Securities Exchange Act of 1934

Steven Ramirez

Excerpt from the Securities Exchange Act of 1934

(3) Frequently the prices of securities on such exchanges and markets are susceptible to manipulation and control, and the dissemination of such prices gives rise to excessive speculation, resulting in sudden and unreasonable fluctuations in the prices of securities which (a) cause alternately unreasonable expansion and unreasonable contraction of the volume of credit available for trade, transportation, and industry in interstate commerce, (b) hinder the proper appraisal of the value of securities and thus prevent a fair calculation of taxes owing to the United States and to the several States by owners, buyers, and sellers of securities, and (c) prevent the fair valuation of collateral for bank loans and/or obstruct the effective operation of the national banking system and Federal Reserve System.

(4) National emergencies, which produce widespread unemployment and the dislocation of trade, transportation, and industry, and which burden interstate commerce and adversely affect the general welfare, are precipitated, intensified, and prolonged by manipulation and sudden and unreasonable fluctuations of security prices and by excessive speculation on such exchanges and markets, and to meet such emergencies the Federal Government is put to such great expense as to burden the national credit.

The Securities Exchange Act of 1934 (P.L. 73-291, 48 Stat. 881) was the first federal legislative initiative specifically intended to regulate stock exchanges and publicly held companies that have distributed securities (i.e., stocks and bonds) to the public. The act requires publicly held companies to make periodic public disclosures and disclosures in connection with proxy solicitations. The act also mandates certain disclosures in connection with tender offers for the shares of publicly held companies. Finally, the act regulates trading by certain company insiders and broadly prohibits all fraud in connection with the sale of securities.

With respect to stock exchanges including the National Association of Securities Dealers, which operates the NASDAQ market, or the New York Stock Exchange, the act requires registration and adherence to certain principles of self-regulation to ensure that exchanges operate transparently and fairly. Every securities broker and every securities dealer must be a member of a so-called self-regulatory organization. If either a securities firm or an individual affiliated with a securities firm violates the rules or regulations of the exchange, or the federal securities laws, or just and equitable principles of trade, the law permits the government to impose sanctions. These sanctions can range from fines to censures to permanent barring from the securities industry. The act also includes civil and criminal penalties against those who violate its provisions. The Securities and Exchange Commission (SEC) is the primary regulatory agency that enforces the federal securities laws, including the Securities Act of 1933, and the Securities Exchange Act of 1934.

CONSTITUTIONAL BASIS

Congress promulgated the act under its authority to regulate interstate commerce, pursuant to Article II, section 8 of the U.S. Constitution. The act therefore requires the use of an instrumentality of interstate communication or transportation before it applies. The courts have held that the use of mails or a telephone suffices to meet this requirement, even if the use is completely intrastate.

CIRCUMSTANCES LEADING TO THE ADOPTION OF THE ACT

In the election of 1932, President Roosevelt promised to deliver economic reform in the effort to resolve the Great Depression, an unprecedented economic calamity that ultimately gave rise to an unemployment rate of 25 percent and to a 33 percent contraction of the nation's economy. The Securities Act of 1933 was the first piece of President Roosevelt's New Deal, and Congress enacted it during the first one hundred days of his administration. Nevertheless, President Roosevelt made it clear that more securities regulation was needed, specifically legislation "relating to better supervision of the purchase and sale of all [securities] dealt with on exchanges." The Securities Exchange Act of 1934 was this act, fulfilling the New Deal's promise for systematic securities reform. The New Deal represented the first massive federal regulation of the economy.

The regulation of securities was a natural starting place for the New Deal reforms, as the market crash of 1929 seemed to have triggered the deep economic malaise that became the Great Depression. Roosevelt sought to "bring back public confidence" in the securities markets and was convinced that truthful and full disclosure was essential to this goal. Congress joined in this conclusion, finding that full disclosure would give investors pause before falling prey to panic selling. Regulating the exchanges and publicly held companies is how lawmakers decided to achieve full disclosure, not just when a company first distributed securities, but on an ongoing basis. Congress was convinced that unregulated exchanges meant cycles of booms and terrible depressions when a company is a public traded company. The Great Depression was all the convincing most needed.

Nevertheless, the financial community opposed the act, preferring a more laissez-faire approach to preserve the status quo. One opponent testified to Congress that the act was a conspiracy to take the nation "down the road from democracy to communism." (Davis, 368). Business interests feared the act would lead to government supervision of much of the business sector, and stock exchanges fought hard to maintain their autonomy. Despite this opposition, the Securities Exchange Act passed both houses of Congress with overwhelming support and became law on June 6, 1934.

EXPERIENCE UNDER THE ACT

By 1995 experts widely acknowledged that the American securities markets were the strongest in the world. A large part of this perception rested upon the effectiveness of the Securities Exchange Act of 1934. The act completed the work that Congress started with the Securities Act of 1933, by insuring traders had the ability to make intelligent investment decisions through full and truthful disclosure. The 1933 Act mandated disclosures when companies distributed securities, and the 1934 Act mandated disclosures when a company publicly traded its securities.

Initially the courts were very receptive to the remedial and investor protection goals of the act. In J.I. Case v. Borak (1964), the Supreme Court held that private investors could obtain remedies under the act's proxy disclosure rules. In SEC v. Capital Gains Research (1963), the Supreme Court decided that the terms fraud and deceit, as used in the act with respect to the regulation of securities professionals, must be construed broadly to reach all unjust and unfair practices used by brokers to abuse the trust of their clients. More recently, the Supreme Court held that trading on nonpublic inside information could amount to securities fraud even when the investor did not obtain the information from an officer or director of the issuer of the traded securities. This is known as the "misappropriation theory" of insider trading, adopted in United States v. O'Hagan (1998).

Still, as the decades passed and memories of the Great Depression faded, courts appeared to have become far more skeptical of the act. In Lampf, Pleva, Lipkind, Purpis & Petigrow v. Gilbertson (1991), the Supreme Court greatly restricted the time period for bringing securities fraud claims before they were barred by the statute of limitations. In Central Bank of Denver v. First Interstate (1994), the Supreme Court severely limited the potential liability of attorneys and accountants under the act. It is fair to say that the early twenty-first century Supreme Court is not positively inclined toward private enforcement of the act, although it appears to continue to strengthen government enforcement. In SEC v. Zanford (2002), the Supreme Court upheld the enforcement authority of the SEC against a miscreant broker.

Recent legislative trimming of the act's operation mirrors this judicial pruning. Specifically, in 1995 Congress enacted (over a presidential veto) the Private Securities Litigation Reform Act, limiting class action lawsuits under the act and shifting most enforcement responsibility to the SEC. In 1998 Congress went an additional step, in the Securities Litigation Uniform Standards Act, and preempted class actions based upon state law. The net effect of these two acts was to greatly undermine the efficacy of private litigation as a means of enforcement.

These legislative steps are particularly notable as Congress tends to chronically underfund the SEC, making it difficult for the agency to enforce the securities law. In addition, the SEC lacks one very important element—it has no authority to repay investors for their losses. Moreover, the SEC is certainly not immune from political pressure that may impact agency decisions and lead to a lax approach to law enforcement. Recently, former Chairman Arthur Levitt disclosed that political influence had undermined the SEC's ability to pursue a number of reform initiatives.

The impact of the Securities Exchange Act of 1934 on society has been controversial. The laissez-faire enthusiasts that unsuccessfully opposed the act have succeeded over the past few decades in undercutting the act's efficacy. They maintain, for example, that the market furnishes sufficient incentives for the disclosure of information such that no mandatory disclosure regime is needed. One commentator, however, has recognized that the market did not seem to function in the way these laissez-faire enthusiasts predicted before 1934. This commentator recognized that "[p]ervasive systemic ignorance blanketed Wall Street like a perpetual North Atlantic fog before the New Deal." This suggests that regulation was needed to free up disclosure and to allow markets to operate more efficiently, as investors make more informed decisions. The act, together with the Securities Act of 1933, seems to have enhanced investor confidence as a result.

See also: Securities Act of 1933.

BIBLIOGRAPHY

Davis, Kenneth S. FDR: The New Deal Years. New York: Random House, 1986.

Posner, Richard. The Economic Analysis of Law. New York: Aspen, 1998.

Ramirez, Steven. "The Law and Macroeconomics of the New Deal at 70." Maryland Law Review 62, no. 3 (2003).

Ramirez, Steven. "Fear and Social Capitalism." Washburn Law Journal 42, no. 1 (2002): 31–77.

Ramirez, Steven. "The Professional Obligations of Securities Brokers Under Federal Law." University of Cincinnati Law Review 72, no. 2 (2002): 527–568.

Roosevelt, Franklin D. The Public Papers and Addresses of Franklin D. Roosevelt. New York: Random House, 1938.

Stiglitz, Joseph. Globalization and its Discontents. New York: W.W. Norton, 2002.

Relationship with Other Laws

Steven Ramirez

There are a number of federal securities acts other than the Securities Exchange Act of 1934. The most important of these is the Securities Act of 1933. The Securities Exchange Act of 1934 does not generally regulate the initial distribution of securities like the Securities Act of 1933. The Securities Act of 1933 imposes disclosure obligations upon companies when they are issuing securities.

As previously discussed, for over six decades the federal securities laws, including the Securities Exchange Act of 1934, provided investor remedies that were in addition to any remedies under state law. In 1998, however, Congress reversed this outcome and preempted all class actions under state "Blue Sky" laws, which generally extended investors more generous avenues of recovery than those remaining under the act after the Private Securities Litigation Reform Act of 1995.