Commentary March 24, 2010, 11:05PM EST

Lessons from the Lehman Autopsy

(page 2 of 2)

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Photo illustration by Sean McCabe

There will be time enough to sort out legal culpability for Lehman's demise. The Justice Dept. is investigating, and civil litigation is under way. Valukas lays out facts without playing judge or jury. "There are many reasons Lehman failed," he noted, "and the responsibility is shared."

Beyond the bank itself, Valukas pointed to evidence that Lehman's auditor, Ernst & Young, committed malpractice when it sat on a whistleblower's warnings and failed to keep the bank's board apprised of suspicious executive conduct. Ernst has denied any professional failings or liability.

The regulators also bear blame in Valukas' account. Some of the most unnerving portions of his report explain that while Lehman failed to keep investors informed, staff members from the Securities & Exchange Commission and Federal Reserve Bank of New York did know what was going on—and shrugged their shoulders.

Public-Spirited Pit Bull

Government overseers, some of whom worked on site in Lehman's offices in 2008, had access to the bank's pertinent records. Former Lehmanites told Valukas that the government didn't raise significant objections or direct Lehman to take corrective action. SEC spokesman John Nester said in an interview with Bloomberg News: "We are looking closely at the examiner's findings as part of our ongoing review of the accounting and disclosures of major financial institutions and their role in the financial crisis." This is the same agency, of course, that yawned at warnings about Bernard Madoff's globe-spanning Ponzi racket.

"The unavoidable question is whether the SEC will hold someone responsible for what happened at Lehman," says Michael J. Missal, a partner in Washington with the law firm K&L Gates. Missal, who makes a living defending companies faced with government investigations, is another of those attorneys capable, when asked by a court, of transforming himself into a public-spirited, if generously compensated, pit bull. He published an impressive bankruptcy examiner's report of his own in 2008 in the case of New Century Financial, one of the subprime mortgage giants that, with Wall Street's assistance, recklessly inflated the housing bubble.

So, how do we energize the regulatory ranks with the punch that a Valukas or Missal brings to this kind of work? One fantasy would be to replace wholesale the SEC's Enforcement Division with lawyers drawn from the staffs of past high-level bankruptcy examiners. In addition to the Lehman and New Century cases, solid investigative work was done in the wake of Enron's collapse in 2001 and the 2005 implosion of Refco, a large brokerage.

The obstacles to creating a regulatory Delta Force are familiar ones: pay and prestige. "The law firms offer money and status," says Max Stier, president of the nonprofit Partnership for Public Service. "Even when good people come into government service, many soon leave through the revolving door." Stier's Washington group runs programs to enrich government careers and encourage corporate employees to try public service. He has held legal jobs in all three branches and practiced with a Washington law firm. Stier acknowledges that government salaries will never compete with private-sector compensation. He observes that at many key agencies, the revolving door has spun all the more swiftly for the past generation as a bipartisan consensus celebrated the notion that the financial markets effectively police themselves and regulators should get out of the way. If we didn't know already, the Valukas report reminds us once and for all to drop that delusion. Done right, regulation promotes capitalism by deterring excess and fraud. "Political leaders need to prioritize talent at agencies like the SEC, which historically hasn't happened," says Stier.

One intriguing suggestion for how to put Stier's advice into action comes from Scott McCleskey, a former vice-president for compliance at Moody's Investors Service (MCO). In a Mar. 20 op-ed in The New York Times, McCleskey, who now works for Complinet, a compliance-consulting firm, proposed the creation for financial regulators of an analog to the U.S. Foreign Service. Too many SEC staff members are inexperienced attorneys; the best ones tend to depart after a few years for private practice. McCleskey argued that the Foreign Service model—with its specialized training; attractive pension eligibility after as little as 20 years on the job; and long-term career tracks, allowing for variety and new challenges—would draw more impressive applicants and cut down on turnover.

Perhaps President Barack Obama could persuade Valukas to take a sabbatical and serve as the first dean of a new Federal College of Financial Regulators. It wouldn't hurt to ask.

Barrett is an assistant managing editor at BusinessWeek.

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