SEC Monitoring of Foreign Firms’ Disclosures

James Naughton is Assistant Professor of Accounting Information and Management at Northwestern University. This post is based on a discussion paper authored by Professor Naughton; Rafael Rogo, Assistant Professor of Accounting at the University of British Columbia; Jayanthi Sunder, Associate Professor of Accounting at the University of Arizona; and Ray Zhang of the Accounting Division at the University of British Columbia.

Foreign firms represent a significant proportion of firms trading in US markets. These firms, like listed US firms, are subject to monitoring by the Securities Exchange Commission (SEC). However, because of SEC’s tripartite mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, it is not obvious how SEC monitoring of foreign firms compares with US firms. In particular, SEC may balance the need for rigorous monitoring of foreign firms to protect US investors with an approach that facilitates capital formation by attracting foreign firms to list in the US. In addition, due to the heterogeneity of foreign firms and their home institutions, it is not obvious how the intensity of SEC monitoring is distributed across different countries. In our paper SEC Monitoring of Foreign Firms’ Disclosures, which was recently made publicly available on SSRN, we examine whether SEC’s monitoring activities differ for US versus foreign firms and whether it varies based on attributes of the home country’s institutions.

We conduct our analyses using a comprehensive sample of SEC comment letters to proxy for SEC’s monitoring activities. Even though the content of the comment letter reflects both SEC monitoring effort and the quality of a firm’s financial reports, the presence of a comment letter is a good proxy for whether a firm’s financial statements were reviewed by the SEC because the vast majority of SEC reviews produce a comment letter. Our sample consists of 41,540 firm-years of data during the period August 1, 2004 through December 31, 2012, which consist of 36,732 firm-years of data for US firms and 4,808 firm-years of data for foreign firms. We categorize firms as foreign if they are identified as a foreign private issuer by the SEC. We focus on foreign private issuers because these are the firms that the SEC considers to be foreign in terms of reporting and disclosure requirements. Our sample contains 14,502 unique firm-years where the SEC issued a comment letter for a filing made in that year, of which 13,002 are for US firms and 1,500 are for foreign firms.

Collectively, our analyses show that foreign firms are subject to less intensive SEC monitoring than comparable US firms. While this is seemingly inconsistent with SEC’s mission to protect US investors, we posit and show that SEC reduces monitoring when it can rely on the public and private enforcement institutions in the foreign firm’s home country. In the case of foreign firms with no foreign regulator to share the monitoring effort, the intensity of SEC’s monitoring is comparable to that for US firms. Further, the SEC provides increased monitoring for those foreign firms where there is likely to be higher levels of information asymmetry between the firm and US investors. In addition, we find that SEC monitoring is higher for foreign firms that have higher levels of trading by US investors, consistent with the idea that the SEC protects US investors.

Our study highlights the heterogeneity in monitoring needs of foreign firms and suggests that it is important to understand the consequences of growing cooperation, both implicit and explicit, among international regulators.

The full paper is available for download here.

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