Insider Activities

Duty of Care and Duty of Loyalty

In addition to the specific laws and regulations discussed in this booklet, insider activities are governed by fiduciary principles of common law-the body of law made up of cases decided by the courts.

The common law establishes generally accepted fiduciary legal principles and it imposes two basic duties on management and the board — the "duty of care" and the "duty of loyalty." Under the duty of care, management and the board must diligently and honestly administer the bank’s affairs in a manner measured against what a reasonable and prudent person would do in similar circumstances. Under the duty of loyalty, management and the board must place the corporate interests of the bank above their personal interests. Many banks, as a matter of policy, have expanded the application of the common law duties to all employees.

Under the duty of care, the courts usually hold a director responsible for knowing what a reasonable and prudent director would have known, and the courts evaluate the director’s conduct based on that knowledge. When a court examines whether a director has fulfilled the duty of care, the court will measure the director’s conduct against the applicable standard established by law. Failure to exercise the duty of care may subject a director to personal liability.

The duty of loyalty requires directors and management to act in the best interests of the bank and to ensure that insiders do not abuse their positions by benefiting personally at the bank’s expense. In general, a conflict of interest exists when the personal or business interests of insiders are inconsistent with the continued safe and sound operation of the bank or with a business opportunity of the institution. Insiders should avoid placing themselves in a position that creates a conflict of interest or the appearance of a conflict of interest. For example, a director or officer has a conflicting interest in a transaction if he or she appears on both sides of the transaction or derives any personal benefit from it in the sense of self-dealing. A conflict of interest can also exist if a director or officer has such a substantial interest outside of the bank that it could reasonably affect his or her judgment with respect to the bank’s business. Such a conflict of interest may arise out of one’s personal business interests and/or in connection with transactions that benefit friends, relatives or business associates.

A bank’s relationship with its insiders must at all times be prudent, at "arm’s length" and in compliance with all applicable laws and regulations. Management and members of the board must fully disclose any personal interest that they may have in matters affecting the bank and must ensure that these business and personal relationships with the bank are always at arm’s length. Disinterested directors should approve transactions involving the interests of other affiliated parties, and directors should abstain from voting and deliberating on any matter involving their own interests. Banks should note that, with respect to loans that are subject to Regulation O’s "prior board approval" requirement (12 CFR 215.4(b)), a majority of the entire board must approve the loan.

The "usurpation of corporate opportunity" doctrine, a part of the duty of loyalty, prevents insiders from improperly taking business opportunities away from the bank.

Independence and unbiased decision making are important aspects of the duty of loyalty. As a result, the SEC requires a majority of directors of public companies to be independent of management and all members of the audit committee of public companies to be independent of management. ^[3]

These duties and obligations are described in more detail in The Director’s Book, published by the OCC. For additional information on audit committee requirements, refer to the "Internal and External Audits" booklet of the Comptroller’s Handbook.

A director who violates any banking law or regulation, engages in an unsafe or unsound banking practice, or breaches a fiduciary duty (or permits another person to do so) may be held personally liable and may be subject to civil money penalties, administrative actions, or other sanctions. The director may be held responsible either alone or jointly with other board members.

Previous: Policies Next: Holding Companies and Other Affiliates