Legal Risk
From Open Risk Manual
Definition
Legal Risk is the risk of losses arising from an unintentional or negligent failure to meet a professional (legal) obligation to specific clients (including fiduciary and suitability requirements), or from the nature or design of a product.
It is a recognized risk category in regulatory frameworks worldwide (Basel II/III standards) usually denoted as Clients, Products and Business Practices.
Basel Level 2 & 3 Event Type Classification
- Suitability, Disclosure & Fiduciary
- Fiduciary breaches / guideline violations
- Suitability / disclosure issues (KYC, etc.)
- Retail consumer disclosure violations
- Breach of privacy
- Aggressive sales
- Account churning
- Misuse of confidential information
- Lender Liability
- Improper Business or Market Practices
- Antitrust
- Improper trade / market practices
- Market manipulation
- Insider trading (on firm’s account)
- Unlicensed activity
- Money laundering
- Product Flaws
- Product defects (unauthorised, etc.)
- Model errors
- Selection, Sponsorship & Exposure
- Failure to investigate client per guidelines
- Exceeding client exposure limits
- Advisory Activities
- Disputes over performance of advisory activities
Examples by Business Line
Types of legal risk vary by business line. An indicative list:
- General Business Line: Regulatory breaches, Compromised customer information, Fiduciary breach
- Retail Banking: Mis-selling, Client Suitability
- Commercial Banking: AML Non Compliance
Mitigation
Legal Risk is mitigated with strong internal controls and supported by the firm's risk culture embedded in employees
Issues and Challenges
- As with all operational risks, difficult to obtain objective measures of actual risk, both before and after the application of controls
External Links
- Operational Risk in the Basel ii framework
- Revised international capital framework is the text of the new Basel II Accord.