Chapter 1: Introduction To The Securities Industry

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Primary Market

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the sale of securities by issuers to investors (i.e. IPO or weekly auction of Treasury bills)

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Secondary Market

Back 2

system for trading of financial instruments between investors (i.e. sale of stock from one party to another on the floor of the NYSE)

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The Securities Act of 1933

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- The first federal regulation of the securities markets
- Covers the primary market (new issues)
- Goal: insure that investors are provided with the information needed to make informed investment decisions.
- Goal: provide specific rules for the conduct of issuers and the investment bankers.

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The Securities Exchange Act of 1934

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- Covers the secondary market (investors trade among themselves)
- Established the SEC and gave it authority in the area of domestic securities dealing in both the primary and secondary markets, as well as gives regulatory oversight regarding the extension of credit in the security industry to the Federal Reserve Board.
- SRO: Although exchanges must register with the SEC and enforce SEC rules, day-to-day operations are handled by the exchange. Therefore, exchanges, such as the NYSE, are self-regulated organizations and set their own rules and regulations for their members

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Maloney Act of 1938

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- Enabled the creation of non-exchange SROs. Most security transactions do not place on an exchange, but are conducted in the over-the-counter (OTC) market
- In 1939, the NASD was created to act as the self-regulatory organization for the OTC market.
- Enabled the creation of the Municipal Securities Rulemaking Board (MSRB) in 1975

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The Trust Indenture Act of 1939

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Added security for bond investors - The act requires an agreement (indenture) between the issuing corporation and a trustee who would act for the owners of the bonds in case of the corporation’s liquidation

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The Investment Company Act of 1940

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Covers companies that are formed to pool investors’ money and invest that money in Securities (i.e. open-investment companies; mutual funds)

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The Investment Advisors Act of 1940

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- Regulate firms that sell their investment advice for a fee.
- Defines the investment advisor, while exempting lawyers, accountants, teachers, and engineers, and publishers who investment advice is incidental to their profession. An exemption is if anyone decides to hold themselves out to the public as an investment adviser and charge a separate fee for that service.
- Examples of Investment Advisors: portfolio managers, manager of wrap accounts (single fee paid for investment and transaction costs)

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The Securities Investor Protection Act of (SIPC) 1970

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Enabled the creation of industry-funded insurance that covers the customers of brokerage firms in cases where a firm becomes insolvent

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The Employee Retirement Income Security Act of 1974 (ERISA)

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- Covers the administration of private qualified retirement accounts (e.g. 401(k) plan).
- Provides standard for the funding, vesting and other aspects of such plans, as well as fiduciary responsibilities of pension fund trustees.

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The Insider Trading Act of 1988

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Although cover in the ’33 and ’34 act, this act sets criminal penalties. The maximum fine is $1 million and the maximum jail time is 10 years.

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The Federal Telephone Consumer Protection Act of 1991

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Any person who calls prospects (cold calls) for profit must maintain a do-not-call list and refrain from soliciting business from persons who request to be placed on that list.

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The Penny Stock Rule of 1991

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non-exchange traded and non-Nasdaq listed securities that trade for less than $5 per share
- A firm must have a signed disclosure document from potential buyers stating that the investor understands the risks involved.

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Principals

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must pass the General Securities Principal Examination (Series 24)

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Representatives

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must complete the U-4 form and pass qualifying examination (e.g. Series 7; General Securities Representative Exam

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Registration of Personell

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- Under MSRB rules, a representative selling municipal securities may have either a Series 7 or Series 52 (Municipal Securities Representative) registration. The Series 53 covers Municipal Securities Principals.
- There is a 90-day apprenticeship, during which time a rep can not have dealings with the public, nor receive any commissions.
- Registration is not required of person who engages in the sale of non-securities such as commodities, commodity futures, and fixed insurance products.
e. An individual’s registration is in effect only while associated with a broker-dealer. An RR who leaves the securities industry and then reenters after 2 years must retake any required qualification examinations.

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Rules Governing Registered Representatives

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- Supervision
- Continuing Education
- Accounts Requiring Employer Approval
-Gift and Compensation
-Sharing in Profits and Losses
-Outside Business Activities
-Private Securities Transactions

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Supervision

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- Keep and preserve records for carrying out supervisory procedures
- Review and endorse, in writing, all transactions and all correspondence of registered representatives pertaining to securities transactions.
- Approve customer accounts and review customer accounts periodically to detect and prevent abuses
- Inspect each office of supervisory jurisdiction at least annually
- Ascertain the good character, business repute, qualifications, and experience of anyone being certified for registration and monitor their good standing on a continuing basis.

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Continuing Education

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- Regulatory Element: second anniversary of their initial securities registration and every three years thereafter. RR is notified 30-days prior to anniversary and has 120 days to comply. If the rep does not comply by the 120th day the rep’s registration becomes inactive
- Firm Element: Annual training administered by the RR’s firm.

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Accounts Requiring Employer Approval

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i. If an employee of a NYSE member firm wished to open an account with another member firm, prior written authorization of the employer is required. If the individual works for an NYSE or MSRB member firm, duplicate confirmation must be sent to the employer. In the case of an NASD member firm, duplicate confirmations are sent if requested by the employer.

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Gift and Compensation

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i. Limit = $100 per recipient per year to personnel employed by another member of the NASD.
ii. Exemptions: occasional meals, tickets to sporting and cultural events, reminder advertising, and expenses related to legitimate business travel.

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Sharing in Profits and Losses

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i. Circumstances where it is permitted: The employee has made a financial contribution to the account, the employee shares in profits or losses in direct proportion to the employee’s financial contribution; the member carrying the account gives permission for the arrangement.

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Outside Business Activities

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i. RRs must provide written notice to their employing broker-deal before participating in any business activities outside the scope of their normal relationship with the firm.
ii. Includes: board memberships, night school instruction, paid public speaking.
iii. Exemption: unpaid charitable work

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Private Securities Transactions

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i. Private securities transactions (selling away) are transactions outside the regular scope of an associated person’s employment with a member firm.
- It requires written approval from the employing member.
- Governed by the NASD

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Disciplinary Proceedings: Process

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Respondent has 25 days to file a response. If not response then a 2nd notice is sent. If no response after 14 there is assumption of guilt

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Hearing Panel Penalties

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- Censure a member firm or an associated person
- Fine a member firm or associated person
- Suspend the membership of a firm or suspend the registration of an associated person, either for a definite period or until specific conditions are met
- Expel a member firm or cancel its membership; revoke or cancel the registration of an associated person
- Suspend or bar an associated person from association with any member firm
vi. Impose any other fitting sanction

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Appeals

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- Once a ruling has been made by the Hearing Panel, the respondent has 25 days to file an appeal with the NASD National Adjudicatory Council (NAC).
- NAC can affirm, modify, reverse, increase, or reduce any sanction, or impose any other fitting sanction.
- Process: Hearing Panel  NAC  SEC  Fed Courts

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Letter of Acceptance, Waiver, and Consent (AWC)

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- Describes the rules violated and the sanctions imposed. The respondent can sign or reject the letter
- The Department of Enforcement can impose a fine of not more than $2500 and / or censure the member or associated person

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Code of Arbitration - Aspect

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- Member vs. member disputes must be submitted to arbitration
- Findings of the arbitration board are binding
- A client cannot be forced to submit to arbitration
- For disputes less $2500 arbitration can be handled by one arbitrator, otherwise three arbitrators are appointed.