§15.2 - Definition of a Security

• Jurisdiction: Washington

§15.2DEFINITION OF A SECURITY

Offers and sales of securities in the United States generally fall within one of three categories: (1) registered, (2) exempt from registration, or (3) unlawfully sold in the absence of registration. Complicating this simple paradigm is the fact that the federal and state exemptions from registration are not entirely uniform. Thus, an offering of securities may be exempt from registration under federal law but nevertheless require registration under the laws of one or more states in which the offering is conducted, just as an offering that is exempt under state law may be required to be registered under federal law. Finally, regardless of whether an offering is registered or exempt from registration, state or federal antifraud rules will almost certainly apply to the offering, resulting in a need to provide meaningful disclosure to investors regarding the risks related to the offering and the issuer.

(1) Significance of being a security

Registering an offering is expensive and time consuming, but participating in an unlawful offering naturally may give rise to civil and, in some cases, criminal liability for the issuer of the securities and its affiliates. Thus, identification of an available exemption from registration is a critical issue. Even if it is determined that a specific transaction in securities is exempt from registration, the antifraud provisions of federal and state securities laws will nevertheless apply. Securities liabilities, including liabilities relating to registration and liabilities relating to violation of the antifraud provisions, generally apply only to the issuer. However, officers, directors, controlling shareholders, underwriters, and professionals providing services in connection with an offering, including lawyers, can be held liable under both federal and state securities laws. For all these reasons, it is critical to determine whether any particular transaction is one involving a security.

Practice Tip: In Washington, a person can be a "seller" under RCW 21.20.430(1) if the person's "acts were a substantial contributive factor in the sales transaction." Haberman v WPPSS, 109 Wn.2d 107, 131, 744 P.2d 1032 (1987) amended, 750 P.2d 254, appeal dismissed, 488 U.S 805 (1988). Notwithstanding the United States Supreme Court's subsequent rejection of the "substantial factor" test articulated in Pinter v. Dahl, 486 U.S. 622, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988) (interpreting a federal statute), the Washington Supreme Court specifically reaffirmed that "substantial factor" standard for cases under the state statute in Hoffer v. State, 113 Wn.2d 148, 776 P.2d 963 (1989). Lawyers should note that in Hines v. Data Line Systems, Inc., 114 Wn.2d 127, 787 P.2d 8 (1990), the court held that, as a matter of law, a law firm's participation in a private placement of securities was not sufficient to make it a "seller" under RCW 21.20.430(1), because the firm's actions were in the nature of routine professional legal services and were not the catalyst for the sales transactions with investors. In a case of importance to lawyers and accountants, the United States Supreme Court held that there is no aiding and abetting liability under Section 10(b) of the Exchange Act, 15 U.S.C. §78j (see below). Cent. Bank v. First Interstate Bank, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994). Similarly, the United States Supreme Court has refused to expand the implied private right of action for securities fraud under Section 10(b) to include investor claims for so-called "scheme" liability against those who advise or do business with securities issuers, unless the investor satisfies the element of reliance against these secondary parties. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 128 S.Ct. 761, 169 L.Ed.2d 627 (2008).

(2) Federal definition

The same general principles that determine whether any investment constitutes a security apply to transactions involving real estate. Because a complete analysis of the nature of a security is beyond the scope of this chapter, the following discussion will focus on the general definitional issues that may relate to real estate transactions.

The term "security" is broadly defined in the two principal federal securities statutes: the Securities Act of 1933, 15 U.S.C. §§77a-77a, as amended (Securities Act), which governs the offer and sale of securities, and the Securities Exchange Act of 1934, 15 U.S.C. §§78a-78oo, as amended (Exchange Act), which generally governs post-distribution trading in the securities markets and includes the reporting obligations of public companies. Both the Securities Act and the Exchange Act also contain antifraud provisions relating to transactions in securities.

Section 2 of the Securities Act states as follows:

When used in this subchapter, unless the context otherwise requires—

(1) The term "security" means any note, stock, treasury stock, security future, 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.

15 U.S.C. §77b(a)(1).

The corresponding definition of "security" within §3(a)(10) of the Exchange Act substantially repeats the Securities Act definition, with two exceptions: the exclusion of the phrase "evidence of indebtedness" and the inclusion of the following carve-out from the broader definition: "but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited."...