Criminal & civil consequences

When a person violates the Uniform Securities Act (USA), the result can be either a criminal violation or a civil violation.

• Criminal violations can lead to court-imposed fines and possible jail time.
• Civil violations can lead to liabilities (typically restitution owed to an investor) and penalties imposed by the state administrator.

The key difference comes down to one question: Was the violation willful?

Criminal penalties

A willful violation means the person knew what they were doing before taking the action. When a violation is proven willful, criminal penalties may apply.

Criminal consequences aren’t imposed by the administrator. They’re handled through the U.S. court system. As we’ve discussed previously, the administrator stays in close contact with the legal system and petitions the court when seeking legal action. The state administrator typically works with the state attorney general to bring criminal charges.

There isn’t a specific list of USA provisions that must be violated to trigger criminal penalties. Instead, any willful violation can make a person subject to criminal charges and prosecution. In practice, the most serious violations are more likely to be pursued in court. According to the North American Securities Administrators Association’s (NASAA’s) 2019 report, over 8,000 complaints were lodged with state administrators, but only 218 criminal enforcements occurred.

If the conduct is prosecuted criminally, a person could face:

For violations of state laws

• $5,000 maximum fine*
• 3-year maximum jail sentence*

For violations of federal laws

• $10,000 maximum fine*
• 5-year maximum jail sentence*

*These penalties are levied on a per-violation basis. For example, a person found guilty of three violations could face a maximum fine of $15,000 and up to 9 years of imprisonment.

Criminal prosecutions have a 5-year statute of limitations at both the federal and state level. That means a violation that occurred more than 5 years ago can’t result in criminal legal consequences.

Many test takers remember the criminal penalty details using these shortcuts:

• Federal: “5-10-5 rule”
• State: “5-5-3 rule”

These refer to: statute of limitations - maximum fine - maximum jail.

If you want to see criminal enforcement actions your state administrator has participated in, start with NASAA’s ‘contact your regulator’ page to find your administrator. On the administrator’s website, look for an enforcement section. It typically includes actions involving registration, plus criminal and civil actions. For example, here’s a historical summary of all enforcement actions taken by Colorado’s state administrator.

Civil liabilities

Even if a USA violation isn’t willful, it can still create civil liability. Civil liability usually comes up when an investor is owed restitution.

For example, suppose an investment adviser representative (IAR) recommends that a client buy a security, but the security is a non-exempt, unregistered security. As we’ve already learned, the only way to sell a non-exempt unregistered security is through an exempt transaction. If no exempt transaction applies, the security shouldn’t have been recommended or sold. In that case, the IAR (and, by extension, the investment adviser) could be liable for restitution.

The USA identifies three primary restitution categories tied to civil liability: securities sales, securities purchases, and investment advice. These apply when the transaction or advice is connected to a USA violation.

Restitution for securities purchases (client buys)

• Original cost of the security*
• Less any income received from security
• Plus the legal rate of interest**
• Plus any legal fees

*A common exam “trick” is whether the investor should be repaid the original cost or the current market value. It’s always the original cost. If an investor was sold a security illegally and its value later dropped, repaying only the current value wouldn’t make the investor whole.

**The legal rate of interest is set by each state administrator. It’s meant to compensate the investor for the time their money was tied up in an investment they shouldn’t have been sold.

Restitution for securities sales (client sells)

• Client may recover (buy back) the security
• Less any income paid by the security
• Less any legal fees

Restitution for investment advice

• Cost of the investment advice
• Plus actual damages due to investment advice
• Less any income received from security
• Plus the legal rate of interest
• Plus any legal fees

You don’t need to over-focus on the small differences among these formulas. The general idea is consistent: the investor should be made whole, and legal fees are typically recoverable.

One detail to keep straight: the legal rate of interest generally applies when the investor’s money was tied up (for example, after an improper purchase). It does not apply in the securities sale scenario (assuming a violation occurred). In that case, the investor’s remedy is to get the security back, along with any income the security paid while it wasn’t in the investor’s possession.

There are two general ways a civil liability can be settled:

• Right of rescission
• Legal actions

Right of rescission
If a registered person discovers they violated the USA during a securities transaction and/or while providing investment advice, they can try to fix the problem proactively. The USA provides a right of rescission, which allows the registered person to contact the client and offer restitution. The offer must be in writing and is commonly called a rescission letter.

The rescission letter offers the same restitution described above, depending on the situation. For example, assume an agent mistakenly sells a non-exempt unregistered security to a client and no exempt transaction applies. To reduce future legal risk, the agent sends a written rescission letter offering to buy back the security at its original cost, minus income received from the security, plus the legal rate of interest and legal fees (if any).

After receiving the letter, the client has a few options:

• The client can accept the offer, return the security, and receive restitution.
• The client can reject the offer. If the client rejects it, the agent is released from future liability related to that transaction.
• If the client doesn’t respond within 30 days, the result is the same as rejecting it: the agent is released from future liability.

Legal actions
If the registered person doesn’t offer a rescission letter, the client can pursue legal action. In most cases, this means arbitration or a lawsuit, depending on the client’s agreement with the firm.

Most financial firms require clients and customers to sign arbitration agreements, which prevents the client from suing in court. In that case, the dispute goes to arbitration. If no arbitration agreement exists, the client may file a lawsuit.

Whether the case goes to arbitration or court, the client is generally seeking the same restitution described above. Legal fees are often highest in these situations because of the cost of pursuing arbitration or litigation.

Civil liabilities have a 3-year statute of limitations, but no later than 2 years after discovery of the violation. Civil liabilities also survive the death of all parties. If a client dies before pursuing arbitration or a lawsuit, the client’s estate may proceed on the client’s behalf. While the 2002 version of the Uniform Securities Act uses a different limitations period, the earlier of 2 years from discovery or 5 years from the violation, NASAA continues to test the 1956 version because most states still operate under statutes based on the 1956 Act.

Civil penalties

Separate from civil liabilities owed to clients, the administrator may impose a civil penalty for (non-willful) USA violations. These are essentially fines assessed against registered persons and are often used for repeat offenders. Each state sets its own penalty structure.