A MODIFIED CAREMARK STANDARD TO PROTECT SHAREHOLDERS OF FINANCIAL FIRMS FROM POOR RISK MANAGEMENT

The recent collapse of the world financial system exposed excessive risk taking at many of the largest financial services firms. However, when shareholders of Citigroup sued the board of directors alleging that the board failed to adequately monitor the firm's risk exposure, the Delaware Chancery Court dismissed the suit under the famous Caremark case. Caremark held that a board's failure to monitor will not result in liability unless there was a failure to implement a monitoring system or a "sustained or systematic" failure to use that monitoring system. This deferential standard is premised on an assumption that managers are risk averse and the law should encourage risk taking. However, certain characteristics of financial firms make such firms more prone to risk taking and more susceptible to catastrophic losses resulting from that risk taking than other firms. In this Note, I argue that Caremark should be reworked in cases involving managers of financial firms in order to deter the excessive risk taking that caused such massive losses to shareholders of these firms recently. This standard should take the form of a gross negligence standard that allows the court to take a close look at whether management took the necessary steps to prevent their firm from being exposed to excessive risk.