Is the Fox Guarding the (Investors’) Chicken House?


Matt Taibbi’s recent Rolling Stone article entitled “Is the SEC Covering Up Wall Street’s Crimes?” questions whether corruption plagues the U.S. Securities and Exchange Commission. In that article Taibbi meticulously contends that Wall Street banks and their law firms have, over and over again, shut down fraud investigations by influencing senior SEC officials, who later take lucrative jobs at the very banks that were the targets of the investigations or at the law firms representing those banks.

The most recent concerns regarding the integrity of the SEC developed when it was reported that the SEC had destroyed evidence gathered in thousands of investigations even though the law required that it maintain this evidence. In fact, the SEC reportedly destroyed all the evidence gathered in approximately 18,000 closed investigations and inquiries, including records related to the Madoff ponzi scheme and investigations into the activities of major Wall Street banks. Congress is looking into the matter.

Taibbi argues that document destruction is just the tip of the iceberg. As bad as the document destruction is, and the SEC admits to it, he argues that the reason the documents were destroyed is even worse.

According to Taibbi, the reason is that the SEC’s top-level people almost always leave the SEC to join the banks they were supposed to regulate (or the law firms representing those banks), sometimes shortly after shutting down an investigation of that firm. Taibbi bolsters his argument as follows:

  • Gary Lynch, SEC Enforcement Chief 1985-1989, then joined Davis Polk, a top Wall Street defense firm
  • William McLucas succeeded Lynch, left the SEC in 1998 to join WilmerHale, a notorious Wall Street defense known as “SEC West”
  • Richard Walker succeeded McLucas, left the SEC in 2001 to join Deutsche Bank, which had just received word that an investigation into insider trading at Deutsche Bank had been terminated
  • Stephen Cutler succeeded Walker, and now general counsel for JP Morgan Chase
  • Linda Chatman Thomsen succeeded Cutler and left the SEC to join Davis Polk
  • Robert Khuzami, Walker’s former prot?g? at Deutsche Bank, succeeded Thomsen and is the current head of enforcement.

Taibbi’s article ties his argument together with the story of Darcy Flynn, a mid-level SEC staff attorney who blew the whistle on the SEC. Flynn responded to a written request posted by none other than Chief Khuzami, who asked his subordinates to report any experiences they might have had where “the behavior of counsel representing clients in… investigations has been questionable.” Flynn complied by reporting examples of how firms under SEC investigation or inquiry had conquered the agency by unduly influencing the senior management.

One such example reported by Taibbi involved former enforcement chiefs Gary Lynch and Richard Walker, current enforcement chief Robert Khuzami, and Deutsche Bank. In 2000, the bank’s CEO Rolf Breuer told a German publication that the Deutsche Bank was not in takeover talks to acquire a rival American firm called Bankers Trust. That was untrue, but it was followed by a decline in the price of Bankers Trust stock, which potentially lowered the acquisition price for Deutsche Bank. Flynn and colleagues, suspecting that shareholders of Bankers Trust had been defrauded, opened a Matter Under Investigation (MUI) file.

In that case the SEC staff got past the MUI stage and launched a formal investigation, which gave them power to compel Deutsche Bank to produce documents, information, and witnesses to be deposed. Based on the evidence they gleaned, Flynn et. al. sent an “Action Memorandum to senior SEC staff formally recommending that a civil enforcement action be filed against Deutsche Bank. Deutsche Bank hired former SEC chief Gary Lynch to lobby the SEC to back off.

All that was needed to move forward was a go-ahead from the director of enforcement at the time, Richard Walker. Instead, two weeks later, the enforcement division reportedly sent a letter to Deutsche Bank that read, “Inquiry in the above-captioned matter has been terminated.” The SEC dropped its fraud investigation. Contrary to the its normal practice, the SEC provided no explanation for its decision to close the case.

Taibbi writes: “On October 1st of that year, the mystery was solved: Dick Walker was named general counsel of Deutsche. Less than 10 weeks after the SEC shut down its investigation of the bank, the agency’s director of enforcement was handed a cushy, high-priced job at Deutsche.” The investigation was closed and the records were destroyed.

In 2004, Walker hired Khuzami to join Deutsche Bank. In 2009, Khuzami joined the SEC and became Flynn’s boss. When Flynn related this to Khuzami, he was calling out Khuzami’s own mentor, Richard Walker.

Another revolving door case involves former SEC enforcement chief Stephen Cutler. According to the article, which cites the SEC’s Inspector General as the source of the information, as assistant director of SEC enforcement, Cutler was instrumental in slowing down an investigation into R. Allen Stanford’s $7 billion ponzi scheme. Cutler then left the SEC to work for Stanford. Cutler was quoted as explaining: “Every lawyer in Texas and beyond is going to get rich on this case, OK? I hated being on the sidelines.”

In summary, Taibbi’s article raises legitimate questions regarding the SEC and its relationships with Wall Street banks and their attorneys. These questions need to be investigated and fully aired. The integrity of our capital markets is far too important to be tainted by the perception that the United States is letting “the fox guard the chicken house.”