How We [sic] Failed and Could Do Better

Zachary Fallon

Zachary O. Fallon (Principal and Co-Founder of Ketsal Consulting, LLC and Blakemore, Fallon, Garcia, Rosini, and Russo, PLLC).

Securities law practitioners learn early that there is a distinction between a “security” and a “transaction in a security.” In fact, the first substantive thing the Securities Act of 1933 does is define the term “security” before going on to describe how it regulates the offer and sale of (i.e., transactions in) securities.

Notes, stocks, bonds, and other investment instruments are generally considered securities because they represent bundles of rights and interests commonly known as, or understood to be, securities. The ’33 Act then regulates transactions in them. It’s fairly straightforward, if not technical.

Investment contracts are different, however, because the concept of a transaction is baked within the court-defined test to determine status as such — that is, status as a security. An investment contract is therefore not just a bundle of rights in isolation, but rather the bundle of rights created by a transaction.

Howey says an investment contract exists where there is “an investment of money in a common enterprise with profits to come solely from the efforts of others.” Its historical basis predates the federal securities laws, which, in turn, may explain its general disregard for the statutory distinction between securities and transactions in securities adopted by Congress in the ’33 Act.

Howey’s conflation of rights with the transactions creating those rights is one of the reasons people struggle with the concept of an investment contract. On the one hand, if there is no transaction (i.e., no investment of money), there is no investment contract (i.e., no security). While, on the other hand, bundles of rights should be capable of categorization as securities without regard to transactions in them.

“What we’ve got here is a failure to communicate.”

A better test — that is consistent with the ’33 Act and based on the Howey language above — would eliminate a requirement for an investment of money, leaving us with the following:

An investment contract* exists where there is “a common enterprise with profits to come solely from the efforts of others.”

When you see/create one of these, let then the ’33 Act transactional provisions regulate the “investment[] of money in” it.

Sorry, Howey, but I think we can do better.

* —You’ll have to take my word for it that the concept of a contract under state law differs from that of a securities law contract.

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