The Legal Penalties for Financial Misrepresentation

We examine the sizes, types, and determinants of legal penalties imposed for all 1,050 enforcement actions for financial misrepresentation involving firms with publicly traded equity securities from 1978 through July 2011. These penalties include private class action awards, monetary penalties imposed by the Securities Exchange Commission, Department of Justice, and state Attorneys General and non-monetary sanctions such as censures, trading suspensions, and jail time. The legal penalties are highly systematic, and in particular, indicate deep pockets and legal mandates effects, as both private lawsuit awards and regulatory monetary penalties are related to defendants’ abilities to pay and the changes in laws and enforcement initiatives. Private monetary penalties are positively related to the size and severity of the harm from the misconduct. Controlling for other factors, private and regulatory monetary penalties are positively related to each other as are regulatory penalties and sanctions implying that regulatory penalties complement, rather than crowd-out private penalties and sanctions. Private penalties are also positively related to factors that regulators use to encourage and reward cooperation presenting a “damned if you do, damned if you don’t” dilemma. We also show that the Sarbanes-Oxley Act of 2002 failed to increase the assessment of regulatory penalties while simultaneously decreasing private monetary awards – perhaps an unintended consequence.

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