March 16, 2021
What is a Security?
Colloquially, the word security is used often, and we may feel like we know what security is. However, the legal definition of a security may vary from the definition that non-legally trained individuals may have in mind–we call that a legal term of art. Additionally, both the federal and state governments regulate securities, so knowing whether you are buying or selling security has important legal implications. The federal government entity that regulates securities is the U.S. Securities and Exchange Commission (“SEC”), and each state has a counterpart securities regulation agency used to enforce “blue sky” laws, or laws directly relating to the interstate sale of securities.
Securities and the Howey Test
Security may appear in many different forms but commonly includes the sale of bonds, stocks, and ownership interests in a company.
To understand whether or not something is a security and thus regulated by the SEC, you should understand the term “investment contract” because investment contracts are common forms of securities, and this is the main criteria that the SEC reviews. An “investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”
When you think about purchasing stock from Disney or Microsoft or think about purchasing stock in a startup or even providing seed money to a friend’s startup, you are likely entering into an investment contract. Thus, you are buying security.
How can you tell if something is an investment contract? You use the Howey test, a Supreme Court ruling from 1946 that is still the benchmark today.
Under the Howey test, we have an investment contract where the following conditions are met:
1. There is an offer and resulting sale, or other investment of money or currency, or something else of value is given in consideration for the offer;
2. The investment is in a common enterprise; and
3. There exists a reasonable expectation that profits will be derived from the efforts of others.
If you are purchasing or selling something that fits those requirements, you’re dealing with securities. If you are selling a security, the SEC requires that the security either be registered or that you have an exemption from registration.
Are you selling a security? Are you unsure? Contact Polymath Legal PC today. We can help you determine whether you’re selling a security, and walk you through different compliance options if you are. Call us at (833) 931-6418 today!
Check these links for more information:
SEC, State Securities Regulators, https://www.sec.gov/fast-answers/answersstatesecreghtm.html.
American Bar Association, (April 27, 2017) https://www.americanbar.org/groups/business_law/publications/blt/2017/04/06_loev/.
SEC, Framework for “Investment Contract” Analysis of Digital Assets, https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets.
SEC v. W.J. Howey Co., 328 U.S. 293 (1946).