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Return and liquidity response to fraud and sec investigations

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Abstract

This study measures the long-run costs and benefits associated with fraud and securities enforcement actions by examining the changes in market quality of firms that are investigated by the Securities and Exchange Commission for fraud. The market quality measures we test include returns, price volatility, spreads, and illiquidity. We find a significant deterioration of market quality following the market’s discovery of the misconduct. We also find that during periods in which the SEC is actively investigating the firm daily returns and price volatility improves while spreads widen and liquidity declines. Our work highlights some of the benefits and costs of having an active regulator over US securities markets.

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Notes

  1. http://www.bloombergview.com/articles/2011–08-30/one-more-reason-to-shut-sec-and-start-over-commentary-by-william-d-cohan

  2. We thank Karpoff, Lee, and Martin for graciously providing the data on SEC enforcement proceedings.

  3. Christensen et al. (2016) cite evidence of the debate in Coffee (1984), Easterbrook and Fischel (1984), Shleifer (2005), Mulherin (2007), Leuz and Wysocki (2008), and Zingales (2009).

  4. Feroz et al. (1991) p. 111:

    “The 1934 Act Release No. 5092 requires the public disclosure of material information; this would include formal investigations by the enforcement division. An anonymous SEC enforcement lawyer (WSJ [September 22, 1983], p. 35) explains, ‘When the SEC tells a company it’s a target, securities laws require disclosure to shareholders. This turns a private investigation into a public one... and if the investigation shows the party was innocent, the notification and forced disclosure could have blown a public offering or a reputation needlessly.”

  5. http://www.sec.gov/about/whatwedo.shtml#org

  6. See Karpoff, Koester, Lee, and Martin (2012) for a full description of the hand-collection processes, sources, and aggregation of these data.

  7. http://www.sec.gov/news/digest/1978/dig081078.pdf

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Authors and Affiliations

  1. Wright State University, 3640 Colonel Glenn Hwy, Rike Hall 296, Dayton, OH, 45435, USA

    Brandon C. L. Morris

  2. Boise State University, 1910 University Dr., Boise, ID, 83725, USA

    Jared F. Egginton

  3. University of Mississippi, 357 Holman, University, MS, 38677, USA

    Kathleen P. Fuller

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  1. Brandon C. L. Morris
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  2. Jared F. Egginton
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  3. Kathleen P. Fuller
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Correspondence to Brandon C. L. Morris.

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Morris, B.C.L., Egginton, J.F. & Fuller, K.P. Return and liquidity response to fraud and sec investigations. J Econ Finan 43, 313–329 (2019). https://doi.org/10.1007/s12197-018-9445-y

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