Regulatory Entities, Agencies and Market Participants

1.1.1  The Securities and Exchange Commission (SEC)

• The high-level purpose and mission of securities regulation

  • The SEC is an independent federal government agency responsible for regulating the securities industry, which includes stocks and bonds, among other investment products. It was established by the Securities Exchange Act of 1934.

  • The primary mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
  • It aims to ensure that investors have access to certain basic facts about an investment prior to buying it, and so long as they hold it, promoting transparency and integrity in the marketplace.

• Definition, jurisdiction and authority of the SEC

  • Jurisdiction: The SEC has jurisdiction over all interstate securities transactions, whether they are conducted by professional dealers or individuals.

  • Authority: The agency's authority is derived from various federal securities laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, and the Investment Advisers Act of 1940. These laws give the SEC the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies. It also oversees the nation's securities self-regulatory organizations, like the Financial Industry Regulatory Authority (FINRA) and the stock exchanges (like NYSE and NASDAQ).

  • Enforcement: The SEC can bring civil enforcement actions against individuals or companies that have committed accounting fraud, provided false information, or engaged in insider trading or other violations of the securities laws. It also works closely with law enforcement agencies to prosecute individuals and entities for offenses like these.

1.1.2  Self-regulatory Organizations (SROs)

• Purpose and mission of an SRO

  • Definition: Self-regulatory organizations (SROs) are private entities that regulate and supervise their members through the establishment of rules, standards, and mechanisms for enforcement and dispute resolution. These organizations operate within the framework established by federal securities laws and are overseen by the Securities and Exchange Commission (SEC).

  • Purpose: SROs aim to provide industry-specific oversight to ensure that their members adhere to both federal securities laws and the SRO’s own set of rules and guidelines.
  • Mission: SROs aim to protect investors and the integrity of the market by creating and enforcing rules for their members, promoting ethical market practices, and resolving disputes between members and their customers.

• Jurisdiction and authority of SROs (e.g., CBOE, FINRA, MSRB)

  • Jurisdiction: SROs have jurisdiction over their members, which can include broker-dealers, securities exchanges, and other financial industry professionals. Their jurisdiction typically extends to the conduct of their members in relation to the public, other members, and other SROs.
  • Authority: SROs derive their authority from their rules and bylaws, which are subject to SEC approval. These rules govern the behavior of their members and often cover areas such as professional conduct, trade practices, and qualifications for membership.
  • Examples

    • CBOE (Chicago Board Options Exchange):

      • Purpose: The CBOE is the largest U.S. options exchange and is responsible for creating rules and regulations for options trading.
      • Authority: CBOE has the power to enforce its rules and regulations on its members, ensuring fair trading practices and protecting investor interests in the options market.

    • FINRA (Financial Industry Regulatory Authority):

      • Purpose: FINRA is the largest SRO in the U.S. securities industry. It oversees the activities of brokerage firms and their representatives, ensuring they operate fairly and honestly.
      • Authority: FINRA has the authority to license brokers and brokerage firms, create and enforce rules governing their behavior, examine firms for compliance, and sanction those who violate its rules or federal securities laws.

    • MSRB (Municipal Securities Rulemaking Board):

      • Purpose: MSRB creates rules and regulations for firms and professionals involved in underwriting, trading, and advising on municipal securities.
      • Authority: While MSRB creates rules, it doesn’t have enforcement authority. Instead, enforcement of MSRB rules is carried out by other SROs like FINRA and the SEC.

1.1.3  Other Regulators and Agencies

• Department of the Treasury/IRS

  • Department of the Treasury:
    • Purpose: It is the executive agency responsible for promoting economic prosperity and ensuring the financial security of the U.S.
    • Functions: Manages federal finances, collects taxes, pays U.S. bills, mints coins, and manages the U.S. government's public debt.
  • Internal Revenue Service (IRS):
    • Purpose: It's the revenue service for the U.S. federal government and operates under the Department of the Treasury.
    • Functions: Responsible for collecting taxes, administering the Internal Revenue Code (the main body of federal statutory tax law), and pursuing tax evaders.

• State regulators (e.g., NASAA)

  • NASAA (North American Securities Administrators Association):

    • Purpose: Represents the state securities administrators who are responsible for investor protection and the efficient functioning of capital markets at the state level.

    • Functions: NASAA members license firms and their agents, investigate violations of state law, and file enforcement actions when appropriate. They also educate the public about investment fraud.

• The Federal Reserve

  • Purpose: Often referred to as the "Fed", it's the central banking system of the U.S. established to provide the country with a safe, flexible, and stable monetary and financial system.
  • Functions: Regulates and supervises banks, conducts monetary policy (like setting interest rates), provides financial services to depository institutions and the federal government, and monitors economic trends.

• Securities Investor Protection Corporation (SIPC)

  • Purpose: A nonprofit corporation that provides limited insurance to the customers of failed brokerage firms.
  • Functions: When a brokerage firm is closed due to bankruptcy or other reasons and customer assets are missing, SIPC steps in to help return customers' cash, stock, and other securities, up to certain limits.

• Federal Deposit Insurance Corporation (FDIC)

  • Purpose: An independent agency created by Congress to maintain stability and public confidence in the U.S. financial system.
  • Functions: Insures deposits at banks and savings associations (up to the insurance limit), supervises certain financial institutions for safety and soundness, and resolves banks that are in trouble. If a member bank fails, the FDIC covers depositors, up to a set limit.

1.1.4  Market Participants and their Roles

• Investors (e.g., accredited, institutional, retail)

  • Accredited Investors: Individuals or entities that meet specific financial criteria set by securities regulators, allowing them to invest in certain private securities offerings.

  • Institutional Investors: Organizations that pool large sums of money and invest those funds in securities, real property, and other investment assets. Examples include pension funds, insurance companies, mutual funds, and endowments.

  • Retail Investors: Individual investors who buy and sell securities for their personal accounts, rather than for an organization.

• Broker-Dealers (e.g., introducing, clearing, prime brokers)

  • Introducing Brokers: Facilitate the buying and selling of securities for clients but use another firm (clearing broker) to hold client funds and securities and to settle trades.

  • Clearing Brokers: Handle the order execution, clearing, and record-keeping for introducing brokers. They hold customer funds, securities, and handle trade settlement processes.

  • Prime Brokers: Offer specialized services to certain clients, like hedge funds, including securities lending, leveraged trade executions, and cash management.

• Investment advisers

  • Professionals or firms that provide advice about securities to clients for a fee. They often manage portfolios and offer tailored investment advice.

• Municipal advisors

  • Provide advice to municipal entities about municipal securities, including the structure, timing, and terms of bond issuances.

• Issuers and underwriters

  • Issuers: Entities that issue securities to raise capital. These can be companies, municipalities, or governments.

  • Underwriters: Typically investment banks that help issuers bring their securities to the market. They buy the securities from the issuer and sell them to the public or to dealers.

• Traders and market makers

  • Traders: Individuals or entities that buy and sell securities, either for themselves or on behalf of an institution.

  • Market Makers: Firms or individuals that quote both a buy and a sell price for a financial instrument, aiming to make a profit on the bid-offer spread.

• Custodians and trustees

  • Custodians: Financial institutions that hold customers' securities in electronic or physical form, ensuring they're secure and can be accessed when needed.

  • Trustees: Entities or individuals given the power to manage assets on behalf of a third party, ensuring the assets are managed according to the trust's provisions.

• Transfer agents

  • Help with the record-keeping responsibilities of issuers, ensuring that when an investor buys a security, the title of that security is properly transferred.

• Depositories and clearing corporations (e.g., Depository Trust & Clearing Corporation (DTCC), Options Clearing

  Corporation (OCC))

  • Depository Trust & Clearing Corporation (DTCC): Provides clearing and settlement services to the financial markets, reducing risk and improving the efficiency of the market.

  • Options Clearing Corporation (OCC): Acts as both the issuer and guarantor for options and futures contracts, ensuring that the obligations of the contracts are fulfilled.

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1.2 Market Structure

1.2.1 Types of Markets

• The primary market

  • Definition: This is where securities are issued for the first time to the public.

  • Function: The primary market facilitates the process of capital raising by companies and governments. For instance, when a company decides to go public and raise capital from the general public, it does so through an Initial Public Offering (IPO) in the primary market.

  • Participants: The main participants are the issuers (entities offering the securities, which can be companies or governments) and the underwriters (typically investment banks that help in the issuance process).

• The secondary market (e.g., electronic, over-the-counter (OTC), physical)

  • Definition: After securities are issued in the primary market, they are traded among investors in the secondary market. This is where most of the trading activity takes place after the initial issuance.

  • Function: It provides a platform for the buying and selling of previously issued securities, offering liquidity and price discovery.

  • Types:

    • Electronic: These are modern stock exchanges like the NYSE or NASDAQ where trades are conducted electronically.

    • Over-the-counter (OTC): This is a decentralized market, meaning there isn't a centralized place or exchange where transactions occur. Instead, trading of securities happens directly between parties, often facilitated by dealers. OTC markets are often used for securities that aren't listed on the major exchanges.

    • Physical: These refer to traditional stock exchanges where traders might meet physically to conduct trades. However, with the rise of electronic trading, physical exchanges have become less common.

• The third market

  • Definition: This market involves the trading of exchange-listed securities over-the-counter, outside of the main exchange.

  • Function: It allows institutional investors to trade large blocks of securities directly with one another without impacting the main exchange's price. This can be beneficial for executing large trades without causing significant price movements on the main exchanges.

  • Participants: The third market mainly involves large institutional investors.

• The fourth market

  • Definition: This refers to direct trading of securities between institutions without the involvement of brokers or intermediaries.

  • Function: Institutions can trade directly with one another, often using electronic systems or networks. The fourth market is primarily for large transactions and offers more confidentiality since trades aren't publicly reported.

  • Participants: The main participants are large institutional investors, such as mutual funds, pension funds, and insurance companies.

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1.3 Economic Factors

1.3.1  The Federal Reserve Board’s Impact on Business Activity and Market Stability

• Monetary vs. fiscal policy

  • Monetary Policy: Managed by central banks like the Federal Reserve, it deals with controlling the money supply and interest rates to stabilize currency values and achieve economic objectives such as controlling inflation and unemployment.
  • Fiscal Policy: Managed by governments, it involves changing tax rates and levels of government spending to influence the economy.

• Open market activities and impact on economy

  • Definition: Open market operations involve the buying and selling of government securities in the open market by the Federal Reserve.
  • Impact: By conducting these operations, the Federal Reserve can influence short-term interest rates and the money supply. For example, purchasing government securities injects money into the banking system, potentially leading to lower interest rates and stimulating borrowing and spending.

• Different rates (e.g., interest rate, discount rate, federal funds rate)

  • Interest Rate: The general rate at which borrowing or lending occurs in an economy. It can influence consumer spending, business investments, and overall economic growth.
  • Discount Rate: The interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve's discount window.
  • Federal Funds Rate: The interest rate at which depository institutions lend reserve balances to other depository institutions overnight on an uncollateralized basis.

1.3.2  Business Economic Factors

• Purpose of financial statements (e.g., balance sheet, income statement)

  • Balance Sheet: Provides a snapshot of a company's financial position at a specific point in time, detailing assets, liabilities, and shareholders' equity.

  • Income Statement: Shows a company's revenues and expenses over a period, providing a summary of its financial performance.

  • Cash Flow Statement: Details the inflows and outflows of cash within a company over a period of time. It is divided into three sections:

• Business cycle (e.g., contraction, trough, expansion, peak)

  • Contraction: A phase where economic activity is declining.
  • Trough: The lowest point in a contraction before the economy starts recovering.
  • Expansion: A phase where economic activity is increasing.
  • Peak: The highest point in an expansion before the economy starts declining.

• Indicators (e.g., leading, lagging, coincident, inflation)

  • Leading Indicators: Provide early signs of future economic developments (e.g., stock market performance, building permits).
  • Lagging Indicators: Reflect economic changes that have already occurred (e.g., unemployment rate).
  • Coincident Indicators: Offer real-time data on where the economy is right now (e.g., GDP, industrial production).
  • Inflation: Measures the rate at which the general level of prices for goods and services rises, eroding purchasing power.

• Basic effects on bond and equity markets (e.g., cyclical, defensive, growth)

  • Cyclical Stocks: Shares of companies whose profits are strongly affected by the business cycle. They tend to perform well when the economy is booming but can underperform during downturns (e.g., auto manufacturers).
  • Defensive Stocks: Shares of companies that remain stable regardless of the state of the economy (e.g., utilities or consumer staples like food and beverages).
  • Growth Stocks: Shares of companies that are expected to grow at an above-average rate compared to other companies in the market.
• Principal economic theories (e.g., Keynesian, Monetarist)
  • Keynesian Economics:

    • Founder: Developed by the British economist John Maynard Keynes in the 1930s in response to the Great Depression.

    • Main Ideas:

      • Demand-driven Economy: Keynesians believe that aggregate demand (total demand for goods and services in the economy) is the primary driving force in an economy.
      • Government Intervention: In times of economic downturns, Keynesians argue for government intervention to stimulate demand through fiscal policies like increased government spending or tax cuts. Such interventions can help mitigate the severity of recessions.
      • Multiplier Effect: A change in an economic variable (e.g., government spending) can cause a more significant change in aggregate output. For example, an increase in government spending can lead to increased employment, which can lead to increased consumption, thereby boosting the economy further.
      • Sticky Wages and Prices: In the short run, wages and prices don't adjust quickly to changes in supply or demand, leading to periods of unemployment or inflation.

    • 2. Monetarist Economics:

    • Founder: This theory is most closely associated with the work of the American economist Milton Friedman in the 1960s and 1970s.

    • Main Ideas:

      • Money Supply's Role: Monetarists emphasize the role of the money supply in determining the health of the economy. They believe that controlling the money supply is the key to controlling inflation and stabilizing the economy.
      • Limited Government: Monetarists generally believe that markets are efficient and that the economy will naturally correct itself in the long run. As such, they often argue against active fiscal policies (like government spending to boost demand) in favor of letting market forces play out.
      • Natural Rate of Unemployment: Monetarists believe there's a "natural" rate of unemployment in the economy that can't be permanently lowered through government intervention. Attempts to do so can lead to inflation.
      • Quantity Theory of Money: This is a fundamental principle in monetarism. It states that the money supply multiplied by the velocity of money (how fast money changes hands) equals the price level multiplied by the economy's output. If the money supply grows faster than the economy's output, inflation will occur.

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1.4 Offerings

• Roles of participants (e.g., investment bankers, underwriting syndicate, municipal advisors)

  • Investment Bankers: These are financial intermediaries that help companies raise capital. They advise on transaction pricing, structure, and timing, and often buy securities from the issuer and sell them to the public, thereby assuming the risk of the offering.

  • Underwriting Syndicate: A group of investment banks that work together to issue securities. The syndicate spreads the risk associated with underwriting an offering, especially if it's sizable. The lead underwriter manages the syndicate and is primarily responsible for the offering, while other banks in the syndicate help sell the securities.

  • Municipal Advisors: Professionals who advise municipal entities on financial transactions, especially bond issuances. They provide advice on the structure, timing, and terms of bond offerings.

• Types of offerings

  • Public vs. private securities offering

    • Public Securities Offering: Involves selling securities to the general public, often through a stock exchange. Requires detailed disclosure and is subject to regulatory scrutiny.

    • Private Securities Offering: Also known as a private placement, this is when securities are sold to a select group of investors without being offered to the general public. Less regulated than public offerings.

  • Initial public offering (IPO), secondary offering and follow-on offering

    • Initial Public Offering (IPO): The first time a company's shares are offered to the public. Transforms a private company into a public one.

    • Secondary Offering: Occurs after a company is already public. Involves the sale of new shares by the company or existing shares by current shareholders.

    • Follow-on Offering: Issuance of additional shares by a company that's already public.

  • Methods of distribution (e.g., best efforts, firm commitment)

    • Best Efforts: The underwriter agrees to sell as many shares as possible but doesn't guarantee the sale of all shares.

    • Firm Commitment: The underwriter commits to buying the entire offering from the issuer and then resells it to the public.

• Shelf registrations and distributions (e.g., definition, purpose)

  • Definition: Allows a company to register a large block of securities and then sell them in separate tranches over time.

  • Purpose: Provides flexibility to issuers, allowing them to tap into the capital markets when conditions are favorable.

• Types and purpose of offering documents and delivery requirements (e.g., official statement, program disclosure

  document, prospectus)

  • Official Statement: Detailed document used in municipal bond offerings that provides material information about the issuer and the bonds being offered.

  • Program Disclosure Document: Outlines the specifics of an investment program.

  • Prospectus: A document required by the SEC that provides details about an investment offering for sale to the public. It should contain all material information to help an investor make an informed decision.

• Regulatory filing requirements and exemptions (e.g., SEC, blue-sky laws)

  • Securities Act of 1933:

    • The SEC mandates that companies disclose significant financial and other information to the public. Under the Securities Act of 1933, all offerings in the U.S must be registered, as a means of disclosing important financial information about the company and its operations to investors

    • Registration: Typically, securities sold to the public must be registered with the SEC. Registration involves providing detailed information about the company's business, the security being offered, and the offering itself.

      • Need to provide

        • A description of the company's assets and operations.

        • A description of the security that is being offered for sale.

        • Information about the company's management.

        • Financial statements certified by independent accountants.

    • Exemptions: Not all securities offerings must be registered with the SEC. Some exemptions include:

      • Regulation A: Allows smaller companies to raise capital through the sale of securities without a full registration. It's broken down into two tiers based on the amount of money being raised.
      • Regulation D: Contains rules that allow certain offerings to avoid being registered with the SEC. For example, Rule 506 under Reg D is a popular exemption for startups and other private companies seeking to raise capital from "accredited investors."

  • Blue-sky laws Definition: Blue-sky laws are state securities laws designed to protect investors against fraudulent sales practices and activities. The term "blue-sky" refers to speculative ventures that have as much value as a patch of blue sky.

    • Purpose: While the SEC regulates and enforces federal securities laws, each state has its regulatory framework to protect its residents. Blue-sky laws ensure that securities offerings and sales within a state are made transparently and fairly.

    • Registration at the State Level: Many states require companies to register their securities offerings before they can be sold in that state. This often involves submitting documents, paying fees, and ensuring compliance with state-specific requirements.

    • Exemptions: Just as with federal regulations, state blue-sky laws have exemptions for certain types of securities or transactions. The specifics of these exemptions can vary from state to state. Common exemptions might include intrastate offerings (offerings made solely to residents of one state) or offerings to a limited number of people within a state.

    • Uniform Securities Act: To create some consistency among states, a model set of laws called the Uniform Securities Act has been adopted in various forms by many states. This act provides a framework, but each state can modify it based on its needs and priorities.

    • Coordinated Review: To ease the process for issuers that want to register in multiple states, some states participate in a coordinated review process. This allows for a streamlined review of the offering by several states at once

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RULES

FINRA Rules

• 2266 – SIPC Information
• 2269 – Disclosure of Participation or Interest in Primary or Secondary Distribution
• 5250 – Payments for Market Making

MSRB Rules

• G-11 – Primary Offering Practices
• G-32 – Disclosures in Connection with Primary Offerings
• G-34 – CUSIP Numbers, New Issue and Market Information Requirements

SEC Rules and Regulations Securities Act of 1933

• Section 7 – Information Required in a Registration Statement
• Section 8 – Taking Effect of Registration Statements and Amendments Thereto
• Section 10 – Information Required in Prospectus
• Section 23 – Unlawful Representations
• 215 – Accredited Investor
• 431 – Summary Prospectuses
• Schedule A – Schedule of Information Required in Registration Statement
• Schedule B – Schedule of Information Required in Registration Statement

Securities Exchange Act of 1934

• Section 3(a) – Definitions and Application of Title
• Section 12 — Registration Requirements for Securities
• Section 15 – Registration and Regulation of Brokers and Dealers
• Section 15A – Registered Securities Associations
• Regulation D – Rules Governing the Limited Offer and Sale of Securities Without Registration Under the
• Securities Act of 1933
  • 144 – Persons Deemed Not to Be Engaged in a Distribution and Therefore Not Underwriters
  • 144A – Private Resales of Securities to Institutions
  • 145 – Reclassification of Securities, Mergers, Consolidations and Acquisitions of Assets
  • 147 – "Part of an Issue," "Person Resident," and "Doing Business Within" for Purposes of Section 3(a)(11)
  • 164 – Post-filing Free Writing Prospectuses in Connection with Certain Registered Offerings

Securities Investor Protection Act of 1970 (SIPA)