'Confidence ... thrives on honesty'
Born in a crisis of confidence, the SEC faces questions
(CNN) -- In the wake of corporate accounting scandals, heat from many Democrats and some Republicans in Congress has fallen on Harvey Pitt, the chairman of the Securities and Exchange Commission. Ironically, the organization he heads was created in a bid to restore faith in the country's financial markets.
World War I was followed by an economic boom in which more investors than ever before began "playing the market."
With the United States as the main supplier and lender for a Europe rebuilding from the war, American prosperity seemed guaranteed. Consumer goods were sold by installments and investments were sold on margin, which led many Americans to rethink the idea of debt. Proposals to require financial disclosure and crack down on fraud did not receive much attention.
Some $50 billion in new securities were released into the market in the boom period. Half of them would become worthless when the boom ended.
On Thursday, October 24, 1929, with a record trade volume of nearly 13 million shares, the stock market went into a rapid decline. Banks and other large-scale investors bought shares in an effort to prevent panic, but their efforts had little effect. On October 29, a date dubbed "Black Tuesday," share prices collapsed altogether.
The collapse of the markets put strain on banks, which had stocks in their own investment portfolios. While the banks' money was in shares and in loans, customers feared for the safety of their money and began withdrawing it en masse. These "bank runs" further strained the banks, leading to the failure of 11,000 of the nation's 25,000 banks by 1933. Between 25 percent and 30 percent of the work force were unemployed by 1932.
Congress, at the urging of newly elected President Franklin D. Roosevelt, held hearings to consider new regulation of banks and markets. The first step to restore faith in American financial institutions was the passage of the Securities Act in 1933, which regulated the issuance of new stock. The Securities Exchange Act of 1934 regulated trading in stock and created the SEC with broad regulatory powers.
Under the 1933 law, securities offered for sale must be registered, and the companies issuing them must make detailed periodic financial disclosures. The goal is often described as "transparency" -- the assurance that investors know what they're getting. The 1934 law placed regulation and enforcement in the SEC's hands.
FDR's pick for the first chairman of the SEC was Joseph P. Kennedy, the grandson of Irish immigrants and patriarch of the political dynasty who had become a millionaire by age 30. Kennedy's own fortune was widely attributed to manipulating the markets in the 1920s, but in 1934-35 he effectively closed the same loopholes he had used to such great effect.
The SEC was founded to restore investors' faith in American markets. Now, the challenge for the three commissioners -- there are two vacancies -- is to restore faith in the SEC.
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