Government Preferences and SEC Enforcement

Jonas Heese is Assistant Professor of Business Administration in the Accounting & Management Unit at Harvard Business School.

The Securities and Exchange Commission’s (SEC) enforcement actions have been subject to increased scrutiny following the SEC’s failure to detect several accounting frauds. A growing literature investigates the reasons for such failure in SEC enforcement by examining the SEC’s choice of enforcement targets. While several studies recognize that the SEC and its enforcement actions are subject to political influence (e.g., Correia, 2014; Yu and Yu, 2011), they do not consider that such influence by the government may also reflect voters’ interests. Yet, economists such as Stigler (1971) and Peltzman (1976) have long emphasized that the government may also influence regulations and regulatory agencies to reflect voters’ interests—independent of firms’ political connections. In my paper, Government Preferences and SEC Enforcement, which was recently made publicly available on SSRN, I examine whether political influence by the president and Congress (“government”) on the SEC may reflect voters’ interests.

One of the main factors that drives voters’ political support are employment conditions, which are shown to systematically affect future electoral outcomes. To promote these conditions governments of both parties have long supported large employers through, for instance, bailouts or subsidies in order to prevent huge job losses or the destabilization of an entire industry.

The SEC’s enforcement actions can have devastating consequences for firms and therefore employment (e.g., Karpoff et al. 2008a, 2008b). The government, however, has a range of control devices at its disposal to align the SEC’s decisions with government’s goals (e.g., Weingast, 1984). In particular, Congress sets the SEC’s budget and oversees the agency, while the president appoints SEC commissioners with the advice and consent of the Senate. In fact, commissioners and senior SEC staff might consider the harm to employees that an enforcement action can create. For instance, Robert Khuzami, the former Director of the SEC’s Division of Enforcement, states that the SEC has to ask itself “under what circumstances [it] should indict an entire institution for the misconduct of some number of its employees” as such action may cause harm to innocent employees (Orol, 2013). In line with Khuzami’s statement, Mary Jo White, the current Chair of the SEC, argues that prosecutors should consider the direct and collateral consequences such as the harm to employees when they make a decision as to whether to indict a company as their decision should be “thoughtful and in the public interest” (SEC 2014c). Following the above arguments, I propose that the SEC—as a result of government’s efforts to promote employment conditions—considers the potential harm to employees in its enforcement actions and perceives this harm to be higher, the larger a firm’s workforce is.

To test my hypothesis, I use a sample of firms that have been sanctioned by the SEC for violating GAAP as reported in Accounting and Auditing Enforcement Releases (AAERs) and study how firms’ number of employees relate to AAERs. After controlling for other confounding variables such as firm size, accounting quality, distance to SEC office, political contributions, union membership per industry, and other monitors such as analysts following, I find that large employers are less likely to be subject to an AAER. This finding suggests that government’s employment considerations are reflected in SEC enforcement.

I find further evidence that variations in the government’s sensitivity to voters’ interests result in variations in SEC enforcement actions against large employers. In particular, I find that the lower likelihood of SEC enforcement actions against large employers is more pronounced in presidential election years if firms are based in politically important states, i.e., closely contested states with high Electoral College counts. Next, I find that the lower likelihood of SEC enforcement for locally large employers is more pronounced if the district’s unemployment rate is high and the incumbent congressman serves on a committee that oversees the SEC. These findings in combination with additional sensitivity tests help to rule out that unobserved correlated omitted firm characteristics of large employers could explain my earlier findings as well as to provide more direct insights how political influence from the government affects SEC enforcement.

This paper shows that—in addition to firms’ lobbying for their special interests—political influence to promote the employment conditions and thus voters’ interests is also reflected in SEC enforcement. Thus, this paper enhances our understanding of how the SEC selects its enforcement targets and emphasizes the importance to consider political influence as a response to both voters’ and special interests in explaining the SEC’s enforcement choices. In particular, it suggests that large employers, as they contribute more to the government’s policy of promoting employment, are subject to more lax SEC enforcement than their peers. It also sheds light on an additional, more subtle measure of the government to foster employment, i.e., reduced SEC enforcement for large employers.

The full paper is available for download here.

Both comments and trackbacks are currently closed.