Introduction to Financial Services: The Securities and Exchange Commission (SEC)

Introduction to Financial Services: The Securities and Exchange Commission (SEC)

Updated April 15, 2020
Introduction to Financial Services: The Securities and Exchange
Commission (SEC)
Origins, Structure, and Market Oversight Securities Exchange Act of 1934 (Exchange Act; P.L. 73-
To help restore confidence in the securities markets in the
291). In addition to creating the SEC, this act established
wake of the stock market crash of 1929, Congress passed
self-regulatory organizations (SROs) in the securities
the Securities Exchange Act of 1934, which authorized the
industry, which are SEC-regulated entities, including stock
creation of the Securities and Exchange Commission
exchanges, with quasi-governmental authority responsible
(SEC). The SEC is an independent, nonpartisan regulatory
for policing their members and the attendant securities
agency responsible for administering federal securities
markets. Under the act, the Financial Industry Regulatory
laws. It has broad regulatory authority over significant parts
Authority (FINRA), a SEC-regulated SRO, is the principal
of the securities industry, including stock exchanges,
regulator of broker-dealers.
mutual funds, investment advisers, and brokerage firms.
Investment Company Act of 1940 (ICA; P.L. 76-768).
The SEC oversees federal securities laws broadly aimed at
This act regulates the organization of investment
(1) protecting investors; (2) maintaining fair, orderly, and
companies, including mutual funds. Investment companies
efficient markets; and (3) facilitating capital formation.
such as mutual funds are primarily engaged in investing in
These laws provide clear rules for honest dealing among
the securities of other companies. In an attempt to minimize
securities market participants, including antifraud
the potential conflicts of interest that may arise due to the
provisions, and disclose information deemed necessary for
operational complexity of investment companies, the act
informed investor decisionmaking.
generally requires investment companies to register with
the SEC and publicly disclose key data on their investment
The SEC’s budget is set through the congressional
objectives, structure, operations, and financial status.
appropriations process. The appropriations are offset by
sale fees on stock and other securities transactions that the
Investment Advisers Act of 1940 (IAA; P.L. 76-768).
SEC collects from securities exchanges. Annual collections,
Investment advisers are firms or sole practitioners that are
which tend to exceed the SEC’s annual appropriations, go
compensated for advising others about securities
directly to the U.S. Treasury’s general fund. Over the last
investments, including advisers to mutual funds and hedge
few years, the SEC’s enacted annual budget has been in the
funds. In general, under the act, advisers managing a certain
$1.6 billion to $1.7 billion range. The agency is led by five
amount of assets must register with the SEC and conform to
the act’s
presidentially appointed commissioners, including a
regulations aimed at protecting investors.
chairman, all of whom require Senate confirmation.
Commissioners have five-year staggered terms and no more
Sarbanes-Oxley Act of 2002 (SOX; P.L. 107-204). Passed
than three commissioners may belong to the same political
in the aftermath of accounting scandals at firms such as
party.
Enron and Worldcom during 2001 and 2002, SOX sought
to improve the reliability of financial reporting and the
Significant Securities Laws Overseen by
quality of corporate audits at public companies. Among
the SEC
other things, it created the Public Company Accounting
The SEC oversees an array of securities laws, several of
Oversight Board (PCAOB) to oversee the quality of
which have been amended over time. Applicable significant
corporate accountants and auditors and shifted
securities laws include those described below.
responsibility for the external corporate auditor from
corporate management to independent audit committees.
Securities Act of 1933 (Securities Act; P.L. 73-22). This
act sought to ensure that investors are given salient
Dodd-Frank Wall Street Reform and Consumer
information on securities offered for public sale and to ban
Protection Act (Dodd-Frank Act; P.L. 111-203). Enacted
deceit, misrepresentations, and other kinds of fraud in the
in the wake of the 2007-2009 financial crisis, the 2010
sale of securities. The act requires issuing companies to
Dodd-Frank Act mandated sweeping financial regulatory
disclose information deemed germane to investors as part of
changes, many of which affected the SEC. The act required
the mandatory SEC registration of the securities that those
the SEC to adopt rules to help ensure that those who
companies offer for sale to the public. Potential investors
securitize certain debt retain a significant interest in assets
must be given an offering prospectus containing
that they transfer; reformed the regulation of credit rating
registration data. Certain offerings are exempt from such
agencies; required hedge fund advisers to register with the
registration requirements, including private offerings to
SEC; and created an interagency financial risk monitoring
financial institutions or to sophisticated institutions.
panel, the Financial Stability Oversight Council (FSOC),
with the SEC chair as a member.
https://crsreports.congress.gov

Introduction to Financial Services: The Securities and Exchange Commission (SEC)
Jumpstart Our Businesses Startup Act (JOBS Act; P.L.
2019, the House passed H.R. 3351, the FY2020 Financial
112-106). This 2012 act was broadly aimed at stimulating
Services and General Government (FSGG) appropriations
capital formation for companies, particularly newer and
bill. It included an amendment sponsored by House
smaller firms. It also eases regulatory requirements for
Financial Services Committee Chair Maxine Waters that
certain initial public offerings (IPOs) through the creation
would have forbidden the SEC from using any of its
of a new entity called an emerging growth company and
congressional spending authority to implement, administer,
through Regulation Crowdfunding that permits companies
enforce, or publicize the final rules and interpretations with
to provide securities to retail investors through regulatory
respect to Reg BI. The enacted FY2020 FSGG
exemptions under the Securities Act.
appropriations (P.L. 116-93, Division C) did not include the
SEC restrictions in H.R. 3351. For more information, see
Selected Policy Issues
CRS Report R46115, Regulation Best Interest (Reg BI):
Congress has an ongoing oversight and legislative interest
The SEC’s Rule for Broker-Dealers, by Gary Shorter.
in a range of securities-related regulatory issues involving
the SEC. This In Focus highlights a recent SEC regulatory
Exemptive Relief for Mutual Fund Borrowing
initiative and briefly discusses the agency’s actions in
Mutual funds are the most common pooled investment
response to the coronavirus pandemic.
vehicle. (Others include hedge funds and closed-end funds).
The funds invest in U.S. government debt, such as Treasury
The Regulation Best Interest Rule
bills, corporate and municipal bonds, and corporate equity.
SEC-registered investment advisers, who are directly
Also called open-ended funds, their shares are continuously
overseen by the agency under the IAA, are generally
offered and have no limits on the number of shares. When
subject to a fiduciary standard, requiring them to act solely
an investor wants to liquidate their fund shares, he or she
in the interests of their retail clients. By contrast, broker-
“redeems” them at net asset value (NAV, the value of the
dealers, regulated by the Exchange Act and largely
fund’s assets minus the value of its liabilities).
overseen by FINRA, are generally subject to a less
demanding retail client standard, the suitability standard.
As has been the case with a number of financial sectors, the
The suitability standard requires broker-dealers to
coronavirus has also affected the $19 trillion mutual fund
reasonably believe that their investment advice is suitable
industry. For example, according to Morningstar, which
for their clients with respect to factors such as a client’s
tracks mutual fund developments, investors redeemed $40
financial goals and needs.
billion in shares from taxable bond funds during the week
of March 16, 2020. As a consequence, there have been
Propelled in part by the perception that many retail
concerns that intensified shareholder fund withdrawals
investors do not understand the differences in the standards
could result in funds liquidating assets at a financial loss to
of client care that broker-dealers and investment advisers
address surging redemption demands.
owe to retail investors, the Dodd-Frank Act required that
the SEC conduct a study on various aspects of standards of
On March 23, 2020, the SEC issued an order providing
client care for retail investors. Released in 2011, the SEC
temporary exemptions to the ICA to provide open-end
staff study recommended a uniform fiduciary standard for
funds: (1) greater ability to borrow from certain fund
the retail advice given by all types of financial
affiliates; (2) eased rules for lending between fund
professionals, including broker-dealers.
companies; and (3) the ability to enter into lending or
borrowing arrangements that violate a fund’s stated policies
On June 5, 2019, after adopting a fairly similar set of
if prior approval has been granted by the fund’s board.
proposed rules in April 2018, the SEC commissioners
adopted Regulation Best Interest (Reg BI). Reg BI reforms
Commenting on the relief, which will extend until at least
requirements for broker-dealers when they make investment
June 30, 2020, SEC Chairman Jay Clayton said that it
recommendations to retail customers. According to the
“provides funds with additional flexibility to navigate
SEC, Reg BI is meant to “enhance the broker-dealer
volatile markets while meeting their obligations to
standard of conduct beyond existing ... obligations [by]
investors.”
requiring broker-dealers ... to: (1) act in the best interest of
the retail customer at the time the recommendation is made,
However, Professors Agarwal and Zhao’s 2016 research
without placing the financial or other interest of the broker-
raised some concerns about making it easier for funds to
dealer ahead of the interests of the retail customer; and (2)
conduct interfund loans, as the exemptive relief does. They
address [various broker-dealer] conflicts of interest.”
found that mutual fund managers may use interfund loan
programs to mitigate the impact of investor outflows after
Broker-dealers have until June 2020 to comply with Reg
poor fund performance. As a consequence, they argued that
BI. SEC officials and various business groups argue that
poorly performing managers are less likely to be
Reg BI properly balances the need for an enhanced broker-
terminated, potentially allowing poor fund financial
dealer standard of care with the need to preserve the broker-
performance to continue.
dealer business model, a model deemed to have special
appeal to less-affluent investors. Critics, including investor
Gary Shorter, Specialist in Financial Economics
advocates, argue that it effectively preserves the inadequate
suitability standard, exposing investors to harm from
IF10032
unaddressed broker-dealer conflicts of interest. In June

https://crsreports.congress.gov

Introduction to Financial Services: The Securities and Exchange Commission (SEC)

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.

https://crsreports.congress.gov | IF10032 · VERSION 7 · UPDATED