Companies raise billions of dollars by issuing securities in what is known as the primary market. Contrasted with the Securities Act of 1933, which regulates these original issues, the Securities Exchange Act of 1934 regulates the secondary trading of those securities between persons often unrelated to the issuer. Trillions of dollars are made and lost each year through trading in the secondary market.
One area subject to 34 Act regulation is the actual securities exchange -- the physical place where people purchase and sell securities (stocks, bonds, notes of debenture). Some of the more well known exchanges include the New York Stock Exchange, the American Stock Exchange, and regional exchanges like the Cincinnati Stock Exchange, Philadelphia Stock Exchange and Pacific Stock Exchange. At those places, agents of the exchange, or specialists, act as middlemen for the competing interests to buy and sell securities. An important function of the specialist is to inject liquidity and price continuity into the market. Given that people come to the exchange to easily acquire securities or to easily dispose of a portfolio of securities, the specialist's role is important to the exchange.
The '34 Act also regulates broker-dealers without a status for trading securities. A telecommunications infrastructure has developed to provide for trading without a physical location. Previously these brokers would find stock prices through newspaper printings and conduct trades verbally by telephone. Today, a digital information network connects these brokers. This system is called NASDAQ, standing for the National Association of Securities Dealers Automated Quotation System.
The '38 Act, known as the Maloney Act, regulates NASDAQ both through regulations that apply to the association and by requiring that it have an independent oversight organization - a self-regulatory organization (or SRO). The SRO for NASDAQ was NASD, the National Association of Securities Dealers, now known as FINRA, or Financial Industry Regulatory Authority. NASDAQ's sale by then NASD was completed in 2006, and NASDAQ is now its own exchange. FINRA provides under contract much of NASDAQ's regulatory oversight. The '34 Act requires virtually all broker-dealers to be registered with FINRA, placing brokers under the Securities and Exchange Commission's direct oversight and under the FINRA's oversight.
In the last 30 years, brokers have created two additional systems for trading securities. The alternative trading system, or ATS, is a quasi exchange where stocks are commonly purchased and sold through a smaller, private network of brokers, dealers, and other market participants. The ATS is distinguished from exchanges and associations in that the volumes for ATS trades are comparatively low, and the trades tend to be controlled by a small number of brokers or dealers. ATS acts as a niche market, a private pool of liquidity. Reg ATS, an SEC regulation issued in the late 1990s, requires these small markets to 1) register as a broker with the NASD, 2) register as an exchange, or 3) operate as an unregulated ATS, staying under low trading caps.
A specialized form of ATS, the Electronic Communications Network (or ECN), has been described as the "black box" of securities trading. The ECN is a completely automated network, anonymously matching buy and sell orders. Many traders use one or more trading mechanisms (the exchanges, NASDAQ, and the ECN or ATS) to effect large buy or sell orders -- conscious of the fact that overreliance on one market for a large trade is likely to unfavorably alter the trading price of the target security.
One central element of the '34 Act is the regulation of broker-dealers. The Act regulates them principally by making the definition of broker extremely broad to include "any person engaged in the business of effecting transactions in securities for the account of others" (see Act section 3(a) (4), codified at ). One problematic area in the application of the definition of broker involves persons who refer buyers to a broker or issuer (finders or promoters). A body of case law, subsequent SEC regulation, and FINRA oversight together place tight restrictions on 1) the commissions that brokers can receive for their services, 2) the amount of notice that brokers must give their clients when trading in securities, 3) the broker's due diligence requirements in finding securities that meet their clients needs, and 4) the broker's obligation not to compromise their clients by disclosing or trading on material nonpublic information.
While the '33 Act recognizes that timely information about the issuer is vital to effective pricing of securities, the '33 Act's disclosure requirement (the registration statement and prospectus) is a one-time affair. The '34 Act extends this requirement to securities traded in the secondary market. Provided that the company has more than a certain number of shareholders and has a certain amount of assets (500 shareholders, above $10 million in assets, per Act sections 12, 13, and 15), the '34 Act requires that issuers regularly file company information with the SEC on certain forms (the annual 10-K filing and the quarterly 10-Q filing). The filed reports are available to the public via EDGAR If something material happens with the company (change of CEO, change of auditing firm, destruction of a significant number of company assets), the SEC requires that the company soon issue an 8-K filing that reflects these changed conditions (see Regulation FD). With these regularly required filings, buyers are better able to assess the worth of the company, and buy and sell the stock according to that information.
While the '33 Act contains an antifraud provision (Section 17), when the '34 Act was enacted, questions remained about the reach of that antifraud provision and whether a private right of action existed for purchasers (meaning that ordinary people, and not just the government, could maintain a lawsuit against the bad actor). As it developed, section 10(b) of the 1934 Act and SEC Rule 10b-5 have sweeping antifraud language. Section 10(b) of the Act (as amended) provides (in part):
Section 10(b) is codified at .
It's hard to overstate the breadth and utility of section 10(b) and Rule 10b-5, in the pursuit of securities litigation. Rule 10b-5 has been employed to cover insider trading cases, but has also been used against companies for price fixing (artificially inflating or depressing stock prices through stock manipulation), bogus company sales to increase stock price, and even a company's failure to communicate relevant information to investors. Many plaintiffs in the securities litigation field plead violations of section 10(b) and Rule 10b-5 as a "catchall" allegation, in addition to violations of the more specific antifraud provisions in the '34 Act.
On May 5, 2006, in a notice in the Federal Register, President Bush delegated authority under this section to John Negroponte, the Director of National Intelligence. Administration officials told Business Week that they believe this is the first time a President has ever delegated the authority to someone outside the Oval Office.
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