The Origins of Securities Regulation

• Author: Christopher C. Nicholls
• Profession: Faculty of Law, Western University
• Pages: 27-46

27

CHA PTER 2

THE ORIGINSOF

SECUR ITIES

R EG UL ATIO N

A. INTRODUCTION1

There is nothing inevitable about the form, or even the existence, of

modern securities regulation. This can sometimes b e forgotten. We are

apt to regard familiar and long-lived institutions as somehow natural

and even indispensable owing to a phenomenon famously described

by legal positivist Georg Jelli nek and usually rendered into English

as “the normative power of the actual.”2 Securities ma rkets have been

extensively regulated since before most readers of this book were born.

The mischiefs at which regulation is aimed seem all too prevalent and

loathsome; the goals of regulat ion — to protect innocent investors —

incontrovertibly important. But the specif‌ic form, den sity, and com-

plexity of regulation that sur rounds the sale of securitie s to the public

is unique. No similar reg ulatory apparatus is in place, for example, to

protect purchasers of real est ate; yet, for most Canadians, it is their

home, not their securities portfolio, that represents, by far, their most

signif‌ic ant investment.

Of course, it is essenti al to have laws prohibiti ng securities fr aud and

manipulation (accompanied by appropriate penalties to pun ish violators,

1 Some of the materi al in this chapter dr aws on Christopher C Nicholls, Corpor-

ate Finance and Cana dian Law, 2d ed (Toronto: Cars well, 2013) at 191–212.

2 See, for example, And reas Anter, ed, Die normative Kraft De s Faktischen: das

Staatsverstä ndnis Georg Jellineks (Baden-Baden, Germany: Nomos, 20 04).

SECU RITIE S LAW28

and to deter other potential law breaker s). But securities regulation goes

far beyond the traditional prohibit /punish model. It involves an exten-

sive, and indeed expensive, batter y of regulatory machiner y designed

not merely to detect, punish, and deter wrongful behav iour, but also to

try actively to prevent harm to investors before it ever happens.

How, and why, did the sale of securities attract a level of regulation

more extensive than any other t ype of commercial tran saction in our

economy, with the possible exception, as I have suggested elsewhere,

of the sale of materials that can be used to produce nuclear weapons?3

The answer is found in the pages of history. Legislators and regulators

were f‌irst prompted to regulate securitie s markets chief‌ly in response

to specif‌ic, notorious scandal s that have, or have been perceived to

have, far-reaching economic and social eects. In t he wake of f‌inancial

disasters, legislative and regulatory measures of ever-increasing scale

and scope are def‌iantly imposed upon our markets under the sweeping

justif‌icatory battle cr y that, “This must never happen again.”

B. GREAT BRITAIN AND THE SOUTH SEA

BUBBLE

1) Introduction

One of the earliest and most infamous f‌inancial scandals to which

modern Canadia n securities regulation can trace its origin s was the so-

called South Sea Bubble. This incomparable phra se is associated w ith

the rapid rise and subsequent fall of the price of shares in the South

Sea Company in 1720, one of the most infamous securities “pump and

dump” schemes in history.

2) The Rise of the South Sea Company

The South Sea Company (ocially called the Governors and Company

of Merchants of Great-Britain, Trading to the South S eas and Other Parts

of America, and for Encouraging the Fishery) was created by an Act of

the British Parliament i n 1711. The South Sea Compa ny was established

to assist in the f‌in ancing (or ref‌inanci ng) of the British government debt,

through the method of “engra ftment” — an eighteenth-century public

f‌inancing technique that involved issuing equity secur ities in a trading

company to holders of government debt in exchange for those holders’

3 Nicholls, above note 1 at 191.