The U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) are critical regulating entities for the financial services industry in the United States. They oversee financial markets to ensure that they are fair and orderly, and to protect investors. The role of financial regulators is to facilitate a sound financial services industry that consists of markets, exchanges, and firms that comply with their laws and regulations.
As regulators, the SEC and FINRA exist to keep market participants safe from financial fraud and to help participants to manage their investment risk. There are many reasons why investors should understand the roles and responsibilities of both the SEC and FINRA, as well as how these regulatory bodies differ.
What Is the Financial Industry Regulatory Authority (FINRA)?
FINRA is a government-authorized, not-for-profit organization that oversees U.S. broker-dealers. The organization’s purpose is to protect investors and uphold the integrity of financial markets to ensure they operate fairly. FINRA oversees hundreds of thousands of brokers throughout the U.S., and monitors billions of daily market events.
The SEC supervises FINRA in writing and enforcing investing rules that all registered broker-dealers in the U.S. must follow. FINRA makes sure that these firms comply with these rules, as it facilitates market transparency and educates investors.
💡 Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.
FINRA Regulates Margin Accounts
FINRA also regulates margin accounts, which involve a customer borrowing funds from a firm to make trades. Under FINRA margin requirements, some securities cannot be purchased on margin, in which case a cash account must be used to deposit 100% of the purchase price.
FINRA rules require traders to have 25% or more of the current market value of securities in the account, otherwise they may be required to deposit more funds or securities to meet the 25% threshold. If this requirement is not met, the firm may need to liquidate the securities to bring the account to the required level.
What Is the Securities and Exchange Commission (SEC)?
The SEC is a market regulator whose purpose is to protect investors, maintain fair markets, and facilitate ways for businesses to access capital. This regulatory body consists of 11 regional offices and 6 divisions. It requires public companies, asset managers, and investment professionals to disclose important financial information, so investors are equipped to make the best investment decisions.
The SEC will also enforce federal securities laws to keep lawbreakers accountable in the name of protecting investors. In order to maintain fair and efficient markets, the SEC monitors the market and adjusts rules and regulations according to the evolving market environment.
💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
FINRA vs the SEC
Both institutions were created to protect investors against investment fraud and maintain the integrity of U.S. financial markets, but there are differences between these regulatory agencies.
How are FINRA and the SEC Different?
The SEC was created under the Securities Exchange Act of 1934 and one of its responsibilities is to oversee FINRA, which was created in 2007. FINRA is a self-regulatory organization that oversees and regulates its member’s actions. Unlike the SEC, FINRA is not mandated by the U.S. government. Rather, it’s a private, or self-regulatory organization (SRO) consisting of the registered broker-dealers that FINRA oversees.
The SEC, on the other hand, focuses more on protecting the individual investor. The SEC was born at the advent of the Great Depression in 1929 with the goal of restoring investors’ confidence in financial markets, as well as enforcing the rules. FINRA’s role is narrower. It revolves around regulating brokerage firms and handles the testing and licensing requirements, such as the series 7 exam. All broker dealers must be licensed and registered by FINRA.
How They Are Similar
Both FINRA and the SEC are responsible for protecting investors. Both organizations play important roles in upholding the integrity of the U.S. financial system and take action to protect the public from fraud and other financial bad practices. And both agencies offer tools and insights that help educate investors about how to secure their financial future.
The SEC is the ultimate regulatory watchdog of financial markets, and FINRA regulates the securities industry by overseeing stockbrokers. The work that comes out of the SEC and FINRA helps these agencies to function smoothly. The SEC reviews FINRA’s regulatory work — like managing required industry examinations and inspecting securities firms — which is vital to protecting investors and monitoring financial markets.
FINRA vs the SEC: A Quick Comparison
| FINRA | The SEC | |
|---|---|---|
| What Is It? | A government-authorized not-for-profit that oversees U.S. broker dealers (BDs) | A U.S. government agency; ultimate regulatory watchdog of financial markets |
| What is it’s purpose? | Both uphold integrity of financial markets; maintain fair/ orderly markets; specific regulator for margin accounts | Focuses more on protecting individual investors; created to restore investors’ confidence in financial markets; helps firms to access capital |
| When was it created? | Created in 2007 | Created with the Securities Exchange Act of 1934 |
| Relationship with U.S. Government | Not mandated by U.S. government; a private SRO; consists of registered BDs | A U.S. government agency; born of Great Depression,1929 |
| Function? | Enforces rules; but narrower role than SEC’s; regulates BDs; manages testing/ licensing requirements (e.g., series 7 exam); all BDs must be licensed by FINRA | Enforces rules; oversees FINRA; creates and enforces securities laws |
| Public resources? | Yes, offers tools and insights that help educate investors about how to secure their financial future | Yes, offers tools and insights that help educate investors about how to secure their financial future |
How to Avoid Trouble With FINRA and the SEC
The best way to avoid trouble with FINRA and the SEC is to abide by their rules and regulations. And, if you give your money to an investment or financial professional to manage, you also may want to confirm that this professional is registered with the SEC and licensed to do business in your particular state. It also could be worthwhile to research whether they have ever been disciplined by the regulatory agencies, or if there are any prior complaints against these professionals.
Cash Accounts vs Margin Accounts
Two popular accounts that are typically opened by market participants are either cash accounts or margin accounts. Each type of account comes with its own regulations. With margin accounts — which are regulated by FINRA along with other financial institutions — you have the ability to borrow funds, but with a cash account, you cannot borrow funds.
For investors using cash accounts to purchase securities, there are regulations to abide by. To avoid violations, remember that you can’t borrow funds from your brokerage firm to pay for transactions in your cash account. Transactions using borrowed funds can only be made in a margin account.
The Takeaway
The SEC and FINRA exist to manage U.S. financial markets with investor protection top of mind. Their rules and regulations can adjust according to how the market is evolving. Understanding their mandates and goals is a great tool for investors to understand their rights as market participants in the event they fall victim to fraud.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
Does FINRA approve SEC rules?
No. The SEC is the oversight authority over FINRA, not the other way around.
Is FINRA part of the US federal government?
No. FINRA is an independent, private entity, while the SEC is a government-mandated organization.
Does FINRA report to the SEC?
FINRA is a self-regulatory organization that operates under the purview of the SEC.
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*Borrow at 12%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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