Study guide
This chapter combines outline Topics V and VI, together worth 20 percent of the exam, roughly 12 scored questions. It covers what counts as a security, the three ways securities get registered in a state, the exemption system, and the enforcement machinery: the Administrator's powers plus the civil, criminal, and administrative consequences of violating the act.
What Is a Security, and Issuer Versus Nonissuer Transactions
The Uniform Securities Act defines security with a long list: stocks, bonds, notes, debentures, investment contracts, certificates of interest in profit-sharing agreements, options, warrants, interests in oil and gas programs, variable annuities and variable life insurance, and more. Where the list runs out, courts apply the investment contract test from the Howey case: an investment of money in a common enterprise with the expectation of profit derived primarily from the efforts of others. That is how unusual arrangements, like Cassian's whiskey-cask program promising returns from his aging and resale efforts, become securities. Just as important is the list of things that are not securities: fixed annuities and traditional whole life insurance (the insurer bears the investment risk), commodity futures contracts, currency, and ordinary collectibles or real estate held directly. An issuer is the person who issues or proposes to issue a security. An issuer transaction is one where the proceeds go to the issuer, such as an initial public offering. A nonissuer transaction is any trade not directly or indirectly for the issuer's benefit, which describes everyday secondary-market trading between investors on an exchange. The distinction matters because registration under the act is aimed primarily at issuer offerings, while most nonissuer trades ride on exemptions. The act's baseline rule ties everything together: it is unlawful to offer or sell a security in a state unless the security is registered, the security or transaction is exempt, or it is a federal covered security.
Three Paths to Registering Securities in a State
State securities registration comes in three flavors, and exam questions usually hinge on matching the method to the issuer. Notice filing applies to federal covered securities, which under NSMIA the states cannot require to register. The most tested example is a registered investment company security such as a mutual fund: the state may require the issuer to file notice, submit copies of its federal documents, and pay a fee, but the state cannot pass on the merits. Securities listed on major U.S. exchanges are also federal covered and typically require nothing beyond that. Registration by coordination is for issuers, commonly in an interstate initial public offering, that are simultaneously registering with the SEC under the Securities Act of 1933. The issuer files copies of its federal registration materials with the state, and the state registration becomes effective at the same moment the federal registration does, provided the filing has been on record with the state for the required minimum period (ten days under the model act) and pricing amendments are filed on time. Registration by qualification is the everything-else method, used for purely intrastate offerings or any security not using another method. It demands the fullest disclosure package, is the only method where effectiveness occurs whenever the Administrator so orders, and the Administrator may require that a prospectus be delivered to buyers before sale. Two cross-method facts recur: a securities registration is effective for one year from its effective date, and the person who files the registration may be the issuer, a broker-dealer, or any other person on whose behalf the offering is made.
Exempt Securities and Exempt Transactions
An exemption removes the need to register the security and to file sales literature with the Administrator; it never removes the antifraud provisions. Exempt securities are exempt because of what they are. The core list: U.S. government and municipal securities; securities of Canadian governments and of foreign governments with which the United States maintains diplomatic relations; securities issued by banks, savings institutions, trust companies, and credit unions; insurance company securities; securities of public utilities and railroads whose rates are federally or state regulated; securities of nonprofit organizations; securities listed on major exchanges (also federal covered); commercial paper rated in the top three grades with a minimum denomination of 50,000 dollars and maturity of nine months or less; and investment contracts of employee benefit plans. Exempt transactions are exempt because of how the sale happens, regardless of the security involved. The heavy hitters: isolated nonissuer transactions; unsolicited brokerage transactions, where the client initiates the order; transactions with financial institutions such as banks, insurers, and other broker-dealers; underwriter and fiduciary transactions, including sales by executors, administrators, sheriffs, marshals, receivers, trustees in bankruptcy, guardians, and conservators; pledgee sales of collateral; private placements, defined under the model act as offers to no more than ten non-institutional persons in the state during twelve months, where buyers purchase for investment and no commissions are paid for soliciting retail buyers; and preorganization certificates with no more than ten subscribers and no payment collected. The burden of proving any exemption falls on the person claiming it, and the Administrator may revoke certain exemptions, such as the nonprofit exemption, but can never revoke a federal covered status.
The Administrator's Authority
The Administrator is the state official who enforces the act, and their jurisdiction reaches any offer or sale that originated in the state, was directed into the state, or was accepted in the state, which means two or even three Administrators can share jurisdiction over one transaction. A safe harbor keeps mass media out of this net: an offer is not made in the state merely because it appears in a television or radio broadcast originating outside the state, or in a newspaper published outside the state, or published inside the state but with more than two-thirds of its circulation outside it. The Administrator's tools are broad. They may make, amend, and rescind rules and orders; conduct investigations inside or outside the state, publicly or privately, even before any violation occurs; subpoena witnesses and records and compel testimony (a witness cannot refuse on self-incrimination grounds once given use immunity, but compelled testimony cannot then be used criminally against them); issue cease and desist orders, with or without a prior hearing, to stop conduct; seek injunctions from a court; and deny, suspend, or revoke registrations of persons and securities, including stop orders against securities registrations. Disciplinary orders require statutory grounds plus a finding that the action is in the public interest, and the target is entitled to prior notice, opportunity for a hearing, and written findings. A summary order may suspend a registration immediately pending final determination, but the Administrator must promptly notify the affected person of the order and its reasons, and if the person files a written request, the matter must be set down for a hearing within 15 days after the Administrator receives that request. Distinguish revocation from cancellation: cancellation is non-punitive housekeeping when a registrant dies, dissolves, is declared mentally incompetent, or cannot be located.
Remedies, Penalties, and Appeals
Violations expose a seller to three layers of consequences. Civil liability lets a buyer who was sold a security in violation of the act, through unregistered sales or material misstatements, sue to rescind the transaction. The recovery formula is the consideration paid, plus interest from the date of payment (the model act uses six percent per year, though states may set their own rate), plus costs and reasonable attorney's fees, minus any income received on the security. If the buyer no longer owns the security, damages substitute for rescission. The statute of limitations as tested is the earlier of two years after discovery of the violation or three years after the sale. A seller who discovers its own violation can cut off liability with a rescission offer: a written offer to repurchase at the original price plus interest, less income received. A buyer who fails to accept within 30 days of receiving the offer loses the right to sue on that transaction. Criminal penalties require willful violations and carry, under the model act, a fine of up to 5,000 dollars, imprisonment up to three years, or both; no one may be imprisoned for violating a rule or order they can prove they had no knowledge of. Administrators do not send anyone to prison; they refer cases to prosecutors. Finally, any person aggrieved by an Administrator's order may appeal by filing a petition in the appropriate court within 60 days of the order, and filing the appeal does not automatically stay the order, which remains in effect unless the court says otherwise. Officers, directors, partners, and supervising employees can share liability with the firm unless they prove they did not and could not reasonably have known of the violation.
Key terms
- Security
- — An investment instrument on the act's list or one meeting the Howey investment contract test; fixed annuities, whole life insurance, futures, and currency are not securities.
- Issuer
- — The person who issues or proposes to issue a security; an issuer transaction sends proceeds to the issuer, while a nonissuer transaction is secondary trading.
- Federal covered security
- — A security, such as an exchange-listed stock or mutual fund share, that states cannot require to register, though they may require notice filings.
- Registration by coordination
- — State registration filed alongside an SEC registration that becomes effective simultaneously with the federal registration.
- Registration by qualification
- — The full-disclosure state method, used for intrastate and other offerings, effective only when the Administrator so orders.
- Exempt security
- — A security exempt from state registration because of its issuer or nature, such as government, municipal, bank, or high-grade commercial paper.
- Exempt transaction
- — A sale exempt because of how it occurs, such as an unsolicited order, an institutional trade, a fiduciary sale, or a private placement.
- Private placement (model act)
- — An offering to no more than ten non-institutional persons in the state in twelve months, purchased for investment with no retail solicitation commissions.
- Cease and desist order
- — An Administrator's directive to stop a practice, issuable with or without a prior hearing; enforcement of noncompliance requires a court injunction.
- Stop order
- — An Administrator's order denying, suspending, or revoking the effectiveness of a securities registration.
- Rescission
- — The civil remedy returning the buyer's consideration plus interest, costs, and attorney's fees, less income received; a 30-day letter of rescission can foreclose suit.
- Cancellation
- — Non-punitive termination of a registration due to death, dissolution, mental incompetence, or the registrant ceasing business or being unlocatable.
Exam tips
- When a question involves a client calling in their own idea to buy an obscure unregistered stock, look for the unsolicited brokerage transaction answer; it is the most tested exempt transaction.
- Keep the two exemption families straight: what the security is (exempt security) versus how it is sold (exempt transaction). An exempt transaction can involve a nonexempt security.
- The Administrator never approves a security or vouches for its merits; effectiveness of a registration means only that the paperwork requirements were met, and stating otherwise is a violation.
- Memorize the enforcement numbers as a set: 5,000 dollar fine and 3 years for criminal violations, 2 years from discovery or 3 years from sale for civil suits, 30 days to accept rescission, 60 days to appeal an order, and an appeal does not stay the order.
- Cancellation versus revocation is a classic trap: death, dissolution, or mental incompetence leads to cancellation (no wrongdoing), while violations lead to denial, suspension, or revocation.