Looking Outside the SEC
The SEC revolving door does not exist in a vacuum. It is part of a larger set of interrelated challenges that confront regulatory agencies throughout the federal government.
If the revolving door has weakened the SEC in any way, its harmful effects may be exacerbated by players outside the agency who have been unwilling or unable to do their part in policing the financial markets and holding wrongdoers accountable.
Congress Limits Resources
With regards to budgetary resources set by Congress, the SEC is perennially outmatched by the companies and industries it oversees. At times, these limited resources may force the SEC to settle cases on weak terms, or to rely heavily on the advice of SEC alumni who are representing large financial interests.
Federal Judges Rubber Stamp Weak Settlements
...the court and the public “need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.”
Federal judges can deny proposed SEC settlements if the agency does not provide enough information about the alleged misconduct, but judges often permit the SEC to settle with defendants on weak or vague terms. There are some notable exceptions to this practice. As described in Part V, U.S. District Court Judge Jed Rakoff refused to approve a proposed settlement between the SEC and Citigroup because he said the court and the public “need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.”
In most settlements, however, the public gets only a limited glimpse of the alleged misconduct. This is not a new problem at the SEC. In 2001, for instance, the agency alleged that the accounting firm of Arthur Andersen had helped a company called Waste Management commit “one of the most egregious accounting frauds” the agency had ever seen. The SEC claimed that Arthur Andersen’s practice director, managing partner, and regional audit division head had been made aware of some of the problems. But these individuals were not charged or identified by name, leaving the public in the dark about their involvement in the alleged misconduct. Arthur Andersen later imploded amid accounting scandals at other companies it audited, such as Enron and WorldCom.
Private Litigants Face Significant Hurdles
Private litigation is no substitute for public governmental enforcement, but it can supplement the enforcement efforts of the SEC and other regulatory agencies.
Unfortunately, several laws and court decisions have created significant hurdles for private litigants.
In 1994, the Supreme Court held that secondary financial actors known as “gatekeepers”—including lawyers, accountants, investment bankers, brokers, credit rating agencies, underwriters, and securities analysts—could not be sued by private litigants for “aiding and abetting” securities fraud. These secondary actors often play a crucial role in facilitating corporate fraud, such as when they help a company conceal its true financial condition. As a result of the Court’s ruling, however, they cannot be held liable to shareholders and other private litigants when they aid and abet financial fraudsters.
In one case, a federal appellate court ruled that an outside lawyer could not be held liable to private litigants for facilitating a $2.4 billion fraud at Refco, a former giant of the futures trading industry. The lawyer has since been found guilty of several criminal charges brought by the government—“telling blatant lies, falsifying important documents, and concealing others,” according to the U.S. Attorney for the Southern District of New York.
"...a person may be sued for aiding and abetting a hold up of a gas station but not for aiding and abetting a multi-billion [dollar] fraud like Enron that cost thousands of people their jobs and retirement savings.”
In 2010 testimony about the Supreme Court decision and related cases, Damon Silvers, a counsel for the AFL-CIO, told Congress of a “legal landscape where a person may be sued for aiding and abetting a hold up of a gas station but not for aiding and abetting a multi-billion [dollar] fraud like Enron that cost thousands of people their jobs and retirement savings.” James D. Cox, a professor at Duke University Law School, told Congress that “executives and their counselors who cook the books and defraud investors avoid personal responsibility so long as the product of their chicanery does not bear their name (even though it bears their footprints).”
In 1995, the Private Securities Litigation Reform Act added other burdens. Among other things, it required private litigants to prove that defendants were not just negligent, but had acted knowingly or recklessly in committing fraud.
“You can’t get discovery unless you have strong evidence of fraud, and you can’t get strong evidence of fraud without discovery.”
While the law was intended to limit frivolous lawsuits, it has led to a Catch-22 for private plaintiffs who want to use the courts to obtain evidence to build a case (a process known as discovery): “You can’t get discovery unless you have strong evidence of fraud, and you can’t get strong evidence of fraud without discovery,” said Coffee, the Columbia University law professor, according to The Wall Street Journal.
Other Agencies Can Become Captured or Complacent
Other authorities that have a role to play in policing financial markets and holding wrongdoers accountable include regulators that enforce securities laws at the state level, as well as the Justice Department, which has the authority to bring criminal charges.
Some state regulators are widely regarded as tough enforcers. For instance, the New York State Attorney General’s office—whose former occupant, Eliot Spitzer, was known as the “Sheriff of Wall Street”—has special powers under the Martin Act to investigate and prosecute financial fraud.
Still, the Justice Department and other authorities have come under scrutiny for not bringing more charges against the companies and individuals who helped fuel the financial crisis. These offices are also susceptible to regulatory capture and conflicts of interest arising from the revolving door.
POGO’s report shows that the revolving door is constantly spinning at the SEC. Between 2001 and 2010, more than 400 SEC alumni filed nearly 2,000 disclosure statements saying they planned to represent employers or clients before the agency. These alumni have represented companies during SEC investigations, lobbied the agency on proposed regulations, obtained waivers to soften the blow of enforcement actions, and helped clients win exemptions from federal law. On the other side of the revolving door, when industry veterans join the SEC, they may be in a position to oversee their former employers or clients, or may be forced to recuse themselves from working on crucial agency issues.
SEC spokesman John Nester dismissed concerns about the revolving door.
“We are proud of our efforts to avoid even the appearance of partiality in our work, and the results speak for themselves,” he told POGO.
“[T]he Enforcement staff are skilled and dedicated attorneys who have chosen public service because they believe deeply in our mission to protect investors,” Nester told POGO. “The notion that they would repudiate that goal—and risk their reputations and even criminal prosecution and jail by acting inappropriately—is not one supported by experience.”
Nester added that the academic study on the revolving door had confirmed his experience, “finding that future job prospects for SEC enforcement attorneys had no measurable impact on enforcement outcomes and that SEC alumni appear to have no measurable advantage on behalf of their clients facing SEC investigation.”
However, POGO’s review found that this study does not do much to alleviate concerns about the SEC revolving door. The study sought to quantify any influence the revolving door might have on SEC enforcement actions, but the subtleties involved do not lend themselves to such simple measurement. POGO remains concerned that the steady movement of employees in and out of the SEC creates opportunities for powerful companies and industry groups to “capture” the agency.
...when an employee leaves the SEC on Friday, and shows up on Monday working for a company he used to regulate, such a rapidly spinning revolving door can weaken the agency’s protection of investors, enable regulated entities to exert undue influence, demoralize other government employees, and damage the public’s trust.
POGO does not wish to hamper the SEC’s recruitment efforts or eliminate all movement between the agency and the financial industry. But when an employee leaves the SEC on Friday, and shows up on Monday working for a company he used to regulate, such a rapidly spinning revolving door can weaken the agency’s protection of investors, enable regulated entities to exert undue influence, demoralize other government employees, and damage the public’s trust.
There may not be a single, comprehensive solution to eliminate every potential conflict of interest at the agency. Nonetheless, some steps could be taken to prevent regulated companies and industries from exerting undue influence on our federal regulatory system.
POGO urges the SEC, Congress, federal judges, and the White House to take the following steps to mitigate the revolving door’s most adverse effects.
Let the public see where federal employees go after they leave the government, and disclose their ethics agreements.
- SEC alumni are currently required to file post-employment disclosure statements when they communicate with or appear before the agency in the first two years after they leave. Congress instead should require SEC alumni to file post-employment statements whenever they go to work for a regulated entity.
- Congress should also require all individuals outside the government to file a disclosure statement whenever they communicate with or appear before an official at the SEC or another agency to discuss agency business—including regulations or rules, policymaking, federal funds, examinations, and enforcement actions. Congress should require them to identify their employer or client and with whom they met, and explain the communication in detail. If an individual contacting the agency used to work at that agency, he or she should be required to disclose the previous title and responsibilities.
- The SEC and other agencies should post all disclosure statements online shortly after receiving them.
- The SEC and other agencies should provide online access to ethics records—including advice provided by ethics officials, recusal agreements, and waivers.
Extend the cooling off periods for employees who enter and leave the agency.
- Congress should require employees who leave the SEC and other federal agencies to wait at least two years before contacting the agency on behalf of anyone to discuss agency business, including regulations or rules, policymaking, federal funds, examinations, and enforcement matters.
- Congress should require employees who leave the SEC and other federal agencies to wait at least one year before taking a job with a firm if they had contact with that firm on agency business affecting the firm within a year prior to their departure.
- Congress should make President Obama’s revolving door restrictions for incoming and outgoing political appointees a permanent statute in federal law, and extend the restrictions to other employees throughout the executive branch. However, an exception should be made for those lobbying for an entity without a pecuniary interest.
- Congress should require new employees at the SEC and other federal agencies to wait at least two years before participating in agency business that could affect a former employer or client.
Give the public more information about agency actions.
- When agency officials meet with industry representatives, the agency should provide a webcast of the meeting or provide a complete public record detailing the discussions. Likewise, when agency personnel give speeches to industry groups, they should be made public in a timely manner via the agency website, along with any questions and answers.
- Enforcement cases brought before an administrative law judge should be as transparent and accessible as cases brought before a federal court. The SEC and other agencies should disclose administrative case documents and identify the attorneys who work on those cases.
Give the SEC the resources it needs.
- Congress should ensure the SEC and other federal agencies have sufficient resources to hire and retain a skilled and motivated workforce, keep up with the companies and industries they oversee, and lessen their reliance on private interests to regulate themselves.
Other players should do their part.
- When the SEC charges companies or individuals with wrongdoing, federal judges should require the agency to lay out all the facts and evidence—not just a negotiated set of narrow or vague disclosures—so the public can evaluate at least three key points: the conduct of the accused, whether the punishment fits the offense, and whether the responsible parties have been charged. More disclosure would also help the public and Congress hold regulators accountable, and help defrauded investors and other injured parties seek damages through private lawsuits.
- Recognizing the SEC’s limits, and instead of relying on the SEC alone to protect investors, lawmakers should make it easier for private litigants to uncover financial fraud and hold law-breaking companies and related actors accountable. Congress should pass legislation that would enable private litigants to take action against secondary actors who aid and abet securities fraud. In addition, lawmakers should amend the Private Securities Litigation Reform Act to lower the bar for bringing private lawsuits.
- In order to maximize the effectiveness of private litigation, Congress should require private litigants to place more evidence and underlying facts in the public record— instead of burying the evidence in exchange for out-of-court financial settlements that avert the airing of facts in public trials.
- Other players—including state regulators, state attorneys general, and the Department of Justice—should participate in a healthy rivalry with the SEC to punish law-breaking companies and protect investors
Follow this link to view a full copy of POGO's report, Dangerous Liaisons: Revolving Door at SEC Creates Risk of Regulatory Capture, including endnotes with explanatory text and citations.