The Securities and Exchange Act of 1934 ("1934 Act," or "Exchange Act") primarily regulates transactions of securities in the secondary market. As such, the 1934 Act typically governs transactions which take place between parties which are not the original issuer, such as trades that retail investors execute through brokerage companies.
To protect investors, Congress crafted a mandatory disclosure process designed to force companies to disclose information that investors would find pertinent to making investment decisions. In addition, the Exchange Act regulates the exchanges on which securities are sold. Regulation FD is the primary section of the Exchange Act which discusses disclosures.
The required disclosures and forms of disclosure vary depending on the situation and the registrant. In general, under Section 13(a) of the Exchange Act (codified in 15 U.S.C. § 78m), companies with registered publicly held securities and companies of a certain size are called "reporting companies," meaning that they must make periodic disclosures by filing annual reports (called a Form 10-K) and quarterly reports (called a Form 10-Q). Reporting companies must also promptly disclose certain important events (called a Form 8-K). These periodic reports include or incorporate by reference types of information that would help investors decide whether a company's security is a good investment. Information in these reports includes information about the company's officers and directors, the company's line of business, audited financial statements, and the management discussion and analysis section.
The Exchange Act also mandates disclosure at certain crucial points so that investors can make an informed decision before purchasing stock. Sections 14(a)-(c) (codified in 15 U.S.C. § 78n(a)-(c)) govern disclosure during proxy contests, when various parties might solicit an investor's vote on a corporate action or to vote for certain board members. All disclosure materials must be filed with the SEC.
The Securities Exchange Act requires disclosure of important information by anyone seeking to acquire more than 5 percent of a company's securities by direct purchase or tender offer. Such an offer often is extended in an effort to gain control of the company.
If a party makes a tender offer, the Williams Act governs. The Williams Act is codified as 15 U.S.C. § 78m(d)-(e).
A tender offeror must also file disclosure documents with the SEC that disclose its future plans relating to its holdings in the company This information allows investors to decide whether to sell or not.
Securities and Exchange Commission
Section 4 of the Exchange Act established the Securities and Exchange Commission (SEC), which is the federal agency responsible for enforcing securities laws.
One important function of the SEC is to ensure that companies meet the Exchange Act's disclosure requirements. Companies with more than $10 million in assets whose securities are held by more than 500 owners must file annual and other periodic reports with the SEC. The Commission makes this information available to all investors through EDGAR, its online filing system. The SEC enforces statutory disclosure requirements bringing enforcement actions against companies that disseminate fraudulent or incomplete information in violation of federal securities laws.
SEC's Regulatory Responsibilities
The SEC is also responsible for registering and establishing rules regulating the conduct of market participants, stock exchanges, and self-regulatory organizations (SROs). Under the Exchange Act, the SEC can sanction, fine, or otherwise discipline market participants who violate federal securities laws. The SEC can also issue rules pursuant to specific statutory provisions, to help effectuate those provisions.
Under the Exchange Act, market participants are subject to direct SEC regulation. Securities exchanges, such as the New York Stock Exchange and NASDAQ, must register with the SEC under Section 5 (codified in 15 U.S.C. § 78e) and Section 6 (codified in 15 U.S.C. § 78f).
These registration documents help the SEC monitor the markets for trading activity that might indicate that market participants are violating securities laws (such as insider trading). To further this goal, all securities traded on the securities exchanges must be registered under Sections 12(a) and 12(b) of the Exchange Act (codified in 15 U.S.C. § 78l(a)-(b)), with the issuers of the securities disclosing comprehensive information about themselves in the registration process.
In addition to directly regulating the markets, the SEC oversees SROs, which in turn exercise independent oversight over the markets. Nearly all broker-dealers must register with the FINRA, the most prevalent SRO (responsible for the regulation of broker-dealer firms and securities brokers). The SEC also directly regulates SROs, requiring that SROs develop specified rules and standards of good practice for their members, pursuant to SEC directives. This joint supervision of broker-dealers and their employees is extremely important to investors, because it ensures that broker-dealers and their employees are sufficiently qualified and and that firms keep accurate, truthful records. Broker-dealer firms and employees who violate the FINRA standards of conduct are subject to disciplinary action by FINRA.
Some Prohibitions On Fraud
The Exchange Act also protects investors by prohibiting fraud and establishing severe penalties for those who defraud investors, as well as those who engage in some trading practices that take advantage of information most investors do not have (such as insider trading). When market participants violate federal securities laws, the SEC can bring a civil enforcement action. The SEC or Department of Justice can also bring criminal actions for particularly serious violations. The Exchange Act also allows investors to sue market participants who have defrauded them.
Section 10(b) (codified in 15 U.S.C. § 78j) is the primary anti-fraud statutory provision. The SEC primarily enforced this anti-fraud provision under Rule 10b-5, which prohibits the use of any "device, scheme, or artifice to defraud." Rule 10b-5 also imposes liability for any misstatement or omission of a material fact, or one that investors would think was important to their decision to buy or sell a security. Courts have held that there is a private right of action to sue under 10b-5. Typically, only individuals who have actually bought or sold securities have standing to bring a 10b-5 claim.
Section 9 (codified in 15 U.S.C. § 78i) allows investors to sue for trading activities and patterns of trading conduct that cause investors to think that a stock is doing better or worse than it actually is, or is traded more frequently than it actually is, or that create the appearance of a stable price. These activities mislead investors about the true value of a security, and thus induce the investors to trade. Section 9(e) gives investors an explicit right of action to sue buyers or sellers who manipulate the price of any security traded on a stock exchange. Claims under Section 9, however, are difficult to prove, since investors must show that the price was actually affected by the manipulation, and that the defendant acted willfully.
Section 20 (codified in 15 U.S.C. § 78t) provides for joint and several liability for people who control or abet violators of the Exchange act, thus increasing the chance that an investor will be able to collect any damages that are awarded. Thus, if an employee violates a provision of the Exchange Act, the employer could be held liable. Similarly, if an individual encourages another to violate a provision of the Exchange Act, that individual could be held liable.
For more on the Securities Exchange Act of 1934, see this St. John's Law Review article, this Fordham Law Review article, and this Columbia Undergraduate Law Review article.
Edited by Krystyna Blokhina 6.10.19