The U.S. government has formed different regulatory entities and agencies to regulate and protect financial fraud in the securities market.
In this section, we’ll learn about the Securities and Exchange Commission (SEC), self-regulatory organizations, and other regulators and their functions.
Security Exchange Commission (SEC)
The Securities and Exchange Commission (SEC) is a U.S. federal agency responsible for enforcing federal securities laws and regulating the securities industry.
Established by the Securities Exchange Act of 1934 in response to the Great Depression, the SEC’s primary mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
The agency oversees securities exchanges, brokers and dealers, investment advisors, and mutual funds, aiming to promote transparency, prevent fraud, and avoid market manipulation.
The Securities Act of 1933: It was the first major federal legislation after the Great Depression to regulate the securities market. The Act mandates issuers to fully disclose all information related to securities offered for public sale.
Its primary goals are to prevent deceit, misrepresentations, and other securities fraud. The Act requires registration of most securities offerings in the United States, ensuring investors receive significant information about the securities offered.
The Securities Exchange Act of 1934: The Securities Exchange Act of 1934 was established to govern the secondary trading of securities (stocks, bonds, and debentures) in the U.S. It created the Securities and Exchange Commission (SEC) to enforce federal securities laws and regulate the securities industry.
The Act includes regulating securities exchanges and market participants, the requirement for periodic financial reporting by publicly traded companies, and measures to prevent market manipulation, insider trading, and fraud, ensuring a more stable and transparent market environment.
The Investment Advisers Act of 1940: It set strict guidelines on how investment advisers can advertise their services, mainly to prevent any fraudulent or misleading promotions.
According to SEC Regulation 206(4), any advertising must not be deceptive or manipulative, which includes restrictions on using testimonials or unclarified external charts. Section 205(3) of the Act introduces the concepts of “Accredited Investor” and “Qualified Client.”
- Accredited Investor: Individuals/couples with a net worth exceeding $1 million or have earned above $200,000 for three successive years.
- Qualified Client: Individuals/companies should have at least $1.1 million in assets under management with an investment advisor or a net worth of at least $2.2 million.
The Investment Company Act of 1940: The Investment Company Act of 1940 regulates the organization and activities of investment companies like mutual funds and unit investment trusts to protect investors
The Act aims to demand disclosure of financial health and investment policies, to reduce conflicts of interest, to ensure fair structuring and valuation of fund securities, and to enforce fiduciary responsibilities of fund management. This Act promotes transparency and prevents financial abuses within mutual funds and other investment products.
The Investment Company Act of 1940 places certain limits on the SEC’s power, explicitly excluding the agency from overseeing the investment choices or strategies of investment companies directly or evaluating the quality of their investments. However, it establishes strict rules to protect investors during transactions.
Section 22 mandates that the redemption price of shares must reflect the net asset value calculated daily and requires these payments to be made within seven days.
To guarantee that funds are available for these transactions, the SEC enforces that 85% of an investment company’s assets be held in liquid securities, ensuring they can be quickly and easily priced and sold.
Section 22(d) of the Investment Company Act of 1940 mandates that no registered investment company can sell its redeemable securities to any person except at a public offering price described in the prospectus.
Additionally, no principal underwriter or dealer can sell such securities to anyone other than another dealer, a principal underwriter, or the issuer unless it’s at a price detailed in the prospectus.
Self-Regulatory Organizations (SROs)
Self-Regulatory Organizations (SROs) in the securities market are non-governmental entities that regulate various aspects of the industry.
These organizations create and enforce rules for ethical practices, monitor compliance, arbitrate disputes, and discipline members for violations, all under the supervision of the Securities and Exchange Commission (SEC).
SROs help maintain market integrity and protect investors by ensuring that industry participants adhere to their specific regulations and federal securities laws, offering a specialized, immediate regulatory response to emerging market issues.
Below are some key examples of Self-Regulatory Organizations (SROs) and their responsibilities:
New York Stock Exchange (NYSE): It is one of the largest and most popular stock exchanges, established in 1792. As a critical hub for financial activities, the NYSE provides a platform where stocks, bonds, and other securities are bought and sold.
NYSE ensures fair and orderly trading by implementing strict market regulations, overseeing the listing requirements of companies, and providing transparency in transactions to protect and inform investors.
Additionally, the NYSE facilitates capital raising for listed companies, playing a vital role in the global economy’s financial dynamics.
Chicago Board Options Exchange (CBOE): It is a leading options exchange in the United States, established in 1973. It specializes in trading options contracts on individual equities, indexes, and interest rates.
Chicago Board Options Exchange (CBOE) provides a regulated marketplace for options trading and ensures fair and transparent trading practices.
Its responsibilities extend to enforcing trading rules, maintaining the integrity of the marketplace, and safeguarding investor interests through comprehensive oversight.
Additionally, CBOE offers educational resources to traders and investors to help them understand options trading strategies and risks.
Financial Industry Regulatory Authority (FINRA): This non-governmental organization acts as a self-regulatory body for member brokerage firms and exchange markets in the United States.
Established in 2007, FINRA is responsible for protecting investors and maintaining market integrity by enforcing high ethical standards, writing and enforcing rules governing the activities of securities firms, registering and educating brokers, examining securities firms, monitoring trading, and resolving disputes.
FINRA also oversees the licensing and regulation of brokers, ensures transparency in financial markets, and provides investor education to promote a better understanding of the securities industry’s workings.
Municipal Securities Rulemaking Board (MSRB): This regulatory organization was established by Congress in 1975 to oversee the municipal securities market in the United States. Its primary functions include creating rules and policies for issuing and trading municipal bonds, notes, and other securities.
The MSRB ensures fair practices and transparency in the municipal market, protecting investors and public issuers by regulating securities firms, banks, and municipal advisors engaged in municipal bond transactions.
Additionally, the MSRB provides extensive education and resources to market participants, promoting a better understanding of municipal market activities and compliance requirements.
Other Regulators and Agencies
There are several other regulatory bodies and agencies that regulate the securities market. Below are some examples of other regulators and their responsibilities you must know to pass the SIE exam.
United States Treasury: Established in 1789, it is an executive federal government department responsible for managing the nation’s finances and resources.
The primary task of the Treasury is to formulate and implement federal financial policies, collect taxes, duties, and monies paid to and due to the U.S., pay all bills of the nation, manage federal finances, issue currency, and manage government accounts and public debt.
Additionally, the Treasury oversees national banks, enforces financial and tax laws, and advises on domestic and international financial, economic, and tax policy. It is crucial in stabilizing and sustaining the U.S. and global economy.
In 2014, the Financial Crimes Enforcement Network (FinCEN), a bureau within the United States Treasury, was tasked with enforcing the Currency and Foreign Transactions Reporting Act of 1970.
FinCEN’s mandate is to ensure U.S. financial institutions help detect and prevent money laundering, which is critical in maintaining the economic system’s integrity domestically and internationally.
Internal Revenue Service (IRS): The Internal Revenue Service (IRS) is the U.S. government agency responsible for tax collection and law enforcement. It administers the Internal Revenue Code, overseeing the collection of federal income and corporate and excise taxes.
The IRS also handles tax refunds, issues tax guidance, enforces tax laws, and conducts audits to ensure compliance. Its role is critical in funding federal programs and services for the country’s operation and development.
The Federal Reserve (“The Fed”): Established in 1913, The Federal Reserve is primarily responsible for influencing monetary policy, regulating banks, maintaining financial stability, and providing financial services to depository institutions, the U.S. government, and foreign official institutions.
The Fed controls the money supply and interest rates to manage economic growth and stability. It operates independently within the government framework, using tools like open market operations, discount rates, and reserve requirements to promote maximum employment, stable prices, and moderate long-term interest rates.
State Regulators
In the United States, every state has its own securities regulator responsible for several critical functions: licensing securities firms and advisors, registering securities offerings, auditing branch offices, educating the public about investments, and enforcing state securities laws.
Federal Deposit Insurance Corporation (FDIC): This independent U.S. government agency was created in 1933 in response to the thousands of bank failures in the 1920s and early 1930s.
The FDIC provides vital insurance for depositor funds in banks and savings associations, covering up to $250,000 per depositor per insured bank for each account ownership category.
Its primary mission is to maintain public confidence and encourage stability in the financial system by promoting sound banking practices.
Securities Investor Protection Corporation (SIPC): It is a non-profit, membership-funded corporation created under the Securities Investor Protection Act of 1970.
It serves to protect customers of brokerage firms that are forced into bankruptcy. Unlike the FDIC, which insures bank deposits, the SIPC protects the custody function of brokerage firms, ensuring that customers’ stocks, bonds, and other securities are safe if a brokerage firm fails financially.
The SIPC covers up to $500,000 per customer, including a $250,000 limit for cash claims. However, it’s important to note that the SIPC does not protect against the decline in value of securities.
Foreign Country Regulators: Most countries have their own government agencies to regulate the securities markets, similar to the SEC. For example, India has the Securities Exchange Board of India (SEBI), the United Kingdom (UK) has the Financial Conduct Authority (FCA), and Croatia has the Croatian Financial Services Supervisory Agency.