Securities And Exchange Commission Enforcement Research Articles

Foreign corrupt practices act violations and enforcement

Purpose This study aims to examine the determinants of Foreign Corrupt Practices Act (FCPA) violations and consequences of FCPA enforcements. Design/methodology/approach This paper uses publicly available data from Compustat, I/B/E/S and Thomson Reuters databases, combined with Securities and Exchange Commission (SEC) and Department of Justice (DOJ) cases, to extract insights on FCPA violations and enforcements using econometric approaches. Findings The main determinants of FCPA violations appear to be firm size, multinational structure, country corruption and Sarbanes-Oxley Act control weaknesses. Traditional misreporting risks (F-score and M-score) do not predict FCPA violations. This study discovers significant differences between FCPA violations by motivation, as in, sale generation, rent extraction or cost evasion. Bribes motivated by sale generation or rent extraction are partially driven by the extent of the firm’s global operations, whereas bribes motivated by cost evasion relate to internal influences. This study also finds that enforcement is more salient for criminal violations (DOJ enforcement), compared to civil violations (SEC enforcement). Research limitations/implications This research provides new insights into the determinants of FCPA violations while underscoring the need for effective measures to combat bribery and promote ethical business practices. This research contributes to the ongoing efforts to curtail bribery, offering valuable insights into the characteristics of firms more likely to engage in bribery and contexts in which these activities occur. It provides critical implications for regulatory bodies, highlighting the differential responses of firms to varying types of enforcement, namely, criminal versus civil, as the authors observe greater decreases in internal control weaknesses following DOJ enforcement compared to SEC enforcement. Practical implications For enforcement agencies, the findings underscore the importance of rigorous criminal enforcement against FCPA violations, highlighting the improved control environments prompted by DOJ actions. Managers will find this research relevant, as it demonstrates that a firm’s entry into international markets substantially elevates the risk of its representatives engaging in bribery with foreign officials. In addition, the results are of interest to regulators, revealing that the underlying motivations driving a firm’s activities can significantly alter the factors to consider that might lead to an FCPA violation. Originality/value This paper is the original work of the authors and explores the determinants and consequences of FCPA violations and enforcement actions since 2002. To the best of the authors’ knowledge, it is the first to explore bribe determinants by their motive and documents industry-wide benefits arising from criminal enforcement.

The SEC's September spike: Regulatory inconsistency within the fiscal year

We examine whether performance reporting leads to inconsistent enforcement at the Securities and Exchange Commission (SEC). In a sample of over 13,000 SEC enforcement actions, we show that SEC staff respond to performance-reporting pressures and file more enforcement actions in September, the final month of the SEC's fiscal year, than in any other month. The increase in case volume in September is not fully explained by staff filing more procedural cases or accelerating case filings. Instead, SEC staff pursue less complex cases and agree to more lenient financial and non-financial sanctions to increase case volume in September. We attempt to rule out alternative explanations for our results, including natural SEC workflow and resource constraints. Overall, our findings suggest that performance reporting creates agency conflicts that lead to regulatory inconsistency within the fiscal year.

The road not taken: A comparison of Accounting and Auditing Enforcement Releases and securities class actions

AbstractDespite the controversial debate over the role of public enforcement and private litigation in detecting and deterring financial misreporting, we have only scant literature comparing their enforcement outcomes: The Securities and Exchange Commission (SEC)‐sanctioned cases (Accounting and Auditing Enforcement Releases [AAERs]) and settled class actions against which the SEC did not file cases (securities class‐action lawsuits [SCALs]). This paper documents systematic differences between the two. Specifically, AAERs exhibit a larger magnitude of accruals prior to misreporting, as well as greater financing needs and insider trading during manipulation periods. After controlling for case backlogs in the SEC and the courts, the misreporting amount and period of AAERs are also greater and longer than those of SCALs, although SCALs represent greater settlement amounts. Further analysis indicates that resource constraints do not critically undermine the SEC investigations to detect more material misreporting cases. However, plaintiff investors appear to go forum shopping to earn greater settlement proceeds from SCALs. Finally, relative to SCALs, AAERs experienced significant drops in firm performance, analyst following and CEO tenure around SEC sanctions. Overall, this study provides consistent evidence supporting the SEC's optimization of detection rates under resource constraints and the strategic interaction between SEC enforcement and private litigation.

Is the SEC captured? Evidence from political connectedness and SEC enforcement actions

AbstractThis study examines the impact of political connectedness (PC) on enforcement actions by the Securities and Exchange Commission (SEC). Our analysis confirms that SEC is not captured and shows that firms or executives with stronger PC are more likely to be criminally charged or face bar or suspension than firms or executives with weaker PC. In addition, we document that imposed fines are relatively higher for prosecuted firms and executives with stronger PC. These findings are robust to inclusions of controls for Republican Congress, Republican President, and recent regulatory reforms and are not driven by endogeneity concerns and sample selection bias.

Should Index Providers Be Regulated as Investment Advisers under the US Investment Advisers Act of 1940

The increasing importance of the index industry to the financial marketplace has drawn the attention of the US Securities and Exchange Commission (SEC). The use of custom, foreign, and narrow-based indexes and self-indexing has generated regulatory concerns, including possibilities of improper index selection procedures, misleading index descriptions, inadequate or misleading custom index disclosures, and self-dealing. Suggested remedies include requiring index providers to register with the SEC as investment advisers under the Investment Advisers Act of 1940 (act). Historically, index providers have relied on an exclusion from registration under the act; this proposal queries their entitlement to rely on the exclusion. If index providers are required to register, it is unlikely that regulation under the act would prove useful. Rather, enhanced disclosure and the application of existing securities laws, including those dealing with disclosure and antifraud concerns, and current SEC investigative and enforcement activities in appropriate cases should be sufficient to deal with the SEC’s concerns. <b>TOPICS:</b>Mutual funds/passive investing/indexing, information providers/credit ratings, legal/regulatory/public policy <b>Key Findings</b> ▪ Regulatory concerns are focused on possible abuses occurring in connection with custom, foreign, and narrow-based financial indexes, as well as self-indexing procedures, used by ETFs. These abuses include improper index component selection procedures, index manipulation, misleading index descriptions, inadequate or misleading custom index disclosures, self-dealing and blurred functions between ETF advisers and third-party index providers when creating custom indexes. ▪ One suggested remedy is to deem index providers “investment advisers” under the Investment Advisers Act of 1940 (act). This result would deprive index providers of their current ability to rely on the act’s “Publisher’s Exclusion” and, therefore, require their registration with the US Securities and Exchange Commission (SEC), as well as subject them to the act’s regulatory provisions, including its fiduciary duties and obligations. ▪ It is likely that index provider regulation under the act would not provide satisfactory solutions to the SEC’s concerns but, instead, would cause disruptive effects in the current financial index ecosystem, such as increased investor costs and diminished product innovation. Rather, the application and enforcement of existing securities laws, especially those dealing with disclosure and antifraud concerns and current SEC investigative and enforcement activities, where warranted, should be sufficient to deal with the SEC’s concerns.

SEC scrutiny shopping

We examine whether firms exploit enforcement heterogeneity in response to a heightened risk of investigation by regional Securities and Exchange Commission (SEC) enforcement offices. We find that firms facing high SEC scrutiny risks are more likely to relocate outside the jurisdiction of the SEC regional office. The likelihood of out-of-SEC relocation becomes at least two times higher after exogenous shocks to local SEC enforcement. High scrutiny-risk firms tend to migrate to regions with weaker SEC enforcement history and regions with more peers engaging in misbehavior. Scrutiny shopping is more salient for firms with lower costs of relocation.

COVID-19 considerations for SEC cybersecurity guidance, disclosure, enforcement, and parallel proceedings: navigating the new normal

Purpose To examine the COVID-19 pandemic’s effects on regulated entities within the context of cybersecurity, US Securities and Exchange Commission (SEC) compliance, and parallel proceedings. Design/methodology/approach Describes the SEC’s ability to conduct its operations within the telework environment, its commitment and ability to monitor the securities market, its enhanced monitoring of the adverse effects of SEC-regulated companies from COVID-19, its guidance to public companies of disclosure obligations related to cybersecurity risks and incidents, the SEC Office of Compliance and Examinations’s (OCIE’s) focus on broker-dealers’ and investment advisories’ cybersecurity preparedness, the role and activities of the SEC Division of Enforcement’s Cyber Unit, and parallel proceedings on cyberbreaches and incidents by different agencies, branches of government or private litigants. Findings SEC-regulated entities face many challenges in trying to maintain their ongoing business operations and infrastructure due to severe financial pressures, the threat of infection to employees and customers, and cybersecurity risks posed by remote operations from hackers and fraudsters. The SEC has reemphasized that its long-standing focus on cybersecurity and resiliency within the securities industry will continue, including ongoing vigilance over companies’ efforts to identify, assess, and address the inherent, heightened cybersecurity risks of teleworking and the resource reallocation that business need to sustain their operations until a safe and effective vaccine is developed for COVID-19. Originality/value Expert analysis and guidance from experienced lawyers with expertise in securities, litigation, government enforcement, information technology, data protection, privacy and cybersecurity.

Role and Effectiveness of ASIC Compared with the SEC: Shedding Light on Regulation and Enforcement in the United States and Australia

Australian Securities and Investments Commission’s (ASIC) regulatory oversight of securities and financial markets has increased considerably over time. However, the wisdom of this model has recently been challenged by the Hayne Royal Commission as ASIC’s enforcement activities were found to be relatively toothless. Accordingly, many criticised the agency and called for further ASIC reform. After the Global Financial Crisis, the US Securities and Exchange Commission (SEC) faced similar criticisms of regulatory failure. As such, this paper analyses the SEC regulatory structure, enforcement activities, and governmental resources and compares certain indicators of effectiveness such as the number of employees, budgets, and enforcement activities with those of ASIC over the past quarter-century. By comparing ASIC with the world’s biggest capital market regulator, the SEC, this paper analyses the viability of further reform of ASIC, and argues that ASIC is woefully under-resourced to engage in increased enforcement action.

Measuring the Impact of SEC Enforcement Decisions

This essay examines several metrics of Securities and Exchange Commission (SEC) decisionmaking that may be updated on a regular basis over time using publicly available data to give a picture of how SEC decisionmaking changes over time. I focus on SEC actions against public companies and subsidiaries of public companies and use data from the 2005 to 2018 period. The metrics include: the number of SEC actions per year and per month, the ratio of SEC actions to securities class actions by year, the mean abnormal return from an event study of the first public announcement of the problem that led to the eventual SEC enforcement action by year, the fraction of SEC actions with prior disclosure of the underlying violation by year, and the variability of the market response to the initiation of a SEC action by year. The metrics cannot demonstrate with certainty what motivates internal SEC enforcement decisions but may raise questions that guide future research.

Share price response to the SEC administrative proceedings against Chinese auditors

PurposeThe purpose of this study is to examines whether clients’ share prices responded to three events, including the Securities and Exchange Commission (SEC) launch of administrative proceedings against five Chinese accounting firms on December 3, 2012, for their failure to hand over audit work papers due to conflict of jurisdiction; the issuance of SEC Administrative Law Judge Elliot’s ruling on January 22, 2014; and the settlement of the administrative proceedings on February 6, 2015.Design/methodology/approachThis study uses the Schipper and Thompson approach.FindingsIt is found that share prices responded negatively around December 3, 2012, for USA-listed Chinese companies who were audited by Chinese auditors.Originality/valueThis study provides evidence on how share prices reacted to SEC enforcement actions against an affair of non-audit failure.

SEC credits self-reporting and cooperation in not imposing penalty on ICO sponsor

PurposeTo explain a February 20, 2019 US Securities and Exchange Commission (SEC) settled enforcement action against Gladius Network LLC for failing to register an initial coin offering (ICO) under the federal securities laws, in which Gladius was able to avoid a civil penalty by self-reporting the violation and cooperating with the SEC enforcement staff.Design/methodology/approachExplains Gladius’ self-reporting, cooperation and remedial steps; why the SEC imposed no civil penalty on Gladius; and two similar cases the SEC instituted in July 2018 against companies that conducted unregistered ICOs, did not self-report, and were penalized. Provides analysis and conclusions.FindingsThe Gladius case offers important insight into how the SEC and its staff think about cooperation credit in resolving SEC enforcement actions and sends a clear message that self-reporting to the SEC can result in meaningful cooperation credit. In three recent cases, the Commission has made clear that once it put the industry on notice that ICOs could be securities that must be registered under the federal securities laws, a party risks enforcement action by failing to do so.Originality/valueExpert analysis and guidance from an experienced securities lawyer who counsels clients on all manner of SEC enforcement, examination and regulatory policy matters.

Earnings Management in Domestic and Foreign IPOs in the United States: Do Home Country Institutions Matter?

Using a large sample of domestic and foreign IPOs in the US, we investigate how threats of enforcement by the Securities and Exchange Commission (SEC) and private litigation influence earnings management in IPO prospectuses. We propose that perceptions of foreign institutions may influence SEC enforcement action and private litigation. We provide evidence that enforcement and litigation threats are negatively related to the strength of legal institutions in the foreign IPO’s country of origin. We find earnings management is more pronounced in foreign IPOs from countries with strong legal institutions. We further explore whether earnings management is priced in the IPO market and find no relation between IPO proceeds and earnings management. Our results are consistent with upward earnings management as in Stein (1989), the magnitude of which is reduced when the anticipated cost of enforcement and litigation is higher. Collectively, our results cast doubt on the validity of the bonding hypothesis.

SEC charges “ICO Superstore” as unregistered broker-dealer

PurposeTo analyze the settled order of the US Securities and Exchange Commission (SEC) against TokenLot LLC (TokenLot), which was the SEC’s first action charging a seller of digital tokens as an unregistered broker-dealer.Design/methodology/approachAnalyzes the SEC’s order within the context of other recent actions by the SEC on cryptocurrencies and digital tokens and discusses future implications of the order in this area.FindingsThe SEC’s order against TokenLot as an unregistered broker-dealer was a logical next step in its enforcement activity in the cryptocurrency and digital token space.The order demonstrates that the SEC expects firms in the cryptocurrency space to use the well-established constructs of federal securities laws to evaluate their business activities to ensure those activities are legally compliant.Originality/valuePractical guidance from experienced securities and financial services lawyers analyzing recent developments in a nascent area of SEC enforcement.

Earnings Management in Domestic and Foreign IPOs in the United States: Do Home Country Institutions Matter?

Using a large sample of domestic and foreign IPOs in the US, we investigate how threats of enforcement by the Securities and Exchange Commission (SEC) and private litigation influence earnings management in IPO prospectuses. We propose that perceptions of foreign institutions may influence SEC enforcement action and private litigation. We provide evidence that enforcement and litigation threats are negatively related to the strength of legal institutions in the foreign IPO’s country of origin. We find earnings management is more pronounced in foreign IPOs from countries with strong legal institutions. We further explore whether earnings management is priced in the IPO market and find no relation between IPO proceeds and earnings management. Our results are consistent with upward earnings management as in Stein (1989), the magnitude of which is reduced when the anticipated cost of enforcement and litigation is higher. Collectively, our results cast doubt on the validity of the bonding hypothesis.

Great expectations: a regulatory promise unfulfilled

The primary goal of the US Securities and Exchange Commission (SEC) is to protect investors by deterring wrongdoing resulting in investor loss. The SEC deters wrongdoing in two ways: by threatening penalties and signalling illegal behaviour. If the SEC does not hold individuals accountable or if it is unclear what actions are illegal, wrongdoing will continue. Consent decrees have become the SEC's enforcement norm. Through negotiation both the defendant and the agency avoid costs and save time, but individuals responsible for wrongdoing have largely avoided personal accountability. Although firms have introduced clawback provisions into executive contracts, evidence shows that boards of directors largely have not activated clawbacks. Boards must hold employees personally responsible; thus boards should design executive contracts that clearly state the rationale for clawbacks and a means by which their amounts - amounts both fair and in the best interests of the corporation - can be established.

The Deterrent Effect of the Securities and Exchange Commission’s Enforcement Intensity on Illegal Insider Trading: Evidence from Run-up before News Events

We examine whether public enforcement of US insider-trading laws affects price discovery. Examining insider-trading civil cases filed by the Securities and Exchange Commission (SEC) from 2003 to 2011, we find that the price impact on insider-trading days is much smaller than the effect documented for the 1980s, consistent with increased fear of prosecution. Moreover, we find that preannouncement anticipatory run-up in comprehensive samples of takeover bids and earnings announcements is negatively related to resource-based measures of public enforcement intensity, which suggests that aggressive SEC enforcement deters illegal activity. In addition, we find that quoted bid-ask spreads are negatively related to the SEC’s enforcement intensity, which suggests that greater enforcement improves liquidity. Moreover, the negative and significant relation between run-up and the SEC’s enforcement intensity persists after controlling for quoted spreads.

Cybersecurity enforcement actions: is the SEC bringing strict liability cases?

Purpose To analyze how the US Securities and Exchange Commission (SEC) has sanctioned broker-dealers (BDs) and registered investment advisers (RIAs) when cybersecurity breaches have occurred and to discuss whether the SEC is imposing a strict liability approach. Design/methodology/approach Describes the cyber-attack of a small RIA, the remedial steps the RIA took after the attack, the SEC’s enforcement action, why this particular case is noteworthy, and the case’s implications for RIAs and BDs. Findings RIAs and perhaps BDs may face strict liability from the SEC if they are victims of cybersecurity attacks. Practical implications Firms may want to address the likelihood of an SEC enforcement action if a breach occurs by reviewing recent enforcement actions, SEC reports and statements, and FINRA reports and statements. Originality/value Discusses the possible future of SEC enforcement actions regarding cybersecurity breaches.

SEC issues proposed investment adviser reporting and disclosure rules

Purpose – To explain proposed rules and amendments recently issued by the USA Securities and Exchange Commission (SEC) that would impose more detailed reporting requirements for investment advisers that file Form ADV. A companion article describes the SEC’s proposed registered investment company reporting rules which were issued simultaneously. Design/methodology/approach – Describes the SEC’s reasoning for collecting more detailed data, introduces the proposed separate account reporting requirements for SEC-registered investment advisers, explains proposed amendments to Part 1A of Form ADV, describes a proposed codification of SEC staff positions that provide for so-called “umbrella registrations” by closely related advisory firms, and details two proposed amendments to Advisers Act Rule 204-2, the books and records rule, which would require investment advisers to maintain additional materials related to the calculation and distribution of performance information. Findings – Many questions still remain as to how the final rules will eventually take shape; however, it is evident that investment advisers will be subject to a wider array of reporting requirements. Investment advisors are likely to incur increased costs as a result of the proposed rules and amendments, and production of the reports could necessitate a revamp of their various internal procedures. Also, access to additional and enhanced information will have consequences for investment companies with respect to SEC examinations and enforcement activity. Practical implications – Investment advisers should understand that detailed new regulatory reporting is coming and, more specifically, separately managed account clients of investment advisers should be made aware of the proposed reporting requirements. Originality/value – Practical guidance from experienced investment funds lawyer.

SEC issues proposed investment company reporting rules

Purpose – To explain proposed rules recently issued by the US Securities and Exchange Commission (SEC) that would dramatically expand both public and non-public reporting of portfolios and other data by US registered investment companies. A companion article covers new reports proposed at the same time for investment advisers that file Form ADV with the SEC. Design/methodology/approach – Explains how the proposed rules intend to rescind Form N-Q and adopt a new portfolio holding form, Form N-PORT, which would require expansive monthly portfolio and risk reporting; describes amendments to Regulation S-X which would both enhance and standardize derivatives disclosures in fund financial statements; and details the reporting requirements for a new annual ‘census-style’ reporting form, Form N-CEN, which would replace an obsolete existing SEC form, Form N-SAR. Findings – While it still remains to be seen how the final rules will be written, it is clear that US registered investment companies will be subject to broader reporting requirements. Investment companies are likely to incur increased costs due to the detailed nature of the information being requested and the frequency with which they will be required to file. Access to additional and enhanced information will have consequences for investment companies with respect to SEC examinations and enforcement activity. Practical implications – Senior management and boards of investment companies should understand the basic framework of the proposed requirements. An operations and finance working group may need to be established by companies in order to coordinate the planning and preparation process for the requirements. Firms also should determine whether their service providers have the necessary resources to assist in complying with the proposed filing requirements. Originality/value – Practical guidance from experienced investment funds lawyer.

U.S. Congressional Committees and S.E.C. Enforcement Against Financial Misconduct

We document that firms with powerful representation on U.S. congressional committees that oversee the Securities and Exchange Commission (SEC) are less likely to face regulatory scrutiny for financial misconduct relative to other firms. An exogenous decrease in firms’ powerful committee representation results in an increase in the likelihood that those firms will subsequently face SEC enforcement actions. Furthermore, conditional on receiving SEC enforcement action, the same firms also receive materially smaller monetary penalties relative to other transgressing firms. Our findings appear to be driven by firm-side efforts to supply higher quality financial reports rather than because of political capture. In sum our study highlights a direct effect on financial reporting from political representation on specific U.S. congressional committees.