In the past, investing your money involved a lot of responsibility. Before the market crash of 1929 and the Great Depression, investors seeking to get rich in the booming stock market were largely on their own. Obtaining accurate information on a potential investment was extremely difficult, since businesses were under no obligation to disclose information, and many businesses and entrepreneurs resorted to fraudulent practices to raise money. In the aftermath of the crash, Wall Street was suffering from fraud and ripe for change.
In response, the New Deal Congress passed two pieces of legislation, the Securities Act of 1933 and the Securities Exchange Act of 1934, to mandate oversight of the capital markets and restore some measure of investor confidence. To enforce these new laws, the Securities and Exchange Commission was created in 1934, providing regulation at a federal level. The SEC performs several different but equally important tasks in an effort to protect investors from illegal activities.
Overseeing investment offerings
One of the primary duties of the SEC is to oversee the registration process for new securities. Whenever a company makes a public offering of stocks, bonds, or other securities, the Securities Act of 1933 defines the circumstances under which the company must register its offering with the SEC. Except for private offerings made to a small number of investors, offerings intended to raise only a limited amount of money, and certain offerings made only to residents of a particular state, most companies are required to register with the SEC before beginning to offer securities to the public.
In simple terms, registration requires companies to provide certain information to investors as part of a public offering of securities. Detailed information about the company and the business it conducts must be provided, along with information about how the company is managed. In addition, the company must include a description of the securities being offered. The company must back up its assertions with certified financial statements from independent accountants.
Much of the information that an offering company provides to the SEC must also be included in the prospectus that potential investors receive as part of the offering process. Although the offering company is not required to include certain other types of information in the prospectus, it must nevertheless file it with the SEC. All of the information included in the registration statement is available to the public through the EDGAR database system.
As an example, consider the recent initial public offering of NymexHoldings (NYSE:NMX). By using the EDGAR company search page, you can find a list of filings the company made before its initial public offering last month. Looking over the documents, you'll notice that the first registration statement filed with the SEC was in July. However, although it got the ball rolling on the lengthy registration process, it left out quite a bit of information. The following filings give a short history of the process, starting with the materials given to existing shareholders to approve the decision to make an initial public offering. After shareholders approved the IPO and more information was gathered, Nymex Holdings filed a prospectus with the SEC. Its seventh amendment to its registration statement proved to be the last, and the SEC allowed the registration to become effective the day before shares began trading on the New York Stock Exchange.
As you can see from Nymex Holdings, there is a huge amount of information included in a registration statement. A typical statement includes a description of the particular risks involved with the offering, a summary of the current capital structure of the company, discussion of the company's financial condition and results, an overview of the overall industry and the company's place in it, and a description of the management, shareholders, and key employees of the business. Nymex's 150-page registration statement is not unusually long. Even smaller IPOs, such as the recent offerings from restaurant company Carrols Restaurant Group (NASDAQ:TAST) and medical software company MEDecision (NASDAQ:MEDE), have lengthy disclosures for investors to review.
Once an issuing company has gone through its initial offering of securities, subsequent secondary offerings involve a simpler process. In light of all of the information provided, it's difficult for investors to argue that they weren't informed about some important aspect of an offering company.
Note that the Securities Act of 1933 says nothing about the content of the information that an offering business must provide to the SEC. In enacting the law, Congress did not intend to take decisions about investing out of the hands of individuals. Instead, the law only ensures that investors have a base level of information with which to make an informed choice about whether or not to invest in a given offering. What investors decide to do with the information they get is up to them. If investors are given fraudulent or misleading information, however, the law gives them recourse against the offering company.
Registration of public offerings is an important part of the SEC's work, but it's by no means the commission's sole purpose. Once a security has been issued, the SEC continues to require ongoing reporting and compliance with regulations to ensure continuing investor confidence in U.S. stock markets. The next part of this article discusses the obligations of companies under the Securities Exchange Act of 1934.
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Fool contributor Dan Caplinger checks the SEC website so often that he's on a first-name basis with Edgar. He doesn't own shares of the companies mentioned in this article. The Fool's disclosure policy would make any regulator proud.
