“Insider transactions” – transactions between business organizations and their officers, directors, employees or principal shareholders, or their family members or business entities – are completely common and ordinary events. To avoid potential after-the-fact legal challenges, many state corporation laws and corporate bylaws include provisions specifically permitting such transactions and providing special procedures – typically full disclosure of any conflicts and recusal of any interested board member – for their approval by corporate boards. However, when FDIC-insured banks or their holding companies are involved, greater caution is required.
The potential for challenge exists because transactions between any company and its insiders necessarily involve “conflicts of interests” – meaning the interests of the insider and the company are not identical and in fact, often opposed. For example, the interests of a company (e.g., the New England Patriots) as employer and its principal employees (e.g., Tom Brady) are conflicting. The presumed interest of the Patriots in paying less for players’ services are in conflict with Tom Brady’s presumed desire to maximize his income. Absent proper safeguards, for a director or officer to derive personal benefit from the corporation may be said to violate their legal duty of loyalty to the corporation.
Conflicts of interests are an ordinary and necessary incident to conducting any business, football included. Banking is no exception. In fact, because so many of the services provided by banks are needed by individuals, businesses and nonprofit organizations alike, the occasions for banks to engage in insider transactions are more frequent than for most other businesses.
Insider transactions are an essential and often profitable incident of the banking business. Most banks would be happy to have the profitable loan and transactional business their directors’ companies can bring to the institution. Virtually all banks have executive employment and benefits and other employment-related agreements with their senior executive officers. Mid-level management and branch employees need the same banking services as the rest of us, and often would rather pay interest and fees to their employer than to a competitor.
Banks are often significant sponsors and donors to local charitable and community causes for which bank officers or directors may serve in leadership or fundraising roles. Banks regularly require many business goods and services – office supplies, accounting and legal services, financial advisory, real estate and insurance brokerage services – that local companies owned or managed by the banks’ directors can economically provide. It is impossible for a financial institution to avoid completely engaging in business transactions of one kind or another with its own officers, directors and employees or with entities owned by or related to such insiders.
Proceed With Caution
On the other hand, the FDIC and other bank regulatory agencies have long held that insider fraud and abuse is a significant contributor to bank failures and carefully scrutinize insider transactions in bank examinations and in deciding whether to sue directors and officers after a bank fails.
While insider transactions not involving bank holding company affiliates or insider loans have thus far been left largely unregulated at the federal level, the Massachusetts Division of Banks has imposed recordkeeping, prior board approval and market terms requirements on certain bank-insider transactions of state-chartered banks.
The absence of detailed federal regulations in certain areas should not be viewed as a license to be less careful in structuring and approving insider transactions. Regulators reviewing a transaction after the fact may view an insider’s failure to disclose and obtain advance approval of specific aspects or provisions of a transaction from the bank’s disinterested directors as grounds for invalidating the transaction, or worse, initiating an enforcement referral against the bank or insider involved.
One benefit of detailed regulations is to clearly draw a line between practices that are permissible and those that aren’t. Where regulations are absent or lack detail, drawing the line becomes a more uncertain and often subjective exercise. In those areas, more caution rather than less is advisable.
A banking institution seeking to protect itself and its insiders from regulatory second-guessing can reduce that risk by taking a few common-sense precautions. First, develop and adopt in advance detailed and board of directors-approved written policies governing the institution’s approach and limitations on such transactions. Second, fully document the advance review and approval of material aspects of the transaction by the institution’s disinterested directors or trustees. Third, apply the same rules and standards to transactions with mid-level and branch personnel that apply to senior executive officers and directors. And finally, when entering into any kind of legal transaction with a bank insider, make sure the agreement is approved by qualified corporate legal counsel and bank directors who are truly independent of the insider on the other side of the transaction.
This article is not intended to be, and may not be relied upon as, legal advice, which can only be based upon a careful review of particular facts and circumstances.
Kevin J. Handly is a Boston-based attorney and adjunct professor at Boston University Law School’s Graduate Program in Banking and Financial Law. He may be reached at khandly@
bostonbankinglaw.com.
