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Securities Act of 1933: Rule 144 & Section 11

Instructor: Christopher Muscato

Chris has a master's degree in history and teaches at the University of Northern Colorado.

Finances can be a tricky subject, but in 1933, Congress passed legislation to help with that. In this lesson, we'll explore the Securities Act of 1933 and see how this changed American finance.

American Securities

Investments are good, credit is bad. There's a bit of financial advice for you. Unless it's a bad investment, or it's the good kind of credit. Then it's opposite. Turns out, finances are pretty complicated. The United States dealt with the complicated world of finances when the stock market crashed in 1929, starting the Great Depression.

While trying to untangle the financial mess that got us into that crisis, the government started focusing on the issue of securities. Securities, as defined by the government, are any stock, note, bond, debenture, certificate of interest, or participation in any profit-sharing agreement. Basically, it's a proof of ownership or debt that has actual value and can be sold for profit. Stocks and bonds are common examples- you purchase them, and they change in value, with the goal of eventually being sold at a higher rate. While securities are supposed to be…well, secure, the Great Depression uncovered some problems in how they were being used. So, the government intervened to try and make this financial issue a little less complicated.

This stock certificate for Standard Oil is an example of a security
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The Securities Act of 1933

As Congress investigated the causes of the Great Depression, it became pretty evident that many companies in the 1920s had been fraudulent with their stocks and other securities. Basically, without any government regulation of the market, companies were falsely reporting on their profits and investments, making their stocks seem more valuable than they were. People invested in companies that were actually failing, and as this compounded, the stock market collapsed. So, the government decided that it needed to maintain some sort of legislative control over the sale and reporting of stocks.

The Great Depression was largely a result of securities fraud
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In that spirit, Congress passed the Securities Act of 1933. What this law did was outline rules for the selling of securities that would impact interstate commerce, or any money that passed between states, which in the USA is pretty much all commerce. There were two big implications of the act. First, companies who wanted to publicly sell securities, like stocks, had to formally register with the US Securities and Exchange Commission or the SEC. This made it easier for the government to regulate how companies reported and sold their stocks. The Securities Act also mandated companies to obey the state laws where their securities were being sold. So if a company sold stocks to, say Michigan, they legally had to comply with Michigan's laws regarding securities reporting, monitoring, and taxation. It didn't matter if the company was based in New York or California or anywhere else, the laws of the state where the securities were bought were what mattered. All of this was designed to make it much simpler for the government to monitor and regulate securities trading.

Securities Act Rule 144

Now, under the Securities Act of 1933, securities must be registered with the SEC when they are publicly sold. However, as with nearly every law, there are exceptions. Rule 144 of the Securities Act provides the exceptions allowing for the public sale of restricted securities, those purchased privately, not on the public market, and controlled securities, those owned by an affiliate of the issuing company. According to Rule 144, one of these securities may be sold without being registered under certain conditions. For example, the securities sold cannot equal more than 5,000 shares of a sales price of $50,000 over a three-month period. There are several restrictions, but if they are all met, these controlled and restricted securities may be publicly sold.

Section 11

One of the important issues with laws like the Securities Act, particularly when they are issued after a generation of people who aren't used to the government interfering in business, is giving people a reason to follow the law. In other words, there needs to be a clear process for enforcing the law and punishing those who break it. That's where Section 11 comes in. Under Section 11, the person or company who issues a misleading statement about the value of the securities being sold is legally responsible for fraud.

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