The US Supreme Court ruled that while the Securities Exchange Act of 1934 allows stock exchanges to self-regulate, it does not exempt them completely from antitrust laws. The New York Stock Exchange violated antitrust laws by collectively denying broker-dealers direct-wire connections without proper notice or a hearing. While exchange rules can curb abuses, denying the connections exceeded the NYSE's self-regulatory authority. The NYSE was liable for damages under antitrust laws for this anti-competitive behavior.

1. THE HISTORICAL DEVELOPMENT
OF SECURITIES REGULATION
Lyla Latif
School of Law, Parklands Campus, Commercial Law Department

2. Key Note Address
• We want to understand why the government regulates the corporate world when these
corporates trade in listed securities, especially in light of the wave of privatisation and
trade liberalisation pursuant to the Washington Conference which called for
deregulation.
• In as much as Kenya advocates for privatization and autonomy of the business world
there is some form of regulation through statute that is necessary. However, regulation is
more through administration; such as registration requirements, directors disclosure,
books of account being kept for inspection, auditing and filing tax returns.
• Regulation is necessary for many reasons. Key among them being: controlling the market
(solvent corporates- prospectus), protecting the market (ponzi schemes, tax avoidance
schemes), leading to market growth (FDI and investment) and general well being of the
economy.
• The securities market operates differently than normal businesses that we are used to
understanding. This market affects the money market, which in turn affects the economy
of a nation. It is the backbone of an economy. It determines the strength of our currency
and money supply. It has the potential to affect operations of financial institutions and
create a bull or bear market as well as lead to depression.
• Hence, to effectively understand securities law, we must understand its historical
context.

3. History
• The “Roaring Twenties”
• Public companies listed inviting IPOs. Increased borrowings on securities as collateral.
• Corporate fraud taking place (corporations paying reporters to exaggerate profitability of their companies,
insider trading, tax avoidance, preferential listing of government officials and high ranking individuals, high
salaries)
• Strong economic growth and swift technological change led to increase in stock prices
• Radio discovered
• No legal and regulatory framework. Capitalism at its best.
• Bubbles being created
• Bubble burst.
• In 1929 the stock market crashed
• Great Depression. (Struggling financial institutions, unemployment, fraud revealed and
investigations revealed that crash was attributed to the stock exchange)
• Roosevelt’s government then decided to intervene. Securities Act of 1933 (the Securities Act) and
the Securities Exchange Act of 1934 (the Exchange Act) – to give investors access to information
about the securities they buy and the companies that issue securities; burden of disclosure
placed on companies contrary to the caveat emptor rule; efficacy of these disclosure
requirements backed up by broad liability for fraud. Step towards regulation.
• https://www.youtube.com/watch?v=POMhTJqw1d4
• https://www.youtube.com/watch?v=7WBTP4f970Q

4. Rationale
• To regulate the practice of investing that began by the wealthy who
could afford to buy into joint stock companies and not make
disclosure
• To mitigate risks involved and protect investors and enhance investor
confidence
• Ensure stable growth of the stock market
• Resolve conflict of interest in the self regulation of the market where
instances of insider trading and market manipulation may go
undetected.

5. Historical Development of the Nairobi Stock
Exchange (as it then was)
• Kenya started trading in shares as early as the 1920s when Kenya was still a
British colony. However, this was done through the informal market. White
settlers club. Meeting at coffee shops to discuss stock and its trading.
• Then the need for a formal market grew because there was no avenue
through which long term capital by private enterprises could be accessed
and there were no avenues through which locally registered government
loans could commence floating.
• Hence the Nairobi Stock Exchange was constituted in 1954 as a voluntary
association of stockbrokers registered under the Societies Act.
• The NSE at that time was charged with the responsibility of developing the
stock market.

6. NSE AS AT 1920-1953
• 1920-1953
• Trading whilst still a British colony
• Characterised by informal share trading with no formal rules or regulations to
govern trading activities.
• Based on gentleman’s agreement where standard commissions were charged
and clients obliged to honour their contractual agreements of making good
delivery and settling of relevant costs.
• No physical trading floor nor specialised stockbrokers; share trading was a
part time job for accountants, lawyers, auctioneers and estate agents.
• First stock brokerage firm was established in 1951 by Drummond.
• Foreign investors dominated the market because they had the know-how of
operating organised capital markets and they had high incomes.

7. NSE AS AT 1954-1963
• 1954-1963
• NSE established (formalisation of share trading) because:
• Private sector needed access to long term capital
• MoF recommended for a formal market which would facilitate floating of locally registered government loans
• NSE established under the Societies Act and stockbrokers had to register, but first they needed
clearance from the LSE, which recognised the NSE as an overseas stock exchange.
• A self regulatory framework was adopted – Rules and Regulations of NSE 1954: these spelt out
guidelines for primary issues, the operations of stock brokers, and secondary market trading
activities.
• The sole aim for constituting the NSE and providing the self regulatory framework was in order to
ensure the development of the stock market. Not regulating listed companies.
• To enforce the rules and regulations a committee of 5 was given powers to govern and manage
the NSE (e.g. approving public quotations, adjudication of disputes between members, provided
information on the share prices dealt with during the previous week).
• Despite establishment of NSE, there was no physical trading floor and no specialist. Business
transacted by telephone and prices determined through negotiation. No dealings were recognised
except those for NSE members and fully paid shares. Brokers were free to buy or sell shares of
their customers without consulting each other.

8. Continued
• During this period the securities traded in the NSE mainly included government
stocks, loan stocks, preferential and common share.
• Government stocks were made on the LSE and not on NSE. Still a colony.
• Business started picking up, value of stocks increased, 12 public sector stocks
were listed and the number of stockbrokers also increased.
• To be a member of the NSE, one had to pay an entrance fee and an annual
subscription fee. In addition stockbrokers had to have at least 3 years working
experience at senior level with a registered member of the NSE and had to
deposit Kshs. 50,000 which was refundable at the expiry of the probation period.
Reason?
• Stockbrokers acted as agents, buying and selling securities for their clients, they
provided information and advise to clients and helped firms in determining a fair
issue price.
• Stockbrokers were regulated: not to undercut, not to advertise etc. Like lawyers.

9. NSE AS AT 1963-1970
• 1963-1970
• INDEPENDENCE and transfer of economic and social control to citizens where
majority of businesses would be in the hands of citizens as opposed to the
foreigners. Foreigners continued to hold majority interest in companies if sufficient
capital was not available from domestic sources or so long as it was advantageous to
the new Republic. The Foreign Investment Protection Act (1964) was enacted to
allow foreigners to repatriate their earnings and capital.
• The NSE operated as a regional market in EA where public sector securities included
issues by the Tanzanian and Ugandan governments. This was because there existed a
common market with free movement of capital and maintenance of common
exchange regulations regarding capital movements to countries outside EA.
• Political landscape began changing which created uncertainties for the NSE (KE:
socialist to capitalist and constant constitutional amendments; TZ: nationalising; UG
and TZ decided to be excluded from the Scheduled Territories for Exchange Control):
led to currencies being affected.

10. NSE AS AT 1971-1980
• 1971-1989
• Government decided to directly monitor the operations of the NSE in an effort to
ensure that capital raised in the market was not used for investment outside the
country. Since that was the mentality.
• Tight taxation policies were implemented to reduce repatriation of funds by
foreigners and to raise government revenue (e.g., dividend revenue was doubly
taxed because they were not deductible, corporations not allowed to deduct
expenses of raising share capital of debenture issues from taxable income).
Regulation coming into place, but more towards DRM.
• The Capital Issue Committee was established to regulate the stock market; oversaw
the licensing of all stockbrokers; created a deposit/guarantee with the Treasury to be
used for compensating investors where stockbrokers failed to meet their obligation;
controlled and approved new issues of company shares to the public; screened
issues before they were presented to the public.

11. Establishing the Regulator
1980-1990
• 1980: was the period when the government realised the need to
design and implement policy reforms to foster sustainable economic
development for an efficient and stable financial system.
• This was the period when the government wanted to enhance the
• role of the private sector in the economy (Washington Conference),
• to reduce the demands of public enterprises on the exchequer,
• to rationalise the operations of the public enterprise sector to broaden the
base of ownership and enhance capital market development.
• Commercial banks could not support and sustain a desirable
economic development because they could not offer the necessary
long term credit. A solution was required.

12. Continued
• In 1984 CBK conducted a study on Development of Money and Capital Markets in
Kenya. Their objective was to make recommendations on measures that would
ensure active development and strengthening of the financial sector.
• This study was the road map for structural reforms in the financial markets and as
a result the government then committed itself to the creation of a regulatory
body for the capital markets in its 1986 Sessional Paper on “Economic
Management of Renewed Growth”.
• In 1988 the government set up the Capital Markets Development Advisory
Council with the duties to work out the necessary modalities including the
drafting of a bill to establish the CMA.
• One year later (Nov. 1989) the bill was passed and received presidential assent.
• 2 months later (Jan. 1990) the CMA was constituted and inaugurated on
7.03.1990.

13. Trading System
• As a result, a year later in Nov. 1991 share trading moved from coffee-house to
floor based open outcry system. This system was opted to enhance transparency
by according all brokers an equal opportunity to bid for securities.
• A proposal was made to install the Central Depositing System (CDS); to establish
legislation to ensure best practices and the need to acquire the best technology.
• CDS would enhance liquidity and efficiency in the trading system by reducing the
period of delivery and settlement; it would facilitate electronic transfer of
ownership without the physical movement of certificates; to shorten the
registration process – CDS put in place in 2004. Need to control this:
• Investor Compensation Fund established.
• CMA published guidelines on disclosure standards.
• Audit committees set up to promoted good corporate governance practices.

14. Division of the NSE
• NSE was split into the
• Main Investment Market Segment (MIMS)
• It is the main quotations market with more stringent listing requirements similar to past
structure of the exchange.
• Alternate Investment Market Segment (AIMS)
• AIMS were set up so as to provide access to the capital markets for small and medium sized
companies with high growth potential. This provided an alternative method of raising capital
to those companies that find it difficult to meet the more stringent listing requirements of the
MIMS. This was particularly necessary in order to respond to changing needs of issuers and to
provide access to capital markets to younger innovative companies with high growth
potential.
• Fixed Income Securities Market Segment (FISMS)
• It was introduced as a special trading window for fixed income securities. It aims at providing
a separate independent market for fixed income securities such as treasury bonds, corporate
bonds, preference shares and debenture stocks. It expanded the bond market at the
exchange. The segment also lists other short-term financial instruments such as treasury bills
and commercial papers.

15. Current Status of the NSE
• 66 listed companies
• Daily trading volume of USD 10 million
• Total market capitalization of approximately USD23 billion
• In 2006 introduced an Automated Trading System (ATS) which ensures that
orders are matched automatically and are executed by stockbrokers on a
first come first serve basis.
• Securities lending, short selling and same day turn around trades are not
yet permitted.
• This year we are expecting trading of currencies and equities indices.
• Foreigners can now hold over 75% of NSE listed companies.
• Draft NIFC Bill.

16. Silver versus New York Stock Exchange (1963)
• Petitioners, two Texas over the counter broker-dealers in securities, who were not members of
the New York Stock Exchange, arranged with members of the Exchange in New York City for
direct-wire telephone connections which were essential to the conduct of their businesses. The
members applied to the Exchange, as required by its rules promulgated under the Securities
Exchange Act of 1934, for approval of the connections. Temporary approval was granted and the
connections were established; but, without prior notice to petitioners, the applications were
denied later, and the connections were discontinued, as required by rules of the Exchange.
Allegedly as a result, one of the petitioners was forced out of business and the other's business
was greatly diminished. Notwithstanding repeated requests, officials of the Exchange refused to
grant petitioners a hearing or even to inform them of the reasons for denial of the applications.
Petitioners sued the Exchange and its members in a Federal District Court for treble damages and
injunctive relief, claiming that their collective refusal to continue the direct-wire connections
violated the Sherman Act.
• Held: The duty of self-regulation imposed upon the Exchange by the Securities Exchange Act of
1934 did not exempt it from the antitrust laws, nor justify it in denying petitioners the direct-wire
connections without the notice and hearing which they requested. Therefore, the Exchange's
action in this case violated §1 of the Sherman Act, and the Exchange is liable to petitioners under
§§ 4 and 16 of the Clayton Act.

17. Continued
• (a) Absent any justification derived from the Securities Exchange Act of 1934 or otherwise,
removal of the direct-wire connections by collective action of the Exchange and its members
constituted a per se violation of §1 of the Sherman Act (breach of contract), since it was a group
boycott depriving petitioners of a valuable business service which they needed in order to
compete effectively as broker-dealers in the over the counter securities market (anti trust
behaviour).
• (b) In the light of the design of the Securities Exchange Act of 1934 to give the exchanges a major
part in curbing abuses by self-regulation, the rules applied in the present case were germane to
the performance of the duty implied by §§ 6 (b) and 6 (d) to have rules governing members'
transactions and relationships with nonmembers.
• (c) The statutory scheme of the Securities Exchange Act of 1934 is not sufficiently pervasive to
create a total exemption from the antitrust laws, but particular instances of exchange self-
regulation which fall within the scope and purposes of the Act may be regarded as justified in
answer to the assertion of an antitrust claim.
• (d) In denying petitioners the direct-wire connections without according them the notice and
hearing which they requested, the Exchange exceeded the scope of its authority under the
Securities Exchange Act of 1934 to engage in self-regulation. Therefore, it was not justified in
doing what otherwise was an antitrust violation.