Robert Khuzami

SEC Chair Mary Jo White's first big test

June 12, 2013: 5:00 AM ET

Appointing Robert Rice as SEC counsel is more than your typical revolving door case. Rather, it could have a chilling effect on the regulator's whistleblower program.

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FORTUNE -- While her staff fiddles over whether to address Senate report allegations of false J.P. Morgan London Whale disclosures, SEC Chair Mary Jo White has an immediate staffing matter that should command her attention.

White set her first big test in motion last week when she chose Robert Rice as SEC counsel. The appointment is more than your typical revolving-door case. Rather, it could wind up having a serious chilling effect on the SEC's whistleblower program.

Rice comes to the SEC from Deutsche Bank (DB), which he joined in 2004 as "head of regulatory and internal investigations for the Americas. Since 2010, he has been responsible for developing and executing global legal strategies in governance, litigation, and regulation for all aspects of the bank's businesses," according to an SEC press release.

But the SEC press release failed to disclose a complaint over an improper firing of an SEC whistleblower that names Rice as a respondent and "describes several meetings" with the newly appointed SEC counsel, the Financial Times reported on June 9. The fired whistleblower had alerted Deutsche executives to his concerns about a purported massive accounting fraud at the bank.

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The allegations by the whistleblower of an up to $12 billion understatement of losses at Deutsche are serious enough that Germany's central bank is looking into them. Some argue that Deutsche might have failed had the extent of its losses (like Lehman's) been known at the time.

Eric Ben-Artzi, the whistleblower who filed the complaint, is not alone. According to the Financial Times, two other Deutsche employees unbeknownst to Ben-Artzi actually beat him to the punch in blowing the whistle on the bank.

Did White not know about the complaint against Rice (lack of due diligence) or was this a lapse of transparency (not good for those enforcing disclosure laws)?

The SEC requires companies "to include information about significant pending lawsuits or other legal proceedings" in their annual filings. And the SEC mandates that company proxies include 10 years' worth of information on "legal actions involving a company's executive officers, directors, and nominees for director." In its 2009 final proxy disclosure rules, the SEC wrote that such information "is important to an evaluation of an individual's competence and character to serve as a public company official."

So what about full and open transparency concerning legal matters involving appointed public officials, particularly at the SEC?

According to the Financial Times, Rice led Deutsche's internal investigation into the alleged multibillion-dollar misstatement. While Deutsche asserts that it did nothing wrong, the SEC is supposedly still looking into the accounting fraud allegations.

Because of this, Rice and the SEC would seem to be in a bit of a conflict. The SEC requires company proxies to disclose certain potential conflicts of interest and related party transactions by directors. Shouldn't Rice's involvement on this significant Deutsche matter been openly disclosed?

Despite the importance of the case, the level of SEC earnestness about its investigation into Deutsche remains in doubt. Up until January this year, the SEC's enforcement chief was Robert Khuzami, a former Deutsche Bank general counsel. During his tenure, Khuzami demonstrated little sense of the injury and economic effects caused by the banks in the crisis. And this Deutsche case seems to be dragging.

The appointment of Rice smells a lot like another hire involving Mary Jo White, this one at her previous employer, law firm Debevoise and Plimpton. That case involved Paul Berger who, according to a timeline produced by the Senate minority staff of the Committee on Finance and the Committee of the Judiciary, was instrumental in the firing of Gary Aguirre, an SEC investigator who later filed for wrongful dismissal and won a record award. Aguirre had wanted to interview soon-to-be Morgan Stanley (MS) CEO John Mack about whether Mack had passed an insider tip to hedge fund Pequot. (White was acting as counsel to Morgan Stanley's board.) After Aguirre's firing, the SEC dropped any plans to interview Mack, Berger indicated interest in working at Debevoise to White through a colleague, and he landed a spot at the firm, where he still works today.

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The episode sent a signal that SEC investigators should not step out of line. Given White's involvement in that matter, Rice's appointment is all the more concerning.

The Government Accountability Project (GAP) supports Ben-Artzi's wrongful dismissal claim. In a press release in December, GAP legal director Tom Devine said, "Dr. Ben-Artzi was a model corporate citizen who discovered SEC violations that could incur serious liability, and stuck his neck out internally to warn bank management. Deutsche Bank's response was to personally harass him, and fire him as soon as it pinned down what he knew. The retaliation was crude, and not camouflaged. Quite clearly, the point was to scare other would-be whistleblowers into silence. The lesson learned is that working within Deutsche Bank's corporate compliance and reporting system is an act of professional suicide."

Perhaps White deliberately wanted to send a bold warning to future SEC whistleblowers by choosing Rice. But if this is not her intention, will she correct the mistake or flunk her first big test?

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board education and advisory firm.

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