Where compliance meets risk

By Scot Blythe | April 14, 2009 | Last updated on April 14, 2009
4 min read

For many, compliance is about know your client forms and trade blotters — that which is circumscribed by securities regulation. That model, however, may well be broken, not so much because of what it prescribes, but because of what it leaves out.

The financial crisis has highlighted two issues. The first is that risk comes in many forms, all of which can have serious consequences, whether for a firm’s reputation, or indeed, its survival. The second is that regulators often don’t know where the risks lie in complex products.

David Sobel, chief compliance officer at Abel Noser in New York, foresees sweeping regulation reform in the U.S. But he also thinks risk management and compliance go hand in hand. He is speaking next month at the Strategy Institute’s 11th annual compliance conference in Toronto.

“My own personal bent is that they’ve never been separated,” he says. “I consider everything compliance does as risk management, whether it be regulatory or legal risk or financial risk in the trading room or customer risk from dealing with reps, it’s all risk management. Compliance is a part of that.”

While Sobel has been well ahead of the regulatory curve, he concedes that compliance has not always been top of mind in the financial industry.

“There was a very long period, especially in the1980s and in the 1990s when compliance and risk management were secondary items,” he says. “Making money was the first item and nobody really questioned it. But that’s always a swing and the pendulum swings back and forth and we went through a tremendous period of high-risk low-regulation. What that ended up with is what we have right now.”

That is changing. “I think we’re going to see more and more laws coming out. We’ll probably see the Securities Act of 2010 here in the United States supplant the Securities Act of 1934. Right now, there are three bills in Congress. We will see the Hedge Fund Act of 2009.”

Previous attempts to get hedge funds to register faltered, in part because many felt that regulation cast two wide a net. But now everyone will be caught in that net, Sobel thinks.

“I can tell that in my own point of view, within the next two years anybody who deals with money — especially investment advisors, money managers, broker-dealers, hedge funds — they’ll all be under the same regulatory regime; anybody who deals with money is going to be regulated.”

That said, change has been a long time in coming, partly because regulators have not been able to see through the complexity of products and investment vehicles devised by Wall Street.

“I don’t think they actually understand private equity. Really, you have to understand it to be able to regulate it,” he explains. “I think that was one of the issues with the hedge funds, because hedge funds really are not hedge funds anymore. The most basic hedge is that you buy stocks and sell futures in the S&P or something like that. To hedge yourself, so that if the stock goes down, the futures go up, if the futures go up the stock goes down. They don’t do that anymore.”

For Sobel, risk management involves taking into account much more than what a regulator would specify.

“When I start a compliance program, the first thing I do is I create a kind of a risk matrix and under that risk matrix I go through every specific aspect of the business and I drill down to the most micro part of it and I will get maybe six or seven possible risks that come out of that,” he says. “And that might be as innocuous as reputational risk; it might be as heavy as financial risk, regulatory risk, legal risk, any of those areas.”

After the risk matrix is constructed, Sobel then looks at the rules and regulations. “Many of the rules and regulations that I set up at Abel Noser go far beyond what is specifically required in the [official] rules and regulations, because I see other risks that regulators really don’t care about. They don’t care about if I lose money,” he says.

“So I may add another level of regulation that FINRA (the Financial Industry Regulatory Authority) and the SEC really doesn’t care about. But I do. I can never separate that compliance function from the risk function.”

Sobel also sees a heightened role for fiduciary obligations that currently apply to investment advisors, a standard that is higher than product suitability.

“There’s absolutely no difference between an investment advisor’s fiduciary duty and a broker-dealer’s fiduciary duty,” he argues. “Any broker-dealer that says they don’t have a fiduciary duty is living with their head in the sand. If you’re dealing with money from a client, you’ve got a fiduciary duty, period. I think the courts are starting to lean that way also. Eventually it’s not going to be a question. The only people who are fighting that right now are those people who don’t want to live up to that standard.”

For more information on the upcoming Strategy Institute conference, please click here.


Scot Blythe