Regulatory Interventions in Response to Non-Compliance with Mandatory Derivatives Disclosure Rules

We investigate regulatory actions in response to violations of mandatory derivatives disclosure rules (SFAS 161) and the outcomes of such regulatory interventions using a hand-collected sample of derivatives disclosures. Derivatives are used by nearly two-thirds of U.S. non-financial firms, and they are one of the most complex types of financial contracts. Consequently, inadequate derivatives disclosures could pose significant challenges to financial statement users in assessing the risk and financial health of enterprises. First, we document that firms with high proprietary costs and agency costs are less likely to comply with SFAS 161. Next, by examining derivatives-related SEC comment letters (CLs), we further show that such non-compliance significantly increases the likelihood of receiving a CL. We also find that the CL resolution process is longer for firms with strong proprietary motivations than for those with strong agency incentives. Finally, we find that compliance with regard to derivatives disclosures following the CL resolution improves for firms with high agency costs, but not for firms with high proprietary costs. Collectively, our results imply that when derivatives-related proprietary costs are high, benefits of non-compliance likely outweigh the costs. Moreover, the SEC’s review effectiveness depends crucially on whether firms’ initial motivation for non-compliance is proprietary versus agency