Courtesy of Roger Silvers
In a recent study, I investigate cross-border coordination among national securities regulators and its impact on enforcement and financial reporting. The paper provides an in-depth look at the cross-border enforcement program at the U.S. Securities and Exchange Commission (SEC), using publicly available data. The results are consistent with the IOSCO Multilateral Memorandum of Understanding (MMOU) acting as a catalyst that increases the SEC’s ability to pursue cross-border cases, and improves financial reporting as a result of stronger enforcement.
Studies that seek to isolate the economic effects of regulation, enforcement, and new laws often suffer from the criticism that changes in these factors usually arise from market-related failures, cycles, or investor preferences. As a result, observed outcomes (such as changes in enforcement, earnings attributes, liquidity, cost of capital, and ownership structure) may be correlated with regulatory changes but driven by unobserved and unrelated variables. But the creation of the MMOU is an unusual occurrence—a measurable shock to cross-border information flows that is arguably independent of firms, investors, and even the regulators themselves. Implementation of the MMOU was prompted by unusual factors, like the events of 9/11 (not market cycles) and occurred at different times in different countries, thereby allowing the study to draw causal inferences that would otherwise be impossible.
Enforcement efforts that cross national boundaries are curtailed by a lack of jurisdiction. Regulators face confidentiality provisions (e.g., blocking statutes and secrecy laws), dual criminality requirements (which stipulate that assistance can only be rendered if the activities in question are illegal in both jurisdictions), or the need for a foreign regulator to have an independent interest in a matter. And even when cooperation is unimpeded, a lack of competence or legal authority in foreign counterparts can weaken cross-border enforcement.
The MMOU was expressly designed to reduce these frictions by standardizing the protocols for cooperation and information sharing. In addition, IOSCO performs a rigorous review in which applicants must demonstrate that they have the legal authority and competence to comply with the arrangement. Dual criminality requirements, confidentiality provisions, and independent-interest stipulations are not valid reasons for an MMOU signatory to refuse to cooperate. As a result, the MMOU gives the SEC better access to local information from auditors (e.g., work papers), regulators (e.g., depositions and local regulatory correspondence), banks (e.g., account and transaction identification), and third parties (e.g., internet and telephone records, accounts receivable confirmations from local customers, and depositions and testimony from local witnesses). The MMOU can create new capabilities like freezing assets outside a regulator’s jurisdiction.
My study provides a historical perspective on the use of memoranda of understanding at the SEC, starting with the first memorandum, which was with Switzerland, and tracing them to the present (including IOSCO’s MMOU). These arrangements are not legally binding, so it is unclear whether they have significant effects on cross-border enforcement. Interestingly, there is no discernable change in the probability of enforcement due to bilateral arrangements. For this purpose, I have defined enforcement in an economic sense, as interventions by the SEC that aim to correct or punish firms or individuals for, inter alia, misreporting, insider trading, or aiding and abetting other firms in the perpetration of fraud.
However, the probability of enforcement increases dramatically for U.S.-listed foreign firms whose home countries join the MMOU, even after controlling for other factors. A battery of tests reveals that such increases are unique to the precise times and countries when, and where, the MMOU connects the SEC to the home regulator (and not attributable to time trends or other cross-sectional attributes). These results are consistent with the conclusion that the MMOU facilitates the discovery of useful information, reduces investigation costs, and enables future enforcement actions.
These results add to the legal literature on unenforceable arrangements—so-called ‘soft law. Reciprocal cooperation arrangements are proliferating, and several organizations, including IOSCO, contend that formalizing an intent to cooperate is useful despite lacking legal force. My results indicate that these arrangements can yield important changes in cooperation. Prior literature debates not only the use of non-binding arrangements but also the merits of their bilateral versus multilateral forms (Ahdieh 2015). This study is well suited to provide insights about network (multilateral) versus bilateral configurations, because the setting includes both bilateral and multilateral arrangements linking the SEC to various foreign regulators, at different times, yet seeking the same outcomes. I show that multilateral arrangements dominate their bilateral predecessors in generating measurable changes in cross-border enforcement. This implies that network configuration creates more powerful incentives for cooperation than bilateral ones.
Using the dates of MMOU application as staggered shocks to the SEC’s capacity to oversee U.S.-listed foreign firms (meaning that they occur at different times for different countries), my study finds evidence that MMOU-facilitated enforcement affects issuers’ financial reporting choices. More specifically, there is less evidence of earnings management, more timely recognition of losses (conservatism), and a stronger link between accounting outputs and stock prices under the MMOU (implying that they are more useful for valuation and that investors rely more heavily on their content).
In sum, the paper makes four primary contributions: (1) identifying enforcement, (2) providing insight into cross-border enforcement cooperation between regulators (as opposed to enforcement more generally), (3) establishing the existence of, and reasons for, heterogeneity in the effectiveness of soft-law cooperative arrangements, and (4) linking enforcement to earnings properties and thereby reconciling the different findings in prior literature. Other transnational efforts can benefit from leveraging the experience of IOSCO’s attempts to foster cooperation among its members.
Roger Silvers is an assistant professor at the University of Utah, and was an academic fellow for the U.S. Securities and Exchange Commission serving as a senior economist in the Division of Economic Risk and Analysis. His research about cross-border securities enforcement has been presented to over 200 regulators from more than 70 countries around the globe, including workshops at the SEC, plenary addresses at IOSCO’s “Committee 4 on enforcement and the exchange of information meeting” and the SEC’s 28th “Annual International Institute for Securities Market Growth and Development.”