Securities Regulation
Definition of Security
(last updated 31 Jan 13)
Clay Wheeler
Statutory definition
Securities Act § 2 Definitions
When used in this subchapter, unless the context otherwise
requires-(1) The term "security" means any note, stock, treasury
stock, bond, debenture, evidence of indebtedness,
certificate of interest or participation in any profitsharing agreement, collateral-trust certificate,
preorganization certificate or subscription, transferable
share, investment contract, voting-trust certificate,
certificate of deposit for a security, fractional
undivided interest in oil, gas, or other mineral rights,
any put, call, straddle, option, or privilege on any
security, certificate of deposit, or group or index of
securities (including any interest therein or based on
the value thereof), or any put, call, straddle, option, or
privilege entered into on a national securities exchange
relating to foreign currency, or, in general, any interest
or instrument commonly known as a "security", or any
certificate of interest or participation in, temporary or
interim certificate for, receipt for, guarantee of, or
warrant or right to subscribe to or purchase, any of
the foregoing.
Statutory definition
Enumerated
“Catch all”
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note,
stock,
treasury stock,
bond,
debenture,
collateral-trust certificate,
preorganization certificate or
subscription,
voting-trust certificate,
fractional undivided interest in oil, gas,
or other mineral rights,
any put, call, straddle, option, or
privilege on any security, certificate of
deposit, or group or index of securities
(including any interest therein or based
on the value thereof),
any put, call, straddle, option, or
privilege entered into on a national
securities exchange relating to foreign
currency,
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evidence of indebtedness,
certificate of interest or participation in
any profit-sharing agreement,
transferable share,
investment contract,
certificate of deposit for a security,
interest or instrument commonly
known as a "security",
certificate of interest or participation in,
temporary or interim certificate for,
receipt for, guarantee of, or warrant or
right to subscribe to or purchase, any
of the foregoing.
SEC v. HJ Howey Co
(US 1946)
“Howey test”
Supreme Court:
… an investment contract for
purposes of the Securities Act
means a contract, transaction or
scheme whereby a person invests
his money in a common enterprise
and is led to expect profits solely
from the efforts of the promoter or
a third party, it being immaterial
whether the shares in the
enterprise are evidenced by formal
certificates or by nominal interests
in the physical assets employed in
the enterprise.
“Howey test”
Supreme Court:
… an investment contract for
purposes of the Securities Act means
a contract, transaction or scheme
whereby
[1] a person invests his money
[2] in a common enterprise and
[3] is led to expect profits
[4] solely from the efforts of the
promoter or a third party,
Some hypotheticals …
Security?
A
An investor buys
shares of Citrus
Corporation, a firm
that owns citrus
groves in Florida and
that harvests and
markets citrus fruits.
B
C
An investor buys a row
of citrus trees from
W.J. Howey
Company. Howey-inthe-Hills, a related
service company,
cares for the grove
and harvests/markets
the crop.
An investor buys a
citrus grove in Florida
and contracts with a
local farmer, Jones, to
manage the
farm. Jones does all
the cultivation/
harvesting/marketing.
Shareholders
Investors
corporation
Investor
Mgmt
company
Trees
Farmer
Jones
Grove
Apply Howey test …
investment contract … means
[1] a person invests his money
[2] in a common enterprise and
[3] is led to expect profits
[4] solely from the efforts of the promoter or a
third party,
Intl Bro. of Teamsters v. Daniel
(US 1979)
Statutory definition
Exchange Act § 3. Definitions and application
(a) Definitions. When used in this chapter, unless the
context otherwise requires-(10) The term "security" means any note, stock,
treasury stock, bond, debenture, certificate of interest or
participation in any profit-sharing agreement or in any
oil, gas, or other mineral royalty or lease, any collateraltrust certificate, preorganization certificate or
subscription, transferable share, investment contract,
voting-trust certificate, certificate of deposit, for a
security, any put, call, straddle, option, or privilege
on any security, certificate of deposit, or group or index
of securities (including any interest therein or based on
the value thereof), or any put, call, straddle, option, or
privilege entered into on a national securities exchange
relating to foreign currency, or in general, any
instrument commonly known as a "security"; or any
certificate of interest or participation in, temporary or
interim certificate for, receipt for, or warrant or right
to subscribe to or purchase, any of the foregoing; but
shall not include currency or any note, draft, bill of
exchange, or banker's acceptance which has a maturity
at the time of issuance of not exceeding nine months,
exclusive of days of grace, or any renewal thereof the
maturity of which is likewise limited.
Intl Bro. of Teamsters v. Daniel
Supreme Court:
“An employee who participates in a
noncontributory, compulsory pension
plan by definition makes no payment
into the pension fund.”
“The existence of this comprehensive
legislation [ERISA] governing the use
and terms of employee pension plans
severely undercuts all arguments for
extending he Securities Acts to
noncontributory, compulsory pension
plans.”
Justice Lewis Powell
“Howey test (modified)”
Supreme Court:
investment contract … means
[1] a person invests his money
[2] in a common enterprise and
[3] is led to expect profits
[4] solely from the efforts of the
promoter or a third party,
[5] not subject to comprehensive
legislative scheme
Apply Howey test …
investment contract … means
[1] a person invests his money
[2] in a common enterprise and
[3] is led to expect profits
[4] solely from the efforts of the promoter or a
third party,
[5] not subject to comprehensive legislative scheme
Apply Howey …
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
[1] invest
money
[2] in common
enterprise
[3] led to
expect profits
[4] from efforts
of others
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
[1] invest
money
[2] in common
enterprise
[3] led to
expect profits
[4] from efforts
of others
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
[1] invest
money
[2] in common
enterprise
[3] led to
expect profits
[4] from efforts
of others
Paid cash
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
[1] invest
money
Paid cash
[2] in common
enterprise
Horizontal
[3] led to
expect profits
[4] from efforts
of others
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
[1] invest
money
Paid cash
[2] in common
enterprise
Horizontal
[3] led to
expect profits
Not game
[4] from efforts
of others
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
[1] invest
money
Paid cash
[2] in common
enterprise
Horizontal
[3] led to
expect profits
Not game
[4] from efforts
of others
Primarily
promoters
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
[1] invest
money
Paid cash
Bought
“stock”
[2] in common
enterprise
Horizontal
[3] led to
expect profits
Not game
[4] from efforts
of others
Primarily
promoters
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
[1] invest
money
Paid cash
Bought
“stock”
[2] in common
enterprise
Horizontal
--
[3] led to
expect profits
Not game
[4] from efforts
of others
Primarily
promoters
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
[1] invest
money
Paid cash
Bought
“stock”
[2] in common
enterprise
Horizontal
--
[3] led to
expect profits
Not game
Expected
housing
[4] from efforts
of others
Primarily
promoters
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
[1] invest
money
Paid cash
Bought
“stock”
[2] in common
enterprise
Horizontal
--
[3] led to
expect profits
Not game
Expected
housing
[4] from efforts
of others
Primarily
promoters
--
SEC v Edwards
(US 2004)
sale/leaseback
payphones
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
[1] invest
money
Paid cash
Bought
“stock”
Bought
payphone
[2] in common
enterprise
Horizontal
--
[3] led to
expect profits
Not game
Expected
housing
[4] from efforts
of others
Primarily
promoters
--
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
[1] invest
money
Paid cash
Bought
“stock”
Bought
payphone
[2] in common
enterprise
Horizontal
--
Many
purchasers
[3] led to
expect profits
Not game
Expected
housing
[4] from efforts
of others
Primarily
promoters
--
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
[1] invest
money
Paid cash
Bought
“stock”
Bought
payphone
[2] in common
enterprise
Horizontal
--
Many
purchasers
[3] led to
expect profits
Not game
Expected
housing
Fixed
return
[4] from efforts
of others
Primarily
promoters
--
Apply Howey
SEC v SG Ltd
(1st Cir 2001)
“stock” in
StockGeneration
UHF v Forman
(US 1975)
“stock” in
Co-op City
SEC v Edwards
(US 2004)
sale/leaseback
payphones
[1] invest
money
Paid cash
Bought
“stock”
Bought
payphone
[2] in common
enterprise
Horizontal
--
Many
purchasers
[3] led to
expect profits
Not game
Expected
housing
Fixed
return
[4] from efforts
of others
Primarily
promoters
--
Exclusively
promoters
Some hypotheticals …
When are real estate
investments “securities”?
Security?
A - Beachfront Resorts
offers buyers "rooms"
in a beachfront
hotel. All rents from
hotel rooms are pooled,
and each buyer
receives a pro rata net
rentals for her
room. Buyers cannot
occupy their rooms,
except for 2 designated
weeks each
year. Beachfront
Resorts emphasizes
that rent will cover P&I.
B - Dubois is a real
estate agent who offers
Hawaiian condos. To
sell condos, Dubois
recommends that
buyers consider a
management contract
with Hotel Corp-Pacific - condo management
and rent collection
services. Dubois gets no
compensation from
HCP, and not all buyers
use HCP. Under HCP's
rent pooling agreement,
rents from various
condos are pooled;
buyers can occupy for
only 2 weeks/year.
Dubois tells buyers rent
pooling will pay P&I.
C - Fox Hills Golf Villas
offers "weeks" at its golf
complex condos. Buyers
can use their week of
occupancy in two
ways: (1) rent their
condo (on their own or
through Fox Hills) and
receive a rental
payment, or (2) occupy
the condo themselves.
Fox Hills emphasizes
that buyers who choose
to rent will be able to
cover P&I.
D - Disney World
Opportunities
("Dwops") offers
residential lots in a
resort community near
Disney World. Dwops
requires buyers to pay
"dues" for a Dwopsoperated country club
and other community
facilities, such as a club
house, gardens,
swimming pool, tennis
courts, and water
treatment. Dwops
emphasizes to
investors the potential
appreciation of the lots.
More line-drawing …
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Business interests
“Insurance proceeds”
“Stock”
“Notes”
Definition of “security”
Business organizations
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Corporate “stock”
– “Sale of business” doctrine
– Compare to sale of assets
– Stock is stock
Partnership interests
– Active partners
– Passive partners
– Williamson test
Hybrid entity interests
(LP / LLP / LLC)
– Rules of thumb
– Changes over time
Viatical settlement
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Ministerial vs management
Disclose risk of AIDS cure
Williamson v. Tucker (5th Cir. 1981)
[A]n investor who claims his general partnership or joint venture
interest is an investment contract has a difficult burden to
overcome....
... A general partnership or joint venture interest can be
designated a security if the investor can establish ... that
1. an agreement among the parties leaves so little power in the
hands of the partner or venturer that the arrangement in fact
distributes power as would a limited partnership; or
2. the partner or venturer is so inexperienced and unknowledgeable
in business affairs that he is incapable of intelligently exercising his
partnership or venture powers; or
3. the partner or venture is so dependent on some unique
entrepreneurial or managerial ability of the promoter or manager
that he cannot replace the manager of the enterprise or otherwise
exercise meaningful partnership or venture powers.
Security
Corporation
(C corp / S corp)
• Stock (PHC)
• Stock (CHC)
Limited partnership
(LP / LLLP)
• Limited partner
interest
Limited liability
company (LLC)
General partnership
(GP / LLP)
Non-security
• General partner
interest
• Member interest
• Member interest
(manager-managed)
(member-managed)
• Williamson test
(1) agreement disempowers
(2) investor unsophisticated
(3) manager dominates
• General partner
interest
Security
Corporation
(C corp / S corp)
• Stock (PHC)
• Stock (CHC)
Limited partnership
(LP / LLLP)
• Limited partner
interest
Limited liability
company (LLC)
General partnership
(GP / LLP)
Non-security
• General partner
interest
• Member interest
• Member interest
(manager-managed)
(member-managed)
• Williamson test
(1) agreement disempowers
(2) investor unsophisticated
(3) manager dominates
• General partner
interest
Hypothetical?
A - Albert and Amanda
invest in an Scorporation that they
formed under the New
Columbia BCA. Albert
and Amanda are the
only shareholders, and
they enter into a
shareholders'
agreement in which
they do away with the
board of directors and
agree to co-manage
the business. Albert
and Amanda are both
sharp cookies.
B - Bif and Barbie invest
as limited partners in a
limited partnership that
acquires houses for
investment. General
partner, Goodacre
Investments, is charged
under the limited
partnership agreement
to develop, lease and
sell the properties.
Under the agreement,
Bif and Barbie retain
authority to approve the
purchase and develop
new properties, and to
remove Goodacre. Bif
and Barbie are who they
are.
C - Carl and Carol are 2
of 23 investors who
invest in Rivanna
Trawlers Unlimited, a
general partnership.
RTU buys fishing boats
and hires an outside
management company.
Things go poorly and the
partners get rid of the
management company.
They then sue the
management company
for fraud – under the
federal securities laws.
D Daniella, a securities
associate with Dewey
& Howe LLC, is excited
when she learns she
will be made “member“
of the firm. She is told
that she will have to
invest $20,000. She is
also told it would be
unseemly for her to ask
any questions about
the firms’ operating
agreement, even
though "due diligence"
is a regular part of her
practice. When
Daniella becomes a
member, she learns
that the firm faces an
SEC investigation for
its work with Enron.
She had no idea.
.
More line-drawing …
“Notes”
•
Commercial vs.
consumer
•
Family resemblance
test
•
Relationship to –
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–
’33 Act exemption
’34 Act exception
Federal securities laws
Securities Act § 2(a)(1) When used in
this Act, unless the context otherwise
requires-(1) The term "security" means any note ...
Securities Act § 3
(a) Exempted securities. Except as
hereinafter expressly provided, the
provisions of this Act shall not apply to any
of the following classes of securities:
(3) Any note … which arises out of a
current transaction or the proceeds of
which have been or are to be used
for current transactions, and which
has a maturity at the time of issuance
of not exceeding nine months,
exclusive of days of grace, or any
renewal thereof the maturity of which
is likewise limited;
Exchange Act § 3
(a) When used in this Act, unless the
context otherwise requires -(10) The term "security" means any
note ....but shall not include currency
or any note, draft, bill or exchange,
or banker's acceptance which has a
maturity at the time of issuance of not
exceeding nine months, exclusive of
days of grace, or any renewal thereof
the maturity of which is likewise
limited.
Federal securities laws
U = All investments
Securities
Notes
Subject
to
’33 Act
Not register
“current tx”
< 9 mos
Not subject to
’33 Act
Subject to
’34 Act
Not subject to
’34 Act – “note”
< 9 mos
Reves v. Ernst & Young (US 1990)
Family resemblance test
presume "note" = "security"
Unless
(1) motivation of seller and buyer
(2) plan of distribution
(3) reasonable expectations of
investing public
(4) other factors reduce risk
(regulatory scheme)
Members
Co-op
Compare tests
Family resemblance test
(Reves v. Ernst & Young)
Investment contract
(1) motivation of seller and buyer
(2) plan of distribution
(3) reasonable expectations of
investing public
(4) other factors reduce risk
(regulatory scheme)
[1]
[2]
[3]
[4]
(Howey & progeny)
a person invests his money
in a common enterprise and
is led to expect profits
solely from the efforts of the
promoter or a third party,
[5] not subject to comprehensive
legislative scheme
Security?
A -Adelaide buys a
motorcycle and
gives her bank a
promissory note in
which she promises
to repay her loan in
36 equal payments
over 36
months. The note is
secured by the bike.
B - Big Motors (a
NYSE-listed
company) raises
capital for current
operations by issuing
unsecured
promissory notes
(maturing in six
months) in $1 million
denominations to
institutional
investors. First Lynch
Securities acts as a
"best efforts"
underwriter.
C - Co-Op raises
capital for its gasohol
operations by selling
unsecured (and
uninsured)
promissory notes to
its members. The
notes, issued in small
denominations and
payable on demand,
pay variable rates of
interest competitive
with bank CDs.
D – Do-Something,
Inc. raises capital
for its operations by
offering unsecured
promissory notes in
$1,000
denominations at
high interest rates to
many
investors. The
notes mature in 6
months and, if not
redeemed, are
payable in 6-month
intervals thereafter.
The end