“Securities” are investment interests that include bonds, corporate stock, promissory notes taken in exchange for investment of capital, and less standardized interests such as ownership interests in partnerships and limited liability companies.
Both federal and state laws regulate the purchase and sale of securities as well as the professionals and businesses that engage in commerce in securities. Both sets of laws apply independently, and the requirements of each must be satisfied. Individual states enacted laws regulating securities and the securities industry starting in the early twentieth century. These state laws are commonly referred to as “blue-sky laws,” because they were designed to protect gullible investors against scam artists who took money in exchange for interests no more substantial than shares in the blue sky. Following the great stock market collapse of 1929 and the ensuing Great Depression, Congress passed federal securities legislation, including the Securities Act of 1933 and the Securities Exchange Act of 1934, both of which have been amended many times since they were first enacted. The federal securities laws are enforced by the Securities and Exchange Commission (SEC).
Arkansas adopted its first blue-sky law in 1913. Subsequently, the Arkansas General Assembly has enacted new securities acts several times over the years. Arkansas’s current securities act was enacted in 1959. Like the securities acts of roughly half of the states in the United States, the Arkansas Securities Act is modeled on the Uniform Securities Act of 1956. The act has been amended many times since then, but the overall framework remains intact. In brief, the Arkansas Securities Act governs the purchase and sale of securities, and it regulates companies that are in the business of buying and selling securities (often called “broker-dealers” or “brokerage firms”) or that are in the business of advising investors about what securities to buy and sell (“investment advisers”). The act also regulates the individual brokers or advisers who work for these firms. The act authorizes the Arkansas Securities Commissioner, who heads the Arkansas Securities Department, to promulgate regulations and to enforce the law. The commissioner is appointed by the governor and can be removed by the governor at any time. The commissioner is assisted by employees of the Securities Department.
Before discussing the major features of securities legislation, it is necessary to determine whether a security exists. The statutes purport to define “security,” but the definitions are both broad and vague.
As mentioned above, securities are investment interests. Frequently, these investments are in business enterprises, although non-profit organizations and government bodies may sell securities (for example, municipal bonds). When the investment is made in a business enterprise, it is sometimes hard to know in advance whether a particular interest is a security. Usually, corporate stock is a security, but shares or units in a partnership or limited liability company are not so easily categorized. Often, it depends on whether the investor is active in the business and able to influence the business’s profitability (less likely to be a security) or whether the investor is essentially passive, relying on others to operate the business and produce profits (more likely to be a security).
The following discussion is a very general summary of several of the major aspects of securities legislation:
A) Regulation of securities transactions. In general, before securities may be sold in Arkansas, the sale must be either registered or exempt under both federal and state law. Registration typically occurs when a company or other entity (called an “issuer”) wants to sell securities to the public in exchange for investment capital. For example, if a hypothetical Arkansas corporation called “Razorback Razorblades, Inc.,” sells one million shares of its stock to the public, documents registering that sale are filed with the SEC. If an offer to buy or sell the securities is made in Arkansas, documents registering the sale or giving notice of the sale are filed with the Arkansas Securities Department. The registration documents include “prospectuses” that contain detailed disclosures about the company and the risks of investing in it. Because it is a public document, the prospective purchaser has the opportunity to read the prospectus before deciding to purchase the security.
Registration is time-consuming and expensive, and most securities transactions are exempt from the registration requirement; they are sold without registration. There are two kinds of exemptions: exempt securities and exempt transactions. Exempt securities are entirely free from the requirement of registration. Exempt securities include United States treasury bills and notes, bank stock, and securities issued by charitable or religious organizations.
However, most securities are not exempt securities and therefore are sold under transaction exemptions. This means that the particular sale is exempt from the registration requirement. If the security is subsequently resold, that resale must also be either registered or exempt. The sale must be exempt under both federal and state law, and those laws are not identical. Common federal exemptions include (1) private sales made only to purchasers who are wealthy (called “accredited investors”) or who are financially sophisticated and knowledgeable about the issuer’s business, and (2) sales made either privately or publicly only to accredited investors. Recent federal legislation permits certain “crowdfunded” sales to be made to any purchaser, wealthy or sophisticated or not. Common state exemptions include (1) sales made only to seven or fewer organizers of the issuer; (2) sales made to institutional buyers, such as banks and insurance companies; (3) sales made only to persons who already own securities of the issuer; and (4) sales made privately only to accredited investors. In most cases, in order to take advantage of a transaction exemption, certain documents must be filed with the SEC and the Arkansas Securities Department.
B) Prohibition of misrepresentations. Even if a transaction made in Arkansas is either registered or exempt, it must not be made by means of a misrepresentation—a statement that is false or that is substantially misleading.
C) Consequences of a sale made in violation of the law. If a security is sold without either registration or an exemption, or if it is made by means of a misrepresentation, the purchaser has the right to rescind the purchase—to give back the security and get a refund of the money paid for it or, in some cases, damages that are equivalent to a refund. In addition, if the case is brought under Arkansas law, the purchaser is entitled to interest at six percent and to payment of attorneys’ fees.
If the sale is made by means of fraud—a deliberate misrepresentation—the purchaser may rescind or sue for damages that may be greater than a refund would be. These suits may usually be brought under either federal law or under Arkansas law, and they may be brought for violation of the securities laws, for ordinary common-law fraud, or for both. A purchaser who wins in a case of common-law fraud under Arkansas law may recover punitive damages as well as actual damages. Also, if the sale is made fraudulently, the SEC and the Arkansas Securities Commissioner can bring a lawsuit to enjoin the fraud and impose a monetary penalty on the guilty party. Finally, if the sale is made fraudulently, the United States Attorney or a prosecuting attorney in Arkansas can bring a criminal case against the guilty party and seek a fine or imprisonment or both.
D) Regulation of securities professionals. Both federal law and Arkansas law require that brokerage firms in Arkansas be registered with the SEC and the Arkansas Securities Department as well as with the Financial Industry Regulatory Authority (FINRA), which is a government-sanctioned association of brokerage firms that regulates its members. In addition, individual brokers employed by these firms (“registered representatives”) must be registered with FINRA and in each state in which the registered representative conducts business. Brokerage firms are required to maintain a minimum amount of net capital. The minimum net capital requirement is intended to ensure that the firm is solvent and can pay investors who wish to withdraw money from their accounts. Under Arkansas law, if a sale is made by a broker or brokerage firm that is not registered as required by Arkansas law, the purchaser can rescind and get a refund of the amount invested.
Investment adviser firms must be registered with either the SEC or the states in which they do business, depending on the total amount of assets the firm is managing. Individual advisers who are employed by either an SEC-registered firm or an Arkansas-registered firm must register in Arkansas if they conduct business in Arkansas. If an investor is advised by a firm or person who should be registered but is not, the investor can sue under the Arkansas Securities Act to recover the fee paid for the advice, interest at six percent, and attorneys’ fees.
For additional information:
Arkansas Securities Act, Ark. Code Ann. §§ 23-42-101 to -509 (2012 & Supp. 2015).
Arkansas Securities Department. http://www.securities.arkansas.gov/ (accessed August 30, 2016).
Fendler, Frances S. Private Placements and Limited Offerings of Securities: A Guide for the Arkansas Practitioner. Little Rock: Arkansas Bar Association, 2010.
Hazen, Thomas Lee. Treatise on the Law of Securities Regulation. 6th ed. Eagan, MN: Thomson West, 2009.
Long, Joseph C. Blue Sky Law. 3 vols. New York: Clark Boardman Callaghan, 2014.
Securities Act of 1933, 15 U.S.C. §§ 77a to -77aa (2012).
Securities Exchange Act of 1934, 15 U.S.C. §§ 78a to -78mm (2012).
Frances S. Fendler
University of Arkansas at Little Rock
William H. Bowen School of Law