WASHINGTON — A law professor recently detailed with the Department of Justice is petitioning two bank regulators to mandate that at least some of a large bank's directors be unaffiliated with the bank's holding company.
While it's not
"It's time for public interest advocates to make use of this tool, as the banking lobby has been doing for many years," said Jeremy Kress, who submitted his petition urging bank regulators to adopt an unaffiliated bank standard to the Office of the Comptroller of the Currency and the Federal Reserve on Thursday.
Kress, a co-faculty director of the University of Michigan's Center on Finance, Law & Policy recently worked with the Department of Justice advising on bank merger policy.
The regulators will have to consider the petition and provide a response to it, although there is no set time frame for them to complete their consideration.
The petition asks that the OCC and the Fed pursue a similar rule to the Federal Deposit Insurance Corp.'s
The Fed and the OCC, Kress said in the petition, should require large banks to appoint at least some directors who are unaffiliated with their holding companies. The overlap between bank directors and the banks' holding companies leads to problematic conflicts of interest, Kress said. He made similar arguments in a
"The vast majority of large-bank directors also serve as board members of their parent holding companies," he said. "These dual directors are poorly situated to exercise the independent judgment necessary to protect a bank from exploitation by its nonbank affiliates."
When a bank operates as part of a diversified large financial conglomerate, that conglomerate can exploit the bank's federal safety net by transferring government subsidies to its nonbank affiliate, Kress said in the petition.
"For instance, a bank's affiliate may seek to avail itself of federal subsidies through preferential loans, asset sales, or other intracompany transactions," he said.
This could expand the scope of government subsidies and encourage the nonbank affiliates to take excessive risks, which could impair a bank's financial conditions.
When a bank's directors also sit on the board of the bank's holding company, those directors have an incentive to engage in this pattern, Kress argued. The bank holding company's directors are accountable to the shareholdings for maximizing the value of the financial conglomerate, not just the bank subsidiary, Kress said.
"They may want the bank to engage in preferential loans, asset transfers, or other intracompany transactions that benefit its affiliates," he said.
The petition points to some of the largest banks in the country that have this arrangement. Of the four largest banks by asset size — JPMorgan Chase Bank, Bank of America, Citibank and Wells Fargo Bank — only Citibank has a director who doesn't also sit on the bank holding company's board. According to the petition, 119 of 153 bank directors in the sample pulled by Kress sit on the bank's holding company and on the board of the bank subsidiary.
While Kress said that the FDIC's corporate governance proposal — which would apply to banks with more than $10 billion in assets — would prevent conflicts of interest among its regulated banks, it's particularly imperative for the OCC and the Fed to do this rulemaking because of the kinds and size of banks that they regulate.
"The FDIC's corporate governance guidelines apply only to state nonmember banks," he said. "However, the bank subsidiaries of the largest diversified financial conglomerates tend to be state member and national banks."
But because regulators don't typically make rules about who may sit on bank boards of directors, the legal foundation of such a rule could be subject to court challenge, said David Zaring, a bank law professor at Wharton. That's particularly true in an
Such a challenge could be faced with some confidence, Zaring said, since regulators do supervise banks for management quality. Corporate governance is typically a matter of state law or securities regulation, but if the bank is publicly traded, bank regulators communicate frequently to assess and manage board members, part of the management "M" in the CAMELS examination process.
Because of that, Zaring said that he doesn't think such a rule would be viewed as beyond the power of the regulators under the
"The challenge would have to be along the lines of: 'The regulators didn't identify a problem this would fix' — that they acted arbitrarily in pushing an unaffiliated director standard without identifying reasons for it, in other words," Zaring said. "Those challenges can work, but the banking regulators would have to feel optimistic that they would win that sort of litigation."
