The SEC showed its true colors yet again at a panel at Stanford Law School at the end of March, although not as dramatically as last year. In last spring’s SEC panel at Stanford, the then head of examinations, Andrew Bowden, made such fawning remarks about private equity, including repeatedly saying he’d really like his son to work in the industry, that he resigned three weeks after we publicized the segment. Nevertheless, this conference was another demonstration of depth of regulatory capture at the agency.

As before, the real action came in when the audience members asked questions. They were all fielded by Andrew Ceresney, a former Debevoise & Plympton partner, now head of enforcement. We’re going to look at two questions in succession.

This one, the second in the Q&A section, has an individual investor reiterating objections that Elizabeth Warren, as well as SEC commissioners Kara Stein and Luis Aguilar, made about the SEC’s practice of being far too willing to waive an automatic sanction, that of the loss of “well known security issuer” status for serious violators. Kara Stein’s stinging 2015 dissent to a Deutsche Bank waiver gives a flavor for how the SEC is all too willing to go easy in the face of criminality:

With these WKSI advantages comes a modicum of responsibility. WKSIs must meet the very low hurdle of not being ineligible. This means that, among other things, they have not been convicted of certain felonies or misdemeanors within the past three years. In granting this waiver, the Commission continues to erode even this lowest of hurdles for large companies, while small and mid-sized businesses appear to face different treatment. Deutsche Bank’s illegal conduct involved nearly a decade of lying, cheating, and stealing. This criminal conduct was pervasive and widespread, involving dozens of employees from Deutsche Bank offices including New York, Frankfurt, Tokyo, and London. Deutsche Bank’s traders engaged in a brazen scheme to defraud Deutsche Bank’s counterparties and the worldwide financial marketplace by secretly manipulating LIBOR. The conduct is appalling. It was a complete criminal fraud upon the worldwide marketplace. Prior Commissions sensibly did not grant WKSI waivers for criminal misconduct. At least, that was the practice until September 19, 2013, when Commission staff granted a waiver to a large institution that pleaded guilty to criminal fraud. This Commission granted another waiver on April 25, 2014, to another large institution that had also been criminally convicted of manipulating LIBOR.

To put none too fine a point on it, this decline in the SEC’s already low standards took place on White’s and Ceresney’s watch.

Now consider this section from the Stanford Law panel. I’m dispensing with the transcript because it’s important to hear the tone and pacing during this short interaction (or watch here starting at 1:40:10):

You can see that soon the questioner starts speaking, some in the crowd, which was heavy on securities lawyers, start fidgeting about. Members of the audience told me there was also sniggering as soon as he mentioned Elizabeth Warren.

Ceresney didn’t let the older man finish his question. He cut him off and proceeded to give a lengthy, technical answer that amounted to a brushoff. And the retiree had also indicated he had two issues he had wanted to raise. It’s not even clear whether the granting of waivers was one of his two beefs, or whether he was citing that as part of a bigger concern.

Ceresney made two points. The first amounted to: “I have nothing to do with this matter. It’s handled elsewhere in the agency.” The second was that the SEC has a well-established process for granting these waivers, so there is nothing to see here.

As attentive readers will recognize, the SEC’s bureaucratic box ticking is besides the point. What Warren, Stein, and Aguilar have contested to is not the process but the results. The SEC looks like it is putting its finger on the scales to favor big, powerful firms. Might that have something to do with revolving door incentives, since they are among the universe of potential employers for departing senior SEC professionals?

Marc Fagel, the former regional director of the SEC’s San Francisco office, asked the next question. A member of the audience who was sitting right behind him reported on what happened off camera:

The gentleman from the public started talking about Senator Warren’s report criticizing the SEC. I saw Fagel almost immediately start to gaffaw in a prolonged and exaggerated way, as if he was trying to make sure that the SEC people in the room would see that he was on their side in believing that the unwashed public doesn’t know what it’s talking about and shouldn’t even attempt to criticize the SEC. As soon as the guy finished his back and forth with Ceresney from the SEC, Fagel jumped up and asked his fawning question.

Here is that “fawning question” (this is a different clip than the one above despite having the same image when idle; or watch here starting at 1:43:45):

Marc Fagel, Partner, Gibson, Dunn & Crutcher: Thank you. Um, and this goes partly to Andrew but partly to the others, I’d like to hear from you. You did reference the deterrent effect. And there’s no question when an enforcement action is brought the industry changes. By the same token, when examiners make findings and those are reported back by leadership like Mark Wyatt, and a lot of great examiners in the room, the industry makes changes. When you speak at a panel or Mary Jo speaks, the industry makes changes. Doesn’t seem like enforcement is always necessary. And couldn’t there be greater use of just relying on the exam findings or on public pronouncements which don’t have the same devastating effects to people who are at the receiving end of an enforcement action. I’d like to hear from other panelists as well if you think if you would change your conduct just sitting on a panel like this or reading about these things in the paper. Andrew Ceresney, Director of Enforcement Division at U.S. Securities and Exchange Commission: Well, I’ll just briefly answer. I think that’s right, I don’t think the only thing that causes change in conduct is enforcement actions. But I do think that when you have a violation, um, it’s appropriate to have an enforcement action um, for that violation. Um, there are obviously deficiency letters still issued in connection with exams where there are issues found, and those um, are typically, are typically remedied. But the one thing I’ll just say with regard to a deficiency letters and OC and our relationship with OC, over the years, in the last five years, about ten percent of exams have resulted in referrals to enforcement. It’s been pretty constant. And so, this idea that we’re not using deficiency letters or otherwise using our other powers to remedy conduct, I don’t think that’s borne out by the evidence. But from my perspective, obviously, um, enforcement actions serve serve two primary purposes: one to punish misconduct, and two, to deter misconduct. And, and so, we bring the actions when we think, we think it’s appropriate, when somebody has violated the law, we think a sanction’s appropriate.

Neither side of this exchange is pretty. Fagel asserts that when the SEC gives speeches, that conduct changes. What evidence is there of that? The agency is widely recognized as being resource constrained and reluctant to litigate cases. In fact, in private equity, firms at thumbing their noses at recent SEC enforcement actions. As we’ll discuss at greater length in our post tomorrow on this conference, private equity firms are actually admitting in their latest annual form ADV disclosures that they are engaging in conduct that the SEC has sanctioned, basically defying the agency to come after them (remember that from a securities law perspective, the time for disclosure was before investors committed funds, not after they are stuck in illiquid investment vehicles).

But the shocking part of Fagel’s remarks is his contention that the SEC should protect the careers of people who’ve engaged in misconduct. We have a former enforcement official stating that members of the financial services industry should be treated as a special class, exempt from damage to their reputation and paychecks from enabling fraud. It’s hard to come up with a better formula for encouraging people to go out and steal.

In fact, the agency should be delighted if Fagel’s claim were actually true, that individuals were getting demoted or sidelined because the SEC caught them out. There’s perilous little evidence of that happening, save for lower level fall guys like Goldman’s “Fabulous Fab” Tourre. Whistleblowers almost without exception incur vastly more in career costs than just about any players in the units they single out.

Similarly, legislators, economists, pundits, and members of the public have demanded for prosecutions of bankers who’ve broken the law. No more free passes for white collar criminals. The SEC can only refer cases for prosecution, but its other remedies include suspending or revoking firms’ and individuals’ securities licenses, steps it very rarely takes, as well as fining responsible employees. We need far more personal accountability, yet Fagel wants finance to become a business that it pure upside to its members, even when they’ve engaged in or failed to stop fraud.

As former securities regulator Ed Walker said via e-mail,

There is nothing as disgusting as watching the revolving door in action. This guy is saying he shouldn’t have enforced the law because now he understands just how wonderful the people he unfairly persecuted are. He has no self-respect.

The worst is that the SEC has arguably reinforced Fagel’s upside-down world view. Gary Weiss, in “Goodbye Marc Fagel and Good Riddance, called Fagel “a quintessential example of the “‘captured regulator.'” Let me not spare you the details:

Fagel was the driving force behind one of the darkest chapters of the SEC’s recent history: Its 2006 probe of research firm Gradient Analytics and its client Rocker Partners, and the subpoena of reporters who told the truth about the company that inspired the probe, Overstock.com, and its crazy CEO, Patrick Byrne. Gradient’s “crime” was that it questioned Byrne’s management and Overstock’s accounting and earnings capacity, which was richly borne out by future events. The probe was based on trumped-up allegations of collusion between Gradient and Rocker, as became clear when it emerged that the former Gradient employees who were the SEC’s star witnesses — as well as Byrne’s, in a civil suit he had filed — had been fired for cause. After all the publicity died down, Gradient and Rocker were quietlyexonerated. It was bad enough that Fagel, who spearheaded this wrong-headed witch hunt, let himself be led around by the nose by a CEO who was so unhinged that he directed lewd and obscene remarks to a reporter for Fortune, Bethany McLean, and fantasized that a fictional character from the Star Wars movies had ruined his business. All this was known to Fagel, and he should have been canned for poor judgment. But on top of that idiotic Keystone Cops routine, there was the little matter of the subpoenas. They were issued to three leading financial reporters, Herb Greenberg of Marketwatch, Jim Cramer of TheStreet.com, and Carol Remond of Dow Jones News Service, who had been critical of the company’s management and accounting.. The subpoenas, which were whipped up by Fagel and other SEC lawyers who swallowed Byrne’s conspiracy theories, were such a major embarrassment that they made the front page of the New York Timeswhen they were withdrawn by SEC chairman Chris Cox. The shamefaced Cox actually scolded his own enforcement division for doing such a harebrained thing. But it was even worse than it appeared to be at the time. At the same time that Fagel & Co. were chasing their tails at the behest of a nutty CEO, Bernie Madoff was ripping off his customers and the major Wall Street bankers, including many with large operations in San Francisco, were stealing from everyone in sight. So what happened to the official who dreamed up this absurd waste of government resources? He was promoted in May 2008, just in time to not cover himself in glory during the financial crisis that was in the process of unfolding.

So get this: Fagel while at the SEC didn’t just ignore a whistleblower, in the case of Madoff. He aggressively persecuted whistleblowers, even in the face of obvious signs that the CEO who was targeted was unhinged and therefore might not be credible. But after this colossal, embarrassing, and highly public cock-up, the SEC protected and even rewarded him! So why shouldn’t he expect the same generous treatment for his clients who defend and engage in abuses?

So if you ever need a poster child for why the revolving door is terrible for enforcement, you can point in general to the SEC’s industry-friendly position that its intermittent wrist slaps change behavior, and in particular, to the sorry conduct of Marc Fagel.