The Director’s Tutorial

Today, as never before, directors need to be on top of their game. They must understand their responsibility as a director of a financial institution.

This tutorial is designed to help board members learn how to fulfill their responsibility to their shareholders and regulators, as well as create a comfort that they know and understand the processes used by regulators.

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CREDITS

The content of this presentation was copied from the FFIEC and OCC websites.

The content was formatted to simplify training for Bank Directors.

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P R E S E N T E D B Y : D E B O R A H W I L L I A M S

A C E I N T H E H O L E M A N A G E M E N T , L L C

A L L R I G H T S R E S E R V E D 2 0 0 9

A Directors Tutorial

C H A N G E I N T H E F I NA N C I A L M A R K E T P L A C E H A S C R E AT E D A M O R EC O M P E T I T I V E A N D C H A L L E N G I N G E N V I R O N M E N T F O R A L LF I NA N C I A L I N S T I T U T I O N S . A S A C O N S E Q U E N C E O F T H I S C H A N G E ,T H E RO L E O F T H E F I NA N C I A L I N S T I T U T I O N B OA R D M E M B E R H A SG ROW N I N I M P O RTA N C E A N D C O M P L E X I T Y.

R E C E N T C O R P O R AT E S C A N DA L S , T H E E C O N O M I C I M PA C T O NF I NA N C I A L I N S T I T U T I O N S A N D T H E PA S S A G E / R E V I S I O N S O F T H ES A R B A N E S - OX L E Y A C T O F 2 0 0 2 H AV E A G A I N B RO U G H T T H EP U B L I C ' S AT T E N T I O N T O T H E N E E D F O R A S T RO N G A N DI N D E P E N D E N T B OA R D O F D I R E C T O R S . W H I L E F I NA N C I A LH E A D L I N E S M AY C H A N G E , T H E B A N K I N G I N D U S T RY ' SL O N G S TA N D I N G P R I N C I P L E S O F C O R P O R AT E G OV E R NA N C ER E M A I N VA L I D T O DAY.

Financial Directors

General Guidelines

A financial institution’s board of directors oversees the conduct of the institution’s business. The board of directors should:

select and retain competent management;

establish, with management, the institution’s long- and short-term business objectives, and adopt operating policies to achieve these objectives in a legal and sound manner;

monitor operations to ensure that they are controlled adequately and are in compliance with laws and policies;

oversee the institution’s business performance; and

ensure that the institution helps to meet its community’s credit needs.

These responsibilities are governed by a complex framework of federal and state law and regulation. These guidelines do not modify the legal framework in any way and are not intended to cover every conceivable situation that may confront an insured institution. Rather, they are intended only to offer general assistance to directors in meeting their responsibilities. Underlying these guidelines is the assumption that directors are making an honest effort to deal fairly with their institutions, to comply with all applicable laws and regulations, and to follow sound practices.

Maintain Independence

Independence:

The first step both the board and individual directors

should take is to establish and maintain the board’s

independence. Effective corporate governance requires

a high level of cooperation between an institution’s

board and its management. Nevertheless, a director’s

duty to oversee the conduct of the institution’s

business necessitates that each director exercise

independent judgment in evaluating management’s

actions and competence. Critical evaluation of issues

before the board is essential.

Directors who routinely approve management decisions

without exercising their own informed judgment are

not adequately serving their institutions, their

stockholders, or their communities.

Keep Informed

Informed:

Directors must keep themselves informed of the activities and condition of their institution and of the environment in which it operates. They should attend board and assigned committee meetings regularly, and should be careful to review closely all meeting materials, auditor’s findings and recommendations, and supervisory communications. Directors also should stay abreast of general industry trends and any statutory and regulatory developments pertinent to their institution. Directors should work with management to develop a program to keep members informed. Periodic briefings by management, counsel, auditors or other consultants are helpful, and more formal director education seminars should be considered.

The pace of change in financial institutions today makes it particularly important that directors commit adequate time to be informed participants in the affairs of their institution.

Ensure Quality Management

Management:

The board of directors is responsible for ensuring

that day-to-day operations of the institution are

in the hands of qualified management. If the

board becomes dissatisfied with the performance

of the chief executive officer or senior

management, it should address the matter

directly.

If hiring a new chief executive officer is necessary,

the board should act quickly to find a qualified

replacement. Ability, integrity, and experience are

the most important qualifications for a chief

executive officer.

Supervise Management

Supervise:

Supervision is the broadest of the board’s duties and

the most difficult to describe, as its scope varies

according to the circumstances of each case.

Consequently, the following suggestions should be

viewed as general guidelines.

Establish Policy

Monitor Implementation

Provide Independent Reviews

Heed Supervisory Reports

Avoid Preferential Transactions

An explanation of each of these guidelines follows:

Establish Policies

Policies:

The board of directors should ensure that all significant activities are covered by clearly communicated written policies that can be readily understood by all employees. All policies should be monitored to ensure that they conform with changes in laws and regulations, economic conditions, and the institution’s circumstances. Specific policies should cover at a minimum: loans, including internal loan review procedures

investments

asset-liability/funds management

profit planning and budget

capital planning

internal controls

compliance activities

audit program

conflicts of interest

code of ethics

These policies should be formulated to further the institution’s

business plan in a manner consistent with safe and sound practices.

They should contain procedures, including a system of internal

controls, designed to foster sound practices, to comply with laws and

regulations, and to protect the institution against external crimes and

internal fraud and abuse.

The board’s policies should establish mechanisms for providing the

board the information needed to monitor the institution’s operations.

In most cases, these mechanisms will include management reports to

the board.

Monitor Implementation

Reports should be carefully framed to present information in a form meaningful to the board. The appropriate level of detail and frequency of individual reports will vary with the circumstances of each institution. Reports generally will include information such as the following: the income and expenses of the institution

capital outlays and adequacy

loans and investments made

past due and negotiated loans and investments

problem loans, their present status and workout programs

allowance for possible loan loss

concentrations of credit

(continued on next page)

•losses and recoveries on sales, collections, or other dispositions of assets

•funding activities and the management of interest rate risk

•performance in all of the above areas compared to past performance as well

as to peer groups’ performance

•all insider transactions that benefit, directly or indirectly, controlling

shareholders, directors, officers, employees, or their related interests

•activities undertaken to ensure compliance with applicable laws (including,

among others, lending limits, consumer requirements, and the Bank Secrecy

Act) and any significant compliance problems

•any extraordinary development likely to impact the integrity, safety, or

profitability of the institution

Reports should be provided far enough in advance of board meetings to allow for meaningful review. Management should be asked to respond to any questions raised by the reports.

Experience has shown that certain aspects of lending are responsible for a great number of the problems experienced by troubled institutions. The importance of policies and reports that reflect on loan documentation, performance, and review cannot be overstated.

Provide for Independent Reviews

The board also should establish a mechanism for independent third party review and testing of compliance with board policies and procedures, applicable laws and regulations, and accuracy of information provided by management. This might be accomplished by an internal auditor reporting directly to the board, or by an examining committee of the board itself. In addition, an annual external audit is desirable even when not required by regulation. The board should review the auditors’ findings with management and should monitor management’s efforts to resolve any identified problems.

In order to discharge its general oversight responsibilities, the board or its audit committee should have direct responsibility for hiring, firing, and evaluating the institution’s auditors, and should have access to the institution’s regular corporate counsel and staff as required. In some situations, outside directors may wish to consider employing independent counsel, accountants or other experts, at the institution’s expense, to advise them on special problems arising in the exercise of their oversight function. Such situations might include the need to develop appropriate responses to problems in important areas of the institution’s performance or operations.

Heed Supervisory Reports

Board members should personally review any reports of examination or other supervisory activity, and any other correspondence from the institution’s supervisors. Any findings and recommendations should be reviewed carefully. Progress in addressing problems should be tracked. Directors should discuss issues of concern with the examiners.

Avoid Preferential Transactions

Avoid all preferential transactions involving insiders

or their related interests. Financial transactions

with insiders must be beyond reproach. They

must be in full compliance with laws and

regulations concerning such transactions, and be

judged according to the same objective criteria

used in transactions with ordinary customers.

The basis for such decisions must be fully

documented.

Directors and officers who permit preferential

treatment of insiders breach their responsibilities,

can expose themselves to serious civil and

criminal liability, and may expose their institution

to a greater than ordinary risk of loss.

Statement Concerning Responsibilities of Bank Directors and Officers

The Federal Deposit Insurance Corporation has issued this

statement in response to concerns expressed by representatives of

the banking industry and others regarding civil damage litigation

risks to directors and officers of federally insured banks.

Duties of Directors and Officers

Directors and officers of banks have obligations to discharge

duties owed to their institution and to the shareholders and

creditors of their institutions, and to comply with federal and

state statutes, rules and regulations.

Service as a director or

officer of a federally

insured bank represents

an important business

assignment that carries

with it commensurate

duties and

responsibilities.

Banks need to be able to

attract and to retain

experienced and

conscientious directors

and officers.

When an institution

becomes troubled, it is

especially important that

it have the benefit of the

advice and direction of

people whose experience

and talents enable them

to exercise sound and

prudent judgment.

Similar to the

responsibilities owed by

directors and officers of

all business corporations,

these duties include the

duties of loyalty and

care.

The duty of loyalty requires directors and officers to administer the affairs of the bank with candor, personal honesty and integrity. They are prohibited from advancing their own personal or business interests, or those of others, at the expense of the bank.

The duty of care

requires directors and

officers to act as prudent

and diligent business

persons in conducting

the affairs of the bank.

This means that directors are responsible for selecting, monitoring, and evaluating competent management; establishing business strategies and policies; monitoring and assessing the progress of business operations; establishing and monitoring adherence to policies and procedures required by statute, regulation, and principles of safety and soundness; and for making business decisions on the basis of fully informed and meaningful deliberation.

Directors must require and

management must provide the

directors with timely and ample

information to discharge board

responsibilities. Directors also are

responsible for requiring

management to respond promptly to

supervisory criticism. Open and

honest communication between the

board and management of the bank

and the regulators is extremely

important.

Officers are responsible for running the day to day operations of the institution in compliance with applicable laws, rules, regulations and the principles of safety and soundness. This responsibility includes implementing appropriate policies and business objectives.

The FDIC will not bring civil suits against directors and officers who fulfill their responsibilities, including the duties of loyalty and care, and who make reasonable business judgments on a fully informed basis and after proper deliberation.

L AW S U I T S B RO U G H T B Y T H E F D I C AG A I N S T F O R M E R D I R E C T O R S A N D O F F I C E R S O F FA I L E D B A N K S A R E I N S T I T U T E D O N T H E B A S I S O F D E TA I L E D I N V E S T I G AT I O N S C O N D U C T E D B Y T H E F D I C . S U I T S A R E N O T B RO U G H T L I G H T LY O R I N H A S T E .

T H E F I L I N G O F S U C H L AW S U I T S I S AU T H O R I Z E D O N LY A F T E R A R I G O RO U S R E V I E W O F T H E FAC T UA L C I RC U M S TA N C E S S U R RO U N D I N G T H E FA I LU R E O F T H E B A N K . I N A D D I T I O N T O R E V I E W B Y S E N I O R F D I C S U P E RV I S O RY A N D L E G A L S TA F F, A L L L AW S U I T S AG A I N S T F O R M E R D I R E C T O R S A N D O F F I C E R S R E QU I R E F I NA L A P P ROVA L B Y T H E F D I C B OA R D O F D I R E C T O R S O R D E S I G N E E .

Procedures Followed To Institute Civil Lawsuits

In most cases, the FDIC attempts to alert proposed defendants in

advance of filing lawsuits in order to permit them to respond to

proposed charges informally and to discuss the prospect of pre-

filing disposition or settlement of the proposed claims.

The FDIC brings suits only where they are believed to be sound

on the merits and likely to be cost effective. On that basis, where

investigations have been completed, the FDIC has brought suit (or

settled claims) against former directors and officers with respect to

24% of the banks that have failed since 1985.

The FDIC's lawsuits are premised on the establ ished

legal pr inciples that gover n the conduct o f d irectors

and of f icers. Lawsuits against former directors and

of f icers o f fa i led banks result from a demonstrated

fa i lure to sat is fy the dut ies o f loyalty and care.

Nature of Suits Filed

Most suits involve evidence falling into at least one of the following

categories:

• Cases where the director or officer engaged in dishonest conduct or approved

or condoned abusive transactions with insiders.

• Cases where a director or officer was responsible for the failure of an

institution to adhere to applicable laws and regulations, its own

policies or an agreement with a supervisory authority, or where the

director or officer otherwise participated in a safety or soundness

violation.

• Cases where directors failed to establish proper underwriting policies and to

monitor adherence thereto, or approved loans that they knew or had

reason to know were improperly underwritten, or, in the case of

outside directors, where the board failed to heed warnings from

regulators or professional advisors, or where officers either failed to

adhere to such policies or otherwise engaged in improper extensions of

credit. Examples of improper underwriting have included lending to a

borrower without obtaining adequate financial information, where

the collateral was obviously inadequate, or where the borrower clearly

lacked the ability to pay.

One factor considered in determining whether to bring an action against a

director is the distinction between inside and outside directors. An inside

director is generally an officer of the institution, or a member of a control

group. An inside director generally has greater knowledge of and direct day to

day responsibility for the management of the institution.

By contrast, an outside director usually has no connection to the bank other than

his directorship and, perhaps, is a small or nominal shareholder. Outside

directors generally do not participate in the conduct of the day to day business

operations of the institution. The most common suits brought against outside

directors either involve insider abuse or situations where the directors failed to

heed warnings from regulators, accountants, attorneys or others that there was

a significant problem in the bank which required correction.

In the latter instance, if the directors fail to take steps to implement corrective

measures, and the problem continued, the directors may be held liable for losses

incurred after the warnings were given.

COORDINATION AND

COMMUNICATION BETWEEN

EXTERNAL AUDITORS AND

EXAMINERS

INTERAGENCY POLICY STATEMENT

The federal bank and thrift regulatory agencies are issuing this policy statement to improve the coordination and communication between external auditors and examiners. This policy statement provides guidelines regarding information that should be provided by depository institutions to their external auditors and meetings between external auditors and examiners in connection with safety and soundness examinations.

Coordination of External Audits and Examinations

In most cases, the federal bank and thrift regulatory agencies provide institutions with advance notice of the starting date(s) of full-scope or other examinations. When notified, institutions are encouraged to promptly advise their external auditors of the date(s) and scope of supervisory examinations in order to facilitate the auditors' planning and scheduling of audit work. The external auditors may also advise the appropriate regulatory agency regarding the planned dates for the auditing work on the institution's premises in order to facilitate coordination with the examiners.

Some institutions prefer that audit work be completed at different times from examination work in order to reduce demands upon their staff members and facilities. On the other hand, some institutions prefer to have audit work and examination work performed during similar periods in order to limit the impact of these efforts on the institutions' operations to certain times during the year. By knowing in advance when examinations are planned, institutions have the flexibility to work with their external auditors to schedule audit work concurrent with examinations or at separate times.

Other Information Provided By The Institution

Consistent with prior practice, a depository institution should provide its external auditors with a copy of certain reports and supervisory documents, including:

• The most recent regulatory Report of Condition (i.e., "Call Reports" for banks, and "Thrift Financial Reports" for savings institutions);

• The most recent examination report and pertinent correspondence received from its regulator(s);

• Any supervisory memorandum of understanding with the institution that has been put into effect since the beginning of the period covered by the audit;

• Any written agreement between a federal or state banking agency and the institution that has been put into effect since the beginning of the period covered by the audit; and

• A report of:

-- Any actions initiated or undertaken by a federal banking agency since the

beginning of the period covered by the audit under certain subsections of

section 8 of the Federal Deposit Insurance Act, or any similar action taken

by an appropriate state bank supervisor under state law; and

-- Any civil money penalty assessed under any other provision of law with respect

to the depository institution or any institution-affiliated party, since the

beginning of the period covered by the audit.

External Auditor Attendance at Meetings Between Management and Examiners

Generally, the federal bank and thrift regulatory agencies encourage auditors to attend examination exit conferences upon completion of field work or other meetings between supervisory examiners and an institution's management or Board of Directors (or a committee thereof) at which examination findings are discussed that are relevant to the scope of the audit. When other conferences between examiners and management are scheduled (i.e., that do not involve examination findings that are relevant to the scope of the external auditor's work), the institution shall first obtain the approval of the appropriate federal bank or thrift regulatory agency in order for the auditor to attend the meetings. This policy does not preclude the federal bank and thrift regulatory agencies from holding meetings with the management of depository institutions without auditor attendance or from requiring that the auditor attend only certain portions of the meetings.

Depository institutions should ensure that their external auditors are informed in a timely manner of scheduled exit conferences and other relevant meetings with examiners and of the agencies' policies regarding auditor attendance at such meetings.

Meetings and Discussions Between Auditors and Examiners

An auditor may request a meeting with any or all of the appropriate federal bank and thrift regulatory agencies that are involved in the supervision of the institution or its holding company during, or after completion of, examinations in order to inquire about supervisory matters relevant to the institution under audit. External auditors should provide an agenda in advance to the agencies that will attend these meetings. The federal bank and thrift regulatory agencies will generally request that management of the institution under audit be represented at the meeting. In this regard, examiners generally will only discuss with an auditor examination findings that have been presented to the depository institution's management.

In certain cases, external auditors may wish to discuss with regulators matters relevant to the institution under audit at meetings without the representation from the institution's management. External auditors may request such confidential meetings with any or all of the federal bank and thrift regulatory agencies, and the agencies may also request such meetings with the external auditor.

Confidentiality of Supervisory Information

While the policies of the federal bank and thrift regulatory agencies permit external auditors to have access to the previously mentioned information on depository institutions under audit, institutions and their auditors are reminded that information contained in examination reports, inspection reports, and supervisory discussions--including any summaries or quotations--is confidential supervisory information and must not be disclosed to any party without the written permission of the appropriate federal or thrift regulatory agency. Unauthorized disclosure of confidential supervisory information may subject the auditor to civil and criminal actions and fines and other penalties.

Thank You

This information was taken from the FDIC website, edited, formatted and

presented free of charge to bank management as a training tool for directors

by Ace In The Hole Management, LLC.

Due to the lengthy content of information on the FDIC website, this

presentation does not contain in its entirety the information from the website.

We have selected sections which reflect expectations and requirements of

financial institution directors.

If you wish to view the FDIC website, there are several additional sections

related to bank directors at www.fdic.gov.

Ace In The Hole Management, LLC

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314.803.6593

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