To Serve & Protect

To Serve & Protect

The first framework for financial regulation

Modern financial regulation began in the wake of the stock market crash of 1929. A decade of exuberance and prosperity led individuals and banking institutions to invest heavily in the stock market. Year after year of stable returns created a false sense of security – enticing investors to leverage their positions to maximize profits. When the demand for stock prices became unsustainable, prices began to fall. Those who were highly leveraged lost most, if not all, of their investments. The sudden loss of wealth and capital eviscerated economic activity worldwide, thus leading to the ten-year period known as The Great Depression.

The sobering reality of the situation was that the economic activity generated by the financial bubble of the 1920s was fueled by greed, reckless behavior, and a lack of culpability. Most of the financial institutions at the time did not break any existing laws. They were behaving as expected – through financially motivated self-interest and competition. To prevent such a disaster from happening again, it became clear to even the strongest pundits of free markets that regulatory guidelines were needed.

Lawmakers focused on three main weak points which allowed the recklessness in stock investing to occur: initial public offerings of securities, secondary market trading for securities, and how investment companies’ were structured. These three pivots of concern were broken up into new laws known as The Securities Act of 1933, The Securities Act of 1934, and the Investment Company Act of 1940, respectively. The government body which would oversee these new regulations and enforce the laws was to be called the Securities & Exchange Commission (SEC).

The bottom line of all three acts were to force registration of security issuers and create transparency to the public for investment organizations. Firms and households alike need to be fully aware of the risks associated with their respective investments. In the long run, this transparency led to confidence in financial markets and longer-term efficiency of capital allocation throughout the economy.?

????????The SEC is an independent government agency under the Executive Branch. It is run by?five directors, all which have divisional responsibility of making sure regulatory reports from public companies are processed correctly and on time. There are even Canons of the SEC which the directors pledge to follow, along with The Constitution of the United States and local laws. Their duty is to protect the financial system for the benefit of the American people and prevent any issues which can cause harm to the nation’s financial system at large. All directors and members of the SEC must abide by these principles and cannot be swayed by political parties or influential persons in the market. Lastly, the members of the SEC cannot be an active fiduciary as it could compromise their moral obligation.

Although the SEC acts as the arbiter of securities regulation, its powers reach beyond this scope. In matters of Chapter 11 Bankruptcy for public companies, the SEC can oversee the litigation and ensure that the company actions during and after the bankruptcy remain compliant to securities laws.

Most importantly, the SEC can enforce lawful compliance with regulatory matters. When the SEC finds a publicly traded company out of compliance, they can create administrative proceedings which are like a trial. During hearings employees, the individuals being investigated, nor anyone else directly related to the company can speak about it. Some meetings might even open to the public, while others can be denied under certain circumstances. If the firm in question is found guilty, the SEC can impose fines, disgorgement of ill-gotten gains, and even permanently ban individuals from serving as officers in publicly traded companies. These administrative actions can make their way into federal court and even criminal prosecution, which would then be referred to the Department of Justice (DOJ).

Similarly, to a trial, the SEC are allowed their own extension of discovery in their enforcement. They can request previously private company records and data. However, the SEC must explicitly request the records being sought – like a warrant. Any legal advice or clarification asked by the company of interest must also be given in reply by the agency. Additionally, these notices issued by the SEC can be confidential for 120 days when requested – giving public companies the opportunity to enact contingency plans, reorganize, confer with legal counsel, etc before the news is made public and the stock is affected.

Critics of the SEC will be quick to identify controversial cases or moments when politicization seemed ripe within the organization. Further, it has not been able to prevent financial crises and has guidelines which are out of date for modern financial assets. Nonetheless, the SEC remains a tried and tested organization which stands as a watchdog to bad actors and lays the framework for how a protective government agency interacts with the free market.??

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