The Real Regulatory Revolving Door

A reader who has first hand knowledge of some of the major US financial regulators flagged a CounterPunch article by Pam Martens as the best discussion of the “revolving door” problem that he had ever seen.

The interesting thing about this article is that it highlights a problem that is not widely recognized and therefore has no safeguards against it. As our correspondent explains:

The most important aspect of this is that the “revolving door” problem is most acute, not with the actual regulated firms, but with the professional firms that provide services to regulated entities, especially law firms (it is also a serious issue with compliance consulting firms, although that is something of a separate issue.)

One reason for that is that the standards are different for lawyers than for financial professionals. Financial professionals are forbidden from joining any company they have recently examined; but lawyers are forbidden only from working on cases they have had contact with–there are no specific prohibitions on working for law firms that have cases that they have had contact with, as long as they don’t work on those cases (as if that could ever be enforced.)

That means that lawyers like Linda Thomsen, who as head of Enforcement would have been familiar with every case of significance, could go directly to work for a securities law firm already handling cases which she would most certainly have been familiar with, without Ethics making so much as a peep. I don’t know how that can be seen as anything other than a serious conflict of interest.

I strongly disagree with the argument that SEC lawyers have incentives to drop cases to curry favor with future employers. On the contrary; they have every incentive to break big cases, which is the stuff that careers are made of. And it is the law firms, not the financial firms, that will most likely be their future employers.

Where they do have an incentive, however, is to quickly settle those cases; they get credit for making the case, but the penalties inflicted are not enough to cripple the big Wall Street firms that (through the law firms they hire) will be the ultimate source of income for the lawyers after they move into the private sector. If they were to do nothing, they would be seen as incompetent, and nobody would hire them; but if they do too much, they disrupt the revenue stream that ultimately feeds the securities law industry.

A key section of the Martens article, which is worth reading in its entirety:

The team that produced this report on one of the most long-running and convoluted frauds [Madoff] in the history of Wall Street included Inspector General H. David Kotz who came to the SEC-IG post in December 2007 after five years as Inspector General and Associate General Counsel for the Peace Corps. The Deputy Inspector General, Noelle Frangipane, also came to the SEC from the Peace Corps where she had served as Director of Policy and Public Information.

This lack of Wall Street cronyism by the top two in the Inspector General’s office might have been refreshing to some in Congress and compensated for their not knowing the difference between puts and calls and peaks and troughs and the intricacies of Mr. Madoff’s split-strike conversion strategy (he splits with your money while converting you to a pauper). But the background of the member of the team heading up the Inspector General’s Office of Investigations, J. David Fielder, should have rang serious alarm bells to Congressional investigators.

For the ten years leading up to July 2007, J. David Fielder worked for the SEC as a Senior Counsel in the Division of Enforcement. In February 1999, he moved to the Division of Investment Management, first as Senior Counsel on the Task Force for Adviser Regulation, then as Advisor to the Director. In November 2000, SEC Chairman, Arthur Levitt, appointed Fielder Counsel to the Chairman.

In July 2007, Mr. Fielder was invited to join the corporate law firm, Haynes and Boone LLP, as a partner. In other words, Mr. Fielder’s government issue rolodex filled with the names, home numbers and email addresses of his colleagues at the SEC along with the investigatory matters in his head is deemed fungible currency among corporate law firms and can be freely exchanged for partner status, instantaneously moving one from the lowly wages and attendant lifestyle of public servant to the rarefied bracket and luxuriant trappings of corporate law firm partner.

But what happened next is where things get interesting. In March 2009, just as the SEC Inspector General was hot in pursuit of Madoff aiders and abettors, Mr. Fielder gave up his lucrative partner status at Haynes and Boone to accept the lowly post of Assistant Inspector General of Investigations, working under a boss from the Peace Corps. In other words, he gave up big bucks for a demotion at the SEC.

What Mr. Fielder did might not raise alarm bells were it not happening on a regular basis throughout the corridors of Washington and Wall Street. To understand the implications, this maneuver deserves an appropriate name. A revolving door is assumed to mean one gets all the right connections as a public servant and cashes them in to the highest bidder in private industry. That concept doesn’t typically entertain the door revolving back to public servant status. On Wall Street, they call a maneuver like that a round trip: you buy 100 shares and eventually sell the same 100 shares. You end up back where you started: a round trip.

Just how many lawyer round trippers are involved in the Madoff investigation? Enough to raise a strong stench of circular corruption.

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  1. rob

    Sorry if I’m being thick, but what’s the implication of Felder moving back to the SEC? That he moved back to impede the investigation?

  2. Ina Pickle

    The correspondent may be right about a revolving door, but he is wrong about the ethical rules governing lawyers. You cannot work against the former client, not just on any cases you had before, but on any new cases. The client owns your loyalty for the rest of your professional life. The client can waive some conflicts, but not others.

    So: the rules on lawyers are actually much stricter than the person thinks. Yes, you can SOMETIMES work for a firm that has the other side of a case or deal, provided that you are “chinese walled.” But that is really not common (probably more common in transactional law than litigation). Few lawyers and law firms are willing to take the risk of an accusation – these are career ending events if you were to break the confidence and accidentally share something that hurt the former client. Also, clients get royally pissed that you affiliated with somebody who works against them. What the correspondent doesn’t seem to realize is that the stricter rules tend to make you even more bound to the client because you can tend to be stuck to one large client in fields where competitors tend to sue each other. So in some fields, like oil and gas, a firm might work for several majors. In a field like investment banking, not so much.

    With deals, companies will have their preferred lawyers and not change much. Also, the more you move your business around, the more you can block firms from helping your enemies. I have sometimes suspected that firms went on campaigns to sew up potential opposing counsel.

    This is a little simplistic, but the person seems to have an overly negative idea of the ethics rules under which lawyers operate. Law firms take conflicts checks VERY seriously, as do individual lawyers. If practices around Wall Street have changed, it is out of necessity. Several investment banks *used* to be a hundred years old: that is a lot of conflicts history. And you would still have to get the clients’ consent.

    I honestly believe in regulatory capture. But what you ought to ask yourself, perhaps, is how one can take graduates from the same two or three colleges and business schools, and expect different thinking from them if they are plopped into different work environments? They are still socializing with the same bunch educated at the same two schools, still living with those people, working with those people – but one group is supposed to be policing the other. If you ask me, take a look at everybody who went to Harvard over the past 25 years, and there is the start of your revolving door. The “elites” in all fields across the East Coast already have a lot in common before they start work.

  3. LeeAnne

    So Felder has been rehired by the SEC after 2 years of orientation by the law firm Haynes and Boone LLP to become counter intelligence for the Madoff operation back at the SEC? Do we have an espionage thriller here?

    A lawless industry fueled by political and regulatory capture would use more than just a few tools perfected by military and criminal organizations for covert activities.

    I’m looking forward to an expose of the finance industry’s private investigation and para military organization hires with their personnel migration patterns.

  4. DownSouth


    Reforming the polity at this point is more important than reforming the economy. If we attempt economic reform before political reform is accomplished, we’re just going to wind up with more disasters like the 2003 drug benefit for the elderly or the recent (and ongoing) bank bailout. What with Obama’s backroom deals with BigPharma that we already know about, plus heaven knows what else we don’t know about, the more astute observer can already see where healthcare reform is headed–huge benefits to powerful insiders, little benefit to the general good and huge cost to taxpayers.

    I notice this post, along with a couple of other recent posts dealing with the Fourth Estate , deal more with political reform than with economic reform. I believe this is key, and I salute your efforts, as I am convinced that substantive economic reform is impossible without first achieving political reform.

    The most radical creed of the American Revolution was that of the separation of Church and State. As Daniel Yankelovich put it, “the enemy was entrenched inherited privilege embodied in the church and in most branches of European royalty in collusion with each other.” Granted, the revolution was nominally against the British monarchy, but the Founding Fathers were acutely aware that the monarchy and the church were so inextricably interwoven as to be all but one and the same.

    Today we face a similar problem, but instead of an unholy alliance between church and state, we have an equally pernicious alliance between major business corporations and state.

    The first American revolution institutionalized the separation of church and state. I think we need a second American revolution that promulgates separation of big business and state.

    You’ve already posted on a couple of the problem areas that require reform before the deathgrip that big business enjoys on the polity can be loosened. Let me repeat those and add a couple more (this is not meant to be a complete list):

    • The Fourth Estate (the press, media)
    • The Revolving Door
    • Campaign Finance
    • The Academe (and here I’m not just talking about the aberrant economics departments and their capture by business interests, but the equally perverse Nobel prize committee)

  5. dd

    The educational issue is key. Hiring like-minded individuals all schooled in the de-regulatory school of law and economics produced gross skepticism about government efficiency and efficacy. In addition the basic enforcement framework changed under Reagan and the old style regulators who believed in public service were replaced with the law and econ trainees who implemented cost/benefit and the CATS system to track “efficiency.” That pretty much eliminated ground up major investigations that spanned years of data collection and analysis. It also meant the skill set required for tenacious investigatory legwork was lost. It wasn’t just the enforcement side but also the examination side. It was clear from the Bear debacle that the skill set for doing complete and through exams was lost. That was the backbone of the agency 30 years ago and probably the last time major IBs were subjected to ground up exams with all the attendant verifications and the net capital calculations grounded in publicly quoted market valuations.

  6. fresno dan

    “I strongly disagree with the argument that SEC lawyers have incentives to drop cases to curry favor with future employers. On the contrary; they have every incentive to break big cases, which is the stuff that careers are made of. And it is the law firms, not the financial firms, that will most likely be their future employers.”
    As someone in a regulatory agency, I appreciate someone explaining how the conflict really works. Indeed, the more actions one is associated with (and whether valid or not) the more one is in demand because of one’s “experience” in “resolving” such matters. I take the view that a lot of the regulatory operations are minor shake downs – how many significant actions were actually taken against Wall Street firms? Sure, the fines LOOK large, but they are like parking tickets to a billionaire. And if the parking traffic enforcer gets a bonus to generate parking tickets, whats the harm?
    Other than the collapse of honor and propriety

  7. Tao Jonesing

    @Ina Pickle,

    Windows Explorer ate the comment that I took an hour writing up in reply to your analysis. I don’t have the patience to recreate it, but I will summarize: your understanding of conlicts analysis for former clients is incorrect. Law firms can represent new clients against former clients without seeking a waiver, and they do so all the time. A waiver is only required when a firm obtained confidential information in the prior representation that is material to the new representation. See, e.g., California Rule of Professional Conduct 3-310(E), which is pretty representative of every jurisdiction’s rules regarding former representation.

  8. jake chase

    The truth about the SEC is not intuitive. One must have worked there as I did forty years ago (when, allegedly, it WAS enforcement minded) to understand that teh agency is a small army of bureaucrats who are simply biding their time either until retirement or escape to lucrative private practice. To the extent any enforcement takes place, it is directed against a fringle element of tin horn promoters, penny stock floggers, arrant confidence men whose pitches are so transparently idiotic that anyone falling for them really has only himself to blame. As for the top tier finaglers, they are strictly off limits. When a white shoe firm has a client with a problem, he calls the man at the top of the enforcement chain, who instructs the juniors accordingly.

    Instead of this regulation tapdance, what we need to enforce honesty in business is integrity in the legal system. Unfortunately, we have defendant oriented federal judges who are universally hostile to shareholder interests, as well as state regulation which insulates management against liability in order to pile up franchise fees. Delaware is the leading culprit in this regard. The Congress could solve this problem by insisting upon federal charters for publicly traded corporations. They never will because the corporations will never permit it.

  9. Stephen V.

    While I cannot fault Ina’s analysis above, I have little faith that any significant relief is forthcoming from either the political or the legal sphere.
    Some serious Congressional investigating / enforcement / and conflict of interest crackdowns would be very educational for John Q. Public and might have some deterrent effect.
    Wm. BUITER writes today of a Tobin Tax proposal:

    He doesn’t think much of the idea, however.
    The cost of capital to the banking sector is subsidised, causing the sector to be too large.

    The solution is clear, and it is not a tax on financial transactions: bring default risk back into the calculations of unsecured creditors and other counterparties of the financial sector. This would eliminate the capital subsidy to the industry.

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