Broker regulation: why is the regulator the guardian of your investments?

Written by
Fact checked by
Updated
Oct 2023

Identifying a regulated broker offering adequate protection is a significant challenge for investors. The task is complicated by the varying levels of safeguards provided by different regulatory authorities.

Thus, it’s advisable to choose a broker overseen by top-tier regulators as they impose stringent requirements, robust investor protections, and close market monitoring to establish a secure framework that reduces risks of misconduct.

THE ESSENCE

As a legal expert at BrokerChooser, I closely monitor and analyze regulators and available regulatory data around the world. I often observe customers losing money with brokers because they didn’t verify the regulator. Here are my crucial insights to investors about the regulatory bodies:

  • Regulatory stringency and oversight standards vary significantly between regulators.
  • Choose a broker regulated by a top-tier body, not just any regulator.
  • Expect stringent oversight and high standards from top tier regulators.
  • BrokerChooser recommends strictly regulated brokers; choose safely from our list of 100 brokers.

How are brokers regulated?

A regulated broker is one that is licensed by a regulatory authority. Regulators are government or self-regulatory organizations operating in a given country. They create rules and standards that brokers must follow, monitor their compliance with these requirements, and take enforcement actions when they break the rules or otherwise treat customers unfairly.

Regulators oversee brokers that operate within their jurisdiction. For instance, the Financial Conduct Authority (FCA) is an independent regulator for investment and financial services providers in the United Kingdom. The FCA's authority and oversight applies strictly to brokers conducting business in the UK market. Other jurisdictions have their own regulatory bodies that govern brokers in their specific location.

Regulatory oversight reduces the chance of brokers doing something unethical. However, they cannot prevent all misconduct completely. There is always a possibility that some misconduct could slip through, despite regulations.

The main mandates of a regulator typically include:

  • Licensing and registration: overseeing the licensing and registration of brokerage firms, ensuring that they meet the necessary legal, financial, technical and investor protection requirements to operate as financial intermediaries.
  • Rulemaking: creating and enforcing rules and regulations that govern the conduct of brokerage firms. These rules aim to promote predictability, transparency and fairness on the market.
  • Market oversight: monitoring the activities of brokerage firms, including (among others) their conduct of business (e.g. sales practices) and compliance with prudential standards aiming at ensuring that brokerage firms are stable businesses as well as fit and proper to serve customers.
  • Enforcement: investigating and enforcing compliance with financial regulations. They can take action against brokerage firms that engage in fraudulent or unethical conduct.
  • Investor protection: establishing rules and standards to protect clients using the services of brokerage firms. This includes (among others) rules related to the handling and segregation of client funds and assets.

There are significant differences in the stringency of legal and regulatory requirements and oversight applied by national regulators.

The ones that are operating in a sophisticated legal environment, applying strict oversight and offering a high level of investor protection are categorized as top-tier regulators by our analyst team.

They impose and enforce higher standards on brokers, making them a preferred choice for investors and traders seeking a higher level of security and reliability.

Mid- or low-tier regulators may not implement as rigorous oversight, potentially exposing investors to more significant risks. Brokerages under such regulators might not be held to the same standards in terms of client protection, market surveillance, and transparency. Always exercise caution when considering brokers governed by mid- or low-tier regulators.

Here are some examples of top tier regulators known for their strict oversight of brokers:

Top tier regulators
Regulator Country
Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) The United States
Financial Conduct Authority (FCA) The United Kingdom
Australian Securities and Investments Commission (ASIC) Australia
Canadian Investment Regulatory Organization (CIRO) Canada

Data updated on February 25, 2024

Click on the broker names below to see the regulator overseeing them and what this means with respect to their daily operations.

How do regulators protect customers?

Authorization and licensing

Regulators establish criteria that brokers must meet to be able to get a license to conduct business within their jurisdiction. This includes (among others):

  • Qualification requirements - for example, firms must ensure its staff members have satisfactory qualification by passing exams, registering with proper authorities, and meeting continuing education standards.
  • Prudential requirements - firms are compelled to maintain sufficient liquid capital to support stable operation and readily refund client assets when it is needed.
  • Technical requirements - regulators require sophisticated IT and operational systems and processes to support operations and allow (among others) for the storage and retention of detailed audit trails, documents and client information.
  • Handling of client funds - regulators impose strict asset segregation rules and mandatory participation in investor protection schemes to keep client assets safe in the event of broker insolvency. Such investor protection schemes provide compensation to investors if a brokerage firm goes bankrupt by ensuring the return of investors’ assets up to a certain limit.
  • Transparency requirements - brokers must disclose, in an easily understandable and transparent way, all relevant costs, risks, and potential conflicts of interest so clients can make informed decisions about services.
  • Conduct requirements - aiming at ensuring that firms are treating customers fairly and equally as well as putting their needs first (for example false statements and high-pressure tactics are prohibited to ensure marketing activities are fair, transparent and not misleading).

By setting those standards, regulators provide a framework for acceptable brokerage activities and help protect investors.

Oversight

Regulators closely monitor brokers to ensure they continuously comply with applicable regulatory requirements and standards. This can involve (among others):

  • Reviewing prevailing market practices
  • Reviewing broker policies, procedures, and operations
  • Conducting on and off-site inspections and investigations
  • Requiring regular reporting from brokers
  • Following up on tips, complaints, or red flags

Ongoing oversight enables regulators to identify problems early and take corrective action if brokers are falling short.

Enforcement

When regulators find evidence of breach of regulatory requirements or misconduct, they have the authority to take enforcement action. This can include:

  • Fines and penalties
  • Suspension or revocation of licenses
  • Bans from the industry
  • Referral for criminal prosecution

Dispute Resolution

Many regulators offer alternative dispute resolution services to help resolve disagreements between brokers and clients. These can provide an accessible forum for addressing grievances without going through the court system. For example, in the UK, investors can take complaints about misconduct by brokers to the Financial Ombudsman Service, which can investigate and settle disputes outside of court. This allows investors to seek resolution of issues like mishandling of funds or inadequate disclosure of risks in a more efficient and cost-effective way than lawsuits.

FAQs

What are the main roles of a regulator?

The main roles of a regulator are to set standards for broker licensing and authorization as part of its market oversight activity, monitor whether brokers comply with regulations and take action in case of violations, as well as provide cost-effective alternative dispute resolution services.

What are some red flags of an ineffective regulatory system?

Red flags of an ineffective regulatory system include (among others) lack of sophisticated and straightforward licensing criteria, unprepared, reactive and poorly resourced supervision, delayed or weak enforcement, lack of transparency, and inadequate dispute resolution processes.

Why should brokers care about regulation?

Brokers should care about appropriate regulation because it creates standards that allow them to operate on a level playing field. It also protects their reputation by rooting out bad actors that could tarnish public perception of the industry.

How are regulators funded?

Regulators are typically funded by governments with taxpayers’ money and/or fees levied on the firms and professionals such regulators oversee. Having laws in place to provide them with their own budget via government funding helps ensure their independence from those they regulate.

Can regulators fully prevent broker misconduct?

While regulators play a crucial role, they cannot fully prevent all instances of broker misconduct. However, robust oversight measures can reduce risks and the frequency of incidents relating to broker misconduct. Regulation combined with sound compliance, culture and ethics contributes to a healthier marketplace.

Got questions?
Engage with our growing community of traders and investors like you to find your answers.
Join now

Further reading

Author of this article

Zoltán Kormányos J.D.

Legal Eagle Leader | Regulation • Scam • Safety

I'm a financial regulation enthusiast with more than 5 years of professional experience in the financial and legal sectors as a lawyer. My hands-on expertise covers a range of areas including financial market infrastructures, asset managers, broker-dealers, crypto exchanges and other crypto service providers operating in different jurisdictions such as the US, the UK, and the EU.

Everything you find on BrokerChooser is based on reliable data and unbiased information. We combine our 10+ years finance experience with readers feedback. Read more about our methodology.

Follow us

Regional settings

×
I'd like to trade with...