If you’ve studied for the SIE, Series 6, Series 7, or another FINRA or NASAA exam, you’ve already 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 (typically 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 a need arises, such as:
Real-world examples of issuers include:
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:
Thanks to a 1946 Supreme Court decision - SEC v. W. J. Howey Co - we can use a specific set of criteria to decide whether something meets the definition of a security.
In that case, W. J. Howey Co. (a Florida citrus business) sold parcels of orange grove land and offered buyers a leaseback arrangement through an affiliated company. This structure allowed Howey to raise money from the land sales while continuing to operate the groves.
For exam purposes, the key takeaway isn’t the business details. The important point is the legal result: the Court held that the leaseback program was 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:
A security exists when all four elements are present.
Let’s apply the Howey Test to a well-known security: Amazon.com Inc. common stock (ticker: AMZN).
Because Amazon common stock meets all four prongs, it is a security.
For test purposes, focus on:
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:
*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, a 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 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 a purchase or sale of the currency or commodity at a fixed price for a short period of time.
Some exam questions focus on the difference between an issuer transaction and a non-issuer transaction. This is closely related to the difference between the primary and secondary markets.
Issuer transactions occur in the primary market. When a security is created and sold by an issuer, investors pay money in exchange for that 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 IPO, its shares began trading in the secondary market between investors. If an investor who bought shares in the IPO later sells those shares to another investor, that sale is a non-issuer transaction. The proceeds go to the selling investor, not to Airbnb.
A simple way to tell the difference is to follow the money:
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