United States securities regulation

The SEC was created by the Securities Exchange Act of 1934 to enforce the Securities Act of 1933.[3] The SEC oversees several important organizations: for example, FINRA, a self-regulatory organization, is regulated by the SEC. FINRA promulgates rules that govern broker-dealers and certain other professionals in the securities industry. It was formed when the enforcement divisions of the National Association of Securities Dealers (NASD), FINRA, and the New York Stock Exchange merged into one organization. Similarly, the Securities Investor Protection Corporation (SIPC) is overseen by the SEC.[1]

Seal of the U.S. Securities and Exchange Commission

All brokers and dealers registered with the SEC under 15 U.S.C. § 78o, with some exceptions, are required to be members of SIPC (pursuant to 15 U.S.C. § 78ccc) and are subject to its regulations.[4]

The laws that govern the securities industry are:[5]

1. Securities Act of 1933 – regulating distribution of new securities
2. Securities Exchange Act of 1934 – regulating trading securities, brokers, and exchanges
3. Trust Indenture Act of 1939 – regulating debt securities
4. Investment Company Act of 1940 – regulating mutual funds
5. Investment Advisers Act of 1940 – regulating investment advisers
6. Sarbanes-Oxley Act of 2002 – regulating corporate responsibility
7. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 – regulating trade, credit rating, corporate governance, and corporate transparency
8. Jumpstart Our Business Startups Act of 2012 – regulating requirements for capital markets

The federal securities laws govern the offer and sale of securities and the trading of securities, activities of certain professionals in the industry, investment companies (such as mutual funds), tender offers, proxy statements, and generally the regulation of public companies. Public company regulation is largely a disclosure-driven regime, but it has grown in recent years to the point that it has begun to dictate certain issues of corporate governance.[3]

State laws governing issuance and trading of securities are commonly referred to as blue sky laws and mostly deal with fraud and fraud investigation privileges, registration of securities, and registration of broker-dealers. In general, states allow injunctions to stop businesses from potentially fraudulent activity and states give broad investigative power, generally to the attorney general, to investigate fraudulent activity.[3]

Securities regulation came about after the stock market crash that occurred in October 1929.[3] Before the Wall Street Crash of 1929, there was little regulation of securities in the United States at the state and federal level. An economic depression followed the Wall Street Crash of 1929, which motivated President Franklin Roosevelt to create laws regulating securities transactions during his famous "first 100 Day” period of his New Deal.[6] Congress discovered that the stock market crash was largely due to problems with securities transactions, including the lack of relevant information about securities given to investors and the absurd claims made by the sellers of securities in companies that did not even exist yet. This lack of information lead to a disclosure scheme that requires sellers of securities to disclose pertinent information about the company to investors so that they are able to make wise financial decisions. The crash spurred Congress to hold hearings, known as the Pecora Commission, after Ferdinand Pecora.[3]

Crowds outside New York Stock Exchange after Wall Street Crash of 1929

Prior to the Securities Act of 1933, securities were mainly regulated by state laws, which are also known as blue sky laws. After the Pecora hearings, Congress passed the Securities Act of 1933 prescribing rules for the interstate sales of securities, and made it illegal to sell securities in a state without complying with that state's laws. This statute broadly defines a security as “any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest, or participation in any profit-sharing agreement.” In simpler terms, a security is a medium of investment that creates a certain level of financial obligation.[3] The statute requires a publicly traded company to register with the U.S. Securities and Exchange Commission (SEC). The registration statement provides a broad range of information about the company and is a public record. The SEC does not approve or disapprove the issue of securities, but rather permits the filing statement to "become effective" if sufficient required detail is provided, including risk factors.[7] The main objective of the act was to eliminate information gaps with two methods: first, companies were required to give investors financial and other pertinent information about the securities offered, and second, Congress disallowed fraudulent information and other misinformation in the sale of securities.[5] The company can then begin selling the stock issue, usually through investment bankers.

The following year, Congress passed the Securities Exchange Act of 1934, to regulate the secondary market (general-public) trading of securities. Initially, the 1934 Act applied only to stock exchanges and their listed companies, as the name implies. In the late 1930s, it was amended to provide regulation of the over-the-counter (OTC) market (i.e., trades between individuals with no stock exchange involved). In 1964, the Act was amended to apply to companies traded in the OTC market.[5] Overall, these first two statutes served to regulate the exchange of securities, require the disclosure of information, and inflict consequences on individuals that do not disclose information properly, whether it be intentional or erroneous. These laws were the first of many to rebuild investor confidence and protection.

The government continues to reform security regulation. In October 2000, the SEC issued the Regulation Fair Disclosure (Reg FD), which required publicly traded companies to disclose material information to all investors at the same time.[8] Reg FD helped level the playing field for all investors by helping to reduce the problem of selective disclosure. In 2010, the Dodd–Frank Wall Street Reform and Consumer Protection Act was passed to reform securities law in the wake of the financial crisis of 2007–2008.[9] The most recent regulation came in the form of the Jumpstart Our Business Startups Act of 2012 which worked to deregulate capital markets to reduce cost of capital for companies.[5]

Over the years the courts formed United States securities case law. Some notable decisions include the 1988 decision by the Supreme Court of the United States in Basic Inc. v. Levinson, which allowed class action lawsuits under SEC Rule 10b-5 and the "fraud-on-the-market" theory, which resulted in an increase in securities class actions. The Private Securities Litigation Reform Act and the state model law Securities Litigation Uniform Standards Act was a response to class actions.[10]

Congress has amended securities acts many times. The Holding Company Act and the Trust Indenture Act in particular have changed significantly since they originally passed. The titles of securities acts, including the year of original enactment, are the so-called "popular names" of these laws, and practitioners in this area reference these statutes using these popular names (e.g., "Section 10(b) of the Exchange Act" or "Section 5 of the Securities Act"). When they do so, they do not generally mean the provisions of the original Acts; they mean the Acts as amended to date. When Congress amends the securities laws, those amendments have their own popular names (a few prominent examples include Securities Investor Protection Act of 1970, the Insider Trading Sanctions Act of 1984, the Insider Trading and Securities Fraud Enforcement Act of 1988 and the Dodd-Frank Act). These acts often include provisions that state that they are amending one of the primary laws. Other laws passed since then include Private Securities Litigation Reform Act (1995), Sarbanes–Oxley Act (2002), Jumpstart Our Business Startups Act (2012), and various other federal securities laws.[11]

Although practitioners use popular names to refer to federal securities laws, these laws are generally codified in the U.S. Code, which is the official codification of U.S. statutory law. They are contained in Title 15 of the U.S. Code: for example, the official code citation for Section 5 of the Securities Act of 1933 is 15 U.S.C. section 77e. Not every law adopted by Congress is codified because some are not appropriate for codification: for example, appropriations statutes are not codified. There are also extensive regulations under these laws, largely made by the SEC. One of the most famous and often used SEC rules is Rule 10b-5, which prohibits fraud in securities transactions as well as insider trading. Interpretations under rule 10b-5 often deem silence to be fraudulent in certain circumstances. Efforts to comply with Rule 10b-5 and avoid lawsuits under 10b-5 have been responsible for a large amount of corporate disclosure. Due to the frequent use of the 10b-5 rule, codification becomes both efficient and necessary.[11]

The Securities Act of 1933 has a broad definition for "securities" including notes, bonds, security futures, treasury stock, certification of interest, and much more. The United States Supreme Court heard several cases to define exactly what encompassed a "security".[2] The Supreme Court has used the Howey test to define what securities are since its decision in the 1946 SEC v. W. J. Howey Co. case. The Howey test defines securities as investment contracts that involve investment of money or property, in a common enterprise, with profits coming from the sole efforts of people other than the investor.[12] With that definition there are several exemptions, both in types of securities that are regulated and transactions that are regulated.[13] This is a significant test because it determines whether or not certain transactions qualify for SEC registration and adherence to disclosure rules. In 1946, the Supreme Court determined three parts to this test that qualifies a transaction as an investment contract:[14]

1.     There is an investment of money or assets

2.     The investment is in a common enterprise

3.     There is a reasonable expectation of profits (or assets) and reasonable reliance on the efforts of others

Since the 1933 Act registration requirements can be very complex, costly, and take a lot of time to complete, many people look for alternative ways to sell securities. There are securities exemptions and transaction exemptions that do not require registration with the SEC, but the issuers of these security transactions are still liable for any fraud that may occur. Securities exemptions include insurance policies, annuity contracts, bank securities, United States government issued securities, notes/drafts with a maturity date less than nine months after the issue date, and securities offered by nonprofit (religious, charitable, etc.) organizations. Transaction exemptions include intrastate offerings (Rule 147), private offerings (Rule 506, Regulation D), small offerings (Regulation A; Rules 504 & 505), and resale of restricted securities (Rule 144).[3]

The no-action letter is a tool to reduce risk and ensure the SEC will not take action in a given situation. Prior to a transaction an individual can apply for a no-action letter with the SEC outlining exactly what the individual plans to do. The SEC can then grant the request by sending a letter promising to take no legal action if the individual acts as indicated in the letter. This letter is not binding to state commissioners, but commissioners generally follow the Federal precedent set by the SEC. Often no-action letters are acquired before performing a transaction or security exemption.[3]

• Financial regulation
• Securities commission
• Securities market participants (United States)

• The Securities and Exchange Commission Official site
• The Securities Law Home Page
• Introduction to the Federal Securities Laws
• The Securities Compliance Index