Issuers

If you’ve already studied for the SIE, Series 6, 7, or any other FINRA or NASAA exam, you’re probably well acquainted with the definition of a security. In layman’s terms, securities are investments initially sold to the public by issuers. Issuers are persons (usually companies, organizations, or governments) that raise capital (money) through selling securities. Investors purchase securities, effectively funding that issuer’s activities.

From a small start-up company to the government, issuers come in all shapes and sizes. Issuers raise capital when a need is identified. Needs could range from expanding a business, hiring a significant amount of employees, or paying for deficit spending (like our government does). Real-world examples of issuers include:

US Government
City of Los Angeles
Verizon
Microsoft
Visa

Securities

Issuers raise capital by selling securities to the public. The Uniform Securities Act (USA) explicitly identifies the following as securities:

Stocks, including:
- Common stock
- Preferred stock
Debt instruments, including:
- Notes
- Bonds
- Debentures
- Collateral trust certificates
- Certificate of indebtedness
Pre-organization certificates
Voting trust certificates
Certificate of deposit for a security
Investment contracts
Certificate of interest or participation in any:
- Profit-sharing agreement
- Oil, gas, or mining program

You’re probably aware of at least a few of the items listed above, and possibly don’t know a large portion of the listed security types. Even if you’re unaware* of all of these items, it’s uncommon for test questions to focus on their characteristics. You’re much more likely to be tested on whether a product is considered a security.

*A future section in this material is dedicated to covering the basics of these securities. You can most likely skip this section if you’ve just passed the SIE, Series 6, or 7, as the security characteristics you’re most likely to be tested on were covered thoroughly on those exams.

Thanks to a 1946 Supreme Court decision - SEC v. W. J. Howey Co - we can rely on a specific set of criteria to determine if something meets the definition of a security. Long story short, W. J . Howey Co was a corporation based in Florida focused on the citrus business. They owned a large plot of land full of orange groves, sold half of the land, and set up a deal for those purchasing the orange grove property to loan back the land to an affiliated company of W.J. Howey. This allowed W.J. Howey to raise money from the sale of half of their orange grove land, while still being able to utilize the land for citrus harvesting.

The specifics are not important for test purposes, but the court case resulted in a majority of the court ruling the leaseback program as a security that would be subject to Securities and Exchange Commission (SEC)* and state (blue sky) regulation.

*The SEC is an agency of the US Government, in charge of enforcing the rules and regulations of several federal securities laws, including the Securities Act of 1933 and the Securities Exchange Act of 1934. You don’t need to know much about the SEC for this exam, but they may be mentioned from time to time as a federal securities regulator.

In the Supreme Court’s majority decision written by Justice Murphy, a four-prong requirement known as the Howey Test was created to determine if an item or product met the definition of a security:

Investment of money
Common enterprise
Expectation of profit
Third-party effort

A security exists when all four elements are present. An investment of money is quite self-explanatory, but let’s go through the rest. Common enterprise occurs when there are multiple investors in a business venture. The expectation of profit is common sense, but it’s important to know profit potential always co-exists with the risk of loss. Third-party effort refers to profit made due to the efforts of someone other than the investor.

Let’s apply the Howey Test to a well-known security: Amazon.com Inc. common stock (ticker: AMZN). Purchasing Amazon stock is definitely an investment of money, trading at $125 per share as of June 2023. Thousands, if not millions of investors own a piece of the 500+ million shares outstanding, confirming the existence of a common enterprise. A purchase of stock always comes with the expectation of profit, and Amazon is no exception, especially with a total return of roughly 225,000% since the company began publicly trading in 1997. Profits made by Amazon investors are not due to their efforts (although common stockholders maintain the right to vote on issues of importance), but instead by the efforts of a third party - Amazon’s employees.

Amazon common stock meets the 4-prong Howey Test, and therefore is a security. For test purposes, it’s important to understand the legal definition and characteristics of a security, plus the typical security types available in the market.

What are some common examples of non-securities? The following could be cited on the exam as not meeting the Howey Test, and therefore not considered securities:

Insurance products (unless variable*)
Collectibles
Art
Condominiums used as a personal residence**
Commodities***
Currencies****

*There are two commonly cited variable insurance products - variable annuities and variable life insurance. If the word ‘variable’ is not in the name, then it’s not a security. Keep it simple!

**Condominiums might seem a bit out of place, but they could meet the definition of a security by meeting all the requirements of the Howey Test. For example, assume you own a condominium as a time share and rent it out through a third-party management service when you’re not using the property. If you think about it, it meets all 4 prongs of the security test. It’s an investment of money, common enterprise is involved (the timeshare aspect), and there’s a profit motive involved with renting the property through a third-party management service.

***A commodity is an economic good. Examples include oil, corn, soybeans, gold, rice, and wheat.

****While currencies and commodities are not considered securities, options on them are. An option is a type of derivative that allows a purchase or sale of the currency or commodity at a fixed price for a short period of time.

Transactions

Some test questions may focus on the difference between an issuer and a non-issuer transaction. If you’ve studied for another licensing exam prior to the Series 63, you’ve probably learned about the primary and secondary markets.

Issuer transactions occur in the primary market. When a security is created and sold by an issuer, the investment is sold to investors in return for capital (money). The proceeds of the security sale are provided to the issuer. For example, AirBnB’s initial public offering (IPO) is an example of an issuer transaction occurring in the primary market. The company raised $3.5 billion after selling over 50 million shares to the public.

Once AirBnB’s stock was sold in the IPO, its shares began trading in the secondary market between investors. Any investor purchasing shares in the IPO can sell those shares at a later date. If this occurs, this is known as a non-issuer transaction. The proceeds of the sale go to the selling investor, not Airbnb.

An easy way to determine if a transaction is an issuer or non-issuer transaction relates to the flow of money. If the issuer receives the proceeds from the transaction, it’s an issuer transaction. If anyone else receives the proceeds, it’s a non-issuer transaction.

Key points

Issuers

Persons that raise capital by offering securities to investors

Securities

Formal name for an investment
Common types:
- Stocks
- Bonds

Howey test

Four-prong test determining if a product is a security
Four requirements:
- Investment of money
- Common enterprise
- Expectation of profit
- Third-party effort

Issuer transactions

Issuer receives sales proceeds
Occur in the primary market

Non-issuer transactions

Any person other than the issuer receives sales proceeds
Occur in the secondary market