Exchanges and Over-the-Counter Markets There are two types of secondary securities markets: exchanges and

Exchanges and Over-the-Counter Markets There are two types of secondary securities markets: exchanges and

over-the-counter markets. Exchanges are actual places where buyers and sellers (or their representatives) meet to trade securities. Examples are the New York Stock Exchange and the Tokyo Stock Exchange. Over-the-counter (OTC) markets are arrangements in which investors or their representatives trade securities without sharing a physical loca- tion. For the most part, computer and telephone networks are used for this purpose. These networks are owned and managed by the market’s members. An example is the Nasdaq system, which is operated by the National Association of Securities Dealers (NASD).

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Exchanges may be privately owned, as are those in the United States and the United Kingdom. Privately owned exchanges are managed by their owners, or members (typically brokerage firms), who may pay hundreds of thousands of dollars for the privilege of owning a seat (a membership) on the exchange. Private exchanges are self-regulated; that is, they determine the rules and regulations that must be followed by their members, by traders, and by companies whose securities are listed, or accepted for trading, on the exchange.

Exchanges may be owned and operated by banks or banking organi- zations, as are many European exchanges—those in Luxembourg and Germany, for example. If the exchanges are owned by the banking insti- tutions, these institutions then control both the primary and secondary markets for securities. Both bank-owned and privately owned exchanges are, of course, subject to regulation by the countries in which they are located.

Finally, there are state-controlled exchanges, such as those in France, Belgium, and several Latin American countries. These are gener- ally the most restrictive exchanges and are characterized by stringent listing standards, especially for foreign companies.

There are two types of pricing systems for securities: the pure auc- tion and the dealer market. In the pure auction process, investors want- ing to buy or sell shares of stock submit their bids through their brokers, who relay these bids to a centralized location, where bids are matched and the transaction is executed. The party that does the matching is referred to as the specialist. For each stock in the market, there is only one matchmaker, one specialist. In a dealer market, individual dealers buy and sell shares of stock, trading with individuals and other dealers. We refer to these dealers as market makers since they “make” a market in the stock, providing liquidity to the market. In a dealer market, there may be many dealers for a given stock. Though a market can use either or some combination of the two systems, exchanges tend to use the auc- tion process and over-the-counter markets use a dealer market.

Markets in the United States Governments provide no guarantees regarding securities. However,

through legislation and regulation of markets, transactions, and trans- actors, the U.S. government has attempted to guard against fraudulent practices and manipulative behavior on the part of market participants. The federal organization charged with the regulation of U.S. financial markets is the Securities and Exchange Commission (SEC). The SEC is a federal agency that administers federal securities laws and was estab- lished by the Securities and Exchange Act of 1934. The SEC consists of

Securities and Markets

five members, each appointed by the President of the United States for a term of five years. The SEC carries out the following activities:

■ Issues rules that clarify securities laws or trading procedure issues. ■ Requires disclosure of specific information. ■ Makes public statements on current issues. ■ Oversees self-regulation of the securities industry by the stock

exchanges and professional groups such as the National Association of Securities Dealers.

Major federal legislation is listed in Exhibit 2.2; in addition, the states have all passed laws that reinforce or extend federal legislation.

EXHIBIT 2.2 Federal Regulation of Securities Markets in the United States

Law

Description

Securities Act of 1933 Regulates new offerings of securities to the public. It requires the filing of a registration statement con- taining specific information about the issuing corpo- ration and prohibits fraudulent and deceptive practices related to security offers.

Securities and Establishes the Securities and Exchange Commission Exchange Act of 1934

(SEC) to enforce securities regulations and extends regulation to the secondary markets.

Investment Company Act Gives the SEC regulatory authority over publicly-held of 1940

companies that are in the business of investing and trading in securities.

Investment Advisers Act Requires registration of investment advisors and regu- of 1940

lates their activities.

Federal Securities Act Extends the regulatory authority of the SEC to include of 1964

the over-the-counter securities markets. Securities Investor

Creates the Securities Investor Protection Corpora- Protection Act of 1970

tion, which is charged with the liquidation of securi- ties firms that are in financial trouble and which insures investors’ accounts with brokerage firms.

Insider Trading Sanctions Provides for treble damages to be assessed against vio- Act of 1984

lators of securities laws.

Insider Trading and Secu- Provides preventative measures against insider trading rities Fraud Enforce-

and establishes enforcement procedures and penal- ment Act of 1988

ties for the violation of securities laws.

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