The SEC and the Financial Industry: Evidence from Enforcement against Broker-Dealers

Abstract

The Securities and Exchange Commission plays a central part in the U.S. regulatory framework for the supervision of the _financial industry. How has the SEC carried out this mission? Despite recurrent crises, systematic studies of SEC performance data are surprisingly scarce. As the SEC reforms itself to address the shortcomings revealed in 2007-2008, a systematic examination of the agency's past record can help identify priorities and evaluate the agency's renewed efforts. This study takes a first step in studying empirically SEC enforcement against investment banks and brokerage houses, examining the agency's record in the period right before the 2007-2008 crisis. This data suggests that defendants associated with big.firms fared better in SEC enforcement actions as compared to defendants associated with smaller firms in three important dimensions. First, SEC actions against big.firms were more likely to involve corporate liability exclusively, with no individuals subject to any regulatory action. Second, big-firm defendants were more likely to end up in administrative rather than court proceedings, controlling for types of violation and levels of harm to investors. Third, within administrative proceedings, big-firm employees were likely to receive lower sanctions, notably temporary or permanent bars from the industry. These patterns have important implications for major debates concerning corporate liability, regulatory capture, and the public and private enforcement of securities laws.

The revolving door and the SEC’s enforcement outcomes: Initial evidence from civil litigation

“…Members of Congress, academics, former employees of the SEC and investors have raised questions about the impact of the revolving door on the SEC's efficacy and independence (e.g., Coates, 2000;Freeman, 2004;Perino, 2004;Langevoort, 2006;Gadinis, 2012;Lewis and Einhorn, 2009;Grassley, 2011). Our study is the first to empirically examine the effects of the SEC's revolving door phenomenon by collecting detailed data on the career choices of SEC enforcement lawyers.…”

“…Thus, this data is meant to give the reader an indication of the frequency with which the typical SEC_SPECIALIST law firm actively defends clients against the SEC in our sample. Lawyer-cases for lawyers still with the SEC 389 Lawyer-cases for lawyers that quit to join a non-law firm 89 Lawyer-cases for lawyers that quit to a law firm ("Revolvers") 188 Gadinis (2012) argues that corporate liability helps to deflect sanctions away from managers and employees, which, in turn, provides judges, juries and regulators with the opportunity to castigate misconduct "without sending a real human to jail." Therefore, naming individual officers, especially the CEO, likely requires a greater burden of proof and enforcement effort.…”

The SEC’s Enforcement Record against Auditors

“…These are not statistically different suggesting that the SEC does not appear to discriminate between Big N and non-Big N auditors in choosing between corporate liability and individual partner liability. In contrast, Gadinis (2012) finds that the SEC discriminates between big and small broker dealers. 19 We also estimate a multivariate probit regression that examines the determinants of an audit firm being named as a defendant, controlling for the severity and the nature of the violation.…”

“…The SEC has the discretion to bring enforcement actions against individual partners for their role in financial misrepresentation or against their employers, the audit firm, or against both. On the one hand, actions against an individual partner can be considered aggressive enforcement because (i) personal liability has arguably higher deterrent effects (e.g., Arlen and Carney, 1992;Coffee, 2007;Klausner, 2009;Gadinis, 2012); (ii) sanctioning the whole firm can result in penalizing other clients and colleagues who are not culpable (Margolis, 1979); and (iii) penalizing an individual partner in a local audit firm with one or two partners is tantamount to sanctioning the entire firm.…”

“…In contrast, in a civil action, the SEC files a complaint with a U.S. District Court and asks the court for a sanction. Stronger sanctions are more likely to need civil actions (Gadinis, 2012). Further, if the SEC decides to initiate administrative proceedings, it can close the matter quickly as any proposed settlement does not need the approval of the administrative law judge.…”