Series 63 Module 2 – How the Uniform Securities Act regulates broker-dealers and the agents in their employment

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You must understand the differences in the roles that a broker-dealer and an agent carry out. 

Broker-dealers are business units that can be organized in many different ways.

For example, while not very common, some can be sole proprietorships, for example.

Normally, however, they will be organized in three ways: as a corporation, a limited liability company (LLC), or a partnership.

Broker-dealers then employ individuals known as agents.

These agents help them carry out their business and represent the broker-dealer. 

In many instances, however, those who issue securities can also employ agents.

If mentioned in an exam question and no other background is given, you can assume that an agent is working for a broker-dealer. 

Who and who aren’t considered to be broker-dealers? 

Under the Securities Act, someone that affects securities transactions on the accounts of their clients or in accounts of their own is a broker-dealer.

It will be necessary to register as a broker-dealer in each state from which the business operates if this is the primary focus of the business.

They must also have an office in that state from which they buy and sell securities.

Agents will also work for and on behalf of a broker-dealer.

A broker-dealer is operating in an agent’s capacity when they carry out transactions on behalf of a client and use that client’s account. 

They act in the role of a dealer when transacting out of a proprietary (their own) account. 

Broker-dealers also can carry out an investment banking function. 

Here they underwrite new issues brought to the market by a corporation, for example.

When an individual buys or sells securities from their own account they are not classified as a securities dealer but as an individual investor.

That’s because they are not buying and selling these securities for others, as a broker-dealer would but instead, on their own behalf. 

When studying for the Series 63 exam, it is critical to understand underwriting and the broker-dealer’s role in it.

This is particularly true when a corporation distributes new issues of shares.  

They will be compensated for carrying out this task and will need to pay any agents working for them that helped to carry out the task.  

These agents, for example, would have looked for potential clients that are interested in buying the new issue from the corporation. 

They can receive money in another way, however, and that is through the spread, which is the difference between the price paid to the issuer for the securities and the price the public bought these securities at. 

Definition exclusions: Broker-dealers

While we know what it is they do, we need to understand what natural and legal person does not fall under the definition of a broker-dealer.

This exclusion from the definition of broker-dealer is for the purpose of state registration.

Here’s who will be excluded:

  • Broker-dealer employed agents
  • Stocks, securities, and bonds issuers bought and sold by broker-dealers
  • Banks, trust companies, and savings institutions

Although most banks are excluded from the definition of a broker-dealer, many will engage in securities-related activities

They do this through subsidiaries acting in a broker-dealer capacity. 

Because these subsidiaries fall under the definition of broker-dealers, they would then be subject to the various SEC regulations governing them.

Additionally, the subsidiary will be required to register as a broker-dealer, not the bank.

A question in the exam about a bank and its securities activities can, unless otherwise specified, be assumed to be related to a relevant subsidiary.

There are other reasons for exclusion from the definition of a broker-dealer too and we are going to look at them now.

First, we have no place of business in the state.

This concerns where the broker-dealer operates from.

When an individual or firm has no place of business in a state, they aren’t considered a broker-dealer if:

  • They perform transactions only in the state, either with or through the issuers of the transaction-linked securities, other banks, savings institutions, investment or insurance companies, trusts, or broker-dealers with assets not lower than $1 million.
  • As a person in the state where they hold a business, they hold a license under the state’s securities act and they do business therein with existing customers who reside outside of the state. We call this the snowbird exception and it applies to agents of broker-dealers and investment advisers and those that represent them. 

In a nutshell, as per the Uniform Securities Act, the definition of a broker-dealer will not include those without an office in the state.

Companies that deal exclusively with exchange-traded securities, other broker-dealers, and financial companies won’t need to register when operating in the state.

The reason for this exclusion is that this investor category is highly sophisticated and has the necessary expertise.

According to the Uniform Securities Act, broker-dealers may do business with customers who are temporarily in a state, and this rules out the need to be registered in various states,

There is also a 30-day period in which a broker-dealer can continue to do business with a customer when they change their residence and move to another state.

Once that 30-day period is over, however, and they want to continue with that customer, registration in the new state is necessary. 

This does not include clients who have not changed residence to another state permanently, however, for example, someone on contract work that has moved to another state temporarily. 

Here’s a simple breakdown of what we have just covered:

  • When defined as a broker-dealer but there is no place of business in the state, registration is necessary.
  • When they are not defined as a broker-dealer and they have no place of business in the state, no state registration is necessary.

The provisions as laid out by the United Securities act are what those defined as broker-dealers work under.

Here’s how you can remember it. 

  • A broker-dealer is someone that has retail clients in a state or who has a place of business there
  • If a person does not have a place of business in the state but is providing services to other broker-dealers, financial institutions, securities issuers, and/or temporarily residing in a state, they are not considered to be a broker-dealer.

Second, we need to deal with exclusions that pertain to the use of the internet.

The Uniform Securities Act has been updated to provide guidance in this regard for both broker-dealers and investment advisers.

For example, a broker-dealer website is seen as a form of advertising. 

Does this mean that it qualifies the broker-dealer as having an office in a state?

A range of requirements will need to be met for it not to be:

  • All communication online will have to show that a broker-dealer is either fully registered in a state or if they are exempt from registration (if that is the case).
  • Individualized responses that form part of follow up communication with potential prospects in the state and either carry out or try to carry out securities transactions or provide investment advice to an individual for compensation cannot be made without a state broker-dealer, investment adviser, agent, or investment adviser representative registration requirement compliance or must include the necessary exemptions/exclusions.
  • Any response that forms part of follow-up communication with potential prospects in the state, attempting to conduct securities transactions or provide investment advice to an individual for compensation cannot be made unless the individual/firm is state registered or includes the necessary exemptions/exclusions as required.
  • No specific advice, only general information can be made on a website.  
  • If a website or communication is for an agent or an investment adviser representative, there must be disclosure as to who their broker-dealer or investment adviser is.
  • An investment adviser or broker-dealer has the responsibility to review content posted on the internet by their representative or agent.
  • Communication regarding products and services by an agent or representative must have the necessary authority from a broker-dealer or investment adviser.

If an entity or individual acting as a broker-dealer runs a website or promotes on the internet in general, state registration is not necessary. 

Should a follow-up query from the website lead to either a broker-dealer or investment adviser providing investment advice, state registration is a necessity if they are to do so, or they must be exempted in some way. 

Broker-dealer requirements for registration

According to the Uniform Securities Act, broker-dealers must register in the state in which they conduct business.

On the exam, unless you are told otherwise, they must be registered with States where they are defined as broker-dealers.

Here’s what that registration process entails. 

It will be carried out through the securities administrator.

Registration is for broker-dealers, agents, investment advisers, and their representatives.  

The process is as follows

  • Provide the application
  • Give the ok for service of process
  • Filing fees must be paid
  • A bond may be required if the administrator so requests
  • Obtain your license by passing the necessary exams required by the administrator

Here are the steps in a little more detail beginning with applying to the administrator.

A broker-dealer will submit a Form BD, while an agent will submit a Form U4 at this stage of the process.

Information will include:

  • Location and form of the broker-dealer
  • How will they conduct their business?
  • Qualifications of the organization’s partners, officers, directors, or anyone else who controls the organization
  • An overview of their business history (this should include the histories of any partners, officers, directors, or others who may influence their control)
  • Any administrative orders or court-issued injunctions must be disclosed
  • A disclosure must be made if they have been adjudicated by any regulatory body
  • Disclosure of whenever they have been denied, suspended, or revoked registration that restricted their activities or prevented them from working on investment-related businesses by any regulatory bodies
  • Disclosure of any charges, convictions, or guilty pleas to investments or investment-related business misdemeanors
  • Disclosure of any other felony charges, convictions, or guilty pleas
  • Broker-dealers should disclose the end date of their fiscal year and their financial condition and history.
  • For applications for individuals who will act as agents, citizenship information is required

The next step is agreeing to service of process.

All securities professionals who apply for state registration will need to consent to service of process.

Any noncriminal securities-related complaints against the applicant will now be sent to the administrator, who acts as his attorney.

All legal documents regarding the applicant that the administrator receives will have the same legal effect as if they had been served to the applicant.

In both Form BD and Form U4, the consent of process will be submitted by the applicant with the initial application.

Upon submission, this consent is permanent.

Consent to service of process only applies to the state the applicant registers in. 

If they wish to register in four states, they must agree to accept service of process in each.

Then we have paying filing fees.

The initial application for registration requires that filing fees are paid.

Again, when applications are renewed, they will need to be paid again with renewal needing to take place by 31 December.   

Refunds of a fee portion will be made if an application is withdrawn or rejected.

Broker-dealers and investment advisers may apply to register a successor firm (whether it exists currently or not) without paying any fee for the portion of the year that remains.

A fee for successor firms won’t be levied until the renewal date.

As for a successor firm, this is when another firm takes over the operations of an existing one.  

The Series 63 exam might include trick questions that pertain to registration dates.

Just remember if someone has registered in November, by 31 December, registration will need to take place again. 

We will now look at the financial requirements as part of the application process.

Broker-dealers may be subject to minimum financial standards by administrators as a way to protect investors.

This is intended to ensure that the broker-dealer always has a minimum level of net capital.

The Securities Exchange Act also outlines net capital requirements, and those of the state should not exceed the federal requirements.

The administrator can require extra protection on client accounts if the broker-dealer has discretionary authority or custody over client funds and this is carried out through surety bonds. 

Bond totals are decided by administrators and in accordance with limitations as per the Securities Exchange Act.

Surety bonds can be replaced by either securities or a cash deposit if the administrator allows.

If a broker-dealer has enough net capital, however, bonds aren’t a necessity.  

Regardless of how many states they are registered in, broker-dealers are mostly regulated by the SEC.

Administrators will enforce anti-fraud statutes, however.

Last, we will discuss the effectiveness of registration.

Registration is effective at noon on the 30th day after the date on which the application is filed or when an amendment to the application is filed.

Applications must have all the correct information provided or they won’t be deemed complete. 

An earlier effective date for the registration and licensing is possible if ordered by the administrator.

If registration is withdrawn, this happens on the 30th day following the administrator receiving the submission.

Registrations cannot be withdrawn if the broker-dealer has legal proceedings against them.  

When registrations are withdrawn, broker-dealers are still under state jurisdiction for another year.  

Broker-dealer requirements for post-registration

Broker-dealers need to carry out a range of administrative requirements to ensure their registrations remain in good order. 

To begin with, if any material information changes that make registration inaccurate or not completed, a corrected copy must be filed promptly.  

By law, certain documents must be kept, usually for a period of three years. 

These include:

  • Account records
  • Records of original entry (or blotters)
  • All correspondence (including any electronic correspondence)
  • Papers
  • Books
  • Advertising
  • Memoranda
  • And anything else as set out by the administrator

On occasions, certain financial records could be requested by the administrator as well. 

When it comes to broker-dealers that are SEC-registered, the administrator will never exceed the requirements of the Securities Exchange Act in terms of record-keeping.

Let’s talk about how records are preserved and maintained.

Well, there are a few ways in which this is done:

  • Hard copies (the original form of the records)
  • Microfiche, microfilm, or other such media
  • Electronic storage media or in a cloud

The broker-dealer must ensure that records:

  • Are arranged and indexed properly
  • Copies can be easily supplied. These must be complete and true to the originals 
  • Printouts of records can be made available if requested
  • Duplicates of the records are stored away from the originals

A procedure is necessary for records kept electronically. 

  • This ensures records are preserved and safeguarded against the loss, alteration, or destruction thereof. A backup system for these records is also needed. 
  • Only authorized staff can access these records
  • All reproductions of the records are complete and true. Specifically, this relates to non-electronic records that are reproduced on electronic storage media.

We should mention a broker-dealer’s website when we discuss data storage.

Essentially, they are considered advertisements, and therefore must be treated in that manner. 

Records of the original design of the website will need to be kept for three years.

In the event it is revised at any point, the new design will need to be maintained.

New retention requirements apply for the new design and the copy it includes.

Supervision requirements pertaining to broker-dealer agents

NASAA rules don’t cover supervisory levels of registration, there simply are none.

For FINRA, the registered principal is covered.  

Consequently, the highest-ranking officer at a broker-dealer will only be registered as an agent with NASAA.

Broker-dealers are responsible for supervising those registered as agents of their companies as well as those that act in an independent capacity, a contractor for example.

This could include financial planners as they often that operate in a contractor capacity affiliated with broker-dealers.

While they are not technically employees they remain under supervision as per regulations with anything to do with securities.  

As per the Uniform Securities Act, those that work under a broker-dealer’s supervision are not required to have the same qualifications.

New agents, for example, wouldn’t need the same knowledge, experience, or background as the person that supervises them either.   

Agents of broker-dealers and their classification: Who is an agent and who isn’t?

The definition of an agent is a critical place to start in this section.

According to the Uniform Securities Act, an agent is someone who represents an issuer or a broker-dealer and on their behalf either carries out or tries to carry out securities transactions. 

This is a natural person and never an entity. 

To put it another way, the brokerage firm is the entity or legal person.

In securities transactions, the agent is the person that represents the firm.

In terms of remuneration for agents, this comes in the form of commissions on the transactions that they carry out. 

The title agent can also refer to someone in the company, for example, an officer, director, or partner.

They are given this additional title due to the role that they perform – and that role is trying to sell securities. 

They will need to be registered as agents if they are acting in a sales capacity for the broker-dealer. 

Who is excluded from the definition of an agent?

We know what an agent is, but who wouldn’t fit the definition?

Staff who are working for a broker-dealer are not considered agents under what circumstances?

Well, you can almost always rule out those that perform clerical or administrative duties and these staff will not need to be registered. 

A question that often appears in the Series 63 exam deals with year-end bonuses at broker-dealers.

When paid from the profit made not based on the performance of individuals related in terms of their sales figures, then clerical staff can be included without necessary registration. 

But if administrative/clerical staff carry out sales-related functions, registration as agents is a must.

This would include administrative staff accepting orders from customers, or even taking orders over the phone as these are the duties of an agent. 

The case of staff making cold calls is an interesting one that crops up in the Series 63 exam from time to time. 

As long as they just provide information, a cold caller is not considered an agent.

Exclusions: Personnel representing issuers

Issuers can also sell securities. 

While this is rare, the public can buy securities directly from them in certain situations  

Then how would it work if an issuer sold their securities without using an underwriter for instance?

Let’s look at a specific scenario that will help explain what we need to understand. 

As a means of raising capital, a company has made securities available to investors.

A broker-dealer will charge them a host of fees and commissions if they use them as an underwriter.

There is another option, however. 

The company can either hire an independent sales force to sell the securities for them, or it can use its own staff.

Should this occur, would this sales force or the staff used need to be registered as agents?

There are three factors that will help determine this:

Well, that will depend on three factors:

  • The securities that are being sold
  • The process of selling those securities
  • The purchasers of those securities

Individuals who represent issuers in the sale of securities do not meet the definition of an agent.

When performing transactions for an issuer they do not need to register in a state as one in the following situations:

  • For securities deemed exempt
  • For securities exempt from registration 
  • There are no commissions or remunerations paid for soliciting any state customers

Carrying out exempt securities transactions

An exempt security is one that needs not be registered.

A number of securities are considered exempt under the Uniform Securities Act.

What is important here is how this affects individuals and how they are excluded from the term “agent”.

That’s only possible if they represent an issuer and carry out exempt transactions as highlighted below:

  • Securities that are either guaranteed or issued by the United States, including those that are linked to U.S. states, their political subdivisions, agencies, or those that originate from Canada or its provinces.
  • Any security issued or guaranteed by a foreign government, with which the United States has diplomatic relations, is exempt.
  • Bank guaranteed or issued securities as long as the bank operates and is organized under U.S. law. 
  • Commercial paper ranked among the top three by a rating agency. It must mature in nine months or less and can only be in denominations of $50,000
  • Investment contracts issued by employee stock purchase, pension, or profit-sharing plans

Carrying out exempt transactions 

Let’s take a look at exempt transactions since we have already discussed when someone is not considered an agent when effecting exempt securities.

Here are the various examples you should consider:

  • Brokerage transactions that are unsolicited. They are exempt because the client initiates the trade.
  • Transactions between an issuer and an underwriter
  • Transactions involving banks, trust companies, insurance companies, investment firms, and other financial institutions
  • Offers of private placements to a limited number of investors

Carrying out transactions with issuer employees

One final exemption comes when a transaction is completed by a director, partner, or employee of the issuer.

So long as no indirect or direct remuneration is paid or commissions are given, these are exempt.

Registration requirements for agents

In the case of agents who are not exempt, the registration requirements are similar to what we’ve covered regarding broker-dealers.

That means they must complete Form U4 and then file it.

A candidate’s registration becomes effective once they have passed the exam, and their employer has received notification from the administrator. 

From this point onwards, they can begin to solicit clients. 

Agents will not need to include their citizenship when they apply for registration like a broker-dealer would need to. 

This means those who aren’t US citizens can still act as agents. 

There may also be a question about fingerprint requirements on the exam.

Unlike FINRA, which does require fingerprints, they won’t need to be submitted with an agent’s application. 

It is illegal for anyone to act as an agent in a state unless they are registered under the Uniform Securities Act.

Individuals can only conduct securities transactions if they are registered, or if they are exempt from registration in that state, and this is true for any unsolicited orders they may receive as well.

In contrast with the de minimis exemption that is granted to investment advisers and their representatives, this is a very different situation.

An issuer or broker-dealer cannot employ anyone as an agent if they do not have the necessary registration.

What if their registration is pending and they have been hired as an agent?

Well, they can work for a broker-dealer in this situation if they are carrying out activities for which registration isn’t required.

This means they can carry out:

  • Clerical duties
  • Administrative duties

Customers can be contacted as long as there is no solicitation, no offer of securities, and no service to open accounts.

An agent’s own registration will not be valid if they work for a broker-dealer note registered in the state.

Should the broker-dealer they work for have their registration revoked for any reason, their license ceases to operate too.

The agent’s active registration has been effectively canceled since there is no broker-dealer affiliation anymore.

We need to look at the financial requirements of agents.

Unlike broker-dealers, agents do not have certain financial requirements that they are required to meet. 

This means that a certain level of net worth is not a necessity for anyone that wants to become an agent. 

There can be requests from the administrator that they become bonded, however.

Most notably, this will be when they have discretionary approval over the account of a client.  

And multiple registrations?

Generally, an agent cannot work for more than one broker-dealer or issuer at a time.

This situation is possible, however, if they are affiliated and this occurs through indirect or direct common control.

Working for more than one broker-dealer or issuer can be allowed through an exemption granted by the state administrator too. 

The agent has to follow a certain process if they wish to be associated with a second broker-dealer, however. 

This sees them filing a separate Form U4 while undergoing a registration process for the second affiliation. 

Next, we cover partners, officers, and directors of a firm and their automatic registration as this appears often in the Series 63 exam. 

An agent is determined by their role while working at a broker-dealer and not their title.   

When registered broker-dealers or investment advisers expand their business into other states, they will need to register there as well. 

They must complete Form BD or ADV in the new state, following the same process as the original registration.

The form will include all the names of the officers, partners, and directors who already act as agents for the firm.

When the firm’s registration becomes effective, those individuals are automatically registered in the new state.

To solicit transactions in the new state, the firm’s other agents will have to file amended Form U4s and wait for approval from the administrator in the new state before they can begin their work as an agent. 

The same applies to those acting as investment adviser representatives.

Post-registration requirements for agents

Once an agent registers, maintaining their license is very simple.

Their registration will need to be renewed at the end of each calendar year, but the broker-dealer that they work for will generally carry this out on their behalf.  

In the event that they make any changes to their registration details during the course of the year, this must be completed on Form U4 within 30 days of these changes and submitted to the state administrator. 

When it comes to termination procedures, there are two situations where the administrator will need to be informed. 

 These are:

  • If the broker-dealer terminates the agent’s contract,
  • If the broker-dealer terminates it involuntarily.

When an agent moves from one broker-dealer to another, a notification should be lodged with the administrator informing them of the move. 

This must be carried out by the agent, the broker-dealer they are leaving as well as the one they are going to start new employment with. 

The withdrawal takes effect 30 days after the agent submits Form U4, if there have been no investigations against them.

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