CFP Board Financial Planning Competency Handbook. Board CFP

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associated with the sale of securities. The Act of 1933 clearly defines a security, when and how a security can be sold to the public, and what type of disclosure must accompany the sale of a new security. Further, the law dictates that every financial planner who deals with the sale of new securities must possess an appropriate securities license and exhibit a fundamental understanding of the rules, regulations, and procedures of the Securities and Exchange Commission (SEC) (created the next year). While this law specifically outlines requirements for broker-dealers, it was not until 1940 that investment advisors – those who provide investment advice for a fee – were specifically required to follow federal regulations.

      It is interesting to note, however, that rules from the Securities Act of 1933 are often breached. When this happens, both investment advisors and financial planners come under criticism and increased scrutiny. Consider a 2010 Securities and Exchange Commission ruling regarding World Trade Financial Corporation of San Diego, California. During the period from 2004 to 2005, brokers associated with the firm sold to the public more than 2.3 million shares of a company called iStorage. Investors paid nearly $300,000 for the shares, resulting in more than $9,000 in commissions. Unfortunately for all those involved, the stock was essentially worthless and unregistered. iStorage was the creation of a stock promoter who was known to create companies and subsequently “pump and dump” the stock – a process of stock promotion to increase share prices in an attempt to defraud investors. As a result of the securities violation, the iStorage creator was sentenced for securities fraud, while the firm and its planners were fined and temporarily suspended from conducting business.22 As this example highlights, understanding financial institution laws, rules, and regulations provides only a minimal level of protection for financial planners and their clientele. It is equally important to work within the law and to constantly monitor client portfolios to preempt unscrupulous planners who may attempt to fraudulently deal with clients.

      The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC). According to the SEC, “The Act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation’s securities self-regulatory organizations (SROs). The various stock exchanges, such as the New York Stock Exchange and American Stock Exchange, are SROs. The National Association of Securities Dealers, which operates the NASDAQ system, is also an SRO. The Act also identifies and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and persons associated with them.”23

      Until the late 1930s, the sale of bonds and debt instruments was largely unregulated. The Trust Indenture Act of 1939 required debt securities such as bonds, debentures, and notes to be registered if offered to the general public. This was another important regulatory law that was passed during the Great Depression.

      The Investment Company Act of 1940 was written to regulate “the organization of companies, including mutual funds, that engage primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The regulation was designed to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations. It is important to remember that the Act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments.”24

      Of particular importance to financial planners, however, is the Investment Advisers Act of 1940. This law established investment advisor regulations. The Act requires that firms or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors, unless otherwise exempted in the law. Beginning in 2010, planners who have at least $100 million of assets under management, or advise a registered investment company, must register with the SEC. Other planners are required to register at the state level. Of course, the 1940 Act covers many more aspects of investment. Today, most states require investment advisors to pass a test (Series 65) verifying that they have read the Act and understand the many nuances of the law.

      Federal regulations occurred only incrementally from the 1940s through the later part of the twentieth century. A major law impacting financial planners was drafted in 2002 – the Sarbanes-Oxley Act. This law mandates corporate responsibility and enhanced financial disclosures to combat corporate and accounting fraud. The Act also created the Public Company Accounting Oversight Board to oversee the activities of the auditing profession.

      More recently, the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 was instituted as the most far-reaching piece of financial industry regulation since the Great Depression. The Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law on July 21, 2010. The SEC describes the Act as follows: “The legislation set out to reshape the U.S. regulatory system in a number of areas including but not limited to consumer protection, trading restrictions, credit ratings, regulation of financial products, corporate governance and disclosure, and transparency.”25 Potential impacts of the law on financial planners include likely changes to state and federal regulations defining more explicitly what financial planning entails from a consumer perspective, who may practice as a financial planner, and how financial planners may be compensated.26

      Although many financial planners are less directly impacted, financial planners also need to be aware of banking and insurance regulations. For example, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Fair Debt Collection Practices Act, the S.A.F.E. Mortgage Licensing Act, the Truth in Lending and Savings Acts, the Sarbanes-Oxley Act, the Fair and Accurate Credit Transactions Act, and laws related to privacy of consumer financial information all come into play during the course of a planner’s career. Thus, it is important not only to be aware that these types of banking and insurance regulations exist, but also to acknowledge that certain planning activities may fall under the watchful eye of non-traditional financial planning regulators. For example, financial planners should be mindful that in 1945 the McCarran-Ferguson Act granted the states, rather than the federal government, regulatory authority of insurance companies and products. Although some aspects of the Gramm-Leach-Bliley Act conflict with the 1945 law, it is essential for any planner who works with, provides recommendations about, or sells insurance products to understand the unique laws and rules issued by each state in which the planner works. Rather than reporting to one federal agency or self-regulatory organization, those who practice financial planning using insurance products might be subject to multiple regulatory constraints.

      LEARNING OBJECTIVE

      The student will be able to:

      a. Compare the secondary market institutions and their regulators for each security (stocks, bonds, ETFs, real estate, commodities, and options exchanges) and of primary market institutions (investment banking firms, mutual funds, and hedge funds).

Rationale

      Each country regulates securities markets, broker-dealers, insurance professionals, and financial planners differently. Nearly all federal rules, regulations, and laws directed at the oversight of American financial institutions have resulted from abuses observed in the marketplace. Although financial institutions serve a multitude of stakeholders, including governments and firms, federal regulators tend to introduce laws that limit the market power and scope of operations of banks, trust companies, credit unions, insurance companies, and other investment companies when consumers at the household level are harmed. As such, regulation tends to be reactionary, which often

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