Is 'Not Guilty' the Same as 'Innocent'? Evidence from SEC Financial Fraud Investigations

Abstract

The Securities and Exchange Commission (SEC) routinely investigates firms for financial fraud, but investors only learn about regulators' concerns if managers voluntarily disclose news of the investigation, or regulators sanction the firm. We investigate the effects of disclosing investigations using confidential records on all opened investigations, regardless of outcome. Markets exhibit some ability to identify which investigations will eventually lead to sanctions. Nonetheless, even when no charges are ultimately brought, firms that voluntarily disclose an investigation have significant negative returns, underperforming non-sanctioned firms that stayed silent by 12.7% for a year after the investigation begins. Consistent with limited investor attention, disclosing in a more prominent manner is associated with worse returns. CEOs who disclose an investigation are also 14% more likely to experience turnover. Our results are consistent with transparency about bad news being punished, rather than rewarded, by financial and labor markets.

Identification and Early Warning of Financial Fraud Risk Based on Bidirectional Long-Short Term Memory Model

“…If listed company nancial fraud one day is exposed, it is hard to escape the punishment of regulatory departments. At the same time, company's investors and creditors may decide to withdraw, worsening the company's nancial situation [5,6]. In addition, nancial fraud scandals will also a ect the brand image of listed companies and reduce consumers' brand trust, resulting in a decline in sales performance.…”

Financial Crime and Punishment: A Meta-Analysis

“…Hence, our results confirm the conclusions of and of Pritchard and Ferris (2001): the very first hint of financial crimes triggers the most important and significant abnormal market reaction. This echoes the difference between "not guilty" and "innocent" for the markets stressed by Solomon and Soltes (2019). They stated that being associated to a potential crime will be sanctioned by the market, even when no charges are ultimately brought after an alleged intentional financial fraud.…”

“…The very first hint of financial crime could trigger the most important and significant abnormal market reaction, even when compared to the sanction publication itself, as demonstrated by regarding the U.S. Securities Exchange Commission (SEC) investigations of violations of accounting laws or Pritchard and Ferris (2001) regarding the publication of potential securities frauds followed by the class action filings. Solomon and Soltes (2019;p. 1) stress the difference between "not guilty" and "innocent" for the markets: "even when no charges are ultimately brought [after SEC financial fraud investigations], firms that voluntarily disclose an investigation have significant negative returns, underperforming non-sanctioned firms that stayed silent by 12.7% for a year after the investigation begins."…”

Enhanced financial fraud detection using cost‐sensitive cascade forest with missing value imputation

“…The identifications of intentional misreporting (fraud) are based on flags in AA: (i) fraud is flagged if the restatement disclosure references financial fraud, irregularities, or misrepresentations; and (ii) fraud is also flagged if the restatement is neither an error in accounting and clerical applications nor a misapplication of a rule. As most SEC investigations do not lead to formal public enforcement (Solomon & Soltes, 2021), we exclude the SEC investigation flags to mitigate the false positives. While combining AA with AAER may reduce the false negatives, it may also induce false positives because fraud flags in AA may involve fraud committed by lower‐level staff seeking personal gain.…”