Regulations and Securities Market Players

Information Security Identification: Confidential

Regulations and Securities Market Players

Domain Refresher Training


© 2011 iNautix Technologies India Private Ltd. iNautix Technologies India Private Ltd is a subsidiary of The Bank of New York Mellon Corporation. Trademark(s) belong to their respective owners. For professional use only. Not for distribution to the public. The information contained herein, including any attachments, is proprietary to, and constitutes confidential information of iNautix. It may not be reproduced, retransmitted or redistributed in any manner without the express written consent of iNautix. .

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

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© 2011 iNautix Technologies India Private Ltd. iNautix Technologies India Private Ltd is a subsidiary of The Bank of New York Mellon Corporation. Trademark(s) belong to their respective owners. For professional use only. Not for distribution to the public. The information contained herein, including any attachments, is proprietary to, and constitutes confidential information of iNautix. It may not be reproduced, retransmitted or redistributed in any manner without the express written consent of iNautix. . 3

Section 1

Securities Market - Overview




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> 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




A SECURITIES MARKET IS AN EXCHANGE WHERE SECURITIES ARE TRADEDPRIMARY 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

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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

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Dealer or Principal CapacitySubject to risk on transaction

Mark-up or markdown

Broker or Agency Capacity No risk on transaction

Commission

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Major Players in a Market (Cont’d)

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.

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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.




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

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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

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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.

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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

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Stock Exchange Setup

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Exchange

Broker C

Branch B

Advisor B

Client B

Account B

Branch A Branch C

Advisor CAdvisor A

Client CClient A

Account CAccount A

Broker BBroker A



Trading Execution ProcedureON 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

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Sources of RevenueTRADING 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

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Typical Stock Exchange Systems

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UpdatesQuote Quotation

Execution

Trade Reporting

Computer to

ComputerLinks

Quote and Trade Data

VendorsOrders

Trade

Market Surveillance

Quote Data

Trade Data

Broker Dealers

Trade Confirmation

Reports Clearing and

SettlementLocked-In

Trades

Nasdaq Workstatio

n



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

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© 2011 iNautix Technologies India Private Ltd. iNautix Technologies India Private Ltd is a subsidiary of The Bank of New York Mellon Corporation. Trademark(s) belong to their respective owners. For professional use only. Not for distribution to the public. The information contained herein, including any attachments, is proprietary to, and constitutes confidential information of iNautix. It may not be reproduced, retransmitted or redistributed in any manner without the express written consent of iNautix. . 18

Section 2

Regulations



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

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Regulatory Bodies in USSEC (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

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Regulations & Economic Events - Timeline

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1900

Maj

or E

cono

mic

Eve

nts

Impo

rtant

Law

s G

over

ning

U

.S. S

ecur

ities

Mar

ket

2010

Securities Act (1933)

Securities Exchange Act

(1934)

Investment Advisers Act(1940)

Securities Investor Protection Act

(1970)

Insider Trading Sanctions Act

(1984) Sarbanes-Oxley Act (2002)

Patriot Act (2001)

2000

Wall Street Crash of 1929

Black Wednesday (Sep 16, 1992)

Stock market crash(1973–1974)

Black Monday(1987)

Dot-com Bubble (2000)

Oil Crisis 1973

Great Depression

1929

Subprime crisis (2007)

Japanese asset price bubble(1991–2003)

Asian financial crisis(1997)

Flash Crash (2010)

1900

BASEL-I (1988) BASEL-II

(2004)

Dodd–Frank Wall Street Reform

(2010)



Regulatory Bodies - Interaction

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Regulatory Bodies - Interaction

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Laws Governing the Securities MarketTHE 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

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Laws Governing the Securities MarketINVESTMENT 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 actSECURITIES 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

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Laws Governing the Securities MarketINSIDER 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

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Laws Governing the Securities MarketPATRIOT 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.

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Broker-Dealer RegulationWHAT'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

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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

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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

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http://www.expertpanel.ca/eng/reports/research-studies/index.html

http://www.sec.gov/divisions/marketreg/bdguide.htm

http://www.sifma.org/research/pdf/RsrchRprtVol4-5.pdf

http://www.stockmarketinvestinginfo.com/smi_mainplayers.html

http://www.nyse.com/about/1088808971270.html

http://www.investopedia.com/university/electronictrading/trading3.asp

http://www.yourdictionary.com/finance/supermontage-system



Thank You

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Regulations and Securities Market Players

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