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Quelle Surprise! Fed Defends Incompetent Bank Management Against Investors

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Reader Hecht pointed out a new piece by Steven Davidoff at the New York Times’ Dealbook, illustrating the lengths to which the Fed will go to defend incumbent bank managements.

The story recounts the sorry conduct of the bank regulator with regard to two small banks, one the $1.1 billion in assets savings & loan First Financial Northwest, the second Cardinal Bankshares, which has a mere $250 million in assets. Both are under supervision of the Fed, neither bank is doing well (First Financial is under “special supervision” as a result of having lost over $90 million in recent years), yet in both cases, true to an apparent long-standing practice, the Fed is siding with the management that is responsible for the banks being in bad shape over activist investors who look to be urging sound measures.

Davidoff recounts the First Financial case in more detail. There, Stilwell Group, which bought 7.9% of the stock, got Fed approval to have its general counsel appointed as a board member. He then made radical suggestions at a first board meeting:

“terminate the director emeritus program,” which Mr. Schneider claimed paid directors as much as $150,000 a year even after their death for doing “nothing.” He also proposed to “remove the directors’ photographs from the executive suite walls” since the photos rewarded poor past performance and the bank was “not a country club or an English manor.”

Finally, as a symbol of First Financial’s newfound austerity, Mr. Schneider [the Stilwell nominee] wanted to “serve only hard candy at the upcoming annual meeting.” He also protested the board’s policy of free iPads for directors.

$150,000 for current, much the less ex, directors of a bank that small is a ridiculous amount of money. Schneider resigned when the board refused to act on his recommendations (note the Times says that Schneider wanted his demands implemented immediately; Schneider counters that the board was unwilling to act. Given the obvious feather-bedding, I suspect Schneider could tell he would be stonewalled).

Stilwell renominated Schneider and sought to have a second director appointed. The Fed intervened, invoking regulations that define 25% ownership of a bank voting shares as “control” and hence subject to Fed approval. But this is ridiculous. Stilwell doesn’t come close to having 25% of the shares, and even if it had won both board seats, it would have only 22% of director votes.

In the case of Cardinal, the activist investor, Schaller Equity Partners, got itself in the Fed’s crosshairs by proposing to place five of six directors (this when it owns 9.8% of the stock). The Fed said if it did that, it would regulate Schaller as a bank holding company, which would make its life miserable. The Fed is pushing hard to neutralize Schaller’s efforts:

Schaller has subsequently dropped the number of its nominees to three to placate the Fed. Even so, the regulator has taken more steps to ensure that Schaller does not have control over these nominees, claiming that even this number of directors could still make Schaller a bank holding company. The directors are now executing passivity agreements that will limit their ability to coordinate activity with Schaller.

This stance, of favoring bad bank managers over reform-minded investors, speaks volumes about the Fed’s priorities. These aren’t complex, difficult to operate banks where management has special know-how. If the dissidents wanted to throw the entire management team out, it would not be hard to replace.

The fact that the Fed so reflexively defends banks against any outside influence, even positive ones, is proof of how the Fed is badly in need of reform. One idea that has been set forth by the Alternative Banking Group of Occupy Wall Street is ending the private ownership of the Fed by banks and barring members of management and boards that the Fed regulates from serving as Fed directors. There are plenty of recently retired financial firm executives who know tradecraft, and the Fed through its supervisory powers can get lots of information about what is happening in markets, rather than relying on the spin of people like Jamie Dimon). The Fed is already a popular target for Congressmen on the right and left ends of the spectrum. If it does not relent from its profoundly pro-bank posture, it may find more changes foisted upon it.

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9 comments

  1. Tyler

    If it does not relent from its profoundly pro-bank posture, it may find more changes foisted upon it.

    Well then I hope they don’t relent! In fact, I hope they go off the deep end of obeisance. Maybe if they completely wreck the economy, more changes would be foisted upon them.

  2. jake chase

    I would be careful about celebrating the intentions of these so called ‘investors’. A typical contemporary investor approach often tends to be smash and grab. Does anybody smell a hedge fund dressed up in reformer costume? The best way to rob a bank may be to acquire 9.6% of it and replace a few idi ot directors. But of course nobody would do a thing like that at a time like this.

    1. Yves Smith Post author

      No, there are activist investors who take a stake, make themselves a complete nuisance to force managers to clean up companies, and sell when the stock trades up when management relents and announces changes (or alternatively, they get corrupt cronies thrown out).

  3. Fíréan

    A not uncommon activity of the Stilwell Group, and 7.9% +/- seems to be their preferred shareholding.

    Quote : “The Stilwell Group Requisitions Special Shareholder Meeting for Kingsway Financial Services Inc. (KFS) to Remove the CEO and the Chairman from the Board

    NEW YORK, Nov. 11 ( 2008) /PRNewswire/ – The Stilwell Group served a requisition for a special shareholders meeting on Kingsway Financial Services Inc. (TSX:KFS, NYSE:KFS) (“Kingsway”) today to remove Shaun W. Jackson and F.Michael Walsh from Kingsway’s board of directors and to replace them with the Stilwell Group’s nominees, Spencer L. Schneider, Esq. and Larry G. Swets, Jr., CFA.
    Mr. Schneider has been engaged in the private practice of law in New York City since 1986. He has been a director of American Physicians Capital Inc.(NASDAQ: ACAP) since 2002 and was instrumental in helping to replace previous
    management and help ACAP withdraw from non-core businesses. Mr. Swets has been an insurance company executive and advisor, including serving as Director of Investments for Kemper Insurance from June 1997 to May 2005. Mr. Swets served
    Kemper in evaluating business units, executing corporate transactions and divestitures, and developing financial projections and analysis for the company during its runoff stage.

    The Stilwell Group is a New York-based money management firm which currently owns 4,325,000 or 7.85% of KFS’s outstanding shares of common stock. The Stilwell Group is keenly interested in seeing Kingsway quickly reduce costs, focus on its core businesses, and increase long-term shareholder value. “unquote

  4. Robert Klein

    It should interest your readers to note that hostile takeover expert Joseph Stilwell is reputed to belong to a very controversial “new age” spiritual group, known best by the name of its leader: Sharon Gans. In operation for nearly 40 years, under various names, this group has been accused of racism, child abuse, financial impropriety, and homophobia. The New York branch of the FBI has looked into the activities of this group, though no charges have yet been filed.

    You can find out some things about this group by going to the website http://www.esotericfreedom.blogspot.com. If you would like to read articles about the San Francisco origins of this group, you can go to http://www.survivorshandbook.com, where you will see links to a series of investigative newspaper articles. If you would like to photo-verify the identities of some individuals with whom your church has likely dealt, you may also go to http://stopsharongans.blogspot.com.

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