Is Investor Protection the Top Priority of SEC Enforcement?

Stavros Gadinis a Post-Graduate Fellow at Harvard Law School has published a paper: Is Investor Protection the Top Priority of Sec Enforcement? Evidence from Actions Against Broker.

Recent financial collapses have focused policymakers’ attention on the financial industry. To date, empirical studies have concentrated on corporate issuer activity, such as securities offerings and class actions. This paper makes a first step in studying SEC enforcement against investment banks and brokerage houses. This study suggests that the SEC favors defendants associated with big (listed) firms compared to defendants associated with smaller firms through two channels. First, the SEC is more likely to choose administrative rather than court proceedings for big-firm defendants, controlling for types of violation and levels of harm to investors. Second, within administrative proceedings, big-firm employees are likely to receive lower sanctions, notably temporary or permanent bars from the industry. To explain this gap, the paper first investigates whether big-firm violations are qualitatively different from small firms’ violations, but finds no support for this. This paper instead finds tentative support for the hypothesis that SEC officials favor prospective employers, as big firms headquartered in desirable locations receive lower sanctions.

Unfortunately, he does find a correlation.

“The analysis shows that, for the same violation and comparable levels of harm to investors, a big-firm defendant is on average 75% less likely than a small-firm defendant to end up in court rather than in an administrative proceeding, facing a higher likelihood of being banned from the industry as a result. More importantly, among cases that the SEC assigns to administrative proceedings, big-firm defendants are 60% more likely than small-firm defendants to receive no industry ban, controlling for violation type and harm to investors. The gap between big and small firms persists when limiting the analysis to the individual employees of such firms, who should not be shielded by public policy considerations potentially prevalent when the SEC considers enforcement against a large broker-dealer firm.”

Stavros offers the “revolving door” theory as a tentative explanation for the difference. Although, he has no basis for offering this explanation.

There could be many reasons for the difference in treatment. Larger firms could be better represented, with their legal team steering them towards a better result.

I have not gotten deep in the data to see if there are weaknesses in the way he categorized harms and treatment. I encouraged you to take a look at the study and let me know what your thoughts are.

Thanks to David Zaring for pointing out this paper in The Conglomerate.


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