by David Cosgrove
This is a general overview of the dozens of state statutes specifically applicable to the retail sale of precious metals. This overview is not intended to, nor does it provide legal advice to any specific wholesaler, retailer or other entity. Nor does it review all laws that may be implicated by the varied conduct of retailers, such as merchandising, advertising, telemarketing laws, or federal laws. The state statutes implicated by the retail sale of precious metals may be a state’s securities code, commodities code, if enacted, or a combination of both.
In analyzing whether the retail sales of precious metals may be in compliance or violation of the securities laws of a state, the threshold issues is whether the products offered by the retailer are considered “securities” under the various securities laws of each state. In most states, the securities laws do not declare whether precious metals are considered “securities”. However, most states do have a catchall category, “investment contracts,” which covers products not otherwise specifically enumerated in the securities laws under the definition of a security. Therefore one is required to analyze whether a retailer’s product would fall under the definition of an “investment contract,” and thus be considered “securities” under the state’s securities laws.
In most states, the securities laws rely on the Howey Test (defined below), the Forman Test (defined below), the Risk Capital Test (defined below), or some combination thereof, as noted in the following survey. However, if the state’s definition of a security includes the retailer’s products, then one need not resort to and apply the foregoing tests. Rather, one must find a separate exemption and/or register the security with the state.
In analyzing whether a retailer is in violation of the commodities laws of a state, the threshold issues are (a) whether the state has specific commodities laws, and/or (b) if such commodities laws are included under the state’s securities laws, whether such commodities laws provide requirements distinct from the securities laws.
In most states that have separate commodities laws, a retailers products would likely be considered commodities, and without an exemption, the retailer would be required to register with the CFTC or the state equivalent prior to selling such commodities. However, in all states that have commodities laws, the states’ laws provide exemptions from registration if certain steps or actions are taken. We recommend that retailers consult with qualified counsel for a retailer-specific analysis to ensure that its business practices allow it to claim one of the exemptions under the commodities laws of each particular state.
The Howey/Forman Test
Most states follow two U.S. Supreme Court cases when interpreting “investment contract” under their state securities laws. The Court interpreted “investment contract” under federal securities laws as “(1) a contract, transaction, or scheme whereby a person invests his money (2) in a common enterprise, and (3) is led to expect profits solely from the efforts of the promoter or a third party”¹ (“Howey Test”). The Supreme Court later modified the third requirement, holding that in spite of the term “solely,” what is necessary is only “a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others”² (“Forman Test”).
The typical precious metals retail business does not meet the second and third prongs of the Supreme Court test, under Howey or the more expansive definition under Forman. There is no common enterprise because, even if a retail customer buys metals for investment purposes, this investment is not “interwoven with and dependent on the fortunes of others.”³ The success of that investment depends on the market for the particular metal, not the actions or fortunes of the retailer or other retail customers. Under the third prong, a retail customer who purchases coins for investment purposes cannot reasonably expect to receive profits from the managerial efforts of the retailer. Only the market for a particular metal can determine if a retail customer will make a profit.
Several states have adopted the Risk Capital test, either in addition to Howey or instead of it.4 States applying Risk Capital purport to focus more attention on the investor’s expectations, rather than the conduct and activities of the seller.5 Despite these claims, the elements and application of the Risk Capital test are very similar to the Howey/Forman test: (1) an offeree furnishes initial value to an offeror, (2) a portion of this initial value is subjected to the risks of the enterprise, (3) the furnishing of the initial value is induced by the offeror’s promises or representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the initial value, will accrue to the offeree as a result of the operation of the enterprise, and (4) the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise.
The above elements, or a variation thereof, are used in most states that have adopted the Risk Capital test. A typical retailer is not likely to be found to be selling securities in states that apply the Risk Capital test: the typical retailer does not subject investors’ money to the risks of it’s enterprise, and investors’ benefits, if any, accrue based upon market forces, not upon the operation of the retailer’s enterprise.
State Commodities Laws
About half the states have adopted a Commodities Code.6 A few additional states’ securities statutes include “commodity” within the definition of securities.
If a state has a commodities code, the sale of a precious metal is a commodity unless it fits into an exception. Most states include gold, silver, platinum, palladium, and copper in the definition of precious metals. Most commodities codes exclude numismatic coins from the definition of commodity. A numismatic coin is usually defined as a coin whose fair market value is at least 15% higher than the value of the metal it contains. Furthermore, most commodities codes prohibit commodity contracts unless the seller is registered with the CFTC. A commodity contract is typically defined as an account, agreement, or contract for the purchase or sale of a commodity, primarily for investment purposes.
In most states, however, a contract is not a commodity contract if it requires physical delivery of the commodity to the purchaser within 28 days of payment of any portion of the purchase price, and the purchaser actually received the commodity within 28 days.
However, contracts for precious metals are sometimes specifically and separately addressed. Commodities contracts for precious metals are generally exempt from regulation if delivery of the metal meets deadlines that vary among the states. Delivery can be specifically segregated or in fungible bulk form7 to a depository that is not the seller. Generally, the practice of placing investor coins into general accounts at the depository and keeping a record that an individual investor is entitled to a certain quantity, grade and type of coin usually constitutes delivery in “fungible bulk form”. However, if the retailer itself is the depository, the retailer would not qualify under the exemption. Additionally, depending on the state, some or all approved depositories must meet certain requirements.8
Accordingly, retailers should be cautious in states with specific commodities law: (1) when the retailer sells items other than numismatic coins; and (2) when the retailer contracts do not require delivery within the specified time frame or when the depository does not meet the requirements under the state’s laws. Finally, most commodity codes have an outright ban on the use of margin accounts in the absence of CFTC registration.
Commodities have become popular investments for the general public. We expect additional states to adopt Commodities Codes to regulate the sale of precious metals. The law in this area is ever changing and in a process of expansion. Based on our results, twenty-five states our of the fifty-one jurisdictions total have Commodities Codes, or a similar law, with specific requirements that pertain to the retailers by reason of selling precious metals.
Commodities Transactions—Margin and Leverage Contract
For states that do allow margin or leverage precious metals contracts, the state commodity codes require physical delivery to take place within seven days from payment of any portion of the purchase price. The amount paid for must be delivered to a financial institution, approved depository or approved storage facility. The depository and storage facility requirements must meet the same requirements as those for exempt commodities transactions discussed above. Therefore, for margined and leveraged precious metals transactions under state law, the delivery period is shortened from 28 days to 7 days, but the storage requirements are the same.
However it is important to understand that the recent federal financial reform legislation (“Frank-Dodd Act”) brings certain commodity contract transactions under the direct purview of the CFTC. More specifically, it prohibits parties from entering into, or offering to enter into, any commodity transaction on a leveraged or margined basis unless “actual delivery” occurs within 28 days or “creates an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery” of the commodity in connection with their line of business. This exception is not tailored specifically to precious metal transactions, but covers all margin and leverage commodity contracts. However, nothing in the Frank-Dodd Act nor the Commodity Exchange Act defines the terms “seller”, “buyer”, or “actual delivery”. Further, this provision makes no mention of any depository or storage requirements, like in the state commodities laws.
These new requirements will likely pre-empt any state requirements of such transactions. Although it is currently unknown how the courts or the CFTC will interpret these new requirements, these requirement may essentially prohibit individual consumers from purchasing and storing commodities acquired through the use of margin or leverage contracts. The discrepancy in the length of time allowed for delivery and storage requirements has yet to be resolved. State law requires delivery to a depository within 7 days, but the new federal law requires delivery within 28 days, but provides nothing for storage. Accordingly, retail commodity dealers should be careful when providing commodities transactions on margin or through leverage.
Individual State Analysis*
The Cosgrove Law Group has produced a voluminous table that includes is a state-by-state assessment of the relevant securities laws and commodities laws, conclusions as to whether a retailer may be found to be in violation of either, and any general recommendations necessary for potential compliance within the securities laws and commodities laws of each state. Again, this overview is not intended to evaluate the current compliance status of any particular retailer or its varied practices and procedures.
Some specific issues worth highlighting include: (1) only two states, MO and NM, explicitly ban the use of margin accounts in sales of commodities, (2) meeting the exclusion from the “MDDC” definition under Illinois law would be beneficial, so we suggest how to do so with full physical delivery within 28 days, (3) as to the Indiana securities registration requirement applied to commodities, we do not recommend, but one should at least consider, a letter request to Indiana’s Commissioner, (4) meeting the “qualified seller” definition under Iowa law is crucial for gaining the exemption for precious metals commodity contracts, (5) a retailer might avoid the definition of “security” in its actions and we provide general recommendations, (6) general observations on how retailers might avoid New Hampshire’s “investment metal contract” definition, which triggers its securities laws, (7) retailers may need to file a registration statement with N.Y. Attorney General, (8) the Rhode Island precious metals sales law may not be implicated by certain practices, (9) Minnesota adopted an expansive regulatory regime for bullion coin dealers in 2013, and (10) Utah law requires special attention.
Frequently, states that do not have commodities codes may have municipalities or counties that impose registration or licensure obligations on businesses wishing to purchase or sell precious metals or gem stones within that given jurisdiction. Requirements vary, but generally include submittal of a business license form, background check, fee, and/or special arrangement with the commission of revenue within that jurisdiction. Motivation for such requirements stems from tax revenue implications. Cosgrove Law Group, LLC is able to conduct further research on a county and municipality basis. Please contact us should you need this additional research performed.
¹ Sec. and Exch. Comm’n v. Howey, 328 U.S. 293, 298-99 (1946) (numbering added).
² United Hous. Found., Inc., v. Forman, 421 U.S. 837, 852 (1975).
3 State v. Reber, 977 S.W.2d 934 (Mo. App. S.D. 1998).
4 Hawaii’s formulation of this test has become the model for most states that use Risk Capital. Hawaii Comm’r of Sec. v. Hawaii Market Center, 485 P.2d 105 (Haw. 1971).
5 Hawaii Market, 485 P.2d, at 109
6 Based on the Model State Commodity Code created by the North American Securities Administrators Association.
7 Black’s Law Dictionary defines “fungible” as “commercially interchangeable with other property of the same kind,” and “bulk” as “not divided into parts.”
8 For example, most states have a provision similar to the following: “For purposes of this subsection, physical delivery shall be deemed to have occurred if the depository does not belong to the seller or an affiliate, and is either (I) a financial institution, (ii) a depository, the warehouse receipts of which are recognized for delivery purposes for any commodity on a contract market designated by the Commodity Futures Trading Commission, (iii) a storage facility licensed or regulated by the United States or any agency thereof, or (iv) a depository designated by the director. Depending on the state, it is required that the depository issues and the purchaser received, a certificate, document of title, confirmation, or other instrument evidencing that the total quantity of precious metals purchased has been delivered to the depository and is being and will continue to be held by the depository on the purchaser’s behalf, free and clear of all liens and encumbrances, other than liens of the purchaser, tax liens, liens agreed to by the purchaser, or liens of the depository fees and expenses, which have previously been disclosed to the purchaser.”
* Contact David B. Cosgrove at Cosgrove Law Group, LLC for legal advice regarding your individual business or a specific evaluation of the specific products and services you are offering or for assistance on developing compliance or best business practices. Contact Cosgrove Law, LLC or other legal counsel immediately if you have received an inquiry or demand from any Government Agency. Finally, Cosgrove Law Group, LLC is also experienced in the effective resolution of customer disputes and complaints.