the reputations of both the companies engaging in the transactions and their financial advisers - and, in turn, impaired public confidence in those institutions. these potential risks and the resulting damage are particularly severe when markets react through adverse changes in pricing for similarly structured transactions that are designed appropriately. assessments of the appropriateness of a transaction for a client traditionally have required financial firms and advisers to determine if the transaction is consistent with the market sophistication, financial condition, and investment policies of the customer. given recent events, it is appropriate to raise the bar for appropriateness assessments by taking into account the business purpose and economic substance of the transaction. when banking organizations provide advice on, arrange, or actively participate in complex structured finance transactions, they may assume legal and reputational risks if the end user enters into the transaction for improper purposes. legal counsel to financial firms can help manage legal and reputational risk by taking an active role in the review of the customer ’ s governance process for approving the transaction, of financial disclosures relating to the transaction, and of the customer ’ s objectives for entering into the transaction. on the regulatory side, the federal reserve has been working with the other federal banking agencies and the securities and exchange commission to develop interagency guidance on complex structured finance transactions. we believe it is important for all participants in complex structured finance transactions to understand the agencies ’ concerns and supervisory direction. our goal is to highlight the “ lessons learned ” from recent events as well as what we believe on the basis of supervisory reviews and experience, to be sound practices in this area. as in other operational areas, strong internal controls and risk - management procedures can help institutions effectively manage the risks associated with complex structured finance transactions. here are some of the steps that financial institutions, with the assistance of counsel and other advisers, should take to establish such controls and procedures : • ensure that the institution ’ s board of directors establishes the institution ’ s overall appetite for risk ( especially reputational and legal ) and effectively communicates the board ’ s risk tolerances throughout the organization. • implement firm - wide policies and procedures that provide for the consistent identification, evaluation, documentation, and management of all risks associated with complex structured finance transactions - in particular, the credit, reputational, and legal risks. • implement firm - wide policies and procedures that ensure that the financial institution obtains a thorough understanding of the business purposes and economic substance of those transactions identified as involving heightened legal or reputational risk and that those transactions are approved

susan schmidt bies : financial innovation and effective risk management remarks by ms susan schmidt bies, member of the board of governors of the us federal reserve system, to the financial services institute 2004, washington, dc, 6 may 2004. * * * introduction thank you for inviting me to speak at this very timely seminar on the evolution of the financial services industry. the industry has indeed evolved over the four - and - one - half years since passage of the gramm - leach - bliley act - and perhaps in many respects, it has evolved in directions different than some envisioned when the act was under consideration in the congress. today i would like to discuss the evolution of the industry and the development of innovative products, services, and activities, especially in the areas of complex structured finance transactions and credit risk transfer. i will then discuss the role of counsel in ensuring the effective risk management of these innovations through a robust enterprise - wide risk - management framework. industry evolution and innovation the gramm - leach - bliley act recognized the market reality that the limitations imposed by the glass - steagall act in the 1930s and other statutory restrictions had been rendered nearly irrelevant by financial innovation, much of it outside the banking industry. gramm - leach - bliley realigned the law to reflect the existing realities of the marketplace and to permit banks to do more efficiently what they were already doing in costly ways. the statute relaxed long - standing restrictions on affiliations among commercial banks, securities firms, and insurance companies ; authorized the federal reserve board and the treasury to designate additional financial holding company activities as “ financial in nature ” or “ incidental to a financial activity ; ” and authorized the federal reserve board to determine whether activities are “ complementary to a financial activity. ” to avoid extending to these new activities the subsidy implicit in deposit insurance and in access to the federal reserve ’ s discount window and payment system guarantees, the act requires that many of these activities be conducted through a legally separate bank holding company affiliate, provided also that the holding company meets the “ well - managed ” and “ well - capitalized ” criteria for designation as a financial holding company. when gramm - leach - bliley became law in 1999, many predicted the rise of the financial conglomerate - an entity that would provide a full range of banking, securities, and insurance products and services to institutional and retail customers. however, this prediction has not been realized, and the pace of change has been relatively slow since 1999. the