Although the Securities and Exchange Commission (SEC) has broad regulatory power, the Series 65 tends to focus on the state administrator. Therefore, this unit will primarily cover enforcement related to state-based rules and regulations. When a federal-based rule or regulation needs to be covered, it will be noted.
The state administrator has many responsibilities related to supervising the securities markets and financial professionals. The Uniform Securities Act (USA) was signed into law by politicians, and the administrator enforces the provisions set forth in the law. While they maintain no power to change the USA, the administrator interprets and enforces the legislation as they see fit. This is similar to a police officer; they can’t change the law themselves, but have some flexibility in how they enforce it.
The most important role of the administrator is to enforce the anti-fraud provisions of the USA. Preventing investors from being taken advantage of by financial professionals, issuers of securities, and even other investors is their most significant function. In order to do so, the USA equips the administrator with the following powers:
We covered the registration of persons and securities thoroughly in the previous unit. The registration process empowers the administrator to act as a “gatekeeper” of sorts. If it can be argued an action taken against the registration status of a person is in the public interest*, the administrator has broad powers to prevent them from working in the industry (temporarily or permanently).
*Any action taken against a person’s registration status must qualify as “in the interest of the public.” Technically, if it cannot be argued to benefit the public in some way, the administrator cannot deny, suspend, or revoke a registration.
If an applicant has a checkered past, it’s possible their registration will be denied. That’s why there’s a significant amount of information to be disclosed during the application process. The system prevents “bad faith actors” from entering the securities industry.
If effective registration is granted, the administrator continues to supervise a registered person’s or issuer’s activities to ensure compliance with securities laws and regulations. It’s possible an activity or event may place the person’s or security’s registration status in jeopardy. If the circumstance is bad enough, their registration status can be suspended or revoked. Suspensions temporarily prohibit a registered person from operating in a state or a security from being sold in a state. Revocations permanently remove registration, effectively barring a person from operating in a state or a security from being sold in a state. The specifics of denials, suspensions, and revocations are covered later in this unit.
If an agent or investment adviser representative’s (IAR’s) registration is suspended or revoked, it has no bearing on their firm’s registration. However, if a broker-dealer’s or investment adviser’s registration is revoked, it results in all registrations of their employees becoming inactive. Remember, an agent or IAR must be associated with a broker-dealer or investment adviser to be properly registered. If their firm just lost its registration status, they are no longer able to operate as a representative of that firm. Regardless, they may re-associate with a different firm and subsequently apply for registration.
Denials, suspensions, and revocations are punitive actions (punishments) the state administrator can take against an applicant or registered person. A person or security’s registration status can also be withdrawn or canceled, which isn’t typically related to a punishment (covered in a future chapter). Bottom line - one of the administrator’s primary powers is to manage the registration process, which ultimately determines the financial professionals and securities allowed to engage the investing public.
If the administrator has reason to believe an unethical or illegal action has taken place in their state, they have broad investigatory powers at their disposal. In most cases, complaints and tips from the public are the primary reasons investigations occur. According to the North American Securities Administrators Association’s (NASAA’s) 2019 report, over 8,000 complaints were received by state administrators, which led to 5,320 investigations. Those investigations led to 1,640 enforcement actions.
There are several layers to this power, so let’s look at some of the language in the USA:
The administrator may conduct public or private investigations within or outside of this State that the administrator considers necessary or appropriate to determine whether any person has violated, is violating, or is about to violate [the USA]
The administrator may conduct investigations publicly by making a broad announcement of the investigation, or privately. Their investigations can take place within or outside of the administrator’s state, but they must have jurisdiction. You’ve probably heard of jurisdiction on shows like COPS. Police officers usually have jurisdiction in the cities or states they operate in. If an illegal action occurs outside their jurisdiction, they typically have no power to prosecute or pursue legal action. The same doctrine applies to the state administrator.
The administrator has jurisdiction if a financial professional (registered person) and/or client was physically in their state during:
*Please visit the links above if you need a refresher on the legal definitions of offers and sales. The details are important!
We discussed federal covered advisers previously; as a refresher, these typically are larger advisers in terms of assets under management. While the SEC primarily regulates these advisers, can the state administrator investigate them? It depends. The state administrator may only investigate a covered adviser if they suspect the adviser is committing fraud in their state. Otherwise, the administrator maintains no powers over federal covered advisers other than requiring a notice filing.
If jurisdiction exists, the administrator has the power to investigate any registered person or issuer. Investigations may result in some form of punishment, like a suspension or revocation. Or, nothing may occur. It all depends on what the state administrator finds during the investigation.
The administrator may require or permit a person to testify, file a statement, or produce a record, under oath or otherwise as the administrator determines, as to all the facts and circumstances concerning a matter to be investigated or about which an action or proceeding is to be commenced.
The administrator has subpoena power and can require a person to provide information on a given subject. However, they may not violate a person’s 5th amendment right against self-incrimination. Known as the immunity procedure, the administrator cannot force a person to testify if their testimony may result in criminal procedures against them.
The administrator may publish information concerning an action, proceeding, or an investigation… if the administrator determines it is necessary or appropriate in the public interest and for the protection of investors.
The administrator retains the right to publicly disclose information related to an investigation, but is not required to. If a punitive action is taken against a person or issuer, the results are usually disclosed publicly.
An important role taken on by the state administrator relates to the interpretation and enforcement of the USA. To do so, rules, forms, orders, and notices are created to ensure compliance with the law.
Rules
A rule is created when a legal provision needs to be clarified or interpreted further for all registered persons and related parties. Rules can be created and applied to all states through the NASAA, or by a specific state administrator that only applies to their state. For example, here’s an NASAA rule relating to investment advisory contracts. While the USA covers these contracts, further interpretation and discussion was obviously needed.
Orders
Orders are similar to rules, but typically apply to a specific circumstance or person. For example, here’s an order from New Mexico’s administrator relating to single-agent broker-dealers in the age of COVID-19. The order doesn’t apply to all broker-dealers; just those with only one agent.
A unique type of order an administrator can issue is a cease and desist order. These are common in the legal world, both within and outside the securities industry. Cease and desist orders essentially are formal warnings prior to taking legal action. If the administrator believes an unethical or illegal action may be occurring, they could issue a cease and desist as a “warning shot” of sorts. There’s no legal obligation to pursue an action, so it’s possible nothing comes after the order is issued (especially if the unethical or illegal action ceases).
If the administrator believes the unethical or illegal action is continuing, the state administrator can attempt to petition a court for an injunction. This would legally force the person from continuing that activity if the court judge agrees with the merit of the request. The administrator doesn’t have the ability to enforce legal actions like injunctions, but they are closely tied to the legal system. While they could suspend or revoke the person’s registration, the administrator may be in the middle of their investigation. Suspensions and revocations are typically not applied until after an investigation is finalized.
Petitioning the court for an injunction could prevent further harm to investors in the short term. After the investigation is complete, the administrator could pursue several actions:
*All of these actions are discussed in detail later in this unit. Follow the links above for more information.
Forms
A large part of making proper disclosures is the use of forms. The administrator can create, change, or remove forms to ensure registered persons are complying with the USA. While the law requires financial professionals to disclose certain pieces of information, forms offered by the administrator facilitate the disclosure of that information. These are the primary forms to be aware of for the exam:
| Form | Use |
|---|---|
| Form BD | Broker-dealer registration form |
| Form ADV | Investment adviser registration form |
| Form ADV-E | Audit result form for advisers taking custody |
| Form ADV-W | Investment adviser registration withdrawal form |
| Form U4 | Agent & IAR registration form |
| Form U5 | Agent & IAR registration withdrawal form |
Notices
Notices are public acknowledgements of a situation or market condition. For example, here’s a notice from Colorado’s state administrator regarding their operations during the COVID-19 crisis. The notice states the administrator’s staff are primarily working from home, examinations of financial professionals are being performed remotely, and licensing (registration) applications continue to be processed normally.
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