What Is the Securities and Exchange Commission (SEC)?

Key Takeaways:

• The establishment of the Securities and Exchange Commission (SEC) in 1934 was a direct response to the financial market abuses of the 1929 crash, aimed at regulating security markets and protecting investors.
• Key legislative responses to the financial crisis, including the Securities Act of 1933 and the Glass-Steagall Act, laid the groundwork for the SEC’s formation and the modern regulatory framework of the financial market.
• The SEC operates as an independent regulatory body, focusing on ensuring fair, transparent, and honest operations within the securities market to increase public trust and prevent fraud.
• Over the years, the SEC has evolved to adapt to changing market dynamics, including the emergence of new technologies and investment products like cryptocurrencies, highlighting its ongoing relevance and necessity in investor protection.

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 an independent agency of the United States government tasked with safeguarding the integrity of the securities industry. Its primary mission is to protect investors by ensuring fair, orderly, and efficient markets. This mission is carried out by closely monitoring a wide range of financial instruments, transactions, and practices within the investment industry.

The SEC works diligently to prevent fraud, manipulation, and other illegal activities in the securities market. By upholding these standards, the SEC aims to foster public trust in the market, making it a safe and secure environment for investors to participate in.

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 initial attempt to regulate the securities market, as Blue Sky Laws already existed at the state level. However, these laws proved to be 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 Does the SEC Operate?

While the SEC’s primary mission is to safeguard the interests of investors, it primarily regulates entities within the securities industry rather than directly interacting with individual investors. This indirect approach allows the SEC to focus on ensuring that securities markets operate fairly, transparently, and honestly, ultimately benefiting investors.

Regulatory actions by the SEC generally target stock exchanges, brokers, investment advisors, asset managers, and brokerage firms. For instance, when a company decides to go public, the SEC mandates the filing of a registration statement, which must be declared “effective” by the SEC before the company can sell its securities to the public.

This comprehensive registration statement includes audited financial information, a detailed overview of the company’s operations, a thorough analysis of potential risks, and other crucial data that informs investors about the security and helps them make informed decisions. The SEC’s effectiveness is further enhanced through the establishment of rules and close monitoring by various 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.

1. 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
• Telecommunications
• 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.

2. 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. For instance, 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:

• Analytics Office: Helps the SEC to take actionable steps in the asset management industry.
• Chief Counsel’s Office (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): 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.
• Rulemaking 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.

3. 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.

4. 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.

5. 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.

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. The following section outlines the various offices and programs as described by the Securities and Exchange Commission.

Understanding SEC Examination Programs and Offices

• The Investment Adviser/Investment Company (IA/IC) Examination Program: Conducts examinations of investment advisers, mutual funds, and exchange-traded funds.
• The Clearance and Settlement (CS) Examination Program: Provides oversight for clearing agencies.
• The FINRA and Securities Industry Oversight (FSIO) Examination Program: Examinations related to the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB).
• The Event and Emerging Risks Examination Team (EERT): Addresses emerging market risks and mobilizes expertise to SEC’s regional offices when needed.
• The Broker-Dealer and Exchange (BDX) Examination Program: Oversees examinations of 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): Manages cybersecurity, the SEC’s CyberWatch program, and entities under Regulation Systems Compliance and Integrity (Regulation SCI).
• The Office of Chief Counsel (OCC): Coordinates regulatory efforts, reviews proposed rules, and plays a pivotal role in investigations and audits.
• The Office of Risk and Strategy (ORS):Focuses on operational strategy and supports each division’s unique programs within the SEC.

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.

Conclusion

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, allowing trades to be opened and closed in a matter of minutes. As a result, 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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