When a person violates the Uniform Securities Act (USA), the result can be either a criminal violation or a civil violation.
The key difference comes down to one question: Was the violation willful?
A willful violation means the person knew what they were doing at the time of the act. If the violation is proven willful, criminal penalties may apply.
Criminal consequences aren’t imposed by the administrator. They’re handled through the 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 expose a person to criminal charges and prosecution. In practice, the most serious violations are the ones most 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 the following:
For violations of state laws
For violations of federal laws
*These penalties are levied on a per-violation basis. For instance, 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:
These refer to: statute of limitations - maximum fine - maximum jail.
If you’re curious, you can look up criminal enforcement actions your state administrator 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 matters. For example, here’s a historical summary of all enforcement actions taken by Colorado’s state administrator.
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 non-exempt and unregistered. As we’ve already learned, the only way to sell a non-exempt unregistered security is through an exempt transaction. If no exemption applies, the security shouldn’t have been recommended or sold. In that case, the IAR (and, by extension, the investment adviser) can be held liable for restitution.
The USA describes three primary categories of restitution tied to civil liability:
These apply only when the transaction or advice is connected to a USA violation. The calculations are similar, but the details matter.
Restitution for securities purchases (client buys)
*A common “trick” on the exam relates to whether the investor should be compensated for the original cost of the security or the current market value. It’s always the original cost. Think about it - assume an investor was sold a security illegally and its value declined dramatically. Would it be fair to only compensate them for the current value of the security? Obviously, no.
**The legal rate of interest is determined by each state administrator. Its purpose is to compensate the investor for the time their money was locked up in an investment they shouldn’t have been sold.
Restitution for securities sales (client sells)
Restitution for investment advice
You don’t need to over-focus on the small differences among these formulas. The general idea is that the investor should be made whole, and legal fees are typically recoverable.
One detail to keep straight: the legal rate of interest is commonly used to compensate the investor for the time their money was tied up in an investment they shouldn’t have owned. However, the legal rate of interest does not apply when an investor sells a security to a registered person (assuming a violation occurred). In that situation, the investor should receive the security back, plus any income the security paid while it wasn’t in the client’s possession.
There are two general ways a civil liability can be settled:
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. This 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 exposure, the agent sends a written rescission letter offering to buy back the security at its initial cost, minus income received from the security, plus the legal rate of interest and legal fees (if they exist).
After the client receives the letter, they have a few options:
Legal actions
If the registered person doesn’t offer a rescission letter, the client can pursue legal action. In most cases, that 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 generally 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 dispute is handled through arbitration or a lawsuit, the client is still seeking the same restitution described above. Legal fees are often highest in these cases because of the cost of pursuing arbitration or litigation.
Civil liabilities are subject to a 3-year statute of limitations, but no later than 2 years after the discovery of the violation. Additionally, civil liabilities survive the death of all parties. If a client dies before pursuing arbitration or a lawsuit, their estate may move forward on their 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.
In addition to civil liabilities paid 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 reserved for repeat offenders. Each state sets its own penalty structure.
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