The Board of Governors of the Federal Reserve (FRB) on August 3, 2017 issued a notice inviting comment regarding Proposed Guidance on Supervisory Expectations for Boards of Directors (Proposal). The Proposal applies to boards of bank holding companies, savings and loan holding companies, state member banks, U.S. branches and agencies of foreign banking organizations, and designated systemically important nonbank financial companies (SIFIs). The Proposal, which was the culmination of a multi-year review by the FRB regarding board practices, generally seeks to differentiate the responsibilities between an institution’s board of directors and senior management. The Proposal addresses three areas:

(1) Board effectiveness (BE) guidance that will provide a framework for board assessment.

(2) Rescission and/or revision of existing supervisory expectations placed on boards.

(3) Reduction of board involvement in supervisory communications, including Matters Requiring Immediate Attention (MRIAs) and Matters Requiring Attention (MRAs).

Comments are due by October 10, 2017.

General Goals of the FRB’s Proposed BE Guidance

The proposed BE guidance indicates that board responsibilities should focus on five factors intended to support safety and soundness of an institution overseen by a particular board:

  • Setting clear, aligned and consistent direction regarding the institution’s strategy and risk tolerance;
  • Actively managing information flow and board discussions;
  • Holding senior management accountable;
  • Supporting the independence and stature of independent risk management and internal audit personnel; and
  • Maintaining a capable board composition and governance structure.

The proposed BE guidance would apply to all SIFIs, U.S. intermediate holding companies of Regulation YY foreign banking organizations, and banks and savings and loan holding companies with total consolidated assets of $50 billion or more.

The Problem

Directors have long been concerned with the increasing attempts by regulators to move directors’ responsibilities closer to day-to-day management of their financial institutions. Such regulatory initiatives have increased the breadth and depth of materials and issues for which directors are asked to be responsible, thereby ultimately increasing their potential liability if the institution were to run into trouble or fail. This was discussed in an op-ed, Why Would Anyone Sane Be a Bank Director? (subscription required) published in the Wall Street Journal on August 29, 2017.

The Proposal notes that the FRB identified 27 Supervision and Regulation letters containing a total of 170 board requirements that could be eliminated or revised. Existing supervisory expectations would be eliminated or revised for domestic bank and savings and loan holding companies (including insurance and commercial savings and loan holding companies) with total consolidated assets of $50 billion or more (“larger firms”) and domestic bank and savings and loan holding companies (including insurance and commercial savings and loan holding companies) with total consolidated assets of less than $50 billion (“smaller firms”). Larger firms’ supervisory expectations would be aligned with the proposed BE guidance, while smaller firms’ supervisory expectations would be aligned with Supervisory Guidance for Assessing Risk Management at Supervised Institutions with Total Consolidated Assets Less than $50 Billion (SR 16-11). SR 16-11 requires boards of smaller firms to monitor and approve more granular items, such as business strategies, significant policies, individual risk significance, risk guidance, and oversight of senior management’s implementation of board-approved business strategies.

In addition, the FRB has focused on the amount of information obtained from examinations, which ought to be directly communicated to directors. Currently, Supervisory Considerations for the Communication of Supervisory Findings (SR 13-13) requires all MRIAs and MRAs to be presented to boards of directors, to ensure board supervision over senior management’s handling of the supervisory finding. Under the Proposal, SR 13-13 would be revised so that MRIAs and MRAs would be directed to a board only when the board must address its governance responsibilities or when senior management previously failed to take remedial action. Most MRIAs and MRAs would therefore be directed only to senior management.

Potential Impact on Board Expectations

By focusing on where board efforts are more traditionally concentrated, the Proposal, if adopted, would represent a departure from a longstanding trend – furthered by the Dodd-Frank Act in response to the financial crisis – which increased regulation and expectations of boards and conflated the roles of senior management and directors. However, FRB Governor Jerome H. Powell stated, in an August 30, 2017 speech, that the Proposal would not “lower the bar for boards or lighten the loads of directors” and the intent is instead only to “enable directors to spend less board time on routine matters and more on core board responsibilities.” So, while the Proposal’s intent is to move supervision to a more flexible, principles-based approach, it should not be expected to materially reduce directors’ obligations.

The FRB is seeking comments on all aspects of the Proposal, but is especially interested in comments related to: (1) applicability to U.S. intermediate holding companies of foreign banking organizations; (2) additional attributes of effective boards; (3) self-assessment; (4) conflicts with governance of insurance and commercial savings and loan holding companies; (5) differentiation between responsibilities of directors and senior management; and (6) additional supervisory expectation letters that should be eliminated or revised.

Comparable Treasury Report

Similarly, the Department of the Treasury has signaled concern about the increasing obligations placed on directors, in its recent report, A Financial System That Creates Economic Opportunities. The Treasury’s report discusses the blurring of lines between management and director responsibilities, as well as the weight of the responsibilities imposed on directors.

Conclusion

Expectations for change coming out of the FRB Proposal should be modest, at least until the FRB’s new Vice Chair for Supervision is confirmed and has a chance to provide input on this issue. As was noted in the WSJ op-ed, neither the FRB nor the Treasury included two very important factors in their analyses – consideration of: (1) the principal job of directors as determining how to earn an objectively measurable profit by making subjective decisions about the level of risk an institution should assume; and (2) the harsh reality that bank directors live with – a potential lawsuit against them if their institutions fail.

Further, in a manner comparable to the FRB and Treasury, the FDIC should reevaluate its director and officer litigation standards to ensure that economic incentives are properly aligned and directors understand that, if they act prudently, they will not be sued or held responsible for economic circumstances beyond their control.