14.2 The Framework of Securities Regulation

The 1934 Securities Exchange Act reshaped financial markets after the 1929 crash. It created the SEC to oversee securities trading, curb fraud, and boost transparency. The Act's key provisions aimed to restore investor trust and ensure fair, honest markets.

Public companies face strict reporting rules under SEC oversight. They must file detailed financial statements, disclose material events, and follow insider trading regulations. These requirements help investors make informed decisions and maintain market integrity.

Historical Context and Regulatory Framework

Context of 1934 Securities Exchange Act

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• Enacted in response to 1929 stock market crash and Great Depression
  • Crash exposed widespread fraud, manipulation, lack of transparency in securities markets (insider trading, misleading financial statements)
• Purpose was to restore investor confidence, prevent fraudulent practices, ensure fair and honest markets, require disclosure of important information
• Key provisions created Securities and Exchange Commission (SEC) to oversee and regulate securities industry
  • Required companies to register securities with SEC before offering them for sale to public (initial public offerings)
  • Prohibited certain types of market manipulation (pump and dump schemes) and insider trading
  • Established periodic reporting requirements for public companies (annual reports, quarterly financial statements)

Securities Act of 1933

• Preceded the 1934 Act and focused on primary market transactions
• Established disclosure requirements for companies issuing new securities
• Required registration of securities offerings with the SEC

Securities and Exchange Commission (SEC)

Structure and functions of SEC

• Independent federal government agency responsible for enforcing federal securities laws and regulating securities industry
• Composed of five commissioners, including chair, appointed by President and confirmed by Senate
  • Commissioners serve staggered five-year terms, no more than three from same political party
• Primary functions include interpreting and enforcing securities laws, issuing rules and regulations
  • Oversees inspection of securities firms, brokers, investment advisors, ratings agencies (Moody's, Standard & Poor's)
  • Oversees private regulatory organizations in securities, accounting, auditing fields (Financial Industry Regulatory Authority)
  • Coordinates U.S. securities regulation with federal, state, foreign authorities (Department of Justice, state securities regulators)
• Organized into five main divisions
  • Corporation Finance reviews registration statements, periodic reports
  • Investment Management regulates investment companies (mutual funds), investment advisers
  • Trading and Markets oversees major securities market participants (stock exchanges, broker-dealers)
  • Enforcement investigates and prosecutes civil cases for violations of securities laws (including securities fraud)
  • Economic and Risk Analysis provides economic analysis to support SEC rulemaking, enforcement actions

Reporting and Registration Requirements

Reporting requirements for public companies

• Public companies must register securities with SEC before offering them for sale to public
  • Registration requires filing registration statement, including prospectus with detailed company information (business operations, financial statements, risk factors)
• Must file periodic reports with SEC to keep investors informed
  • Annual reports (Form 10-K) provide comprehensive overview of business, audited financials, management discussion and analysis
  • Quarterly reports (Form 10-Q) provide unaudited financials, updates on operations
  • Current reports (Form 8-K) disclose material events or corporate changes between annual and quarterly reports (mergers, acquisitions, changes in executive management)
• Must comply with proxy rules when soliciting shareholder votes
  • Proxy statements filed with SEC and provided to shareholders, disclosing information on matters to be voted on, company management and compensation
• Insider trading and beneficial ownership reporting
  • Company insiders (officers, directors, large shareholders) must report transactions in company securities to SEC (Forms 3, 4, 5)
  • Beneficial owners (owning more than 5% of company's stock) must report holdings to SEC (Schedule 13D, 13G)
• Directors and officers have a fiduciary duty to act in the best interests of shareholders