Securities Regulation – The Basics
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2009 NASAA
Attorney/Investigator Training Seminar
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Tampa, Florida
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Prepared By
Joseph Brady
Deputy General Counsel
NASAA
202-737-0900
jb@nasaa.org
I.
SECURITIES REGULATORS
A. State – All 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands
have agencies that regulate securities. These agencies may be independent commissions,
divisions within the office of the state attorney general or secretary of state, or housed
within agencies dedicated to the regulation of related financial services. The Canadian
provinces and Mexico also regulate securities. These agencies are listed on NASAA’s
website, along with contact information and links to their statutes and regulations. See
www.nasaa.org.
B. Federal – The Securities and Exchange Commission is the federal counterpart to the state
securities regulators. See www.sec.gov.
C. SRO’s – “Self-regulatory organizations” such as the Financial Industry Regulatory
Authority (“FINRA”) oversee the activities of their members and the operations of the
major stock exchanges, all subject to SEC oversight. See www.finra.org. In July 2007,
the National Association of Securities Dealers (“NASD”) and the regulatory arm of the
New York Stock Exchange completed a merger, resulting in the formation of FINRA.
D. Criminal prosecutors – District attorneys (local prosecutors), state attorneys general, and
the offices of the federal U.S. Attorneys have criminal jurisdiction over securities law
violations. See www.ndaa.org; www.usdoj.gov.
II. AN OVERVIEW OF SECURITIES REGULATION
A. History – State statutes regulating securities transactions date back to the early 1900’s.
Kansas is credited with enacting the first “Blue Sky” law in 1911. The core federal
securities acts were passed between 1933 and 1940, and were intended to address the
fraud and manipulation on a national scale that led to the market crash of 1929.
B. The basic structure – Securities statutes and regulations address five essential regulatory
areas. They:
1.
2.
3.
4.
5.
Define securities and other core concepts in the securities field;
Require the licensing of broker-dealers, investment advisers, and their agents;
Require the registration of securities;
Impose standards of conduct, including antifraud rules and operational requirements;
Create enforcement remedies and procedures.
C. Merit v. disclosure regulation – Two basic approaches to securities regulation have
emerged over the last 100 years. Under merit regulation, regulators have the authority to
prevent a securities offering if it would tend to work a fraud on purchasers; would be
made with unreasonable amounts of underwriter commissions or other compensation; or
would be unfair, unjust, or inequitable to the public. Under disclosure regulation,
regulators play the more limited role of making sure that investors have complete and
accurate disclosure of all material information related to the offering. The decision to
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invest is left entirely to the supposedly well-informed investor. In general, the federal
approach has been one of disclosure regulation, while the states have applied both
approaches: all states require disclosure of material information, but many continue to
apply a merit approach to offerings under their jurisdiction. See USA 1956 § 306.
III. THE MAJOR SECURITIES LAWS
A. Statutes (and legislative history).
State statutes.
The USA 1956 – The majority of state securities laws are based on the Uniform
Securities Act (“USA”), written in 1956 by the National Conference of Commissioners
on Uniform State Laws (“NCCUSL”), and adopted in some form by nearly 40 states.
The uniform act was revised in 1985, but relatively few states adopted it.
The USA 2002 – A recently updated version of the uniform act, known as “USA 2002,”
has been approved by NCCUSL and is being considered by state legislatures. So far, 18
states have adopted some form of USA 2002. See the NCCUSL website at
www.nccusl.org; see also Uniform Laws Annotated, available on Westlaw. The USA
2002 modernizes the prior versions in several respects, by conforming the registration
provisions with the preemption provisions in NSMIA, by providing for the licensure of
investment adviser representatives, and by strengthening administrative enforcement
mechanisms.
Variations as adopted – The law in each state differs in some respects from the Uniform
Act on which it is based, so the law as adopted in each state must be consulted.
However, they all basically follow the template described above by addressing
definitions, licensing, registration, standards of conduct, and remedies.
Federal statutes.
The Securities Act of 1933, 15 U.S.C. § 77a et seq. – The “Securities Act” was adopted
to regulate the issuance of new securities to the public. With respect to those offerings, it
requires the filing of a registration statement with the SEC and distribution of a
prospectus to potential investors. It also contains antifraud provisions.
The Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. – The “Exchange Act”
was adopted to create the SEC, to regulate the exchanges where secondary trading in
securities takes place, to require periodic reporting by public companies, to regulate
proxy voting by shareholders, and to prohibit fraud, market manipulation, and insider
trading.
The Investment Advisers Act of 1940, 15 U.S.C. § 80b-1 et seq. – The “IAA” was
adopted to regulate the activity of investment advisers through licensing and antifraud
provisions.
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The Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq. – The “ICA” was
adopted to regulate the activities of mutual funds and other investment companies, which
are engaged primarily in the business of investing in securities.
B. Regulations.
State – Each state has adopted its own set of securities regulations. State administrative
codes are available on Westlaw.
Federal – The SEC's regulations are collected in various parts of the Code of Federal
Regulations, beginning at 17 C.F.R. § 200.1. Regulations under the Securities Act are
found at 17 C.F.R. § 230.100 et seq., and regulations under the Exchange Act are found
at 17 C.F.R. § 240.0-1 et seq.
C. SRO Rules – The SRO’s promulgate their own rules, subject to SEC approval, that
govern the conduct of their members. The most important SRO rules for state securities
regulators are the Conduct Rules issued by FINRA, available on their website at
www.finra.org. Most states incorporate the FINRA Conduct Rules either by reference or
by setting forth parallel language in their statutes or regulations, providing states with
important enforcement tools. Noteworthy Conduct Rules include rules governing just
and equitable principles of trade, suitability (or “know your client” and supervision.
D. Constitutional provisions – Constitutional provisions establish limits on the scope of state
regulation. For example, the Commerce Clause (Article I, Section 8, Clause 3)
empowers Congress to regulate commerce between the states, thus implying that the
states are limited in their ability to regulate interstate commerce. Hence the term
“Dormant Commerce Clause.” In addition, the Supremacy Clause (Article VI, Clause 2)
is the basis for the preemption doctrine, which is frequently invoked by those seeking to
limit state regulation.
E. Case law – Decisions from state and federal courts, as well as the SEC and state
securities agencies, are enormously important.
F. Interpretive letters – State securities regulators generally have statutory authority to issue
opinion letters. See USA 1956 § 413(e). The SEC issues a variety of informal
guidelines, including “Staff Legal Bulletins” and “Staff No-Action Letters,” available on
the SEC’s website.
G. Treatises – Professor Joe Long’s treatise on Blue Sky law is an excellent resource,
available on Westlaw. The multi-volume treatise written by Loss and Seligman is also
very useful, particularly as to federal securities law.
H. The rule of liberal construction – One of the most often-cited principles is that the
securities laws are remedial statutes intended to protect investors from fraud and abuse,
and that they should be interpreted broadly and flexibly, and with an eye toward
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economic reality and not just form, to achieve their remedial purposes. A good review of
the federal cases reciting this principle is found in SEC v. Zandford, 535 U.S. 813, 819
(2002). State courts also consistently adhere to this rule of liberal construction.
IV. THE RELATIONSHIP BETWEEN STATE AND FEDERAL LAW: INTERPRETATION
AND PREEMPTION
A. Shared interpretation – State and federal law serves as a dual system of securities
regulation in the areas of licensing, registration, and enforcement. As a result, state
courts often consult federal law when applying state law provisions that have a
counterpart in the federal statutes. See, e.g., Payable Accounting Corp. v. McKinley, 667
P.2d 15 (Utah 1983). When appropriate and necessary to protect investors, however,
state courts will also decline to follow the federal rule. See, e.g., Siporin v. Carrington,
23 P.3d 92 (Az. Ct. App. 2001) (rejecting the D.C. Circuit’s holding in Life Partners that
viaticals are not securities). Although the states’ regulatory role has now been preempted
in certain areas, federal law is still a useful and often-consulted resource in state cases.
Many state statutes expressly encourage the interpretation of state law in a manner that is
consistent with federal law, and the USA 2002 § 608 expressly provides for
administrators to consult and coordinate with other regulators in order to promote
uniformity between state and federal standards.
B. Preemption – Federal law also can have a negative impact on state securities law through
the preemption doctrine. There are three types of preemption: (1) express preemption,
where federal law expressly states that state law is preempted; (2) field preemption,
where federal law is so comprehensive that it leaves no room for supplementary state
regulation; and (3) conflict preemption, where it is impossible to comply with both state
and federal requirements, or where state regulation interferes with the achievement of
Congressional objectives.
NSMIA – In the National Securities Markets Improvement Act of 1996 (“NSMIA”),
Congress expressly preempted state law in three important areas. It removed the states’
authority to impose registration requirements or conduct merit review as to “covered”
securities, such as securities traded on national exchanges. See 15 U.S.C. § 77r(a). It
also removed the states’ authority to impose books and records requirements or reporting
requirements for brokers and dealers that differ from those imposed by federal law. See
15 U.S.C. § 78o(h). Finally, it preempted the states’ authority to license certain
investment advisers including those with over $25 million in assets under management.
See 15 U.S.C. § 80b-3a.
Savings clause – However, NSMIA also contains a savings clause clearly preserving the
states’ authority to bring enforcement actions for fraud and deceit, regardless of the type
of security involved. See 15 U.S.C. § 77r(c); see also Capital Research and Management
Co. v. Brown, 147 Cal. App. 4th 58 (Cal. Ct. App. 2007) (state enforcement action for
failure to disclose mutual fund revenue sharing agreements expressly preserved under
NSMIA savings clause).
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V. WHAT IS A SECURITY?
A. A key threshold question – Often this is the most hotly contested issue in a securities
case. If an investment offering is not a security, then securities regulators do not have
jurisdiction to regulate the offering or to take enforcement action against those who sell it
to the public in violation of the law.
B. The typical investments – Under the securities acts, securities include an extensive list of
items normally thought of as securities, such as stocks, bonds, and notes. See USA 1956
§ 401.
C. The Howey test – Both federal and state securities laws also include catchall terms,
intended to cover the enormous variety of investments that scam artists may invent to
defraud the public. The most widely used category is the “investment contract,” defined
in SEC v. Howey, 328 U.S. 293 (1946). The Supreme Court held that plots in citrus
groves sold to investors along with service contracts were in fact securities. In reaching
this conclusion, the Court defined “investment contract” as any transaction, [1] a person
invests money [2] in a common enterprise and [3] is led to expect profits [4] solely from
the efforts of others.
More on the four elements of an investment contract.
1. An investment of money. This requires an investment of cash or noncash
consideration and not the purchase of a consumable commodity or service.
2. Common enterprise (Commonality). This element is usually meant to mean multiple
investors with interrelated interests in a common scheme – horizontal commonality.
Some courts have held that it is sufficient if a single investor has a common interest
with the manager of the investment scheme – vertical commonality.
3. The expectation of profits. The anticipated profits must come from the earnings of
the scheme and not merely as additional contributions from investors. The expected
return on an investment must be the principal motivation for the initial investment.
4. Efforts of others. Although the Supreme Court’s definition of investment contract
requires that profits be derived solely from the efforts of others, other courts have
accepted that the investor’s efforts in the enterprise may contribute to profits. The
efforts of the managers, however, must be predominant (the key element of passivity
on the part of investors).
Derived from state cases – The Supreme Court relied heavily on state cases to create its
definition of the investment contract, because when Congress adopted the federal
securities laws, state courts had already developed the investment contract concept.
A widely used test – Investment contracts include many of the most notorious securities
scams, including worm farms, payphone sale and leaseback schemes, viaticals and life
settlements, and others. A recent Supreme Court case applying the Howey test is SEC v.
Edwards, 540 U.S. 389 (2003) (payphone investments are investment contracts).
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D. The risk capital test – This is an alternative definition of an investment contract, first
enunciated in Silver Hills Country Club v. Sobieski, 361 P.2d 906 (Cal. 1961) (club
memberships sold to raise construction funds held to be securities). It has essentially
three elements: (1) an investment, (2) in the risk capital of an enterprise, (3) with the
expectation of benefit. The risk capital test offers some flexibility over the Howey test,
including the broader concept of benefits rather than profits, no common enterprise
requirement, and less emphasis on the efforts of others.
E. Hybrid products – These are financial products that have a combination of features. One
of the most important examples is the variable annuity, which has an insurance
component as well as an investment component. They are securities under federal law.
See SEC v. Variable Life Insurance Co. of America, 359 U.S. 65 (1959). States vary in
their treatment. Some define securities to include variable annuities, some only exclude
fixed annuities, and others rely on an investment contract analysis to assert jurisdiction
over these products.
VI. LICENSING
A. Broker-dealer – Defined as any person engaged in the business of effecting transactions
in securities for the account of others or for his own account. See USA 1956 § 401(c).
The definition excludes issuers and banks. USA 1956 § 201(a) prohibits anyone from
transacting business in the state as a broker-dealer unless registered. Broker-dealers
register by filing a Form BD via the Central Registration Depository (“CRD”), the
electronic system operated jointly by NASAA and FINRA.
B. Investment adviser – Defined as any person who, for compensation, engages in the
business of advising others, either directly or through publications or writings, as to the
value of securities or the advisability of investing in securities, or who for compensation
and as part of a regular business, issues analyses or reports concerning securities. See
USA 1956 § 401(f). The definition excludes banks and bona fide newspapers or
magazines of general and paid circulation. It also excludes broker-dealers whose
advisory services are solely incidental to the broker-dealer business and who receive no
special compensation for the advisory services. For a good discussion of the brokerdealer exclusion to the definition of investment adviser see Financial Planning
Association v. SEC, 482 F. 3d 481 (D.C. 2007).
USA 1956 § 201(c) prohibits anyone from transacting business in the state as an
investment adviser unless registered. NSMIA created two categories of investment
advisers. Those with less than $25 million in assets under management register with the
states, while those with over $25 million register with the SEC. See 15 U.S.C. § 80b-3a;
17 C.F.R. § 275.203A-1. State-regulated investment advisers register by filing a Form
ADV via the IARD, an electronic system similar to the CRD. USA 2002 § 405 requires
federally covered investment advisers to submit notice filings with the states in which
they have clients or places of business. Notice filings include copies of documents filed
with the SEC, filing fees, and consent to service of process.
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C. Fiduciary duty – Investment advisers owe their clients a fiduciary duty under the
Investment Advisers Act of 1940. See SEC v. Capital Gains Research Bureau, Inc., 84
S. Ct. 275 (1963). In Capital Gains, the Court held that an investment adviser had a
fiduciary duty to disclose to his clients that he was placing trades for his personal account
so that he could profit from subsequent recommendations he was making to his clients.
In contrast, broker-dealers are subject to the fiduciary duty only under certain
circumstances—when, for example, they are executing specific trading orders for clients,
or when a relationship of trust and confidence has evolved between the firm and the
client. Over the last two decades, broker-dealers have increasingly offered advisory
services, particularly in connection with fee-based accounts. As a result, some believe
that the distinction between broker-dealers and investment advisers has become blurred
and that the fiduciary duty should apply to broker-dealers as well as investment advisers.
D. Agent of a broker-dealer – USA 1956 § 401(b) defines “agent” to be any individual who
represents a broker-dealer or issuer in effecting or attempting to effect purchases or sales
of securities. USA 1956 § 201(b) prohibits broker-dealers from employing an agent
unless the agent is registered. Broker-dealer agents register by filing a Form U4 via the
CRD. They must also pass a state test (the series 63) and a federal test (usually the series
7).
E. Representative of an investment adviser – USA 2002 § 102(16) defines investment
adviser representative as an individual employed by or associated with an investment
adviser, who gives investment advice regarding securities, holds him or herself out as
providing investment advice, or manages client accounts. They are registered solely by
the states, regardless of the amount of money their firms have under management. The
USA 1956 has no provision for the registration or regulation of investment adviser
representatives, but the USA 2002 does. See USA 2002 § 404. They register by filing a
form U4. They must also pass a state test (usually the series 65) or an accepted
professional designation. The following designations are accepted by the states:
Certified Financial Planner (CFP); Chartered Financial Consultant (ChFC); Personal
Financial Specialist (PFS); Chartered Financial Analyst (CFA); and Chartered Investment
Counselor (CIC).
F. Access to licensing information – Regulators can obtain access to all of the data about
brokers, investment advisers, and their agents contained in the CRD and the IARD.
Members of the public can access information on CRD and IARD through records
requests to state regulators and to a limited extend via “FINRA BrokerCheck,” available
on the FINRA website. They can access information on IARD via the “IAPD,” available
on the SEC’s website.
G. Standards for denial – USA 1956 § 204 sets forth the standards for denial of licensing
applications (and for revocations and suspensions). They include violations of the Act;
prior convictions; dishonest or unethical practices in the securities business; and lack of
training, experience, or knowledge.
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H. Expungement – In 2004, the SEC approved FINRA’s new Conduct Rule 2130, governing
expungement of complaint information from the CRD records of broker-dealer agents.
The rule has been modified and now appears in the FINRA consolidated rulebook as
FINRA rule 2080. It arose from the concern that agents were routinely obtaining
expungement orders from arbitration panels regardless of their degree of culpability,
especially in settlements. Investors were thus being deprived of important information
about the integrity of their broker agents. The rule requires an affirmative finding that at
least one of three narrow tests has been met as a precondition for expungement; it
requires arbitration panels to hold hearings or at least develop an adequate record upon
which to base their expungement recommendations; it requires court confirmation of all
expungement recommendations; and it contemplates that state securities regulators will
intervene in appropriate cases to ensure that the rule is properly applied. NASAA has
recently submitted a number of amicus briefs in expungement confirmation cases,
supporting the states’ right to intervene and challenging expungements on the ground that
the rule has not been properly applied. See Briefs filed in the Gibson, O’Neill, and Kay
matters, available on the NASAA website; see also Karsner v. Lothian, 532 F. 3d 876
(D.C. Cir. 2008) (Maryland securities commissioner had right to intervene to protect
interest in the integrity of state records).
VII. REGISTRATION OF SECURITIES
A. The basic requirements – USA 1956 § 301 makes it unlawful to offer or sell any security
in the state unless it is registered or exempt from registration. The Act provides for three
types of registration:
1. By notification, under § 302, for seasoned issuers who meets certain standards
relating to defaults on previously issued securities and average net earnings;
2. By coordination, under § 303, for securities undergoing federal registration pursuant
to the Securities Act;
3. By qualification, under § 304, for all other securities that must be registered under
state law. This is the most elaborate registration process and it requires the
submission of extensive information about the offering, including the nature of the
business, financial statements, background of principals, and copies of the prospectus
or other offering materials.
B. Exemptions from registration – USA 1956 § 402 lists a variety of exemptions, based on
the nature of the security or the nature of the transaction. The exempt securities include
government securities, bank securities, securities listed on national exchanges, securities
issued by non-profits, and commercial paper with a term of less than 9 months.
C. Stop orders – USA 1956 § 306 provides that the administrator may issue stop orders
denying or suspending registration if the order is in the public interest, and if any one of
several listed grounds exist, including these: the registration statement is incomplete, the
underlying enterprise would be illegal, the offering would tend to work a fraud upon
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purchasers, or the offering would be made with unreasonable amounts of underwriter or
seller compensation.
D. NSMIA – Historically, states had the authority to require the registration of securities
offerings to the same extent that federal regulators did. However, NSMIA preempted the
states’ authority to impose registration requirements or other conditions on so-called
“covered” securities. See 15 U.S.C. § 77r(a). Covered securities are defined to include
securities traded on national exchanges, securities issued by investment companies, and
securities that are subject to the federal limited offering exemptions. See 15 U.S.C. §
77r(b). With respect to covered securities, states are now entitled only to notice filings,
which include a filing fee, a consent to service of process, and copies of the federal
registration statement. 15 U.S.C. § 77r(c).
By virtue of NSMIA, registration by notification under USA 1956 § 302 is obsolete, and
USA 2002 § 302 replaces it with a notice filing provision.
E. Regulation D, Rule 506 – NSMIA also preempted the states’ authority to require the
registration of offerings under Rule 506 of Regulation D, which are private offerings
limited to 35 nonaccredited investors. See 15 U.S.C. § 77r(b)(4)(D); 17 C.F.R. § 230.501
– 508. Over the last several years, some promoters have argued that Rule 506 offerings
are exempt from state registration even if they fail to comply with all of the requirements
of the rule, such as the prohibition against general solicitation. Most but not all courts
have rejected the argument. NASAA has submitted a number of amicus briefs on the
subject. See, e.g., Brief submitted in the Consolidated Management Group case (Apr. 10,
2007), available on the NASAA website.
VIII. MAJOR TYPES OF SECURITIES LAW VIOLATIONS
A. The big three: (1) offering or selling a security without a license; (2) offering or selling a
security that has not been registered with the appropriate securities regulator; and (3)
committing fraud in connection with the offer, sale, or purchase of a security.
B. Other important violations: (1) unsuitable recommendations; (2) market manipulation;
(3) unauthorized trading; (4) churning (excessive trading to earn commissions); (5)
insider trading (trading on the basis of non-public information); (6) theft of customer
funds; (7) failure to maintain books and records; and (8) failure to supervise.
IX. FRAUD
A. The elements –
1. USA 1956 § 101 – This provision contains three subsections that make it unlawful, in
connection with the offer, sale, or purchase of any security, (1) to employ schemes to
defraud; (2) to make untrue statements of material fact or to omit facts necessary to
make other statements not misleading; or (3) to engage in any act, practice, or course
of business that operates as a fraud or deceit upon any person.
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2. USA 1956 § 102 – This provision makes it unlawful for any person who receives
compensation for investment advice to employ schemes to defraud or to engage in
any act, practice, or course of business that operates as a fraud or deceit upon any
person.
3. Derivation – The USA antifraud provision was modeled after Section 17(a) of the
Securities Act and Rule 10b-5 under the Exchange Act.
4. Registration and licensing irrelevant – The fraud must involve a security but the
provision applies regardless of whether the security is registered or whether the
person offering or selling it is licensed.
5. “Offer” and “sale” – These terms are defined very broadly in USA 1956 § 401 to
include contracts to sell, and “every attempt to offer or dispose of” a security.
6. Materiality – The statements must relate to “material” information. The federal test,
widely followed in state courts, is whether there is a substantial likelihood that a
reasonable purchaser or seller would consider it important in deciding whether or not
to purchase or sell. See TSC Industries, Inc. v. Norway, Inc., 426 U.S. 438 (1976).
7. Scienter – Under federal law, scienter is a required element under Section 10(b). See
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Federal courts generally apply a
recklessness standard. Scienter is not a required element in many, if not most, states,
either in civil actions or enforcement proceedings.
8. Other elements – Reliance and damages need not be established in enforcement
proceedings.
B. NASAA’s “Top Investment Scams” – NASAA periodically issues a list of the top
investment scams and posts it on the NASAA website. Typically, it includes these
frauds: (1) affinity fraud; (2) churning; (3) equity indexed annuities; (4) oil and gas
investments; (5) personal information scams; (6) prime bank schemes; (7) pump and
dump schemes; (8) recovery rooms; (9) promissory notes; (10) sale and leaseback
contracts; (11) self-directed pension plans; (12) unsuitable recommendations; and (13)
variable annuities.
C. Tactics common to many scams – (1) sale by unlicensed salesmen, often independent
insurance agents; (2) sale of unregistered securities; (3) promises of huge profits in a
short time, with a guaranteed minimum; (4) claims of little or no risk – “can’t lose”
assurances; (5) failure to disclose risk, fees, and other material terms – for example, that
returns may be substantially less then portrayed, that investors may lose their investment,
that substantial fees will be charged, and that the investment cannot be resold easily or
cannot be liquidated for an extended period of time; (6) cold calls from distant locations;
(7) little or no documentation about the investment; (8) urgency and claims for immediate
payment to “hold” a position; (9) claims of a rare or exclusive opportunity; (10) claims of
access to inside information; (11) phony testimonials or references from people who
allegedly made money; (12) excessive use of jargon without explanations; (13) belittling
the investor’s intelligence; (14) playing on common religious beliefs (affinity fraud); (15)
fake account statements; (16) after investment, difficulty contacting or even finding the
broker; and (17) attempts to sell another investment as a way to recover losses.
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X. REMEDIES
A. Investigations – USA 1956 § 407 authorizes the administrator to conduct investigations
into possible violations of the Act. It includes the power to subpoena witnesses and
documents.
B. Injunctive actions – USA 1956 § 408 authorizes the administrator to bring actions in civil
court for injunctions and for the appointment of receivers.
C. Administrative actions – Although the USA 1956 did not expressly authorize
administrative enforcement actions for cease and desist orders or monetary penalties,
most states exercise that authority either impliedly under USA 1956 § 412, or under
specific provisions they have chosen to add to their securities laws. USA 2002 filled this
gap in § 604. Agency proceedings to revoke or suspend licenses are provided for in both
versions of the USA. See USA 1956 § 306; USA 2002 § 604.
D. Civil liability – USA 1956 § 410 provides that those who offer or sell a security in
violation of the Act are liable to the buyer for rescission or damages. Section 410
imposes joint and several liability upon control persons and those who materially aid in
the illegal sale, subject to an affirmative defense that they did not know, and in the
exercise of reasonable could not have known, of the facts giving rise to liability. It also
contains a 2-year statute of limitations.
E. Criminal referrals – USA 1956 § 409 criminalizes violations of the act, and provides for
fines and imprisonment. It also provides for the Administrator to refer evidence to the
attorney general or district attorney for use in a prosecution.
F. Enforcement considerations – The SEC, many states, and NASAA have compiled
guidelines for enforcement authorities to consult when deciding whether to take
enforcement action and what sanctions to seek when they do file a case. See, e.g., SEC
Release 2006-4 (Jan. 4, 2006); NASAA’s Principal Considerations, available on the
NASAA website; MD Code of Regulations, 02.02.01.04 (factors considered in
determining amount of fine).
XI. PRIVATE ACTIONS UNDER FEDERAL LAW AND ARBITRATION
A. Private right of action – The implied private right of action under Rule 10b-5 was first
recognized in 1947. See Kardon v. National Gypsum Co., 73 F. Supp. 798 (E.D. Pa.
1947); Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6 (1971).
Congress and the courts have recognized that civil liability under the securities laws is an
important deterrent against fraud and abuse, one that complements government
enforcement actions. See, e.g., Basic Inc. v. Levinson, 485 U.S. 224, 230-32 (1988).
B. Elements – The elements of a private cause of action for securities fraud generally
include (1) a misrepresentation or omission; (2) of a material fact; (3) in connection with
the purchase or sale of a security; (4) with scienter, defined as recklessness; (5) inducing
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reliance; (6) causing; (7) damages. Reliance is presumed in cases of fraud on the market.
See Basic, Inc. v. Levinson, 485 U.S. 224 (1988)
C. Congressional hurdles – Based on a perception that private claimants and their lawyers
were preying on legitimate companies by filing meritless lawsuits aimed at extracting
lucrative settlements, Congress passed the Private Securities Litigation Reform Act of
1995. It imposed heightened pleading requirements and other limitations in class action
lawsuits alleging securities fraud in federal court. See 15 U.S.C. § 78u-4. Because some
private claimants attempted to evade these limitations by filing in state court rather than
federal court, Congress passed the Securities Litigation Uniform Standards Act of 1998.
It essentially banned class actions for securities fraud under state law in state courts. See
15 U.S.C. § 77p(b).
D. Ongoing issues – Corporate defendants continually seek to limit their liability in class
action cases by asking courts to narrowly construe the federal securities laws. See
Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164
(1994) (aiders and abettors are not liable in a private action under 10b-5). Recently, in
Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761 (2008),
the Supreme Court held that plaintiffs may seek recovery for fraudulent acts under
Section 10(b) only if those acts were known to and relied upon by the market. The
presumption of reliance applicable to misrepresentations in a fraud-on-the-market case
does not apply to fraudulent conduct.
E. Arbitration – Recourse to the courts is often unavailable to investors who have claims
against their brokers, because broker-dealers almost invariably include binding arbitration
clauses in customer agreements. The Federal Arbitration Act, 9 U.S.C. § 1 et seq.,
generally makes pre-dispute arbitration agreements enforceable, and the U.S. Supreme
Court has specifically upheld the enforceability of arbitration agreements under the
securities acts. See Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987)
(upheld as to 10b-5 claims); Rodriquez de Quijas v. Shearson/American Express, Inc.,
490 U.S. 477 (1989) (upheld as to Securities Act claims).
XII. NASAA
A. NASAA is the association of the securities regulators in the states, the territories, Canada,
and Mexico. It is a non-profit corporation organized under the laws of the District of
Columbia.
B. NASAA assists its members in protecting investors. NASAA –
1. Operates the CRD licensing system in conjunction with FINRA, pursuant to a
contract;
2. Offers training programs to its members;
3. Develops exam modules for investigators;
4. Supports multi-states investigations and enforcement actions;
5. Publishes investor education materials;
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6. Files amicus briefs in cases involving the interpretation of the securities laws or
investor protection;
7. Comments on proposed rules and laws in the securities field.
C. NASAA is headquartered in Washington, D.C., but it has established a large network of
sections and project groups staffed by volunteers from its member agencies around the
country. These groups focus on specific tasks and issues, and they provide expertise on a
wide range of securities issues involving broker-dealers, investment advisers, corporation
finance, investor education, legislation, and enforcement.
D. NASAA’s website – A key resource for regulators and investors is our website, at
www.nasaa.org. It contains, for example, contact information for all state securities
regulators, a host of information about the CRD and the IARD systems, model rules,
comment letters, and amicus briefs.
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