The Fiduciary Duties of Bank Boards

Even Bank Directors Are Not “Platonic Masters”: The fiduciary duties of bank boards extend to efforts to exploit banking regulations and manipulate bank regulators

When a board of directors takes action for the primary purpose of thwarting the effectiveness of shareholders’ election of directors, that board violates its duty of loyalty. The rationale for this rule is simple: as between shareholders and directors, shareholders are the principals and directors the agents. In a principal/agent relationship, the principal has the authority to choose the agent and in the context of directors and shareholders, it is fundamentally disloyal for the director/agent to usurp the principal/shareholders’ authority to elect directors. [1] Among non-banking, commercial corporations, this is a matter of settled law and boards are largely loathe (whether to avoid liability or predictable repercussions) to take any corporate action that would thwart the effectiveness of a shareholder vote, such as attempting to prevent a contested election of directors. Yet boards of banking organizations—almost as a matter of course when confronted with an activist investor—will shamelessly take actions with the obvious “purpose of obstructing the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contest against management.” [2]

The reason for this disparity is simple: shareholders and others charged with policing bank directors’ compliance with their fiduciary duties have simply failed to grasp that otherwise lawful (or at least, colorably permissible) actions (including those regarding banking laws and regulations) nonetheless violate boards’ fiduciary duties to shareholders when they are taken for the purpose of disrupting the shareholder franchise. An obvious example is amending corporate bylaws—an ostensibly legitimate exercise of power in the abstract, it reflects a direct assault on shareholder rights when taken for the purpose of diminishing shareholder voice. But the same analysis applies when banking organizations exploit bank regulations and manipulate bank regulators for the purpose of thwarting the effectiveness of a shareholder vote. [3] Where the primary purpose of a board’s action is the same—disenfranchising shareholders—the instrumentality of that purpose makes little difference, and the same standards for liability should apply.

Banks are highly regulated entities. For any banking organization, there is a plethora of regulatory schemes, with different regulators, laws and regulatory agendas, that are frequently in tension—or even inconsistent—with one another. There are also myriad rationales offered in support of bank regulation, which include protecting the safety and soundness of the financial system and financial institutions, ensuring access to credit and other banking products, and preventing unfair competition for banking services. Protecting an entrenched board from accountability to shareholders, however, is clearly not a legitimate goal of any bank regulatory scheme. The fact that entrenched boards are able to exploit banking regulations (such as prior approval requirements for certain share purchases or proxy solicitations) and banking regulators (who may have fallen prey to regulatory capture) does not translate to a conclusion that their actions are in furtherance of any legitimate regulatory objective.

The seminal case of Blasius Industries v. Atlas Corporation stands for the proposition that a board cannot interfere with or impede exercise of the shareholder franchise without a compelling justification. Where the board of a banking organization acts to prevent a contested election or prevent an activist shareholder from voting or soliciting proxies in a contested election, fiduciary duty mandates that a board demonstrate a compelling justification for interfering with shareholders’ right to choose directors. Where the mode of action is lobbying a bank regulator (for example, to prompt regulatory proceedings under a statute within the regulator’s jurisdiction), the requirement for a compelling justification is the same as if the board sought to amend the company’s bylaws for the same purpose. When evaluating a board’s actions, purpose matters; and where that purpose is preventing or impeding a contested election, it is difficult to imagine that a compelling justification exists to support that board’s actions, regardless of whether or not those actions are cloaked in an expressed desire to ensure compliance with banking regulations.

Several states have enacted bank regulations affecting share purchases, voting proxies or the like, requiring prior approval from a banking regulator prior to engaging in the subject activity. The purpose of these regulatory schemes is to give the regulator a chance to decide if further investigation is needed to determine, for instance, whether the purchase or other action might raise safety and soundness or other legitimate regulatory concerns. Prior approval provisions make it easier for bank regulators to further regulatory objectives because they can analyze the potential impact of a transaction before it happens, but it is unclear (at best) that any compelling justification exists when a bank board lobbies a regulator to take action (that the board knows or should know will deprive all shareholders of the right to choose directors) merely because a shareholder had not complied with a prior approval procedure that may or may not even apply to the purchases or other actions at issue.

For example, in anticipation of a 2018 proxy fight with Blue Lion Capital (“Blue Lion”), Homestreet, Inc. (“Homestreet”) lobbied the Washington State Department of Financial Institutions (the “ Washington DFI”) to cause the Washington DFI to issue an interpretation stating that obtaining proxies with respect to more than 25% of the outstanding shares of a Washington bank amounted to a “change of control” for which prior approval was required. This interpretation, which was issued on March 15, 2018, brought an immediate halt to a proxy contest that Blue Lion had started almost two months earlier on January 17, 2018. In that case, the Homestreet board took action (lobbying the Washington DFI) that was clearly intended to interfere with an activist investor’s ability to mount a proxy contest and thereby limited the full exercise of shareholders’ franchise. [4] Whatever interest the Homestreet board might have had in causing the Washington DFI to issue a regulatory interpretation that was clearly designed to disrupt an ongoing contested election for directors, it is difficult to imagine that interest rising to the level of “compelling justification” as set out in Blasius. [5]

The fact that a corporation is engaged in the business of banking doesn’t and shouldn’t mitigate the obligation of its directors to act as faithful fiduciaries to its shareholders. More specifically, there is no wholesale carveout to directors’ duty of loyalty for actions involving banking regulations and regulators. It makes no difference whether a board acts to impede a shareholder vote through more “traditional” corporate actions (such as bylaw amendments, share issuances, etc.) or by exploiting banking regulations and regulators—the effect is the same and the board’s actions should be reviewed using the same standards.

As Chancellor Chandler noted in Blasius. “[t]he theory of our corporation law confers power upon directors as the agents of shareholders: it does not create Platonic masters.” [6] With respect to directors of banking organizations, neither does the existence of bank regulations and bank regulators that may be exploited and manipulated in order to interfere with shareholders’ fundamental right to elect directors “create Platonic masters.”

Endnotes

1See, Blasius Industries, Inc. v. Atlas Corporation, 564. A. 2^nd 651 (Del. Ch. 1988)(noting that a decision by a “board to act for the primary purpose of preventing the effectiveness of a shareholder vote inevitably involves the question who, as between the principal and the agent, has authority with respect to a matter of internal corporate governance” and that such a decision “does not involve the exercise of a corporation’s power over its property , or with respect to its rights or obligations; rather it involves allocation between shareholders as a class and the board, of effective power with respect to governance of the corporation”).(go back)

2See, Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971)(holding that management’s use of corporate machinery for the purpose of perpetuating itself in office and preventing a contested election for directors were “inequitable purposes, contrary to established principles of corporate democracy”).(go back)

3See generally, Schnell at 439 (noting that inequitable action does not become permissible simply because it is legally possible).(go back)

4See, press release issued by Blue Lion on May 21, 2008 available at https://www.sec.gov/Archives/edgar/data/1518715/000089706918000371/cg1119.htm (noting that Homestreet had hired four different law firms to lobby the DFI to issue an interpretation effectively limiting Blue Lion’s ability to solicit proxies representing more than 25% of the outstanding votes in its ongoing proxy fight with Homestreet).(go back)

5This is particularly the case given that, in Delaware and jurisdictions that follow the precepts of Delaware law, “compelling justification” is a extremely high standard. See, Williams v. Geier, 671 A.2d 1638 (Del. 1996)(noting “Blasius’ burden of demonstrating a ‘compelling justification’ is quite onerous, and therefore applied rarely”). As far as other states following Blasius, as one commentator has noted, “[b]ecause of the importance of shareholder voting rights as a counterbalance to managers’ power, it is not surprising that states tend to follow Delaware in requiring managers to show compelling justification in these cases.” Michael Barzuza, The State of State Antitakeover Law, 95 Va. L. Rev. 1973, 2015 (2009)(go back)

6Blasius at 663.(go back)