Chapter 16 - The Securities And Exchange Commission

Because securities are intangibles, you cannot determine from the engraving or printing on a bond, or stock certificate its quality or worth. Beautifully engraved certificates may evidence ownership in an oil-less oil well or in a submerged real estate development; or in a "blue chip" like Standard Oil of N. J. or Morgan Guaranty Trust Co. Shakespeare's statement about people applies as well to securities: "There's no art to tell the mind's construction in the face."

Because a security cannot be inspected and evaluated like a house, a suit of clothes, or a roast of beef, there have been, on occasions, frauds, deceits, misrepresentations, manipulation, and other swindles in the sale of securities to the public. In an endeavor to eliminate these abuses, and to protect the public against misrepresentation, promoter's greed, and outright fraud, the Securities and Exchange Commission (SEC) was created by Act of Congress in 1934. The Act recognized that because the sale of securities often extends across state lines, federal regulation and control of the business was needed.

Laws Administered by the Commission

There are five major legislative acts, designed for the protection of investors and the public, which it is the function of the SEC to administer. We'll cover these one at a time. The first is the Securities Act of 1933.

Truth in Securities

This act is called the "truth in securities" law and aims to provide "investors with financial material and other information concerning securities offered for public sale, and (2) to prohibit misrepresentation, deceit and other fraudulent acts and practices in the sale of securities generally." A principal requirement under the act is the registration of securities. Before public offering of a security issue, a formal registration statement must be filed with SEC. This statement is required to include such information as (a) description of registrant's property and business, (b) provisions of security to be sold and the relationship of the subject issue to other capital securities (if any) of the registrant, (c) names of officers and directors of the company and usually the extent of their security holdings therein, (d) certified financial statements. The disclosures made in the registration statement must be true and accurate, and no vital fact about the company withheld. Only after this securities statement is effective, may the securities be publicly offered or sold.

This required registration of a new security does not constitute in any way approval or endorsement of the subject issue by SEC, and the commission does not have power to disapprove of an issue by virtue of its apparent lack of investment merit, or worth. Further, the SEC does not pass upon the fairness of the terms (commissions, underwriting profits, promoter's fees, etc.) under which the securities are to be distributed. The standard to be met in the registration statement "is an adequate and accurate disclosure of the material facts concerning the company and the securities it proposes to sell."

There are certain exemptions to registration; among them private offerings to a limited number of persons who are properly informed about the company, and do not intend to resell the securities at once; offerings restricted to residents of the state in which the company is domiciled and proposes to operate; municipal, germinant, banks, and carrier securities; and securities not exceeding $300,000 in amount (in which case notification must be sent to a regional SEC office, and an offering circular delivered to prospective buyers).

Securities Act of 1934

SEC's function in connection with this act is to secure and make available to the public reports by companies listed on national stock exchanges. SEC has surveillance over proxy solicitations (of listed companies) and disclosures of facts upon which shareholders may be asked to vote. Large holders (of more than 10%) of listed shares must report monthly to SEC (and the exchange) their holdings of equity issues and any purchases or sales made within thirty days. SEC also, under this act, has certain responsibilities in respect to margin trading, fair trading practices in the market (no manipulation), and financial safeguards for customers in the matter of hypothecation of their securities by, and financial responsibility of, brokers.

National Association of Securities Dealers

Further, exchanges must register with SEC, and so must over-the-counter dealers doing a business in interstate commerce. The National Association of Securities Dealers, Inc. is a recognized association of over-the-counter dealers. It operates in co-operation with SEC, and has as its objective to "adopt, administer, and enforce rules of fair practice and rules to prevent fraudulent and manipulative acts and practices, and in general to promote just and equitable principles of trade for the protection of investors." NASD has the power to expel members found guilty of unethical practices; while the SEC has the power to suspend broker-dealer licenses. (SEC has three major sanctions it can pursue: civil injunction, criminal prosecution, and administrative remedy.)

The National Association of Securities Dealers is the outgrowth of the Code of Fair Competition for Investment Brokers, drawn up in 1933. With the cooperation of SEC the Maloney Act was enacted in June, 1938, permitting the organization of brokers and dealers into membership associations which would register with SEC. NASD was formed as a result of this act and is the only association registered with SEC. In general the legislation was concerned with establishing the mechanism of the over-the-counter market in corporate securities. (Stock exchanges had long regulated and controlled the business practices of their members.) NASD became the means for accomplishing this control in unlisted securities. It is a truly national organization of brokers and dealers, without regard to their geographic location or the kind and volume of business done.

The New York Security Dealers Association originated newspaper quotations in 1926 and turned this function over to the NASD in 1939. Now, under NASD sponsorship, 150 newspapers publish regular quotations on over 2500 securities. NASD has Quotations Committees on the local, regional, and national levels, which are responsible for selecting the more actively traded securities to be included, and assuring that accurate quotations on them are released for publication. There are 28 Rules of Fair Practice which a NASD member is honor-bound to observe.

Obviously the existence of such a nationwide and powerful organization as NASD does a great deal to assure investor confidence in the over-the-counter market, and to provide an efficient, fair, and fluid market for the trading of securities not listed on any exchange.

Public Utility Holding Company Act of 1935

There were certain abuses in public utility financing and management prevalent in the 1920^ which the act sought to eliminate. Some of these abuses were: inadequate disclosure of information to investors, overcapitalization; excessive service charges upon operating companies; pyramiding of capitalization; and unsound assembly of companies into a holding without reference to efficient integration for economical operation.

Under the act, SEC secures regular reports, regulates issuance and sale of holding company, and subsidiary, securities and sets the standards under which companies may purchase or sell either securities or properties. Further, SEC has regulatory powers over dividend payments, integration and simplification of physical properties and corporate structures, and may secure compliance either voluntary or by federal court action.

Other Laws Administered by SEC

Under the Trust Indenture Act of 1939, SEC has the power to see that trust indentures, under which one million dollars or more in securities may be outstanding, conform to certain standards. Under the Investment Company Act of 1940, SEC requires registration of investment policies; submission of management contracts to security holders; and prohibits pyramiding of companies. These are of course but a few of the responsibilities of SEC under the act.

Finally, SEC under the Investment Adviser's Act of 1940, requires registration of investment counselors and advisors and sets certain standards under which they must operate; and under Chapter X of the Bankruptcy Act, SEC may serve as adviser to the U. S. District Courts in the reorganization of a debtor corporation in which there may be a substantial public interest.

From all this you can perceive that through the operation of SEC many forward steps have been taken in the proper regulation of the securities business, and for the protection of the investor and the public.

Resume

1. SEC promotes "truth in securities."
 
2. SEC regulates not only issuance of new securities, but trading practice with respect to outstanding ones.

3. SEC has broad regulatory powers over brokers, dealers, advisors, the national exchanges and the over-the-counter market.

4. SEC has powers to enforce its determination by legal advice.

5. For complete information about SEC, you are referred to a publication of the Commission dated April 1, 1958, called "The Work of the Securities and Exchange Commission" from which much of the foregoing has been summarized.

Are You Ready To Move Onto The Next Lesson? Click Here...