Okay folks. I have a question. In reviewing an executive officer's account, I have come across some checks paid to one of the directors. In researching this further, it looks like this director made a "loan" to the officer for a downpayment on their house. This was paid off a month later with interest after the officer's old home sold. In addition, I've seen other instances where this officer makes checks to the director. I'm guessing he is borrowing money for other things. The issue obviously is there is a conflict of interest. In addition, this officer oversees the loan that the director's sons guarantee (bad loan that the sons have had to continually inject cash into....downgraded but at prime rate). I am curious, I've found the FDIC's risk mgmt manual regarding warning signs for insider transactions. Is there any other guidance out there that applies to this situation? Or is it simply a conflict of interest and not a very good practice. One last thing, the board performs this person's review and salary ( a committee of the board that the director is not on). So, any insights you have would be greatly appreciated. Thanks!!!

Review your code of conduct - an employee or director being indebted to another employee or director (outside of prior approval at the board level for an executive officer) ought to be prohibited.

I agree with TT on this, but I have found that sometimes you have to be careful how you handle these situations, because sometimes heads will roll, but not the right one. Good luck, I hope someone else will provide us both with more of an insight to this, I am knew to this role myself.

Are you a publicly traded company (i.e.--subject to SEC rules)?

No, we are not publicly traded. All I can find is an FDIC insider warning signs document. I've talked with the individual as well as the President (who knew these transactions took place every once in a while) who feel that this is not an issue of the board, or anyone's business (except mine since I'm the auditor)! It was a very touchy subject since this employee has been doing this for like 20 years. He stated that he uses this board member as his personal banker due to the restrictions with Reg. O. Any other thoughts? I think I might drop the issue as it doesn't go against our code of ethics or any other guidance that I can find. Any other help is appreciated. Thanks!

I would suggest respectfully asking if he has reviewed this arrangement with the remainder of the board and your regulator. If the answer was no, I would suggest including a recommendation in your next HR audit that this type of situation be addressed in the code of conduct.

I agree that this is a touchy situation, and that, depending on his temperment, and your support from the audit committee, you need to proceed with caution.

You might want to review this OIG report to the FDIC regarding auditing of bank management. In it, it includes:

"The DSC Manual suggests that examiners review a bank's written code of conduct and that examiners determine whether a policy covers conflicts of interest. The DSC Manual states, in part, that the early detection of apparent fraud and insider abuse is an essential element in limiting risk and that "Corporate Culture/Ethics" is one such area in which potential problems may exist. The DSC Manual also states that the "Absence of a written code of conduct may make it difficult to discipline directors, officers or employees who may be involved in questionable activities.…"

The DSC Manual provides examiners with a list of "Warning Signs" in relation to the existence of potential problems surrounding a bank's corporate culture/ethics including, but not limited to, the absence of a code of ethics; lack of oversight by the institution's BOD, particularly outside directors; and the lack of management independence in acting on recommended corrective actions. The DSC Manual instructs examiners to inquire into bank policies and procedures designed to bring conflicts of interest to the attention of the BOD when it is asked to approve loans or other transactions in which an officer, director, or principal stockholder may be involved. Examiners are also instructed to scrutinize any loan or other transaction in which an officer, director, or principal stockholder is involved."

Whenever you have an executive officer indebted to a director, you are jeopardizing the independance of the board member and possible management actions of the executive officer and it would have an overriding influence that is not in the best interests of the bank.

You can read the whole report here: http://www.fdicoig.gov/reports04/04-033-508.shtml

It also points out the dangers of allowing one director or executive officer too much power or oversight.

It is not a good idea.......

This is certainly a bad practice and the bank officer should not be handling this director's loans or those of his family or business associates. Pay attention to the timing of any loans to the director, or draws on lines of credit, looking for patterns showing that the funds are really coming from the bank.

I am pondering a few other things here, but for now at a minimum you should try to address these things to ensure independence. I would suggest the transfer of accounts " to protect the officer, so that no one can ever say the accounts were not handled properly" because of the personal relationship. You can make it sound like you are on his side, looking out for his best interests. It is actually better for him not to handle those accounts, and is certainly better for the bank.

Even though there may not be an FDIC/OCC/FRB regulation that directly describes this as a prohibited activity. I think if the regulators find this, they may explode. This is a HUGE corporate governance issue. If you were a bank that had to comply with SarbOx, someone may as well right up the Rule 404 failure now, however, since you aren't, compliance with Rule 404 doesn't help you solve the problem. It appears that this is going to be a "we've always done it that way, and we haven't been criticized by the examiners yet" type of a scenario, and for bringing it up you are going to be painted as the bad guy, even though if this is going on you are 100% correct in being concerned. And, conversely, if you don't bring it up and the regulators find it, you'll probably be blamed for not bringing it up. Best of luck--I don't envy you having to take this on.

Thanks...yeah, I'm not too excited about handling this. I think I'm going to call an executive session in the next audit committee meeting. Since this person is also on my audit committee serving as management (not voting of course). I will talk with the audit committee on this one privately and get their thoughts as to how to proceed. I may also talk with HR as they are in charge of the code of ethics policy. Thanks everyone!