Opinion | Bridge the human resources gap at Sebi
Successful leveraging of investments in technology, data science and risk prediction requires high-quality professionals
As we had seen in the first part of this series, ignoring the differences in other factors, one Securities and Exchange Board of India (Sebi) employee will have to be almost as effective as 10 US Securities and Exchange Commission (SEC) employees to ensure the same level of monitoring of listed entities in India as in the US. In key divisions, such as corporate finance, which is inter alia responsible for ascertaining the quality of financial statements of listed entities, SEC has more than 15 times as many employees as Sebi. This paucity of staff is reflected in the data. In 2016, SEC completed 868 enforcement actions in an admittedly better governed corporate landscape while Sebi disposed of 330 enforcement actions. At the end of FY17, Sebi had more than 1,800 pending enforcement cases. Therefore, the staff strength at Sebi needs to increase significantly to improve its monitoring and enforcement functions. Note that the difference in market capitalizations of the companies overseen by Sebi versus those overseen by SEC may not provide a relevant comparison, given the fixed costs involved in monitoring firms irrespective of their size and/ or market capitalization. Further, governance mechanisms, such as ownership by institutional investors, analyst coverage, etc., are usually absent in the smaller firms. So, the case can be made that the fixed costs involved in monitoring and regulating smaller firms are disproportionately higher than those of larger firms.
Successful enforcement actions by Sebi can have the twin effect of penalizing the guilty, on one hand, and creating a significant deterrent effect on the other. As Mary Jo White, the 31st chairperson of the SEC argues: “Strong enforcement has a uniquely deterrent value in white collar crimes—sophisticated and knowledgeable market participants pay very close attention to what the SEC is doing and modify their conduct accordingly.” However, for such deterrent effects to be felt in India, Sebi must equip itself to adroitly gather evidence with the objective of “investigate to legislate”. Such a proactive strategy of gathering evidence requires crack teams that integrate cross-functional expertise.
For instance, the division of risk, strategy, and financial innovation, often referred to as SEC’s “think tank”, consists of highly-trained staff from a variety of academic disciplines with deep knowledge of the financial industry and markets. For example, this think tank includes on its payroll almost 50 PhD financial economists. It also has statisticians, financial engineers, programmers, and other experts. This division is involved in performing two significant functions. First, it undertakes quantitative research and risk assessment. Second, it provides economic analysis in support of commission rulemaking. SEC also includes a strong group of economists and experts who support the division of enforcement by, among other things, estimating the amount of ill-gotten gains and providing critiques of expert witness testimony. The staff at the think tank work closely with outside industry and academic experts to inform SEC about current market trends and innovations and their potential impact on financial regulation. And, significantly, they pursue active research agendas, including contributing to peer-review publications and participating regularly in industry conferences to remain engaged with current research methods and maintain their expertise in cutting-edge approaches and methodologies.
The accounting quality model employed by SEC for assessing the quality of financial statements integrates statistical models drawn from academic research in accounting with teams comprising data scientists, accountants, lawyers specialized in corporate law, software engineers, and academics. SEC now utilizes such teams to generate more than 200 custom metrics of earnings quality that are available to SEC staff as part of a dashboard. These include measures of earnings smoothing, auditor activity, tax treatments, key financial ratios, and indicators of managerial actions. Similarly, the analysis & detection centre, which undertakes the background work for enforcement of white-collar crimes in capital markets, comprises teams of specialists including (1) a former Federal Bureau of Investigation agent skilled in conducting insider trading investigations; (2) two quantitative analysts trained in applying statistical metrics to trading data; (3) a trading strategies expert; (4) an index arbitrage and exchange-traded fund specialist; (5) a market structure expert skilled in analysing latent compliance and regulatory risks in market centres; (6) a broker dealer analyst; (7) a high-frequency trading expert; and (8) an experienced accountant investigator who utilizes market intelligence to connect the dots between traders and their potential sources of information.
Sebi needs to similarly develop teams that possess not only broad expertise across functional areas but also the depth of knowledge within their respective areas. Successful leveraging of investments in technology, data science and risk prediction requires high-quality professionals. So, Sebi needs to follow regulators across the world in utilizing lateral hires as well as in creating a revolving door policy. Such policies need to be complemented by providing Sebi employees high-powered incentives. Providing competitive compensation would enable Sebi to attract and retain the best talent.
Krishnamurthy Subramanian is associate professor of finance at the Indian School of Business, Hyderabad.
This is the second in a four-part series.
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