The definition of «securities» in the USA

What is the problem, actually, to define the concept of securities? For civil law lawyers it is not really an obscure notion. Of course, there are a lot of disputes among the commentators and writers in civil law system too, but again, for common law lawyers it is too difficult to determine, whether the certificate or instrument is security or not, and not in theory, like in civil law, but mainly in practice: the basis for development of that definition is a mass of judge's decisions. So, what?

To make it clear, let me just show you the definition in the 1933-34 Securities Act and Securities Exchange Act. «The term "security" means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, 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, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, 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, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing».

Do not read the definition list, just look at the amount of the terms, at the volume of the definition and at the absence of any explanation or description of each instrument listed in the definition. So, we are able to point the problems of definition list one by one: it is too obscure, too saturated and too particular.

Actually, the statutory phrase «investment contract» captures the generic concept of what a security is, and interpretation of this phrase has provided basic guidelines for defining a security. The landmark case on the definition of an investment contract SEC v. W. J. Howey Co set forth the Howey test. Under Howey test, a contract, transaction, or scheme is an investment contract if «a person (1) invests his money (a person involved in the transaction has to invest money, not any other resource) (2) in a common enterprise (the enterprise is contain no less that 2 people, and all of them work for one common purpose) and (3) is led to expect profits (the investor is always put up money to get profit) (4) solely from the efforts of the promoter or a third party (but investor does not endeavor and does not take part in any affairs of the company except voting or any other controlling functions)».

Thus, that test determined the evolution of court interpretations and became significant starting point of Supreme Court interpretations in that area and set up the principle of economic reality. That principle means that in determining whether the Howey test is satisfied, the focus is on the «economic reality» surrounding the investment package as a whole, not exclusively on any single factor.

Following this economic reality approach, some courts made up a «sale of business doctrine», which holds that that the acquisition of 100% or perhaps even a controlling block of a business' stock doesn't constitute the purchase of a security by the buyer. That doctrine was rejected by the Supreme Court because it caused a lot of problems in statutory regulation of security transactions, but it showed that the application of Howey as the exclusive test of what is a security is wrong, and other investment instruments such as stock and notes expressly included in the statute, are analyzed differently. They are presumptively considered to be securities, but the presumption can be overcome.

In conclusion I'd like to describe you the structure of Securities law in the USA. It consists of doctrines, which is like a sign for the Supreme Court that there is a problem in court practice that has to solved; statutes, which provide protection of investors; tests, which help judges to define, whether the instrument involved in the transaction is basically security or not.

В. И. Еланская