Government regulation is the theme of this month’s articles and so far we have looked at regulations in the form of tax law and regulations covering small (and large) businesses, but what about protecting your money? What regulations are there to protect the individual investor? Let’s take a look at that question.
Let’s start with the way we do banking. What protects your money in the bank? For starters, the regulatory body you are most familiar with is the Federal Deposit Insurance Corporation or FDIC. The FDIC insures your deposits up to $100,000 from loss due to the failure of an insured bank or savings institution. Because of the $100,000 limit, it is important that you make sure you don’t have too much money in a given insured institution. There are a number of rules about how you might aggregate deposit accounts to maximize your protection. For further information, go to the FDIC
If you have money in a credit union, your money still has federal insurance protecting you from loss. For a complete description of the protection, you can go the National Credit Union Administration’s (NCUA)
In addition to deposit insurance, it’s important that you know the banking industry (including savings institutions and credit unions) is heavily regulated. The insuring agencies (FDIC and NCUA) conduct periodic inspections of the books and operations of insured institutions and, depending on who chartered the institution, federal or state regulators also examine the financial statements and operations of banks, savings institutions and credit unions. Most banks also have external auditors perform annual audits of their books and records. The regulatory and industry oversight of financial institutions is quite impressive.
With a large part of the typical investor’s wealth tied up in equity and fixed income investments, it is important that the investor feels his or her investments are safe. When the word "safe" is used here, it means safe from loss due to fraud or mismanagement. Investing in equity and fixed income securities will always carry a market risk. Market risk is the risk that the value of your investment will decrease in value. Notwithstanding the mutual fund scandals over the past several years, such market movements are typically outside the control of your broker.
So what happens when a brokerage goes out of business and takes your assets with it on its way down to the bottom? Are you out of luck? Thankfully, the answer is no, you are not out of luck. The following description of the Securities Investor Protection Corporation
comes from its website:
The Securities Investor Protection Corporation either acts as trustee or works with an independent court-appointed trustee in a missing asset case to recover funds. The statute that created SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities that are already registered in their names or in the process of being registered. All other so-called "street name" securities are distributed on a pro rata basis. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $100,000 on claims for cash. Recovered funds are used to pay investors whose claims exceed SIPC's protection limit of $500,000. SIPC often draws down its reserve to aid investors.
The corporation is funded by the industry and, according to it’s website, has helped to recover approximately $14.2 billion in investor funds since 1970. While not all brokerages offer SIPC coverage, approximately 99% are SIPC covered institutions. Make sure your broker is part of the SIPC system.
Like banks, securities issuers and brokerage firms are subject to substantial regulatory oversight. Beginning in 1933, Congress started to create legislation designed to protect investors. The Securities Act of 1933
established registration requirements for issuers of securities that were designed to:
The Securities Act of 1933
- Insure that investors receive all pertinent information regarding the financial status and certain other information about issuers of securities held for sale to the public; and,
- Prevent misrepresentations and fraud in the sale of securities.
is the statute that establishes the requirement that all public companies register their securities and governs the information required to be disclosed in a "registration statement."
The Securities Exchange Act of 1934
established the Securities and Exchange Commission. The SEC has broad authority to regulate virtually all aspects of the securities industry. The SEC is the policeman of our nation’s securities business. Companies that wish to issue securities file registration statements with the SEC. The SEC reviews them for compliance and, to the extent possible, ensures the public receives timely, accurate information. The SEC oversees the operations of the nation’s securities exchanges and other self-regulatory organizations responsible for the proper operation of the nation’s securities industry.
Since the inception of the SEC, there has been other legislation enacted with the aim of providing investors with the information necessary to make informed decisions regarding investments. The most recent of these, the Sarbanes-Oxley Act of 2002
, was enacted in response to the corporate accounting fraud characterized by such business failures as WorldCom, Enron and other high profile failures. While much work has been done as a result of Sarbanes-Oxley, only time will tell if this legislation will be effective in combating the fraud that rocked the United States securities industry.
In addition to federal securities regulation, most states have regulations applicable to securities issuance also.
Federal and State regulators are considered by many people to be both overbearing bureaucrats and also welcome protectors of the public interest. In the case of securities regulators, their activities serve a vital role in keeping our nation’s securities markets both operational and trustworthy.
Have a great November.