Before you start trading in the market, it's essential to know who protects investors from fraud and other illegal activities. A complicated regulatory structure is in place, designed to watch out for investors.
How well this system works is sometimes subject to debate. There have been market specialist firms at the New York Stock Exchange fined over $240 million for stealing profits—they were taking trading opportunities they were supposed to give to investors.
You may have read about mutual fund executives trading after the market closes or a stockbroker trading an older adult’s retirement account. In these cases, the system is working because you're reading about it, and they have been caught.
How Is the Stock Market Highly Regulated?
The securities industry is one of the most highly regulated industries in the United States. The U.S. Congress is at the top of the heap of security industry regulators. It created most of the structure and passes legislation that affects how the industry operates.
It also authorizes budgets for the Securities and Exchange Commission (SEC) and other agencies involved in regulatory duties.
The SEC is the top regulatory agency responsible for overseeing the securities industry. It registers new securities and handles all the filings that public companies must make, such as annual and quarterly reports.
The SEC, FINRA, and the Exchanges
The SEC also oversees all of the stock exchanges and any organization connected with the selling of securities. It also has a robust anti-fraud unit that monitors advertising and marketing to ensure companies comply with strict securities sales rules.
Financial Industry Regulatory Authority
Working independently from a government agency, the Financial Industry Regulatory Authority (FINRA) is an independent organization that creates and enforces rules that apply to brokers, broker-dealer firms and funding portals. They are a self-regulatory body that is responsible for policing the securities industry. It was created in 2007 when the National Association of Securities Dealers merged with the New York Stock Exchange's regulatory functions.
FINRA set standards for stockbrokers and other industry professionals and licenses them after comprehensive examinations.
FINRA also provides resources for individual investors and administers exams that professionals need to pass to work in the securities industry. FINRA is not an organization without authority. It can levy individuals and organizations for unethical behavior and can revoke licenses. They also provide dispute resolution services such as mediation and arbitration.
FINRA takes complaints from investors about securities professionals they feel have acted unethically or illegally. They monitor the trading activities of member firms to detect illicit trading patterns and other unlawful activities. Investors looking for a broker or information on their existing broker can use FINRA's BrokerCheck to find out about them.
The individual exchanges also have sophisticated regulatory oversight functions within their operations. For example, the NASDAQ has an Investigations and Enforcement Team who investigates misconduct and enforces the exchange's rules. NASDAQ has also contracted FINRA to undertake specific functions and activities for the exchange while leaving the responsibility and control with NASDAQ.
Individual States and Brokerages
Individual states also have securities divisions, although they are usually not as sophisticated as FINRA. Often they handle complaints and register securities that will be sold within the boundaries of the state, although this varies by state.
The final step of securities protection lies with brokerage firms and professionals. Every licensed broker or dealer involved in securities must keep individual records and perform checks and audits of their operations to ensure they conduct business within acceptable legal and ethical guidelines.
What Can Investors Do?
Individual investors are not without regulatory authority. Reporting suspicious, illicit or unethical securities behavior is essential to ensuring the bad seeds are caught. Regulatory agencies cannot do all the work themselves.
Investors can also use the regulatory agencies' tools and published knowledge to inform themselves and keep their capital safe and working for them. When choosing brokers or dealers, do a background check and ask for references. It can be challenging to identify a securities professional that is violating the law, but you can reduce the chances of being used by one to further their agenda by doing your due diligence.
- The SEC is responsible for overseeing all stock exchanges and any organization connected with the selling of securities.
- FINRA sets standards and approves or revokes licenses for stockbrokers and other professionals.
- Individual states and brokerages are also tasked with handling complaints, registering securities, keeping records, and/or performing checks and audits to ensure no illegal activity occurs.