The revolving door between the Securities and Exchange Commission (SEC) and the private sector has been the subject of a great deal of scrutiny in recent years. The SEC regulates, and enforces laws concerning, public companies, with a mission that includes “protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation“. However, SEC employees who leave the agency regularly find themselves aiding the very corporations the SEC is regulating, and working against the SEC’s regulatory activities. Between 2001 and 2010, over 400 former SEC employees filed statements that they intended to represent an external party before the SEC.
In our study, forthcoming at the Journal of Accountancy and Public Policy and available at SSRN, we examine the impact of the revolving door on the SEC’s comment letter process, a crucial process by which the SEC exercises its regulatory mission.
The Sarbanes-Oxley Act of 2002 requires the SEC to review companies’ filings at least once every three years, and the SEC sends comments to the company when SEC staff believe that the disclosures in its filings can or should be improved. This review process leads to a dialogue between the firm and SEC staff, in which the SEC may make requests of the firm, for example to amend one or more past filings, and in which the firm may negotiate for more desirable outcomes, for example to simply revise future filings. Firms often involve external lawyers in this conversation with the SEC, and these lawyers may have formerly been employed by the SEC.
Because former SEC lawyers would be more familiar with SEC staff than lawyers who had never been employed by the SEC, we would expect them to be more effective at negotiating with the SEC on behalf of their clients. Specifically, we would expect to observe greater resistance to the SEC comment letter process—in the form of more negotiation—when a company retains a former SEC lawyer relative to other lawyers. In addition, we would expect to observe that companies that retain former SEC lawyers have more favorable outcomes, especially a lower probability of amending prior filings.
In order to examine these predictions empirically, we identify lawyers involved in the comment letter conversations, and hand-collect data on their backgrounds and characteristics from public sources, primarily LinkedIn profiles and the biographies on their law firms’ websites. Our study uses data from 1,384 lawyers, who together with their law firms had at least two conversations in our sample. Our dataset of comment letter conversations spans 2005 to 2016.
We first examine what types of firms hire former SEC lawyers. Among other determinants, we find that older and larger firms, those with a history of litigation, and those that do not use highly-ranked audit firms, are more likely to hire former SEC lawyers over other lawyers. This suggests that financial and repetitional concerns, and the risk of litigation and misstated financials, may contribute to the decision to hire a former SEC lawyer. In order to mitigate selection bias, in our analyses we propensity-match conversations involving former SEC lawyers against those involving other lawyers along lawyer and law firm characteristics, the issues raised in the initial comment letter, and firm characteristics.
We examine resistance to the SEC using a composite measure of the extent of negotiation based on the length of the comment letter conversation in days, the number of letters exchanged, and whether the conversation took multiple rounds to resolve. We find that firms that involve former SEC lawyers negotiate to a greater extent with the SEC than firms that involved other lawyers.
We next examine whether firms that involve firmer SEC lawyers are less likely to amend their filings relative those that involve other lawyers. We find that the former firms have about a 32 percent lower odds of issuing amendments after receiving a comment letter. Furthermore, their abnormal stock returns are 3.9 percentage points greater in the period after receiving a comment letter, further evidence that former SEC lawyers help secure more favorable outcomes of the comment letter conversation than do other lawyers. Finally, we find that these results are driven by former SEC lawyers who had left the SEC more recently, consistent with our results being driven by their familiarity with former colleagues still at the SEC.
Our study contributes to several streams of research. First, we extend the literature on the revolving door by examining post-revolving SEC employees on the SEC comment letter process, a widespread and important mechanism for disclosure oversight by the SEC. Second, we contribute to the growing literature on the SEC comment letter process, in which few studies have examined factors that could impede the process. Finally, we contribute to the emerging literature on the role of external legal counsel in financial disclosures.
The SEC Revolving Door and Comment Letters
More from: Michael Shen, Samuel Tan
Michael Shen is an Assistant Professor of Accounting at NUS Business School, National University of Singapore, and Samuel T. Tan is an Assistant Professor of Accounting at the School of Accountancy, Singapore Management University. This post is based on their recent paper, forthcoming in The Journal of Accounting and Public Policy.
The revolving door between the Securities and Exchange Commission (SEC) and the private sector has been the subject of a great deal of scrutiny in recent years. The SEC regulates, and enforces laws concerning, public companies, with a mission that includes “protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation“. However, SEC employees who leave the agency regularly find themselves aiding the very corporations the SEC is regulating, and working against the SEC’s regulatory activities. Between 2001 and 2010, over 400 former SEC employees filed statements that they intended to represent an external party before the SEC.
In our study, forthcoming at the Journal of Accountancy and Public Policy and available at SSRN, we examine the impact of the revolving door on the SEC’s comment letter process, a crucial process by which the SEC exercises its regulatory mission.
The Sarbanes-Oxley Act of 2002 requires the SEC to review companies’ filings at least once every three years, and the SEC sends comments to the company when SEC staff believe that the disclosures in its filings can or should be improved. This review process leads to a dialogue between the firm and SEC staff, in which the SEC may make requests of the firm, for example to amend one or more past filings, and in which the firm may negotiate for more desirable outcomes, for example to simply revise future filings. Firms often involve external lawyers in this conversation with the SEC, and these lawyers may have formerly been employed by the SEC.
Because former SEC lawyers would be more familiar with SEC staff than lawyers who had never been employed by the SEC, we would expect them to be more effective at negotiating with the SEC on behalf of their clients. Specifically, we would expect to observe greater resistance to the SEC comment letter process—in the form of more negotiation—when a company retains a former SEC lawyer relative to other lawyers. In addition, we would expect to observe that companies that retain former SEC lawyers have more favorable outcomes, especially a lower probability of amending prior filings.
In order to examine these predictions empirically, we identify lawyers involved in the comment letter conversations, and hand-collect data on their backgrounds and characteristics from public sources, primarily LinkedIn profiles and the biographies on their law firms’ websites. Our study uses data from 1,384 lawyers, who together with their law firms had at least two conversations in our sample. Our dataset of comment letter conversations spans 2005 to 2016.
We first examine what types of firms hire former SEC lawyers. Among other determinants, we find that older and larger firms, those with a history of litigation, and those that do not use highly-ranked audit firms, are more likely to hire former SEC lawyers over other lawyers. This suggests that financial and repetitional concerns, and the risk of litigation and misstated financials, may contribute to the decision to hire a former SEC lawyer. In order to mitigate selection bias, in our analyses we propensity-match conversations involving former SEC lawyers against those involving other lawyers along lawyer and law firm characteristics, the issues raised in the initial comment letter, and firm characteristics.
We examine resistance to the SEC using a composite measure of the extent of negotiation based on the length of the comment letter conversation in days, the number of letters exchanged, and whether the conversation took multiple rounds to resolve. We find that firms that involve former SEC lawyers negotiate to a greater extent with the SEC than firms that involved other lawyers.
We next examine whether firms that involve firmer SEC lawyers are less likely to amend their filings relative those that involve other lawyers. We find that the former firms have about a 32 percent lower odds of issuing amendments after receiving a comment letter. Furthermore, their abnormal stock returns are 3.9 percentage points greater in the period after receiving a comment letter, further evidence that former SEC lawyers help secure more favorable outcomes of the comment letter conversation than do other lawyers. Finally, we find that these results are driven by former SEC lawyers who had left the SEC more recently, consistent with our results being driven by their familiarity with former colleagues still at the SEC.
Our study contributes to several streams of research. First, we extend the literature on the revolving door by examining post-revolving SEC employees on the SEC comment letter process, a widespread and important mechanism for disclosure oversight by the SEC. Second, we contribute to the growing literature on the SEC comment letter process, in which few studies have examined factors that could impede the process. Finally, we contribute to the emerging literature on the role of external legal counsel in financial disclosures.