(The news featured below is a selection from the news covered in the Federal Securities Law Reporter, which is distributed to subscribers of SEC Today.)

SEC Official Pledges to Focus Examination Resources on Firms Engaged in Complex Transactions

With the explosive growth of structured finance transactions and their attendant complex derivatives, Associate Director Mary Anne Gadziala said the Commission's examination program will continue to pour significant resources into reviewing the internal controls and risk management systems of securities firms as well as those organizations that have been approved as consolidated supervised entities. A basic concept to keep in mind, she said, is that risk management is not a one-time assessment and system design, but instead involves a dynamic and continuous process of assessing risks. Her remarks were made at the recent Structured Products Americas conference in Coral Gables, Florida.

Complex structured finance transactions are innovative financing techniques that create customized financing and investment products to suit the financial needs of customers. Since they are customized, they are often unique, illiquid and difficult to price, Gadziala said. While their proper use contributes to market efficiency, she noted that they can also expose financial institutions to elevated levels of risk.

While there is no consistently used legal or technical definition of complex structured finance transactions, Gadziala said there is a consensus on three key characteristics. First, they are cash-based or involve the synthetic linking of pooling of assets. Second, they delink the credit risk of the pooled assets from the originator of the credit, often through transfer to a special purpose vehicle or another entity with a finite life. Third, they split or tranche the resulting liabilities within the structured product based primarily on risk levels, producing different returns.

The principle that financial institutions should develop and maintain robust control and risk management infrastructures is not a new one, Gadziala advised. These infrastructures should enable financial institutions to identify, evaluate and address the risks associated with their business activities, and to conduct their activities in accordance with applicable regulations. In Gadziala's view, the process begins with a strong risk management and compliance culture embedded in the entire financial institution. She emphasized that the focus on compliance and risk management should be a part of all of the firm's decisions.

The SEC recognized the importance of strong internal controls and risk management in its regulations for organizations choosing to become CSEs in order to take advantage of the use of their internal mathematical modules and value at risk to compute regulatory capital charges. The rules require a CSE to establish, document and maintain a system of internal risk management controls to assist with its business activities, including market, credit and legal risks.

Gadziala emphasized that SEC staff will examine risk management systems to ascertain if they have a dynamic and continuous process of assessing risks and ensuring that the controls at each financial institution are commensurate with the risks undertaken. As the risks change, she said, so should the relevant controls. The elevated risks of complex structured finance transactions, and the need for consideration of improved risk management controls, are just a few examples of the newly identified risks and risk controls. Gadziala believes that firms and regulators should work together to identify new risks and ensure that effective risk management controls are implemented by financial firms.