The 20 Rising Stars of Compliance 2007 - (Page 8) RISING STARS 20 COMPLIANCE The five largest U.S. investment banks— Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley— are the only broker-dealers without commercial bank holding companies at the moment that are required to have risk management integrated with compliance policies under the SEC’s Consolidate Supervised Entity requirements. The SEC adopted CSE Rules in 2004 so brokerages would avoid additional European regulation. Under European Union law, these firms were lacking EU-equivalent regulation because they were not regulated by U.S. banking regulators. The current SEC proposal stemmed from the earlier CSE rules, and is known as the financial responsibility rules for broker-dealers. INDUSTRY RESPONSE There is no timeframe for the proposal’s approval. The SEC has received more than 50 comment letters, many of which criticize the proposed addition of risk analysis to the compliance function—especially for the smaller broker-dealers. “What works for the big firms doesn’t necessarily work for the smaller firms, even the second-tier firms,” says David Sobel, chief compliance officer at Abel Noser, an institutional broker-dealer in New York. Some letters have criticized the SEC proposal for not really guiding on what sorts of risk management compliance policies brokerdealers would need to have. They note that being made to meet the requirement opens the door for the SEC to inspect on risk management compliance. A July 3 letter from the American Bar Association stated that if the SEC intends to inspect firms on risk management compliance, it should specify what examiners will want to see. “While a prudential approach to regulation requires broker-dealers to take on the responsibility of developing appropriate risk management controls without explicit guidelines, it also requires a more flexible approach from regulators in assessing the appropriateness of those controls,” the letter stated. SUBPRIME COLLAPSE ADDS IMPETUS It is clear that compliance officers need to increasingly consider risk and new rules over the last five years have added more risk functions to compliance. The unfolding subprime meltdown may propel the issue forward. Annette Nazareth, commissioner at the SEC, warned during a speech in June in New York, that regulators will be looking 8 COMPLIANCE RISING STARS “While a prudential approach to regulation requires broker-dealers to take on the responsibility of developing appropriate risk management controls without explicit guidelines, it also requires a more flexible approach from regulators in assessing the appropriateness of those controls.” at the sorts of risks certain investments, such as leveraged loans, pose to investors. She said the SEC is concerned about the liquidity of resources of players in the loan market, such as hedge funds. At that time two Bear Stearns hedge funds were invested in sub-prime mortgage loans whose borrowers were defaulting. These hedge funds and some others since have shuttered because they could not cover the loans. While compliance officers are not yet required to proactively prevent the types of risks that led to the events at the Bear Stearns funds, compliance officers are seeing a correlation. “A large part of compliance is really risk management,” David Prince, general counsel and chief compliance officer with Stephens Inc. in Little Rock, Ark. said. At the very least, compliance and risk management should be working together; the consequences of risks are evident in the collapse this year of the Bear Stearns hedge funds, he explained. Besides, Prince explained, marrying risk to compliance is also a good business strategy. Working together can contribute to product development, he said. Risk management can be a middle facilitator between product development and compliance, and the result, he added, could be profitable. SEPTEMBER 2007
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