Prosecutorial Discretion in Mutual Fund Settlement Negotiations, 2003-7 Eric Zitzewitz * Dartmouth College January 2009 Abstract This paper examines the negotiated settlements of 20 market timing and late trading cases, comparing the restitution obtained for shareholders with an estimate of shareholder dilution. This restitution ratio varies from 0.04 to 5, or from 0.1 to 10 if penalties are included. While some of this variation is explained by differences in the defendants’ conduct, controlling for this, settlement negotiations that involved New York as well as the Security and Exchange Commission (SEC) resulted in restitution ratios that were higher by a factor of 5-10. An analysis that uses the firms’ headquarters location and customers’ state of residence as instruments for New York’s involvement suggests that this difference is causal, and not the result of New York involving itself in cases likely to lead to large settlements. Given the much larger staff and institutional expertise of the SEC, it is likely that these differences in outcomes are due to differences in effective aggressiveness, not prosecutorial resources. Differences in aggressiveness are consistent with popular conceptions of the regulators’ career concerns, as well as with theories of industry focus and regulatory capture. JEL Codes: K32, L51, H77, G28, K42 * Associate Professor of Economics, Dartmouth College, 6016 Rockefeller Hall, Hanover NH 03755. Tel: (603) 646-2891. Email: eric.zitzewitz@dartmouth.edu . The author would like to thank Cindy Alexander, Kenneth Arrow, Severin Borenstein, Jeremy Bulow, Elizabeth Casscio, John Chalmers, John Coffee, Stefano DellaVigna, David Dubofsky, James Freyer, Robert Hall, Eric Helland, Michael Herron, Michael Kremer, Jon Reuter, Nancy Rose, Richard Ruback, Bruce Sacerdote, Richard Schmalensee, Carl Shapiro, Christopher Snyder, Steven Tadelis, Peter Tufano, Matthew White, Justin Wolfers, and seminar participants at Berkeley, Dartmouth, Stanford, the 2008 American Law and Economics Association meetings, the 2008 Claremont Securities Fraud Ligitation conference, the 2009 ASSA meetings, and the 2008 IDC-Caesarea Center Finance conference for helpful discussions and comments. I also thank Charles Biderman of TrimTabs and Andrew Clark of Lipper for sharing data and for helpful conversations about their data. Over the last seven years, I have consulted, usually on a short-term basis, for many types of entities with an interest in these cases, including state and federal regulators, mutual fund firms, plaintiffs’ and defense attorneys, litigation consulting and accounting firms, and a fair value pricing service, and I have benefited from conversations with many anonymous individuals. 1