Securities and Exchange Commission

The SEC helps maintain the structural integrity of American capital markets by regulating the flow of information about public companies and by enforcing securities laws.

Public corporations are a keystone of the American economy, producing goods and services that raise living standards, providing employment, and increasing the economic welfare of the nation. To begin or to grow a business, corporations may raise Capital;sources ofcapital from the public by selling shares in themselves. Investors are more likely to invest in such corporate securities if they have adequate information to make sound decisions, if the operations of capital markets are transparent, and if strong penalties minimize the impact of unscrupulous or negligent market participants. The Securities and Exchange Commission (SEC) was founded to ensure and maintain those conditions.Securities and Exchange Commission

The American business landscape underwent a fundamental change during the last third of the nineteenth century, transforming from a predominantly agrarian to an industrial economy. The rise of big business in American history is well documented, although its causes and effects–economic, social, and political–continue to be disputed. As was the case in the railroad industry of the mid-nineteenth century, manufacturers derived significant economic benefits from using technology to expand the scale of production. These benefits were an important cause of the rise of large corporations.

Mass Mass productionproduction results in economies of scale that reduce the cost of producing goods, allowing them to be sold at lower prices. Cheap goods increase consumption and thus the standard of living. However, businesses based on mass production require large amounts of capital to finance their plant and equipment, distribution channels, advertising budgets, and personnel. A vibrantly functioning market for corporate securities is crucial to the formation of capital in an economy.

The majority of large companies raise much of the capital they need from the public at large. Investors, of both modest and substantial means, purchase stocks and bonds in corporations for a variety of reasons. Some invest in securities to accumulate wealth over the long term. Others trade in corporate securities to make short-term profits by anticipating price movements. Yet others invest in those businesses they think are likely to be relatively more successful. Through their decisions, investors provide capital to business and allocate capital among businesses. Investment banking houses, such as that of J. P. Morgan, and stock exchanges, such as the New York Stock Exchange, serve as primary and secondary markets that help organize and direct the formation and flow of such investment capital.

Uninformed Investors

At the turn of the twentieth century, public investors largely financed the growth in size, scale, and scope of American businesses. The implied rule governing the relation between buyers and sellers of securities seemed to be “buyer beware.” Holders of stocks and bonds obtain ownership rights (either directly or as collateral) to a company’s assets without possessing them. It is the corporate managers and not the owners who actually decide on the purchase, use, and disposition of corporate assets. This separation of ownership from control over assets makes it inherently difficult for the investing public to know how their money is being used.

At the beginning of the twentieth century, investors made their decisions with none of the financial and related information about companies on which investors later came to rely. Instead, rumors, tips, and guesswork shaped many investment decisions. Moreover, during this period, stock exchanges and over-the-counter markets were unregulated. The purchase and sale of securities in unregulated markets exacerbated the potential for unscrupulous and unfair business practices. These conditions limited the efficacy of American capital markets during the early twentieth century.

Speculation and Regulation

Financial history has witnessed a great many speculative bubbles and cycles of boom and bust. Usually, a boom in a given sector of the economy–such as housing, Internet stocks, or conglomerates–is triggered by some external event that causes some sectors of the economy to become more profitable than others. As more people begin to invest in these profitable sectors, they seek credit to finance further investments. Some of this credit-based investment is fueled by speculative behavior, a bet that the price of the commodity or asset being traded will increase over time. Instead of investing for the purposes of use or income, speculative investments are made solely for the purpose of realizing a profit on resale. “Flipping a house” is a telling contemporary example of this behavior.

As Business cyclesa boom gathers force and more and more investors are drawn into it, prices rise until they reach a fever pitch. Sooner or later, whether triggered by another external event or by some investors seeking to cash in their paper profits, a bust follows the boom. The very same investors who once sought to get into the market now want to get out. It makes sense for every individual in a theater to run to the door when someone shouts “fire.” Just as a pandemonium results when all theatergoers rush for the exits, so markets collapse when all investors want to sell. Cycles of boom and bust cause enormous financial hardship and even ruin to many investors. One of the greatest such periods of hardship was the Great Depression;securitiesGreat Depression.

Between 1899 and 1930, the number of Americans investing in securities increased twentyfold to about 10 million people. Not all were astute and informed investors; many were looking to make a quick profit. (A probably apocryphal story holds that John D. Rockefeller stopped investing in the stock market when his shoeshine boy asked him for stock tips.)

Not only were more people investing in securities during the early twentieth century, but they were also doing it with borrowed money. Rather than personally paying for an entire purchase at the time of a trade, investors would use credit to finance the bulk of their purchases, believing that stock prices would go up quickly enough to allow them to repay their debts and still realize a profit.

The extended boom of the early twentieth century ended with the Stock market crash of 1929stock market crash of 1929. The crash began a three-year bust phase, as the markets continued to fall, reaching their lowest value in 1932. As stock prices fell, borrowers defaulted on their repayments. Some went bankrupt. Lenders became less willing to lend money in this risky climate. The lack of available credit further diminished the demand for securities. The falling demand was responsible for the continued decrease in stock prices.

This collapse of the stock market during the Great Depression was so severe that it took until 1963 for the volume of stock traded on the New York Stock Exchange to match the volume traded in 1929 at the peak of the boom-bust cycle. It was in this context that President Franklin D. Roosevelt instituted his New Deal programs. These ambitious and far-reaching programs of government intervention and regulation were established in the belief that unregulated markets contribute to economic instability.

The SEC’s Mission

In the effort to better inform investors and to regulate capital markets, the Securities Exchange Act of 1934Securities Exchange Act of 1934 established the SEC as an official oversight agency for the nation’s securities markets. The law not only regulated these markets but also required all publicly traded companies to disclose detailed financial information about their business activities. It expanded the requirements established by the Securities Act of 1933, which had confined the disclosure demand to only new companies seeking to issue stock for the first time.

At the end of the decade, Congress passed the Trust Indenture Act of 1939Trust Indenture Act of 1939, which required all companies offering debt securities, such as bonds and notes, to conform to the standards in the law. In addition, a number of related laws were promulgated that have direct bearing on the scope and function of the SEC. For instance, the Investment Company Act of 1940Investment Company Act of 1940 required companies whose primary business is to invest and trade in securities to disclose their financial condition and investment principles to the public. Similarly, the Investment Advisers Act of 1940Investment Advisers Act of 1940 required investment advisers to register with the SEC and to act in accordance with laws that protect investors. Lastly, the Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002 introduced far-reaching changes to the structure and functioning of the securities markets. Some of these included requiring management to take personal responsibility for the assertions made in financial statements, creating the Public Company Accounting Oversight Board to supervise the accountants who audit such statements, and protecting whistle-blowers who inform on corporate malfeasance and fraud.

Organizational Structure

The SEC is headed by five commissioners, each of whom is appointed by the president of the United States, with the advice and consent of the Senate. The president names one of these five commissioners as the chair of the SEC. To minimize the influence of partisan politics on the work of the SEC, no more than three of the five commissioners can belong to the same political party. Commissioners are appointed for a period of five years, and their appointments are staggered to ensure continuity of leadership.

The SEC is composed of four divisions, each overseeing a specific aspect of the capital markets. The Division of Corporation Finance is responsible for ensuring that companies comply with the disclosure rules that they are subject to by law. The Division of Trading and Markets is charged with monitoring the activities of all the key participants in the securities markets, including exchanges and credit-rating agencies. This division seeks to foster fair and efficient capital markets, while the Division of Investment Management aims to foster capital formation by regulating the activities of mutual funds that manage the savings of the public. Finally, the Division of Enforcement is directed when necessary to initiate investigations, bring civil action, and prosecute those companies or persons who violate securities laws. Overall, despite the inevitable pull and push of politics, and despite the continued challenges of speculative bubbles, unscrupulous traders, and fraudulent managers, the SEC has maintained its reputation as a fair and effective regulatory agency that has enabled American capital markets to be among the most efficient and effective in the world.

Further Reading

  • Chatov, Robert. Corporate Financial Reporting: Private or Public Control? New York: Free Press, 1975. Exhaustive analysis of the SEC as an independent regulatory agency in the context of its relationship with the accounting profession. The central question posed by the book is: What is the proper location of regulatory authority–private bodies or public institutions?
  • Karmel, Roberta S. Regulation by Prosecution: The SEC vs. Corporate America. New York: Simon & Schuster, 1982. Impassioned critique by a former commissioner of the SEC’s tendency to emphasize its prosecutorial powers. Her argument in favor of deregulating capital markets to foster capital formation was prescient.
  • Kindleberger, Charles, and Robert Aliber. Manias, Panics, and Crashes: A History of Financial Crises. 5th ed. Hoboken, N.J.: John Wiley & Sons, 2005. A classic work on herd behavior on Wall Street and Main Street by a highly respected economic historian. Describes the typical gamut of behavior–from speculative fevers to panics–that fuels boom and bust cycles.
  • McCraw, Thomas K. Prophets of Regulation. Cambridge, Mass.: Harvard University Press, 1984. Gracefully written chapter by a Pulitzer Prize-winning historian on James Landis, the founding chair of the SEC. Good synopsis of the arguments for and against regulating capital markets and persuasive description of the new style of regulation embodied by the administrative state era inaugurated by the New Deal.
  • Porter, Glenn. The Rise of Big Business, 1860-1920. 2d ed. Arlington Heights, Ill.: Harlan Davidson, 1992. A historian summarizes the causes and consequences of the rise of big business in American history. Ably covers the political, economic, technological, and social dimensions of large-scale business.
  • Seligman, Joel. The Transformation of Wall Street: A History of the SEC and Modern Corporate Finance. 3d ed. New York: Aspen, 2003. Thorough conspectus of the SEC from its inception to the passage of the Sarbanes-Oxley Act of 2002, by a noted legal scholar and securities lawyer.
  • Vise, David A., and Steve Coll. Eagle on the Street. New York: Charles Scribner’s Sons, 1991. Engaging and gripping account of the SEC during the 1980’s, a time of innovative financial instruments such as the junk bond and of shifts away from the ideology of regulation toward that of free-market solutions.

Bond industry

Great Depression

HealthSouth scandal

Mutual fund industry

New Deal programs

Stock market crash of 1929

Stock markets

Tyco International scandal

Wall Street