‘Tis the season.

The media, Congress, academia and a host of other Monday morning quarterbacks are well on their way to using their crystal clear powers of 20-20 hindsight in a rush to judgment to criticize and critique the actions of industry boards and management in finger-pointing post-mortems on the recent economic “crisis.”

Things are always clearer in the rearview mirror. For directors to have known that the relatively small fire that was the true “subprime” market would be fueled and fanned into the comprehensive, frenzied, industry-wide, multinational panic that ensued would have required a financial crystal ball. And that “crystal ball” would have needed to allow them to foresee and to avoid the very things that state and federal regulatory agencies, auditors, accountants, Congress, rating agencies, lawyers and expert advisors in the field obviously did not.

Former Federal Reserve Chairman Alan Greenspan, testifying before Congress on October 23, 2008, acknowledged that the current “crisis” could not have been predicted, calling it a “once in a lifetime credit tsunami.” If the full extent of the firestorm that was generated by the reaction to the mortgage market was truly “foreseeable,” virtually everyone missed it.

The Duty of Care

The common law “duty of care” does not require directors to be prescient, to cross-examine management and others on every aspect of the business, or to hire separate special advisors for every decision. Mortgage lending has been a mainstay of banking forever, and most mortgage loans by banks were and are appropriate. Mortgage-backed investments, including GSE securities, were just one step short of Treasury general obligations in the world of bank investments. International Basel Capital Accords assigned mortgage obligations a very low risk rating, so even international bankers and regulators were apparently likewise unaware. Concentration issues are easy to question in hindsight but where they occurred in this instance they were concentrations of “good things” at the time. No one can control the actions of the media and politicians in public commentaries on an industry that is particularly subject to rumor and speculation, accurate or otherwise, and that is particularly vulnerable to the impact of “reputation risk” on the industry as a whole. Likewise, it is particularly difficult to predict the impact, much less the extent of the impact, of those actions on the industry.

Taking management and directors to task for failing to foresee the current situation and position their institutions accordingly would have required them, in most instances, to call into question the entire system, from the adequacy of legislative, regulatory, audit and rating agency oversight through all of the varied participants in the mortgage and financial industry market. No system of oversight is infallible, and second-guessing every aspect of operation of the institution will surely grind business to a halt. Even if certain aspects of the situation may have been subject to some question, certainly the extent of the damage was not foreseeable. Director oversight can only utilize the facts as they exist at the time. If the Chairman of the Federal Reserve admits that he could not have predicted what happened, it’s unlikely that individual institution directors and management could have or should have. The situation does not represent, and was not precipitated by, an endemic failure of management to conduct themselves in an appropriate fashion or of boards to fulfill their duties as directors. It was and remains an unprecedented firestorm that can be “blamed,” if blame is important, on any number of complex causes. However, the thing that is foreseeable is that lawmakers, the media and plaintiffs’ lawyers will surely be on the hunt for scapegoats.

Going Forward

Therefore, it isn’t really time to join the panic and fan the fire by calling into question everything that management or the board does or did or everything that consultants and other advisors did or do. While appropriate inquiry and follow up is always an important part of the responsibility of directors, micro-managing the organization is not. In the absence of reasons to question reliance on management, boards can and should allow management to utilize their expertise to run the organization. And, in the rare instance where necessary and appropriate, directors can and should initiate and undertake careful, thoughtful and appropriate changes.

What is important is to learn from what happened and to apply those lessons going forward. Heightened awareness is certainly appropriate. Boards should look closely at their organizations with regard to risk analysis and risk management in not only the mortgage market but with regard to all aspects of the “CAMELS” assessments including liquidity plans and other current “hot button” areas of interest. Minutes should document the consideration, analysis and actions (if any) taken in response.

No army of lawyers and layers of advisors can insure that mistakes will never be made, and no crystal ball will avoid the criticism and second-guessing that follows those mistakes. Management and boards are called upon to make important business decisions all day every day, and banks are in the business of undertaking and managing appropriate risk. The common law “duty of care” requires directors to exercise ordinary care and to take reasonable and prudent steps, in light of the circumstances, to act as fiduciaries in their oversight capacity. That may, and does, entail asking additional difficult questions, and/or seeking additional independent input, when appropriate and as issues arise. And that is obviously so in the rare situation where there are reasons not to rely on management or advisors or where conflicts of interest exist.

However, those obligations do not require directors to micro-manage the organization, seeking multiple independent advisors for every decision. Directors are not insurers of performance, although there are those who would differ. Care must be taken to avoid balkanization of the board and management, including inside and outside directors, leading to mistrust and grinding the corporate and business processes to a halt. Ultimately, that structure and operating environment is not likely in the best interests of the organization and its constituencies.

The basic duties and obligations of directors have not changed as a result of the current situation, and the hope is that state and federal legislatures will not over-react in a time of crisis to create new and expanded director responsibilities, making it even more difficult for institutions to attract and to retain good board members in this challenging environment. As in all business downturns, the Monday morning quarterbacks will be advising as to how the plays “should have been” called with the benefit of 20-20 hindsight, and we can expect the usual parade of the “obviously guilty” to the C-SPAN gallows to be grilled by those who were probably in the best position to foresee and to do something about all of this before it happened.


As the inevitable wave of director litigation related to the current financial “crisis” makes its way through the courts, plaintiffs’ lawyers will be watching to see whether judges and juries are willing to ignore the business judgment rule which protects directors in their good faith actions. A recent New York State Supreme Court ruling dismissing a shareholder suit against the directors of Bear Stearns regarding their decision to sell to JPMorgan Chase fortunately reinforced the business judgment rule through the courts refusal to second-guess the actions of the Bear Stearns board in their decision-making process. Hopefully other courts will follow to reinforce the long-standing business judgment protections for decisions and actions taken in good faith by diligent directors.

The “duty of care” for financial institution directors will require that directors learn from the present situation, assess their organizations in the light of what has happened and apply those lessons going forward. It requires that directors, as always, continue to act as vigilant fiduciaries in their oversight of the institution and make whatever organizational, financial, product, structural or management changes, if any, may be necessary and appropriate in light of the circumstances. Unless there are reasons to act otherwise in light of the specific facts and circumstances, as with most challenges the best and most productive response is to approach and resolve issues with management and the board as a cohesive team, focused on a common objective of delivering value to the constituencies of the institution consistent with safe and sound banking and business practices.