Securities and Exchange Commission Historical Society

Wrestling with Reform: Financial Scandals and the Legislation They Inspired

Looking Back

Not all scandals lead to legislation and the laws that resulted are seldom what were expected at the outset.  Factors ranging from quirks of character to random chance shape the laws that emerge in the wake of scandal, but in the cases described here five factors stand out. 

A successful law needs a strong advocate, whether a regulator such as Joseph Norman Dolley or a legislator like Senator Paul Sarbanes or Representative Michael Oxley.  Given the many hurdles legislation must clear, a champion with clear vision and leadership skills is usually required to navigate the legislative shoals.  A powerful advocate cannot guarantee success – despite leadership from Senators Alfonse D’Amato and Donald Riegle, a definition of insider trading failed – but having one increases the chances of success.

Bills that become law usually contain an uncontroversial core around which a consensus can be built.  Some aspects of legislation will always rankle; what usually matters is whether the fundamentals can be agreed upon by a majority.  Merit regulation had many champions and few opponents, so the Arizona Securities Act passed easily.  Attempts to add a definition of insider trading and address corporate takeovers at the same time slowed the progress of insider trading legislation and its uncontroversial augmented penalties.  Similarly, with the Foreign Corrupt Practices Act (FCPA), the record-keeping provisions suggested by the U.S. Securities and Exchange Commission were widely accepted, but the dispute over criminalization and disclosure delayed the passage of legislation.  Only with a change in the Presidential administration did the more controversial aspects of the legislation pass.

Another factor is the importance of the prevailing political climate in shaping legislation.  The first securities law flourished in Progressive-era Kansas, a time and place ripe for experiments in reform.  The FCPA passed only when the moderately liberal Carter Administration succeeded the conservative Ford Administration.  The Insider Trading and Securities Fraud Enforcement Act (ITSFEA) faced an upstream fight against a Reagan Administration inclined towards deregulation, and passed only after its more controversial aspects were set aside.

Political climate can be a moderating influence, but a powerful scandal can override it.  The size and impact of the scandal itself plays a critical role in shaping the response, as does whether there is one large scandal or a series of smaller ones.  A slew of successive disclosures of impropriety pushed both the ITSFEA and the FCPA forward.  

Then there is the strength of the opposition to legislation.  Investment bankers opposed the Blue Sky Law but were overwhelmed by the public outrage stoked by the numerous swindles.  Opposition from the accounting industry long stalled progress on the FCPA and the Sarbanes-Oxley Act.  Both were overcome, the former by a change in the political atmosphere, the latter by the mounting wave of scandals.

The Sarbanes-Oxley Act process demonstrates all five factors in play.  It had two advocates who shaped and guided it through the respective houses of Congress.  There was common ground for reform, but fierce debate over its extent.  Scandals came in waves, eroding the resistance posed both by ideological opponents to regulation and the influential accounting lobby.  These forces resulted in creating a stronger measure of reform than the law initially introduced.

Scandals share other common elements—financial loss, public outrage, high-flown rhetoric—but their legislative responses depend on the political, economic and cultural climate. Wrestling with reform inevitably means weighing the promise of good with the potential for harm.  From Progressive-era Kansas, where legislators balanced new protections against the power vested in individuals to enforce them, to 21st century Washington, where acolytes of unfettered enterprise compromised with believers in corporate accountability, lawmakers have had to make difficult choices, always dealing with specific circumstances and operating within a distinctive historical context.

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