The Federal Reserve Bank’s April 28 Report on the Supervision and Regulation of Silicon Valley Bank is an important resource for corporate boards on the management and oversight of enterprise risk. While much of the Report focuses on the failure of Fed supervisors to forcefully respond to the SVB crisis as it evolved, it also offers instructional detail on what the Fed found to be a “textbook case of mismanagement by the bank.”
While obviously focused on the banking sector, the Report’s leadership lessons could be applied just as easily to leadership structures in other highly regulated industries subject to economic volatility. This is especially the case as corporate law is increasingly concerned with the ability of the board to identify, and respond to, “red flags” relating to compliance and other corporate risks.
From an overarching perspective, the Report serves to place the responsibility for SVB’s failure on the bank’s board of directors and management for failing to manage its risks, especially with respect to interest rate and liquidity risk. Specific criticisms included the following:
Neither the board of directors nor senior management fully appreciated the unique vulnerabilities of the bank, including foundational and widespread managerial weaknesses, a highly concentrated business model, and a reliance on uninsured deposits.
– The full board of directors did not receive adequate information from management about risks at SVB For example, information updates provided to the board did not appropriately highlight liquidity issues until November 2022, despite deteriorating conditions.
– The board and management failed to effectively oversee the risks inherent in SVB’s business model and balance sheet strategies.
– Sufficient steps were not taken in a timely fashion to build a governance and risk-management framework intended to keep pace with its rapid growth and business model risks.
– The board and did not hold management accountable for effectively managing the firm’s risks.
– The bank failed its own internal liquidity stress tests and did not have workable plans to access liquidity in times of stress.
– The bank changed its own risk-management assumptions to reduce how these risks were measured rather than fully addressing the underlying risks.
– The incentive compensation payable to SVB’s senior management was tied to short-term earnings and equity returns and did not include risk metrics. This gave managers a financial incentive to focus on short- term profit over sound risk management.
– The SVB chief risk officer lacked requisite expertise, and when that CRO departed the position went unfilled for a critical period of time.
– Neither the board nor management satisfactorily responded to regulatory concerns with respect to appropriate risk management, internal governance structures, internal audit coverage and the lack of “large bank experience” on the board.
Certainly, these and other identified risks arose from a highly complex business model operating within a vulnerable environment within which federal supervision and regulation was admittedly flawed. Yet this litany of risks reflects a series of fundamental risk oversight themes that are broadly applicable across industry sectors:
1. Board members should possess sufficient strategic and operating sophistication and judgment to enable them to appreciate the unique vulnerabilities of the company and its business model.
2. Risk oversight is an increasingly significant fiduciary responsibility, and directors should be capable of identifying “red flags” when they arise.
3. Boards will be expected to exercise heightened oversight of management, the business model and internal controls during periods of rapid growth and economic volatility.
4. As the Delaware courts have made abundantly clear, robust management-to-board reporting mechanisms on the business and compliance risks of organization are of vital importance.
5. Board oversight of the recruitment, retention, termination and replacement of key officers such as the CLO, the CRO, the CCO and the CFO is critical, in part to ensure that these key positions are held by competent, experienced, qualified individuals.
6. The structure and content of executive incentive compensation arrangements often have significant regulatory, compliance and oversight implications and benefit from legal review and board monitoring.
7. Specific industry experience remains an important element in board composition decisions, especially with respect to companies that operate in highly regulated or particularly volatile operating environments.
8. Boards may benefit from directing management to prepare, and monitor the appropriate application of, a risk profile for the organization that is grounded in legal and financial compliance.
9. The role of internal auditor should be monitored by the board to assure that it is properly supported and coordinated with the roles of the general counsel and the compliance officer.
10. Executive leadership is expected to proactively focus on the safe and sound management of the actual risks of the company, rather than responding only when faced with specific regulatory concerns.
The stability of the banking sector-particularly small and mid-sized banks-is a top-of-the line economic and political concern. The magnitude of leadership failures allegedly contributing to the failure of Silicon Valley Bank and similar institutions is worthy of close attention. At their core, these failures also offer powerful governance lessons to a broad cross section of companies in complex operating environments.