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Introduction to the Securities Laws

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Investors want it, shareholders want it, broker-dealers want it, and so does the government. The only question is: what is “transparency”? In a business context, “transparency” means that a company, particularly one involved in the public markets, is entirely candid with all its constituents in such a way that the company keeps very few or no secrets regarding the health and prospects of the company. In the case of a public company, the SEC requires that a company report a great deal of information – both financial and with regards to business operations – in order to give investors the highest possible level of insight into how the company operates.

Agents through which securities markets and the placement of securities in the hands of investors occurs. While a great deal of the process is automated in today’s world, there is still a need for actual people who act as “market makers” in the sale and trading of securities. Such people are typically known as “broker-dealers.” These people play the dual role of pricing and creating markets for the sale of securities and they act as intermediaries between parties selling and buying a company’s securities.

Overview to the Securities Laws

While much of business law is a state based plethora of regulations and case law, this is not the case with the securities laws. While there are still some state laws with regards to securities offerings, those laws have largely been supplanted by the federal Securities and Exchange Commission Acts. The SEC Acts of 1933 and 1934 (codified as 15 USCS § 77 and § 78 respectively) still remain the law, although they have been modified many times since their passage. The complexity and the extent to which the securities market is interwoven with interstate commerce has led the federal government to take the lead in regulating the manner in which public securities are sold and traded. See 15 USCS § 78b. As such, the bulk of the law that we will be discussing in this chapter is applicable no matter where you are practicing.

A Quick History of the Securities Markets

You no doubt have heard of the “Great Depression” and the stock market crash of 1929 and the resulting financial chaos of the early 1930’s. What you might not know is just what caused the crash. In retrospect, there were probably at least two coinciding factors.

On the one hand, there was the rampant speculation of investors who were making large bets, often with leveraged dollars, on the burgeoning stock market. It was typically the case that these investors were making their investments with little or no actual knowledge of the companies that they were investing in. 

At the same time, lax or non-existent securities laws had allowed all involved in the process – from listed companies to investment bankers to broker-dealers – to create an environment made more of speculation and greed than of financial common sense. Companies were allowed to list securities that had little or no financial value based on shoddy statements about the business. Moreover, the information that was being provided by the companies was largely unsound; based on either rampant speculation or outright lies.

In such an environment, it did not take too long for the house of cards to collapse. In the end, the financial markets, as they were in 1929, were in shambles. Even as the markets started to piece themselves back together in the early 1930’s, the Depression had deepened so severely, and investors were so jaded by their experience in the 20’s, that there was very little return to the markets, which remained stagnant for some time afterwards.

Enter the Securities and Exchange Commission

In response to the financial chaos of the 20’s and 30’s, Congress began investigating ways of rectifying the problems that plagued the financial markets and corporate reporting in general. Thus, they created the Securities and Exchanges Commission (“SEC”), and tasked it with a variety of obligations. Amongst these obligations were the following:

  • Create “transparency” in the securities issuance process. This means requiring companies to provide more information to the investors with regard to the company’s financial health and prospects
  • Organize an effective system of financial reporting
  • Regulate the financial markets including the exchanges, the investment banks and broker-dealers

See Spilker v. Shayne Laboratories, Inc., 520 F.2d 523 (9th Cir. 1975).

All of these tasks, in addition to a variety of others, were rapidly adopted and addressed by the SEC. Over time, the SEC created a body of regulatory law, in addition to a system of administrative courts and proceedings, which laid the foundation for modern administration of the entire field of securities and securities trading. While the times have changed and the entire process has evolved a great deal, the basic laws as originally laid down have remained remarkably unchanged.

In the following sections we will discuss the basic laws that were laid down during the period between the time of the crash and the re-emergence of the securities markets.