Addressing Gaps in the Dodd-Frank Act: Directors’ Risk Management Oversight Obligations

In the years leading to the recent financial crisis, finance theorists introduced innovative methods, including quantitative financial models and derivative instruments, to measure and mitigate risk exposure. During the financial crisis, financial institutions facing insolvency revealed pervasive misunderstandings, misapplications, and mistaken assumptions regarding these complex risk management methods. As losses in financial markets escalated and caused liquidity and solvency crises, commentators sharply criticized directors and executives at large financial institutions for their risk management decisions. By adopting the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress directly and indirectly addresses certain risk management oversight concerns at large, complex financial institutions. To improve risk management oversight at these institutions, Congress imposed several structural reforms altering the composition and obligations of financial institutions’ boards of directors. Unfortunately, even after the adoption of the Dodd-Frank Act reforms, financial institutions remain vulnerable to the same critical errors in enterprise risk management oversight that engendered systemic risk concerns during the recent financial crisis. While the Dodd-Frank Act may enhance a board’s risk management oversight capabilities, significant concerns persist regarding reliance on board committees. Organizational literature suggests that cognitive biases and structural limitations that influence group decision making will continue to plague boards’ efforts to effectively manage risk. This Article argues that better-tailored reforms are necessary to address weaknesses in enterprise risk management regulation and to reduce the threat of systemic risk.