SkarpChapter 24 of 27
Regulatory Framework I: SEC, FINRA, and the Rulemaking Process
Zoom out to see how the SEC and FINRA create and enforce the rules that govern securities markets, firms, and associated persons.
Big Picture: Who Makes the Rules in US Securities Markets?
Zooming Out
This module steps back from specific misconduct to show who creates and enforces the rules you have been studying in US securities markets.
Federal Laws and the SEC
Congress passes federal securities laws (like the 1933 and 1934 Acts) and gives authority to the Securities and Exchange Commission (SEC) to write regulations and enforce them.
Self-Regulatory Organizations
Under the SEC sit self-regulatory organizations (SROs) such as FINRA, stock exchanges, and the MSRB for municipal securities, which adopt and enforce rules for their members.
Firms and Procedures
At the firm level, each broker-dealer writes internal policies and procedures that must comply with both federal law and SRO rules.
SIE Focus
For the SIE, you must understand the hierarchy, who regulates whom, and how rules are made, investigated, and enforced.
SEC Authority and Federal Securities Laws
SEC’s Origin and Role
The SEC was created by the 1934 Act and is the primary federal regulator of US securities markets, administering multiple key statutes.
Key Laws: 1933 Act
The 1933 Act governs the primary market: new securities sold for the first time to raise capital, usually through public offerings and private placements.
Key Laws: 1934 Act
The 1934 Act governs the secondary market, where previously issued securities trade among investors, and it established the SEC itself.
Other Major Statutes
The Investment Company Act and Investment Advisers Act (both 1940), plus Sarbanes–Oxley and Dodd–Frank, regulate funds, advisers, and corporate governance.
SEC Powers
The SEC makes rules, oversees registrations (issuers, SROs, exchanges), enforces disclosure, and brings civil enforcement actions for violations.
FINRA as a Self-Regulatory Organization
What is FINRA?
FINRA is a self-regulatory organization (SRO) that regulates broker-dealers and their associated persons under SEC oversight.
SRO Definition
A self-regulatory organization is a non-governmental entity, like FINRA or an exchange, that adopts and enforces rules for its members under SEC oversight.
FINRA’s Core Functions
FINRA writes rules, examines firms, registers and qualifies individuals, operates systems like TRACE, and enforces compliance.
What FINRA Regulates
FINRA rules cover communications, suitability, supervision and WSPs, outside activities, and many prohibited sales and trading practices.
FINRA vs Government
FINRA is not a government agency, but its rules have real force because the SEC oversees FINRA and can approve or disapprove its rules.
MSRB and Regulation of Municipal Securities
What Are Municipal Securities?
Municipal securities are debt issued by states, cities, or their agencies, often with interest that is exempt from federal income tax.
MSRB’s Role
The Municipal Securities Rulemaking Board is an SRO that writes rules for municipal securities dealers and advisors under SEC oversight.
MSRB Does Not Enforce
MSRB does not enforce its rules; enforcement is carried out by FINRA for broker-dealers and by federal bank regulators for banks.
What MSRB Rules Cover
MSRB rules address fair dealing, suitability, political contributions (G-37), qualifications, and recordkeeping in municipal securities.
SIE Exam Trap
Do not confuse MSRB with the SEC: MSRB is a rulewriter only, while enforcement is delegated to other regulators.
Hierarchy: Laws, SEC Rules, SRO Rules, and Firm Procedures
Regulatory Pyramid
Visualize a pyramid: at the top are federal laws, then SEC rules, then SRO rules, and at the bottom, firm policies and procedures.
Top: Federal Statutes
Congress passes broad securities laws (like the 1933 and 1934 Acts) that create obligations and grant authority to the SEC.
Next: SEC Rules
Under those statutes, the SEC issues detailed regulations such as Regulation D, Regulation M, and Regulation Best Interest.
Then: SRO Rules
FINRA, MSRB, and exchanges write rules for their members, but these must be consistent with federal law and SEC regulations.
Base: Firm Procedures
Firms adopt written supervisory procedures and compliance manuals that must follow all higher rules and can be stricter, but never weaker.
How a Rule Is Born: From Idea to Enforceable Obligation
Step 1: Spotting a Problem
Regulators notice issues, such as retail customers misunderstanding complex products like leveraged ETFs, triggering complaints and exam findings.
Step 2: Studying and Consulting
The SEC and FINRA study the issue, may issue concept releases or Regulatory Notices, and invite industry and public feedback.
Step 3: Drafting a Rule
FINRA drafts a proposed rule, files it with the SEC, and the SEC publishes it for public comment before deciding whether to approve it.
Step 4: Becoming Official
After SEC approval, the new requirement is added to the FINRA rulebook and becomes binding on member firms and their reps.
Step 5–6: Implementation & Enforcement
Firms update procedures and training; FINRA exams test compliance and can bring cases if firms or reps ignore the new rule.
Enforcement: SEC vs FINRA vs MSRB
SEC Enforcement
The SEC enforces federal securities laws and its rules, bringing civil or administrative cases with penalties like fines, bars, and injunctions.
FINRA Enforcement
FINRA enforces its own rules, MSRB rules for broker-dealers, and some federal requirements against member firms and associated persons.
MSRB’s Limited Role
MSRB writes rules but does not enforce them; FINRA and federal bank regulators handle enforcement, depending on the type of firm.
Types of Sanctions
Common sanctions include censures, fines, restitution, suspensions, bars from the industry, and expulsion of firms from FINRA membership.
Overlapping Actions
Serious misconduct can trigger parallel actions by FINRA, the SEC, and even the Department of Justice in criminal cases.
Thought Exercise: Following a Violation Up the Pyramid
Scenario Setup
A rep, Pat, skips required principal approval for options trades and makes unsuitable, speculative recommendations to inexperienced customers.
Your Task
On scratch paper, list the levels of rules violated, the types of rules broken, which regulators might act, and possible sanctions for Pat and the firm.
Self-Check Hints
Think: firm WSPs, FINRA suitability and supervision rules, possible antifraud laws, and enforcement by FINRA, the firm, and maybe the SEC.
Quiz 1: Who Does What?
Test your understanding of the main regulators and their roles.
Which statement best describes the relationship between the SEC and FINRA?
- FINRA is a federal agency that supervises the SEC.
- FINRA is an SRO overseen by the SEC, and its rules must be approved by the SEC.
- The SEC and FINRA are both SROs that regulate only municipal securities dealers.
- The SEC enforces FINRA rules, but FINRA does not write any rules of its own.
Show Answer
Answer: B) FINRA is an SRO overseen by the SEC, and its rules must be approved by the SEC.
FINRA is a self-regulatory organization registered with and overseen by the SEC. FINRA writes rules for its members, but those rules must be filed with and approved by the SEC. The SEC is a federal government agency; FINRA is not. FINRA regulates a broad range of broker-dealer activities, not just municipal securities.
Quiz 2: MSRB and Municipal Securities
Check your understanding of the MSRB’s role.
Which of the following is TRUE regarding the Municipal Securities Rulemaking Board (MSRB)?
- The MSRB enforces its rules directly against municipal securities dealers.
- The MSRB is a government agency that regulates all state and local borrowing.
- The MSRB writes rules for municipal securities dealers and advisors, and FINRA enforces those rules for broker-dealers.
- The MSRB only regulates municipal securities sold in the primary market.
Show Answer
Answer: C) The MSRB writes rules for municipal securities dealers and advisors, and FINRA enforces those rules for broker-dealers.
The MSRB is a self-regulatory organization that writes rules for municipal securities dealers and municipal advisors. It does not enforce its rules. FINRA enforces MSRB rules for broker-dealers, and federal bank regulators enforce them for banks. It covers both primary and secondary market municipal activities.
Key Terms Review
Use these flashcards to lock in core definitions for the SIE.
- Securities Industry Essentials (SIE) exam
- The Securities Industry Essentials (SIE) exam assesses a candidate’s basic knowledge of the securities industry, including industry terminology, securities products, the structure and function of the markets, regulatory agencies and their functions, and regulated and prohibited practices.
- self-regulatory organization (SRO)
- A non-governmental entity, such as FINRA or a national securities exchange, that is registered with and overseen by the SEC and is responsible for regulating the practices of its members through the adoption and enforcement of rules.
- broker-dealer
- A firm in the business of buying and selling securities either for the accounts of others (broker) or for its own account (dealer), or both, and subject to registration and regulation under federal securities laws and SRO rules.
- primary market
- The market in which new securities are issued and sold for the first time, such as through public offerings and private placements, to raise capital for issuers.
- secondary market
- The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading.
- municipal securities
- Debt securities issued by states, municipalities, or their agencies and authorities, including general obligation and revenue bonds, often offering interest that is exempt from federal income tax.
- SEC (Securities and Exchange Commission)
- The primary federal securities regulator in the United States, created by the Securities Exchange Act of 1934, responsible for administering federal securities laws, adopting rules, overseeing SROs, and bringing civil enforcement actions.
- FINRA (Financial Industry Regulatory Authority)
- A self-regulatory organization registered with and overseen by the SEC that writes and enforces rules for broker-dealers and their associated persons, administers qualification exams, and conducts examinations and disciplinary actions.
- MSRB (Municipal Securities Rulemaking Board)
- A self-regulatory organization that writes rules for municipal securities dealers and municipal advisors under SEC oversight; its rules are enforced by FINRA for broker-dealers and by federal bank regulators for banks.
- firm written supervisory procedures (WSPs)
- A broker-dealer’s internal policies and procedures that establish how it supervises its business and personnel to comply with federal securities laws and SRO rules; WSPs must be reasonably designed to achieve compliance and are themselves enforceable obligations.
Key Terms
- broker-dealer
- A firm in the business of buying and selling securities either for the accounts of others (broker) or for its own account (dealer), or both, and subject to registration and regulation under federal securities laws and SRO rules.
- primary market
- The market in which new securities are issued and sold for the first time, such as through public offerings and private placements, to raise capital for issuers.
- secondary market
- The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading.
- enforcement action
- A formal proceeding brought by a regulator such as the SEC or FINRA alleging violations of laws or rules and seeking sanctions such as fines, suspensions, bars, or other remedies.
- municipal securities
- Debt securities issued by states, municipalities, or their agencies and authorities, including general obligation and revenue bonds, often offering interest that is exempt from federal income tax.
- self-regulatory organization (SRO)
- A non-governmental entity, such as FINRA or a national securities exchange, that is registered with and overseen by the SEC and is responsible for regulating the practices of its members through the adoption and enforcement of rules.
- written supervisory procedures (WSPs)
- A broker-dealer’s internal policies and procedures that establish how it supervises its business and personnel to comply with federal securities laws and SRO rules; WSPs must be reasonably designed to achieve compliance and are themselves enforceable obligations.
- Securities and Exchange Commission (SEC)
- The primary federal securities regulator in the United States, created by the Securities Exchange Act of 1934, responsible for administering federal securities laws, adopting rules, overseeing SROs, and bringing civil enforcement actions.
- Municipal Securities Rulemaking Board (MSRB)
- A self-regulatory organization that writes rules for municipal securities dealers and municipal advisors under SEC oversight; its rules are enforced by FINRA for broker-dealers and by federal bank regulators for banks.
- Financial Industry Regulatory Authority (FINRA)
- A self-regulatory organization registered with and overseen by the SEC that writes and enforces rules for broker-dealers and their associated persons, administers qualification exams, and conducts examinations and disciplinary actions.