Regulatory spillover effects in OTC markets

We assess a recent SEC initiative that suspends inactive shell companies from trading in over-the-counter (OTC) stock markets. Critics argue these suspensions do little to reduce fraud in OTC markets because they simply redirect fraudsters’ efforts to other OTC targets. Building on research that finds regulatory intervention among exchange-listed firms often produces positive spillovers, we test whether shell company suspensions are associated with fraud deterrence among other OTC firms operating within the same regulatory jurisdiction as the suspended firm. We find that the SEC’s shell company suspensions are associated with a significant reduction in fraud among peer firms, particularly over short horizons. We find that “reactive” trading suspensions—those that are an explicit response to alleged cases of wrongdoing—also have significant fraud deterrence effects. Overall, our results suggest that regulatory spillover effects previously documented in highly regulated markets also exist in a market characterized by relatively low regulation and disclosure.