Friends in High Places: Political Ties and SEC Oversight of Foreign Firms

Jill E. Fisch is the Saul A. Fox Distinguished Professor of Business Law and Co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School and Xian Gu is an Associate Professor in Finance at Durham University Business School. This post is based on their recent paper.

Foreign firms that are traded in the U.S. markets, represent a significant proportion of publicly-traded firms. Such firms are subject to U.S. securities regulation. The legal bonding theory suggests that by subjecting themselves to U.S. law, foreign issuers enhance their value in the eyes of investors. However, compared to U.S. domestic firms, foreign firms are much less frequently the subject of official SEC enforcement actions. In this study, we provide a first investigation of how the political landscape, specifically the bilateral political ties between the U.S. and a foreign issuer’s home country, plays a role in SEC’s oversight of U.S.-listed foreign firms.

The SEC’s oversight of publicly-traded firms includes both routine monitoring through comment letter reviews of firm’s reporting compliance and pursuing enforcement actions against firms if their public reporting is deficient. One difficulty in analyzing SEC’s selection of enforcement targets lies in the limited public information on the SEC’s first-stage informal inquiry.  In this study, we investigate both comment letters and formal enforcement actions and integrate our results into one picture.

We examine 10-K and 20-F related comment letters, and enforcement actions against foreign issuers related to accounting and auditing issues. Our empirical analysis reveals two main sets of findings. First, political ties between a foreign firm’s home country and the U.S. are an important determinant of SEC oversight, including both the likelihood of receiving comment letters and that of being subject to an SEC enforcement action. If a foreign firm’s home country has stronger political ties with the U.S., then the frequency of comment letters issued by the SEC is lower, the tone of the comment letters is less negative and litigious, and the firm is less likely to be the subject of an SEC enforcement action. The effect of political ties is more pronounced during Democratic presidencies. We did not find any significant impact of the political relationship on private securities fraud litigation, i.e. class action lawsuits.

Second, the SEC’s routine monitoring via comment letters complements enforcement actions for foreign firms in general. International political ties also play an important role in the interactions between SEC’s routine monitoring and enforcement for foreign firms: when the political ties between foreign firms’ home countries and the U.S. are stronger, the complementary effect of comment letters on enforcement is mitigated. Foreign firms from countries with stronger ties to the U.S. appear to receive more “light touch” comment letters at the routine-monitoring stage but face a lower probability of being subjected to formal enforcement. Foreign firms from countries with weaker ties to the U.S. are more likely to face enforcement. This may indicate the SEC’s choice to pursue a cooperative strategy with favored firms through comment letters rather than a confrontational strategy. This approach also helps the SEC leverage its limited resources and bring enforcement actions with higher publicity value.

In Morrison v. National Australia Bank (2010) (Morrison, henceforth), the U.S. Supreme Court limited the extraterritorial reach of the antifraud provisions of the U.S. securities laws in an effort to reduce global class actions against international corporations. A question after the Morrison decision was whether the SEC would respond by changing its enforcement efforts. We examine whether the SEC responded to Morrison, and whether the relationship between SEC monitoring and enforcement changed after Morrison. We find that while Morrison did not significantly change the relationship between political ties and SEC enforcement, SEC monitoring through comment letters has become more sensitive to political ties. This indicates that the SEC may have invested greater effort in monitoring firm disclosures, especially when firms’ home countries have stronger ties to the U.S., in response to the reduced likelihood of private litigation after Morrison.

Overall, our study provides supporting evidence of the potential impact of the international political environment on SEC oversight. The paper also highlights the importance of considering the role of both SEC monitoring and formal enforcement actions in generating compliance by foreign firms with the U.S. securities law.

The complete paper is available for download here.

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