Regulation always comes with a Catch-22. If you want true oversight of an industry’s cutting-edge practices, you need to hire experts from that industry as watchdogs. But if you appoint veterans to police the sector from which they come, you have to worry about whether or not they will be objective or whether the agency will just become a “revolving door” of professionals who use their time as regulators to curry favor with—or do favors for—those they are supposed to be scrutinizing.
The financial sector is arguably criticized more than any other in this regard. Especially after the collective failure of both Wall Street traders and SEC regulators to properly understand the realities governing new, emerging mortgage-backed securities and credit swaps, more and more onlookers began to castigate an industry overseen by many government-salaried employees who would soon head back to executive bank jobs.
A 2011 report from the Project on Government Oversight highlighted the concern. While it concluded that most regulators acted with all expected integrity, it noted that there have been “instances in which former SEC employees appear to have exerted undue influence on current commission staff, or in which the temptations of traveling through the revolving door appear to have weakened SEC regulatory and enforcement actions.”
But according to a new report conducted by four business professors and published by the American Accounting Association, these instances do not represent a widespread failure of regulation of the financial sector. In fact, when it comes to financial fraud—the focus of the study—the revolving door may actually lead to more stringent enforcement actions.
This is because some SEC officials likely use their time in the public sector to aggressively pursue financial fraud and thus prove themselves as regulatory experts to potential future employers. “Talented SEC lawyers can potentially earn substantially higher wages in the private sector, especially at a law firm,” say the report’s authors, who hail from Emory University in Atlanta, Rutgers Business School in New Jersey, the Foster School of Business in Washington and Nanyang Technical University in Singapore.
And this incentive prompts some SEC officials to pad their resumes with impressive-looking enforcement actions. “The existence of revolving doors that allow capable lawyers to work at the SEC before they move to other opportunities is not detrimental to the SEC’s enforcement efforts,” states the report. The authors go on to conclude that “these results alleviate concerns expressed by the press, policy makers and Congress that revolving doors are detrimental to the SEC regulatory efforts, at least, on average. If anything, future job prospects make SEC lawyers increase their enforcement efforts while they are at the SEC.”