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Securities Regulation
South Texas College of Law Houston
Leahy, Joseph K.

Topic 1 – Introduction to Securities Regulation
Securities generally
Securities can be issued in unlimited amounts and virtually without any costs since securities are nothing in themselves but rather represent only an interest in something else.
Securities are created rather than produced.
Why regulate
Assuring that when securities are created and offered to the public, investors have an accurate idea of what that “something else” is and how much of an interest in that “something else” the security in question represents.
Continuous flow of information about the corporation or other entity that is represented by the securities being actively traded in the secondary markets.
Protect public investors by ensuring that material information is disclosure. Value or fairness of a transaction is NOT evaluated public investors. Minority of states that evaluate based on a merit/fairness standard
An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to buy, sell, or vote. 
Facilitate capital formation/aggregation
Federal securities law apply if both:
Jurisdictional nexus – interstate commerce””
Instrument is within the definition of “security”
 Regulate the companies issuing securities (“issuers”) as well as purchasers and sellers of securities
Securities Market
New Issue Markets – IPO
Trading Markets –
The securities exchanges and over-the-counter markets are the secondary markets for publicly traded securities.
outweighs, in number and volume, the offerings of newly created securities
New York Stock Exchange 
American Stock Exchange
Regional exchanges: the Boston Stock Exchange, the Chicago Board Options Exchange, the Cincinnati Stock Exchange, the Inter–Mountain Exchange, the Midwest Stock Exchange, the Pacific Stock Exchange, and the Philadelphia Stock Exchange
Part One: Securities Offerings
Unit I. Is this Financial Instrument a “Security”? (Chapter 4)
Unit II. Is the Security Exempted From Registration? (Chapter 4) §3 exemptions
Unit III. Was the Security Sold in an Exempt Transaction? (Chapters 5, 6 & 8) §4 exemptions
Unit IV. What Must Be Done to Register the Security? (Chapters 2-3)
Definition of a Security: “Investment Contract” (Securities Act§ 2(a)(1) & Exchange Act § 3(a)(10))
§2(a)(1) & 3(a)(10)– statutory definition of security in both acts are virtually identical.
General – broadly and expansively defined to prevent parties from dressing xtrn in ways that avoid reg. Look at the character of the xtrn. Note; stock; treasury stock; security future; bond; debenture; evidence of indebtedness; collateral-trust certificate; pre-organization 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; or group or index of securities
Specific definition – well settled securities. Any interest or instrument commonly known as a “security,” any certificate of interest, or participation in profit-sharing agreement.
Unless the context otherwise requires– even if it meets specific or general, it may not be a security – interpreted contextually and is driven by policy.
Definition “embodied a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”
Securities laws ONLY apply to “securities” (threshold question)
Factors to consider
Flexible definition
facts & circumstances Investment contracts
character of the financial instrument
existence of a parallel federal regulatory scheme
Commercial Character Test
Howey Test
Risk Capital Analysis/Test
Family resemblance
Reves factor
Economic reality test
Williamson factors
Commercial Character Test – SEC v. Joiner Leasing
Facts:Company sought to sell assignments of oil leases to purchasers through a national mailing campaign along with an offer to undertake test drilling.
Decision (commercial character test): Securities may include novel, uncommon, or irregular instruments that are widely offered or sold under a course of dealing that establishes their investment character in commerce
Investment Contract (Howey)
Investment contract means a contract, transaction, or scheme whereby a person invest his money in a common enterprise with an expectation of profit solely on the efforts of a third party.
Facts: company sold orange groves and service contract for the orange groves to investors who had no knowledge of how to manage orange groves, but were attracted by potential for high profits; court applied Howey test and looked to economic reality of the trx and found that the sales contracts and the service contracts together constituted “investment contracts” and thus were securities under 2a1; thus they could not be offered without being registered or having an exemption. The “touchstone” of an investment contract is “the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others,”
Elements of Howey test – analysis of the investment package as a whole
Invest money, services or property
investors contributed money to buy the orange groves with the expectation of profit
investment services and property can also count as “money”
the manner in which the groves were sold matters; investors given sales pitch, tours of the groves, and the groves were right next to their hotel; told they would produce profit
consumption v. investment – if there is some personal consumption, then it may not be an investment (Forman)
The mere fact that an employment agreement contains a profit sharing arrangement will not be enough to create a security.
Common enterprise
Horizontal Commonality –pooling of like interests among investors.
Pooling of interest/money of the investors, which ties the fortune of each investor to the success of the overall venture. (all beavers/orange groves together)
success of the investor’s interest rises and falls with others involved in the enterprise
All court agree that horizontal commonality meets the common enterprise prong.
look for pooling of investor funds also found if there is original intent to have multiple investors, even if there ends up only being 1 investor (SEC v. Lauer)
pooling of investors' contributions and distribution of profits /losses on a pro-rata basis among investors
Vertical commonality – shared interest among investors and promoter. Some case have found that vertical commonality will suffice.
Broad view – Long v. Shultz Cattle Co –fortunes of the investors are inextricably tied to the promot

f scale to justify placing disclosure cost on the issuer
Topic 3: The Economic Realities Test—Downsizing the Definition of “Security”
Focus on economic substance over form in determining whether instrument is a “security”
acknowledge that the reality of what is an investment in form may not be in substance [Forman] Aka the investment consumption test or common sense test
Forman – even if someone did invest in the venture for profit, any appreciation on the “investment” would be on the apartment, not on the stock in question.  Look at purchaser’s primary motive at the time by reviewing the marketing materials. Not “purely incidental”
International Brotherhood of Teamsters: noncontributory compulsory pension plan is not an investment contract, because of the economic reality – the employee sells his labor to make a living, not as an investment, and it is the employer who makes the contributions to the investment, not the employee.
Real Estate/Condominiums as a Security: The standard sale of real estate is not a sale of a security. Investment contracts may be present, particularly in the sale of condos where the unit will not be occupied by the purchasers. Property interest combined w/ service contract
emphasis on economic benefits derived from managerial efforts
offering of participation in a rental pool arrangement
Unit must be offered for rental at any time in the year, use an exclusive rental agent, or otherwise restricted in occupancy or rental of the unit.
Securities include investments in a condominium from the developer when purchaser seeks financial gain from the efforts of others, participation in rental pool arrangement, and limited possessory interest
Rental pool arrangement – Purchaser receive a fractional undivided share of condominium rental revenue regardless of the actual use of each unit
General Partnership – there is presumption that GP interests are NOT investment contracts because general partners exercise control over their interests – thus it is not profit derived from efforts of others;
the main inquiry is whether the partnership agreement grants so much power to the GP such that it’s unreasonable to expect profits to be derived from efforts of others – it’s irrelevant whether the power was actually exercised
rebut the control presumption with showing that partner’s can’t exercise control in the economic reality or Williamson factors
Williamson factors –
Partner has only significantly limited power under partnership agreement,
Partner is substantially inexperienced and unknowledgeable in business, or
Partner is inextricably dependent on the efforts of a third party
Limited partnership interests are likely investment contracts b/c limited partners don’t exercise as much control over the partnership –