SEC restructures to catch next Madoff


Bernard Madoff

Reeling from the fallout of the Madoff scandal, the Securities and Exchange Commission has been searching for a new strategy and new leadership in its mission to protect the investing public from fraud.  As part of this effort, the S.E.C. recently unveiled six new organizational departments that will lead units aimed at supervising particular domains of finance: asset management, market abuse, structured and new products, foreign corrupt practices, and municipal securities and public pensions.  These changes come with a public recognition that in the rapidly changing world of modern finance the Commission must be constantly vigilant to keep pace with innovation in the markets, as well as a keen awareness that in the wake of the Madoff fiasco the public and Congress are demanding swift action to improve the quality of financial industry oversight.

But while the Commission seeks new and innovative strategies for fulfilling its policy objectives, its core mission of overseeing financial markets continues to depend on its ability to directly probe into the activities of market players, and starting at the end of January, the front-lines inspectors in America’s financial capital will have a new chief, private fund industry expert Norman Champ ’89, who will take on the role of Regional Associate Director for the S.E.C.’s New York Regional Office.  Champ brings a wealth of experience as an attorney and industry insider, having worked for eight years at Davis Polk & Wardwell before becoming general counsel at Chilton Investments, a private investment management fund based in Stamford, Connecticut with over $7 billion in assets under management.  Champ served until the end of 2009 as Executive Vice President and General Counsel at Chilton, in addition to representing the interests of the hedge fund industry as a member of the board of directors of the Managed Funds Association. 

During this year’s January term, Mr. Champ came to Harvard Law School to teach an intensive course on the laws and regulations that govern the structure of the private fund industry, a subject he had taught two years before in the winter term of 2008.  According to Champ, those two years had seen tremendous changes in the industry.  The havoc caused by the financial crisis in September of 2008, as well as the stunning revelation of the Madoff fraud, left the private fund industry in a state of shock, with investors in a panic and fund managers worried about the reliability of their business partners. 

“I don’t think it really occurred to people that Lehman, Merrill, would be swallowed up and gone,” said Champ, speaking with the Harvard Law Record.  The realization of counterparty risk meant that overnight the entire hedge fund industry had to scramble to evaluate the creditworthiness of its prime brokers and other counterparties.  In the aftermath of the crisis, the entire hedge fund industry has come under intense legislative and regulatory scrutiny as lawmakers in Washington seek to outline a bold reform agenda.  Champ points to the verification of customer assets as a key priority of the SEC’s present investigations.  “Are the securities really there?” This is the question that many wish had been asked earlier in the Madoff case, and thus a rallying point for the Commission.

And now with the high profile prosecution of Raj Rajaratnam, hedge funds have again come to the public eye in a negative light.  To Champ, insider trading is just one of many forms of bad behavior that must be taken seriously by compliance officers at funds, whose jobs it is to detect and curtail such abuses from the inside.  “Good policies and procedures that are inforced can make a huge dent in illicit activity.  If top managers are willing to support compliance, it creates a culture of trust and eliminates a lot of problems.”   The role of the compliance officer is crucial, says Champ, if the company is going to avoid the devastating consequences of merely being investigated for the possibility of any insider trading, a fact illustrated by the collapse of the Galleon Group funds within 24 hours of Rajaratnam’s arrest.  As Congress contemplates the extension of registration requirements to all hedge funds, these compliance concerns will only become more important for the managers of funds.

With regard to his decision to leave the private fund industry and enter government service, Champ says that his decision was primarily based on the good relationship he had with outgoing Regional Associate Director Tom Biolsi.  When the commission began looking for a replacement, Biolsi suggested to Champ that he consider the position because of the invaluable analytical tools he could bring to the job.     One of the most challenging aspects of the commission’s work, says Champ, is penetrating the minutiae of fund management to recognize the red flags requiring attention right away.  As a long time fund executive and General Counsel, Champ hopes to bring his experience to bear in a way that strengthens the capacity of the commission to provide effective and efficient oversight of the thousands of regulated entities in the New York area.

Despite new legislative restrictions on the independence of hedge funds that are likely to be passed, Champ believes that the private fund industry is becoming more concentrated and solidified in the financial landscape.  “What started as an entrepreneurial movement has become more institutionalized, but because of investor demand.”  The concentration is in part, says Champ, due to the benefits such institutionalization can provide in strict compliance policies and a consistent reputation for good business practices and strong investment performance.  And yet, because of the diversity of investor tastes in the private fund world, Champ says, “You have hot money investors that always want to go after the small funds, so you’re always going to have some entrepreneurs.”  In this sense the hedge fund industry embraces the creative destruction that comes as one fund fails only to be replaced by another, each pursuing their own innovative investment strategies.  Although such instability might alarm some outsiders, Champ points out that investors do a considerable amount of due diligence before entrusting their funds to a manager, especially since most funds require minimum investments of over $1 million.  “Investors have the ultimate motivation of having their money on the line.”

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