Excerpt from the Securities Act of 1933
- (a) Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly—
- to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or
- to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale.
The Securities Act of 1933 (P.L. 73-22, 48 Stat. 74) was the first federal legislation specifically intended to regulate a company's sale of securities (i.e., stocks and bonds). The act required that all sales of securities be registered with the government unless there was a specific exemption to the contrary. The process of registration included the submission of a prospectus, a disclosure document that states all material facts relating to the securities and the company issuing them. The acts provided remedies for investors who are misled regarding the securities, or who purchase securities that should be registered but are not. The act also included civil and criminal penalties for violating its provisions.
The key operative provision of the act required that no securities be sold in interstate commerce without an effective registration statement in effect for the securities. There are exemptions provided for securities transactions that are not a public offering; certain specified small offerings; intrastate offerings; and transactions by other than the issuing company or under-writer. These exemptions, potentially very complicated in application, meant that ordinary transactions over a stock exchange were not covered by the Securities Act of 1933. The act was instead intended to regulate companies seeking to raise capital through a public offering.
Constitutional Basis
Congress promulgated the act pursuant to its authority to regulate interstate commerce, granted by Article II, Section 8 of the U.S. Constitution. The act therefore requires the use of an instrumentality of interstate communication or transportation before it applies. Courts have held that the use of mails or a telephone suffices to meet this requirement, even if the use is completely intrastate.
Circumstances Leading to the Adoption of the Act
The Securities Act of 1933 was a key component of President Franklin D. Roosevelt's New Deal. The New Deal represented the first massive federal regulation of the economy. FDR intended the New Deal to help resolve the Great Depression, an unprecedented economic calamity that ultimately gave rise to an unemployment rate of 25 percent and a 33 percent contraction of the nation's economy. In the election of 1932, FDR promised to deliver economic reform, and the New Deal was an effort to fulfill this promise.
The regulation of securities was a natural starting place for the New Deal reforms, as the stock market crash of 1929 seemed to have triggered the deep economic malaise that became the Great Depression. Roosevelt sought to "bring back public confidence" in the securities markets and was convinced that a truth in securities act, at the federal level, was the right medicine. One-half of the $50 billion in new securities sold during the 1920s turned out to be worthless. Investor confidence was so devastated by the carnage that the issuance of new securities fell from $9.4 billion in 1929 to $380 million in 1933. By 1933 there was considerable economic and political pressure for regulation.
Nevertheless, the financial community opposed the act, adhering to a more laissez-faire approach that would have preserved the status quo. Some commentators worried that the bill would actually slow economic recovery by slowing the capital formation process and discouraging the flotation of new securities. Some even worried there would be a "capital strike," whereby financiers simply would not undertake any entrepreneurial activity. In the end, the forces arrayed against reform did not have a favorable political context, due in large part to continued macroeconomic distress, and the bill passed Congress. It was signed into law on May 27, 1933.
Experience Under the Act
There was no capital strike and instead the nation's securities markets flourished, becoming a worldwide model. By the mid-1990s, for example, initial public offerings of securities by new firms grew from $43.6 billion in 1991 to $66.5 Billion in 1992, and to $112 billion in 1993. This flow of capital to new firms translated into a major competitive advantage for U.S. business. By 1995 experts widely viewed the American securities markets to be the strongest markets in the world.
Initially the courts were very receptive to the remedial and investor protection goals of the act. In SEC v. Howey (1946), the U.S. Supreme Court articulated a broad definition of securities that gave the act an extended reach. Similarly, in Wilko v. Swan (1953), the Supreme Court held that an arbitration agreement could not be raised as a defense to an action under the Securities Act. The Court refused to relegate investors to private arbitration proceedings, and instead affirmed investors could not waive the remedies under the act. This meant that investors would always retain the ability to vindicate their rights under the act in a court.
Still, as the decades passed and memories of the Great Depression faded, courts appeared to become far more skeptical of the act. In Rodriguez v. Shearson (1989), the Supreme Court overruled Wilko and held that an arbitration agreement barred a customer from suing in court under the Securities Act of 1933. In Gustafson v. Alloyd (1995), the Supreme Court severely limited the scope of remedies available under the act, holding that one of the most important remedial sections of the act only applied to initial public offerings made pursuant to a statutory prospectus, and not to exempt distributions or transactions on the secondary market. This was a surprise given that the plain meaning of the statute made no mention of any such requirement.
In addition to court rulings limiting the effect of the act, Congress has adopted certain additional limitations. Specifically, in 1995 Congress enacted (over a presidential veto) the Private Securities Litigation Reform Act, effectively limiting class actions under the act and shifting a large extent of the act's enforcement to the Securities and Exchange Commission. In 1998 Congress went an additional step, in the Securities Litigation Uniform Standards Act, preempting class actions based upon state law. The net effect of these two acts is to greatly undermine the efficacy of private litigation as a means of enforcement.
The impact of the Securities Act of 1933 on society has been controversial. The laissez-faire enthusiasts who opposed the act, unsuccessfully, succeeded over the past few decades in raising questions about the efficacy of the act. They maintained, for example, that the quality of securities issued before the act was comparable to the quality of securities issued after the act. They further maintained that the market furnished sufficient incentives for the disclosure of information so no mandatory disclosure regime was needed. One commentator, Judge Richard Posner, who is a leading proponent of laissez faire efficiency, has argued that security regulations may be a waste of time.
Empirical studies to date have suggested that the act did not significantly raise investor returns, but Congress did not intend the act to accomplish such a goal. Congress intended to enhance the flow of information so investors could make intelligent investment decisions. On this point, every empirical study to date has shown that performance of new issues was less volatile after the act. This suggests that markets operated more efficiently after the act, as investors made decisions in a more intelligent manner.
The laws have been consistent with greater investor confidence, and this too was one of Congress's aims of the act. Economists increasingly believe that mandatory securities disclosure regimes, such as the Securities Act of 1933, are part of a sound regulatory infrastructure needed to facilitate the optimal performance of market-based economies.
George Stiglitz, 2001 Nobel laureate in economics, has specifically argued that the lack of adequate securities regulation is one of the reasons why the developing world has not achieved the promises of globalization. Other economists share this conclusion. Regardless of whether the securities laws have enhanced the efficient operation of markets by supporting more intelligent decision-making, it is clear that the act contributed to a stable macro economy and lowered the cost of capital by enhancing investor confidence. In the sixty years following its enactment, the economy suffered no shocks of the same magnitude of the Great Depression. On the other hand, shortly after significant dilution of the private enforcement of the act in 1995, and the judicial limitations imposed upon the act's reach, the United States experienced a severe crisis in investor confidence in the summer of 2002 that clearly increased the nation's cost of capital.
Relationship With Other Laws
There are a number of federal securities acts other than the Securities Act of 1933. The most important of these is the Securities Exchange Act of 1934. The Securities Exchange Act of 1934 does not generally regulate the initial distribution of securities like the Securities Act of 1933. Instead, the Securities Exchange Act of 1934 imposed continuing disclosure obligations on publicly held companies whether or not they were issuing securities. The 1934 Act also regulated the securities industry, including stock exchanges, broker-dealers and other securities professionals. Finally, it regulated certain aspects of publicly held companies like corporate governance, tender offers, and proxy solicitations.
As previously discussed, for over six decades the federal securities laws, including the Securities Act of 1933, provided investor remedies that were in addition to any remedies under state law. In 1998, however, Congress reversed this outcome and preempted all class actions under state "Blue Sky" laws, which generally extended investors more generous avenues of recovery than those remaining under the act after the Private Securities Litigation Reform Act of 1995.
Bibliography
Davis, Kenneth S. FDR: The New Deal Years. New York: Random House, 1986.
Posner, Richard. The Economic Analysis of Law. New York: Aspen, 1998.
Ramirez, Steven. "The Law and Macroeconomics of the New Deal at 70." MarylandLaw Review 62, no. 3 (2003).
Ramirez, Steven, "Fear and Social Capitalism." Washburn Law Journal 42, no. 1 (2002): 31–77.
Roosevelt, Franklin D. The Public Papers and Addresses of Franklin D. Roosevelt. New York: Random House, 1938.
Stiglitz, Joseph. Globalization and its Discontents. New York: W.W. Norton, 2002.
