Table of Contents
- 1 What is the Securities and Exchange Commission (SEC)?
- 2 The History of the SEC
- 3 Did the SEC Restore the Public’s Confidence?
- 4 What are Blue Sky Laws?
- 5 How the SEC Operates
- 6 What are Self-Regulatory Organizations?
- 7 The SEC Organization
- 8 Division of Corporation Finance
- 9 Division of Investment Management (DIM)
- 10 Division of Enforcement
- 11 The SEC and Cryptocurrency
- 12 Conclusion
- 13 Identity.com
The investment bubbles on Wall Street contributed significantly to the great depression of 1930. It is historically known as the Wall Street crash; brokers sold worthless stocks to the investing public with the hope of “getting rich quick.” A few years later, it all came crashing down. When America entered the Great Depression, it experienced one of its worst economic downturns, leading to the highest unemployment rates in its history. This experience made investors perceive the securities market as unfair to the poor, causing many to lose confidence in the stock market.
There were many difficult questions facing the United States: How can security markets be regulated effectively? How will investors be protected? How can rules guide broker activities? These questions led to the creation of the Securities and Exchange Commission.
What is the Securities and Exchange Commission (SEC)?
The Securities and Exchange Commission (SEC) is the independent regulatory agency that governs and monitors the U.S. securities industry with a focus on protecting investors’ interests. The SEC monitors instruments in the security markets, transactions, and activities of the professionals responsible for the day-to-day running of the investment industry. The goal is to present a fair, honest, and transparent market while preventing fraud, criminal gimmicks, deceptive acts, etc., all to restore the people’s faith in the security market.
The History of the SEC
The SEC is an independent agency that upholds necessary rules for the security market participants and prevents market manipulations. Though the SEC is independent, it is government-owned; it was passed into law by Congress in 1934. Below is the timeline of events that led to the creation of the SEC:
- 1929 — The financial market abuse contributed immensely to the great depression. It brought about the Wall Street crash — as the market crashed, so did the confidence of the investing public.
- 1932 — The Pecora hearing, named after Ferdinand Pecora, happened two years after the crash. The Pecora hearing, by the U.S. Senate banking committee, clearly stated the misconduct of the financial institutions and how they misled investors and engaged in insider trading. Prior to 1932, there was no federal law against insider trading.
- 1933 — The 1932 Pecora hearing led to the Securities Act of 1933. The Securities Act was not the first shot at regulating the securities market, as there were Blue Sky Laws at the state levels, but they were obviously ineffective. If they had been effective, the Great Depression wouldn’t have occurred. The 1933 Securities Act required the registration of securities sales in the United States, focusing on investor protection. This means being truthful about the risk and historical performance of each instrument on sale.
- 1933 — The Glass-Steagall Act was another response to the Pecora hearings of 1932. It separated investment banking from commercial banking. This same act created the Federal Deposit Insurance Corporation (FDIC) to protect bank depositors in the American banking system.
- 1934 — The President signed the Securities Exchange Act on June 6, 1934, which led to the creation of the SEC. With the authority of Congress, the SEC can regulate the security industry and penalize individuals and companies that violate the security laws.
The SEC and PUHCA 1935
One of the goals of Congress and President Franklin D. Roosevelt after the Great Depression was to restore public confidence in the U.S. financial industry. This resulted in the creation of the SEC in 1934, as seen in the above timeline. In the pursuit of sustaining the investing public’s confidence, Congress introduced the Public Utility Holding Company Act of 1935 (PUHCA 1935).
The PUHCA 1935 requires utility companies to register with the SEC and to provide financial and operational information. By limiting their operations to a single state, it gave the SEC authority to subject holding companies to effective state regulations. Pyramid structures naturally break up if they are present in some holding companies. In addition, it prevents a few investors from controlling multiple subsidiaries, which can lead to unfair advantages and practices. In addition, PUHCA ensures that utility holding companies are continuously engaged in regulated activities.
Did the SEC Restore the Public’s Confidence?
As a result of various legislations, the SEC was created, and it has taken multiple measures to increase market integrity, protect investors, and reduce investment fraud. Whether the SEC has succeeded in restoring public faith in the security market is subjective, but recent decades have seen the enforcement of different laws and rules to establish a more transparent and safe investing ecosystem. Moreover, the enforcement of these laws has brought massive progress over the decades.
What are Blue Sky Laws?
Blue Sky laws are state-level laws to protect investors against securities fraud. The laws generally regulate the issuance of securities within a state, including financial services professionals within that state. Most Blue Sky laws also give individual investors the right to bring a cause of action if they are victims of securities fraud. These laws vary from state to state, but the intention behind them remains the same: to protect the investors by ensuring that they are not in the dark as far as the security product is concerned. However, before investing their capital, investors should be given enough information about the securities of interest. Even though Blue Sky laws exist, it is important to remember that their past failure led to the creation of the SEC, the federal agency that protects investors.
How the SEC Operates
Due to the SEC’s role of protecting investors, one might expect it to work directly with investors; instead, it regulates stock exchanges, brokers, asset managers, investment advisors, and brokerage firms.
For example, if your company decides to go public, the SEC requires you to file a registration statement, which the SEC must declare “effective” before you can sell your securities. This registration includes audited financial information, state of operations, risk factors, and other important information that will educate the investing public about your security to determine its usefulness for each investor. The SEC achieves its goals through established rules and close monitoring via different self-regulating organizations (SROs).
What are Self-Regulatory Organizations?
Self-Regulatory Organizations (SROs) are non-governmental agencies established by the SEC to regulate professional groups in the industry, e.g., groups of stock brokers, broker-dealers, etc. To ensure professionalism, equality, and proper ethics in the industries in which these SROs are created, the SEC oversees their operations, rules, and regulations. Examples of different SROs in the United States.
- Financial Industry Regulatory Authority, Inc. (FINRA)
- International Securities Exchange (ISE)
- The New York Stock Exchange (NYSE)
- Depository Trust Company (DTC)
- The Financial Planning Association (FPA)
- Emerging Markets Clearing Corporation (EMCC)
- Fixed Income Clearing Corporation (FICC – formerly: Government Securities Clearing Corporation)
- Chicago Board of Trade (CBOT)
- American Council of Life Insurers (ACLI)
- National Futures Association (NFA)
- Fixed Income Clearing Corporation (FICC)
- Options Clearing Corporation (OCC)
- National Securities Clearing Corporation (NSCC)
- American Institute of Certified Public Accounts (AICPA)
- National Stock Exchange (NSX – now rebranded as NYSE National)
The SEC Organization
The SEC has its headquarters in Washington, D.C., with 11 regional offices across the U.S. Additionally, the agency has over 4,000 staff divided across its six divisions. These six divisions of the SEC have been very instrumental in investors’ protection and are listed below alongside their functions.
Division of Corporation Finance
This division, also known as “Corp Fin,” ensures accurate and timely information to the investors. It oversees the disclosure and periodic review of the essential documents companies are to file to the SEC before their initial public offering (IPO). Documents include registration statements, annual and quarterly filings, proxy materials, and annual reports. In addition, Corp Fin also drafts and interprets the rules and regulations that mandate these disclosures. The reviews carried out by Corp Fin are based on industry sectors. The division breaks down these reviews into the following eleven broad categories:
- Healthcare insurance
- Financial Services
- Information Technology & Services
- Natural Resources
- Beverages, Apparel & Mining
- Transportation & Leisure
- Manufacturing & Construction
- Consumer Products
- Real Estates & Commodities
- Electronics & Machinery
Breaking down the reviews into different categories allows the SEC to approach each sector head-on. The purpose of these reviews is to ensure compliance with the disclosure requirement of the securities laws.
Division of Investment Management (DIM)
This division regulates investment companies, advisors, and other financial firms offering financial advice to investors. It ensures that the information supplied to the investing public is clear and not misleading. Simultaneously, helping the SEC to interpret laws and regulations so that they are understandable by the investing public (e.g., a grandma should be able to read through these notes and understand without the help of a third party). This division also ensures that the regulatory cost placed on investors is fair. The following are the offices under the Division of Investment Management:
The Analytics Office helps the SEC to take actionable steps in the asset management industry.
Chief Counsel’s Office (CCO)
The CCO assists the division and the SEC as a body in the public interpretation of the Investment Act of 1940 amidst many other duties.
Disclosure Review and Accounting Office (DRAO)
This office handles the analysis and reviews of filings of investment companies under the federal security laws, e.g., variable insurance products, unit investment funds, mutual funds, etc.
Managing Executive’s Office (MEO)
MEO works hand-in-hand with the Division of Investment Management to achieve the SEC’s goal of investors’ protection through two offices, namely, the Business Management Office and the Business Solutions & Technology Office.
The SEC is a regulatory body, and enforcing its rules makes the market more efficient and fair for investors who aren’t “moneybags.” This is the office responsible for those rule creations or proposals. The decisions made in this office bring about changes or modifications to the Investment Advisers Act, Investment Company Act, and other federal security laws for the asset management industry.
Division of Economic and Risk Analysis (DERA)
This division integrates data analytics into the decision-making process of the SEC as it analyzes available economic data to detect potential violations, risks, and market trends. DERA is involved in all of the SEC’s functions and operations, this includes examination, rulemaking, and enforcement. The following are some of the activities carried out by DERA:
- It identifies and analyzes issues, trends, and innovations in the investment market.
- It develops customized analytic tools and analyses to proactively detect market risks and possible violations of federal securities laws.
- DERA uses data to create analytical programs to detect risk patterns, enabling the commission to target possible misconduct early.
- It provides high-quality economic and statistical analyses and specific-matter expertise to the SEC and other divisions.
- It works with outside academia and industry experts to strengthen the commission’s knowledge base about the market.
- It manages and analyzes public and private data to support relevant initiatives and projects.
- It contributes to the knowledge reserve and the development of the industry through high-quality research and publication in peer-reviewed journals.
- Participates and contributes to academic and industry conferences.
Division of Trading and Markets
This division creates the rules and procedures that maintain a fair, orderly, and efficient market for all participants. Furthermore, the division oversees the significant security market participants, including security firms, security exchanges, and self-regulatory organizations (including the Municipal Securities Rulemaking Board (MSRB), the Financial Industry Regulatory Authority (FINRA), and other agencies). According to the SEC, the Division of Trading and Markets carries out the following activities:
- It takes on the role of surveilling the markets.
- It implements the commission’s financial integrity program for broker-dealers.
- It reviews proposed new rules and proposed changes to existing regulations based on SROs filings. Under the delegated authority from the commission, the division can approve these proposed changes or new rules in some cases.
- Helps the commission to establish rules and issue interpretative notes to the public on issues affecting the operation of the securities market.
Division of Enforcement
In 1972, a significant change occurred as the Securities and Exchange Commission (SEC) created the Division of Enforcement to consolidate all enforcement activities. Instead of various divisions of the SEC enforcing their respective rules, this division became responsible for collecting evidence of possible violations through market surveillance, reports from investors, and other divisions of the commission. It then investigates these alleged violations of federal security laws and initiates legal steps if the said violations are proven. As a result of these investigations and legal actions, investors have been refunded for their fraudulent capital in some cases.
Division of Examinations
As the division responsible for the SEC’s National Examination Program, this division encompasses most of the SEC’s missions. It ensures a fair market and investors’ protection and supports capital formation through risk-focused strategies. The results of the examinations carried out by the division are used for the following:
- To inform rule-making initiatives
- Improve industry practices
- Pursue Misconducts
- Identify and monitor risks.
The Division of Examinations is present among market participants conducting on-site exams or evaluations. The results gathered help the commission in accurately achieving its mission. This division promotes compliance with federal security laws through exams, outreach, and publications. For effectiveness, the division is organized into different offices to carry out the mission of the National Exam Program. Below is a list of these offices/programs as presented by the Securities and Exchange Commission:
The Investment Adviser/Investment Company (IA/IC) Examination Program
This program conducts examinations for investment advisers and companies, e.g., mutual funds and exchange-traded funds.
The Clearance and Settlement (CS) Examination Program
This office conducts examinations of clearing agencies.
The FINRA and Securities Industry Oversight (FSIO) Examination Program
This office handles examinations for Financial Industry Regulatory Authority (FINRA) and The Municipal Securities Rulemaking Board (MSRB).
The Event and Emerging Risks Examination Team (EERT)
By mobilizing expertise and resources to SEC’s regional offices when needed, EERT controls emerging market threats.
The Broker-Dealer and Exchange (BDX) Examination Program
The BDX examination program handles examinations for broker-dealers, transfer agents, national securities exchanges, the Public Accounting Oversight Board, municipal advisors, and the Securities Investor Protection Corporation.
The Technology Controls Program (TCP)
This examination program is responsible for SEC’s CyberWatch program and also handles the examinations of bodies subject to Regulation Systems Compliance and Integrity (Regulation SCI).
The Office of Chief Counsel (OCC)
Coordinates with other regulatory bodies by reviewing proposed rules and plays a critical role in investigations and audits.
The Office of Risk and Strategy (ORS)
The ORS focuses on operational strategy supporting each division’s different programs.
The SEC and Cryptocurrency
Is cryptocurrency a security or a commodity? Is it to be under the oversight of the Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC)? As evidenced by his recent interviews, Gary Gensler, Chairman of the SEC, isn’t helping the situation either, as the crypto community asks these questions. This uncertainty remains a silent concern to many crypto firms and entrepreneurs. Many have subtle fears of building an idea or a company on top of the blockchain ecosystem.
In the words of a Bloomberg editor, crypto users want a guiding power that will dictate their modus operandi while maintaining government compliance. They want these rules to be formal, written and published. These rules must be open, public, and transparent, supporting permissionless innovation. Innovators wish for regulations to put the small player with no economic war chest on the same playing ground as the highly capitalized individuals or firms. Since cryptocurrency keeps gaining popularity, and the SEC’s mission is to protect investors, the next few months, perhaps years, will likely solidify the cryptocurrency industry and the SEC’s relationship without any parties being hurt (or not).
The consensus of the cryptocurrency industry is that new tools need new rules. Cryptocurrency advocates believe that the industry should not be regulated by the SEC or the CFTC: it needs to be a new commission.
The SEC’s journey so far has shown the progress of the commission in investors’ protection. Compared to what led to the Great Depression of 1930, establishing different structures, offices, and programs has significantly reduced investors’ exposure. This is 2023, and technology is advancing rapidly, so a trade can be opened and closed in a matter of minutes; investors can lose their capital in a matter of seconds if it falls into the wrong hands. The fast growth of technology in the securities sector only means one thing — an agency like SEC is needed now more than ever before.
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