Part I – What is a Security?
Statutory Definitions – If you have a security all the rules and regulations kick in. Congress wrote a definition to encompass all the schemes people might think up. Def begins “unless the context otherwise requires.” Not sure what this means. Cases treat it differently. Phrase is a vehicle for enormous judicial discretion – lets courts out of the definition. Security means “any” note – intended to convey conclusiveness.
a. §2(a)(1) of 33 Act – The term “security” means any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit sharing agreement, collateral-trust certificate, preorganization certificate or subscription transferable share, investment contract, voting-trust certificate, certificate of a 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 in 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.
b. §3(10) of 34 Act – The term “security” means any note, stock, treasury stock, security future, bond, debenture, certificate of interest or participation in any oil, gas, or other mineral royalty or lease, any collateral-trust 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 r 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”;…
Federal Securities Laws – disclosure of information and prevention of fraud.
c. Congress decided to intervene because the 1929 Stock Market Crash and the Great Depression. How do securities compare with other consumer goods? Securities are not inherently valuable, they only represent an interest in a company.
d. Goals of the Federal Securities Laws –
i. Disclosure of Information
1. Consumer Protection – Information is more accessible today, but this also makes it more difficult for consumers to synthesize. In the 1930s the average company was owned by individual investors, whereas today institutional investors are more prominent. So many people today are invested in the stock market. Far fewer percentage wise were invested in the 1930s.
2. Allocative efficiency – capital gets allocated more efficiently when prices accurately reflect what companies are worth relative to each other.
3. Criticism that with demanding disclosures the information can be exploited by competitors. Company may have a disincentive for R&D. So there is some tension between consumer protection and allocative efficiency.
ii. Companies often say they would disclose more if there was not a threat of private law suits. Various private actions that investors can bring, some are strict liability.
1. Corporate governance – disclosure enables investors to get a handle on how the directors and officers are functioning. Brandeis – “sunlight is the best disinfectant.”
a. Louie Loss – The architect of the securities regulation field. “If you have to undress in public you watch your weight.”
b. Small companies have the most fraud, according to the SEC. They are not subject to the disclosure obligations.
ii. Fraud – But you could always sue for fraud before the acts, so why did the federal securities laws include a number of fraud causes of actions if every single jurisdiction already provided one?
1. Personal jurisdiction was limited (Pennoyer v. Neff), so a federal action allowed nationwide service of process.
2. Uniformity so that GA citizens are not better off than FL citizens.
3. Some of the provisions are tricky. Federal stats make them more accessible because some of the requirements are easier to satisfy.
4. If disclosure were not mandated, it is arguable that the market would provide the rough equivalent. But there are problems with this.
a. The ability to time information. Even assuming that the company eventually discloses, then it still will not encourage investments in the market.
b. Information may be withheld to thwart competitors.
c. Standardization
b. Pressures causing the SEC to loosen up on disclosure requirements:
i. Institutional investors are very sophisticated and though to lead less protection. There presence shields less sophisticated investors in the same company.
ii. Globalization – Other countries are much less demanding and the SEC wants to facilitate globalization. To accommodate foreign securities we loosen up on them. But it is hard to rationalize two standards, so we ease up on the domestic as well.
iii. EMH –
iv. How well the markets have been doing for so long. If there is a downturn the law will conform accordingly though and the SEC will receive more attention.
c. What the SEC does not do:
i. It does not screen out risky, off the wall schemes. It is only concerned with fraud and disclosure. There is no merit approach, although a few states do. Philosophy is that let the investors make their own decisions based on adequate information. Brandeis theory. These laws were also developed during the Depression, and if you limit risky investments, how will new businesses ever start up. Policing investments also take significant resources.
d. Sources of Federal Securities law.
i. Seven stats were adopted between 1933 and 1970, but the 33 Act and the 34 Act are the most important.
ii. SEC Rules – have the force of law; must be consistent with the statute and the C.
iii. Interpretive Releases – interpretation of a statute from the SEC. Technically not the law, but as a practical matter are just as important.
iv. No action letters – SEC can give a favorable response (no action), no response, or adversely (cannot promise that they will n
rospectus (this was a private transaction), Weavers in return received a share of net profits could use the barn, and had a right to veto future borrowing of the company. Company went into BR and the bank attempted to claim the CD. Weavers claimed this was a security and that fraudulent misrepresentations had induced their investment. Court held this was not a security.
i. What does the fact that the court noted it was a private transaction suggest about the Howey test? Suggests that you need horizontal commonality. But this was an accepted term by this case so you would have thought the court would have called it that. Maybe the court meant that it was the combination of the private transaction and unique agreement. It looked bargained for.
ii. This was the first decision to focus on uniqueness. Should uniqueness matter – it is not in the LH.
iii. Weavers sued under 10b and 10b-5 (the 34 Act). They did not sue under the 33 Act but could have. If they had sued under 33 Act, it has a provision §4(2) which states that the provision of §5 shall not apply to a transaction by an issuer not involving any public offering. But you can make a public offering to one person, so would they have been better under the 33 Act.
1. Possible that something could be a security under the 33 Act and not the 34 Act.
iv. Prospectus – disclosure document. Hallmark of a security so the absence is some evidence that it is not a security.
v. Veto power – Weavers had too much control to be solely on the efforts of others.
vi. Howey – was not referred to a lot in this opinion. Maybe the Court thought the factors it mentioned applied more broadly than just investment k, but to securities generally. Court said this was not the type of instrument that comes to mind when a security is used.
h. United Housing Foundation v. Forman USSC p. 127 – Whether shares of a stock entitling a purchaser to lease an apartment in Co-Op City, a state subsidized and supervised non-profit housing co-operative are “securities.” The investors were purchasing stocks which allowed them to live in an apartment. If they sold back their investment they would not make any money (had to offer stock back at the same price). Court holds this is not a security.
i. “Solely” – FN 16; The SC acknowledges the opinion of the 9th Circuit, which states the word solely should not be read to strictly but should rather be construed realistically, so as to include w/in the definition those schemes which involve in substance, if not form, securities.
ii. And when the SC reformulates the Howey test (bottom p. 130),
