What Should We Expect of Bank Directors? It Depends on Whom You Ask

By | March 21, 2018

Courtesy of Joseph A. Smith Jr.

In August, the Board of Governors of the Federal Reserve (Fed) issued for comment a release entitled “Proposed Guidance on Supervisory Expectation for Boards of Directors” (Proposed Guidance).[1]  This note will briefly review the Proposed Guidance and the comments the Fed received on it.  I will focus primarily on the debate between and among commenters over whether any relaxation of the supervisory regime regarding large complex banking organizations is justified.

The Proposed Guidance

The Proposed Guidance is part of a broader effort by new Fed leadership to recalibrate and, where appropriate relax, post-financial crisis supervisory and regulatory requirements, based on the passage of time and improvement in the health of the economy.[2] One object of “rightsizing” is the Fed’s expectations for banking organization boards of directors. As then-Fed Governor Powell noted in a speech last April:

After the crisis, there was a broad increase in supervisory expectations for [banking organization] boards. But it is important to acknowledge that the board’s role is one of oversight, not management. We need to ensure that directors are not distracted from conducting their key functions by an overly detailed checklist of supervisory process requirements.[3]

To address this perceived misallocation of board time and energy, the Fed conducted “a multi-year review … of practices of boards of directors, particularly at the largest banking organizations”[4] and issued the Proposed Guidance.

In furtherance of the policy just discussed, the Proposed Guidance revises Federal Reserve supervisory expectations by (i) defining the core responsibilities of boards; (ii) revising protocols regarding communication of supervisory findings; and (iii) commencing a program to align its supervisory guidance regarding boards with performance by boards of their core responsibilities.

The Proposed Guidance’s defines a board’s core responsibilities as follows: (1) set clear, aligned, and consistent direction regarding the firm’s strategy and risk tolerance, (2) actively manage information flow and board discussions, (3) hold senior management accountable, (4) support the independence and stature of independent risk management and internal audit, and (5) maintain a capable board composition and governance structure. Neither the Proposed Guidance nor previous statements by Chairmen Powell that preceded it mention regulatory compliance as a core responsibility.

In support of its recalibration of supervisory expectations for directors, the Proposed Guidance repeals prior guidance that had required that all Matters Requiring Attention and Matters Requiring Immediate Attention be addressed to the board of directors.[5]  Under the Proposed Guidance, such matters would be directed to senior management of a banking organization rather than its board.  MRIAs and MRAs would only be directed to the board for corrective action when the board needs to address its corporate governance responsibilities or when senior management fails to take appropriate remedial action. The Proposed Guidance goes on to state that, “The board would remain responsible for holding senior management accountable for remediating supervisory findings.”

The Proposed Guidance also revises a long list of prior guidance to reallocate responsibility for compliance to management rather than the board.

The Comments

The Fed received forty-three comments on the Proposed Guidance, including one from the author of this note.[6]  The comments addressed a number of technical matters, including application of the Proposed Guidance to intermediate holding companies, diversity of board membership, independence of audit and risk management functions, and the need for interagency coordination in the revision of supervisory guidance.

While the comments just mentioned were well done and responsive to the Fed’s request for input, the more significant comments were those that either (i) supported the Proposed Guidance as a needed corrective to over-regulation following the financial crisis; or (ii) opposed it as an uncalled for weakening of a still needed enhancement to pre-crisis supervisory and regulatory rigor.  As more fully discussed below, where you stand in this debate depends on your view of banks generally, and large complex banks in particular.

Commenters in Support of the Proposed Guidance

This group of commenters[7] included organizations or firms involved in or representing the financial services industry.  While their comments varied in emphasis and detail, they were in general concerned with removing from directors any implied obligation to directly engage in regulatory compliance activities; rather, they supported the Proposed Guidance’s emphasis on standard setting and oversight. In general, this group was of the further view that there is and should not be a “one size fits all” approach to board oversight; the nature of the firm should dictate how its board organizes and conducts itself.

Commenters in Opposition to the Proposed Guidance

Comments from this group[8] consist of academics and advocacy groups.  These commenters are opposed to the Proposed Guidance based on the view that continued rigor in supervision of large complex banking organizations is justified by the potential adverse consequences of a failure of one or more of such institutions, and by the compliance track records of such firms and their treatment of consumers in particular.  With regard to the passage of time since the financial crisis, this group channels William Faulkner: “The past is never dead. It’s not even past.” Its members are particularly critical of changing the requirement that boards get all MRAs and MRIAs, believing that it removes an important check on management.  In sum, this group thinks the threat of another financial crisis remains real and that the major banking organizations have not earned their way out of a strict compliance regime.  The recent travails of Wells Fargo are mentioned as a case in point, both as to continued bad conduct by the firm and inattention by its directors.

What’s Next?

The comment period has closed and now the Fed must decide whether to: issue the Proposed Guidance in final form “as is,” modify the Proposed Guidance in some form based upon comments received, or withdraw it.  A few suggestions come to mind in light of Wells Fargo’s recent travails, my preparation of a comment, and review of the comments of others.

First, while I am appreciative of the Fed’s desire to make board standards broad-based and almost precatory, I don’t think such an approach is healthy for the Fed or for the banking organizations it supervises.  Legal and regulatory compliance should be an explicit core responsibility of the boards of banking organizations of all sizes.  While the directors should not be required to implement compliance programs, it isn’t asking too much for boards to implement (or require that management implement) a system to record MRAs and MRIAs and to track the organization’s progress in dealing with them.  The technology is available to do this, and there is no reason not to.  Failure to do so undermines public trust and confidence in corporate governance and supervision, and can lead to bad results for the institution and its supervisors.  If the Wells Fargo situation teaches nothing else, it teaches this.

Secondly, like it or not, our financial system is anchored in a few large and complex firms.  Oversight of such firms is, in fact, a demanding task and can affect the contribution such firms make to the nation’s economic growth and prosperity.  An overly rigorous regulatory regime may be great for safety and soundness but may also bring unwanted side-effects in terms of, for example, the cost and availability of credit.  Accordingly, supervisory and regulatory simplification based on cost-benefit analysis is worth doing and doing well.  While such an effort will be long and labor intensive, it can lead to the right outcome provided that it is done collaboratively, through the FFIEC, FSOC or another cooperative channel set up for this purpose.[9]  Agencies acting alone to reduce the regulatory burden risk losing public confidence and perhaps sowing the seeds of a future crisis.

Finally, directorships of large complex banking organizations are not part-time jobs.  Directors should have few or no additional directorships other than the banking one and should be expected to spend significant amounts of time on the job.[10]  The banking organization should allocate substantial amounts of money to directors, both in compensation and support.  Both regulators and insurers should require this.

The Fed, led by Chairman Powell, has done well by initiating a discussion on the role of directors in overseeing large and complex firms.  The comments it has received have continued a debate over the role of large complex financial firms in our economy and the part to be played by their directors in their safe, sound and compliant operation.  This is an important debate and its taking place in a highly desirable forum.  I hope the Fed will take this opportunity to let the debate run a full course and will consider changes to its stated expectations as a result.




[1] The Proposed Guidance and the comments received on it are available under “Other Proposals” at https://www.federalreserve.gov/apps/foia/proposedregs.aspx  (Proposals Link).

[2] Several speeches by Fed leadership have signaled their desire to reassess and recalibrate changes made to supervision and regulation post-financial crisis. These include: brief remarks by Mr. Jerome H. Powell, Member of the Board of Governors of the Federal Reserve System, at the Global Finance Forum, Washington, DC, 20 April 2017 (Global Finance Forum Remarks).  Available at: https://www.bis.org/review/r170425b.pdf ;   Governor Jerome H. Powell, The Role of Boards at Large Financial Firms, Large Bank Directors Conference, Chicago, IL , August 30, 2017 (Large Bank Board speech).  Available at: https://www.federalreserve.gov/newsevents/speech/powell20170830a.htm. Remarks by Randal K. Quarles, Vice Chairman, Board of Governors of the Federal Reserve, at the 26th International Financial Symposium, Tokyo, Japan, February 22, 2018.  Available at:   https://www.federalreserve.gov/newsevents/speech/quarles20180119a.htm

[3] Global Financial Forum Remarks, op cit. note 3.

[4] Supplementary Information section of Proposed Guidance, available at Proposals Link, op cit. note 1.

[5] Federal Reserve SR letter 13-13/CA letter 13-10.

[6] See: https://sites.duke.edu/thefinregblog/2017/08/29/response-to-the-federal-reserves-proposal-to-enhance-the-effectiveness-of-boards-of-directors/

[7]See, e.g., comments of Committee on Capital Markets Regulation; Goldman Sachs Group, Inc.; Financial Services Roundtable; The Clearing House Association LLC, et al; Davis Polk & Wardwell LLP, available at Proposals Link, op cit. note 1.

[8] See, e.g., comments of Americans for Financial Reform; Public Citizen; Better Markets, Inc.; and Kristen A. Hutchens (joined by 16 leading legal and business scholars) at Proposals Link, op cit. note 1.

[9] See, e.g., Comment of the Conference of State Bank Supervisors, available at Proposals Link, op cit., note 1.

[10] See, Kress, Jeremy C., Board to Death: How Busy Directors Could Cause the Next Financial Crisis (June 22, 2017). 59 B.C. L. Rev. ___ (2018 Forthcoming); Ross School of Business Paper No. 1370. Available at SSRN: https://ssrn.com/abstract=2991142 or http://dx.doi.org/10.2139/ssrn.2991142  ; Comment of Ross School of Business, available at Proposals Link, op cit. note 1.

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