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 America. 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.
These regulators 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. Arm yourself with this vital information to help make better investment decisions.
What Is 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 the markets operate fairly. FINRA oversees more than 600,000 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.
Specifically 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.
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 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 have similar responsibilities of 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’ website offers 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: Quick Look
| FINRA | The SEC | |
|---|---|---|
| What Is It? | 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/ how 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 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 this professional has ever been disciplined by the regulatory agencies, or if there are any prior complaints against these professionals.
If you want to take it a step further, you could examine which types of financial instruments this professional recommends. At all times, it’s best to know that you and your investment advisor are aligned with your investment goals; that they are choosing securities that are right for you, your future, and your financial goals.
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.
You can get started investing by opening a brokerage account with SoFi Invest. You might want to take advantage of its new features, like margin lending, which lets you borrow money against your current assets. If you are an active investor who prefers the do-it-yourself approach, SoFi offers all the tools needed so you can make the right investment decisions that are best suited for your investing style and future goals.
FAQ
Does FINRA approve SEC rules?
No. In the line of hierarchy, the SEC is the oversight authority over FINRA.
Is FINRA part of the U.S. 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.
Photo credit: iStock/damircudic
*Borrow at 10%. 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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