The obsolescence of Wall Street: a contextual approach to the evolving structure of federal securities regulation.

• Author: Seligman, Joel

This article is dedicated to Professor Al Conard, a wonderful colleague, who after many years as an active emeritus member of the University of Michigan Law School has recently retired to a new home away from Ann Arbor. Many of us miss him daily, and I offer this article in the spirit of a Festschrift contribution in his honor.

At its core, the primary policy of the federal securities laws(1) involves the remediation of information asymmetries. This is most obviously true with respect to the mandatory disclosure system, which compels business corporations and other securities issuers to disseminate detailed, generally issuer-specific information when selling new securities to the public and requires specified issuers(2) to file annual and other periodic reports containing the same or similar information.(3) This system was, in essence, a response to the failure of business and foreign government issuers sufficiently to disclose information material to investment decisions in the period preceding the enactment of the Securities Act of 1933 (Securities (Act)(4) and the Securities Exchange Act of 1934 (Exchange Act).(5) The remediation of information asymmetries is also a primary policy objective of the Securities and Exchange Commission's regulation of broker-dealers.(6) The Securities and Exchange Commission (SEC) uses a variety of reporting,(7) record keeping,(8) minimum net capital,(9) and inspection(10) techniques to deter broker-dealers from charging securities customers excessive commissions or "markups" in individual transactions(11) and to protect customers from entrusting their securities or monies to broker-dealers on the verge of insolvency.(12)

While the theory and techniques of federal securities regulation are relatively straightforward, the scope of the mandatory disclosure system and broker-dealer regimens has been fluid over time. Exemptions for intrastate(13) and private -- rather than public -- initial sales,(14) municipal(15) and federal government securities,(16) as well as unanticipated new financial products(17) have limited or expanded the scope of federal securities regulation with increased celerity in recent years.

The immediate future of federal securities regulation is likely to be devoted in considerable part to the resolution of boundary questions. The reasons for this are less matters of statutory construction than they are matters of politics and context. In terms of information asymmetries, there is often little practical difference between financial instruments subject to the federal securities laws and those that are exempt. In many instances, the exemptions to securities laws were adopted because of the success of political lobbies such as those that championed state securities regulation or municipal issuers.(18) Yet, once adopted, laws do not endure eternally because of inertia. As the factual context against which Congress and the SEC have acted changes, an ongoing process of law revision continuously occurs.

This article begins in Part I by describing the dynamic elements in federal securities regulation. These include (i) changes in the investor community, (ii) internationalization of issuers and investors, (iii) computer technology, and (iv) the maturing of financial economics.

Part II illustrates how these dynamics will continue to change the boundaries of federal securities regulation in three illustrative areas: (i) state securities regulation, or so-called blue sky laws; (ii) the scope of the Securities Act of 1933; and (iii) municipal securities regulation. Each of these topics illustrates a different type of boundary problem. First, state securities regulation was intended to be concurrent with federal securities law. But its initial raison d'etre -- regulating the merits of new securities offerings -- has increasingly been called into question because of the growing significance of international securities trading. Second, the scope of the Securities Act of 1933 has recently been effectively narrowed because of congressional and SEC initiatives in response to competitive international securities markets and the growth of institutional investors. Here, however, matters are more complicated than they may seem at first.(19) In part, what may appear to be a significant reduction of a mandatory disclosure regime may involve instead a substitution of ongoing obligations, implied by financial economics theory. Finally, the logic of the exemption for new securities issuances by municipalities has dissipated over time, at least for certain categories of municipal securities as they have come more closely to resemble corporate issuances.(20)

When these boundary questions are viewed jointly, three basic themes emerge:

First, the remediation of information asymmetries endures as a policy justification for important aspects of federal securities regulation. But the need for a mandatory disclosure system varies significantly from context to context and is not static over time.

Second, there are coordination and "level playing field" advantages to subjecting like firms and financial products to a single regulator. But the probability of this logical outcome occurring is highly dependent on political factors.

Third, the single factor most likely to change fundamentally the scope of securities regulation in the foreseeable future is internationalization. Increasingly, U.S. securities markets are being integrated into world trading markets. This may portend the evolution of a new type of federalism in which national securities regulation is "local" and international regulation is the equivalent to national regulation today. But this outcome seems unlikely to occur for a considerable period of time. The vast preponderance of U.S. securities are unlikely to be of much interest to international investors. More importantly, significant differences between the U.S. investor community and those abroad would make it highly difficult to integrate regulatory regimes without considerable sacrifice of the primary techniques for protecting noninstitutional investors in the United States.

As a matter of analytical style, this article illustrates a contextualist approach. For a considerable period of time, the dominant analytical style in corporate and securities law has been a variant of economic, or law and economics, analysis. The virtue of this type of analysis is that it focuses on what its authors deem to be crucial variables and reaches conclusions derived from the core of a specific legal problem. The defect of this type of analysis is that so much is assumed or often assumed away.

In contrast, the contextualist approach attempts a more ambitious description of the legal -- meaning statutory, rule, and agency interpretation -- historical, and empirical framework of specific problems. The defect of this type of approach is that when a problem is accurately set against its full context, analysis is less likely to reach simple, far-reaching conclusions. This is also the virtue of contextual analysis. To put matters directly, the world of corporate and securities law is often a more complicated, more slowly evolving one than the law and economics theorists would have us believe. While there is great value in economic analysis in this and many other fields, this value is best appreciated against a broader historical and empirical framework than some of its votaries have provided.

1. THE OBSOLESCENCE OF WALL STREET

   Formally, many aspects of securities trading before the enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934 are familiar. To define security in terms such as "any note, stock, treasury stock, bond, debenture."(21) is to employ a contemporary vocabulary. Similarly, the mechanisms of securities trading -- the underwriter,(22) broker,(23) dealer,(24) or securities exchange(25) -- are denoted in these sixty-year-old laws in terms that, while sometimes vague, are easily parsed by today's readers.

   But the factual context in which securities trading occurred before the New Deal's enactment of the federal securities laws is much less familiar. It was a simpler world. In 1930 the United States had a population of approximately 123 million,(26) of whom approximately 1.5 million -- or 1.2% -- had securities accounts.(27) Institutional investment was in its infancy. In the years 1926-1929, investment companies -- the best known of which today is the mutual fund -- increased their total assets to over $8 billion.(28) an amount equal to less than ten percent of the New York Stock Exchange's $89.7 billion valuation on September 1, 1929.(29) Nonetheless, the innovation of buying a portfolio of securities, rather than individual stocks, made the investment trust, in the mellifluous judgment of John Kenneth Galbraith, "`the most notable piece of speculative architecture of the late twenties, and the one by which, more than any other device, the public demand for common stocks was satisfied.'"(30) Public demand, it cannot be overemphasized, was limited to just over one percent of the overall population.

   The period before the New Deal's adoption of the federal securities laws also witnessed the first significant, and distinctly unsatisfactory, experience of public investment in foreign securities. Between 1923 and 1930, American investors purchased close to $6.3 billion of foreign bonds.(31) Then, in rapid order, the collapse of the world economy led to substantial depreciation of over ninety percent of all foreign bonds sold in the United States. By December 1931, the aggregate market price for fourteen Latin-American nations' bonds was twenty-six percent of their face value. Peruvian bonds were selling at less than seven percent of their par value.(32)

   Before the 1930s, Wall Street had already experienced technological revolutions. The nineteenth century had witnessed the arrival of the telegraph, the telephone, and the stock quotation ticker, which made...