Uniform Securities Act
(Last Revised or Amended 2002)
The Uniform Law Commissioners has a long history of working in state securities law, turning to the subject of securities regulation four different times in its history. The first act was the Uniform Sales of Securities Act of 1930, which predates the first major federal effort in 1933. The dating of this first act seems appropriate in light of the events of 1929. Recognizing the need for state uniformity, the Uniform Law Commissioners had begun their work eight years earlier, in 1922. There were not many enactments, however.
A second Uniform Securities Act was promulgated by the Uniform Law Commissioners in 1956 to replace the 1930 Act. It was enacted in 37 jurisdictions. The first revision of this mainstay of state securities regulation occurred in 1985; amendments were added to the 1985 Act in 1988, but the revision was enacted in only six states. The Uniform Law Commissioners have now promulgated a fourth Act which replaces both the 1956 and 1985 Acts. It 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 summary describes the 2002 Uniform Securities Act.
Federal and State Law
Initially it is necessary to recognize that there are two concurrent securities regulatory regimes: one at the federal level and the other at the state level. Federal regulation of securities began effectively with Congress’ enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission (SEC). These two Acts, plus the Investment Company and the Investment Adviser Acts enacted in 1940, all of them much amended over the years since their original enactment, are still the core federal law on securities regulation. But there are more federal statutes relevant to securities regulation: Section 103 of the 2002 Act lists a total of 13. From 1956 through 2002, drafters of the successive versions of the Uniform Securities Act have had to deal with the relationship with federal law. Coordinating federal and state regulation has been a substantial objective of the drafters of the new 2002 Uniform Act.
The failure of the 1985 Act to gain many enactments was rooted in the duplication of regulation problem, the role of merit regulation at the state level, and many states’ reluctance to address the subject when there was such controversy about its provisions. In 1996, 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, it prohibits a state from subjecting an offering of “federal covered securities” to merit review and other registration requirements. A principal effort of the 2002 Uniform Act is to reconcile, and to achieve better coordination of, federal and state securities regulation.
State Role in Securities Regulation
The states have an important role in securities regulation. There is fraudulent activity at a level that eludes federal law protection, even when federal law applies. And by no means is every security sold a “federal covered security.” Many schemes to defraud investors involve locally generated pyramid schemes, misrepresentation, and scam sales. 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 the federal level is 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 regulatory resources and that blends with federal regulation and enforcement in a more efficient system for investor protection. Uniformity of law among the states is essential for this to happen, but it needs to be a uniform law that coordinates with federal law.
Elements of Securities Regulation
Securities regulation exists to prevent fraudulent sales of securities to investors. 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 must be prohibited and enforcement powers given to an appropriate regulatory agency. These powers include the ability to make rules and regulations, issue stop-orders, bring criminal prosecutions and pursue civil actions in court. The 2002 Uniform Act brings all of this up-to-date with expansion of enforcement authority at the state level.
Registration and Filing for Securities Offerings
There are three methods for dealing with public offerings of securities under the new Act: notice filing, registration by coordination, and registration by qualification.
Notice filing is for certain “federal covered securities”. These are securities which by reason of federal preemption are no longer registered at the state level. They 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 securities issued by SEC registered investment companies (most of which are the mutual funds); or are securities issued under specified exemptions in the Securities Act of 1933. Public offerings of listed securities and mutual funds, of course, will be registered with the SEC. The notice filing under the 2002 Uniform Act is for federal covered securities other than listed securities, and includes a consent to service of process, payment of a filing fee, and, depending on the state securities administrator’s requirements, can include copies of material filed with the SEC as part of registration there. The intent of both NSMIA and the 2002 Uniform Act is to remain essentially revenue neutral as to the states. The 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 Act for registration by notification has been eliminated in the 2002 Act, both because it has rarely been used in recent years and because most securities to which it was applicable are now preempted 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, which have been going through a process of upgrading. The new Act’s registration by coordination provision is little changed from the 1956 Act, which originated it. The objective of the 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 the coordination registration process, the state securities administrators association has implemented a system for coordinated review of such an offering by the states in which the offering is to be made. The new Act provides support for that effort. The new Act continues to permit “merit” regulation, which for the limited number of SEC registered issues to which it would apply remains, to that extent, inconsistent with the disclosure basis for SEC registration. A provision of the new Act does require that to the extent practicable any merit standards should be published so as to provide notice. It is hoped that such standards would be uniform among those states imposing such regulation. A number of states do not apply merit regulation.
Qualification registration at the state level applies to all other offerings being made within a state, for which an exemption is not available. These can include intra-state offerings and offerings that are within exemptions from SEC registration because of their relatively small size. This provision in the new 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 Act, except for modernizing language.
The 2002 Act, like the 1956 Act, contains a number of exemptions from the general requirement that all securities offerings must be registered. Some exemptions are for securities, such as government (both U.S. and foreign) and municipal securities, and some are for transactions in securities, such as unsolicited brokerage and limited offering transactions.
Relevant to transaction exemptions is the definition of “institutional investor” in the new Act. It seeks both to make uniform the varied definitions in current state laws and to be consistent under federal law. With respect to securities exemptions, authority is given to the state securities administrator to limit the availability of the 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.
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 under the Act. In addition, the antifraud provisions of the 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 investment advisers, and the individuals who are agents of broker-dealers or issuers or who are investment adviser representatives, all defined terms in the Act. Here again there is a necessary interaction of federal and state law. The 2002 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 under the Securities Exchange Act to be registered with the National Association of Securities Dealers (NASD) and are regulated by both that self-regulatory organization and by the SEC. Nevertheless, under NSMIA and the 2002 Act they are still subject to registration with, and antifraud enforcement by, the states. The individuals who are agents of broker-dealers are also required to be dually registered, and agents of issuers are in general required by the Act to be registered in the states. The new uniform Act clarifies these federal-state interrelationships and promotes an efficient coordination of the duality of 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 exercised its constitutional preemptive power to allocate regulatory authority between the SEC and the states. State registration of large investment advisers (those having assets under management in excess of $25 million) was preempted and is exclusively with the SEC. However, under the Act and as permitted by NSMIA notice filings by such “federal covered investment advisers”, who must be registered with the SEC, are to be made at the state level, along with payment of filing fees and consents to service of process. Smaller investment advisers (those having assets under management of less than $25 million) are left to exclusive state registration and regulation. The new Uniform Act provides for the notification by larger advisers and the registration of smaller advisers.
The individuals who are investment adviser representatives of both federal covered investment advisers and the 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 in the creation of a centralized filing system for such representatives. The new Act supports such a system..
There are certain clarifying exclusions from the definitions of broker-dealer, agent, investment adviser, and investment adviser representative and certain exemptions from their registration in the 2002 Uniform Act, which are in general consistent with the federal statutes and with the 1956 Act.
The third method of securities regulation, of course, is enforcement, against anyone for fraudulent practices in securities transactions and against issuers and securities professionals for failure to comply with the registration regimes applicable to them. The new Uniform Act continues the enforcement powers of the state securities regulators contained in the 1956 Act with some enhancements. Enforcement includes civil and criminal actions in the courts and administrative proceedings. The new Act authorizes the state securities administrator to issue, under appropriate procedures, cease and desist orders for violations of the Act, and authorizes courts to enforce such orders. Also contained in the Act are authority for conduct of investigations and issuance of subpoenas and provision of assistance to securities regulators in other jurisdictions The Act also includes civil liability provisions for defrauded persons to obtain damages or rescission that are substantially the same as in the 1956 Act, except that the statute of limitations is lengthened to be the same as the federal statute of limitations for securities fraud liability.
Fraud in connection with securities is a broadly defined term under both federal and state securities law, and the 2002 Act preserves that breadth. In fact, the applicability of the anti-fraud provisions has been expanded by having moved some exclusions from definitions in the 1956 Act to exemptions from registration in the 2002 Act. The antifraud provisions in the 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 Act. The new Act tracks the definition of “security” in federal law, with some additional explicit language to make clear that the 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 Act also codifies a generally accepted definition of an “investment contract”, a term included in the federal and state definition of “security”, for the assistance of state courts. Following federal law, interests in pension plans subject to ERISA are excluded from the definition of “security”, as are insurance contracts which are also regulated under other law.
The new Act, as did the 1956 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 require 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 new Act also creates a Securities Investor Education and Training Fund to support such a program, the funding of which is left to state by state determination. These initiatives are in recognition that financial literacy is increasingly important as participation in the country’s equity markets has significantly broadened.
Coordination and Uniformity
In NSMIA, Congress declared that its policy is to increase Federal and State cooperation in securities matters. To implement this, it 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, including sharing of information regarding registration or exemption of securities issues and development and maintenance of uniform securities forms and procedures. Congress made it explicit that the policy it enunciated was not intended to be preemptive of state law.
The 2002 Uniform Securities Act responds to this federal initiative by containing 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 Act, both the 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. For this to happen both federal/state coordination and uniformity among the states must be the objectives. The 2002 Uniform Act provides a platform for these to occur at the state level.