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Elements of Effective Regulation

Overview

The integrity of world markets is maintained when regulators require investment professionals to register or otherwise demonstrate that they have achieved appropriate credentials through exams, continuing education, and professional experience and knowledge. Understanding and verifying the work experience, responsibilities, and knowledge of those working in the investment business helps ensure that only the most highly qualified, ethically sound professionals serve as investment advisers and analysts.

CFA Institute has a broad range of codes and standards that provide investment professionals and their firms with the ethical foundation necessary to sustain a high level of professional integrity, including the Asset Manager Code and the Code of Ethics and Standards of Professional Conduct

An effective regulatory system does the following:

  • Recognizes the benefits of a stable regulatory environment
  • Recognizes that statutory regulation is not always needed or even the best approach and that deferral to, and support of, relevant and recognized self-regulatory entities may be the best way to address certain issues
  • Works to foster efficient, objective, and transparent markets
  • Uses underlying principles of regulation and enforcement that are consistent for similar transactions and activities
  • Hires regulators with requisite experience and in-depth knowledge of capital markets and the roles and activities of market participants
  • Incorporates sufficient flexibility to respond rapidly and efficiently to changes
  • Maintains sensitivity to the needs of investors when adopting and implementing policies that reduce regulations for certain types of issuers of investment products
  • Keeps cost — in terms of fees, compliance costs, and other burdens imposed on registrants, issuers, and investors — to a minimum
  • Maintains objectivity and accountability with respect to market participants and policymakers

These elements seek qualified and fair-minded regulators that oversee markets that can react and evolve in ways that enhance investor interests.

Around the world, certain entities have been vested with self-regulatory power over defined market sectors. These self-regulatory organizations, or SROs, typically report to statutory regulators, who maintain oversight authority. Given that there are inherent conflicts within a system that relies on participants to govern themselves, the structure of SROs must be balanced.

Trading Market Regulation

A number of practices can help maintain an efficient and transparent inter-market trading system, preventing duplication of regulations and minimizing investor confusion:

  • Encouraging equity-trading facilities within a legal jurisdiction to operate under the same trading regulations
  • Seeking regulatory direction that establishes rules governing how various markets interact with each other − and how they make accessible their inter-market bids and offers
  • Generally promoting fair treatment across markets.

Market Trade Reporting

Transparent and equitable trade reporting; access to price, trading, and market data; and basic minimum listing requirements are all elements of appropriate trading market regulation.

Exchange Listing Standards

Listing standards provide investors with assurances that companies will be required to meet certain standards of responsibility. Maintenance of these standards and the continued preservation of investor confidence are essential for ongoing capital formation.

SROs

The Securities Exchange Act of 1934 (Exchange Act) governs the way in which the nation's securities markets and its brokers and dealers operate. Most "brokers" and "dealers" must register with the SEC and join a "self-regulatory organization," or SRO. SROs generally include exchanges, associations, depositories, and the like.

The Securities and Exchange Commission (SEC) delegates authority to SROs to formulate and enforce standards and rules for securities transactions and broker/dealers.  In 2007, the enforcement arms of the New York Stock Exchange and the National Association of Securities Dealers merged to form a new SRO, the Financial Industry Regulatory Authority (FINRA). Congress created the Municipal Securities Rulemaking Board (MSRB) as an SRO in the mid-1970s to promulgate investor protection rules to govern broker/dealers and banks dealing in tax-exempt bonds, 529 college savings plans, and other types of municipal securities.

The aim of FINRA's equity and debt research analyst and research report rules is to foster objectivity and transparency in research reports and public appearances and provide investors with more reliable and useful information to make investment decisions. 

In general, FINRA's equity and debt research rules require clear, comprehensive and prominent disclosure of conflicts of interest in research reports and public appearances by research analysts. The rules further prohibit certain conduct where the conflicts are considered too pronounced to be cured by disclosure. Several of the equity research rules' provisions implement provisions of the Sarbanes-Oxley Act of 2002, which mandates separation between research and investment banking, proscribes conduct that could compromise a research analyst's objectivity and requires specific disclosures in research reports and public appearances.

FINRA's equity research rules also conform to the JOBS Act (The Jumpstart Our Business Startups Act) of 2012.

FINRA’s Rule 2241 governs conflict conflicts of interest in connection with the publication of equity research reports and public appearances by research analysts.  The rule requires firms to establish and implement policies and procedures to identify and manage research-related conflicts of interest.  Its Rule 2242 governs conflicts of interest in connection with the publication of debt research reports and public appearances by debt research analysts.  The rule imposes requirements similar to Rule 2241 on debt research distributed to retail investors, with some modifications to reflect the unique nature of the debt markets.  The rule specifies the prohibited and permissible interactions between the debt research personnel and sales and trading and principal trading personnel.  The rule also exempts from many of its provisions and all of the specific disclosure requirements debt research that is distributed only to eligible institutional investors. And its Rule 1050 requires equity research analysts to be registered with FINRA and pass a qualification examination or obtain a waiver.  

CFA Institute Viewpoint

Analysts have fiduciary duties toward their clients, duties that exceed those considered acceptable in other business relationships because of the trust placed in them. When analysts serve as fiduciaries, they owe undivided loyalty to their clients and must place client interests before their own. Such priorities enhance investor confidence in the capital markets, and in the reputation of investment research analysts, their firms, and financial markets.

The way firms manage analyst research has considerable impact on the validity and accuracy of the resulting reports. In order to ensure the independence, transparency, and objectivity of analysts' work, firms must avoid a reporting or compensation structure that might create conflicts of interest for analysts.

Firms also need to empower analysts to exercise diligence and thoroughness, providing a reasonable basis for investment recommendations or investment actions; to self-certify their work; to avoid material misrepresentations; and to keep adequate records to support their reports or actions

Our work on analyst objectivity is based on our Research Objectivity Standards, which offer specific, measurable standards for managing and disclosing conflicts of interest and recommend specific practices to guide investment firms and their respective employees.

 

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