As the dust (hopefully) begins to settle during this time of bank and market uncertainty, and a lull continues for bank M&A activity, it may be just the time to review your institution’s governance structure, documents, and mechanisms to bring them up to date and to provide important alternatives and flexibility for responding to M&A and other corporate opportunities. And to generally put the institution in a position to better respond to market opportunities and events as they unfold.
In addition to the fact that it remains the responsibility of the board and management to review governance structures and mechanisms on an ongoing basis and to ascertain that they are appropriate for the operations, plans, and intended activities of the organization, a proper governance structure will better enable the institution to respond to changing regulatory requirements, control its destiny as a potential acquisition target and to be in a position to quickly respond to acquisition opportunities as a potential buyer.
What is appropriate varies for each institution and the business plans for that institution. Some things may change as a result of pending regulatory initiatives under the Dodd-Frank federal reform legislation. There are, however, certain items that make sense on a general basis for all institutions.
So what are some of the more important things to look for in this “tune-up”?
Governance documents should provide appropriate authorization for issuance of common (and perhapspreferred) stock to address planned capital needs and to provide a buffer, if possible, for unanticipated events and opportunities. “Quality” capital is becoming an important consideration, and hybrid securities will be taking a back seat. A broad authorization for preferred stock with terms to be set by the board of the institution can provide flexibility for fairly quick capital issuances, and additional authorized common (or classes of common) may make sense as well for growth including potential acquisitions. Expanded opportunities may also be appropriate for stock-related incentive compensation programs, subject to careful scrutiny by compensation committees and documentation of risk and other considerations in the process.
Of course the appropriate structure varies by institution, and is impacted by the willingness of existing shareholders to authorize additional shares where such flexibility is not currently provided. Sub-S institutions will need to carefully review the impact of any proposed changes in capital structure on Sub-S status. Perhaps more than any other single item, capital flexibility is important in enabling the institution to take advantage of current and prospective growth opportunities and provides a backup if credit quality issues arise.
This too varies by institution. While some institutions address indemnification coverage in articles of incorporation (or association for national banks), some in the code of regulations or bylaws, some by contract, and some through silence in governance documents with a fallback to relevant state and federal law, it is important that boards and management understand and address this issue. D&O insurance is becoming more expensive and difficult to acquire as industry issues continue, and coverage limitations and exceptions are growing. And there is of course the limitation on coverage with regard to agency actions and penalties. Prospective officers and board members may well inquire as to indemnification coverage in the recruiting process, and insurers will need to determine how those issues are handled by the institution. There is no “one size fits all,” and the time to be looking at this issue is preferably long before the lawsuit is served.
Committee Structures and Composition
Standing and special committees have long had an important place in the banking industry, and Sarbanes-Oxley has further focused on “best practices” for nonpublic companies (including banks) in regard to committee structures and independence. Certain standing committees should be reflected in governance documents, and all committees should adopt and maintain detailed committee charters to provide guidance with respect to committee activities and expectations, as well as membership requirements. Audit, compensation, and governance committees should be focused on “independent” directors, even for non-SEC companies, and the board should take care to ascertain the “independence” of committee members and document that consideration. Again, while not specifically applicable to nonpublic companies, the committee structure and independence concepts contained in Sarbanes-Oxley, Dodd-Frank, and in the listing rules for NYSE and NASDAQ provide a good “best practices” template for all institutions.
Even if the institution is uncertain as to its continued independence plans, adopting appropriate anti-takeover protections can provide a method to enable the institution to better control its destiny should unwanted overtures arise, and to secure the best transaction (and price) for shareholders. While true “hostile” takeovers are rare in banking, they can be costly and difficult to prevent in the long run. Incorporating appropriate protections in governance structures can provide defensive leverage, a stronger negotiating position, and critical time to consider an appropriate response. Takeover preparedness is important, and defensive protections including a staggered board, “rights plans,” “supermajority” provisions, “fair price” protections, and other structural and procedural protections will enable the institution to better control its destiny and to maintain appropriate leverage in dealing with unwanted acquisition overtures. And each can be structured so that they are not an obstacle to board-approved transactions.
Likewise, potential acquiring institutions should review their governance structure to examine whether there may be inappropriate obstacles for taking advantage of acquisition opportunities as they arise. Takeover preparedness is important for both potential buyers and potential sellers, and institutions should endeavor to adopt a governance structure which will maximize opportunities for protecting the institution in the event of an unwanted acquisition overture while providing flexibility for responding to opportunities as a potential buyer. Potential acquires should likewise examine their governance materials for the ability to take advantage of potential assisted transactions for closed-bank and troubled bank opportunities, which tend to arise quickly and sometimes with little or no warning.
The current market has spawned a number of proposals for increased shareholder activism including “say on pay” activities and expanded shareholder access to the proxy process. Some are now the law through Dodd-Frank and related SEC initiatives, and may become further applicable through regulatory “creep” and new agency rules, as well as “best practices.”
How these proposals will eventually develop remains to be seen, but in the present environment organizations (public and nonpublic) should anticipate that further state and federal pro-shareholder legislation and regulation is likely. For public companies, the SEC is becoming more supportive of shareholder activism proposals generally, which may quickly make their way into state corporate law and/or banking regulations in the present environment. New shareholder access rules will likely be in effect for the 2011 annual shareholder meeting season.
Certain aspects of state corporate law is arguably being “federalized” by congressional and SEC shareholder proposals, and bank regulators may be pressured into taking a more active role in bank shareholder issues and activities.
While the impact of this expanded shareholder activism remains to be seen, it is very likely to place additional governance burdens on boards and institutions, increase costs, and create further need for careful review and consideration of governance structures and activities for all organizations.
Holding Company and Bank
Many institutions, particularly community banking organizations, have similar (if not identical) boards at the holding company and the bank. While this can and sometimes does present issues for “piercing the veil” between the holding company and the bank and may be appropriate to avoid, nonetheless in all instances care should be taken to avoid inconsistencies between holding company and bank governance structures and documents. Not that they are not and should not be different, but they should be reviewed carefully to avoid inconsistencies that impact board and committee composition and activities. When the holding company is the sole shareholder of the bank subsidiary, making changes is relatively easy but may entail regulatory involvement at the bank level and taking care to assure compliance with relevant banking law requirements which differ from the general state corporate law requirements generally applicable to the holding company.
Depending on the structure, certain changes in governance structure and documents require shareholder approval. Others may be accomplished through amendments to governance documents which may be undertaken by the board without the necessity of seeking and obtaining separate shareholder approvals. In addition, certain changes involve the necessity of seeking and securing prior regulatory and/or debt-holder approvals. Changes may also impact existing employment, vendor, creditor, and other contract relationships, and care must be taken to avoid inadvertently triggering certain provisions in related contracts which may have an unintended result.
Proposed changes should be reviewed with appropriate professionals including financial and M&A advisors, investment bankers, accounting and tax professionals, and legal counsel. Again there is no “one size fits all,” and what is appropriate varies by institution and the current, and anticipated, issues and activities impacting the institution. Having a documented record of consideration of proposed changes by objective outside professionals can assist in addressing shareholder and regulatory issues that may arise.
As an aside, regulatory authorities should be kept in the loop all along in order to avoid any surprises and in order to avoid creating any inappropriate and unnecessary concern or suspicion as to the intentions of the institution in undertaking proposed changes.
The time may be right to conduct an overall review and assessment of the governance structure of your institution to better position the institution to address current and prospective industry and market issues, and to better position the institution to be able to respond to a changing environment and unforeseen events. Maximizing flexibility and self-direction for the organization should be one of the primary goals, consistent with the interests and goals of the institution, the constituencies of the institution, and safe and sound banking and corporate practices. Doing so now certainly beats scrambling to do so in the heat of shareholder disputes, unwanted takeover solicitations, litigation, regulatory concerns, or immediate capital needs, and will enable the institution to better control its own destiny.