The Role of Regulatory Compliance in Finance

Regulatory compliance in finance isn’t just a box-ticking exercise to meet industry standards—it’s the foundation for a successful business.¹ It helps financial organizations mitigate legal risks, prevent reputational damage and build trust.²

Understanding the importance of financial compliance (beyond mere adherence to regulations) can help an institution leverage legal requirements to streamline operations instead of viewing them as a burden. Read on to learn the legal aspects of finance and discover how following regulations fosters ethical practices, strengthens business-customer relationships and promotes stability.

Local, state, and federal governments have agencies that oversee all financial markets. These bodies not only enforce applicable financial regulations, but also evaluate the competence of financial institutions, investigate misconduct, and regularly inspect organizations to ensure compliance. Key regulatory authorities in the financial sector include:¹

• Securities and Exchange Commission (SEC): The SEC regulates stock exchanges, investment firms and other players in the financial market. The agency’s primary goals are to protect investors, maintain fair markets, and prevent fraud
• Financial Industry Regulatory Authority (FINRA): This is a nongovernmental, not-for-profit organization authorized by Congress to ensure fairness and honesty in the financial services industry
• Financial Crimes Enforcement (FinCEN): It’s a branch of the U.S. Department of the Treasury. The agency is responsible for protecting the financial system from abuse and fighting financial crimes, such as money laundering

Meeting legal requirements is necessary for any financial service provider to thrive. However, what role does regulatory compliance play in finance?

Investors are often the most vulnerable stakeholders in the financial ecosystem. Meeting regulatory requirements ensures that financial institutions operate in investors' best interests.

FINRA’s suitability rule, for example, mandates that investment experts recommend financial products that meet each customer's individual needs. Before giving any financial advice, they must understand the potential risks and rewards of the recommendation and consider customer-specific information, such as:³

• Investment objectives
• Risk tolerance
• Income and net worth
• Current financial situation and needs
• The period in which someone intends to invest their money

This regulation promotes professional ethics in finance by mandating that industry players always act in good faith when serving customers. While complying with this rule is a legal obligation, it can also help build trust between financial institutions and their clients.

According to the International Monetary Fund (IMF), “banks involved in money laundering cases suffer significant drops in equity prices and increased costs for insuring against defaults.”⁴ To minimize these crimes and protect financial institutions from their resulting repercussions, FinCEN has set anti-money laundering (AML) rules. It requires banks and other financial organizations to take several precautions against financial crime, including:^5,6

• Establishing an AML program (policies and procedures) designed to address money laundering risks tailored to their firms
• Monitoring and reporting suspicious financial activities to FinCEN
• Maintaining records of transactions and customer data, such as client-identifying information and methods of verifying a customer’s identity

When financial organizations follow these regulations, they are not only fulfilling their legal duty but also protecting their businesses from illicit financial activities. Compliance can also improve their management of money laundering risks by ensuring that each institution understands its risk profile and implements robust solutions to address threats.

Regulatory compliance in finance fosters transparency between a financial institution and investors, which promotes trust and better client-business relationships. For example, the SEC requires companies offering securities—such as investment contracts, bonds and stocks—to disclose any information that may affect an investor’s assessment of the financial products. The details must be accurate and timely.^7,8

Additionally, financial advisors and broker-dealers must fully and fairly disclose any conflicts of interest before recommending an investment product or offering financial advice to clients. A conflict of interest occurs when financial experts have an economic incentive to recommend a product—perhaps because it can generate more revenue for them—without prioritizing an investor’s best interests.⁹

The SEC says that conflict of interest disclosures must empower investors to make well-informed decisions about a financial recommendation. Failure to disclose or manage conflicts of interest could be considered a breach of legal duty, attracting regulatory penalties.⁹

One of the most significant roles of regulatory compliance is to avoid legal action that could damage a firm’s reputation or result in devastating fines. Noncompliance penalties may vary depending on:¹⁰

• The nature and severity of the violation
• The regulatory framework in place
• The business size

For instance, a violation of FINRA’s anti-money laundering regulations can occur in three ways, with each eligible for a different monetary sanction:¹⁰

• Failure to reasonably monitor or report suspicious transactions: Fines for small firms range from $10,000 to $310,000. Midsize or large businesses could be fined at least $50,000.
• Deficient anti-money laundering compliance program: Small organizations pay between $10,000 and $100,000 while big ones incur fines ranging from $20,000 to $310,000
• Failure to provide for timely and independent testing of the firm’s AML program: Small institutions pay a fine of $5,000 to $50,000 while large ones pay between $20,000 and $200,000

These amounts can be costly, especially for startups and growing institutions. Financial services compliance helps ensure the money that would have been used to pay for regulatory fines is invested in revenue-generating activities.

According to Business Insider, regulation in finance has skyrocketed since the 2008 financial crisis. As a result, it’s increasingly challenging for financial institutions to keep up. Additionally, modern technology, such as artificial intelligence, has resulted in new compliance requirements as organizations transition from paper-based operations to digital ones.¹¹

One of the largest challenges that has risen in recent years is the fight to protect customer data online. As digital payments and mobile financial apps have become the norm, financial technology companies have to work even harder to protect customers from having their private financial information and data from being compromised, which has serious consequences for both the consumer and the financial institution. This includes hiring cybersecurity teams, building multi-factor authentication into any access points, and encrypting sensitive data anywhere they can.

Financial firms can partner with regulatory technology companies to stay on top of compliance and regulatory changes.¹¹ These companies specialize in technology-based solutions that help financial organizations identify their compliance risk in finance as well as adhere to the relevant regulations.¹²

Finance specialists who want to thrive must comply with industry regulations as they advise investors. The Online MS in Finance and Analytics from Santa Clara University can improve your financial expertise and broaden your understanding of regulatory compliance in finance.

Developed by acclaimed faculty members with professional experience in Silicon Valley, this curriculum prepares you to be a leader in investment management, capital markets and the corporate finance sector. Because the program is online, you can tailor the coursework to fit your individual needs and balance your studies with other commitments, such as family, work and more.

You’ll graduate with the knowledge necessary to be competent and meet financial industry standards. To learn more, talk to an admissions outreach advisor today.