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Regulators Set to Tighten Grip, Focus on Accountability and Transparency in 2009

The current financial meltdown has been partially blamed on a lack of regulation. To correct the problems that contributed to the crisis, regulators should target specific problem areas while making sure they don't overregulate and asphyxiate the markets.

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Why It's Important: Analysts have blamed a lack of regulation in the credit default swap market for the current financial meltdown. In October former Federal Reserve Chairman Alan Greenspan admitted to a Congressional hearing that he had put too much faith in the self-correcting power of free markets. Blame for the crisis has also been placed on the lack of restrictions on the activities of investment banks and hedge funds, as well as a lack of incentive structures that reward long-term performance rather than short-term gains. "Regulation is going to be the key driver for the reconstruction of the financial markets in the short term," says Eric Bass, head of SMART Business Advisory and Consulting's financial services practice.

Where the Industry Is Now: The Treasury has proposed a sweeping restructuring of financial regulation. Currently no federal agency has direct supervision over hedge funds, nonbank lenders, private equity funds or over-the-counter derivatives trading. Meanwhile the Fed and Treasury have engaged in extraordinary measures to bail out failing financial institutions, including the $700 billion TARP initiative. Fannie Mae and Freddie Mac have been placed under government conservatorship, while Goldman Sachs and Morgan Stanley (the only two remaining bulge-bracket investment banks) converted into highly regulated commercial bank holding companies. Executive compensation also has come under increasing scrutiny.

Focus in 2009: Regulators will focus on specific sectors, such as derivatives, hedge funds and mortgage securities, with an eye on accountability and transparency, says JR Regan, who is responsible for global strategy, risk, compliance and security solutions, at BearingPoint. Credit rating agencies also will come under closer scrutiny. (The SEC in December approved rules that force the rating agencies to crack down on conflicts of interest.) But regulators will be careful not to overregulate.

While proposing one specific regulation -- that companies selling mortgage-backed securities be required to hold a significant number themselves — Greenspan reportedly told Congress that "Whatever regulatory changes are made, they will pale in comparison to the change already evident in today's markets. Those markets ... will be far more restrained than would any currently contemplated new regulatory regime." SMART's Bass suggests there is a need for a two-tiered regulatory system based on the size of a bank; otherwise, small banks could be overwhelmed.

Litigation is expected to increase dramatically as regulators scrutinize companies that have failed, been acquired or are asking for bailout money. The FBI already is investigating Freddie Mac, AIG and Lehman, and is expected to ask many other firms to produce data to support investigations.

Industry Leaders: Every financial firm must comply with e-discovery requests and other regulations or face stiff fines. "Many firms are using some form of automation for compliance, but few have taken it all the way through," says Zach McCoy, VP, operations and business development, Kaplan Compliance Solutions.

Technology Providers: Compliance technology alone does not provide compliance. "Most banks have already invested in enabling technologies," says SMART's Bass. "[New] technology will be implemented to obtain better efficiency and time limits and accuracy for delivery of information." The focus will be on business processes, governance and organization. Compliance vendors include SunGard, IBM, Kaplan Compliance Solutions, CA, Advent Software, Complinet, FRS Global, PNC Global Investment Services and Orchestria.

On the e-discovery side, where automation is a necessity, vendors are positioning their products and services to capitalize on rising litigation. The e-discovery market is highly fragmented with dozens of vendors competing, including AXS One, Stratify, Kazeon, CaseCentral, Proofpoint, Recommind, Varonis, Guidance Software, NextPage, ZL Technologies and Attenex.

Price Tag: Costs can vary from several thousand dollars for a stand-alone compliance/automation tool to several million dollars for a comprehensive enterprisewide implementation.

Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio

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