The backbone of the legal regime of securities regulation in the US was enacted after a period of great panic and loss in the securities markets and during an era of economic hardship. Just before entering the Great Depression, the United States experienced good economic development. The 1920s was a period of great optimism; production and employment levels were rising and many people were living better than they ever had.97 Excessive optimism, however, has a tendency to create bubbles.98
The first significant bubble in this period was the boom of the Florida real estate market. Houses were being sold at more than double the price for which they had been sold a few years before, and opportunistic ‘entrepreneurs’, such as Mr. Charles Ponzi, were selling non-existent real estate developments.99 Speculation was rampant, with purchasers entering the market with the exclusive intent of reselling their rights to the property at a profit.100 The introduction of binders, a legal mechanism that gave the right
97 John Kenneth Galbraith, The Great Crash: 1929 (Houghton Mifflin Company 1997) 1-3.
98 Especially if coupled with easy monetary policy, as it was the case with the Florida real estate bubble at
the time. The Federal Reserve had lowered its discount rate from 4.5% in the end of 1922 to 3% in the second quarter of 1923. See William B. Stronge, The Sunshine Economy (University Press of Florida 2008) 98.
99See Galbraith 4-5 (n 97). 100 Stronge 97 (n 98).
to the buyer on the property without the effective transfer on public registries for thirty days, simply facilitated the process.101
In 1926, the real estate market in Florida collapsed. The problem began with a lack of workers who could continue construction as it was demanded, the logistical problems of the area and the increasing awareness of the unethical practices engaged by real estate promoters.102 Then, in September 1926, a hurricane struck the region, causing severe damage and putting an end to any speculative activity that would otherwise have still been in place.103
At the beginning of 1928, the same speculative frenzy and make-believe mindset took over the stock market in New York.104 The amount of broker’s loans, used for purchases of securities on margin,105 was on the rise, increasing from $3,480,780,000106 at the end of 1927 to $6,000,000,000 at the end of 1928.107 This was a clear sign that speculation was escalating.
At the same time, in order to keep pace with the necessities of the market and the willingness of people to put their money in stocks and bonds, investment trusts were being created.108 These trusts were so popular and their managers so well-regarded that their securities value was superior to the underlying assets that they had, sometimes achieving a premium of 100%.109
Within this environment, fraud and manipulation were also common. Some investment banks were not sufficiently careful in verifying the health of the companies
101 Binders were introduced because the recording offices in Florida were overloaded with work, and they
were used to guarantee the rights until transfer would be made. Ibid 98.
102Ibid 100-02. 103 Ibid 102.
104 Galbraith 11-14 (n 97).
105 Purchases of securities where the broker loans the money to the purchaser and the security is kept by
the broker as collateral.
106 This was already a significant amount, since in the early twenties the value of these loans floated around
one to one and a half billion dollars.
107 Galbraith 11-14 (n 97).
108 During the years of 1928 and 1929, around 451 investment trusts were created. Ibid 21. 109 Ibid 49-50.
they were underwriting; in other instances, they had outright knowledge as to the worthlessness of the underwritten securities, but had no interest as they would subsequently dump them in the market through aggressive marketing strategies.110 Other actors would also manipulate securities prices; common instruments that could be engaged to do so included the creation of parallel markets and the facilitation of market manipulation through short sales111 and high-volume stock purchases.112
In October 1929, after a year of strong appreciation,113 the New York Stock Exchange experienced a crash that put the market into a downward spiral, resulting in a loss of 87% of market value by mid-1932.114 The stock market crash was a sign of the bad times that were coming, constituting, for many, the beginning of the Great Depression.115
The federal statutes for securities regulation were enacted as responses to the market failures that had led to the crash.116 While state securities regulations had existed since 1911,117 the ‘blue-sky’118 statutes were problematic. They could barely be enforced across state lines, leaving fraudsters from other states practically immune to these laws.119 Moreover, evidence shows that the information provided on offering circulars before the enactment of the securities laws of 1933 and 1934 were poor, conveying inadequate information to allow for an informed investment decision.120
110 Ibid 53-54.
111 Short sale is the sale of stock without owning it. Usually the stock is borrowed and sold, and has to be
given back at a later date. Short sellers expected the stock price to drop, so they can repurchase the stock in the market at a lower price and return it to the owner, making a profit on the transaction.
112 James Burk, ‘The Origins of Federal Securities Regulation: A Case Study in the Social Control of Finance’
(1985) 63 Social Forces 1010, 1016.
113 From the date Herbert Hoover accepted its Republican nomination, on August 12, 1928, to September
19, 1929, the New York Times Industrial Average rose from 257.98 to 460.2, a 44% increase. See ibid .
114 Compared to the market’s peak value before the crash. See ibid .
115 For an overview of the Great Depression, see Daniel Leab and others, The Economic Depression (ABC-
CLIO 2010) 2-6.
116See Eric Rauchway, The Great Depression & the New Deal: a Very Short Introduction (Oxford University
Press 2008) 62.
117 The first securities regulation statute was enacted in Kansas. See ‘Securities Commission’ (West Virginia State Auditor's Office) <https://www.wvsao.gov/securitiescommission/history.aspx> accessed 7 July 2014.
118 The term used for States’ securities statutes in the U.S. 119See Burk (n 112).
The Securities Act of 1933 and the Securities Exchange Act of 1934 intended change this situation.121 The 1933 act was designed to impose disclosure duties on issuers of securities to better inform investors as to their decisions, while the 1934 act created the Securities and Exchange Commission and regulated stock exchanges and ongoing disclosure duties for issuers.