14.2 The Framework of Securities Regulation - Business Law I Essentials | OpenStax (2024)

The Securities Exchange Act of 1934

In 1929, the United States stock market crashed and lost $25 billion, which would be approximately $319 billion today. The Stock Market crash of 1929 was one cause of the American Great Depression of the 1930s, which caused the failure of nearly half of American banks and created unemployment rates of almost 25 percent by 1933. These dire economic conditions created the need for breadlines, quite literally, hungry people who waited in line at charitable and government organizations for loaves of bread, and shanty towns, or areas where families who had lost their homes lived in cloistered tents on the outskirts of cities. Farmers could not even afford to harvest their crops.

14.2 The Framework of Securities Regulation - Business Law I Essentials | OpenStax (1)

Figure 14.3 Florence Owens Thompson and her children were living on frozen vegetables and birds they killed in this famous photograph taken in 1936 in California. (Credit: Dorothea Lange/ wikimedia/ License: Public Domain)

It was amid this social and economic unrest that Congress passed the Securities Exchange Act of 1934. Signed by President Franklin D. Roosevelt, the Securities Exchange Act of 1934 recognized that the stock market crash of 1929 was caused by wild speculation, large and sudden fluctuations, and manipulations involving securities. An article in the 1934 California Law Review described the condition of the market at the time by writing, “Artificial prices of securities were the rule rather than the exception.… The result was vast economic power, with all that implies in a democracy, in the hand of men whose ethical standards were substantially those of gangsters.”

Roosevelt wanted to enact legislature to try to prevent this wild speculation in securities from happening again and to restore the public’s faith. He recognized that stock market crashes would not only destroy wealth in securities markets, but they were also instrumental to the financial security of the nation as a whole. The passing of the Security Exchange Act of 1934 was not only a reaction to the market crash, but it also represented a broad shift in the social and economic paradigms and legal frameworks of the United States. Previously, the United States had largely followed a laissez-faire economic policy. Laissez faire, as popularized by Scottish economist Adam Smith and British philosopher Herbert Spencer, describes an economic philosophy that markets function best when left to their own devices, i.e., without, or with minimal, government involvement or regulations. The rejection of laissez faire was part of a larger social shift that opposed the long hours, unsafe working conditions, and child labor that had become commonplace as a result of the Industrial Revolution.


Section 4 of the Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) to enforce its ongoing mission. The SEC is an independent agency of the United States federal government. It regulates securities laws and regulations. The first chairperson of the SEC was Joseph P. Kennedy, the father of President John F. Kennedy. The SEC is led by five presidentially appointed commissioners and has five divisions: Division of Corporation Finance, Division of Investment Management,Division of Trading and Markets, Division of Enforcement,and Division of Economic andRisk Analysis.

The SEC also oversees self-regulatory organizations (SROs), or private organizations that create and enforce industry standards. These organizations are allowed to “police” themselves, but are subject to compliance with SEC regulations. The various well-known securities exchanges such as the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotation System (NASDAQ), and the Chicago Board of Options are SROs. Per Section 12(g), companies with total assets exceeding $10 million and with 500 or more owners of any class of securities must register with the SEC unless they meets exemption requirements.

The SEC makes new laws in response to emerging technologies. For example, Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012 was added, and in it, Section 4(a)(6) allows crowdfunding, or raising small amounts of money from many people to fund a venture or project, usually over the internet. Crowdfunding transactions are exempt from registration as long as the amount raised does not exceed $1,070,000 in a 12-month period.

Secondary Markets

The Securities Exchange Act of 1934 governs secondary markets, or what is typically referred to as the “stock market.” In contrast to the primary market, which involves the initial sale of a security, such as through an initial public offering (IPO), secondary markets involve subsequent buyers and sellers of securities. One key difference is that primary market prices are set in advance, while secondary market prices are subject to constantly changing market valuations, as determined by supply and demand and investor expectations. For example, when Facebook initiated its IPO in May of 2012, the price was $38 per share, and technical issues on the NASDAQ complicated the offering. After the IPO, the stock traded sideways, meaning that it stayed within a range that did not indicate strong upward or downward movement. However, Facebook has gone on to trade at values more than four times its initial IPO valuation, due to investor beliefs and expectations. Not all stocks go up in value after their IPO; some vacillate between highs and lows and frustrate investors with their unstable valuation swings.

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Figure 14.4 Stocks on the secondary market fluctuate in value. (Credit: 3844328/ pixabay/ License: CC0)

Reporting Requirements

The Securities Exchange Act of 1934 created numerous reporting requirements for public companies. The purpose of these requirements was transparency, that is, keeping the public up to date and informed of changes that might impact securities prices. Public companies with securities registered under Section 12 or that are subject to Section 15(d) must file reports with theSEC. Section 12 requires the registration of certain securities and outlines the procedures necessary to do so. Information required by Section 12 includes the nature of the business, its financial structure, the different classes of securities, the names of officers and directors along with their salaries and bonus arrangements, and financial statements. Section 15 requires brokers and dealers to register with the SEC. Individuals who buy and sell securities are considered traders, and therefore, are not subject to filing under Section 15. Section 15(d) requires registered companies to file periodic reports, such as the annual Form 10-K and the quarterly Form 10-Q. These reports will be explained in detail in the next section of this chapter. The SEC Commission makes these reports available to all investors through the EDGAR website to help them make informed investment decisions.

Registration Requirements

The Securities Act of 1933 required companies initiating securities offers and exchanges to register with the SEC, unless they met exemption criteria. Section 5 of the Securities Exchange Act of 1934 built upon this foundation and made it unlawful to transact on unregistered exchanges and specifically extended this regulation to the usage of the mail and interstate commerce. 15 U.S. Code § 78fstates that exchanges must not only register with the SEC, but they must also have rules that “prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest …”

Blue Sky Laws

When the Securities Exchange Act is discussed, blue sky laws are often mentioned. In 1911, Kansas bank commissioner J.N. Dolley became concerned about what he called “swindles,” in which investors at the time lost money by investing in “fake mines” or “a Central American plantation that was nine parts imagination.” Therefore, he lobbied for the first “comprehensive” securities law in the United States because, as he phrased it, these investments were backed by nothing except the blue skies of Kansas. So, state-level securities laws aimed to combat fraud are called blue sky laws. The SEC does not have jurisdiction over activities within states and does not enforce blue sky laws.

14.2 The Framework of Securities Regulation - Business Law I Essentials | OpenStax (3)

Figure 14.5 In addition to the Securities Exchange Act of 1934, blue sky laws provide an additional state-level layer of legal protection for the public. (Credit: Elia Clerici/ pexels/ License: CC0)

As an expert in financial regulation and securities markets, I've dedicated years to studying the intricate workings of the systems that underpin our economy. My expertise extends from the historical foundations of securities laws to the contemporary applications of regulatory frameworks. Let's delve into the concepts outlined in the article you provided:

Securities Exchange Act of 1934 (SEA): This landmark legislation was enacted in response to the devastating effects of the 1929 stock market crash and the ensuing Great Depression. The SEA aimed to regulate the securities industry and restore public confidence in the financial markets. Key provisions of the act include the creation of the Securities and Exchange Commission (SEC), which oversees securities laws and regulations, and the imposition of reporting requirements on public companies to ensure transparency.

Securities and Exchange Commission (SEC): Established by the SEA, the SEC is a federal agency responsible for enforcing securities laws and regulations. It consists of five commissioners appointed by the President and oversees various divisions, including the Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, Division of Enforcement, and Division of Economic and Risk Analysis. The SEC plays a crucial role in maintaining the integrity and fairness of the securities markets.

Self-Regulatory Organizations (SROs): These are private organizations, such as stock exchanges, that establish and enforce industry standards under the oversight of the SEC. Examples include the New York Stock Exchange (NYSE), NASDAQ, and the Chicago Board Options Exchange. SROs play a vital role in regulating securities trading and ensuring compliance with SEC regulations.

Jumpstart Our Business Startups (JOBS) Act: Enacted in 2012, the JOBS Act aimed to facilitate capital formation for small businesses and startups. It introduced provisions such as Regulation Crowdfunding (Title III), which allows companies to raise funds from individual investors over the internet without undergoing the traditional IPO process, provided certain conditions are met.

Secondary Markets: These are markets where existing securities are bought and sold among investors, as opposed to primary markets where new securities are issued. The SEA regulates secondary markets to ensure fair trading practices and transparency. Prices in secondary markets are determined by supply and demand dynamics and investor expectations, leading to constant valuation fluctuations.

Reporting Requirements: Public companies are required to disclose financial and operational information to the SEC regularly to ensure transparency and protect investors. These requirements include filing annual reports (Form 10-K) and quarterly reports (Form 10-Q), as well as disclosing information about corporate governance and executive compensation.

Registration Requirements: Under the SEA, companies offering securities for sale must register with the SEC, unless exempted. Registration ensures that investors receive adequate information to make informed investment decisions and protects against fraudulent activities. Exchanges where securities are traded must also register with the SEC and adhere to regulatory standards.

Blue Sky Laws: These are state-level securities laws aimed at preventing fraud and protecting investors from unscrupulous practices. The term "blue sky" originated from a Kansas banker's description of worthless investments as backed only by the "blue skies of Kansas." While the SEC oversees federal securities regulations, blue sky laws provide additional protections at the state level.

By understanding these concepts and their historical and regulatory significance, one gains a comprehensive understanding of the Securities Exchange Act of 1934 and its impact on financial markets and investor protection.

14.2 The Framework of Securities Regulation - Business Law I Essentials | OpenStax (2024)
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