six months of the company’s formation [Dutch East India Company] and was an integral component to its success” (Chambers, 2006, p. 1).
The revolutionary idea of opening company ownership to the people allowed the company to bring in more than 6 million guilders, with share price jumping about 15% in initial trading, and a subsequent increase of 300% over the next 20 years. As a result, the Dutch East India Company was able to finance its growth to unprecedented heights: “50,000 civilian employees, with a private army of 40 warships, 20,000 sailors and 10,000 soldiers and a mind blowing dividend flow… With a market for its stocks and bonds, the Dutch East India Company became probably the most powerful business in the history of the world” (Chambers, 2006, p. 1).
In the United States, investments in the securities of companies became popular at the end of the nineteenth and beginning of the twentieth centuries. Macey and Miller (1991) explain this development as being a result of a variety of factors happening at the same time:
The growth of large industries such as railroads and heavy manufacturing stimulated unprecedented demands for capital. At the same time, increases in wealth among the middle classes created a new source of capital that could be tapped effectively by means of public securities issuance. Developments in transportation and communication technology made widespread promotion and distribution of securities practicable. Realizing the potential purchasing power of the rising middle class, bond issuers began to offer securities in denominations of $100 instead of the traditional denominations of $1,000 or even $10,000. A surge of new investment followed.
(pp. 352–353)
In addition to traditional blue chips, shares in large and well-known corporations, many speculative securities appeared that promised get-rich-quick opportunities: gold mines or oil companies – usually something distant and at the very early stages of development. “The speculative securities in the early 1900s were typically equity securities issued by mining and petroleum companies, land development schemes (such as irrigation and tract housing projects), and patent development promotions” (Macey & Miller, 1991, p. 353). Many investors lost money in these schemes. The securities markets at the time had a severe informational problem – it was difficult, if not impossible, to verify the claims made about the securities, especially if the shares were part of a distant gold mine in the Wild West.
These speculative securities were also promoted and sold outside of normal distribution channels – often by door-to-door salesmen and in other face-to-face solicitations. The securities salesmen were also among the first ones to utilize mailing lists – which traditional brokers referred to as “sucker lists” – where securities were hyped beyond any measure: “one-third of which [letter] is devoted to an extravagant flattery of the intelligence of the recipient, and the remaining two-thirds to the extolling of the excellent merits of the Gold Hammer Mines and Tunnel Company, from the investment standpoint; after which this most valuable stock is offered at the amazingly low price of seven and one-half cents a share” (as cited in Macey & Miller, 1991, p. 354).
As a result, thousands and millions of dollars were lost to fraud: “pure fake” and “near fake” enterprises. Other enterprises may have been legitimate and not an outright fraud, but too overhyped, too risky, and too speculative. The end result for investors was the same – loss of money. Investors could not rely on the truthfulness of statements made in connection with securities transactions and that put the whole securities market in jeopardy. A banking journal at the start of the twentieth century wrote, “So many people have lost their money on ‘fake’ investments that they seem to be incapable of distinguishing the false from the genuine, and hence are distrustful of all” (as cited in Macey & Miller, 1991, p. 394).
These developments required Kansas in 1911 to enact legislation to protect its citizens from these con artists. As Kansas Banking Commissioner J. N. Dolley explained, these fakers were duping unwitting investors by selling worthless interests in fly-by-night companies and gold mines along the back roads of Kansas. Yet, no actual assets backed up these securities; nothing but the blue skies of Kansas (Gelber, 2013). The first actual usage of the term blue sky dates back to June 5, 1895, when an article in the Colorado newspaper, the Castle Rock Journal, said: “When a promoter by artful persuasion succeeds in getting money for something which has no value except in the mind of the credulous purchaser he is said to have been selling ‘blue sky’” (Gelber, 2013). As a result, these types of securities were called blue sky and hot air securities (Wooldridge, 1906), and later just blue sky securities.
Soon after Kansas, other states followed with their own regulations and, as a result, a network of comprehensive securities legislations developed at the state level. These state laws are commonly referred to as blue sky laws:
The name that is given to the law indicates the evil at which it is aimed, that is, to use the language of a cited case, “speculative schemes which have no more basis than so many feet of ‘blue sky’”; or, as stated by counsel in another case, “to stop the sale of stock in fly-by-night concerns, visionary oil wells, distant gold mines and other like fraudulent exploitations.”
(Hall v. Geiger-Jones Co., 1917, p. 539)
These laws created the first requirements for disclosure and securities registration. The issuers were required to file periodic reports of financial conditions of the company; before selling the securities in a state, the company was required to provide a business plan and a copy of the securities offered for sale. The state had the right to ban the company from doing business in the state if it did not “promise a fair return on the stocks, bonds or other securities” (as cited in Macey & Miller, 1991, p. 361).
So, as a result, the first type of securities regulations that could have started the development of investor relations and financial communication in the United States, blue sky laws, were created as
a means to thwart the schemes of a class of people who were denigrated repeatedly as fly-by-night operators, fraudulent promoters, robbers, cancers, vultures, swindlers, grafters, crooks, gold-brick men, fakirs, parasites, confidence men, bunco artists, get-rich-quick Wallingfords, and so on. Against this class of bad operators was counterpoised a class of victims, usually portrayed as innocent, weak minded, vacillating, foolish, or guileless, and usually cast in the roles of widows, orphans, farmers, little idiots or working people.
(Macey & Miller, 1991, p. 389)
The legislation was needed not just for their protection, however. In fact, “if consumers could not discover accurate information about the quality of securities offered for sale, a loss of confidence in securities markets generally might result” (p. 394). It was needed for the protection of society as a whole. “The functioning of capital markets in facilitating capital formation would be severely impaired, to the detriment of issuers, buyers, and the economy at large” (Macey & Miller, 1991, p. 390).
Blue sky laws were not universally praised, however. Some issuers had concerns regarding how these laws could affect their ability to raise capital and the extra burden the regulations imposed on them. But probably the biggest opponent of blue sky laws was the Investment Bankers Association (IBA). IBA saw these laws as an attempt to keep money within state borders and prevent, or at least impede, inter-state security trade – and perhaps not without reason. One of the local Louisianan financial professionals was quoted as saying: “the sooner we learn the lesson of keeping our money at home and patronizing home industry, instead of putting it into the hands of the New York Stock Exchange speculators and gamblers, the better it will be for our State and the South” (as cited in Macey & Miller, 1991, p. 361).
World War I and the Great Depression slowed down the development of financial markets as well as investor relations and financial communications. However, the most important federal regulations appeared at that time, in large part in response to the stock market crash of 1929 – the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws paved the way for professionalization of investor relations and continue to influence the practice of financial communications today.
The history of the professional period of investor relations and financial communication