On the SEC’s 2010 Enforcement Cooperation Program

Andrew J. Leone is Keith I. DeLashmutt Professor of Accounting Information & Management at Northwestern University Kellogg School of Management; Edward X. Li and Michelle Liu are Associate Professors of Accounting at CUNY Baruch College Zicklin School of Business. This post is based on their recent paper, forthcoming in the Journal of Accounting & Economics.

Leniency programs can be powerful enforcement tools. For example, the Department of Justice’s Antitrust Leniency Program has been successful in cracking down on cartel activities since 1993. By encouraging violators’ self-reporting and voluntary remediation, regulators can conserve valuable resources and rectify more misconduct than they otherwise would. However, the Securities and Exchange Commission’s (SEC’s) leniency program, which began with the 2001 Seaboard Report, long illustrated a different reality. Files (2012) finds that cooperating with the SEC can leave firms worse off. The press also harshly criticized the SEC for failing to detect egregious frauds during the Financial Crisis, despite a budget surge since 2001. To address these concerns, the SEC issued a new initiative in 2010 and, for the first time, formalized a multitude of new cooperation polices in the SEC Enforcement Manual. In our forthcoming paper in the Journal of Accounting & Economics, we investigate the effects of these policy changes.

Our investigation is important because resource constraints impact SEC enforcement. Given looming budget cuts, understanding the interplay between the SEC and firms under a resource-conserving leniency program is crucial to effective enforcement. Given prior findings, we ask whether the SEC continued to penalize cooperation after 2010. The answer is unclear because the SEC still retained considerable arbitrary power. In addition, would misconduct firms become more likely to cooperate with the SEC after 2010? These firms, out of an abundance of caution, could still be reluctant to cooperate.

We provide initial answers to these questions. To capture deliberate financial misconduct, we limit our sample to income-decreasing accounting restatements. We measure SEC sanctions using the incidence of enforcement and monetary penalties against firms. We consider four distinct cooperative firm actions suggested by the Seaboard Report: self-investigation, timely reporting, prominent disclosure, and replacing executives. The first refers to a firm initiating its own investigation. The next two refer to the timing and channels of the misconduct firm’s public disclosure. The last captures voluntary remediation, as the SEC stressed holding culpable executives accountable. Replacing executives signals cooperation in good faith and, importantly, prevents wrongdoers from sabotaging the cooperation.

We find evidence suggesting that after 2010, a different enforcement regime has likely emerged. Based on a simple composite score of the four cooperative actions, we estimate that for the 2002-2010 period, a one unit increase in the cooperation score increased the probability of enforcement by 4.2% and penalties by $2.04 million. In contrast, for the 2011-2014 period, a one unit higher cooperation score is related to a 4.6% lower chance of enforcement and $2.55 million less in fines.

For specific cooperative actions, the SEC penalized self-investigation, prominent disclosure, and replacing executives in the 2002-2010 period, whereas it rewarded replacing executives and timely reporting in the 2011-2014 period. Further analysis suggests that after 2010, the SEC continued to penalize self-investigation firms only if they did not communicate their findings to the SEC.

In addition, we also find that the SEC publicized formal cooperation agreements with firms on its website, and after 2010, it acknowledged firm cooperation in Accounting and Auditing Enforcement Releases (AAERs) using more detailed descriptions, as opposed to the generic, standard language previously used. Furthermore, after 2010, the SEC staff was over two times more likely to mention enforcement cooperation in public speeches. These findings are consistent with the SEC improving program transparency by establishing clear case precedent and restricting its own prosecutorial discretion. Collectively, the evidence suggests that the SEC appears fully committed to a new regime.

Last, we examine whether misconduct firms changed their cooperation behavior after 2010. Compared to the year 2010, we find some evidence suggesting that in the 2011-2014 period, misconduct firms are more likely to replace executives, but they conduct fewer independent investigations. Given our findings that after 2010, the SEC generally penalizes self-investigations but rewards replacing executives, this evidence suggests that firms may have changed their cooperation strategies, likely to adapt to the SEC’s new leniency practices. Overall, our study highlights that having a more explicit leniency program is crucial to encouraging the behavior the program intends.

The complete paper is available for download here.

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