The stock market is a highly volatile and high-octane arena for investments. When you buy or sell stocks, is there someone watching your back? Protecting you from illegal or suspicious traders trying to make a quick buck by using fraudulent means? Understanding the stock markets and choosing the right stocks to buy is hard work. If we also have to start wondering about the authenticity of the trades we make, then the stock markets would not survive. In India, the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), and the National Stock Exchange (NSE) play an important role in regulating the stock markets. However, what about the US markets? Who regulates them? It is one of the largest and highly-traded markets making it susceptible to fraud and illegal activities. Hence, before you start looking at investing in stocks in the US, ensure that you understand the regulatory control over the stock markets in the US.
Regulators of the US Stock Market – A Historical View
Around a century ago, stock markets in the US were not highly regulated. While investors were getting acquainted with a new way of generating wealth, the market started teeming with fraudsters offering make-money-quick schemes and easy credit accessibility plans. The Great Depression of 1929 saw many of these schemes crash and investors suffered heavy losses. In the years that followed, people had no confidence left in the stock market. The government realized that the best way for the economy to recover was to restore people’s faith in the capital markets.
Subsequently, Congress passed the Securities Act, 1933, and the Securities Exchange Act, 1934. As per section 2 of the Securities Exchange Act, 1934, the government defined transactions in securities as ‘transactions that are affected with the national interest, making it necessary to provide for regulation and control of such transactions and practices and matters relating to them.’ The government laid down laws and created structure and oversight to help restore people’s confidence in the markets. It also established institutions to help enforce these laws and ensure investor protection.
The Securities Exchange Act, 1934 provides for, inter alia, the creation of the Securities and Exchange Commission (SEC). It gives the SEC broad authority over all aspects of the securities industry, including the power to register, regulate and oversee brokerage firms, transfer agents and clearing agencies, as well as the self-regulatory organizations (SROs) which include the stock exchanges and the National Association of Securities Dealers, Incorporated (NASD), Municipal Securities Rulemaking Board (MSRB), and clearing agencies (SROs that help facilitate trade settlement).
Who Regulates the US Stock Markets Today?
The stock markets in the US are subject to a lot of stringent regulations. As an investor, it is important to learn about the regulatory bodies and their rules to avoid finding yourself on the other side of the proverbial line. Most of these rules have penalties and/or imprisonment for those who run afoul of the law. Here is a lowdown on the regulators of the US stock markets today:
1. The Securities and Exchange Commission (SEC)
As we mentioned above, the SEC was established in 1934 to bring a sense of regulation and control over the securities markets in the US. It is an independent agency with quasi-judicial powers. It comprises five presidentially-appointed commissioners, each with a five-year term. Also, not more than three commissioners are selected from the same political party. The President designates one commissioner as the Chairman of the SEC.
The primary responsibility of the SEC is to monitor and enforce laws to govern the securities markets in the US. Here are three primary legislation enforced by the SEC:
- Securities Act, 1933: The SEC ensures that it takes all measures to prevent fraud in the sale of securities. It ensures that there is adequate disclosure of information regarding public securities to investors.
- Securities Exchange Act, 1934: The SEC extends the Act of 1933 to include securities that are traded on stock exchanges and OTC (over the counter) markets.
- Investment Advisor Act, 1940: The SEC ensures that all investment advisors (individuals or firms) register with it and follow the standards specified by it.
The SEC has five divisions that interpret and enforce laws, issue new regulations, offer oversight of various institutions in the market, and ensure coordination of regulation among different regulatory bodies. These divisions are:
- Division of Corporate Finance – This division ensures that the investors get information about the company’s financial prospects and other details to make informed decisions about buying its stocks.
- Division of Enforcement – It enforces the regulations stipulated by the SEC and prosecutes civil suits and administrative proceedings.
- Division of Investment Management – This division is in charge of regulating investment companies, registered investment advisors, and variable insurance products.
- Division of Economic and Risk Analysis – It provides insights from data analytics and economics to help the SEC formulate regulations.
- Division of Trading and Markets – This division establishes standards for efficient markets and helps maintain an orderly structure.
2. Financial Industry Regulatory Authority (FINRA) – Erstwhile National Association of Securities Dealers (NASD)
The Financial Industry Regulatory Authority or FINRA is the largest independent regulator of every broker or brokerage firm associated with the securities markets in the US. It is authorized by the government to protect investors by ensuring that the broker-dealers operate in a fair and honest manner. It oversees more than 6.24 lakh brokers across the US and analyzes millions of daily events related to the stock markets.
Some primary objectives of FINRA are:
- Ensuring that every investor receives adequate protection
- Testing, qualifying, and certifying everyone selling a securities product
- Ensuring that every advertisement about any securities product is not misleading but states the facts
- Ensuring that an investor receives complete disclosure about the investment product before buying
To meet these objectives, FINRA performs the following functions:
- Write and enforce rules to govern the activities of all registered broker-dealer firms and brokers in the US
- Ensure all registered firms and brokers comply with the rules
- Foster transparency in the capital markets
- Initiate investor education programs
In 1939, the National Association of Security Dealers (NASD) was established and registered with the SEC. This was done as a response to the amendments to the Securities Exchange Act, 1934 (Maloney Act, 1938) allowing the NASD to supervise the conduct of its members under the oversight of the SEC. Subsequently, the NASD launched a new computerized stock trading system called the NASDAQ or National Association of Securities Dealers Automated Quotations.
By 2000, the NASDAQ became an independent entity and separated from the NASD. Seven years later, the SEC formed a new self-regulatory organization (SRO) as a successor to the NASD and merged this new SRO with the member regulation, enforcement, and arbitration functions of the New York Stock Exchange. This was called the Financial Industry Regulatory Authority (FINRA).
FINRA also has the ability to levy penalties and fines for unethical practices and can revoke licenses too. Investors can approach FINRA for unethical or illegal practices by broker-dealers.
3. Self-Regulatory Organizations (SROs)
The US stock market has many self-regulatory organizations or SROs that enforce the regulations set by the SEC. They have to register with the SEC and are governed by it too. SROs are usually the primary regulators of broker-dealers. All stock exchanges and FINRA are SROs. To be effective, each SRO needs to formulate rules to ensure investor protection and integrity.
Understanding the regulatory system and the role of regulators is important to understand how the markets take care of your interests. Ensure that you read through the role of each regulator and understand your rights before investing in the US markets.
Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.