Legal Framework: Chapter Synthesis
This synthesis ties together all six Legal Framework units to help you navigate registration requirements, exemptions, and enforcement on the exam.
The Four Securities Professionals
| Professional | Role | Registers With | Compensation |
|---|---|---|---|
| Investment Adviser (IA) | Firm providing advice | SEC OR state (not both) | Fees (AUM-based, hourly, flat) |
| Investment Adviser Rep (IAR) | Individual representing IA | State only | Salary, fees |
| Broker-Dealer (BD) | Firm executing transactions | SEC AND state (both) | Commissions, markups |
| Agent | Individual representing BD/issuer | State only | Commissions |
Think of it this way: Investment advisers (IAs) and IARs are on the advice side. Broker-dealers (BDs) and agents are on the transaction side. After an IAR advises a client, an agent at a BD executes the trade.
Exam Tip: Gotchas
- IAs register with SEC OR state, never both. BDs register with both. This is the key distinction.
- IARs and agents register with state only. The individuals always register at the state level.
Registration Decision Tree
Step 1: Is This Person an IA/BD?
Investment Adviser (Three-Prong Test):
All three must be met:
- Gives advice on securities
- In the business of advising (regular activity)
- Receives compensation (direct or indirect)
Broker-Dealer:
- In the business of effecting securities transactions
- For others (broker) or own account (dealer)
Step 2: Are They Excluded from the Definition?
| IA Exclusions (L.A.T.E.) | BD Exclusions |
|---|---|
| Lawyers | Banks, savings institutions |
| Accountants | Issuers |
| Teachers | Agents (register separately) |
| Engineers | No place of business + institutional only |
Memory Aid: L.A.T.E. professionals are excluded from IA definition when advice is incidental to their profession and they receive no special compensation for it.
Step 3: Are They Exempt from Registration?
| IA Exemptions (State) | BD Exemptions |
|---|---|
| No place of business + institutional clients only | No place of business + institutional only |
| No place of business + 5 or fewer retail clients (de minimis) | Existing clients temporarily in state |
| Existing clients temporarily in state (snowbird) | NO de minimis for BDs |
Exam Tip: Gotchas
- De minimis = 5 or fewer, not 6. "No more than 6" or "6 or fewer" exceeds the limit.
- De minimis applies to IAs only. There is no de minimis exemption for BDs or agents.
- Federal IA exemption: Insurance companies, not banks. State law differs.
Step 4: Federal or State Registration?
For Investment Advisers (AUM-Based):
| AUM | Registration |
|---|---|
| Less than $25 million | State only (SEC prohibited) |
| $25M to $100M | State only (unless 15-state rule) |
| $100M to $110M | Eligible for SEC (optional) |
| $110M or more | SEC required |
| Below $90M (if SEC registered) | Must withdraw from SEC |
Memory Aid: The buffer zones: $100M = eligible, $110M = required, $90M = must leave.
Key Thresholds Reference
| Threshold | What It Means |
|---|---|
| 5 or fewer clients | De minimis exemption for out-of-state IAs |
| $25 million AUM | Below this = state registration only |
| $90 million AUM | Below this = must withdraw from SEC |
| $100 million AUM | Eligible for SEC registration |
| $110 million AUM | Required to register with SEC |
| 15 states | Optional SEC registration trigger |
| $500 prepayment (state) | Substantial prepayment threshold |
| $1,200 prepayment (federal) | Substantial prepayment threshold |
| 25% ownership | Control person under Advisers Act/USA |
| 10% ownership | Control person under Exchange Act 1934 |
| 30 days | State registration effective date |
| 45 days | SEC registration effective date |
Exclusions vs Exemptions
| Category | Excluded | Exempt |
|---|---|---|
| Definition | NOT an IA/BD at all | IS an IA/BD but no registration required |
| Antifraud rules | Still apply | Still apply |
| Example (IA) | Lawyer giving incidental advice | IA with no office + 5 or fewer clients |
| Example (BD) | Bank | BD with no office + institutional only |
Why does this matter? Excluded professionals never meet the definition, so they never register. Exempt professionals do meet the definition but qualify for an exception based on their client base or business model.
Key Forms Reference
| Form | Who Files | Purpose | Filed With |
|---|---|---|---|
| Form ADV Part 1 | Investment Advisers | Registration, business info | SEC or state |
| Form ADV Part 2A | Investment Advisers | Brochure (narrative disclosure) | Delivered to clients |
| Form ADV Part 2B | Investment Advisers | Brochure supplement (IAR info) | Delivered to clients |
| Form U4 | Agents, IARs | Individual registration | State (via CRD) |
| Form U5 | BDs, IAs | Terminate individual registration | State (via CRD) |
| Form BD | Broker-Dealers | BD registration | SEC and state |
| Form ADV-W | Investment Advisers | Withdraw registration | SEC or state |
Exam Tip: Gotchas
- Form ADV Part 2 = Brochure. Must be delivered to clients initially and annually.
- Form U4 is for individuals (agents, IARs). Form BD is for the firm.
- ADV-W withdrawal: State = 30 days jurisdiction. SEC = 60 days jurisdiction.
Penalties and Enforcement
Criminal Penalties (1956 USA Baseline)
- Maximum fine: $5,000 per violation
- Maximum imprisonment: 3 years per violation
- Statute of limitations: 5 years from the date of the violation
Memory Aid: State penalties = 5-5-3 ($5,000 fine, 5 years to prosecute, 3 years prison). All numbers are 5 or under.
Civil Liability
- Rescission offer: Seller offers purchase price + legal interest minus income received; buyer has 30 days to respond (silence = seller released)
- Statute of limitations: 3 years from the transaction OR 2 years from discovery, whichever is earlier
- Joint and several liability: Any controlling person, officer, director, or materially aiding party can be held for the full amount
Administrator Powers
| CAN Do | cannot Do |
|---|---|
| Issue cease and desist orders | Issue injunctions (court only) |
| Deny, suspend, revoke registrations | Impose criminal penalties (court only) |
| Investigate violations | Approve or pass on securities merit |
| Subpoena witnesses and documents | Make arrests |
| Assess administrative penalties | Sentence violators |
Think of it this way: The administrator has investigative and administrative power, but only courts can impose criminal penalties or issue binding legal orders like injunctions.
Exam Tip: Gotchas
- Administrator cannot issue injunctions. Only courts can do that.
- Administrator does not "approve" securities. Registration does not mean approval.
- Cease and desist ≠ injunction. C&D is administrative; injunction is judicial.
Registration Actions
| Action | Meaning | Requires Hearing? |
|---|---|---|
| Denial | Refuse initial registration | Prior hearing required |
| Suspension | Temporarily halt registration | Prior hearing required |
| Revocation | Permanently terminate registration | Prior hearing required |
| Cancellation | Nonpunitive termination (death, missing, etc.) | No hearing required |
| Withdrawal | Voluntary termination by registrant | No hearing required |
Exam Tip: Gotchas
- Cancellation is nonpunitive. Used when registrant dies, becomes incompetent, or cannot be located.
- Denial, suspension, revocation require prior hearing. Due process protection.
- Summary actions (without prior hearing): The administrator can postpone or suspend registrations and deny or revoke exemptions. A hearing must be granted within 15 days of a written request.
Exam Question Framework
When you see a legal framework question, ask:
- Who is this person? (IA, IAR, BD, agent, issuer)
- Are they excluded from the definition? (L.A.T.E., banks, etc.)
- If not excluded, are they exempt from registration? (de minimis, institutional only, etc.)
- If registration required, with whom? (SEC vs state, AUM thresholds)
- What form do they file? (ADV, U4, BD)
- What are the consequences of violation? (criminal vs civil, state vs federal)