Table of Contents
SERIES 65 | FINANCIAL REGULATION COURSES
A security is any financial instrument or investment arrangement that represents an ownership interest, a creditor relationship, or a right to acquire an ownership interest in an entity — defined under Section 2(a)(1) of the Securities Act of 1933 to include any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganisation certificate or subscription, transferable share, investment contract, voting-trust certificate, or certificate of interest in any property — with the critical inclusion of the broad and flexible category of investment contract that the Supreme Court has interpreted to encompass any arrangement involving an investment of money in a common enterprise with an expectation of profits derived from the efforts of others.
The legal definition of a security determines the boundaries of the entire federal securities regulatory framework — only instruments that qualify as securities are subject to the registration requirements of the Securities Act of 1933, the anti-fraud provisions of the Securities Exchange Act of 1934, the oversight of the Securities and Exchange Commission, and the conduct obligations imposed on broker-dealers and investment advisers who deal in them. Understanding what constitutes a security — and equally important what does not — is foundational knowledge for every securities industry professional and is directly and extensively tested on the Series 65 examination.
The legally controlling definition of security in the federal securities regulatory framework is found in Section 2(a)(1) of the Securities Act of 1933. Congress drafted this definition deliberately broadly — using an enumerated list of specific instruments supplemented by open-ended categories — to prevent sophisticated financial promoters from evading investor protection requirements by structuring investment schemes in forms not specifically contemplated by the statute.
The enumerated instruments explicitly included in the definition are those that Congress and investors in 1933 understood clearly to be securities — stocks, bonds, notes, debentures, and other conventional financial instruments that represented ownership interests or creditor relationships in companies and other entities. These core instruments — common stock in public companies, corporate bonds, treasury notes and treasury bonds issued by the United States government, municipal bonds issued by state and local governments — are unambiguously securities without requiring any analytical framework beyond recognising what they are.
The open-ended categories — most importantly the investment contract — extend the definition beyond these conventional instruments to capture novel financial arrangements that may share the essential economic characteristics of securities even if they do not take a conventional form. The investment contract category has been the primary vehicle through which courts and the SEC have extended securities regulation to new financial instruments and arrangements as the financial markets and economy have evolved over the decades since 1933.
The Securities Exchange Act of 1934 incorporates a substantially similar but not identical definition of security in Section 3(a)(10) — covering the regulation of secondary market trading — and the Investment Advisers Act of 1940 incorporates a definition in Section 202(a)(18) that governs the scope of securities advisory regulation.
The most practically important and most examination-relevant interpretive framework for determining whether a particular arrangement constitutes a security is the Howey test — derived from the Supreme Court's 1946 decision in Securities and Exchange Commission v. W.J. Howey Company.
The facts of the Howey case involved a Florida company that sold parcels of a citrus grove development to investors alongside a service contract under which the company would cultivate, harvest, and market the citrus crop and remit the net proceeds to the investors. The investors had no practical ability to manage the land themselves — they were relying entirely on the Howey Company's management and marketing expertise to generate the investment return. The question before the Court was whether this arrangement constituted an investment contract — and therefore a security requiring registration under the Securities Act.
The Supreme Court held that the arrangement was an investment contract and therefore a security — establishing the four-part Howey test that has defined the investment contract category ever since. Under the Howey test an investment contract exists when there is an investment of money, in a common enterprise, with an expectation of profits, derived from the efforts of others.
Each element of the Howey test requires separate analysis in any specific case. The investment of money element is broadly satisfied — it does not require literal cash investment and courts have held that investment of goods, services, and other non-monetary consideration can satisfy this element. The common enterprise element requires that the investor's fortunes be linked to the efforts or fortunes of others — either horizontally through pooling with other investors or vertically through dependence on the promoter's efforts. The expectation of profits element requires that the investor be motivated by an expectation of financial return — arrangements where the investor purchases something for consumption or personal use rather than investment return may not satisfy this element. The efforts of others element is the most critical for modern application — it requires that the expected profits derive predominantly from the entrepreneurial or managerial efforts of others rather than from the investor's own efforts.
The range of instruments that qualify as securities under the statutory definition and the Howey test encompasses the full spectrum of conventional investment vehicles used in professional investment management and private capital markets.
Common stock — the ownership interest in a corporation that entitles the holder to participate in corporate governance through voting rights and to receive a proportionate share of corporate earnings through dividends and residual claims on assets — is the paradigmatic security. Every share of common stock listed on the New York Stock Exchange, the Nasdaq, or any other national securities exchange is unambiguously a security subject to the full framework of federal securities regulation.
Preferred stock — the hybrid instrument that combines fixed dividend features of fixed income instruments with the equity ownership characteristics of common stock — is also a security in all its conventional forms. Both common stock and preferred stock are included in the explicit enumeration of the statutory definition and have never been the subject of serious legal dispute about their status as securities.
Bonds and notes — instruments evidencing an indebtedness of the issuer to the holder, obligating the issuer to repay principal at maturity and to pay periodic interest — are explicitly enumerated in the statutory definition. Corporate bonds, government bonds including treasury notes and treasury bonds, municipal bonds, and asset-backed securities including mortgage-backed securities are all securities subject to federal securities regulation. The note category requires case-by-case analysis — not every instrument labelled a note is a security, as the Supreme Court established in Reves v. Ernst and Young in 1990, requiring courts to apply a family resemblance test that examines the economic reality of the instrument rather than its label.
Mutual funds, exchange-traded funds, closed-end funds, and unit investment trusts — pooled investment vehicles registered under the Investment Company Act of 1940 — are securities both as to the fund shares themselves and as to the underlying securities in their portfolios.
Options and warrants — derivative instruments conveying the right to purchase or sell an underlying security at a specified price — are securities when they reference underlying securities and are therefore subject to federal securities regulation through the jurisdiction of the SEC and the self-regulatory oversight of the Options Clearing Corporation and FINRA.
Equally important as knowing what constitutes a security is knowing what does not — because transactions in non-securities instruments are not subject to the Securities Act's registration requirements, the Securities Exchange Act's anti-fraud provisions in their securities-specific form, or the oversight of registered broker-dealers and investment advisers in their securities-regulatory capacity.
Commodity futures contracts — standardised exchange-traded agreements to buy or sell a specified commodity at a predetermined price on a specified future date — are not securities. They are regulated by the Commodity Futures Trading Commission under the Commodity Exchange Act rather than by the SEC under the Securities Exchange Act. This regulatory distinction is fundamental — participants in futures markets deal with futures commission merchants regulated by the CFTC and the National Futures Association, not with broker-dealers regulated by FINRA.
Real estate in its direct ownership form — purchasing a home, a rental property, or commercial real estate outright — is not a security. The purchaser is making a direct investment in a physical asset with the ability to manage it themselves — they are not relying on the efforts of others to generate their return. However real estate interests packaged into investment structures where investors rely on the efforts of others to manage the property and generate returns — real estate investment trusts, real estate limited partnerships, and certain real estate crowdfunding arrangements — may constitute securities depending on the specific structure and the applicability of the Howey test.
Collectibles, precious metals, and physical commodities — art, wine, gold bullion, silver, and similar physical assets — are not securities when purchased in their direct physical form. Their value is determined by market supply and demand for the physical item rather than by the financial performance of an issuer or the efforts of others.
Certain insurance products — pure insurance contracts that transfer risk from the policyholder to the insurer — are not securities, though variable annuities and variable life insurance products that contain investment elements with returns dependent on the performance of underlying securities portfolios are classified as securities and must be sold by licensed broker-dealer representatives.
The investment contract category — the most flexible and most frequently litigated element of the securities definition — continues to be applied by the SEC and courts to novel financial arrangements that share the essential economic characteristics of securities even when they do not resemble conventional stocks or bonds.
Limited partnership interests in investment funds are securities — the limited partner investors provide capital and rely on the general partner's management expertise and efforts to generate investment returns, satisfying all four elements of the Howey test. This is why hedge funds, private equity funds, and venture capital funds that raise capital from investors are offering securities — even though the offering may be exempt from registration under Regulation D's private placement exemptions — and why the advisers to such funds are investment advisers subject to the Investment Advisers Act of 1940.
Cryptocurrency and digital assets present the most consequential and most actively debated current application of the securities definition and the Howey test. The SEC has taken the position that many cryptocurrencies and digital tokens — particularly those sold in initial coin offerings and those whose value depends primarily on the development efforts of a founding team or development organisation — are investment contracts and therefore securities subject to federal registration and anti-fraud requirements. The question of whether a specific digital asset is a security under the Howey test is determined by the economic reality of the specific arrangement rather than by the technology or the label applied to the instrument.
The National Securities Markets Improvement Act of 1996 created the category of federal covered securities — securities that are exempt from state registration requirements and subject only to federal securities regulation — including securities listed on national securities exchanges including the New York Stock Exchange and Nasdaq, securities of registered investment companies including mutual funds and exchange-traded funds, and securities offered under certain federal registration exemptions including Rule 144A offerings to qualified institutional buyers.
State securities administrators — the NASAA member regulators operating under state blue sky laws — retain jurisdiction over securities that are not federal covered securities, including securities of smaller companies that are not nationally listed and many private placement securities. State registration requirements for non-federal-covered securities are administered concurrently with federal requirements — issuers must satisfy both federal and applicable state registration obligations for non-covered securities.
The anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 promulgated thereunder — the primary federal anti-fraud framework — apply to all purchases and sales of securities. Section 17(a) of the Securities Act of 1933 applies to all offers and sales of securities. These anti-fraud provisions apply regardless of whether the security is registered or exempt from registration — even a security lawfully sold under a Regulation D private placement exemption cannot be sold through material misstatements or omissions without violating the anti-fraud provisions.
This means that the securities definition determines not only the registration obligations applicable to an offering but also the applicability of the anti-fraud framework — instruments that are securities are protected by Section 10(b) and Rule 10b-5 while instruments that are not securities are not protected by those provisions regardless of how fraudulent the transaction may be. Victims of fraud in non-securities transactions must rely on state common law fraud claims or other legal theories rather than the federal securities anti-fraud framework.
Securities is tested on the Series 65 examination as the threshold definitional concept that determines the scope of the entire federal securities regulatory framework — including the registration requirements of the Securities Act of 1933, the anti-fraud provisions of the Securities Exchange Act of 1934, and the conduct obligations of registered investment advisers and broker-dealers.
The key points to retain are these.
A security is defined under Section 2(a)(1) of the Securities Act of 1933 to include any note, stock, bond, debenture, evidence of indebtedness, transferable share, investment contract, and other enumerated instruments — with the investment contract category providing the flexibility to capture novel financial arrangements sharing the essential economic characteristics of securities. The Howey test — from SEC v. W.J. Howey Company — defines an investment contract as an arrangement involving an investment of money, in a common enterprise, with an expectation of profits, derived from the efforts of others. All four elements must be satisfied simultaneously.
Instruments that are clearly securities include common stock, preferred stock, corporate bonds, government bonds including treasury notes and treasury bonds, municipal bonds, mutual fund shares, exchange-traded fund shares, options, warrants, and most limited partnership interests in investment funds. Instruments that are not securities include commodity futures contracts — regulated by the CFTC under the Commodity Exchange Act — direct real estate ownership, physical commodities, collectibles, and pure insurance products without investment components.
The anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 apply to all purchases and sales of securities regardless of registration status — even exempt private placements must be sold without material misstatements or omissions. Federal covered securities — including exchange-listed securities and registered investment company shares — are exempt from state registration requirements under NSMIA and subject only to federal securities regulation, while non-covered securities remain subject to concurrent state blue sky law requirements administered by NASAA member state securities administrators.
