The Securities Exchange Act of 1934: Establishing the SEC
Although the 1933 Act set ambitious goals and standards for disclosure, it was silent on the practical aspect of enforcement. To plug this hole, Congress passed the Securities Exchange Act of 1934, which established the Securities and Exchange Commission (SEC) to implement the 1933 Act.
Overview of the 1934 Act
The 1934 Act established the ground rules under which the purchasers of securities may resell and trade shares by:
Requiring sellers of securities to register as broker dealers
Creating regulated securities exchanges
Defining the duties of companies whose securities are traded among investors
In effect, the 1934 Act requires a company to make certain information available to the public so that company’s shareholders may resell their stock to members of the general public.
Many of the securities sold in the United States are private placement offerings, which aren’t subject to registration under the 1933 Act but are subject to the civil liability and anti-fraud provisions of the 1934 Act.
Keeping offerings private under Regulation D
The term private placement refers to the offer and sale of any security by a brokerage firm to certain investors but not to the general public.
Private offerings are “exempt from registration under the 1933 Act, subject to specific exemptions contained in Sections 3(b) 4(2) of the 1933 Act as interpreted by SEC Regulation D.” However, private placements may still be subject to portions of the 1934 Act and to state securities laws requiring registration as well as to certain provisions of the Sarbanes-Oxley Act (SOX).
Regulation D Sections 504–506 establish three types of exemptions from the registration requirements of the 1933 Act:
Rule 504 applies to transactions in which no more than $1 million of securities are sold in any consecutive 12-month period. Rule 504 doesn’t limit the number of investors. These types of offerings remain subject to federal anti-fraud provisions and civil liability provisions of the 1934 Act if they raise more than $1 million.
Rule 505 applies to transactions in which not more than $5 million of securities are sold in any consecutive 12-month period. Sales of the security can’t be made to more than 35 “non-accredited” investors but can be made to an unlimited number of accredited investors. An issuer under this section can’t use any general solicitation advertising to sell its securities.
Rule 506 has no dollar limitation of the offering. An exemption under this section is available for offerings sold to not more than 35 non-accredited purchasers and an unlimited number of accredited investors. Rule 506 requires an issuer to make a subjective determination that at the time the shares are sold, each non-accredited purchaser meets a certain sophistication standard.
For purposes of Regulation D, an accredited investor is defined in Rule 501(a) as someone who has the following characteristics:
Is a director, executive officer, or general partner of the issuer
Has a net worth either individually or jointly with his or her spouse that equals or exceeds $1 million
Has income that exceeds $200,000 per year (or $300,000, jointly with spouse) for each of the two most recent years and reasonably expects an income that exceeds $200,000 in the current year
Powers given to the SEC
Under the 1934 Act, the SEC has the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation’s securities stock exchanges.
Periodic reporting requirements under the 1934 Act require full disclosure of facts subsequent to filing that are material or significant enough to affect investors’ decision-making processes. The 1934 Act also identifies and prohibits certain types of conduct in the markets, such as insider trading and market manipulation, and provides the SEC with disciplinary powers over regulated entities and persons associated with them.
The SEC’s rule-making authority for SOX
The 1934 Act gives the SEC the authority to supplement securities laws by making its own rules for carrying them out. The SEC passes its own regulations, which have the same force, effect, and authority as laws passed by Congress.
Periodic reporting under the 1934 Act
The Securities Exchange Act of 1934 directs the SEC to require periodic reporting of information by companies with publicly traded securities. These companies must submit 10-K Annual Reports, 10-Q Quarterly Reports, and Form 8-K for significant events. These reports are made available to the public through the SEC’s EDGAR database.
Additionally, the 1934 Act imposes special reporting requirements on companies in the following contexts:
Proxy solicitations: The SEC uses a procedure called proxy to allow geographically distant shareholders to participate in elections without attending meetings. Naturally, persons seeking control, including insiders hoping to retain control, solicit those proxies for their candidates. Companies must file materials with the SEC in advance of any such solicitations.
Tender offers: The 1934 Act requires disclosure of important information by anyone seeking to acquire more than 5 percent of a company’s securities by direct purchase, also known as a tender offer.
Exchanges and associations: The 1934 Act requires that exchanges, brokers and dealers, transfer agents, and clearing agencies report to the SEC.
The 1933 Act covers offers and sales by issuers (companies whose securities are offered), while the 1934 Act defines what information those companies must make available to permit their shareholders to trade company shares after purchasing them.
Insider trading provisions
Section 16 of the Securities Exchange Act of 1934 establishes that it’s illegal for management, directors, and other people having “inside” knowledge about a company to use that information themselves or to pass it on to others so that they can use it improperly to gain a financial benefit for themselves. Every member of the public should have an equal advantage when it comes to investing in public companies.
SOX Section 403(a) strengthens Section 16 of the 1934 Act by requiring company insiders to disclose to the SEC information about their stock transactions within two business days of when they occur. These disclosures are made on an 8-K filing.
Trading securities while in possession of information that’s not available to the public is illegal if that information is material to the value of the investment.