Partisan Regulatory Actions

Partisan Regulatory Actions 

July 3 | By Vivek Pandey

Professor Vivek Pandey presents evidence that the SEC treats firms differently based on political ideology. 

It’s no secret that Americans are more politically divided than ever. Intense political polarization has crept into every corner of society—even those we once assumed were free of partisan influence.

In “Partisan Regulatory Actions: Evidence from the SEC,” my co-authors and I turn our attention to the U.S. Securities and Exchange Commission to find out how the country’s top financial regulator—the “top cop on the beat”— is faring in this hyper-partisan climate.

We hoped that as independent watchdogs, SEC regulators would show few signs of partisan influence when initiating enforcement actions and issuing fines. 

To uncover the truth, we analyzed SEC investigations launched into firms for a variety of violations against securities laws, such as insider trading, financial fraud, market manipulation, and misleading statements. While details on ongoing investigations are not public, data on closed investigations are obtained through FOIA (Freedom of Information Act) requests to the SEC. When investigations result in an enforcement action, SEC publicly releases information on the enforcement actions taken in response to alleged legal violations. 

The scope of our research encompasses over 2100 unique S&P 1500 firms, 2200 investigations, and 800 AAERS between 2001 and 2021.

Below, I summarize five takeaways from the paper:

1)    There is strong evidence that the SEC treats firms differently based on political ideology. 

The SEC has five Commissioners who are appointed by the President with the consent of the U.S. Senate. Five-year terms are staggered so that one Commissioner’s term ends every year, although a Commissioner can serve up to 18 more months after their term expires if they have not yet been replaced. Importantly, many Commissioners have party affiliations, and as a rule, three out of five commissioners cannot be affiliated with the same party (for those without an official party affiliation, we assume party of the appointing President). If the majority of the Commissioners are Republican, we label that year a Republican year in our analysis. If it is Democrat, it is a Democratic year. 

On the firm side, we look at CEO’s individual campaign contributions to determine which way they lean (for a smaller sample, we also use voter registration records to identify CEO’s party). The firm itself will likely donate to both sides out of strategic necessity, so we find that a CEO’s individual contributions offer a better marker of partisan leaning. 

In our research, we discovered a clear difference in how the SEC treats firms that are aligned with the agency (defined by the party of three out of five commissioners) versus firms that are misaligned. 

2)    The SEC is more likely to launch an investigation against a firm that is misaligned with the agency’s political ideology. 

We discovered that misaligned firms are 0.8 to 1 percentage point more likely to become the target of an investigation than other firms. One percentage point may not seem like a lot, but it amounts to a 16% higher likelihood of being investigated than an average firm.

3)    Political misalignment does not affect the likelihood of an AAER.

In better news, we discovered that misaligned firms are equally likely to be named in an AAER (Accounting and Auditing Enforcement Release, a common type of enforcement action for accounting or disclosure related violations) compared to other firms, even though they are more likely to be investigated. 

4)    Once named in an AAER, misaligned firms face harsher penalties. 

While top leadership (Commissioners) are political appointees, the vast majority of SEC staff— who initiate and pursue investigations and provide recommendation for type and severity of penalty to issue to a firm—are not. Common penalties include fines, restitution to harmed investors, bars and suspensions, administrative penalties, and referral to the Department of Justice for criminal prosecution. The commissioners receive that recommendation and vote on whether to bring an enforcement action, and if yes, which penalties to impose. Our research demonstrates that the monetary penalties are more severe for firms that are misaligned. When the SEC has more partisan Commissioners (those with party affiliations, and/or who were appointed by a President whose party also controlled the Senate at the time of appointment), our results are even stronger. We find that Commissioners who preside over more partisan actions go on to reach higher levels of leadership in public and private sector after leaving the SEC, creating a powerful incentive to come down on perceived political opponents with greater force. 

5)    Non-political appointees demonstrate no less bias than political appointees. 

We found some of the strongest partisan influence on the investigation side, even though investigations are initiated and conducted by non-political bureaucrats, not political appointees. These bureaucrats, while not explicitly partisan, perceive partisanship at the top of their organization and respond accordingly. They anticipate that by pursuing actions that align with the preferences and priorities of SEC Commissioners, they will advance in their own careers. Indeed, we find that attorneys at SEC offices that bring more partisan enforcements are more likely to be promoted. The tone from the top percolates downward. 

The Bottom Line

Our research presents evidence of partisanship within the SEC from top to bottom—a finding that is relevant to the investors the SEC is charged with protecting, the companies it monitors, and the taxpayers who fund it. The findings we have uncovered point to potential waste of public resources. In directing excessive resources toward investigating ideologically misaligned firms, it may be directing inadequate resources toward potential financial misconduct by other firms.
While these are not the results we would hope to find in an independent agency, not all is lost. Political affiliation did not impact the likelihood of AAER enforcements, indicating that some checks and balances exist. Partisanship has seeped into the SEC, but it is not untrammeled partisanship. And the more it becomes known, the more likely it is to be addressed. Despite their own political inclinations, Commissioners do not want to be seen as compromised in their decision-making, at least not to the public. The picture is far from rosy, but it leaves room for hope. 

Vivek Pandey is an assistant professor of accounting at Simon Business School. 

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