80 Years of regulations and accounting standards.

• Author: Young, Michael R.
• Position: Interview

The 80 years of FEI's existence have paralleled a remarkable and even unprecedented era of financial regulation. The onset of the era was marked before FEI's birth by the Stock Market Crash of 1929 and the resulting disrepute of laissez faire as an approach to financial regulation.

The result was financial regulation that, in contrast to socialist trends then taking root in parts of Europe, was built around three themes: fundamental faith in the operation of free markets, the recognition that free markets, in order to function properly, needed reliable information and a societal interest in the avoidance of catastrophic loss.

The first--and in some ways most significant--innovation of the era occurred with the passage of the Securities Act of 1933. Rather than adopting an approach of "government knows best," the '33 act put in place an approach respecting the interests of individuals in making their own investment decisions, but seeking to improve the quality of financial information upon which those decisions could be made.

The main provision of the '33 act called upon companies to register securities offerings before stock was issued to the public. A corresponding provision provided to investors the right to sue companies that violated the act. The underlying philosophy hypothesized that "sunlight" would be "the best disinfectant."

However, the '33 act left a gaping hole--the regulation of securities that had already been issued. That hole was plugged the following year by the Securities Exchange Act of 1934.

Designed to extend the disclosure requirements of the 33 act to securities being traded after their issuance, the 1934 act created a new regulatory commission, the U.S. Securities and Exchange Commission, and gave the SEC broad authority to make rules regarding periodic reports to be filed by public companies' The '34 act also put in place a broad prohibition against fraudulent financial reporting.

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While the acts of 1933 and '34 reflected fundamental faith in free markets, additional legislation enacted at the same time headed in a slightly different direction.

The Glass-Steagall Act sought to attack financial instability through a radical change in what financial institutions would be permitted to do. The approach was to divorce banking and securities activities by prohibiting commercial banks from underwriting non-government securities and investment banks from receiving deposits.

Almost from its enactment, observers questioned exactly what ill Glass-Steagall was intended to cure and whether separating the two financial activities was really the best approach.

With these basic reforms in place, financial markets flourished and expanded for more than half a century. That is not to say everything went smoothly. There were ups and downs, among them a back-office crisis in the late 1960s leading to the closure of a number of New York Stock Exchange firms.

The response to that--directed to the avoidance of catastrophic loss, at least for the individual investor--was the Securities Investor Protection Act which, in 1970, required brokers and dealers to become members of a new Securities Investor Protection Corporation. The goal was to provide investors insurance of up to $500,000 in the event of broker insolvency.

In the mid-1990s, questions began to be raised as to whether a new type of reform was needed. This time, the catalyst was an ostensible upsurge in reported instances of accounting manipulations and fraudulent financial reporting.

In context, this increase in accounting manipulations could be seen as a natural outgrowth of the regulatory structure put in place by the two regulatory acts of the 1930s. That structure, which was innovative during the Great Depression, provided for the periodic transmission of financial information to investors--only...