The road not taken: A comparison of Accounting and Auditing Enforcement Releases and securities class actions

Abstract

Despite the controversial debate over the role of public enforcement and private litigation in detecting and deterring financial misreporting, we have only scant literature comparing their enforcement outcomes: The Securities and Exchange Commission (SEC)‐sanctioned cases (Accounting and Auditing Enforcement Releases [AAERs]) and settled class actions against which the SEC did not file cases (securities class‐action lawsuits [SCALs]). This paper documents systematic differences between the two. Specifically, AAERs exhibit a larger magnitude of accruals prior to misreporting, as well as greater financing needs and insider trading during manipulation periods. After controlling for case backlogs in the SEC and the courts, the misreporting amount and period of AAERs are also greater and longer than those of SCALs, although SCALs represent greater settlement amounts. Further analysis indicates that resource constraints do not critically undermine the SEC investigations to detect more material misreporting cases. However, plaintiff investors appear to go forum shopping to earn greater settlement proceeds from SCALs. Finally, relative to SCALs, AAERs experienced significant drops in firm performance, analyst following and CEO tenure around SEC sanctions. Overall, this study provides consistent evidence supporting the SEC's optimization of detection rates under resource constraints and the strategic interaction between SEC enforcement and private litigation.