Securities experts always followed the mantra that companies can sell their "garbage" stock to the public so long as the company acknowledged it is "offering garbage and you shouldn't really buy this but you have the chance to buy it," said ex-SEC Chairman Harvey Pitt.
For some reason this logic no longer holds true, Pitt said Tuesday on CNBC's "Squawk Box."
What Happened: No one expected retail or other investors to be gullible enough to take a gamble on stocks of companies on the verge of bankruptcy, such as Hertz Global Holdings Inc (NYSE: HTZ), Pitt said.
The car rental company took advantage of its unusual stock appreciation to try and raise capital through a -billion stock sale.
Why It's Important: The Securities and Exchange Commission should take action to force Hertz and similar companies to become "far more aggressive" in their disclosures, Pitt said. Investment banks working with Hertz to raise capital also need to do more, he said.
"Investment banking firms have liability, and when they offer securities one of the issues that will come to bear is whether these investments are suitable," Pitt said.
"To my way of thinking, an investment banking firm runs the risk of effectively selling a litigation claim. Because at the end of the day, if this operates the way it ought to, it's like musical chairs and someone is going to be left without a seat."
What's Next: The SEC has no legal authority to outright prevent a stock sale, and this shouldn't change moving forward, Pitt said.
Hertz, Chesapeake Energy Leading The 'Bankruptcy Bubble'
Hertz Allowed To Sell Potentially Worthless Stock By Bankruptcy Court
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