Civil and Criminal Liability, and Preparing for the Exam

The civil remedy

A person who sells a security in violation of the registration provisions, or who sells by means of an untrue statement of a material fact or an omission of a material fact necessary to make statements not misleading — where the buyer did not know of the untruth or omission — is liable to the buyer.

The seller has a defence, and it is an affirmative one with the burden on the seller: proving that they did not know, and in the exercise of reasonable care could not have known, of the untruth or omission. That defence is not available at all for a violation of the registration provisions, which is strict.

The remedy where the buyer still owns the security is rescission: on tender of the security and any income received on it, the buyer recovers the consideration paid, plus interest from the date of payment, plus costs and reasonable attorneys' fees, less the amount of any income received on the security.

Memorize that as four items in, one item out: price, interest, costs, attorneys' fees — minus income received.

Where the buyer no longer owns the security, the remedy is damages: the amount recoverable on a tender, less the value of the security when the buyer disposed of it, plus interest from the date of disposition.

Note what the measure is not. It is not the market loss. A buyer who paid $10,000 for a security now worth $9,000 recovers $10,000 plus interest, costs and fees on tender — not $1,000.

A tender may be made at any time before entry of judgment, and every cause of action under the section survives the death of a plaintiff or defendant.

Who else is liable

Section 410(c) extends liability well beyond the individual who made the sale.

Jointly and severally liable, to the same extent as the primary violator, are: every person who directly or indirectly controls that person, including every partner, officer or director and everyone occupying a similar status or performing similar functions; every employee of that person who materially aids in the conduct; and every broker-dealer or agent who materially aids in it.

Each of them has the same affirmative defence — proving they did not know and in the exercise of reasonable care could not have known of the facts giving rise to the liability. And there is contribution among those liable, as in contract.

So a supervisor, a firm and an agent who materially assisted can each be sued for the whole amount, and each must prove their own lack of knowledge and reasonable care. That is why supervisory systems exist and why materially aiding a sale you have doubts about is not a neutral act.

Limitation periods and the letter of rescission

No action may be brought under section 410 more than three years after the contract of sale or the rendering of investment advice, or more than two years after discovery of the facts constituting the violation, whichever occurs first.

Read the last three words carefully. It is whichever comes first, so the outside limit is three years from the sale and the inside limit is two years from discovery. A buyer who discovers the problem two and a half years after the sale has six months, not two years.

Criminal prosecution has its own period: no indictment or information may be returned more than five years after the alleged violation.

The letter of rescission is the seller's way out. If, before suit and while the buyer still owns the security, the buyer receives a written offer to refund the consideration paid plus interest, less any income received, and fails to accept within thirty days of receipt, the buyer may not sue. Where the buyer no longer owns the security, an equivalent offer bars suit unless the buyer rejects it in writing within thirty days.

So a firm that discovers it has made a defective sale can extinguish the liability by offering the money back promptly. Thirty days is the number, and the buyer's silence counts as acceptance of the bar in the first case and as acceptance of the offer's effect generally.

One more provision worth knowing: a condition, stipulation or provision binding a person to waive compliance with the Act is void. A customer cannot agree in advance to give up these remedies, and a firm that puts such a clause in an account agreement has not achieved anything.

Criminal penalties

Section 409 provides that any person who willfully violates any provision of the Act — except the section on filing false statements, which has its own knowledge requirement — or who willfully violates any rule or order under it, shall on conviction be fined not more than $5,000 or imprisoned not more than three years, or both.

The number pair to memorize is $5,000 and three years, and the qualifier is willfully. No person may be imprisoned for violating a rule or order if they prove they had no knowledge of it.

The Administrator does not prosecute. The Administrator may refer available evidence to the attorney general or the proper district attorney, who may — with or without a referral — institute criminal proceedings.

And nothing in the Act limits the state's power to punish conduct that is a crime under other statutes or at common law. Fraud remains fraud regardless.

So the three layers of consequence for a single course of conduct: administrative — denial, suspension, revocation, bar, censure, cease and desist; civil — rescission or damages, with the firm and supervisors jointly liable; and criminal — a fine and imprisonment on a willful violation. They are cumulative, not alternative.

A three-week plan

The Series 63 is short, concentrated and heavily weighted toward conduct. Three weeks at a few hours a week is realistic for someone who has recently sat the SIE or the Series 7, and most candidates take it within a few weeks of a top-off exam while the compliance material is fresh.

Week 1 — Modules 1 and 2. The Act's structure, the definitions and registration. The definitions do more work here than in any other securities exam, so spend the time. End the week by writing out the four regulated categories and their exclusions from memory.

Week 2 — Module 3. Communications, agreements, compensation, custody, discretion and prohibited practices. This is 45 percent of the exam in one module. Read NASAA's Statement of Policy on Dishonest or Unethical Business Practices straight through — it is five pages and it is a list of exam answers.

Week 3 — Module 4 and consolidation. Enforcement and liability, then practice exams. Take at least two full-length timed practice exams on different question sets, with error analysis between them.

Throughout, use retrieval rather than rereading: close the material and write down the enumerated practices, the definitions and the numbers before checking. The evidence on this is strong and it contradicts how the material feels — rereading produces confidence without retention.

The numbers worth memorizing as a block, because the exam asks for them directly: registration effective at noon on the thirtieth day; registrations expire December 31; withdrawal effective in thirty days with one year of retained jurisdiction; summary suspension hearing within fifteen days of a written request; private placement limit of ten non-institutional offerees in twelve months; adviser de minimis of five non-institutional clients in twelve months; civil action within three years of the sale or two years of discovery, whichever is first; rescission offer refused within thirty days; criminal penalty of $5,000 and three years; prosecution within five years; and the exam's own 65 questions, 60 scored, 75 minutes, 43 to pass, with 30/30/180-day retake waits.

And one habit that pays for itself: for every fact pattern, ask first which defined term applies. Most questions on this exam are decided at that step and not at the rule.