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Chapter 3. Role of Government in Financial Markets
• why regulate? • types of regulation • regulation in the U.S.
I. Why regulate?
• regulation necessary when there is a market failure – market outcome is NOT optimal by itself
• financial markets important to entire economy
• some investors have access to more/better information – use it to profit at expense of others – discourage participation in markets
II. Types of Regulation
• Disclosure – issuers make financial information public – level playing field?
• issues about accuracy of info made public – fraud – creative but legal accounting
• Financial activity – how orders to buy/sell securities are handled – rules to avoid conflicts-of-interest – rules against insider trading (trading on info not available to public)
• conflicts of interest between – investment banking clients – brokerage clients
• did brokerage houses give stocks high ratings to gain the business of those companies?
• Financial institutions – depository & nondepository – permissible activities – protection of investor funds
• Foreign participation – type/amount of institution ownership
III. Regulation in the U.S.
• result of financial crises – panic 1907 – crash of 1929 & Great Depression – S&L crisis 1980s
Federal Reserve System
• 1913, after panic of 1907 • central bank to prevent bank panics • regulator of financial institutions • control of money supply and interest rates
• creation of SEC and rules about disclosure, insider trading
• insurance for bank deposits • other bank regulations later repealed
• changes in regulation of S&Ls • changes in permissible activities of S&Ls
Current issues in regulation
• conflicts between stock research and investment banking at securities firms
• accounting rules & conflicts between accounting & consulting
• mutual fund oversight
Case 1: Mutual funds
Elliot Spitzer, NYS Attorney General • late trading
– allowing certain clients to trade mutual fund shares after 4 p.m.
• market timing – allowed CERTAIN investors to buy and sell share
to profit from daily market movements – not illegal UNLESS only certain investors allowed
to do it
• fees – Spitzer complaining that fees are excessive – BUT fees are within SEC guidelines
Case 2: Martha Stewart
• currently on trial • accused of
– obstruction of justice (lying) – stock fraud – NOT insider trading
• Stewart sold ImClone stock before big drop – did she get tipped off? – (company Pres. or by broker)
• Stewart then lied to investigators & tampered with evidence
• Martha Stewart lied to prevent the stock in here own company from falling – stock fraud
• Stewart claims that she had a prior agreement with her broker to sell when price fell below $60
• read more at Slate.com