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Securities Regulation
SUNY Buffalo Law School
Westbrook, Amy Deen

What is a Security?
Definition of a Security: 1933 Act: § 2(a)(1)
“…any note, stock, bond, debenture, investment contract, etc…any interest or instrument commonly known ass a security…unless the context otherwise requires…”
o   Instruments commonly known as securities
o   Instruments specified by the Act to be securities
o   “Investment contract”, broad catch-all phrase
“Investment Contract Provision” cases:
SEC v. W.J. Howey Co.:
Howey was a company with big tracts of land with citrus groves and a resort; got tourists to live in the resort and purchase these tracts of land
Offered new tract owners a separate contract with a company to care for the citrus trees and sell the fruit on their behalf.
Issue: Whether, under the circumstances, the land sales contract, the warranty deed and the service contract together constitute and “investment contract” within the meaning of § 2[a](1)? YES
Court held that an investment contract is 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 (4 Parts)
Threshold: contract, transaction or scheme
A person invests his money
Where could the money be used otherwise, would they have invested in the public market otherwise
Did the investor have a choice
In a common enterprise
Is led to expect profits
Solely from the efforts of the promoter or third party
Detailing the 4 Prongs:
The Investment of Money: International Brotherhood of Teamsters v. Daniel
Guy with a compulsory, non-contributory pension plan drove truck for the company for about 20 years, but someone had embezzled his money for a period of timeàCompany calls this a “break in service”
Argues his interest in the pension plan was a security so he had the protection of securities laws
Holding: Pensions do not fall under this meaning
‘Investment of Money’ prong in Howey wasn’t met:
didn’t have a choice
employee makes no payment in the pension fund
selling of labor doesn’t count
employers contributions are not considered investments on the employees behalf because there is no specificity. Employer just contributes according to man-week hours and employee gets benefits from the trust upon retirement. Someone working 30 years and 20 years will get the same pension checks so there is not individual investment.
‘Expectation of Profits From a Common Enterprise” prong not met
income comes from employer contributions, a source no way dependant on the efforts of fund managers.
Pension plans are covered by another federal scheme ERISA 1974 so SEC not needed. Other appropriate federal schemes supersede Howey Test but state law usually does not.
“unless the context otherwise requires” this is the get out of jail free card for SEC.
In a Common Enterprise: SEC v. SG Ltd. (NOT on TEST)
Pyramid schemeà Fake companies were created and you could buy stock in them
SG determined what the returns were worth
People’s returns were based on other people signing up and giving their money
SEC sued for violation of regulations; SG Ltd. Claims it’s just a game like gambling on the internet
Howey Test
Investment of money b/c they paid cash and were promised an investment return
Common enterprise
This was a problem because went through the different types of commonality and found in this case horizontal commonality
Everything is pooled together; everyone shared in profits and risks of enterprise
Expected profits
Expected returns from the efforts of others
Is Led to Expect Profits: United Housing Foundation, Inc v. Forman
Can’t just say that you always expect profits from investments; Court is influenced by what you would have done with the money otherwise
Building housing developments in NYCà Financed by selling people “stock” in the housing developmentà Co-op
Buy 18 shares of rooms at $25 each share per roomà stock in a 4 room apartmentà $1800 for the apartment…Basically a recoverable deposit
Called it stock but:
Paid no dividends
Voting rights per apartment, not per unit of stock
Actually a deposit you could get back
If want to sell it had to be sold back to the Co-op for a certain price
Rent ended up being much higher than promisedà If the shares are like securities then the information on the costs are misleading
Sued under Rule 10(b)(5)
Want a securities remedy
Court found the stock was not a security
Four Key Characteristics of Stock
Pays dividends
Transferable/ negotiable
Voting rights in proportion to number of shares held
Appreciable value
Court said people bought the stock b/c wanted an apartment, not to make a profit
SEC v. Edwards
Edwards sold payphones to people, then leased them back and cared for them
Purchaser gets a fixed return of 14% per year/ $82 month
Payphones broke a lot and were slowly replaced by cell phones so Edwards went bankrupt
Fixed profits- do these still satisfy this prong?

it is no longer a sale of business and is stock
No More Sale of Business Doctrine (Says not a security b/c you’re buying stock)
Limited liability companiesà Alternative to corporations and partnerships as an organizational form
Good for starting businesses b/c LLC has tax advantages
Relationship between Howey Test and “Notes”:
Characteristics of Notes – they are basically debt
–          specified interest rate
–          principal amount
–          specified maturity term
–          no voting rights
Demand Notes
–          issuers give the investors the right to get the principal back at any time
–          can demand the note at any time
Reves v. Ernst & Young
–          in this case the investors bought demand notes from a company that went bankrupt. The investors then sued the auditor of that note-issuing company.
–          Issue: are notes securities?
–          Holding: Yes
o   3 Tests to choose from
§  “Family Resemblance” Test – a note is presumed a security:
·         If it has a term of more than nine months
·         If it is NOT on the family resemblance list of things not a security (ex. Note secured by mortgage, note delivered in short term consumer financing),
·         Or if it resembles something on the list. To determine if there is a resemblance the court looked at:
o   Motivations of seller & buyer
§ If seller wants to raise money and buyer wants to make profit then YES
§ If to facilitate the sale of an asset then NO
o   Plan of distribution
§ If there is a common trading for speculation and investment then YES
o   Reasonable expectations of investing public
o   Presence of alternative regulations
·         Looking at these 4 it is a security.
·         *** This is a multifactor balancing test (unlike Howey), not all factors need to be met therefore it is difficult to deem a note a security as a matter of law
§ Investment v. Commercial – another test for notes but this court did not use it.
Howey Test – some courts use this but this court thought it was not really applicable for notes. You should use stock/note tests