The Revolving Door and the SEC's Enforcement Outcomes: Initial Evidence from Civil Litigation

We investigate the consequences of the “revolving door” for trial lawyers at the SEC’s enforcement division. If future job opportunities motivate SEC lawyers to develop and/or showcase their enforcement expertise, then the revolving door phenomenon will promote more aggressive regulatory activity (the “human capital” hypothesis). In contrast, SEC lawyers can relax enforcement efforts in order to develop networking skills and/or curry favor with prospective employers at private law firms (the “rent seeking” hypothesis”). We collect data on the career paths of 336 SEC lawyers that span 284 SEC civil cases against accounting misrepresentation over the period 1990-2007. Our overall evidence is consistent with the “human capital” hypothesis. However, we find some evidence of “rent seeking” when SEC lawyers are based in Washington DC and when defense firms employ more former SEC lawyers. The revolving door likely impacts numerous aspects of SEC regulation setting and enforcement. This study examines accounting-related civil cases and is not able to study administrative or nonaccounting enforcement cases. Further, the study does not address the choice of which cases to pursue, the incentives of employees other than trial lawyers, or how the revolving door affects rule making. Subject to these caveats, our study provides an important first look into the effects of revolving door incentives on the SEC’s enforcement process and lays the groundwork for future research. This paper benefited greatly from discussions with Joseph Grundfest (former SEC Commissioner), Robert Khuzami (former Director of SEC Enforcement), Andrew Vollmer (former SEC Deputy General Counsel), and other former SEC personnel who asked to remain anonymous. We received valuable comments from Joanna Wu (editor), Rachel Hayes (discussant) and participants at the Journal of Accounting & Economics 2014 Conference. We thank Ross Watts (discussant), Joe Weber (discussant), Truc Thuc Do, Scott Lee, Jerry Martin, Zoe-Vonna Palmrose, Srini Sankaraguruswamy, Michael Smallberg and David Hilzenrath of POGO, Michael Roberts, Xuesong Xu, Jun Yang, and seminar participants at the 2011 ALEA Meeting, 2012 AAA Annual Meeting, 2012 Conference on Financial Economics and Accounting, 2013 FARS Mid-Year Meeting, 2013 National Taiwan University Conference, Indian School of Business, Fordham University, Miami University, National University of Singapore, University of Florida, Texas A&M University, University of Minnesota, and Delaware University for their comments. We would like to thank Jonathan Karpoff, Scott Lee and Gerald Martin for graciously sharing their SEC enforcement data and Rebecca Files for sharing her restatement data. We are grateful for financial support from the Foster School of Business, Stanford Graduate School of Business, Nanyang Business School (Singapore Ministry of Education Academic Research Fund Tier 1), Goizueta Business School, Columbia Business School and the Whitcomb Center at Rutgers Business School.