How Investment Banks Are Regulated

Investment banks in the United States are continuously reviewed and regulated by the Securities and Exchange Commission, or SEC. They are also occasionally regulated and investigated by Congress. Investment banks technically exist because they were legally distinguished from commercial banks through prior acts of Congress.

Investment Banks and Glass-Steagall

Investment banks became an official legal designation following the Banking Act of 1933, commonly referred to as Glass-Steagall. The Banking Act was a response by Congress to the financial calamity of the Great Depression, where more than 10,000 banks closed their doors or suspended operations.

Proponents of Glass-Steagall argued that the financial sector would be less risky by reducing conflicts of interest between banks and customers. Hearings were held by the Pecora-Glass Subcommittee to determine whether depositors faced undue risks from banks with security affiliates. No substantial evidence was ever presented, and it was determined that banking should be separated but protected by the Federal Deposit Insurance Corporation, or FDIC.

This gave rise to investment-only banks. Congress defined them as banks in the business of underwriting and dealing in securities. By contrast, commercial banks became defined as those that took deposits and made loans.

The barriers between commercial and investment bank affiliation were removed in 1999 by the Financial Services Modernization Act, or Gramm-Leach-Bliley. In this legislation, a broader term was adopted for all types of money intermediaries—financial institutions.

Key Congressional Regulations Affecting Investment Banks

Several other influential acts of Congress followed the Banking Act. The 1934 Securities Exchange Act provided new regulations for securities exchanges and broker-dealers. This act created the SEC. The Investment Company Act and the Investment Advisers Act were passed in 1940, creating regulations for advisers, money managers, and others.

Following a stock market decline in 1969, concerns were raised that trading volumes were growing too large for investment banks to handle. Congress reacted by founding the Securities Investor Protection Corporation, or SIPC. Investment bank capital requirements were updated in 1975 with the Uniform Net Capital Rule, or UNCR. The UNCR forced investment banks to maintain a certain level of liquid assets and provide details in quarterly Financial and Operational Combined Uniform Single, or FOCUS, reports.

Problems with different international capital standards led to the 1988 Basel Accord. Even though it was primarily designed for commercial banks, it was a seminal moment in creating supranational regulations for financial institutions. U.S. Congress attempted to repeal the separation between investment and commercial banks in 1991 and 1995 before finally succeeding with Gramm-Leach-Bliley. This act allowed for the creation of financial holding companies that could own both commercial banks and investment banks with insurance companies as affiliates.

The Sarbanes-Oxley Act (SOX) was passed in 2002, which was intended to regulate executives and empower auditors. After the financial crisis of 2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank brought an enormous amount of new regulations for all kinds of financial institutions.

SEC Regulatory Powers Affecting Investment Banks

The powers of the SEC are an extension of those enumerated in Congressional legislation. Nearly every aspect of investment banking is regulated by the SEC. This includes licensing, compensation, reporting, filing, accounting, advertising, product offerings, and fiduciary responsibilities.

The SEC oversees the securities world and its participants, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud are core to the mission of the SEC.

Article Sources
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  1. U.S. Securities and Exchange Commission. "Rules and Regulations for the Securities and Exchange Commission and Major Securities Laws."

  2. Federal Reserve History. "Banking Act of 1933 (Glass-Steagall)."

  3. United States Senate. "Subcommittee on Senate Resolutions 84 and 234."

  4. Federal Trade Commission. "Gramm-Leach-Bililey Act."

  5. U.S. Securities and Exchange Commission, Office of Investor Education and Advocacy. "The Laws That Govern the Securities Industry."

  6. U.S. Securities and Exchange Commission. "Key. SEC Financial Responsibility Rules," Pages 130, 137.

  7. BIS. "History of the Basel Committee."

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