Wrinkles in the Ethics Rules

Revolving Door Rules Apply Unevenly

There is a complex set of ethics rules governing what SEC employees can and can’t do when they go through the revolving door, but the rules have gaps and apply unevenly.

SEC “Middle Managers” Excused from Cooling Off Period

At the SEC’s request, certain senior employees at the agency have been exempted from a “cooling off period” that would have restricted their ability to represent clients before the SEC shortly after leaving the agency.

The cooling off period, which is supposed to limit influence-peddling and avoid troubling appearances, prohibits highly placed employees from contacting the agency on behalf of a client within one year of leaving. Explaining this restriction in 2007, an internal SEC newsletter said that, where ethics are involved, “appearances do matter.”

“Think of how it would look for a Division Director to leave office on Friday and contact his or her former staff on Monday on behalf of a private client.”

“Think of how it would look for a Division Director to leave office on Friday and contact his or her former staff on Monday on behalf of a private client,” the SEC wrote.

Nonetheless, the newsletter explained, some alumni have been excused from the cooling off requirement.

In 1991, the SEC wanted to exempt several positions from this restriction. The agency asked the Office of Government Ethics (OGE) to waive the rule for senior agency litigators, including the Enforcement Division’s chief litigation counsel.

The SEC’s ethics official at the time argued that OGE should grant the waiver because SEC litigators do not make policy and are unlikely to exert undue influence on the agency after leaving. He also argued that the exemption was necessary for the SEC to recruit talented lawyers. Unless they were given an exemption, senior litigators “would have difficulty conducting a securities law litigation practice” after leaving the SEC because “Commission litigation is a major component of such a practice,” he said.

OGE agreed to exempt the positions, allowing the SEC’s former senior litigators to interact with the agency shortly after leaving.

For example, David L. Kornblau was a chief litigation counsel in the Enforcement Division—one of the exempted positions. Kornblau resigned from the agency in August 2005 and became an in-house counsel at Merrill Lynch. Several months later, he disclosed that he would be representing the bank in connection with 17 separate matters pending before the SEC, at least some of which involved enforcement cases in which other parties were charged, according to agency records.

See the letter where the SEC asks for exemptions from revolving door cooling off requirements.

In 2003, the SEC wanted to exempt other positions from the cooling off requirement. The agency had obtained the authority to pay some employees on a new pay scale (known as the SEC “K” or “SK” scale) in order to compete more effectively with employers in the financial industry. (An SEC supervisor who was paid as a GS-15 employee on the federal pay scale, for instance, became an SK-17 employee under the SEC’s new system, and was eligible for pay increases beyond what a typical GS-15 employee could receive.)

In a letter to OGE, an SEC ethics official pointed out that the one-year cooling off rule applied to any executive branch employee who was paid at least $134,000 at the time. This meant that some SK employees would be covered by the ban as a result of a pay increase to a level of $134,000 or greater, even if their responsibilities did not change.

The SEC ethics official asked OGE to exempt all SK employees from the cooling off rule. She observed that SK employees include “supervisory accountants, attorneys, economists, and various analysts and administrative specialists.” These employees, she said, are “quintessential government middle managers” who do not “make policy decisions affecting the Commission’s overall operations” and are “not situated to influence overall Commission policy…once they leave.” She also warned that the cooling off ban would make it “exceptionally more difficult for [SK] employees to seek work outside the Commission.”

For these reasons, she argued, SK employees should not be covered by a cooling off rule that’s targeted at other senior policymakers in the federal government. OGE agreed to provide a blanket exemption for all SEC employees paid on the agency’s SK scale.

The SEC’s Inspector General criticized the SK exemption in a January 2011 report about a former SEC official in the Trading and Markets Division who had gone on to work for a high-frequency trading firm. The exemption has “enabled some SEC employees who are highly compensated and who hold prominent positions to evade the ban, despite [the fact] that they are the very type of employees the ban was intended to cover,” the report says.

...a “counsel to a Commissioner who has a salary in excess of $200,000, has been privy to a wealth of confidential SEC information, and has high-level contacts at the SEC due to his position is currently able to leave the Commission and immediately represent industry interests to the Commission.”

For instance, a “counsel to a Commissioner who has a salary in excess of $200,000, has been privy to a wealth of confidential SEC information, and has high-level contacts at the SEC due to his position is currently able to leave the Commission and immediately represent industry interests to the Commission,” the Inspector General observed.

The Inspector General also noted that “Justin Daly, who had served as counsel to Commissioner Kathleen Casey before leaving the Commission in February 2010 to become a lobbyist at Ogilvy Government Regulations, would not be subject to [sic] cooling-off ban and could immediately lobby the SEC,” as described in a July 2010 New York Times article.

Indeed, POGO found that Daly started lobbying the SEC within months of leaving, representing clients such as CME Group and The Blackstone Group to discuss proposed agency regulations, according to federal lobbying disclosures.

The Inspector General concluded that the SK “blanket exemption…opens the door to potential abuse,” and urged the agency to work with OGE to limit the exemption.

SEC spokesman John Nester told POGO the exemptions were “no longer deemed necessary.” But, as of February 2013, more than two years after the Inspector General called for their curtailment, they were still in place. In October 2012, Nester said the SEC was “in the process of working with OGE” to remove them. In a February 2013 email to POGO, Nester said the issue was still “pending with OGE.”

Uneven Cooling Off Periods for Other SEC Alumni

The government-wide cooling off bans can last for one year, two years, or a lifetime, depending on what the alumni did at the agency and what they are seeking to do on behalf of a private-sector employer or client. A different set of rules apply to President Obama’s political appointees. For instance, an appointee who leaves the government and becomes a federally registered lobbyist cannot lobby any senior executive branch official for the remainder of Obama’s administration.

Not only are there different rules for various SEC alumni, there are also different rules for former senior officials at other federal agencies. For instance, a former Treasury Secretary has to wait at least two years before he can represent anyone before any executive branch employee. But this mandatory two-year cooling off period for “very senior personnel” does not cover the SEC chairman and commissioners.

“Every one of those commissioners should have the two-year ban,” said Richard Painter, a professor at the University of Minnesota Law School, according to a 2012 Bloomberg article.

In addition to being uneven, these timeout periods—which only restrict SEC alumni from personally appearing before the agency on certain issues—do not cover all the ways in which former employees can take advantage of their inside knowledge and connections.

For instance, the timeout periods do not prevent SEC alumni from providing “behind the scenes” assistance to their new private-sector colleagues. Even if a former SEC employee does not personally appear before the agency, she can still provide invaluable assistance to her new employers or clients, such as telling them who to contact or which arguments to use in appealing to the agency.

“[A]s long as you’re not going to talk to us you can do anything,” a former SEC ethics official told the agency’s Inspector General, according to its 2011 report. The former ethics official noted that some state bar associations have issued rules that would prevent former SEC attorneys from switching sides on an enforcement matter, but said they wouldn’t necessarily prevent those alumni from lobbying the agency on industry-wide regulations. The Inspector General observed that “employees who leave the Commission may have unlimited social contacts with their former SEC colleagues.”

Loose Rules for Industry-to-SEC Revolving Door

The cooling off rules for industry veterans who join the SEC and other agencies may not go far in restricting federal employees from handling agency work that could affect their former employers or clients.

Daniel M. Gallagher, Jr.

SEC Commissioner Daniel M. Gallagher, Jr.

Daniel M. Gallagher, Jr., an SEC Commissioner, took office in November 2011 after working at WilmerHale. (He actually passed several times through the SEC-WilmerHale revolving door before ending up in his current position.)

Gallagher’s former clients include powerhouse financial firms such as Bank of America, Deutsche Bank AG, and GE Capital Corp., according to his financial disclosure statement.

Now, as an SEC Commissioner, Gallagher may be in a position to make critical decisions about SEC regulations and enforcement actions affecting the public’s interest—and, in some cases, the interests of his former clients.

Some of these former clients have come under SEC scrutiny.

For instance, three former Deutsche Bank employees have independently alleged that the bank hid up to $12 billion in paper losses during the financial crisis, according to Financial Times. They made their complaints—which Deutsche Bank called “wholly unfounded”—to the SEC and other regulators. By allegedly hiding the losses, Deutsche Bank was “able to maintain its carefully crafted image that it was weathering the crisis better than its competitors,” Jordan Thomas, a former SEC enforcement attorney who is representing one of the whistleblowers, told Financial Times.

Other former Gallagher clients have a stake in the SEC’s implementation of the Dodd-Frank Act.

Bank of America, for instance, wrote to the SEC in February 2012 to oppose the proposed Volcker Rule, which would restrict the bets that federally insured banks place in the financial markets. Congress required the SEC and other federal regulators to implement the rule as part of the Dodd-Frank Act.

SEC spokesman John Nester told POGO the agency is equipped to handle potential conflicts of interest that arise when an employee is in a situation to oversee a former employer or client. “SEC employees and Commissioners recuse themselves on a case by case basis in accordance with government wide ethics law and regulation,” Nester said. “Agency staff and Commissioners are required to undergo training concerning their recusal obligations, and the Ethics Office frequently consults with staff members and Commissioners individually about their recusal obligations.”

When asked if the SEC’s work is ever affected by the need for senior officials to recuse themselves, Nester said the agency “is blessed with a deep pool of talented experts on just about any issue that comes up, so it really hasn’t been an issue.”

However, it is not always clear how the SEC handles specific situations in which potential conflicts of interest arise. POGO filed a FOIA request for records showing how the SEC has implemented an ethics agreement signed by Commissioner Gallagher, but the agency provided only 10 pages in part, and withheld approximately 1,500 pages in their entirety. The sheer volume of the material suggests that sorting out Gallagher’s potential ethical conflicts takes an extensive effort.

Richard Painter

University of Minnesota Professor Richard Painter

Richard Painter, a professor at the University of Minnesota Law School, wrote in a 2009 book that the existing rules are “too lenient.”

The rules state, for instance, that a new agency employee may not be able to work on a “particular matter involving specific parties”—e.g., “contracts, grants, licenses, product approval applications, investigations, [or] litigation”—if it is likely to affect a former employer or client. However, the definition of “particular matter involving specific parties” does not cover “rulemaking, legislation, or policy-making of general applicability.”

"Someone who has been paid to urge the SEC to write a particular rule a certain way” could then “go into the SEC and shortly thereafter help write the same rule.”

“A person entering government service from a bank…must wait a year before participating in a government bailout of that same bank, but may, without waiting a year, immediately draft regulations affecting banks in general,” Painter wrote in 2009. Likewise, “[s]omeone who has been paid to urge the SEC to write a particular rule a certain way” could then “go into the SEC and shortly thereafter help write the same rule.”

Some current and former SEC officials told POGO that concerns about the industry-to-government revolving door are overblown. On the positive side, they said, it has enabled the agency to recruit talented financial industry veterans.

The SEC has “made a special effort to hire into the [Enforcement] Division highly-talented persons with a wide range of expertise; not just lawyers, but also traders and risk managers and persons skilled in the debt and derivatives markets,” said agency spokesman John Nester. “This makes us better able to detect wrongdoing and detect it early.”

Former SEC Chairman Mary Schapiro has echoed this point, stating that “[p]eople from the private sector know where the bodies are buried, where the private sector has taken short cuts or engaged in conduct that is less than exemplary,” according to The Washington Post. “Armed with that knowledge,” Schapiro added, “they tend to be vigorous defenders of the public interest.”

David B.H. Martin, a former head of the SEC’s Corporation Finance Division, told POGO that “the revolving door brings the agency talent” and provides a “healthy amount of ventilation.”

Nonetheless, the preponderance of SEC employees who come from financial industry backgrounds may contribute to a pro-industry bias throughout the agency, and could cast doubt on the agency’s decision-making. It may also lead to specific situations in which SEC employees have to either work on issues that could affect a former employer or client, or recuse themselves from important agency business. (See Appendix B)

Revolving in the Dark

For an agency that seeks to ensure a “transparent capital market,” the SEC is not always transparent about its revolving door.

Granted, the SEC deserves credit for being one of the few agencies that require their former employees to file disclosure statements when they go through the revolving door. These statements enabled POGO to identify hundreds of SEC alumni who went on to represent companies overseen by the agency. In addition, anyone who visits the SEC’s website can find records such as waiver requests and meeting memos that offer a glimpse at the interactions between the agency and industry representatives—including many SEC alumni.

But those who want more detailed information about the work that SEC employees do before, during, or after their time at the agency are likely to encounter significant hurdles.

Redacted disclosure statements


 A heavily redacted document given to POGO by the SEC.

Although the SEC provided POGO with thousands of disclosure statements in response to a FOIA request, the agency does not post the statements online. (POGO has made those statements available online in its SEC Revolving Door Database.) And many of the statements given to POGO were heavily redacted, making it hard to tell which employer or clients the SEC alumni were representing or what they hoped to achieve by contacting the agency.

In some cases, the SEC blacked out the names of the former employees who filed post-employment disclosure statements, shielding them from public scrutiny.

“Release of the staff names could subject the employees to harassment from the public in the performance of their official duties,” SEC FOIA branch chief David Henshall wrote in April 2012 in response to POGO’s FOIA request.

Why did some SEC alumni get this special treatment, while others did not?

SEC spokesman John Nester told POGO in 2011 that some former employees requested confidentiality.

Vague or incomplete records of SEC-industry interactions

Another potential way to monitor the SEC revolving door is to examine the interactions between the SEC and industry representatives, many of whom used to work at the agency.

At times, however, presentations made by SEC employees to industry groups are inaccessible to the public.

In March 2012, several SEC officials spoke at a conference in Miami hosted by a securities industry lobbying group. The full remarks of then-Chairman Mary Schapiro can be found on the SEC’s website, but the same is not true of comments made by other SEC officials, who spoke on panels filled with agency alumni about “handling a regulatory investigation.”

Sen. Chuck Grassley

Sen. Charles Grassley (R-IA)

These conferences have occasionally been the subject of controversy. In 2011, Senator Charles Grassley (R-IA) raised concerns about comments made by then-SEC enforcement chief Robert Khuzami to a group of securities defense lawyers. Khuzami appeared to be contradicting the SEC’s enforcement manual, Senator Grassley said, by indicating that the agency would start letting defense attorneys know if an SEC investigation into their client is being accompanied by a Department of Justice investigation. The comments “sound the alarm for anyone concerned about the SEC being overly cozy with those it should be investigating,” Senator Grassley remarked.

Even when the SEC does disclose records of regulatory meetings between the agency and industry representatives, it is not always clear what transpires in those meetings.

To her credit, then-Chairman Mary Schapiro announced in 2010 that the SEC would disclose more information about meetings with outside parties to discuss the implementation of Dodd-Frank. Under this policy, the agency asks meeting participants to provide an agenda of proposed discussion topics to be made part of the public record. The SEC has also been disclosing its meetings with outside parties to discuss another law, the Jumpstart Our Business Startups (JOBS) Act, according to agency spokesman John Nester.

Still, these records are often vague about the arguments advanced by industry representatives at the meetings. The records are certainly no substitute for the kind of real-time access that could be provided through a live webcast of the meetings.

Finally, when the SEC litigates a case in federal court or imposes a penalty that must be approved by a federal judge, the public can typically review the case documents and identify the members of the litigation team—including attorneys who end up going through the revolving door. Unfortunately, the same level of transparency is not provided in SEC enforcement actions that are brought before an administrative law judge.

These administrative proceedings are relatively opaque, even when the SEC charges a defendant with a violation that could have serious consequences for investors and other stakeholders.

 the agency’s “haphazard record-keeping…makes it needlessly difficult to ascertain whether an employee has adhered to the conflict-of-interest restrictions.”

Secret ethics advice

The SEC routinely advises former employees about potential conflicts of interest arising from their representation of private-sector employers or clients. In addition, the agency urges current staffers to recuse themselves from working on agency matters if there’s even an appearance of a conflict of interest related to a past employer or client.

Unfortunately, information about ethics advice, recusal agreements, and conflict-of-interest waivers is typically not revealed to the public.

One problem is that the SEC has not consistently recorded this information. In 2011, the SEC Inspector General reported that the agency’s “haphazard record-keeping…makes it needlessly difficult to ascertain whether an employee has adhered to the conflict-of-interest restrictions.”

But even when the SEC does keep organized ethics records, the agency typically does not share this information with the public. As described above, the agency withheld approximately 1,500 pages of ethics records related to SEC Commissioner Daniel M. Gallagher, Jr., in response to POGO’s FOIA request.

 Images from the SEC, the California Bar Journal and Flickr user @jbtaylor.

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.

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