Transcript Slide 1

117th Annual Illinois Banker’s
Conference
June 25-27, 2008
Corporate Governance Best Practices
Presented By:
Dave Muchnikoff
Silver, Freedman & Taff, L.L.P.
3299 K Street, N.W., Suite 100
Washington, D.C. 20007
(202) 295-4513
[email protected]
Silver, Freedman & Taff, L.L.P.
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Corporate Governance
USA Today, 2-18-08
Silver, Freedman & Taff, L.L.P.
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Corporate Governance
Why Corporate Governance – other than
because banking and securities laws and
regulations says you must?
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Corporate Governance
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What is your bank’s legal status? The rules
on corporate governance are different
depending on that legal status:
Non-publicly reporting bank or bank
holding company
Publicly-reporting bank or bank holding
company
Stock listed on NASDAQ or NYSE or AmEx
Assets of less than $500 million
Assets of $500 million or more
Assets of $3 billion or more
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Corporate Governance
Fiduciary Obligations
Directors have “a duty to attempt in good faith to assure that a
corporate information and reporting system, which the board
concludes is adequate, exists…failure to do so…may…render a director
liable for losses causes by non-compliance with legal standards.”
In re Caremark Int’l. Inc. Deriv. Litig., 698 A. 2d 959, 970 (Del. Ch. 1996)
Board liability exists if, after “having implemented [a reporting or
information system or controls, the Board] consciously fail[s] to
monitor or oversee its operation, thus disabling themselves from being
informed of risks or problems requiring their attention”
Stone v. Ritter, 911 A.2d 362, 370 (Del 2006)
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Corporate Governance
Federal Sentencing Guidelines – Overview
Culture of Compliance – §8B2.1(a): company must exercise due
diligence to prevent and detect criminal conduct and otherwise
promote a culture that encourages ethical conduct and a
commitment to compliance with law
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Director/senior management visible commitment to
clearly articulated values is vital
Companies/executive penalized when corporate culture
found to be unethical
Board Leadership/Oversight – §8B2.1(b)(2): directors must take an
active leadership role, be knowledgeable about the content and
operation of the ethics and compliance program and exercise
reasonable oversight over it implementation and effectiveness
Train Everyone – §8B2.1(b)(4): compliance and ethics training
includes the board and senior management
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Corporate Governance
What Did Sarbanes-Oxley Give Us?
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Greater transparency
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Increased scrutiny
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More vocal shareholder activists
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Unprecedented media visibility
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Shareholder frustration and
anger.
Majority voting and proxy
access
Executive Compensation
and Option Backdating
Section 404 refinement
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Corporate Governance
What Did Sarbanes-Oxley Give Us?
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Rise of shareholder activism
 Acceptance, proliferation of governance ratings
 CEO compensation and succession
 Ratcheting up involvement in director succession
 Classified vs. annual elections
 Majority voting vs. plurality
 Targeting of individual director nominees for
withhold/no votes
 Say on Pay
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Danco & Jonovic 1990
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Corporate Governance
Corporate Governance Best Practices
Topics:
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Board Self-Evaluations
Majority Voting and Other Director Election
Developments
Tally Sheets and Other Compensation Committee Best
Practices
Equity Grant Procedures
CEO Succession Planning
Reminders
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Board Self-Evaluations
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Board Self-Evaluations
General
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Process by which a board or board committee assesses
its own performance with the goal of enhancing future
effectiveness by identifying strengths and weaknesses in
the primary areas of the board’s or committee’s
responsibilities.
Required for NYSE-listed companies, optional for all
others.
As with most things, there are pros and cons.
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Board Self-Evaluations
Benefits
 Compels directors to identify strengths and
weaknesses and assess how the board or
committee has actually been functioning
compared to how it should be functioning.
 Can identify potential problem areas before they
become real problems.
 Fosters better communication among directors.
 Helps re-focus directors on long-term goals and
strategies.
 Assists with director nomination process.
 Improves directors’ sense of personal
accountability.
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Board Self-Evaluations
Risks
 Information gathered discoverable in litigation.
Ways to mitigate:
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Limit retention of written materials.
Follow-up and take corrective action.
Can negatively affect board collegiality and
discourage board service.
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Board Self-Evaluations
Oversight of Process
 For NYSE-listed companies, must be
nominating/corporate governance committee.
 Audit, compensation and nominating/corporate
governance committees of NYSE-listed
companies must conduct their own selfevaluations.
 For non-NYSE-listed companies, should be
committee charged with corporate governance
matters or some other independent body of the
board.
 Use of outside parties (e.g., counsel,
consultants).
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Board Self-Evaluations
How to Conduct
 No requirements – board/committee needs to
decide what’s right for it.
 Questionnaires
 Interviews
 Board discussion
 Summary report
 Follow up!!
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Board Self-Evaluations
Performance Objectives
 Again, no “one size fits all.” Typical areas of
coverage include:
 Role of the board.
 Board organization and composition.
 Board meetings.
 Board compensation.
 Committee evaluations should cover same areas
plus check how well committees are performing
their obligations outlined in committee charters.
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Board Self-Evaluations
Individual Director Evaluations
 Controversial.
 Benefits include:
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More direct feedback to directors.
Early warning system for problem directors; opportunity to turn
things around.
Instills stronger sense of personal accountability.
Risks include:
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Negative effect on board collegiality.
Reluctance of directors to criticize peers.
Discourage new directors from joining board and may lead
existing directors to leave board.
Encourage counterproductive participation.
Liability risk.
Silver, Freedman & Taff, L.L.P.
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Board Self-Evaluations
Methods of Conducting Individual Director
Evaluations
 Chairman or lead director evaluates each
director.
 Self-assessment questionnaires.
 Peer evaluations.
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Board Self-Evaluations
Public Disclosure of Evaluations
 Only the fact that they’re performed, but not the
results.
 Can be communicated in proxy statement or in
corporate governance guidelines, if company has
them.
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Board Self-Evaluations
Director Nominations
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Ongoing board evaluation is the
key
Selection and replacement of
directors
 Should reflect the strategic
direction of the company
Are competencies continuously
aligned with strategic
challenges?
Do directors spend the
necessary time?
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Do directors feel they
automatically stay until
retirement?
Do you have a formalized
selection process?
Do directors have first-hand
experience with characteristics
of high-performing companies?
Are board members engaged?
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Majority Voting and Other
Director Election
Developments
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Majority Voting and Other
Director Election Developments
Overview
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Historically, most companies used a plurality standard –
whoever gets the most votes for the position wins.
Critics say not meaningful where election uncontested,
as it only takes one vote to get elected.
Under majority voting, number of votes cast for must
exceed number withheld (or cast against, if applicable).
Majority of companies in S&P 500 have adopted majority
voting.
Companies without significant institutional shareholder
bases less likely to feel pressure to follow suit.
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Majority Voting and Other
Director Election Developments
Implementation Options
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Policy
Bylaw amendment
Charter amendment
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Majority Voting and Other
Director Election Developments
Legal/Practical Issues
 Resignation of directors who don’t receive
requisite majority vote.
 Board can find itself in Catch-22 situation.
 Contested elections.
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Majority Voting and Other
Director Election Developments
Other Important Considerations
 Proposed elimination of broker voting discretion
for uncontested elections.
 E-proxy (notice and access model) now available
for companies and dissident stockholders
starting. Can make it easier for dissidents to
wage proxy contests.
 Movement for shareholder access to
management’s proxy materials.
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Majority Voting and Other
Director Election Developments
Related Initiatives by Corporate Governance
Reform Activists
 Board declassification.
 Elimination of “shark repellants” and other
supermajority vote charter provisions.
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Tally Sheets and Other
Compensation Committee Best
Practices
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Tally Sheets and Other Compensation
Committee Best Practices
Wall Street
Journal, 4-14-08
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Tally Sheets and Other Compensation
Committee Best Practices
What is a tally sheet?
 Centerpiece of best compensation committee practices.
 Identification and quantification of all elements of the
executive’s pay, including compensation that would be
owed to him or her upon retirement or other termination
of employment.
 Shouldn’t just be an annual exercise – tally sheet should
be reviewed and discussed before making any decision
on the executive’s pay.
Silver, Freedman & Taff, L.L.P.
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Tally Sheets and Other Compensation
Committee Best Practices
What should go into the tally sheet?
 Tailored to fit each executive’s compensation
package.
 Should capture all elements.
 Can generally track SEC compensation disclosure
rules, but not a perfect fit.
 Numerical components of tally sheet will be
reflected in various areas of compensation
disclosures.
 Disclosure of compensation committee practices
should include discussion of tally sheet exercise.
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Tally Sheets and Other Compensation
Committee Best Practices
Other Things Compensation Committees Should Be Doing
 Reevaluate compensation philosophies and components of existing
program.
 Accumulated wealth analysis
 Survey use – don’t cherry pick.
 Internal pay equity.
 Employment agreement provisions:
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Evergreen Provisions
Definition of “termination for cause”
Change in Control payouts
Gross Ups
Compensation consultants should be engaged by and report directly
to the compensation committee.
Annually review compensation committee charter.
Director Compensation:
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Trend away from meeting fees in favor of annual retainers
Increased proportion of pay in equity
General disdain for director “retirement” plans
Reduction or discontinuation of perquisites
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(New Math) 
(SEC Rules) +
Proxy=Confusion
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Firms Disclose Formulas
Behind Executive Pay,
Leaving Many Baffled
Wall Street Journal, 3-21-08
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Washington Post, 5-5-08
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Equity Grant Procedures
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Washington Post, 5-14-08
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Equity Grant Procedures
General
 Still a white hot area – numerous SEC
investigations ongoing and shareholder lawsuits
filed, and guilty pleas continuing to roll-in for
backdating. Recent Broadcom enforcement
action shows SEC’s interest has not waned.
 Restatements.
Silver, Freedman & Taff, L.L.P.
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Equity Grant Procedures
Practices Being Scrutinized
 Backdating - choosing a grant date with the benefit of
hindsight so that the date selected is earlier than the
date on which the grant was actually approved, with the
selected grant date usually being a date on which the
market price is lower than the date on which the grant is
actually approved.
 Spring-Loading - the granting of equity awards in
anticipation of the issuer’s disclosure of material
information that is likely to have a positive effect on the
issuer’s stock price.
 Bullet Dodging - purposefully waiting until material
negative information is publicly disclosed before granting
an equity award.
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Equity Grant Procedures
Why are these practices problematic?
 Effectively results in discounted options; most
shareholder-approved plans require options to be
granted “at the market” or at a premium.
 Potentially a breach of directors’ fiduciary duties.
 Potential restatements.
 Big potential tax problems if options purporting to be
granted “at the market” are later determined to be
below market:
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Lose ISO treatment, if intended.
Won’t qualify as “performance-based compensation” under
Internal Revenue Code Section 162(m).
Constitutes deferred compensation under Internal Revenue Code
Section 409A, potentially resulting in excise tax on executive.
Silver, Freedman & Taff, L.L.P.
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Equity Grant Procedures
What should be done to minimize risk of
problems?
 Review existing equity grant practices.
 Tighten internal controls.
 Adopt formal written grant policy.
Silver, Freedman & Taff, L.L.P.
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Equity Grant Procedures
Adopting an Equity Grant Policy
 No “one size fits all” approach.
 Determine role played by equity grants in overall
compensation programs.
 Key components:
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Frequency and timing of grants – consider limiting to fixed dates
or during open trading windows.
Designate equity grants compliance person(s).
Delegation of grant authority to officers – critical to ensure
permissibility of delegation under state law and plan documents.
Delegation should not cover grants to Section 16 reporting
persons (i.e., Form 4 filers).
Limit grant approvals to in-person or telephonic meetings of
board or compensation committee and avoid written consents if
possible. If written consents must be utilized, do not use “as of”
dating.
Forms of equity award agreements. Should be approved by
compensation committee before grants are made and executed
as soon as possible after grants are made. If multiple forms of
agreements are used depending on level of employee, critical to
have controls in place to ensure right form of agreement used.
Silver, Freedman & Taff, L.L.P.
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Equity Grant Procedures
SEC Compensation Disclosure Implications
 CD&A should include disclosure of any practices
of timing equity grants in coordination with
public release of material information.
 Disclosure required in “Grants of Plan-Based
Awards” table if date on which compensation
committee approves award differs from grant
date or if exercise price of a stock option differs
from closing price on grant date.
Silver, Freedman & Taff, L.L.P.
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CEO Succession Planning
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CEO Succession Planning
Why Is It Important?
 CEO plays critical role in implementation and
development of strategic policy.
 Company always needs to be prepared for a change in
top executive position, regardless of CEO’s age.
 CEO’s departure could be sudden and unexpected or
known well in advance – company needs to prepare for
either contingency.
 Delays in replacing CEO may raise investor and
employee angst.
 Important to plan for succession of other key senior
executive positions for many of the same reasons.
Silver, Freedman & Taff, L.L.P.
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CEO Succession Planning
What Should a Succession Plan Entail?
 Prepare early: 3-5 years out
 No “one size fits all.”
 Determine who will lead process. Usually an
independent committee, such as compensation or
nominating/corporate governance.
 Communicate/partner with CEO.
 Should cover CEO and other senior executive positions.
 Reflect board’s understanding of critical factors to
company’s future success, direction and culture.
 Identify and periodically update qualities and
characteristics for effective CEO.
 Should cover sudden and unexpected departures as well
as planned successions.
 Tie succession planning to the strategic business plan.
 Stockholder preferences
 Consider insiders before going outside.
Silver, Freedman & Taff, L.L.P.
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Succession Planning at Community Banks
 Hiring leaders from the outside is risky
 Lack of continuity
 Less loyalty
 Can be disruptive, hurt morale and change the culture – sometimes for
the better but often for the worse
 Outside candidates are far more likely to fail than internally developed
candidates
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Easier for the board to make the wrong choice with an outside
candidate, particularly if selection criteria are not defined
Promoting leaders from the inside can have its issues
 Reward longevity or loyalty, not talent
 Lack of development program or process
 Lose opportunity for “cross-pollination” from other institutions
But still generally better to grow and develop leaders
Silver, Freedman & Taff, L.L.P.
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Succession Planning at
Community Banks
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Reminder Areas
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Reminder Areas
Reminders
 Executive Sessions of Directors
 Approval of Related Party Transactions
 Insider Trading Matters
 Regular Review of Committee Charters and
Other Corporate Governance Documents and
Additional Considerations
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Reminder Areas
Executive Sessions
 Under NYSE rules, non-management directors must
meet at regularly scheduled executive sessions outside
management’s presence, and if any non-management
director is not independent, independent directors must
meet in executive session at least annually.
 Under NASDAQ and AMEX rules, independent directors
must meet in regularly scheduled executive sessions.
 “Regularly” not defined in NYSE or NASDAQ rules, but
should be at least twice a year. AMEX requires at least
one executive session annually.
 No limit on potential topics of discussion, but can’t act in
lieu of full board.
 Who should lead sessions?
 Minutes of executive sessions and feedback given to
management.
Silver, Freedman & Taff, L.L.P.
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Reminder Areas
Related Party Transactions
 Under NYSE, NASDAQ and AMEX rules, audit committee
or other “independent body” of directors must review
and approve related party transactions.
 SEC disclosure threshold raised from $60,000 to
$120,000, but must identify any transactions below this
level involving independent directors.
 SEC rules also now require discussion of policies and
procedures for review and approval of related party
transactions.
 Must identify any transaction where policies and
procedures not followed.
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Reminder Areas
Insider Trading Matters
 Insider trading “alive and well.”
 If don’t have a written insider trading policy, adopt one
now.
 Appropriate window/blackout periods.
 Directors and Section 16 officers not only ones who
should be subject to window/blackout periods – anyone
with regular access to material inside information should
have to follow them.
 10b5-1 plans – for insiders and issuers. SEC closely
scrutinizing for abuse.
 Regularly review who Section 16 reporting officers are;
consider having board adopt resolution designating
these persons.
 Require all directors and Section 16 officers to notify
filing coordinator in advance to ensure timely Form 4
filing and avoidance of short-swing profit liability.
Silver, Freedman & Taff, L.L.P.
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Reminder Areas
Regular Review of Committee Charters and Other
Corporate Governance Documents and Additional
Considerations
 Use as checklists to make sure board and key committees
doing what they’re supposed to be doing and update as
needed. Also review codes of conduct for same purpose.
 When rotating committee assignments, make sure members
satisfy applicable independence and other membership
requirements:
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Audit: general NYSE/NASDAQ/AMEX independence definition,
heightened independence standard of SEC Rule 10A-3 and
financial sophistication requirements.
Compensation: general NYSE/NASDAQ/AMEX independence
definition plus “Non-Employee Director” definition of SEC Rule
16b-3 and “Outside Director” definition of Internal Revenue
Code Section 162(m).
Corporate governance guidelines not required unless listed on
NYSE; if adopting voluntarily, don’t set too many rules to
follow.
Silver, Freedman & Taff, L.L.P.
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Dave M. Muchnikoff
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Former Senior Attorney and
Assistant Branch Chief, SEC
Division of Corporation
Selected to 2005 BTI Client AllStar Team level on a Survey of
Fortune 1000 companies
Certified Public Accountant
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Frequent contributor on financial
institution issues to financial
services organizations.
Specializing in SEC reporting,
corporate governance, public and
private debt and equity offerings,
mergers and acquisitions, charter
alternatives, bulk loan sales and
purchases and securitizations.
Silver, Freedman & Taff, L.L.P.
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Silver, Freedman & Taff, L.L.P.
Our attorneys
regularly practice in
the financial
institutions area
with many having
governmental
experience. We
have represented
over 300 financial
institutions over
the past 30 years.
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Debt and Equity Securities Offerings
SEC and Shareholder Reporting
Recapitalizations
Compensation and Employee
Benefit Matters
Securitizations
Credit Union to Thrift Conversions
Mergers and Acquisitions
Charter Conversions
Holding Company and MHC
Formations/Reorganizations
Bank and Thrift De Novo Formations
Regulatory and Enforcement
Matters
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THANK YOU
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