The SEC revolving door and comment letters

The revolving door between the Securities and Exchange Commission (SEC) and the private sector has been the subject of intense scrutiny in recent years. The SEC regulates and enforces laws related to public companies. Its responsibilities include “protecting investors, maintaining fair, orderly and efficient markets, and facilitating the formation of capital.” However, leaving SEC officials regularly find themselves supporting the very companies the SEC regulates and working against the SEC’s regulatory activities. Between 2001 and 2010, over 400 former SEC employees filed statements that they intended to represent an outside party before the SEC.

In our study, forthcoming in the Journal of Accountancy and Public Policy and available from SSRN, we examine the impact of the revolving door on the SEC’s comment letter process, a critical process by which the SEC carries out its regulatory function.

The Sarbanes-Oxley Act of 2002 requires the SEC to review companies’ records at least every three years. The SEC sends comments to the company when employees of the SEC believe that disclosures in their filings can or should be improved. This review process results in a dialogue between the firm and SEC officials, in which the SEC can make requests to the firm, such as amending one or more previous filings, and in which the firm can negotiate more desirable outcomes, such as B Easily revise future submissions. Companies often involve outside counsel, who may have been formerly employed by the SEC, in this discussion with the SEC.

Because former SEC attorneys are more familiar with the SEC’s staff than attorneys who have never been employed by the SEC, we would expect them to negotiate more effectively with the SEC on behalf of their clients. In particular, we would expect to see greater resistance to the SEC comment letter process – in the form of more negotiations – when a company hires a former SEC counsel compared to other counsel. Additionally, we would expect companies that employ former SEC attorneys to experience more favorable outcomes, specifically a reduced likelihood of changing previous filings.

To empirically examine these predictions, we identify attorneys involved in the comment letter interviews and manually collect data on their backgrounds and characteristics from public sources, primarily LinkedIn profiles and the biographies on their law firm websites. Our study uses data from 1,384 attorneys who, along with their law firms, conducted at least two interviews in our sample. Our dataset on comment letter conversations spans from 2005 to 2016.

First, we examine the types of firms hiring ex-SEC attorneys. Among other things, we find that older and larger firms, those with a history of litigation, and those that do not employ top-tier accounting firms are more likely to hire former SEC attorneys than other attorneys. This suggests that financial and recurring concerns, as well as the risk of litigation and misreported financials, could all contribute to the decision to hire a former SEC attorney. To mitigate selection bias, in our analyzes we compare interviews with former SEC attorneys to interviews with other attorneys based on attorney and law firm characteristics, issues raised in the first comment letter, and firm characteristics.

We examine resistance to the SEC using a composite measure of the size of negotiations based on the length of the comment letter conversation in days, the number of letters exchanged, and whether the conversation took multiple rounds to resolve. We find that firms that employ former SEC attorneys deal with the SEC to a greater extent than firms that employ other attorneys.

Next, we examine whether law firms that hire more reputable SEC attorneys are less likely to change their filings compared to law firms that hire other attorneys. We find that the former are about 32 percent less likely to make changes after receiving a comment letter. Additionally, their abnormal stock returns are 3.9 percentage points higher in the time after receiving a comment letter, further evidence that former SEC attorneys contribute to more favorable outcomes of the comment letter interview than other attorneys. Finally, we note that these results are driven by former SEC attorneys who recently left the SEC, which is consistent with our results based on their familiarity with former colleagues who still serve with the SEC.

Our study contributes to several research streams. First, we expand the literature on the revolving door by examining SEC officials following the move to the SEC comment letter process, a widely used and important disclosure oversight mechanism by the SEC. Second, we contribute to the growing literature on the SEC comment-writing process, in which few studies have examined factors that might impede the process. Finally, we contribute to the emerging literature on the role of outside counsel in financial disclosures.