This chapter reviews foundational concepts that the Series 9 exam builds on. You likely first learned this material while preparing for an earlier FINRA exam, and you may also have real-world experience with these topics. There’s no quiz for this chapter, but you’ll want to review and retain these ideas because they show up throughout later chapters.
You’re probably already familiar with the idea of a security. In plain terms, securities are investments that issuers sell to investors. Issuers are organizations that raise capital (money) by selling securities. When investors buy those securities, they’re providing funding that the issuer can use to operate or pursue its goals.
Issuers can be anything from a small start-up to a government. They raise capital when a need arises, such as:
Real-world examples of issuers include:
Issuers raise capital by selling securities to the public. Legally, a security is an investment of money into a common enterprise that is managed by a third party. For example, Coca-Cola Company stock (ticker: KO) is a security. If an investor purchases KO stock, they’re investing in a common enterprise (Coca-Cola) that is managed by a third party (Coca-Cola’s Board of Directors and management team).
All of the following investments, which are detailed later in this chapter, are considered securities:
Securities are first offered to investors in the primary market. Transactions in this market are often called issuer transactions because the issuer is selling the security and receives the proceeds.
For example, Instacart (ticker: CART) was offered to investors in the primary market through an initial public offering (IPO) in September 2023. Instacart sold 14.1 million shares at $30 per share, resulting in roughly $423 million in sales proceeds collected by the company.
After a security is first sold in the primary market, it can trade between investors in the secondary market. Transactions in this market are called non-issuer transactions because the issuer is not a party to the trade and does not receive the proceeds.
For example, investors who hold CART stock can sell it to other investors in the stock market. If a sale occurs, the selling investor collects the sales proceeds (not the issuer).
Common stock is an equity security that represents ownership in a company. Investors typically buy common stock for two reasons:
Preferred stock is another major equity security that represents ownership in a company. Its primary benefit is dividend income. While many issuers do not pay dividends on their common stock, preferred stock investors generally expect dividend payments.
A debt security represents a loan made to an issuer. When a debt security is sold in the primary market, the issuer receives capital (money) from investors and promises to repay the borrowed funds with interest. Governments (U.S. and municipal) and corporations frequently issue debt securities to finance their operations.
Investment companies issue securities tied to pooled investment vehicles. For example, a mutual fund collects capital from investors (shareholders) and then invests that money according to the fund’s stated objectives. A growth stock fund, for instance, invests shareholder capital in stocks selected by the fund manager.
A hedge fund is similar to an investment company, but it is privately offered to wealthy individuals and financial institutions. Because these investments are typically not available to the general public, fewer rules and regulations apply to the issuer. By contrast, investment companies are actively regulated because they’re available to all investors.
A broker-dealer is an entity engaged in the business of effecting transactions in securities for the account of others or for its own account. In practice, these firms act as intermediaries between investing customers and the securities markets. If a customer wants to buy or sell a security, a broker-dealer can facilitate the transaction.
A broker, or agency transaction occurs when a professional connects a buyer and seller, typically in return for a commission. This is what the broker-dealer definition refers to as trading “for the account of others.” Broker/agency roles aren’t unique to finance. Real estate brokers work the same way: they connect a buyer and seller, and if a transaction occurs, they’re paid a commission.
Brokers in finance work similarly. When a broker-dealer acts in a broker (agency) capacity, it connects its customer with another party to buy or sell a security, sometimes in return for a commission.
A dealer, or principal transaction, occurs when a professional trades directly with a customer using the firm’s own inventory. This is what the broker-dealer definition refers to as trading “for its own account.” Dealer/principal roles also exist outside finance. Car dealerships are a useful analogy:
Dealers in finance work the same way. When a broker-dealer acts in a dealer (principal) capacity, it may buy securities from customers into inventory at a marked-down price and then sell those securities to other customers at a marked-up price, earning the spread.
Together, the terms broker and dealer can sound contradictory. A broker-dealer can’t act as both broker and dealer in the same transaction, but it can act in either capacity depending on the trade. One trade might be completed as a broker (agency) transaction, earning a commission for connecting a buyer and seller. The next trade might be a dealer (principal) transaction, selling securities out of inventory at a marked-up price.
The following video is borrowed from Achievable’s SIE program, but you may encounter Series 9 test questions on the same topic.
The Securities and Exchange Commission (SEC) is the primary regulator in the securities markets. The SEC has three primary goals:
Protecting investors is largely about preventing fraud and unethical behavior. In general, the SEC focuses most on protecting retail investors. Institutional investors typically have substantial legal and financial resources, which makes it less likely (though not impossible) for them to be victimized by bad actors.
Maintaining fair, orderly, and efficient markets is about supporting confidence in the financial markets. This goal applies primarily to the secondary market.
Facilitating capital formation means maintaining and regulating a system that allows issuers to raise capital (money) by selling securities.
The Financial Industry Regulatory Authority (FINRA) is the primary regulator representatives deal with in day-to-day industry practice. Although it is technically a private organization, FINRA is a self-regulatory organization (SRO) that has been granted regulatory authority (by the industry and the SEC) over securities professionals (member firms and representatives).
Generally speaking, FINRA handles “lower level” priorities related to firms and representatives, while the SEC oversees securities markets (primary and secondary markets). FINRA enforces its own rules and the rules of other SROs (e.g., the MSRB - discussed below).
The Options Clearing Corporation (OCC) is the primary options clearinghouse in the securities industry. Like most clearinghouses, the OCC’s main role is to help ensure transactions are processed and completed properly. In 2022 alone, it cleared over 10 billion options contract trades. The OCC operates under the SEC’s jurisdiction.