The Securities Fraud Deterrence and Investor Restitution Act: More Effective Than Current Regulation?

INTRODUCTION Recent events have shown that the securities markets, although regulated both federally and by the states, are still subject to violations and scandals. Congress has addressed this problem by holding hearings and enacting legislation that attempts to decrease violations. A House member introduced H.R. 2179: The securities Fraud Deterrence and Investor Restitution Act1 in an attempt to give the securities and Exchange Commission (sec) more power to regulate the securities markets. A controversial amendment to the bill would prohibit states from setting any requirements that differ from or add to federal regulations regarding various areas of securities regulation.2 Part II of this Note will give a brief description of the history of securities regulation in the United States. Part III will describe the substance of H.R. 2179 and amendments to it, as well as analyze the arguments for and against the bill. Part IV will recommend that more information be gathered before taking any action and will be followed by the conclusion. II. SECURITIES REGULATION HISTORY A. State Securities Regulation State governments, as opposed to the federal government, were the first entities to regulate securities. A security is an instrument that evidences the holder's ownership rights in a firm, the holder's creditor relationship with a firm or government, or the holder's other rights.3 The term security encompasses many financial instruments, including a note, stock, treasury stock, bond, debenture, transferable share, and investment contract.4 Before direct regulation of securities began, states regulated them indirectly, by using gambling statutes to prohibit betting on stock price changes and regulatory commissions or other means to supervise corporations' activities.5 There was also case law in many states that prescribed brokers' duties to their customers.6 Many states then enacted securities laws called laws.7 Kansas was the first state to adopt blue-sky laws in 1911,8 and forty-seven states adopted them before 1931.9 These laws attempted to stop the sale of fraudulent securities.10 In Kansas, the statute employed merit review by giving the banking commission the power to determine if the public sale of a security should or should not be allowed based on broad criteria, such as if the issuer not intend to do a fair and honest business' or 'does not promise a fair return.'11 The Martin Act,12 passed by New York in 1921, is another example of a state law. The Act is thought to be even more stringent than current federal regulations because the New York Attorney General only has to show that the perpetrators, which may include corporations, individuals, investment banks or other third parties, have committed an intentional act that constitutes fraud.13 The Act does not require that the persons committing the act willfully or knowingly did something illegal in order for there to be liability for these parties.14 The Martin Act has been in the news many times recently, as New York Attorney General Eliot Spitzer has pursued securities enforcement actions under its authority.15 Although many states enacted laws, they were not thought to effectively protect stockholders.16 They were difficult to enforce because a change in the politics of a state could change enforcement priorities.17 There were also problems with funding as well as various other problems.18 These issues were among those that provided the incentive for the enactment of many federal securities laws. B. Federal securities Regulation and the Formation of the securities and Exchange Commission Although there were several attempts to federally regulate securities before that time, Congress did not enact major legislation regulating securities until the early 1930s. Alexander Hamilton initiated the first attempt when he imposed limitations in the charter of the Bank of the United States. …