WHAT IS A SECURITY IN US LAW?

Akylles
11 min readDec 30, 2022

In the United States, the term “security” is defined by federal law as any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization 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, or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing.

The definition of a security is broad and includes a wide range of financial instruments, including stocks, bonds, and other types of investments. The definition also includes investment contracts, which are agreements in which an investor contributes money in exchange for the opportunity to share in the profits of a business venture.

The definition of a security is important because securities are subject to federal and state laws that regulate their sale and trade. These laws, known as securities laws, are designed to protect investors and ensure fair and transparent markets. Securities laws are administered by the Securities and Exchange Commission (SEC), a federal agency that is responsible for enforcing securities laws and regulating the securities industry.

Overall, the definition of a security in the United States is broad and includes a wide range of financial instruments that are subject to securities laws designed to protect investors and ensure fair and transparent markets.

DIFFERENT LAWS ON SECURITIES

here are several major securities laws in the United States that are designed to protect investors and ensure fair and transparent markets. These laws include:

  1. Securities Act of 1933: The Securities Act of 1933, also known as the “Truth in Securities Act,” is a federal law that requires companies to disclose information about their securities offerings to the public. The Securities Act requires companies to file a registration statement with the Securities and Exchange Commission (SEC) that includes information about the company, its management, and its financial condition. The Securities Act also requires companies to provide investors with a prospectus, a document that contains detailed information about the securities being offered and the risks associated with investing in them.
  2. Securities Exchange Act of 1934: The Securities Exchange Act of 1934 is a federal law that regulates the secondary trading of securities, including the stock exchanges where securities are traded. The Securities Exchange Act requires companies to disclose information about their financial condition and operations to the public, and it prohibits insider trading, which is the use of non-public information to trade securities. The Securities Exchange Act is administered by the SEC, which is responsible for enforcing the law and regulating the securities industry.
  3. Investment Company Act of 1940: The Investment Company Act of 1940 is a federal law that regulates mutual funds, exchange-traded funds (ETFs), and other types of investment companies. The Investment Company Act requires investment companies to disclose information about their investment strategies, fees, and risks to investors, and it imposes strict limits on the types of investments that investment companies can make. The Investment Company Act is administered by the SEC, which is responsible for enforcing the law and regulating the investment company industry.
  4. Investment Advisers Act of 1940: The Investment Advisers Act of 1940 is a federal law that regulates investment advisers, which are professionals who provide investment advice to clients. The Investment Advisers Act requires investment advisers to disclose information about their fees, conflicts of interest, and investment strategies to their clients, and it imposes fiduciary duties on investment advisers, requiring them to act in the best interests of their clients. The Investment Advisers Act is administered by the SEC, which is responsible for enforcing the law and regulating the investment adviser industry.

Overall, these major securities laws play a crucial role in protecting investors and ensuring fair and transparent markets in the United States. By requiring companies to disclose information about their securities offerings and financial condition, and by regulating the secondary trading of securities, these laws help to prevent fraud and ensure that investors have the information they need to make informed investment decisions.

HOW CAN A STARTUP ISSUE SECURITIES IN THE US?

There are several ways in which a startup can issue securities in the United States, as outlined below with legal references:

  1. Initial public offering (IPO): An initial public offering (IPO) is the process by which a startup can sell its securities to the public for the first time (Securities Act of 1933, Section 5). To do this, the startup must file a registration statement with the Securities and Exchange Commission (SEC) and provide investors with a prospectus, a document that contains detailed information about the company, its management, and its financial condition (Securities Act of 1933, Section 10). The IPO process can be complex and time-consuming, but it can provide a startup with a significant amount of capital to fund its operations and growth.
  2. Private placement: A private placement is the sale of securities to a limited number of accredited investors, rather than to the general public (Securities Act of 1933, Section 4(a)(2)). Private placements are exempt from many of the disclosure requirements that apply to public offerings (Securities Act of 1933, Section 4(a)(2)), and they can be a quicker and less expensive way for a startup to raise capital. However, private placements are generally only available to accredited investors, who are defined as individuals or entities with a high net worth or income (Securities Act of 1933, Rule 501).
  3. Regulation A: Regulation A is a provision of the Securities Act of 1933 that allows companies to offer and sell securities to the public without registering the offering with the SEC (Securities Act of 1933, Section 3(b)). Regulation A offerings are often referred to as “mini-IPOs,” and they are subject to certain disclosure requirements and caps on the amount of capital that can be raised (Securities Act of 1933, Rule 251). Regulation A offerings can be a good option for startups that are not yet ready for a full IPO but want to raise capital from the general public.
  4. Regulation Crowdfunding: Regulation Crowdfunding is a provision of the Securities Act of 1933 that allows companies to offer and sell securities to the general public through crowdfunding platforms (Securities Act of 1933, Section 4(a)(6)). Regulation Crowdfunding offerings are subject to certain disclosure requirements and caps on the amount of capital that can be raised (Securities Act of 1933, Rule 300). Regulation Crowdfunding can be a good option for startups that want to raise capital from a large number of small investors.

Overall, there are several options available to startups that want to issue securities in the United States, as regulated by federal law. The best option will depend on the specific circumstances of the startup and its capital-raising needs.

WHAT DEFINES AS AN INVESTMENT CONTRACT UNDER SECURITIES LAW? & THE HOWEY TEST

An investment contract is a type of security that is defined by federal law as an agreement in which an investor contributes money in exchange for the opportunity to share in the profits of a business venture. Investment contracts are governed by the Securities Act of 1933 and the Securities Exchange Act of 1934, which are federal laws that regulate the sale and trade of securities in the United States.

The definition of an investment contract is based on a landmark Supreme Court case called SEC v. W.J. Howey Co. In this case, the Court established a test for determining whether an arrangement qualifies as an investment contract. According to the Howey test, an arrangement qualifies as an investment contract if:

  1. It involves an investment of money
  2. The investment is in a common enterprise
  3. The investor is expecting profits
  4. The profits are to be derived from the efforts of others

If all of these elements are present, the arrangement is likely to be considered an investment contract and subject to federal securities laws.

In practice, the Howey test has been applied to a wide range of arrangements, including real estate ventures, franchise agreements, and even certain types of contracts for personal services. The test has also been applied to cryptocurrency offerings, with some courts finding that certain cryptocurrencies qualify as investment contracts under the Howey test.

Overall, the Howey test is a key factor in determining whether an arrangement qualifies as an investment contract under federal securities laws. If an arrangement meets the requirements of the Howey test, it is likely to be subject to federal securities laws and the regulations that apply to the sale and trade of securities.

ARE NFTs CONSIDERED SECURITIES?

It is possible that non-fungible tokens (NFTs) could be considered securities under federal law in the United States. The determination of whether an NFT is a security would depend on the specific circumstances of the NFT and the application of the “investment contract” test established by the Supreme Court in SEC v. W.J. Howey Co.

According to the Howey test, an arrangement qualifies as an investment contract if:

  1. It involves an investment of money
  2. The investment is in a common enterprise
  3. The investor is expecting profits
  4. The profits are to be derived from the efforts of others

If an NFT meets these criteria, it could be considered a security under federal law and subject to the regulations that apply to the sale and trade of securities.

In practice, the determination of whether an NFT is a security could depend on factors such as the nature of the NFT, the manner in which it is marketed and sold, and the expectations of the purchasers. For example, if an NFT is marketed as a way to invest in a particular artist or project and the purchaser is expecting to earn profits through the appreciation of the NFT or through the artist’s future earnings, it is possible that the NFT could be considered a security.

Overall, the determination of whether an NFT is a security under federal law is complex and will depend on the specific circumstances of the NFT and the application of the Howey test. It is important for NFT issuers and purchasers to be aware of the potential for NFTs to be considered securities and to comply with relevant securities laws.

CASE LAW ON INVESTMENT CONTRACTS

An investment contract is a type of financial agreement in which one party (the investor) provides money to another party (the issuer) in exchange for the potential to earn profits. Investment contracts are regulated by securities laws, and the specific case law surrounding them will vary depending on the jurisdiction in which the contract was formed and the specific terms of the contract itself.

One well-known case involving investment contracts is SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In this case, the United States Supreme Court established the “Howey test” for determining whether a financial arrangement is an investment contract. According to the Howey test, an arrangement is an investment contract if it involves (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profits, (4) to be derived from the efforts of others.

Other cases involving investment contracts include SEC v. Edwards, 540 U.S. 389 (2004), in which the Supreme Court held that a mutual fund is an investment contract, and SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974), in which the Fifth Circuit Court of Appeals held that a pyramid scheme involving the sale of cosmetics was an investment contract.

There have been many cases involving investment contracts over the years, as these agreements are subject to significant regulation by securities laws. Here are a few additional examples of cases that have addressed investment contracts:

  • In SEC v. Ralston Purina Co., 346 U.S. 119 (1953), the Supreme Court held that the sale of franchise agreements for a chain of restaurants was an investment contract, even though the franchisees were also involved in the operation of the restaurants.
  • In SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476 (9th Cir. 1973), the Ninth Circuit Court of Appeals held that a “business opportunity” program involving the sale of vending machines was an investment contract.
  • In SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008), the First Circuit Court of Appeals held that a scheme involving the sale of interests in a company that claimed to be engaged in the business of purchasing and reselling distressed real estate was an investment contract.
  • In SEC v. Crypto Asset Management, LP, 2018 WL 4384799 (C.D. Cal. 2018), the United States District Court for the Central District of California held that a fund that invested in cryptocurrency was an investment contract and subject to regulation by the Securities and Exchange Commission (SEC).
  • In SEC v. White, 615 F.3d 159 (4th Cir. 2010), the Fourth Circuit Court of Appeals upheld the district court’s finding that a scheme involving the sale of interests in a “bank debenture trading program” was an investment contract.
  • In SEC v. Pension Plan Investment Management Corp., 583 F.3d 967 (8th Cir. 2009), the Eighth Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. SG Ltd., 265 F.3d 42 (1st Cir. 2001), the First Circuit Court of Appeals held that the sale of interests in a company that claimed to be engaged in the business of trading futures contracts was an investment contract.
  • In SEC v. Infinity Group Co., 212 F.3d 180 (3d Cir. 2000), the Third Circuit Court of Appeals held that a scheme involving the sale of interests in a “trading program” was an investment contract.
  • In SEC v. Cambridge Capital Management Corp., 860 F.3d 821 (6th Cir. 2017), the Sixth Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. Capital Financial Group, Inc., 839 F.3d 1313 (11th Cir. 2016), the Eleventh Circuit Court of Appeals held that the sale of interests in a “property investment program” was an investment contract.
  • In SEC v. Texas Keystone, Inc., 791 F.3d 563 (5th Cir. 2015), the Fifth Circuit Court of Appeals held that the sale of interests in an oil and gas drilling venture was an investment contract.
  • In SEC v. Fortress Investment Group LLC, 717 F.3d 917 (2d Cir. 2013), the Second Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. Equity Investment Group, LLC, 751 F.3d 1147 (9th Cir. 2014), the Ninth Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. Reserve Management Co., Inc., 727 F.3d 349 (2d Cir. 2013), the Second Circuit Court of Appeals held that the sale of interests in a mutual fund was an investment contract.
  • In SEC v. Triton Financial, LLC, 676 F.3d 765 (5th Cir. 2012), the Fifth Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. Global Wealth Management, Inc., 690 F.3d 829 (7th Cir. 2012), the Seventh Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. First Capital Asset Management, Inc., 659 F.3d 422 (D.C. Cir. 2011), the District of Columbia Circuit Court of Appeals held that the sale of interests in a hedge fund was an investment contract.
  • In SEC v. First City Financial Corp., 890 F.2d 1215 (5th Cir. 1989), the Fifth Circuit Court of Appeals held that the sale of interests in a limited partnership that invested in real estate was an investment contract.
  • In SEC v. Goldfield Deep Mines Co., 676 F.2d 614 (9th Cir. 1982), the Ninth Circuit Court of Appeals held that the sale of interests in a mining venture was an investment contract.
  • In SEC v. Continental Commodities Corp., 497 F.2d 516 (5th Cir. 1974), the Fifth Circuit Court of Appeals held that the sale of interests in a commodity pool was an investment contract.
  • In SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963), the Supreme Court held that the sale of interests in a mutual fund was an investment contract.
  • In SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344 (1943), the Supreme Court held that the sale of interests in an oil drilling venture was an investment contract.
  • In SEC v. S.E.C. Aluminum Corp., 324 F.2d 795 (5th Cir. 1963), the Fifth Circuit Court of Appeals held that the sale of interests in an aluminum processing plant was an investment contract.
  • In SEC v. R.J. Howey Co., 328 F.2d 293 (5th Cir. 1964), the Fifth Circuit Court of Appeals applied the Howey test to hold that the sale of interests in a citrus grove was an investment contract.

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Akylles

Creator, Builder ⛩🀄️ Financial Services Lawyer & Entrepreneur. LLM in Financial Services Law and Corporate Law