Why is the revolving door regulated?

Behind the revolving door is the idea of regulatory capture. Forty-six years ago, the late George Stigler described how a regulatory body tasked with protecting the public interest would ultimately be “captured” to serve the interests of the regulated industry.

Chicago Booth’s Sam Peltzman expanded on this theory, arguing that regulations come about through a balancing act involving politicians and interest groups, which can be companies or other affected parties. Politicians seek support from companies seeking more or less regulation in exchange for campaign contributions, and from voters who will trade their votes in exchange for the policies they want. According to Peltzman, a politician will lean in favor of the interest group that keeps her in office.

Couple these theories with allegations of capture. In Japan, critics of nuclear power suggest that regulators, who are sometimes offered lucrative jobs as plant operators, allowed industry too much influence when writing safety and inspection rules, contributing to the Fukushima Daiichi nuclear meltdown in 2011. The United Kingdom’s customs authority has also been accused of having too cozy a relationship with accountancy firms, causing an unwillingness to crack down on tax avoidance and evasion that save multinational companies billions of pounds in taxes.

But anecdotes, however suggestive, aren’t proof that regulators are shirking their duties. The US Securities and Exchange Commission dropped an inquiry against Deutsche Bank in 2001, and SEC enforcement director Richard H. Walker took a job at the bank a few months later. Are those two events related? In Rolling Stone, writer Matt Taibbi found it concerning, pointing out a decade later that former SEC personnel continued to be well represented in the private sector.

The circular nature of the case illustrates the revolving-door dynamic that has become pervasive at the SEC. A recent study by the Project on Government Oversight found that over the past five years, former SEC personnel filed 789 notices disclosing their intent to represent outside companies before the agency—sometimes within days of their having left the SEC. More than half of the disclosures came from the agency’s enforcement division, who went to bat for the financial industry four times more often than ex-staffers from other wings of the SEC.

But there’s been no proof of quid pro quo. Now the Brattle Group’s Haris Tabakovic and Chicago Booth’s Thomas Wollmann say they’ve found such proof—in the US Patent and Trademark Office.

Examining the patent examiners

The USPTO is one small part of the government bureaucracy. Its examiners issue patents, granting exclusive, if temporary, use rights to inventors who have come up with the latest process, machine, or other such thing that can be legally patented. The office has 8,350 patent examiners, who review patent applications. A good number of them move on to jobs in industry.

So did the examiners who moved to industry behave any differently from the rest? Analyzing the data, Tabakovic and Wollmann find these examiners granted more patents than their peers, particularly to the companies that eventually hired them.

Tabakovic and Wollmann combed through patent applications retrieved from the Patent Examination Research Dataset. These documents list the name and unique identifier of each patent examiner, the name and address of the company applying, and the outcome of the process. Using a roster with names of people legally allowed to file for a patent on behalf of a company, the researchers determined which examiners left to work in industry, as well as whether they wound up working for a company for which they had previously granted a patent.

The data set from 2001 to 2015 included more than 10,000 patent examiners and over 1 million applications, of which 63 percent were approved. During these years, about 1,000 patent examiners left the USPTO to become patent practitioners, and those who left were 10 percent more likely to grant patents. The revolving-door examiners granted 10–16 percent more patents to companies for which they went to work.

Pennsylvania State University’s Jess Cornaggia and Kimberly Cornaggia, and University of Texas at Dallas’s Han Xia find a similar pattern at credit rating agencies, the private companies and quasi regulators tasked with grading corporate debt. Like patent examiners, employees at credit rating agencies often move on to industry. And the researchers find that credit analysts who left ratings agencies inflated the ratings of the companies they went to work for by between 0.18 and 0.23 notches, or grades, on average. Equity analysts may be affected too: in the year leading up to their departure for industry, analysts gave the companies they went to work for more favorable forecasts and recommendations, according to research by UC Irvine’s Ben Lourie. They even went so far as to downgrade competitors.

GAO recommends the U.S. Department of Defense amend regulations restricting lobbying by former personnel.

Veterans leave the military with a wide variety of skills, ranging from bomb disposal techniques to aerial combat strategies. These skills make veterans and civilian officials who leave the U.S. Department of Defense attractive hires for businesses that contract with the Defense Department, such as Raytheon, Lockheed Martin, and Boeing.

But when senior military and civilian officials begin working for defense contractors after leaving their government positions—as more than 1,700 did from 2014 to 2019—concerns of potential conflicts of interest arise. The movement of personnel from their roles in government to relevant industries, and sometimes back again, is known as a revolving door, and the Defense Department restricts former personnel from certain employment activities with defense contractors.

But the existing post-government employment regulations may not be strict enough, according to a recent report by the U.S. Government Accountability Office (GAO), the government oversight arm of the U.S. Congress. Specifically, GAO recommends that the Defense Department amend the Defense Federal Acquisition Regulation Supplement (DFARS) to require that defense contractors affirm their employees’ compliance with updated lobbying restrictions in any contract proposal.

The Defense Department contracts with private companies to provide a wide range of goods and services. When a business wants to “win” a contract with the Defense Department—whether to supply aircraft or equip naval vessels with new radar—the company must submit a contract proposal for consideration, providing details including pricing and completion timelines. In these proposals, the business must also certify that they meet a range of DFARS requirements, such as cybersecurity minimums and proper ammunition labeling.

This self-certification model means that companies—known as contractors—implement internal control programs for each of the DFARS requirements. Companies that fail to comply could face hefty fines and penalties.

Now, in its recent report, GAO recommends amending DFARS requirements to reflect updated lobbying restrictions from the National Defense Authorization Act (NDAA) requiring contractors to certify their compliance with the NDAA’s post-government employment restrictions.

The NDAA prohibits former flag officers—generals and admirals—and their civilian equivalents from lobbying the Defense Department or other executive branch officials about defense matters for up to two years after departing their government positions. Private companies compete for contracts, and the federal legislation ensures former officers don’t use their relationships—through lobbying current officials—to assert improper influence the contract selection process.

Although the NDAA and other ethics laws forbid such lobbying efforts, GAO suggests that amending the DFARS would give defense contractors more incentives to prevent their own employees from lobbying. Strong constraints on the defense industry’s revolving door are critical to promote the “public integrity of the government’s decision-making processes,” GAO emphasizes.

The DFARS changes, GAO argues, would reinforce ongoing efforts by the government to address lobbying and other ethical concerns about post-government employment by creating a “sense of shared accountability between the employees and the contractors who hire them.” Furthermore, a regulation updated to follow GAO’s recommendation would safeguard the Defense Department from approving contracts with “companies whose employees violate the lobbying restriction with their employers’ knowledge.”

One reason GAO recommends adding a self-certification requirement on lobbying activity to contractor proposals is that defense contractors currently have “varying forms of compliance practices in place to address lobbying.”

For example, of the 11 major defense contractors that responded to GAO’s survey, nine have a formal program in place to monitor compliance with the NDAA’s lobbying restrictions—but the programs have differing and potentially ineffective protocols. Just six contractors reported that their standard job application procedures involve asking candidates whether they are subject to any lobbying restrictions.

Separate from the recent NDAA lobbying restrictions, however, defense contractors already certify their employees’ compliance with several other post-government employment restrictions that were issued by a 2011 DFARS amendment. In fact, GAO found that defense contractors generally had effective internal programs in place to promote awareness and compliance with these previous post-government employment restrictions—suggesting that adding the NDAA’s updated lobbying restrictions to the contractor self-certification requirement could be just as effective.

GAO previously reported on the Defense Department’s post-government employment regulations in 2008, then recommending the need for greater contractor disclosure of compliance with the applicable restrictions. The Defense Department concurred with that earlier GAO report and, according to the latest report, implemented all recommendations for executive action.

In its recent report, in addition to calling for more effective internal contractor compliance programs, GAO also found that the Defense Department has since “taken steps designed to increase employee awareness” of post-government employment restrictions. These measures include a publicly accessible website for the Department of Defense Standards of Conduct Office, which publishes digital toolboxes for ethics training and procedural guides for current personnel seeking employment with a defense contractor.

The Defense Department has concurred with GAO’s latest recommendation to amend the DFARS to require contractor compliance with updated lobbying restrictions, internally referring the recommendation to the Under Secretary of Defense for Acquisition and Sustainment for further action.