Securities and Exchange Commission (SEC) Defined, How It Works

The U.S. Securities and Exchange Commission (SEC) is an independent federal government regulatory agency responsible for protecting investors and maintaining fair and orderly securities markets. Congress created the SEC in 1934 as the first federal regulator of the securities markets. The SEC's efforts are meant to protect shareholders (especially retail investors) against fraudulent and manipulative practices in the market and ensure that companies provide accurate and complete disclosures about significant financial events, including corporate takeovers. It also approves registration statements for bookrunners among underwriting firms.

Securities offered in the U.S. must be registered with the SEC before being sold to investors. Financial services firms such as broker-dealers, advisory firms, asset managers, and their professional representatives must also register with the SEC to do business.

How the Securities and Exchange Commission (SEC) Works

The SEC oversees organizations and individuals in the securities markets, including securities exchanges, brokerage firms, dealers, registered investment advisors, and investment funds. Through established securities rules and regulations, the SEC promotes disclosure and sharing of market-related information, fair dealing, and protection against fraud. It provides investors access to registration statements, periodic financial reports, and other securities forms through its electronic data-gathering, analysis, and retrieval database, better known as EDGAR.

The SEC is headed by five commissioners appointed by the president, one of whom is the chair. The commissioners have a five-year term, but may serve an additional 18 months until a replacement is found. Present SEC chair Gary Gensler took office in April 2021. The law requires that no more than three of the five commissioners come from the same political party to promote nonpartisanship.

The SEC consists of five divisions and 23 offices. Their goals are to interpret and enforce securities laws, issue new rules, oversee securities institutions, and coordinate regulations among different parts of the government. The five divisions and their roles are as follows:

• Division of Corporate Finance: Ensures investors are provided with material information (that is, relevant to a company's financial prospects or price) as they make investment decisions.
• Division of Enforcement: In charge of enforcing SEC regulations by investigating cases and bringing civil suits in federal court and administrative proceedings. It also works with law enforcement agencies like the Federal Bureau of Investigation (FBI), various states' investigatory units, the U.S. Secret Service, and other entities involved in uncovering financial fraud. When necessary, it refers cases to the DOJ for criminal prosecution.
• Division of Investment Management: Regulates investment companies, variable insurance products, and federally registered investment advisors.
• Division of Economic and Risk Analysis: The SEC's economics and data analytics unit.
• Division of Trading and Markets: Establishes and maintains standards for fair, orderly, and efficient markets.

How the SEC Enforces Securities Law

Since the 1930s, the SEC has enforced securities laws and regulations through two primary mechanisms, often in conjunction with criminal cases brought by DOJ and other prosecutorial authorities:

1. Civil action in federal court: The SEC initiates lawsuits in the U.S. District Court, seeking remedies like court orders to halt illegal activities, monetary fines, and the return of illicit profits. Federal judges preside over these cases, giving the defendant the right to a jury trial.
2. Administrative proceedings: These are internal hearings conducted by administrative law judges within the SEC. Administrative actions can lead to injunctions against the activity about which the SEC has concerns, bans on working in the securities industry, financial penalties, and the repayment of profits from an unlawful enterprise.

In civil suits, the SEC seeks three main sanctions:

1. Injunctions: Orders that prohibit future violations. A person or company that ignores an injunction is subject to fines or imprisonment for contempt.
2. Fines: Civil money penalties
3. Disgorgement of illegal profits: In certain cases, the SEC may also seek a court order barring or suspending individuals from acting as corporate officers or directors.

Below is a table of the most common results of the SEC's successful enforcement actions:

The potential forums for the SEC's enforcement actions changed significantly following a June 2024 Supreme Court decision in SEC v. Jarkesy. The court ruled that the SEC's practice of imposing civil penalties through administrative proceedings in cases of securities fraud violates the Seventh Amendment right to a jury trial. The decision requires the SEC to pursue such penalties in federal court, potentially affecting the rapidity and scope of its enforcement actions.

Thus, while the SEC can still pursue some administrative actions (those involving nonmonetary damages), cases involving civil penalties for securities fraud and similar matters (insider trading, accounting fraud, and market manipulation) must now be brought in federal court.

Criminal cases continue to be referred to law enforcement agencies, including the FBI, DOJ, and any relevant agencies in states where crimes are alleged to have occurred.

The SEC also serves as the first level of appeal for actions sought by the securities industry's self-regulatory organizations, such as FINRA or the New York Stock Exchange.

SEC's Office of the Whistleblower

Established in 2011 under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC Whistleblower Office has become a significant part of the agency's enforcement efforts. As the unit's name suggests, the office administers a program that offers major incentives to those who come forward with high-quality information about potential securities law violations.

Since its inception, the Office of the Whistleblower has been highly effective, leading or developing further many successful enforcement actions and recovering billions for investors. Whistleblowers who voluntarily provide original information that results in fines and disgorgements exceeding $1 million are eligible for awards ranging from 10% to 30% of the amount collected.

In fiscal year 2023, the SEC awarded almost $600 million to whistleblowers, its highest yet. "This success directly benefits investors, as whistleblower tips have contributed to enforcement actions resulting in orders requiring bad actors to disgorge more than $4 billion in ill-gotten gains and interest," said Gurbir S. Grewal, director of the SEC’s Division of Enforcement. The awards show "there is a significant incentive for whistleblowers to come forward with accurate information about potential securities law violations."

The SEC Office of the Whistleblower couldn't function without efforts to protect whistleblowers from retaliation, or too many would fear coming forward. The SEC thus also enforces rules prohibiting actions meant to impede those reporting to the SEC or retaliating against them for doing so.

History of the SEC

During the U.S. stock market crash of October 1929, the stocks of many companies quickly became worthless, bankrupting many. Because many had previously provided false or misleading information, public faith in the integrity of the securities markets plunged. To restore investor confidence, Congress passed the Securities Act of 1933, which aimed to ensure more transparency in financial statements so investors could make informed decisions about investments. A year later, Congress passed the Securities Exchange Act of 1934, which created the SEC. The SEC was tasked with ensuring that publicly traded companies made truthful statements about the major aspects of their businesses and that brokers, dealers, and exchanges treated investors in an honest and fair manner. As such, the act granted the SEC broad authority to oversee the securities industry, including the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies.

Beginnings, up to 1970s

The SEC began operations on July 2, 1934. Joseph P. Kennedy, the father of future President John F. Kennedy, was appointed the first chair. During its early years, the SEC played a major part in the rollout of the financial reforms of President Franklin D. Roosevelt's New Deal. The Investment Company Act of 1940 and Investment Advisers Act of 1940 expanded the SEC's regulatory scope to include oversight of investment companies and advisers.

The SEC continued to evolve in the decades after World War II as it responded to new challenges and a boom in U.S. capital markets during an extended period of expansion for the U.S. economy. Major legislation during this period included the Securities Acts Amendments of 1964, which extended SEC oversight to over-the-counter markets and increased disclosure requirements. During this time, the SEC began to focus on insider trading and cases of market manipulation, reflecting the increasing complexity of financial markets.

The Rise of the CFTC

In 1974, Congress established the Commodity Futures Trading Commission (CFTC) to regulate derivatives markets, including futures, options, and swaps. While the SEC oversees securities and capital markets, the CFTC's purview encompasses commodities and their derivatives. Although the two agencies often collaborate on matters of overlapping jurisdiction, such as security futures products, their historical relationship has been characterized more by competition than cooperation.

The tension between them quickly came to a head in 1982, forcing Congress to intervene and compel them to agree to the Shad-Johnson Accord, later written in legislation. The term "accord" was reminiscent of the Camp David Peace Accords between long-standing and bitter adversaries, underscoring the contentious nature of the regulators' relationship. Their rivalry affected the markets, with investors often confused about which of the SEC and CFTC's competing regulations, often for the same investments, to follow. To resolve this confusion, the agreement granted the CFTC exclusive authority over all futures contracts, including those based on broad-based stock indexes. The SEC received jurisdiction over options on securities and stock indexes.

While the accord provided far greater regulatory clarity for investors, the interagency rivalry persisted for decades. Although largely defused in the aftermath of the 2008 financial crisis and subsequent legislation, tensions between the CFTC and SEC have at times resurfaced, most notably over the regulation of cryptocurrencies.

1980s to 2008

In the 1980s and 1990s, the SEC adapted to technological changes, such as the rise of electronic trading platforms and the globalization of financial markets. The National Securities Markets Improvement Act of 1996 was meant to bring greater consistency to state and federal securities regulations. Following major corporate scandals after the dot-com bubble of the late 1990s and early 2000s burst, such as those involving Enron and WorldCom, the Sarbanes-Oxley Act of 2002 (SOX) was passed to regain public confidence in the markets.

The law's changes were meant to be sweeping, though it wouldn't be long before a far greater set of scandals rocked the markets. SOX required corporate executives to personally certify the accuracy of financial statements, making them criminally liable for any misrepresentations. SOX also strengthened auditor independence by restricting the types of non-audit services they can provide to clients (therefore giving companies incentives to look the other way, lest they endanger other parts of their firms) and established the Public Company Accounting Oversight Board (PCAOB) to oversee the audits of public companies.

In 2007, the Financial Industry Regulatory Authority (FINRA) was born from the merger of the National Association of Securities Dealers and the New York Stock Exchange's regulatory arm. FINRA has become the largest independent regulator overseeing broker-dealers in the country.

While the SEC continues to hold a broader mandate, overseeing the entirety of the securities markets and ensuring fair treatment for investors, FINRA focuses on regulating the specific activities of brokerage firms and registered representatives. The SEC's oversight of corporate finance, economic analysis, enforcement, and trading activities is still central. However, FINRA's role in writing and enforcing rules for broker-dealers, examining firms for compliance, and resolving disputes between investors and firms added another layer of protection for the investing public.

Post-Crisis Landscape

The financial crisis of 2007 to 2008 was the SEC's most significant challenge since the Great Depression. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 aimed to prevent future crises by increasing transparency in financial markets and reducing risks within the financial system. Dodd-Frank significantly expanded the SEC's authority to bring administrative proceedings against a broader range of individuals and entities.

Before Dodd-Frank, the SEC could only pursue administrative actions against those directly regulated by the commission, such as registered investment advisors or broker-dealers. The act broadened this authority to include "any person" associated with securities law violations. This means the SEC can now bring administrative actions against a broader range of individuals, including those not directly regulated by the agency, such as corporate officers, employees, and individuals associated with unregistered entities.

Each year, the SEC brings many civil enforcement actions against firms and individuals that violate securities law, and it's involved in every significant case of financial misconduct, either directly or in conjunction with the DOJ. Typical offenses the SEC prosecutes include accounting fraud, disseminating misleading or false information, and insider trading. 

After the financial crisis of 2007 to 2008, the SEC helped prosecute the financial institutions that caused the crisis, returning billions of dollars to investors. It charged 204 entities or individuals and collected almost $4 billion in penalties, disgorgement, and other monetary relief. Goldman Sachs, for example, paid $550 million, then the largest penalty ever for a Wall Street firm and the second-largest in SEC history, exceeded only by the $750 million paid by WorldCom. Given the wounds to the economy, many in the public criticized the agency for not doing enough to bring those responsible to justice.

In June 2024, the Supreme Court's decision in SEC v. Jarkesy brought a significant shift in the SEC's enforcement powers. The ruling addressed the expanded authority granted to the SEC by Dodd-Frank. The majority in Jarkesy determined that the SEC's practice of imposing civil penalties through administrative proceedings in fraud cases violates the Seventh Amendment right to a jury trial. The ruling required the SEC to pursue such penalties in federal court rather than through its in-house administrative law judges. The decision has far-reaching implications for the SEC's enforcement of securities laws, potentially slowing its ability to bring enforcement actions.

The Bottom Line

The SEC is an independent federal agency established in 1934 to regulate the U.S. securities markets and protect investors. Created in the wake of the 1929 stock market crash, the SEC oversees securities exchanges, broker-dealers, investment advisors, and other market participants. It also enforces federal securities laws, proposes securities regulations, and oversees the securities industry, the nation's stock and options exchanges, and other electronic securities markets.

Over time, the SEC's role and authority have evolved in response to changing markets and legislative actions. The agency has played a crucial role in maintaining confidence in U.S. markets, both at home and abroad. However, recent developments, including the 2024 Supreme Court decision in SEC v. Jarkesy, have reshaped the SEC's enforcement abilities. The 2024 ruling limits the SEC's ability to impose civil penalties through administrative proceedings, requiring such actions to be pursued in federal court for securities fraud cases.

As the financial landscape continues to evolve, particularly with the rise of new technologies and investments, the SEC's role remains critical in balancing investor protection with the promotion of capital formation and market efficiency.