RELATIVE RISK REVISIONS AND SEC SCRUTINY

Abstract

I examine whether feedback from the stock market has a real effect on the Securities and Exchange Commission’s (SEC) decisions in the filing review process. In other words, does the SEC learn from market feedback? I find that the SEC is more likely to issue risk factor-related comment letters when revisions in investors’ assessed risk relative to revisions in firms’ disclosed risk (hereafter, “relative risk revisions”) are higher. Additional tests indicate that this association is concentrated in firms whose stock prices contain more new information and in firms that the SEC is likely to focus on. Falsification tests indicate that alternative explanations do not account for this learning effect. This evidence corroborates the potential mechanism through which market feedback influences the SEC’s real decision in the filing review process. Additional tests suggest that relative risk revisions are associated with firms’ future negative operating and capital market outcomes, justifying the SEC's scrutiny. Moreover, firms receiving risk factor-related comment letters as a result of the SEC’s learning reveal a decrease in relative risk revisions the following year, attributable to reduced investor risk assessment revisions and increased firm risk factor disclosure. Overall, the evidence suggests that the SEC learns from information embedded in stock prices, improving the filing review process.