Oversight Liability for Risk-Management Failures at Financial Firms – Article by Robert T. Miller

From Volume 84, Number 1 (November 2010)

Many people believe that excessive risk taking at large financial firms was an important cause of the financial crisis of 2007–2008 and that preventing another crisis requires improving risk-management systems at such institutions. One way to do this would be to use board oversight liability to hold directors personally liable for failing to properly monitor the risks that their firms are running. The purpose of this Article is to determine what role director oversight liability can efficiently play in improving risk-management practices at large financial firms.

A key contention of this Article is that previous treatments of this problem have largely failed to appreciate what risk managers at large financial firms actually do, and so the Article begins by explaining some of the financial models that risk managers typically use to measure the market risk and credit risk on portfolios of assets. A realistic appreciation of these models shows that the measurements of risk that they yield must necessarily incorporate paradigmatic business judgments, most importantly because these models aim to predict future results on the basis of historical data. In other words, the predictive ability of the models is founded on the business judgment that the future will resemble the past in relevant respects. Risk-management decisions are therefore always business decisions.