On the Role of Companies’ External Securities Law Advisors – Facilitators or Gatekeepers?

In order to retain their access to large scale capital at low cost, there is no question that companies need to actively manage their compliance with the ever-increasing regulatory requirements in the United States pertaining to corporate disclosure. Managing this obligation isn’t easy and, inter alia, necessitates securities law expertise. In a recent paper, we explore one avenue that companies use to navigate the complexity of disclosure regulation – seeking advice from external securities law experts.

Pursuant to Section 408 of Sarbanes Oxley Act of 2002, the Security and Exchange Commission’s (SEC) Division of Corporation Finance (DCF) enforces disclosure requirements by reviewing the periodic filings of publicly traded companies at least once every three years to ensure the quality and completeness of public company disclosures. Upon review, if a disclosure is found to be deficient, the DCF initiates a dialogue with a company by issuing what are known as comment letters to seek clarification from the company regarding its regulatory filings and/or to request that companies revise their disclosures to conform to SEC disclosure regulations (e.g., Reg S-K, Reg S-X, etc.). We exploit the unique feature that comment letters are publicly disclosed upon resolution after August 2004 and, as such, reveal the parties involved in resolving the disclosure inquiry.

In today’s highly litigious business environment, one may believe that every public company would seek counsel from external securities law experts for whenever the SEC comes knocking. Surprisingly, we find evidence that only 35% of our sample of public companies seek legal advice from external securities law experts when faced with a disclosure inquiry from the SEC. Our empirical results suggest that public companies with less SEC filing experience, greater external scrutiny, higher proprietary costs, and greater litigation risk are more likely to involve external securities law experts. Further, disclosure inquiries that are more complex and less related to U.S. GAAP accounting issues are also more likely to involve securities law experts. As bad news potentially can be more risky and contentious, we find some evidence that companies tend to seek advice from securities law experts more frequently when they reveal bad news consequent to the disclosure inquiry.

Interestingly, we also find that the involvement of external securities law experts appears to influence the outcome of the inquiry. Namely, the presence of external securities law experts is associated with more correspondence between the SEC and the company as well as more requests to redact otherwise publicly available information in those exchanges. We also find that companies are less likely to amend a prior disclosure in response to an SEC inquiry if their securities law expert is among the 100 prestigious law firms ranked by American Lawyer magazine. The impact of external securities law expertise is even greater when experts directly author the comment letter responses.

Overall, we believe the collective body of evidence we present in the paper suggests that external securities law experts on average are not playing a governance or monitoring role to help resolve the SEC inquiry by providing greater transparency. As such, consistent with Hopkins et al. (2015), the evidence largely contrasts the presumed role of the general counsel or a legal expert on the board of directors.[1] Instead, securities law experts seem to aid the company in resisting the inquiry either due to managers explicitly hiring them to do so, or due to lawyers providing advice consistent with facilitating resistance.


[1] Hopkins, J., Maydew, E. and M. Venkatachalam (2015). “Corporate General Counsel and Financial Reporting Quality.” Management Science, 61(1): 129-145.

This post comes to us from Zahn Bozanic, Preeti Choudhary, and Kenneth Merkley, assistant professors from The Ohio State University, Georgetown University, and Cornell University, respectively. The post is based off their co-authored paper entitled “Securities Law Expertise and Corporate Disclosure”, available here. Professor Choudhary is a Senior Research Fellow at the Public Company Accounting Oversight Board (PCAOB) during the 2015-2016 academic year. The views expressed in this blog and the paper do not necessarily reflect the views of the PCAOB, individual board members, or staff of the PCAOB.