What is a Security for Purposes of Registration Requirements with the Securities and Exchange Commission?
Because of the Stock Market Crash of 1929 followed by Great Depression in the 1930s, sweeping changes occurred to the financial markets in the form of new legislation. These changes were put in place to prevent the abuses believed to have led to the Stock Market Crash and Great Depression. These acts included the Securities Act of 1933 and the Securities Exchange Act of 1934.
The enactment of these two pieces of legislation started a long history of cases attempting to define the question, “what is a security?” Why is this important for the registration requirements with the Securities and Exchange Commission (SEC)? The answer is simple, the definition of a security might be more expansive than you may think. A security can include stocks, bonds, and notes. Furthermore, it can include investment contracts, franchises, and other items.
The first key case to set forth the standard for determining the definition of a security is the Howey Test. This test is named after the case of SEC v. Howey of 1934. The main question in Howey was whether leaseback agreements were legally an investment contract. An investment contract was one type of the investments listed as a security under the 1933 Act and the 1934 Act. Factually, in this case, the Supreme Court did find that the leaseback agreement was a security under the 1933 and 1934 Acts, and therefore the Defendants were liable for not registering the security with the SEC.
Further, the Supreme Court established a test to determine whether something is an investment contract, and, therefore, subject to registration under the 1933 and 1934 Acts.
Under the Howey Test, a financial transaction is an investment contract if:
(1) It involves an investment of money.
(2) There is an expectation of profits from the investment.
(3) The investment of money is in a common enterprise.
(4) Any profit coming from the efforts of a promoter or a third party.
If the financial transaction meets these requirements, then under the Howey Test, it is a security that is subject to registration with the SEC.
However, as we discussed in previous articles, there are several exemptions to registration with the SEC contained in various provisions of a number of different acts and statutes. In addition, there have been many other cases regarding the definition of what is a security and Howey is no longer the only test.
The rules, laws, and regulations on what is a security, including investment contracts, stocks, bonds, notes, private equity funds, venture capital funds, hedge funds, or any other type of fund are quite complex, especially when defining a security subject to registration and claiming the correct exemption from registration. In addition, the penalties for not registering or using the wrong exemption from registration can be quite severe. You should never engage in a securities transaction or a transaction that you suspect could be subjected to the Securities Act of 1933 or the Securities Exchange Act of 1934 without speaking with a knowledgeable securities attorney.
For more information
If you are considering a securities transaction or have questions, please contact our office by calling our office at (513) 241-0400 or using the contact form on our website. We look forward to hearing from you!