Issuers & securities

Issuers

If you’ve studied for the SIE, Series 6, Series 7, or another FINRA or NASAA exam, you’ve likely seen the basic definition of a security. In plain terms, securities are investments that are initially sold to the public by issuers.

Issuers are persons (usually companies, organizations, or governments) that raise capital (money) by selling securities. Investors buy those securities, which provides funding for the issuer’s activities.

Issuers can be anything from a small start-up to a government. They raise capital when they identify a need, such as:

• Expanding a business
• Hiring a large number of employees
• Paying for deficit spending (as governments may do)

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) and the Securities Act of 1933 both explicitly identify the following as securities:

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

Thanks to a 1946 Supreme Court decision - SEC v. W. J. Howey Co - we also have a practical way to decide whether something is a security.

In that case, W. J. Howey Co. (a Florida citrus business) sold parcels of orange grove land and paired the sale with a leaseback arrangement. Buyers could purchase the land and then lease it back to an affiliated company to manage and harvest the groves. This structure allowed Howey to raise money from investors while keeping the groves in operation.

For exam purposes, the detailed facts aren’t the focus. What matters is the outcome: the Court treated the leaseback program as a security subject to Securities and Exchange Commission (SEC) and state (blue sky) regulation.

In the majority opinion written by Justice Murphy, the Court established a four-part standard known as the Howey Test. It’s used to determine whether an item or product meets 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.

• Investment of money is straightforward: the investor commits money (or something of value).
• Common enterprise means multiple investors are involved in the venture.
• Expectation of profit means the investor is seeking a financial return. Profit potential always comes with the risk of loss.
• Third-party effort means any profit is primarily 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).

• Investment of money: Buying Amazon stock requires paying the market price (about $125 per share as of June 2023).
• Common enterprise: Thousands (and likely millions) of investors own shares out of the 500+ million shares outstanding.
• Expectation of profit: Stock purchases are typically made with the goal of earning a return. Amazon’s total return since it began publicly trading in 1997 has been roughly 225,000%.
• Third-party effort: Investors’ profits depend primarily on Amazon’s business performance, driven by the work of Amazon’s employees and management (even though common stockholders can vote on certain matters).

Amazon common stock meets the four-prong Howey Test, so it’s a security. For test purposes, you’ll want to know the legal definition and characteristics of a security, along with the common security types available in the market.

What are some common examples of non-securities? The following may 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 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 out of place, but they can meet the definition of a security if they satisfy all the Howey Test requirements. 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. In that situation, it can meet all four prongs: it’s an investment of money, it involves a common enterprise (the timeshare structure), there’s an expectation of profit (rental income), and profits depend on third-party effort (the management service).

***A commoditiy 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 the purchase or sale of the currency or commodity at a fixed price for a short period of time.

Transactions

Some test questions focus on the difference between an issuer transaction and a non-issuer transaction. If you’ve studied for another licensing exam before the Series 65, you’ve probably seen this framed as the primary versus secondary market.

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

After AirBnB’s stock was sold in the IPO, its shares began trading in the secondary market between investors. If an investor who bought shares in the IPO later sells those shares, that sale is a non-issuer transaction. The proceeds go to the selling investor, not Airbnb.

A simple way to tell the difference is to follow the money:

• If the issuer receives the proceeds, it’s an issuer transaction.
• If anyone else receives the proceeds, it’s a non-issuer transaction.