Bridge over ocean
1 November 2019 Issue Brief

Market Rules Covering Individuals, Firms & Trading Markets

Effective market regulatory systems promote transparency, uniformity, and consistency of application while discouraging regulatory arbitrage. In order to maintain high ethical standards and foster investor confidence, regulatory systems also need to avoid even the appearance of inappropriate influence by outside bodies, including the political system.

Effective regulation requires an enforcement system with “teeth” so that market participants — both investors and companies — know that violations will not be tolerated. Standards and regulations must be enforced in a consistent manner and with consequences that are effective in deterring future violations.

The Securities Exchange Act of 1934 (Exchange Act) governs the way in which the nation's securities markets and its brokers and dealers operate.

Most "brokers" and "dealers" must register with the SEC and join a "self-regulatory organization," or SRO. SROs generally include exchanges, associations, depositories, and the like.

Market Regulatory Harmonization and Convergence

Overlapping securities laws, regulations, or systems that cross multiple jurisdictions may be overly burdensome and unnecessarily complex.

Harmonization and convergence of the regulations governing capital markets could help improve cross-border listings and transactions. Likewise, fair and consistent application of regulatory systems and enforcement across global markets will help prevent the creation of a two-tiered market and could also enhance market integrity and bolster investor confidence.

The Securities and Exchange Commission (SEC) delegates authority to SROs to formulate and enforce standards and rules for securities transactions and broker/dalers.  In 2007, the enforcement arms of the New York Stock Exchange and the National Association of Securities Dealers merged to form a new SRO, the Financial Industry Regulatory Authority (FINRA).

Congress created the Municipal Securities Rulemaking Board (MSRB) as an SRO in the mid-1970s to promulgate investor protection rules to govern broker/dealers and banks dealing in tax-exempt bonds, 529 college savings plans, and other types of municipal securities.

As with broker-dealers, investment bankers must register with FINRA and comply with its rules, including the requirement to “observe high standards of commercial honor and just and equitable principles of trade.” As the self-regulatory body for broker-dealers, FINRA functions as the equivalent of the self-regulatory bodies governing other professionals, such as lawyers and accountants.

Major U.S. financial market SROs include:

  • The Financial Regulatory Authority (FINRA)
  • The New York Stock Exchange
  • Municipal Securities Rulemaking Board (MSRB)
  • Chicago Mercantile Exchange
  • Chicago Stock Exchange
  • Depository Trust & Clearing Corporation (DTCC)
  • Financial Accounting Foundation
  • Governmental Accounting Standards Board
  • International Capital markets Association
  • International Swaps and Derivatives Association (ISDA)
  • National Futures Association
  • NYSE MKT (formerly the American Stock Exchange AMEX)
  • The Pacific Exchange
  • The Philadelphia Stock Exchange
  • Pittsburgh Stock Exchange
  • American Arbitration Association

The Department of Labor’s Fiduciary Rule

The Dodd–Frank Wall Street Reform and Consumer Protection Act, which is commonly referred to as Dodd–Frank, was passed on July 21, 2010 in response to the financial crises of 2007-2008.  (See Department of Labor (DOL) Fiduciary Rule Proposal.) Dodd-Frank It made changes in the U.S. financial regulatory environment that affected all federal financial regulatory agencies and almost every part of the nation's financial services industry. A version of the legislation was introduced in the U.S. House of Representatives in July 2009. On December 2, 2009, revised versions were introduced by the then Financial Services Committee Chairman Barney Frank and in the U.S. Senate by former Senate Banking Committee Chairman Chris Dodd. 

Section 913 of the Dodd-Frank gave the U.S. SEC authority to impose a fiduciary duty of care upon brokers or dealers that was required already of investment advisers under the Investment Advisers Act of 1940 when giving personalized investment advice. Dodd-Frank stipulated, however, that the broker-dealer would not "have a continuing duty of care of loyalty to the customer after providing" the advice. This solution was quickly recognized as unworkable.

Section 913 also called on the SEC to study the applicability of a uniform fiduciary duty for brokers, dealers and investment advisers who cater to retail customers. The SEC’s report to Congress recommended that the Commission adopt a rule requiring everyone who provides personalized investment advice to retail customers to "act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice." It also recommended that broker-dealers and investment advisers be required to eliminate or disclose their conflicts of interest.

The Investment Advisory Committee (IAC) of the SEC, on which Kurt Schacht, CFA, Managing Director of the Advocacy Division of CFA Institute, is a member, issued a report to the Commission advising that the matter be settled by ensuring that those who hold themselves out as “advisers’ either through their titles or by the services they provide are bound by the “fiduciary” standard of care within the Investment Advisers Act (IAA). Otherwise they would have to promote themselves as “sales” staff or brokers, under which they would be subject to the lower, suitability, standard. 

The SEC’s Division of Trading and Markets establishes and maintains standards for fair, orderly, and efficient markets. The Division’s staff provide day-to-day oversight of the major securities market participants: the securities exchanges; securities firms; self-regulatory organizations (SROs) including the Financial Industry Regulatory Authority (FINRA), the Municipal Securities Rulemaking Board (MSRB), clearing agencies that help facilitate trade settlement; transfer agents (parties that maintain records of securities owners); securities information processors; and credit rating agencies.

The Division also oversees the Securities Investor Protection Corporation (SIPC), which is a private, non-profit corporation that insures the securities and cash in the customer accounts of member brokerage firms against the failure of those firms. It is important to remember that SIPC insurance does not cover investor losses arising from market declines or fraud.

The Division's additional responsibilities include:

  • Carrying out the SEC’s financial integrity program for broker-dealers;
  • reviewing (and in some cases approving, under authority delegated from the Commission) proposed new rules and proposed changes to existing rules filed by the SROs;
  • Assisting the Commission in establishing rules and issuing interpretations on matters affecting the operation of the securities markets; and
  • Surveilling the markets.

Division of Investment Management

The SEC’s Division of Investment Management assists the SEC in executing its responsibility for investor protection and for promoting capital formation through oversight and regulation of the U.S.’ $66.8 trillion investment management industry. This important part of the U.S. capital markets includes mutual funds and the professional fund managers who advise them; analysts who research individual assets and asset classes; and investment advisers to individual customers. Because of the high concentration of individual investors in the mutual funds, exchange-traded funds, and other investments that fall within the Division's purview, the Division of Investment Management is focused on ensuring that disclosures about these investments are useful to retail customers, and that the regulatory costs which consumers must bear are not excessive.

The Division's additional responsibilities include:

  • Assisting the Commission in interpreting laws and regulations for the public and SEC inspection and enforcement staff;
  • Responding to no-action requests and requests for exemptive relief;
  • Reviewing investment company and investment adviser filings;
  • Assisting the Commission in enforcement matters involving investment companies and advisers; and
  • Advising the Commission on adapting SEC rules to new circumstances.

Short Selling

Short selling occurs when a seller sells a security he/she does not own or when a security that has been borrowed is delivered for the account of a seller, in order to settle the sale. In general, short selling may serve to benefit the market by providing price discovery and market liquidity.

CFA Institute Viewpoint

The integrity of world markets is maintained when regulators require investment professionals to register or otherwise demonstrate that they have achieved appropriate credentials through exams, continuing education, and professional experience and knowledge. Understanding and verifying the work experience, responsibilities, and knowledge of those working in the investment business helps ensure that only the most highly qualified, ethically sound professionals serve as investment advisers and analysts.

CFA Institute has a broad range of codes and standards that provide investment professionals and their firms with the ethical foundation necessary to sustain a high level of professional integrity.

A number of practices can help maintain an efficient and transparent inter-market trading system, preventing duplication of regulations and minimizing investor confusion:

  • Encouraging equity-trading facilities within a legal jurisdiction to operate under the same trading regulations;
  • Seeking regulatory direction that establishes rules governing how various markets interact with each other − and how they make accessible their inter-market bids and offers;
  • Generally promoting fair treatment across markets.

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