SEC Overload Impairs Enforcement

A recent study published in The Accounting Review delves into the repercussions of the Security and Exchange Commission’s (SEC) workload on its investigative and penalty-issuing capabilities. The research sheds light on how the SEC’s heavy workload acts as a significant constraint, hindering its ability to initiate new investigations and levy penalties on companies under scrutiny.

For the first time, researchers were able to measure the SEC’s caseload across its regional offices, thanks to a recent Freedom of Information Act request for SEC records. The study, titled “Wearing out the Watchdog: The Impact of SEC Case Backlog on the Formal Investigation Process,” analyzed all SEC investigations into companies between 2000 and 2017. The article is authored by Samuel Bonsall from The Pennsylvania State University, along with Eric Holzman and Brian Miller from Indiana University.

Holzman explains, “Following notable oversights such as Enron and Madoff, the SEC attributed its failure to investigate to being overburdened and understaffed. We sought to determine how the workload of the SEC’s regional offices affected their ability to scrutinize firms suspected of misreporting through enforcement investigations.”

The researchers began by establishing the number of ongoing formal investigations or workload at each of the SEC’s twelve regional offices on a month-to-month basis. They found that the average workload per SEC regional office was 226 ongoing investigations.

Using company restatements of financial statements as a starting point, the research team examined whether the SEC was less likely to open a new investigation into a restating company if the assigned regional office was busier than usual just before the restatement. They discovered that 15% of restatements in the study led to a formal SEC investigation into the company, with investigations typically commencing around three months after the restatements.

Miller adds, “Our findings indicate that recent increases in case backlogs at the SEC’s regional offices reduced the likelihood of the assigned regional office or any other office initiating an investigation into a restating firm. Furthermore, heavier workloads at the investigating office decreased the likelihood of the SEC resolving the investigation with an enforcement action.”

Holzman points out an unexpected finding, stating, “Contrary to investor expectations, a busier SEC office was less likely to investigate restatements associated with significant drops in share price. This suggests that investigating high-harm company restatements, which may be more challenging, becomes more burdensome when the SEC’s workload is heavier.” The study also found that heavier workloads were linked to lower SEC penalties and fewer instances of the SEC requiring changes to a restating company’s board of directors.

Holzman concludes, “Further research should explore whether increased SEC funding, more flexible hiring policies, or other measures could alleviate the impact of large case backlogs on the initiation and resolution of SEC investigations.”