Following the onset of the Great Depression, our country was forced to re-evaluate the way the stock market operated. Realizing the need for an arm of the government to oversee our capital markets, the Securities and Exchange Commission was created in 1934. In its role, the federal body’s goal is to ensure a competitive yet fair marketplace that’s run in a smooth fashion. To help achieve this goal over the years, the SEC has launched myriad investigations into companies and their business and reporting practices.
These investigations are launched for all sorts of reasons, but one thing seems to have held true, at least in the fairly recent past: that SEC investigations, whether informal or formal, tend to have some seriously gravitational affects on stock prices in the near and potentially long term.
Evidence of near-term underperformance
A study in 2005 by The Leonard N. Stern School of Business showed that a company’s market share declined, on average, by 6.18% and 6.23% respectively following the announcement of an informal or formal investigation. It also displayed that the stocks typically under-performed the market for the following three months as uncertainty surrounding emerging information maintained its grasp. However, following those initial three months, the stocks tended to regress toward the mean, leading them to outperform the market. Data was compiled from over 240 informal and formal investigations from 1998 to 2003.
The latest victim
For a while now, talk has surrounded Linn Energy LLC (NASDAQ:LINE)‘s hedging strategy and the way it was handled from an accounting point of view. While a select group warned of potential misrepresentation, others seemed to overlook this fact in favor of a distribution which ranked near the top of its industry. These hedging strategies and their representation are now directly under the SEC’s microscope with Linn Energy LLC (NASDAQ:LINE)’s distribution payments and acquisition of Berry Petroleum hanging in the balance. As a result, the past two days have been especially hard on investors with the stock down over 31%. Like Linn Energy LLC (NASDAQ:LINE), many others have come under SEC investigation in the past, and their subsequent performance has been more than lackluster:
Better watch your book
Ebix Inc (NASDAQ:EBIX), an insurance software company, has been under investigation since last November but had denied these allegations initially. Just 13 days ago, an acquisition deal was called off by an arm of Goldman Sachs after further investigations were announced by the U.S. Attorney for the Northern District of Georgia. The stock reacted to the announcement by dropping 44% and 13% in the two days following as investors sold off. This reaction is justified in the fact that the probe surrounds alleged accounting misconduct.
