Securities Law in 2021: The Definitive Guide

The law governing securities evolves constantly to keep pace with changes in the industry. Regulatory agencies like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) F/K/A National Association of Securities Dealers (NASD) enforce various rules and regulations designed to promote fair and full disclosure of material facts related to financial markets and individual securities transactions. This guide provides a surface-level overview of the securities laws in the United States and what those laws mean for you. Important Terms in Securities Law A security is an intangible financial instrument that entitles its owner to claims of ownership on assets and earnings of the issuer or the voting power that accompanies the claims. Securities exist in the form of: Notes, Stocks, Treasury stocks, Bonds, Certificates of interest, Collateral trust certificates, Transferable shares, Investment contracts, Voting trust certificates, Certificates of deposit for a security; or A fraction, undivided interest in mineral rights. Stock markets in the United States collect trillions of dollars on investments through the securities trade.  The individuals buying or selling securities are referred to as investors. The term “retail investor” refers to an individual who typically purchases securities from a broker and, in most cases, does not purchase a large quantity of securities. The term “institutional investor,” on the other hand, often refers to a company investing large sums of money in securities.  The company buying and selling securities for investors is known as a broker-dealer. Firms like Morgan Stanley and Merrill Lynch employ brokers to serve clients by buying and selling securities on their behalf.  History of Federal Securities Law Prior to the Great Depression, the United States lacked an expansive securities regulation at the federal level. As a result, companies falsified and misrepresented financial information without fear of consequences. During the 1920s, the stock market expanded rapidly as the U.S. economy grew and stock prices reached record highs. Between August 1921 and September 1929, the Dow increased by 600%. Excitement surrounding the stock market fueled retail investors to get involved. Many retail investors purchased stocks “on margin,” meaning they only paid a small portion of the stock price and borrowed the remaining amount from a bank or broker. Despite the audacity of the claim, many believed that stock prices would continue rising forever. In early September 1929, stock prices started to decline. Not yet alarmed, many investors saw an opportunity to buy into the stock market at a lower price. The Stock Market Crash of 1929 On October 18, 1929, stock prices decreased more significantly. October 24 signaled the first day of panic among investors. Known as “Black Thursday,” a record 12,894,650 shares were traded throughout the day. On October 28, the Dow suffered a record loss of 38.33 points, or 12.82%. The following day—”Black Tuesday”— held more devastating news for investors as stock prices dropped even more. 16,410,030 shares were traded on the New York Stock Exchange in a single day. The 1929 stock market crash resulted in billions of dollars lost and signaled the beginning of the Great Depression. The Aftermath In the wake of the crash, the U.S. Senate formed a commission responsible for determining the causes. The investigation uncovered a wide range of abusive practices within banks and bank affiliates and spurred public support for banking and securities regulations. As a result of the findings, Congress passed the Banking Act of 1933, the Securities Act of 1933, and the Securities Exchange Act of 1934. New York County Assistant District Attorney Ferdinand Pecora finalized the final report and conducted hearings on behalf of the commission and was later selected as one of the first commissioners of the SEC. Federal Securities Laws and Regulations The American banking systems suffered significantly in the wake of the stock market crash, as approximately one in three banks closed their doors permanently. Following the crash, the U.S. government imposed tighter rules and regulations on the financial industry. As securities evolve, regulatory agencies are responsible for imposing up-to-date regulations to protect investors. Banking Act of 1933 The Banking Act of 1933 (the Banking Act), implemented by Congress on June 16, 1933, signaled the start of many changes in the securities industry. First, the Banking Act established the Federal Deposit Insurance Corporation (FDIC), created to provide deposit insurance to depositors in United States depository institutions in an effort to restore the public’s trust in the American banking system.  Glass-Steagall provisions Four sections of the Banking Act—referred to as the Glass-Steagall legislation—addressed the conflicts of interest uncovered by Ferdinand Pecora during his investigation into the stock market crash of 1929. The Glass-Steagall legislation sought to limit the conflicts of interests created when commercial banks are allowed to underwrite stocks and bonds. In the previous decade, banks put their interest in promoting stocks and bonds to their own benefit, rather than considering the risks placed on investors. The new legislation banned commercial banks from: Dealing in non-governmental securities for customers; Investing in non-investment grade securities on behalf of the bank itself; Underwriting or distributing non-governmental securities; and Affiliation or employee sharing with companies involved in such activities. On the other side, the legislation prohibited investment banks from accepting deposits from customers. Deterioration and reinterpretation of Glass-Steagall provisions The separation of commercial and investment banks proved to be a controversial topic throughout the financial industry. Only two years after passing the Banking Act, Senator Carter Glass—the namesake of the provisions—sought to repeal the prohibition on commercial banks underwriting securities, stating that the provisions had unduly damaged securities markets.  Beginning in the 1960s, banks began lobbying Congress to allow them to enter the municipal bond market. In the 1970s, large banks argued that the Glass-Steagall provisions were preventing them from being competitive with foreign securities firms. The Federal Reserve Board reinterpreted Section 20 of the Glass-Steagall provisions to allow banks to have up to 5% of gross revenues from investment banking business. Soon after, the Federal Reserve Board voted to loosen regulations under the Glass-Steagall provisions after hearing arguments from Citicorp,...

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