Stock Exchange Regulations And The Sarbanes-Oxley Act

The stock exchange scandals and revelations of accounting and financial irregularities, caused the passage of the Accounting Reform and Investor Protection Act of 2002. This is often referred to as the Sarbanes Oxley Act of 2002 after the legislators who sponsored it.

This legislation sought to improve the accuracy of financial statements and to ensure full disclosure of information. It also created an oversight board for accounting practices and strengthened the independence of public accounting firms in their auditing activities.

Other features were increased corporate responsibility for the accuracy of financial statements, to protect the objectivity of securities analysts and improve the SEC’s resources and oversight functions.

As the accounting fraud scandals were occurring, the role of stock analysts came under great scrutiny. These analysts worked for investment banks and issued research reports about stocks along with recommendations to buy, hold, or sell. Curiously, even after Enron executives admitted to accounting fraud, most stock analysts retained a buy recommendation for the company.

As you might imagine, this caused further embarrassment to the financial services industry and reputation of the stock exchange as a whole.

The fact that few analysts issued sell recommendations during the bear market led the New York attorney general to conduct an investigation. Most Wall Street firms and investment banks came under the New York attorney general’s jurisdiction because they were based in New York City.

The investigation led to the discovery of e-mails and other evidence showing conflicts of interest. Analysts gave favorable recommendations to companies that were clients or potential clients of their investment banks.

Privately these analysts had disparaged or even ridiculed the stock value of certain companies, while publicly they had recommended the stocks in an effort to win investment banking business.

In 2003, in a settlement with the New York attorney general’s office and the SEC, ten of the nation’s leading investment banks agreed to pay a total of $1.4 billion in fines and to change certain practices. The settlement established a $432.5 million fund to provide independent stock research for investors. Two stock analysts were barred from the industry for life and fined a total of $20 million.

Trust us, we know what we are doing

The financial services industry has historically lobbied governments for self regulation and oversight. The core argument makes much sense since bankers typically know more about banking than politicians. However, history has proved again and again that bankers and traders are prone to overreach and cannot be trusted without much greater government oversight.

The experience of the financial crisis of 2008 onwards in the United States and Europe shows the scale of the power of the financial services industry and how wrong things were. On the one hand, financiers had pressed for - and mostly been granted - a free hand in how they ran their businesses. Yet when their risk models proved wrong and firms such as Bear Stearns and Lehman Brothers ceased trading, the same financiers needed government money to stop the entire system from crashing.

Even while many banks still had governments holding large blocks of their stock (around 2010-1) there were some CEOs arguing that it was wrong to stop them paying large bonuses for performance. The outrage among normal people - now footing the bill as taxpayers - was right and proper. In time, the regulations on investment banks, hedge funds and private equity groups will hopefully be much tighter and provide much less room for the overreach that is so common.

Even in 2012, there have still been debates amongst bankers about the need for them to take risks and for governments to be able to wind their firms up if necessary. Politicians and civil servants are understandably reticent to hear these arguments.

In fact, in June 2012, Mr Douglas Flint, Chairman of the Board of the International Institute of Finance (IIF) said, “One of the most important lessons of the financial crisis was that banks must be able to take risks, must be able to fail, and therefore must be capable of being resolved upon failure. With the determination of national authorities and the cooperation of private financial institutions, we believe that an effective resolution system can be put in place“.

With a 'banking union' under construction in Europe in 2012, there is clearly a lot more regulation to come...

To learn more background information about markets, please visit:

What Is A Stock Exchange And What Does It Do?

What Is An Efficient Capital Market?

Stock Exchanges And National Economies

Investment Institutions On The Stock Exchange

Executing A Trade On The Stock Exchange

Why Are There So Many Stock Exchange Scandals?

Stock Exchange Investment

Learn About The Important Role Of Stock Rating Agencies

How Big Should Stock Market Bonuses Be?