Return and Liquidity Response to Fraud and SEC Investigations

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This study measures the long-run costs and benefits associated with fraud and securities enforcement actions by examining the changes in market quality of firms that are investigated by the Securities and Exchange Commission for fraud. The market quality measures we test include returns, price volatility, spreads, and illiquidity. We find a significant deterioration of market quality following the market’s discovery of the misconduct. We also find that during periods in which the SEC is actively investigating the firm daily returns and price volatility improves while spreads widen and liquidity declines. Our work highlights some of the benefits and costs of having an active regulator over US securities markets.