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Securities and Exchange Commission: CNBC Explains

The United States Securities and Exchange Commission—or SEC—is the watchdog of Wall Street.

The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.
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The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.

So how does it work and what power does it really have? CNBC explains.

What is the purpose of the SEC?

The mission of the SEC, as it says on its website is, "to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."

In other words, the SEC is out to catch those in the financial industry who are breaking SEC rules and by doing so, keep the stock markets honest and maintain investor confidence. We'll see how it actually does this in a bit.

As it's set up, the SEC is a federal agency and receives its funding from Congress. The SEC employs approximately 3,500 people from Washington, DC—where it's headquartered—and in its 11 regional offices, which include the cities of New York, Chicago, Los Angeles, Denver, Atlanta and Miami.

How does the SEC work?

The authority given by Congress to the SEC allows it to bring civil enforcement actions against individuals or companies alleged to have committed accounting fraud, bribery, provided false information, or engaged in insider trading or other violations of the securities law.

Its main areas of enforcement are:

  • Insider trading
  • Accounting fraud
  • False or misleading investment information

And the SEC has oversight in all areas involved in the securities markets which include:

  • Securities exchanges
  • Securities brokers and dealers
  • Investment advisors
  • Mutual funds

What are the SEC rules and regulations?

There are a lot of them that you can see by clicking on this link. But more have been added over time, and it's possible more could come in the future as circumstances dictate.

For instance, rules were added through laws like the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform Act.A law from the 1970s let the SEC go after U.S. companies and individuals who pay bribes to officials of foreign governments.

But the bottom line for most of the rules is to keep the markets honest by stopping insider trading, and make sure firms provide up to date and truthful company information to investors.

Who is exempted from SEC rules?

There are some areas of trading that are excluded and would not be subject to SEC regulations. They include:

  • Private stocks or bonds offered to a limited number of persons or institutions
  • Offerings of limited size
  • intrastate offerings
  • securities of municipal, state, and federal governments

The SEC says it allows these exemptions to "foster capital formation by lowering the cost of offering securities to the public."

Does the SEC only cover U.S. companies that are publicly traded?

No. All companies—both domestic and foreign that trade in the U.S.—must file financial statements with the SEC and are subject to SEC regulations.

What are comment letters and no-action letters?

If the SEC has questions about something a company or individual has done that might be illegal—and the emphasis is on might—it sends out what are called comment letters. This is a request for specific information on certain stock buying or selling or accounting practices.

It may mean an investigation but does not necessarily end in charges or prosecution. The answers to the letter may be enough to satisfy the SEC and no further action is taken.

There may be several rounds of letters and responses until the issues are resolved—or charges are made.

No-action letters are letters by the SEC indicating that the staff has not recommend any type of enforcement action against a person or company—if that person or company has engaged in a particular action that came under scrutiny.

What kind of fines or imprisonment can the SEC impose?

None. Only the Justice Department, which includes the FBI, and the U.S. Attorney's office can prosecute anyone in violation of SEC rules.

What happens is that if the SEC wants to charge someone with a crime, it goes to the Justice Department with its case and Justice or the U.S. Attorney's office would prosecute.

Violators are usually then charged with mail and wire fraud—which can lead to a sentence of up to 20 years in prison. More general "securities fraud" would be up to 25 years in prison.

If someone is convicted, they can face up to 20 years in prison for criminal securities fraud and/or a fine of up to $5 million for each "willful" violation of the act and the regulations under it.

Only fines, not imprisonment, apply if the defendant can demonstrate "no knowledge" of the rule or regulation that is violated. Corporations face penalties of up to $25 million for any individual rule violation.

As for prison, terms for insider-trading convictions have lengthened in recent years. From 2009 to 2011 the median jail sentence was 30 months, up from a median term of 18 months during the 2000s. From 1993 through 1999, the median length of prison terms was only just under a year.

And someone charged by the SEC could face civil penalties if they are convicted.

Here's an example of what can happen to someone charged and convicted.

Raj Rajaratnam
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Raj Rajaratnam

Raj Rajaratnam was a former hedge fund manager and founder of the Galleon Group, a New York-based hedge fund management firm.

On October 16, 2009, he was arrested by the FBI on allegations of insider trading—charges first investigated by the SEC.

He stood trial in New York, and on May 11, 2011 was found guilty on all 14 counts of conspiracy and securities fraud. On October 13, 2011, Rajaratnam was sentenced to 11 years in prison and fined with a civil penalty of $92.8 million in November 2011.

Other Wall Street related convictions brought by the SEC include Bernie Madoff,Martha Stewart and Jeff Skilling of Enron fame.

When did the SEC come about?

It was created in 1934 to restore the public’s confidence in the stock market after the Great Depression of 1929.

Before 1929, there was little support for federal regulation of the securities markets. Only some states had laws—called Blue Sky Laws—governing the sale of stocks and bonds to cut down on fraud but they were said to be virtually ineffective.

It was when the stock market crashed in October 1929 that public confidence in the markets plummeted. Investors large and small, as well as the banks who had loaned to them, lost money.

In order for the economy to recover, public faith in the markets needed to be restored. So, Congress quickly held hearings and passed the Securities Act of 1933. This law, together with the Securities Exchange Act of 1934, created the SEC.

How is the SEC set up?

The SEC consists of five commissioners appointed by the President. They hold staggered five-year terms.

One of them is designated by the President as Chairman of the Commission and is the agency's chief executive. By law, no more than three of the Commissioners may belong to the same political party in order to ensure non-partisanship.

The commission convenes regular meetings that are open to the public and the news media—that is unless the discussion is on confidential subjects, such as whether to begin an enforcement investigation.

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