Finance is an important industry that dictates a lot about people’s lives. If you want to see the world and travel, you’ll need enough money to do so. If you want to start a family and provide for your children, you’ll need the right cash flow. If you want to retire at a reasonable age, you’ll need to save enough money. You’re entering into a career that oversees a very sensitive aspect of everyday life. To quote a popular saying:
“If you want to keep someone happy, don’t mess with their food or money.”
In many circumstances, financial professionals have control over significant amounts of money, which comes with an immense amount of responsibility. In order to operate legally and ethically in this field, you’ll need to know the rules of finance. At times, you’ll even need to think like a criminal to understand the incentives behind prohibited activities that you’re responsible for identifying and reporting.
There are many regulators that play a role in enforcing financial rules and regulations. You initially learned about them for the SIE exam, plus we’ve discussed them throughout this program. We’ll focus on the specifics of these regulators in this review:
As we learned in the primary market chapter, the Securities and Exchange Commission (SEC) is the primary securities regulator in the financial markets. Operating as an independent agency of the US Government, the SEC was technically created by the Securities Exchange Act of 1934 although it also enforces rules and regulations in the Securities Act of 1933 and the Investment Company Act of 1940. The SEC has three primary goals:
Protecting investors should be self-explanatory. In almost every instance we’ve discussed the SEC in this material, their intent is to shield investors from fraud and unethical actions. In general, the SEC is most concerned with protecting smaller, retail investors. Institutions have access to significant legal and financial resources, making it unlikely for institutions to be victims of bad actors. Think about it - how many times do you remember rules not applying to transactions involving institutions? Regulation D is a prime example.
Maintaining fair, orderly, and efficient markets relates to ensuring confidence in the financial markets. This goal relates mainly to the secondary market and the laws within the Securities Exchange Act of 1934, which we discussed in the secondary markets chapter.
Facilitating capital formation involves maintaining and regulating a system that allows issuers to raise capital (money) by selling securities. Although many rules exist that make the process of registering securities difficult and costly, the SEC strikes a balance between necessary regulation and ease of raising capital. Non-exempt issuers selling significant amounts of securities to the public often must go through the formal registration process, but many exemptions exist for smaller issues and securities sold to private audiences.
The Financial Industry Regulatory Authority (FINRA) is the primary regulator you’ll deal with while in the industry. Technically formed as a private organization, FINRA is a self-regulatory organization (SRO) that’s been approved to exercise regulatory power by the SEC.
Although it’s more complicated than this, FINRA primarily handles “lower level” priorities. The SEC oversees the overall primary and secondary markets, where billions of dollars of securities are issued and sold annually. FINRA primarily regulates financial firms and their representatives. They do so by enforcing their own rules and the rules of other SROs (like the MSRB).
You can also thank FINRA for having to take the SIE and Series 6, both of which FINRA writes questions for and administers. Passing these exams allows you to become a registered representative and work with customers of securities firms. In order to legally operate in the industry, registration with FINRA is typically required.
To register with FINRA, you’ll need to fill out and file Form U-4, which stands for the Uniform Application for Securities Industry Registration or Transfer. In most cases, your firm will streamline the process and help you fill out the form. It might feel intrusive, but you’ll have to provide a large amount of background information on yourself, including:
Certain actions in a person’s past may prevent them from working in the financial industry. While any criminal-related event (even if there wasn’t a conviction or guilty plea) must be reported on form U-4, only convictions or guilty pleas may prevent a career in the securities field. Known as statutory disqualifications, these events typically relate to criminal activities and rule violations. These specific items could automatically lead to a registration application (U-4) being denied:
One of the first things your firm may have requested from you was disclosure of past criminal convictions (or even arrests). This is the main reason why; if a felony or securities-related misdemeanor exists, it may prevent you from working in the industry. In some circumstances, a firm may apply for an exception and attempt to register a person with a previous disqualifying event. For example, a broker-dealer may feel a felony conviction eight years ago may be forgivable and ask for an exception. This process is known as an Eligibility Proceeding. The request is filed with FINRA, and then forwarded to the SEC, who ultimately determines if an exception is granted.
To verify the information filled out on the U-4, firms conduct background investigations on their new hires. FINRA rules require firms to investigate the good character, business reputation, qualifications, and experience of every representative they plan on registering. In addition to the background check, fingerprints will be collected and sent to the FBI. This process ensures people are who they say they are, plus they aren’t wanted for any outstanding crimes. It’s an intense process, but it verifies the right people are working in finance.
Once the information on the U-4 is confirmed by background check, the employee signs the U-4. In addition to vowing the information on the form is correct, the person’s signature approves an arbitration agreement that’s embedded in the U-4. As we learned in a previous section, this prevents representatives from suing their employer unless allegations of harassment or discrimination exist.
After the U-4 is signed, the firm will submit it to FINRA’s Central Registration Depository (CRD). The CRD is a large database containing information on registered representatives across the industry. Customers can gain access to some U-4 information on their representatives by using FINRA’s BrokerCheck (you might even be in there right now). Additionally, the CRD contains information on FINRA member firms, which are financial firms registered with FINRA. Broker-dealers are common member firms registered with FINRA.
From time to time, the U-4 will be required to be updated. This could be for harmless reasons like name or address changes. Other times, the update may disclose an event that could lead to being terminated. If an event involving a statutory disqualification occurs while the representative is already registered, the U-4 must be updated within 10 days of the event. For example, a representative being convicted of a securities-related misdemeanor while registered would fall into this category. In many of these scenarios, the event leads to the representative’s registration being revoked and termination from employment.
When a representative’s employment ends at a firm, the firm must submit a U-5 to FINRA within 30 days. If the registration is removed by FINRA due to a rule violation, the registration is revoked. However, not every termination of employment is bad. When a representative voluntarily quits or retires, their registration is canceled. Revocation of a license is punitive (a punishment), but cancellation is not. The information supplied on the U-5 is also available on BrokerCheck.
After a person’s registration is revoked or canceled, FINRA still maintains regulatory power over them for a 2 year period. Let’s assume a person quits their job and their registration is canceled. If a legitimate customer complaint alleging fraud is filed after they quit, FINRA can still revoke the person’s license, which would effectively prevent them from re-entering the industry at a future date.
Form U-6 is filed if a representative or firm is subject to disciplinary action or a reportable event occurs. Reportable events include criminal convictions and financial disclosures (bankruptcy and compromises with creditors). Additionally, the results of disputes facilitated through arbitration are disclosed on this form. Like the U-4 and U-5, the information supplied on the U-6 is available on BrokerCheck.
The Municipal Securities Rulemaking Board (MSRB) is an SRO that writes rules that pertain to the municipal securities markets and its participants. However, their rules do not apply to municipal issuers. Additionally, they only write rules; the MSRB does not have any enforcement power. These organizations enforce their rules:
Enforces MSRB rules for securities firms
Enforces MSRB rules for banks
The North American Securities Administrators Association (NASAA) comprises a group of state securities administrators. Each state has its own administrator, which is an office dedicated to enforcing the rules and regulations in the Uniform Securities Act. NASAA is basically the SEC, but at the state level. You won’t need to know much about NASAA for the Series 6, but you’ll learn plenty more about them if you take the Series 63, 65, or 66. Each of those exams is written and administered by NASAA.
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