Compliance and Enforcement: SEC investigations, FINRA enforcement, state securities regulators

Introduction

Compliance and enforcement in the securities industry are critical to maintaining market integrity and protecting investors. This guide provides an in-depth look at the roles and processes of the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and state securities regulators. Each of these entities plays a vital role in ensuring that securities laws are followed and that violations are appropriately addressed.

Securities and Exchange Commission (SEC)

Overview of the SEC

The SEC is a federal agency responsible for enforcing federal securities laws and regulating the securities industry. Established by the Securities Exchange Act of 1934, the SEC's mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

SEC Investigations

Initiation of Investigations

SEC investigations can be initiated in several ways, including tips from whistleblowers, routine examinations, and referrals from other regulatory agencies. The SEC's Office of the Whistleblower plays a crucial role in this process by encouraging individuals to report potential securities law violations.

Official Link: Office of the Whistleblower - SEC.gov

Types of Investigations

1. Informal Investigations: These are preliminary inquiries where the SEC staff gathers information voluntarily from individuals and entities.
2. Formal Investigations: These involve the issuance of subpoenas to compel the production of documents and testimony.

Investigation Process

1. Document Collection: The SEC collects relevant documents, including emails, financial records, and other communications.
2. Interviews and Testimonies: SEC staff conducts interviews and takes sworn testimonies from witnesses.
3. Analysis: The collected data is analyzed to determine whether there has been a violation of securities laws.

Official Link: How Investigations Work - SEC.gov

Enforcement Actions

Types of Enforcement Actions

1. Civil Actions: The SEC can file civil lawsuits in federal court seeking injunctions, disgorgement of ill-gotten gains, and civil penalties.
2. Administrative Proceedings: The SEC can initiate administrative proceedings before an administrative law judge, seeking sanctions such as fines, suspensions, or bans from the securities industry.

Common Violations

1. Insider Trading: Trading based on non-public, material information.
2. Accounting Fraud: Manipulating financial statements to mislead investors.
3. Market Manipulation: Engaging in practices that distort the market price of securities.

Official Link: Enforcement Manual - SEC.gov

Case Studies

Example 1: Insider Trading

In a notable case, the SEC charged a corporate executive with insider trading for using confidential information to trade stocks before a major merger announcement. The executive was fined and banned from serving as an officer or director of a public company.

Example 2: Accounting Fraud

The SEC brought charges against a company for inflating its revenue figures to meet market expectations. The company settled the charges by paying a substantial fine and agreeing to improve its internal controls.

Financial Industry Regulatory Authority (FINRA)

Overview of FINRA

FINRA is a self-regulatory organization (SRO) that oversees brokerage firms and their registered representatives. It operates under the supervision of the SEC and is responsible for enforcing compliance with federal securities laws and FINRA rules.

FINRA Enforcement

Investigative Process

1. Surveillance and Examinations: FINRA conducts routine examinations and surveillance to monitor compliance with its rules.
2. Investigations: When potential violations are identified, FINRA initiates investigations to gather evidence and determine whether enforcement action is warranted.

Types of Violations

1. Sales Practice Violations: Misrepresenting investment products or engaging in unsuitable recommendations.
2. Operational Violations: Failing to maintain accurate books and records or inadequate supervision of registered representatives.

Enforcement Actions

Sanctions

1. Fines: Monetary penalties imposed on firms or individuals.
2. Suspensions: Temporary bans from the securities industry.
3. Expulsions: Permanent bans from the securities industry.

Disciplinary Proceedings

FINRA's Office of Hearing Officers conducts disciplinary hearings where evidence is presented, and decisions are made regarding appropriate sanctions.

Official Link: Notice of Filing of Proposed Rule Change To Amend Rule 2165

Case Studies

Example 1: Sales Practice Violation

FINRA fined a brokerage firm for failing to supervise a registered representative who made unsuitable recommendations to elderly clients. The firm was required to pay restitution to the affected clients and enhance its supervisory procedures.

Example 2: Operational Violation

A brokerage firm was expelled from FINRA membership for failing to maintain accurate books and records. The firm's executives were also barred from the securities industry.

State Securities Regulators

Overview

State securities regulators, often part of a state's attorney general's office or a separate securities commission, enforce state securities laws, commonly known as "blue sky laws." These regulators play a crucial role in protecting investors at the state level.

Investigative Process

Initiation

State securities investigations can be initiated through complaints from investors, referrals from other regulatory agencies, or routine examinations.

Types of Investigations

1. Fraud Investigations: Investigating allegations of securities fraud, including Ponzi schemes and unregistered securities offerings.
2. Compliance Examinations: Routine examinations of investment advisers and broker-dealers to ensure compliance with state laws.

Enforcement Actions

Types of Actions

1. Cease and Desist Orders: Orders to stop illegal activities immediately.
2. Civil Lawsuits: Filing lawsuits in state court seeking injunctions, restitution, and penalties.
3. Criminal Prosecutions: Referring cases to state prosecutors for criminal charges.

Coordination with Other Regulators

State securities regulators often coordinate with the SEC and FINRA to ensure comprehensive enforcement of securities laws. This coordination can involve joint investigations and sharing of information.

Official Link: Enforcement / Investigations FAQs - Virginia SCC

Case Studies

Example 1: Ponzi Scheme

A state securities regulator uncovered a Ponzi scheme where the perpetrator promised high returns to investors but used new investors' money to pay earlier investors. The regulator issued a cease and desist order and worked with state prosecutors to bring criminal charges.

Example 2: Unregistered Securities Offering

A company was found to be offering securities without proper registration. The state securities regulator filed a civil lawsuit seeking an injunction and restitution for affected investors.

Conclusion

Compliance and enforcement in the securities industry involve a complex interplay between federal, self-regulatory, and state entities. The SEC, FINRA, and state securities regulators each play distinct yet complementary roles in ensuring that securities laws are followed and that violations are addressed. By understanding the processes and actions of these regulators, investors and market participants can better navigate the regulatory landscape and contribute to the integrity of the securities markets.

Official Links for Further Reading:

1. SEC Enforcement Manual - SEC.gov
2. How Investigations Work - SEC.gov
3. Enforcement / Investigations FAQs - Virginia SCC

This comprehensive guide aims to provide a clear and detailed understanding of the compliance and enforcement mechanisms in the securities industry, ensuring that readers are well-informed about the roles and processes of the SEC, FINRA, and state securities regulators.