SECURITIES REGULATION:
THE BASICS
2009 ATTORNEY/INVESTIGATOR
TRAINING SEMINAR
JOSEPH BRADY•DEPUTY GENERAL COUNSEL•NASAA
202-737-0900•JB@NASAA.ORG
What is NASAA?
2


Membership association for the securities regulators in the fifty states, U.S.
territories, the District of Columbia, the Canadian provinces and Mexico.
How we can help you:




Corporate Office Leadership:






Amicus briefs in state and federal courts in support of our members and other
groups.
Support for multi-state investigations.
Assisting with Comment letters.
Russ Iuculano, Exec. Dir.
John Lynch, Dep. Exec. Dir./Controller
Deborah Fischione House, Director of Policy
Rex Staples, General Counsel
Bob Webster, Director of Communications
Visit us on the web at www.nasaa.org.
Alphabet Soup
3




FINRA. The Financial Industry
Regulatory Authority is a self
regulatory organization for brokerdealers and their associated persons.
It was formed from the merger of the
regulatory functions of the National
Association of Securities Dealers
(NASD) and the New York Stock
Exchange (NYSE).
SRO. Self-regulatory organization.
SEC. The Securities and Exchange
Commission.
NSMIA. National Securities Market
Improvement Act of 1996.





USA. Uniform Securities Act.
RR. Registered representative,
associated person of a brokerdealer, or an agent of a brokerdealer.
IAR. Investment adviser
representative.
BDs and IAs. Broker-Dealers and
Investment Advisers.
CRD and IARD. The Central
Registration Depository and the
Investment Adviser Registration
Depository are the systems used to
process the registrations of brokerdealers and their associated persons
and investment advisers and their
representatives.
SECURITIES REGULATORS
4




State – All 50 states, the District of Columbia,
Puerto Rico, and the U.S. Virgin Islands have
agencies that regulate securities.
Federal – Securities and Exchange Commission.
SROs – “Self-Regulatory Organizations” such as
FINRA.
Criminal Prosecutors – District attorneys, state
attorneys general, and the offices of the federal
U.S. Attorneys.
Overview of Securities Regulation
5
History: State
statutes
regulating
securities
transactions
date back to
the early
1900s.
Kansas is
credited with
enacting the
first “Blue
Sky” law in
1911.

1.
2.
3.
4.
5.
Basic Structure – Five Essential
Regulatory Areas:
Define securities and core concepts.
Licensing of firms and professionals.
Registration/Exemption of securities.
Standards of conduct.
Remedies.
Major Securities Laws - Statutes
6

State Statutes – The Uniform Securities Act
Uniform Securities Act 1956
 Revised Uniform Securities Act 1985
 Uniform Securities Act 2002


Federal Statutes
Securities Act of 1933, 15 U.S.C. § 77a et seq
 Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq
 Investment Advisers Act of 1940, 15 U.S.C. § 80b-1 et seq
 Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq

Major Securities Laws - Regulations
7


State and Federal. State and federal regulators
enact rules governing the regulation of securities in
their respective jurisdictions.
Rules of Self-Regulatory Organizations. Selfregulatory organizations enact rules applicable to
their member firms and associated persons.
Major Securities Laws – Other Sources
8



Case Law. Decisions from state and federal courts
in addition to SEC and state administrative
proceedings.
Interpretive and No Action Letters. State and
federal regulators issue no action and interpretive
letters providing guidance on the application of
securities laws to various scenarios.
Treatises. Professor Joe Long’s treatise on Blue Sky
law is an excellent resource.
State and Federal Law:
Interpretation and Preemption
9

Shared Interpretation
 Dual
system of
regulation.
 State and federal
court decisions.
 Coordination between
state and federal
regulators.

Preemption
 Express
preemption.
 Field preemption.
 Conflict preemption.
 NSMIA.
 Registration.
 Books
and records.
 Investment advisers.
 Savings
clause for
fraud and deceit.
What is a Security?
10
“Security” means any note;
stock; treasury stock; bond;
debenture; evidence of
indebtedness; certificate of
interest or participation in any
profit-sharing agreement;
collateral-trust certificate;
preorganization certificate or
subscription; transferable share;
investment contract; voting-trust
certificate; certificate of deposit
for a security; certificate of
interest or participation in an
oil, gas, or mining title or lease
or in payments out of
production under such a title or
lease; or, in general, any
interest or instrument commonly
known as a “security,” or any
certificate of interest or
participation in, temporary or
interim certificate for, receipt
for, guarantee of, or warrant or
right to subscribe to or
purchase, any of the foregoing.
“Security” does not include any
insurance or endowment policy
or annuity contract under which
an insurance company promises
to pay [a fixed sum of] money
either in a lump sum or
periodically for life or for some
other specified period.

SEC v. Howey, 328 U.S. 293 (1946) and
the “investment contract.”
An investment of money.
 In a common enterprise.
 With the expectation of profits.
 To come predominantly from the efforts of
others (the key element of passivity).


Risk capital test. Alternative to Howey
definition of “investment contract.”
An investment.
 In the risk capital of an enterprise.
 With the expectation of benefit.

Is it Security?
11
Product
Classification
Variable Annuity.
Security under federal law.
Consult state law for inclusion.
Fixed Annuity.
Not a security.
Equity Indexed Annuity.
Proposed SEC rule would treat
some as a security.
Limited Partnership Interest.
Security.
General Partnership Interest.
Generally not a security.
CD Issued by a National Bank.
Not a security.
Licensing: Firms and Individuals
12

Broker-Dealers.




Broker-dealers are defined in
the USA as any person
engaged in the business of
effecting transactions in
securities for the account of
others or for his own account.
Form BD with CRD.


Agents.


Individual salespeople who
represent broker-dealers.
Form U4 with CRD.
Investment Advisers.

Investment advisers are
defined in the USA as any
person who, for compensation,
engages in the business of
advising others as to value or
advisability of investing in
securities.
Form ADV with IARD.
Investment Adviser
Representatives.


Individuals who represent
investment advisers and
provide investment advice to
clients.
Form U4 with CRD.
Duty of Care – Broker-Dealers v. Advisers
13
Broker-Dealers

Suitability
FINRA Rules (2310)
 Only applies to
recommendations to
customers.
 Reasonable grounds that
security is suitable based
on customer’s security
holdings, financial
situation/needs.
 Generally not fiduciary.

Investment Advisers

Fiduciary Duty
SEC v. Capital Gains
Research Bureau, Inc., 84
S. Ct. 275 (1963).
 Recommendations must
be in the customer’s best
interest.
 Eliminate conflicts and
where not possible
manage through
disclosure.

Registration of Securities
14


Unlawful to offer or sell any security in a state
unless it is registered or exempt from registration
Basic types of registration:
 Notification.
Available to seasoned issuers who meet
certain standards relating to defaults on previously
issued securities and average net earnings. (Obsolete)
 Coordination. Securities undergoing federal
registration pursuant to the 1933 Securities Act.
 Qualification. All other securities that are not otherwise
registered or exempt.
Exemptions
15

State law exemptions.
 Exempt
transactions.
 Exempt securities.

Federal law exemptions.
 NSMIA
preempted state authority to review “covered
securities” which include the following:
 Securities
traded on national exchanges
 Securities issued by investment companies (mutual funds)
 Private
offerings – Regulation D, Rule 506.
Sale of Securities to Public Investors
16
Common Violations
17




Offering or selling a security or providing
investment advice without a license.
Offering or selling a security that has not been
registered or is otherwise not exempt.
Committing fraud in connection with the offer, sale
or purchase of a security.
Failure to supervise.
Fraud
18

Relevant state and federal statutory provisions:

USA 1956 §101 – General Fraud Provision. Unlawful in
connection with the offer, sale or purchase of any security:
To employ schemes to defraud;
 To make any untrue statements of material fact or to omit facts
necessary to make other statements not misleading;
 To engage in any act, practice or course of business that operates
as a fraud or deceit.


USA 1956 §102 – 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 on any person.
The Key Elements of Fraud
19

“Offer” and “Sale.”


Materiality.


Generally, is there a substantial likelihood that a reasonable
purchaser or seller would consider the information important in
deciding whether or not to purchase or sell.
Scienter.


Under the broad definitions in state uniform acts this would also
include every attempt to “offer or dispose” of a security
Generally not a requirement in most state civil or criminal
enforcement proceedings.
Reliance and Damages.
Remedies
20


Injunctive actions in civil courts.
Administrative actions.
 Cease
and desist/desist and refrain orders.
 Orders denying, suspending, revoking licenses and
registrations.


Civil remedies for private plaintiffs.
Criminal penalties.
 Some
states have criminal prosecutorial authority.
 Most states have to refer to criminal authorities.