Regulators shut down Silicon Valley Bank (SVB) on March 10, 2023, the day after its chief executive officer told customers in a conference call that the bank was on solid financial footing. A week later, SVB’s parent company filed for bankruptcy. At the end of December 2022, SVB had total assets exceeding $200 billion, making it the second largest bank failure in United States history. It will be interesting to read the investigation report of the Federal Reserve Board (SVB’s regulator) on what went wrong, including failures of regulatory oversight. The report is due May 1, 2023.

It is not really surprising that a management team of bankers may be incompetent, greedy and gambling with other people’s money. We have seen it before. However, it is deeply concerning that this sort of thing was allowed to happen until it became clear for depositors to notice that their bank was insolvent. All of the safeguards failed, including the ones related to the Sarbanes-Oxley and Dodd-Frank Acts. Those responsible must be identified and disciplined. Recklessness and deceit are unacceptable. But so are ignorance, incompetence, complacency and conflicts of interest.

Why Accountability Matters

Accountability is the state of being accountable, answerable or liable for something that one is responsible for.¹ Accountability is a hallmark of good governance. Risks compound exponentially when accountability is weak or nonexistent. Management controls and oversight mechanisms are basically irrelevant if there are no consequences for actions and omissions. Human behavior cannot be trusted blindly. Trust but verify is a golden rule. It applies to everyone, and especially to those responsible for managing other people’s money. After verification, there must be consequences for breaches of trust. There lies the accountability part of good governance: consequences.

Few bankers were held accountable after the financial crisis of 2008-09. In the United States, only one famously went to prison (after pleading guilty to the charges against him).² Few bankers were indicted, and those who were settled out of court at the expense of shareholders. It is difficult to obtain reliable information on the accountability that took place, because there was in fact very little accountability to report on. In 2017, the Boston Consulting Group reported that fines related to the financial crisis totaled $206 billion in the United States (where the financial crisis originated) and $115 billion elsewhere.³ These fines are penalties, not accountabilities. As long as there is little or no accountability to those responsible for banking wrecks, it can be expected that history will repeat itself. The failures of SVB, Signature, Silvergate, First Republic and Credit Suisse prove this point.

Where Accountability Resides

Accountability resides wherever there is responsibility. The greater the responsibility, the greater should be the accountability. In theory, both are equally important for good governance. In practice, accountability is a poor and neglected cousin within the governance family. In the case of SVB, accountability resides with the following actors who had important responsibilities:

• SENIOR MANAGEMENT – Senior managers such as the chief executive officer and chief financial officer were responsible for managing the day-to-day affairs of SVB. They knew about its growing solvency problem during 2022. Yet they continued to maintain an asset mix of investments not adapted to the risk of rising interest rates. They also failed to hedge risk exposures as an alternate course of action. In addition, managers neglected to diversify SVB’s customer base, and ignored that very large deposits were uninsured. All of this indicates extremely poor judgement. Adding insult to injury, employee bonuses were paid only a few hours before regulators took control of SVB. Moreover, senior executives exercised options and sold large blocks of shares for personal gain during 2022 and early 2023, a few weeks before SVB’s collapse. These actions demonstrate opportunism and greed.

• BOARD MEMBERS – Board members are responsible for exercising oversight on senior management, including risk management practices. These responsibilities are outlined in laws and regulations. Members of the board’s risk committee met 18 times during 2022, in sharp contrast to only 7 meetings in 2021. Evidently, they knew things were not right. However, none of the risk committee members had financial risk management expertise in a retail banking context. To make matters worse, SVB did not have a chief risk officer appointed during most of 2022. The competence and experience of SVB board members, in particular those of its risk and audit committees are under the spotlight and subject to lawsuits. Boards must ensure that members collectively have the right competencies and experience for risk oversight. Board members knew, or ought to have known, that SVB risks were not properly managed.

• AUDITORS ­– SVB’s external auditor was global accounting firm KPMG. On February 24, 2023, (two weeks before SVB’s collapse) KPMG issued an audit report without reservation on the financial position of SVB. KPMG does not appear to have alerted anyone (publicly or privately) that SVB was not adequately capitalized, and that its financial risks were not properly mitigated. Nor did KPMG appear to have raised issues about the validity of the risk and risk management information disclosed in SVB’s annual report dated December 31, 2022. In a public statement, KPMG argued that it is not responsible for what happens after an audit is completed.⁴ However, the audit firm should have noticed that SVB’s financial position was deteriorating during 2022. KPMG had access to minutes of the board, including those of the risk committee. Auditors are responsible for evaluating the ability of an organization to remain a going concern, and to alert board members and regulators if they cannot issue an audit opinion on this basis.

• REGULATORS – The Federal Reserve Board faces criticism for not preventing the SVB collapse.⁵ Critics point to many red flags, including SVB’s rapid growth, its concentration of customers to one region and industry, its unusually high level of uninsured deposits, and its significant investments in fixed rate securities at a time of rising interest rates.⁶ The Federal Reserve could have forced SVB to raise capital during 2022, as it became evident that the market value of its assets was too low relative to uninsured deposits. The Federal Reserve stress tests apparently did not consider the effects of rising interest rates, which is very concerning.⁷ Nonetheless, it is reported that Federal Reserve officials issued warnings to SVB management as far back as 2019 regarding its unusual business model and the risks involved. But SVB management did not act on these warnings.⁸ It is now revealed that the chief executive officer of SVB was a director on the board of the Federal Reserve Bank of San Francisco, which was responsible for the regulatory oversight of SVB.⁹ A flagrant conflict of interest.

• CREDIT RATING AGENCIES – Stakeholders rely on credit rating firms such as S&P Global and Moody’s Investor Service to evaluate the ability of organizations to pay their debts. In the case of banks, credit ratings indicate creditworthiness in relation to debts and deposits. The ratings help bondholders and depositors evaluate the solvency of a bank that they invest in or do business with. Moody’s downgraded SVB’s credit ratings on March 8, 2023 (two days before its shutdown by regulators). But the downgrade was not below investment grade, which means that Moody’s considered SVB to be a low risk of default. S&P Global and Moody’s maintained investment grade ratings right until the time that SVB was taken over by regulators. The process for credit rating downgrades is said to be slow and cumbersome.¹⁰ Critics argue that credit rating agencies are paid by the companies they rate, which is a conflict of interest.

Sarbanes-Oxley and Dodd-Frank Requirements

The Sarbanes-Oxley Act came into force after the accounting scandals of 2001-02, which included the likes of Enron, WorldCom, Global Crossing, Tyco International and Adelphia Communications. The purpose of Sarbanes-Oxley is to improve corporate governance, financial reporting and auditor independence. Under Sarbanes-Oxley, the chief executive officer and chief financial officer must certify (sign-off) that they have reviewed their company’s financial reports, and that the reports are not misleading. They must also certify that they are responsible for controls relating to financial reporting and disclosures, and that these controls have been evaluated. In addition, they must attest that any fraud or significant deficiency has been disclosed to auditors and audit committee members. Companies must have a majority of board members that are independent from management, and all members of the audit committee must be independent.

The Dodd-Frank Act was adopted in response to the financial crisis of 2008-09, after many banks and insurance companies failed or required bailouts to avoid failure. The purpose of Dodd-Frank is to ensure stability of the United States financial system by improving accountability, ensuring the viability of financial organizations, and protecting consumers from abusive financial practices. Regulators are directed to develop rules that prevent financial crises, and that avoid the need for governments to bailout bank failures. Banks with assets exceeding $250 billion are subject to greater scrutiny and capitalization requirements than smaller banks. Banks with assets exceeding $10 billion must have a board-level risk committee responsible for the oversight of risk and risk management practices. The risk committee must include at least one risk management expert with experience in identifying, assessing and managing risk exposures in large complex firms.

Important Questions

The SVB collapse is a spectacular domino of management and governance failures. Safeguards were insufficient and ineffective. A bank failure that should not have happened actually did, and its effects are not insignificant. The Federal Reserve needed to act very quickly and guarantee deposits totaling $173 billion to avoid contagion across the financial system. Losses from the Federal Deposit Insurance Corporation (FDIC) are expected to be $20 billion. The FDIC also provided emergency funding of $70 billion to cover deposit flight, and $35 billion in loans to facilitate the sale of SVB assets. SVB shareholders lost everything, and its bondholders and creditors may not recover much if anything. At the end of 2022, the market value of SVB was $13.6 billion, and the book value of its debts (excluding deposits) totaled $22 billion. The SVB failure caused a spillover effect to other regional banks with similar risks. The banking sector lost $465 billion in market value after the SVB collapse. Worst of all, these events distracted the Federal Reserve in its effort to fight inflation.

Was there gross negligence in managing risks at SVB? Were the risks appropriately disclosed in financial statements and annual reports? Did board members have the necessary competencies and experiences to exercise their duties? Was there effective oversight by the risk committee and audit committee of the board? Where were the auditors? Did the auditors act in accordance with what should be expected of them? Why did management ignore the issues raised by regulators? Did the regulators carry out any enforcement? How much of the failure is due to ignorance, incompetence and complacency? Were there conflicts of interest, deceit, fraud and other reprehensible acts? Were those responsible knowledgeable and competent? If not, who hired them and why?

Expert Reactions

According to Michael Barr, top regulator of banks at the Federal Reserve: “SVB failed because the bank’s management did not effectively manage it interest-rate and liquidity risk, and suffered a devastating and unexpected run by its uninsured depositors.”¹¹ In particular, the interest-rate model of the bank “was not at all aligned with reality” said Mr. Barr.¹² “This is a colossal failure in asset-liability risk management” said Mark Williams, a former bank examiner of the Federal Reserve and now a master lecturer of finance at Boston University. “The CFO and, I would argue, the board failed to adequately protect shareholder value. The board-appointed risk management committee, which works closely with the CFO, should have done adequate scenario analysis to examine the deposit withdrawal risk [given that very large deposits were uninsured]” added Mr. Williams.¹³

Michael Barr acknowledged that “there may have been shortcomings in the central bank’s oversight [of SVB activities].”¹⁴ Mr. Barr is now leading a review of the Federal Reserve regulatory supervision of SVB, and a report is due May 1, 2023. He mentioned that the Federal Reserve is committed to ensuring that it “fully accounts for any supervisory or regulatory failings, and that we will fully address what went wrong.”¹⁵ The Federal Reserve will also determine if stricter regulations would have prevented SVB from failure, or at least made it more resilient.¹⁶ It is not clear why the Federal Reserve should be investigating and reporting on its own regulatory shortcomings.

“I’m at a loss for words to understand how this business model [of improper asset-liability risk management] was deemed acceptable by regulators” said Aaron Klein, a congressional aide who worked on the Dodd-Frank Act.¹⁷ “Supervisors didn’t do their job here” said professor Douglas Diamond of the University of Chicago, who won a Nobel Memorial Prize last year for his work on bank runs.¹⁸ “The aftermath [of the recent banking failures] is evidence of a significant supervisory problem” said Karen Petrou, managing partner of Federal Financial Analytics, a regulatory advisory firm for the banking industry.¹⁹ “It’s a failure of supervision” said Peter Conti-Brown, an expert in financial regulation and a Federal Reserve historian at the University of Pennsylvania. “The thing we don’t know is if it was a failure of supervisors” Mr. Conti-Brown added.²⁰ “One of the most absurd aspect of the Silicon Valley Bank failure is that its CEO was a director of the same body in charge of regulating it” said Senator Bernie Sanders, announcing that he would introduce legislation “to end this conflict of interest by banning big bank CEOs from serving on Federal Reserve boards.”²¹

A Call for Accountability

Surprisingly, few experts, analysts or news media are calling for greater accountability of those responsible. Everyone is focused on what went wrong, much less on the accountability required. Perhaps everyone believes that impunity will win the day, once again. This downbeat attitude is prevalent. As the saying goes: the more things change, the more they remain the same.

Fortunately, President Biden has taken a clear stand: “I am firmly committed to holding those responsible for this mess fully accountable, and to continuing our efforts to strengthen oversight and regulation of larger banks so that we are not in this position again.”²² President Biden also called on Congress to allow regulators to impose tougher penalties on the executives of failed banks, including clawing back compensation, and barring them from working again in the industry. The President demanded that the FDIC be able to force the reimbursement of compensation paid to executives at a broader range of banks should they fail, and to lower the thresholds for regulators to impose fines and bar executives from working at other banks. “Strengthening accountability is an important deterrent to prevent mismanagement in the future” President Biden said.²³

It’s time to recognize that accountability is a quintessential part of good governance. There must consequences for those who fail responsibilities that they are handsomely paid for. They absolutely need to be disciplined and prevented from similar positions of trust in the future. Let’s hope that rules and regulatory oversight will be strengthened after this new lesson learned. But my advice is to keep your eyes open and watch your money. Reckless banking is a systemic risk.

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¹ Collins online dictionary.
² Jesse Eisinger, Why Only One Top Banker Went to Jail for the Financial Crisis, (NY Times Magazine, April 30, 2014).
³ Reuters, Banks paid $321 billion in fines since the financial crisis: BCG (March 2, 2017).
⁴ Jonathan Weil, KPMG in the spotlight over Silicon Valley Bank, Signature Bank audits (Financial News, March 13, 2023).
⁵ Christopher Rugaber et.al., Fed Under the Gun For Bank Failure, Faces Tough Decisions (National Post, March 15, 2023).
⁶ Christopher Rugaber et.al., Fed Under the Gun For Bank Failure, Faces Tough Decisions (…).
⁷ James Mackintosh, There Is a Cost to Moral Hazard, (Wall Street Journal, March 16, 2023).
⁸ Christopher Rugaber, U.S. Bank Rules Under Review After Failures (Globe and Mail, March 29, 2023).
⁹ Jeanna Smialek, Before SVB’s Fall, the Fed Spotted Big Problems (Globe and Mail, March 20, 2023).
¹⁰ Matt Grossman and Eric Wallerstein, SVB’s Distress Wasn’t Reflected in Credit Ratings (WSJ, March 17, 2023).
¹¹ Andrew Ackerman and Andrew Duehren, Fed’s Barr Calls Silicon Valley Bank a ‘Textbook Case of Mismanagement’ (WSJ, March 27, 2023).
¹² Christopher Rugaber, U.S. Bank Rules Under Review After Failures (Globe and Mail, March 29, 2023).
¹³ Norman Marks, Was Silicon Valley Bank a failure of risk management? (normanmarks.wordpress.com, March 14, 2023).
¹⁴ Andrew Ackerman and Andrew Duehren, Fed’s Barr Calls Silicon Valley Bank a ‘Textbook Case of Mismanagement’ (…).
¹⁵ Andrew Ackerman and Andrew Duehren, Fed’s Barr Calls Silicon Valley Bank a ‘Textbook Case of Mismanagement’ (…).
¹⁶ Andrew Ackerman and Andrew Duehren, Fed’s Barr Calls Silicon Valley Bank a ‘Textbook Case of Mismanagement’ (…).
¹⁷ Christopher Rugaber et.al., Fed Under the Gun For Bank Failure, Faces Tough Decisions (…).
¹⁸ Andrew Restuccia and Andrew Ackerman, Biden Asks Congress for More Authority to Punish Bank Executives (WSJ, March 17, 2023).
¹⁹ Ben Eisen and Andrew Ackerman, Where Were the Regulators as SVB Crashed? (Wall Street Journal, March 11, 2023).
²⁰ Jeanna Smialek, Before SVB’s Fall, the Fed Spotted Big Problems (Globe and Mail, March 20, 2023).
²¹ Jeanna Smialek, Before SVB’s Fall, the Fed Spotted Big Problems (Globe and Mail, March 20, 2023).
²² Nick Timiraos et.al., SVB, Signature Bank Depositors to Get All Their Money as Fed Moves to Stem Crisis (Wall Street Journal, March 12, 2023).
²³ The Associated Press, Biden Calls For Tougher Penalties For Failed Banks (National Post, March 18, 2023).