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Those arguing that Wall Street and other major industries cannot survive without a strong regulatory structure because regulators keep markets fair must now answer a basic question: Who regulates the regulators? The query comes in the wake of a recent blatant conflict of interest at the Securities and Exchange Commission (SEC), the regulatory group charged with overseeing brokerages and self-regulatory organizations such as the National Association of Securities Dealers. Earlier this year SEC Chairman Arthur Levitt, who has repeatedly scolded the securities industry and has argued for higher ethical standards, called officials at one of the larger, more controversial firms, a firm that has had a few problems with the SEC, and asked that it give a top job to one of his key assistants.

Richard Lindsey, former head of the SEC's market regulation division and a man who had a huge impact on the securities industry, was hired as a senior managing director by Bear Stearns, a New York based brokerage, a few weeks after Levitt's call. Lindsey's job is to be the number two man at the company's clearing division, which processes trades for brokerages.

Bear Stearns's operations have been under investigation by the SEC and prosecutors, who are examining whether the firm ignored signs of fraudulent activity at small firms. The SEC under Levitt has held firms to a higher standard than just ensuring that their own shops are clean; these firms are now expected to help clean up corruption they see outside their firms.

Levitt, supposedly the ultimate clean-as-a-hound's-tooth regulator, now has, at the least, the veneer of a conflict of interest.

"It's a question of appearance," said one aide to a congressional representative who wants the matter investigated. Compounding this ethical miasma is the continuing nature of the conflict. About a week after Lindsey departed the SEC for the greener pastures of Bear Stearns, the SEC's enforcement staff told Bear Stearns that the government plans to file civil charges against the firm for actions taken by the trade processing unit. At last report, the two sides were engaged in settlement talks.

Despite the insistence of regulators that nothing untoward or unethical has come out of the Levitt/Lindsey affair, several questions are triggered by these recent events: Is Lindsey's hiring an insurance policy for Bear Stearns? A classic measure in which the regulators and a big player of an industry get together to try to reach agreements at the expense of new competitors? A way to keep the regulators at bay by bringing one of them aboard? Neither Bear Stearns nor the SEC will say much, outside of one telling comment recently credited to Bear Stearns in the Baltimore Sun.

"We consider Richard Lindsey a tremendous asset to the firm," said a spokesman for Bear Stearns. No doubt he is.

But none of this revolving door regulator environment is unusual. Levitt has said that he often recommends SEC officials for private sector jobs in the securities industry. But even now that the Lindsey appointment has become a cause célèbre on Wall Street and raised questions about the so-called squeaky-clean regulators who are going to police the securities industry, Levitt still doesn't get it.

Levitt's problem is not that he gave a recommendation when someone called him about one of his aides. Levitt's more obvious problem is that he initiated the process at a time when his office was involved in potentially sensitive litigation. He telephoned Bear Stearns and asked that they hire Lindsey, according to Senator Carl Levin (D-Michigan), who has oversight responsibilities for the securities industry.

Levin, who reportedly told Levitt that the call was ill-advised, wants to hold hearings on ethical standards. And, in a typical reaction of lawmakers whose system has been exposed as, at best, flawed, more laws will likely come out of those hearings. The system is a mess, so let's make the system bigger, critics could conclude.

The SEC wouldn't comment on the matter. But the two most troubling parts of this story--troubling because they go beyond the hypocrisy of personalities who preach x and do y, a description of most officials in the public sector--are the institutional principles at stake. Arthur Levitt will likely have no problems from this incident. He checked with his Ethics Office and it gave him its approval to make the call. This kind of thing goes on all the time in the world of Washington regulators.

And it's usually legal for regulators to move from the public sector into the private sector that they regulated without too much difficulty. Firms are happy to hire them just as venal Arkansas S&Ls back in the 1980s were delighted to hire the first lady of the state, Hillary Clinton, to represent them before regulatory boards. Like pseudo-journalists switching back and forth between the public and the private sectors (e.g., David Gergen), these former public officials and regulators easily make the transition to the private sector and then back to the public sector.

It was these kinds of relationships that led some railroad executives in the late nineteenth century to push for the founding of the Interstate Commerce Commission. The big boys welcomed the ICC as a way of keeping out new "cutthroat" competition.

Historian Gabriel Kolko called this kind of bogus regulatory structure "political capitalism." And he noted that "The first regulatory effort, the Interstate Commerce Commission, had been cooperative and fruitful; indeed, the railroads themselves had been the leading advocates of extended federal regulation after 1887."

Political capitalism, or a system that incorporates central banking and privileged quasi-private public institutions, also led to the founding of the Securities and Exchange Commission in the midst of the Great Depression. The specious regulatory structure was never better explained than by Franklin Roosevelt when he spoke of one of Levitt's predecessors.

Asked about his surprising appointment of the sleazy Joseph Kennedy as first chairman of the SEC-- Kennedy was a notorious swindler who would go on to buy elections for his sons--FDR had a logical explanation: "To catch a thief, appoint a thief."

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Gregory Bresiger writes about the securities industry from New York. Further Reading: Gabriel Kolko, The Triumph of Conservatism: A Reinterpretation of American History, 1900-1916 (New York: The Free Press, 1985).

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