Subtle Hazards Revisited: The Corruption of a Financial Holding Company by a Corporate Client's Inner Circle

Abstract

I argue here that the involvement of financial holding companies (FHCs) in the recent corporate scandals shows that the "subtle hazards" of combining commercial and investment banking are not those identified by the United States Supreme Court in Investment Co. Institute v. Camp. Rather, the basic subtle hazards risk is that FHC relationship investment bankers become part of a company client's inner circle of management and participate in improper and often illegal transactions that benefit the inner circle at the expense of a company's investors and its other corporate constituencies. Investment bankers draw commercial bankers and the FHCs within the influence of the destructive circle. I contend that evidence from the corporate scandals shows that FHCs incurred this risk and suffered significant harm from it. I then argue that bank regulators need to address the risk by ensuring that a FHC has in place procedures to keep itself and its employees from falling within the influence of the inner circles of its investment banking clients. The Federal Reserve, I propose, should require (and not just recommend) FHCs to have senior transaction and relationship oversight committees with the power necessary to review and veto inappropriate transactions and relationships between the FHC's investment bank or any other nonbank affiliate and their company clients, and it should regularly evaluate the committee's performance as part of its examination of a FHC.

Keywords: Banking, corporate governance

JEL Classification: K22, K23