Exams focused on laws and regulations test the rules you must follow. Just as important, though, is knowing when a rule doesn’t apply. In most cases, you can treat that as one of two situations: the law provides an exemption, or the situation falls under an exclusion. Both are exceptions, but they exist for different reasons.
An exemption exists when the law explicitly says the rules don’t apply to a particular person, product, or circumstance. For example, road speed limits apply to automobiles on public roads. An ambulance responding to an emergency (for example, with lights flashing) may be exempt from the speed limit. Even if it’s traveling 30 miles per hour over the posted limit, it generally wouldn’t be pulled over or penalized under the speed limit law because the law provides an exception for that situation.
Bringing it back to finance, Treasury bonds are considered exempt securities. Treasury bonds are securities: investors buy them expecting a return, and they can potentially lose money. Even so, securities laws exempt them from registration at both the federal and state level (we’ll learn more about this later). This allows the Department of the Treasury to sell Treasury bonds without filing registration and disclosure paperwork with the SEC.
*If this is the first you’re hearing about Treasury securities being exempt from registration, don’t worry about it. We’ll cover the specifics later in this material.
An exclusion exists when the person or circumstance isn’t the kind of thing the law is meant to regulate in the first place. In other words, the law doesn’t apply because the situation is outside the law’s scope. Using speed limits again: if a cheetah ran down the road faster than the posted limit, it obviously wouldn’t be subject to the speed limit law. Speed limits regulate cars, trucks, and other road vehicles - not animals. In that sense, the cheetah is excluded from speed limit laws.
Back to finance again: fixed annuities are considered excluded securities*. Fixed annuities are insurance products that aren’t subject to market value fluctuations, and as a result they aren’t considered securities. Like Treasury bonds, they aren’t required to be registered or regulated under securities laws. However, they avoid those rules for a different reason. Treasury bonds avoid registration because the regulations explicitly say they’re exempt, while fixed annuities avoid registration because they don’t meet the definition of a security.
*For now, all you need to know is that a fixed annuity is an insurance product that isn’t subject to securities laws or regulations.
As you work through the rest of this material, you’ll see many different rules and regulatory frameworks. You’ll want to know both (1) what the rule is and (2) when it doesn’t apply. Test questions may focus on exemptions and exclusions - and on the difference between them. For example:
All of the following securities are eligible for exemptions from registration, EXCEPT:
A) Treasury bonds
B) Treasury bills
C) STRIPS
D) Fixed annuities
Can you figure it out?
Answer: D) Fixed annuities
All Treasury (US Government) securities, including Treasury bills, Treasury bonds, and STRIPS, are exempt from registration requirements. Although they are securities (which are typically subject to securities laws and regulations), applicable rules and regulations (which we’ll learn more about later) explicitly state US Government securities are not subject to registration requirements (an exemption).
Fixed annuities are not subject to registration requirements either, but for a different reason than US Government securities. They do not meet the definition of a security, and therefore are excluded from securities laws.
We’ll dive deeper into securities in the next chapter, which should clear up any confusion about exempt securities or products excluded from securities laws.
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