President Promises "No Problem" Ordering State Takeover of Banks

Late last month, President Hugo Chavez threatened to nationalize Venezuelan banks that had violated banking regulations. "Do you want me to nationalize the banks," he demanded in his weekly radio and television program entitled Alo Presidente? The Venezuelan banking sector had approximately 248 billion bolivars ($115.5 billion) in deposits spread out amongst 50 banking institutions both privately-owned and state-operated at the end of October 2009, according to Softline Consultores, a banking consulting firm in Caracas, Venezuela.

President Chavez stated that he would do whatever was necessary to prevent irregularities amid a scandal that has already prompted the Venezuelan government to take over management of four private Venezuelan banks. The four banks are Banco Confederado SA, Banco Canarias de Venezuela CA, Banco ProVivienda a/k/a Banpro Banco Universal, and Bolivar Banco CA, which collectively account for approximately 6% of Venezuela's banking sector. This month the Venezuelan government took over four additional banks, which brings the total nationalized banks to eight, and their collective deposits represents 9% of the Venezuelan banking sector.

Last week, the Venezuelan government closed down and will nationalize the eighth banking institution in less than three weeks in a growing government intervention to control fraud and greed in the Venezuelan banking sector. A state-run banking agency has appointed officials to oversee operations of the banks. The Venezuelan National Banking Council and the Venezuelan Banking Association, both privately operated entities, have voiced their support for the government’s takeover, saying the initiative is aimed at protecting depositors.

The four private banks that were nationalized last month were all purchased in September and October 2009 by a group of investors headed by Ricardo Fernandez Barrueco, who is involved in the food industry and sells products to a network of state-run subsidized food markets known as Mercal. Allegations amongst banking officials and private bank owners include widespread violations that have allegedly led to Venezuela’s financial problems. Banking officials, private bank owners, and in certain cases their attorneys have been arrested and jailed on charges of misappropriating or assisting to misappropriate deposits, failing to meet lending targets, making unauthorized share transactions and diverting deposits by providing loans to other businesses in which bank owners were investors. Apparently, corporate governance fiduciary duties which prohibit directors and controlling shareholders from engaging in transactions, in which there would be a conflict of interest or self-dealing, were not of paramount concern.

Additionally, Venezuelan Attorney General Luisa Ortega Diaz has barred 16 bank executives from leaving Venezuela. President Chavez has sent a very strong warning to the Venezuelan private banking sector, “[t]o all private bankers in the country, he who slips, loses, independent of the size of the bank.” As a result, at least 10 people have been jailed, including the recently dismissed president of the Venezuelan National Securities Commission, Antonio Marquez Sanchez. Mr. Sanchez allegedly allowed a transfer of bank shares on the Caracas Stock Exchange without approval from the Venezuelan banking regulatory agency. In particular, Mr. Marquez authorized a transfer of Banco Canarias shares (one of the private banks that was nationalized in November) to another bank, Banco ProVivienda (BanPro) (another private bank that was nationalized in November). Venezuelan securities and banking authorities stated that BanPro owner Barrueco, was arrested last month for fraud because he illegally used depositor funds to purchase Canarias bank.

Earlier this year, President Chavez purchased Banco de Venezuela, a unit of Spain based Banco Santander SA, for $1.05 billion to expand the Venezuelan government’s presence in the banking sector. Currently, the Venezuelan government controls 21 percent of the Venezuelan banking sector. The Venezuelan banking sector would not be the first sector to be nationalized. President Chavez has ordered the nationalization of major business entities in the steel, electricity, oil, metal and cement industries. The Venezuelan government this year, has already taken control of Stanford Bank SA, Banco Comercial, and closed the local offices of Antigua based Stanford International Bank Ltd. after the majority shareholder, R. Allen Stanford, a Texan financier was accused by U.S. regulators of defrauding investors of $8 billion. Approximately $3 billion came from Venezuelan investors.

During the past ten years, President Chavez has nationalized a number of privately-owned businesses such as coffee processing plants, sugarcane mills, and cattle ranches. In part, it is these “takings” of privately operated businesses that has brought a lot criticism of President Chavez’s nationalization policy. The current scandal regarding Mr. Barrueco and the banking sector has prompted opponents of President Chavez to point to the scandal as evidence that President Chavez has failed to control corruption and cronyism involving government officials and certain individuals in the private-sector. However, the issue may go deeper than cronyism or corruption. It goes to the historical relationship between certain government officials and the often unrestrainable need to “capitalize” on their position by engaging in “private” transactions with certain members of the private sector. It is a dark dichotomy that has plagued numerous governments, including the American government, in the developmental stages of their economies from a local to global economies, and also when certain business sectors remain unregulated tradable markets that are vulnerable to speculators. President Chavez stated that "[w]e aren't here to make money." This philosophy must seem very bizarre from the perspective of capitalistic driven economies. Where the maximization of profit and aquisition of money is often the predominant focus.

President Chavez’s nationalization measures are a major cause of concern for multinational banks. At least four international banks have a very strong presence in the Venezuela banking sector, including Spain based Banco Bilbao and Vizcaya Argentaria SA, Amsterdam based ABN Amro Holding NV and U.S. based Citigroup Inc.

Federal Reserve Bank Director's Conflict of Interest Faux Pas or Breach of Fiduciary Duty to the Public?

Last week, the Federal Reserve Board announced revisions to the policy governing eligibility, qualifications, and rotation for directors of Federal Reserve Banks and their Branches. The revisions addressed situations where, as a result of a company changing character, affiliations and stockholdings that were previously permissible may become impermissible for Class B and Class C directors. Like many Americans, I was unsure as to what had gone wrong. Nor did I truly comprehend the magnitude of what the Federal Reserve was disclosing. After all, it is rare that the Federal Reserve makes any announcements other than raising or lowering interest rates or providing much needed liquidity into the banking system. Issues concerning the Federal Reserve’s governance policy are rarely shared with the public. The answer to deciphering the question required research regarding the structure and purpose of the Federal Reserve. Much of the data was readily available on the Federal Reserve’s website.

In the early 1900s, financial panics plagued the nation, leading to bank failures and business bankruptcies that severely disrupted the economy. The failure of the nation’s banking system to effectively provide funding to troubled depository institutions contributed significantly to the economy’s vulnerability to financial panics. In 1913, Congress passed the Federal Reserve Act “to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.” Congress designed the structure of the Federal Reserve System to give Congress a broad perspective on the economy and on economic activity in all parts of the nation. It is a federal system, composed of a central, governmental agency—the Board of Governors—in Washington, D.C., and twelve regional Federal Reserve Banks located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco. Each Federal Reserve Bank has at least one Branch (there were 25 Federal Reserve Bank Branches as of 2004). The Board and the Reserve Banks share responsibility for supervising and regulating certain financial institutions and activities, for providing banking services to depository institutions and the federal government, and for ensuring that consumers receive adequate information and fair treatment in their business with the banking system.

Each Federal Reserve Bank has its own board of nine directors chosen from outside the Bank as provided by law. The boards of the Reserve Banks are intended to represent a cross-section of banking, commercial, agricultural, industrial, and public interests within the Federal Reserve District. Three directors, designated Class A directors, represent commercial banks that are members of the Federal Reserve System. Three Class B and three Class C directors represent the public. The member commercial banks in each District elect the Class A and Class B directors. The Board of Governors appoints the Class C directors to their posts. From the Class C directors,the Board of Governors selects one person as chairman and another as deputy chairman. No Class B or Class C director may be an officer, director, or employee of a bank or a bank holding company. No Class C director may own stock in a bank or a bank holding company. The directors in turn nominate a president and first vice president of the Reserve Bank, whose selection is subject to approval by the Board of Governors.

Each Branch of a Reserve Bank has its own board of directors composed of at least three and no more than seven members. A majority of these directors are appointed by the Branch’s Reserve Bank; the others are appointed by the Board of Governors.
Directors of the Reserve Banks provide the Federal Reserve System with a wealth of information on economic conditions in virtually every corner of the nation. This information is used by the Federal Open Market Committee (FOMC), which is made up of the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC oversees open market operations, which is the main tool used by the Federal Reserve to influence overall monetary and credit conditions. Timely market information is used by the FOMC and the Board of Governors in reaching major decisions about monetary policy.

The Federal Reserve System is considered to be an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive branch of government. The system is, however, subject to oversight by the U.S. Congress. However, Congress has rarely exercised its power to do so, but that may change in this long overdue age of enhanced financial regulation. For example, House Financial Services Committee endorsed a bill by Representative Ron Paul that would subject the Federal Reserve System to sweeping Congressional audits. Additionally, the chairman of the Senate Banking Committee, Christopher Dodd has proposed legislation that would strip the Federal Reserve Board most of its bank regulatory power. The Federal Reserve System and Reserve Banks operate very much the same way that it did almost 100 years ago when it was established. So then how did this conflict of interest arise? The answer may have more to do with how our economy has changed as opposed to how the banking system has remained unchanged.

The Federal Reserve’s change in governance policy addressed the conflict of interest situation regarding Stephen Friedman, a director and former top executive at Goldman Sachs, who was also serving as a public board member of the New York Federal Reserve. Class B public board members may not be officers, directors or employees of commercial banks or bank holding companies. Class C public board members may not own stocks in commercial banks or bank holding companies. The Friedman conflict came to fruition when the Federal Reserve Banks were bailing out Goldman Sachs last year, by permitting Goldman Sachs to change its status from an investment bank to become a commercial bank to be able to receive federal bailout funds. This, of course, made Goldman Sachs subject to the Federal Reserve’s authority. When Mr. Friedman accepted his post as a public director, Goldman Sachs was still an investment bank outside the banking supervisory authority of the Federal Reserve. However, the financial crisis last October changed the course of history. Goldman Sachs, the first investment banking firm on Wall Street, would be bailed out by the government and become part of the Federal Reserve Banking System. Lehman Brothers, the second investment banking firm on Wall Street, would be allowed to file for bankruptcy. (See, Cabrera Pierre-Louis’ prior corporate justice blog post regarding Lehman Brothers’ tragic demise on Sept. 8th and Sept. 15th.) It is ironic that Lehman Brothers was permitted to slip into oblivion, whereas the New York Federal Reserve Bank negotiated Bear Stearns' acquisiton by J.P. Morgan Chase, a commerial bank that changed its status from J.P. Morgan, an investment bank, to a commercial bank renamed J.P. Morgan Chase in its merger with Chase Manhattan Bank in 2000. It is as if the financial banking world had gone topsy tury.

I have a simple question. If it is true that Mr. Friedman had a conflict of interest, does that also mean that Mr. Friedman breached his fiduciary duty to the public, in particular his duty of loyalty? If the answer is yes then under an intrinsic fairness test would Mr. Friedman’s conduct in voting for a transaction in which he was personally interested be appropriate? To be fair to Mr. Friedman, we do not know whether his 8 fellow public directors were also personally interested in matters on which they voted on behalf of the public? Which begs the question--what is the remedy when a majority of a public board is personally interested in matters on which it has voted? Rescission? These are difficult questions. They are exactly the questions that Congress should consider during its deliberations regarding proposed enhanced financial regulation.

The Federal Reserve's new conflict of interest policy prompted Mr. Friedman to resign in May 2009 from the New York Federal Reserve Banks’ board. It is interesting that Mr. Friedman did not elect to resign as a director of Goldman Sachs' board. After all Mr. Friedman was representing the public in his capacity as a director of the New York Federal Reserve, what greater honor and duty could exist?

Lydie Nadia Cabrera Pierre-Louis