An Analysis of Database Challenges in Financial Misconduct Research

Jon KarpoffUniversity of Washington

Allison KoesterGeorgetown University

Scott LeeUniversity of Nevada, Las Vegas

Jerry MartinAmerican University

Databases – misreporting studiesRestatement announcements

GAO – Government Accountability Office AA – Audit Analytics

Securities class action lawsuitsSCAC – Stanford Securities Class Action Clearinghouse

Administrative proceedings & Litigation releases that censure accountants

AAER – Accounting and Auditing Enforcement Releases secondary designation assigned by the SEC

Documenting each database’s features

Create a comprehensive database with:1. All 1,099 cases (includes 10,415 events) for which the SEC

brings an enforcement action for §13(b) violations Books & records and internal control violations (FCPA)

2. Assemble data related to these cases from:• www.sec.gov• www.usdoj.gov• Wolters Kluwer Law & Business Securities electronic library• PACER (court documents)• Lexis-Nexis’ All News and Dow Jones’ Factiva (press releases and articles)

3. Merge in GAO, AA, SCAC, and AAER database events • Which §13(b) violations are included/missed by each database?• What ancillary information is included/missed by each database?

A total of 23 unique event days with specific incremental information about Brocade’s financial misrepresentation

Consider a firm picked up by all 4 databases:Brocade Communications

How can so many dates be relevant?

Jan 6, 2005: Brocade press release (issued after trading hours) announces its 2001-2003 financial statements will be restated due to improper accounting for stock options

Mar 10, 2005: SEC begins an informal inquiry June 10, 2005: SEC begins a formal investigation

Brocade Communications

Brocade makes four restatement announcements…

… a class action lawsuit is filed, and settled 3 years later…

Brocade Communications

… and the SEC issues 15 different Administrative Proceedings and/or Litigation Releases spanning 5 years

Brocade Communications

GAO hits 4 of 23 events AA hits 2 of 23 events

SCAC hits 2 of 23 events

AAER hit rate = 2 of 23 events

Both AAERs relate to the SEC’s censure of two former Brocade executives who are CPAs.

5 Database Features and Brocade1. Initial revelation dates

• GAO and AA identify the initial misconduct date• Brocade’s announcement occurred after the U.S. markets close

• First event in SCAC is 4 months after initial revelation• AAERs are 4 YEARS later

2. Scope limitations• Of 23 events, GAO captures 4, AA, SCAC, and AAER capture 2 each

3. Omissions• Only AA misses “same-type” events (unusual by selection)

4. Multiple events per case• All databases have this

5. Extraneous events• Can’t illustrate with a case chosen because it includes a §13(b)

Focusing on one aspect of a complex event

Number of Cases after Integrating Related Events for each Database

GAO AA SCAC AAER FSREvents Cases Events Cases Events Cases Events Cases Events Cases

In eachdatabase 2,707 2,321 11,001 8,358 3,421 3,116 3,568 1,356 10,415 1,099

Associated with a §13(b) violation

10,415 1,099

Table 2, Panel A

Number of Events and Integrated Cases associated with a §13(b) violation

GAO AA SCAC AAER FSREvents Cases Events Cases Events Cases Events Cases Events Cases

In eachdatabase 2,707 2,321 11,001 8,358 3,421 3,116 3,568 1,356 10,415 1,099

Associated with a §13(b) violation

427 290 239 188 389 346 2,865 939 10,415 1,099

Table 2, Panel A

We are concerned with how these databases perform in describing §13(b) violations

GAO AA SCAC AAER FSREvents Cases Events Cases Events Cases Events Cases Events Cases

In eachdatabase 2,707 2,321 11,001 8,358 3,421 3,116 3,568 1,356 10,415 1,099

Associated with a §13(b) violation

427 290 239 188 389 346 2,865 939 10,415 1,099

Table 2, Panel A

Important: All comparisons refer ONLY to the subset of events and cases in each database associated with a §13(b) violation

Feature #5: Extraneous cases

• NOT suggesting that extraneous events/cases should be omitted from each database

• Documenting the culling process facing researchers who use these databases to study financial misrepresentation

Table 6, Panel A

Omitted cases with at least one same-type event AND a 13(b) violation during the database time period

GAO AA SCAC AAER

Cases identified by the database   290 188 346 939 Cases missed by the database   127 220 36 160Number of cases that should have been identified 417 408 382 1,099

% of cases missed   30.5% 53.9% 9.4% 14.6%

 

Feature #3b: Omitted Cases (during coverage period)

Table 4, Panel B

Feature #2: Scope Limitations

Table 3, Panel B

• NOT suggesting GAO should include all 4,336 events• But, remember the hazard of considering only the “elephant’s tusk”

GAO AA SCAC AAER FSRUsing all event dates per case

identified by the database -7.82% -4.64% -5.61% -7.49% -39.93%

Using all event dates per case identified by the FSR database -50.36% -38.38% -51.41% -44.38% -39.93%

% market reaction is understated using non-FSR database

84% 88% 90% 83% 0%

Economic Magnitude of Features #2 and #3(Scope Limitation and Omissions)

Table 7, Panel B: Mean market-adj. CAR over all event dates identified in each case

Feature #1: Initial revelation dates

Figure 3: Initial Revelation Date, by Event Type

Feature #1: Initial revelation dates

Table 3, Panel A

Lessons1. Financial misconduct cases are complex

2. Scope limitations can affect economic significance inferences• Researchers should look beyond individual databases

3. High event/case omission rates contaminated control samples

4. Ad hoc culling tends to select extreme incidents which yields unrepresentative and biased inferences

5. Financial misconduct is NOT necessarily fraud- 25% of 13(b) violations do NOT involve fraud charges- 50% for AAERs- 90% for securities class action lawsuits and restatement announcements

Thank you