Posted on: 18 July 2023
Compliance with securities laws can be lots of work. If a company is seeking investments, it has to be carefully how it sells interests in its operations. A key part of all this is that you know what makes an asset legally a security. Here is what a securities law attorney will usually say.
The Howey Test
In the U.S., the legal definition of a security comes from the federal Supreme Court case SEC v. W.J. Howey Co. A securities law attorney will typically call this the Howey test. The Howey Company was selling interests in orange groves, and the court determined that the sold assets were securities and had to comply with federal regulations. If an asset meets the Howey test, you should assume it's legally a security.
First, the asset must be part of a third-party investment of money or other assets of value. Second, the assets must come from a common enterprise. That means many people or entities pooled their money to invest, rather than just one or a few. Third, those parties must reasonably expect a profit. Finally, the profit expectation must come from the efforts of others rather than the investors' effort. In other words, the investors' income is passive rather than active.
Notably, this doesn't bar someone from participating in the business and acting as an investor. Employee stock options, for example, are securitized assets. A corporate lawyer will tell you that the options are legally separate from the employees' regular pay. The employees' pay is active income, and any profit from the options would be passive. Also, the employees can hold the options even after they leave the company.
Examples of Securities
Many money-raising vehicles for businesses are securities. The classic security is a share of stock. A company provides a fractional stake in itself. Investors expect profits from some combination of dividends, market movements, and share repurchases.
Futures and options are securities tied to other assets. An option gives you the right to purchase the asset at a later time. Futures are time-sensitive options. Options and futures exist in markets for stocks, commodities, and other similar assets.
Mutual funds and ETFs are essentially securities comprised of pooled securities. They offer the opportunity to invest in sectors of the economy without focusing on a single asset.
Bonds are securities, too. Governments and businesses issue bonds with a promise of interest and the eventual return of the principal at a maturity date.
For more information, contact a securities law attorney near you.Share