WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission pulled out all the stops when it tapped University of Texas law professor Henry Hu to head the first new division created at the agency in 37 years.
An unusually generous temporary contract brought Hu to Washington in September of 2009 to oversee the new Division of Risk, Strategy and Financial Innovation, part of the agency’s effort to address an embarrassing failure to catch swindler Bernard Madoff and adapt to new Wall Street products that could become the next financial weapons of mass destruction.
Hu, with three degrees from Yale and the author of papers on derivatives and financial regulation, looked perfect to lead the “think tank” division that SEC Chairman Mary Schapiro tasked with anticipating market problems.
But Hu departed in January, leaving the division searching for a chief economist and new permanent director, and with questions swirling about how much was accomplished during his roughly 16 months on the job.
His hiring has been praised by some outside the agency as a creative effort to bring in top talent, but the arrangement rubbed some staffers the wrong way, including an SEC decision to cover the bulk of his daily living expenses.
SEC documents obtained by Reuters through a Freedom of Information Act request show Hu sought reimbursement for thousands of dollars per month. The agency’s internal watchdog is now reviewing whether the arrangement was appropriate.
As the SEC works to implement dozens of new rules under the Dodd-Frank financial overhaul law and to revamp equity market structure, critics say the accomplishments and direction of the new division are still not clearly defined.
The division resulted from melding the SEC’s offices of economic analysis and risk assessment. Later, in March 2010, the office of interactive disclosure - which works to make financial disclosures more accessible - was added.
The aim was a multidisciplinary division, but it is not clear whether it has truly succeeded in chipping away at the entrenched culture at the SEC which is known for placing a higher value on the role of lawyers.
That could leave the SEC vulnerable as Wall Street continues its breakneck pace of product development, and as the SEC needs airtight economic and market analysis to justify its rulemaking and to prevent successful legal challenges.
For some, the mission of the new division, known for short as “Risk Fin,” was always too muddled.
Roy Smith, a finance professor at New York University’s Stern School of Business, said his first impression was the division’s job seemed “vague” with a lot of “cosmetic features to it.”
“I’m sure they meant well at the time,” said Smith, a former partner at Goldman Sachs.
Critics and agency employees told Reuters in interviews that Schapiro relied too much on a single person without clearly spelling out how it would operate.
SEC employees, who requested anonymity since they were not authorized to speak publicly, say the chairman’s office had to send an adviser to keep an eye on the division during Hu’s final months. In another action around that time, the division’s now acting director, Jonathan Sokobin, an economist, was unofficially put in charge of running things while Hu remained as the official director.
In a series of emails, Hu said Schapiro offered him “a once-in-a-lifetime opportunity” to serve as an agent of change at a place with “long-established culture, norms, and practices.”
Now back at the University of Texas and writing several books, Hu touted the division’s accomplishments under his tenure. One such accomplishment, he told Reuters, was to elevate the stature of economists and other non-lawyer types that have not traditionally had a voice at the SEC.
“SEC staff who were not traditional lawyers — nerds such as myself — were given a real, highly visible seat at the table,” he said in an emailed statement.
But Schapiro seems to have heeded complaints that economists were devalued by the new division structure.
She told the Senate Banking Committee in February that the new division head would also get the title of Chief Economist, restoring that position’s stature at the agency.
Former SEC Chief Economist James Overdahl, who left the SEC in March 2010, said Schapiro’s initial decision to make the position junior to the division director had hurt its effort to replace him.
“People noticed that the commission no longer had an economist reporting to the chairman’s office,” he said.
Schapiro created the roughly 60-person Risk Fin division as the SEC was trying to wrap its mind around derivatives, complex structured products and other innovations seen by many as major contributors to the financial crisis. The idea was to combine the expertise of lawyers, economists and Wall Street experts.
In addition to tapping Hu, the SEC also hired former hedge fund director Richard Bookstaber for the division as well as Gregg Berman, who worked at the RiskMetrics Group and holds a Ph.D. in physics from Princeton University.
“Henry Hu did some good hiring in that group,” said Donald Langevoort, a law professor at Georgetown University. “People like Rick Bookstaber, who the commission has never had before. Those kind of people, with success in the financial markets.”
Berman has since transferred to the Trading and Markets Division, while Bookstaber spends part of his time working as a senior policy adviser for the Financial Stability Oversight Council created by Dodd-Frank.
John Nester, an SEC spokesman, told Reuters that the Risk Fin division has helped to create a culture of collaboration within the agency.
“It’s a division with diverse skill sets that infuses a focus on data, analytics, and market analysis into the work we do. And, as the newest division, it continues to develop and adjust to the needs of the SEC and the investing public,” he said.
Robert Cook, the director of the SEC’s Division of Trading and Markets, said in an interview that the risk experts have been extremely helpful to his division, from derivatives rules to market structure reforms.
As examples, he cited Risk Fin’s help in creating a limit-up, limit-down proposal to curb volatility in the stock market, as well as its involvement in the analysis of the flash crash and its input on proposed rules for security-based swap reporting and block trades.
“It’s really a collaborative process,” Cook said. “On something like that we are not coming up with the idea and then running it by them as a rubber stamp. They are in the room helping to make decisions.”
Money is always tight at the SEC, leading to questions about the wisdom of the agency’s decision to designate Austin, Texas as Hu’s duty station.
This made him eligible to receive thousands of dollars a month in per diem payments toward his meals and long-term stays in a Marriott-owned apartment in Chevy Chase, Maryland. The agency also paid for flights between Austin and Washington, D.C.
Current and former SEC employees told Reuters in interviews that, in their own experience, they had never heard of the SEC agreeing to pay for ongoing living expenses.
When asked to comment on the expenses, SEC spokesman Nester said the arrangement helped bring the SEC “the recognized expert we wanted to get this vital division off the ground.”
Travel vouchers obtained by Reuters through a Freedom of Information Act request show that Hu sought reimbursement from the SEC ranging from about $4,000 a month to as high as $8,000 per month.
From December 2009 through December 2010, the vouchers, stamped as “processed,” added up to roughly $80,000, according to the records. The division’s total travel budget was about $345,000 in fiscal 2010 that ended Sept. 30.
Meanwhile, the SEC still paid a portion of his salary and benefits while the University of Texas paid the rest.
In the 2nd-year renewal of his agreement with the SEC, which was never fully exercised, the agency agreed to pay $198,333 of Hu’s $307,611 university salary plus $47,800 toward his insurance and retirement benefits, according to reviewed documents.
The maximum annual salary for SEC division heads who are full-fledged federal employees was capped at $230,700 in 2010.
In an email, Hu said he did not seek special arrangements. “I did not in any way seek any departures whatsoever from what top SEC staff informed me as to the chief approach and its terms.”
David Kotz, the inspector general at the SEC, said his office is investigating to see if the arrangement was proper.
But one former top economist at the SEC said it seemed excessive, even if it was authorized.
“The allocation of so much travel expense to a single person, where the travel did not directly promote the mission of the agency is extremely troubling,” said Larry Harris, now a finance professor at the University of Southern California’s Marshall School of Business.
Reporting by Sarah N. Lynch; Editing by Karey Wutkowski and Tim Dobbyn