Tuesday, September 4, 2007

Banking Corporate Governance

ATENEO DE MANILA LAW SCHOOL
CENTER FOR CONTINUING LEGAL EDUCATION
Makati, Philippines

BANK DIRECTORS AND OFFICERS:
LEGAL AND REGULATORY ISSUES IN CORPORATE GOVERNANCE
[23 MARCH 2007]

BY
DEAN CESAR L. VILLANUEVA, BSC, CPA, LLB, LLM, DJS, FAICD


A proper appreciation of the legal issues pertaining to the duties and responsibilities of the Board of Directors of banking institution requires primarily a thorough review of the provisions of various circulars issued by the Bangko Sentral ng Pilipinas that pertain to the area called “Corporate Governance,” namely:

• Circular No. 283, series of 2001

• Circular No. 296, series of 2001

• Circular No. 341, series of 2002

• Circular No. 391, series of 2003

• Circular No. 456, series of 2004


(Hereinafter collectively referred to as “BSP Circulars on Corporate Governance,” or simply “BSP Circulars”).

Pursuant to the rule-making powers of the Monetary Board of Bangko Sentral ng Pilipinas (“BSP”) under the New Central Bank Act, BSP Circulars constitute “subsidiary legislation,” and have the force of law.

Bank directors therefore should not view the provisions of the BSP Circular on Corporate Governance as merely reiterating or mimicking existing corporate law doctrine on directors’ duties and responsibilities, and the extent of their personal liabilities, but to realize that the BSP Circulars on Corporate Governance have effectively raised the stakes, perhaps to the highest level.

The purpose of this paper therefore is to assist bank directors and officers in realizing the clarion call for the very high degree of corporate governance, and the dire consequences of ignoring such call, that the passage of BSP Circulars have effectively engendered in the banking sector.

I. CORPORATE STANDARDS ON DIRECTORS’ DUTIES AND RESPONSIBILITIES

1. Presumed Premise of Bank Directors’ Duties

Mechanically, the BSP Circulars seek to introduce amendments to BSP Manual of Regulations; but in legal effect, the circular introduced as an integral part of the Manual the equivalent of the Code of Governance, similar to that promulgated by the SEC as the “Code of Corporate Governance” under Memorandum Circular No. 2, series of 2002, and that promulgate by the Insurance Commissioner entitled “Corporate Governance Principles and Leading Practices,” under IC Circular No. 31-2005.

The SEC Code defines “corporate governance” to mean —
A SYSTEM WHEREBY SHAREHOLDERS, CREDITORS AND OTHER STAKEHOLDERS OF A CORPORATION ENSURE THAT MANAGEMENT ENHANCES THE VALUE OF THE CORPORATION AS IT COMPETES IN AN INCREASINGLY GLOBAL MARKET PLACE.

The IC Code defines “corporate governance” to mean —
THE SYSTEM BY WHICH COMPANIES ARE DIRECTED AND MANAGED. IT INFLUENCE HOW THE OBJECTIVES OF THE COMPANY ARE SET AND ACHIEVED, HOW RISK IS MONITORED AND ASSESSED, AND HOW PERFORMANCE IS OPTIMIZED.

In the case of the BSP Circulars, particularly Circulars Nos. 283, 296 and 456, they concentrate on laying down, both in broad and in detailed format, the duties and responsibilities of the Board of Directors and each of the directors.
Section 1 of Circular No. 283 provides for the power and authority of the Board of Directors of banking institutions, thus:

POWERS AND AUTHORITY OF THE BOARD OF DIRECTORS. – The corporate powers of a bank/quasi-bank/trust entity shall be exercised, its business conducted and all its property shall be controlled and held by its board of directors. The powers of the board of directors as conferred by law are original and cannot be revoked by the stockholders. The directors hold their office charged with the duty to act for the bank/quasi-bank/trust entity in accordance with their best judgment.

The mandated powers of the Board of Directors can be summarized in three parts, namely:

(a) Exercise all the Corporate Powers of the banking institution;

(b) Conduct all of its business; and

(c) Control and hold all of its properties.

The language of Section 1 of Circular No. 283 is practically lifted from Section 23 of the Corporation Code, which reads:

SEC. 23. The board of directors or trustees. — Unless otherwise provided in this Code, the corporate powers of the all corporations formed under this Code shall be exercised, all business conducted and all property of such corporations controlled and held by the board of directors or trustees to be elected from among the holders of stocks, or where there is no stock, from among the members of the corporation, who shall hold office for one (1) year and until their successors are elected and qualified.

Since the basic definition of the powers and responsibilities of bank directors under Circular No. 283 has been lifted directly from Section 23 of the Corporation Code, one may fall under the mistaken notion that the Circular merely reiterates well-established Corporate Law principles on directors’ duties and responsibilities; and having come to such a premise, a bank director going through the circular may come to the wrong conclusion that the standards of duty, care and prudence that colleague directors in other industry enjoy would also apply to them. Such a premise is wrong, as in fact the provisions of the BSP Circulars show a clear intention to raise the bar of standards for diligence and care, and thereby increase the scope of liability, of directors of banking institutions.

2. Tantalizing Concept of the “Business Judgment Rule”

Section 23 is one of the hallmark provisions of the Corporation Code, as it clearly defines the source and extent of the powers and authority of the Board of Directors of every corporation. In fact, the opening phrase in the section that “Unless otherwise provided in this Code,” emphatically shows that all corporate power in every corporation is vested directly by law with the Board of Directors, and not with the stockholders; that the only time that stockholders would have a say in the management of the corporate enterprise is only in those instances when the Corporation Code expressly requires the ratificatory vote of the stockholders; and that consequently, unless otherwise so provided, every corporate powers being vested directly and solely in the Board, the determination and resolution of the Board is the final word on the matter.

The legal consequences of these corporate doctrine is that realization that although directors are elected into the Board by the stockholders, nevertheless once elected, they are not legally agents of the stockholders, and that the powers that the Board of Directors exercises is not one delegated to them by the stockholders, but is vested directly in the Board by law. As a general rule, therefore, even when the stockholders of the corporation in a meeting duly called for the purpose pass a resolution on a particular corporate act, contract or transaction, the same is not binding on the Board of Directors, who by resolution can proceed at a course opposite the determination of the stockholders. The only exception to this rule is in those specific instances where the Corporation Code provides that the resolution of the Board requires the ratificatory vote of the stockholders in order to be valid. Thus, in Ramirez v. The Orientalist Co., the Supreme Court held:

Both upon principle and authority it is clear that any action or resolution of the stockholders on corporate matters should be ignored. The functions of the stockholders of a corporation, it must be remembered, are of limited nature. The theory of a corporation is that the stockholders may have all the profits but shall turn over the complete management of the enterprise to their representatives and agents, called directors. Accordingly there is little for the stockholders to do beyond electing directors, making by-laws, and exercising certain other special powers defined by law. In conformity with this idea it is settled that contracts between a corporation and third persons must be made by the directors and not by the stockholders. The corporation, in such matters, is represented by the former and not by the latter. This conclusion is entirely accordant with the provisions of section 28 of our Corporation Law [now Section 23 of the Corporation Code].

This long-established corporate doctrine is embodied in the “business judgment rule,” which basically has two (2) recognized branches, namely:

 Contracts and transactions entered into by the Board of Directors within the powers of the corporation cannot be reversed by the courts, not even on the behest of the stockholders of the corporation; and

 Directors and officers acting within such business judgment cannot be held personally liable for the consequences of such acts.

To put the matter in better perspective, let us read the language that the Supreme Court used to define the legal consequences of the application of the business judgment rule in the decision in Montelibano v. Bacolod-Murcia Milling Co., Inc., thus —

When a resolution is “passed in good faith by the board of directors, it is valid and binding, and whether or not it will cause losses or decrease the profits of the [corporation], the court has no authority to review them. . . It is a well-known rule of law that questions of policy or management are left solely to the honest decision of officers and directors of a corporation, and the court is without authority to substitute its judgment [for that] of the board of directors; the board is the business manager of the corporation, and so long as it acts in good faith its orders are not reviewable by the courts.”

In Gamboa v. Victoriano, it was held that courts cannot supplant the discretion of the board on administrative matters as to which they have legitimate power of action, and contracts which are intra vires entered into by the board are binding upon the corporation and courts will not interfere unless such contracts are so unconscionable and oppressive as to amount to a wanton destruction of rights of the minority.

Only recently, in Philippine Stock Exchange v. Court of Appeals, the Supreme Court upheld the management prerogatives of the Board of Directors of the Philippine Stock Exchange (PSE) as against the control of the SEC, through the reiteration of the business judgment rule, thus:

Questions of policy and of management are left to the honest decision of the officers and directors of a corporation, and the courts are without authority to substitute their judgment for the judgment of the board of directors. The board is the business manager of the corporation, and so long as it acts in good faith, its orders are not reviewable by the courts.

3. Common Fiduciary Duties of Directors

To avoid abuse on the part of corporate officers and directors, and because directors and officers do owe a fiduciary obligation to both the corporation (as their principal) and to the stockholders (as the beneficial owners of the corporate enterprise), then common law has provided for the following duties, thus:

• DUTY OF OBEDIENCE – To act and enter into contracts and transactions that are within the corporations express powers, or at least incident to its existence.

• DUTY OF LOYALTY – To represent the corporate interest above personal interests, and to prefer the corporation’s interest to that of one’s own interests, especially in conflict situations.

• DUTY OF DILIGENCE – To manage the corporations, its operations, assets and properties with reasonable diligence, care and prudence; and the degree of diligence required is the same as that one requires of one’s self in the management of one’s affairs, or the “diligence of a good father of a family.”

• DUTY TO INFORM – To allow the stockholders to inspect and copy corporate books and records and to submit on demand the latest audited financial statements of the corporation.

The Corporation Code has confirmed and expressed in statutory language the fiduciary duties of directors and officers. For purposes of this paper, the more important duties are those of diligence and loyalty, which are covered by BSP Circular 283.
Notice the language used by the Corporation Code in defining the duties of diligence and loyalty:

SEC. 31. Liability of directors, trustees or officers.—Directors or trustees who willfully and knowingly vote for or assent to patently unlawful acts of the corporation or who are guilty of gross negligence or bad faith in directing the affairs of the corporation or acquire any personal or pecuniary interest in conflict with their duty as such directors or trustees shall be liable jointly and severally for all damages resulting therefrom suffered by the corporation, its stockholders or members and other persons.

When a director, trustee or officer attempts to acquire or acquires, in violation of his duty, any interest adverse to the corporation in respect of any matter which has been reposed in him in confidence, as to which equity imposes a liability upon him to deal in his own behalf, he shall be liable as a trustee for the corporation and must account for the profits which otherwise would have accrued to the corporation. (n)

SEC. 34. Disloyalty of a director. — Where a director, by virtue of his office, acquires for himself a business opportunity which should belong to the corporation, thereby obtaining profits which should belong to the corporation, he must "account to the latter for all such profits by refunding the same, unless his act has been ratified by a vote of the "stockholders" owning or representing at least two-thirds (2/3) of the outstanding capital stock. This provision shall be applicable, notwithstanding the fact that the director risked his own funds in the venture. (n)
The statutory language used in the Corporation Code, affirm the jurisprudential rulings of the Supreme Court that as a general rule, directors acting within the scope of their authority, their being no fraud or bad faith should not be held personally liable. Note that under Section 31, the basis for attaching personal liability to directors must overcome a high standards, by the use of terms “willfully and knowingly vote,” “patently unlawful acts,” and “guilty of gross negligence or bad faith.” In other words, ordinarily directors and officers cannot be held personally liable for corporate acts and contracts, and only when their personal actuations reach a level of malice, fraud or gross negligence can directors be held personally and solidary liable for corporate liabilities. This is in line with the second branch of the business judgment rule. Notice also that even in the case of conflict of interests situation, when a director has appropriated for himself a corporate opportunity, Section 34 allows such erring director to keep the profits earned when ratified by the stockholders.

The business judgment rule, as affirmed in statutory language under Section 23 of the Corporation Code, and the common law and statutory definitions of the fiduciary duties of directors and officers, have always been the source of legal comfort for corporate directors and officers, not only as to the source of their powers, but also as the shield against being personally held liable for corporate acts, contracts and transactions. Are such corporate principles available doctrine to directors of banking institutions? The language of the BSP Circulars does not sustain an affirmative reply. In effect, the BSP Circulars affirm a shift in paradigm when it comes to the duties of the Board of Directors of a banking institution.

II. THE SHIFT IN PARADIGM

1. Jurisprudential Shift

Even before the promulgation of Circular No. 283, Philippine commercial system had already began to shift the standards for banking institutions, their directors and officers, as reflected in decisions of the Supreme Court. The shift came from a societal determination that the banking industry is one that is vested with public interests.

In its decision in Bank of Commerce v. Court of Appeals, the Supreme Court confirmed what society always considered to be the fact, that since banking is vested with public interests, then in the case of dealings with their depositors, the degree of diligence required is more than that of a good father of a family but that “with the highest degree of care.” Only recently, the Supreme Court held in Philippine Commercial and Industrial Bank v. Court of Appeals, that —
Time and gain, we have stressed that banking business is so impressed with public interest where the trust and confidence of the public in general is of paramount importance such that the appropriate standard of diligence must be very high, if not the highest, degree of diligence. A bank’s liability as obligor is not merely vicarious but primary; the defense of exercise of due diligence in the selection and supervision of its employees is of no moment.

In Bank of Commerce v. Court of Appeals, the Court held: “In the case of banks in dealing with their depositors, the degree of diligence required is more than that of a good father of a family . . . [but] with the highest degree of care.”
Insofar as the banking institutions are concerned therefore, the degree of diligence required of them in the performance of their banking functions is not that of “reasonable diligence” or that “diligence of a good father of a family,” but rather of the “highest degree of diligence.” The application of the “highest degree of diligence” practically and legally means that banks, their directors and officers, in the performance of banking functions, practically have no room for error; and if loss or damage is caused, banks and their responsible officers and directors shall be made to bear the same. This conclusion is taken from Transportation Law, where common carriers are also required by law and jurisprudence to exercise the highest degree of diligence, and in case of damage or loss, the defense of diligence of a good father of a family is not allowed. Thus, in case of damage sustained by a passenger, all he needs to prove in court is the amount of damage sustained and the fact that he had a contract of carriage with the common carrier, and the “extraordinary diligence” provided by law for common carriage will automatically presume that there was diligence, and the burden of evidence is with the common carrier to prove that it had exercised extraordinary diligence in the conduct of its affairs and in the hiring and training of its employees.
The jurisprudential declaration that the standard of care and diligence that banking institutions and their directors and officers must discharge in all business dealings where they perform a fiduciary function has since been affirmed by a long line of decisions of the Supreme Court.

It must be noted though that the Supreme Court in the case of Reyes v. Court of Appeals, clarified that such “highest degree of diligence” is not expected of all banks all the time, but only in those instances “only when the bank is bound as a fiduciary.” In the case of Reyes, the bank which acted in a commercial transaction that was not inherently a banking function, was held only to the level of reasonable diligence. But nevertheless, the doctrine in Reyes is clear: where the bank is mandated to owe a fiduciary obligation, then the level of diligence expected of the bank, its directors and officers, is that of the highest degree of diligence. This doctrine is of important consideration in looking at the provisions of the BSP Circulars.

2. Statutory Shift

The General Banking Law of 2000 also adopted such a jurisprudential shift in the degree of diligence required of banking institutions, their directors and officers. Firstly, in its declaration of State policy, Section 2 of GBL 2000 has declared that “the fiduciary nature of banking that requires high standards of integrity and performance,” thus —

SEC. 2. Declaration of Policy. - The State recognizes the vital role of banks in providing an environment conducive to the sustained development of the national economy and the fiduciary nature of banking that requires high standards of integrity and performance. In furtherance thereof, the State shall promote and maintain a stable and efficient banking and financial system that is globally competitive, dynamic and responsive to the demands of a developing economy.
In Philippine National Bank v. Pike, the Supreme Court has considered said section of GBL 2000 as a confirmation that the diligence required of banking institutions of the high standard, thus:

With banks, the degree of diligence required, contrary to the position of petitioner PNB, is more than that of a good father of a family considering that the business of banking is imbued with public interest due to the nature of their functions. The stability of banks largely depends on the confidence of the people in the honesty and efficiency of banks. Thus, the law imposes on banks a high degree of obligation to treat the accounts of its depositors with meticulous care, always having in mind the fiduciary nature of banking. Section 2 of Republic Act No. 8791, which took effect on 13 June 2000, which makes a categorical declaration that the State recognizes the “fiduciary nature of banking that requires high standards of integrity and performance.”

Though passed long after the unauthorized withdrawals in this case, the aforequoted provision is a statutory affirmation of Supreme Court decisions already in esse at the time of such withdrawals.

The PNB decision declaring that the entirety of the banking business has been declared to be imbued with public interests and requiring thereby the highest form of diligence has since been affirmed in subsequent decisions of the Supreme Court as to be without any doubt.

In fact, the extraordinary diligence required of banks has extended from dealings with their depositors into other bank activities, thus:

• Banks must not only exercise “high standards of integrity and performance,” but that it must also ensure that its employees do likewise because this is the only way to ensure that the bank will comply with its fiduciary duty.

• Although its employees may be the ones negligent, a bank’s liability as an obligor is not merely vicarious but primary, as banks are expected to exercise the highest degree of diligence in the selection and supervision of their employees.

• Banks cannot merely rely on certificates of title in ascertaining the status of mortgaged properties; as their business is impressed with public interest, they are expected to exercise more care and prudence in their dealings than private individuals. Indeed, the rule that persons dealing with registered land can rely solely on the certificate of title does not apply to banks.

• Banks, being greatly affected with public interest, are expected to exercise a degree of diligence in the handling of its affairs higher than expected of an ordinary business firm, and that consequently, when the certificate of sale issued in the foreclosure sale provides a redemption period of two (2) years, instead of only one year, the bank is estopped from objecting to the enforceability of the two-year redemption period.

Secondly, GBL 2000 formally adopted the “fit and proper” rule for bank directors, thus:

SEC. 16. Fit and Proper Rule. – To maintain the quality of bank management and afford better protection to depositors and the public in general, the Monetary Board shall prescribe, pass upon and review the qualifications and disqualifications of individuals elected or appointed bank directors or officers and disqualify those found unfit.

After due notice to the board of directors of the bank, the Monetary Board may disqualify, suspend or remove any bank director or officer who commits or omits an act which render him unfit for the position.

In determining whether an individual is fit and proper to hold the position of a director or officer of a bank, regard shall be given to his integrity, experience, education, training, and competence.

In turn, Circular No. 341 has provided specific rules and guidelines covering the conduct of banking business in an unsafe and unsound manner.

Thirdly, among other provisions, the GBL 2000 adopts formally a provision on “unsafe and unsound manner” of conducting banking business, thus:

SEC. 56. Conducting Business in an Unsafe or Unsound Manner. – In determining whether a particular act or omission, which is not otherwise prohibited by any law, rule or regulation affecting banks, quasi-banks or trust entities, may be deemed as conducting business in an unsafe or unsound manner for purposes of this Section, the Monetary Board shall consider any of the following circumstances:

56.1. The act or omission has resulted or may result in material loss or damage, or abnormal risk or danger to the safety, stability, liquidity or solvency of the Institution;

56.2. The act or omission has resulted or may result in material loss or damage or abnormal risk to the institution’s depositors, creditors, investors, stockholders or to the Bangko Sentral or to the public in general;

56.3. The act or omission has caused any undue injury, or has given any unwarranted benefits, advantage or preference to the bank or any party in the discharge by the director or officer of his duties and responsibilities through manifest partially, evident bad faith or gross inexcusable negligence; or

56.4. The act or omission involves entering into any contract or transaction manifestly and grossly disadvantageous to the bank, quasi-bank or trust entity, whether or not the director or officer profited or will profit thereby.

Whether a bank, quasi-bank or trust entity persists in conducting its business in an unsafe or unsound manner, the Monetary Board may without prejudice to the administrative sanctions provided in Section 37 of the New Central bank Act, take action under Section 30 of the same and/or immediately exclude the erring bank from clearing, the provisions of law to the contrary notwithstanding. (n)

In turn, Circular Nos. 296 and 391 have provided for specific provisions covering the qualifications and disqualifications of bank directors and officers.
With the promulgation of the BSP Circulars, the Monetary Board had effectively completed the shift in paradigm in how the Boards of Directors of banking institutions must view their duties and responsibility, and to gauge the extent of their personal liability for their banks’ debts and obligations.

3. Expansion of Directors’ Constituencies

The first fundamental shift adopted under Circular No. 283 is the express expansion of the constituencies of banking institutions. Generally under principles of Corporate Law, directors owe fiduciary obligations only to the corporation itself and to the stockholders or members thereof; and that directors owe no fiduciary obligation to corporate creditors, who must rely upon the terms of their contractual relations with the corporation as the basis by which to stake a cause of action against the corporation.

Section 2 of BSP Circular 283 not only confirms that “[t]he position of bank/quasi-bank/trust entity director is a position of trust,” but goes on to say that “[a] director assumes certain responsibilities to different constituencies or stakeholders,” and expressly enumerates them as follows:

(a) the banking institution itself;

(b) the stockholders;

(c) the depositors and other creditors;

(d) the management and employees; and

(e) the public at large.

The section goes on to say that “these constituencies or stakeholders have the right to expect that the institution is being run in a prudent and sound manner.” Although the general corporate law principle is that it is the stockholders who have a direct equitable stake in the operations of the corporation, Circular No. 283 expands that to include the depositors, creditors, management, employees and the public at large, as having a direct stake in the operations of banking institution and to “expect that the institution is being run in a prudent and sound manner.”

The language of Circular No. 283 thereby has effectively expanded the fiduciary obligations of the directors not only to the banking institution and its stockholders, but practically to the entire community on which its operates. This conclusion is reinforced by the language of Section 1 of the circular that provides that “[t]he powers of the board of directors as conferred by law are original and cannot be revoked by the stockholders. The directors hold their office charged with the duty to act for the bank/quasi-bank/trust entity in accordance with their best judgment.” The language not only confirms the prevailing theory of “original power” (as distinguished from “stockholders’ delegated power”) embodied in Section 23 of the Corporation, but more so when taken in connection with the expanded definition of constituencies in Section 2 of the Circular, emphasizes that bank directors cannot hide behind the fiduciary obligations to the principal stockholders as a shield to not meet their fiduciary obligations to other specified stakeholders, such as the public at large.

The legal and equitable implications of the provisions of Circular No. 283 mean that unlike their counter-part directors in non-bank publicly-listed companies who need to focus only on serving the interests of their corporations and stockholders, bank directors are legally mandated to walk the thin line of balancing the interests of various constituencies, whose interests often are incompatible or diametrically opposed.

This “public” responsibility of the Board of Directors of banking institutions is strengthened by Section 3 of the Circular which enumerates the “specific duties and responsibilities” of the Board of Directors of every banking institution, where under paragraph 12 it is provided that: “To ensure that the bank/quasi-bank/trust entity have beneficial influence on the economy. The board has a continuing responsibility to provide those services and facilities which will be supportive of the national economy.” Likewise, Section 4(2) of the Circular provides clearly that: “While a director should always strive to promote the interest of all stockholders, he should also give due regard to the rights and interests of other stakeholders.” Finally, Section 4(2) of the Circular provides that a direct shall “act honestly and in good faith, with loyalty and in the best interest of the institution, its stockholders, regardless of the amount of their stockholding, and other stakeholders such as its depositors, investors, borrowers, other clients and the general public. . . . While a director should always strive to promote the interest of all stockholders, he should also give due regard to the rights and interest of other stakeholders.”

Having clearly defined the expanded constituencies of the Board of Directors (to whom the directors owe a fiduciary obligation), the issue to be resolved is what is the standard or degree by which the fiduciary duties must be measured. This is where the language of the Circular does not jive with the jurisprudential rule.

If we accept, as we must under the terms and language of Circular No. 283, that bank directors also owe a fiduciary duty to creditors and the public at large, then the doctrine in Reyes v. Court of Appeals must kick-in, i.e., the degree of diligence owed by the bank, its directors and officers, in practically all of its dealings (the public at large), must that of the “highest degree.” And yet Section 4(2) of the Circular provides: “A director must always act in good faith, with care which an ordinarily prudent man would exercise under similar circumstances.” But the Circular itself does not characterize the banking industry as one vest with public interests, although the language used exudes such policy. Since the Supreme Court has by jurisprudence classified the banking industry as one vested with public interests, and it has decreed that the degree of diligence owed to depositors (to whom there was no mandated fiduciary duty) cannot just be that of a good father of family, then it would be hard for the Court to thereby backdown from its ruling that the degree of care and diligence required of banks, their directors and officers is of the highest degree, especially now that the Circular has expressly included depositors, creditors, management, employees, and the public at large, to come within the constituencies of the Board of Directors of banking institutions.

4. Exacting Duties and Responsibilities Lead to Exacting and Expanded Liabilities

The rest of the provisions of Circular No. 283, including Circular No. 456, go on to classify and enumerate duties and responsibilities under the following categories:

(a) General Responsibilities of the Board of Directors; (b) Specific Duties and Responsibilities of the Board of Directors; and (c) Specific Duties and

Responsibilities of a Director.

4.1. GENERAL RESPONSIBILITIES OF THE BOARD OF DIRECTORS. – In summary, Section 2 of the BSP Circular demands from the Board of Directors of every banking institution, that it discharge the following general responsibilities:
(a) THE BOARD SHALL BE PRIMARILY RESPONSIBLE FOR CORPORATE GOVERNANCE OF THE BANK;

(b) IT MUST ESTABLISH STRATEGIC OBJECTIVES, POLICIES AND PROCEDURES THAT WILL GUIDE AND DIRECT THE ACTIVITIES OF THE BANK; and

(c) IT MUST ESTABLISH THE MECHANISM FOR MONITORING MANAGEMENT'S PERFORMANCE.
It may be true that the Board of Director may still retain the services of experts and good counsel, but the section emphasizes that the "buck stops" with the Board, and it cannot escape liability for failing to discharge such direct duties but alleging that it had left the matter to Management and expert consultants. This point is driven home by the following provision of the section: "While the management of the day-to-day affairs of the institution is the responsibility of the management team, the board of directors is, however, responsible for monitoring and overseeing management action." (emphasis supplied)

4.2. SPECIFIC DUTIES AND RESPONSIBILITIES OF THE BOARD OF DIRECTORS. – As if to ensure that the Board of Directors cannot hide behind the cloak of generality, Section 3 of BSP Circular 283, goes on to enumerate in details the "specific" duties and responsibilities of the Board, as follows:

1. Appoint officers qualified to administer the bank's affairs effectively and soundly, and establish adequate selection process for all personnel.

 Primary responsibility to appoint competent management team at all times, applying fit and proper standards on key personnel

 Integrity, technical expertise and experience in the institution’s business, shall be key considerations in selection process

 Since mutual trust and close working relationship are important, Board’s choice should share its general operating philosophy and vision for the institution
 Establish appropriate compensation package consistent with the interest of all stakeholders.

2. Establish objectives and draw up a business strategy for achieving them.

 Business plans should be established to direct its on-going activities, consistent with the banks objectives

 Ensure that performance against plan regularly reviewed, with corrective action taken as needed

3. Conduct the corporate affairs with high degree of integrity.

 Reputation being a very valuable asset, in the institution’s dealings with the public, it observes a high standard of integrity

 Prescribe corporate values, codes of conduct and other standards of appropriate behaviour for itself, senior management and other employees

 Activities and transactions that could result in conflicts-of-interest or unethical conduct shall be strictly prohibited

 Provide policies that will prevent the use of the bank's facilities in furtherance of criminal and other illegal activities

4. Establish and ensure compliance with sound written policies.

 Adopt written policies on all major business activities, i.e., investments, loans, assets and liability management, business planning and budgeting

 Provide mechanism to ensure compliance with said policies

5. Prescribe clear assignments of responsibilities and decision-making authorities, incorporating a hierarchy of required approvals from individuals to the board of directors.

 Establish in written limits of discretionary powers of each officer, committee, sub-committee and such other group for the purpose of lending, investing or committing the bank to any financial undertaking or exposure to risk at any time

 Adopt a schedule of matters and authorities reserved to it for decision, such as: major capital expenditures, equity investments and divestments

6. Effectively supervise the bank’s affairs.

 Establish system of checks and balances which applies in the first instance to the Board itself

 Adopt a mechanism for effective check and control by the Board over the CEO and key managers and by the latter over the line officers

7. Monitor, assess and control the performance of management.

 Adopt appropriate reporting system to provide relevant and timely information to effectively assess management's performance

 For this purpose, it may constitute a governance committee

8. Adopt and maintain adequate risk management policy.

 Responsible to formulate and maintain written policies and procedures relating to institution's risk management, which shall include

 a comprehensive risk management approach

 a detailed structure of limits, guidelines and other parameters used to govern risk-taking

 a clear delineation of lines of responsibilities for managing risk

 an adequate system for measuring risk

 effective internal controls and a comprehensive risk-reporting process

9. Constitute the following committees (optional for banks with net worth of less than P20 million but mandatory if a subsidiary of other banks):

 Audit Committee, which shall:

 Comprised of:

- Board members

- at least two (2) of whom shall be independent directors, including the Chairman

- preferably with accounting, auditing, or related financial management expertise or experience

 Upon being set-up, the Board of Directors shall draw-up a written charter or terms of reference which clearly sets out the Audit Committee’s authority and duties, as well as the reporting relationship with the Board.

- Charter shall be approved by the Board of Directors and reviewed and updated periodically

 With the following powers and functions

- Provide oversight of the institution’s financial reporting and control and internal and external audit functions

- Be responsible for the setting-up of the internal audit department and for the appointment of the internal auditor who shall both report directly to the Audit Committee

- Monitor and evaluate the adequacy and effectiveness of the internal control system

- Shall have explicit authority to investigate any matter within its terms of reference, have full access to and cooperation by Management, and full discretion to invite any Director or Executive Officer to attend its meetings, and adequate resources to enable it to effectively discharge its functions

- Shall ensure that a review of the effectiveness of the institution’s internal control, including financial, operational and compliance controls, and risk management, is conducted at least annually

 Corporate Governance Committee, which shall

 With a composition of at least two (2) of whom shall be Independent Directors

 Shall have a written charter that describes the duties and responsibilities of its members, and which shall be approved by the Board and reviewed and updated at least annually

 Assist the Board of Directors in fulfilling its corporate governance responsibilities

 Review and evaluate the qualifications of all persons nominated to the Board as well as those nominated to other positions requiring appointment by the Board of Directors

 Shall be responsible for ensuring the Board’s effectiveness and due observance of corporate governance principles and guidelines

 Shall oversee the periodic performance evaluation of the Board and its committees and Executive Management

 Shall conduct an annual self-evaluation of its performance

 Shall decide whether or not a Director is able to and has been adequately carrying out his/her duties as director bearing in mind the Director’s contribution and performance (e.g., competence, candor, attendance, preparedness and participation)

 Shall adopt internal guidelines that address the competing time commitments that are faced when Directors service on multiple boards

 Shall recommend to the Board regarding the continuing education of Directors, assignment to Board committees, succession plan for the Board members and Senior Officers, and their remuneration commensurate with corporate and individual performance

 Shall decide the manner by which the Board’s performance may be evaluated and propose an objective performance criteria approved by the Board, which shall address show the Board has enhanced long-term Shareholders’ value.

 Risk Management Committee, which shall

 Composed of at least three (3) members of the Board of Directors

- who shall possess a range of expertise

- as well as adequate knowledge of the Institution’s risk exposures

 Shall have a written charter that defines the duties and responsibilities of its members, which shall be approved by the Board of Directors and reviewed and refined periodically

 Shall develop appropriate strategies for preventing losses and minimizing the impact of losses when they occur

 Shall oversee the system of limits to discretionary authority that the Board delegates to Management

- shall ensure that the system remains effective

- that the limits are observed

- that immediate corrective actions are taken whenever the limits are breached

 Shall have the following core responsibilities:

- Identify and evaluate Exposures – Committee shall assess the probability of each risk becoming reality and shall estimate its possible effect and cost, and that priority areas of concern are those risks that are the most likely to occur and are costly when they happen

- Develop Risk Management Strategies – Committee shall develop a written plan defining the strategies for managing and controlling the major risks, and identify practical strategies to reduce the chance of harm and failure or minimize losses if the risk becomes real

- Implement Risk Management Plan – Committee shall communicate the Risk Management Plan and Loss Control Procedures to affected parties, shall conduct regular discussions on the Institution’s current risk exposure based on regular Management reports, and direct concerned units or offices on how to reduce these risks

- Review and Revise the Plan as Needed -- Committee shall evaluate the Risk Management Plan to ensure its continued relevancy, comprehensiveness, and effectiveness, shall revisit strategies, look for emerging or changing exposures, and stay abreast of developments that affect the likelihood of harm or loss. It shall report regular to the Board of Directors the entity’s over-all risk exposure, actions taken to reduce the risks, and recommend further action or plans as necessary.

 Nomination Committee, which shall:

 Be composed of at least three (3) members of the Board, preferably all independent
members

 Review and evaluate the qualifications of all persons nominated to the Board, as well as those nominated to other positions requiring appointment by the B.

10. To meet regularly.

 Independent views in board meetings shall be given full consideration and all such meetings shall be duly minuted

11. Keep individual members of the Board and shareholders informed.

 Present a balanced and understandable assessment of the bank’s performance and financial condition

 Provide appropriate information that flows internally and to the public

 All Board members shall have reasonable access to any information about the institution

12. Ensure that Bank has a beneficial influence on the economy.

 The Board has continuing responsibility to provide those services and facilities which will be supportive of the national economy

13. Assess Board's performance and effectiveness annually as a body, as well as its various committees, CEO and bank itself.

 Composition of Board shall also be reviewed regularly with the end in view of having a balanced membership

 Towards this end, a system and procedure for evaluation shall be adopted which may include, but not limited to, the setting of benchmark and peer group analysis

14. Keep their authority within the powers of the institution as prescribed in the articles of incorporation, by-laws and in existing laws, rules and regulations.

 Appoint a compliance officer who shall be responsible for coordinating, monitoring and facilitating compliance with existing laws, rules and regulations

 Compliance officer shall be vested with appropriate authority and provided with appropriate support and resources.

The use of the “active” words and tense to describe the specific duties of the Board of Directors is to remove any doubt in the minds of the directors of what exactly it is they have to achieve and to fulfill as the very personification of the banking institution.

4.3. SPECIFIC DUTIES AND RESPONSIBILITIES OF EVERY DIRECTOR. – Section 4 of BSP Circular 283 then goes on to address every individual director to clarify that he is not only part of a group vested with collective responsibility, but an individual officer of the banking institution, he is compelled to have specific duties and responsibilities, as follows:

1. Conduct fair business transactions with the bank and ensure that personal interest does not bias board decisions.

 Directors should avoid conflict-of-interests situations; if unavoidable, it should be done in the regular course of business and upon terms not less favorable to the institution than those offered to others

 Basic principle to be observed: a director should not use his position to make profit or to acquire benefit or advantage for himself and/or his related interests

 He should avoid situations that compromise his impartiality

2. Act honestly and in good faith, with loyalty and in the best interest of the institution, its stockholders, regardless of the amount of their stockholdings, and other stakeholders such as its depositors, investors, borrowers, other clients and the general public.

 He must always act in good faith, with the care which an ordinarily prudent man would exercise under similar circumstances

 While a director should always strive to promote the interest of all stockholders, he should also give due regard to the rights and interests of other stakeholders

3. Devote time and attention necessary to properly discharge their duties and responsibilities.

 Devote sufficient time to familiarize themselves with the institution’s business

 Must be constantly aware of the institution’s condition and be knowledgeable enough to contribute meaningfully to the Board’s work

 Must attend and actively participate in board and committee meetings, request and review meeting materials, ask questions, and request explanations

 If a person cannot give sufficient time and attention to the affairs of the institution, he should neither accept his nomination nor run for election as member of the Board

4. To act judiciously.

 Before deciding on any matter before the Board, every director should thoroughly evaluate the issues, ask questions and seek clarifications when necessary

5. To exercise independent judgment.

 Should view each problem/situation objectively

 When there is disagreement, to carefully evaluate the situation and state his position

 Should not be afraid to take a position even though it might be unpopular

 Corollarily, he should support plans and ideas that he thinks will be beneficial to the institution

6. Have a working knowledge of the statutory and regulatory requirements affecting the institution, including the content of its articles of incorporation and by-laws, the requirements of the BSP, and where applicable, the requirements of other regulatory agencies.

 He should also keep himself informed of the industry developments and business trends in order to safeguard the institution’s competitiveness

7. Observe confidentiality.

 Must observe confidentiality of non-public information acquired by reason of their position as directors

 May not disclose said information to any other person without the board authority
Note that the Circular No. 283 ensures that directors, whether individually or collectively, will not be able to hide behind the defenses of “lack of knowledge of legal provisions,” (read: “I am not a lawyer” or defense of good faith) by providing in Section 4(6): “To have a working knowledge of the statutory and regulatory requirements affecting the institution, including the contents of its articles of incorporation and by-laws, the requirements of the Bangko Sentral ng Pilipinas, and where applicable, the requirements of other regulatory agencies.”
Likewise, the Circular ensures that no director may hide behind the defense of not being aware of his duties and responsibilities (read: “I was never informed” or defense of good faith), by providing in Section 5 as follows:

(a) Each director shall be furnished by the banking institution with a copy of the specific duties and responsibilities of the directors under the Circular, within thirty (30) banking days from the promulgation of the Circular and at the time of election;

(b) Each director shall acknowledge receipt of the copies of such specific duties and responsibilities; and

(c) Each director shall certify that he or she fully understands the same.
Circular No. 283 is intended to be the benchbook upon which every member of the

Board of Director of every banking institution must be thoroughly familiar with, and which he or she must consult time and again in determining duties and responsibilities, but more importantly indicates the high level of competence, dedication and resources asked of him or her. The circular is clearly meant to send the message: that bank directorship is very serious business of one of the highest order because the banking industry is one vested with public interests; “[i]f a person cannot give sufficient time and attention to the affairs of the institution, he should neither accept his nomination nor run for election as member of the Board;” otherwise, he runs the risks of exposing himself to serious personal financial obligation to a host of constituencies.

—oOo—

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