[Re-printed from Wall Street Lawyer, Feb. 2003, p. 8, Glasser LegalWorks.]
A New Uniform Securities Act
by Richard B. Smith
The Uniform Law Commissioners have turned to the subject of securities regulation four times in their history. The first act was the Uniform Sales of Securities Act of 1930, which predates the first major federal securities statute. Recognizing the need for state uniformity, the Uniform Law Commissioners began their work eight years earlier, in 1922. While a number of states had securities legislation, few states enacted the 1930 Uniform Act.
A second Uniform Securities Act was promulgated in 1956. This model was substantially enacted in 37 jurisdictions. The first revision of this mainstay of state securities regulation occurred in 1985 (and some amendments were added to the 1985 Uniform Act in 1988), but the revision was enacted in only six states.
The Uniform Law Commissioners have now promulgated a fourth uniform law, which replaces both the 1956 and the 1985 Uniform Acts. The 2002 Uniform Act is a carefully balanced result of four years of intensive consideration and drafting, and reflects consensus support from most representatives of the broad array of government and private sector interests that participated in the process. This article describes the 2002 Uniform Securities Act.
Federal and State Law
As securities lawyers are aware, there are two concurrent securities regulatory regimes: one at the federal level and one at the state level. Federal regulation of securities effectively began with Congress’ enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the SEC. These two statutes, plus the Investment Company Act and the Investment Advisers Act, both enacted in 1940, (and all much amended since) are still the core federal law on securities regulation.[i]
The lack of support for the 1985 Uniform Act had several causes: concerns about duplication of regulation, the role of merit regulation at the state level, and the reluctance of many states to address the subject when there was such controversy about its provisions. Congress partially resolved this problem in the National Securities Markets Improvements Act of 1996 (NSMIA) and the Securities Litigation Uniform Standards Act of 1998. In NSMIA, Congress preempted significant parts of state power to duplicate federal regulation. For example, NSMIA prohibits a state from subjecting an offering of “federal covered securities” to merit review and other registration requirements.[ii]
The 2002 Uniform Act is a carefully balanced result of four years of intensive and drafting.
From 1956 through 2002, drafters of the successive versions of the Uniform Securities Act have had to deal with the relationship between state and federal law. Coordinating federal and state regulation was a substantial objective for the drafters of the 2002 Uniform Act.
State Role in Securities Regulation
The states have an important role in securities regulation. There is fraudulent activity at a level that eludes federal regulators, even when federal law applies. And by no means are all securities “federal covered securities.” Many schemes to defraud investors involve locally generated pyramid schemes, misrepresentation, and scams. Without state regulation accompanied by civil and criminal enforcement of the law in state courts, there would be little hope of redress for many victimized investors. State enforcement is also available when there are fraudulent schemes involving federal covered securities. In effect, Congress and the SEC have acknowledged that federal regulators are unable to cope with all the enforcement that needs to be done.
The 2002 Uniform Act is an effort to give states regulatory and enforcement authority that minimizes duplication of resources and blends with federal regulation and enforcement more efficiently. Uniformity of law among the states, and coordination with federal law, are essential for this to happen.
Elements of Securities Regulation
Securities regulation exists to prevent fraudulent sales of securities to investors. In general, the purpose is achieved by three methods. First, initial public offerings of securities by issuers and control persons must be registered. Second, broker-dealers and their agents, and investment advisers and their representatives, must be registered. Third, fraud in securities transactions is prohibited and enforcement powers are given to an appropriate regulatory agency. These powers include the ability to make rules and regulations, to issue stop-orders, to bring criminal prosecutions, and to pursue civil actions in court. The 2002 Uniform Act addresses all three of these functions.
Registration and notice filing for securities offerings
There are three methods for dealing with public offerings of securities under the 2002 Uniform Act: notice filing, registration by coordination, and registration by qualification.
Notice filing under the 2002 Uniform Act is for federal covered securities other than listed securities.[iii] This filing consists of a consent to service of process, a filing fee, and (depending on the state securities administrator’s requirements) can include copies of material filed with the SEC. The 2002 Uniform Act provides a platform for eventually effectuating one-stop filing, whereby documents filed with the SEC can be electronically filed with states within which offerings are to be made.
Offerings of securities that are not federal covered securities must be registered at the state level (unless exempt) by means of either coordination or qualification. The provision in the 1956 Uniform Act for registration by notification has been eliminated—both because it has rarely been used in recent years and because most securities to which it was applicable are now federal covered securities.
Coordination registration at the state level is available for securities that, even though not federal covered securities, are registered with the SEC. These would include securities that do not meet the listing standards of exchanges. The new registration by coordination provision is little changed from the original 1956 version.
The 2002 Uniform Act provides a platform for eventually effectuating one-stop filing.
The objective of coordination is the simultaneous registration of the offering at the SEC and in the states where the offering is to be made. In order to facilitate coordinated registration, the state securities administrators association has implemented a system for coordinated review of these offerings by the states.[iv] The 2002 Uniform Act provides support for that effort.
The 2002 Uniform Act continues to permit “merit” regulation. For the limited number of SEC-registered issues to which merit regulation would apply, it remains inconsistent with the disclosure model of federal registration. The 2002 Uniform Act does require that, to the extent practicable, merit standards should be published so as to provide notice. It is hoped that such standards would be uniform among those states imposing merit regulation.[v]
Qualification registration at the state level applies to all other offerings for which an exemption is not available. These can include intra-state offerings and offerings that are exempted from SEC registration because of their relatively small size. This provision in the 2002 Uniform Act, including the required information content of the state registration (which is applicable also to issues being registered by coordination), is little changed from the 1956 Uniform Act, except for modernizing language.
The 2002 Uniform Act, like the 1956 Uniform Act, contains a number of exemptions from the general requirement that all securities offerings must be registered. Some exemptions are for the securities themselves—typically for government and municipal securities.[vi] Other exemptions are for transactions, such as unsolicited brokerage and limited offering transactions. In this regard, the 2002 Uniform Act contains a revised definition of “institutional investor” that seeks both to make uniform the varied definitions in current state laws and to be consistent with federal law.
The 2002 Uniform Act continues to permit “merit” regulation.
It is important to recognize that all of these exemptions are only from the registration of securities. They do not free broker-dealers, investment advisers, agents, or investment adviser representatives from the separate registration requirements applicable to them. In addition, the antifraud provisions of the 2002 Uniform Act continue to apply to anyone engaging in an exempted transaction or in a transaction involving an exempted security.
Registration of securities professionals
The second method of securities regulation is the registration and continued oversight of broker-dealers and their agents, investment advisers and their representatives, and the individuals who are agents of issuers (all defined terms in the 2002 Uniform Act). Here again, federal and state law necessarily interact. The 2002 Uniform Act systematizes and reorganizes the provisions dealing with these securities professionals and coordinates them, to the extent feasible, with federal regulation.
In NSMIA, Congress limited, in certain respects, the state regulation of broker-dealers. In practice most broker-dealers are required to be registered with the NASD and are regulated by both that self-regulatory organization and the SEC. Nevertheless, under NSMIA and the 2002 Uniform Act, they are still subject to registration with, and antifraud enforcement, by the states. The individuals who are agents of broker-dealers also must be dually registered, and agents of issuers generally are required to be registered in the states. The 2002 Uniform Act clarifies these federal-state interrelationships and promotes an efficient coordination of dual registration and regulation in the public interest to the benefit of both the regulators and the regulated.
NSMIA took a somewhat different tack with respect to investment advisers and the individuals who are investment adviser representatives. For investment advisers, Congress allocated regulatory authority between the SEC and the states. Registration of large investment advisers (those having assets under management in excess of $25 million) by states was preempted and is the exclusive province of the SEC. However, under the 2002 Uniform Act and as permitted by NSMIA, such SEC-registered “federal covered investment advisers” are to effect notice filings, pay filing fees, and execute consents to service of process at the state level. Smaller investment advisers (those having assets under management of less than $25 million) are left to exclusive state registration and regulation.[vii]
The individuals who are investment adviser representatives of both federal covered investment advisers and investment advisers subject to state registration) must be registered with the states in which they do business, unless exempted. There is no system for federal registration of’ investment adviser representatives, but the NASD is cooperating with the national association of state securities regulators to create a centralized filing system for these representatives. The 2002 Uniform Act supports such a system.
The 2002 Uniform Act contains certain clarifying exclusions from the definitions of broker-dealer, agent, investment adviser, and investment adviser representative, and certain exemptions from their registration. In general, these exclusions and exemptions are consistent with the federal statutes and with the 1956 Uniform Act.
In contrast to the 1956 Uniform Act, the 2002 Uniform Act does not exclude banks from the definition of broker-dealer. This follows the change in federal law in the 1999 Gramm-Leach-Bliley Act, which adopts a “functional” regulatory approach to the oversight of bank involvement in the securities business. Thus, banks engaging in securities activities that are not simply intra-state are now subject to SEC regulation of those activities, including registration as broker-dealers, unless they engage only in specific types of transactions that Congress believed would not implicate investor protection problems. Congress deliberately did not preempt state law in this area, but followed the long traditional model of concurrent federal and state securities regulation.
The 2002 Uniform Act adopts the same functional regulatory approach toward banks, with all but two of the types of transactions permitted under federal law. The Uniform Law Commissioners could see little reason for banks not to be functionally and concurrently regulated as all other professionals are if they choose to engage in the securities business. In fact, many banks have subsidiaries that are broker-dealers and have placed their securities activities in those entities, thus obviating any need for the bank itself to register as a broker-dealer.
[T]he 2002 Uniform Act does not exclude banks from the definition of broker-dealer.
A new provision in the 2002 Uniform Act provides qualified immunity from defamation claims for statements in a required report concerning terminations of employment. This is intended to promote the complete and accurate disclosure of disciplinary problems.
The third method of securities regulation, of course, is enforcement against anyone engaged in fraudulent practices in securities transactions and against issuers and securities professionals for failure to comply with the registration regimes applicable to them. The 2002 Uniform Act continues the enforcement powers of the state securities regulators contained in the 1956 Uniform Act with some enhancements. Specifically, the 2002 Uniform Act:
ARTICLE 1authorizes the state securities administrator to issue, under appropriate procedures, cease and desist orders for violations, and authorizes courts to enforce such orders;
ARTICLE 2authorizes the state securities administrator to conduct investigations, issue subpoenas, and provide assistance to securities regulators in other jurisdictions; and
ARTICLE 3includes civil liability provisions for defrauded persons to obtain damages or rescission that are substantially the same as in the 1956 Uniform Act, except that the statute of limitations is lengthened to be the same as its federal counterpart.
Fraud in connection with securities is a broadly defined term under both federal and state law, and the 2002 Uniform Act preserves that breadth. In fact, the applicability of the antifraud provisions has been expanded by moving some exclusions from definitions in the 1956 Uniform Act to exemptions from registration in the 2002 Uniform Act. The antifraud provisions in the 2002 Uniform Act apply within the state equally to state-registered entities and persons, to federal covered investment advisers, and to anyone in connection with transactions in any securities, including federal covered securities.
The definition of “security” largely determines the scope of the 2002 Uniform Act. This definition tracks the definition of “security” in federal law, with some additional explicit language to make clear that the 2002 Uniform Act applies to uncertificated as well as certificated securities, to interests in limited partnerships and limited liability companies, and to investments in viatical settlements of insurance contracts (as to which there has been evidence of abuses). The 2002 Uniform Act also codifies a generally accepted definition of an “investment contract,” a term included in the federal and state definition of “security,” to assist state courts. Following federal law, interests in pension plans subject to ERISA are excluded from the definition of regulated under other law.
The 2002 Uniform Act, like the 1956 Uniform Act, leaves open for resolution state-by-state whether variable annuity contracts issued by insurance companies should be excluded from the definition of “security.” Variable annuities, which operate like and compete with mutual fund investments, are securities under federal law. Because the separate accounts of insurance companies that issue variable annuities would likely be registered with the SEC as investment companies, they would under NSMIA be federal covered securities not subject to state registration. Including them within the definition of security would have the effect of making their sale subject to the notice filing and antifraud provisions of the 2002 Uniform Act and requiring agent registration for their sellers.
While not strictly related to enforcement, it is worth noting that the 2002 Uniform Act contains a new provision that would authorize the state securities administrator to develop and implement programs for investor education, with particular emphasis on the prevention and detection of securities fraud, The 2002 Uniform Act also creates a Securities Investor Education and Training Fund to support such a program; the funding of the program is left to state-by-state determination. These initiatives recognize that financial literacy has become increasingly important as participation in the country’s equity markets has significantly broadened.
Coordination and Uniformity
In the NSMIA, Congress declared that its policy is to increase federal and state cooperation in securities matters. To that end, Congress instructed the SEC, at its discretion, to cooperate, coordinate, and share information with state securities regulators so as to maximize effectiveness of securities regulation, maximize uniformity in federal and state regulatory standards, and minimize interference with the business of capital formation. Congress made it explicit that the policy it enunciated was not intended to be preemptive of state law.
The 2002 Uniform Act responds to this federal initiative with a provision that contains a reciprocal instruction, in substantially the same language, from the state legislature to its securities administrator. Thus, upon enactment of the 2002 Uniform Act, both federal and state regulators would have the same marching instructions from their respective legislatures to make securities regulation as efficient, effective, and coordinated as practicable in the public interest and for the protection of investors. Achieving this goal requires both federal/state coordination and uniformity among the states. The 2002 Uniform Act provides a platform for meeting these conditions at the state level.
Organization of the 2002 Uniform Act
The 2002 Uniform Act contains seven Articles:[viii]
- General Provisions, consisting of five sections, including the definitions section.
- Exemptions from Registration of Securities, consisting of four sections.
- Registration of Securities and Notice Filing of Federal Covered Securities, consisting of seven sections.
- Broker-Dealers, Agents, Investment Advisers, Investment Adviser Representatives, and Federal Covered Investment Advisers, consisting of twelve sections, including registration and notice filing sections and exemption subsections.
- Fraud and Liabilities, consisting of ten sections.
- Administration and Judicial Review, consisting of twelve sections.
- Transition, consisting of three sections.
To date, the 2002 Uniform Securities Act as approved by the Uniform Law Commissioners has received the endorsement of the North American Securities Administrators Association and the Securities Industry Association. The Council of the Section of Business Law has recommended approval of the Act by the American Bar Association. Introductions of the Act in the state legislatures will begin this year.
* Mr. Smith (email@example.com) was Chairman of the Drafting Committee of the National Conference of Commissioners on Uniform State Laws for the Uniform Securities Act (2002). He is a retired partner of Davis Polk & Wardwell and a former Commissioner of the Securities and Exchange Commission.
[i] There are other federal statutes relevant to securities regulation. Section 103 of the 2002 Uniform Act lists a total of 13.
[ii] “Federal covered securities” include securities that are (or on completion of the offering will be) listed on the New York or American Stock Exchanges, on NASDAQ, or on other exchanges that the SEC approves; or are issued by SEC-registered investment companies (most of which are mutual funds); or are issued under specified exemptions in the Securities Act of 1933.
[iii] Under NSMIA, notice filings cannot be required for listed securities.
[iv] The September 2001 issue of WALLSTREETLAWYER.COM features two articles about coordinated review.
[v] As of September 2002, issuance of a stop order denying or revoking effectiveness of a registration statement was authorized: in 46 jurisdictions if the offering “will work or tend to work a fraud upon purchasers or would so operate”; in 34 jurisdictions if the offering “has been or would be made with unreasonable amounts of underwriters’ and sellers’ discounts, commissions, or other compensation, or promoters’ profits or participations, or unreasonable amounts or kinds of options”; and in only 16 jurisdictions if the offering “is being made on terms that are unfair, unjust, or inequitable.” The 2002 Uniform Act includes all three formulations, but has bracketed the latter (which is considered the hard-core form of merit regulation) to indicate that enactment is optional.
[vi] The 2002 Uniform Act authorizes the state securities administrator to limit the availability of a securities exemption for nonprofit organizations’ securities if debt obligations are being publicly offered. A number of states have been confronted with problems, sometimes of fraud and sometimes simply of inadequate disclosure, in the sale of church bonds.
[vii] There is one exception to state authority over smaller investment advisers: advisers who offer services almost exclusively over the Internet (and thus have no overriding connection to any particular state) may register with the SEC. SEC Release No. IA-2091 (Dec. 12, 2002), available at .
[viii] The complete Act with Official Comments is available at <www.law.upenn.edu/bll/ulc/securities/2002final.htm.>