Why Regulate Securities?
The development of federal securities law was spurred by the stock market crash of 1929, and the resulting Great Depression. In the period leading up to the stock market crash, companies issued stock and enthusiastically promoted the value of their company to induce investors to purchase those securities. Brokers in turn sold this stock to investors based on promises of large profits but with little disclosure of relevant information about the company. In many cases, the promises made by companies and brokers had little or no substantive basis, or were wholly fraudulent. With thousands of investors buying up stock in hopes of huge profits, the market was in a state of speculative frenzy that ended in October 1929, when the market crashed as panicky investors sold off their investments en masse.
In response to this calamity and at President Franklin Roosevelt's instigation, Congress enacted laws to prevent speculative frenzies like those in the 1920s. After a series of hearings that brought to light the severity of the abuses leading to the crash of 1929, Congress enacted the Securities Act of 1933 (the "Securities Act"), and the Securities Exchange Act of 1934 (the "Exchange Act").
The key theme of the federal securities law is disclosure. The Securities Act and Exchange Act give investors access to information about the securities they buy and the companies that issue those securities. Federal securities laws primarily accomplish this by requiring companies to disclose information about themselves and the securities they issue. The efficacy of these disclosure requirements is backed up by extensive liability for fraud under the Securities Act and the Exchange Act for both issuers and sellers of securities. Congress intended to ensure that investors had access to balanced, non-fraudulent information.
An Overview of the Regulatory Framework
The Securities Act and the Exchange Act are federal laws that provide for private causes of actions under which investors may recover for fraud and certain violations of the registration and disclosure processes mandated by the federal securities laws.
The Exchange Act created the Securities and Exchange Commission(SEC), a federal agency with the authority to regulate the securities industry. The SEC has power to promulgate rules pursuant to the federal securities acts, and to enforce federal law and its own rules. Under the Exchange Act, the SEC has the authority to register, regulate and discipline broker-dealers, regulate the securities exchanges, and review actions of the securities exchanges' self-regulatory organizations (SROs).
Long before Congress enacted the federal laws, most states also had their own securities laws, which today are known as blue sky laws. Congress drafted the federal securities laws against the backdrop of pre-existing state regulation. In interpreting the federal securities laws, courts often reach back into relevant state law to interpret definitions or concepts that Congress used when drafting federal law. State law and federal law do not, however, correspond perfectly. Although there is some overlap, state law may provide for causes of action unavailable under federal law and vice-versa. State laws can be very different from state-to-state, and from federal law. Key differences are: (1) the kinds of products and transactions covered by the laws; (2) the registration requirements for brokers, dealers, and issuers; and (3) the breadth and causes of action available under anti-fraud provisions. For example, New York's securities law, the Martin Act, permits only the Attorney General to bring a suit for violations. In New York, individual investors must bring private suits for common-law fraud law in order to recover. In many cases, federal law preempts state blue sky laws, requiring investors to sue in federal court and under federal law.