The Truth About the SEC and Wall Street

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The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.

When JPMorgan Chase needed to hire a lawyer in May of this year to advise the bank on how to respond to regulatory probes into its multi-billion-dollar “London Whale” loss, it turned to William McLucas.

The general counsel of JPMorgan Chase — then and now—is Stephen Cutler. Both men worked together at the law firm Wilmer Cutler Pickering Hale and Dorr before Cutler left for the bank in 2007.

But it was another connection that raised some eyebrows: both McLucas and Cutler are former heads of the enforcement division of the Securities and Exchange Commission. (See: What the SEC Is and Does)

For as long as any one can remember, there has been a lot of concern among self-styled “watchdogs” about the movement of officials between the SEC and the businesses it regulates or the law firms that represent those businesses. The assumption has long been that SEC officials who plan to join Wall Street firms would pull their punches to curry favor with future employers—and would later be able to extract more leniency for their Wall Street clients from former colleagues still at the commission.

But a study released earlier this month suggests both of these concerns might be misplaced.

Research by accounting professors at Emory University, Rutgers, Singapore’s Nanyang Technological University and the University of Washington demonstrates that SEC enforcement lawyers who step through the much-reviled “revolving door” to join law firms where they represent clients on SEC matters were actually tougher on the securities industry than their cohorts.

Those lawyers also fail to get the SEC to give their clients preferential treatment, the study finds.

This has produced a lot of head-scratching. Why isn’t the revolving door working to taint the enforcement and regulatory process as expected?

It’s not as if the revolving door isn’t constantly turning. A study published in May by the Project On Government Oversight (POGO) revealed extensive interplay between the SEC and Wall Street.

Here’s how the Washington Post summarized the findings:

Over the past five years, 219 former SEC employees filed disclosures with the SEC saying that they planned to represent clients or employers in dealings with the agency, POGO found.

Many of those former SEC employees were appearing before the agency on multiple matters; altogether, they filed almost 800 disclosure statements, the private watchdog group reported.

So why isn’t the enforcement process more corrupted?

The most popular theory is that SEC lawyers who plan on going to Wall Street use aggressive enforcement as a way to get the attention of law firms and investment banks and to signal their legal prowess. That is, being a tough lawyer for the government is an advertisement that you’ll also be a tough lawyer for Wall Street. (Related: NYSE, SEC in Talks to Settle Data Probe)

Matt Levine at DealBreaker proposes an even more cynical view of things. He thinks that Wall Street firms end up buying off the most aggressive enforcement folks just to get them out of their hair.

“Even if you’re an unbearable jerk and an idiot and cannot be useful in defending lawsuits, if you’re annoying enough at the SEC then some bank will hire you and pay you $500,000 a year to sit in a windowless room with no internet access. Better than leaving you at the SEC to continue pestering them,” Levine writes.

The most pervasive theory, however, isn’t about signaling future employers or buying off tough enforcers. It’s that tough enforcement creates the market for former Wall Street firms to hire SEC lawyers. That is, SEC lawyers are incentivized to increase the cost of regulatory compliance by Wall Street firms because one of the primary ways of ameliorating these increased costs is hiring an SEC lawyer. If you’re at the SEC and want a big Wall Street payday, better make sure that firms are scared enough of the SEC that they’ll pay top dollar for lawyers who know how to work with the commission.

Not everyone is persuaded by the study. Over at Naked Capitalism, the pseudonymed Yves Smith complains that it is “garbage-in, garbage-out.” The problem, she says, isn’t about mid-level lawyers moving between the Commission and Wall Street. The real problem with the SEC, she writes, is the tone set by the most senior people and lawmakers in the pay of Wall Street. This study wouldn’t have picked up on anything like that, she writes.

I think Smith has a good point here—but doesn’t go far enough. Of course Wall Street has enormous influence over the Securities and Exchange Commission. The SEC is basically a creature of Wall Street, created and operated to restore investor confidence—and therefore Wall Street access to investor funds. Its entire history of regulation has been lurching from one crisis to another, each time creating new regulations that consolidated power, wealth and influence into the hands of fewer and fewer Wall Street firms. (Related: Why Regulation Won't Fix Finance)

It is only the parts of the financial sector, such as hedge funds, that operate outside of the Wall Street firm-SEC complex that have preserved some diversity and decentralization. And, of course, the regulators have done their best to use the TBTF crisis of 2007-2009 into an excuse to regulate those hedge funds.

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