What’s the Harm of Corporate Scandals?

In our experience, one of the primary reasons that whistleblowers come forward to report possible securities violations (and the reason that many attorneys like us chose to devote our professional lives to representing whistleblowers) is concern about the harm that financial misconduct causes. In some cases, this harm is easy to perceive and measure: shareholders may watch their hard-earned investments plunge in value, while innocent employees who played no role in the misconduct may find their livelihoods jeopardized.

Now, a recent study by two finance professors from the University of Minnesota and the Stockholm School of Economics provides empirical evidence that corporate scandals cause another type of harm, which is harder to quantify yet still deeply destructive: a loss of investor confidence in the stock market. The study, Corporate Scandals and Household Stock Market Participation, sought to determine how corporate scandals affect investor confidence by examining whether ordinary “household” investors changed their investment patterns following the revelation of corporate fraud in their home state (the theory being that investors would more likely become aware of a local scandal). The authors found “unambiguous evidence that household stock market participation decreases… following corporate scandals in the state where the household resides.” Moreover, they concluded that corporate scandals cause household investors to decrease their stock holdings not just in “fraudulent” companies – i.e. companies implicated in a corporate scandal – but also in “non-fraudulent” companies.

This study is enormously significant because it confirms what many of us working in the securities field have long believed based on logic and anecdotal evidence: that securities fraud hurts not only the directly-affected investors, but also the markets as a whole. This is a crucial message not just for investors and investor advocates, but also for public corporations, broker-dealers and investment managers, all of whom financially benefit from robust stock market participation. As this study underscores, stopping securities fraud and corporate scandals is not about impeding business: it’s about protecting investors and, in so doing, protecting the markets themselves.
By Jordan Thomas and Vanessa De Simone