Unwanted SEC Attention and Voluntary Disclosure

Abstract

We examine whether and how management alters their voluntary disclosure practices consequent to SEC investigative attention. We assert that management will attempt to manage the message portrayed to its stakeholders and the SEC through the firm’s voluntary disclosure practices in order to reduce the likelihood of adverse outcomes. We expect that management will be advised through its legal counsel to include a greater (reduced) amount of hedging and/or cautionary (optimistic and/or prospective) language in its disclosures, since doing so might provide greater protection from regulators and litigants who may allege that investors were misled by management. We find that investigation firms increase (decrease) the amount of hedging and/or cautionary (optimistic and/or prospective) language in their disclosures, and that most of the disclosure changes happen early in the investigation. We find some evidence of an increase in litigious disclosure and a decrease in disclosure optimism when either a firm discloses it is under SEC investigation or it is subject to media scrutiny during the investigation. In terms of investigation revelation, we find that most disclosure changes occur around the time of initial revelation, and that those changes are driven more so by the firm’s initial revelation than the media’s revelation. In examining the sequence of revelation, we find that the majority of disclosure changes occur around the firm’s initial revelation, not the media’s revelation. Lastly, we find that a comprehensive disclosure strategy reduces the likelihoods of SEC enforcement actions and Section 302 material weaknesses. Our study contributes to the voluntary disclosure and regulatory enforcement literatures by showing how heightened regulatory attention can shape firms’ voluntary disclosure practices.