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Regulating Regulators

June 30, 1999

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, 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’ 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 often recommends SEC officials for private sector jobs in the securities
industry. But even now, now that the Lindsey appointment has become a cause
celebre 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.

This kind of rigged regulatory system is a sign of a state capitalism economy in
which the largest firms and the regulatory agencies seem to have a symbiotic
relationship. It was these kinds of relationships that led some railroad executives in
the late 19th 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, in his book href="http://www.amazon.com/exec/obidos/ASIN/0029166500/ludwigvonmisesin"target="_new">
The Triumph of Conservatism, 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–a structure in which dubious characters are often put in charge
of policing even more dubious characters–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 an logical explanation: "To catch a thief, appoint a thief."

* * * * *

Gregory Bresiger writes about the
securities industry from New York.


Also see Is the Market Too Big Too Drop, an analysis of how the SEC subsidizes stocks.


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