Regulatory Framework

Securities Legislation

The modern U.S. securities regulatory framework was built primarily in response to the stock market crash of 1929 and the Great Depression that followed. Before these landmark laws, securities markets operated with little oversight, rampant fraud, and minimal investor protections. Understanding the major securities laws, their purposes, and their key provisions is essential for the SIE exam, which dedicates approximately 9% of its questions to regulatory topics.

Securities Act of 1933 (The Paper Act)

The Securities Act of 1933 was the first major federal securities law, enacted in response to the widespread fraud and lack of transparency that contributed to the 1929 market crash. Its two primary objectives are:

1. Disclosure: Require that investors receive significant financial and other information about securities being offered for public sale (through a registration statement and prospectus).
2. Anti-Fraud: Prohibit deceit, misrepresentations, and other fraud in the sale of securities.

The 1933 Act is often called the "Paper Act" or the "Truth in Securities Act" because it focuses on the initial issuance and sale of new securities (the primary market). It requires issuers to file a registration statement with the SEC before offering securities to the public. The registration statement includes detailed information about the company's business, financial condition, management, and the securities being offered. The prospectus, which is part of the registration statement, must be delivered to investors before or at the time of sale.

Key concepts under the 1933 Act include:

• Registration Statement: Filed with the SEC on Form S-1 (for IPOs) or other applicable forms. The SEC reviews the filing for completeness and adequacy of disclosure but does NOT approve or disapprove the investment merit of the securities.
• Cooling-Off Period: The minimum 20-day period between the filing date and the effective date. During this period, the preliminary prospectus (red herring) may be distributed, but no sales can be made and no final offering price can be stated.
• Prospectus: The key document containing all material information about the offering. The final prospectus must be delivered to all purchasers.
• Exempt Securities: Certain securities are exempt from registration, including U.S. government securities, municipal bonds, commercial paper (maturity of 270 days or less), and securities of banks and savings institutions.
• Exempt Transactions: Certain transactions are exempt from registration, including private placements (Regulation D), intrastate offerings (Rule 147), and small offerings (Regulation A/A+).

Securities Exchange Act of 1934 (The People Act)

The Securities Exchange Act of 1934 established the Securities and Exchange Commission (SEC) and governs the secondary trading of securities. While the 1933 Act focuses on new issues, the 1934 Act regulates the ongoing trading of securities after they have been issued. It is often called the "People Act" because it regulates the people and entities involved in securities trading.

Key provisions of the 1934 Act include:

• Creation of the SEC: Established the SEC as the primary federal regulator of the securities markets, with authority to oversee exchanges, broker-dealers, and self-regulatory organizations.
• Registration of Exchanges and Broker-Dealers: Requires all national securities exchanges and broker-dealers to register with the SEC.
• Periodic Reporting: Requires publicly traded companies to file periodic reports (10-K annual, 10-Q quarterly, 8-K current events) to provide ongoing disclosure to investors.
• Proxy Solicitation: Regulates the process by which companies solicit shareholder votes.
• Insider Trading (Section 10b / Rule 10b-5): Prohibits fraud and manipulation in connection with the purchase or sale of securities, including insider trading.
• Tender Offers: Regulates the process of one company making a public offer to buy shares of another company.
• Short Sales: Grants the SEC authority to regulate short selling.
• Credit Regulation: Grants the Federal Reserve Board authority to regulate the extension of credit for purchasing securities (Regulation T for broker-dealers, Regulation U for banks).

Investment Company Act of 1940

The Investment Company Act of 1940 regulates the organization and activities of companies that invest in securities and offer their own securities to the public. This act is primarily concerned with mutual funds, closed-end funds, and unit investment trusts (UITs). Key provisions include:

• Investment companies must register with the SEC
• At least 40% of the board of directors must be independent (non-interested persons), and a majority of 75% is recommended
• Investment company shares must be sold at the current net asset value (NAV) plus any applicable sales charge
• Changes to the fund's investment objectives require shareholder approval
• Restrictions on leverage, affiliated transactions, and custodial arrangements
• Annual and semi-annual reports must be provided to shareholders

Investment Advisers Act of 1940

The Investment Advisers Act of 1940 regulates investment advisers -- persons or firms that, for compensation, engage in the business of advising others about securities. The act requires most investment advisers with $100 million or more in assets under management (AUM) to register with the SEC; smaller advisers generally register with state regulators. Key concepts include:

• Investment advisers owe a fiduciary duty to their clients (the highest standard of care)
• Advisers must disclose all material conflicts of interest
• Brochure delivery requirement (Form ADV Part 2) to new clients and annually thereafter
• Performance-based compensation is generally prohibited for retail clients
• Custody and recordkeeping requirements

The Dodd-Frank Wall Street Reform Act (2010)

The Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in 2010 in response to the 2008 financial crisis. It is the most comprehensive financial reform legislation since the 1930s. Key provisions relevant to the SIE exam include:

• Created the Financial Stability Oversight Council (FSOC) to monitor systemic risk
• Established the Consumer Financial Protection Bureau (CFPB) to protect consumers in financial transactions
• Implemented the Volcker Rule, which restricts banks from proprietary trading and limits their investments in hedge funds and private equity
• Enhanced regulation of over-the-counter derivatives (swaps and security-based swaps)
• Strengthened whistleblower protections and created financial incentives for reporting securities violations to the SEC
• Explicitly prohibited spoofing in commodity and securities markets
• Raised the accredited investor threshold by excluding primary residence equity from the net worth calculation

JOBS Act (2012)

The Jumpstart Our Business Startups (JOBS) Act of 2012 was designed to make it easier for small companies to raise capital. Key provisions include:

• Created the Emerging Growth Company (EGC) category with reduced reporting requirements for companies with less than $1.07 billion in annual revenue during IPO
• Expanded Regulation A+ (Tier 1 up to $20 million, Tier 2 up to $75 million) as a streamlined alternative to full SEC registration
• Legalized equity crowdfunding (Regulation Crowdfunding), allowing companies to raise up to $5 million from the general public through SEC-registered platforms
• Lifted the ban on general solicitation for certain private placements under Rule 506(c) (if all purchasers are accredited investors and the issuer takes reasonable steps to verify their status)

Self-Regulatory Organization (SRO) Structure

The U.S. securities regulatory system operates on a two-tiered model: the SEC serves as the ultimate federal regulator, while Self-Regulatory Organizations (SROs) handle the day-to-day regulation of their members. SROs are authorized by the SEC to create and enforce rules governing the conduct of their members. This structure allows for more efficient and industry-specific regulation while maintaining federal oversight.

FINRA (Financial Industry Regulatory Authority)

FINRA is the largest SRO for the securities industry. It was formed in 2007 through the merger of the National Association of Securities Dealers (NASD) and the regulatory arm of the New York Stock Exchange. FINRA's responsibilities include:

• Member Regulation: Overseeing approximately 3,400 brokerage firms and more than 624,000 registered securities representatives
• Qualification Exams: Administering licensing exams, including the SIE, Series 6, Series 7, Series 63, Series 65, and Series 66
• Rulemaking: Creating and enforcing rules governing member firm conduct, sales practices, and market integrity
• Examination and Enforcement: Conducting regular examinations of member firms and pursuing disciplinary actions for rule violations
• Market Surveillance: Monitoring trading activity across U.S. securities markets to detect manipulation, insider trading, and other violations
• Dispute Resolution: Operating the largest securities dispute resolution forum (arbitration and mediation) for resolving disputes between investors and firms

All broker-dealer firms that conduct securities business with the public must be members of FINRA. FINRA membership is a prerequisite for operating as a broker-dealer in the United States (with narrow exceptions for firms that conduct only government securities or institutional business).

MSRB (Municipal Securities Rulemaking Board)

The MSRB writes rules governing the municipal securities market, including rules for municipal securities dealers and municipal advisors. Unlike FINRA, the MSRB does not have enforcement authority. Instead, FINRA enforces MSRB rules for broker-dealers, the SEC enforces them for non-bank dealers, and federal banking regulators enforce them for bank dealers. The MSRB also operates the EMMA (Electronic Municipal Market Access) system, which provides free public access to municipal securities disclosures and trade data.

NYSE and Other Exchanges

The New York Stock Exchange (NYSE), Nasdaq, CBOE (Chicago Board Options Exchange), and other national securities exchanges are also SROs. Each exchange has its own listing standards, trading rules, and disciplinary procedures. Exchanges must register with the SEC and have their proposed rules approved by the SEC before implementation. The CBOE is the primary exchange for listed options trading and sets rules for options market participants.

Registration Requirements

Any individual who wants to work in the securities industry as a registered representative must meet specific registration requirements. This involves passing qualifying examinations, filing registration forms, and maintaining ongoing education requirements. The SIE exam frequently tests your knowledge of these processes.

Form U4 and Form U5

Form U4 (Uniform Application for Securities Industry Registration or Transfer) is the registration form used to apply for registration with FINRA and with the states. The form collects detailed personal information, employment history, disciplinary history, criminal history, financial information (including bankruptcies and judgments), and other disclosure items. Key facts about Form U4:

• Filed by the sponsoring firm, not by the individual (an individual cannot self-register; they must be sponsored by a FINRA member firm)
• Must be filed within 30 days of the individual's association with the firm
• All information must be kept current; updates are required within 30 days for most changes (and within 10 days for certain customer complaints, regulatory actions, and criminal matters)
• Contains disclosure questions (DQ) covering criminal history, regulatory actions, civil judicial actions, customer complaints, terminations, and financial disclosures (bankruptcies, liens, judgments)
• The form is available to the public through FINRA's BrokerCheck system (with some personal information redacted)

Form U5 (Uniform Termination Notice for Securities Industry Registration) is filed when a registered person leaves a member firm. The firm must file Form U5 within 30 days of the termination date. The U5 includes the reason for termination and any updated disclosure information. If an individual disagrees with the information on their U5, they may file a comment through the CRD system but cannot prevent the firm from filing it.

Statutory Disqualification

Statutory disqualification is a condition that prevents an individual or firm from associating with a FINRA member firm. Grounds for statutory disqualification include:

• Conviction of certain felonies within the past 10 years (any felony or certain securities-related misdemeanors)
• Expulsion or suspension from a self-regulatory organization
• Being subject to an SEC order denying, suspending, or revoking registration
• Filing a false or misleading application or report with a regulatory body
• Being subject to a court injunction involving securities-related activities

A statutorily disqualified person is not automatically barred from the industry permanently. FINRA has a process by which a member firm may apply for relief, allowing the disqualified person to associate with the firm under heightened supervision. This requires FINRA's explicit approval.

Continuing Education

FINRA requires all registered persons to participate in a continuing education (CE) program that has two components:

• Regulatory Element: Required on the second anniversary of initial registration and every three years thereafter. Content is determined by FINRA and covers regulatory, compliance, ethical, and sales practice standards. If a registered person fails to complete the Regulatory Element by the required date, their registration becomes inactive until it is completed. They cannot engage in any activities requiring registration while inactive. As of 2023, FINRA transitioned the Regulatory Element to an annual format delivered through an online learning platform.
• Firm Element: Developed and administered by each member firm annually. The content is tailored to the firm's business, products, and the needs of its registered persons. Firms must maintain a written training plan and deliver the training at least annually. The Firm Element covers products, services, and regulatory developments relevant to the firm's business.

Communications Rules

FINRA Rule 2210 governs communications with the public by member firms. All communications must be fair, balanced, and not misleading. The rule categorizes communications into three types, each with different pre-approval and filing requirements.

Categories of Communications

• Retail Communication: Any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30-calendar-day period. Examples include advertisements, websites, social media posts visible to the public, sales literature, and mass emails to retail clients. Retail communications are subject to the most rigorous oversight requirements.
• Institutional Communication: Any written communication distributed or made available only to institutional investors (such as banks, insurance companies, registered investment companies, and entities with $50 million+ in assets). Institutional communications do not require pre-approval by a principal but must be subject to the firm's supervisory procedures.
• Correspondence: Any written communication distributed to 25 or fewer retail investors within any 30-calendar-day period. This includes individual emails, letters, and direct messages. Like institutional communications, correspondence does not require pre-approval by a principal but must be supervised.

Filing Requirements

Certain retail communications must be filed with FINRA's Advertising Regulation Department:

• During the firm's first year of FINRA membership, all retail communications must be filed with FINRA at least 10 business days before first use (pre-use filing)
• After the first year, most retail communications must be filed within 10 business days of first use (post-use filing)
• Communications about investment companies (mutual funds), options, and public direct participation programs (DPPs) must always be filed within 10 business days of first use, regardless of firm tenure

Social Media

FINRA applies the same communications standards to social media as to other forms of communication. Whether a social media post is classified as retail communication, institutional communication, or correspondence depends on the audience. A post visible to the general public is a retail communication. FINRA distinguishes between static content (such as a firm's profile page, which functions like an advertisement) and interactive content (such as real-time conversations in chat rooms or social media comments, which are more like correspondence).

Key social media rules include: firms must have written supervisory procedures for social media use; registered representatives must not make exaggerated, misleading, or promissory claims on social media; and firms must retain records of business-related social media communications in compliance with FINRA's recordkeeping requirements.

Testimonials and Endorsements

Under the SEC's Marketing Rule (Rule 206(4)-1, effective November 2022 for investment advisers) and FINRA guidance, the use of testimonials and endorsements in communications is now permitted with appropriate disclosures and compliance procedures. Previously, testimonials were broadly prohibited. Under current rules, firms using testimonials must disclose whether the person providing the testimonial is a client, whether they received compensation, and include material facts about the relationship. Performance advertising must follow specific requirements, including showing net-of-fee returns and relevant time periods.

Customer Protection

The regulatory framework includes several important protections for investors. The SIE exam frequently tests your knowledge of SIPC coverage, margin regulations, and the customer complaint process.

SIPC (Securities Investor Protection Corporation)

The Securities Investor Protection Corporation (SIPC) was established under the Securities Investor Protection Act of 1970. SIPC is a nonprofit membership corporation funded by member broker-dealer assessments. Its sole purpose is to protect customers of failed broker-dealer firms by returning missing securities and cash to customers. SIPC is NOT a government agency and is NOT the same as the FDIC.

Important details about SIPC coverage:

• Coverage is per customer, not per account. However, accounts held in different capacities (individual, joint, IRA, trust) may qualify as separate customers
• SIPC covers stocks, bonds, mutual funds, and other securities, as well as cash held in securities accounts
• SIPC does NOT cover: commodity futures contracts, fixed annuity contracts, currency, or investment contracts (such as limited partnerships) not registered with the SEC
• SIPC does NOT protect against market losses or declines in value
• SIPC does NOT protect customers of investment advisers (only broker-dealers)

Regulation T (Margin Requirements)

Regulation T, issued by the Federal Reserve Board under authority granted by the Securities Exchange Act of 1934, governs the extension of credit by broker-dealers to customers for the purpose of purchasing securities. Key provisions include:

• The current Reg T initial margin requirement is 50%, meaning customers must deposit at least 50% of the purchase price of marginable securities (the broker-dealer may lend the remaining 50%)
• Payment for securities purchased in a cash account must be received within 2 business days after settlement (settlement + 2, or effectively T+3 from the trade date under T+1 settlement)
• Not all securities are marginable: new issues during their initial distribution, OTC securities not on the approved list, and options contracts have special margin requirements
• FINRA imposes a maintenance margin minimum of 25% equity (individual firms may require higher amounts, known as "house requirements")
• If account equity falls below the maintenance requirement, the firm issues a margin call requiring the customer to deposit additional funds or securities

Customer Complaints

FINRA rules require member firms to have procedures for handling customer complaints. A customer complaint is any written grievance by a customer or a person authorized to act on behalf of a customer involving the activities of the firm or its associated persons. Key requirements include:

• All written customer complaints must be reported to the firm's compliance or supervisory personnel
• Firms must report certain complaints on Form U4 (for the registered representative involved) and on Form U5 (upon termination)
• Customer complaints are reported on FINRA BrokerCheck, making them visible to the public
• Firms must maintain records of all complaints for a minimum of 4 years
• Customer disputes may be resolved through FINRA arbitration (binding for industry disputes; generally required if the customer signed a pre-dispute arbitration agreement) or FINRA mediation (voluntary, non-binding)