Series 63 Study Guide Navigation
- Series 63 Study Guide Home
- Module 1 | Definitions from the Uniform Securities Act
- Module 2 | How the Uniform Securities Act regulates broker-dealers and the agents in their employment
- Module 3 | How the Uniform Securities Act regulates Investment Advisers and their representatives
- Module 4 | Securities registration, exemptions, and their issuers
- Module 5 | Administrative provisions and remedies
- Module 6 – Customer and prospects communication
- Module 7 – Obligations and ethical practices
We know that the administrator is charged with regulating securities in their state, both transactions as well as individuals.
We’ve covered how individuals need to be registered but now, we look at securities.
What are and who issues securities?
We start with a definition of securities from the Uniform Securities Act.
This is how the law sees securities
- Money has been invested
- This money has been invested into a common enterprise
- The investor expects to make a profit through their investment
- These profits are thanks to other people’s efforts other than the investor
In this context, we are talking about a company where shares can be purchased.
These are listed as securities under the Uniform Securities Act.
- Treasury stock
- Puts, calls, options, straddles, or privileges on a security
- Promissory note
- Participation in a profit-sharing agreement or certificate of interest
- Collateral trust certificate
- Certificates of participation (mining, gas, oil lease, or title)
- Investment contract
- Preorganization certificate or subscription
- Voting trust certificate
- Transferable share
- Certificates of deposit for a security
- Certificates of participation to any of the above
These instruments are not considered to be securities:
- Insurance/endowment policies and annuity contracts that pay fixed monetary amounts intermittently or as a lump sum. These are life insurance products without the word variable in their description or title
- Retirement plan interest
- Precious metals, grains, and other commodities
- Condominiums that serve as residences
This difference between a security and what is not considered to be one comes up on the Series 63 exam often.
So it’s worth knowing these lists above.
Let’s talk about nonsecurity investments in more detail.
For some, this is a popular way to invest.
However, their sale does not fall under the securities laws.
If by using one of these investment instruments to commit fraud, the registered agent has not violated any securities laws.
They can be convicted under other laws, however.
When someone distributes securities or proposes to do so, the term used to describe them is an issuer of those securities.
Regular issuers include:
- Federal government
- State government
- Municipal government
- Agencies and subdivisions of the above
Most securities require registration but not all.
That’s because some issuers’ securities are exempt.
A security that is sold in more than one state must be registered in each state where it is sold.
Sale proceeds generated from the sale of securities that go to the issue are known as an issuer transaction.
This is the most common way in which securities are sold and it’s carried out in this manner to raise capital for projects, for example.
If an issuer transaction brings new securities to the market, that is known as a primary offering and the first time the public can buy these securities is called an initial public offering (IPO).
In all the situations above, the money raised by the sale of the securities goes back to the issuer.
There are nonissuer transactions too which differ slightly.
In this case, the entity issuing the securities does not receive any proceeds from their sale to investors.
The New York Stock Exchange and other secondary markets are where these securities are traded.
And the proceeds?
Who do they go to?
Well, it’s the investor who owns the shares and who has put them up for sale that receives the proceeds thereof.
This process is known as secondary trading.
If a large amount of company stock is put up for sale by a large shareholder, because of the large number of shares on offer, registration with the SEC is a prerequisite.
While it is a large sale of stock, it is not primary stock and therefore still a nonissuer transaction with the proceeds going to the person selling the stock.
The registration of securities as per state law requirements
Let’s look at how the Uniform Securities Act requires that securities are registered.
The Uniform Securities Act: Registration of securities
Let’s look at some insight that the Uniform Securities Act provides into the sale of securities in a state.
“It is unlawful for any person to offer or sell any security in this state unless:
- It is registered under the act;
- The security or transaction is exempted from registration under the act; or
- It is a federal covered security.”
In a nutshell, securities will always need to be registered if they are to be sold in a state.
Again, it’s not all of them because they are exemptions as is the case with a federal covered security or those where the transaction is exempt.
Let’s look a little deeper by understanding what 1996’s National Securities Markets Improvement Act (NSMIA) says about federal covered securities which are exempt from registration.
Federal covered securities examples include:
- Those listed on national stock exchanges
- Those issued by an organization that is Investment Company Act registered
- Those issued by federal governments
- Those issued by state governments
A notice filing may be asked for by the state when these securities come up for sale.
Essentially, these are copies of documents already filed with the SEC, along with filing fees.
How state require securities to be registered
The Uniform Securities Act provides a few methods by which issuers can register their securities.
For federal covered securities, these are the methods most commonly used:
- Notice filing
Let’s look at notice filing first.
State regulatory authorities do not have jurisdiction over federal-covered securities, as defined by the NSMIA.
If you want to sell them, you would still need a broker-dealer or agent license and you must comply with all the state’s anti-fraud laws.
The Uniform Securities Act also requires that notice filings for these securities are posted.
What is a notice filing, exactly?
This is a way for the state to collect revenue through its filing fees.
The reason for this is that state administrators have limited review powers when it comes to reviewing documents filed with their office.
For the most part, notice filing fees are lower than those of those other registration methods.
Notice filing requires the following documents to be sent to the state administrator:
- The registration document and others sent to the SEC
- Any amendments to the initial federal registration statement
- Value of the securities report
- Serve of process consent
These all serve as the securities’ condition of sale.
Even though it isn’t necessary to register covered securities with the SEC, a state administrator could require all documents related to them which you should remember for the exam.
Next, we look at registration by coordination.
This is used often for securities traded on OTC Link or OTC Bulletin Board.
Under 1933’s Securities Act, coordination can be used if a registration statement is filed in connection with the same offering.
If this method is used for registration, it’s necessary to consent to service of process is necessary along with the following records:
- An up-to-date prospectus and any prospectus amendments filed with the SEC
- Articles of incorporation and bylaws
- Underwriting agreement
- Any other information that the issuer has filed as required by the Securities Act and at the request of the administrator
In addition to the federal registration, the registration by coordination is also in effect as long as:
- No stop orders were issued by the administrator
- No pending proceedings are currently waiting against the issuer
- Registration has been on file for the minimum number of days specified by the administrator.
- A statement of proposed offering prices, maximum commissions, and underwriting discounts are on file.
If a security is to be made available in more than one state, registration by coordination is the best way to do so.
Then there is registration by qualification which is a popular method if a security is available in one state.
This might be termed an intrastate offering for the Series 63 exam.
The state administrator requires certain information and a consent of service to process.
Here’s what must be provided:
- Organization’s name, address, business nature, property description
- Details of directors and officers.
- Details of anyone owning more than 10% of shares
- Details of the remuneration received by owners over the last financial year
- Details of the issuer’s capitalization
- Details of the issuer’s long-term debt
- How much proceeds they expect to generate
- How the organization will use the proceeds generated
- The security offered as well as the number of shares to be issued
- The offering price of those shares
- What the selling and underwriting costs are for the issue
- Connected to the offering, what stock options will be created
- Sales literature, circular, pamphlets used in the offering (copies thereof)
- A copy of the prospectus
- The legality of the security on offer confirmed by the opinion of counsel
- A specimen copy of the security on offer
- A balance sheet within four months of the offering (it must be audited)
- An income statement for the past three years (before the date of the balance sheet)
Registration procedures: State securities
Initially, a registration application must be filed with the state securities administrator by the issuer or their representative.
Some provisions will apply to registrations.
We start with filing the registration statement.
This information must be received by the state administrator:
- Securities to be issued (total).
- Where the securities will be offered and a breakdown of the values for each state they are offered in.
- If there is any adverse order or judgment in place by a regulatory authority concerning the offering that is being registered.
- The securities effective date
- How the sale proceeds will be used
A Series 63 exam may contain a question about the one thing the registration statement does not have, a securities rating.
Registration statements can be filed by other parties, not just issuers.
Broker-dealers can do the same, and even if a large block sale is made, the stockholder can file a registration statement.
A filing fee will be determined by the administrator.
They base this fee on the total offering price with the fee being a percentage of this.
Next, we look at ongoing reports.
A person who has filed a registration statement may be asked by the administrator to keep it up to date at all times.
For exam purposes, you should remember that reports can be requested once per quarter.
We move on to escrow.
If securities are issued, administrators may require them to be escrowed.
Usually, this occurs if:
- It was issued in the past three days
- When a security is offered at a price that’s very different from its offering price and to a promoter
- If the security has been issued for a consideration other than cash to any other person
The proceeds of the sale can fall under an administrative rule as well.
For example, proceeds could be impounded until a certain sales threshold is reached.
If this is the case, the money generated is placed in escrow up until that point.
Administrators may require that a special subscription form is completed as well.
It is required to keep a copy of this form for three years or file it with the administrator.
Lastly, there are requirements for prospectus delivery.
If registered by qualification, the administrator could rule that the prospectus must either be delivered before the sale or with it.
Securities exempt from the need for registration
We discussed already that certain securities and transactions under the Uniform Securities Act won’t need to be registered because they hold an exemption.
Following the initial issue, exempt issues will retain their exemption.
Every transaction needs to be justified as an exempt transaction, however.
There are a variety of categories of exempt securities and transactions in Section 402 of the Uniform Securities Act.
Federally covered securities are a nonexempt security and are the most common you will find.
While registration isn’t necessary, a notice for federally covered securities might need to be filed with the administrator and is usually the case in those offered by investment companies.
For transaction exemptions, the exemptions must be established on each transaction.
In the public interest, administrators might suspend, deny, or revoke any exemption for a securities transaction without prior notice.
This, however, isn’t an option with federal covered securities.
Security exemptions have nothing to do with the buyer, but everything to do with who issues them.
The same can be said for an exempt transaction.
Here, the nature of the sale, not who it is made to will determine exemption.
These transactions are judged by merit.
This is because they are an action and this occurs each time.
Here’s an example.
A securities agent is trying to sell a security that must be registered in that state, where it isn’t considered exempt.
Should they sell it in an exempt transaction, for example to an institutional buyer or a bank then that means it isn’t necessary for the sale to be registered.
Registration will be necessary if they sold it to an individual investor, however.
The following securities are exempt:
- Government and municipal securities from both the US and Canada
- Securities from foreign governments: Any securities issued, insured, or guaranteed by foreign governments are exempt. Those from their subdivisions, however, are not.
- Depository institutions: Included here are banks, federal savings and loan associations, and federal credit unions.
- Securities from insurance companies: Securities issued (stocks and bonds), guaranteed, or insured by these institutions, so long as they are authorized to do business in their state, are considered exempt.
- Securities from public utilities: Those issued or guaranteed by a public holding company or a public utility. Railroad or common carrier equipment trust certificates are included in this.
- Federal covered securities: Included here are issuer securities that are either above or equal to common stock. This means debt security, preferred stock, warrants, and rights.
- Nonprofit organization issued securities: These securities are not for pecuniary profit and can be issued by a range of organizations.
- Cooperative issued securities: In this example, nonprofit membership cooperatives issue securities to their members.
- Employee benefit plan securities: Including profit-sharing plans, saving plans, pension plans, and employee stock purchases and deals with investment contracts issued by them.
- Some money market instruments: Banker’s acceptances and commercial paper are the most common.
Exemptions have been mentioned numerous times, but you must be able to distinguish between them and exceptions (also called exclusions).
That’s because antifraud provisions as set out in the act will still apply to exempt securities.
Because a life insurance policy is not a security, blue-sky laws do not apply to it.
There are always antifraud provisions in place, however.
For example, if an insurance company’s stock or other securities are exempt, they could be prosecuted for a violation of the Uniform Securities Act but not for selling fixed annuities.
Other short-term securities are exempt, such as a promissory note, bill of exchange, draft, or banker’s acceptance.
However, there are a few prerequisites:
- Maturity must come in the next nine months
- The minimum denominations are $50,000 at issue
- It has received one of the three highest ratings from a nationally recognized rating agency
Categories of federal covered securities are also something we need to focus on when talking about exempt securities.
Here’s a list of those that are not regulated by the state securities administrator but will be subjected to antifraud provisions:
- Securities listed on various exchanges, like the NYSE America, LLC, New York Stock Exchange, Nasdaq Stock Market as well as other exchanges. If rights or warrants have the same seniority as these securities, they are considered federally insured. Bonds and stocks that are senior to these securities are also insured.
- Investment company securities include open-end and closed-end management investment companies, unit investment trusts, and face-amount certificates.
- Exempt securities offers and sales including those guaranteed or issued by the United States. This also includes securities from Federal Reserve board-regulated banks, and municipal issuers (but not if the issuer is found in the state where the securities are offered in). Including those marketed to qualified purchasers under Regulation D as private placements.
Bonds issued by municipalities are also federal covered securities, and while they are not required to be registered in states, there are some exceptions to this rule.
Municipal securities issued within a state might have certain requirements imposed on them, whereas securities issued by other states might not be required to be registered.
That’s as a result that the latter are considered as federal covered securities.
However, municipal securities issued in the administrator’s state do not enjoy the same advantages.
Municipal securities issued by a state are not covered by the same exemption because the state retains authority over them.
While they are considered exempt, except in the case of their own state as outlined above, municipal securities do not appear in the definition of federal security in the NSMIA, which can create confusion.
You should always pay attention to where the security originated.
Let’s take a bond as an example that is issued in Miami.
Except for Florida, no state rules can be enforced on this bond since it is considered a federal covered security.
Florida securities laws may also exempt it from the state’s securities laws, but the state administrator can request certain details about the security for his office to review.
Although many securities listed on the Nasdaq Stock Market and exchanges, and investment companies, are considered federally covered, not all of them are.
Many stocks traded on OTC Link and the OTC Bulletin Board are also registered with the SEC and states, but are not covered by the federal securities laws.
Adding to the confusion, a security that is federally covered does not have to be registered with the SEC in all cases.
Municipal and U.S. government securities are examples of securities that do not need to be SEC-registered but are federally covered.
Transactions considered to be exempt
Some securities even though not exempt themselves will receive an exemption
That’s because they are traded within what is considered an exempt transaction.
There are a number of transactions that are considered exempt under Section 402 of the Uniform Securities Act.
Here are those that appear on the Series 63 exam.
First is isolated nonissuer transactions.
No matter if they are carried out by a broker-dealer or aren’t, they include secondary transactions that don’t occur very often.
And mostly when they do happen, the transaction involves security professionals.
This happens when individual investors hold stock that will be selling all or part of.
This sale is made to another single investor.
Due to the fact that they are not trading in the typical manner in which stocks are traded, and the transaction is one-on-one, the transaction is exempt.
Second is unsolicited brokerage transactions.
It is the client who starts this exempt transaction, not the agent, and here is how it works.
A customer calls the registered agent with requests to buy or sell securities from their account.
During a transaction of this type, the administrator can make certain requests in an effort to prevent fraud.
They can, for instance, request that a specific form is filled out when a transaction like this is made.
This form indicates that this was an unsolicited transaction.
Retail customers are not allowed unsolicited transactions in this manner and they are always considered to be solicited.
Third is underwriter transactions.
The transaction occurs between the issuer and the underwriter of a particular issue, for example, but also with other parties on whose behalf the offering is made.
Different underwriters can be involved with the transaction should it form part of a selling syndicate.
Fourth is bankruptcy, conservator, or guardian transactions.
Transactions are considered exempt when carried out by any fiduciaries including an executor, trustee in bankruptcy, sheriff, marshal, or an administrator.
Note that UTMA or UGMA custodians are not covered here and it’s something that could pop up in the Series 63 exam.
Fifth is institutional investor transactions.
As defined in the Investment Company Act of 1940, these include offers or sales to financial institutions.
Included are employee benefit plans, saving institutions, banks, trust companies, insurance companies, and investment companies but their assets must be over $1 million.
Broker-dealer transactions, in which they act as fiduciaries, are also included.
As all of these transactions are considered exempt no matter the order size.
Fifth is limited offering transactions.
This includes private placement offerings during the 12 consecutive months that have passed and to 10 or fewer offerees (but not institutional investors).
Some provisos must be met:
- The seller reasonably believes that the purchase is being made for investment purposes only
- No compensation or commissions are paid for the solicitation of institutional investors
- These transactions do not involve advertising or general solicitation
Sixth is preorganization certificates.
These transactions are seen as exempt if:
- There are no commissions or other incentives paid for soliciting subscribers
- The number of subscribers is less than ten
- No payments are made to subscribers
Here is a reminder as to what preorganization certificates are.
New corporations must provide evidence in their documents of incorporation indicating that minimum funding is assured.
Should this evidence not be there, the corporation won’t get a charter.
Therefore subscriber limitations rather than the number of offerees is key for the exemption for private placements.
Because the purpose of these certificates is to make it as easy as possible for a new enterprise to obtain the required number of subscriptions, as specified by corporate law.
Therefore, preorganization subscriptions can be advertised publicly.
A payment might not be required until registration is effective unless another exemption is available.
In other words, registration is never excused, only postponed.
Seventh is transactions that take place with existing security holders.
Those who already own existing securities from the issuer are exempt from these transactions.
This applies to convertible securities, warrants, and rights.
Exemptions are only allowed if no direct or indirect remuneration or commissions are paid when soliciting current holders of the issuer’s security.
Our final exempt transaction is nonissuer transactions by pledges.
Nonissuer transactions executed by a bona fide pledgee are exempt.
A pledgee is someone who receives the security as collateral for a loan, but cannot exercise the right to evade the provisions of the Uniform Securities Act.
It’s always a good idea to keep in mind the differences between accredited investors and institutional investors.
Institutional investors are mutual funds, a bank, a pension fund, or an insurance company and these will also work with large sums of money.
Regulation D, specifically Rule 501, outlines the requirements for accredited investors.
To be considered an accredited investor, they must meet these requirements:
- The buyer must have a net worth of more than $1 million (either with a spouse or individually) not including their primary residence.
- A second option is for the investor to earn more than $200,000 per year (or $300,000 together with their spouse) and that they should reach that amount again in the current year.
An administrator’s power over exemptions
A rule or order from a state administrator may exempt a security, transaction, or order.
In addition, they can waive the exemption requirement for a security or transaction.,
So by rule or order, an administrator has the power to revoke or deny the registration exemption of:
- Securities issued by organizations that are not for private profit
- Pension plans, profit-sharing plans, savings plans, stock options for employees, or other benefit plans
State administrators can also deny exemptions to securities that are considered exempt if they wish, including U.S. and Canadian government issues.