Portfolio News: In Through the Out Door

Written by admin on March 31st, 2010

A report by the SEC inspector general finds that the agency failed to properly investigate hedge fund manager David Einhorn’s allegations of wrongdoing at Allied Capital, a private equity firm with a former regulator on its payroll.


In 2007, the SEC agreed to a settlement with Allied that was less than a wrist slap. No penalties were imposed on the company or any of its officers, even though Allied admitted that one of its factotums had engaged in “pretexting” to get Einhorn’s phone records (though Allied denied authorizing the pretexting). And then, poof! When Kotz commenced his probe in 2009, all of the work papers from the OCIE examination were “inexplicably deleted” from a computer drive shared by various OCIE officials. An unidentified official testified that the files were probably deliberately zapped.

If something smells fishy about all this, it’s because something was fishy—and the fishy something is the revolving door.

When the SEC decides to bring charges against a company, it is required to give the company something called a Wells Notice, a notice that the SEC is about to commence enforcement action. Thanks to the “high-powered counsel” hired by Allied, including an unidentified former SEC enforcement director, the company got special treatment. They obtained a highly irregular “pre-Wells” meeting with the SEC Enforcement Division, which apparently resembled the surrender ceremony on the USS Missouri in 1945—with the SEC playing the role of the Japanese. Allied’s lawyers talked the SEC out of bringing fraud charges against the company or its officers, including one found to have overvalued the investments on its books.

Why not? After all, their lawyers said they did nothing wrong, and why would they lie? I’m not kidding. An Associate Director of the OCIE indicated that he “trusted” a former SEC official now working for Allied, and that “anyone who had worked at the SEC was ‘not going to be doing anything illegal.’”

All of the SEC officials involved lived happily ever after. I’m sure they blessed other SEC probes with their efficiency and determination. The official who supervised the Allied probe got a special “thank you” from Allied. This person (his name is blanked out in the report) left the SEC a year later to work for the company, apparently as a registered lobbyist. The exact position he got is unclear in the report, but we do know that the SEC ethics office had no problem with that. Apparently the SEC’s conflict-of-interest rules can be summed up as a cheery “okeydokey!”

So, there you have the “revolving door” in all its glory. Allied raised $1 billion from investors while the SEC was flubbing its probe, and eventually was acquired by another company after immense losses and the bankruptcy of one of its key units. Einhorn, who is unusual in the hedge fund world because he steers clear of investing with borrowed money, went on to his famously accurate Lehman agitation, and the rest of us are left with a question: what can be done to prevent a repetition of this kind of horror? Kotz made seven specific recommendations, among them that the SEC ensure that “other than traditional Wells meetings are not utilized by aggressive counsel to influence decisions in enforcement actions.” (So I guess “traditional Wells meetings” are OK for use by “aggressive counsel.”) Kotz also recommended that the SEC see to it that “OCIE management is not unduly influenced” by former SEC employees.”

In response to a request for comment, SEC spokesman John Nester issued a statement saying, “We agree with each of the report’s recommendations, have already implemented several of them and expect to complete the process in June.” That’s nice, but the problem is that Kotz’s recommendations don’t go nearly far enough.

The SEC already has a “conduct rule” prohibiting SEC staffers from representing companies they investigated for two years after leaving the agency—but only in appearances before the commission itself. That rule needs to be expanded so that SEC officials don’t get employment even remotely connected with their former duties, and the prohibited period needs to be more substantial—perhaps to five years. Such a rule needs to be imposed at all federal agencies and the Federal Reserve. And regulators need to be paid like professionals hired as career employees, and not paid bubkes in the expectation they’ll get real jobs later.

Senator Chris Dodd’s regulatory overhaul scheme would keep bank officials off the boards of the regional Fed banks and require that the head of the New York Fed be appointed by the president, rather than handpicked by the Fed boards that are often stacked with bankers.

That’s a start, but it’s not enough. Unless the SEC and Congress put a stop to the revolving door, monstrosities like the Allied Capital fiasco are likely to be repeated. The SEC, meanwhile, needs to stop covering up for its current and former staffers and release an unexpurgated version. It also needs to address this question: Which other SEC targets have received the “Allied Capital treatment,” and what is being done to bring them to justice?


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