Appalled by the stock market crash of 1929 and the subsequent economic collapse, the federal government moved assertively during the 1930s to regulate both the issuance and sale of corporate securities. The federal government's traditional laissez-faire policy towards the stock markets had left the states to regulate stock sales through "blue sky" laws, which attempted to protect investors from unscrupulous stock sellers who promised everything, including the blue sky above. But the revelations of fraud and manipulation that followed the market crash revealed the inadequacy of state regulation. New Deal laws would separate commercial and securities banking; require full disclosure of financial information for all stock issues; limit margin purchases of stocks; and create an independent regulatory body, the Securities and Exchange Commission, to oversee stock exchange practices.
Of the fifty billion dollars in stock sold in the United States during the great bull market of the 1920s, the House Commerce Committee estimated that half had been undesirable or worthless. From 1932 to 1934 an intensive investigation by the Senate Banking Committee demonstrated how bankers and brokers had bilked investors and contributed to the financial catastrophe. Under examination by the committee's chief counsel, Ferdinand Pecora, prestigious financiers admitted that their banks' securities houses had unloaded dubious stocks onto unwary investors. The investigation exposed abuses ranging from speculative pools and insider deals to preferential distribution of stock. Generating months of headlines, the Pecora investigation swung public opinion behind efforts to reform and regulate the securities markets.
THE LEGISLATIVE BATTLES
Securities regulation became intertwined with banking reform. The Glass-Steagall Act of 1933 ordered complete separation of commercial banks from their securities houses and provided federal insurance for bank deposits. In the previous congressional session, the bill sponsored by the two southern Democrats, Virginia Senator Carter Glass and Alabama Representative Henry Steagall, would not have divided banking and securities functions as rigidly, but the populist Senator Huey Long (Democrat-Louisiana) had killed the bill by filibuster. Glass and Steagall reintroduced the measure during the New Deal's "first hundred days" and tightened its provisions in response to the Pecora investigation's dramatic exposure of the abusive relationship between banks and their investment firms. Public opinion helped propel the bill to enactment in June.
Simultaneously, a bill to regulate the issuance of stocks was making its way through Congress. Samuel Untermyer, who had served as chief counsel of the Pujo investigation of the "Money Trust" in 1912, produced a plan by which the U.S. Post Office would supervise stock and bond sales. Former Federal Trade Commission (FTC) chairman Huston Thompson countered with a bill to empower the FTC to revoke the registration of stocks from any company it found to be "in unsound condition or insolvent." Dissatisfied with both approaches, President Franklin D. Roosevelt enlisted Harvard law professor Felix Frankfurter to prepare yet another bill. Frankfurter recruited a trio of young lawyers, James M. Landis, Benjamin V. Cohen, and Thomas G. Corcoran, who became known as Frankfurter's "happy hotdogs." The Frankfurter group reflected Supreme Court Justice Louis Brandeis's opposition to concentrations of economic power in either government or private finance. They considered it unwise to permit the government to judge the soundness of corporations and wrote a bill that instead required companies to publish complete and accurate financial information about their stock to allow investors to judge the risks for themselves. To insure truthfulness, the bill set criminal penalties for fraudulent stock registration. The Senate passed Thompson's bill, while the House adopted the Landis-Cohen-Corcoran version, as sponsored by Representative Sam Rayburn (Democrat-Texas). In conference committee, the House bill prevailed and became the Federal Securities Act of 1933. President Roosevelt appointed James Landis to the Federal Trade Commission, which would administer the new law.
The Pecora investigation and the Roosevelt administration next focused on stock exchange operations. Stock exchanges had operated as private trading grounds for brokers who bought and sold stocks for clients. Richard Whitney, president of the New York Stock Exchange, resisted efforts to oversee his operations. "You gentlemen are making a great mistake," he told Senate investigators. "The Exchange is a perfect institution." Once again several groups vied with conflicting legislative drafts. A task force headed by John Dickinson and composed of Treasury and Commerce department officials and Wall Street attorneys proposed creation of a "Federal Stock Exchange Authority" that would include representation from the stock markets. The authority would regulate the exchanges but would not specifically prohibit such controversial market practices as pools and short selling. Opposed to the Dickinson group, Cohen and Corcoran worked with Pecora's staff to draft a tougher measure that would empower the Federal Reserve Board to set margin requirements for stock purchases, separate broker and trader functions, outlaw all pools and short selling, and require all stock-issuing corporations to file quarterly reports with the FTC. President Roosevelt, although publicly neutral, privately favored the Cohen-Corcoran version, known as the Fletcher-Rayburn bill for its sponsors Senator Duncan Fletcher (Democrat-Florida) and Representative Rayburn.
Richard Whitney personally led the lobbying campaign against the Fletcher-Rayburn bill, warning corporations that the federal government could use the legislation to "dominate and actually control" their businesses. John Dickinson testified that the bill's high margin requirements would encourage widespread stock selling that would have a deflationary effect. Seeking to prevent the Federal Reserve Board from becoming "mixed up with stock market gambling," Senator Carter Glass proposed giving authority to police the stock exchanges to a new Securities and Exchange Commission (SEC). Unlike Dickinson's proposal, Glass made no provision for the stock exchanges to have representation on this independent regulatory commission. The final compromise, rather than specifically outlawing controversial trading practices, assigned the SEC to investigate them and set future policy. President Roosevelt signed the Securities Exchange Act into law on June 6, 1934.
SECURITIES AND EXCHANGE COMMISSION ENFORCEMENT
The SEC consisted of five commissioners appointed by the president and confirmed by the Senate, no more than three of whom could be members of the same political party. Initially, the commissioners chose their chairman (a later revision would give this right to the president). Roosevelt appointed James Landis and Ferdinand Pecora to the SEC, but encouraged them to elect a prominent stock trader, Joseph P. Kennedy, as the first chairman, to help ease Wall Street's fears.
Weighing the magnitude of the vast securities trading business against its small staff and limited budget, the SEC set out to guide and supervise the exchanges rather than to prohibit specific abuses. It demanded that all exchanges, and all corporations that listed their stocks on them, register with the commission. By registering, exchanges agreed to enforce SEC rules and to punish or expel members who violated them. Of the twenty-five exchanges that registered, the SEC shut down four and persuaded others, such as the New York Produce Exchange, to abandon their securities operations. Those that closed included the Boston Curb Exchange, for having listed illegal stocks, and the New York Mining Exchange, known as the "penny stock market," for fleecing the poorest investors.
Joseph Kennedy's resignation from the SEC after a year made James Landis chairman. Like Kennedy, Landis pursued a conciliatory policy that emphasized exchange self-regulation. Landis particularly worried that strict federal regulations would endanger economic diversity by falling harder on the smaller exchanges and driving some brokers out of business. Liberal detractors accused him of fostering self-control by Wall Street rather than government control of Wall Street. Despite this conciliatory policy, critics on Wall Street blamed the SEC for the market collapse and recession that occurred in 1937. That year, William O. Douglas became SEC chairman and challenged the giant New York Stock Exchange to reorganize or risk having the SEC step in to run the exchange. The exchange's board of governors endorsed the SEC's recommended rules revision, which provided for public representatives on the board and a paid president and technical staff for the exchange. The SEC's public disclosure requirements also brought to light the financial misconduct of former exchange president Richard Whitney, who admitted insolvency, was suspended from trading, and was imprisoned for embezzlement. Whitney's disgrace symbolized the new financial order.
While the SEC could supervise operations that were centralized on the floor of a few stock exchanges, it faced a more daunting problem with the thousands of brokers scattered across the nation, buying and selling stocks for investors. In 1938, Senator Francis Maloney (D. Conn.) sponsored legislation to encourage formation of a private National Association of Securities Dealers to supervise over-the-counter brokers and dealers. The SEC was given authority to review the association's rules, but the association took on the burden of regulation.
New Deal legislation transformed the nation's stock exchanges from private clubs into semipublic institutions with a federal commission to monitor their activities, police against manipulative and deceptive stock selling, and set standards for accounting procedures, in the interest of protecting investors. The SEC became widely acclaimed as one of the most successful experiments in federal regulation. During the latter half of the twentieth century American stock sales and values soared as millions of citizens invested in stocks with some confidence of protection from fraud. Although the SEC withstood the later trend toward deregulation, this enormous shift of personal savings from bank accounts to securities caused banks to protest the Glass-Steagall Act as a "New Deal dinosaur." Banks lobbied successfully for its repeal in 1996, when Congress permitted banks and securities firms to once again enter each other's business, with appropriate regulatory oversight.
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Donald A. Ritchie