The revolving door.

• Author: Zheng, Wentong
• Position: Market expansion theory in industry regulations

ABSTRACT

The revolving door between the government and the private sector has long been presumed to lead to the capture of regulators by industry interests. A growing body of empirical literature, however, either finds no conclusive evidence of a capture effect or finds evidence of an opposite effect that the revolving door indeed results in more aggressive, not less aggressive, regulatory actions. To account for these incongruous results, scholars have formulated and tested a new "human-capital" theory positing that revolving-door regulators have incentives to be more aggressive toward the regulated industry as a way of signaling their qualifications to prospective industry employers.

But even with the insights offered by the human-capital theory, the prevailing analyses of the revolving door are still incomplete. This Article theorizes on yet another incentive created by the revolving door that deserves being recognized as a structural force inherent in the regulatory process: the incentive for regulators to expand the market demand for services they would be providing when they exit the government. This "market-expansion " incentive may manifest itself differently in different regulatory settings. In the enforcement setting, it may result in more enforcement actions, broadened jurisdictional reach of the enforcement actions, and higher penalties in the enforcement actions. In the rulemaking setting, it may result in agencies' expanded rulemaking authority, the use of flexible standards rather than bright-line rules, and agencies' preference for complex as opposed to simple rules or standards.

This market-expansion theory represents a paradigmatic shift in conceptualizing the role of individual regulators in the regulatory process. Contrary to the prevailing analyses, which posit that revolving-door regulators take the industry's needs as given and merely respond to those needs, the market-expansion theory suggests that revolving-door regulators may exert efforts to expand the industry's needs. Recognizing this market-expansion incentive has important implications for a wide range of policy issues, including agency aggrandizement, overenforcement versus underenforcement, regulatory settlements, compliance monitors, private rights of action, and professional responsibility.

INTRODUCTION

A familiar phenomenon in American government and law, the "revolving door" (1) between the government and the private sector has been swinging hard in recent years. Since the beginning of President Obama's second term, several high-level government officials have walked through the proverbial door in both directions. Mary Jo White, a litigator who spent the last decade defending Wall Street banks and executives at the law firm Debevoise & Plimpton LLP, was confirmed as the new chairwoman of the Securities and Exchange Commission (SEC). (2) The departing chairwoman of the SEC, Mary Schapiro, became a consultant at the Promontory Financial Group, a high-powered consulting firm that draws nearly one-third of its senior executives from government agencies overseeing the financial industry. (3) Jack Lew, the new Treasury Secretary, once worked as a senior executive at Citigroup. (4) Former U.S. Trade Representative Ron Kirk stepped down to join the law firm Gibson Dunn & Crutcher. (5) Former Treasury Secretary Tim Geithner became president of the private equity firm Warburg Pincus several months after stepping down from his government position. (6) Going a bit further back in time, other top administration officials leaving the government for the private sector included Christine Varney, the antitrust chief at the Department of Justice, who stepped down to join the law firm Cravath, Swaine & Moore in 2011, (7) and Peter Orszag, President Obama's budget director, who joined Citigroup as a vice chairman in 2010. (8)

Not only has the revolving door frequently made news headlines, but it has had a deep impact on the law. Indeed, the revolving door has been such a fixation in the law that special features or structures have been created to mitigate its effects in many areas, such as administrative law, criminal procedure, and professional responsibility. (9)

Among the concerns voiced about the revolving door, the most enduring one is the risk of regulators being captured by industry interests. Discussions of regulatory capture and its impact on the regulatory process permeate scholarly literatures in law, political science, and economics. (10) The revolving door has long been considered an important mechanism of regulatory capture: in order to secure a post-government position in the private sector, the theory goes, regulators must bend the rules to curry favor with their prospective employers. (11)

Under the influence of the capture narrative, the risk of capture has become the dominant concern about the revolving door. The potentially debilitating role of the revolving door was highlighted by Mary Schapiro during her Senate confirmation hearing, in which she stated that a conflict might be created by SEC regulators "walking out the door and going to a firm and leaving everybody to wonder whether they showed some favor to that firm during their time at the SEC." (12) The revolving door has also been blamed for a series of high-profile regulatory failures ranging from the SEC's failures to prevent the Ponzi schemes of Bernard Madoff and R. Allen Stanford to federal regulators' failures to prevent the BP oil spill in the Gulf of Mexico. (13)

A closer examination of the empirical evidence on the capture effect of the revolving door, however, reveals that the capture narrative has been built largely on presumptions. A growing body of empirical literature either finds no conclusive evidence that the revolving door leads to capture, or finds exactly the opposite evidence. (14) For instance, a recent study finds that SEC lawyers are more, not less, aggressive in their enforcement efforts when they subsequently leave the SEC to join law firms specializing in defending clients charged by the SEC. (15)

To account for these incongruous empirical results, scholars have begun to formulate and test alternative theories of the revolving door. One such theory, which has been corroborated by empirical studies in recent years, focuses on incentives the revolving door creates for regulators to signal the type of human capital valued by industry employers. (16) According to this "human-capital" theory, when industry-employers could not perfectly observe regulators' human-capital, revolving-door regulators would want to be more aggressive, not less aggressive, in their enforcement actions as a way of signaling their qualifications to industry employers.

But even with the insights offered by the more nuanced human-capital theory, the prevailing analyses of the performance incentives created by the revolving door are still incomplete. This Article argues that the current revolving-door literature is seriously lacking in not adequately recognizing what could be referred to as the "market-expansion" incentive created by the revolving door. Under this market-expansion theory, revolving-door regulators may have incentives to expand the market demand for services they would be providing when they exit the government. This market-expansion incentive may manifest itself differently in different regulatory settings. In the enforcement setting, it may result in more enforcement actions, broadened jurisdictional reach of the enforcement actions, and higher penalties in the enforcement actions. In the rulemaking setting, it may result in agencies' expanded rulemaking authority, the use of flexible standards rather than bright-line rules, and agencies' preference for complex as opposed to simple rules or standards. In either case, revolving-door regulators' focus may not be on finding the best way to appeal to industry interests as the capture and human-capital theories suggest, but on finding the best way to maximize, through their own efforts, the market demand for their post-government services. (17)

Recognizing revolving-door regulators' market-expansion incentive has far-reaching implications. Most importantly, the market-expansion theory represents a paradigmatic shift in conceptualizing the role of individual regulators in the regulatory process. Although prescribing starkly different performance incentives, both the capture and human-capital theories posit that regulators take the industry's needs as given and merely respond to those needs. Under the market-expansion theory, however, regulators exert efforts to expand the industry's needs. In this sense, the market-expansion theory represents an entirely different way of approaching the power dynamics between regulators and the regulated industries.

Given how extensively the revolving door has become intertwined with the modern regulatory state, recognizing revolving-door regulators' market-expansion incentive has the potential to change the conventional ways of thinking about a wide range of policy issues, including agency aggrandizement, overenforcement versus underenforcement, regulatory settlements, compliance monitors, private rights of action, and professional responsibility. This Article explores the policy implications of the market-expansion theory in those areas. (18)

This Article does not intend to argue that every regulator is subject to the market-expansion incentive, any more than the capture theories intend to argue that every regulator is subject to capture. Nor does this Article attempt to establish that the market-expansion incentive is the dominant incentive facing regulators in every regulatory setting. The goal of this Article is to propose the market-expansion incentive as a possibility that has so far been underrecognized and under-theorized. A future line of research will be necessary to empirically test the market-expansion theory and to identify the specific regulatory...