11/22/2009 05:12 am ET Updated May 25, 2011

Passive Bank Directors Pose Systemic Risks

Inattentive regulators, swashbuckling CEOs, greedy mortgage originators and misinformed borrowers have all been identified as contributing factors to the financial panic after the fall of Lehman Brothers a year ago. Each of these players did indeed make an important contribution to the meltdown and panic a year ago.

But passive directors, especially those serving on the boards of systemically important firms have remained largely exempt from regular public criticism. I recently reviewed the boards of the top 17 recipients of TARP money. My research report for the Center for American Progress: A Fair Deal For Taxpayers, Public Directors Are Necessary to restore Trust and Accountability at Companies Rescued by the U.S. Government found that an amazing 92% of the directors who were in place before the financial crisis of 2008 are still in place.

This fact alone is cause for concern. How can directors who approved the decisions that led to the crisis be relied upon to steer a successful passage out of the turmoil? More importantly, how can they be expected to provide innovative leadership in the difficult post-crisis environment.

The enforcement spotlight is now turning to the directors of large interconnected or systemically important financial firms. Three inquiries have focused on the role of Bank of America directors in the decision to acquire Merrill Lynch in December of last year. Andrew Cuomo, NY Attorney General, Judge Ned Rakoff of the NY Federal District Court, and Congressman Ed Towns, Chair of the House Government Oversight and Accountability Committee have all sought to compel Bank of America to reveal more detail about which officers or directors approved the required disclosures

First, last Friday, Andrew Cuomo, New York Attorney General, served subpoenas on 5 directors of Bank of America, members of the Audit Committee, as a part of his continuing probe of the failure to disclose to investors $8.98 billion of Merrill losses and 5.6 billion dollars of Merrill bonuses that emerged during the last quarter, just before the merger was approved by shareholders on December 5, 2008. The Wall Street Journal quotes Cuomo as asking whether the directors "were misled, or were they little more than rubber stamps for management's decision making."

Federal Judge Jed Rakoff, rejected the SEC settlement of its enforcement action against Bank of America for failure to disclose the bonuses. Rakoff wrote that Bank of America executives "effectively lied to their shareholders." B of A was the recipient of $45 billion dollars in federal bailout money, the $3.6 billion in bonuses it paid out to executives was money "from Uncle Sam." Rakoff rejected the settlement, ordered a trial no later than February first in his courtroom and concluded that the settlement "does not comport with the most elementary notions of justice and morality."

Chairman Edolphus Towns has also been investigating the details of the Merrill Lynch acquisition. Most recently, Towns, gave B of A a noon deadline, which they missed, to deliver a response to his questions about attorney client communications. This effort to pierce the shield of attorney client privilege to determine whether securities or financial regulations were violated, is unusual, although not completely unheard of.

Now that Bank of America directors are under the glare of the national spotlight, will the directors at other systemically important banks get the message: Wake up.