Securities
This section covers the definition of a security under the Uniform Securities Act (USA), what is and is not a security, state registration methods, federal covered securities under the Securities Act of 1933 (SA 1933), exempt securities, exempt transactions, Regulation D private placements, and Regulation A. References to the Securities and Exchange Commission (SEC) and the Securities Exchange Act of 1934 (SEA) appear throughout.
Memory Aid: SCAM (Securities Exchange Act of 1934)
The '34 Act protects investors from scams by establishing:
- S - SEC creation (§4) + Federal Reserve Board (FRB) margin authority + Reg T
- C - Credit regulation (margin rules)
- A - Antifraud (§10(b), Rule 10b-5)
- M - Anti-Manipulation (§9 - wash trades, matched orders, painting the tape)
Distinct from the Securities Act of 1933, which governs new-issue registration, disclosure, and prospectus delivery. SCAM applies to the '34 Act only.
Definition of a Security
Statutory Definition (USA Section 401(m))
A security includes any of the following:
- Note, stock, treasury stock, bond, debenture
- Evidence of indebtedness
- Certificate of interest or participation in any profit-sharing agreement
- Collateral-trust certificate
- Preorganization certificate or subscription
- Transferable share
- Investment contract
- Voting-trust certificate
- Certificate of deposit for a security
- Certificate of interest or participation in an oil/gas/mining title or lease
- Any interest or instrument commonly known as a "security"
- Any warrant or right to subscribe to or purchase any of the foregoing
The Howey Test (Investment Contract)
An investment contract exists when there is:
- An investment of money
- In a common enterprise
- With the expectation of profits
- Derived solely from the efforts of others
The Howey Test is used to determine whether unusual instruments (e.g., orange groves, cryptocurrency offerings) qualify as securities.
What is NOT a Security
- Fixed annuities - insurance or endowment policy under which an insurance company promises to pay a fixed sum of money (insurance product, not a security)
- Variable annuities ARE securities - payments depend on the investment results of a segregated fund
Exam Tip: Gotchas
- Fixed annuities and whole life insurance are NOT securities because the insurance company guarantees a fixed payment. Variable annuities and variable life insurance ARE securities because returns depend on the performance of a separate account invested in securities.
- A certificate of deposit (CD) at a bank is NOT a security. But a "certificate of deposit for a security" IS a security. The exam tests this distinction.
State Registration of Securities (USA Sections 301-305)
Registration Requirement
It is unlawful to offer or sell any security in a state unless:
- It is registered under the USA, OR
- The security or transaction is exempt under Section 402, OR
- It is a federal covered security
A registration statement may be filed by the issuer, any other person on whose behalf the offering is to be made, or a registered broker-dealer.
Three Methods of State Registration
| Feature | Registration by Filing (Section 302) | Registration by Coordination (Section 303) | Registration by Qualification (Section 304) |
|---|---|---|---|
| Also called | Registration by notification | Coordination with SEC | Qualification with state only |
| Prerequisite | Federal registration statement filed under SA 1933; issuer meets strict eligibility criteria | Federal registration statement filed under SA 1933 in connection with the same offering | None - any security may use this method |
| Who uses it | Seasoned issuers meeting financial thresholds; open-end investment companies/unit investment trusts (UITs) | Most common method for initial public offerings (IPOs) and public offerings simultaneously registered with the SEC | Intrastate offerings (single state); issuers not filing with the SEC |
| Effective date | Automatically effective when federal registration becomes effective, if state filing on file for at least 5 business days and fee paid | Automatically effective when federal registration becomes effective, if state filing on file for at least 10 days and pricing info on file for 2 full business days | Effective only when the Administrator so orders (Administrator sets the date) |
| SEC involvement | Yes - requires federal registration statement | Yes - requires federal registration statement | No - entirely state-level; SEC has no jurisdiction |
| Key requirements | Issuer in business at least 36 months; class of equity registered under SEA Section 12 held by 500+ persons; net worth of $4M (or $2M with earnings); minimum share price $5 | 3 copies of latest prospectus; undertaking to forward all future amendments; pricing information | Most extensive disclosure: officer/director info, capitalization, use of proceeds, financial statements, legal opinion, specimen of security |
Registration Duration
Registration is effective for 1 year from its effective date (not the filing date).
Stop Orders
The Administrator may issue stop orders to suspend or revoke the effectiveness of a registration statement.
Exam Tip: Gotchas
- Registration by coordination becomes effective at the moment the SEC registration becomes effective, but ONLY if all state conditions are met. If conditions are not yet met, state registration becomes effective as soon as all conditions are satisfied.
- Registration by qualification is the ONLY method that does not require a concurrent federal registration. The effective date is entirely at the Administrator's discretion.
- All three methods are effective for ONE YEAR. The exam may try to distinguish this from broker-dealer (BD) or investment adviser (IA) registrations (which expire on December 31).
Exemptions and Exclusions from Registration
Critical Distinction
- Exclusion - the item does not meet the definition of a security (it was never subject to registration)
- Exemption - the item IS a security but has been released from registration requirements
- The burden of proving an exemption is on the person claiming it (USA Section 402(d))
Federal Covered Securities (SA Section 18, National Securities Markets Improvement Act (NSMIA) 1996)
A federal covered security is a security that is a "covered security" under Section 18(b) of the Securities Act of 1933. Federal covered securities are exempt from state registration - states cannot require registration, qualification, or merit review.
Notice Filing
States may require a notice filing consisting of:
- Documents filed with the SEC as part of the federal registration statement
- Consent to service of process
- A filing fee
The Administrator retains antifraud authority over federal covered securities.
Categories of Federal Covered Securities (SA Section 18(b))
| Category | Section | Examples |
|---|---|---|
| Exchange-listed securities | 18(b)(1) | Securities listed on NYSE, NASDAQ, AMEX, or other national exchange with substantially similar listing standards |
| Investment company securities | 18(b)(2) | Securities of registered investment companies (mutual funds, UITs, face-amount certificate companies) |
| Securities sold to qualified purchasers | 18(b)(3) | Securities offered/sold to "qualified purchasers" as defined by SEC rule |
| Section 3(a)(2) securities | 18(b)(4)(C) | Bank securities, government securities |
| Regulation D offerings | 18(b)(4)(D) | Securities offered under SEC Rule 506 (Rule 504 and Regulation A offerings are NOT federal covered) |
Exam Tip: Gotchas
- Rule 506 offerings under Regulation D ARE federal covered securities (states cannot require registration). But Rule 504 offerings are NOT federal covered - states can require full registration.
- States cannot block or deny the sale of a federal covered security through registration requirements, but they CAN investigate and take enforcement action for fraud. The Administrator's antifraud authority is never preempted.
- Notice filing is NOT the same as registration. The state cannot impose merit review or additional disclosure requirements beyond what is filed with the SEC.
Exempt Securities (USA Section 402(a))
Exempt securities are exempt based on what the security IS (identity of the issuer), not how it is sold. They are exempt from registration requirements but NOT exempt from antifraud provisions.
| Category | Examples |
|---|---|
| Government securities (402(a)(1)) | U.S. government, state, political subdivision, or any agency/instrumentality thereof; includes revenue obligations |
| Canadian/foreign government (402(a)(2)) | Canada, Canadian provinces, foreign governments with U.S. diplomatic relations |
| Bank securities (402(a)(3)) | Securities issued by banks organized under federal or state law |
| Savings institution securities (402(a)(4)) | Federal savings and loan associations, state-organized building and loan associations |
| Insurance company securities (402(a)(5)) | Securities of insurance companies organized under state law (does NOT include variable annuities) |
| Federal credit union securities (402(a)(6)) | Federal credit unions, state-organized credit unions, industrial loan associations |
| Regulated utilities/carriers (402(a)(7)) | Railroads, common carriers, public utilities, holding companies subject to Interstate Commerce Commission (ICC) or state rate regulation |
| Exchange-listed securities (402(a)(8)) | Securities listed on NYSE, AMEX, Midwest Stock Exchange; includes senior or equal-rank securities of the same issuer |
| Nonprofit securities (402(a)(9)) | Securities of organizations operated exclusively for religious, educational, benevolent, charitable, fraternal, social, athletic, or reformatory purposes; chambers of commerce; trade/professional associations |
| Short-term commercial paper (402(a)(10)) | Promissory notes/drafts with maturity of 9 months or less, denominations of at least $50,000, rated in top 3 categories |
| Employee benefit plan securities (402(a)(11)) | Investment contracts in connection with employee stock purchase, savings, pension, profit-sharing plans (requires 30-day advance written notice to Administrator) |
Exam Tip: Gotchas
- Exempt securities are exempt from REGISTRATION only. The Administrator retains full antifraud authority over ALL securities, including exempt ones. Fraud is never exempt.
- Exchange-listed securities are exempt at the state level under 402(a)(8). After NSMIA (1996), most are also "federal covered securities" under SA Section 18(b). The exam may test either concept.
- Insurance company securities are exempt, but variable annuities are NOT - because their payments depend on investment performance of a segregated account.
Exempt Transactions (USA Section 402(b))
Exempt transactions are exempt based on how the security is sold (the nature of the transaction), not what it is. The same security can be exempt in one transaction and require registration in another.
| Transaction | Key Requirements |
|---|---|
| Isolated non-issuer transaction (402(b)(1)) | Any isolated non-issuer transaction, whether through a broker-dealer or not; must be truly "isolated" (infrequent, not part of a pattern) |
| Non-issuer transaction by registered agent (402(b)(2)) | Security outstanding 90+ days; issuer actually in business (not shell/blank check); sold at current market price; audited financials available; listed on exchange or issuer in business 3+ years or $2M+ assets |
| Unsolicited brokerage transaction (402(b)(3)) | Non-issuer transaction through a registered broker-dealer (BD) pursuant to an unsolicited order; Administrator may require written acknowledgment from customer |
| Underwriter transactions (402(b)(4)) | Transactions between issuer and underwriter, or among underwriters |
| Mortgage/deed of trust bonds (402(b)(5)) | Bond secured by real or chattel mortgage if entire mortgage and all bonds sold as a unit |
| Fiduciary transactions (402(b)(6)) | Transactions by executor, administrator, sheriff, marshal, receiver, trustee in bankruptcy, guardian, or conservator |
| Bona fide pledges (402(b)(7)) | Pledge transactions without intent to evade the act |
| Institutional buyer transactions (402(b)(8)) | Sales to banks, savings institutions, trust companies, insurance companies, investment companies, pension/profit-sharing trusts, other institutional buyers, or broker-dealers |
| Limited offering exemption (402(b)(9)) | Offers to no more than 10 persons (excluding institutional buyers) in a state during any 12 consecutive months; buyers must be purchasing for investment; no commission paid for soliciting |
| Preorganization certificates (402(b)(10)) | No more than 10 subscribers; no commissions paid; no payment made by subscribers |
| Existing security holder transactions (402(b)(11)) | Offers to existing security holders (e.g., rights offerings, stock dividends); no commissions paid (other than standby commission), OR issuer files notice and Administrator does not disallow within 5 business days |
| Simultaneous registration offers (402(b)(12)) | Offers (not sales) while registration pending under both USA and SA 1933; no stop order in effect |
Exam Tip: Gotchas
- The limited offering exemption (402(b)(9)) counts OFFEREES, not purchasers - offers to no more than 10 persons. Institutional buyers are excluded from the count. The Administrator can increase or decrease this number.
- Unsolicited orders are exempt, but if the broker-dealer recommended the trade (solicited), that is NOT exempt under 402(b)(3).
- Preorganization certificates (402(b)(10)) require that NO PAYMENT is made. If any subscriber pays money, the exemption is lost.
Regulation D (SEC Rules 504 and 506)
| Feature | Rule 504 | Rule 506(b) | Rule 506(c) |
|---|---|---|---|
| Maximum offering | $10 million in 12 months | Unlimited | Unlimited |
| Accredited investors | No limit | No limit | No limit (must verify accredited status) |
| Non-accredited investors | No limit | Up to 35 sophisticated investors | None allowed |
| General solicitation | Permitted if sold only in states with registration/exemption | Not permitted | Permitted |
| Federal covered security? | No - subject to state registration | Yes | Yes |
| Resale restrictions | Restricted unless state-registered | Restricted (Rule 144) | Restricted (Rule 144) |
| SEC filing | Form D | Form D | Form D |
Exam Tip: Gotchas
- Rule 506 offerings ARE federal covered (states cannot require registration). Rule 504 offerings are NOT federal covered - states can require full registration.
- Rule 506(b): no advertising, up to 35 non-accredited purchasers, federal covered.
- Rule 506(c): advertising OK, ZERO non-accredited, must verify accredited status, federal covered.
Regulation A (Mini-Registration)
Regulation A is sometimes called a "mini-registration" or "mini-IPO" because it requires an offering circular (Form 1-A) filed with the SEC. It is NOT technically an exemption from SEC registration; it is a conditional exemption with its own filing requirements.
| Feature | Tier 1 | Tier 2 |
|---|---|---|
| Maximum offering | $20 million in 12 months | $75 million in 12 months |
| Investor limits | None | Non-accredited limited to 10% of annual income or net worth |
| State registration | Subject to state registration (not federal covered) | Preempts state registration (federal covered) |
| Financial statements | Not required to be audited | Must be audited |
| Ongoing reporting | None | Semiannual reports required |
| SEC filing | Form 1-A (offering circular) | Form 1-A (offering circular) |
Exam Tip: Gotchas
- Regulation A Tier 2 offerings preempt state registration, but Tier 1 offerings do NOT. This mirrors the Rule 504 vs. 506 distinction: smaller offerings remain subject to state law.