Welcome to the world of laws and regulations! If you’ve already prepared for the SIE, Series 6, or 7 exams, you should already have a decent understanding of the various securities laws we pay most attention to. While we’ve loosely discussed them at times throughout the Achievable material, you’ll need to be well aware of the following securities laws:
The Uniform Securities Act*, often referred to as the USA or blue sky laws**, is a model legislation that is adopted by the states. Meaning, it’s a framework of laws and regulations that states can adopt and implement to properly regulate the securities industry. This makes it easier for financial firms and professionals to comply with state securities laws. Otherwise, each state would create and enact its own regulations, which could vary significantly from state to state. A financial firm operating in multiple states would have to comply with each state’s rules if the USA didn’t exist, making compliance very difficult or near impossible.
*The majority of this material is based on the USA. There have been multiple versions of this legislation, but two are primarily utilized by the states. These are the Uniform Securities Act of 1956 and the Uniform Securities Act of 2002. While both are similar, there are slight differences that are generally unimportant for the exam. If you want to see the actual laws, click the previous links. If you’re not a fan of reading lengthy legislation, don’t worry! We read, analyzed, and summarized the important testable parts in this learning program.
**State securities laws were originally referred to as “blue sky laws.” It was said that certain advisors and brokers would go so far as “sell the blue sky” as they were attempting to take advantage of unknowing investors.
State laws and regulations created and enacted under the USA are similar from state to state. They cover a wide range of issues, including:
These laws and regulations are enforced by the state administrator. Think of them like the SEC, but at the state level. Although it sounds like a human being, the administrator is an office of people that work together to enforce the USA. In the real world, we use different terminology than the legal terms you’ll have to learn for this exam. For example, the state of California refers to their state administrator as The Department of Financial Protection and Innovation.
All of the following securities acts after the USA are federal securities laws. Depending on the question, it may be important to identify what jurisdiction (state or federal) a law falls under.
The Securities Act of 1933 governs primary market sales of securities at the federal level. When an issuer plans on offering securities interstate (in more than one state), they are subject to the rules and regulations in this legislation. The specifics are covered later in this material, which starts in the federal securities registration chapter.
The Securities Exchange Act of 1934 governs secondary market securities transactions and market participants at the federal level. The majority of the relevant rules in this section relate to market manipulation and prohibited actions, which are covered later in this unit.
The Investment Company Act of 1940 regulates investment companies, which include mutual funds, closed end funds, and unit investment trusts (UITs). Relevant rules and regulations from this legislation were covered in the chapters linked in the previous sentence.
The Investment Advisers Act of 1940 regulates federal-covered advisers. We’ll learn more about the generalities of investment advisers and relevant rules and regulations later in this unit.
The Insider Trading Act of 1988 regulates the usage of inside information, primarily making it illegal for investors to utilize this type of information when performing securities transactions. By definition, insider trading involves trading on material, non-public information. Material information is any information that can drive someone to make an investment decision. Non-public information is not widely available or disseminated.
Insiders of publicly traded companies have access to significant amounts of material non-public information. For example, the executives at a large biotechnology company will know about a new medical product prior to releasing it publicly. If the product was groundbreaking, the executives could buy a bunch of stock prior to its release. Once the product is announced publicly, the demand and price of the stock would increase, creating a significant profit for the insiders.
This would be a big problem if the SEC found out. Insiders can discuss and obtain insider information, but cannot trade on it. As soon as a trade occurs, the person providing the insider information (the tipper) and the person receiving and trading on the insider information (the tippee) are subject to serious consequences. If a customer tells you they have insider information and they want you to place a trade, you cannot do it. You will be held liable and may be sued by the SEC.
Regardless of the size of the profit made or the loss avoided, the SEC takes insider trading very seriously. In civil court, perpetrators can be sued for up to three times the profit achieved or loss avoided. Known as “treble damages,” any investor in the security at the time of the trade (known as contemporaneous traders) can sue those responsible for insider trading for up to this amount.
Criminal charges and fines can also be levied against those found guilty of insider trading. If a person is caught, they could be fined up to $5 million and sent to jail for up to 20 years. When the problem is widespread across a financial firm, the firm can be fined up to $25 million. Collected fines are typically distributed to the SEC’s Fair Fund, which holds and distributes money to victims of financial fraud.