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E-MailBeckwith B. Miller is a Managing Member at Ethics Metrics LLC. This post is based on an Ethics Metrics publication.
On May 8, 2017, Ethics Metrics LLC submitted comments to the SEC, Analysis of Bank Holding Company Disclosures, that address a key issue that arises in the Commission’s 30-year old Industry Guide 3, Statistical Disclosure by Bank Holding Companies as well as in the Financial Stability Board’s Thematic Review of Corporate Governance, dated April 28, 2017.
This critical issue centers on deliberate omissions of material information by U.S. depository institution holding companies (DIHCs), omissions permitted by federal bank regulators, purportedly in the public interest. These disclosure omissions conflict with the duty to disclose material information in the public interest contained in U.S. federal securities laws and the G20/OECD Principles of Corporate Governance (Principles).
The issue of public interest has been cited by many parties, with an imbalanced application that favors federal banking regulators’ inclination to permit large DIHCs to conceal troubling information, since 1999. Among large DIHCs (assets above $10 billion) incomplete disclosure has been on the rise, leading increasingly to situations in which material negative information about those DIHCs is known to federal banking regulators, the DIHCs’ boards and management, as well as their independent auditors, but not to investors. Material information thus concealed includes (1) compliance violations that trigger formal enforcement actions (FEAs), events of default, duty to disclose material contracts (FEAs) under REG SK, securities fraud and class-action lawsuits and (2) internal fraud. Both (1) and (2) are indicators of ineffective board oversight, material weaknesses and fraudulent statements. The result is material information that is known to the DIHCs but intentionally withheld from investors, based on federal bank regulations, in public offerings of DIHC securities, creating a situation where DIHCs and their regulators and auditors possess superior information relative to the investing public. Large DIHCs sometimes allude to this information asymmetry by disclosing that bank regulatory oversight protects the FDIC Deposit Insurance Fund and the stability of the financial markets, but does not protect investors.
These DIHC issues are analogous to yet different from cases of material omissions in other economic sectors, such as Enron, Refco, and Vivendi, as DIHCs’ selective disclosures and superior information impact an entire industry by creating an inefficient market. Two major investor groups, in particular, are adversely impacted: First, over 1,100 global investors, that are registered investment advisers (RIAs) with the SEC, hold approximately 76% of the $1.8 trillion of public equity in the 100 largest DIHCs. Second, the largest DIHCs report approximately $4.3 trillion of counterparty exposures in their FR Y-15 Systemic Risk Reports. This exposure extends both to RIAs and other DIHCs.
