Key Definitions
Before you can understand how securities are regulated, you need to know what qualifies as a security, and several related terms that appear throughout the Uniform Securities Act (USA).
Offer and Sale (USA Section 401)
These two terms define when securities regulation kicks in.
- Offer: Every attempt or offer to dispose of, or solicitation of an offer to buy, a security for value
- Sale: Every contract of sale, disposition of, or attempt to dispose of a security for value
- Includes any security given as a bonus, dividend, or gift if it is part of a transaction involving a sale
What does NOT count as an offer or sale:
- Bona fide pledges or loans (using securities as collateral)
- Stock dividends (if nothing of value is given by the shareholder)
- Stock splits
Exam Tip: Gotchas
- A security given as a "gift" or "bonus" CAN be a sale under the USA if it's part of a larger transaction involving value. Not all gifts are automatically excluded.
Security (USA Section 401)
The USA uses a broad definition of "security" that includes:
- Stocks, bonds, notes, debentures
- Investment contracts
- Certificates of interest or participation
- Voting trust certificates
- Limited partnership interests
- Variable annuities
- Collateral trust certificates, preorganization certificates, and many more
The Howey Test
The Supreme Court case SEC v. W.J. Howey Co. established a four-part test to determine whether an arrangement qualifies as an investment contract (and therefore a security). All four prongs must be met:
| Prong | Requirement |
|---|---|
| 1 | An investment of money (or other consideration) |
| 2 | In a common enterprise |
| 3 | With a reasonable expectation of profits |
| 4 | Derived primarily from the efforts of others |
Key principle: The Howey Test looks at the economic reality of the transaction, not what it's called. A "membership," "token," or "interest" can still be a security if all four prongs are met.
Think of it this way: If you give someone money, pool it with other investors, expect to profit, and rely on someone else to do the work, you have bought a security, regardless of what the seller calls it.
Exam Tip: Gotchas
- The Howey Test requires ALL four prongs. If any one is missing, the arrangement is not an investment contract (and therefore not a security).
What Is NOT a Security
| Item | Why Not |
|---|---|
| Fixed annuities | Insurance product, not variable/investment-linked |
| Whole, term, and universal life insurance | Insurance products regulated by state insurance departments |
| Bank CDs | Insured deposit products |
| Commodities futures | Regulated by the Commodity Futures Trading Commission (CFTC), not the SEC |
| Collectibles (art, coins, stamps) | Tangible property, not investment contracts |
| Real property (real estate) | Tangible property (but Real Estate Investment Trusts (REITs) and limited partnerships in real estate ARE securities) |
Exam Tip: Gotchas
- Variable annuities ARE securities (because their value depends on the performance of underlying investments). Fixed annuities are NOT. The word "variable" is your clue.
Federal Covered Security (Securities Act Section 18, USA Section 401)
A federal covered security is a security where federal law preempts state registration requirements. The National Securities Markets Improvement Act of 1996 (NSMIA) created this category.
Think of it this way: Federal covered securities have already cleared the bar at the federal level, so states cannot add their own registration requirements on top. States can still charge filing fees and go after fraud, but they cannot block the sale.
Federal covered securities include:
- Securities listed on national exchanges (NYSE, Nasdaq, AMEX/NYSE American)
- Securities issued by registered investment companies (mutual funds, ETFs)
- Securities sold to qualified purchasers
- Securities exempt under specific federal provisions (e.g., Regulation D Rule 506 offerings)
What states CAN and CANNOT do with federal covered securities:
- Require state registration: No
- Require notice filings and fees: Yes
- Enforce antifraud provisions: Yes
Exam Tip: Gotchas
- Rule 506 offerings are federal covered securities. States cannot require registration for these offerings, but they CAN collect notice filing fees and enforce antifraud rules. This distinction is frequently tested.
Person (USA Section 401)
- Includes individuals, corporations, partnerships, associations, trusts, and other entities
- Broadly defined to cover virtually any legal entity
Issuer (USA Section 401)
- Any person who issues or proposes to issue a security
- For certificates of interest or participation, the issuer is the person performing the underlying obligations
- Understanding this term matters for distinguishing issuer from non-issuer transactions
Non-Issuer Transaction
- A transaction in which the proceeds do NOT go to the issuer
- Most everyday stock market transactions are non-issuer transactions (secondary market trades)
- Example: You buy shares of Apple on the NYSE. Apple doesn't receive the money; the seller does
Issuer vs. non-issuer transaction:
| Feature | Issuer Transaction | Non-Issuer Transaction |
|---|---|---|
| Who receives the proceeds? | The issuer (company) | The selling shareholder |
| Examples | IPO, secondary offering | Regular stock market trade |
| Registration requirements | Generally must be registered | May qualify for exemptions more easily |