Beckwith B. Miller is a Managing Member, Gary F. Henry is Chief Executive Officer and Howard R. Sutherland is a Member of the Advisory Board at Ethics Metrics LLC. This post is based on an Ethics Metrics Publication by Mr. Miller, Mr. Henry and Mr. Sutherland.
U.S. Government Initiatives (USGIs) to “foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry” are failing because of a deeply ingrained industry practice and bias. Bank regulatory oversight protects the FDIC’s Deposit Insurance Fund and the stability of the financial markets, but not investors.
This practice centers on information asymmetries permitted by federal bank regulators that classify material information, including formal enforcement actions (FEAs), internal fraud and external fraud, as confidential for regulated depository institution holding companies (DIHCs). As a result, many of the 100 largest (assets +$10 billion) DIHCs, from 2002 to the present, are able intentionally to withhold material information, including negative events that ordinarily require disclosure, from investors and the public. Disclosure of 565 FEAs, reflecting events of default in credit agreements and material contracts required to be disclosed by the SEC, led to default for 39% of these 565 DIHCs. Only 11 FEAs were issued for largest DIHCs but the default rate was 55%. The risk profiles for many of the current 100 largest DIHCs, that did not disclose a FEA, match the risk profiles of the 112 DIHCs with assets between $1 billion and $32 billion that did disclose a FEA. This information concerning the largest DIHCs was suppressed because the government could not afford the failure of any one of the largest DIHCs with the limited financial resources of the FDIC. This undisclosed material information, however, is directly relevant for evaluating the risk of default and actual defaults of large, systemically interconnected DIHCs and overall systemic risk as defined in the Dodd Frank Act, Sec 203(b) and Sec. 203(c)(4)(D): “the financial company is, or is likely to be, unable to pay its obligations (other than those subject to a bona fide dispute) in the normal course of business.”
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