Regulations and Securities Market Players

1. Regulations and Securities Market Players Domain Refresher Training

2. Course Outline • 1. Securities Market Players • Overview • Market Structure • Major Players • Trading – Accounts and Orders • Exchange – NYSE, NASDAQ, ECN’s • 2. Regulations • Regulatory Bodies in US • Laws Governing the Securities Market • Broker-Dealer Regulation

3. Section 1 Securities Market - Overview

4. Securities Market - Overview • A securities market is an exchange where securities are traded • Primary Vs. Secondary Markets • The primary market refers to the market where new issues (stocks and bonds not sold before) are sold • A secondary market is the market in which assets are traded after they have been sold through the primary market. In this market, investors trade directly with each other through an exchange

5. Securities Market - Overview • A securities market is an exchange where securities are traded • Primary Vs. Secondary Markets • The primary market refers to the market where new issues (stocks and bonds not sold before) are sold • A secondary market is the market in which assets are traded after they have been sold through the primary market. In this market, investors trade directly with each other through an exchange

6. Exchange Types • National Stock Exchanges • Trade numerous issues of diverse shares to a wide number of investors • Operate as auction markets where buyers and sellers are driven by price • Eg: NYSE, AMEX, LSE , CBOE (Futures) • Regional Exchanges • Serve smaller markets and typically trade smaller issues • A company that cannot list its shares on a national stock exchange may choose to list its share on a regional exchange • Eg: Boston Exchange • Over-the-Counter Markets (OTC) • Operates as an order- driven market where buyers and sellers submit bids and a dealer buys or sells the stock from his own inventory  • In the U.S., the Nasdaq system is used as the quotation system for the OTC market • Eg: OTCBB

7. Dealer or Principal Capacity Subject to risk on transaction Mark-up or markdown Broker or Agency Capacity No risk on transaction Commission

8. Major Players in a Market (Cont’d) • Broker • Middleman in a trade and Buys and sells securities for customers • An individual or firm that charges a fee or commission for executing buy and sell orders submitted by an investor. • Investor takes ownership of assets and is exposed to inventory risk. No inventory risk to the broker. • Dealer • Principal in a securities transaction -trade for their own account • An individual or firm willing to buy or sell securities for their own account. • Dealer takes ownership of assets and is exposed to inventory risk. • Certain securities are available for purchase by retail investors from dealers who sell the securities directly from their own accounts. • The dealer's only compensation for the sale comes in the form of the markup, the difference between the price the security was purchased at and the price the dealer charges to the retail investor.

9. Major Players in a Market (Cont’d) • Market Maker • Provide continuous bid and offer prices within a prescribed percentage spread for shares designated to them • 4 to 40 (or more) market makers for a particular stock depending on the average daily volume • Play an important role in the secondary market as catalysts, particularly for enhancing stock liquidity • Investment Professional • An individual who has passed the NASD's registration process and is licensed to work in the securities industry • Usually a brokerage firm employee acting as an account executive for clients • Sell to the public; they do not work on exchange floors

10. Major Players in a Market (Cont’d) • Custodians • A financial institution that has the legal responsibility for a customer's securities • A custodian has the ability to gather assets, effectively employ technology, and process huge volumes of transactions • Functions: • Manage customer’s account • Settle trades • Collect Incomes generated from investment • Invest cash as directed • Reporting performance of the account • Corporate action Processing

11. Major Players in a Market (Cont’d) • Clearing Houses • Financial institution that provides clearing and settlement services for financial and commodities derivatives and securities transactions • Its purpose is to reduce the risk due to Brokerage firms failing to honor their trade settlement obligations • Depository • Organization holding securities either in certificated or dematerialized form, to enable book entry transfer of securities • Functions • Safekeeping Securities • Deposit and Withdrawal • Dividend, interest, and principal processing, as well as corporate actions including proxy. • Securities Lending and Borrowing, Matching, and Repo Settlement • Pledge - to provide legal framework to protect the interest of the borrower and lender.

12. Role of an Exchange • Raising capital for businesses • Mobilizing savings for investment • Facilitating company growth • Redistribution of wealth • Corporate governance • Creating investment opportunities for small investors • Government capital-raising for development projects • Barometer of the economy

13. Exchange Broker C Branch A Branch B Branch C Advisor A Advisor C Advisor B Client A Client B Client C Account A Account B Account C Stock Exchange Setup Broker A Broker B

14. Trading Execution Procedure • On The floor • Investor tells broker to buy shares • Broker’s order department sends the order to their floor clerk on the exchange • The floor clerk alerts one of the firm’s floor traders to other floor trader willing to sell • The two agree on a price and complete the deal • Broker calls the investor back with the final price. The process may take a few minutes or longer depending on the stock and the market • Electronically • The electronic markets use vast computer networks to match buyers and sellers, rather than human brokers • Individuals don’t have access to the electronic markets • The broker accesses the exchange network and the system finds a buyer or seller depending on the order

15. Sources of Revenue • Trading and trading services • Exchange charges (directly and indirectly) for trades that occur and for software supplied to its members • Listing • To be listed on the Stock Exchange, a corporation must meet/maintain certain financial standards and pay listing fees • A Stock Exchange listing is a certification that enhances a firm’s credibility • Information • The Stock Exchange is (indirectly) an information vendor • Regulation • The Stock Exchange monitors and regulates the trading activity of its members • Through the listing relationship and the listing standards, it can affect corporate governance behavior

16. Quotation Broker Dealers Quote Quote Data Updates Nasdaq Workstation Quote and Trade Data Vendors Execution Orders Trade Reporting Trade Computer to Computer Links Trade Data Reports Clearing and Settlement Trade Confirmation Locked-In Trades Market Surveillance Typical Stock Exchange Systems

17. Electronic Communication Networks • Electronic trading systems that automatically match buy and sell orders at specified prices • Registered with SEC as Brokers/Dealers • The primary products that are traded on ECNs are stocks and currencies • Subscribers enter orders into the ECN via a custom computer terminal or network protocols • Contra-side orders are matched for execution while unmatched orders are posted on system for other subscribers to view

18. Section 2 Regulations

19. Why Regulate? • Globalization of financial markets – countries compete to get a piece of the pie • International standards and best practices are being negotiated and developed – every country must be able to participate • Fundamentally - ensuring the markets’ safety and soundness

20. Regulatory Bodies in US • SEC (Securities and Exchange Commission) • Regulatory agency created during the great depression that followed the crash of 1929 • It works with criminal law enforcement agencies to prosecute individuals and companies alike for offenses which include a criminal violation • Enforces the statutory requirement that public companies submit quarterly and annual reports • CFTC (Commodity Futures Trading Commission) and National Futures Association • Prohibits fraudulent conduct in the trading of futures contracts • Division of enforcement - investigates and prosecutes alleged violations of the commodity exchange act and CFTC regulations • FINRA(Financial Industry Regulatory Authority) • Protects America’s investors by making sure the securities industry operates fairly and honestly • Investigates and regulates - Trade Reporting Facilities and other over-the-counter operations

21. Regulations & Economic Events - Timeline Dodd–Frank Wall Street Reform (2010) BASEL-I (1988) BASEL-II (2004) Investment Advisers Act (1940) Important Laws Governing U.S. Securities Market Insider Trading Sanctions Act (1984) Securities Exchange Act (1934) Sarbanes-Oxley Act (2002) Securities Act (1933) Securities Investor Protection Act (1970) Patriot Act (2001) 1900 1900 2000 2010 Great Depression 1929 Dot-com Bubble (2000) Subprime crisis (2007) Oil Crisis 1973 Major Economic Events Stock market crash (1973–1974) Black Wednesday (Sep 16, 1992) Flash Crash (2010) Wall Street Crash of 1929 Black Monday (1987) Asian financial crisis (1997) Japanese asset price bubble(1991–2003)

22. Regulatory Bodies - Interaction

23. Regulatory Bodies - Interaction

24. Laws Governing the Securities Market • The Securities Act of 1933 • First major federal legislation to regulate the offer and sale of securities • Prior to this law, securities were chiefly governed by state laws referred to as blue sky laws • Primary objective - prohibit deceit, misrepresentations, and other fraud in the sale of securities to the public • The Securities Exchange Act of 1934 • Laws governing stocks, bonds, and debentures in the secondary market • Regulate the exchanges and broker-dealers in order to protect the investing public • Extended the registration and disclosure requirements of the Securities Act of 1933 to all companies with securities listed for sale on a national exchange, as well as other companies with assets over $1 million and more than 500 shareholders

25. Laws Governing the Securities Market • Investment Advisers Act of 1940 • Requires that firms or sole practitioners who are paid to advise others about investments register with SEC • Investment advisor does not have to give advice as his/her principal business activity – simply doing so with some regularity is enough to abide by this act • Securities Investor Protection Act of 1970 • Supervise the liquidation of financially troubled securities firms and the payment of the claims of their customers • It covers up to $500,000, of which no more than $100,000 can be cash claims • Insider Trading Sanctions Act of 1984 • Companies are required to announce times to their employees as to when they can safely trade without being accused of trading on inside information

26. Laws Governing the Securities Market • Insider Trading and Securities Fraud Enforcement Act of 1988 • Talks about the fines and penalties that can be levied • SEC may seek civil and criminal penalties against anyone it believes to have violated this Act • Sarbanes-Oxley Act of 2002 • Senior executives take individual responsibility for the accuracy and completeness of corporate financial reports • Timely reporting of material changes in financial condition • Describes specific criminal penalties for fraud by manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers • Restricts auditing companies from providing non-audit services for the same clients

27. Laws Governing the Securities Market • Patriot Act of 2001 • Amongst other acts the financial industry related acts that were modified were Money Laundering Control Act of 1986 and Bank Secrecy Act • Aggregate amounts of transactions processed from areas of the world where money laundering is a concern to the U.S. government is collected • Improve communication between law enforcement agencies and financial institutions • Increases record keeping and reporting requirements, thereby dealing with currency smuggling and counterfeiting, including quadrupling the maximum penalty for counterfeiting foreign currency • Dodd–Frank Wall Street Reform and Consumer Protection Act (2010) • Passed as a response to the late-2008 recession • Regulatory changes covering capital investment by banks and insurance companies • Regulations to increase transparency of derivatives • Consumer protection reforms and uniform standards for "plain vanilla" products • Provides incentives to promote banking among low- and medium-income residents.

28. Broker-Dealer Regulation • What's needed • Register with SEC • Member of an SRO & SPIC • Complies with all applicable state requirements • “Associated persons" satisfy qualifying requirements • Conduct regulation of Broker- Dealers • Anti-fraud provisions prohibit misleading omissions of material facts • Broker-dealer also has an obligation to determine customer-specific suitability • Clearly disclose date, time, identity, price, and number of shares in a transaction • Notify customers purchasing securities on credit about the credit terms and the status of their accounts • Investment banking operations of broker-dealers must refrain from insider trading • Limit order display rule requires that specialists and market makers publicly display certain limit orders they receive from customers • Privacy of consumer financial information

29. Broker-Dealer Regulation • Conduct regulation of broker-dealers cont d.. • Financial responsibility of broker-dealers • Making and preserving accurate books and records • Maintaining minimum amounts of liquid assets, or net capital • Taking certain steps to safeguard the customer funds and securities • Other Requirements • Maintaining AML program • Lost and stolen securities program • Guidelines for communicating information • Business continuity planning

30. Reference • Research study - Financial industry regulation in Canada – • http://www.expertpanel.ca/eng/reports/research-studies/index.html • Broker-dealer regulation guide – • http://www.sec.gov/divisions/marketreg/bdguide.htm • Regulations for research analyst – • http://www.sifma.org/research/pdf/RsrchRprtVol4-5.pdf • Main stock market players – http://www.stockmarketinvestinginfo.com/smi_mainplayers.html • Wikipedia, Investopedia, Answers.com for Regulatory bodies, Laws • NYSE – http://www.nyse.com/about/1088808971270.html • NASDAQ – http://www.investopedia.com/university/electronictrading/trading3.asp • SuperMontage–http://www.yourdictionary.com/finance/supermontage-system • ECN –en.wikipedia.org/wiki/Electronic_Communication_Network

31. Thank You