Securities Regulation
Professor Black
Spring 2008
I. Definition of a Security
A. Introduction
1. The definition of “security” in the Securities Act of 1933 and the Securities Exchange Act of 1934 covers a broad range of transactions. Although the term includes familiar instruments such as stock, notes, bonds, and “in general, any instrument commonly known as a ‘security,’” the statutory definition also encompasses a wide variety of novel and unique instruments.
2. The term “security” is defined in §2(a)(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities Exchange act of 1934. Although the language of these statutes somewhat differs, they have been construed in an identical manner.
a. ’34 Act: “When used in this title, unless the context otherwise requires- The term ‘security’ means any notes, stock, treasury stock, security future, bond debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate…or, in general, any interest or instrument commonly known as a ‘security’…”
B. Investment Contract
1. SEC v. W.J. Howey, Co.
a. Facts: The transaction involved the offering of small parcels of land in a citrus grove in Florida, coupled with a service contract for cultivating and marketing the produce. The prospective purchasers were informed that the venture was not economically feasible without arranging for a service contract. The SEC alleged that these contracts together formed an investment contract, and therefore, since the interests being sold were not registered, the company had violated §5’s registration requirements.
b. Issue: Whether the land sales contract coupled with the service contract constitute an “investment contract” within the meaning of §2(a)(1).
c. Decision: This is an investment contract.
d. Rationale:
i. The Supreme Court noted that the term investment contract had been employed in previously enacted “blue sky” laws and had come to signify “a contract or scheme for ‘the placing of capital or laying out of money in a way intended to secure income or profit from its employment.’”
ii. The court emphasized that “investment contract” embodies a “flexible rather than a static principle” and that the term had been broadly construed by state courts as a means of protecting the investing public. “Form was disregarded for substance and emphasis was placed upon economic reality.”
e. The Howey Test: The test requires “a contract, transaction or scheme” and:
i. A person investing money
ii. In a common enterprise and
iii. Is led to expect profits
iv. Solely from the efforts of the promoter or a third party
2. International Brotherhood of Teamsters v. Daniel
a. Facts: A multiemployer collective bargaining unit produced a compulsory and noncontributory pension plan for employees. Employees had no choice as to participation and did not have the option of demanding that the employer’s contribution be paid directly to them as a substitute for pension eligibility. The employees paid nothing to the plan themselves. In order to receive a pension an employee was required to have 20 years of continuous service, including time worked before the start of the plan. An employee with a break in service was deemed ineligible and he brought suit against the collective bargaining unit claiming that the unit misrepresented and omitted to state material facts with respect to the value of a covered employee’s interest in the pe
SEC v. SG Ltd. (A common enterprise)
a. Facts: SG operated a website offering on-line denizens an opportunity to purchase shares in eleven virtual companies listed on the website’s virtual stock exchange. SG arbitrarily set the purchase and sale prices of each of these imaginary companies and guaranteed that investors could buy or sell any quantity of shares at posted prices. SG placed no upper limit on the amount of funds that an investor could squirrel away in its virtual offerings. There is a particular company called the “privileged company” where SG boasted that investing in those shares involved no risk and the shares would unfailingly appreciate. The shares later plummeted and SG stopped responding to participant requests for the return of funds, but continued to solicit new participants from its website. The SEC alleges that SG’s operations constituted a fraudulent scheme in violation of the registration and antifraud provisions of the federal securities laws.
b. Issue: Whether virtual shares in an enterprise existing only in cyberspace fall within the purview of the federal securities laws.
c. Pro. History: The district court concluded that the transaction sin the privileged company’s shares did not constitute transactions in securities.
The district court drew a distinction between what it termed “commercial dealings” and what it termed “games.” The District Court said that purchases of the privileged company’s shares were “clearly marked and defined game” and therefore fell beyond the jurisdictional reach of the federal securities laws.
