It goes without saying that free-wheeling auditors prefer to keep their distance from the Securities and Exchange Commission. But now a new study suggests that the benefit of staying away from the SEC may be literal as well as figurative.
Auditors located farther away from the SEC’s 11 regional offices are less independent from their clients, because they feel less likely to get “caught” and punished for misdeeds, according to the study, by Mark Lefond of the University of Southern California, Jere Francis of the University of Missouri, and Xuesong Hu of the University of Oregon.
Thus, the authors find, geography does indeed seem to matter when it comes to SEC enforcement.
“To paraphrase an ancient Chinese proverb, the mountains are high and the SEC Regional Office is far way,” the authors write. For auditors situated nowhere near an SEC regional offices, being “far away” implies a perceived freedom from regulation.
The findings pertain particularly to non-Big Four audit firms, which tend to have less consistency in their audit quality.
Analyzing more than 8,000 enforcement releases from 2004 through 2008, the authors conclude that auditors who work closer to SEC offices are more aware of regulations, and more sensitive to the costs associated with breaking rules. The average distance between the SEC regional offices and auditors’ offices in the study was 256 kilometers. For audit firms that were punished during this time period, their average driving distance from an SEC regional office was just 180 kilometers.
“Proximity to a SEC Regional Office increases the probability of being investigated by the SEC,” the authors write.
The theory begins to unravel a bit when it comes to the Northeast, which benefits — or suffers, depending on one’s perspective — from greater oversight from the SEC’s headquarters in Washington, D.C., and from being smaller than other regions.
That anomaly reveals a “mother ship” phenomenon of sorts. Mirroring the effect of regional offices on auditors, SEC regional offices feel the regulatory pull of the agency’s main office.
“SEC Regional Office personnel in close proximity to the D.C. headquarters may have greater awareness of the monitoring role played by the D.C. headquarters,” they write. That “provides greater incentives for the SEC regional offices that are in closer proximity to the D.C. headquarters to more closely monitor companies and auditors in their regions.”
Thus, the moral for auditors looking to compromise their independence is a simple one: Keep your distance from the SEC — and especially from the center of its power.