The U.S. Securities and Exchange Commission (SEC) is a federal agency responsible for administering federal securities laws that protect investors. The SEC also ensures that securities markets are fair and honest and, if necessary, enforces securities laws through the appropriate sanctions. Basically, the SEC oversees the activities of all participants in the securities markets—including publicly held corporations, public utilities, investment companies and advisers, and securities brokers and dealers—to ensure that investors are adequately informed and their interests are protected. Small businesses are most likely to come into contact with the SEC when they decide to make a public offering of debt or securities. Any business wishing to issue stock must first file a registration statement with the SEC. Another role of the SEC is to serve as adviser to the federal courts in Chapter 11 cases (corporate reorganization proceedings under Chapter 11 of the Bankruptcy Reform Act of 1978).
Organization and Responsibilities of the SEC
The SEC was created by Congress in 1934 under the Securities Exchange Act as an independent, nonpartisan, quasi-judicial regulatory agency. The commission is made up of five members: one chairman and four commissioners. Each member is appointed by the president to a five-year term, with the terms staggered. The commission’s staff is made up of lawyers, accountants, financial analysts, engineers, investigators, economists, and other professionals. The SEC staff is divided into divisions and offices, which includes 12 regional and branch offices, each directed by officials appointed by the SEC chairman.
The chairman and commissioners of the SEC are responsible for ensuring that publicly held corporations, brokers or dealers in securities, investment companies and advisers, and other participants in the securities markets comply with federal securities law. These laws were designed to help public investors make informed investment analysis and decisions—principally by ensuring adequate disclosure of material information. The SEC does not, however, make any evaluations of the quality of the company making the IPO; it is concerned only with assuring that the registration statement and prospectus documents contain the information necessary for potential investors to make informed decisions. The SEC also has the authority to initiate legal penalties—both civil and criminal—against companies if the agency determines that the IPO materials contain serious omissions, misleading information, or outright falsehoods. “If the SEC finds mistakes during the registration process, it can delay your IPO,” said Chuck Berg in Cincinnati Business Courier. “If it finds mistakes or omissions after your company goes public, your company may soon have a thorough—and unpleasant—understanding of legal liability.”
There are seven major laws that the SEC is responsible for administering:
- Securities Act of 1933
- Securities Exchange Act of 1934
- Public Utility Holding Company Act of 1935
- Trust Indenture Act of 1939
- Investment Company Act of 1940
- Investment Advisers Act of 1940
- Sarbanes-Oxley Act of 2002
The Securities Act of 1933, also known as the “truth in securities” law has two primary objectives: 1) to require that investors be provided with material information concerning securities offered for public sale; and 2) to prevent misrepresentation, deceit, and other fraud in the sale of securities. The SEC ensures that both of these objectives are met.
The Securities Exchange Act of 1934 extended the “disclosure” doctrine (from the Securities Act of 1933) to securities listed and registered for public trading on the U.S. securities exchanges. In 1964, the Securities Act Amendments extended disclosure and reporting provisions to equity securities in the over-the-counter market. The act seeks to ensure (through the SEC) fair and orderly securities markets by prohibiting certain types of activities and by setting forth rules regarding the operation of the markets and participants.
The SEC also administers the Public Utility Holding Company Act of 1935. Subject to regulation under this act are interstate holding companies engaged in the electric utility business or in the retail distribution of natural or manufactured gas. Reports to be filed with the SEC by these holding companies include detailed information concerning the organization, financial structure, and operations of the holding company and its subsidiaries. Holding companies are subject to SEC regulation in areas such as corporate structure, acquisitions, and issue and sales of securities.
The Trust Indenture Act of 1939 applies to bonds, debentures, notes, and similar debt securities offered for public sale and issued under trust indentures with more than $7.5 million of securities outstanding at any one time. Other provisions of the act prohibit the indenture trustee from having conflicts of interest; require the trustee to be a corporation with minimal combined capital and surplus; and impose high standards of conduct and responsibility on the trustee.
The SEC also ensures compliance with the Investment Company Act of 1940. This act seeks to regulate the activities of companies engaged primarily in investing, reinvesting, and trading in securities, and whose own securities are publicly offered. It is important for potential investors to understand that although the SEC serves as a regulatory agency in these cases, the SEC does not supervise a company’s investment activities, and the mere presence of the SEC as a regulatory agency does not guarantee a safe investment.
The Investment Advisers Act of 1940—also overseen by the SEC—establishes a style, or a system, of regulating investment advisers. The main thrust of this act requires all persons, or firms, that are compensated for advising anyone about securities investment opportunities to be registered with the SEC and conform to the established standards of investor protection. The SEC has the power and ability to strip an investment adviser of his or her registration if a statutory violation has occurred.
In 2002 Congress passed the Sarbanes-Oxley Act and it was signed into law. Parts of this sweeping legislation are the responsibility of the SEC to administer. The act came about in the wake of serious allegations of accounting fraud and a string of bankruptcies of very high-profile, publicly traded companies. The act established stricter reporting requirements and increased the personal responsibility that both CEOs and CFOs must take on when signing corporate reports. Meeting the requirements of this law has increased the workload for publicly traded firms and the firms that do their auditing work. In particular, Section 404 of the Sarbanes-Oxley Act requires that a company’s annual report include an official write-up by management about the effectiveness of the company’s internal controls. The section also requires that outside auditors attest to management’s report on internal controls. An external audit is required in order to attest to the management report.
Finally, the SEC is given some responsibility connected with corporate bankruptcy reorganizations, commonly referred to as Chapter 11 proceedings. Chapter 11 of the Bankruptcy Code grants the SEC permission to become involved in any proceedings, but the SEC is primarily concerned with proceedings directly involving significant public investor interest.