Will Judge William Pauley III now join Judge Jed Rakoff as one of the few heroes of the crisis?

The Wall Street Journal makes an excellent catch today on a Pauley ruling that slapped down a chummy settlement between the SEC and Wall Street dismantling the separation of analysts from investment bankers imposed after the scandals of the previous bubble. The ruling was out yesterday, but nobody else got the story, and WSJ gives it great play on page one.

If you’ve ever wondered what regulatory capture means, here’s a good example:

The proposal would have allowed employees in investment-banking and research departments at Wall Street firms to “communicate with each other …outside of the presence” of lawyers or compliance-department officials responsible for policing employee conduct—an activity strictly prohibited by the settlement.

Remember Rakoff? He’s the New York judge who embarrassed the hapless SEC by inititally rejecting its incredibly generous with Bank of America for misleading investors on its Merrill Lynch deal.

Now we have another New York judge embarrassing the SEC for its weak approach to Wall Street. It’s puzzling that the Journal doesn’t mention the Rakoff/BofA matter.

Still, that’s something of a quibble. The story is otherwise good.

Some outsiders expressed surprise that the nation’s top securities watchdog sided with Wall Street in an effort to unwind a major provision of the $1.4 billion settlement. The agreement settled allegations that securities firms issued overly optimistic stock research in order to win lucrative investment-banking business. “I am all for judges being the hero, but isn’t the SEC supposed to be?” said James D. Cox, a law professor at Duke University. “The issue of communication between analysts and bankers was at the heart of the entire issue that led to the global settlement. My initial question is: Who at the SEC allowed this to happen?”

Here’s what Judge No. 2 had to say about the SEC:

“The parties’ proposed modification would deconstruct the firewall between research analysts and investment bankers erected by the parties when they settled these actions,” Judge Pauley wrote in his ruling. Approving the request by the SEC and securities firms “would be inconsistent with” the settlement “and contrary to the public interest.”

Barry Ritholtz follows this story with excellent context on how the SEC has been underfunded and diluted:

What I found was deeply disturbing: Over the past 30 years, the financial world has grown exponentially in size, breadth and complexity of products, trading volume, and total assets under management. In terms of personnel, assets under management, numbers of trader, managers, sales people, and mathematical PhDs., who work on the street increased dramatically.

The SEC did not.

Check out the charts he pulls.


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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.