Literature Review: “The Effect of Enforcement Transparency: Evidence from SEC Comment-Letter Reviews”

In recent years, more attention has been given to policies surrounding transparency in financial reporting practices, such as banks disclosing results of stress tests and the recently proposed “Public Accounting Oversight Board (PCAOB) Enforcement Transparency Act of 2017”. In 2004, the SEC began publicly disseminating comment letters in an attempt to increase transparency.

A recent paper, “The Effect of Enforcement Transparency: Evidence from SEC Comment-Letter Reviews”, by Miguel Duro, Jonas Heese and Gaizka Ormazabal, examines the effects that the public disclosure of comment letters has on companies’ financial reporting. The publicly disseminated comment letter research was performed with data from the Audit Analytics Comment Letter database.

Past theoretical research has suggested that publicly disclosing comment letters may increase “market discipline”. Market discipline would increase as management seeks to avoid negative reactions from investors related to SEC comments. It has additionally been theorized that public disclosure may serve to increase “supervisory discipline” throughout the SEC, as regulatory actions of the SEC that previously took place in private, would enter the public sphere and become subject to public opinion.

To explore the extent of the effects that the public disclosure of comment letters has, Duro et al. designed a study exploiting a novel dataset of comment letters issued before 2004 (private reviews) and after 2004 (public reviews) and made comparisons to stock market reactions related to earnings announcements (earnings response coefficients) in time periods before and after the letter was issued.

Their study found that firms produce more informative reports when comment letters are publicly disseminated. For public reviews, there was a 10% increase in earnings response coefficients (ERC) in the 360 days following the start of a SEC review, while there was no change observed in ERC in the 360 days after a private comment letter was issued.

Further tests were performed to examine what factors were present in financial reporting that may result in increased earnings response coefficients pursuant to public reviews. It was found that when comment letters are made public, company filings include longer narratives, have a lower chance of restatements, and there were less discretionary accruals in earnings announcements. Those factors provide a more complete picture of the company’s position, benefitting the company, the SEC, and investors or firms who are concerned with company performance.

The interaction between public reviews and earnings response coefficients was particularly evident with companies that received substantive comments, such as those necessitating longer reviews, as well as with companies whose financial reports are closely monitored by dedicated institutional investors that specialize in monitoring firms. This supports the notion that publicly available comment letters increase market discipline, as company management will exert more effort to quickly resolve, or altogether avoid, SEC concerns that may trigger investors’ concerns. unwanted investor attention.

However, the evidence found in the study did not directly support that the effects of public dissemination are related to supervisory discipline. The results show that when comment letters were made public, the letters were more likely to be shorter and address fewer topics, but this may be affected by other factors, such as the number of SEC supervisors. After the 2004 policy change, the SEC employed more supervisors. As the number of reviews performed is divided by the number of supervisors, supervisors perform fewer reviews, suggesting more attention may be allowed for material issues.

The overall findings of the study by Duro et al. indicate that the disclosure of regulatory oversight activities can complement public enforcement with market monitoring. As Duro et al. note, attempts to increase transparency extend beyond the United States, making it increasingly important to study the effects of public dissemination of regulatory oversight actions.

This paper has previously been reviewed in the Harvard Law School Forum on Corporate Governance and Financial Regulation. The full paper is available for download here.

The Audit Analytics SEC Comment Letter Database has an extensive collection of SEC staff reviews and company responses, indexed according to approximately 2,5000 proprietary issues. For more information on comment letters, or for subscription information, please contact Audit Analytics at (508) 476-7007 or