New study says SEC revolving door not important. Don’t believe it.
My hat is off to the four authors of a new study called “Does the Revolving Door Affect the SEC’s Enforcement Outcomes?” which was to be presented Monday at the American Accounting Association. As the New York Times was the first to report, researchers from Emory, Rutgers, the University of Washington and Singapore’s Nanyang Technological University set out to reach a quantitative answer to a question everyone thinks they already know the answer to. Instead, the study found that there’s no measurable impact on enforcement from lawyers moving in and out of the SEC.
I wasn’t surprised that there’s scant statistical evidence of ambitious lawyers at the Securities and Exchange Commission punting on cases to curry favor with future clients; most SEC lawyers expect to go work for law firms, and firms like to hire regulators with a reputation for toughness, not laxity. (Remember the bidding wars for former Enron prosecutors?) But I was taken aback by a secondary finding in the study: Firms with a high concentration of SEC alumni don’t achieve measurably better results than other firms for clients in enforcement actions. That should cause some eyebrows to rise among the clientele of firms like Wilmer Cutler Pickering Hale and Dorr and Paul, Weiss, Rifkind, Wharton & Garrison, which pride themselves on offering clients counsel based on the collective experience of their corps of SEC alums. If clients really aren’t faring any better when they hire firms with specialized SEC enforcement defense practices, why bother to pay for their experience?
But there’s one big reason to take that aspect of the study with a grain of salt. It comes down to the inability of even the most nuanced statistical analysis to measure the unmeasurable.
Here’s why. The study was based on data collected from 284 SEC enforcement actions for fraudulent financial reporting, spanning 17 years (between 1990 and 2007) and involving 336 SEC lawyers. As a proxy for aggressive enforcement, the authors looked at four factors: the monetary value of the damages the SEC collected as a percentage of shareholder losses from the misconduct; whether the SEC tried and won the case, rather than settling; whether regulators referred the case to the Justice Department for criminal prosecution; and whether the SEC brought claims against the CEO as well as the firm. Of the 336 SEC lawyers who tried the 284 enforcement actions, 196 were still working at the SEC at the end of the study’s time frame. Another 37 didn’t join law firms, which means there were 103 so-called revolvers who left the SEC to join firms.
The researchers compared the enforcement results of the revolver lawyers with those who didn’t go to big firms and found no difference, which undercuts the so-called rent-seeking hypothesis that SEC lawyers compromise enforcement to enhance their future career prospects. In fact, the study found that the lawyers with the toughest enforcement records on damages, criminal referrals and charging the CEO were the likeliest to join law firms with specialized SEC practices. That supports what the study calls the “human capital hypothesis,” which theorizes that SEC lawyers aim to impress future employers with their expertise and competence.
To check the prevailing human capital theory – which seems to upend conventional wisdom on the deleterious effect of the revolving door – the study also examined the impact of SEC alums once they’ve left the agency and gone into private practice. Researchers looked at whether firms with a concentration of former SEC lawyers “are able to extract milder enforcement outcomes for the clients they represent against the SEC,” and found “no evidence of such an influence.” According to the study, that lack of influence “further supports the earlier inference that revolving doors are not associated with lax enforcement outcomes.”
But an analysis last year by the Project on Government Oversight suggests that SEC alums may exert a much more subtle influence at their old agency when they begin to represent clients in private practice. According to POGO, companies frequently hire SEC alums long before a matter becomes an enforcement action, to write no-action letters or represent potential defendants in examinations and investigations. The POGO paper doesn’t have the statistical underpinnings of the new study but cited “several recent reports and studies that point to instances in which former SEC employees appear to have exerted undue influence on current commission staff,” including four investigations by the SEC’s own inspector general. As evidence of the frequency with which former SEC lawyers appear before their old colleagues, POGO has a “revolving door” database of reports by agency alums disclosing their representation of clients appearing before the SEC; 219 former SEC lawyers filed at least 789 such letters between 2006 and 2010.
Without some accounting for the influence of former SEC lawyers at the pre-enforcement stage, said POGO investigator Michael Smallberg, the new study may be too quick to minimize the impact of the revolving door. “I don’t think one could fully ‘alleviate concerns’ about the revolving door without researching the interactions between current and former SEC staffers in these other areas,” Smallberg told me in an email.
He also pointed to a recent academic paper asserting that the entire regulatory process – from rule-making to enforcement – is affected by the cultural affinity between agencies and their alumni. “Regulators are more likely to have personal connections with industry lobbyists or to envision themselves in their shoes,” wrote James Kwak, a law professor at the University of Connecticut. “This may not directly affect their ideological sympathies or their assessment of the merits of an issue, but it could easily affect their identification – which side they consciously or unconsciously perceive as their in-group.”
I challenge the four authors of this week’s accounting study to come up with a measure of that influence. Then we can have a fully informed discussion about the revolving door.
I emailed one of the study’s authors, Rutgers professor Simi Kedia, but didn’t hear back.
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