Government Protections Against Stock Market Abuses

Government Protections Against Stock Market Abuses
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  • 0:01 SEC
  • 0:58 Fraudulent Accounting
  • 2:27 Insider Trading
  • 3:30 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Lombardo
Companies are monitored and policed by the Security and Exchange Commission in order to protect stockholders against market abuses. In this lesson, you will learn how the SEC prevents insider trading and fraudulent accounting.

SEC

Who protects stockholders from unethical business conduct? In this lesson, we will explain how the government protects against stock market abuses, such as fraudulent accounting and insider trading. Fortunately, there are some safeguards in place to help protect stockholders and their interests. The Securities and Exchange Commission's (SEC) mission is to protect stockholders' rights and ensure ethical activities by corporations.

The Securities and Exchange Commission was formed in 1934 as a result of the stock market crash and the need to protect investors' interests. You can view the SEC as a government superhero agency out to protect against corporate financial evil. Let's take a look at two areas stockholders are specifically concerned about: fraudulent accounting and insider trading. Both of these unethical practices can hurt stockholders' investments.

Fraudulent Accounting

The SEC has recently spent more time ensuring that companies provide accurate and transparent financial information to stockholders due to numerous financial crises, such as Enron. The elimination of fraudulent accounting, or falsifying an accounting document for financial gain, allows stockholders to make more informed decisions about their investment practices.

By law, stockholders are supposed to have access to all company financial information. Congress passed a new law in 2002 that broadened the powers of the SEC to monitor information disclosure by companies. The Sarbanes-Oxley Act was passed to establish new standards for corporate accountability. In addition, new penalties were also created in case companies were unethical in their corporate financial disclosures.

The biggest change was that the new law allowed the SEC to ensure that companies were utilizing internal controls and audits to ensure the validity of their financial records. Previously, companies were using accounting firms to conduct their financial statements and also act as their auditors, which created an atmosphere ripe for bad financial decisions. The Sarbanes-Oxley Act ensures that independent verification is conducted, so CEOs and COOs must be aware of their own financial health.

Insider Trading

Another area that has threatened stockholder investments is the issue of insider trading, which is when a person has access to confidential information about a company's financial situation and then uses the information to buy or sell the company's stock before the public has a chance to learn the information.

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