CHAPTER 2
Definition of Terms

INTRODUCTION

In order to successfully complete the Series 63 exam, it is important to have an in-depth understanding of the terms used within the securities industry—specifically within the framework of the Uniform Securities Act. The terms used by the USA, also known as the Act, may have broader meanings than we are accustomed to in everyday usage.

Security

A security is anything that can be exchanged for value that involves a risk to the holder. A security also represents an investment in an entity managed by a third party. The Howey test was used by the Supreme Court to determine whether something is a security. The test states that a security must meet the following four characteristics:

1. It must be an investment of money.
2. It must involve a common enterprise.
3. It must give the investor an expectation of a profit.
4. It must entail the management of a third party.

The following are examples of securities:

• Stocks
• Bonds
• Notes
• Debentures
• Evidence of indebtedness
• Transferable shares
• Warrants, rights, or options for securities

Most times when you see the term “certificate,” you have a security that is a:

• Certificate of interest in profit sharing or a partnership agreement.
• Preorganization certificate.
• Collateral trust certificate.
• Voting trust certificate.
• Certificate of interest in oil or a gas mining title.
• Certificate of deposit for a security, such as an American depositary receipt (ADR) or an American depositary share (ADS).

The term “variable” will also identify a security, as in:

• Variable annuity
• Variable life insurance
• Variable contract

The phrase “interest in” is another key to identifying a security on the Series 63 exam. All of the following are securities:

• Farmland and animals
• Whiskey warehouse receipts
• Commodity options (not futures)
• Insurance company separate accounts
• Real estate condominiums or cooperatives
• Merchandise marketing programs, franchises, or schemes
• Multilevel distributorships, such as Amway

The term “option” is also a good way to identify a security, such as:

• Stock option
• Index option
• Futures option
• Commodity futures option

The following are not considered securities:

• Real estate
• Retirement plans, such as IRAs and 401(k)s
• Bank accounts
• Collectibles
• Precious metals
• Fixed annuities/fixed contracts
• Whole and term life policies
• Antiques
• Futures contracts (commodities)
• Trade confirmations
• Prospectuses

The term “future,” when it appears alone, is an indication that a security is not involved. However, if the question is asking about a commodity future option or a single stock future, then a security is involved. Also the term “fixed” is a good indication that a security is not involved. If a person commits a fraudulent act in the sale of an investment that is not deemed to be a security, then that person has not violated securities laws but rather has committed a fraudulent act in violation of other state and federal laws.

Person

The term “person,” as it is used in the USA, refers to any entity that may enter into a legally binding contract. Any entity that can enter into a legally binding contract may transact business in the securities markets. Agreeing to buy or sell a security represents a legally binding contract. For the Series 63, a person is any of the following:

• Natural person
• Corporation
• Trust
• Government organization
• Partnership
• Joint stock company
• Sole proprietor
• Association
• Unincorporated organization

A nonperson is an individual or entity that may not enter into a legally binding contract and therefore may not transact business in the securities market. The following are examples of nonpersons:

• A minor
• Someone deemed to be legally incompetent
• A deceased individual

Broker Dealer

A broker dealer is a person or a firm that maintains a place of business and affects transactions in the securities markets for its own account or for the account of others. A broker dealer must be registered in its home state as well as in the states of its “individual” clients. A broker dealer is not:

• An agent.
• A bank.
• A savings and loan.
• A person with no place of business in the state, who deals exclusively with financial institutions or issuers.
• A person with no place of business in the state who conducts business with existing clients who do not reside in the state and are in state for less than 30 days.

Agent

An agent or registered representative may only be an individual (natural person) who represents the issuer or a broker dealer in the purchase and sale or the attempted purchase and sale of securities with the public. Agents are required to register in their home state, their state of employment, and the state of residence of their customers. An agent is not required to register if:

• They represent the issuer or a broker dealer in an underwriting transaction.
• They represent a bank or a savings and loan in the issuance of securities.

Agents who represent exempt issuers are not required to register. Examples of exempt issuers are:

• U.S. government
• State and municipal governments
• Canadian federal and municipal governments
• Commercial paper with maturities of less than 270 days, sold in denominations exceeding $50,000
• Investment contracts associated with employee pension plans, profit sharing, stock purchase, or savings plans
• Foreign national governments recognized by the United States

Issuer

An issuer is any person that issues or simply proposes to issue a security. Issuers include:

• Corporations.
• U.S. government and agencies.
• State and local governments.

In an issuer or primary transaction, the issuer receives the proceeds from the sale.

Nonissuer

A nonissuer is any entity that does not issue or propose to issue a security. All secondary market transactions that take place on an exchange or in the over-the-counter (OTC) market are nonissuer transactions, and the selling security holder receives the proceeds from the sale.

Investment Adviser

An investment adviser is any person who is actively involved in and receives a fee for any of the following:

• Issuing research reports or analysis
• Publishing a market letter based on market events
• Advising clients as to the advisability of the purchase or sale of a security
• Providing investment advisory services as a complement to their services and claiming to provide such services for a fee
• Presenting themselves as investment advisers, also known as the shingle rule
• Pension consultants

Pension Consultants

A pension consultant is anyone who advises employees on how to fund their employee benefit plan. A person would also be considered to be a pension consultant if he or she advises the employees on the selection of asset managers or investment advisers for the plan.

An investment adviser is not:

• A bank or savings and loan.
• A broker dealer.
• An agent.
• A lawyer, accountant, teacher, engineer (LATE) whose services are ­incidental to their business and who do not receive a specific fee for such services.
• Any person exempted by the administrator.
• A federally covered adviser.
• Publishers of newspapers and magazines.

Investment Counsel

The investment Advisers Act of 1940 provides a strict definition as to which professionals may call themselves an investment counsel. An investment counsel must be principally in the business of giving continuous investment advice and must supervise or manage the accounts. The Act does not define how much of the professional's time must be dedicated to providing advice, just that the professional's principal business is giving advice. A key to meeting the definition of an investment counsel are the key words “continuous and regular supervisory or management services.” A professional who provides a wide range of services indicates that the professional in question is not principally involved in giving investment advice.

Form ADV

An investment adviser will begin the formal registration process by filing Form ADV. The ADV form will provide detailed information regarding the investment adviser. The form has four parts: Part 1A, Part 1B, Part 2A, and Part 2B. Form ADV Parts 2A and 2B are provided to clients.

ADV Part 1A provides general information about the investment adviser, including:

• The principal office address.
• Information regarding direct owners.
• Type of organization, such as corporation or partnership.
• How the adviser will conduct business.
• If the firm engages in other activities, such as that of a broker dealer.
• Biographical data on the officers,...