Securities Regulation Outline

DEFINITION OF A SECURITY
Analytical Framework for Defining a Security: there is a 4-step analysis to go through when
confronted with “defining a security.”
· First, apply the definitions in SA §2(a); and SEA §3(a)(10).
o Then apply the Rule that says they are interpreted the same-Landreth Timber
o Apply generally policy of the Act; namely, that Congress sought to define the term security broadly and generally so as to include within that definition many types of instruments that in our commercial world fall within the ordinary concept of security.
§ The purpose of the Securities Act was to regulate investments;
§ for the protection of the investing public at a time when the market was untrustworthy.
· Second, state the economic reality test;
o The name given to an instrument is not dispositive; however, the name is not wholly irrelevant to the decision of whether the instrument constitutes a security.
o There may be occasions when the use of traditional names such as “stocks” or “bonds” will lead a purchaser to justifiably assume that the federal securities laws apply.
· Third, state the Weaver Test for what constitutes a security; and then
o Test: the test for what constitutes a security is what character the instrument is given in commerce by terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.
§ A security is an instrument in which there is common trading whereby the instruments traded have an equivalent in value to most persons and can be traded publicly.
· Apply the facts and analogize to one of the instruments that have been held to be a security or not:

INVESTMENT K: put in for flexibility as to what is a security.
Howey Test:

Investment of money ( or something of value)
In a common enterprise

Horizontal: pooling money between investors and getting a return. ALWAYS SATISFIES COMMON ENTERPRISE
Vertical:

Mutual dependence on investor and promoter for success. If promoter succeeds you succeed and vice versa, more likely common enterprise
Non mutual success: depends on promoter for investor success but promoter success not dependent on investor success. Not likely upheld.

Leading to an expectation of profits solely from the efforts of the promoter or a third person

Solely from efforts of others: “whether efforts made by those other than investor are undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise”
Expectation of Profits: could be fixed returns like rent. Some think buying property for tax reduction is form of profit
Solely doesn’t mean solely??

RISK CAPITAL TEST: Hawaii Test, not accepted by federal courts but not rejected either. Many states accept this under state law. Elements for an Investment K:

Offeree furnishes initial value to an offeror and
A portion of the initial value is subjected to the risks of the enterprise, and
Furnishing of initial value is induced by the offeror’s promises/representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the initial value, will accrue to the offeree as a result of operation of enterprise and
offeree has no practical and actual control over managerial decisions of the enterprise.

· Can probably take some negative control but not affirmative control.

LIMITED PARTNERSHIP: protected by securities laws

General Partner: manager, active, incurs liability
Limited Partner: passive investor, no management function, personally liable if too active.
Traditionally: limited partners interest was a security because state law said they couldn’t have control
Now, some limited partners have some control so it’s a grey area

GENERAL PARTNERSHIP:

G/R: normally not protected under securities laws b/c general partners have equal power by statute
Exceptions (protect unsophisticated investors):

If agrm’t leaves so little power as to effectuate a limited partnership then might be deemed a security
If general partner is highly inexperienced and unknowledgeable (unsophisticated)
If general partner is so dependant on the unique entrepreneurial or management ability of another general partner

Partners have enormous control: make agreements with outside world
Usually don’t satisfy “solely from the efforts of others” because enormous legal rights
If you contract away your power, still have agency power

FRANCHISES:
· G/R not investment ks b/c the franchisee exerts considerable control over the venture
· How much control a franchisee has in operating the business is critical
· Koscot Test:

CONDOMINIUMS: Aggregation approach: condominium in conjunction with one of following is a security:
· Rental agreement or other similar service, are offered and sold with emphasis on the economic benefits to the purchaser to be derived from the managerial efforts of the promoter, or third party designated or arranged by promoter
· Offering of participation in rental pool agreement
· Agreement where investor must hold his condominium for rent for a certain part of year, must use an exclusive agent, or is otherwise materially limited in his occupancy or rental of the unit.

STOCK AS A SECURITY:
General Rule: if an item is labeled stock (or even if it is not) and has all attributes of stock, then it is covered by plain language of Securities Acts as a security. Don’t apply Howey test to stock

Characteristics of Stock Test: (Landreth v. Landreth Timber Co.)

right to receive dividends contingent upon an apportionment of profits
negotiability
ability to be pledged or hypothecated
the conferring of voting rights in proportion to number of shares owned and
capacity to appreciate value

Preferred Stock: usually gets paid dividends and in liquidation, ahead of common stock.

United Housing Foundation v. Forman: when a purchaser is motivated by a desire to use or consume the item purchased the securities laws do not apply. If no profits involved, probably to use or consume the interest acquired. Not a stock or investment k.

Sale of Business Doctrine: if mechanics of a deal are the same as a typical securities transaction then regardless that 100% of company is sold, still subject to sec regs protection- held that transfer of stock incidental to sale of closely held business did not constitute a sale of securities. Rejected by Court in Landreth Timber

Employee Pension Plans: when an employer invests money in a pension plan, not the employee, it is a non-voluntary pension plan and therefore not a security

court has not decided whether voluntary pension plans are investments
probably still covered under ERISA

Bank CDs: Not a security b/c:

The context clause of SEA §3(10) provides that an instrument which seems to fall within the broad sweep of the Act is not to be considered a security if the context requires otherwise; and

The context requires otherwise because it is unnecessary to subject issuers of bank certificates of deposit to liability under the antifraud provisions of the Securities Acts because holders of bank certificates are adequately protected under the federal banking laws.

Note: the presence of other federal regulation was used again to prevent the expansion of the definition of sec