Abstract
We examine the impact of the enforcement of financial regulations by the French Financial Market Authority on sanctioned firms. The early stages of the enforcement process are by law confidential, with an internal investigation and bilateral exchanges between the defendant and its regulator. The public hearing by the Enforcement Committee leads to a single publication of the decision, being the only public communication. Using an event study methodology, we find that the confidentiality of the initial steps of enforcement procedures is respected and that markets account for the publication of sanctions. Still, reactions are limited in absolute and relative terms, both compared to past studies and in terms of reputational penalty. Some parameters trigger a stronger reaction, but not the most straightforward (such as the cash fine or behavioral sanction). The results echo the reputation for leniency of sanctions (scarce procedures, lax verdicts, low fines, ending neglected by analysts and investors), despite consecutive regulatory tightenings and long procedures. They question the efficiency of enforcement.
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Sources: AMF, Author
Sources: AMF, Thomson Reuters. Author’s calculations
Sources: AMF, Thomson Reuters. Author’s calculations
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Notes
This gap in the literature can be accounted for by the (increasingly) limited open access to data. Indeed, sanction reports are frequently published anonymized (part of the sanction decision of the Enforcement Committee (AMF EC), i.e. ex ante) or anonymized ex post at the EC AMF Chairman’s discretion. The compounded anonymization rate is 57% (de Batz 2017a, b). Additionally, some dates can be missing in sanction reports. Lastly, in 2018, a regulatory change led to an anonymization of most of the sanctions from 2004 to 2013.
Like in the United Kingdom (UK, Armour et al. 2017). Conversely, in the US, the trigger event can be early communication by the Regulator and/or the defendant.
Sanctions by the AMF suffer from a reputation of being scarce (i.e. low probability of being caught) and lenient (i.e. lax verdicts with low fines). They do not receive a straightforward coverage by the media nor by financial analysts: most identified misconducts are dealt with bilaterally and confidentially between the AMF and the regulated entity. Even the highest sanction in history (35 million euros sentenced in July 2017) did not cast an unequivocal analysis. In fact, financial penalties are low in absolute and relative terms, despite four-consecutive reinforcements of AMF’s enforcement powers since its creation in 2003. For example, the maximum legal fines were repeatedly increased (up to 100 million euros, or 10 times the gains realized for firms, see Table 1). In the end, the translation of sanctions into returns of listed companies is a priori unclear. This marks a sharp difference with other jurisdictions (Anglo-Saxon countries in particular) or with sanctions by other French Regulatory Authorities (such as the Competition Authority).
For example, in Karpoff et al. (2008a), only 8% of the 585 firms received a fine from their regulatory agencies over the period 1978–2002. The mean was 107 million dollars (60 million when excluding an exceptional case).
The (actual or perceived, Garoupa 1999) detection rate by the Regulator (or by other market participants) is low, even though misconducts on financial markets are frequent. The probability of being caught depends on the public expenditures on enforcement, courts, police, etc. They are by nature constrained. No data exists on frauds which went undetected. Bussmann and Werle (2006) estimated, in the global survey, that only 4% of the detected economic crimes were identified by law Enforcement Agencies, most of them being detected by the firms themselves. On average, only 2 to 5% of the American listed companies are investigated per year by the Securities and Exchange Commission (US SEC), according to Cumming and Johan (2013). Drake et al. (2014) stressed that, from 1996 to 2004, out of the 15% of large American publicly traded firms engaged in fraud each year, only 4% are in the end detected.
Similarly, the detection rates for cartels are low, despite being larger in terms of scope and duration. In the US, Bryant and Eckard (1991) estimated the annual probability of being caught for a cartel from 13 to 17%. In Europe, Combe et al. (2008) estimated it from 12.9 to 13.1% from 1969 to 2008, based on European Commission data.
The sanctioned entity can face higher insurance premia, more expensive funding conditions, tougher client relationships, and additional investments to compensate for the demonstrated market failure (IT, process improvements, marketing, and communication, etc.).
Such as Canada, China, France, Germany, Japan, Luxembourg, Malaysia, the Netherlands, and the UK.
This article focusses on the role of dissemination of information of the press, and not on the creation (Drake et al. 2014). The coverage by mass media can alleviate information problems for listed firms (Fang and Peress 2009), in particular for individual investors (Fang et al. 2014). Miller (2006) demonstrated that an accounting fraud is more likely to be echoed in the press for firms which already receive more attention from the press. (Past researches typically conclude with higher market reactions. Rogers et al. (2016) showed that the media plays an economically important role in price formation in securities markets, by widening the dissemination of insider trading disclosures.
A wide range of regulatory breaches can damage one’s reputation: financial fraud, corporate malfeasance (anti-trust violation, bribery, tax evasion, illegal political contributions, employer discrimination, etc.), false or misleading advertising, product recalls, airplane accidents, environmental violations, illicit allegations, etc. Their impacts are typically investigated with an event study methodology.
Accounting and Auditing Enforcement (AAER), US SEC formal or informal investigations, Wells Notice issuance, sanctions, and class action filing.
Lin and Rozeff (1995), for example, demonstrated that 85 to 88% of private information is incorporated into prices within one trading day.
For shorter term reactions, out of an extensive literature review of 55 similar studies (details are available on demand), the following averages for Cumulative Average Abnormal Returns were estimated:
For the most frequently used event window (55% of the sampled studies, most frequently US), \( CAAR_{{\left[ { - 1; + 1} \right]}} = - 7.7\% \), ranging from − 25 up to − 0.5%, with a standard error of 7.6%;
For shorter event windows: \( CAAR_{{\left[ {0; + 1} \right]}} = - 7.6\% \), ranging from − 20.6 up to − 0.7%, with a standard error of 7.6%; \( CAAR_{{\left[ { - 1;0} \right]}} = - 3.2\% \), ranging from − 6.3 up to − 0.8%, with a standard error of 2.3%;
For longer short term event windows ([− 2; + 2], [− 3; + 3], [− 5; + 5], and [− 7; + 7]), \( CAAR_{{\left[ { - {\text{i}}; + {\text{i}}} \right]}} = - 9.4\% \), ranging from − 19 up to − 1%, with a standard error of 7.6%.
These averages are higher with the two past studies on France (\( CAAR_{{\left[ { - 1; + 1} \right]}} = - 1.05\% \) and \( CAAR_{{\left[ { - 1; + 1} \right]}} = - 2.98\% \), not statistically significant), as well as short-term estimates on Europe, the UK, and Germany (− 1.55% in \( CAAR \)).
24 sanctions were made per year on average, to which add 6 settlements per year since 2012, when this new procedure was first concluded. When excluding the 9% acquittals, 94% of the guilty sanctions included a cash fine, for an average 688,320 euros, paid to the French Treasury (or to the guarantee fund to which the professional belongs).
There is neither binding rule nor clear guidelines on how to value fines. Time consistency and the maximums set legally are the two key objective parameters to set a fine, to which add specificities of the respondent (gravity and duration of the financial misconduct(s), financial situation of the defendant, magnitude of the obtained gains or advantages, losses by third parties, etc.). Maximum fines were increased three times over the period under review and can amount up to 100 million euros for market abuses committed by professionals, or 10 times any profit.
(1) Warning and/or blame, depending on the seriousness of the wrongdoing(s); and (2) “ban on activity”, covering temporary or permanent ban on providing some or all services, suspension or withdrawal of professional license, and temporary or permanent ban on conducting some or all businesses.
Most sanctions are published, in particular in recent years, except if such disclosure would seriously jeopardize the financial markets or cause disproportionate damage to the parties involved. The EC decides whether to publish its decision, where to publish it (mostly on the French Official Journal for Legal Notices (BALO) and on the website of the AMF, possibly in a given set of magazines, at their expenses) and whether to anonymize it (entirely or partially).
In the USA a significant share of financial scandals are revealed by the press (Choi and Kahan 2007), associated with a statistically significant impact on prices (Miller 2006).
Conversely, in France, the press is mostly a re-broadcaster of scandal news detected by the regulator (and not a producer of news), hence improving the dissemination of information among actual stakeholders and potential investors and contributing to the efficiency of stock markets (Fang and Peress 2009; Fang et al. 2014).
Law on market abuses of 21, June 2016 (Law no. 2016-819) and Law on transparency, the fight against corruption and modernized business life, of 9, December 2016 (Law no. 2016-1691, IV Art. 42-46)
The main changes include: (1) The maximum fine remains 100 million euros but can stand for up to 15% of the annual turnover for a legal entity and has been increased up to 15 million euros or ten times any profit earned for an individual failing to meet his professional obligations. (2) The ban from activity can now exceed 10 years. (3) The powers of the Enforcement Committee have also been broadened to public offerings of unlisted financial instruments (without prospectus) and to crowdfunding. (4) The scope of regulatory breaches eligible to settlement procedures has been widened to all market abuses (insider dealing, price manipulation and dissemination of false information), and no longer only the failures of regulated professions to meet professional obligations. (5) Finally, any decision published on the AMF website should remain online at least for 5 years (which was already the case), but any reference to personal data should be anonymized after 5 years (which was only partially the case).
Contrary to events such as annual and quarterly publication, or profit warnings. The exogeneity is also supported by the fact that some sanctions were, in the end, excluded from the sample due to confounding events such as the publication of the results from another judicial procedure or M&As.
The results of the event studies are robust when using a market model not adjusted for the sectors, though lower. Detailed results are available in de Batz (2018). Controlling for the sector is supported by the long period under review (2004–2016, including the Great Financial Crisis), and the wide range of sectors of the sanctioned firms.
Equity returns are defined as the daily log difference in value of the equity (including reinvested dividends).
Given the wide range of size of sanctioned companies, the broadest benchmark index for the French stock markets (CAC All Shares) proxies the market portfolio. Euronext main sectors are used for each firm. The 10 main sectors are: financials (38% of the sample); industrials (15%); technology (13%); consumer goods (8%); consumer services (8%); health care (6%); basic materials (6%); telecoms (2%); utilities (2%); oil and gas (2%).
Conversely, in Karpoff et al. (2008a), the reputational penalty equals the expected loss in present value of future cash flows, due to lower sales and higher contracting and financing costs.
AMF classification: insider trading, price manipulation, failure to meet with the information regulatory requirements vis-à-vis investors or the Regulator, failure to meet with professional obligations, proceedings, and takeovers.
Complementary variables were built: the duration of the procedure from ignition to the sanction decision, in years, as in Karpoff et al. (2008b), and the lag between the decision and its publication, in months.
Three dummies were used to control for the impact of the anonymization: anonymized when first published, partial anonymization, and ex post anonymization, at the AMF EC Chairmen’s discretion.
Several variables characterize the appeals: whether the decision was appealed or not by the sanctioned entities, as in Karpoff et al. (2008b); whether the AMF appealed the decision of the AMF EC; the number of courts appealed to; whether the decision was confirmed or not; and the duration of the appeal procedure.
Generally speaking, a focus is made on the individuals within an organization convicted of crime, as recommended by Cohen (1996), either employees (with a principal-agent relationship derived from the employer-employee contract) or top managers. From an investor’s perspective, the top management involvement in a fraud could be particularly detrimental, demonstrating the improper management of the firm and questioning the capacity of the management to handle future challenges. Karpoff et al. (2008b) showed how financial mis-presentation can prejudice careers of top managers: more than 90% of them lose their jobs by the end of the US SEC enforcement procedure.
Recidivism is one of key aggravating factor regularly stated by the AMF to define the size of the sanction. Repeat offenders are sanctioned more severely than first-time offenders.
According to the Euronext classification. The most frequent sectors (dummy variables) are: financial services, industry, consumer goods and services, and technology.
Detailed results and analyses are available on demand or in de Batz (2018).
Euronext is organized around three pillars:
- 1)
The European Union regulated market for equity securities operates in five markets (including Paris). They are segmented by market capitalizations: compartment A (above 1 billion euros), compartment B (from 150 million to 1 billion euros), and compartment C (below 150 million euros).
- 2)
Alternext targets small-and-mid-sized companies by offering a simplified access to capital markets with fewer requirements and less stringent ongoing obligations than on the EU-regulated market.
- 3)
The free market provides the easiest access to capital markets through a direct quotation procedure for any company, whatever the size (from micro-cap to medium-sized international companies) searching to access capital markets (free from the Euronext’s eligibility criteria and information disclosure requirements). This market targets primarily sophisticated or professional investors.
- 1)
In our sample, delisting can be accounted for three main sets of reasons, by decreasing frequency: (1) bankruptcy; (2) mergers or acquisitions with/by another listed company, leading to delisting; and (3) managerial decision to delist due to the regulatory constraints and the legal and financial risks associated, preferring other financing sources (less regulatory constrained). Karpoff et al. (2008a) also found for the US that there is high delisting rate, which reduces massively the size of the sample. The study also stresses that the delisted companies tend to be associated the poorest stock performance over the whole enforcement period.
Given the size of the bank (14 times the average market capitalization of the sample), and its listing on several stock exchanges, any action from the French AMF would unlikely provoke a significant abnormal reaction from global shareholders. Additionally, confounding events could lead to misinterpret the results.
When excluding the 4 sanctions of the major international bank excluded from the sample.
Robustness checks were performed by modifying the length of estimation window (100 and 90 days). The results are not sensitive to such variations. Detailed results are available on demand.
Detailed results are available on demand.
Kirat and Rezaee (2019) concluded with a statistically significant − 0.7% in \( AAR_{0} \) on the day of the announcement of the sanction in the press and a \( CAAR_{{\left[ {- 2;2} \right]}} \) of − 1.7%, with a sample of 47 companies over the period 2004-2017. Djama (2008) found no impact of the beginning of the procedure and a significant negative impact of the publication of the decision (− 6.9% in \( AAR_{0} \) − 8.3% in \( CAAR_{{\left[ {0;1} \right]}} \)), for accounting fraud with a sample of 37 sanctions of 28 listed companies, from 1995 to 2005.
Such as + 2.96% in one-year stock performance following a 1-standard deviation increase in the financial penalty for 20 country panel, in Köster and Pelster (2017).
The maximum was − 34.4% in the US cumulated over the days for which the firms were subject to a regulatory event, in Karpoff et al. (2008a).
As stated by Armour et al. (2017), multi-stage events make it difficult to ensure that the later stages really relate to the original announcement and not to further information that was released during subsequent stages or conversely that relevant information was not released between the reported stages.
Detailed results are available on demand or in de Batz (2018).
First subsample “Average” (19 sanctions): cash fines higher than the average.
Second subsample “3 factors” (19 sanctions) if two out of the three following conditions: a cash fine higher than the median; a disciplinary sanction (warning or blame); and recidivism (pre- and/or post-AMF creation).
Compared to the market capitalizations, to fines by other French Regulatory Authorities, or to international standards. The average abnormal market correction stands for a limited 0.001% of the market capitalization.
32 settlements were signed from 2012 to 2016. A settlement is an alternative and shorter kind of sanction dedicated to the least severe regulatory breaches (until late 2016), subject to an AMF proposal and an acceptance by the firm.
In the US, from 1978 to 2002, the average monetary fines stood for 107 million dollars. In the US, in Karpoff and Lott (1993), the fines stand for 6.5% of the stock losses. In the UK, based on the estimations of Armour et al. (2017), the average fine set by the Regulator amounts to 0.26% of the market capitalization.
Loi de Modernisation de l'Économie (LME, no. 2008-776).
In the case of the industrial sector, the estimations of model 1 over the periods [− 1; 0] and [− 1; + 6] show that the negative contribution is due to some market anticipation, which is more than compensated in the subsequent period.
Derived variables were also tested, as in Armour et al. (2017), such as the natural log of the cash fine or the ratio of the fine to the market capitalization the day before the sanction. The results were also insignificant.
The introduction of the settlements also supports that trend: dedicate more means to sanction the most severe regulatory breaches, by settling for the least serious—though significant—regulatory breaches. Indeed, since a peak in 2009, sanctions have been trending downwards. Sanctions hit a historical low point in 2016 and 2017 (15 per year, comparing with 23 on average per year over the 2004–2018 period), followed by a slight rebound in 2018 (20).
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Acknowledgements
This work did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors. The Author wants to acknowledge the Autorité des Marchés Financiers (AMF) for giving access to regulatory information. Additionally, Catherine Bruneau, Gunther Capelle-Blancard, Cédric Euchenne, Evžen Kočenda, Fabrice Riva, and anonymous referees have to be thanked for their useful feedbacks and support, as well as the wide range of collaborators of the AMF, who accepted to be interviewed.
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de Batz, L. Financial impact of regulatory sanctions on listed companies. Eur J Law Econ 49, 301–337 (2020). https://doi.org/10.1007/s10657-019-09638-1
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DOI: https://doi.org/10.1007/s10657-019-09638-1