By Jay Fishman, J.D.
Senior Writer Analyst, CCH, Inc.
It has been four years since the National Conference of Commissioners on Uniform State Laws adopted the Model Uniform Securities Act of 2002 and yet since that time only 10 jurisdictions out of 54 have adopted it: Missouri (2003); Idaho, Iowa, Oklahoma, South Dakota (2004); Kansas, Maine, South Carolina, Virgin Islands (2005); and Vermont (2006). Hawaii and Minnesota are slated to adopt the Act in 2007 and Washington State in 2008. Adding fuel to the fire, the National Securities Markets Improvement Act of 1996 essentially told the states that their non-uniformity would be punished by federal preemption; the 1999 Gramm Leach Bliley Act evidenced the need to regulate the securities, insurance and banking industry altogether because of each industry’s escalating cross-over activities into the others’ territory; and globalization of the world economy came to prominence at the dawn of the Twenty-First Century. With all of these events converging over a short five-to-seven year period, one would think all the state securities commissions would eagerly adopt the Model Act to have in place provisions for regulating these new activities and to demonstrate a continuing move toward uniformity as proof to the SEC that any further federal preemption is wrong.
Yet an Act whose thoroughness largely succeeds in capturing today’s securities trends is still not adopted by a majority of jurisdictions four years after it’s adopted as a model act. Why? The primary reason comes down to two provisions and it’s most interesting—and ironic—because these provisions, while in a securities act, primarily impact the banking and insurance industries. As the impact has been seen as negative, the banking industry lobbied to strike the “banking” provision while the insurance industry lobbied to strike the “insurance” provision, resulting in both industries so far successfully stalling the entire Act’s passage in many jurisdictions that had considered adopting it.
Banking provision. The Model Uniform Securities Act of 2002 contains two banking provisions, one in the definition section and one in the exemption section. The provision in the exemption section is a modernized version of the old banking exemption from the 1956 Uniform Securities Act and is not particularly controversial.
The controversial provision is an exclusion from the definition of “broker-dealer.” A “broker-dealer” does not include, among other listed persons and entities:
“a bank or savings institution if its activities as a broker-dealer are limited to those specified in subsections 3(a)(4)(B)(i) through (vi), (viii) through (x), and (xi) if limited to unsolicited transactions; 3(a)(5)(B); and 3(a)(5)(C) of the Securities Exchange Act of 1934 (15 U.S.C. Sections 78c(a)(4) and (5)) or a bank that satisfies the conditions described in subsection 3(a)(4)(E) of the Securities Exchange Act of 1934 (15 U.S.C. Section 78c(a)(4)); an international banking institution; or a person excluded by rule or order issued under this Act.”
The above provision is controversial and seen by the banking industry as having a negative impact because it is more restricted than the broker-dealer definition exclusion for banks in the Securities Exchange Act of 1934. The 1934 Act excludes banks from the broker-dealer definition when they make private securities offerings under section 3(b), 4(2) or 4(6) of the Securities Act of 1933. The Model Uniform Securities Act of 2002 does not grant this exclusion from the definition of broker-dealer for banks. The other departure occurs with de minimis exclusion in the 1934 Act for banks that effect no more than 500 transactions in securities in any calendar year (other than transactions made under any of the other exclusions), provided these “no more than 500 transactions” were not effected by an employee of the bank who is also an employee of a broker or dealer. The Model Uniform Securities Act of 2002 limits this exclusion to unsolicited transactions.
Insurance provision. The insurance provision even more than the banking provision has been the single greatest reason for failure to adopt the Model Act in many jurisdictions. What makes this provision so contentious is that it revolves around variable annuities, a risky investment. As with the banking provision, there are actually two provisions in the Model Uniform Securities Act, one in the exemption section and one in the definitions section. The provision in the exemptions section is not particularly controversial. The controversial provision is in the definition section--it is an exclusion from the definition of a “security.” Specifically, the Model Act excludes from the definition of a security:
“an insurance or endowment policy or annuity contract under which an insurance company promises to pay a fixed [or variable] sum of money either in a lump sum or periodically for life or other specified period.”
Historically, variable annuities were regulated solely by the insurance industry but in the age of Gramm Leach Bliley, securities broker-dealers and agents have begun to sell these products to investors, causing a stir by the securities industry that now asserts its own right to regulate variable annuities. In truth, variable annuities can be great investments for persons in particular financial circumstances that favor them, but the complexity of these products combined with the high commissions on them create a conflict of interest for the sales representatives. The reps. have begun a practice of holding free lunch seminars to discuss variable annuities with attendees, resulting in many sales made to unsuitable persons. In the last two or three recent years this trend toward unsuitable has snowballed, with horror stories of people losing their life savings. Many of the victim have been senior citizens.
The fraud to seniors has escalated the fight by the securities industry for control of variable annuities. At the state level, the Model Act of 2002 was drafted to give states the option to include or exclude variable annuities from their securities definition. But the insurance industry has fought back with a huge lobbying effort to prevent states contemplating adoption of the Model Act from including variable annuities within their “security” definition, and this insurance industry effort has been largely successful because nine of the ten “adopting” states have adopted the Act with an exclusion for variable annuities. Furthermore, the insurance industry has stalled adoption of the entire Act in many other jurisdictions, e.g., Hawaii, because of the variable annuities provision. Whether the insurance industry will try to repeal the Act of the one state—Vermont—that does include variable annuities in its securities definition remains to be seen.