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By STEVE YAHN, who has written for and edited national publications for more than 30 years

The Division of Risk, Strategy and Financial Innovation was the vision of Mary Schapiro, chairperson of the Securities and Exchange Commission. The first new SEC division in 37 years, Risk Fin was created to provide interdisciplinary analysis across the entire spectrum of SEC activities, including policymaking, rulemaking, enforcement and examinations. In addition to this role as an agency "think tank," Risk Fin was intentioned to help break down silos that compartmentalized the SEC's institutional expertise.

Whatever progress has been made, however, could be at risk now that the unit's founding director, Henry T.C. Hu, is returning to his first love, a research and teaching position at the University of Texas.

"I think that Henry Hu was an excellent choice to get that program started, and I think he did get it started fast," said Thomas Day, managing director of Risk Policy at Sungard Ambit, an Arlington, Va.-based financial services company. "But I think the SEC has always struggled with this idea of really applying risk management thought, leadership, practice and principles on top of the regulatory activity they perform for the markets."

LAWYERS IN CONTROL

The mandate for Risk Fin was to hire individuals who had financial, quantitative and transactional experience in corporate governance, derivatives, risk management and trading at major hedge funds, investment banks and law firms, as well as individuals with advanced academic training, including Ph.Ds in economics, finance and mathematics.

In reality, critics charge, the Risk Fin division has been long on hiring academics and woefully short on hiring practitioners who have extensive industry experience.

"So Risk Fin has the potential to do some great things, but I think they need to resource it with sufficient staff and preferably not academics, but instead people with deep and profound industry knowledge," Day said.

Also, critics note that despite the systemic financial crisis of the past couple years, the SEC remains overly focused on particular investor protection rules and operating within the box of being very much focused on the retail rather than the institutional sector. This overemphasis on retail was due to historical SEC practice in general rather than any failing of Hu's group.

"My understanding is that the SEC is overly focused on the legal profession, so historically there's been a focus on having lawyers running divisions and lawyers making decisions ," said Christopher Laursen, a Washington, D.C.-based senior consultant for NERA Economic Consulting, a global economic and policymaking analysis firm. "But in light of the financial crisis, you've got to understand how the markets operate and what the industry practices are and what the technical details are to really understand if a certain rule or law is being complied with. And so in my opinion, there's still a kind of high-level control by the lawyers."

Added Day at Sungard Ambit: "I think because, historically, the SEC has been so identified with investor protection in the retail space, you won't find very extremely talented risk managers who want to do compliance activity. This is check-box stuff that doesn't demand a lot of creative thinking."

NEW STARS RISING OR RUNNING?

But Risk Fin is starting to make progress in bringing in risk management professionals. This effort was highlighted by Chairperson Schapiro recently recruiting Richard Bookstaber as senior policy adviser for the Risk Fin group. Bookstaber is widely regarded as a brilliant thinker with a strong industry grounding. He worked at Bridgewater Associates, ran the quantitative equity fund at FrontPoint Partners and was in charge of risk management at Moore Capital Management.

"I think by bringing in a celebrity leader like Bookstaber, you'll be able to attract more talented junior people," Day said.

That's hope for the future. At present, the Risk Fin group appears to still be struggling.

"One of the things they have to address is high turnover," said a person with first-hand knowledge of upper-ranks activity at the SEC. "Part of that is just because of change. But they've lost a lot of very good people. They've hired some people, but I think they had hoped to be farther along in terms of staffing than they are at this point. They've lost a lot of institutional memory and some key players over the last year, and I think that's definitely a concern."

Again, it comes back to Hu. One point of internal tension, noted this observer, was putting the economic analysis director under the control of Henry Hu and his group.

"For two decades prior to that, the economic analysis group had its own identity and had a more prominent role," this observer said. "Part of the thinking in putting the economists within the Risk Fin group was the idea that you could use economists on the risk assessment side to try to identify risk and catch bad guys. But one of the things I would like to see and what Mary has come to believe is that the chief economist position has got to be returned to a higher-profile position. And having it report to the Risk Fin director makes it a less desirable position. I think there's a role for a direct voice, having a chief economist who reports directly to the chairman of the commission."

NERA's Laursen called for more staff as "boots on the ground," noting that the Risk Fin group needs to assist the SEC in developing more sophisticated examination techniques. This calls for examiners to make regular visits to retailers and institutions, not just hold one meeting a year with them.

"From my perspective," Laursen said, "you've got to have that type of 'boots on the ground' approach to get everybody level-set to say, 'Here's what we expect, here's what the interpretations are, and here's where the line is.' And then you have to enforce that. It takes quite a while to build up expectations with the firms as to what you do expect, but if you're doing that the right way, you've set the proper foundation for ongoing examinations."

The bottom line, according to Risk Fin observers, is that, to pick up speed, the division needs to bring in more experienced practitioners.

"I think they need to bring someone in there who has profound industry knowledge. The SEC has the ability to act, but I don't think they've ever resourced that division with enough firepower or the proper kind of firepower," Day said.

January 1, 2011

Copyright 2011© LRP Publications