Gary DeWaal and Associates LLC

Bridging the Week by Gary DeWaal: June 9 to 13 and 16, 2014 (Fiduciary Obligations of Directors; Individual Segregation Confusion; BD Capital)

Bridging the Week    My View   
Published Date: June 15, 2014

Clues, not concrete developments, generally highlighted last week in the financial services industry worldwide as a myriad of regulators provided diverse views on various topics, including boards of directors’ responsibilities, capital requirements for US broker-dealers, position limits for speculative traders and market structure. However, in the UK, the Financial Conduct Authority announced a comprehensive augmentation of its client money and custody rules.

As a result, the following matters are covered in this week’s Bridging the Week:

Video Version:

Article Version:

Diverse US Regulators Address Roles of Boards of Directors in Corporate Governance; Fed Governor Tarullo Suggests Augmenting Directors’ Fiduciary Obligations

Two senior US regulators addressed boards of directors’ roles in dealing with regulatory concerns last week. In one speech dealing with boards of financial institutions specifically, Daniel Tarullo, a member of the board of governors of the US Federal Reserve (“FRB”), argued that it warrants consideration to amend state laws to change the fiduciary obligations of directors to ensure they are better aligned with regulatory objectives. In a separate speech, Luis Aguilar, a commissioner of the US Securities and Exchange Commission, encouraged boards of all companies to take a heightened role in addressing cyber-risks confronted by their companies.

In his presentation, Mr. Tarullo expressly inquired whether the fiduciary obligations of directors of regulated financial institutions should be expanded to align boards better with regulatory objectives.  Although he acknowledged that requiring an expansion was beyond the authority of the FRB (as it would be governed by state laws), he indicated there was merit to considering such an approach:

“[T]he question arises as to whether the fiduciary duties of the boards of regulated financial firms should be modified to reflect what I have characterized as regulatory objectives. Doing so might make the boards of financial firms responsive to the broader interests implicated by their risk-taking decisions even where regulatory and supervisory measures had not anticipated or addressed a particular issue. And, of course, the courts would thereby be available as another route for managing the divergence between private and social interests in risk-taking.”

According to Mr. Tarullo, amending the fiduciary obligation of directors is important to consider in addition to continuing to align corporate governance and financial regulation in more traditional ways. These ongoing measures include: (1) changing the incentives for those making decisions within a financial firm (although he notes that, to date, amended incentive systems have generally better aligned the interests of shareholders and employees, but have intensified the conflict between regulatory and shareholder interests); (2) adding substantial constraints or requirements upon certain decisions (e.g., the regulatory conditioning of the authority of certain large banks to declare a dividend based on their passing financial stress tests); and (3) requiring improvement in the risk-assessment and risk-management capacities of management and boards.

Although he supports requiring directors to better oversee risk management and control functions, Mr. Tarullo cautions that it is somewhat “too reflexive” to require boards to certify compliance with too many regulatory requirements, however:

“There are many important regulatory requirements applicable to large financial firms. Boards must of course be aware of those requirements and must help ensure that good corporate compliance systems are in place... We should probably be somewhat more selective in creating the regulatory checklist for board compliance and regular consideration.”

Separately Mr. Aguilar discussed measures boards of directors can and should take to ensure their organizations are addressing cyber-risks. However, in doing so, he did not suggest any changes to the fundamental relationship between boards and shareholders, although he addressed boards of corporations generally, not just of financial institutions.

According to Mr. Aguilar, boards have been taking on greater responsibility for the risk management of their companies. These risks should be augmented to include cyber-risk, he says:

“Clearly, boards must take seriously their responsibility to ensure that management has implemented effective risk management protocols. Boards of directors are already responsible for overseeing the management of all types of risk, including credit risk, liquidity risk, and operational risk — and there can be little doubt that cyber-risk also must be considered as part of board’s overall risk oversight.”

To date, he believes there have been gaps between the potential magnitude of cyber-risks and “… steps, or lack thereof that many corporate boards have taken to address these risks.” Where boards have considered cyber-risk, they have too often relied exclusively on personnel who have implemented measures purportedly designed to address such risks, notes Mr. Aguillar.

As a result, the SEC commissioner encourages directors proactively to heighten their oversight of cyber-risk, by among other things, considering their firms’ cyber-security measures against objective standards such as those published by the National Institute of Standards and Technology in February 2014 in its Framework for Improving Critical Infrastructure Cybersecurity (for a copy, click here). Mr. Aguilar also recommends that boards be involved in corporations’ preparedness plans to address how to respond when a cyber-attack might occur.

And briefly

My View: This is another example of the growing failure of international regulators adequately to consider the practicalities of clients seeking to conduct business internationally. The CFTC’s implementation of Part 30 for so many years was a beacon of light in the international financial arena because the Commission readily accepted US persons (1) trading most non-US futures and related products generally after they received appropriate disclosures; and (2) accessing non-US futures and related options through certain qualified non-US brokers subject to comparable (not equivalent) regulations as FCMs.

And even more briefly:

For more information, see:

CFTC Grants First No Action Under Expedited Process For Certain CPO Relief:

CFTC Staff Questions for June 19 Position Roundtable:

Federal Reserve’s Tarullo: Boards of Directors’ Role in Financial Firm Oversight:

FCA Announces Changes in Client Money and Custody Asset Rules to Be Implemented in Stages Beginning July 1:

ICE Clear Europe Seeks Expedited Payment by Clearing Members for Losses Other Than From a Clearing Member Default:

See also:
FIA Objection to ICE Clear Europe’s Investment Loss Coverage:

LCH.Clearnet Ltd Authorized as CCP under EMIR:

See also:
LCH.Clearnet Ltd Rulebook (see in particular, Chapter III, Regulation 7)
ESMA Questions and Answers regarding Implementation of Regulation (EU) No 648/2012 on OTC Derivatives, central counterparties and trade repositories (last updated May 21, 2014; particularly CCP Question and Answers No. 8):

SEC’s Aguilar Encourages Boards of Directors to Heighten Oversight of Cyber-Risks:

SEC Commissioner Stein Calls for Review of BD Capital Model:

UK Treasury, Bank of England and Financial Conduct Authority to Study Wholesale Financial Markets:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 14, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article. 

Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained in this article is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

All quotations are from published statements.

© 2024 Gary DeWaal and Associates LLC | 1 (212) 382-4615 | 1180 Avenue of the Americas, Suite 809, New York, NY 10036