"FIN RAH!" ... A WELCOME CHANGE: WHY THE MERGER WAS NECESSARY TO PRESERVE U.S. MARKET INTEGRITY

Fordham Journal of Corporate & Financial Law, 2008 by Cervantes, Yesenia

From 1932 to 1934, the Senate Banking and Currency Committee conducted an "investigation of stock exchange practices, usually called the Pecora Hearings, in recognition of the decisive role played by the committee's counsel, Ferdinand Pecora."76 The investigation revealed an abundance of corruption and supervisory deficiencies.77 One area of focus concerned the NYSE's listing procedures, specifically its approval process and due diligence when registering a company's stock.78 Enforcement of its listing requirements became unmanageable and virtually nonexistent with the increase in new stock applications between 1926 and 1929,79 leading to the listing of worthless securities.80 Frank Altschul, chairman of the NYSE's Committee on Stock List, stated at the Pecora Hearings "that the NYSE ceased making any independent investigation of an application for the listing of additional stock by a firm whose stock was previously listed unless there appeared patently suspicious matter in the listing application."81 Pecora successfully identified an instance where the NYSE failed to investigate even when there was such a suspect matter.82

Specialist trading was also closely scrutinized. Specialists are responsible for maintaining a fair and orderly market in a specific security by "acting as brokers' brokers who [execute] purchase or sell orders when the market price reachefs] [a] stipulated price . . . ."83 Allegations "were made repeatedly" throughout the hearings accusing specialists of using "their pivotal position to orchestrate pool operations or exploiting] their knowledge of the specialist books in trading for their own accounts."84 The NYSE's lack of oversight in these areas was later used as leverage to gain approval for restructuring of the organization's board.85 Conclusion of the hearings led to the creation of the SEC in 1934 and manifold industry regulations in an attempt to restore investor confidence in the U.S. markets.86 Even with the newly created SEC, the market came close to suffering another crash between 1937 and 1938.87 Many condemned the government's efforts and cited them as the cause of the recession that ensued shortly after the passage of the federal securities laws.88

SEC Chairman, William O. Douglas, in advocating the Act, attributed the economic downturn to the NYSE's regulatory deficiencies89 and prevailing conflicts of interest.90 Douglas feared repercussions stemming from the brokerage firms' outcries, such as hindrance from future securities legislation and repeal of some of the SEC's powers.91 Douglas called for complete revamping of the NYSE's board to include a salaried, independent (non-industry) chair92 and to focus on representing the interests of the public. The existing structure consisted of "floor traders and specialists who dominated New York Stock Exchange governance."93 Douglas believed that independence of board management would help eliminate the conflicts that had proliferated throughout the industry,94 mainly involving member trading.95 Douglas suspected that members' short sale trading had precipitated the extreme decline in the markets in 1937.96 On March 17, 1938, on the heels of former NYSE President Richard Whitney's expulsion from the industry for embezzlement,97 revisions to the Exchange's constitution were adopted.98 Douglas resigned from the SEC in 1939 after President Franklin D. Roosevelt selected him to serve as a Supreme Court Justice.99