Most legal scholarship today takes place outside the public view – in faculty workshops, conferences, and academic journals. But as the law has become more central to our personal and national lives, it seems more necessary than ever to connect the academy to the larger world. The best work being done at Virginia and at other top schools examines the consequences of legal rules in a way that invites understanding – and, when appropriate, change. In this way, the practice of law and the production of legal scholarship are very much alike. They both require a broad view of the problem combined with a ceaseless curiosity in teasing out every material issue.
Paul Mahoney is a pioneer in the use of empirical methods in legal scholarship. His writings on the federal securities reforms of the 1930s challenge conventional wisdom about the nature of the securities markets of the 1920s and the effects of the statutory reforms. His combination of law and empirical finance is part of a new wave in corporate and securities law scholarship.
In the following excerpt, “The Political Economy of the Securities Act of 1933,” Mahoney analyzes the politics and effects of the first federal securities statute. He observes that although the act is famous as a disclosure statute, many of its substantive provisions forbid issuers and underwriters from communicating with the markets during the registration process. This, he concludes, was the key to understanding why high-prestige investment banks favored the statute.
Excerpt from The Political Economy of the Securities Act of 1933 (Paul G. Mahoney, 30 J. Legal Stud. 1 (2001))
Commentators have tended to [take] at face value that the “truth in securities" act is a disclosure statute. Less well understood is that the Securities Act is equally a secrecy statute. It forbids most public disclosure of pending offerings prior to the filing of a registration statement with the Securities and Exchange Commission. The statute also mandates a minimum delay of 20 days between the filing of the registration statement and the beginning of retail selling. While traditionally described as mere pieces of the technical apparatus of “full disclosure," these provisions imposed important limitations on both retail and wholesale competition.
I try to show that these “technical" details can be best understood as means of eliminating several specific competitive techniques that low-status securities dealers used successfully against high-status dealers in the late 1920s and early 1930s.
IV. THE CRISIS OF THE SYNDICATE METHOD
As competition increased at the retail level, sellers began to seek an advantage over their rivals by violating those provisions of syndicate agreements that specified the timing and price of the distribution. The increased speed of distributions and the focus on retail selling during the 1920s made it difficult for managing underwriters to monitor and control the behavior of hundreds, or occasionally thousands, of securities dealers participating in the sale of a new issue. By the late 1920s, investment bankers realized that the viability of the syndicate system was threatened.
Established bankers described the phenomenon as a decline in the professionalism of the investment banking business. Like lawyers or doctors today, many investment bankers of the 1920s viewed themselves as members of a learned profession, the standards of which were being eroded by new entrants who were mere salesmen. A measure of that concern is the creation, at the [Investment Banker’s Association of America annual convention in the fall of 1926, of the Committee on Business Problems. The bulk of that committee's first report, delivered at the 1927 convention… addressed changes in distribution methods.
The report noted two tactics in particular: “beating the gun," or selling prior to the agreed-upon distribution period, and selling at discounted prices….
A. Beating the Gun
In the late 1920s, a practice known as “beating the gun" became common. Under the normal underwriting practice, underwriting and selling syndicate agreements contained an undertaking not to sell securities until they were “released" by the managing underwriter through a telegram or telephone call. To beat the gun was to violate the syndicate agreement by taking orders from customers before the securities had been released for sale.
Beating the gun allowed one distributor to get a head start on the others in the competition for retail customers. It was, however, inconsistent with the premise of a syndicated selling effort— that each seller complied with contractual restraints on price, timing, and (sometimes) territory. Managing underwriters were sensitive to the complaints of retailers who complied with syndicate agreements and, in so doing, lost customers to others who had not complied.
In order to prevent the practice, originating houses tried to keep the timing and price of the issue secret until the last minute. This was not always possible, however, particularly for issues of large companies. These companies were closely followed by the financial press, and newspapers or investment magazines might print the details of a coming large issue of securities before the issuing house had formally released the information to the syndicates. Thus selling group members were able to take orders from customers with reasonable confidence that they would be able to provide the security at the time and price quoted, even though they were contractually obligated to wait.
The IBAA Subcommittee on Distribution concluded that the root of the problem was excessive preoffering publicity.... The chairman of the subcommittee spoke approvingly of issuing houses that kept a tight lid on information about the timing and price of offerings but recognized that this “ideal condition" was difficult to achieve. Speaking of the large houses of issue, he noted, “They are doing all they can to get the information to every one of you men at the same time, and what they want is someone to tell them a practical way, someone to also try and keep publicity out of the paper."
V. THE REGULATORY SOLUTIONS
The Securities Act and other New Deal financial reforms addressed the specific competitive concerns outlined above. They had, in broad terms, three effects. They provided the government's aid in enforcing the syndicate system by outlawing beating the gun and discounting. They slowed down the distribution process and divided it into distinct wholesale and retail phases. Finally , they removed commercial banks as competitors for underwriting business. The consequence was to neutralize the competitive advantages of integrated firms and return to a system in which wholesale banks originated new issues and sold them through stand-alone distributors. This section shows how the technical details of the Securities Act achieved those results.
A. Beating the Gun
The Securities Act achieved precisely what the IBAA's Committee on Business Problems wanted to achieve but could not—it made it possible for a lead underwriter to provide distributing houses with detailed information about a pending issue secure in the knowledge that the latter could not agree to sell securities until the official offering date. The act also assured the absence of retail solicitation prior to the offering date by suppressing preoffering publicity.
The Securities Act requires that a registration statement be filed and become effective before any person may sell the securities…. Before the registration statement was filed, all public discussion of the issue was banned. Securities lawyers today still counsel their clients against any premature public statements relating to the offering—to make such a statement is to “jump the gun," although I doubt many securities lawyers know that the phrase antedates the Securities Act.
The statute also directly attacked newspaper and radio advertisements by defining each as a “prospectus" that, with limited exceptions, could not be published prior to effectiveness. The prohibition on newspaper publicity was broad enough to cover a story printed after interviewing a company officer about the pending offering. No longer would detailed information about pending offerings appear in the morning papers prior to the offering date, stimulating customers to call their brokers.
The Securities Act pursued socially useful goals. In particular, its disclosure requirements forced the promoters of corporations undertaking initial public offerings to disclose their financial stake in the new corporation, thus combating an abuse that had persisted in both England and the United States since the mid-1800s. Its starting point for solving the problem was the same as that developed in the Companies Act in England— mandatory disclosure of promoters' and underwriters' fees and stakes in a company.
The statute did more than this, however. It prohibited contact with potential retail buyers in advance of an offering, making it difficult for one retailer to poach another's customer. In tandem with the IBAA and the Maloney Act, it enabled the IBAA to prohibit and monitor the use of price discounts in connection with public offerings. It also effectively divided offerings into wholesale and retail periods. These features helped leading wholesale and retail firms enforce restrictions on retail competition that were central to the syndicate system of underwriting, thus protecting their market against incursions from integrated firms. None of these things was necessary in order to achieve the simple goal of requiring full disclosure. They benefited investment banks, particularly high-prestige investment banks, and likely raised costs to issuers and investors.
The Securities Act accordingly provides a useful cautionary tale about the efficacy of economic regulation. The act is generally regarded as one of the greatest success stories of the New Deal. Unlike many regulatory statutes, it has been largely untouched by claims that it raises entry barriers or enforces cartel agreements among members of the regulated industry. Yet a closer look at the statute, in light of the competitive conditions in the underwriting market in the 1920s, shows that even the Securities Act was a likely source of rents for the firms it subjected to regulation.