Chapter 2 - Knowledge of Capital Markets

Knowledge of Capital Markets is the first section of the SIE exam. This section accounts for 16% of the overall exam and comprises 12 questions. This study topic is subdivided into four subsections.

1.1.1 The Securities and Exchange Commission (SEC)

The High-level Purpose and Mission of Securities Regulation

The government did not regulate the securities industry until the infamous Stock Market crash of 1929 and the subsequent Great Depression of the 1930s.

The behavior of traders, investors, and financial organizations was a world away from what is allowed today. To say it was a free-for-all would be something of an understatement! These practices, in part, contributed to the crash of 1929.

After 1929, the federal government stepped in to exercise some control over financial activities in general, the securities industry, and the behavior of its participants through oversight and governance.

Fast-forward to the 1930s, two pieces of legislation were created and passed by the US Congress: the Securities Act of 1933 (also known as the"Prospectus" or"Paper Act") and the Securities Exchange Act of 1934 (also known as the"People and Places Act"). The 1934 Act created the SEC.

The Definition, Jurisdiction, and Authority of the SEC

The SEC's original purpose was, and remains to this day, the creation and implementation of regulations and laws designed to protect retail investors from theft and fraud in the public securities markets. A retail investor is defined later in this chapter but is, in simple terms, not a sophisticated or professional investor.

In More Detail: The 1933 Securities Act

This piece of legislation took the power away from individual states and vested it firmly in the hands of the federal government.

The most important provision of the 1933 Act is that it introduced the requirement for corporations to register with the SEC using a prospectus document (hence the name, the"Prospectus Act") before issuing securities to the general public on the primary market regardless of whether they were issuing stocks (equity securities) or bonds (debt securities).

However, this regulation only applies to corporations: municipal and federal government issues are legally allowed to bypass these registration regulations.

In More Detail: The 1934 Securities Exchange Act

This companion act, passed a year after the Securities Act in 1934, was designed to regulate securities trading on the secondary market (the 1933 Act controlled trading in securities on the primary market).

The Act also created the SEC, vesting in it the jurisdiction and interpretation of all laws relevant to the domestic securities market.

The 1934 Securities Exchange Act controls the actions of broker-dealers, investors, corporations, and financial professionals regarding publicly traded corporations.

1.1.2 Self-Regulatory Organizations (SROs)

Purpose and Mission of an SRO

FINRA is the financial services sector's central SRO. Alongside the SEC, FINRA regulates the securities industry.

FINRA was created following the merger of the National Association of Security Dealers (NASD) and the regulatory element of the New York Stock Exchange (NYSE).

Jurisdiction and Authority of SROs

FINRA sets four primary standards for financial professionals as follows:

• The Code of Arbitration – last stop and binding arbitration in disputes
• The Code of Procedure – for trade practice complaints
• The Code of Conduct – defining ethical standards of behavior
• Uniform Practice Code – to ensure consistent trading in the secondary market

FINRA is the main but not the only organization regulating the trade in securities in the USA.

The Municipal Securities Rulemaking Board (MSRB) is an S