Chapter Sixteen

Securities Firms
and Investment
Banks

Copyright © 2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill.
 Services Offered by Securities
Firms Versus Investment Banks

 Securities
Securitiesfirms
firmsand
andinvestment
investmentbanks
bankshelp
helpnet
netsuppliers
suppliersof
offunds
funds
(e.g.,
(e.g.,households)
households)transfer
transferfunds
fundstotonet
netusers
usersof
offunds
funds(e.g.,
(e.g.,
businesses)
businesses)at ataalow
lowcost
costand
andwith
withaamaximum
maximumdegree
degreeofofefficiency
efficiency
 Investment

Investmentbanking
bankinginvolves
involvestransactions
transactionssuch
suchasasthe
theraising
raisingofof
debt
debtand
andequity
equitysecurities
securitiesfor
forcorporations
corporationsororgovernments
governments

 Includes
Includesthetheorigination,
origination,underwriting,
underwriting,andandplacement
placementof ofsecurities
securitiesinin
money
moneyandandcapital
capitalmarkets
marketsfor
forcorporate
corporateororgovernment
governmentissuers,
issuers,as
as
well
wellas
ascorporate
corporatefinance
financeactivities
activities(e.g.,
(e.g.,advising
advisingononmergers
mergersand
and
acquisitions
acquisitions(M&As)
(M&As)and andthe
therestructuring
restructuringof ofexisting
existingcorporations)
corporations)

 Investment
Investmentbanks banksspecialize
specializeininorigination,
origination,underwriting,
underwriting,and
and
distributing
distributingissues
issuesof ofnew
newsecurities
securities(commercial
(commercialside
sideof
ofthe
thebusiness)
business)

 Securities
Securitiesservices
servicesinvolve
involveassistance
assistancein
inthe
thetrading
tradingof
ofsecurities
securitiesin
in
the
thesecondary
secondarymarkets
markets(brokerage
(brokerageservices
servicesor
ormarket
markettrading)
trading)

 Securities
Securitiesfirms
firmsspecialize
specializeininthe
thepurchase,
purchase,sale,
sale,and
andbrokerage
brokerageof
of
existing
existingsecurities
securities(retail
(retailside
sideof
ofthe
thebusiness)
business)
© 2022 McGraw-Hill Education. 16-2
Total Value of U.S. Mergers and Acquisitions
Managed by Investment Banks, 1990-2019

© 2022 McGraw-Hill Education. 16-3

Size, Structure and Composition
of the Industry

 Size
Sizeof
ofthe
theindustry
industryisisusually
usuallymeasured
measuredby bythe
theequity
equitycapital
capitalof
of
firms
firmsparticipating
participatingin
inthe
theindustry
industryrather
ratherthan
thanby
by“asset
“assetsize”
size”

 Equity
Equitycapital
capitalininthe
theindustry
industrywas
was$263.2
$263.2billion
billioninin2018
2018

 Number
Numberofoffirms
firmsin
inthe
theindustry
industrychanged
changeddramatically
dramaticallyover
overtime,
time,
with
withthe
themajor
majorcause
causebeing
beingregulatory
regulatorychanges
changes(e.g.,
(e.g.,Financial
Financial
Service
ServiceModernization
ModernizationActActof
of1999)
1999)

 5,248
5,248firms
firmsinin1980
1980

 9,515
9,515firms
firmsinin1987
1987

 5,052
5,052firms
firmsinin2006
2006

 3,788
3,788firms
firmsinin2018
2018

 Investment
Investmentbanking
bankingindustry
industrywas
wasirrevocably
irrevocablychanged
changedas
asaa
result
resultof
ofthe
thefinancial
financialcrisis
crisis

 Five
Fivelargest
largestinvestment
investmentbanks
banksat
atthe
thebeginning
beginningof
of2008
2008were
wereall
all
gone
goneasasinvestment
investmentbanks
banksby
bythe
theend
endof
ofthe
theyear
year
© 2022 McGraw-Hill Education. 16-4
Subgroups of Industry Firms


 Firms
Firmsin
inthe
theindustry
industrycan
canbe
bedivided
dividedalong
alongseveral
severaldimensions:
dimensions:

 Largest
Largestfirms
firmsare
arediversified
diversifiedfinancial
financialservice
service(or
(ornational
nationalfull-service)
full-service)
investment
investmentbanks
banksthat
thatservice
serviceboth
bothretail
retailand
andcorporate
corporatecustomers
customers

 Assist
Assistretail
retailcustomers
customersby
byacting
actingas
asbroker-dealers
broker-dealers
 Assist

Assistcorporate
corporatecustomers
customersby
bysecurities
securitiesunderwriting
underwriting

 National
Nationalfull-service
full-servicefirms
firmsfall
fallinto
intothree
threesubgroups:
subgroups:
1.1. Commercial
Commercialbanks banks(or(orfinancial
financialservices
servicesholding
holdingcompanies)
companies)are
arethethe
largest
largestofofthe
thefull-service
full-serviceinvestment
investmentbanks
banks(e.g.,
(e.g.,JPMorgan)
JPMorgan)and
and
have
haveextensive
extensivedomestic
domesticand andinternational
internationaloperations
operations
2.2. National
Nationalfull-service
full-servicefirms
firmsspecialize
specializemore
moreinincorporate
corporatefinance
financeoror
primary
primarymarket
marketactivities
activitiesandandare
arehighly
highlyactive
activeinintrading
tradingsecurities,
securities,
or
orsecondary
secondarymarket
marketactivities
activities(e.g.,
(e.g.,Goldman
GoldmanSachs)
Sachs)
3.3. Large
Largeinvestment
investmentbanksbanksmaintain
maintainmore
morelimited
limitedbranch
branchnetworks
networks
concentrated
concentratedininmajor
majorcities
citiesoperating
operatingwith
withpredominantly
predominantly
institutional
institutionalclient
clientbases
bases(e.g.,
(e.g.,Greenhill
Greenhill&&Co.)
Co.)
© 2022 McGraw-Hill Education. 16-5
Subgroups of Industry Firms
(Continued)

 Remainder
Remainderof ofindustry
industryisiscomprised
comprisedof
offirms
firmsthat
thatperform
performaamix
mix
of
ofprimary
primaryand
andsecondary
secondarymarket
marketservices
servicesfor
foraaparticular
particular
segment
segmentofofthe
thefinancial
financialmarkets:
markets:

 Regional
Regionalsecurities
securitiesfirms
firms
 E.g.,

E.g.,Raymond
RaymondJames
JamesFinancial
Financial

 Specialized
Specializeddiscount
discountbrokers
brokers
 E.g.,

E.g.,Charles
CharlesSchwab
Schwab

 Specialized
Specializedelectronic
electronictrading
tradingsecurities
securitiesfirms
firms
 E.g.,

E.g.,E*Trade
E*Trade

 Venture
Venturecapital
capitaland
andprivate
privateequity
equityfirms
firms

 Other
Otherfirms
firmsinclude
includeresearch
researchboutiques,
boutiques,companies
companieswith withlarge
large
clearing
clearingoperations,
operations,and
andother
otherfirms
firmsthat
thatdo
donot
notfitfitinto
intoone
oneofofthe
the
categories
categoriesabove
above
© 2022 McGraw-Hill Education. 16-6
 Investment Banking


 Investment
Investmentbanking
bankingrefers
refersto
toactivities
activitiesrelated
relatedto
tounderwriting
underwritingand
and
distributing
distributingnew
newissues
issuesof
ofdebt
debtand
andequity
equitysecurities
securities

 New
Newissues
issuescan
canbebeeither
eitherfirst-time
first-timeissues
issuesofofaacompany’s
company’sdebt
debtor
or
equity
equitysecurities
securitiesororthe
thenew
newissues
issuesofofaafirm
firmwhose
whosedebt
debtor
orequity
equityisis
already
alreadytrading
trading(i.e.,
(i.e.,seasoned
seasonedissues)
issues)

 $10.86
$10.86trillion
trillionof
ofdebt
debtand
andequity
equitywas
wasunderwritten
underwrittenglobally
globallyin
in2019
2019

 Securities
Securitiesunderwriting
underwritingcan
canbe
beundertaken
undertakenthrough
througheither
eitherpublic
publicor
or
private
privateofferings
offerings

 Public
Publicoffering
offeringrepresents
representsthe
thesale
saleof
ofaasecurity
securityto
tothe
thepublic
publicat
atlarge
large

 Securities
Securitiesmay
maybe
beunderwritten
underwrittenon
onaabest
bestefforts
effortsor
oraafirm
firmcommitment
commitmentbasis
basis

 In
Inaaprivate
privateoffering,
offering,an
aninvestment
investmentbankbankacts
actsas
asaaprivate
privateplacement
placement
agent for a fee, placing the securities with one or a few large
agent for a fee, placing the securities with one or a few large
institutional
institutionalinvestors
investors(e.g.,
(e.g.,life
lifeinsurance
insurancecompanies)
companies)

 Investment
Investmentbank
bankmay
mayalso
alsoparticipate
participateas
asan
anunderwriter
underwriterin
in
government,
government,municipal,
municipal,and
andmortgage-backed
mortgage-backedsecurities
securities
© 2022 McGraw-Hill Education. 16-7
 Venture Capital


 Difficulty
Difficultyfor
fornew
newand andsmall
smallfirms
firmsin
inobtaining
obtainingdebt
debtfinancing
financing
from
fromCBs
CBsisisthat
thatCBs
CBsare
aregenerally
generallynot
notwilling
willingtotomake
makeloans
loansto
to
new
newcompanies
companieswith withno
noassets
assetsor
orbusiness
businesshistory
history
 Venture

Venturecapital
capital (VC)
(VC)isisaaprofessionally
professionallymanaged
managedpool poolof
of
money
moneyusedusedtotofinance
financenewnewand
andoften
oftenhigh-risk
high-riskfirms
firms

 Generally
Generallyprovided
providedto toback
backananuntried
untriedcompany
companyand andits
itsmanagers
managers
ininreturn
returnforforan
anequity
equityinvestment
investmentininthe
thefirm
firm

 VCVCfirms
firmsarearenot
notgenerally
generallypassive
passiveinvestors;
investors;they
theyprovide
providevaluable
valuable
expertise
expertiseto tothe
thefirm’s
firm’smanagers
managersandandmay
mayhelp
helpwith
withrecruiting
recruiting

 Many
Manydifferent
differenttypes
typesof ofVC
VCfirms:
firms:
 Institutional

InstitutionalVC
VCfirms
firmsare
arebusiness
businessentities
entitieswhose
whosesole
solepurpose
purposeisisto
to
find
findand
andfund
fundthe
themost
mostpromising
promisingnew
newfirms
firms
 Include
Includelimited
limitedpartner
partnerVC
VCfirms,
firms,financial
financialVC
VCfirms,
firms,and
andcorporate
corporateVC
VCfirms
firms
 Angels

Angelsare
arewealthy
wealthyindividuals
individualswho
whomake
makeequity
equityinvestments
investments
© 2022 McGraw-Hill Education. 16-8
 Venture Capital vs. Private Equity


 VC
VCand
andprivate
privateequity
equity(PE)
(PE)are
areoften
oftenused
usedinterchangeably,
interchangeably,but
but
there
thereare
aredistinct
distinctdifferences
differencesin
inthe
thetwo
twotypes
typesof
ofinvestments:
investments:

 VC
VCfirms
firmsconcern
concernthemselves
themselvesmore morewith
withstartup
startupbusiness
business
concerns
concerns

 VC
VCfirms
firmstend
tendtotoutilize
utilizeteams
teamsofofeither
eitherscientific
scientificor
orbusiness
business
professionals
professionalstotohelp
helpidentify
identifynew
newand
andemerging
emergingtechnologies
technologiesinin
which
whichtotoplace
placetheir
theirmoney
money

 PE
PEfirms
firmsdeal
dealmore
morewithwithexisting
existingcompanies
companiesthatthathave
havealready
already
proven
proventhemselves
themselvesininthe thebusiness
businessfield
field


 As
Asaaresult
resultof
ofthe
thefinancial
financialcrisis,
crisis,the
thedifferences
differencesbetween
betweenVC
VC
and
andPE
PEfirms
firmshave
havebecome
becomeless
lessdistinct
distinct

 Fewer
Fewernew
newventures
venturesbeing
beingbrought
broughtforth forthmeans
meansgreater
greater
competition
competitionbetween
betweenVC
VC and
and
© 2022
PEPEfirms
McGraw-Hill firms
Education. 16-9
 Market Making


 Market
Marketmaking
making involves
involvesthe
thecreation
creationof
ofaasecondary
secondarymarket
marketin
in
an
anasset
assetby
byaasecurities
securitiesfirm
firmororinvestment
investmentbank
bank
 Market

Marketmaking
makingcan
caninvolve
involveeither
eitheragency
agencyor
orprincipal
principal
transactions:
transactions:

 Agency
Agencytransactions
transactionsare
aretwo-way
two-waytransactions
transactionsmade
madeon onbehalf
behalfofof
customers
customers

 In
Inprincipal
principaltransactions,
transactions,the
themarket
marketmaker
makerseeks
seekstotoprofit
profiton
onthe
the
price
pricemovements
movementsof ofsecurities
securitiesand
andtakes
takeseither
eitherlong
longor
orshort
short
inventory
inventorypositions
positionsfor
forits
itsown
ownaccount
account

 Designated
Designatedmarket
marketmakers
makers(DMMs)
(DMMs) provide
provideliquidity
liquidityin
inaa
given
givenNYSE
NYSEsecurity
securityby
byassuming
assumingrisk
riskand
anddisplaying
displayingquotes
quotes
in
inthe
theexchange
exchangelimit
limitorder
orderbook
book

 Accounted
Accountedfor forabout
about17%
17%of
ofliquidity
liquidityadding
addingvolume
volumeininNYSE-listed
NYSE-listed
securities
securitiesinin2019
2019
© 2022 McGraw-Hill Education. 16-10
 Trading


 Trading
Tradingisisclosely
closelyrelated
relatedtotomarket-making;
market-making;aatradertradertakes
takesan
an
active
activenet
netposition
positionininan
anunderlying
underlyinginstrument
instrumentor orasset
asset
 There

Thereare
areatatleast
leastsix
sixtypes
typesof
oftrading
tradingactivities:
activities:
1.1. Position
Positiontrading
tradinginvolves
involvespurchases
purchasesof oflarge
largeblocks
blocksofofsecurities
securitieson on
the
theexpectation
expectationof ofaafavorable
favorableprice
pricemove
move
2.2. Pure
Purearbitrage
arbitrageinvolves
involvesbuying
buyingan anasset
assetininone
onemarket
marketatatone
oneprice
price
and
andselling
sellingititimmediately
immediatelyininanother
anothermarket
marketat ataahigher
higherprice
price
3.3. Risk
Riskarbitrage
arbitrageinvolves
involvesbuying
buyingsecurities
securitiesininanticipation
anticipationofofsome
some
information
informationrelease
release(e.g.,
(e.g.,merger
mergeror ortakeover
takeoverannouncement)
announcement)
4.4. Program
Programtrading
tradingisisthe
thesimultaneous
simultaneousbuyingbuyingandandselling
sellingof
ofaaportfolio
portfolio
of
ofat
atleast
least15 15different
differentstocks
stocksvalued
valuedat atmore
morethan
than$1$1million,
million,using
using
computer
computerprograms
programsto toinitiate
initiatesuch
suchtrades
trades
5.5. Stock
Stockbrokerage
brokerageinvolves
involvestrading
tradingsecurities
securitiesononbehalf
behalfofofcustomers
customers
6.6. Electronic
Electronicbrokerage
brokerageinvolves
involvesdirect
directassess,
assess,viaviathe
theInternet,
Internet,totothe
the
trading
tradingfloor,
floor,therefore
thereforebypassing
bypassingtraditional
traditionalbrokers
brokers
© 2022 McGraw-Hill Education. 16-11
Investing and Cash Management


 Investing
Investinginvolves
involvesmanaging
managingpools
poolsof
ofassets
assetssuch
suchas
as
closed-
closed-and
andopen-end
open-endmutual
mutualfunds
funds

 Securities
Securitiesfirms
firmscan
canmanage
managesuch
suchfunds
fundseither
eitheras
asagents
agentsforfor
other
otherinvestors
investorsor oras
asprincipals
principalsfor
forthemselves
themselvesandandtheir
their
stockholders
stockholders

 Objective
Objectiveininfunds
fundsmanagement
managementisisto toselect
selectasset
assetportfolios
portfoliosto
to
beat
beatsome
somereturn-risk
return-riskperformance
performancebenchmark,
benchmark,suchsuchas
asthe
the
S&P
S&P500
500Index
Index

 Securities
Securitiesfirms
firmsand
andinvestment
investmentbanks
banksoffer
offerbank
bankdeposit-
deposit-
like
likecash
cashmanagement
managementaccounts
accounts(CMAs),
(CMAs),money
moneymarket
market
mutual
mutualfunds
fundsthat
thatoffer
offercheckwriting
checkwritingprivileges
privileges

 Can
Canbebecovered
covereddirectly
directlyor
orindirectly
indirectlyby
byfederal
federaldeposit
deposit
insurance
insurancefrom
fromthe
theFDIC
FDIC
© 2022 McGraw-Hill Education. 16-12
 Mergers and Acquisitions


 Investment
Investmentbanks
banksfrequently
frequentlyprovide
provideadvice
adviceon,
on,and
and
assistance
assistancein,
in,mergers
mergersand
andacquisitions
acquisitions

 Assist
Assistininfinding
findingmerger
mergerpartners
partners

 Underwrite
Underwriteany anynewnewsecurities
securitiesto
tobe
beissued
issuedby
bythe
themerged
mergedfirms
firms

 Assess
Assessthe thevalue
valueof oftarget
targetfirms
firms

 Recommend
Recommendterms termsofofthe
themerger
mergeragreement
agreement

 Assist
Assisttarget
targetfirms
firmsininpreventing
preventingaamerger
merger

 Mergers

Mergersand
andacquisitions
acquisitions activity
activity

 $1.82
$1.82trillion
trillioninin2019
2019

© 2022 McGraw-Hill Education. 16-13

Other Service Functions


 Other
Otherservice
servicefunctions
functionsinclude
includethe
thefollowing:
following:

 Custody
Custodyand
andescrow
escrowservices
services

 Clearance
Clearanceand
andsettlement
settlementservices
services

 Research
Researchand
andadvisory
advisoryservices
services

 In
Inperforming
performingthese
thesefunctions,
functions,investment
investmentbanks
banksnormally
normallyact
act
as
asagents
agentsfor
foraafee
fee

 Fees
Feescharged
chargedare areoften
oftenbased
basedononthe
thetotal
totalbundle
bundleof
ofservices
services
performed
performedforforthe
theclient
clientby
bythe
thefirm
firm

 Portion
Portionof
ofthe
thefee
feeor
orcommission
commissionallocated
allocatedtotoresearch
researchand
and
advisory
advisoryservices
servicesisiscalled
calledsoft
softdollars
dollars

 IBs
IBsare
aremaking
makingincreasing
increasinginroads
inroadsinto
intotraditional
traditionalbank
bankservice
service
areas,
areas,such
suchas
assmall-business
small-businesslending
lendingand
andthe
thetrading
tradingof
of
loans
loans
© 2022 McGraw-Hill Education. 16-14
Recent Trends

 Industry

Industrytrends
trendsdepend
dependheavily
heavilyon
onthe
thestate
stateof
of the
thestock
stock
market
market and
andthe
theeconomy
economy

 Commission
Commissionincomeincomefell
fellafter
afterthe
the1987
1987stock
stockmarket
marketcrash
crash
 Record

Recordstock
stockmarket
markettrading
tradingvolumes
volumesbetween
between19921992
through
through20002000resulted
resultedininaarecovery
recoveryin incommission
commissionincome
income
 Improvements

Improvementsin inthe
theU.S.
U.S.economy
economyin inthe
themid-2000s
mid-2000sled ledto
to
even
evengreater
greaterincreases
increasesin incommission
commissionincome,income,butbutincome
income
fell
fellwith
withthethestock
stockmarket
marketinin2006-2008,
2006-2008,due dueto
torising
risingoil
oil
prices
pricesandandthe
thesubprime
subprimemortgage
mortgagecollapse
collapse
 Commission

Commissionincomeincomeagain
againrose
rosein inthe
theearly
earlyand
andmid-
mid-
2010s,
2010s,as asthe
theeconomy
economyand andthe
thestock
stockmarket
marketrecovered,
recovered,
but
butititstarted
starteddeclining
decliningagain
againin inlate
late2010s
2010s

© 2022 McGraw-Hill Education. 16-15

 Recent Trends (Continued)


 By
Bythe
themid-2010s,
mid-2010s,whilewhilethe
theindustry
industryhadhadput
putmost
mostproblems
problems
from
fromthe
thefinancial
financialcrisis
crisisbehind
behindit,
it,the
theindustry
industrywas
wasaffected
affectedbyby
post-crisis
post-crisisconsequences,
consequences,withwithincreased
increasedregulation
regulationon
onrisk
risk
taking
takingand
andcapital
capitalrequirements
requirements

 Result
Resultof
ofnew
newregulations
regulationsisisthat
thatprofitability
profitabilityisisdown:
down:pretax
pretaxprofits
profits
inin2013,
2013,2014,
2014,and
and2015
2015fell
fellto
to$26.3b,
$26.3b,$27.0b,
$27.0b,and and$23.8b,
$23.8b,
respectively
respectively

 Since
Since2013,
2013,many
manycompanies
companieshave
havetaken
takenstrategic
strategicinitiatives
initiativesto
to
respond
respondto
tonew
newregulations
regulationsand
andde-risk
de-risktheir
theirfirms
firms

 Led
Ledto
tobalance
balancesheet
sheetreductions,
reductions,asaswell
wellas
asdownsizing
downsizingor or
disposition
dispositionofofselect
selectbusinesses,
businesses,trading
tradingproducts,
products,and
andinvestments
investments

 Corporate
Corporatestrategies
strategiesincreasingly
increasinglyfocus
focusononclient
clientservices
servicesand
and
away
awayfrom
frommaking
makinglarge
largebets
betsthrough
throughprincipal
principalinvestments
investments
© 2022 McGraw-Hill Education. 16-16
Securities Industry Pretax Profits,
in billions of dollars, 2001 - 2018

© 2022 McGraw-Hill Education. 16-17

Balance Sheets


 Assets
Assets

 Many
Manyof ofthe
theassets
assetsappearing
appearingononthe
thebalance
balancesheet
sheetofofsecurities
securities
firms
firmsare
arecash
cashlike
likemoney
moneymarket
marketinstruments,
instruments,not
notcapital
capitalmarket
market
positions
positions

 Receivables
Receivablesfromfromother
otherbroker-dealers
broker-dealersaccounted
accountedfor
for29.3%
29.3%ofof
total
totalassets
assets

 Reverse
Reverserepurchase
repurchaseagreements
agreementsaccounted
accountedforfor29.1%
29.1%ofofassets
assets

 Long
Longpositions
positionsininsecurities
securitiesand
andcommodities
commoditiesaccounted
accountedforfor
22.6%
22.6%of ofassets
assets

© 2022 McGraw-Hill Education. 16-18

 Balance Sheets (Continued)


 Liabilities
Liabilities

 Major
Majorsimilarity
similaritybetween
betweensecurities
securitiesfirms
firmsand
andallallother
othertypes
typesof
ofFIs
FIs
isisaahigh
highdegree
degreeof offinancial
financialleverage
leverage(i.e.,
(i.e.,all
allthese
thesefirms
firmshold
holdhigh
high
levels
levelsof ofdebt)
debt)

 Difference
Differenceininthe thefunding
fundingisisthat
thatsecurities
securitiesfirmsfirmstend
tendto touse
use
liabilities
liabilitiesthat
thatare
areextremely
extremelyshort-term
short-termand andmarket-based
market-based

 Repurchase
Repurchaseagreements
agreementswere werethe
themajor
majorsource
sourceof offunds,
funds,
amounting
amountingto to34.3%
34.3%of oftotal
totalliabilities
liabilitiesand
andequity
equity

 Other
Othermajor
majorsources
sourcesof offunds
fundswere
werepayables
payablesto tocustomers
customers(21.5%),
(21.5%),
payables
payablesto toother
otherbroker-dealers
broker-dealers(11.9%),
(11.9%),and andsecurities
securitiesand
and
commodities
commoditiessold soldshort
shortfor
forfuture
futuredelivery
delivery(8.3%)
(8.3%)

 Equity
Equity

 Equity
Equitycapital
capitalamounted
amountedto toonly
only6.1%
6.1%of
oftotal
totalassets,
assets,while
whiletotal
total
capital
capital(equity
(equitycapital
capitalplus
plussubordinated
subordinatedliabilities)
liabilities)accounted
accountedfor
for
9.1%
9.1%ofoftotal
totalassets
assets
© 2022 McGraw-Hill Education. 16-19
Assets and Liabilities of Broker-
Dealers, in billions of dollars, 2016

© 2022 McGraw-Hill Education. 16-20

Regulation


 Securities
Securitiesand
andExchange
ExchangeCommission
Commission(SEC)
(SEC)isisthe
theprimary
primary
regulator
regulatorof
ofthe
thesecurities
securitiesindustry
industry

 Established
Establishedinin1934
1934largely
largelyininresponse
responseto toabuses
abusesby bysecurities
securitiesfirms
firms
that
thatmany
manyat atthe
thetime
timefelt
feltwere
werepartly
partlyresponsible
responsiblefor
forthe
theeconomic
economic
problems
problemsininthe
theU.S.
U.S.

 Primary
Primaryrole
roleofofSEC
SECincludes
includesadministration
administrationof ofsecurities
securitieslaws,
laws,review
review
and
andevaluation
evaluationofofregistrations
registrationsof ofnew
newsecurities
securitiesofferings,
offerings,review
reviewandand
evaluation of annual and semiannual reports summarizing
evaluation of annual and semiannual reports summarizing the the
financial
financialstatus
statusofofall
allpublicly
publiclyheld
heldcorporations,
corporations,and
andthe
theprohibition
prohibitionof of
any
anyform
formof
ofsecurity
securitymarket
marketmanipulation
manipulation

 National
NationalSecurities
SecuritiesMarkets
MarketsImprovement
ImprovementAct
Act(NSMIA)
(NSMIA)of of1996
1996
reaffirmed
reaffirmedsignificance
significanceof
ofSEC
SECas
asprimary
primaryregulator;
regulator;states
statesare
arenot
not
allowed
allowedtoto

 Require
Requirefederally
federallyregistered
registeredsecurities
securitiesfirms
firmstotobe
beregistered
registeredininaastate
state

 Require
Requireregistrations
registrationsof
ofsecurities
securitiesfirms’
firms’transactions
transactionsor
orimpose
impose
substantive
substantiverequirements
requirementson onprivate
privateplacements
placements
© 2022 McGraw-Hill Education. 16-21
 Regulation (Continued)


 While
WhilethetheSEC
SECsets setsthe
theoverall
overallregulatory
regulatorystandards
standardsforforthe
the
industry,
industry,the
theFinancial
FinancialIndustry
IndustryRegulatory
RegulatoryAuthority
Authority(FINRA)
(FINRA)
isisinvolved
involvedin inthe
theday-to-day
day-to-dayregulation
regulationof oftrading
tradingpractices
practices
  FINRA
FINRAisisananindependent,
independent,not-for-profit
not-for-profitorganization
organization
authorized
authorizedby byCongress
Congress
  FINRA
FINRAwrites
writesand andenforces
enforcesrules
rulesgoverning
governingthetheactivities
activitiesof
of
securities
securitiesfirms,
firms,examines
examinesfirms
firmsfor
forcompliance
compliancewith
withthose
those
rules,
rules,works
worksto tofoster
fostermarket
markettransparency,
transparency,and andsupports
supports
investor
investoreducation
education
  FINRA
FINRAmonitors
monitorstradetradeabuses,
abuses,trading
tradingrule
ruleviolations,
violations,and
and
securities
securitiesfirms’
firms’capital
capital(solvency
(solvencypositions)
positions)
  FINRA
FINRAalso
alsoperforms
performsmarket
marketregulation
regulationunder
undercontract
contractfor
forthe
the
major
majorU.S.
U.S.stock
stockexchanges
exchanges
 Wall

WallStreet
StreetReform
Reformand andConsumer
ConsumerProtection
ProtectionActActof
of2010
2010
© 2022 McGraw-Hill Education. 16-22
Regulation (Concluded)


 U.S.
U.S.Congress
Congressalso
alsooversees
overseesthe
theindustry
industry

 U.S.
U.S.Senate
SenatePermanent
PermanentSubcommittee
Subcommitteeon onInvestigations
Investigationswas
was
created
createdwith
withthe
thebroad
broadmandate
mandatetotodetermine
determinewhether
whetherany
any
changes
changesare
arerequired
requiredininU.S.
U.S.law
lawto
tobetter
betterprotect
protectthe
thepublic
public

 Spring
Springof
of2010
2010
 Subcommittee

Subcommitteehearing
hearingfocused
focusedon
onthe
thecontributing
contributingrole
roleof
of
investment
investmentbanks
banks(e.g.,
(e.g.,Goldman
GoldmanSachs)
Sachs)ininthe
thefinancial
financialcrisis
crisis
 Subcommittee

Subcommitteebrought
broughtup upevidence
evidenceandandinternal
internalGoldman
Goldman
documents
documentsthat thatshowed
showedGoldman
Goldmanknew
knewthe
thehousing
housingmarket
marketwas
was
on
onthe
thebrink
brinkofofcollapse
collapsebutbutcontinued
continuedtotosell
sellmortgage-backed
mortgage-backed
securities
securitiestotoinvestors
investors
 Goldman

Goldmanallegedly
allegedlybetbetagainst
againstthe
thesecurities
securitiesititbuilt
builtand
andsold
soldwith
with
the
theknowledge
knowledgethatthatthe
thehousing
housingmarket’s
market’scollapse
collapsewould
wouldbring
bringthe
the
firm
firmaasizable
sizablepayday
payday
© 2022 McGraw-Hill Education. 16-23
Securities Investor Protection
Corporation (SIPC)

 Securities
SecuritiesInvestor
InvestorProtection
ProtectionCorporation
Corporation(SIPC)
(SIPC)protects
protects
investors
investorsagainst
againstlosses
lossesof
ofup
upto
to$500,000
$500,000on onsecurities
securitiesfirm
firm
failures
failures

 Not
Notananagency
agencyor orestablishment
establishmentof ofthe
theU.S.
U.S.government,
government,and andhas
has
no
noauthority
authorityto
toinvestigate
investigateor
orregulate
regulateitsitsmember
memberbroker-dealers
broker-dealers

 Created
Createdunder
underthetheSecurities
SecuritiesInvestor
InvestorProtection
ProtectionActActofof1970
1970as asaa
non-profit
non-profitmembership
membershipcorporation
corporation

 Oversees
Overseesthe theliquidation
liquidationof
ofmember
memberbroker-dealers
broker-dealersthat thatclose
close
when
whenthethebroker-dealer
broker-dealerisisbankrupt
bankruptor orininfinancial
financialtrouble
troubleand and
customer
customerassets
assetsarearemissing
missing

 Focus
Focusisison
onrestoring
restoringcustomer
customercash
cashand andsecurities
securitiesleft
leftininthe
the
hands
handsof ofbankrupt
bankruptof ofotherwise
otherwisefinancially
financiallytroubled
troubledbrokerage
brokerage
firms
firms
© 2022 McGraw-Hill Education. 16-24
 Global Issues


 Securities
Securitiesfirms
firmsand
andinvestment
investmentbanks
banksare
areby
byfar
farthe
themost
mostglobal
global
of
ofany
anygroup
groupof
offinancial
financialinstitutions
institutions

 Both
BothU.S.
U.S.and
andEuropean
EuropeanIBs
IBscompete
competefor
forbusiness
businessworldwide
worldwide

 As
Asdomestic
domesticsecurities
securitiestrading
tradingand
andunderwriting
underwritinggrew
grewininthe
the1990s
1990s
and
and2000s,
2000s,sosodid
didforeign
foreignsecurities
securitiestrading
tradingand
andunderwriting
underwriting
 Result

Resultof
ofthe
thefinancial
financialcrisis
crisisininthe
thelate
late2000s
2000swas
wasthat
thatlarge
large
investment
investmentbanks
banksaround
aroundthetheworld
worldbecame
becamemore
moreconcerned
concernedthan
than
ever
everwith
withcapital,
capital,liquidity,
liquidity,and
andleverage;
leverage;however,
however,they
theydid
didnot
not
want
wantto
tolose
loseground
groundin inthe
theglobal
globalcompetition
competitionfor
forclients
clients

 Global
GlobalIBs
IBslooked
lookedfor
forstrategic
strategicalliances
alliancesthat
thatwould
wouldallow
allowthem
themtoto
compete
competeininforeign
foreignmarkets,
markets,ororthey
theyexited
exitedthose
thosemarkets
marketsaltogether
altogether

 One
Oneofofthe
themore
moregrievous
grievousactions
actionsbybysome
someglobal
globalIBs
IBsduring
duringthe
the
financial
financialcrisis
crisiswas
wasthe
themanipulation
manipulationof
ofthe
theLIBOR
LIBOR
© 2022 McGraw-Hill Education. 16-25
Foreign Transactions in U.S.
Securities Markets

© 2022 McGraw-Hill Education. 16-26

U.S. Transactions in Foreign
Securities Markets

© 2022 McGraw-Hill Education. 16-27

Value of International Security
Offerings (in billions of dollars)

© 2022 McGraw-Hill Education. 16-28