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SEC Wants Fixes, Not Fines

In overhauling the commission, Donaldson also is borrowing heavily from big banks, which rely on risk assessment to protect their loans and investments, and stealing a page from Spitzer.

Spitzer said his staff of a dozen attorneys doesn't try to cover the entire financial services sector. Instead they target areas where financial conglomerates may be exploiting small investors. In the past three years, Spitzer has uncovered e-mails in which stock analysts disparaged companies they were publicly touting, as well as the mutual fund abuses.


Charles A. Fishkin, left, plays a key role in SEC Chairman William H. Donaldson's plan to change the way his agency approaches its regulatory function. (Susan Biddle -- The Washington Post)

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Now the SEC is trying a similar approach. Staff members from every division have been asked to identify every potential risk to investors, and the newly created Office of Risk Assessment will help consolidate the lists and set priorities for action.

The compliance division already has changed the way it does inspections. Rather than doing a top-to-bottom look at a limited number of individual firms each year in hopes of spotting improprieties, examiners are fanning out across market sectors looking at areas of concern identified in advance.

"We've got to be nimble at identifying problems before they become embedded in a large number of firms," said Lori A. Richards, who heads the unit. The risk-assessment office "will help us determine and prioritize areas of emerging risk and allow me to deploy examiners to . . . those highest-risk areas."

Richards said the agency has 80 such "mini-sweeps" underway. The approach has already led to discoveries of such seedy practices as categories of mutual funds with excessive trading costs and brokers who steer elderly and vulnerable investors to expensive and inappropriate variable annuity policies.

The enforcement division, meanwhile, has hired its own industry experts to do independent research and soak up what division head Stephen M. Cutler calls the industry "buzz." Cutler also went straight to the source, challenging brokers and compliance officers last fall to conduct soul-searching internal reviews for potential conflicts of interest and report their findings to the agency.

"Just because a certain way of doing things is second nature to you, and appears to be standard operating procedure on the Street, doesn't mean it's the correct way of doing things," Cutler warned in a speech last September. "Find the problems and correct them now."

Since then, a dozen major firms have done such self-assessments and met with Cutler's staff to discuss the results. Some of the findings are simple: To minimize insider trading issues, traders who invest a bank's own money shouldn't sit near people who process customer orders.

While there was no explicit agreement, several Wall Street executives said they conducted their reviews under the assumption that nothing they disclosed would lead to immediate enforcement action.

Still, the whole process has made Wall Street jumpy, said the executives, who spoke on the condition of anonymity because of the sensitivity of dealing with regulators. "People are just so afraid of regulators right now," one executive said. "They are afraid of their own shadows, to tell the truth. . . . They just want to know what regulators want."

The effort is somewhat controversial among consumer groups and academics who fear that the SEC will be co-opted and fail to crack down on violators who turn themselves in.

But Cornelius M. Kerwin, provost at American University and an expert on the regulatory process, said the commission has little choice but to seek some kind of partnership with Wall Street. "They are trying to deal in real time with information that is changing faster than at any time in my professional life," he said. "I don't know they can hope to keep up with the private sector and the resources and fire they have."

Outside analysts say they wonder whether the whole focus on risk will have much lasting effect. House subcommittee on government efficiency Chairman Todd R. Platts (R-Pa.) has questioned whether the small risk-assessment office can drive the kind of systemic change Donaldson envisions.

In addition, the focus on risk assessment and prudential regulation is very much Donaldson's baby, and it is not at all clear whether, as a political appointee, he will be around next year. "What you never know is whether any management initiative will survive the person who does it," said David M. Becker, a former SEC general counsel. "It takes a long time to change the way people do business."

Even Fishkin concedes the initiative will work only if the career staff buy in for the long term. "It's the difference between going on a crash diet and losing weight over time. Diets don't work, but over time if people gradually modify their daily lifestyles, they have a better chance of losing weight," he said.


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