This article focuses on specific regulations that have been passed in the United States in reference to securities issues. Prior to the Wall Street Crash of 1929, there were minimum regulations of securities in the United States at the federal level. Eight specific regulations are discussed, with special emphasis on the Sarbanes Oxley Act. There will be an exploration of how risk assessment may assist organizations with making sure that regulations are followed. Many organizations are beginning to add risk assessment to their compliance and ethics programs.
Keywords Committee of Sponsoring Organizations (COSO); Dodd Frank Act; Enterprise Risk Management; Internal Auditing; Regulation Fair Disclosure; Risk Assessment; Sarbanes Oxley Act; Securities and Exchange Commission; Securities Regulation; Self Regulatory Organizations; Whistleblowers
Law: Securities Regulations
Securities Act of 1933
Prior to the Wall Street Crash of 1929, there were minimum regulations of securities in the United States at the federal level. However, as a result of the Crash, Congress held hearings to investigate why the situation occurred. After finding abuses, Congress passed the Securities Act of 1933. The purpose of the Act was to regulate the interstate sales of securities and make it illegal to sell securities into a state without complying with state laws. The two basic objectives were to:
- Require that investors receive significant information concerning securities being offered for public sale.
- Prohibit deceit, misrepresentation, and other fraud in the sales of securities.
In addition, the law required organizations to file a registration statement with the Securities and Exchange Commission if they wanted to sell securities publicly. The registration statement was designed to provide information about the organization and made sure that the information was on file as a public record. The information required on the form included:
- A description of the issuer's properties and business;
- A description of the security to be offered for sale;
- Information about the management of the issuer:
- If not registering common stock, information about the securities; and
- Financial Statements certified by independent accountants.
However, it should be noted that the Securities and Exchange Commission does not provide approval for the statement. Rather, it is responsible for validating the statement if the organization has provided sufficient details, especially information about potential risk factors. Once the statement becomes effective, the organization can began to sell the stocks. The stocks tend to be sold via investment bankers.
It should also be noted that not all offerings have to be registered with the Securities and Exchange Commission. Some of the exceptions from the registration requirement include:
- Private offerings to a limited number of persons or institutions.
- Offerings of limited size.
- Intrastate offerings.
- Rule 144.
- Securities of municipal, state and federal governments.
Additional Securities Regulations
Other pertinent securities regulations passed in the United States include:
- Regulation Fair Disclosure (Reg FD): A regulation that requires publicly traded companies to disclose information to all investors at the same time. The purpose of this regulation is to create an environment where all investors have the same information and to reduce the problem of selective disclosure.
- The Securities Exchange Act of 1934: An act responsible for regulating the secondary market trading of securities. After the introduction of the Act, it only applied to stock exchanges and their listed companies. However, in the late 1930s, the Act was amended to include regulation of trades between individuals when no stock exchange was involved. The Act also regulates broker-dealers without a status for trading securities. A telecommunications infrastructure was developed for those trades that do not require a physical location.
Today, a digital information network is used to connect the brokers. This system is called the National Association of Securities Dealers Automated Quotation System (NASDAQ). The Act of 1934 regulates NASDAQ through relations that apply to the association and by requiring that it have an independent organization overseeing it (i.e. self-regulatory organization). The self-regulatory organization for NASDAQ is the National Association of Securities Dealers (NASD). There was an amendment in 1964, which extended the change in the late 1930s to include the regulation of companies trading in the over-the-counter market.
- The Public Utility Holding Company Act of 1935: A law passed by Congress, which facilitated regulation of electric utilities by limiting their operations to a single state, which made them subject to state regulations and/or forcing divestitures so that each became a single integrated system servicing a limited geographic area. In addition, the Act was designed to keep utility holding companies involved in regulated businesses from engaging in unregulated businesses. Therefore, the Securities and Exchange Commission would have to approve a holding company's activities in non-utility business prior to their engaging. This requirement was to ensure that the holding companies kept regulated and unregulated businesses separate.
- The Trust Indenture Act of 1939: A law passed in 1939 that prohibits bond issues valued at over $5 million from being offered for sale without a formal written agreement (an indenture), signed by both the bond issuer and the bondholder, that fully discloses the particulars of the bond issue. The act also requires that a trustee be appointed for all bond issues, so that the rights of bondholders are not compromised. The Trust Indenture Act of 1939 was passed for the protection of bond investors. In the event that a bond issuer becomes insolvent, the appointed trustee may be given the right to seize the bond issuer's assets and sell them in order to recoup the bondholders' investments (Investopedia, n.d.).
- The Investment Company Act of 1940: Investment companies were still new in 1940. Given the problems that happened in the late 1920s and the passage of the initial Acts in the early 1930s, Congress felt compelled to pass an Act that would provide investors confidence in these new companies as well as protect the public interest from this type of security. As a result of these concerns, the Investment Company Act of 1940 was passed. The Act established separate standards for investment companies as well as defined and regulated investment vehicles, including mutual funds. However, certain investments (i.e. hedge funds) were exempted.
The Act categorized the investment companies into three different classifications:
Face-amount Certificate Company: An investment company in the business of issuing face-amount certificates of the installment type.
Unit Investment Trust: An investment company, which, organized under a trust indenture, contract of custodianship or agency, or similar instrument, does not have a board of directors, and issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities, but does not include voting trust.
Management Company: Any investment company other than a face-amount certificate company or a unit investment trust. The most well-known type of management company is the mutual fund.
- The Investment Advisers Act of 1940: A federal law that was implemented in order to regulate the actions of investment advisors.
- The Securities Investor Protection Act of 1970: A federal law created as a special scheme for the liquidation of insolvent securities' brokerage firms and established the Securities Investor Protection Corporation (SIPC) to administer a fund to protect customers of failed brokers. The primary purpose of the Act is to reimburse customers for losses due to broker failures and to boost public confidence in securities markets (Joo, 1999).
If a customer has cash and securities missing from their customer accounts, he/she may be eligible for SIPC assistance. However, SIPC's fund cannot be used to pay claims of any failed brokerage firm customer who is also a general partner, officer, or director of the firm; the beneficial owner of five percent or more of any class of equity security of the firm (other than certain nonconvertible preferred stocks); a limited partner with a participation of five percent or more in the net assets or net profits of the firm; someone with the power to exercise a controlling influence over the management or policies of the firm; and/or a broker, dealer or bank...
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