Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

Surprising new proposals for corporate governance reforms are being issued by an agency not generally associated with investor protection—the Federal Reserve.  

On December 20, 2011, the Federal Reserve Board issued proposed rules to strengthen regulation and supervision of large bank holding companies and systemically important non-bank financial firms. The proposal, which applies to U.S. bank holding companies with consolidated assets of $50 billion or more, addresses issues such as capital, liquidity, credit exposure, stress testing, risk management and early remediation requirements.

However, the new rules also provide for a series of significant corporate governance reforms. The new rules would require better oversight of any covered company’s liquidity risk management by its board of directors, who, together with senior management, would be ultimately responsible for the liquidity risk assumed by the company. 

Under the proposed rules, senior management of a covered company would be required to establish and implement liquidity risk management strategies, policies and procedures, and the board of directors would be required to review and approve them. In addition, the company would be required to establish and maintain an independent review function to review and evaluate the adequacy and effectiveness of the company’s liquidity risk management processes.

Contributed by Yoko Goto

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On November 23, the Financial Stability Oversight Council voted to solicit public input in developing rules for designating financial market utilities as systemically important. A notice seeking comments will published in the Federal Register shortly, triggering a 30-day comment period.

The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act proposes to categorize the largest or most interconnected financial firms as systemically risky, requiring them to provide advance notice to regulators of any changes to their operations that would materially affect their level of risk, and subjecting them to additional risk management standards and examination and enforcement oversight.

While this goal seems clear-cut, the task of identifying systemically risky firms is proving to be a thorny problem. To begin the process of fleshing out the new rules, the FSOC is soliciting comments on the criteria that should be used to evaluate a financial market utility’s level of systemic risk; how exposure to or interdependency with other financial firms or market utilities should be weighted; and how to measure the significance that a potential failure might have on the broader markets.

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The Obama administration has renewed a push to toughen regulations on banks that are “too big to fail.” The proposal, dubbed the “Volcker Rule” after the former Federal Reserve Chairman Paul Volcker, would limit the scope and size of banks and other financial institutions by ensuring that no bank will engage in “proprietary trading” -- that is, trading operations unrelated to serving customers.

Proprietary trading places bank capital at risk through speculation. Although such trading is engaged in by only a handful—probably four or five—of American mega-sized commercial banks, the commercial banking sector could take a dangerous hit if these bets go wrong. 

Proponents of the Volcker Rule argue that such a prohibition is essential to ensure the stability of the commercial banking sector and to protect banking customers from undue risk undertaken by corporate management. It would also discourage banks from engaging in insider trading using inside information and data gleaned from their customer relationships.

The proposed Volcker Rule has been met with strong resistance in Congress. Critics argue that the objective of the proposal could be achieved under a provision in the House bill adopted last year which let regulators ban speculative trading by banks if it is deemed too risky. They also contend that it will be hard for regulators to differentiate between transactions that a bank makes for its clients from those made in its own account.

One thing that is clear is that if “too big to fail” banks expect an implicit guarantee of taxpayer support, they should be prepared for much greater regulatory review of the risks they undertake.

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