There are several situations where persons can avoid registration as a broker-dealer. As you learned in earlier chapters, registration involves required disclosures, extensive paperwork, and filing fees. Firms can save time and money when they can legally avoid that process.
One way to do this is by qualifying for an exclusion. An exclusion means the person does not meet the legal definition of a broker-dealer, so registration isn’t required.
These are the exclusions discussed in this chapter:
The Uniform Securities Act (USA) specifically identifies three types of persons that are consistently excluded from the definition of a broker-dealer:
Agents are natural persons (human beings) who represent broker-dealers. In other words, agents are the employees, and broker-dealers are the employing firms.
Issuers may raise capital by selling their own securities to investors. They aren’t treated as broker-dealers unless they facilitate trading in another issuer’s securities.
For example, Charles Schwab is an issuer of its own common stock, which would normally fall under the issuer exclusion. However, the exclusion doesn’t apply because Schwab also facilitates trading in securities from other issuers.
Banks and savings institutions offer financial products to their own customers, and it’s generally safe to assume they aren’t included in the definition of a broker-dealer. The same is true for trust companies, which help clients manage trusts.
One important limitation: this exclusion does not extend to bank holding companies. The Federal Reserve Bank of St. Louis describes bank holding companies this way:
“Bank holding companies are corporate entities that own one or more banks”
Bank holding companies often have multiple subsidiaries, including one or more banks. They may also own subsidiaries that are directly engaged in the securities business.
For example, Bank of America operates a banking business but also owns the broker-dealer business Merrill Lynch. Because it owns a broker-dealer, Bank of America can’t rely on the banking exclusion.
Bottom line: banks, savings institutions, and trust companies are excluded from the definition of a broker-dealer, but bank holding companies are not.
A firm may also be excluded from the definition of a broker-dealer if both of these conditions are met:
A firm that engages in broker-dealer activity and has an office in the state (a place of business) is not excluded and must register.
For example, Northwestern Mutual has part of its business dedicated to broker-dealer activities and has its headquarters in Wisconsin. Even if it only worked with institutional investors, it would still need to register with Wisconsin’s state administrator because it has a physical presence in the state.
By contrast, a firm can avoid registration if it has no place of business in the state and limits its activity to institutional-type clients.
As discussed in the Investors chapter, investors are often grouped into two broad categories: retail and institutional. The list above is made up of institutional categories. You don’t need to memorize what each institution is (for example, the details of a profit-sharing trust). The key point is that broker-dealers can avoid registration when they transact only with these types of investors.
This approach reflects the USA’s focus: regulators are most concerned with protecting retail investors. Institutional investors are generally considered sophisticated and in less need of protection from state administrators. That’s why the USA doesn’t require registration for broker-dealers that transact only with institutional investors - so long as the broker-dealer has no place of business in the state.
A firm can also avoid registration as a broker-dealer if these conditions are met:
This is commonly called the vacation rule or the snowbird exclusion. Like the institution rule, it requires that the broker-dealer have no office or physical presence in the state.
If an existing customer travels to a state where the broker-dealer doesn’t do retail business and doesn’t maintain an office, the broker-dealer may continue to transact with that customer without registering in the new state. The exclusion applies as long as the customer is not a resident of the new state and is there temporarily.
For example, assume ABC Brokerage Firm is headquartered in Idaho and is properly registered with the Idaho state administrator. One of its customers, an Idaho resident, travels to Texas for a two-week vacation. ABC can continue to execute securities transactions for that customer while the customer is in Texas without registering in Texas.
Generally, “vacation” is treated as 30 days or fewer in the new state. A broker-dealer could be required to register if the customer stays longer than a month. However, you may encounter situations where the customer stays longer than 30 days and the broker-dealer still qualifies for the exclusion.
Although the snowbird rule is often explained using vacations, the legal language focuses on non-residents. If a customer goes to another state for school or a work assignment but keeps residency in the original state, the exclusion can still apply even if the stay lasts several months.
When the USA was originally written, representatives from Canada participated in the lawmaking process. That’s why the law specifically addresses Canadian firms.
Canadian broker-dealers don’t avoid registration entirely, but they may qualify for a less burdensome process called limited US registration.
Canada has its own registration system for financial firms. You don’t need the details, but you can assume it’s similar in purpose to the US system. If a broker-dealer is located in Canada, is properly registered in Canada, and maintains no offices in any US state, it may apply for limited US registration.
This matters when a Canadian broker-dealer wants to transact with a customer located in a US state. For example, if a Canadian customer of a Canadian broker-dealer travels to (or moves to) a US state, the question becomes whether they can continue doing business together. The USA allows limited registration for Canadian broker-dealers in certain circumstances.
Limited registration requires the Canadian broker-dealer to maintain effective registration with the appropriate self-regulatory organization (SRO) or stock exchange in Canada and remain in “good standing” with Canadian regulators. In addition, the following requirements must be met:
If these conditions are met, Canadian broker-dealers can transact in a US state in one of two circumstances.
First, a Canadian broker-dealer can obtain limited registration if it’s doing business with a Canadian person who is temporarily in a US state, as long as there was a pre-existing relationship.
For example, assume a Toronto-based broker-dealer has an existing relationship with Leon, a Canadian customer. Leon travels to California for the winter. The broker-dealer can obtain limited registration and continue to do business with Leon as long as he’s there temporarily. “Temporarily” is defined as less than 183 days (about 6 months).
The second circumstance involves Canadian persons who are full-time residents of a US state. This rule applies only if the broker-dealer’s transactions are exclusively in a Registered Retirement Savings Plan (RRSP), which is similar to an Individual Retirement Plan (IRA).
Using the same example, assume Leon moves from Toronto and becomes a full-time resident of California. The Canadian broker-dealer can still use limited registration and continue to do business with Leon, but only for transactions in Leon’s RRSP.
If Canadian broker-dealers plan to rely on limited registration in the United States for extended periods, they must renew their applications, similar to American broker-dealers.
As discussed in the disclosures and fees chapter, registration for American persons lasts until the end of each calendar year (December 31), and renewal is required to avoid a lapse. The renewal concept is the same for Canadian broker-dealers, except the cutoff is December 1. To avoid a lapse, Canadian broker-dealers should renew by the end of November.
The following video summarizes the key points covered in this chapter:
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