Investor protection in the financial market. What is important to know about regulation ?

YEREVAN, February 7. /ARKA/. The financial market is diverse and includes a huge number of participants, including unscrupulous ones. Therefore, when choosing a platform, intermediaries and instruments, it is important for investors to understand what mechanisms can protect them from fraudsters. For this purpose, it is necessary to learn about the control processes in the market and organizations that monitor the transparency of transactions. Such functions are assumed by financial regulators. These can be both government agencies and independent associations.

Financial regulators

Regulators ensure that brokers comply with country-specific and/or international laws; they monitor operations on local and global exchanges. They also confirm the right of investment companies to enter the financial market by granting them licenses and subsequently continuously inspecting their activities. In addition, financial regulators establish conflict resolution mechanisms and protect the rights of investors.

As countries have different legal systems and markets, there are several types of regulation. In some countries, a single organization takes on the role of regulator. This is often the central bank. 
In the US, for example, a different principle is used. There, the securities exchange is separated from the financial sector, so regulation is handled by several organizations, including:

- The Federal Reserve, which oversees the monetary policy of the government, commercial banks, and some currency market issues; 
- The Securities and Exchange Commission (SEC), which works on the stock market. The objects of its regulation are the issue of securities, activities of exchanges, intermediaries (brokers, dealers, funds, etc.); 
- The Commodity Futures Trading Committee (CFTC), which regulates the derivatives market (contracts under which parties take certain actions in relation to an asset).


Non-profit organizations

In the United States non-profit organizations play a major role in protection of investors.
- Financial Industry Regulatory Authority (FINRA). It is the largest independent organization that supervises brokers throughout the country and monitors the transparency of transactions.
- Securities Investor Protection Corporation (SIPC) is a non-profit securities investor protection corporation. It is funded by member brokers.

In the event of bankruptcy or liquidation of a SIPC and FINRA member company, clients, including foreign clients, receive a guarantee of investment protection. This is done through the appointment of a management company or transfer of funds to another broker.

The securities market in the European Union is supervised by a universal regulator - ESMA (European Securities and Markets Authority). One of its main functions is to protect investors and ensure the best conditions for them. For this purpose MiFID and MiFID II directives were created. According to the latter, companies must classify clients in order to offer services and conditions depending on the experience and characteristics of the investor. In addition, each country has its own regulator. Thus, there is a two-tier system of control over brokers.

In the UK, regulation is carried out on two fronts. The banking system is controlled by the Bank of England and the financial services market by the Financial Conduct Authority (FCA). The latter develops and implements uniform rules and standards for financial institutions, monitors market participants to prevent fraud risks. To protect investors, the FCA works to increase their awareness and literacy.

In Armenia, market supervision functions are vested in one organization - the Central Bank, whose responsibilities include ensuring investor protection, price transparency, stability of market development and reduction of systemic risks. The Central Bank controls the only Armenian Securities Exchange. In December 2023, the Chairman of the Central Bank Martin Galstyan noted that the regulator was going to tighten the national regulation because of the growing activity of investment companies and funds.

Broker verification is the key to your safety

Keep in mind that even in markets that are strictly controlled by government agencies and independent organizations, there are still many unscrupulous brokers. They adjust to the situation and update fraudulent schemes. An investor who encounters fraud risks irrevocably losing funds - even in cases when brokers have been punished. Therefore, when becoming a participant in the financial market, one should not only rely on the protection of regulators, but also protect oneself from threats.



How to choose a reliable broker and protect oneself from fraudsters

1 Make sure that the broker has a valid license from the regulator. 

Understanding that reliability is one of the main criteria for investors, companies usually emphasize the availability of a license and place it on their website. To be sure of the authenticity of the document, check whether the regulator itself lists this organization among the licensed ones. For example, the list of companies, which have received official authorization for brokerage activities in Armenia can be found on the websites of the Central Bank and the Armenian Securities Exchange in the 'Trading' section. You can also check whether a company has a license through aggregator sites that collect data from registries in various countries.

2. If the broker is part of a holding company, he/she should provide information about the main company. Examine the holding company's website and make sure that the organizations are actually related. 

For example, in Armenia, brokerage services are provided, in particular, by Freedom Broker Armenia, which is part of the American Freedom Holding Corp. The website of the subsidiary company has a special section telling about the activities of the main organization. It provides information about the history, standards, revenue and ratings. The holding itself also lists Freedom Broker Armenia as one of its subsidiaries on its website.

3. Reliable brokers try to draw clients' attention to their status by telling on their website about membership in associations, major partners and awards they have won. If you do not see such references (in the sections "Partners", "About Us", "News"), think whether it is worth choosing this particular broker. Perhaps the company does not have a good reputation. It is useful to look at ratings compiled by major agencies and experts on thematic portals.

4. Find out in advance about all commissions the broker asks for his/her services, including additional ones. If you do not receive full information about fees and cannot find out how the cost of account maintenance is calculated, you should not cooperate with that company 

5. Find out which markets the broker has access to. Reliable companies work with the major stock exchanges of a particular country and on international platforms.

Fraudsters in the market are still effectively using such an instrument as a pyramid scheme. Its classic structure implies that the company does not produce any products and does not carry out economic activities, but promises to pay high interest to depositors from the funds of new investors. When the flow of those who are ready to join dries up, the majority of participants do not receive profit and lose their own money.

A financial pyramid may hide its scheme and present itself as an investment company that offers to buy securities of high-yielding industries, or as a forex broker. There are several signs characteristic of fraudsters: 
- lack of a license from a status regulator
- short period of existence, minimal authorized capital, single founder
- promise of guaranteed super-high income
- requirement of preliminary contributions
- absence of published reports and charter
- requests for advertising

6. Speak personally with the company's representatives. Even if the managers make a pleasant impression, assess their competence by asking a lot of questions and going into details.

7. Try contacting tech support. Usually scammers cannot provide quality service.

8. To fully vet a financial intermediary, contact law firms that assess the reputation of counterparties and the existence and authenticity of their license.



Conclusion

An investor can transact in both domestic and foreign markets, and their regulation is often different. So it's important to understand exactly what requirements your broker must meet, and what laws and organizations should protect you from ruinous losses to your business. 

The material was prepared within the framework of a joint project "The Year of Investing in Oneself " by ARKA, AMI Novosti-Armenia news agencies and Freedom Broker Armenia.

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10:10 02/07/2024