OCC's Fine Print Contains Tough Requirements for Directors

WASHINGTON — Bank boards that thought they skirted having to "ensure" management was in compliance with heightened regulatory standards should think again.

The Office of the Comptroller of the Currency bowed to industry pressure in late September to remove the word "ensure" from its heightened expectations guidelines for the biggest institutions after bankers argued it would create unintentional litigation risk for boards of directors.

But few noticed a month later when the OCC inserted virtually the same language in its updated supervision policy on how examiners should deal with issues uncovered during an exam, which are called matters requiring attention.

"I was struck by the reappearance of the 'ensure' language in the MRA guidance since the OCC decided to take out that word in heightened expectations because of the connotation it conveyed about the board guaranteeing certain managerial responsibilities," said Julie Williams, a managing director and head of the domestic advisory practice at Promontory Financial Group, and a former general counsel at the agency. The OCC is "setting an expectation for boards that cuts across banks of all sizes."

The industry thought it had scored a key victory when the OCC backed off language in its proposed heightened expectations that said a banks' board should "ensure that the bank establishes and implements an effective risk governance framework that complies with the guidelines."

Bankers successfully argued that the word ensure would leave bank directors vulnerable to litigation in the event a problem at the bank was discovered.

But key parts of that wording returned in the OCC's updated Oct. 30 policy for examiners regarding MRAs.

"Examiners must impress upon the board its responsibility to ensure that management implements corrective actions within a reasonable period of time and to confirm that those actions are effective," the updated policy says. "Failure to do so could lead to enforcement actions."

OCC officials who spoke to American Banker said part of the reason for adding "ensure" to the supervision policy is because boards should be held to a greater responsibility when a matter is identified that requires specific and immediate attention. That is a different situation than how regulators view the heightened expectations guidelines, which is more general requirements for all large bank boards.

"Matters requiring attention is a specific supervisory concern between OCC and a specific bank that requires both the board and management to ensure all concerns are corrected in an agreed upon timeframe," said John Eckert, director of the OCC's operational risk and core policy. "It is in the directors' best interest to make sure the concern is resolved."

Molly Scherf, the OCC's deputy comptroller for large banks, added that the heightened expectations guidance also had a more "enforceable" legal expectation because it was something directed at banks. The updated supervision policy, meanwhile, is aimed at examiners, and doesn't trigger the same legal concerns, the second official said.

"We were concerned that it would create undo litigation risk and that was completely unintended in what we meant by the word 'ensure,'" said Scherf. The supervision policy and procedures manual "doesn't create that same litigation risk."

But both officials agreed that the two policies are driving at the same idea: forcing bank boards to hold management responsible for being in regulatory compliance.

That idea by itself is a concern for boards, however, because the line between directors and management is getting blurred, observers said.

"There's a risk if a board is expected to take on more management duties because, one, they're not qualified to do that. And two, it takes time away from the directors to perform their supervisory role — to lead the direction of the bank and the strategy — as well as overseeing management," said David Baris, president of the American Association of Bank Directors and a partner at BuckleySandler. "And if the board doesn't meet these expectations, they're reminded that they're potentially subject to personal civil money penalties. I'd say that's enough to convince some board members that they're better off being on a local school board."

Observers also raised concerns that the OCC went further in the updated supervision policy by adding that bank boards must ensure corrective actions are "effective."

"The word I would object to is 'effective'," said Eric Fischer, a senior fellow at Boston University's Center for Finance, Law and Policy. "Whether the corrective actions were the 'effective' changes or not is more a matter of judgment and hindsight."

OCC officials said part of the reason for having "effective" in the board expectations was to make sure directors are engaged with management throughout the bank's effort to correct a problem so there's a less likelihood that examiners would ultimately take a more severe action, such as a consent order.

"Our goal is to be preemptive to address these concerns so we can avoid increased action down the road," Eckert said.

Industry observers said they agree with the intent of what the OCC's doing by forcing boards to be more engaged, but the wording still raises problems.

"You can ensure steps are taken but it's another thing to ensure effective steps are taken," said Joseph Vitale, a partner in the bank regulatory practice at Schulte Roth & Zabel. "But I think the main purpose for the OCC is to put boards on notice that they have a responsibility here. They can't sit back and let management deal with it and then rubberstamp it. The main purpose of this is to spur boards to be more active."

Baris added that he agrees with the four bullet points the OCC uses in its updated supervision policy regarding MRAs, including holding management accountable for deficient practices and directing them to make the necessary corrections. It also requires boards to approve all the necessary changes and establish processes to monitor progress, as well as "verify and validate the effectiveness" of the corrective actions that management took.

"Those are all legitimate points," he said. "But the concern would be when the OCC says these expectations 'include' other expectations requiring boards to 'ensure' timely and effective correction. A requirement to ensure effective correction means that the board assumes or is tempted to assume a management role."

Observers said the updated supervision policy can also have a far-reaching impact because it is very common for examiners to find a matter requiring attention during a regular exam, regardless of the bank's size.

At the same time, they agreed that the new exam guidance is an improvement over the OCC's prior policy. They said it is more organized and sets a framework for banks and examiners by categorizing "five concerns," the consequences of not addressing those issues and determining when a matter requiring attention has been satisfied.

Prior to this guidance update "the OCC didn't have the five Cs and it wasn't this distilled," Williams said. "They are trying to get more consistency in how MRAs are written up, and how they are handled and overseen. It can help banks and it also helps the agency in doing a horizontal look across the industry."

The OCC said part of its reason for updating the matters requiring attention was in response to recommendations made by international regulators that reviewed the OCC's supervision of large and midsize institutions last year. They said having a format so there is more consistency in the exam reports will also allow them to compare reports and identify common risks.

With the updated supervision policy, "we're able to get a better sense of systemic risk quicker than the prior process," Scherf said.