In new research, William Christopher Gerken, Steven Irlbeck, Marcus Painter and Guangli Zhang track the movements of Securities and Exchange Commission-associated smartphone devices to shed light on the SEC’s investigatory process and understand how office visits from its staff alter firm behavior and outcomes.
The Securities and Exchange Commission plays a crucial role as the watchdog of Wall Street by detecting financial misconduct and enforcing securities laws, but much of its investigative process has remained opaque to researchers and the public. Historically, research on the SEC relied solely on outcomes of enforcement cases that led to a fine or legal action. Researchers have recently made progress in this area by analyzing formal investigation outcomes regardless of legal action, but this still does not allow us to gauge the extent of interaction between firms and the SEC outside of formal investigations. In a new paper, we “watch the watchdogs” by building a geospatial database that allows us to uncover unprecedented insights into the SEC’s monitoring of public firms.
Anonymized smartphone data
We can shed light on the SEC’s investigative process by identifying smartphones that spend significant time during working hours at the SEC headquarters and regional offices. Data from users who agree to share their location with smartphone applications are aggregated and anonymized by commercial data vendors. We can then pair this data with other data to distinguish devices that are associated with the SEC from devices connected with other entities. As the figure below illustrates —using Atlanta as an example —we can then track when these SEC associated devices visit the headquarters of publicly traded firms. During our sample, which ran from January 2019 to February 2020, we find that 17% of the 2,342 firms within one kilometer of 11 regional SEC offices and the SEC headquarters in D.C. received at least one visit from an SEC-associated device.
Descriptive Findings of SEC monitoring
Using our nationwide database of SEC monitoring activity, we document four key descriptive findings:
- The majority of SEC visits (84%) to company headquarters occur outside of formal investigations, suggesting there is substantial monitoring and information-gathering that is not captured in previously used SEC databases.
- Firms that are larger and have a history of SEC enforcement actions against them are more frequently visited by SEC devices.
- SEC visits often cluster within industries, consistent with the agency’s use of industry “sweeps” to shape market behavior.
- SEC-associated devices frequently visit firms outside their home region, indicating monitoring is not strictly bound by geographic constraints.
SEC visits, stock price reactions, and insider trading
What happens to a firm’s stock price when the SEC visits? On average, it drops between 1.4 percent and 1.94 percent in the three months after a visit relative to the overall market. The drop is much greater when the visited firm is involved in an enforcement action, but we continue to see a drop for firms with no enforcement action against them. This price drop could be explained by several factors, including sophisticated investors obtaining news of the visit or the visit leading the firm to correct questionable accounting practices.
The presence of a regulator at firm headquarters presents a dilemma for firm insiders who own shares in the company. There is a strong incentive to sell when the SEC visits, as the officer could avoid abnormal losses. However, the SEC visit could also prompt firm insiders to shape up as it increases awareness that they are being scrutinized by the watchdog.
Our analysis finds evidence consistent with both of these incentives. On average, firm insiders are 16% less likely to sell shares in the firm in the two week surrounding a visit from an SEC-associated device. However, those that do sell avoid substantial losses. As Figure 2 shows, a firm insider who sells shares around a visit avoids three-month abnormal losses of nearly 5 percent. We also show that sales by firm insiders and opportunistic insiders tend to be followed by the most substantial price drops.
Implications of our findings
Our study illuminates previously unexplored interactions between regulators and public firms, offering new insight into the SEC’s monitoring practices. Our use of geospatial data that exclude any information that could identify someone allows us to document that many interactions between the SEC and firms happen outside of formal investigations. The material impact of SEC visits raises questions about what constitutes material information and whether firm insiders should be restricted from trading around these visits. Collectively, our results further our understanding of how regulators interact with public firms and highlights the importance of watching the watchdogs.
Authors’ Disclosures: the authors reports no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
This article first appeared on Columbia Blue Sky on September 26.
