Setting speed limits on financial reporting and clinical trial disclosures

Above: Professor Cheng Qiang, Dean of the SMU School of Accountancy, delivering the welcome address at the ‘Tri-University Accounting Research Conference’

By Flora Teoh

SMU Office of Research & Tech Transfer – From the movie The Wolf of Wall Street that detailed the corrupt practices in stockbroking, to the 2008 financial crisis that arose in large part due to questionable lending practices by banks, we get a glimpse of how financial misconduct profoundly affects the lives of ordinary people when it goes unchecked.

In a more recent case, the United States Securities and Exchange Commission (SEC) uncovered in 2015 a serious conflict of interest at multinational bank JPMorgan Chase, which had favoured its own costlier investment products over external funds and failed to inform clients of this preference. Together, these examples illustrate the importance of strong regulatory oversight on companies’ financial dealings.

However, what happens when regulators themselves become part of the entities that they regulate? This issue was examined in detail at the ‘Tri-University Accounting Research Conference’ on 13 April 2019, held at the Singapore Management University (SMU). The conference provides a platform for faculty members to discuss their research and establish collaborations across the three universities.

A total of six papers were presented by faculty from SMU, the National University of Singapore and Nanyang Technological University on diverse subjects ranging from the effect of terrorism on national reputation to how proprietary information influences CEO turnover. Professor Cheng Qiang, Dean of the SMU School of Accountancy, delivered the welcome address at the conference, which was followed by a networking dinner at CHIJMES.

Providing companies an edge in financial reporting

Above: Assistant Professor Samuel Tan from the School of Accountancy presenting his paper titled “Individual Lawyers, the SEC Revolving Door, and Comment Letters”

In the morning session, Assistant Professor Samuel Tan from the SMU School of Accountancy presented a paper titled “Individual Lawyers, the SEC Revolving Door, and Comment Letters”. Co-authored with Assistant Professor Michael Shen from the National University of Singapore, the paper examined whether former SEC employees were more likely to obtain a favourable outcome for their current employer during an SEC process known as the comment letter.

“Comment letters are part of the SEC's process of reviewing companies’ filings. The importance of this process can be summed up in the SEC’s own writing: it is done ‘for the protection of investors’,” explained Professor Tan. “The comment letter process can involve requests by the SEC to improve disclosures or enhance compliance with laws,” he said.

By comparing the comment letter process between companies that retained lawyers who formerly worked with the SEC, and those that retained lawyers without an SEC background, the researchers found that outcomes linked to former SEC lawyers ranged from taking a longer time to resolve comment letters to a reduced likelihood of implementing changes in the company's financial reports.

“Lawyers who formerly worked at the SEC help their clients put up more resistance and secure better outcomes when dealing with the SEC’s comments on their financial reports,” noted Professor Tan.

The findings by Professor Tan and Professor Shen show how the human element adversely impacts financial reporting. “We demonstrate how relationships between SEC employees and former SEC lawyers could lead to a systemic weakening of the comment letter process, which could have negative consequences for financial reporting,” said Professor Tan.

Clinical trials come under increased scrutiny

Above: Assistant Professor Yin Wang from the School of Accountancy presenting his paper titled “The Real Effects of Clinical Trial Disclosures” 

Similar to the financial industry, the pharmaceutical industry is another industry under heavy scrutiny: while companies are expected to be upfront about a drug’s adverse effects, they ultimately hold all the cards and may choose to withhold information detrimental to drug sales, risking patients’ lives.

This was the case with Vioxx, a painkiller developed and marketed by Merck & Co. in 1999, which was linked to an undisclosed side effect of an increased risk of heart attacks. Vioxx was withdrawn from the market in 2004, but not before causing coronary heart disease in at least 80,000 patients, of whom it is estimated at least 38,000 died.

Following this scandal, the US Food and Drug Administration (FDA) implemented the FDA Amendments Act (FDAAA) in 2007, which mandates companies to register their clinical trials on the website ClinicalTrials.gov and publish their findings within a year of trial completion.

In the afternoon session of the conference, Assistant Professor Yin Wang from SMU’s School of Accountancy presented a paper titled “The Real Effects of Clinical Trial Disclosures”, co-authored with Professor Thomas Bourveau from Columbia University and Professor Vedran Capkun from HEC Paris.

Their study, which was strongly motivated by the Vioxx scandal and the FDAAA, investigated how a regulatory change in the pharmaceutical industry could produce a reduction in information asymmetry in both capital markets and the general public. Increased information disclosure would lead to economic and social benefits for investors and patients, they hypothesised.

“There is a growing stream of literature in accounting that examines the real effects of mandated corporate disclosures on both capital and product markets,” explained Professor Wang.

Examining the pharmaceutical industry through this lens, Professor Wang and co-authors first analysed the capital market responses through the bid-ask spread (a measure of information asymmetry) among 145 pharmaceutical companies compared to other unaffected companies before and after the FDAAA came into force in 2007. They found reduced information asymmetry post-FDAAA implementation, indicating that the new regulation enabled investors to gather timely information about the results of clinical trials.

The authors also observed an increased number of adverse event complaint reports to the FDA as well as drug and medical device recalls for affected firms after the FDAAA was implemented, which they attribute to enhanced public monitoring and access to clinical trial information.

“The FDAAA regulatory change provides a setting to investigate the plausibly causal relation between disclosure requirement and reduction of information asymmetry,” said Professor Wang. “We show that while the FDAAA is a legal requirement with low enforcement and compliance, there are still some benefits to be derived from its implementation for both investors and the general public.”

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