Outrageous: Watchdog Windfall

Why did banking overseers ignore the Wall Street mess? They were too busy
angling for jobs there.

Ever since the news broke that Bernie Madoff had bilked investors out of as much as $50 billion, Washington lawmakers have been demanding answers from Wall Street's watchdogs. How could they have missed the biggest con in history? After all, one reason Congress created the Securities and Exchange Commission in the 1930s was to protect investors.

In January, the SEC's inspector general offered one possible explanation: He told Congress that "social and professional relationships" with the longtime Wall Street figure may have clouded investigators' judgment.

No kidding. Madoff himself once boasted that he was "very close" to regulators. "In fact," he added, "my niece even married one." A far more common phenomenon is the revolving door that has these regulators switching roles from overseers to employees. Today's Wall Street boardrooms are virtual retirement communities for the SEC watchdogs who used to supervise them. It's a mutually beneficial arrangement.

The watchdogs get cushy perks and big salaries—as chief legal officer for Morgan Stanley, former SEC enforcement chief Gary Lynch earned $6.6 million in 2007. And the Wall Street titans get insider knowledge and access to fat Washington Rolodexes. Both come in handy in a pinch: "For Wall Street firms under fire, hiring former SEC officials is a tried-and-true practice," the New York Times noted when Deutsche Bank hired one to defend against a federal investigation into its handling of IPOs.

The list of former honchos cashing in on this sweet deal reads like an old SEC leadership directory. To name just a couple: Richard Walker, the agency's former enforcement director, left the SEC in 2001 to become general counsel at Deutsche Bank; Stephen Cutler, who stepped down from the SEC in 2005, signed on as chief counsel for JPMorgan Chase in 2006.

Then there's ex-enforcement chief William R. McLucas, who jumped in 1998 to WilmerHale, peddling his insider savvy to this Washington-based law firm whose specialties include—what else?—defending securities firms facing SEC crackdowns. Among his clients: Zach Zachariah, a Florida cardiologist charged last year by the SEC with a scheme that allegedly netted more than $540,000 in illegal insider trading profits (the defendant denies guilt).

Sure, there's nothing wrong with an experienced lawyer helping a company comply with regulations or fight unjust legal charges, just as there's nothing wrong with Shana Madoff marrying the man she loves. But we can no longer tolerate what Sen. Charles Grassley (R-IA) calls a "culture of deference at the SEC in dealing with big players on Wall Street." Now more than ever, we need strong oversight to restore confidence in our markets.

In 2006, Grassley was among those who dispatched congressional investigators to examine this inside game. In a strongly worded report, they accused the SEC of undermining its own lead investigator during an insider trading probe of the hedge fund Pequot Capital Management. One of those identified was then-SEC enforcement chief Cutler. Only two weeks after Cutler met with a well-connected attorney representing Pequot, the report says, 17 possible violations were slashed to just three, making the job of proving illicit trading even more difficult (the firm denied giving tips, and ultimately no action was taken). "The report," said SEC whistle-blower and former investigator Gary Aguirre, "confirms the existence of an elite cadre of securities lawyers able to stop an SEC investigation in its tracks. When officials leave the SEC for their $2 million-a-year job in private practice, it's their turn to harvest favors."

True or not, we can't afford the possibility that top regulators, with an eye toward future employment, may go soft on the industries they oversee. The consequences go far beyond Bernie Madoff's Ponzi scheme. This game of footsie clearly aided the irresponsible atmosphere on Wall Street that caused the subprime bubble and the ensuing economic collapse. "We got into this mess because of a reluctance to regulate," says Barbara Roper, director of investor protection for the Consumer Federation of America. "I don't think you get independent oversight from people who view an SEC job as a stepping-stone into industry."

In January, President Obama announced rules that would prohibit former presidential appointees in his new administration, including those in the SEC, from lobbying their agency for the duration of his presidency. It also prohibits them from communicating with members of their former agencies for two years after they leave government for the private sector. That's a good start. But it won't solve this problem. Though a five-member board of presidentially appointed commissioners sets SEC policy, it's the enforcement chiefs and other staff who are in charge of actually policing corporate America.

President Obama should ban key former SEC workers from going into jobs defending insider traders and Wall Street firms under investigation or, at a minimum, institute a lengthy waiting period. He should also give internal overseers such as the SEC's inspector general more power and authority to monitor ties between regulators and the industry officials they oversee, including, at the very least, previous working relationships.

Finally, another option is—are you sitting down?—to increase salaries for some senior government officials. Maybe then our most experienced public servants, like all those SEC enforcement chiefs, wouldn't be so quick to cash in at the peak of their abilities. And maybe Wall Street's watchdog will finally start doing its job.

Do More

• Make yourself heard. Contact the White House and let the president know that his conflict-of-interest policies should go beyond presidential appointees.
  
• Learn more. Read a recent major report on the Washington revolving door.
  
• Cheer on the good guys. Let Senator Grassley know you appreciate his oversight of the SEC and that he shouldn't let up. Call his office at 202-224-3744; follow his legislation regarding this topic.

From Reader's Digest - May 2009

 

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