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(The article featured below is a selection from SEC Today, which is available to subscribers of that publication.)

Khuzami Reflects on Past Year as Enforcement Director

Enforcement Director Robert Khuzami reviewed the events of his first year at the SEC in a March 19 speech to the Society of American Business Editors and Writers. Khuzami said the environment has changed significantly since last year when the SEC was the subject of withering criticism in light of the financial crisis and the Madoff scandal. The SEC is a completely different place today, he said.

Congress increased the SEC’s funding for fiscal year 2009 and Khuzami is hopeful it will do so again in 2010. He noted how underfunded the agency is when considering the magnitude of its regulatory and enforcement responsibilities.

Congress is considering legislation that would increase the SEC’s authority with respect to hedge funds and derivatives. Khuzami said the legislation would make available more trade data that would enable the SEC to do its job more effectively.

In the past year, Khuzami reported that the SEC has attracted a lot of new talent, including individuals with expertise in risk management, derivatives, rating agency operations and portfolio management. He credited Chair Mary Schapiro for reinvigorating the Commission. Khuzami added that the SEC has learned from its mistakes.

Khuzami reviewed the changes in the Enforcement Division which began with an in-depth self-assessment. The result was the creation of specialized units where the staff could develop expertise and receive specialized training. Khuzami believes that specialization will give the SEC a better chance to catch those who otherwise may go undetected.

Khuzami noted that the masterminds of white collar crime leave the fewest footprints. They are often planning their defense at the same time they are committing the fraud. He gave the example of insider traders who accumulate research papers on a company whose shares they have illegally purchased to show to enforcement staff in an investigation.

The masterminds also use the complexity of products or the opacity of markets to conceal their misconduct, according to Khuzami. For example, he said they may rely on over-the-counter derivatives trading, accounting tricks or difficult-to-value assets. The specialized units will help the staff make informed decisions about where to focus their enforcement efforts, he said.

Khuzami gave a brief description of each of the units. The structured and new products unit will focus on complex financial instruments such as credit default swaps, collateralized debt obligations, securitized and other structured products. The group will follow market trends and the development of new products, or new twists on old products, he explained.

Khuzami cited as an example the “maturity wall” that will hit in 2012 at the beginning of a three-year period in which more than $700 billion in high yield corporate debt issued as part of the past wave of private equity acquisitions comes to market. He said the maturity wall raises concerns that the debt may overload the market, which in turn may create incentives to engage in improper pricing, disclosure or offering prices.

The specialized units are still in formation but should be fully staffed by around mid-April, according to Khuzami.

Khuzami also reviewed the adoption of new cooperation tools, including cooperation agreements. Khuzami said that one who has flipped and agrees to cooperate in an investigation can provide the missing link in connecting someone to wrongdoing or to unlocking complex transactions.

The Division flattened its management structure and redeployed personnel to the frontlines of conducting investigations. Khuzami said this change will increase the resources dedicated to investigations and will avoid some of the extra processes that result from an overly managed organization.

The Division also has its first managing executive. Khuzami believes that a 1,200 person division, whether public or private, needs a chief operating officer type of role. Many tasks were handled by investigative personnel who did not have the training or expertise, he said, and it distracted from the investigative focus.

A new office of market intelligence will centralize the intake and analysis of tips, complaints and referrals. The office will be staffed by people with cross-discipline expertise, he said.

Schapiro also created a new Office of Risk, Financial Innovation and Strategy which is staffed with experts in a variety of market disciplines. Khuzami believes the expertise in the office will greatly assist the specialized units with its data analysis.

He closed with a review of some of the challenging cases the Division has brought over the past year, even while it was in the midst of what he called the most profound reorganization in its history. Khuzami said he is very optimistic about the future of the Division and the SEC as a whole.