State Securities Law, the Administrator and What Is a Security

Every question on the Series 63 rests on a short list of defined words. Before you can decide whether a person must register, whether a transaction is exempt, or whether a practice is unethical, you need to know what the law means by person, security, issuer, offer, sale and "in this state." This chapter builds that vocabulary. It starts with why states regulate at all and which model law the exam tests, explains how federal law reshaped state authority in 1996, introduces the state regulator called the Administrator, and then works through the Act's definitions with many examples. It ends with the antifraud rule that no exemption can escape. The definition of securities and issuers is a tested item in its own right, and the rest of the vocabulary shows up throughout the exam.

1.1Blue-Sky Laws, NASAA and the Uniform Securities Act

Why states regulate securities

States regulated securities long before the federal government did. Kansas passed the first state securities law in 1911, and most other states soon followed. These laws are called blue-sky laws, a name that comes from the complaint that some promoters were selling investments backed by nothing more than the blue sky. Congress did not pass the first federal securities law until 1933, after the market crash of 1929.

The federal laws did not replace the state laws. Instead, the two systems run side by side. A broker-dealer selling to customers in Ohio must satisfy both federal law and Ohio's law, and the Ohio regulator can act against anyone who breaks Ohio's rules in Ohio. This is why a securities professional who already holds federal and FINRA qualifications still has to pass a state law exam, such as the Series 63, before doing business with the public in most states.

NASAA and the model law

If every state wrote its own securities law from scratch, a firm doing business in 30 states would face 30 different rulebooks. To reduce that problem, the National Conference of Commissioners on Uniform State Laws approved a model statute in 1956 called the Uniform Securities Act. A model act is not a law anywhere until a state legislature adopts it, and states are free to adopt it with changes. Most states based their securities laws on it.

The North American Securities Administrators Association, or NASAA, is the association of the securities regulators of the U.S. states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands, the Canadian provinces and territories, and Mexico. It was organized in 1919. NASAA writes model rules and statements of policy, coordinates multistate enforcement, and writes the Series 63 exam, which FINRA administers. Over the years NASAA amended the 1956 Act and added commentary explaining how it should be read. NASAA's annotated edition of the Act carries both the original drafters' Official Code Comments and NASAA's own later comments, and this course calls them together NASAA's commentary. For example, after Congress changed federal law in 1996, NASAA added the terms federal covered security and federal covered adviser to the Act in 1997.

Which law the exam tests

The Series 63 tests the Uniform Securities Act of 1956 as amended by NASAA, including NASAA's commentary, along with NASAA's model rules and statements of policy and the federal laws and FINRA rules listed in NASAA's outline. Throughout this course, "the Act" means that version. When a question says "under the Uniform Securities Act," it is asking about the model Act, not about the law of any particular state. Real state laws vary, but the exam never tests a state-specific variation.

In 2002 the uniform-law commissioners approved a newer model, the Uniform Securities Act of 2002, and some states have adopted it. The 2002 Act uses different section numbers and, in places, different terms and time limits. NASAA's exam materials state that the 2002 Act is not tested. Some study materials blend the two acts, so if you meet a rule elsewhere that does not match what you learn here, trust the 1956 Act as amended by NASAA.

How the Act is organized

The Act has four parts, and knowing them helps you find your way around the rest of this course.

• Part I prohibits fraud and other unlawful practices. Section 101 is the general antifraud rule you will study in Lesson 1.7, and Section 102 covers advisory fraud.
• Part II requires registration of broker-dealers, agents, investment advisers and investment adviser representatives.
• Part III requires registration of securities, lists the ways to register, and covers federal covered securities.
• Part IV holds the general provisions, including the definitions in Section 401, the exemptions in Section 402, the Administrator's powers, penalties and civil liability, and the rules on when the Act applies to a transaction in Section 414.

1.2NSMIA and the Administrator

The National Securities Markets Improvement Act of 1996

By the 1990s, a company selling stock nationwide had to register the offering with the SEC and also with nearly every state, and each state could review the deal on its own terms. Congress decided that this duplication was costly for national markets. The National Securities Markets Improvement Act of 1996, usually called NSMIA, moved the regulation of the largest national offerings and the larger advisory firms to the federal level, while leaving the states their role as local police against fraud.

NSMIA created two terms you will use constantly.

• A federal covered security is a security that federal law, in Section 18(b) of the Securities Act of 1933, places beyond the states' power to require registration. The main examples are securities listed on the major national exchanges, such as the New York Stock Exchange or Nasdaq, shares of investment companies registered with the SEC, such as mutual funds, and securities sold in private offerings under the SEC's Rule 506. The Act defines the term by pointing to that federal list.
• A federal covered adviser is an investment adviser registered with the SEC under Section 203 of the Investment Advisers Act of 1940. These are mostly the larger advisory firms. Chapter 4 teaches the dividing line between SEC and state registration.

What the states lost and what they kept

The states lost the power to require registration of federal covered securities or to review their merits, and they lost the power to require registration of federal covered advisers. NSMIA also stopped states from imposing their own capital, custody, margin, books-and-records and similar financial rules on SEC-registered broker-dealers beyond what the SEC requires, which Chapter 2 covers.

The states kept a great deal, however.

• They kept full antifraud authority. A state may investigate and bring enforcement actions for fraud or deceit, and for unlawful conduct by a broker-dealer, in connection with any security, including a federal covered security.
• They kept the power to require notice filings and fees. A notice filing is a filing of copies of federal documents and a fee, without any state review of the merits. For example, a mutual fund can be required to notice-file before its shares are offered in the state, and an issuer selling under Rule 506 can be required to file a copy of its federal Form D. Exchange-listed securities need no state filing at all. A federal covered adviser can be required to notice-file and pay a fee before doing business in the state.
• They kept the registration of broker-dealers, agents, and the investment adviser representatives of federal covered advisers who have a place of business in the state. The states also still register the smaller advisers that are not federal covered advisers.

The Administrator

The Act calls the state's securities regulator the Administrator. The word appears in brackets in the model text because each state substitutes its own title, such as securities commissioner or securities division director, and Section 406 lets each state decide which official or agency administers the Act. On the exam, "the Administrator" means the securities regulator of the state whose law applies. Its authority covers activity in its own state, which Lesson 1.6 defines.

The Act also places a limit on the Administrator. Section 406 makes it unlawful for the Administrator or any employee to use for personal benefit any nonpublic information filed with or obtained by the office.

A preview of the Administrator's powers

Chapter 7 teaches the Administrator's powers in full, but here is the outline. The Administrator may make rules, forms and orders, but only when doing so is necessary or appropriate in the public interest or for the protection of investors. It may issue interpretive opinions and no-action determinations. It may investigate inside or outside the state and issue subpoenas. It may deny, suspend or revoke the registration of broker-dealers, agents, investment advisers and investment adviser representatives, and it may deny, suspend or revoke the registration of securities. It may issue cease-and-desist orders and ask a court for an injunction. What it cannot do is send anyone to jail on its own: for criminal cases, it refers evidence to the state's prosecutors.

1.3Persons, Issuers and Nonissuer Transactions

Person

Almost every rule in the Act begins with the word "person." Under Section 401, a person is an individual, a corporation, a partnership, an association, a joint-stock company, a trust where the interests of the beneficiaries are evidenced by a security, an unincorporated organization, a government, or a political subdivision of a government.

Notice how broad that list is. A city or a state agency is a person. So is a business trust whose ownership interests are securities, and so is an informal investment club that never incorporated. Because "person" includes organizations, the Act's rules reach firms as well as people. Other definitions narrow things down when the Act means only human beings. For example, an agent must be an individual, while a broker-dealer can be any person.

Study materials and exam questions sometimes ask who is not a person. The usual answers are an individual who has died, a minor, and an individual a court has declared legally incompetent. None of them can enter a binding contract on their own, so the Act's rules apply in practice to the executor, guardian or custodian who acts for them. Be clear about where this comes from: the Act's text defines person to include every individual and lists no exceptions. The idea is a convention that follows from the fact that such an individual cannot act for himself or herself, so expect it only when a question asks who is not treated as a person and every other choice is plainly on the Act's list.

Issuer

An issuer is any person who issues or proposes to issue any security. A corporation selling its own stock is an issuer, and so is the United States Treasury, a city selling municipal bonds, or a startup planning its first offering. Note the words "proposes to issue": a company is already an issuer while it is preparing an offering, before it has sold anything.

The Act adds two special rules.

• For certain securities that are really receipts or trust interests, the issuer is the person who performs the acts and takes on the duties of depositor or manager under the trust agreement. This applies to certificates of deposit for a security, voting-trust certificates, collateral-trust certificates, and shares in an unincorporated investment trust that has no board of directors, such as a unit investment trust. For a unit investment trust, the sponsor that deposits the securities and sets up the trust is the issuer.
• For certificates of interest or participation in oil, gas or mining titles or leases, or in payments out of production under them, the Act says there is no issuer at all.

Issuer and nonissuer transactions

The Act defines nonissuer as "not directly or indirectly for the benefit of the issuer." An issuer transaction is one that benefits the issuer, usually because the issuer receives the money. A nonissuer transaction is one in which the issuer receives nothing, because one investor is selling to another.

The distinction matters because the Act treats the two very differently. When an issuer raises money from the public, investors need full disclosure about a business they are funding. Once the securities are outstanding and trading between investors, the Act offers several exemptions for that trading, which Chapter 6 covers. Most trading on a stock exchange is nonissuer trading: when you buy 100 shares of a large listed company through your broker, the shares come from another investor, and the company receives nothing.

Two more definitions: state and guaranteed

The Act defines state as any state, territory or possession of the United States, the District of Columbia, and Puerto Rico. And it defines guaranteed as guaranteed as to payment of principal, interest or dividends. A guaranteed security is one where a person other than the issuer, such as a parent company, promises that those payments will be made.

1.4What Is a Security

The statutory list

Whether something is a security decides whether the Act applies at all. If an instrument is a security, its offer and sale must be registered or exempt, the people selling it generally must be registered, and the antifraud rule applies. If it is not a security, the Act has nothing to say about it.

Section 401 defines a security with a long list. A security means any of the following.

• A note, stock, treasury stock, bond, debenture, or evidence of indebtedness.
• A certificate of interest or participation in any profit-sharing agreement.
• A collateral-trust certificate, a preorganization certificate or subscription, or a transferable share.
• An investment contract.
• A voting-trust certificate, or a certificate of deposit for a security.
• A 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.
• In general, any interest or instrument commonly known as a security.
• 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 above.

The list works in layers. The first items name familiar instruments. The phrase investment contract catches arrangements that do not look like traditional securities, which Lesson 1.5 explains. The phrase "commonly known as a security" catches anything the market already treats as one. And the last line pulls in anything built on top of a security, such as a warrant to buy stock or a receipt representing shares held by a bank.

Examples of securities

Using the list, all of the following are securities under the Act.

• Common and preferred stock, including treasury stock, which is stock a company has issued and later bought back.
• Corporate bonds and debentures, government and municipal bonds, and promissory notes, since a note and any evidence of indebtedness are on the list.
• Warrants and rights to buy stock, and American depositary receipts, which are receipts for foreign shares.
• Preorganization certificates or subscriptions, which are promises to buy shares in a corporation that has not yet been formed.
• Interests in oil, gas or mining programs, including oil payments, which are rights to a share of the money from production.
• Limited partnership interests and real estate investment trust shares, because the investor provides money and others manage the business.
• A variable annuity, because the payments depend on the investment results of a separate account invested in securities.

What the Act excludes: insurance and fixed annuities

The definition ends with an important exclusion. A 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. Ordinary life insurance, an endowment policy and a fixed annuity are therefore not securities, and the securities law has no impact on them; state insurance regulators oversee them instead.

The words "a fixed sum of" are the reason a variable annuity is still a security. The insurer behind a variable annuity does not promise a fixed sum; the payout rises and falls with the securities in its separate account. NASAA's commentary says this wording was chosen on purpose so that variable annuities would not be excluded.

Things that are generally not securities

Some things people invest in are not on the list and are not investment contracts in their ordinary form.

• Commodity futures contracts, such as contracts for wheat, oil or gold for future delivery. These are regulated by federal commodities law, not the securities laws.
• Collectibles and physical assets held by the investor, such as gold coins, gemstones, artwork, rare stamps or wine.
• Real estate bought for personal use, such as a home or a vacation cabin the owner uses.
• Retirement plans themselves, such as an individual retirement account or a traditional pension that the employer funds and every eligible employee joins automatically. The plan is a wrapper; the stocks, bonds and fund shares held inside it are securities.

Each of these can turn into a security when it is packaged as an investment that someone else manages for profit. A program that sells interests in a pool of managed commodity futures, a scheme that sells rare coins with a promise to manage and resell them, or a resort condominium sold with a mandatory rental pool can all be investment contracts. NASAA's commentary also notes that some Administrators, and the SEC, take the position that an employee benefit plan involves an investment contract, at least when joining is voluntary and employees must contribute their own money to take part; the Act exempts those plan interests from registration if the Administrator gets 30 days' written notice before the plan begins, which Chapter 6 covers.

1.5Investment Contracts and the Howey Test

Why the law needs a flexible test

Promoters have always been inventive. If the definition of security named only stocks and bonds, a promoter could avoid the law simply by selling something with a different label, such as a "membership," a "unit" or a "land contract." The term investment contract closes that gap. Neither the Act nor the federal securities laws define it, so its meaning comes from the courts. NASAA's commentary to the Act points to the leading case.

The Howey case

In SEC v. W. J. Howey Co., decided in 1946, the United States Supreme Court looked at a Florida company that owned large citrus groves. The company sold narrow strips of grove land to the public, typically only an acre or two and sometimes less than an acre, and offered each buyer a 10-year service contract under which its affiliate would cultivate, harvest and market the fruit. Most of the acreage sold was covered by those service contracts. The buyers were mostly business and professional people from other states, many of them guests at the company's resort hotel, who had no equipment or experience to grow citrus. The fruit from all the plots was pooled, and each buyer received a share of the net profits.

The company argued it was simply selling land and offering a separate management service. The Court disagreed. It looked past the form of the deal to its economic reality: the buyers were investing money in a citrus business run by others and expected a return from the company's work. The land deeds were just a convenient way of measuring each investor's share.

The four elements

From Howey comes the test you must know. An investment contract is a contract, transaction or scheme in which a person makes:

1. an investment of money,
2. in a common enterprise,
3. with an expectation of profits,
4. to come solely from the efforts of the promoter or a third party.

An arrangement that meets all four elements is a security, no matter what it is called, whether ownership is shown by formal certificates or by interests in physical property, and whether the investor receives a stock certificate, a deed or nothing at all.

The Court added several points that exams like to test. It does not matter whether the enterprise is speculative or conservative, or whether the property sold has value of its own. It is enough that the promoter offers the essential ingredients of an investment contract, even if some buyers choose not to accept the management contract, because the law covers offers as well as sales. And a good-faith mistake about the law is no excuse for failing to register.

Applying the test

The best way to learn Howey is to run real-looking facts through the four elements.

The same reasoning applies to newer products. Regulators and courts use the Howey elements to analyze arrangements that did not exist in 1946, including some sold as digital assets. The label never decides the question; the economic reality does.

1.6Offers, Sales and the Reach of State Law

Sale and offer

The Act's registration and antifraud rules are triggered by offers and sales, so the Act defines both broadly.

• A sale or sell includes every contract of sale of, contract to sell, or disposition of, a security or interest in a security for value.
• An offer or offer to sell includes every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value.

The words "for value" matter. A true gift is generally not a sale. But the offer definition is very wide: a phone call, an email, a sales seminar or a social media post soliciting interest can each be an offer, even if nobody ever buys.

Special rules that create offers and sales

The Act adds several rules that stop people from avoiding registration with clever packaging.

• Bonus securities. A security given with, or as a bonus for, the purchase of a security or anything else is part of what the buyer purchased and is considered offered and sold for value. If a car dealer gives every buyer 50 shares of the dealer's stock, those shares were sold.
• Assessable stock. A purported gift of assessable stock is considered an offer and sale. Assessable stock is stock on which the issuer can later demand additional payments from the holder, so the "gift" comes with a cost.
• Warrants, rights and convertibles. Every offer or sale of a warrant or right to buy another security, or of a security that can be converted into another security, also counts as an offer of that other security. NASAA's commentary explains that the security called for by a warrant must therefore be registered, unless an exemption applies, before the warrants are offered, even if the warrants themselves are given away free.

What is not an offer or sale

The Act lists four things that are not offers or sales.

• A bona fide pledge or loan, such as pledging stock as collateral for a bank loan.
• A stock dividend, if stockholders give nothing of value for it. This holds even when each stockholder can choose between the dividend in cash or property and the dividend in stock, because giving up the cash is not treated as paying for the stock.
• Any act incident to a class vote by stockholders on a merger, consolidation, reclassification of securities, or sale of corporate assets in exchange for another corporation's securities.
• Any act incident to a judicially approved reorganization in which a security is issued in exchange for outstanding securities, claims or property interests, or partly in exchange and partly for cash.

The Act also keeps the deal-making that precedes a public offering outside its registration requirement. Under federal law, preliminary negotiations and agreements between an issuer and its underwriters are not offers at all. The Uniform Act reaches the same practical result through an exemption: any transaction between an issuer and an underwriter, or among underwriters, is an exempt transaction. Either way, an issuer and its underwriters can negotiate the terms of a deal before the security is registered. It is the later offer to the public that must be registered or exempt.

When an offer or sale happens "in this state"

Every state's Act covers only activity in that state, so Section 414 tells you when an offer or sale is "in this state." For the seller, the Act's antifraud rule, its registration requirements for securities and for broker-dealers and agents, and its civil liability rules apply when an offer to sell is made in the state, or when an offer to buy is made and accepted in the state. Parallel rules apply to buyers.

An offer is made in this state, whether or not either party is then present in the state, when the offer either originates from this state, or is directed by the offeror to this state and received at the place to which it was directed. A mailed offer counts as received when it reaches any post office in the state.

An offer is accepted in this state when the acceptance is communicated to the offeror in this state and was not previously communicated to the offeror outside the state.

The result is that one offer can be made in two states at once, so both states' laws apply. NASAA's commentary says this is intentional: a state should not be usable as a base for defrauding people elsewhere.

NASAA's commentary adds two practical points. First, merely sending a confirmation or delivering the security into a state, or a buyer's mailing a check from that state, does not by itself bring that state's law into play, unless the confirmation or delivery is the seller's acceptance of the buyer's offer. Second, a person who mails an offer to someone's home in one state cannot be caught by the law of another state merely because the mail was forwarded there without the sender's knowledge.

Newspapers, radio and television

Section 414 also deals with advertising that crosses state lines. An offer is not made in a state just because a bona fide newspaper or other publication of general, regular and paid circulation is circulated there, if the publication is not published in that state. It is also not made in the state of publication if the publication has had more than two-thirds of its circulation outside that state during the past 12 months. In the same way, an offer is not made in a state just because a radio or television program that originates outside the state is received there. A program originates where the microphone or camera is, not where a relay station sits.

In practice, an ad in a regular newspaper is an offer only in the state where the paper is published, and not even there if more than two-thirds of its circulation is out of state. But the door does not stay fully open. If a reader in another state responds by sending an order, and the seller accepts it in the reader's state, the reader's state law applies to that sale.

1.7The General Antifraud Provision

The text of Section 101

The first section of the Act is its broadest. Section 101 makes it unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly, to do any of the following three things.

1. To employ any device, scheme or artifice to defraud.
2. To make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.
3. To engage in any act, practice or course of business that operates or would operate as a fraud or deceit upon any person.

The official commentary notes that this section is substantially the same as the SEC's Rule 10b-5. A material fact is a fact that a reasonable investor would consider important in deciding whether to buy, sell or hold. The second clause covers two kinds of lies: saying something false, and telling a half-truth by leaving out a fact that would change the meaning of what was said. The Act also states that fraud, deceit and defraud are not limited to common-law deceit, so the antifraud rule reaches more than the narrow, traditional courtroom meaning of fraud.

Why it applies to everyone and everything

Read the words carefully: "any person" and "any security." The antifraud rule has no exemptions. The commentary says so directly. That leads to several conclusions the exam tests often.

• It applies to exempt securities, such as government and municipal bonds, and to securities sold in exempt transactions, such as private placements.
• It applies to federal covered securities, such as listed stocks and mutual fund shares, because NSMIA preserved the states' antifraud authority.
• It applies to every person, registered or not. An issuer, an unregistered promoter, a registered agent and an individual investor can all violate it.
• It applies to purchases as well as sales. A broker-dealer that tricks a customer into selling shares to it cheaply violates the rule just as surely as one that sells by misrepresentation.

Antifraud rules for advice and what comes next

Section 101 covers fraud in connection with the offer, sale or purchase of securities. A separate section, Section 102, covers fraud by people who give investment advice for compensation, and Chapters 4 and 5 teach it along with the conduct rules built on it. The Act itself does not list penalties next to Section 101. Instead, the consequences come from the Administrator's administrative powers, court injunctions, criminal prosecution and civil lawsuits by investors, all of which Chapter 7 covers. NASAA's statements of policy on unethical practices, which Chapter 11 covers, describe in detail the kinds of conduct the Administrator treats as dishonest or unethical.

Chapter Summary

• States regulated securities first, beginning with Kansas in 1911, and their laws are called blue-sky laws. The Series 63 tests the Uniform Securities Act of 1956 as amended by NASAA, with NASAA's commentary, not the 2002 Act or any single state's law.
• NASAA is an association of regulators that writes model rules and the exam; it has no enforcement power. Each state's Administrator registers, investigates and disciplines.
• NSMIA, passed in 1996, took from the states the power to require registration of federal covered securities and federal covered advisers. The states kept antifraud authority, notice filings, fees, and the registration of broker-dealers, agents and many investment adviser representatives.
• A person includes individuals, organizations of every kind, governments and political subdivisions. An issuer is any person who issues or proposes to issue a security, and a nonissuer transaction is one not for the benefit of the issuer.
• A security is defined by a long statutory list ending with any instrument commonly known as a security. Insurance, endowment policies and fixed annuities are excluded, but variable annuities are securities.
• Commodity futures, collectibles, personal real estate and retirement plans themselves are generally not securities, but any of them can become an investment contract when packaged as a managed investment.
• Under the Howey test, an investment contract is an investment of money in a common enterprise with an expectation of profits from the efforts of others. Substance controls over labels.
• Offer and sale are defined broadly. Bonus securities and gifts of assessable stock are sales, and offering a warrant or convertible is also an offer of the underlying security. Pledges, stock dividends, merger votes and court-approved reorganizations are not offers or sales.
• An offer is made in a state when it originates there or is directed to and received there, and it is accepted in a state when acceptance is communicated to the offeror there. Bona fide newspapers published elsewhere, papers with more than two-thirds of circulation out of state, and broadcasts from outside the state do not create an offer in the state.
• Section 101 forbids fraud, material misstatements and misleading omissions by any person in connection with the offer, sale or purchase of any security, and no exemption excuses it.

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