There are several situations where persons can avoid registration as a broker-dealer. As you learned in earlier chapters, registration involves extensive disclosures, 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 (work for) 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 generally 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. That fact alone wouldn’t make Schwab a broker-dealer. However, Schwab facilitates trading in securities issued by other companies, so the issuer exclusion doesn’t apply.
Banks and savings institutions offer financial products to their customers and are generally excluded from the broker-dealer definition. 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 subsidiaries that are directly engaged in the securities business. For example, Bank of America operates a banking business and also owns the broker-dealer 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 true:
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 broker-dealer activity and maintains 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 in a state when it has no place of business there and limits its activity to institutional clients. As discussed in the investors chapter, investors are often grouped into two broad categories: retail and institutional. The list above consists of institutional investors.
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 state registration when they transact only with institutional investors and have no place of business in that state.
This approach reflects the USA’s focus on protecting retail investors. Institutional investors are generally considered sophisticated and less in need of protection from state administrators. That’s also why the “no place of business” requirement matters: if a firm has an office in the state, regulators assume retail investors could walk in and be solicited.
A firm can also avoid registration as a broker-dealer if these conditions are met:
This is commonly called the vacation rule or snowbird exclusion. Like the institution rule, it requires that the broker-dealer have no office or other 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 during the trip without registering in Texas.
In general, “vacation” is treated as 30 days or fewer in the new state. If the customer stays longer than a month, the broker-dealer could be required to register. However, you may encounter situations where the customer stays longer than 30 days and the broker-dealer can still rely on the exclusion.
Also notice that the rule technically refers to non-residents, not “vacationers.” If a customer goes to another state for school or a work assignment and keeps residency in the original state, the exclusion can still apply even if the stay lasts several months.
When the USA was originally written, Canadian representatives 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 serves a similar purpose to US registration. If a broker-dealer is located in Canada, is properly registered there, and maintains no offices in a given US state, it may apply for limited registration in that state.
This becomes relevant when the 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 is whether the relationship can continue. The USA allows limited registration for Canadian broker-dealers in certain situations.
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, these 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 have full-time residence in a US state. This 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 to transact 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 US broker-dealers. As discussed in the disclosures and fees chapter, US registration runs through the end of the calendar year (December 31) and must be renewed before year-end to avoid a lapse. The renewal concept is the same for Canadian broker-dealers, except the cutoff date is December 1. To avoid a lapse, renewal should be completed by the end of November.
The following video summarizes the key points covered in this chapter:
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