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Federal Reserve Gov. Daniel Tarullo touched a sensitive nerve in a recent speech when he stated that special corporate governance measures are needed in banking and he discussed the possibility of “broadening” the fiduciary duties of bank directors, with respect to risk oversight.

He cited a recent paper by two law school professors that proposed board oversight responsibility for the level of risk-taking by an institution and the application of a simple negligence standard to this board responsibility.  Shareholder loss and/or systemic harm in the traditional sense, a decline in stock price or bankruptcy for example, would not be required for a stockholder to sue the board.  Rather, the triggering event would be a “significant loss” at the firm, resulting from an alleged breach of a board’s risk oversight responsibilities.

Judges would determine if the board-approved risk management processes, including its assessment of the appropriate level of risk and potential risk outcomes, were reasonable.  This broadened fiduciary duty would apply only to those firms “capable of imposing systemic loss.”

Under current corporate law, directors have the fiduciary duties of due care and loyalty that are owed to the company and its stockholders.  Due care requires boards to obtain adequate information about, and give appropriate consideration to, a decision.  The standard applied for determining whether there is a breach of the duty of care is gross negligence.

Broadening a board’s fiduciary responsibilities with respect to risk oversight would expose a board to liability for good faith judgments as to risk management and would require boards to function in a management capacity.

Since the Great Recession, governance has evolved through regulatory mandates and best practices and boards are more extensively engaged in risk oversight than ever before.  They are also already significantly exposed to litigation and potential liability to both regulators and shareholders.

Any expansion of the board’s underlying fiduciary duties with respect to risk management could be a dangerous development for directors of all banks.

To read the entire article, please visit www.americanbanker.com.