If a security is exempt from the registration requirements of the 1933 Act, it still must comply with the provisions of the 1934 Act. It also allows the SEC to control self-regulatory organizations (SROs), such as the National Association of Securities Dealers (NASD). In 2007, the NASD merged with the New York Stock Exchange's SRO to form the Financial Industry Regulatory Authority (FINRA).

The FINRA acts as an SRO for securities exchanges and securities firms that perform investment services with the public. It provides arbitration, mediation, and market regulation for these exchanges and firms, and offers professional training, testing, and licensing for registered persons.

The Investment Company Act of 1940 regulates the investment companies. It requires them to register with the SEC and prohibits them from the following activities:

• purchasing securities by paying the margin
• borrowing from a bank or broker
• short-selling a security that has already been promised for delivery
• participating in joint accounts
• owning more than 10% of another company

The National Securities Markets Improvement Act of 1996 (NSMIA) states that federal securities are not required to be registered with each state since they are backed at the federal level. This reduces duplicate registration of securities at the state and federal levels. Securities that should be registered at the federal level are municipal securities, securities issues by investment companies, and securities that have been approved by the SEC and listed on a national stock exchange (i.e. New York Stock Exchange).

The Investment Advisers Act of 1940 helped define the role and liabilities of an adviser. If he manages more than $25 million in assets, he must register with the SEC. If the assets managed are less than $25 million, he only has to register with his state. This act also provides guidelines as to how much an adviser can collect in fees and commission.

TYPES OF SECURITIES PROFESSIONALS

An investment adviser (IA) is any compensated person or company who advises others directly, through publications, or through writings regarding the value, purchasing, or selling of securities. An adviser also analyzes and issues securities reports, and is required to register with the SEC. However, if his clients are residents of the state where his principal office or primary business is, he is exempt from registering with the SEC. An IA is legally required to put the interest of clients before his own.

An investment adviser representative (IAR) refers to anyone employed by or associated with an IA. If a person only performs clerical duties or if he is listed as a partner, officer, or director of an IA, he does not need to register as an IAR. However, he must register as an IAR if he is doing the following:

•making investment recommendations
•giving securities advice
•managing client portfolios
•supervising employees who perform any of these duties

A secretary working at the front desk is not considered an adviser representative, and it is a violation for the secretary to give financial advice, receive compensation, or solicit clients.

A broker-dealer is a person or an entity (i.e. brokerage firm) that effects securities transactions for the account of others or for its own account. Like the name suggests, broker-dealers have dual roles. As brokers, they act as agents, buying and selling securities on behalf of a client's account. As dealers, they act as principals, executing transactions for their own account. Providing market volume and liquidity is another key role of a broker-dealer. Most broker-dealers must register with the SEC and a self-regulatory organization. Although broker-dealers are expected to deal fairly with their clients, they are not legally obligated to put the interest of clients before their own (unlike investment advisers, who are required by law to do so).

An agent (also called a sales representative or aregistered representative) is a person who acts for or represents a broker-dealer or an issuer in effecting securities transactions. The principal is the person for whom the agent is acting.

An unregistered person who is assisting a registered agent is only able to give a client information concerning his account, read stock and bond quotes to a client, or fax a document requesting a client’s signature. This person may not accept unsolicited securities orders, share in the agent’s commissions, or solicit, purchase, or sell orders.

Broker-dealers are either any person or company effecting securities transactions for the account of others or for their own account. Like their name suggests, they have dual roles. As brokers, they act as agents, buying and selling securities on behalf of a client's account. As dealers, they act as principals, executing transactions for their own account. Providing market volume and liquidity is another key role of a broker-dealer. Most broker-dealers must register with the SEC and a self-regulatory organization. Although broker-dealers are expected to deal fairly with their clients, they are not legally obligated to put the interest of clients before their own (unlike investment advisers, who are required by law to do so).

A situation when the individual represents an issuer of exempt securities including U.S. government securities, foreign government securities, municipal notes and bonds, and securities of banks, trust companies, and savings institutions. Another situation when the individual is representing an issuer to effect exempt securities transactions. Exempt transactions include:

1. transactions between an issuer and an underwriter;
2. transactions with a trust company or savings institution;
3. private placements;
4. sales to qualified purchasers; and
5. a transaction for a partner, director, or employee of the issuer where no compensation is received directly or indirectly.

THE ADMINISTRATOR

The Administrator administers and enforces securities laws in each state. They keep the records of any purchases made or being sold in their states through a notice file and state fee submitted by an Issuer. The administrator‘s authority under the Uniform Securities Act :

1. issue rules and orders;
2. deny, suspend, revoke, or cancel registrations;
3. bar a registrant from associating with a certain registered broker-dealer or investment adviser;
4. limit registrant activities;
5. investigate violations of securities law in and out of State;
6. require written responses to findings;

6. require written responses to findings;
7. issue subpoenas for attendance or production of documents;
8. issue and apply to a court to enforce subpoenas at request of another State’s Administrator;
9. administer oaths and affirmations;
10. take evidence;
11. publish results of investigations and hearings; and
12. cooperate with other regulators.

An offer is an attempt to dispose a security for a value but no consideration is exchanged. Broker-dealers or agents can offer a security in registration, and take non-binding indications interest, no money can be accepted. A delivery of a prospectus to a client is considered an offer to solicit securities.

Consideration is a promise of anything valuable by the parties making a contract. Without consideration, the contract is invalid.

“Sale” is every contract for sale, contract to sell, or disposition of, a security or interest in a security for a value, and “offer to sell” includes every attempt or offer to dispose of, or solicitation of an offer to purchase, a security or interest in a security for value.

Sale includes:

1. securities sold as a unit or sold as a bonus with the purchase of a security;
2. a gift of assessable stock involving an offer and sale; and
3. a sale of a warrant or right.

Sale does NOT includes:

1. Gift of a non-assessable stock
2 . Pledge of securities for a loan

Jurisdiction is the territorial range of authority or control, or the power to interpret or apply the law. Jurisdictional provisions determine which administrators have authority over certain types of securities transactions. Administrators have jurisdiction if a security offered or sale originates in their state, is directed into their state, is accepted in their state. Jurisdiction doesn’t mean registration is mandatory. There are offers and sales that do not require registration.

Before regulatory authority, Administrators need jurisdiction over a security transaction. An administrator has jurisdiction over an offer to buy or sell a security and acceptance of an offer, if the offer:

1. originated in the Administrator’s state;
2. was directed or sent to the Administrator’s state; or
3. was accepted in the Administrator’s state.

If an offer is made or accepted in a particular state, that state’s Administrator will have jurisdiction. An offer is considered to be made in a particular state, even if either party is not present in the state at the time when:

1. The offer originates in that state; OR
2. The offer is directed to the state and received in the place where it was directed.

An offer is NOT made in a particular state if :

1. A newspaper is circulated but not published in the state;
2. A newspaper is published in the state but has had more than 2/3 of its circulation outside the state within the
      past year; or
3. A radio or television program is broadcast in state but the communication originates outside the state.

ADMINISTRATIVE ACTIONS

The Administrator can issue punitive and non-punitive orders to punish the guilty individuals or to exempt the non-guilty individual. The various punitive orders are: Stop Orders; Summarily Suspend orders; Cease and Desist Orders; and requests for Injunctions. The administrator cannot issue the injunction or jail a person, only a court of law can.

STOP ORDERS

Stop orders is a power to deny, suspend, or revoke an individual’s registration, by providing:
1. Prior notice;
2. An opportunity for a hearing within 15 days of when the Administrator receives written request; and
3. Written findings of facts and conclusions of law.

DENIAL, REVOCATION, SUSPENSION, WITHDRAWAL, RESTRICTION, CONDITION, OR LIMITATION OF REGISTRATION 
1. The order must be in the best interest of the public and provide necessary protection to investors. An
    administratorcan issue an order if the security professional:

2. has filed an incomplete application for registration in the past 10 years,
     which, contained a false or misleading statement in a material fact;

3. willfully violated or willfully failed to comply with a rule within the previous 10 years;

4. has been convicted of a felony or within the previous 10 years has been convicted of a misdemeanor involving
      a security or money;

5. is ordered or restrained by a court of competent jurisdiction;

6. is the subject of an order?

7. is the subject of an adjudication or determination?

8. is insolvent;

9. refuses to allow or otherwise impedes the administrator from conducting an audit or inspection;

10. has failed to reasonably supervise an agent;



11. has not paid the proper filing fee within 30 days after having been notified by the administrator of the
     deficiency.

12. After a notice and opportunity for a hearing, has been found within the previous 10 years:

13. by a court of competent foreign jurisdiction to have willfully violated the laws related to securities or money;

 a. to have been the subject of an order by a securities regulator of a foreign jurisdiction denying, revoking, or
      suspending the right to engage in the business of securities;

 b. to have been suspended or expelled from membership by or participation in the
       securities exchange or securities association of a foreign jurisdiction.

14. is the subject of a cease and desist order issued by the SEC or by a State;

15. has engaged in dishonest or unethical practices in the securities or money related business within the
     previous 10 years;

16. is not qualified based on factors such as training, experience, and knowledge of the securities business. However, a denial order may not be based on this paragraph if the individual has successfully completed all examinations required.
      The administrator may require an applicant who has not been registered in a State within the two years preceding the filing of an application to successfully complete an examination.



The Administrator cannot suspend or revoke a trained and knowledgeable registrant due to lack of experience.

ORDERS TO SUMMARILY SUSPEND

The Administrator can postpone or “summarily” suspend registration during serious violations of securities regulations or serious defects regarding the company’s net capital that requires immediate suspension of individual’s license until a hearing has been held. The Administrator is not required to give notice before summarily suspending the license, but must notify the applicant and employing broker-dealer of the decision, the reasons for the action, and that a hearing will be scheduled within 15 days if requested. If the hearing is lost, an appeal can be filed in a court of law within 60 days. Appeals do not act as a stay of an order.

CEASE AND DESIST ORDERS

The USA states that the Administrator can issue a cease and desist order without prior hearing if he finds any person has engaged or is about to engage in any practice constituting a violation to prohibit further illegal activities. The Administrator can bring an action in court to enforce compliance with the cease and desist order. The Administrator must provide a prior notice and hearing to the applicant before entering a suspension, revocation, or denial order but he can immediately issue cease and desist orders, to quickly put an end to the outrageous behavior.

OTHER ADMINISTRATIVE PROVISIONS

REQUESTS FOR INJUNCTIONS

The Administrator can ask state courts to issue an injunction to prohibit violation conduct in the securities regulations. The state judge can fine the firm and its principals. Failure to follow a court ordered injunction, will find the individual in contempt of court, and can be jailed. Intentional violation of administrator’s a direct order is contumacy.

INVESTIGATIONS AND SUBPOENAS

The administrator can initiate investigations to determine any violation act about to be happen or have already been violated. Administrators and subordinates cannot disclose the confidential information learned during an investigation or proceeding. When conducting the investigations, the Administrator has the power to collect detailed statements under oath, subpoena witnesses, and require that certain documents be produced. The Administrator can choose if investigation is made public or should take place in the Administrator’s home state or another state. Administrators can issue subpoenas in their own state at the request of a securities agency or another state’s Administrator (from within the state and outside the state-interstate inspectorial power) if the actions being investigated would constitute a potential violation under the laws of the Administrator’s own state. If an individual fails to respond to a subpoena, he can be held in contempt of court if he or she fails to follow the court’s order.

JUDICIAL REVIEW

Administrator issued orders can be appealed for a state court review within 60 days of the decision and are in effect during the appeal process. The individual cannot continue doing business during the appeal process.

AMENDMENTS

Administrator can amend or repeal any rule, form, or order related to registration, reports, definitions of terms, and other activities necessary to carry out provisions of the Act, if he determines that doing so would protect investor’s interests or serve the public’s interest. Only a state’s legislature can alter state’s Blue-Sky and invests the Administrator with the power to amend or issue rules interpreting or clarifying the state's Blue Sky Laws.

UNLAWFUL REPRESENTATIONS OF ADMINISTRATOR AUTHORITY

Administrator is not approved or has an aptitude as a security professional or can deem an investment opportunity as a good investment. Such suggestions are a violation of Sec. 405 of the USA entitled "Unlawful Representations Concerning Registration or Exemption. The rule states that it “is unlawful to make, or cause to be made, to any prospective purchaser, customer, or client any representation inconsistent with either of the following statements”:

• The fact that an application for registration has been filed or that a person or security is already registered does
   not mean that any submitted document is true, complete, and not misleading.

• No fact, exemption, or exception means that the Administrator has given approval to any person, security, or
  transaction.

FILING SALES AND ADVERTISING LITERATURE

The USA requires the filing of a prospectus, pamphlet, circular, form letter, advertisement, sales literature, or other advertising record relating to a security or investment advice intended for distribution to clients or prospective clients. All advertising and sales-related materials by broker-dealers and investment advisers must be filed with the Administrator, unless:

• The transaction or security for which the advertisement is describing is exempt. (These exemptions are
   discussed later in Module 4)OR
• The advertisement is for a federal covered security.

NON-PUNITIVE ORDERS, PENALTIES, AND LIABILITIES

The three types of orders, penalties, and liabilities: non-punitive orders, criminal penalties, and civil liabilities.

NON-PUNITIVE ORDERS

A non-punitive order does not involve punishment but include withdrawal and cancellation of orders. Cease and desist, denial, suspension, and revocation orders are considered punitive orders if the securities professionals decide to withdraw or cancel his or her license. When a license is no longer wanted, or needed with no violations, the Administrator accepts this as a withdrawal. Withdrawals become effective 30 days after filing for the withdrawal. If registered individuals die, go out of business, are declared mentally incompetent, or cannot be located, the Administrator cancels their license without punishment.

CRIMINAL PENALTIES

Intentional violation of a USA provision or order is criminally liable. Criminal penalties for USA violations are 3 years in prison, a $5,000 fine, or both per violation. A prison sentence is only allowed if the accused cannot prove about his prior knowledge of the violated rule or order. A criminal action must be brought by a criminal court within 5 years of the alleged misdeed or the statute of limitations runs out. The Act informs that in criminal proceedings a person claiming an exemption, exception, preemption, or exclusion has the burden of proof to claim and must provide all the evidence to prove his/her claim Criminal penalties are imposed by the courts. The Administrator does not have the authority to impose criminal (or civil) penalties, but he can hand over evidence to the attorney general or district attorney.

CIVIL LIABILITIES

Civil liability arises from the unlawful selling of stock, or from investment advisors who breach their fiduciary duty. Buyers can sue the seller for purchasing an unlawfully sold security. A purchaser has a right of action if:

1. The securities were sold in violation of USA registration provisions or state advertising provisions;
2. The offer or sale was made by an unregistered person;
3. Violation of state law requirements regarding sales literature about the sale;
4. The seller misrepresents the securities, makes an untrue statement, or omits a material fact; or
5. The seller violates any requirements mandated by the Administrator, such as failing to deliver a prospectus.
6. Lack of supervision 

Waiver of legal rights make the contract void, illegal, and unenforceable.

The statute of limitations for civil action is 2 years from discovery or 3 years from the actual event, whichever comes first. A case brought under the USA survives the death of any plaintiff or defendant. As with criminal proceedings, a person claiming an exemption, exceptions, preemption, or exclusion in a civil matter has the burden to prove the applicability of the claim.

LETTER OF RESCISSION

If a registered security professional realizes that he has effected an illegal sale, he can make the buyer a formal offer of rescission in which the seller will buy back the unregistered security at cost plus interest. The buyer has 30 days to accept or decline the offer, but if the buyer declines or fails to accept within 30 days the buyer loses the right to sue.

RIGHT TO RECOVER

If a purchaser of securities is suing the seller, the purchaser can recover the full purchase price, plus interest, court costs, and reasonable attorney fees, minus any income received from the security. If a client is suing his investment adviser, the client has a right to recover the cost of the advice, plus any loss on the stock, interest, and reasonable costs and attorney fees, minus any income received from the advice.


REGISTRATION OF SECURITIES PROFESSIONALS

OVERVIEW

The Uniform Securities Act regulates the securities sale and activities of securities professionals and deals with registration requirements. It requires that only registrated securities professionals of the state can conduct securities business in that state. The registration requirement protects investors from any convicted felons or prone to fraudulent behavior.

Investment Advisers, Investment Adviser Representatives, Broker-dealers, and Agents all share common registration requirements as well as other requirements for registration and post registration specific to each type of securities professional.

All securities professionals share the following 4 common requirements to register with a state Administrator:

1. Filing an application
2. Paying a registration fee
3. Filing a Consent to Service of Process
4. Possibly posting a surety bond

APPLICATION

The application must contain all the following information requested by the Administrator:

1. The applicant’s place and form of business organization (for investment advisers and broker-dealers)
2. The applicant’s proposed method of doing business
3. The applicant’s qualifications and business history
4. Applicant’s financial condition and history
5. Any injunction or administrative order or conviction of a misdemeanor involving a security or any aspect of the
  securities business and any conviction of a felony.

An application for registration is complete when with all required fees and documents are submitted to the Administrator. Securities Professionals are required to renew their registration every year by December 31st. When requesting a renewal of a registration, individuals must submit an updated application.

FILING FEE

Every applicant must pay a filing fee during initial filing or submitting of an application for renewal. If an application is denied or withdrawn, the Administrator retains part of the fee.


CONSENT TO SERVICE OF PROCESS

An investment adviser must submit a consent to service of process form, stating the Administrator’s power to accept service of process connected to a civil or administrative action. The purpose of the consent is to provide convenience for clients wishing to pursue a complaint against the applicant in court, by allowing the client to serve notice directly to the Administrator. And specifically, if the securities professional being sued is no longer associated with his former employer and cannot be located.
This requirement brings up the issue of which state administrator should be served in interstate transactions. If a client, who resides in Michigan, does business with an agent of a broker-dealer in Ohio, and wishes to sue that agent for a violation of the Uniform Securities Act, the client may file the papers with either the Michigan or the Ohio Administrator. Even if the agent was never registered in Michigan, the Michigan Administrator will accept the notice on behalf of the agent.
The Consent to Service of Process form is only required upon initial application, and is not required to be resubmitted upon renewal.


SURETY BONDS

A “surety bond” is an obligation posted by securities professional and issued by a bonding company to cover the costs of any possible legal actions arising from any Uniform Securities Act violations. The bond requirement applies to registered investment advisers, broker-dealers, or agents that have custody of, or discretionary authority over client funds or securities. A securities professional has the option of depositing cash or securities, instead of posting a bond. 

If a court orders a security professional to pay a judgment but if he is unbale to meet the financial obligations, the bonding company pays to a certain amount. Broker-dealers or investment advisers who meet certain financial conditions do not require bonds. Bonds do not apply to investment adviser representatives.

The provisions regarding examinations, effective dates, and expirations.

Examinations

The Administrator requires applicants to pass an examination and waive for certain categories of persons.

EFFECTIVE DATE

Registration becomes effective at noon on the 30th day after filing the application or amendment, if no denial order was issued and there are no pending proceedings regarding denial, revocation, suspension, cancellation, or withdrawal of registration. The Administrator has the authority to grant an early registration if he finds such action appropriate.

EXPIRATION

All registrations expire or terminate annually on December 31st, unless the Administrator revoke or suspend a registration sooner. A securities professional can stop the expiration of his or her registration by applying for a renewal.





FORMS

Designated Forms satisfy certain registration requirements. For e.g.

1. Form ADV: Investment Advisers use Form ADV to register with the Administrator
2. It is a disclosure document divided into two parts: Part I-disclose detailed information about adviser’s business;
    and Part II-discloses information about the adviser to the client.
3. Form BD: A broker-dealer registers himself using Form BD.
4. Form U-4: Form U-4 is filed by investment advisers to register each investment adviser representative AND by
    Broker- dealers to register each agent.
5. Form U-5: Form U-5 is filed by investment advisers whenever an investment adviser representative leaves the
    firm or is terminated AND by Broker-dealers if an agent leaves the firm or is terminated.
6 Form U-10: Form U10 is for a person who will register as an investment advisor only.

REGISTRATION OF INVESTMENT ADVISERS

DEFINITIONS

“Custody” is a legal responsibility or control over another’s assets. “Discretion” is an authority to act on client’s behalf for securities purchases and sales (action), the asset (security), or amount (quantity) must be in granted in a client signed discretionary document; and no written authorization is required to choose time and price. 

REGISTRATION

Investment advisers are organized sole proprietor, corporation, or partnership state registered investment adviser to transact business in that state. An investment adviser’s application must also state the qualifications and business history of any officer, partner, director or any other person in a controlling position and any information to be furnished to clients or prospective clients.

The two exemptions for an investment adviser registration:

First, a person with no place of business within the state will be exempt from registering as an investment adviser IF the person’s clients are only:

1. Federal covered IA, state IA or broker-dealer;
2. Institutional investor
3. Bona fide preexisting clients whose principal place of residence are not in this State if the IA is registered in
    their state of residence;
4. Any other person adopted by this (Act).

FEDERAL V. STATE REGULATION

Not all investment advisers can register with the state, because some are required to register only on a federal level with the SEC. Large investment advisers must register with the SEC while small investment advisers must register with the state.




WHERE TO REGISTER?

Advisors like Private Fund manager with less than $150 million assets under management (AUM) do not require SEC registration if relying on an exemption and are subject to reporting obligations of an exempt reporting Adviser. State Registration is required per state law, unless exempt at the state level of SEC registered.

Venture Capital Fund Adviser do not require SEC registration if relying on an exemption and are subject to reporting obligations of an Exempt Reporting Adviser. State Registration is required per state law, unless exempt at the state level of SEC registered.

Foreign Private Advisers do not require SEC registration. State Registration is required per state law, unless exempt at the state level of SEC registered.

Intrastate adviser (not advising private funds) do not require SEC registration. State Registration is required per state law, unless exempt at the state level of SEC registered.

Family office(s) Advisers do not require SEC registration. State Registration is required per state law, unless exempt at the state level of SEC registered.

SBIC Adviser do not require SEC registration. State Registration is required per state law, unless exempt at the state level of SEC registered.





THRESHOLDS FOR SEC REGISTRATION:

Small Adviser less than $25 million are prohibited from SEC registration unless there is an exemption. State registration is required unless there is an exemption.

Mid-sized Adviser between $25 million to $110 million are prohibited from SEC registration but allowed if assets are between $100 million and less than $110 million (buffer zone). State registration is required unless exercising the buffer zone.

Large Adviser like $110 million or more require SEC registration and exempted from state registration.

Venture capital funds are exempt from registration.

POST-REGISTRATION REQUIREMENTS

Post-registration requirements for investment advisers include requirements regarding custody, discretion, net capital, record keeping, financial reports, and client disclosures.

CUSTODY

The term “custody” is a legal responsibility for, or control over, someone’s assets. The NASAA requires investment advisers with custody to:



1. notify Administrator promptly in writing using Form ADV;
2. keep each client’s securities separate, and keep detailed records securities belonging to each client;
3. notify all clients in writing of custodian’s name, address, and the way funds will be maintained;
4. send account statements to clients at least once every quarter; AND
5. arrange to have an unannounced annual inspection by an independent accountant, who will submit his or her
    report to the Administrator.

Advisers that have custody and require a prepayment of $1,200 in fees at least 6 months in advance, must submit a balance sheet to the administrator along with Form ADV. The Uniform Securities Act provides that it is unlawful for any investment adviser to take or have custody of any securities or funds of any client IF:

1. the Administrator prohibits the custody; or
2. If he fails to notify the Administrator that he has or may have custody.

Advisers may submit the unaudited balance sheets that have discretion only. If the adviser has custody, the balance sheet must be audited by an independent public accountant.

CUSTODY AVOIDANCE

Investment advisers try to “avoid custody” of their client’s funds if possible because it is much easier to have qualified custodian to maintain client assets, keeping track of interest earned, dividends received, purchases and sales of securities, deposits and withdrawals, etc. This qualified custodian holds and keeps track of client assets.





He keeps track of the securities and cash balances that change daily, and sends quarterly account statements to the client. The adviser obtains written discretionary authorization from the client to manage and trade within the account, and an authorization to send a billing statement to the custodian, disclosing deducted management fee from the client’s account, and the assets’ value under management at the time the fee was calculated and the time covered by the fee.

The adviser must send a copy of the billing statement to the client. Qualified custodians as per The NASAA Model Rule on Custody:

1. banks and Savings Institutions insured by the FDIC;
2. registered broker-dealers;
3. registered futures commission merchants; and
4. foreign financial institutions.

Qualified custodians also maintain the high net capital requirement, send audited balance sheet to regulators or clients, prepare and pay for an annual audit by a CPA. Advisers also “avoid” custody because of the frightening prospect of being a bank that is responsible for many other people's money.

To avoid custody in an event when a client’s securities are sent to an adviser, advisers must keep records of securities sent and when they were returned, and must return the assets within 3 business days, to avoid following the financial requirements or update his or her Form ADV. If an adviser receives a check from the client payable to a third party, the adviser must avoid 2 things to avoid custody:





1.the adviser must forward the check to the third party within 24 hours; and
2. the third party must truly be a third party, not just another company related to the adviser’s firm.

DISCRETION

Investment Advisers holding custody over clients’ funds and securities enjoy full discretionary authority. Investment Advisers not having custody must obtain written discretionary authority from the client regarding asset or security, the activity (whether to buy or sell), and the amount. However, the adviser can choose the time and the price.

NET CAPITAL REQUIREMENTS

NASAA recommends that advisers having custody over client’s assets must, continually, maintain a minimum net worth of $35,000. Advisers with discretionary authority need to maintain a net worth of $10,000. An adviser requiring prepayment of fees of $500 or more at least 6 months in advance must always maintain a positive net worth. However, each state is free to set its own minimum financial requirements for advisers. An adviser must satisfy the minimum net worth requirements of the state where his business is located. An adviser, lacking minimum net worth established by the Administrator, must file a report of financial condition by the close of next business day with the Administrator. The Administrator may waive the requirement to post surety bonds for advisers who meet the minimum required financial standards.





RECORD KEEPING

The USA states that every registered investment adviser shall make and keep accurate accounts of: correspondence, memoranda, papers, books, and other records for three years as approved by the Administrator’s rule. However, Investment advisers make and keep records for 5 years. All records are subject to periodic, special, or other examinations by administrator’s representatives, within or without the state, as the Administrator deems necessary or appropriate for the protection of investors. Even if a company goes bankrupt, the investment adviser must maintain records for 5 more years and notify the Administrator of its location.
If an investment adviser has business locations in two states, he must follow the Record keeping requirements of his home state.

RECORDS MAINTAINED ELECTRONICALLY MUST:

1. be preserved from any loss, alteration, or destruction.
2. limit the access only to authorized personnel and the Administrator, its examiners, and representatives; and
3. ensure the reproduction of non-electronic original records on electronic storage media is complete, true, and
    legible when retrieved.

FINANCIAL REPORTS

Financial reports must be filed as per the Administrator’s requirements. Any inaccurate or outdated information in a filed information requires a correction amendment.




CLIENT DISCLOSURE

Advisers must disclose all material conflicts of interest to clients in writing, or any information the Administrator deems appropriate. Client disclosures are complied with the Brochure Rule.

THE BROCHURE RULE

Investment Advisers Act of 1940 and NASAA model rules introduced The Brochure Rule that describes the time and type of disclosures that must be made to the client. Clients must receive a brochure within 48 hours before a contract is signed with the advisor or at the time account is opened otherwise they must be given 5 business days to cancel the contract without penalty. No Brochure is required by the clients like investment companies or contracts for impersonal advisory services (newsletter) of less than $200.

Firm can create the brochure or may use Part II of the Form ADV if it contains the following information:<

1. services and fees;
2. types of Conditions imposed on clients;
3. description of affiliations with other securities professionals and businesses;
4. whether investment advisor acts as broker or dealer and receives other benefits from transactions; and
5. whether investment advisor exercises discretion, suggests brokers to clients, or receives additional
    compensation.
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Broker-dealers are either any person or company effecting securities transactions for the account of others or for their own account. Like their name suggests, they have dual roles. As brokers, they act as agents, buying and selling securities on behalf of a client's account. As dealers, they act as principals, executing transactions for their own account. Providing market volume and liquidity is another key role of a broker-dealer. Most broker-dealers must register with the SEC and a self-regulatory organization. Although broker-dealers are expected to deal fairly with their clients, they are not legally obligated to put the interest of clients before their own (unlike investment advisers, who are required by law to do so).

State. A representative’s adviser does not need to register in state if it is registered under the SEC; the representative is required to be registered in any state he has office in.

REGISTRATION OF BROKER-DEALERS

REGISTRATION

A broker-dealer’s application must also state the qualifications and business history of any officer, partner, director or any other person in a controlling position.

REGISTRATION EXEMPTIONS

If a broker-dealer does not have a place of business in-state, he does not have to register. The Administrator allows nonregistered broker-dealers to do business exclusively with the following:

EXEMPTIONS FROM REGISTRATION:

1. A broker-dealer with no business place in this State are exempted from registration if the transactions in this
   State are with:
   a. the issuer of the securities involved in the transactions;
   b. a person registered as a broker-dealer or not required to be registered under this (Act);
   c. an institutional investor;

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d. a nonaffiliated IA with investments under management more than $100,000,000 acting for the accounts of
   others pursuant to written discretionary authority;
e. a bona fide preexisting customer whose principal place of residence is not in this State and the broker-dealer is
   registered in the client’s home State;
f. a bona fide preexisting customer whose principal place of residence is in this State but was not present in this
   State when the customer relationship was established, if:
    . the broker-dealer is registered in the State where the relationship was established;
    . will register after the customer’s first transaction in this State.
g. not more than three customers in this State during the previous 12 months.
h. any person exempted by rule or order issued.

POST-REGISTRATION REQUIREMENTS:

NET CAPITAL REQUIREMENTS:

The state Administrator requires a broker-dealer to retain a minimum amount of net capital, but it should not exceed the amount established by the SEC. Net capital is the broker-dealer’s liquid net worth.

RECORD KEEPING:

The USA states that every registered broker-dealer shall make and keep records of correspondence, memoranda, papers, books, etc. for three years as prescribed by the Administrator unless prescribed otherwise.

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Broker-dealers keep most of their records for 3 years, 2 years on site.The requirements for maintaining electronic records for Investment Advisers and Broker-dealers are same.
Financial reports must be filed as required by the Administrator and any inaccurate or outdated information filed with the Administrator requires a correction amendment promptly. The Administrator has power to subject all required records of a registered broker-dealer to periodic or special examination.

CLIENT DISCLOSURE

Broker-dealers must disclose all material conflicts of interest to clients in writing. The Brochure Rule also applies to broker-dealers acting as an investment adviser. Disclosures must be sent to the client 48 hours before he signs a contract with the advisor or at the time the account is opened if not Clients must be given 5 business days to cancel the contract without penalty. Brochure is not required for clients like investment companies or contracts for impersonal advisory services of less than $200.

REGISTRATION OF AGENTS OF BROKER-DEALERS

Broker-dealers and agents are not same: Broker-dealers are the firm; the agents are representatives of the firm.

REGISTRATION

All agents must be registered under the Uniform Securities Act and must complete the registration requirements like an application, consent to service of process, and filing fee to become registered under the Act if:


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1. The agent has a place of business in the State, OR:
2. The investors are individuals (not institutions).

The registration of a broker-dealer constitutes the automatic registration of a partner, director, or officer as an agent IF they were with the firm at the time of registration.

THE UNIFORM SECURITIES ACT STATES:

1. Agent registration is effective only while the agent is employed by or associated with a registered broker-
   dealer or an issuer offering, selling, or purchasing securities in-state.
2. It is unlawful for a broker-dealer or an issuer to employ or associate with an unregistered agent required to be
    registered in a certain state.
3. An agent can work for only one broker-dealer or issuer at a time unless the broker-dealer or issuer are affiliated
    by direct or indirect common control or as otherwise authorized by law.

REGISTRATION EXEMPTIONS

An agent does not have to register if the agent does not have an in-state office, and his customers are:


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A. the issuer of the securities involved in the transactions;

B. a person registered as a broker-dealer under this (Act) or is not required to be registered under this (Act);

C. an institutional investor;

D. a nonaffiliated federal covered investment advisor with investments under management more than
    $100,000,000 acting for the account of others pursuant to discretionary authority in a signed record;

E. a bona fide preexisting customer whose principal place of residence is not in this State and the person
    is registered as a broker-dealer under the Act of 1934 or not required to be registered under the Act of 1934
    and is registered under the securities act of the State in which the customer maintains a principal place of
    residence;

F. a bone fide preexisting customer whose principal place of residence is in this State but was not present in this
    State when the relationship was established, if;

(I) the broker-dealer is registered in the State in which the customer relationship was established and
    where the customer had maintained a principal place of business;

(ii) Will become registered in this State;

G. any other person exempted by rule adopted or order issued under this (Act); and


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H. A person who deals solely in U. S. Government securities and is supervised by the FRB, the Comptroller of the
    Currency, the FDIC, or the Office of Thrift Supervision.

I. Foreign transactions- Canada exemption

(i) An individual who represents an issuer with respect to an offer or sale of the issuer’s securities and is not
    compensated.

(ii) An individual who represents an issuer and who effects an exempt transaction. Except for a transaction in a
   note, bond, debenture, or other evidence of indebtedness secured by a mortgage or a sale or offer to sell
   securities of an issuer, if part of a single issue in which: a) not more than 10__ non-qualified purchasers are
    present in this State during any 12 consecutive months: b) no general solicitation is made: c) no commission or
    remuneration is paid; d) is purchased for investment purposes.

(iii) An individual who represents an issuer that effects transactions solely in federal covered securities and is not
    compensated on transactions in those securities.

4. Transactions with a non-affiliated federal covered investment advisor with investments more than
    $100,000,000 and has discretionary authority.

5. An individual that represents an issuer about the purchase of the issuer’s own securities;

6. An individual who represents an issuer and who restricts participation in performing clerical or ministerial acts:


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or 7. Any other person exempted by rule adopted or order issued under this (Act).

FOLLOWING AGENTS ARE EXEMPTED:

Agents can transact business with an existing customer who is in another state temporarily, without having to register. Agents whose applications are still pending in a state for registration allows the agent to conduct business for up to 60 days with an existing client who has moved into the State if:
1. The application is not denied by the Administrator;
2. the agent is not ineligible to register;
3. the broker-dealer represented by the agent is registered;
4. the agent is registered with a national securities association, such as FINRA; and
5. the agent is registered in at least one other state.
Individuals representing the issuer of securities involved in the transaction, are not considered agents if the security or the transaction is exempt. For example, by purchasing Treasury bills, notes, and bonds, he or she is not required to be registered because he or she is not considered an agent. These are government securities, and are exempt.

CUSTOMER ORDERS:

The firm must create an order ticket for every order it accepts from a client before the order is executed. The order ticket must include the client’s account number, the time the order was received from the client, entered, and was executed. Supervisors do not need to approve every order before it is entered but must approve every new account that is opened before the first order for that account is entered. The supervisor must promptly review client orders after they have been executed.

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COMMISSIONS

Agents may split commissions with other agents who are employed by the same broker-dealer or two affiliated broker-dealers, AND registered in the state where the transaction occurred.

TERMINATION

The registration of an agent is only effective while he is associated with a registered broker-dealer or an issuer. When an agent terminates his or her association with a broker-dealer, the agent and broker-dealer must notify the Administrator. When the agent moves from one broker-dealer to another, the agent’s prior employer, and new employer must notify the Administrator.

REGISTRATION OF CANADIAN BROKER-DEALERS AND AGENTS

Registration of Canadian Broker-dealers and Agents NASAA stands for the “North American Securities Administrators Association,” and therefore, includes regulators in the Canadian provinces. The USA allows Canadian brokerage firms to do business with existing clients who temporarily move into a U.S. state, without the rigorous registration requirements of that state. The Canadian firm must be registered in Canada, be a member of a Canadian SRO or stock exchange, and must NOT have an office in state. Canadian broker-dealers and agents must submit a Consent to Service of Process, a copy of the registration statement that was filed for Canadian registration, and proof of good standing in their Canadian district.

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Broker-dealers or agents who are registered in this fashion may only do business with existing clients and the clients who are in the states temporarily. If a broker-dealer has an office in state, wants to solicit new clients, or contact clients who have moved to the US permanently, he must be fully registered with the state.
Though the North American Free Trade Agreement (NAFTA) has eliminated the barriers to free trade and investments between the United States, Canada, and Mexico, the Mexican broker-dealers and agents are not awarded the same privileges.

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REGISTRATION OF SECURITIES AND ISSUERS

A “security”
• “ Security” means a note; a stock; a treasury stock; a security future; a bond; a debenture; an evidence of indebtedness; certificate of interest or participation in a profit-sharing agreement; collateral trust certificate; preorganization certificate or subscription; transferable share; investment contract; voting trust certificate ; certificate of deposit for a security; fractional undivided interest in oil, gas, or other mineral rights; put, call, straddle, option, or privilege on a security, certificate of deposit (this is not a bank CD, but a bank who is holding securities for deposit in a bankruptcy), or a group or index of securities, including those entered into on a national securities exchange relating to a foreign currency; or , in general, an interest or instrument commonly known as a “security”; or a certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing .

A. includes both a certificated and an uncertificated security;

B. does not include an insurance or endowment policy or annuity contract by an insurance company who
    promises a fixed (or variable) sum of money either in a lump sum or periodically for life for specified period;

C. does not include an interest in a contributory or non-contributory pension or welfare plan subject to ERISA;


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D. includes as an “investment contract” an investment in a common enterprise with the expectation of profits are
    derived by one person other than the investor and a “common enterprise” means an enterprise in which the
    fortunes of the investor are interwoven with those of investors, a third party, or other investors; and;

E. includes as an “investment contract,” among other contracts, an interest in a limited partnership and a limited
    liability company and an investment in a viatical settlement or similar agreement.;

A security is not a :

1. Fixed annuity
2. Fixed life insurance, universal life insurance, or endowment;
3. Commodity or futures contract; or
4. Individual retirement account (IRA) or Keogh plan

“Sale:” or “sell:” includes every contract of sale of, contract to sell, or disposition of, a security or interest in a security for value.

“Offer:” or “Offer to Sell:” means an attempt to dispose of a security for value, or the solicitation of an offer to buy a security.

FRAUD

Regarding offer, sale, or purchase of a security, it is unlawful for a person to directly or indirectly:
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1. employ a device, scheme, or artifice to defraud;
2. make untrue statement(s) of material fact(s) or omit to state material facts(s) necessary to make the statements
    made not misleading; or
3. engage in acts, practices, or course of business that operates or will operate as fraud or deceit upon any
   person.

INVESTMENT CONTRACTS

Investment contract is a term used to describe multiple types of investments. To determine whether a certain transaction involved is an investment contract; state and federal courts use a four-part test established in the United State Supreme Court case of Howey v. SEC and is referred as the “Howey Rule”.

The “Howey Rule” says that an investment contract is “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” Thus, there are four elements to an investment contract:

1. An investment of money
2. A common enterprise
3. An expectation of profits
4. Results solely from the efforts of others.

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ISSUERS

“Issuer” is a person who issues or proposes to issue a security. The term person refers to individuals and the legal entities, including a corporation, partnership, association, joint stock company, trust where the beneficiaries’ interests are in securities, unincorporated organization, or governmental body.

A Non-issuer transaction is one where the issuer does not receive the transaction proceeds.

REGISTRATION REQUIREMENTS FOR SECURITIES

REGISTRATION PROCESS

Registration and selling process of securities at a state level begins by filing registration statement with the state Administrator. After the security registration, the issuer and underwriters go into a cooling off period, during which sales or advertisements of the securities is not allowed. The cooling off period allows regulators to review the registration statement

Advertising of new issues is prohibited during the cooling-off period, but a Tombstone Advertisement may be published. A Tombstone Advertisement explains basic facts regarding a sale of securities, designed to acquaint the public with a distribution. Tombstone advertisements do NOT solicit for the purchase or sale of securities and a disclaimer fact is displayed. Delivery of prospectus to a client is considered a solicited offer to purchase securities, reading a tombstone advertisement is considered an unsolicited offer to buy securities.


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REGISTRATION REQUIREMENTS

Securities that require registration with the state should contain the following information in the registration statement prior to filing:
1. filing fee based on percentage of total offering;
2. total offering;
3. list of other states in which a registration statement has been or will be filed;
4. amount of securities offered; and
5. adverse order, judgment, or decree entered by a court, the securities agency or Administrator in any State of
    the SEC about the offering.
Documents filed within the last 5 years may be incorporated into the registration statement by reference. Filing may be done by the issuer, a registered broker-dealer, an underwriter, or any person working on the behalf of offeror.

ADDITIONAL FILING REQUIREMENTS:

During the registration process, the Administrator may request additional documents and information such as financial information and articles of incorporation, charter or other organizational documents. The Administrator may request that a prospectus be sent to each person who received a sale or offer. A prospectus is a formal written offer to sell securities that sets forth the plan for a proposed business enterprise or the facts concerning an existing one that an investor needs to make an informed decision. The purchaser must receive a final or preliminary prospectus and a document from the broker-dealer executing the transaction no later than the due date of confirmation of the transaction.

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The Person who files registration statement for the non-issuer distribution offer may not submit additional information requested by the Administration, if he does not know or have a reasonable access to the information. Reasonable access is determined by examining the effort and cost that the individual will endure in obtaining the information.

EFFECTIVE DATE OF REGISTRATION:

A registration statement is effective for one year from the effective date of registration unlike the registration effective dates of securities professionals. A broker-dealer registered on July 5th, his registration will expire on Dec. 31st of each year, unless renewed. However, if the security is registered on July 5th, it remains active for an entire year. After the expiration, any securities covered under the statement are no longer registered. An investor wishing to resell these securities must either renew or re-register the securities or must find an exemption that allows them not to be registered. The latter circumstance is common, because there are many exemptions to registration on the state level.

AMENDMENTS TO REGISTRATION STATEMENTS:

Any inaccurate or incomplete information in the registration statement, requires an amendment correction to be sent to the Administrator. If an amendment is filed, the effective date of registration will be a year from the date of the amendment, not the original filing date. If an issuer, wants to increase the number of shares being sold of any registered security, may file an amendment and does not have to submit a new registration statement, if the issuer’s public offering price (POP), underwriters’ discount, and commission schedule stay the same.


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WITHDRAWAL OF REGISTRATION STATEMENT:

If securities of the same class are outstanding, a registration statement cannot be withdrawn for one year from its effective date. However, in some situations, Administrator permits the withdrawal.

DENIAL, SUSPENSION, OR REVOCATION OF REGISTRATION:

Administrator can request any information pertaining to a security registration statement. The state may inquire what the security is, all offering documents, any sales literature regarding the security, copies of the agreements between the issuer and the underwriter, and whether the security has been registered with the SEC or any other regulator. After examining all this information, the Administrator can issue a stop order to deny, suspend, or revoke a security’s registration IF it’s in the public’s interest AND:
1. the registration statement is incomplete, misleading, or inaccurate;
2. securities regulation has been willfully violated about the offering;
3. there is a stop-order or court injunction regarding the offering;
4. the issuer’s enterprise includes or would include illegal activities;
5. the offering has or would tend to defraud purchasers;
6. the offering creates unreasonable underwriter compensation, excessive promoter profits, amounts of options,
    and kinds of options;
7. the security is not eligible for registration;
8. the security is seeking registration by coordination and failed to comply with the coordination requirements; or;
9. the proper filing fee has not been paid.
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To prevent a security from registration due to unpaid filing fee, the administrator can only enter the denial order and must vacate upon the payment of fee. Once the security is effective, the Administrator may not institute a stop order to deny, suspend, or revoke a registration of a security because the facts were disclosed to him unless the proceedings begin within 30 days.

NOTICE REQUIREMENTS

Securities professionals must receive prior notice and an opportunity for a hearing before the Administrator may enter a stop order, likewise before a denial, suspension, or revocation order of a security may be entered. However, just like securities professionals, the Administrator may issue a Cease and Desist Order or an Order to Summarily Suspend without prior notice or an opportunity to be heard.

FEDERAL SECURITIES

At the federal level, the securities issuance is governed by the Securities Act of 1933, while FINRA governs the underwriting of corporate securities. Not all securities are required to be registered with the states if the security falls under one of the exemptions to state registration. Federal securities are defined in the National Securities Market Improvement Act of 1996 (NSMIA). The following securities will only register with federal regulators:


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BLUE CHIP EXEMPTION:

1. securities listed on the New York Stock Exchange, American Stock Exchange, CBOE, Midwest Exchange or
    Nasdaq, or other national securities exchange that has listing standards approved by the SEC;
2. federal exempt issuers such as Municipal securities (except those issued by a municipality in the
    Administrator’s state); and
3. securities issued by an investment company that is registered, or has filed for registration, under the
    Investment Company Act of 1940, including securities issued by open-end and closed-end mutual funds, unit
    investment trusts, and face amount certificates.

Federal covered securities do not require registration with the state but some have a notice filing requirement, such as investment company shares. Notice filing is a submission of notice document to the state by the issuer. A state Administrator require the notice filing to include a copy of documents filed with the SEC, notice filing fee, and a consent to service of process form. The Administrator may also require a copy of Form D with the Appendix signed by the issuer not later than 15 days after the first sale of the federally covered security in the State. Stocks listed on AMEX, NYSE, and NASDAQ do not require notice filings.

Any individual, securities professional exempt from state registration because the security is a federal covered security, can still be held liable under state law for any violations. The Administrator may issue a stop order suspending the offer and sale of a federal covered security and removes the stop order when the deficiency is corrected and no penalty will be imposed by the Administrator.

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Unlike state Blue-Sky registration requirements where the securities are registered for one full year from the effective date of registration, securities registered on a federal level under the Securities Act of 1933 are registered permanently.

REGISTRATION METHODS:

The three different ways to register securities with the State Administrator: Coordination, Filing, or Qualification. With the general registration requirements, the registration must be completed using one of these three registration methods.

COORDINATION

Under the Securities Act of 1933, the issuer first registers the securities with the SEC and then coordinates with the states where the securities will be offered for sale to register with each state. An escrow account, or an account with money or securities held by a third party until the conditions of a contract are met, may be required for securities offered by coordination because proceeds are likely to be impounded by the Administrator and not released to the issuer until the specified amount has been raised.
The Coordination method is used by issuers of securities involving inter-state or federal matters that, in addition to registering on a federal level, are not big enough to be granted a break at the state level. The registration statement with the state is coordinated with federal registration but does not need to be filed at the same time. Coordinated securities is sold using a specific form stipulated by the Administrator.

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The Uniform Securities Act provides that a registration statement for a security registered by coordination, in addition to the general registration requirements, must contain or be accompanied by the following records:

1. three copies of the latest form of prospectus filed under the Securities Act of 1933;
2. If requested by the Administrator, Copies of articles of incorporation and bylaws; agreement with or among
    underwriters; any indenture or other instrument governing the issuance of the security; and a copy or
    description of the security;
3. copies of any other information requested by the Administrator;
4. all future amendments to federal prospectus; and
5. a consent to service of process.

The effective date of registration when using the coordination method is the date when the federal registration becomes effective, if the following conditions are satisfied:

1. no stop order is in effect or pending against the issuer;
2. registration statement has been filed for at least 10 days; and
3. a statement of the minimum and maximum offering prices and maximum underwriting discounts and
    commissions has been on file for at least 2 business days.

NOTICE OF FEDERAL REGISTRATION STATEMENT EFFECTIVENESS

The registrant notifies the Administrator about the date when federal registration statement will be effective along with any price amendment if any.


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This notice should be sent timely, or the Administrator may issue a stop order without prior notice or hearing, denying the effectiveness of the registration statement or suspending it until compliance is met. The Administrator must notify the registrant. Upon registrant’s compliance, the stop order is void as of the date of its issuance.

COOLING-OFF PERIOD

The Securities Act of 1933 requires a cooling off period, the period between registration filing and the effective date, for the federal and state levels. The minimum cooling-off period at the federal level is 20 days and the state level is 10 days. The SEC or Administrator has the power to halt, extend, or shorten the cooling-off periods. The difference between coordination registration and registration by filing because under coordination, the administrator can ask the issuer to provide extensive documentation.

FILING

Filing registration requires federal registration filed with the SEC, like coordination method. Then the registrant notifies the Administrator that requirements are met. This method, also called registration by notification, is not allowed in some states but used by established companies meeting strict financial requirements.

Registration by filing is a different concept than the notice filing requirement of federal securities.

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THE REGISTRATION BY FILING APPLICATION MUST CONTAIN:

1. eligibility statement;
2. issuer’s name, address, and form of organization;
3. description of offering; and
4. copy of prospectus filed with SEC.

If all or part of the offering is a non-issuer distribution (for the benefit of someone other than the issuer) the application must contain that person’s name, address, amount of securities held, and reasons for making the offering.

The Uniform Securities Act states that not all states allow registration by filing but for those that do, must use the filing method if the security complies with all the following requirements:

1. filed registration statement under Securities Act of 1933;
2. under Securities Exchange Act of 1934 registered class of equity securities held by 500 or more shareholders;
3. issuer’s total net worth of $4 million or more and pretax net income of $2 million for at least 2 of the previous 3
    years;
4. issuer actively engaged in business for at least 36 calendar months prior to registration;
5. for at least 30 days during the 3 months prior to filing, have 4 registered market markers for issuer’s
    registered securities per the Securities Act of 1934;
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6. aggregate commissions or discounts cannot exceed 10% of the aggregate offering price for underwriters;
7. issuer or subsidiary have paid all dividends on preferred stock nor defaulted on any bond or long-term lease
   since the end of the last fiscal year prior to filing registration; and
8. offering price of security equity must be $5 or more.

With the method of filing, the effective or release date is the same as the federal registration on meeting the following conditions:
1. no stop order issued by SEC of Administrator;
2. required information and documents have been on file for at least 5 days; and
3 registration fee paid.

State registration becomes effective when all requirements are satisfied even if federal registration became effective earlier.

The filing method of registration is rarely used compared to the coordination method, the Administrator cannot require as much additional information from the registrant. While the Administrator requires 10 days to review all the paperwork for registrations using the coordination method, he only requires 5 days of review for the filing method.

QUALIFICATION

Registration by qualification is used when no federal registration is required or when federal registration is already in effect; therefore, it can be used in any state for any type of security.
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The Administrator may require specified form for the securities registered by qualification to be sold and may require an escrow account to hold the proceeds until a specific amount is raised.

The USA requires the registration statement of qualification to contain:

1. basic information on the issuer: name, address, form of organization, etc.;
2. information regarding the issuer’s directors, officers, and persons owning 10% or more of the issuer’s securities;
3. name, address, and amount of securities owned of anyone doing a non-issuer distribution connected to the offering;
4. capitalization and long-term debt of the issuer;
5. kind and amount of securities to be offered, proposed offering price, estimated underwriter compensation and
    finder's fees;
6. estimated cash proceeds to be received by the issuer, purposes for which the proceeds will be used;
7. copy of any prospectus, pamphlet, circular, form letter, advertisement, or other sales literature to be used;
8. copy of the security being registered, copy of articles of incorporation and by-laws, and copy of any indentures;
9. balance sheet of issuer within 4 months before the filing of the registration statement; and
10. description of pending litigation, action or proceeding.

In qualification method, the effective date of registration is determined by the Administrator. With the coordination and filing methods, the effective date of registration is the same as the federal registration effective date if the information has been on file with the state for 10 days, or 5 days, respectively but the qualification method only requires a specific response from the Administrator.

SEC RULE 147

This rule covers securities sold within the borders of a single state. Intrastate offerings are exempt from registration with the SEC, but must be registered with the State. Therefore, intrastate offerings would register using the qualification method.

EXEMPTIONS OF SECURITIES FROM STATE REGISTRATION REQUIREMENTS

Securities may be exempt from filing requirements if they are classified as exempt securities, or the type of transaction involved is exempt from registration. Exemptions save the issuer time and money. A security can be exempt under federal law but not state law, and vice versa. If the rules overlap, the most restrictive rule applies. When an exempt security or exempt transaction is claimed, the person requesting the exemption has the burden of proof.

EXEMPT SECURITIES

The Uniform Securities Act recognizes a limited number of securities that are exempt from all filing requirements and are called Security Exemptions:
1. US Government; States; by a political subdivision of a state;
2. a security issued by a foreign government with which the US maintains diplomatic relations or any of its
    political subdivisions;
3. a bank (domestic or international depository institution)
4. a security issued by an insurance company (endowment policies, fixed annuities)

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6. a federal covered security, and certain options, rights, warrants provided the security is senior or substantially
    equal to the listed security;
7. a security issued by a charitable, non-profit, fraternal and not for a pecuniary profit;
8. a security issued by a cooperative, cannot be offered or sold to the public, cannot be sold for pecuniary profit
    (commission);
9. an equipment trust certificate, if any security issued by the person would be exempt under this section or
    would be a federal covered security under this section.
10. a promissory note (commercial paper) or banker’s acceptance maturing in no more than 9 months, issued for
    at least $50,000, and rated in one of the 3 highest rating categories from national rating organization.

Exemptions under the USA are complicated for example, while solicitations of unregistered, nonexempt securities are prohibited, solicitations of unregistered, exempt securities are allowed, since they are exempt.

EXEMPT TRANSACTIONS

Transaction exemptions by The Uniform Securities Act. Certain methods of sale allow for legal trading of unregistered securities. Transaction exemptions include the following:
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1. An isolated non-issuer transaction

2. A non-issuer transaction by or through a broker-dealer, and a resale of a sponsored UIT (90 days in the public
    hands);

  a. the issuer is not in bankruptcy;
   b. the security is sold at a price reasonable in the current market value;
   c. the security is not part of an unsold allotment;
   d. a nationally recognized securities manual;
   e. the security is federal covered;

3. A non-issuer transaction in a foreign security approved for margin by the FRB;

4. A non-issuer transaction in a SEC reporting company;

5. A non-issuer transaction in a security that:

    a. has an investment grade rating;
    b. has a fixed maturity, or a fixed interest or dividend, if:
      I. no default this year or in the previous three years;
      II. has not been in bankruptcy in the last 12 months;


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6. A non-issuer transaction through a broker-dealer effecting an
      unsolicited order or offer to purchase;

7. A non-issuer transaction executed by a bona fide pledge without the purpose of evading this (Act);

8. A non-issuer transaction by a federal covered IA with investments under management more than $100,000,000
    acting in the exercise of discretionary authority;

9. A transaction in a security, if the terms and conditions have been approved by the administrator after a
    hearing;

10. A transaction between the issuer and an underwriter;

11. A transaction in a debt instrument secured by a mortgage or other security agreement if;

     a. sold as a unit;
     b. no general solicitation;
     c. no commission is paid;


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12. A transaction by an executor, administrator of an estate, sheriff, marshal, receiver, trustee in bankruptcy,
       guardian, or ;conservator;

13. A sale or offer to sell to:

      a. an institutional investor;
     b. a federal covered IA;
     c. any other person exempted by rule or order issued under this (Act);

14. A sale or an offer to sell securities of an issuer, if part of a single issue in which:

     a. not more than 25 purchasers are present in this State during and 12 month consecutive months, other than          those designated in paragraph (13);
      b. no general solicitation or general advertisement is made;
      c. no commission is paid directly or indirectly;
      d. purchase is made for investment purposes;

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15. Sales to existing security holders including holders of convertible securities, options, or warrants, and no commission other than a standby commission are paid;

16. An offer to sell but not a sale of a security not exempt from registration under the 1933 Act if:

      a. a registration statement has been filed
      b. no stop order has been given or known of;

17. An offer to sell, but not a sale, of a security exempt from registration under the 1933 Act if:
      a. a registration has been filed under this Act, but is not yet effective;
      b.a solicitation of interest is provided in a record;
      c. a stop is not in effect or known of;

18. A transaction involving the distribution of the securities involved about a merger, consolidation, exchange of
      securities, sale of assets, or other reorganization;

19. A recession offer, sale, or purchase;

20. An offer or sale to a person who is not a resident of this State and not present in this State.
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MODEL RULES FOR ETHICAL PRACTICES

The NASAA not only updates the Uniform Securities Act, but it also issues model rules (Statements of Policy) that govern the actions of securities professionals. Perceptively, engaging in forgery, embezzlement, non-disclosure, incomplete disclosure, and deceptive practices are prohibited and unethical. However, there are two model rules that are most significant.

The FIRST model rule that is most significant is the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers. This states that a person who is an investment adviser, an investment adviser representative, or a federal covered adviser is a fiduciary, has a duty to act primarily for the benefit of its clients, and shall not engage in the following unethical business practices:

• Recommend a purchase, sale, or exchange of any security to a client without reasonable grounds to believe that the recommendation is suitable for that client based on the information he provided. These unsuitable transactions are prohibited and unethical.
• Exercise discretionary power when placing an order for the purchase or sale of securities for a client without obtaining written discretionary authority from the client (within 10 business days after the date of the first transaction)
• Trade a client’s account (that is excessive in size or frequency because of its financial resources, investment objectives, and character) to directly benefit the adviser; in other words, forbids excessive number of transaction orders that an adviser can make for a client (also called churning)
• Place an order to purchase or sell a security for a client’s account without the authority to do so (in some cases, written third-party consent is required)
• Borrow money or securities from a client unless the client is a broker-dealer, an affiliate of the investment adviser, or a financial institution engaged in the business of loaning funds

• Loan money to a client unless the investment adviser is a financial institution engaged in the business of loaning funds or the client is an affiliate of the investment adviser
• Misrepresent (to a client) the qualifications of the investment adviser or any employee of the investment adviser
• Misrepresent (to a client) the nature of the advisory services being offered or fees to be charged. Another prohibited and unethical practice is the process of omitting material facts that are necessary regarding statements of qualifications, services, or fees
• Provide a report or recommendation to any advisory client prepared by someone other than the adviser without disclosing that fact (exception: when adviser uses published research reports or statistical analysis to give advice to the client)
• Charge a client an unreasonable advisory fee
• Fail to disclose information in writing before advice is rendered regarding compensation for advisory charges, advisory fees, and all conflicts of interest
• Guarantee a client a specific result by the advice given to him (i.e. a gain, no loss, etc.)
• Publish, circulate, or distribute any advertisement that does any of the following:

►Refers to testimonials concerning advice, analysis, report, or other services rendered
►States past specific recommendations that were (or would have been) profitable to a person, unless the advertisement includes a list of all past recommendations (even if they were not profitable) made during the immediately-preceding period of at least one year.
►Represents that a graph, chart, formula, etc. can be used to determine which securities to buy or sell and when to do so
►Represents that any report, analysis, etc. will be furnished entirely free, without any direct (or indirect) condition or obligation
►Contains untrue statement of material fact

The term advertisement includes any letter, notice, circular, or other written communication addressed to more than one person, OR any notice or other announcement in any electronic or paper publication by radio or television, OR by any medium that offers any one of the following:

• An analysis, report, or publication concerning securities
• An analysis, report, publication, graph, chart, formula, etc. used to determine when to buy or sell a security or which security to buy or sell
• Any other investment advisory service concerning securities
• Disclose the identity, affairs, or investments of a client unless required by law to do so (i.e. court ordered subpoena, IRS request) or unless consent is given by the client
• Take action (directly or indirectly) where the investment adviser has possession of securities, and does not comply with current requirements or subsequent amendments. It is also forbidden and unethical for custody to be prohibited or for the administrator to go un-notified
• Enter into, extend, or renew an investment contract, unless the contract is in writing and divulges the following services:

►Terms of the contract
►Advisory fee
►Formula for computing the fee
►Amount of prepaid fee to be returned in the event of contract termination or non-performance
►Whether the contract grants discretionary power to the adviser (and that no assignment of the contract will be made by the investment adviser without the consent of the other party to the contract)

►Fail to establish, maintain, and enforce written policies and procedures reasonably-designed to prevent the misuse of material, nonpublic information
►Enter into, extend, or renew any advisory contract(s) contrary to the provisions of Section 205 of the Investment Advisers Act of 1940
►Indicate (in an advisory contract) a condition, stipulation, or provision that binds a person to waive compliance with any provision of this act, the Investment Advisers Act of 1940, or any other practice contrary to the provisions of Section 215 of the Investment Advisers Act of 1940
►Engage in fraudulent, deceptive, or manipulative acts, practices, or business
►Engage in unlawful conduct (indirectly, through or by another person) that disrupts the provisions of this act

The SECOND model rule that is most significant is the NASAA Model Rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents. This rule states that each broker-dealer and agent shall observe high standards of commercial honor, and just and equitable principles of trade during the conduct of business. Acts and practices that oppose these standards may constitute grounds for denial, suspension, or revocation of registration (or any other action authorized by statute). Broker-Dealers are prohibited from the following acts and practices:

• Engaging in a pattern of unreasonable and unjustifiable delays in the delivery of securities purchased by customers or in the payment (upon request) of free credit balances reflecting completed transactions of its customers
• Failing to segregate the free securities of clients or the securities held in safekeeping
• Hypothecating (pledging securities as collateral for a loan in a margin account) a customer's securities without having a lien, unless the broker-dealer secures a properly-executed, written consent from the customer promptly after the initial transaction (except as permitted by Rules of the Securities and Exchange Commission)

• Charging unreasonable and inequitable fees for the following miscellaneous services performed:

►Collection of monies due for principal, dividends or interest
►Exchange or transfer of securities
►Appraisal, safekeeping, or custody of securities (and other services related to its securities business)

• Offering to buy a security from or sell a security to a person at a specified price (unless the broker-dealer is willing to buy or sell at that price, and under the conditions listed at the time of the initial offer). Backing Away is the failure of to fulfill the obligation to buy or sell the minimum quantity of a particular security.
• Representing that a security is being offered to a customer at market price OR a price relevant to market price, unless the broker-dealer knows (or has reasonable grounds to believe) that a market for the security exists other than that made, created or controlled by the broker-dealer (or by anyone with whom he working or associated). Making these false quotes are prohibited and unethical.
• Failing to disclose that the broker-dealer is controlled by, controlling, affiliated with, or under common control with the issuer of a security before entering into a contract with or for a client for the purchase or sale of a security. The existence of this control on a client must be disclosed to him in writing (written disclosure can also be sent) at or before the transaction is complete.
• Failing to make a bona fide public offering of all the securities allotted (to a broker-dealer) for distribution (whether acquired as an underwriter, a selling group member, or from a member participating in the distribution as an underwriter or selling group member)
• Failure or refusal to provide a customer (upon reasonable request) with information to which he is entitled, or failure to respond to a formal, written request or complaint

Agents of Broker-Dealers are prohibited from the following acts and practices:

• Engaging in the practice of lending or borrowing money or securities from a client, or acting as a custodian for money, securities or stock power of a client
• Carrying out securities transactions which are not recorded on the regular books or on the records of the broker-dealer the agent represents (unless the transactions are authorized in writing by the broker-dealer prior to execution of the transaction (“Selling Away")
• Establishing an account containing fictitious information in order to execute prohibited transactions
• Directly or indirectly sharing in profits or losses in the account of any client without his written consent (the broker-dealer the agent represents must also give consent)
• Dividing the agent's commissions, profits or compensations (of a purchase or sale of securities) with a person not registered with the same broker-dealer (or under direct or indirect common control)

Broker-Dealers AND Agents are prohibited from the following acts and practices:

• Trade a client’s account (that is excessive in size or frequency because of its financial resources, investment objectives, and character) to directly benefit the adviser; In other words, forbids excessive number of transaction orders that an adviser can make for a client (also called churning)
• Recommend a purchase, sale, or exchange of any security to a client without reasonable grounds to believe that the recommendation is suitable for that client based on the information he provided. These unsuitable transactions are prohibited and unethical.
• Executing a transaction on behalf of a customer without the authorization to do so
• Complete a transaction for a client’s account without first obtaining written authorization from him (unless time or price are the reasons for the transaction completion)
• Completing a transaction in a margin account without securing a written margin agreement from the client promptly after the initial transaction

• Starting a transaction with or for a client at a price not reasonably-related to a security’s current market price. Receiving an unreasonable commission or profit is also prohibited and unethical.
• Failing to provide an offering (no later than the due date of transaction confirmation) to a client who is purchasing securities. The offering must consist of a final prospectus OR a preliminary prospectus with an additional document (the combination of these must include all information that is in the final prospectus).
• Completing or inducing a security transaction by means of manipulative, deceptive, or fraudulent device/practice/plan/program/design/contrivance including (but not limited to) the following:

►Carrying out a security transaction that involves no change in the beneficial ownership
►Beginning a security transaction knowing that an order of the same (relative) size, amount, and price has been (or will be) started by another party in order to create a false or misleading appearance of active trading (provided that nothing in this subsection prohibits a broker-dealer from entering bona fide cross transactions for his clients)
►Completing a series of security transactions that create actual or apparent active trading. Raising or lowering the price of the security (in order to induce a purchase or sale) is also prohibited and unethical.

• Guaranteeing a client against any kind of loss
• Publishing or circulating (or causing to be published or circulated) any notice, circular, advertisement, newspaper article, investment service, or communication which intends to report any transaction as a purchase or sale of a security (unless the broker-dealer believes the transaction was bona fide) or which intends to quote the bid price for a security (unless the broker-dealer believes the quotation represents a bona fide bid)

• Using an advertising or sales presentation deceptively or misleadingly. Examples are as follows:

►The distribution of nonfactual data
►Material or presentation that is based on conjecture
►Unfounded or unrealistic claims or assertions in any brochure, flyer, or display by words, pictures, graphs
►Anything designed to supplement, reduce, supersede, or defeat the purpose or outcome of any prospectus or disclosure

FRAUD

The Uniform Securities Act (USA) prevents fraud (intentional deception made for personal gain or to damage another individual) in the securities industry. A fraudulent act is usually not something that is accidental or inadvertent, but must be intentional. An individual who commits fraud is subject to the suspension or revocation of his license. According to the Uniform Securities Act, it is unlawful for a person involved in the offer, sale, or purchase of a security to directly or indirectly do the following:

• Employ a device, scheme, or artifice to defraud
• Make untrue statements of material facts, or omit to state the necessary material facts
• Engage in acts, practices, or business that operates as fraud or to deceive another person

FALSE OR MISLEADING STATEMENTS

No person may make false or misleading statements in the sale or purchase of a security. Fraudulent or misleading statements can also be made through the circulation of advertisements, reports, or other communication that reports a transaction. Additionally, the following behaviors are prohibited:

• Claiming that a security has been approved by the SEC, state administrator, or other regulating authority (i.e. FINRA)
• Stating a security is about to be listed (without the knowledge that the statement is true)
• Promising to perform certain services without intending to do so
• Promising free services and then charging hidden fees
• Using inflated or promissory language
• Providing false information or inaccurate market quotations
• Falsely stating the amount of a commission or markup
• Overstating or misrepresenting the status of a client’s account
• Spreading rumors to produce transactions
• Misrepresenting dividends, or selling a security based on an impending dividend

OMITTING MATERIAL FACTS

When performing a securities transaction, an individual can also commit fraud by failing to disclose (or withholding) material facts (important facts vital to deciding whether or not to engage in a particular transaction).

ADMINISTRATIVE ACTIONS AND PENALTIES

If an agent, broker-dealer, investment adviser, or investment adviser representative deceives an investor by lying or leaving out important information, the administrator will suspend or revoke the individual’s license.

If there is criminal intent and the amount of money is high enough, the administrator can refer the violation to the Attorney General or district attorney (who, in turn, might file criminal charges possibly resulting in jail time and extensive fines). If the activity occurred in more than one state, the administrator can refer it to the U.S. Attorney’s Office. The accused cannot be imprisoned if he can prove that he had no knowledge of a particular rule or order, and if he did not reasonably know that his actions were a bad idea.


COMMUNCATION WITH CLIENTS

REQUIRED DISCLOSURES

When communicating with clients, the brokerage firm has the responsibility to make disclosures either orally or in writing (depending upon the situation). Then, the brokerage firm must confirm that these disclosures were received. When transacting securities, the NASAA requires the following:

• Disclosing that shares are not insured or guaranteed by the FDIC or other governmental agency, and the relevant differences regarding risk, guarantees, and fluctuation of principal & return are fair, complete, and not misleading
• Disclosing the relevant investment risks (i.e. investment rate, market, political, liquidity, and currency exchange)
• Disclosing (before a client agrees to buy or sell a security) that a broker-dealer is affiliated with (or controlled by) the issuer of the security (if such a relationship exists)

SECURITIES TRANSACTIONS ON BANK PREMISES

The NASAA has also issued a model rule that applies to broker-dealers who conduct business with clients on the premises of another financial institution.

When opening a client account on the premises of a bank, the brokerage firm is required to make the following disclosures:

• These products are not insured by the FDIC
• They are not bank deposits or obligations
• They are not guaranteed by the bank
• They are subject to investment risk (including the possibility of loss of principal)

The following rules apply to securities transactions made on bank premises:

• The setting of the broker-dealer’s activities should be in an area that is physically separated from where the bank accepts retail deposits. The broker-dealer is responsible for distinguishing its services from those of the bank.
• The broker-dealer and financial institution must have a written networking arrangement that defines the responsibilities of all parties involved, and the manner in which they will be compensated.
• All account statements must clearly indicate that the broker is providing these services and advertisements. The sales literature must also clearly indicate that services are being provided by a broker-dealer and must include all required product disclosure statements.
• If an agent is terminated, the broker-dealer must promptly inform the bank.

UNLAWFUL REPRESENTATIONS CONCERNING REGISTRATIONS

When a person submits an application to be registered as a securities professional (and a license is granted), it still does not mean that the adviser has been approved or certified by the administrator. When a license is issued, the administrator has made no value judgments about the adviser’s abilities compared to those of other advisers. The license merely demonstrates that proper registration procedure was followed. Therefore, it is unlawful for a securities professional to imply or state that the administrator has approved his ability as a securities professional, or that the administrator has approved a certain securities transaction. Other regulators, such as the SEC or FINRA, use the phrase “no regulator has passed upon this offer for securities or registered professional.”

MISUSING CERTIFICATIONS OR DESIGNATIONS

An adviser must also be careful when claiming special qualifications through certifications. There are specific NASAA model rules that provide guidelines for using certifications, especially when targeted towards elderly investors. These rules are as follows:

• It is unethical for an advisor to state that he has senior-specific training (certification in the advising or servicing of senior citizens or retirees) in order to mislead a person
• A person is prohibited from using a certification that he has not actually earned, is not a real certification, was self-conferred, or implies a level of education or training that the person does not have
• A certification may not be used if it was issued by an organization that is primarily engaged in the sales/marketing business or does not have reasonable standards for assuring that a certified individual is competent, monitored, disciplined for improper conduct, or required to fulfill continuing education requirements

PERFORMANCE GUARANTEES

An agent is prohibited from guaranteeing a minimum rate of return or a specific dollar profit on a client’s investment. He should use the word “guarantee” very carefully, since there is always a chance that a security’s principal could change or disappear completely. Under the Uniform Securities Act, the term “guaranteed” refers to a security for which payment of dividends, interest, and principal are all guaranteed.

There are some instances where an agent can make a guarantee (i.e. T-bonds/notes/bills are guaranteed interest and principal). However, the agent should also warn the client he might still lose money if he sells the security after interest rates have risen and market value has dropped. An agent can also make a guarantee with certain corporate bonds (the bond is guaranteed, but only as long as the parent company remains afloat). Guarantees only come from governments, insurance companies, and parent companies.

FAILING TO DELIVER A FINAL PROSPECTUS

Broker-dealers are responsible for making sure that every customer purchasing a registered, non-exempt security as new issue receives a copy of the final prospectus by the date the transaction is confirmed. This requirement is satisfied if the client is given a copy of the initial prospectus and a supplementary document containing any information that would be in the final prospectus.

FAILING TO FOLLOW A CLIENT’S INSTRUCTIONS

When a client gives a securities professional a clear instruction to buy, sell, transfer, or close an account, the securities professional is required to properly execute the client’s wishes in a timely manner. Unless there is something illegal, vague, or inconclusive regarding the client’s instructions, the adviser must do what the client asks.

PROVISIONS REGARDING PROSPECTIVE CLIENTS

USE OF PHONE

An agent may not call a prospective client before 8:00 a.m. or after 9:00 p.m. in the client’s time zone. However, an agent may contact an existing client in or outside of these hours (when servicing the client’s account). When soliciting a prospective client via phone, an agent must state his name, employer’s name, and employer’s address & phone number. All broker-dealers must maintain a “Do Not Call” list, which contains the names of anyone who has declared not to contact him again.

USE OF INTERNET

Securities professionals must follow certain requirements when disseminating information on products and services via the internet. Broker-dealers or investment advisers must first authorize the dissemination of information on products and services with the administrator. Then the administrator will issue an interpretive order concerning the internet communications. The administrator’s order does not apply equally to state-registered persons versus federal covered advisers.

While information on products and services may be disseminated to residents of the states where the firm or representative is unregistered, transactions via the internet are not allowed with residents of states where the firm or representative is unregistered.

CLIENT FUNDS AND SECURITIES

There are several regulations addressing the responsibilities of a securities professional when handling the funds of a client.

SUITABILITY

One of the main jobs of a securities representative is to make fitting recommendations to investors. These recommendations are based on the client’s profile (i.e. financial status, needs, objectives and risk tolerance). Therefore, an adviser should always try to obtain information regarding the client’s net worth, annual income, tax bracket, investment objectives, other investments, time window, and ability to assume risks. If the client fails to reveal all of the requested information, the adviser will make recommendations based on what is known (not assumed). An adviser may never recommend transactions that are more excessive than the client’s financial resources, or omit details relating to transactional risks.

UNAUTHORIZED TRANSACTIONS AND DISCRETIONARY AUTHORIZATION

An adviser may not issue a trade ticket without first receiving a client’s order to buy or sell the stock. Submitting a trade ticket for a securities transaction that was never ordered by the client is considered an unauthorized transaction and is prohibited. The client will always have the final word regarding investment decisions, unless he gives written, “discretionary authority” to his adviser in advance of the trade. Without being given proper trading authorization (“power of attorney”), an adviser is not permitted to complete transactions without his client’s prior knowledge. If an adviser does obtain discretionary authorization, he is allowed to invest the client’s money without consulting the client about the price, type, amount, time, and whether to buy or sell.

An adviser without discretionary authorization over a client’s account may only exercise judgment as to the time and price of the order. The client must give instructions regarding the type of security, the quantity, and whether or not to buy or sell. If these three things have already been provided by the client, the order may be accepted without written authorization.

COMMINGLING VERSUS CONVERSION OF CLIENT SECURITIES

When a client has a security registered in his name, it will either be sent directly to the client or be held for safekeeping by the adviser (who might charge a fee). Any client securities retained by the adviser must be kept separate from that adviser’s securities, in order to prevent any misuse of customer funds.

Commingling is prohibited and involves the merging of a client’s securities with those of the adviser. An adviser is allowed to keep his stock in the same vault as the client’s stock, as long as the securities are properly separated (for record and book-keeping purposes). As long as there are separate client ledgers and journals of securities transactions and movements, the record is considered to be “clear.”

Conversion (similar to commingling) is when an adviser illegally takes possession of a client’s assets for his own personal use (i.e. an adviser allows a client to write a check in the adviser’s name, and the check is later deposited into the adviser’s personal bank or trading account).

ADDITIONAL REGULATIONS CONCERNING CLIENT FUNDS

There are three vital rules of high relevance when handling the assets of clients. The first rule states that an adviser is prohibited from borrowing money or securities from a client, unless the client is a relative, pre-existing friend, or in the business of lending.

The second rule states that an adviser is prohibited from sharing in the profits or losses in a client’s account, unless the following situations are applicable:

• The sharing is approved by the customer
• The sharing is approved by the adviser’s broker-dealer
• The sharing of profits and losses is proportionate according to the funds invested by each party

The third rule states that an adviser is not allowed to unnecessarily delay the delivery of purchased securities, payment to a client for securities sold in his account, or the delivery of funds that a client has available in his account.


CHURNING involves the excessive trading of securities in a client’s account (usually for the purpose of generating commissions). An advisor who pressures a client into selling too frequently will reap the benefits of multiple commissions while putting his client’s money at risk. Even if these transactions turn a profit for the client, this is still illegal. Churning is based on the overall size of the account and the objective of the account.


PRUDENT INVESTOR STANDARDS

The Uniform Prudent Investor Act (UPIA) was developed in 1994 by the National Conference of Commissioners on Uniform State Laws. The act was based on the Prudent Investor Rule (a legal doctrine that provides guidance to investment managers about the standards for managing an investment portfolio in a legally satisfactory manner).

The Prudent Investor Rule involves the following six basic principles:

1. Sound diversification of assets is fundamental to risk management and is subsequently, a typical requirement of trustees. Diversification is reducing risk by investing in a variety of assets.
2. Analysis of the Risks: Risk and return are so directly related, that trustees have a duty to analyze and make conscious decisions concerning the levels of risk which are appropriate to the purposes and distribution requirements of the trusts they administer. Not all risk is inherently bad, but risk should only be deliberately undertaken when it is likely to contribute to desirable investment performance.
3. Loyalty: A trustee shall invest and manage the trust solely in the interest of the beneficiaries.
4. Impartiality: Trusts with two or more beneficiaries require the trustee to act fairly when investing and managing assets.
5. Costs: Trustees may only incur costs which are appropriate and reasonable in relation to the assets, purposes of the trust, and trustee’s skills.
6. Compliance: Compliance with the Prudent Investor Rule is determined based on facts and circumstances existing at the time of a trustee’s decision or action (not by hindsight).

In acting as a prudent investor would, trustees must consider how the following factors relate to the trust:

• General economic conditions
• Effect of inflation or deflation
• Tax consequences
• Role of each investment
• Expected total return
• Other beneficiary resources
• Need for liquidity, regularity of income, and the preservation & appreciation of capital

• Special value to purposes of the trust
• Verification of relevant facts
• Investing in any property (or other type of investment) consistent with UPIA regulations
• The trustee has the duty to use special skills and expertise

OTHER UNETHICAL BUSINESS PRACTICES

INSIDER TRADING

An agent with access to material, “non-public” information may not make recommendations based it until it is released to the public (no longer considered to be “insider” information). The person sharing the inside information and the person trading on it are both in violation of insider trading rules. Advisers in possession of insider info may only discuss it with a supervisor. The following characteristics describe insider information:

• Advisors cannot use the information to avoid a loss or make a gain, nor can they tip the information to another person
• Industry personnel who come into possession of this information must follow the firm’s written policies, and provide the information to the supervisor and compliance/legal department
• It is no longer to be considered “insider information” when it is made available to the public by the issuer

The civil penalties for insider trading are as follows:

• Penalty for the person who committed the violation: it shall not exceed three times (300%) the profit gained or loss avoided that resulted from the illegal purchase, sale, or communication
• Penalty for the person in control of the violator: it shall not exceed the greater of either $1,000,000 or three times the amount of the profit gained or loss avoided that resulted from the violation

SELLING AWAY

It is unethical for an adviser to execute securities transactions that are not recorded on the regular books of his employer. An adviser is a registered representative of a broker-dealer (who is responsible for supervising the adviser’s activities). “Selling away” or “Selling away from the firm” occurs when an adviser offers a security outside his broker-dealer employer’s knowledge and control. If an adviser wants to offer a security “outside of his employment,” he must do the following things to keep it from being a violation:

1. Submit the transaction to his broker-dealer
2. Broker-dealer must approve the transaction
3. Transaction must be recorded on the books of the broker-dealer

MARKET MANIPULATION

No person, including an adviser, may participate in any form of manipulation or any transaction that gives a misleading appearance of active trading in a security. There are three main types of market manipulations--painting the tape, front-running, and shadowing.

Painting the Tape is where multiple securities professionals manipulated the market by buying or selling a security repeatedly among themselves, in order to create artificial trading activity (resulting in a perceived high trading volume). This is also referred to as “matching trades.”

Front Running is when a brokerage firm executes orders on a security for its own account, while taking advantage of advance knowledge of pending orders from its customers. Front running involves buying or selling. Buying occurs when the broker-dealer buys for the firm’s account before filing customer orders that drive the price up.

Selling occurs when the broker-dealer sells for the firm’s account before filing customer sell orders that drive the price down. It is also an unethical for a broker-dealer to trade a security based on information from the analyst department before the clients have been given the information.

Shadowing occurs when a broker-dealer executes a trade for his own account after executing a substantial trade for a client (but before the client’s trade is reported).

FAILING TO NOTIFY A SUPERVISOR OF A WRITTEN CLIENT COMPLAINT

It is in direct violation of the Uniform Securities Act to ignore a written complaint from a client. Securities professionals are required to respond to all customer complaints. Securities professionals must also notify their supervisors upon receipt of the complaint, and maintain a file with a copy of all complaints.

SOLICITING ORDERS FOR UNREGISTERED, NON-EXEMPT SECURITIES

Soliciting the sale of unregistered, non-exempt securities is prohibited. The administrator uses the registration process to examine the financial statements of a company, the kind of securities that will be offered, and all disclosures that will be provided to investors. Therefore, when an adviser solicits a client, the adviser and his broker-dealer have the duty to make sure that the recommended security has been registered in compliance with the Uniform Securities Act.

WITHHOLDING SALES OF IPO SHARES

Regarding initial public offerings (IPOs), a broker-dealer must always make a genuine, bona fide public offering of all securities to which he was allocated as an underwriter or member of a selling group. He may not withhold a sale.

EXECUTING ORDERS AT UNFAIR PRICES

Broker-dealers are required to honor their quotes and execute transactions at contemporaneous prices (or at prices reasonably related to the CMV). No false price quoting that would lead to a higher commission or markup! Not honoring a quote is a violation called “backing away.”

CHARGING EXCESSIVE FEES

It is an unethical for a broker-dealer to charge a client unusually high or excessive fees for services. However, the broker-dealer is allowed to charge a client reasonable and non-discriminatory fees for services such as appraising, transferring, exchanging or maintaining custody of assets, collecting dividends, and collecting interest payments. Large commissions are permissible if they are justifiable, and if the client is informed prior to execution of the service provided.


MUTUAL FUND SALES & ETHICAL PRACTICE

Mutual funds are investment companies, and NASAA has issued a model rule that governs unethical practices in connection with investment company shares. When soliciting investment company shares, broker-dealers and agents are required to comply with three categories of regulations--- sales load communications, recommendations, and disclosures.

1. SALES LOAD COMMUNICATIONS

These requirements can be broken down into four requirements.

FIRST, broker dealers or agents soliciting investment company shares are required to inform their clients of all sales charges involved in the transactions.

These sales charges include the following:

• Asset-based charges (i.e. management fees and 12b-1 fees, which are the annual expense fees of a mutual fund)
• Contingent deferred sales charges or “back-end loads,” which are fees that mutual fund investors pay when selling Class-B fund shares within a specified number of years from the original purchase date).

SECOND, broker-dealers and agents are also required to inform clients of any available ways to reduce their sales charges. Failure to do so, results in a breakpoint selling violation.

THIRD, broker-dealers and agents are prohibited from stating that the shares are "no-load" shares and have no sales charges. In reality, the shares are sold with any of the following:

• Front-end load: a commission or sales charge applied at the time of the initial purchase of investment company shares that is deducted from the investment amount
• Contingent deferred sales load (“back-end load”)
• SEC rule 12b-1 fee that is greater than .25% of the fund’s average net assets per year

NOTE: No-load shares do exist and contain no front-end or back-end loads. They can charge 12b-1 fees up to .25% of the fund’s net assets. However, if the 12b-1 fee is more than .25% of the assets, the fund is no longer considered a “no-load” fund. If this is the case, broker-dealers and agents are prohibited from implying or stating that the fund contains no loads.

FOURTH, mutual funds may have as many as seven or more classes of shares for a particular fund. There are three main types of mutual fund classes that are most popular--A, B, and C. Each class contains different sales charges. Broker-dealers or agents are prohibited from recommending the purchase of a specific class without reasonable grounds that the particular sales charges are suitable (based on the customer's investment objectives, financial situation, other securities holdings, associated transaction, or other fees). Agents must not only make the required disclosures regarding sales charges, but must also be able to discern which class is most appropriate for a client’s needs (and then be able to explain the consequences of any sales charges to their clients).

2. RECOMMENDATIONS

In addition to the required communications regarding sales charges, broker-dealers and agents soliciting investment company shares must be careful not to make either of the following unsuitable recommendations to a customer:

• Must not recommend the purchase of shares in different mutual funds with similar investment objectives, when the broker-dealer or agent does not believe it is a suitable strategy. Clients who invest in different mutual funds have to pay higher sales charges without receiving any breakpoint discounts.
• Must not recommend the client to liquidate or redeem shares in one investment company in order to purchase shares in a different investment company with similar investment objectives (if not in the client’s best interest). Clients who redeem shares to purchase shares in another mutual fund will probably be required to pay a capital gains tax on any increases in value of the sold fund, and required to pay new sales charges for the purchased shares.

3. DISCLOSURES

The final requirements regarding mutual funds concern disclosures. Broker-dealers and agents are required to make disclosures to clients before making certain statements or implications.

First, an agent is prohibited from stating a fund’s current yield or income without disclosing the fund’s most recent average annual return (for 1, 5, and 10 years) and explaining the difference between current yield and total return.

For instance, an agent may not state that a bond fund’s yield is 10% without first explaining to the client that the yield would only factor-in the dividend payment, while the total return would include the dividend, capital gains distribution, and the rise or drop in net asset value. It is quite possible that while the fund’s yield is 10%, the total return could be negative for the year (i.e. if the interest rates were to rise).

Second, an agent is prohibited from stating that a fund’s investment performance is comparable to that of a savings account, CD, or other bank account without disclosing that the shares are not insured (or otherwise guaranteed by the FDIC or another governmental agency). An agent cannot compare a fund’s growth return of 5% to the current rates of CDs unless the agent makes sure the client understands the difference between the two. While bank CDs are fully insured by the FDIC up to $250,000, principal sums of stock investments are not guaranteed, and often decrease in value or vanish completely.

Third, an agent is also prohibited from stating the existence of insurance, credit quality, guarantees, or similar features regarding the fund’s portfolio without disclosing other relevant investment risks that may adversely affect investment performance (i.e. interest rate, market, political, liquidity, and currency exchange risks).

Fourth, an agent is prohibited from telling a client that the purchase of shares directly before an ex-dividend date is advantageous unless there are specific, clearly-described tax advantages to the customer. This provision refers to a prohibited practice called “selling dividends” (false/misleading statements). An agent who tries to convince a client to purchase investment company shares by promising payments from dividends is misleading the client as to the nature of dividends. When the fund pays a $1 dividend, the net asset value decreases $1 per share. Therefore, the client is better off not paying taxes on the dividend by waiting and buying the shares after they have been reduced $1.

Finally, an agent is prohibited from any of the following:

• Stating that the distribution of long-term capital gains by an investment company is part of the income yield from an investment in the shares
• Making projections of future performance (discussing a fund’s past performance is permissible)
• Making statements not warranted under the existing circumstances
• Making statements based on non-public information


ETHICAL REGULATIONS FOR INVESTMENT ADVISERS AND REGISTERED REPRESENTATIVES

CONFLICTS OF INTEREST

A fiduciary relationship exists between clients and investment advisers, requiring advisers to manage investments in the best interest of their clients. Investment advisers are not selling securities to clients, but rather investing the client’s money through the buying and selling of securities using client’s account. Investment advisers must choose between what is best for themselves and what is best for their clients (and hence, must deal with any conflicts of interest that might arise).

The following are situations that represent a conflict of interest:

• If an adviser or his employees also act as broker-dealers or securities agents
• If an adviser receives compensation for securities transactions
• If an advisor recommends 12b-1 fees or marketing fees to the client
• If an adviser receives compensation for soliciting or referring clients to another adviser or broker-dealer
• If an adviser receives wrap fees, hidden fees through service charges, or reimbursed expenses from other parties
• If an adviser performs agency cross transactions for his clients
• If an adviser executes a client trade on a principal basis
• If an adviser uses third-party research

A potential conflict of interest must be disclosed to the client before engaging in any transactions. If the conflict of interest is severe, the investment adviser must completely abstain from engaging in the action. While disclosure of potential conflicts of interest is usually enough to fulfill a fiduciary’s duty to a client, the fiduciary might also be required to refrain from the following unethical practices:

• Acting as issuer of securities
• Recommending unregistered securities
• Engaging in activities that defraud or deceive clients
• Charging unreasonable fees
• Failing to disclose fee discounts
• Using contracts that limit or avoid liability
• Borrowing from or lending money to clients
• Using testimonials in advertising

ADDITIONAL PROVISIONS FOR INVESTMENT ADVISORS & INVESTMENT ADVISORY REPRESENTATIVES (IARs)

CLIENT CONFIDENTIALITY

The only time an investment advisory firm may release client information is with client approval or if required by law. The SEC, FINRA, IRS and court of law may obtain client information without consent. Otherwise, all client information known by the investment advisory firm must be kept confidential. Confidential information includes information regarding a client’s identity, affairs, and investments.

INVESTMENT ADVISORY CONTRACTS

The Uniform Securities Act states that all investment advisory contracts must be in writing and disclose all material information and charged fees. It also states that the adviser cannot assign the contract to a third party. The following three statements must be included in all contracts:

1. The investment adviser will not be compensated on the basis of sharing capital gains or appreciation of client’s funds. However, this does not prevent a contract providing compensation (based on the total value of the fund averaged over a definite period as of a definite date). Performance-based compensation is allowed, but not on gains only.

2. The investment adviser can only assign the contract if the client consents.

3. With a partnership relationship, the investment adviser will notify the client of any change in membership of the partnership within the reasonable time frame of 60 days. A “majority” change in ownership is an assignment of the contract that requires consent from the client, in order for the contract to remain effective. If a majority owner hypothecates his ownership, this is considered “assignment.”

The first statement deals with compensation, and there are compensation provisions that address this part of the contract. The second statement means that if a client’s account is to be assigned to a new investment adviser (because the old investment adviser sold his business), consent must first be obtained by that client. In addition, according to the third statement, if the investment adviser firm is a partnership (and a partner holding a minority share is admitted, withdraws, or dies), the adviser is required to disclose this fact to the client within 60 days of the change in membership. However, if the partner’s share was more than 50%, “assignment” would occur and the client’s consent would need to be obtained via the signing of new contracts. These requirements might be exempt if the administrator views the exemption as being in the best interest of the public and the Uniform Securities Act.

COMPENSATION PROVISIONS

Investment advisers are allowed to charge an hourly rate for giving financial advice or a percentage of the assets when managing a client’s portfolio. Adviser compensation is based on the total value of a fund averaged over a definite period (dates), and the percentage always stays flat, ensuring that compensation grows in direct relation to the client’s assets. This creates an incentive for the adviser to invest the client’s funds wisely.

Fees charged by advisers must be reasonable in relation to fees charged by other advisers for similar services. Fees and services are subject to the administrator’s review to determine if fees are excessive in nature.

Investment advisers may not be compensated on the basis of a share of capital gains, appreciation, or any portion of the funds of the client. He may only charge fees based on the total value of the trust accumulated during a specified period of time.

However, there is one exception to the rule. An adviser is allowed to receive a share in capital gains and appreciation OR charge performance-based fees IF he is dealing with a high-level investor who understands the risks involved and has enough capital to shield himself from any losses. High-level investors include the following:

• Investment companies
• Hedge funds
• Individuals who have a net worth of $1.5 million or who have $750,000 of assets managed under the firm
• Directors, officers, or IARs working in investment operations
• Qualified purchasers (i.e. corporations with $25 million in net assets, family-owned corporations with $5 million, or individuals with $5 million).

FULCRUM FEE

A fulcrum fee is an additional, performance-based fee that advisers can charge clients, provided that the adviser achieves a return that exceeds a specified benchmark. In the event that the adviser does not meet the specified benchmark, the base fee must be reduced accordingly. Only the following clients may be charged a fulcrum fee:

• A registered investment company
• A client whose account value is greater than $1 million
• A client whose account value is greater than $750,000 with a net worth of $1.5 million or more

SOFT DOLLAR ARRANGEMENTS

Soft dollar arrangements occur when an adviser directs his commissions from client’s transactions to a particular broker-dealer in exchange for services that benefit the client.

The broker-dealer provides services that are designed to assist the adviser in making investment decisions for client accounts in areas such as the following:

• Traditional research reports and related publications
• Discussions with research analysts
• Software analyzing of portfolios
• Conference and seminar fees where company executives discuss the company’s performance, market and economic data services, and types of trading software

In return, the broker-dealer receives commissions that are higher than they would be for normal, execution-only trading relationships. Soft dollars (in contrast with hard dollars that have to be reported), do not have to be directly reported, and are incorporated into brokerage fees and paid expenses. The Securities Exchange Act of 1934 requires soft dollar arrangements to comply with the following three requirements:

1. Advisers must exercise discretion over accounts of others
2. Broker-dealers must provide services to the adviser that assist in making investment decisions for the accounts of clients
3. Advisers must determine that the service value is reasonable in relation to the compensation that the brokerage firm requires

Soft dollars may not be used to pay for the following:

• Advertising and marketing
• Travel expenses
• Meals and entertainment
• Overhead or administrative expenses

• Salaries of employees
• Accounting fees
• Professional licensing fees
• Computer terminals
• The correction of trading errors

CUSTODY AND DISCRETION

If an investment adviser possesses a client’s funds or securities, he is said to have custody of these funds and must give notification via an updated “Form ADV” to the administrator (who retains the power to approve or deny this custody). An adviser who has custody is said to have “full discretion” or “full discretionary authority” (authority to remove money and securities from the client’s account under a power of attorney or other arrangement). Generally, investment advisers try to avoid having custody of their client funds in order to avoid having to maintain high net capital requirements or submit audited balance sheets. Advisers also want to avoid the costs associated with having a CPA conduct an extensive, yearly audit of the their books and records.

An investment adviser can avoid having custody of his client’s assets by arranging for his client to open a securities account with a broker-dealer, and then obtaining written discretionary authority to manage that account. At this point, the adviser has “limited discretion” or “limited discretionary authority” (he only has the power to enter orders to buy and sell securities). The client must specify the asset or security, whether to buy or sell, and the amount. However, the adviser has the discretion to choose the time and price at which the transaction is made.

In general, an adviser may not buy or sell securities in a client account without written consent, except under one condition. Oral client-to-advisor authorization is permissible only for 10 business days after the oral discretion is granted. After the 10-day period, written authorization must be obtained.

If an adviser accidentally receives funds from client, he must record what was sent, when it was sent, and return what was sent within 3 business days in order to avoid custody. However, if the payment was made out to a third party, the adviser will not have custody as long as he forwards the check to that third party within 24 hours.

PRINCIPAL AND CROSS TRADES

A principal trade is one in which an adviser is acting as principal, and either buys securities from the client for his own inventory, or sells securities to the client from his own inventory. A cross trade is one in which an adviser acts as broker-dealer for both the client and another person who is buying from or selling to the client. When carrying out a cross trade, one side must be unsolicited. Conflicts of interest arise from both principal and cross trades. They are both permissible as long as the adviser discloses the capacity in which he is acting (prior to the transaction), and as long as he obtains written consent from each client. These requirements do not apply to broker-dealers who are not acting as investment advisers. Regular broker-dealers perform principal and cross trades as part of their daily business.

ADVERTISEMENTS

Under the Uniform Securities Act, all advertisements must be fair and accurate. Advertisements may not contain following:

• Testimonials of any kind
• Statements affirming that a report, analysis, or other service will be performed for free (if such is not the case)
• Untrue statements of material facts
• Statements that are false or misleading
• Representations of rumors, opinions, or other unfounded statements as factual statements

The Uniform Securities Act also requires the inclusion of past recommendations or stock picks in advertising or sales materials. A list of previous investment recommendations may be included in advertising and sales materials as long as the list includes all of the adviser’s recommendations during the relevant period (not just the favorable recommendations). The relevant period must cover at least 12 months.

Regarding the listing of recommendations, the following information must be included:

• The name of each security
• The dates the recommendations were made
• Whether the recommendation was to buy, sell, or hold a particular security
• The current market price of each security

The following disclosures must be made regarding advertisements:

• If hypothetical returns are used in an illustration, then the assumptions used must be disclosed.
• If an adviser uses research reports or recommendations produced by a third party, the adviser must declare that he is not the author of these materials (unless the adviser is using data prepared by others to formulate his own independent conclusions).