15.2 Regulatory bodies and compliance requirements
3 min read•august 9, 2024
Regulatory bodies like the SEC, FINRA, and CFTC play crucial roles in overseeing financial markets and protecting investors. These agencies work together to enforce laws, monitor trading, and regulate various financial entities, creating a comprehensive regulatory framework.
Compliance requirements are essential for firms in the financial industry. These include , asset protection measures, record-keeping standards, and . Adhering to these requirements helps maintain market integrity and investor trust.
Regulatory Bodies
Federal Financial Regulatory Agencies
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- oversees securities markets, protects investors, and enforces federal securities laws
- SEC regulates public companies, investment advisers, broker-dealers, and investment companies
- operates as a self-regulatory organization under SEC oversight
- FINRA regulates broker-dealers, monitors trading activities, and administers licensing exams for securities professionals
- regulates derivatives markets, including futures, options, and swaps
- CFTC aims to promote competitive and efficient markets while protecting market participants from fraud and manipulation
State-Level Securities Regulation
- State securities regulators operate within each state to oversee securities activities at the local level
- State regulators work in conjunction with federal agencies to enforce securities laws and protect investors
- State regulators often focus on smaller offerings and local investment activities not covered by federal regulations
- State regulators have the authority to investigate securities fraud and take enforcement actions within their jurisdictions
- Coordination between state and federal regulators helps create a comprehensive regulatory framework for the securities industry
Compliance Requirements
Registration and Disclosure
- Compliance policies and procedures establish guidelines for firms to adhere to regulatory requirements and industry best practices
- Firms must develop, implement, and regularly review compliance policies to address potential risks and regulatory changes
- serves as the primary registration document for investment advisers
- Part 1 of Form ADV contains information about the adviser's business, ownership, clients, employees, and disciplinary history
- Part 2 of Form ADV, known as the brochure, provides detailed information about the adviser's services, fees, and investment strategies
- Investment advisers must update Form ADV annually and promptly disclose material changes to clients
Asset Protection and Record Keeping
- requires investment advisers with custody of client assets to implement safeguards to protect those assets
- Advisers must maintain client funds and securities with a qualified custodian (banks, broker-dealers)
- Surprise examinations by independent public accountants are required for advisers with custody of client assets
- mandate the maintenance of accurate and complete records of all business activities
- Firms must retain various types of records, including financial statements, client communications, and trade records
- Electronic record-keeping systems must meet specific requirements for data integrity, security, and accessibility
Ethical Standards and Conduct
- establishes principles of conduct for investment professionals and firms
- Codes of ethics typically address personal trading, insider trading, conflicts of interest, and confidentiality
- Firms must provide their code of ethics to clients and prospective clients upon request
- Regular training and education on ethical standards help ensure compliance and promote a culture of integrity
- encourage employees to report potential violations of securities laws or ethical standards
- Firms must establish procedures for addressing and resolving ethical violations or conflicts of interest
Key Terms to Review (21)
Accredited Investor: An accredited investor is an individual or entity that meets specific financial criteria set by regulatory authorities, allowing them to participate in investment opportunities that are not available to the general public. This designation connects to various aspects of alternative investments, as accredited investors typically have access to private equity and venture capital deals, which are often considered higher-risk but potentially higher-reward investments. The criteria ensure that these investors have the financial sophistication to understand the risks involved, aligning with securities laws and regulations that govern fundraising activities.
Anti-money laundering (AML): Anti-money laundering (AML) refers to a set of laws, regulations, and procedures designed to prevent criminals from disguising illegally obtained funds as legitimate income. AML initiatives aim to detect and report suspicious activities that might indicate money laundering, thereby protecting the financial system from being exploited by illicit activities such as drug trafficking and terrorism financing.
Books and records requirements: Books and records requirements refer to the legal obligations that investment firms, including those in venture capital and private equity, must follow to maintain accurate and comprehensive financial and operational documentation. These requirements ensure transparency, accountability, and compliance with regulatory standards set by various governing bodies, facilitating audits and investigations when necessary.
Code of ethics: A code of ethics is a formal document that outlines the ethical principles and standards that guide the behavior and decision-making of individuals or organizations. It serves as a framework for ethical conduct, ensuring compliance with regulations and promoting integrity within professional settings. A well-established code of ethics is essential for maintaining trust and accountability in business relationships, particularly when it comes to fiduciary duties and managing conflicts of interest.
Commodity Futures Trading Commission (CFTC): The Commodity Futures Trading Commission (CFTC) is a U.S. government agency that regulates the futures and options markets. Established in 1974, its primary mission is to protect market participants and the public from fraud, manipulation, and abusive practices related to derivatives trading. The CFTC oversees the trading of commodity futures and options to ensure fair and efficient markets, thereby enhancing overall market integrity.
Custody Rule: The Custody Rule refers to regulations set forth by the Securities and Exchange Commission (SEC) that govern how investment advisors must manage and safeguard client assets. This rule is crucial as it outlines the responsibilities of investment advisors regarding the custody of client funds and securities, ensuring clients' investments are protected from misuse or theft. Compliance with the Custody Rule also involves specific reporting and audit requirements designed to enhance transparency and protect investors.
Disclosure Obligations: Disclosure obligations refer to the legal requirements for companies and investment firms to provide accurate and complete information to stakeholders, including investors, regulatory bodies, and the public. These obligations are crucial for promoting transparency, ensuring informed decision-making, and maintaining trust in financial markets.
Ethical conduct guidelines: Ethical conduct guidelines are a set of principles and standards designed to guide the behavior of individuals and organizations in a professional context, ensuring that actions align with ethical norms and values. These guidelines help establish a culture of integrity, accountability, and respect within industries, including those related to regulatory bodies and compliance requirements.
Fiduciary duty: Fiduciary duty is a legal obligation where one party, known as the fiduciary, is required to act in the best interest of another party, often referred to as the principal or beneficiary. This concept is crucial in relationships where trust and confidence are established, such as between investors and fund managers or directors and shareholders. It encompasses duties of care and loyalty, ensuring that fiduciaries prioritize their clients' interests above their own.
Financial Industry Regulatory Authority (FINRA): FINRA is a non-governmental organization that regulates member brokerage firms and exchange markets, ensuring transparency and protecting investors in the financial industry. By overseeing the securities industry, FINRA plays a crucial role in maintaining fair and equitable markets while enforcing compliance with federal securities laws and regulations.
Form ADV: Form ADV is a document used by investment advisers to register with the SEC and state regulators, providing essential information about their business, practices, and background. This form is crucial for ensuring transparency and protecting investors by disclosing potential conflicts of interest, fees, services offered, and the adviser’s qualifications.
General Partner: A general partner is an individual or entity in a partnership who has unlimited liability and is responsible for the management of the partnership's operations and decisions. This role is crucial in venture capital and private equity as they lead fund management, make investment decisions, and engage with limited partners to secure funding and provide updates on fund performance.
Internal controls: Internal controls refer to the processes and procedures that organizations implement to ensure the integrity of financial and operational reporting, compliance with laws and regulations, and the safeguarding of assets. These controls help organizations achieve their objectives by mitigating risks, preventing fraud, and ensuring that information is accurate and reliable.
Investor Due Diligence: Investor due diligence is the comprehensive process undertaken by investors to evaluate a potential investment opportunity before committing capital. This involves assessing the financial health, business model, management team, and market potential of the target company, ensuring compliance with applicable regulations and understanding risks involved. By conducting thorough due diligence, investors aim to make informed decisions that align with their investment strategies and mitigate potential losses.
Limited Partnership: A limited partnership is a business structure consisting of at least one general partner, who manages the business and has unlimited liability, and one or more limited partners, who contribute capital and have limited liability based on their investment. This structure is crucial in venture capital and private equity as it enables the pooling of funds while protecting limited partners from personal liability beyond their initial investment.
Portfolio Company Due Diligence: Portfolio company due diligence is the comprehensive process of evaluating and analyzing potential or existing investments in portfolio companies by venture capital or private equity firms. This process involves assessing the financial, operational, legal, and regulatory aspects of a company to identify risks and ensure compliance with relevant laws and regulations. Proper due diligence is crucial for making informed investment decisions and managing ongoing compliance requirements throughout the investment lifecycle.
Registration and disclosure obligations: Registration and disclosure obligations are legal requirements imposed on companies and investment funds to register their securities and provide specific information to investors and regulatory authorities. These obligations ensure transparency, protect investors, and maintain fair and efficient markets by mandating regular updates about a company's financial health, risks, and business operations.
Regulation A+: Regulation A+ is an amendment to the existing Regulation A under the Securities Act of 1933, allowing companies to raise capital through crowdfunding. It facilitates a streamlined process for small and medium-sized enterprises to access funding from a broader pool of investors while providing less burdensome compliance requirements compared to traditional public offerings.
Regulation D: Regulation D is a set of rules established by the Securities and Exchange Commission (SEC) that provides exemptions from the registration requirements for certain securities offerings. This regulation is essential for venture capital and private equity firms as it allows them to raise capital more efficiently by avoiding the lengthy and costly process of registering securities with the SEC, while still ensuring compliance with federal securities laws.
Securities and Exchange Commission (SEC): The Securities and Exchange Commission (SEC) is a U.S. government agency responsible for enforcing federal securities laws, regulating the securities industry, and protecting investors. It plays a crucial role in maintaining fair and orderly functioning of the securities markets, which is vital for effective portfolio diversification, managing the initial public offering (IPO) process, and ensuring compliance with regulations that affect various investment vehicles.
Whistleblower programs: Whistleblower programs are initiatives designed to encourage individuals to report misconduct or illegal activities within organizations, often providing protections and incentives for those who come forward. These programs play a crucial role in promoting transparency and accountability by helping regulatory bodies identify violations of laws or regulations, ensuring that compliance requirements are upheld.