Finansical Market regulation
Investors' protection under securities regulation
Tureen Afroz
According to International Organisation of Securities Commissions (IOSCO), one of the primary objectives of the securities market regulation is the protection of investors. In the 1930s, the regulatory regime of the US securities market heavily advocated 'investor protection' as an objective of its securities regulation. To meet such objective, US regulators relied on the principles of 'market egalitarianism', which would mean that the investors trade in the securities markets on the basis of 'roughly equal information'.
There is no general definition of the 'investor protection' objective of securities regulation. Securities markets are volatile by any means and as such, very much susceptible to fraud. Therefore, the most common definition for 'investor protection' objective asserts that securities regulation must be aimed at the deterrence of fraud on 'small and uninformed investors'.
Apparently there is no problem with such a definition as far as deterrence of fraud is concerned as a regulatory goal. However, it must be noted that such goal is not unique to the securities market regulation. Deterrence of fraud has remained one of the major historical concerns for criminal, contract, tort or corporate law jurisprudence too. What is specific about such goal in the context of securities regulation is that here the target victim group is specifically pre-identified i.e. 'small and uninformed investors'.
There exist a number of regulatory techniques for investors' protection in the securities markets. Some of such most common regulatory techniques are:
Mandatory disclosure techniques
These techniques are used to regulate prospectus and other financial documents. It requires that the 'issuers of shares' must make public disclosure of all information useful for evaluating securities so that such information becomes equally available to all investors in the market.
Insider trading regulation
This technique of investor protection stipulates that the corporate insiders cannot use information unfairly to gain benefit, if the same is not equally available to all other investors in the market. Therefore, insiders are strictly prohibited to trade on privileged information.
Merit regulation
Merit Regulation is a technique of investor protection whereby the regulators would evaluate disclosures by corporations and use their discretion in choosing which firms (or financial products) posed acceptable risks for investors. This is fundamentally different from the disclosure-based regulation, where the responsibility for evaluating corporations and investment risk is left to the investors after an acceptable level of information has been made available to them by the issuer.
Consumer protection techniques
This scheme is based upon the moralistic rules that restrict or prohibit securities market transactions where there is a perception of unequal bargaining power. The regulator, under this technique of investor protection, intervenes to protect parties perceived as vulnerable from exploitation by others in a stronger bargaining position. For example, the securities regulations in France are still influenced by the consumer protection principles.
Investor compensation schemes
The basic purpose of such schemes is to protect the investors if a financial intermediary (such as bank, broker company or broker-dealer company, asset management company etc.) has no financial capacity to repay or return either the money or the securities belonging to their clients. Such schemes work as kind of insurance mechanism in the securities market. Classic examples of investor compensation schemes are the Deposit Guarantee Fund and the Stock Exchange Guarantee Fund in Portugal. Also, the Directive 97/9/EC of the European Parliament and Council requires that European Union Member States should ensure within their territories an Investor Compensation Scheme.
Investor education programs
The purpose of this regulatory technique is to promote public awareness in the securities market. This is based upon the belief that (a) investor education enhances investors' understanding of the role of the regulator; (b) provides investors with the tools to protect themselves against fraud (and other abuses) and to assess the risks associated with particular investments; (c) assists the regulator in the enforcement of the securities laws concerning offerings and sales of securities and maximize the regulators' limited resources. However, there are limits to the efficacy of education as education alone cannot deal with financial fraud and further it cannot be used to lessen the scope of the duties of financial professionals toward consumers.
Investor regulation model
This technique of investor protection in the securities market argues that regulatory attention should be focused on investors and not on professional market participants. It suggests that issuers, stock exchanges, broker dealers, investment advisers and other securities professionals should be deregulated and only the investors should be regulated according to their level of needs for protection. To make this need based regulation operative, the investors will be categorized according to their informational possession, investment understanding and skills. This technique also suggests that regulation of any sort is unnecessary for rational investors. Only the semi-rational and irrational investors will be regulated by imposing restriction on their securities market activities.
Finally, one important observation is to be made. As a regulatory objective of the securities regulation the common definition of investors' protection usually leaves out the possibility of protecting large investors (institutional) or wrongly informed investors (small or large) from frauds. After experiencing major financial frauds of the recent years (For example, financial scandals associated with Parmalat meltdown, Enron and Worldcom bankruptcy, Vivendi Universal accounting scandal etc.), it can be strongly claimed that these later group does also require regulatory protection as with 'small and uninformed investors'.
The writer is an Assistant Professor of Law at BRAC University.
