your bank. There may be other ways not mentioned in this article that an advisory board will fit into your strategic plan.

There are a variety of strategic purposes served by an advisory board. I will describe some of them in this article. Some or none may fit your bank. There may be other ways not mentioned in this article that an advisory board will fit into your strategic plan.

Bank offices in more than one community

If your bank has branches in communities outside of the community where your bank is headquartered, advisory boards consisting of persons from those communities can be helpful to your bank. They can provide insight about the community, attract business to the bank, and help identify better ways to serve the community.

Banks which have purchased banks in other communities

It is common for a bank which has acquired another bank in a different community to create an advisory board consisting of many of the former Board members of the acquired bank if the acquired bank is not maintained as a separate bank subsidiary. It normally is not practical for the acquiring bank to add all of the members of the acquired bank's board to its board, so that a local advisory board serves the purpose of utilizing the local directors' knowledge of and connections to the community.

Banks with no space on their Boards for qualified persons

AABD's Survey reflects that turnover of Board members is generally infrequent. The average length of time that a bank board members serves is over ten years. Additionally, a majority of the respondents indicated that their banks had no retirement age for directors. Only 10% of the bank boards conduct a formal review of incumbent directors before they are renominated, and, on average, only one incumbent director subject to formal review has not been renominated within the past five years. Unless banks change their approach to the nomination process and election of incumbent board members, there will continue to be few spaces for new, qualified board candidates.

An advisory board can serve the purpose of attracting qualified persons to become involved with your bank without having to discard incumbent directors or expanding the size of your board. As you get to know the advisory board members better, your bank can then consider them for Board seats when the slots become available.

Attracting persons who provide needed expertise

As banks expand into new businesses in search of fee income, the need for members of their boards with backgrounds in those businesses increases. For example, if your bank is considering the establishment or acquisition of an insurance agency, it would be desirable to have an insurance agent or an owner or former owner of an insurance agency on the Board. If there is no slot on the Board, having such a person to serve as an advisory director would be advantageous.

Choosing advisory directors based on community characteristics

Many bank boards tend to be largely homogeneous. Board members typically know each other socially, may be in similar businesses, tend to be heavily male dominated, come from the same socio-economic group and may even be very close in age. But the composition of such Boards may limit their contact with certain segments of the community served by the bank.

If there are no available slots on the Board for those who represent various groups within the community, an advisory board may help to reach out to those groups. These groups may be professional or business groups such as accountants, attorneys or health care professionals. They may also be ethnic, religious or racial groups prevalent in the community, or could even be age groups such as persons in their 30's.

Attracting persons who are unwilling to serve as Board members

In the AABD Survey, 20% of the respondents were turned down by director candidates during the past five years. Almost half cited time commitment as the reason for refusing a directorship, while 23% cited personal liability concerns as the primary reason. In the $101-$250 million category, personal liability was given as the primary reason 70% of the time for not accepting a seat on the board.

If your bank has qualified director candidates who are unwilling to serve on your board, they may be willing to serve on your advisory board because the time demands are lower and the risk of personal liability is substantially diminished.

Appointing retiring board members to an advisory board

Sometimes a retiring board member will be appointed to an advisory board for several years. This can be a useful transitional stage that allows banks to continue to receive sage advice from an experienced director. However, if the person is no longer productive, adding him or her to an advisory board will not add any value for the bank.

Liability risks

An advisory board member, if he or she truly fills an advisory role, should have little, if any potential liability. However, as mentioned earlier, the RTC and FDIC, as receivers, sued a relatively small number of advisory board members of failed banks and savings institutions in the late 1980's and early 1990's. Although there is no failsafe way to prevent the FDIC from suing an advisory director of a failed bank or to prevent the federal banking agencies from pursuing enforcement actions, including civil money penalties, against advisory directors, there are ways to help insure that any advisory director who is sued will be successful in his or her defense and will have legal expenses paid by an insurance carrier.

Generally speaking, the FDIC and RTC suits were based on the theory that the advisory directors were really acting as elected directors or appointed bank management and, therefore, were responsible for negligent or willful acts which caused the institution to fail.

It is therefore important that if your bank decides to establish an advisory board, it do it in a manner to minimize any risk of liability for the advisory director. The steps that can be taken include:

• A written description of the role and responsibility of advisory board members, which make it clear that they have no policy-making powers, have no voting authority, and have no management authority in the bank, but their role is solely advisory, subject to the review and approval of the bank's Board of Directors and/or senior management.
• A written record of the proceedings of advisory board meetings, which will reflect that the advisory board was acting consistent with the written description of its role in the bank.
• Some periodic monitoring of the role of advisory directors to verify that they are acting consistent with the written description of their role and responsibilities.
• Review of the bank's D&O Insurance policy to make certain that the advisory directors are sufficiently protected if a lawsuit is filed against them.
• Review of the bank's articles of incorporation and bylaws and local law to make certain that the bank will be obligated to indemnify advisory directors to the full extent allowed by law, and consideration of separate indemnity agreements between the bank and its advisory directors.

For additional suggestions on how to minimize liability, you should consult an excellent book published by the Office of the Comptroller of the Currency entitled The Director's Book - The Role of a National Bank Director, March 1997, pages 5 and 6.

Conclusion

An advisory board may or may not be right for your bank. But as an adjunct to the nomination process for the coming year and in conjunction with your bank's strategic plan, consideration of an advisory board and the kind of advisory board that would fit your bank is warranted.