SEC Investigations and Securities Class Actions: An Empirical Comparison

• Date: 01 March 2016
• DOI: http://doi.org/10.1111/jels.12096
• Author: A. C. Pritchard,Stephen J. Choi
• Published date: 01 March 2016

SEC Investigations and Securities Class

Actions: An Empirical Comparison

Stephen J. Choi and A. C. Pritchard*

Using actions with both an SEC investigation and a class action as our baseline, we compare

the targeting of SEC-only investigations with class-action-only lawsuits. Looking at measures

of information asymmetry, we find that investors in the market perceive greater

information asymmetry following the public announcement of the underlying violation for

class-action-only lawsuits compared with SEC-only investigations. Turning to sanctions, we

find that the incidence of top officer resignation is greater for class-action-only lawsuits

relative to SEC-only investigations. Our findings are consistent with the private

enforcement targeting disclosure violations at least as precisely as (if not more so than)

SEC enforcement.

I. INTRODUCTION

Critics of securities class actions (e.g., Rose 2008) commonly contrast those suits, which

are frequently dismissed, with SEC enforcement actions, which typically settle at the

same time as they are filed. According to those critics, the high dismissal rate for class

actions suggests a scattershot approach and that the SEC is superior to plaintiffs’ lawyers

in targeting disclosure violations. Critics of class actions argue that more precise target-

ing of suits by the SEC yields a stronger deterrent punch for SEC enforcement relative

to class actions. If one assumes that: (1) targeting significantly affects deterrence, and

(2) the SEC could maintain the precision of its targeting if the agency were allocated

greater resources, it follows from this argument that shifting enforcement dollars to the

*Address correspondence to A. C. Pritchard, University of Michigan School of Law, 625 S. State St., Ann Arbor,

MI 48109-1215; email: acplaw@umich.edu. Choi is Murray and Kathleen Bring Professor of Law, New York Uni-

versity; Pritchard is Frances and George Skestos Professor of Law, University of Michigan.

We appreciate helpful comments and suggestions from three anonymous referees, Heather Bracken, John

DiNardo, Merritt Fox, Sara Gilley, Joe Grundfest, David Marcus, James Park, Un Kyung Park, and Randall

Thomas, as well as participants at a Fawley Lunch at the University of Michigan Law School, the 15th Annual

Conference of the Vanderbilt Law & Business Program, the First Annual Workshop for Corporate & Securities

Litigation at the University of Illinois, the Center for Law, Business and Economics Colloquium at the University

of Texas School of Law, the McCarthy Tetrault Workshop at Western University, the American Law & Economics

Association Annual Meeting, and a workshop hosted by Cornerstone Research for helpful comments on earlier

drafts. We are particularly grateful to Cornerstone Research for assisting us with collecting the data on SEC inves-

tigations and enforcement actions used here. Pritchard wishes wish to acknowledge the generous support of the

William W. Cook Endowment of the University of Michigan.

27

Journal of Empirical Legal Studies

Volume 13, Issue 1, 27–49, March 2016

government enforcement would yield a bigger deterrent impact for the marginal dollar

spent (Bratton & Wachter 2011).

In this study, we attempt to shed light on a key premise of this argument—the rel-

ative precision of private and public enforcement in targeting disclosure violations. We

think that critics contrasting securities class actions and SEC enforcement actions may

be comparing apples to oranges. The comparisons ignore a critical institutional detail:

SEC enforcement actions are brought only after the SEC has done a substantial investi-

gation, aided by the SEC’s subpoena power, which yields cooperation from defendants

even when not explicitly invoked. By contrast, plaintiffs filing securities class actions can-

not seek discovery from defendants while a motion to dismiss is pending, so plaintiffs

must rely almost exclusively on publicly available information, which explains the high

dismissal rate.

Instead of looking solely at filed SEC enforcement actions, we compare SEC inves-

tigations with class action suits against public companies. The ultimate goal of both SEC

enforcement lawyers and plaintiffs’ attorneys is to uncover and sanction fraud. We rec-

ognize that class action attorneys and SEC attorneys face different incentives, which

might affect their targeting of suits and investigations. The profit incentive for class

action attorneys is well known. In contrast, the SEC works to maximize the number of

cases brought, penalties, and media attention. In a recent speech, the SEC’s Director of

Enforcement trumpeted that “we filed 755 actions last year—the most ever filed in the

history of the Commission. And we obtained orders for over $4 billion in monetary sanc-

tions—nearly 20% larger than our previous high.”

1

We take those incentives as a given,

and compare the targeting decisions of class action lawyers and the SEC that flow from

them. We conjecture that the SEC and plaintiffs’ attorneys have roughly the same access

to information when they begin an investigation or file a class action suit. We also com-

pare public and private enforcement at later stages in the proceedings: (1) SEC formal

investigations and class actions that have survived a motion to dismiss and (2) settled

SEC enforcement actions and settled class actions.

To facilitate our comparison, we split our cases into three categories: SEC Only,

Class Action Only, and Both. SEC Only involves investigations of public companies only

by the SEC. Class Action Only involves filings against public companies only by private

plaintiffs’ attorneys. Both involves both an SEC investigation and a class action. Using

these three categories allows us to assess the targeting precision of both the SEC and

private plaintiffs’ attorneys.

We compare the relative precision of targeting by the SEC and plaintiffs’ lawyers

using three market-based metrics of information asymmetry: changes in earnings

response coefficients, institutional ownership, and the bid-ask spread. Prior work sug-

gests that these measures correlate with the market’s perception of the likelihood of

fraud. We also examine the decisions of corporate boards to terminate CEOs and CFOs

in response to SEC investigations and class actions. We argue that boards have access to

1

Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting (Nov. 21,

2014), available at: http://www.sec.gov/News/Speech/Detail/Speech/1370543515297.

28 Choi and Pritchard