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What characteristics must a financial instrument have to be a security?

On behalf of Law Office of Clifford J. Hunt, P.A. posted in securities registration filings on Tuesday, July 3, 2018.

Determining whether a financial instrument is to be included within the definition of the term “security” under state and federal law may require a complex analysis. The definition of a security is included in state and federal statutes, but the analysis may not stop there with the mere written words. In fact, a security can take on different forms, from the stocks offered by companies raising capital to the bonds offered by various local and state government entities. Securities include obscure instruments such as whiskey warehouse receipts, as well as common promissory notes.  Determining whether such instruments constitute a “security” may involve the use of judicially-created analysis/tests such as the “Howey test” or the “family resemblance test.”

Many small, emerging growth companies utilize transaction exemptions from registration under state and federal law to raise capital for their companies through the issuance of securities.  Structuring securities offerings to comply with these transaction exemptions or otherwise going through the registration process is complex and can involve pitfalls for individuals lacking experience in such matters. Consultation with an experienced securities lawyer can be essential to understanding applicable securities laws and compliance therewith.

But how is an individual to know if they are offering a security, as opposed to a different form of contract that is not subject to the same scrutiny? A security possesses several characteristics and the remainder of this post will address those. Readers are reminded, as always, that the contents of this post are not legal advice.

First, a security requires an investment by one or more parties who have an expectation of profits from their investment. Second, the parties who invest in the security must do so in a common enterprise. Finally, a security must be supported by a separate person or entity whose efforts are imperative to the production of profits for the investors. The common definition of the “Howey” test to determine whether an instrument is a security is: “an investment of money in a common enterprise with an expectation of profits derived principally from the efforts of others, including promoters or other third parties.”

If an investment meets these criteria it will likely be deemed a security and must be registered as such with the government or be sold in an exempt transaction. Working with a securities attorney can be a good way for individuals to avoid mistakes in the important process of meeting regulatory requirements regarding the registration of securities.

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