When an agency like the Securities and Exchange Commission (SEC) is trying to crack down on industry malfeasance, are there times when it’s better to have a fox in the henhouse?
In yesterday's DealBook, Andrew Ross Sorkin described how an SEC attorney was recently called to testify as a witness in a high-profile case against a Goldman Sachs trader who was allegedly involved in marketing a controversial financial product tied to subprime mortgages.
The SEC attorney, Adam Glass, previously worked as outside counsel to Paulson & Co., a major hedge fund that had significant investments betting against the housing market. Last year, Goldman Sachs paid $550 million to settle charges that it failed to disclose Paulson’s role in structuring and betting against a financial product known as ABACUS that was tied to the performance of residential mortgage-backed securities. Glass was recently deposed in a related case against Fabrice Tourre, a Goldman VP who the SEC alleges was principally responsible for marketing ABACUS to investors. As Sorkin points out, Glass's history could turn out to be problematic for the SEC:
The revelation of Mr. Glass’s involvement in the Abacus deal could undermine the S.E.C.’s case — or at least prove to be a distracting embarrassment.
Perhaps more important, his role once again raises questions about the revolving door between Washington and Wall Street at a time when public distrust about the agency and its lack of enforcement action against the culprits of the crisis is running high.
“There are a lot of talented people out there you could hire who weren’t necessarily part of the problem,” said Mary Kreiner Ramirez, a professor at Washburn University School of Law. “If he was involved in Abacus, how is he supposed to police it?”
In exploring whether the revolving door could potentially hamstring the SEC’s investigations, Sorkin cited POGO’s recent report on former SEC employees who appear before the agency seeking to represent outside clients shortly after leaving government. Our report mainly raised concerns about former SEC employees who go to work for the industry they previously oversaw. But what about SEC employees who come to the agency from industry?
The SEC has been criticized by Harry Markopolos and others for not having enough staff with relevant industry experience. In the aftermath of its failure to catch Bernie Madoff’s Ponzi scheme, the SEC announced that one of its top reforms would be to recruit more staff with specialized capital markets expertise. Glass was hired in late 2009 to join the SEC’s new Division of Risk, Strategy, and Financial Innovation, which was created “to enhance the agency’s capabilities and help identify developing risks and trends in the financial markets.”
This is hardly a new concept at the SEC. Columbia Law School Professor John Coffee, Jr., told Sorkin that FDR justified naming Joseph Kennedy as the first SEC Chairman by arguing that “you need to set a thief to catch a thief.”
But when the SEC turns to industry experts to assist with the agency’s regulatory and enforcement initiatives, there need to be strong measures in place to deal with potential conflicts of interest. One of the recommendations in POGO’s report called for expanded restrictions on new SEC employees coming from industry and public disclosure of SEC records on recusals, waivers, and potential conflicts of interest.
In addition, the Government Accountability Office (GAO) has recommended that the SEC improve its documentation of ethics advice given to employees who disclose potential conflicts of interest. The GAO also pointed out that the Federal Reserve Banks maintain a database that tracks the employment history and banking relationships of examiners and monitors their current staffing assignments, suggesting that the SEC may want to explore creating a similar system.
As the SEC tries to protect investors from the next financial crisis, there may be advantages to utilizing the expertise of Glass and other industry professionals. But it is imperative that the SEC take every possible measure to ensure that these experts are working to advance the agency’s mission and are not giving any special treatment to their former industry colleagues.
Michael Smallberg is a POGO Investigator.
Revolving door interrobang: Librarian In Black
Photo of Jean-Baptiste Huet painting by Mary Harrsch.