(Courtesy of the SEC)
I waited a long time to talk to someone like James Kidney.
For years I tried to find anyone at the Securities and Exchange Commission who would speak candidly about the agency’s enforcement efforts. But even after lawyers left the SEC, usually for big law firms, they almost never wanted to talk to me. Or else they’d give me vague platitudes about what a good job the SEC was doing. I’ve been doing this long enough to know I wasn’t getting the full story.
Then, earlier this year, I got an envelope from the SEC with a CD-ROM disk. It was mailed by the agency’s Freedom of Information Act office, and it was a response to a FOIA request I made two years before. To be honest, I had forgotten I even made the request. The disk contained more than 2,000 pages of interviews that the SEC’s then inspector general, David Kotz, conducted in the summer of 2010, shortly after the SEC sued Goldman Sachs & Co. over its Abacus investment vehicle.
Republican Congressman Darrell Issa had pressed for the investigation over suspicions that the Goldman case was brought for political reasons, to garner support for legislation that Issa opposed, the Dodd–Frank Wall Street Reform and Consumer Protection Act. Kotz interviewed all the SEC lawyers involved in the case, as well as some commissioners, and he questioned them about nearly every aspect of the investigation and charging in the Abacus case. He ultimately found the case wasn’t politically motivated in a September 2010 report.
Going through the agency’s FOIA response, it became clear that Kotz’s questions were largely met with evasive boilerplate—variations on “I don’t recall.” If I didn’t know better, I’d be alarmed that so many top SEC lawyers have such feeble memories. But one interview stood out. A lawyer identified only as “Witness 11″ actually remembered what happened in the Abacus case, and he wasn’t happy about it.
As I described in an article for The Am Law Daily last week, the SEC lawyer spoke frankly about difficulties he encountered getting the agency to interview a senior Goldman executive who was in charge of the Abacus deal, and about the internal controversy over a decision not to charge that executive. He complained to Kotz that the Goldman case was an example of how the SEC is more aggressive with smaller targets, and is too deferential to top players on Wall Street.
Witness 11 was never identified by name in the transcripts, but I eventually determined he was James Kidney, a veteran trial lawyer at the SEC. I also learned that Kidney planned to retire at the end of last month, after 24 years at the agency.
At his retirement party, Kidney gave a speech in which he praised many of his colleagues, but blasted the agency for misplaced priorities. Too often, he said, the SEC went after little guys, while it tiptoed around powerful executives. He criticized the revolving door between the SEC and private firms, as well as the agency’s focus on bringing lots of cases in order to boost enforcement statistics. Kidney’s speech caused a big stir last week when it was reported by the The American Lawyer and described by Bloomberg News.
Afterward, I asked Kidney if he would answer some questions about his speech and his concerns about the SEC. Below is an edited transcript of that conversation.
The American Lawyer: Why did you decide to be so critical of the SEC in your retirement speech?
James Kidney: I have been outspoken about these issues in a casual way internally for years. If I had simply delivered the usual retirement speech, it would have been out of character. Based on the response of the 60-70 people at my retirement party, I believe it went down well. Of course, I have no reason to believe that anyone will act on my ideas. By the way, I had no idea the remarks would have an audience outside of my retirement party until the chapter president of the National Treasury Employees Union, which represents SEC rank-and-file, suggested he would put them in the union local newsletter. I did not know (1) that the whole thing would be linked to a headline in the newsletter or (2) that the newsletter was on a public website. I expected a pithy summary of my speech on a newsletter site emailed solely to union members. I was quite shocked to receive a call from Bloomberg News, which had the text. Had I known the speech would be public, I am sure I would have written it differently.
The SEC has many fine, dedicated employees. Although the Bloomberg News report was a fair summary, the Internet has taken my remarks irresponsibly in some cases as a reason to trash the entire agency. Former management of the division of enforcement and perhaps the commissioners themselves have not, in my view, been as forceful as they should have been, but the rank-and-file at the SEC are mostly very dedicated and talented.
Current enforcement division management shows at least a little promise of improving the situation, such as by reducing use of “neither admit nor deny” settlements in some cases. But there is no sign that insignificant cases will not be pursued beyond reason. There is still a long way to go, in my view, but the line staff is capable of delivering meaningful enforcement if aggressively led.
TAL: Are there many others at the agency who feel the same way?
JK: Certainly there are. Many enforcement division staffers are frustrated by the emphasis on bringing lots of cases because it encourages—or at least does not discourage—management from pursuing small matters. Most staff members did not expect to toil on such matters when they signed on, especially since now one can be fairly sure there are larger offenses to be found and investigated.
TAL: You criticized the revolving door in your speech. Can anything be done about it?
JK: Yes, but it isn’t likely. The positions I am talking about—just below those of the political appointees—are filled by the SEC chairman. Greater effort could be made to find candidates inside the Commission, possibly skipping down an organizational level or two.
The commission does need expertise from Wall Street. But the practice of putting lawyers who previously spent years defending Wall Street banks in positions of executive authority over enforcement has, I believe, contributed to the current distrust of the SEC. No one can shed their last 15 or 20 years of experience like a snake sheds its skin. It is not necessarily that these outsiders intend to go easy on large scale violators. It is that the culture can’t be shaken off so easily.
To the degree that unusual issues arise due to Wall Street operations, experts can be hired or consulted, as is done even now. It is not even at all clear that Wall Street defense lawyers have any more “expertise” on unusual or complex trading practices than do career Enforcement attorneys, the Office of Market Regulation and Corporation Finance.
TAL: You described the agency’s focus on the number of cases brought as a “cancer.” You said you’ve suggested different metrics that would make better use of the agency’s resources. What were your suggestions?
JK: In the last year I circulated a memo to several levels of the Commission suggesting a different way to prioritize cases. I got no feedback at all.
Under my proposal a potential case would be assigned a score from 0-15 based on 16 criteria. The factors included the size of the target company or firm (with larger targets getting bigger numbers), the amount of money lost by investors, and whether senior managers were involved in the wrongdoing. The higher the total, the higher priority a case should be. This was offered as a starting point for discussion. To my knowledge, nothing ever came of it.
TAL: What other concrete steps could the SEC take to better accomplish its mission?
JK: First, the SEC needs to change the formulas it uses to set settlement penalties. It now extracts the same sanctions from the truly culpable, such as a CEO who trades on inside information, as it does from a guy who acts on an inside stock tip from a golfing buddy. In both cases, the penalty is based on the amount of unlawful profit. The outsider should be treated more leniently because he didn’t violate any genuine duty to anyone. The commissioners should grant the enforcement division more leeway to recommend settlements at various levels based on the facts.
Second, the President and Congress should consider finding people with more varied resumes to become commissioners at the SEC. Right now, there are only two commissioners with even slight experience working in the securities business other than as outside counsel to Wall Street banks. A bad trend has continued of senators of both parties naming staff from their own committees to the Commission. There are two now on the Commission. These may be perfectly good people, but they have highly limited experience. Lawmakers should have greater respect for the SEC than as a reward for their own loyal staff.
Appointees should also be considered from major financial centers other than New York. Last I looked, San Francisco, Chicago, Dallas, Atlanta and Philadelphia had large brokerage and financial institutions.
It is not inconsistent to be suspicious of the revolving door at senior staff levels but wish for deeper Wall Street experience among the commissioners. I am not so cynical to believe there are no honest men and women in senior jobs in finance, especially if the resumes are not all from New York. Deep experience will give comfort to the industry and possibly to the public if performance is justified. Also, the SEC is a fairly large business. A senior officer from a large financial firm will have experience running a business, which is also important for a chairman running the SEC.
TAL: Who were the SEC’s best leaders during your tenure?
JK: Bill McLucas remains the gold standard for a division director. He came up through the staff ranks, but after many years went through the revolving door with a deservedly great reputation. [William McLucas is now a partner at Wilmer Cutler Pickering Hale and Dorr.]
Three of the best chairmen during the time I was at the SEC were John Shad, Arthur Levitt and William Donaldson. Shad was chairman at E.F. Hutton & Co. when he was appointed by Ronald Reagan. Surprisingly, Shad was the first chairman with deep experience on Wall Street. The SEC under Shad had an aggressive enforcement program that surprised the securities industry. Levitt was president of the American Stock Exchange for 11 years after 16 years working in other capacities on Wall Street (although he accelerated the revolving door during his tenure and opposed regulation of derivatives). Donaldson, a founder of Donaldson, Lufkin and Jenrette, was chairman and CEO of the New York Stock Exchange. No such experienced “gray heads” of Wall Street are on the Commission now, and none have been since Donaldson left the agency in 2005.
I could also add Richard Breeden, who showed that it is possible for a lawyer without much experience in the securities business to be a good chairman. I still wouldn’t make his resume a template for future appointments, however.
TAL: What will you do in your retirement?
JK: My late wife, a long-time Washington print reporter, completed a manuscript about the white folk who closed the public schools in Prince Edward County Virginia rather than integrate them. I am going to get it published. I am going to do some volunteer work for the Legal Clinic for the Homeless and at the Smithsonian Museum of American History. I am going to be a bit of a gym rat. I might do some writing. I also will find time to do nothing but read and visit my wonderful daughter.