The Uniform Securities Act of 2002

[*Disclaimer: I worked on the drafting of the Uniform Securities Act of 2002 both as Executive Director of the North American Securities Administrators Association and as counsel to the Association. Even so, for purposes of this article, the opinions, facts and impressions are solely my own, and even I may disavow them if any get me in trouble.]

Most practitioners of "blue sky" law either remember or have heard graying others relate the sorry tale that was the Revised Uniform Securities Act of 1985 (RUSA). Back then, I was a state securities regulator from Colorado, and became involved in the RUSA drafting process near its conclusion. In drafting the Colorado Securities Act of 1990, we borrowed RUSA's much-improved format (over the Uniform Securities Act of 1956—USA) and a provision here and there. Several states "cherry-picked" from RUSA, and a few other states actually adopted it with some modifications. Generally speaking, however, RUSA was doomed to failure and now sits right up there on the shelf with the Federal Securities Code.

The securities world changed in 1996 with the adoption of the National Securities Markets Improvement Act (NSMIA). NSMIA imposed many sea changes in the fabric of state securities regulation, many of which, ironically, were foreseen in RUSA. State securities registration regulation was preempted for securities listed for trading on a recognized exchange, traded on the NASDAQ National Market System or issued by registered investment companies, and most securities and many transactions exempt under the Securities Act of 1933. The states' regulation of broker-dealers and agents was left relatively unscathed, except that the states had to live with the books and records requirements imposed by the Securities and Exchange Commission (SEC). The regulation of investment advisers was revolutionized, with the larger advisory firms (>$25 million under management) left exclusively to the SEC, most smaller firms (<$25 million under management) left exclusively to the states where they have a place of business, and regulation of the people who work for either of them left to only those states where they maintain a place of business.

The states and the North American Securities Administrators Association (NASAA) had been adopting (unofficial) amendments to the USA for years, without the aegis of, objection, or any reaction from the National Conference of Commissioners on Uniform State Laws (NCCUSL), the outfit whose mission it is to promulgate uniform state laws. NCCUSL is generally unaccustomed to dealing in laws that are administered on an ongoing basis by state regulators, and even less so an act that is part of a complex regulatory environment with numerous federal statutes, self-regulatory organizations and a host of different regulators. In response to NSMIA, the states and NASAA reacted with remarkable speed, and within the next two years or so, most states had revised their laws, rules and regulations to conform to the new regulatory regime.

Those who championed NSMIA in 1996 were not done yet. By 1999, then Senator Phil Gramm, chairman of the Senate Banking Committee, was working on the Securities Markets Enhancement Act (SMEA), holding discussions with various interested groups to gather ideas for what was to amount to NSMIA II. Many suggestions were forthcoming. By this time, I was the executive director of NASAA in Washington, D.C., and in this new capacity, I was forced to grapple with responses to each of them. In the face of SMEA and other legislative trial balloons, and in the midst of one of the most exuberant securities market run-ups in decades, NCCUSL announced it was launching an effort to draft a new Uniform Securities Act.

At first, there was much skepticism among those who were to participate in the drafting process. Several of the NCCUSL Commissioners involved in the RUSA drafting process returned to serve as members of the new Act drafting committee, as did several veterans from the states and the American Bar Association (ABA). Despite their many scars from past battles, fortunately, there was a new camaraderie, born of the familiarity of working together on numerous issues over the intervening years as well as a significantly altered regulatory landscape. Unlike the RUSA experience, which dealt mostly with securities registration, investment company and investment adviser issues, brokerage regulation would be very much in play in the new USA (NUSA), and the industry was well represented by the Securities Industry Association (SIA). Many other interested groups participated during the deliberations of the group as well. There can be no question that the reporter for the drafting effort, Joel Seligman, Dean of the Washington University School of Law in St. Louis, was a driving and crucial force in the process as was the persistent leadership, patience, acumen and judgment of Richard Smith, who chaired the committee's efforts, and Justin Vigdor, as vice chair.

After four years of meetings and conference calls, and more paper than anyone would care to admit, NUSA was adopted by NCCUSL in Tucson, Arizona, in August of 2002. Subsequently, it has been endorsed or blessed in one way or another by NASAA, the ABA, the SIA, the New York Stock Exchange, the NASD, the Investment Company Institute (ICI) and the Investment Counsel Association of America (ICAA). It has already been introduced as legislation in several states and adopted, for the most part intact, in Missouri and Oklahoma as of the date of this article.

For the private practitioner, the immediate question is "What's it mean to me?" Having participated in every session of the drafting committee and many sidebar and preparatory meetings, both as a state regulator and a private practitioner, I'll attempt to address the key points in NUSA to watch out for, and how it is being received at the state level.

Given that NUSA was only adopted by NCCUSL in August of 2002, efforts to seek its introduction in and enactment by state legislatures were not slated to commence until the fall of 2003. Nonetheless, even without formal NCCUSL prodding, NUSA was introduced and considered in Michigan, Missouri, Kansas, and Oklahoma, and enacted in Missouri and Oklahoma. Particular provisions of NUSA came into play in other legislation in North Dakota and Virginia. Groups in many other states around the country have been established to review NUSA in the context of their own jurisdictions. It is likely that NCCUSL will act at its next full meeting to give NUSA priority status as a "targeted act" so that all the efforts the organization can bring to bear to seek introduction and enactment of one of its products will be instituted commencing in the fall of 2003.

In addressing what's new in NUSA, it must be stressed that the new version is more a commemoration of what has already occurred in most securities state laws by natural evolution. NUSA represents an attempt to make all those separate efforts uniform and to iron out the wrinkles that may remain. I think practitioners will find that NUSA is a much more professional, sophisticated, intricate and precise state securities law than any in its wake. Much more has been set forth in black and white rather than be left to local rules or mere practice and lore. Surely, much has been left to the state administrator's rule making authority, but not often where a matter of national uniformity of process is at stake.

The securities registration provisions are little changed from the USA. NSMIA did most of the job on its own. The exemptions are greatly enhanced and enriched. In drafting the broker-dealer and investment adviser provisions, few stones accumulated over 50 years were left unturned. Practitioners and regulators both will find many previously unanswered questions addressed and answered. The core provisions regarding private civil liability were left alone, in compromise of otherwise irreconcilable positions. The changes to the federal statutes of limitation and repose in Sarbanes-Oxley in late July 2002 to two and five years were then reflected in NUSA in August. Had they not been changed, it is my belief that many states would have raised them from the Lampf-directed one and three in any event. Enforcement powers and processes are also set forth much more precisely than before. In sum, this is an act with great depth, warranting careful study. (It should also be noted that in the months since promulgation, several minor errata have been noted and it is my understanding they will be corrected in an upcoming version. This is a living, breathing process.)

In the legislative experience to date, the inflammatory issues have proven to be (i) the question of banks as broker-dealers [NUSA section 102(4)(C)], (ii) the treatment of variable annuities as securities [NUSA section 102(28)(B), (iii) the transactional securities registration exemption for offers and sales of securities from State A (where neither registered nor exempt) exclusively to investors in other states where the offer and sale is lawful (the so-called "Goldmen issue") [NUSA section 202(20)], (iv) the increased scope of the private offering exemption [NUSA section 202(14)], and (5) a provision that allows state administrators to adopt rules empowering them to grant requests for expungement of certain agent records from the Central Registration Depository (CRD) [NUSA section 607(6)].

The Gramm Leach Bliley Act of 1999 (GLBA) changed the way banks conduct securities and insurance business. Under the Securities Exchange Act of 1934 (’34 Act) and most state securities laws, banks were excluded from the definition of "broker," "dealer" and "broker-dealer." Under the GLBA, the '34 Act definition was pared back. If banks engaged in the business of effecting transactions in securities, they were now brokers and dealers, unless their activities were among a laundry list of specified forms and types of business. Among them was (i) the underwriting of direct participation programs (DPPs) and (ii) effecting no more than 500 securities transactions in a year.

In NUSA, a similar approach was taken to that of the GLBA. Banks are no longer given a blanket exclusion from broker-dealer registration. By operation of NUSA sections 102(4)(C) and 401, if a bank engages in the business of effecting transactions in securities for its own account or the accounts of others, the bank is a broker-dealer—but, not if it restricts that business to any of the exempt businesses noted in the GLBA and listed in the '34 Act—except the federal exemptions for underwriting DPPs and the 500 transaction de minimus exemption. The DPP underwriting exemption was rejected by NCCUSL given the bad experiences of the states in protecting their citizens with regard to private placements. The de minimus exemption was modified, restricted to unsolicited transactions.

These issues were debated long and hard during the NCCUSL deliberations, and the result was a resounding endorsement of the modifications to the GLBA model at both the Committee and full NCCUSL levels. Even so, the American Bankers Association has been unrelenting in its efforts since to reverse the departures from federal law with, in my view, much bluster and little justification or substantive argument. Missouri’s version of NUSA was adopted with the NCCUSL model included. Many months ago, Virginia adopted what would become the NUSA model definition. Earlier this year, the North Dakota securities administrator succeeded in resisting efforts by some bankers to convince legislators to repeal the existing, more restrictive law in favor of the GLBA model. The same issue came up in Rhode Island. The latest version I have of the Oklahoma bill included the NCCUSL model. In sum, although the subject of debate wherever the question is raised, it would appear that the NCCUSL version has had the better of it to date.

Variable annuities constitute for me one of the true oddities of securities law. Generally, it has been my experience that federal law tends to be more conservative and less inclusive than state securities law. It is odd therefore to find an investment treated as a security under federal law but not state law, but that is the manner in which variable annuities are treated, at least in many states, for reasons more political than regulatory.

In any event, given their favorable treatment under tax laws and high agent payout, variable annuities became the favored product for many securities agents in the 1990s, too often without appropriate disclosure or suitable determinations. As complaints mounted, state securities regulators grew frustrated. They could not pursue securities actions against the abusing agents, and it was their perception that their insurance counterparts did not have the authority or expertise to do so.

The fix proposed by NASAA was to alter the USA securities definitional exclusion for insurance policies; to define variable annuities as securities for state law purposes. There was never any question that the variable annuity policies themselves were to be exempt from state securities registration requirements [NUSA section 201(4)]. In fact, state securities registration authority over variable annuities is preempted under NSMIA as they are "covered securities." The goal of the NASAA proposal was to gain regulatory sales practice authority over the broker-dealers and agents selling them.

This amendment was also debated at great length during the Committee and the full NCCUSL deliberations. The American Council of Life Underwriters (the "ACLI") launched an all-fronts war against the change with thermonuclear fervor. [Commentary—contrary to two bits of lame ACLI propaganda, the motivation for NASAA’s proposal was neither a backdoor attempt at substantive regulation of the products nor a grab for more registration revenue. In making the proposal, NASAA and its membership sought to join forces with the NASD and SEC in pursuing a mounting wave of investor abuse, and nothing more. There. Now I feel better.]

The ACLI succeeded at the NCCUSL conference in Tucson in having the treatment of variable annuities changed from one of presumption that variable annuities were securities to merely an option to treat them as such. Since that time, the ACLI has succeeded in preserving the status of variable annuities as excluded from the "securities" definition for state law purposes in each state where the question has arisen, harkening back to the very reason for the oddity in the first place, a matter of politics far more than regulatory reason.

Can a broker-dealer situated in State A sell securities (that are neither registered nor exempt from the requirement for sale to investors in State A) to an investor in State B where their offer and sale is lawful? In A.S. Goldmen & Company v. New Jersey Bureau of Securities, 163 F.3d 780 (3^rd Cir. 1999), the court said they could not. A "sale" took place in both the State of New Jersey, where the broker-dealer was located and the securities were not cleared for sale, and the other states, where they were, under the facts presented. By contrast, such a transaction is lawful by statute for purposes of securities registration in at least a few states, including Colorado, Missouri and Texas.

The SIA argued persuasively for inclusion in NUSA of a transactional securities registration exemption to permit such a transaction, applying across the board to both initial offerings and secondary market transactions. Given the facts of today's marketplace, with bunched orders, and the retention of strict private civil liability for the sale of unregistered, nonexempt securities, the SIA argued that broker-dealers often find themselves in the untenable situation of discovering after the fact that a sale to an investor in a state where a security was not blue-skied has taken place. Oh, and the price has dropped… and the investor’s attorney is on the phone. NCCUSL listened, and such an exemption is included in NUSA at section 202(20).

This exemption has met with significant objection by many state regulators. In one instance, when the transactions exempted were limited to secondary market transactions, resolution was obtained, although the bill was later tabled for further study. State regulators generally have not been receptive to the argument that they should not care if the transaction does not involve an investor in their jurisdiction, and the transaction is lawful in the state where the investor is located, and both states' licensing and anti-fraud provisions still apply. Some have been vehement in their opposition. Several regulators have objected stating they do not wish to be put in the position of having to determine whether there has been compliance with the laws of another jurisdiction. The NASAA representatives on the Committee were not optimistic that state regulators would receive this exemption well, and that has proven true for the most part. The resolution I mentioned in which the exemption was limited to secondary transactions may prove to be a useful consideration in subsequent legislative efforts. While the exemption was retained in the new Missouri Act, it was deleted in the last draft I have of the Oklahoma bill.

If there were any vestiges of the trials and tribulations of RUSA, they certainly emerged in our discussions of private offerings for NUSA. For sure, the level of contention was muted by NSMIA's treatment of Rule 506 offerings, but some spirited discussion took place nonetheless. While coordination of state and federal law with regard to private offering exemptions may be an admirable goal, achieving it is quite another problem. For one thing, there is a broad body of federal rules and regulations addressing the subject. No one found it an appealing proposition to attempt to redefine all of that in NUSA, and cherry-picking one concept or another was equally problematic and fraught with peril.

In the end, and as was true for several contentious issues, the decision here was to leave well enough alone. Most private offerings are now conducted under Rule 506. For those few that might need a state statutory exemption to fall back upon, the USA model from 1956 was retained, with the one change to raise the number of investors permitted from 10 to 25 [see NUSA section 202(14)]. The ABA representatives sought to increase the number to an even higher level, and the NASAA representatives wanted to keep it at 10. Neither side was completely persuasive, and so the compromise was reached. Numeric aspects of any law are always the easiest to change. Those regulators and legislators for whom the increase to 25 is a problem can and will set the number wherever they feel comfortable, as they have always done. With NSMIA's treatment of Rule 506 offerings, it really doesn’t matter anymore.

Of all the regulatory issues I had to confront during my 20-year tenure as a state regulator, none was more vexing than CRD record retention. The CRD is the database for the registration of every securities agent in the country. It is jointly owned by the states and the NASD and operated by the latter. While the NASD can make up its own rules for managing that system (with SEC oversight), fifty-two different open records laws each govern what is a matter of public record in a given jurisdiction. State broker-dealer and agent records are matters of public record in every state in the Union, and available to the public.

While the NASD may think a particular record should no longer be disclosed, one or more state laws might dictate otherwise, and those laws are not administered by the state securities authorities. Broker-dealers are required to report (most) written complaints lodged by customers against any of their registered people to the CRD. As a result, those complaints become a matter of public record under state law. If the complaint is spurious, extortive, mistaken or abandoned by inaction, it is perfectly understandable that the offended individual would want to purge the bad fact from his or her public record.

Although aggrieved agents can give their side of the story on the same CRD record, that is insufficient comfort for most aggrieved agents. At present, NASD rules provide for the removal of unadjudicated written complaints from the records they make available to the public after two years. There is no way to do that under most state laws, absent an order of a court. Even if such a court order is obtained, there remains a question as to whether a court in one state has the authority to remove or expunge another state's public record. So, what a member of the public might not be able to learn and obtain from the NASD's version of the CRD can be obtained easily from the securities agency of any state. Therein lies the rub.

In recognition of the dilemma, the SIA urged changes in NUSA to alter the manner in which state administrators interface with the CRD. Reflecting what we believed to be the sentiment of most state administrators, the NASAA representatives argued that state administrators could not allow themselves to be put in the position of determining on an ad hoc basis what would and would not be expunged from the state's public records. State open records laws are highly volatile subjects in many states.

The SIA and NUSA compromise was to provide the administrator of a regulatory agency with the authority to adopt a rule and thereunder order a public record expunged at NUSA section 607(6). This has proven unpalatable to state securities regulators from both a political and practical sense. In contemplating my position on the proposal, I imagined I was still Colorado's Commissioner, and pictured myself sitting through hearing after hearing listening to arguments from agents as to why a particular record should be altered or expunged. I reacted as have most regulators to date. The provision was not included in the Missouri or the Oklahoma acts, and was not included in the bill introduced in Kansas.

By far and away, I believe the greatest prospect of NUSA from the practitioner's perspective is what I call "up-front uniformity." The mechanical and classification differences in registration systems that abound to one extent or another among the states today will not be eliminated, but should be diminished considerably if states adopt NUSA and its definitions, securities and professional registration provisions.

There is far greater certainty in NUSA. For example, the few lines that described "financial institutions and institutional investors" in the USA have been supplanted by an exhaustive and descriptive list that should give comfort to anyone struggling with the question of who's in and who's out. The paltry and outdated secondary offering exemptions of the USA have been refined, expanded and modernized to accommodate a host of transactions that were not contemplated in 1956. "Snowbird" exemptions are provided for agents for the first time. Notice filing provisions as a whole are set forth with clarity and precision. In sum, practitioners across the country ought to receive NUSA with open arms from the perspective of trying to make blue sky filings and registrations an efficient, simplified and unified process.

On the subject of "back-end uniformity," a.k.a. "enforcement," arguments for uniformity generally seem less persuasive. Is it truly a public policy concern when one state has the authority to impose a civil penalty for fraud while another does not? Transactions are not planned on the basis of what the sentencing guidelines for fraud are in one state as opposed to another. Although considerable time was spent in crafting the broker-dealer, agent, investment adviser, investment adviser representative and anti-fraud regulation and enforcement provisions of NUSA, they will not be as attractive to the practitioner as we hope they are to the regulators. That is indeed the tradeoff. The NCCUSL calculation was that the cost of achieving much greater uniformity on the front-end, i.e., what the industry sought, was making the regulatory and enforcement features on the back-end more attractive to regulators.

I do not mean to undermine or downplay the many improvements and innovations contained in NUSA. It is by no means merely a xeroxed and updated copy of the 1956 Act. There are dozens of important new features. Many will resist adoption out of fear of the unknown, i.e., it is easier to deal with known confusion than learn a new and more orderly system. That is short-term thinking, and hopefully will not prevail.

We never calculated the total years of securities and blue sky experience that were brought to bear on the NCCUSL process, but collectively, it must be high in the hundreds. The hours spent on the project greatly exceeded that number. We'll see if it was worthy of and worth it all in the next few years. Perhaps we have set the stage for the next era of state securities regulation.

©2003 Rothgerber Johnson & Lyons LLP