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At SEC, an unconventional new team Agency hiring more experts, professionals to help assess complex financial systems


by Zachary A. Goldfarb The next time the Securities


and Exchange Commission stops a financial fraud, it might be partly because of work that phys- icist Gregg Berman did studying the tiny particles spun off by ex- ploding stars and distant galax- ies. Today, the Princeton-trained nuclear physicist is investigating for the SEC what was behind the massive flash crash that sent the stock market into a tailspin last month. A specialist at culling conclusions from masses of cha- otic information, Berman is in part trying to ascertain whether wrongdoing played a role. Although lawyers fill most of the SEC’s ranks, the agency has been hiring experts with special- ized quantitative skills and those who have worked on Wall Street and are hip to its tricks. The SEC, like many federal


regulators, failed to anticipate the economic crisis, and post- mortems have revealed that the agency badly needed people who could help it assess the complex markets that make up the mod- ern financial system. What’s more, under the landmark finan- cial regulations pending in Con- gress, the SEC is set to inherit new powers to regulate financial instruments known as deriva- tives as well as hedge funds — making it all the more urgent that the agency have the firepow- er to police those areas. Among those who have gone to the SEC recently are a former managing director at defunct in- vestment bank Salomon Broth- ers; a former senior derivatives trader at American International Group, the insurance giant bailed out by the federal govern- ment; and a veteran hedge fund lawyer.


The training grounds For Berman, 43, the SEC job in


many ways is a far cry from the late nights he spent conducting experiments at Princeton’s parti- cle accelerator in preparation for his doctoral thesis, “The Study of the Beta Decay Spectrum of Sul- fur-35.”


But in other ways, it’s not. “Experimental physics is about


drawing conclusions from very messy data,” said Berman, who started doing financial analysis after receiving his PhD. “And fi- nance and economics and the type of work within the division that I’m at at the SEC is about trying to draw conclusions and make recommendations based on lots of data, data from the marketplace that can be quite messy as well.” Before he turned his attention to last month’s market crash, Berman was working in the agency’s new Division of Risk, Strategy and Financial Innova- tion, which combines economic, computer, financial and legal analysis to uncover wrongdoing in complex and rapidly growing markets. The unit, established in the fall, is like an internal think tank that provides expertise to officials elsewhere at the SEC who are prosecuting cases and developing rules to regulate Wall Street.


Although the head of the divi- sion, Henry T.C. Hu, is a lawyer,


10-YEAR TREASURY DOWN $2.00 PER $1,000, 3.26% YIELD


CURRENCIES $1 = 91.55 YEN; EURO = $1.223 DIGEST EUROPE Moody’s cuts Greek debt rating to junk


Moody’s Investors Service slashed Greece’s credit rating to junk status in a new blow to the country, which is under intense global scrutiny after narrowly avoiding default last month. Moody’s said Monday it was


cutting Greece’s government bond ratings by four notches to Ba1 from A3. It was the second of the three major agencies to ac- cord Greek bonds junk status. Standard & Poor’s did the same in late April.


REGULATION Split CFTC approves box-office futures


Federal regulators on Monday allowed a new online exchange to proceed to trade future box-office receipts for movies. A divided Commodity Futures


Trading Commission approved by the mandated deadline the proposed futures contracts for the new Trend Exchange. That means the movie futures trading can proceed. The vote was 3 to 2. Major Hollywood studios strongly oppose the idea. They say rival studios could sabotage films by betting against them. Allowing future box-office re- ceipts to be traded like crude oil


BILL O’LEARY/THE WASHINGTON POST Rick Bookstaber, left, and Gregg Berman recently joined the Securities and Exchange Commission.


“We need to entice market professionals into government service who are on par with those in


industry.” — Rick Bookstaber, writing in a blog before joining the SEC


his background as an academic makes him an unusual pick for a leadership post at the SEC. As a professor at the University of Texas law school, he has become an authority on emerging issues involving banks, derivatives and hedge funds. Also playing a leading role in


the new division is Rick Books- taber, an economist trained at the Massachusetts Institute of Technology who was managing director for risk at Salomon Brothers and ran a hedge fund that traded on math-based strat- egies. Long before he joined the SEC, he wrote a critically acclaimed book warning of looming dan- gers in the financial system and declaring that regulators needed to change how they work. Just days into the Obama administra- tion, Bookstaber wrote on his blog that the standard govern- ment formulas for reviewing how financial companies operate must be reconceived: “[M]arch- ing in with a subpoena in one hand and a sixty page question- naire in the other is not the way forward.” “This job cannot be done by


SEC lawyers or career govern- ment workers,” he wrote. “We need to entice market profes- sionals into government service who are on par with those in in- dustry.”


Luring young talent


Although the SEC has been able to attract a few seasoned ex- perts who could be making much more money in the private sec- tor, it is having trouble filling out more of its ranks with people


with unconventional résumés. The challenge, Bookstaber said, is in recruiting undergraduate computer science wizards who might otherwise work for Google or trade for hedge funds. “We have to rely on public spirited- ness as opposed to dollars to pull them here,” he said. Legislation pending in Con- gress would add to the SEC’s lim- ited powers to police derivatives, the multitrillion-dollar market of complex financial contracts, and hedge funds, the secretive in- vestment firms. Michael Fioribello, 38, might know more about derivatives than anyone else at the agency. Before going to the SEC, he worked at AIG for nearly a dec- ade, helping to manage the com- pany’s derivatives operation, hedging the firm’s risks by buy- ing and selling financial con- tracts. He said he wasn’t involved in AIG Financial Products, which insured the toxic investments that led to AIG’s collapse. The SEC oversees trading


firms that set up the exchanges where some derivatives trade. It also investigates financial firms or individuals thought to be us- ing derivatives in illegal ways, such as profiting from insider in- formation. Fioribello said he has provided colleagues with in- sights into how financial players structure derivatives to conceal something that could be illegal. “Derivatives often have many


different parts, and some of those may not intuitively make sense. There can be bells and whistles done to reduce trans- parency or otherwise circumvent federal securities laws,” he said.


“I can say I’ve traded many par- ticular products and know whether the price for the trade was right or the rationale for the derivative was right.” Fioribello’s role stands to ex- pand. Under the new legislation, large segments of the derivatives market would be subject to new oversight and standards, and the SEC would play a big role as reg- ulator. Likewise, the SEC would in- herit new responsibilities to in- spect hedge funds under the leg- islation, which requires them to register with the agency and sub- jects them to examinations. Norm Champ, 46, a new asso-


ciate director for examinations for the agency, formerly helped manage a $7 billion hedge fund, where he often encountered SEC regulators who he says didn’t know enough about how hedge funds work. The SEC can investigate hedge funds suspected of wrongdoing and receives information about them from regulated investment banks that do business with them. Some hedge funds also vol- untarily register with the agency. Champ has been advising col- leagues who inspect hedge funds about the ways firms can skirt the law. For example, some hedge funds might value their assets more generously in the first three quarters, earning manage- ment fees on that performance, then mark the assets closer to what they’re worth at the end of the year, when auditors take a closer look. “When you’re in the asset man-


agement business, you can see where the temptations and pit- falls may lie and where people may be tempted to cut corners,” Champ said. “One of the things I mentioned when I interviewed here was that I know where some of those temptations lie, and I think I can help the exam team find those things.” goldfarbz@washpost.com


AIRLINES


or pork bellies would give people who finance movies a way to make money even when a film doesn’t. It also could be used for speculation. Trading would be based on the amount of money a movie takes in during its opening weekend. The exchange would set the ini- tial odds for contracts, but those odds would change based on bid- ding of investors. An investor who buys a contract with longer odds takes on greater risk and the potential to earn more money. — Associated Press


Financial markets were little


changed after the news, which just weeks ago would have sent stocks tumbling on fears that Eu- rope’s debt crisis was worsening. A Greek Finance Ministry


statement insisted that the recov- ery effort was on track. It said the new cut “does in no way reflect the progress made in recent months, nor the prospects emerg- ing from fiscal improvement and better competitiveness.” — Associated Press


TUESDAY, JUNE 15, 2010


JOE RAEDLE/GETTY IMAGES Spirit cancels additional flights because of strike


Striking pilots at Spirit Airlines grounded the carrier again Monday, forcing the discount carrier to cancel all flights through Wednesday. Pilots walked out Saturday in a pay dispute. Spirit Airlines and its striking pilots agreed to meet with mediators on Tuesday, the union said. Spirit, which serves about 16,000 passengers daily, said it wouldn’t fly until Thursday at the earliest.


— Associated Press ALSO IN BUSINESS


U.S. auto recovery official to quit: Ed Montgomery, who led Obama administration efforts to help communities deal with the de- cline of the U.S. auto industry, is departing to become dean of Georgetown University’s Public Policy Institute, the White House announced Monday. Montgomery is set to leave as


executive director of the White House Council on Automotive Communities and Workers on Aug. 15. The council was created to help communities deal with the bankruptcies of General Mo- tors and Chrysler.


Lincoln Financial outlines TARP exit: Lincoln Financial Group said Monday it will issue shares and sell new debt to pay back the $950 million in federal govern- ment bailout aid. The insurer plans to sell $335 million of com- mon stock and up to $750 million in senior notes. The proceeds of the share sale plus a $250 million notes offering will fund the re- purchase of $950 million in pre- ferred shares issued to the Trea- sury in May 2009. The company needs Treasury approval before it can repurchase the shares. — From news services


Faster Forward


Derivatives-spinoff plan gains support Sen. Lincoln’s measure


surviving as financial regulations are finalized


by Brady Dennis An effort to force some of the


nation’s biggest banks to spin off their lucrative derivatives-deal- ing operations appears to be gaining traction, as members of a House-Senate conference begin finalizing details of far-reaching new financial regulations. The measure, championed by Sen. Blanche Lincoln (D-Ark.), was included in the financial overhaul bill recently passed by the Senate. It had been opposed by Obama administration offi- cials, some lawmakers in both parties, multiple banking reg- ulators and Wall Street. Lincoln is seeking to restrict federal aid to banks that operate as major


derivatives dealers. If enacted, the controversial measure likely would mean a sig- nificant hit to the bottom line of big banks such as Goldman Sachs and J.P. Morgan Chase. At their most simple, derivatives are financial bets on the future value of something, such as airline fuel or mortgages.


Critics of the provision claim it could harm the competitiveness of U.S. banks by restricting their ability to help clients hedge risks, as well as possibly driving de- rivatives-trading operations into less-regulated overseas markets. Lincoln’s staff, however, has been circulating clarifications designed to assuage concerns about the measure and, aides said, knock down misconcep- tions.


According to the clarifications, Lincoln’s measure would force bank holding companies to spin off their swaps operations out- side their federally insured bank


but allow firms to retain that business in a separate affiliate. It also would give holding compa- nies two years to institute the changes, and essentially exempt all but the largest banks. Treasury officials have contin- ued to oppose the provision, ac- cording to legislative aides, though the department has not commented on it publicly. In ad- dition, top officials at the Federal Reserve and the Federal Deposit Insurance Corp. have expressed unease about it. Yet two regional Fed presi- dents recently backed Lincoln’s efforts, while Economic Recov- ery Advisory Board Chairman Paul A. Volcker has softened his earlier criticism that the provi- sion was too sweeping. Sen. Christopher J. Dodd (D-Conn.), who quietly tried to forge a com- promise on Lincoln’s measure during the Senate debate, last week said that “at this point, I’m in support of what she has in the


ROB PEGORARO Excerpt from voices.washingtonpost.com/fasterforward


bill.” Meanwhile, House Democrats


offered Monday their first series of proposed changes to the legis- lation as lawmakers began rec- onciling differences in the bills passed by each chamber. For instance, House members led by Rep. Barney Frank (D- Mass.), conference chairman, proposed striking a Senate provi- sion championed by Sen. Al Franken (D-Minn.) that would set up a government panel to as- sign credit ratings. The measure was part of an effort to eliminate conflicts of interest between the agencies and the financial firms who pay for their ratings. In addition to nailing down


details on credit-rating regula- tions, the conference is slated Tuesday to discuss changes to new rules governing investor protections, banking supervision and the insurance industry. dennisb@washpost.com


Starbucks to offer free WiFi beginning July 1


The market rate for public WiFi access in downtowns and uptowns, strip malls and shopping centers, and most other places where people drink coffee in the United States is about to drop to zero. Starbucks announced Monday that starting July 1, it will no longer charge for WiFi Internet access in its U.S. shops. The move is an obvious step for the Seattle-based caffeine colossus, which had begun providing two hours a day of complimentary WiFi to registered Starbucks Card holders in response to the free access offered by competing chains such as Cosi and Caribou. (Those nationwide operations had followed the lead of independent coffee shops.)


Starbucks chief executive Howard Schultz also said the company’s


U.S. locations will begin offering “a new online customer experience,” the Starbucks Digital Network, this fall. Set up with Yahoo, it will provide free or expanded access to news and entertainment sites such as the Wall Street Journal, the New York Times, USA Today, Apple’s iTunes and AOL’s Patch. The free WiFi and the Digital Network will be available only in stores the company operates directly, not those licensed to other operators in places such as supermarkets and airports.


BY ELISE AMENDOLA/ASSOCIATED PRESS


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