Securities Exchange Act of 1934: Rules

Instructor: Carol Cook

Carol has taught high school Government and middle school U.S. History and Global Studies and has a master's degree in teaching secondary social studies.

The Securities Exchange Act of 1934 created the Securities and Exchange Commission, a government agency. This lesson explains how the SEC writes rules to protect investors and create confidence in the securities industry.

Investment Predators

Anyone who wants to understand the pitfalls of working with an unscrupulous stockbroker need only watch the movie The Wolf of Wall Street. The 'Wolf' in the movie manipulates the market by deceiving investors who entrusted him with their money. The script is the biography of an actual broker who was after fast money and came face to face with the law when they caught up with him The movie shows government safeguards against people who try to exploit the system, and these protections are due to the Securities Exchange Act of 1934.

The Securities Exchange Act of 1934

After World War I, Americans felt the effects of a new and burgeoning economy and looked to the stock market to increase their new-found wealth. However, with no rules in place, people relied on companies and brokers to be honest with their investments. Needless to say, this didn't always work out to the investors' advantage, and many people found that their speculations were all but worthless, contributing to the Great Depression.

On the heels of the stock market crash of 1929, government leaders realized they needed to reassure the public of the solvency of American financial systems and the safeguards to protect their personal assets. The president and congressional leaders wanted to restore the public's faith in the economy and find a way to keep them from blindly investing in securities. They realized that people needed to be fully informed to be able to build their personal finances and contribute to the national prosperity.

Outside of the New York Stock Exchange following the 1929 crash
New York Stock Exchange

Congress passed the Securities Exchange Act of 1934 as part of Franklin Delano Roosevelt's New Deal. While the earlier Securities Act of 1933 required disclosure about securities offered for sale, the Act of 1934 ensured continuing disclosure and oversight of the securities industry. This law established the Securities and Exchange Commission (SEC).

Setting Rules

Part of the SEC's responsibility is to issue rules to enforce securities legislation. Laws like the Act of 1934 are written within the legislative branch and are worded very broadly, providing the framework for implementation. After laws are passed, it is up to the executive branch to write the regulations to implement provisions of the law.

Joseph Kennedy, the first Chairman of the Security and Exchange Commission
Kennedy

The SEC, in its rule-making function, defines actions for offering, selling and buying securities on the open market. The rules are prepared in steps - first, by issuing the concept, next by proposing regulations, and, finally, adopting the rules. The public is asked for comments each step along the way before rules are enacted.

While financiers feared that the Act would enable the government to impose control over the capital market, the central purpose of the law and its regulations is the protection of the investor. In the following section, we'll look at the major areas in which the SEC has come up with rules to protect investors.

Requiring Transparency

Most companies that offer the sale of securities to the public or have a large number of investors must register with the SEC before issuing stock. Because securities do not ensure a return on investment, an important part of the rules were written to make sure that investors have the knowledge they need to make informed decisions when speculating on the market.

Companies are required to file annual and quarterly reports with the SEC that provide information such as income and expenditures, stock values, company actions and planned activity. They must also send proxy statements (information about upcoming elections and decisions that investors can vote on) to shareholders by a certain deadline.

A modern-day stockbroker at work
stockbroker

Empowering Shareholders During a Takeover

Let's say Bob Richguy wants to buy a large chunk of the company Megalopolis Internet. He can't just write them a check; he has to file his intentions with the SEC if he wants to buy more than 5 percent of the company's shares. This is known as a tender offer. SEC rules require the purchaser to notify all shareholders and to provide the owners an opportunity to respond. This leaves the power to determine the fate of the company in the hands of the shareholders.

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