A Brief History of the Securities and Exchange Commission

The SEC has been regulating the U.S. stock market since 1934, with significant changes over the years. The organization has introduced various acts and measures aimed at protecting investors from fraudulent activities, with a challenge to find the right balance between investor protection and market efficiency.

Basics

Investing has a long history marred by deception, mistakes, and irrational behavior. However, in recent times, there has been a development that offers hope to individual investors who have been misled by corporations. They now have a way to seek compensation for any wrongdoing.

The Blue Sky Laws and Early Regulation

Investing was originally reserved for the wealthy, who could afford to buy shares in joint-stock companies and bank bonds. The presence of fraud deterred most casual investors from participating. As the stock market grew in importance and became a significant part of the U.S. economy, the government took notice. Investing started to gain popularity among people of all classes as they enjoyed higher incomes. To protect these new investors, the Blue Sky Laws were introduced, starting in Kansas in 1911.

These laws aimed to safeguard investors from deceitful companies and promoters selling worthless securities. They required companies to provide a prospectus that disclosed the interests and motivations of the sellers. However, there were no regulations to prevent issuers from selling securities with unfair terms as long as they informed potential investors.

Unfortunately, the Blue Sky Laws were limited in their effectiveness and enforcement. Companies found ways to bypass full disclosure by offering shares to out-of-state investors through the mail. State regulators also did not thoroughly verify in-state disclosures. By the 1920s, with a booming economy, investors were eager to enter the stock market. Many used margin, a new tool, to increase their returns.

Beginning of the Great Depression

The market was flooded with uninformed investors, creating an environment conducive to manipulation. Brokers, market makers, owners, and even bankers engaged in trading shares amongst themselves to artificially inflate prices before selling them to the unsuspecting public. Despite the public's optimistic frenzy, the excessive reliance on these manipulated stocks eventually led to a market downturn. On October 29, 1929, the dreaded Great Depression began with the infamous Black Tuesday.

The stock market crash on Black Tuesday, marking the onset of the Great Depression, had repercussions beyond the stock market itself. Banks engaging in speculative activities with clients' deposits, coupled with the United States' significant international creditor position, intensified the impact, affecting both domestic and global economies.

While the Federal Reserve's decision to maintain interest rates led to the bankruptcy of numerous margin traders, the government intervened with social programs and reforms to alleviate the crisis. The government criticized the Federal Reserve for its role in fueling the stock market bubble through increased money supply. This realization underscored the need for greater government control over stock market operations, considering its responsibility in addressing associated issues.

The Securities Acts of 1933 and 1934

In 1933, two significant pieces of legislation were passed by Congress. The Glass-Steagall Act aimed to prevent banks from getting heavily involved in the stock market, ensuring their stability during market crashes. Meanwhile, the Securities Act aimed to strengthen the existing state Blue Sky Laws at the federal level. In response to the deteriorating economy and public demand for action, the government further enhanced the original act in 1934 with the Securities Exchange Act.

The Emergence of the SEC

The Securities Exchange Act was signed into law on June 6, 1934, which established the Securities and Exchange Commission (SEC) in response to the inadequate enforcement of the Blue Sky Laws. The crash severely impacted investor confidence, leading to the enactment of additional acts such as the Public Utility Holding Company Act in 1935, the Trust Indenture Act in 1939, the Investment Advisers Act in 1940, and the Investment Company Act in 1940. The SEC was entrusted with enforcing these acts.

Under the leadership of Joseph Kennedy, the SEC gained significant powers. It introduced stricter disclosure and reporting requirements for companies offering securities to the public. The SEC also facilitated the pursuit of civil charges against those found guilty of fraud and securities violations. These measures were well-received by investors gradually returning to the market after World War II, which played a crucial role in reinvigorating the economy.

Restrictions on Risky Investments

To enhance transparency and combat fraud, improved access to financial information was introduced alongside a contentious measure. This measure restricted highly risky, high-return investments to individuals capable of demonstrating to the SEC that they could absorb significant losses. Accredited investors are subject to the criteria established by the SEC, which some perceive as a subjective assessment and a shift from merely safeguarding investors against unsafe investments to safeguarding them from their own decisions.

Efforts to Improve Market Safety

Congressional measures empowering the SEC have been implemented in efforts to improve market safety for individual investors. Lessons learned from past scandals and crises have led to the enactment of laws such as the Sarbanes-Oxley Act in 2002, aimed at preventing fraudulent accounting practices. The Dodd-Frank Wall Street Reform and Consumer Protection Act, triggered by the Great Recession, also sought to regulate the financial industry. Finding the right balance between investor protection and market efficiency remains a challenge for the SEC.

The SEC's Establishment and Leadership

In response to the stock market crash of 1929, Congress took action to restore public trust in U.S. markets. This led to the passage of the Securities Act of 1933 and the Securities Exchange Act of 1934, which established the Securities and Exchange Commission. Under President Franklin D. Roosevelt, the original SEC commissioners included Joseph P. Kennedy as the chair, along with George C. Mathews, James M. Landis, Robert E. Healy, and Ferdinand Pecora.

Currently, Gary Gensler serves as the chair of the SEC. He was nominated by President Joe Biden on February 3, 2021, and assumed office on April 17, 2021. Before joining the SEC, Gensler held various roles, including professor at the Massachusetts Institute of Technology's Sloan School of Management, chair of the Maryland Financial Consumer Protection Commission, and chair of the U.S. Commodity Futures Trading Commission. He also served as a senior advisor on financial legislation and held positions in the U.S. Treasury Department.

Conclusion

The SEC has been an integral part of regulating the U.S. stock market since its inception in 1934. The organization has gone through significant changes over the years, including the introduction of various acts and measures aimed at protecting investors from fraudulent activities. The SEC's efforts to improve market safety and efficiency have been essential in restoring public trust in U.S. markets and in safeguarding the interests of individual investors. The organization's ongoing challenge lies in finding the right balance between investor protection and market efficiency.