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No Harm in SEC Lawyers Going to the Private Sector

Bruce Carton | August 7, 2012

Former Securities and Exchange Commission lawyer Spencer Barasch has become the poster boy for those who believe a revolving door between the SEC and the private sector hinders the aggressive enforcement of securities laws.

In May, the SEC barred Barasch from appearing and practicing before the Commission for one year for violating federal conflict-of-interest rules. Not long after Barasch had left the SEC in April 2005, he allegedly accepted an engagement from financial services firm Stanford Group Co.  that involved work he participated in while at the Commission. Worse, a report by the SEC's inspector general found that Barasch had repeatedly quashed investigations of R. Allen Stanford, the firm's founder, while he was with the SEC—yes, the same Allen Stanford who is now serving a 110-year prison sentence for orchestrating a massive securities fraud.

Barasch had been the associate district director for the Division of Enforcement in the SEC's Fort Worth office from 1998 to 2005, where he allegedly played a substantial role in the agency's investigation into securities law violations by Stanford and his company. In 2005, Barasch left the SEC to join law firm Andrews Kurth. According to the SEC, Barasch was told by the agency's Ethics Office that he was “permanently barred” from representing the Stanford Group before the Commission with respect to any matters on which he had participated while at the Commission. The SEC claims that despite this warning, Barasch accepted an engagement from the Stanford Group a year later, and he represented the firm on matters related to work he had done while at the Commission.  “Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines,” Barasch is famously said to have told investigators.

Barasch subsequently struck an agreement with the U.S. attorney for the Eastern District of Texas to pay $50,000 to settle allegations that he violated 18 U.S.C. Section 207. That statute prohibits former government officials from making a communication or appearance before a federal agency concerning a matter in which the official participated personally and substantially while serving the government.

The Barasch matter led to renewed calls for an end to, or at least harsh limitations on, the ability of SEC employees to accept employment in the private sector. “Today's action sends a strong message that former federal officials cannot abuse the public trust by attempting to profit personally from matters on which they worked as government servants before joining the private sector,” the SEC's inspector general stated in a January 2012 press release. “This misconduct highlights the dangers of a  ‘revolving door' environment between the SEC and the private securities law bar.”

Until someone proves the AAA wrong, I believe it is time for the critics of the revolving door from the SEC to the private sector to stand down.

Heated calls for an end to the revolving door have been common since early 2009, in the wake of the financial crisis. In January 2009, author Michael Lewis and hedge fund manager David Einhorn co-authored an op-ed in The New York Times arguing that the SEC goes too easy on Wall Street because “[i]f you work for the Enforcement Division of the SEC you probably know in the back of your mind (and in the front too) that if you maintain good relations with Wall Street, you might soon be paid huge sums of money to be employed by it.” Lewis and Einhorn proposed that laws should “forbid regulators, for some meaningful amount of time after they have left the SEC, from accepting high-paying jobs with Wall Street firms.” The allegations that Barasch repeatedly thwarted and closed investigations into Stanford Group prior to seeking to represent it (which Barasch denies) played perfectly into this line of criticism.

However, as I have maintained for several years now, there is a compelling argument that the revolving door does not cause SEC lawyers to engage in lax enforcement, but rather just the opposite. The true motivation, I believe, for those who are interested in someday leaving the SEC for private practice is to gain experience and get noticed by bringing important, high-impact cases.

Until now, these two competing views of the revolving door effect at the SEC have had plenty of bluster and emotion behind them, but very little in the way of actual evidence. Two studies on the issue published in 2011 did little to advance the argument either way. In May 2011, the Project on Government Oversight released a report entitled, “Revolving Regulators: SEC Faces Ethic Challenges With Revolving Door.” The POGO study identified a few instances through the years where enforcement actions “may have” been undermined by former employees, but did not find any real systemic problem. In July 2011, the U.S. Government Accountability Office released its own report on the subject, which unremarkably found that there were benefits and disadvantages to movement by employees between the SEC and the private sector.

Finally, however, a study recently released by the American Accounting Association seems to have put the arguments underlying the revolving door issue to some rigorous, scientific testing. In the August 2012 paper “Does the Revolving Door Affect the SEC's Enforcement Outcomes?” the AAA collected and analyzed empirical evidence on the consequences of the revolving door phenomenon at the SEC. The study found that the intensity of SEC enforcement efforts was unaffected when an SEC lawyer later left to join a law firm. In fact, the study found that enforcement was actually more aggressive when an SEC lawyer later left to join certain types of law firms. “Our evidence is thus inconsistent with popular concerns that revolving doors undermine the SEC's enforcement efforts,” the AAA stated.

The AAA study identified the two competing arguments noted above as the “human capital” hypothesis and the “rent seeking” hypothesis. Under the “human capital” hypothesis, future job opportunities in the private sector will make SEC lawyers exert more enforcement effort to showcase their expertise, thereby promoting more aggressive regulatory activity. Under the “rent seeking” hypothesis, by contrast, SEC lawyers will relax their enforcement efforts in order to curry favor with prospective employers in the private sector.

To test these two hypotheses, the AAA collected data on the career paths of 336 SEC lawyers that worked on 284 SEC enforcement actions involving fraudulent financial reporting between 1990 and 2007. The AAA then used four proxies to assess “aggressive enforcement” in each case: (1) the monetary value of the damages collected by the SEC as a percentage of the shareholder losses from the misconduct; (2) whether the SEC won (versus settled) the case; (3) whether, in addition to bringing SEC administrative or civil charges, the SEC lawyer referred the case to the Department of Justice for possible criminal proceedings; and (4) whether the SEC lawyer pursued individual charges against the CEO of the firm.

Using detailed statistical analysis, the AAA paper concluded that the concerns of those who believe that the revolving door leads to lax enforcement (including some members of Congress) are misplaced. In short, the paper concluded, there were no significant differences in the outcomes for enforcement actions by SEC lawyers who eventually left the SEC to join law firms, compared to those who remained at the SEC. Moreover, the study found, the prospect of future employment with a law firm that defended clients charged by the SEC caused SEC lawyers to increase—not decrease—their enforcement efforts while at the agency.

I'm not ready to declare complete victory here. Although the AAA study appears to be thorough and professionally done, the data available on SEC lawyers is limited. In addition, the proxies used to assess “aggressive enforcement” by the SEC, while logical, are likely imperfect. Despite any shortcomings, however, I am pleased that a professional organization actually went beyond the rhetoric that has surrounded this issue for years and conducted an empirical study to see if any objective answers could be found. Until someone proves the AAA wrong, I believe it is time for the critics of the revolving door from the SEC to the private sector to stand down.