Securities Law 101

Updated: Mar 2

Securities law is a specialty area within business law that concerns the offer and sell of


deals with corporate stocks, company or partnership interests, and other indica and of ownership or interest within a business. The federal agency, which administers federal securities laws, is the Securities and Exchange Commission (SEC).


The term “securities” is broadly defined by the U.S. Securities Act of 1933 to include stocks, bonds, notes, convertible securities, warrants , or any other document that represents a share or interest in a business or a debt owed by a business or government entity. In most cases, businesses sell securities to raise capital or money to help cover operating costs to grow the businesses’ operations.


The Securities Act of 1933 also prohibits material misrepresentation, falsity, and other fraudulent acts and practices in connection with the sale of securities. This full disclosure objective of the 1933 Act is implemented by requiring an issuer of securities to file a registration statement with the SEC before securities can be offered for sale to the public unless there is an exemption from registration available to the offeror. The securities cannot be sold until the registration statement has been qualified by the SEC.


The Securities Exchange Act of 1934 was passed to supplement the disclosure requirements of the 1933 Act and to regulate both broker-dealers and the markets for resales of securities on the secondary market (i.e., stock exchanges). The 1934 Act requires registered businesses to provide regular reports to their shareholders, including financial statements and other business activities , and file annually with the SEC and each stock exchange where the corporation has a listed security offering.


There have been many schemes over the years by various actors to avoid registering their securities with the SEC and to circumvent other securities laws. A number of these schemes have been analyzed by the Courts to determine whether an actual “security” is being offered and sold. 7 In SEC v. W.J. Howey Co., the Court found an offering of small parcels of land was security whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it is immaterial whether or not the venture is economically feasible.


The transaction involved the offering of small parcels of land in a citrus grove in Florida, coupled with a service contract for cultivating and marketing the produce. The prospective purchasers were informed that the venture was not economically feasible without arranging for a service contract. In holding that the instrument offered was an “investment contract” and hence, a security, the Howey Court emphasized that “investment contract embodies a “flexible rather than a static principle” and that the term has been broadly construed by state courts as a means of protecting the investing public.


Under what has become known as the “Howey Test,” the term investment contract means “an investment of money in a common enterprise with profits to come solely from the efforts of others.” This usually concerns membership interests or investment into a limited liability company (LLC) where the operating agreement is construed as an investment contract if there is even a single passive or limited member. Courts also frequently examine promotional materials associated with an instrument when determining whether an instrument or arrangement is a security. For instance, if the advertising materials of an offer promise things like great returns or guaranteed incomes, a court will almost certainly find the instrument to be a security, and therefore subject to federal securities regulations.


The Investment Company Act of 1940 regulates investment companies, such as mutual funds. Investment companies are engaged primarily in the business of investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The objective of the 1940 Act is to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis.


With certain exceptions, this Act requires that first or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors. These exceptions include (1) real estate and mortgage companies, (2) charitable funds, (3) holding companies, (4) private funds under 100 investors, (5) qualified purchasers fund, and (6) some venture capital funds. The 1940 Act requires investment companies to disclose their financial condition, investment policies, and company structure and operations to investors when stock is sold initially and on an ongoing basis subsequently.


The Investment Advisor Act of 1940 requires investment advisors and firms providing investment advice to register with the SEC and comply with SEC regulations. Investment advisors are persons who provide advice to others about investments for a fee, and they are also required by most states to register or become licensed. Common examples of investment advisors include hedge fund managers, pension fund managers, and also individuals, partnerships, or corporations.


Securities attorneys representing both business issuers and investment companies prepare and review filings with the SEC, and provide advice and counsel regarding the best strategies for structuring security offering transactions within the boundaries of SEC rules and regulations, including determining filing or exempt strategy; performing due diligence regarding offering disclosures; drafting and negotiating investment documents such as term sheets and subscriptions agreements; and structuring governance and other operating documents on behalf companies or corporation, such as drafting operating agreements and by-laws in compliance with both State and SEC rules and regulations. Securities attorneys also review press releases and other advertising materials on behalf of clients to ensure legal compliance with SEC laws. Lastly, securities lawyers can engage in advocacy and policy on behalf of their clientele, and identify needs for statutory, rule, or policy changes so that these laws better serve the interests of their clients.


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* With edits and supervision by Elizabeth L. Carter, Esq., Managing Attorney


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