Stock Option
The regulatory structure in the United States is largely the result of financial crises that have occurred at various times. Most regulations are the products of the stock market crash of 1929 and the Great Depression in the 1930s. Some of the regulations may make little economic sense in the current financial market, but they can be traced back to some abuse that legislators encountered, or thought they encountered, at one time.
Furthermore, with the exception of financial institution regulation, the three other forms of regulation are most often a function of the federal government, with state governments playing a secondary role. For that reason, our discussion of regulation in the United States concentrates on the federal government and its agencies. When we discuss certain financial institutions in the United States, we briefly examine the role of state governments.
The United States is firmly committed to regulating the issuance of new securities by means of disclosure. These regulations are contained in two important federal legislations: The Securities Act of 1933 (or the Securities Act) and the Securities Exchange Act of 1934 (or the Exchange Act). The acts have been amended periodically. The Securities Act deals primarily with the distribution of new securities and has two objectives. First, it requires that investors be given adequate and accurate disclosure concerning the securities distributed to the public. Second, it prohibits fraudulent acts and practices, misrepresentations, and deceit in the sale of securities. While the Exchange Act covers many regulatory issues, one provision deals with the periodic disclosure provisions designed to provide current material information about publicly traded securities. Thus, while the Securities Act deals with the disclosure requirements for securities when they are first issued the Exchange Act deals with the periodic disclosure requirements for seasoned securities. The Securities and Exchange Commission (SEC) is empowered with the responsibility for administering the two acts. The SEC was created by the Exchange Act.
None of the disclosure requirements as set forth in the two acts or the activities of the SEC constitute a guarantee, a certification, or an approval of the securities being issued. Moreover, the governments rules do not represent an attempt to prevent the issuance of risky securities. Rather, the governments and the SECs sole motivation in this regard is to supply diligent and intelligent investors with the information needed for a fair evaluation of the securities. This approach to regulation relies heavily upon the efficient market hypothesis, which broadly posits that publicly available, relevant information about the issuers will lead to a correct pricing of freely traded securities in properly functioning markets.
US governmental agencies employ a variety of tools in regulating the public trading in securities market. The SEC has the duty of carefully monitoring the trades that corporate officers, directors, or major stockholders make in the securities of their firms. The provisions are set forth in the Exchange Act. To keep the public abreast of these situations, the SEC publishes insiders trades in its monthly Official Summary of Securities Transactions and Holdings.
The organized exchanges, such as the New York Stock Exchange & the American Stock Exchange, also play a role in regulation by setting conditions for listing traded stocks & bonds & by monitoring the relationships of brokers with the public. In this regard, the National Association of Securities Dealers is an important contributor to the regulation of trading. The NASD is a self-regulatory organization, which has SEC authority to require its more than 5,500 member firms to meet certain standards of conduct in issuing securities and selling them to the public. Another of the NASDs responsibilities has recently become quite well known to the investing public. The NASD polices the over-the-counter or NASDAQ stock market. The market is very large because shares from nearly 4,500 different companies can be traded on any day, and the volume of daily trading is about 2. 1 billion shares. NASDAQ has changed its structure in significant ways recently to address regulatory issues and competitive challenges from the NYSE. Recently competition between NASDAQ and the NYSE with respect to the cost of transactions has been intense.
Two agencies share responsibility for the federal regulation of trading in options and futures. The Commodity Futures Trading Commission (CFTC) licenses futures exchanges and monitors trading in them, and it authorizes firms to operate the exchanges and provide services to the public. The CFTC also approves individual futures contracts, which must serve the economic purpose of being useful for hedging. Approval is not endorsement of a contract, and investors trade these securities at their own risk. The second agency is the SEC, which has responsibility for oversight of options markets, if the asset underlying the option is an equity or set of equities. For e. g. the SEC regulates the Philadelphia Stock Exchange (PHLX), which lists numerous options on individual stocks. In addition, the SEC monitors trading on the Chicago Board of Options Exchange (CBOE), where the Standard & Poor 500 stock index option is traded. Though that option settles in cash, its value reflects the prices of equity shares.
In their work with options and futures, these government agencies receive assistance from several self-regulatory organizations. The most important SRO for futures markets is the National Futures Association (NFA), which has since the early 1980s assisted the CFTC in monitoring trading, preventing fraud, and taking disciplinary action when appropriate. For options, the chief SRO since 1939 has been the NASD. The NASD performs many tasks, including licensing brokers and making sure that they disclose all the risks of options to investors who may want to participate in this market.
The Federal Reserve System (or Fed), an independent agency responsible for the nations money and banking system, places numerous restrictions on depository institutions. For e. g. the Fed sets minimum requirements for equity that banks must have relative to their assets. The current rules are based on a 1988 agreement, called the Basle Agreement, among the major industrialized countries. In the past, the Fed established a maximum level of interest rates commercial banks could pay, but happily, the federal government has discontinued such unproductive rule making. Another governmental agency, the Office of Thrift Supervision (OTS), monitors the type and amount of loans that savings and loan associations make.
Like many countries, the United States regulates participation by foreign firms its domestic financial securities markets. As have most of these countries, however, the United States has been extensively reviewing and changing its policies regarding foreign firms activities in the financial markets. Some of the changes in the last decade have been particularly worthy of note. In 1984, the federal government abolished the withholding tax on interest payments to non-resident holders of bonds issued by US firms and governmental units. In 1986, the SEC decided to allow certain foreign firms that meet their home-country regulations to be active in US markets without having to prove compliance with US rules. In 1987, US markets obtained permission to trade futures based on foreign government bonds, and the SEC decided to allow foreign firms to trade futures based on these bonds. In that same year, the SEC began to permit institutional investors to purchase unregistered shares of foreign firms.
Through the Federal Reserve System, the government controls the money supply and tries to exert influence on the level of economic activity. Commercial banks and other depository institutions participate in that process by following rules that the Fed makes.
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