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Bloomberg Reveals That SEC Commissioners Have Friends (Who Are Former SEC Commissioners)

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Bloomberg has a big article today about former SEC commissioner Annette Nazareth's current work as a Davis Polk lawyer-lobbyist-fixer for the financial industry that is sort of sneery but still interesting. It's a long litany of her quasi-misdeeds in dealing with her former agency, although at paragraph 738 there's an obligatory "no indication Nazareth violated the federal ethics law that bars senior officials from representing clients before their agency for one year after they leave"; instead the misdeeds are mostly of this variety:

The overlap [of business and shaaaaaady] was sometimes evident in Nazareth’s salutations, which varied from “Dear SEC friends” and “Dear Mary and David” to “Hello All.” On March 10, 2010, for example, she wrote to “Chairman Schapiro” asking if she’d take a meeting with Credit Suisse “to discuss the SEC’s concept release on equity market structure.” After Schapiro agreed, Nazareth wrote back: “Fantastic, Mary!”

In addition to inconsistent use of first names, Nazareth sometimes summarized proposed legislation for the SEC and pointed out drafting errors in the agency's proposals. "Nazareth’s communications provide an inside look at what happens when the revolving door spins": the summaries were read; the errors were corrected. The Bloomberg article in general does a good job of not actually saying anything Nazareth or her SEC contacts did was unethical, while cheerily letting others pick up that implication. Others oblige:

In Nazareth's e-mails, you can't necessarily see instances of overt capture. There are no smoking guns or tit-for-tat favor-currying. But what you can see are the contours of a friendship that, over time, can weaken a regulator's ability to be unsparing in his or her day job. Nazareth is a Davis Polk attorney, paid millions of dollars by the nation's largest banks and financial firms to help them water down Dodd-Frank and other financial regulation, whose tactics apparently include joking, cajoling, and making workaday small talk with a guy whose job it is to help write those rules. It's the clearest real-life example we have of how the Blob works and how insidious its effects can be.

"No instances of overt capture ... clearest real-life example of how insidious its effects can be" is nicely self-refuting but there you have it.*

Actually you can build a parsimonious principal-agent model of all of this without ever saying "revolving door." You might start on this model with the question: why does the SEC need a private law firm to summarize its own rules? Then you'd maybe build something like:

  • the SEC doesn't have the resources to quickly read and understand all of Dodd-Frank, say;
  • Davis Polk does;
  • so it does;
  • and sends the summary to the SEC;
  • which is grateful.

This is a good model for Davis Polk! Of course Davis Polk is a profit-maximizing entity and ultimately its clients pay for it to do that summarizing; the clients presumably think they get good value. Here I drew you a picture**:

The gratitude flowing from the SEC, through Davis Polk, to the banks is a form of regulatory capture that does not depend on any revolving door; anyone with time on their hands and PowerPoint skills could try to win their way into the SEC's heart by the same method.

Good as this is for Davis Polk, is it good for the SEC? That gratitude presumably favors Davis Polk-client banks over miscreant individual investors who can't even be bothered to do the SEC's job for it. Bloomberg points out that "SEC pay scales generally can’t compete with industry; they top out at about $240,000 for staff and $156,000 for commissioners," with the implication that SECsters feather their nest by planning to jump to more lucrative private-sector work after they're done. This is surely true - it's the only explanation for why the bosses get paid less than the staff, because the bosses have more lucrative exits - but even if SEC staff and commissioners were routinely executed at the end of their tenures they'd still probably enjoy having Davis Polk summarize their rules for them. Because why read your rules when someone else will do it for you, if all it will cost you is a little nebulous gratitude down the line? That's just common sense. Former SEC general counsel Gary Becker knows what I'm talking about:

Early in the Dodd-Frank debate, in November 2009, Nazareth forwarded a summary of a Senate proposal to Becker, who noted that the actual text ran to 1,100 pages. “More nap time for me,” he wrote.

That prompted Nazareth to ask, “Yea, but what about me? No rest for the outside counsel.”

Yup! You get paid $1,000 an hour, you never sleep. You get paid a fixed salary and someone else offers to do your work for you, you block out nap time in your schedule. This is standard stuff: if you can't influence your compensation by what you do, you might as well do less.

But of course you have a staff! Is it not weird that the SEC can't summarize securities legislation itself? The picture that I get from the Bloomberg article isn't really about nefarious back-room dealings between current and former SEC staffers. It's about the private sector being entrepreneurial and staying up all night to understand the rules and then going home to shower and change and coming right back with a smile on its face to call up the regulators and say "I got you a little something, it's a flowchart, hope you like it." While the regulators are overburdened or undercompetent or, um, napping. The problem may not be that the SEC and the industry are too close to each other, but that they're too far apart.

Top Bank Lawyer’s E-Mails Show Washington’s Inside Game
Lawyer’s E-mails Set New High Score in ‘Capture the Regulator’ Game [DI / Kevin Roose]

* Also: "We don't like these kinds of cozy relationships between journalists and the sources they cover," "these kinds of cozy relationships" meaning I guess calling each other by their first names. Some journalistsdisagree.

** Quick aside - that reminds me, remember this? It's Davis Polk's flowchart of the Volcker Rule and it is how I understand the Volcker Rule; it is also how everyone [who understands the Volcker Rule] understands the Volcker Rule, because Davis Polk has the time to read the Volcker Rule and everyone else has at most the time to read Davis Polk's flowchart. (Davis Polk's time costs $500+ an hour, so they can always manufacture more of it.) I submit to you that if you produce the Quasi-Official Annotated Volcker Rule, and you are in the business of representing clients affected by the Volcker Rule, that is good for you - and the more people who think it's quasi-official, the better. Banks, great. The SEC, even better. Journalists, meh, they'll take it.



Banned Financial Adviser Who Ignored SEC Had A Plan All Along: Hoodoo Spells...Really

We thought Dawn Bennett was a little nutty, but it turns out that she's just a lady who keeps tongues in jars to keep regulators off her case.

Now Here Are Some Guys Who Knew How To Rip Off A Client

One aspect of good salesmanship is that you have to offer an attractive proposition not merely to the abstract entity that is your nominal client - El Paso, Italy, Greece - but also to the specific human being who is your contact at that client. Telling a corporate treasurer who is five years from retirement that a trade will have a significantly positive NPV due to huge cash flows in years 11-15 is not always as effective a sales technique as buying him a nice steak and an evening of unclothed entertainment. I suspect, though, that the latter strategy is more highly correlated with whatever you're selling ending up on the front page/op-ed page/ Anyway, I definitely admire these guys for this particular con*: The SEC alleges that Argyll Investments LLC’s purported stock-collateralized loan business is merely a fraud perpetrated by James T. Miceli and Douglas A. McClain, Jr. to acquire publicly traded stock from corporate officers and directors at a discounted price from market value, separately sell the shares for full market value in order to fund the loan, and use the remaining proceeds from the sale of the collateral for their own personal benefit. Miceli, McClain, and Argyll typically lied to borrowers by explicitly telling them that their collateral would not be sold unless a default occurred. However, since Argyll had no independent source of funds other than the borrowers’ collateral, Argyll often sold the collateral prior to closing the loan and then used the proceeds to fund it. Got it? Argyll gave corporate executives margin loans at 50-70% loan-to-value based on the market price of their stock (based on the volume weighted average price over five days leading up to the closing of the loan). They took the stock as "collateral." They then trousered the stock and sold it for, y'know, 100% of the market value, with 50-70% of that funding the loan and the remaining 30-50% funding miscellaneous expenses that presumably included unclothed entertainment for themselves. The loans had three-year terms and were not prepayable for 12-18 months, so the expected life of the scam was at least 12 months (but see below).