Term Paper: Sarbanes-oxley. The Political Pressure

Pages: 29 (7885 words)  ·  Bibliography Sources: 1+  ·  Level: College Senior  ·  Topic: Economics  ·  Buy This Paper


[. . .] And last of all, the Securities and Exchange Commission was established.

The law was often referred to as the "truth in securities" law. According to the SEC's web site, the Securities Act of 1933 has two basic objectives:

require that investors receive financial and other significant information concerning securities being offered for public sale; and prohibit deceit, misrepresentations, and other fraud in the sale of securities.

This act was partly authored, ironically, by Joseph Kennedy, who was considered an expert in that he had made much of his money illegitimately through the sale of liquor. Although regulation enjoyed broad-based support, it had its opponents. The most prominent among them was the president of the New York Stock Exchange. However, he was soon silenced when it was found that he had been embezzling from one of the organization's charities after his post-prohibition investments in New Jersey Applejack had gone sour.

Roosevelt's message to Congress regarding the new Securities Act excoriated about financial practices that are neither ethical or honest, assumes the obligation of government to "give importance to honest dealing," and promises further legislation -- the Securities Exchange Act -- to correct unethical and unsafe practices so that we can return "to a clear understanding of the ancient truth" that financiers are "trustees acting for others." Although progressivism had dominated the United States political scene through the Wilson administration, the last several Presidents had been conservative and valued the market's ability to self-regulate. The last perceived threat to the national economy had come from banking trusts, prompting the establishment of the Federal Reserve. In the 1920's, Andrew Mellon was the Republican Party's principle financial guru. Mellon dropped the wartime progressive tax burden on the super-wealthy from above 70% to below 30%, causing the nation's rich to move their money out of largely tax exempt municipal securities and back into the market.

When a primary market is created for securities (an Initial Public Offering,) a company is required to distribute a prospectus. Smaller securities offerings or private offerings were exempt from the new legislation. Also exempt were intra-state offerings and municipal, state and federal offerings. By exempting small offerings from the registration process, legislators sought to foster capital formation by lowering the cost of offering securities to the public. Smaller offerings didn't have the 'hurdle rate' usually associated with compliance.

The SEC's first focus was to establish guidelines for the registration of new securities. Such a process allowed investors to make informed purchasing decisions when looking at different securities. Originally, compliance efforts were meant to maximize disclosure at a minimal expense. Such regulations pre-dated the establishment of a with-holding tax, so compliance was something novel rather than a new facet of financial bookkeeping.

According to the SEC, Registration must include:

description of the company's properties and business; description of the security to be offered for sale; information about the management of the company; and financial statements certified by independent accountants.

Registration statements and prospectuses (preceded by 'Red Herring' prospectuses) become public soon after filing with the SEC. These measures are primarily set up to defend the initial public market. It is understood that prior to the establishment of this market, the private holders, 'angel' investors and venture capitalists responsible for providing the initial financing for a new venture are willing to incur significantly greater levels of risk in order to reap the reward of a new opportunity. Venture capitalists and private equity departments of large investment banks have evolved into the industry's specialists in this particular field.

Although these requirements were made of companies in 1933, the SEC was established under another act in 1934; the Securities Exchange Act. This act pertained to the secondary market; the market in which people buy and sell securities rather than the initial market in which privately owned securities are made public. This act gave the SEC oversight with reference to the entire securities industry. The SEC was entrusted with the regulation of securities registration and placed over Self-Regulatory Organizations such as the National Association of Securities Dealers. The organization polices insider trading, which has been traditionally considered the biggest moral threat to the securities industry. This is still the case; those that would see their companies fail and act on this material information before it becomes public only enhance the threat of insider trading.

Insider trading is forbidden with respect to the offer, purchase, or sale of securities. The SEC defines an insider as someone who has material, nonpublic information. Material information is any information that is considered relevant to the value of the securities of the firm. Insiders are thought to have a responsibility to their companies and to the market to keep this information confidential. The Association for Investment Management Research maintains a more comprehensive set of standards, which is specific to securities analysts.

The act requires periodic reporting, which has become formalized in the 10-k and 10-q forms that provide the basis for most of the investment information that is available to individuals. Analysts, in addition, have at their disposal the ability to interview company board members on a regular basis and to participate in conference calls. The process by which information is disseminated is expected to be as uniform as possible, within reason. Companies that own more than 10 million in assets, whose securities are owned by more than 500 owners are required to post these SEC filings, which are then made available on the EDGAR web site. In addition, most companies provide Annual reports that act as a dressed-up version of the 10-k. They are considered the organ of management's opinion and its statement of the kind of guidance that they will provide the company over the course of the following year or several years.

The SEC mandates the methodology that companies use in materials that solicit shareholders' votes in shareholder meetings or meetings convened to elect directors or approve other major actions by the board. Such information must be filed with the SEC prior to its dissemination to the public. They must fully disclose all material information to the voters. Exchanges such as the NYSE, ASE, and NASDAQ, and industry organizations such as the NASD and AIMR are required to register with the SEC. The SEC also requires brokers, dealers, transfer agents and clearing houses to register. Originally the SEC mandated commissions, but this has been rescinded since the 1960's, leading to a greater volume of trades.

Public opinion found three culprits for the stock market failure between 1929 and 1932, which have their parallels in the events leading up to the introduction of the Investor Protection act of 2002. It was common wisdom that irrational exuberance had lead to what was thought of as a 'speculative orgy.' Drawing on the anti-authoritarian suspicions of their populist, progressive forbears, many claimed that Investment Bankers and the Federal Reserve were to blame. Congressional leaders shared this opinion, as Walter Sach's megalo-maniacal delusions were not atypical. Many claimed that the guilty parties in the Federal Reserve had diverted credit from productive purposes to sustain the boon. Another set of culprits were the contrarian investors that sold short. Although technical analysis was more even more popular at the time than it is now (and remains one of the only ways to make money in a down market) many resented these specialists for profiting from others' misfortune. Market leaders claimed that such people allowed for stocks to avoid a steep upward climb in value that resulted from there being no sellers, but it was to become a difficult fight for these investors to maintain the legality of short selling.

The second reason was that of securities fraud. However, unlike the securities fraud of the last few years, this fraud usually involved start-ups or relatively new companies. Several examples were given during the Senate investigations into stock exchange practices, which occurred in 1933 and 1934. Some of the investment banks were directly implicated in the issuance of fraudulent securities. Initial Public Offerings today are usually under-written by several bulge-bracket banks, but in the 1930's this was not the case. In the recent collapse, several industries in particular were associated with securities fraud, including telecommunications.

The third reason was that of stock market price manipulation. This included the private sales of publicly traded equity securities and the active manipulation of securities by pools of investors. Bankers would also use depositor's money to trade speculatively. This has happened within the last ten years, but is usually limited to special cases. For instance, Nick Leeson destroyed Barings Bank by buying forward contracts to purchase Japanese Yen immediately before the Kobe earthquake. Companies would also keep stock values high for advertising or commercial purposes. This was more of an accusation than anything else - there are (and were) too many investors to structurally allow any attempt to control stock market prices to take place.

Many consider the Investor Protection Act of 2002 to be the most sweeping array of reforms since… [END OF PREVIEW]

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