by Andrew J. Leone, Edward X. Li, and Michelle Liu

Motivation and Research Design

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 in our article whether cooperating with the SEC continued to leave firms worse off after 2010. The answer is unclear because the SEC still retained considerable arbitrary power in prosecuting firms even if they chose to cooperate. In addition, did firms under investigation become more likely to cooperate with the SEC after 2010? Arguably, these firms, out of an abundance of caution, might 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 firm’s public disclosure. The last captures voluntary remediation, as the SEC has stressed the importance of holding culpable executives accountable. Replacing executives signals cooperation in good faith and, importantly, prevents wrongdoers from sabotaging the cooperation.

Summary of Findings

We find evidence suggesting that, after 2010, a different enforcement regime has 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 a firm’s 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 corresponded with a 4.6% lower chance of enforcement and $2.55 million less in fines.

With respect to specific cooperative actions, self-investigation, prominent disclosure, and replacing executives left firms worse off in the 2002-2010 period, whereas replacing executives and timely reporting appeared rewarding in the 2011-2014 period. Further analysis suggests that after 2010, firms that self-investigated were worse off only if they did not communicate their findings to the SEC.

In addition, we also find that, after 2010, the SEC publicized formal cooperation agreements with firms on its website, and 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’s 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 firms under investigation changed their cooperation behavior after 2010. Compared to the year 2010, we find some evidence suggesting that, in the 2011-2014 period, such firms were more likely to replace executives, but they conducted fewer independent investigations. Given our findings that, after 2010, the SEC generally has left firms that self-investigate worse off but rewarded those 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.

Andrew J. Leone is the Keith I. DeLashmutt Chair of Accounting & Information Management at the Kellogg School of Management at Northwestern University. Edward X. Li is an associate professor of accounting at the Zicklin School of Business at Baruch College. Michelle Liu is an associate professor of accounting at Hunter College, CUNY.