Dubious Study Defends SEC Revolving Door

Nothing like being reminded on a regular basis that you live in the best of all possible worlds.

The New York Times tells us a new study is being presented today at the American Accounting Association which defends the revolving door. I’m at a disadvantage at not having access to the actual report, but a summary at Accounting Today provides a bit more detail about the study methodology. This is the Times’ recap:

The revolving door has long been the focus of government watchdogs here, a symbolic portal that business executives and lawyers pass through on their way to government posts and back again to the private sector. There, the thinking goes, they use their influence with former colleagues to reap benefits for themselves and their companies…

Now, a group of accounting professors has produced a study showing that the revolving door actually toughens enforcement results at the Securities and Exchange Commission — the opposite of what government critics have long maintained.

Yves here. Given that the SEC only hands out parking tickets pursues insider trading with any vigor, the idea that you can use any variant of the word “tough” in connection with SEC enforcement is a stretch. Back to the article:

The study, by researchers at Emory University, Rutgers, the University of Washington and Nanyang Technological University in Singapore, found that S.E.C. enforcement lawyers who leave to join private law firms that specialize in commission matters actually produced tougher enforcement results than their peers while at the agency.

The study also found no evidence that law firms that have hired large numbers of S.E.C. alumni are able to extract more lenient enforcement outcomes from the agency.

Oooh, sounds convincing, right? Well, the big problem is that the study focuses on the wrong level of employee. The direction and tone of a government agency is set at the senior levels, such as the head of the SEC (Mary Shapiro) and its head of enforcement (Robert Khuzami). But the study looked at 336 lawyers who worked on civil litigations. That is pretty much certain to mean that it did not include attorneys who were working in a managerial capacity (almost certainly not the chief of enforcement). That is where the revolving door is most pernicious, for it is the folks at the top who determine what sorts of matters will be pursued and how vigorously. For instance, when I was a young person on Wall Street, people were afraid of the SEC because the head of enforcement in the 1970s, Stanley Sporkin, filed a lot of cases, was aggressive in pursuing them, and was not afraid of losing cases. By contrast, we’ve repeatedly criticized Khuzami, who was the general counsel of the Americas at Deutsche Bank from 2004 to 2009, for his failure to pursue CDO related fraud on anything other than a token basis. As we presented long-form in ECONNED, CDOs were central to the crisis, and turned what would otherwise have been a contained subprime bubble into a global financial crisis. We believe that the reason Khuzami has not given CDOs the attention they warrant is that any serious investigation would embroil Deutsche Bank, an early and aggressive participant and put him in the hot seat.

And by contrast, being tough minded in a senior role is not without consequences. Arthur Levitt, who was the head of the SEC under Clinton, was no doubt expected to be friendly to the industry, since he was the first appointee in decades who had not been an attorney and had been head of the American Stock Exchange. But Levitt was serious about consumer protection, and that put him in bad graces with Congress even though he was securities-firm friendly on other matters (for instance, not taking a tough stand on regulating derivatives, both in the wake of the 1994 blowups and more famously, teaming up with other regulators against Brooksley Born on credit default swaps). Former agency heads normally have no trouble getting on lots of industry boards. The only major company that would have Levitt on its board after his SEC stint was Bloomberg (although Levitt has more recently gotten some no doubt well remunerated “senior advisor” gigs and became a board member of RiskMetrics, which pedaled Value at Risk models).

So the study is already verging on “garbage in-garbage out” by focusing on too junior a level of staffer. But let’s just take what the Times wrote at face value:

In addition, revolving-door lawyers who specifically went on to law firms that specialized in S.E.C. matters produced, while at the agency, more aggressive enforcement outcomes, with higher penalties, a greater likelihood of criminal charges and a greater chance that a chief executive was named as a defendant in the S.E.C. action.

They have the causality backwards. What this actually says is prospective employers are smart enough to recruit the best lawyers from the SEC’s enforcement division. Duh! And we are supposed to believe a plus for the SEC, that it’s real job is to serve a a cheap training ground for white shoe law firms? First, the study fails to consider the fact that this kind of poaching means that the SEC will have trouble developing skilled attorneys (it would have been instructive to know the seniority of the lawyers who left) if they can’t hang on to at least a decent portion of their best lawyers to develop the juniors (by contrast, my impression is the the US Attorney’s Office in the Southern District of New York, which is the kick ass grounds for developing prosecutors, is able to retain a significant portion of good lawyers well beyond their training years). Second, it takes the position, without noting that this is an assumption, that the reason these attorneys outperformed their peers is the prospect of private sector employment. From what I can tell from the summaries, they have no proof for this belief. If you go into any office environment, you’ll have better and weaker performers. You’d need to do more granular work to ascertain what role, if any, trying to groom oneself for an exit to the private sector had in performance while at the SEC. (And by contrast, note that Stanley Sporkin’s exit path was to become general counsel to the CIA and then a federal judge. Nothing private sector about that. So one might just as easily contend that the revolving door is the result of the lack of career paths in government service that are perceived to be attractive to ambitious young attorneys. Similarly, the FDIC requires a two year hiatus between when employees leave the agency and when they can work for regulated firms. If we were to believe the implicit logic of this analysis, the FDIC should be less effective by not having its staff motivated by a private sector carrot for its best staffers. Yet the FDIC is widely considered to be a far more effective regulator than the SEC).

Let’s go to the next part. The authors contend that law firms and private companies that hired SEC lawyers didn’t get more lenient treatment than ones that didn’t.

The study also contends that firms that were targets for litigation by the SEC got no better outcomes when they had either ex-SEC lawyers at their firm or well represented at the law firms they worked at that other companies did. Given the relatively small number of lawyers in question (the 98 who left the SEC between 1990 and 2007), I’m not sure this sample is big enough to reach firm conclusions. Moreover, the Times quoted a skeptic who had concerns similar to mine, that litigation was far from a complete picture of how ex SEC staffers could interact with the agency. It isn’t hard to imagine their highest and best use would be to settle matters quietly, meaning to forestall litigation being filed. Per the Times:

Michael Smallberg, an investigator at the project [Project on Government Oversight], said that while the new study was valuable, it looked only at S.E.C. lawyers who were involved in litigation against investment companies.

“We found interactions between current and former S.E.C. employees that occurred long before an investigation got to the litigation stage,” Mr. Smallberg said. “We don’t have any disagreements with” the accounting group’s findings, he added. “But I don’t think a single study could possibly track all the ways that the revolving door could affect the S.E.C.

But it is a no-brainer that the defenders of elite corruption the status quo will tout this study as proof that nothing needs to be done, that our clearly defective and captured regulatory apparatus is working just fine. And it is if you are on the other side of the table from a diminished, ineffective watchdog like the SEC.