A friend emailed me, asking:
I just read a statement from the OCC about the primary fiduciary duty of bank directors.
Here it is:
"While holding companies of large banks are typically
managed on a line of business basis, directors at the bank level are responsible for
oversight of the bank’s charter—the legal entity. Such responsibility requires
separate and focused governance. We have reminded the boards of banks that their
primary fiduciary duty is to ensure the safety and soundness of the national bank or
federal savings association. This responsibility involves focus on the risk and control
infrastructure. Directors must be certain that appropriate personnel, strategic
planning, risk tolerance, operating processes, delegations of authority, controls, and
reports are in place to effectively oversee the performance of the bank. The bank
should not simply function as a booking entity for the holding company. It is
incumbent upon bank directors to be mindful of this primary fiduciary duty as they
execute their responsibilities."
For whatever reason, I had never come across this before.
This raises some very interesting issues about whether the fiduciary duties of bank directors differ from those of ordinary corporate directors.
First, should bank directors owe some sort of special fiduciary to the bank entity? As I explain in Much Ado About Little? Directors’ Fiduciary Duties in the Vicinity of Insolvency, 1 Journal of Business and Technology Law 335 (2007), there is a longstanding view that directors duties are owed (in part) to the entity:
Technically, Credit Lyonnais does not stand for the proposition that directors of a corporation in the vicinity of insolvency owe fiduciary duties to creditors of the corporation. Instead, Chancellor Allen held that the board of directors of such a corporation “owes its duty to the corporate enterprise.” In a famous footnote, which is worth quoting at full length given its importance to the analysis, Chancellor Allen went on to explain how such a duty differed from the usual conception that directors owe their duties to the shareholders ….
Former Delaware Supreme Court Chief Justice Veasey has likewise embraced an understanding of the problem centered on the notion that directors owe duties to the corporate entity in this context, although we shall see that Veasey’s analysis ultimately proves to be somewhat more nuanced:
… it is important to keep in mind the precise content of this “best interests” concept—that is, to whom this duty is owed and when. Naturally, one often thinks that directors owe this duty to both the corporation and the stockholders. That formulation is harmless in most instances because of the confluence of interests, in that what is good for the corporate entity is usually derivatively good for the stockholders. There are times, of course, when the focus is directly on the interests of stockholders. But, in general, the directors owe fiduciary duties to the corporation, not to the stockholders. This provides a doctrinal solution to the incentive problem that is entirely consistent with the emphasis on board governance, namely, that the board’s duty is to do what is best for the corporation.
From a doctrinal perspective, this emphasis on fiduciary duties to the corporate entity is problematic. As to solvent corporations, the law already distinguishes between duties running to the corporate entity and to the shareholders. This distinction is what differentiates direct from derivative shareholder litigation, after all. ...
In addition to being doctrinally questionable, the notion that directors owe duties to the corporate entity is inconsistent with the dominant contractarian theory of the firm. The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.
In other words, the corporation is not a thing to which duties to can be owed, except as a useful legal fiction. The distinction between direct and derivative shareholder litigation is one area in which that fiction long has been thought useful. This article is not the appropriate forum for determining whether distinguishing between direct and derivative litigation continues to make sense. Having said that, however, it nevertheless seems useful to note the implications of contractarian theory for Credit Lyonnais’ notion that the duties of directors of companies in the vicinity of insolvency run to the entity.
At the outset, we must acknowledge that while the contractarian approach of treating the corporation as a nexus of contracts is an improvement on entity-based conceptions, it too is somewhat misleading. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract—people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, it is perhaps best to understand the corporation as having a nexus of contracts.
If the corporation has a nexus, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation’s “business and affairs . . . shall be managed by or under the direction of the board of directors.” Put simply, the board of directors is the nexus of a set of contracts with various constituencies that the law collectively treats as a legal fiction called the corporation. As such, it simply makes no sense to think of the board of directors as owing fiduciary duties to the corporate entity. Indeed, since the legal fiction we call the corporate entity is really just a vehicle by which the board of directors hires factors of production, it is akin to saying that the board owes duties to itself.
I thus would prefer to see the question phrased as, "do bank directors owe special fiduciary duties to either the shareholders and/or depositors of a bank, which differ from those ordinary directors owe to the shareholders"?
Second, do bank directors owe such duties?
There is some precedent for the proposition that "it is well settled that the fiduciary duty of a bank officer or director is owed to the depositors and shareholders of the bank." Lane v. Chowning, 610 F.2d 1385, 1389 (8th Cir. 1979). See also Irving Bank Corp. v. Board of Governors of the Fed. Reserve Sys., 845 F.2d 1035, 1039 (D.C. Cir. 1988) (noting "Irving's fiduciary duty to protect shareholders and depositors alike"); Hoehn v. Crews, 144 F.2d 665, 672 (10th Cir. 1944) (declaring that bank directors owe high degree of duty to both stockholders and public at large); Gadd v. Pearson, 351 F. Supp. 895, 903 (M.D. Fla. 1972) (noting that bank managers have greater obligation to exercise duty of good faith and use powers in best interest of entity than other corporate officers); Francis v. United Jersey Bank, 432 A.2d 814, 824-25 (N.J. 1981) (holding that directors of reinsurance corporation owed fiduciary duty to creditors because relationship between creditors and corporation involved trust and confidence analogous to that between bank and its depositors); Campbell v. Watson, 62 N.J. Eq. 396, 427 (N.J. Ch. 1901)(establishing the principle that bank directors may owe a fiduciary duty to bank depositors as creditors especially if the directors were aware of a potential problem and did not address it).
Also, 12 U.S.C. § 1818(e)(1) (1982) provides:
Whenever, in the opinion of the appropriate Federal banking agency, any director or officer of an insured bank ... has engaged or participated in any unsafe or unsound practice in connection with the bank, or has committed or engaged in any act, omission, or practice which constitutes a breach of his fiduciary duty as such director or officer, and the agency determines ... that the director or office [sic] has received financial gain by reason of such violation or practice or breach of fiduciary duty, and that such violation or practice or breach of fiduciary duty is one involving personal dishonesty on the part of such director or officer, or one which demonstrates a willful or continuing disregard for the safety or soundness of the bank, the agency may serve upon such director or officer a written notice of its intention to remove him from office.
Note that "a willful or continuing disregard for the safety or soundness of the bank" thus is regarded as a breach of duty.
Similarly, Section 113 of the Federal Deposit Insurance Act prohibits the Federal Reserve Board from taking any action with respect to a functionally regulated subsidiary of a bank holding company unless "(i) the action is necessary to prevent or redress an unsafe and unsound practice or breach of fiduciary duty that poses a material risk to the financial safety and soundness of an affiliated depository institution or the domestic or international payment system ...."
Third, what are we to make of the idea that directors owe duties to both shareholders and depositors? As I explain in In
Defense of the Shareholder Wealth Maximization Norm: A Reply to Professor
Green, 50 Washington and Lee Law Review 1423 (1993), such multi-fiduciary duties are unsound:
As Green acknowledges, management occasionally faces situations in which it is impossible to advance shareholder interests and to protect simultaneously nonshareholders from harm. Yet, whose interests should management pursue when shareholder and nonshareholder interests are in irreconcilable conflict? Green's principal answer seems to be that management should make trade-offs between shareholder and nonshareholder interests, balancing the harms and benefits more or less equitably, although he is clearly prepared to permit management to eliminate shareholder value completely when necessary to protect nonshareholder interests.
His approach … raises a host of practical issues collectively making up the two masters problem. What happens when there is a conflict between shareholders and nonshareholders and also between various nonshareholder constituencies? Suppose, for example, that management is considering closing down an obsolete plant. The closing will harm the plant's workers and the local community, but will benefit share-holders, creditors, employees at a more modern plant to which the work previously performed at the old plant is transferred, and communities around the modern plant. Assume that the latter groups cannot gain except at the former groups' expense. By what standard should management make the decision?
According to Green, these problems are overstated:
[F]iduciaries of various sorts commonly find themselves pulled between competing duties. . . . In all these instances, professionals are expected to do the best they can by both developing and working within a framework of reasonable and defensible priorities. Why cannot corporate directors and senior managers be asked to do the same?
For one thing, what Green asks of them is more easily said than done. As a theological matter, the proposition that no one can serve two masters simultaneously is at least two thousand years old. As a secular proposition, it is certainly even older. Indeed, those of us who find the theological proposition persuasive do so in part precisely because we recognize its validity from our secular experience.
To take one of Professor Green's examples about which I have personal experience, being the “lawyer for the situation” is at best uncomfortable and not infrequently untenable. Consider the example of Louis Brandeis, who coined this term. After a thorough examination of Brandeis' professional conduct, John Frank concluded:
[T]he greatest caution to be gained from study of the Brandeis record is, never be “counsel for a situation.” A lawyer is constantly confronted with conflicts which he is frequently urged to somehow try to work out. I have never attempted this without wishing I had not, and I have given up attempting it. Particularly when old clients are at odds, counsel may feel the most extreme pressure to solve their problems for them. It is a time-consuming, costly, unsuccessful mistake, which usually results in disaffecting both sides.
Even authorities who are disposed more favorably toward the idea of lawyers for the situation acknowledge that that role “is not easy, may fail, and will often bring recrimination in its wake.”
Professor Green fails to offer us a solution for this problem. Instead, he simply ex-presses confidence that those of us in the legal profession will be able to “develop the outlines of a multi-fiduciary” duty after “years of painstaking legal reasoning.” Based on the legal profession's poor experience with “lawyers for the situation,” I am less sanguine.
Even if it proves possible to develop meaningful standards under which a multi-fiduciary duty might be enforced, however, it seems likely that those standards would operate mostly by virtue of hindsight, and thus deprive managers of the critical ability to determine ex ante whether their behavior comports with the law's demands. The conflict of interest rules governing the legal profession again provide a useful analogy. Despite many years of refinement, these rules are still viewed as inadequate, vague, and inconsistent; hardly the stuff of which certainty and predictability are made. Yet, despite the central importance of those virtues in corporate law, this is the principal model Professor Green wishes to foist upon us.
In sum, the OCC bulletin is a fairly accurate statement of what the law is. But not what the law ought to be.
