How undisclosed SEC investigations lead to insider trading

In November 2019, The Wall Street Journal reported that the Securities and Exchange Commission was investigating Under Armour, a Baltimore-based maker of footwear, sports and casual apparel. Though the investigation had begun more than two years earlier, the company had not disclosed the fact that regulators were looking into its accounting practices. On the day the story broke, Under Armour’s shares fell by 19%. Clearly, the market’s reaction showed that investors believed this was relevant information and material to their perception of the shares’—and the company’s—value. 

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Should companies like Under Armour go public sooner about the fact that the SEC is investigating them? If so, when is the right time to disclose such potentially damaging information? And before the company makes the disclosure, do insiders — who may or may not be direct targets of the probe — gain an unfair advantage in being able to sell shares before the information hits the market?

Daniel Taylor, a professor of accounting at Wharton, and his co-authors—Terrence Blackburne of Oregon State University; John D. Kepler of Stanford University; and Phillip J. Quinn of the University of Washington—investigated these questions and more in their research paper titled, “Undisclosed SEC Investigations.” The researchers reviewed data obtained from the SEC on every formal investigation between 2000 and 2017, which was previously not public, to come up with their findings.

“Back in January 2016, the Southern District of New York had a case in front of it, Lionsgate Entertainment, which went all the way through the court system. The ruling was that corporations are not under any obligation to disclose SEC investigations or receipt of a Wells Notice. The court held that “the defendants did not have a duty to disclose the SEC investigation and Wells Notices because the security laws do not impose an obligation on a company to predict the outcome of investigations. There is no duty to disclose litigation that is not ‘substantially likely to occur,’” explains Taylor. 

“That was surprising to me.”

Read more at Knowledge@Wharton.