Regulation of Markets & Securities in the United States By Jean-Christophe Turgeon, Bethany Wood, Zhe Wu and Xiaolu Zhu

Presentation Outline Definitions State Securities Laws Federal Securities Laws and Regulations

“Regulating Securities, Derivatives and Other Contract Markets” As with any regulation they are usually a result of hindsight as noted in the following quote from a federal government report issued in January 2015: “…much of the regulation of securities and derivatives markets has focused on resolving conflicts of interest and requiring full disclosure of material information, unlike bank regulation that tends to focus on prudence. In addition, much securities market regulation has been applied through enforcement against after the-fact violations, rather than as prospective examinations of covered firms.”

7/16/2015 Definition of “Security” A financial instrument that represents: an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option. A security is a fungible, negotiable financial instrument that represents some type of financial value. The company or entity that issues the security is known as the issuer. Examples of securities: Stock, Bond, Options, EFTs, Mutual Funds,

7/16/2015 Definitions Securities regulation in the United States is the field of U.S. law that covers transactions and other dealings with securities. -Federal-level -State-level On the federal level, the primary securities regulator is the Securities and Exchange Commission (SEC). Futures and some aspects of derivatives are regulated by the Commodity Futures Trading Commission (CFTC).

7/16/2015 State Securities Laws Called “Blue Sky laws”: “State regulations designed to protect investors against securities fraud by requiring sellers of new issues to register their offerings and provide financial details. This allows investors to base their judgments on trustworthy data.” “The term is said to have originated in the early 1900s when a Supreme Court justice declared his desire to protect investors from speculative ventures that had "as much value as a patch of blue sky.“ “ (

Modeled after the federal laws Both federal and state laws must be followed, not one or the other Unless either law says an issuer is exempt

North American Securities Administrators Association Predates the SEC by approximately 20 years State Securities Administrators are responsible for: Licensing stockbrokers Investment advisor firms (with less than 100$ Million in assets) Securities firms conducting business in the state Registering various securities offered to the investors of the state Enforcing state securities laws – can include fines, penalities, restitution, prosecution along with legally binding remedies for conduct targeted to specific problems

Investigating complaints made by investors which may include fraud Ensuring brokerage / investment firms are meeting compliance regulations (accurate records and no inappropriate trading on client accounts) Educating investors Advocating the passage of strong and consistent state laws and regulations

Five Major Federal Laws Securities Act of 1933 Securities Exchange Act of 1934 Trust Indenture Act of 1939 Investment Company Act of 1940 Investment Advisers Act of 1940

7/16/2015 Federal Securities Laws and Regulations 1933 Act Regulates the first issue of any security in interstate commerce 1934 Act Regulates the sales after the first issue (secondary trading) of any security in interstate commerce Created the Securities and Exchange Commission (SEC) Regulates the stock exchanges, brokers, and dealers

Trust Indenture 1939 Act -Supplements the Securities Act of 1933 in the case of the distribution of debt securities in the United States -The TIA is administered by the US Securities and Exchange Commission (SEC), which has made various regulations under the act. -In June 1936, the Protective Committee Study "Trustees Under Indentures" was published.

Investment Companies 1940 Act -It is an act of Congress and it was passed as a United Public - Law on August 22, It forms the backbone of United States financial regulation. -Its purpose is to regulate the conflicts of interest in investment companies and security exchange.

Investment Advisor 1940 Act -It is a United States federal law that was created to regulate the actions of investment advisors. -It is administered by the U.S. Securities and Exchange Commission (SEC). -Its purpose is to monitor those who, for a fee, advise people, pension funds, and institutions on investment matters.

Registration under Securities Act All securities that are sold in the States are required to be registered with the following information: Description of properties and businesses owned by the company Description of securities to be sold The company’s management information Financial statements that have been audited and certified by independent auditors.

Securities and Exchange Commission (SEC) Created shortly after the 1929 market crash Its goal was to restore investor confidence Split in 4 divisions: 1.Corporate finance 2.Market Regulation 3.Investment management 4.Enforcement

Corporate Finance Division Oversees the disclosure documents of every public company in the U.S. To ensure transparency for investors to take well informed decisions with all relevant material and financial information: Registration statements for public offering, Quarterly and annual fillings, Annual reports to shareholders, Documents detailing mergers and acquisitions, Proxy/voting information

Market Regulation Division Aims to maintain fair, orderly and efficient markets by regulating the participants in the securities industry (Broker/Dealer firms and Clearing Corporations for example) Interprets any proposed changes to existing regulations and reviews any disagreements over the operations of the securities industry Maintains constant surveillance of market activity to ensure that no policies are being manipulated

Division of Investment Management Ensures the preservation of all rules affecting investment companies and their advisor Requires that all investment companies and federally registered investment advisors file the appropriate documents Looks at public regulations and laws, and makes changes to existing rules if circumstances provide reason to do so

Division of Enforcement This division works closely with the three others and investigates possible violations of securities laws and provides recommendations when further action is needed Needs to cooperate with law-enforcement authorities to press criminal charges

Stock and Corporate Bond market regulation Regulators are active and visible: these markets have a relatively large number of relatively small issuers. There’s not one government issuing currency — there are a whole bunch of companies issuing shares of stock. Regulated by SEC and FINRA.

Financial Industry Regulatory Authority (FINRA) the largest independent regulator for all securities firms doing business in the United States FINRA's mission is to protect investors by making sure the United States securities industry operates fairly and honestly. FINRA oversees about 4,250 brokerage firms, about 162,155 branch offices and approximately 629,525 registered securities representatives.

FINRA’s Functions: Regulation and licensure regulates trading in equities, corporate bonds, securities futures, and options. periodically conducts regulatory exams of its regulated institutions. licenses individuals and admits firms to the industry, writes rules to govern their behavior, examines them for regulatory compliance. sanctioned by SEC to discipline registered representatives and member firms that fail to comply with federal securities laws and FINRA's rules and regulations.

FINRA’s Functions (con’t) It provides education and qualification examinations to industry professionals. It also sells outsourced regulatory products and services to a number of stock markets and exchanges publishes much educational information for the public and has been publishing and disclosing the education and exam requirements for USA

Regulation of Foreign Exchange (FOREX)

Commodity Futures Trading Commission – CFTC CFTC oversees trading on the futures exchanges Like the SEC it does not regulate prices of what is being traded but they regulate the organization and membership on the exchanges, implement rules for trading and attempt to reduce fraud, conflicts of interest or any potential manipulation by the market participants. Founded in 1974, at that time the majority of futures that were traded were in the agriculture sector

Currently futures are being traded on financial entities, currencies, government securities along with commodities (agriculture, oil, wheat, pork bellies etc.) CFTC also regulates derivatives “clearing houses” that are the places were buyers and sellers “meet” CFTC regulates the organizations responsible for the actual trades as well as monitors buyers and sellers to attempt to reduce fraud and other violations. In 2000 the Commodity Futures Modernization Act of 2000 was passed which included a joint process with the SEC to regulate single stock futures.

The CFTC also has “emergency / systemic risk powers” as follows: Ability to suspend trading, order liquidation of positions during market emergencies.

Glass-Steagall Act (1933) An act to primarily prevent the “run on banks” but was also implemented to sever the links between commercial banks and investment banks which is considered the reason for the 1929 market crash. There was a conflict of interest of banks that were participating in both commercial activities and investment activities and there inclination to lean towards speculation. Repealed in 1999 by the Clinton administration

The repeal of the act is believed to have contributed to the 2008 global melt down. During the 9 years after repeal commercial banks participated in extensive derivative and securities trading that resulted in losses in the billions. Result of Repeal and 2008 meltdown: Goldman Sachs and Morgan Stanley converted to bank holding companies from “top tier independent investment banks” Bear Stearns and Merrill Lynch acquired by JP Morgan and Bank of America

Dodd Frank Wall Street Reform and Consumer Protection Act Compilation of federal regulations that was passed to avoid a 2008 crisis in the future. Attempt to lower risk in various parts of the US System Obama administration passed in 2010 and named after Senator Christopher J Dodd and Representative Barney Frank Established the Financial Stability Oversight Council and Orderly Liquidation Authority to monitor performance of companies that are considered “too big to fail” to prevent widespread economic collapse.

Orderly Liquidation Funds – provides funds to help with the liquidation of financials companies under Chapter 11 Volker Rule: A key component of the act that restricts the ways that banks are able to invest and regulates trade in derivatives. “Disallows short term, proprietary trading of securities, derivatives, commodity futures and options on these instruments for banks’ own accounts under the premise that these activities do not benefit banks customers” What this means is that the banks are no longer able to increase their profits with this type of investments.

Sarbanes Oxley Act of 2002 “The Sarbanes-Oxley Act of 2002, sponsored by Paul Sarbanes and Michael Oxley, represents a huge change to federal securities law. It came as a result of the corporate financial scandals involving Enron, WorldCom and Global Crossing. Effective in 2006, all publicly-traded companies are required to implement and report internal accounting controls to the SEC for compliance.”

Provisions under SOX Criminal and civil penalties are detailed for the following issues by firms: Non compliance Certification of internal auditing Increased financial disclosure Affects all US companies along with non-US companies that maintain a presence in the states. Main focus is corporate governance and financial disclosure

Under SOX all financial reporting must include an “Internal Controls Report” that verifies a companies data is accurate and that they have sufficient internal controls in place to ensure the safety of financial data. This also includes year end disclosures. Audit trails must be kept for all activity Under SOX “whistleblowers” are protected when reporting any fraud / illegal activities of the publicly traded companies and any of their subsidiaries. Anyone that attempts to retaliate against the “whistleblower” can be prosecuted criminally by the Department of Justice.

References Utilized: system/p17417#p5 system/p17417#p5 reform-bill.asp reform-bill.asp regulation-who-can-really-police-this-global-market/ regulation-who-can-really-police-this-global-market/

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