Select Page

Secured Transactions
University of Minnesota Law School
Painter, Richard W.

Professor Painter
Securities Law
Spring 2012
All you need to know (plus some)
1.       SA 2(a)(1) and SEA 3(a)(10) define “security” by enumeration, with the limiting phrase unless the context otherwise requires
2.       Policy args: 1) does the instrument need regulation of security laws (disclosure, anti-fraud)?  2) economies of scale 3) investor expectations 4) parallel regulation.
3.       Stock is a security as long as it has the characteristics normally associated with common stock, principally the right to receive dividends contingent upon profits.  Landreth. 
a.       Other indicia of stock: can be negotiated and pledged, carries voting rights, can appreciate in value.
b.      Stock need not pass the Howey test to be a security.   Landreth
c.       Stock in non-profits is not a security b/c atypical.   United Housing Found. v. Forman (1975) (“stock” in housing coop is not a security b/c lacks the common features of stock).
d.      Stock is a security even in the sale of a business.  Landreth  (abolishing the “sale of business” doctrine, which said sale of corp control by stock sale was not a security under Howey).  
4.       Notes 
a.       Family Resemblance Test. Notes are presumed to be securities, but that presumption is rebutted if the instrument is on a list of non-security type notes, e.g. consumer financing.  If the note is not on the list, the note is still not a security if it bears a family resemblance to non-security type notes.  Reves v. Ernst & Young. (uncollateralized and uninsured notes, broadly distributed and marketed as an investment deemed security)
                                       i.            Motives of the buyer and seller.  (security if seller intends to raise capital;  buyer wants to invest for a profit share.   Non-security if the note finances asset or consumer sale, or corrects cash flow)
                                     ii.            “Plan of distribution” of the instrument.  (Security if sold to “broad segment of the public”; transferable and assignable)
                                    iii.            The reasonable expectations of the investing public.  (Security if note marketed as “investment”, emphasis on profits)
                                   iv.            Whether other factors reduce risk, including other regulatory schemes.  (Not a security if contract terms reducing risk (collateral, insurance)
·         Consider existence of another regulatory scheme
b.      Short term notes.  SEA exempts short term notes entirely, but SA 2(1) exempts them only from Sec 5.
                                       i.            “Maturity” of Demand notes:  Reeves said a demand note was not a short term note,  in part because that was meant to include only commercial paper.
                                     ii.            Likely only includes commercial paper.  However, this is undecided after Reeves.
5.       Investment Contract: catch-all shaped by judicial gloss based on the context clause  
a.       Privately negotiated, nonstandard  Ks generally are not ICs
                                       i.            Rationale: disclosure req's are justified by economies of scale not useful for single, nonstandard Ks.
Marine Bank v. Weaver
Weavers pledged a bank CDs to secure bank loan for company, in exchange for profit share and right to use the company's pasture land and barn.   Held, no security.   “Congress intended the securities laws to cover those instruments ordinarily and commonly considered to be securities in the commercial world”. 
b.      Howey Test
1. An INVESTMENT of money or other consideration
If the motive for the purchase is consumption, there is  no “investment” for “profit”, so no IC.  Forman (no IC for shares in housing coop b/c not an investment).
“vertical commonality” : whether activities of promoter are the controlling factor in success or failure of the investment.  An IC may exist even with one investor.
·         “broad vertical commonality” : requires a connx b/t efforts of the promoter and the success of the investor. 
·         “strict vertical commonality”:  requires a connx b/t success of the promoter and the investors.  Promoters and investors must share the risks of the venture. 
“horizontal commonality” requires a pooled investment among different investors.  
·         Though usually no horizontal commonality if there is only 1 investor and 1 promoter, there may be if plan anticipated many investors. SEC v. Lauer (7th Cir 1995). 
3. With reasonable EXPECTATION OF PROFIT  (capital appreciation from original investment or participation in earnings resulting from use of investors' funds.)
“Profits” may include Ks w/ a fixed rate of return. Investments w/ fixed returns are attractive to the most vulnerable investors in need of protections. SEC v. Edwards (2004) (payphones).
4. Derived “solely” from the EFFORTS OF OTHERS. 
The test is  if “efforts made by those other than the investors are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.”   SEC v. Glenn Turner (SCOTUS 1973).  Minimal investor participation is disregarded, so promoters cannot avoid securities laws
Focus on efforts the promoter said was required, not what was required in fact.  Miller v. Chinchilla.
Franchise agreements are ordinarily not ICs b/c success depends on franchisee efforts.  SEC v. Aqua-Sonic Prod (found a franchise K  WAS an IC b/c sales under franchise were ‘optional’, set up for tax write offs.
Investments that don't derive profits from promoter's efforts after purchase are not ICs.  Life Partners (viatical settlements)
c.       Pship / LLC Interests  are not listed in the definition, but may be securities under Howey
                                       i.      Key issue —> whether profits are based on “efforts of others”, considering any legal right to manage, a practical ability to manage (if legal rights are illusory), and reasonable expectation of management control
                                     ii.      GP interests generally aren’t securities because GP buys management power, even if they act as a passive investor.
Exception (Williamson v. Tucker US 1981).  GP interest is a security if the partner shows
1.       An agreement among the parties leaves little so power in the hands of the partner that the agreement in fact distributes power like an LP.  OR
2.       Partner is so inexperienced and unknowledgeable in business that he is incapable of intelligently exercising pship powers, OR
3.       Partner is so dependent on the unique entrepreneurial or managerial ability of the manager that he cannot replace the manager or otherwise exercise meaningful control.
SEC v. Merchant Capital (11th Cir. 2007)
Held, security.  Reason, partners’ management power was meaningless b/c the pship was set up.  1) Timing of voting (before investors are informed),  2) Geographic dispersion of investors, 3) management control of what info is given to investors before voting, 4) Limit on firing manager “for cause”
                                  iii.            LP interests.  LP interests are presumed to be securities
                                                         ·            Exception : if GP retires but remains an “LP” to keep his money in the pship    
                                   iv.            LLC Interests may or may not be a security, depending on the way they are set up.
                                                         ·            Consider whether member-managed or manager managed.  US v. Leonard (2d Cir. 2008) (finding even an member managed LLC was a security because the legal rights were “hollow and illusory” in practice)
a.       Real Estate: Collateral arrangements attached to a land sale may create an IC.  There is an IC if the seller promises post-sale income to buyer and buyer gets “a package of commitments that, taken together, could comprise a business venture harnessing the entrepreneurship of the promoter”. Banco Central. 
                                       i.      Resort Condo interests that will not be occupied by the buyer are ICs if   (SEC Release 5347)
Condo is sold with emphasis on the economic benefits to the purchaser from the managerial efforts of someone else
Seller offers a rental pool arrangement, or
Seller offers an arrangement which restricts the purchaser from using the condo, but must rent it to others with seller's help.
                                     ii.      IC may be found even if seller is not the person providing the management services. Hocking v. Dubois (9th Cir. 1989)
6.       Separate Securities and Pass-Throughs.  Packaging of non-security financial instruments may create a security, either as ICs under Howey or as notes under Reves.
Gary Plastic Packaging v. Merrill Lynch
Merrill sold bank CDs, packaged together with an offer to provide services such as screening the banks which provided the CDs.  Held, D offered a security.  Reason, under Howey, there is an IC b/c the customers relied on D's managerial and financial expertise to make profits.  
7.       Derivative Securities and Synthetic Investments. Dodd-Frank changed much of the substantive law in this area.  Complex derivatives are now subject to regulation as securities and other otherwise.
a.       Derivative Security : instruments that derive value from other assets, such as a stock, stock index, or foreign currency.   Used to hedge positions in the underlying asset.
b.      Call Options gives holder a right to buy a number of shares at a specific price. 
·         “Options” are an enumerated security, so even synthetic options may be securities.  Caiola v. Citibank
a.       Synthetic transxs & Swaps.  K where parties bet on the performance of a hypothetical ownership of an underlying asset.  Under the Commodity Futures Modernization Act, swaps are not securities per se, but 10(b) applies to security based swaps agreements.  Other regulation of equity swaps is done by the CFTC (which regulates futures) rather than the SEC. 
1.       Delaying Amd: 8(a): RS goes effective 20 days after filing or amd, unless SEC issues a formal order.  In practice, issuers opt to use Rule 473, which postpones effectiveness until issuer complies w/ comment letters.

sorb any risk of the offering, so 2(a)(3) does not protect requests from non-participating dealers.
·         163A 30 Day Bright Line Exclusion. Until 30 days b/f filing, issuer commxs are not “offers” if
Commx is “by or on behalf of the issuer” (not by UW/dealers, but including when issuer “authorizes or approves the communication before it is made.”)  163A(a), (c)
Does not refer to offering.  163A(a)
Issuer takes reasonable steps to prevent further distribution or publication of the commx during 30 day period before filing.   163A(a)
Issuer is not disqualified   163A(b)
a.       Issuer not blank check, shell , investment , or business development company
b.      Offering not penny stock or business combo
·         135 notice of proposed offering.  It is not an offer to release info about the offering if 
Made by the issuer or selling SH (not UWs)
Legend says “this is not an offer to sell securities, which will be made through a prospectus”. 135(a)(1)
Content is limited to listed categories in 135(a)(2), including amount, type, and basic terms of the security; purpose of the offering;  timing of the offering
·         Cannot identify UW or state the offering price. 
·         May also correct misstatements about the offering.  135(b)
·         169 Commxs of “regularly released” “factual business info” : not a 2(a)(10) “prospectus” if
                        Info released is “factual business info”, not including forward looking statements.  169(b)(1) 
a.       Factual info re: issuer, its business or financial developments, or other aspects of its business
b.      Ads or other info about issuer’s products or services.
Intended audience is not investors but others, like customers, EEs, and suppliers. 169(d)(3)
Issuer has previously released similar types of info.  169(d)(1)
Timing, manner, and form of commx is consistent with past releases. 169(d)(2)
Does not include info about offering. 169(c).
·         163 WKSIs can engage in unrestricted oral & written offers b/f a RS is filed if
commx is by or on behalf of a WKSI issuer (not UW)
Issuer is not investment company or business development company, and offering not related to business combo.  163(b)(3)
written version of the offer is filed “promptly” with SEC. 163(b)(2)
Written offers have legend.  163(b)(1)
·         I&I failures to provide legend or file excused if in good faith. 163(b)(2)
offer is treated as a FWP–12(a)(2) liability.  163(d)
163 offers remain subject to Reg FD.
·         168 reporting issuers.  Releases of factual and forward looking info are not an offer.
                        Issued by or on behalf of reporting issuer. 
                        Info is factual business or forward looking info
·         Factual = business info and product ads, anything in an SEA report
·         Forward looking = forecasts & discussion of future business plans, and assumption underlying those forecasts
                        Release is same manner & type as previous releases in ordinary course of business
                        Does NOT include info about the offering
·         Rule 137.  B/Ds do not make an “offer” by publishing  info, opinions, and recommxs re: securities of an issuer in registration if 
                        B/D not participating (or planning to participate)
                        Analyst is not compensated for the report and has no special arrangement with the issuer, security holder, or participant
                        Report is made in the regular course of business
[This rule also protect B/Ds from being considered “participating” in the distribution, hence not an UW] ·         Rule 138. B/D, whether or not a participant, does not make an offer by publishing public opinions or recommxs regarding a different kind of security
1.       Issued security is of a different class than the security discussed
·         If offering is for common stock, B/D  can opine on preferred stock or non-convertible debt securities.  And vice versa.
2.       B/D has previously published reports on similar securities (need not be for same issuer)
3.       Issuer is current in SEA reports