NOTE: These notes are prepared solely for the benefit of the students in Acc 611. They are not to be used for any other purpose without the permission of Jagdish S. Gangolly.

A Brief history of securities Regulation in the United States:

The summary below is prepared from the outstanding book Corporate Financial Reporting by Professor Robert Chatov of SUNY, Buffalo.

• 1880s: Holding companies permitted by New Jersey, followed by the so-called charter-mongering states.
  
  
• 1887: ICC established. It later established uniform system of accounting for railroads without seeking help from the accounting profession.
  
  
• 1897 - 1907:Corporate merger movement followed by the panic of 1907.
  • 1907 (Hepburn Act) giving ICC rate-making powers.
  • 1910 (Mann-Elkins Act) permitting ICC to initiate rate proceedings and claculating fair earnings on physical property valuation.
    
  
  
• 1913/4: Sixteenth amendment to the constitution, and the passing of the income tax law, the Federal Reserve Act, the Federal Trade Commission Act, and the Clayton Antitrust Act.
  • With the lawyers avoiding income taxes as a practice area, the accountants became indispensable in the preparation of individual & corporate tax returns.
  • Need for attested financial statements also arose for banks as well as the Federal Reserve Banks, because rediscounted paper was presented to them.
  
  
• 1840s to 1920s: In the absence of specific regulations in the United States, the emerging accounting profession in the United States looked to Britain. This was a result of the British accounting firms establishing footholds in the United States (Barrow, Wade Guthrie & Co., and Price Waterhouse, for instance), and their British personnel. The British system was based on statutory traditions of uniforn systems of accounting & auditing standards leading to a quasi-judicial attitude towards their duties, and on an apprenticeship-based entry into the profession that supported an anti-intellectual tradition. However, subsequent developments in accounting in the United States reflect emphasis on corporate disclosure (as opposed to uniformity)
  
  
• 1926/7: Publication of Professor Ripley's articles in The Atlantic Monthly and the publication of his book Main Street and Wall Street. In those works, he attacked the then existing abuses in the American financial sector. They included lack of cumulative voting, absence of effective government regulation, non-standardised corporate accounting practices, excessive trading on the equity, denial of pre-emtpive rights, selling corporate assets "without let or hindrance". His writings were not really taken seriously by the accounting profession.
  
  
• 1929: The stock market crash: On the so- called Black Thursday ( October 24, 1929), the Times industrial index fell by only 12 points. The following days, however, the market collapsed.
  
  
• 1931 ( Ultramares v. Touche): Chief Justice Benjamin Cardozo, lets the contract law concept of privity stay in tact, but extends the accountants' liability for tort when fraud or constructive fraud could be proved.. Till then, the accounting profession boldly proclaimed their responsibility to the public. The Ultramares case made the accountants more cautious in their proclamation of responsibilities to the public.
  
  
• 1933 ( Securities Act):Often referred to as the "Truth in securities" law. You will find an excellent statement of the objectives of this statute in the discussion of section 2 at the SEC site.
  
  
  • Controversies over section 11: This section demolished three common law doctrines that the accountants had relied upon.
    • Doctrine of Privity: Lack of a contract giving rise to the duty was no longer a factor in the actions brought under the section.
    • Doctrine of causality: It was no longer to establish the errors or misstatements as the proximate cause of loss.
    • Doctrine of reliance: It was no longer necessary for the plaitiffs to prove reliance on the financial statements or the audit report.

  In effect, section 11 on "Civil liabilities on account of false registration statement" made the accountants prospective security owner's legal representative, with fiduciary responsibility. "Section 11 likens the standard of reasonableness to be applied to that which the law commonly requires of a person occupying a fiduciary relationship" Landis.
  

  
  
• Section 19. Special powers of Commission which grants broad and sweeping authority to the Commission "to prescribe the form or forms in which required information shall be set forth, the items or details to be shown in the balance sheet and earning statement, and the methods to be followed in the preparation of accounts, in the appraisal or valuation of assets and liabilities, in the determination of depreciation and depletion, in the differentiation of recurring and nonrecurring income, in the differentiation of investment and operating income, and in the preparation, where the Commission deems it necessary or desirable, of consolidated balance sheets or income accounts of any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer" also of concern to the accounting profession.
  
  
• Section 17. Fraudulent interstate transactions also imposed liabilities on the accountants.
  
  
• 1934 (Securities Exchange Act): Also referred to as investor protection law. The statute covers,
  • CORPORATE REPORTING
    • Companies seeking to have their securities registered and listed for public trading on an exchange must file a registration application with the exchange and the SEC.
    • If they meet the size test (companies with assets exceeding $1 million and shareholders numbering 500 or more), companies whose equity securities are traded over-the-counter must file a similar registration form.
    • Commission rules prescribe the nature and content of these registration statements and require certified financial statements. (These are generally comparable to, but less extensive than, the disclosures required in Securities Act registration statements. )
    • Following the registration of their securities, companies must file annual and other periodic reports to update information contained in the original filing. In addition, issuers must send certain reports to requesting shareholders.
  • PROXY SOLICITATIONS
  • TENDER OFFER SOLICITATIONS
  • INSIDER TRADING
  • MARGIN TRADING
  • TRADING AND SALES PRACTICES
  • REGISTRATION OF EXCHANGES AND OTHERS
  • BROKER-DEALER REGISTRATION

The U.S. Securities and Exchange Commission: What It Is, What It Does

There is an outstanding discussion of the work of the Securities Exchange Commission at the SEC web site. I would very strongly urge you to visit the site and familiarise yourselves with the wealth of information available there.

Commission enforces the following laws:

• Securities Act of 1933, often referred to as "truth in securities" law.
• Securities Exchange Act of 1934, often referred to as "investor protection" law.
• Investment Company Act of 1940
• Investment Adviser Act of 1940
• Public Utility Holding Company Act of 1935
• Trust Indenture Act of 1939
• Chapter 11 of the Bankruptcy Code also authorises the SEC to appear in any reorganisation proceedings in the U.S. Courts and present its views on any issue. You also will find SEC involvement in such Corporate Reorganisations.

You will find a wealth of information in the Annual Report of the SEC.

Organization of the SEC

• DIVISIONS:
  • Division of Corporation Finance
  • Division of Market Regulation
  • Division of Investment Management
  • Division of Enforcement
    • conducts investigations into possible violations of the federal securities laws
    • prosecutes the Commission's civil suits in the federal courts as well as its administrative proceedings.
      • seeks injunctions, which are orders that prohibit future violations
      • seeks civil money penalties and the disgorgement of illegal profits

You can get the following information at the SEC Enforcement Division web site:

• Litigation Releases
• Administrative Proceedings
• initial decisions which are opinions issued by the Administration Law Judges in the contested administrative proceedings
• Commission Opinions on appeal of initial/disciplinary decisions of self-regulatory organisations such as NYSE or NASD
• Alerts to investors regarding warnings on wide-spread frauds & enforcement actions
• Information about bopunties for those reporting Insider Trading Violations
• SEC Division of Enforcement Complaint Center: How to contact the SEC and other agencies about fraud.

What is a security?:

Section 2 of the Securities Act defines a security as any

• note
• stock
• treasury stock
• bond
• debenture
• evidence of indebtednes
• certificate of interest or participation in any profit-sharing agreement
• collateral-trust certificate
• preorganization certificate or subscription
• transferable share
• investment contract
• voting-trust certificate
• certificate of deposit for a security
• fractional undivided interest in oil, gas, or other mineral right
• any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof)
• any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a 'security'
• any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing

As you can see,, the Act defines a security by giving examples rather than listing its characteristics or properties. However, in the words of SEC,

The purpose of these laws is to protect investors in securities markets that operate fairly and to ensure that investors have access to disclosure of all material information concerning publicly traded securities.

One can infer that the congress, in passing these statutes, sought to regulate investment (and not commercial) transactions.An investment transaction has the following properties:

• a contract (security) calling for investment of capital in a common enterprise.
• the investor (holder of the security) is led to expoect a profit on the investment.
• the profit to be earned is the result of the efforts of the entity issuing the security.

Updated on March 15, 1997 by Jagdish S. Gangolly.