The marketplace for consumer deposits, loans, insurance, and investments exists as a mechanism to facilitate the creation and use of capital. Banks, trust companies, credit unions, insurance companies, and other investment firms operate and compete in this large and interrelated marketplace. There are seven primary laws – each of which is discussed in more detail later in the chapter – and one federal depository insurance system that governs financial institutions and the securities industry.21 These laws have emerged over time in reaction to changes in consumer expectations and corporate responsibilities. Financial planners have an obligation to fully understand and apply regulations of financial institutions in their daily practice of financial planning. As illustrated in the diagram, these regulations impact every aspect of financial planning. When combined, the laws form the foundation for financial institution regulation and the functioning of financial institutions.

      INTRODUCTION

      Financial planners work in a highly regulated environment. Often, financial planners must work within both state and federal regulatory guidelines. There are seven key pieces of federal legislation that impact almost all aspects of financial planning. Many of the rules that dictate current practice were enacted in the 1930s in the wake of the Great Depression. The first legislative rule-making action at that time was the Securities Act of 1933. This Act was written to ensure that investors receive financial and other relevant information concerning securities being offered for public sale, and to prohibit fraud, deceit, and misrepresentations 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