Market Watch

Market Watch 1

Market Watch: Regulation of the Stock Market

Samuel Thomas

Legal Environment

Bus670

Professor Gittens

Market Watch 2

The Enrons and Worldcoms made it clear that the financial markets cannot be left under the auspices of corporate directors and officers, without oversight authority. "The corporate abuses and fraud that Enron exemplified, while not a first in the financial markets, they were certainly a first in terms of the magnitude of the losses to stockholders and the confidence the public reposed in the financial sector (Bequai 2003)." As a result of the stock market crash of 1929 regulations such as the Securities Act of 1933 and Securities Exchange Act of 1934 were established to prevent such practices as those that contributed to the downfalls of Enron and Worldcom.

In this report, I will briefly explore some popular reasons why the market crash of 1929 happened, events leading the market crash and regulations the government instituted in order to protect investors.

The 1920's, after the end of World War I, was considered a time of prosperity and technology with innovations such as the car and radio ushered in the . The economy was strong and millionaires were being created daily. But soon this economical bubble was about to burst.

Like the markets of the 1990's, the Dow Jones Industrial Average rose to tremendously heights. Many investors quickly purchased shares of stocks in the hopes of making loads of money. Stocks were seen as extremely safe by most economists, due to the powerful economic boom.

Market Watch 3

Investors purchased stock on margin. For every dollar invested, a margin user would borrow 9 dollars worth of stock. Because of this leverage, if a stock went up 1%, the investor would make 10%! This also works the other way around, exaggerating even minor losses. If a stock drops too much, a margin holder could lose all of their money and owe their broker money as well.

Investors mortgaged their homes, and idiotically invested their life savings in hot stocks, such as Ford and RCA. Few people actually studied the fundamentals of the companies they invested in. Thousands of fraudulent companies were formed to fool unsavvy investors. Most investors never even thought a crash was possible. To them, the stock market always seemed to go up.

"By 1929, the Fed raised interest rates several times to cool the overheated stock market. By October, the bear market had commenced. On Thursday, October 24 1929, panic selling occurred as investors realized the stock boom had been an over inflated bubble (Morgan, E.V.,Thomas, W.A. 1962)." Those investors who made millions investing using margins became insolvent instantaneously. The Dow decreased from 400 to 145 by November 1929, losing about 16 billon dollars in stock capitalization.

To increase the problems, banks invested their deposits in the stock market. Because banks were so heavily invested in the stock market many of the money from customer was lost which resulted in bank runs. Many banks ended up in bankruptcy, so those depositors who never invested in the stock market lost millions.

Market Watch 4

"Before the Great Crash of 1929, there was little support for federal regulation of the securities markets (sec.gov)." Congress solt solutions to identify the problems that lead to the market crash by holding hearings to discuss the situation. From information gathered at the hearings Congress established "The Securities Act of 1933, coming on the heels of the stock market crash of 1929 and the ensuing great depression, aimed to increase the public trust in American markets. It accomplishes this goal through disclosure of important financial information in the registration statement, and in the prospectus (wikpedia.org/wiki/Securities_Act_of_1933)."

What the Securities Act of 1933 means to investors is that, investors will be able to make intelligent investment decisions based on a company's financial information. The SEC requires that the information included in the financial information provided be accurate, it does not guarantee it. In recent years we've several companies whom violated this rule, such as Enron and their fraudulent account practices. Violation of such regulation can include paying a fine and/or jail time.

The Securities Exchange Act of 1934 was the second major congressional act passed to regulate the securities industry after the stock market crash of 1929. The main purpose of the Exchange Act was to establish and maintain fair and honest markets for the sale of securities. The Exchange Act deals with the secondary transactions of securities, whereas the Securities Act of 1933 regulates new issues.

Market Watch 5

The Exchange Act also created the Securities and Exchange Commission (SEC), which is an agency of the U.S. government. The SEC was established to regulate securities trading.

The Act identifies and prohibits certain types of actions in the markets and allows the Commission to have disciplinary powers over regulated entities and persons affiliated with them. Prohibited conduct includes:

A: Manipulation: is the intentionally influencing the market price of a security. Manipulative acts include, 1) intending to create a false or misleading impression of active trading, 2) Attempting to manipulate the price of a security by buying and selling the same security within a group of individuals without the security truly changing ownership, 3) making untrue or misleading statements regarding a material fact for the purpose of inducing others to purchase or sell a security and other actions.

B: Insider trading: is the act of trading on information that is not known to the public. Being aware of information that is not available to the general public gives insiders an opportunity to make huge profits form the short-term trading of their company shares.

C: Other violation include: accounting fraud and providing false or misleading information about securities and the companies that issue them, stealing customers' funds or securities and violating broker-dealers' responsibility to treat customers fairly; and sale of securities without proper registration.

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