The Corner

by Bart Ward

The securities industry in the United States is regulated in two ways, self regulation and by regulatory agencies created through legislative acts. The regulatory pyramid is composed of individual brokerage firms, the stock exchanges (ie., New York Stock Exchange or NYSE), Individual State Regulators, the Financial Industry Regulatory Authority, Inc., or FINRA, the Securities and Exchange Commission (SEC) and the U.S. Congress.

The broad base of the pyramid consists of brokerage firms that are members of the exchanges such as the NYSE. These firms, which buy and sell stocks for customers around the world, are charged with insuring that their employees are trained and meet industry standards. Self-regulation—the way the securities industry monitors itself to create a fair sales and orderly trading environment—begins here.

On the next level are the stock exchanges. NYSE Regulation, Inc. is an active self-regulator in the securities industry. NYSE Regulation has established and published rules, policies and standards of conduct for its member organizations. These standards are applied to every member of the NYSE’s investment community. NYSE Regulation’s team of regulators look for organizations and individuals that violate these standards. State-of-the-art computer surveillance of trading is used to turn up violations. Through an NYSE division known as Member Firm Regulation, teams perform routine and “for-cause on-site examinations of NYSE member firms.” Other exchanges across the country also police their affiliated brokerage firms.

With billions of dollars worth of transactions circulating through the exchange, NYSE Regulation has three areas of importance. They are: Listed Company Compliance, Regulatory Policy and Management and StockWatch. If NYSE Regulation’s regulators spot trouble in a report, they can order the disclosure of more detailed information. They can also have accountants spot-check member firms records at the firms offices. And if violations are discovered, NYSE Regulation can order that firm to change the way it does business or ban the firm from trading on the NYSE.

After the exchanges comes FINRA, which is the combination in 2007 of NYSE and NASDAQ stock market regulation, enforcement and arbitration functions. With approximately 3,000 employees this organization has extremely active registration and regulatory operations. FINRA requires all of its member brokerages to file several reports throughout the year. Each member firm must answer hundreds of detailed questions about its financial condition and sales practices. They also register and regulate investment advisors.

State regulators through commerce and securities departments are also in the business of regulation and accepting investor complaints. Through blue sky laws, that were first introduced in Kansas in 1911, states can and do set up laws dealing with securities issues. Eventually the laws were adopted by many states through the Uniform Securities Act of 1956. The term “blue sky,” comes from the phrase “speculative schemes which have no more basis than so many feet of ‘blue sky.’”

Next is the SEC which cooperates with FINRA and the exchanges’ internal regulators. The federally created agency oversees the securities industry, including the stock exchanges themselves. The SEC sees that the rules of conduct are enforced by FINRA and exchange regulators, requiring companies selling stock to the public to provide information about their operations. Rule breakers nabbed by the SEC face harsh penalties of fines and jail time. The SEC also recommends to Congress new legislation, when necessary, to protect the markets.

Finally, the U.S. Congress sits at the peak of the regulatory pyramid. Congress created the SEC and Congress is responsible for insuring that the SEC has the power or jurisdiction to function effectively. It also decides when changing conditions in the investment world require new laws and new organizations. This was the case when the Securities Investors Protection Corporation was created.

Quote of the Week: “Is the public wrong all of the time? The answer is decidedly, ‘No.’ The public is perhaps right more of the time than not. In stock-market parlance, the public is right during the trends but wrong at both ends!”—Humphrey Neill

Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka based registered investment advisor – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.

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