A History of Securities Law in the Supreme Court

Our new book, A History of Securities Law in the Supreme Court, explores how the Supreme Court has made (and remade) securities law. It covers the history of the federal securities laws from their inception during the Great Depression, relying on the justices’ conference notes, internal memoranda, and correspondence to shed light on how they came to their decisions and drafted their opinions.

We highlight the roles played by the individual justices in shaping the securities laws. For example, Felix Frankfurter and Lewis Powell brought very different attitudes regarding the relation between government and business when they were appointed to the Supreme Court in 1939 and 1971, respectively. For decades, Professor Frankfurter had been an advocate for the role of administrative expertise in taming the excesses of big businesses in a newly national economy. The professor had become a trusted advisor to Franklin Delano Roosevelt, using his influence to lobby for a series of laws aimed at taming the power of Wall Street. He was a key figure in the drafting of the three securities statutes enacted in Roosevelt’s first term. Lewis Powell, by contrast, rose to prominence in his native Richmond by steadily building a practice as a corporate lawyer during the decades following the New Deal. Powell’s advocacy on behalf of his corporate clients gave him faith in the free enterprise system, and a corresponding skepticism of overreaching by the SEC. The stark contrast in attitude between these two justices would be reflected in very different results in the Court’s securities cases during their respective tenures.

Their contrasting ideologies manifested themselves in two key shifts in the Supreme Court’s approach to securities law. The first, at the end of the 1930s, was the Court’s embrace of agency expertise and social control of finance, overturning decades of judicial hostility to legislative interference with freedom of contract. This deferential approach to the SEC and its mission dominated the Court’s jurisprudence over the next thirty-five years. The second shift, beginning in the mid-1970s, was marked by skepticism toward the SEC and securities class actions. Together, these two approaches provide the touchstones that frame the Supreme Court’s securities jurisprudence.

Frankfurter served on the Court from 1939 to 1963, and his colleagues generally shared his New Deal convictions and faith in the administrative state. The justices of the New Deal Court, scarred by the experience of the October 1929 crash and the ensuing depression, saw social control of finance as essential to “saving capitalism from the capitalists,” as Frankfurter put it. Administration by experts was an integral part of Frankfurter’s vision. As that vision played out in the 1940s and 1950s, Frankfurter’s colleagues, most notably the even longer-serving Hugo Black and William O.  Douglas, were more willing to defer to the SEC’s expertise than Frankfurter.

Powell, by contrast, was less impressed by claims of administrative expertise. He saw the SEC as an agency prone to overreaching. His appointment would usher in an era more skeptical of securities regulation. He and a majority of his colleagues in the 1970s and 1980s would be more favorably inclined toward private ordering and less trusting of the expert agency. Powell’s experience as a corporate lawyer bolstered his credibility with his colleagues.  As the Court became more skeptical of administrative experts, it worked to limit the SEC and the securities laws. The trend was further fueled by the rise of class actions, which Powell and his colleagues viewed with distrust. The SEC’s decades-long winning streak would come to an abrupt halt.

Since Powell’s retirement in 1987, the Court’s securities decisions have reflected each of the prior approaches, albeit without the consistency of the earlier eras. The Court’s decisions sometimes reflect Frankfurter’s instinct to defer, and sometimes Powell’s skepticism, jumping back and forth between the two approaches. Powell’s retirement left a void of expertise on the Supreme Court in the field of securities law. Since 1987, none of the justices have had prior experience with the securities laws, either as a regulator or in private practice. That absence of an experienced hand has left the Court to meander in the field of securities law, with no dominant trend other than, perhaps, a general inclination to defer to Congress.

Thus, we present three distinct approaches to deciding securities cases, and three different responses to the rise of expert administrators. The different approaches reflect both the change in the country’s politics and in economic perspectives. It makes a difference, for example, that Congress passed eight securities statutes in the first eight years of the New Deal, followed by very little additional legislation until a series of insider trading statutes in the 1980s, and then more fundamental revisions in 1995, 2002, and 2010. The real action in between was at the SEC and the Supreme Court. The turnover on the Court during Roosevelt’s second term would transform the scope of federal authority under the Commerce Clause. The arrival of Powell and William Rehnquist in 1972 produced another great swing in the field of securities law in the opposite direction. The securities cases from the 1970s into the 1980s offer a sharp reversal from the judicial activism of the Warren Court in the 1960s, more dramatic than in other areas of law.

The chapters are organized by subject, rather than strictly chronologically. Our goal is to show the main trends identified above earlier as they played out in particular areas of securities law.

Chapter 1 introduces the federal securities statutes and the critical role that a number of future justices had in their drafting, enactment, and defense against judicial challenge . New Deal legislation often got a chilly reception in the Supreme Court, with the SEC’s first case before the justices provoking a particularly stinging rebuke. The tide would soon turn, mostly because of eight seats Roosevelt filled in just four years, beginning in 1937.

Chapter 2 follows the Roosevelt administration’s path—both political and legal—to establishing the federal government’s authority to assert social control of finance. We highlight the role of William O. Douglas as an academic reformer of business law and then SEC Chairman taking on the New York Stock Exchange. Turning to the Court, we focus on the fight over Congress’s constitutional authority to enact the Public Utilities Holding Company Act (PUHCA). PUHCA went well beyond the disclosure requirements of the two earlier securities statutes, giving the SEC the mandate to break up the pyramid structure of those holding companies and shape the corporate governance and capital structures of the reorganized firms. PUHCA’s sweeping reforms would trigger a decade-long war in the courts, as the giant utilities resisted the efforts of the SEC to dismantle them, but the Court eventually upheld the law’s constitutionality. We show how the SEC’s mission to establish social control of finance played out in Supreme Court decisions relating to public utility companies. We also follow the SEC along a parallel path in the field of corporate reorganizations under Chapter XI of the bankruptcy laws. These were the SEC’s two most prominent fields of operation in its early days and the source of most of the Court’s early securities decisions.

In Chapter 3, we examine the Court’s oversight of the SEC’s procedures. The Court’s two decisions in the Chenery case in the 1940s remain black letter administrative law to this day.  Those decisions ultimately laid the groundwork for an administrative law affording the SEC great latitude in choosing between litigation and rulemaking in pursuing its policy agenda. That deference to the agency on questions of procedure would persist into the 1970s and 1980s, even as the SEC would struggle to overcome the Court’s pushback in other areas.

Chapter 4 focuses on the Court’s efforts to delineate the boundaries of the SEC’s authority. Recurring decisions addressing the definition of a security and the meaning of “purchase and sale” illustrate how shifting views among the justices shaped the direction of securities law and the SEC’s relations with other parts of government. We see a long era of deference to the SEC, beginning in 1940 and continuing until Lewis Powell’s arrival in 1972. We then see a dramatic reversal, with Powell and his colleagues closely policing the agency to keep it within its statutory bounds and minimize potential interference with other bodies of law and other regulators.

Chapter 5 shows the common law development of insider trading doctrine. In the 1960s, the Court became an active participant in the creation of the securities laws, declaring that the antifraud provisions of the securities acts extended beyond the long-standing bounds of fiduciary duty to take in anonymous trading on public markets by insiders. That judicially-created prohibition, nurtured by the Second Circuit, would soon dominate the more clunky and mechanistic remedy for insider trading that Congress had put into § 16(b) of the Exchange Act. Powell’s arrival on the Court would put the brakes on insider trading law’s development. Powell felt that insider trading was an abuse that should be prohibited, but he worked to constrain the doctrine in a predictable framework. Powell’s efforts, however, would not lead to the outright repudiation of the insider trading law developed in the Sixties; that residual fiduciary duty seed would eventually flower into a much broader prohibition after Powell’s retirement.

Chapter 6 addresses private rights of action under the securities laws. Private litigation got minimal attention from the Court until the Sixties, when two changes spurred the development of securities class actions. The first was the Court’s recognition of implied rights of action under the federal securities laws, supplementing, and in some cases supplanting, the rights explicitly created by Congress. The second was the amendment of Rule 23 of the Federal Rules of Civil Procedure, facilitating the aggregation of claims for money damages in large- scale class actions. These changes set the stage for two of the Court’s most expansive securities law decisions, handed down shortly before Powell and Rehnquist joined the Court. It would not be long, however, before observers would see a dramatic shift in the Court’s attitude toward private securities litigation. Elements were strictly construed to make relief harder for plaintiffs to obtain. Ultimately, the notion of implied rights of action was repudiated by the Court. The Rule 10b-5 cause of action survived their demise, however, and indeed were rejuvenated shortly after Powell retired by the last of the Court’s truly activist securities law decisions, Basic Inc. v. Levinson. Thereafter, the Court’s private right of action cases meandered between expansive and restrictive decisions, mainly reacting to Congress’s statutory intervention. No clear path emerged.

Chapter 7 deals with the intersection between federal securities law and state corporate law. Concern over the inadequacy of state fiduciary law led to a brief flowering of federal corporation law in the 1960s and early ’70s. The retrenchment of securities law through most of the 1970s and ’80s, however, included a strong effort by the Court to preserve the role of state corporate law. Subsequent federal interventions in corporate governance have come in bits and pieces from Congress, not the Court.

Chapter 8 concludes with a more detailed look at statistics that summarize the Court’s decisions in the field of securities law. We also offer our views on the trends that we observed over our period of study, and contrast the different approaches to decision-making visible across ninety years. Finally, we examine the influence—or lack thereof—of individual justices on the path of securities law.