close

Articles

AN OVERVIEW OF CERTAIN DEFINITIONS, EXEMPTIONS AND ANTI-FRAUD PROVISIONS OF THE UNIFORM SECURITIES L

By Peter D. Hutcheon

On December 24, 1997, Governor Whitman signed into law the Uniform Securities Law (1997). This statute in effect replaced the Uniform Securities Law (1967), and reflected a three year effort of the Securities Advisory Committee (SAC) in conjunction with the Bureau of Securities to rationalize and clarify the 1967 Law.

The 1997 act preserves the structure of its predecessor, including its Section numbering. In addition, when the National Securities Markets Improvement Act (NSMIA) was signed into law in October 1996, the draft of what became the1997 act was revised to incorporate provisions responsive to the then new federal legislation; including the preemption of state regulatory authority over mutual funds, offerings of covered securities(basically exchange or NASDAQ National Market – listed securities and securities offered in private placements under Rule 506 of Securities and Exchange Commission (SEC) Regulation D) and the division of regulatory authority with the SEC over investment advisers (with either federal or state registration required depending on the amount of money under management).

The purpose of the effort at statutory revision announced by the SAC was twofold: (1) to make the statutory exempting clearer and more rational, with sufficient residual authority granted to the bureau chief to make flexible adjustments in response to market developments without the need for further statutory amendment and (2) to give the bureau substantially enhanced anti-fraud enforcement powers, including clarification of the substantive anti-fraud provision in the statue. This article identifies selected statutory revisions intended to respond to one or both of those purposes.

Exemptions and Exclusions

After 1986, New Jersey securities law generally required that offers and sales of securities be registered with the Bureau of Securities unless a state-law based statutory exemption was available. Thus, statutory exemptions are of particular importance. Section 60(b) of the old law (which had preserved a private placement exemption when other transactional exemptions were not available), is revised in the 1997 act.

Under new Section 60(b) a security may only be offered and sold in New Jersey when one of three conditions exists: (i) an exemption is available for the security under Section 50 (a) and/or the transaction under Section 50 (b); (ii) the offering is registered with the Bureau of Securities; or (iii) New Jersey law is preempted for a covered security under federal law, so long as a notice filing with applicable fees is made pursuant to Section 60.1 of the 1997 Act. Although the impact of the federal law amendments in NSMIA, which created the concept of covered security, materially reduced New Jersey’s jurisdiction, the state-law exemptions remain significant in a number of situations.

Section 50 (a) (11) under the old law exempted employee benefit plans, such as the issuance of stock options to employees, conditioned upon filing a written notice with the Bureau of Securities 30 days before the plan took effect. The notice filing, which was easily overlooked and of little administrative significance to the Bureau, frequently trapped the inattentive. In addition it was unclear whether the issuance of stock upon the exercise of stock options was also exempt. New Section 50 (a) (11) eliminates the need for a notice filing and expressly extends to securities issued pursuant to an employee benefit plan.

Section 50 (b) (9), the so-called small offering exemption, was limited to offers too not more than 10 persons. New Section 50 (b) (9) changes this to the far more objective and readily administrable standard of an offering A…which results in sales to not more than 10 persons. New Section 50 (b) (9) adds an express restriction that the securities cannot be sold by general solicitation and also gives the Bureau Chief some new powers, discussed below.

Section 50 (b) (12) is revised so that it may be used by sellers other than issuers and to require that the seller furnish any purchaser who is not an accredited investor with written disclosure material either as specified in Section 61 (b) or under an applicable Federal disclosure form. A seller must determine that any non-accredited investor purchaser has the both the ability to bear the risk and the ability to evaluate it. New Section 50 (b) (12) also cures an administrative problem. The old law required that a notice filing be made within 30 days of completion of the offering as a condition to the availability of the exemption. Sometimes the exemption was lost due to neglect, other times the Bureau did not learn about an offering which might have concerned it until after the offering was over. New Section 50 (b) (12) requires a notice filing within 15 days of the first sale and subsequent filings whenever there are material changes in the offering.

In a number of situations the bureau chief is given substantial and flexible authority to design exemptions by administrative action. This is intended to obviate the need for further Legislative enactment as the capital markets develop and/or specific situations arise over time. Some of those are noted here.

Under new Section 49 (b), the definition of agent, the bureau chief may by rule, i.e. regulation, or by order (which would apply in that matter only) waive the requirement of agent registration. New Section 49 (c), the definition of broker-dealer, expressly empowers the bureau chief to exclude by rule or order from the definition …such other persons not otherwise within the intent of this subsection… This revision parallels the existing authority of the bureau chief under Section 49 (g), the definitions of investment adviser, to exclude from registration persons otherwise literally within the definition. New Section 50 (a) (12) authorizes the bureau chief by rule or order to determine that any security or class of securities is exempt from New Jersey registration, either in the interest of uniformity among the several states and harmony with Federal exemption or when the Bureau Chief determines that such exemption is in the public interest.

New Section 50 (b) (9) allows the bureau chief by rule or order as to any transaction A… or class of transactions not only to eliminate or add conditions to the exemption (as in the old law), but also to increase or decrease the number of permitted purchases (not offers as before) and to waive the prohibition on general solicitation. New Section 50 (b) (13), similar to new Section 50 (a) (12), empowers the bureau chief by rule or order to adopt a transactional exemption for any transaction or class of transactions, either to further state uniformity and federal harmony or because the bureaus chief determines that public interest A…does not require registration [of the transaction or class of transactions].

New Section 51 (c) allows the bureau chief by rule or order to determine that an offer to sell or an offer to buy is not made in New Jersey, even if it originates from New Jersey or is directed by the offerer into New Jersey. This change was intended to give New Jersey enhanced regulatory flexibility to step aside, for example, in certain Internet-based transactions, where other federal or state securities regulators might better claim jurisdiction.

Section 56 (e) gives the bureau chief power to increase the scope of the exemption from registration as a broker-dealer under Section 56 (b), such as for example allowing a person to avoid registration while still effecting more than 15 transactions in 12 months or having more than five New Jersey accounts. Similarly, Section 56 (g) gives the bureau chief the authority to determine the availability of the exemptions…[from required registration as an investment adviser], including the waiver of the conditions…[to the availability of those exemptions].

Clarification (and Exposition) of Substantive Standards Applicable to Issuers, Transaction Participants and Industry Professionals

The civil liability provision in the prior law, has been almost completely rewritten as new Section 71. That new Section extends civil liability to purchasers of securities either where an unregistered person is involved or where the purchaser makes a material misstatement of fact or omits any material fact. Civil liability can, thus, be imposed on a seller or buyer of securities who: (i) makes a material misstatement or omission; (ii) employs any device, scheme or artifice to defraud; or (iii) engages in an act, practice or course of business which acts as a fraud or deceit. A person engaged in advising others for compensation on the value or advisability of investments or who issues reports on securities faces civil liability for (i) willful violation of the law or any bureau regulations (which would include a failure to register if required); (ii) employing any device, scheme or artifice to defraud; or (iii) engaging in any act, practice or course of business or conduct which operates as a fraud or deceit.

New Section 71(c) clarifies that rescission damages are available in both situations. New Sections 71(b)(1) and (2) set out the burden of proof and require a claimant to prove that the defendant acted (or failed to disclose) with a requisite intent to deceive.

In addition, new Section 53 gives the bureau chief the power to define dishonest and unethical practices by rule consistent and compatible with the SEC, and self-regulatory organizations and with uniformity among the states. New Section 53(f) makes it illegal for any person soliciting advisory clients to make any material misstatement or to omit any material fact.

New Enforcement Powers

Under new Sections 68.1 and 69 the bureau chief is given power to issue summary cease and desist orders for violation of the act and of bureau regulations or to enforce subpoenas.

Procedural safeguards built into Section 68.1 require the bureau chief to hear applications to lift any summary order on no less than 3 days notice. In addition, a person affected by the summary order may request a hearing before an administrative law judge within 15 days. These new sections materially change the old law, which required the bureau chief to apply to the superior court to enforce a subpoena or to obtain a temporary restraining order. The 1997 act also preserves the bureau chief’s ability to apply to the superior court for enforcement orders.

New Section 70.2 gives the bureau chief the authority to impose civil penalties of up to $10,000 for the first violation and up to $20,000 for each subsequent violation. This cured an enforcement dilemma under the old section which allowed discretion as to the amount of a penalty to impose only for the first two violations, with an automatic $20,000 penalty per violation for all violations above two. On at least one occasion the automatic civil penalty provisions forced the bureau to engage in extensive mathematical computations to justify the aggregate penalty.

Finally, new section 70.1 revises the criminal consequences of securities law violations. Consistent with New Jersey’s criminal code, if the violation knowing or reckless (rather than willful as in the old law), criminal sanctions may be imposed. If the amount involved is $75,000 or more, the violation is a crime of the second degree; if the amount is less than $75,000 then it is a crime of the third degree. Conviction of a second degree crime is punishable by a sentence of 5 to 10 years imprisonment and a fine of up to $150,000. Conviction of a crime of the third degree is punishable by a sentence of 3 to 5 years imprisonment and a fine of up to $15,000.

Conclusion

The securities markets are complex and ever-evolving. The relationship between federal and state jurisdiction in this area, an issue for over 67 years, was materially altered in 1996 with the passage of NSMIA. Nonetheless, state securities administrators and most particularly in New Jersey, the Bureau of Securities, retain major registration and compliance authority, as well as untrammeled anti-fraud enforcement authority. The 1997 act represents a collective effort of regulators, regulated industry members and their professional advisers to make the existing law work better and more clearly, to give the New Jersey regulators stronger and more comprehensive authority to attack securities fraud, and to build in flexibility to be able to adapt to future developments in the capital markets.

This article is reprinted with permission from the December 2000 issue of New Jersey Lawyer, the Magazine, a publication of the New Jersey State Bar Association.

END NOTES

1.The Uniform Securities Law (1967) was codified as New Jersey Statutes Annotated (AN.J.S.A.) 49:3-47 et seq. The Uniform Securities law (1997), which effectively replaced the 1967 law was treated for codification purposes as amending and supplementing the 1967 law, so that the 1997 Act is now codified (in place of the 1967 Law) as N.J.S.A. 49:3-47 et seq.
2. The SAC was created by action of the New Jersey Attorney General in September, 1993. The author is one of the founding members of the SAC and, since November 1994, has served as its Chair.

3. Pub. L. 104-290, title III, Oct. 11, 1996.

4. See, memorandum of The Hon. Franklin L. Widmann, Esq., Chief of the Bureau of Securities (unpublished), dated June 4, 1997 addressed to the author as Chair of the SAC, page 2 AII. Major Thrust of the Proposal, A. Enforcement Beefed Up and Exemptions Fixed. The author wishes to acknowledge the significant assistance provided by Chief Widmann’s Memorandum in preparing this Article. The author also notes that the views expressed in the Article are solely the author’s and do not purport to represent the views of Chief Widmann or of the New Jersey Bureau of Securities.

5. P.L. 1985, ‘405 effective April 9, 1986, codified in N.J.S.A. 49:3-60, especially the amendment of Section 60(b) and the deletion of Sections 60(c) and (d).

6. N.J.S.A. 49:3-60.

7. N.J.S.A. 49:3-50(a)(11).

8. Ibid.

9. N.J.S.A. 49:3-50(b)(9) (emphasis added).

10. Ibid.

11. N.J.S.A. 49:3-50(b)(12).

12. Ibid.

13. N.J.S.A. 49:3-49(b).

14. N.J.S.A. 49:3-49(c).

15. N.J.S.A. 49:3-49(g).

16. N.J.S.A. 49:3-50(a)(12).

17. N.J.S.A. 49:3-50(b)(9).

18. N.J.S.A. 49:3-50(b)(13). The March 24, 1998 Order of the Bureau Chief which permits offers and sales to accredited investors in New Jersey using public solicitation is an example of the type of administrative flexibility provided by Section 50(b)(13). The Order is set forth at 2A CCH Blue Sky L. Rpts. &40,691F. Note that the Order does have significant limitations (no blind pools, reasonable basis to believe no intended redistributions, not usable by an insider, an underwater or an affiliate of either, and not available to a bad boy), reflecting considerable caution in exercising the new authority.

19. N.J.S.A. 49:3-51(c).

20. N.J.S.A. 49:3-56(e).

21. N.J.S.A. 49:3-56(g).

22. N.J.S.A. 49:3-71.

23. Ibid.

24. Ibid.

25. N.J.S.A. 49:3-71(c).

26. N.J.S.A. 49:3-71(b)(1) and (2).

27. N.J.S.A. 49:3-53.

28. N.J.S.A. 49:3-53(f). Note that a solicitor is required under New Jersey law to register as an investment adviser, even though not required to register under Federal law. New Jersey Bureau of Securities No-Action Letter, May 19, 1992, 2A CCH Blue Sky L. Rpts. 40, 610.

29. N.J.S.A. 49:3-68.1 and 69.

30. N.J.S.A. 49:3-68.1.

31. Ibid.

32. N.J.S.A. 49:3-68 and 69.

33. N.J.S.A. 49:3-70.2.

34. In the Matter of Elliot Lloyd Bellen et al. 92 N.J.A.R. 2d (BOS) 1, 24-25 (see especially footnote 21 and related text).

35. N.J.S.A. 49:3-4970.1.

36. Ibid.

37. N.J.S.A. 2C:43-3 and 4306.

38. Ibid.