Regulatory capture and ethics in the SEC revolving door

Regulatory Ethics

When evaluating the publication and reception of a report on government accountability, there are a few details that prove especially helpful when attempting to determine the report's relative accuracy and utility. In particular, a look at the methodology used will provide insight into how the report gathered its data and the reliability of that data. With this in mind, it will be instructive to examine the Project on Government Oversight's 2013 report on the SEC and its revolving-door problem, because the report and its methodology demonstrate how tailoring methodology to a particular evaluative goal produces more accurate and conclusive results in line with the standards of the Government Accountability Office (GAO, 2013, p. 6). Furthermore, considering how the report was treated in the press will serve to demonstrate how studies like this are interpreted and reported on, including which elements do not translate well from a rigorously cited report into a brief article.

Arguably the most important thing to consider when evaluating a report like the one compiled by the Project on Government Oversight (POGO) is the way in which its authors went about compiling their information. In the case of Danger Liaisons: Revolving Door at SEC Creates Risk of Regulatory Capture, POGO based its report "on interviews with current and former SEC officials and thousands of federal records obtained through the Freedom of Information Act" (POGO, 2013, p. 2). This combination of methods is crucial for ensuring accuracy and thoroughness, because interviews and data analysis alone cannot provide a complete picture of something as complex and nuanced as the revolving door problem at the SEC. Augmenting the secondary data available from Freedom of Information Act requests with the more detailed, subjective data provided by interviews allows one to obviate some of the drawbacks and weaknesses of either approach while augmenting their strengths (GAO, 2003, p. 4-5, 29-30; GAO, 2000, p. 3-4; Walker, 2004, p. 7)).

POGO's report focused mainly on the period from 2000 through 2010, and highlights the fact that during that period "more than 400 SEC alumni filed almost 2,000 disclosure forms saying they planned to represent an employer or client before the agency" (POGO, 2013, p. 2). As the POGO report mentions, this number is actually misleading because SEC alumni are only required to submit disclosure forms during the first two years of their time outside the SEC, meaning that the number of alumni representing employers and clients is actually much higher. While there are other records of the problems inherent in the SEC's policies regarding alumni and former industry professionals, these 2,000 disclosure forms represent the most visible example of the larger revolving door problem referenced in the title of the report.

Based on these interviews and SEC documents, POGO performed qualitative analysis in order to determine the relative movement between the SEC and private industry as well as the effect this movement has had on SEC enforcement. This qualitative analysis was important for gaining "an understanding that goes beyond numbers and statistical inference," because the sheer volume of SEC alumni working in industries they formerly regulated is not enough to understand the risk (Wholey, Hatry & Newcomer, 2010, p. 429). This is because the widespread presence of former SEC employees in the financial industry and former financial industry employees in the SEC goes far beyond simply maintaining a pool of experienced employees, to the point that the close connections between industry and regulators actually runs the risk of corrupting that regulation. However, this realization would not be possible without the interviews and qualitative analysis POGO performed in addition to its analyzing of SEC documents, because only when examines precisely what SEC alumni were doing for their employers does the risk to regulatory legitimacy become clear. POGO warns that the relatively lax standards regarding the revolving door as it relates to the SEC runs the risk of "regulatory capture," or the phenomenon in which a regulatory agency is entirely "captured" or beholden to the industry it is meant to regulate. While complete regulatory capture is not yet a reality within the SEC, POGO's report indicates that this will become the case if the current standards governing the revolving door are allowed to remain unchanged.

By "revolving door," the report means the process by which current and former SEC officials are offered lucrative positions within the very industries they previously were meant to regulate even as former industry professionals finds powerful positions within the SEC regulating their former employers. The report provides some rather dramatic examples of this process. For example, during the year 2012, James L. Kroeker left the SEC to work for Deloitte, "one of the 'Big Four' global accounting firms that cater to big corporations," marking a return to Deloitte, a company for whom Kroeker had previously worked before his tenure as chief accountant at the SEC (POGO, 2013, p. 7). In another example, the President's nominee to be the next SEC chairman, Mary Jo White, has spent the greater part of the last decade defending clients from SEC enforcement actions (POGO, 2013, p. 7). These are only two of the many cases cited in the report, but they serve to demonstrate the extremely close relationship between regulators and the industry they are supposed to regulate, to the point that the two are ultimately indistinguishable over longer time frames due to constant movement of personnel between the two areas.

There are actually two elements to POGO's report on the SEC's revolving door problem. At its most basic, the report exists to document and highlight the revolving door practice that occurs by examining in some detail the volume and quality of the work performed by former SEC officials in the service of industries they were previously tasked with regulating. This includes not only examining those individuals who have managed to secure powerful positions within the SEC following their time in the private sector, but also detailing the myriad ways in which SEC alumni use their previous experience in order to protect their new employers from regulation.

This latter phenomenon takes many forms, but in general the most common method depends on securing releases and waivers for a number of different SEC rules and laws. Perhaps most importantly, POGO's report highlights the fact that SEC alumni have been extremely successful in securing waivers and releases for firms with a lengthy track record of malfeasance or even outright fraud (POGO, 2013, p. 8-13). In practically all of these cases, SEC alumni helped their new employers either avoid regulation or punishment altogether, or else minimize punishment so the most harsh punitive measures would not apply. For example, although a short-cut for issuing new securities without registering the offering with the SEC is supposed to be cut off for any organizations subject to SEC actions, over the course of 2003-2010, the SEC granted one hundred waivers to this rule, with forty of those hundred going to firms represented by former SEC employees (POGO, 2013, p. 10).

In addition to this particular kind of waiver, the POGO report details how former SEC officials have helped their employers avoid federal laws, minimize punishments, and even prevent shareholder action that disagreed with the upper management of a firm (POGO, 2013, p. 8-13). While the POGO report does not question the utility of these exemptions in general, it does raise questions as to the standards applied to the issuing of these waivers and releases when so many former SEC officials are involved in the process. In particular, it is hard to imagine how the SEC could effectively evaluate and audit company proposals prepared by individuals with special training in producing precisely what the SEC might want to hear.

These examples lead directly to the second element of the POGO study, which is an analysis as to the effect of the revolving door on regulatory work. While it is hard to deny the existence of the revolving door, various groups have attempted to argue that this revolving door does not actually effect SEC regulation negatively, mainly by suggesting that having experienced industry employees in the SEC and experienced former SEC employees in industry works to ensure that all stakeholders are well-informed about the necessary standards and processes. In fact, this claim to be protecting the special knowledge necessary to make regulation and industry work is used by both the financial industry and the SEC, in one more example of the distinct similarity between positions and statements produced by both the SEC and the industries it is meant to regulate (POGO, 2013, p. 5).

However, the POGO report demonstrates that the evidence in support this position is actually biased to the point of uselessness, because although there is an oft-cited academic study purporting to demonstrate that the revolving door does not effect regulation, it only examined certain areas, such as cases where former SEC officials defended firms from SEC action, and not those instances in which the SEC was tasked with writing new rules or granting waivers and releases (POGO, 2013, p. 23). This is a major oversight because as stated above, one of the areas in which the use of former SEC officials seems to have been most successful is in the securing of waivers and releases. In leaving out these areas, the prime evidence in support of the revolving door demonstrates itself to be woefully inadequate. In contrast, the POGO report details a number of problems with this earlier academic study while demonstrating that some of the things the academic study tried to downplay, such as the SEC's tendency to settle rather than pursue charges to their fullest, are actually evidence of SEC regulation being affected by its close relationship with the industry it is meant to regulate (POGO, 2013, p. 28).

The study's findings are persuasive precisely because they are so comprehensive in their dismantling of the primary academic justification of the revolving door. By demonstrating the critical errors in the primary piece of evidence used in support of the notion that the revolving door does not affect regulation, the POGO report manages to simultaneously draw attention to worrisome trends within the SEC as a whole while demonstrating that the stated justifications for those trends do not hold up when scrutinized closely. The Corporate Crime Reporter's coverage of the POGO report manages to convey this fact effectively, because it summarizes many of the major points of the study while augmenting it with an author interview.