The Definitions That Decide Every Question

Security

The Act's definition of a security is a long list followed by a catch-all. It includes any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in a profit-sharing agreement; collateral-trust certificate; preorganization certificate or subscription; transferable share; investment contract; voting-trust certificate; certificate of deposit for a security; certificate of interest or participation in an oil, gas or mining title or lease; and, in general, any interest or instrument commonly known as a security, together with warrants, rights, receipts, guarantees, and interim or temporary certificates for any of those.

The catch-all is what makes the definition work, and the item doing most of the work is investment contract. That phrase is defined by the courts through the Howey test, which the exam names directly: an investment contract exists where there is an investment of money, in a common enterprise, with an expectation of profits, derived primarily from the efforts of others.

All four elements are required. A limited partnership interest is a security because the limited partner invests money in a common enterprise expecting profits from the general partner's efforts. A general partnership interest usually is not, because the partner supplies the efforts themselves.

What is expressly not a security: an insurance or endowment policy or a fixed annuity contract under which an insurance company promises to pay a fixed sum, in a lump sum or periodically. That exclusion is why a variable annuity is a security and a fixed annuity is not — the variable contract does not promise a fixed sum, so the holder bears investment risk.

Other things commonly and wrongly assumed to be securities: commodities and futures contracts, currency, precious metals held directly, real estate held directly, collectibles, and retirement plans themselves as distinct from the securities held inside them.

Sale, offer, person and issuer

A sale or sell includes every contract of sale of, contract to sell, or disposition of a security or interest in a security for value. An offer or offer to sell includes every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security for value.

The Act then extends both terms in ways that are directly testable:

A security given as a bonus with any purchase is considered part of the subject of the purchase and to have been offered and sold for value. So stock given away with a bond purchase is a sale of the stock.

A purported gift of assessable stock is an offer and a sale.

Every offer of a warrant or a right to subscribe to another security, and every offer of a convertible security, includes an offer of the underlying security.

And four things are expressly excluded: a bona fide pledge or loan; a stock dividend where nothing of value is given other than the surrender of a right to a cash or property dividend; an act incident to a class vote by stockholders on a merger, consolidation, reclassification or sale of assets; and an act incident to a judicially approved reorganization.

So the classic exam answers: pledging securities as collateral for a loan is not a sale; a stock dividend is not a sale; a merger vote is not a sale; a bonus security is.

Person means an individual, a corporation, a partnership, an association, a joint-stock company, a trust where the beneficiaries' interests are evidenced by a security, an unincorporated organization, a government, or a political subdivision of a government. It is deliberately broad — and note what it does not include: a deceased individual, a minor, and a person judged mentally incompetent are not persons for these purposes.

Issuer means any person who issues or proposes to issue a security. Non-issuer means not directly or indirectly for the benefit of the issuer — so a non-issuer transaction is an ordinary secondary market trade between investors.

Guaranteed means guaranteed as to payment of principal, interest or dividends — never guaranteed against loss.

Broker-dealer and agent

A broker-dealer is any person engaged in the business of effecting transactions in securities for the account of others or for their own account. It is an entity concept, and the exclusions matter as much as the definition.

Broker-dealer does not include an agent, an issuer, a bank, a savings institution or a trust company. Nor does it include a person with no place of business in the state who either effects transactions in the state exclusively with issuers, other broker-dealers or institutional buyers, or who is licensed in the state where they maintain a place of business and deals in this state only with an existing customer whose residence is not in this state.

That second exclusion is the de minimis rule the exam tests: a firm with no office in a state may deal there with institutions freely, and may serve an existing out-of-state customer who is temporarily present, without registering.

An agent is any individual other than a broker-dealer who represents a broker-dealer or issuer in effecting or attempting to effect purchases or sales of securities. Agent is an individual concept — a person, never an entity.

The exclusions from agent are among the most heavily tested provisions on the exam. An individual representing an issuer is not an agent when effecting transactions in certain exempt securities, when effecting exempt transactions, when effecting transactions in specified federal covered securities, or when effecting transactions with the issuer's existing employees, partners or directors if no commission or other remuneration is paid for soliciting anyone in the state.

That last one is the one candidates get wrong. The compensation is the trigger: an employee of an issuer selling the issuer's stock to fellow employees is not an agent, but the moment a commission is paid for soliciting, they are.

And a partner, officer or director of a broker-dealer or issuer is an agent only if they otherwise come within the definition — that is, only if they are effecting or attempting to effect transactions.

One more distinction worth stating: clerical and ministerial personnel are not agents, because they are not effecting or attempting to effect transactions.

Investment adviser and investment adviser representative

An investment adviser is any person who, for compensation, engages in the business of advising others — directly or through publications or writings — as to the value of securities or the advisability of investing in, purchasing or selling securities; or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. It expressly includes financial planners who provide those services as an integral component of other financially related services for compensation.

The three-part test the exam uses: advice about securities, as a business, for compensation. All three must be present.

The exclusions: an investment adviser representative; a bank, savings institution or trust company; a lawyer, accountant, engineer or teacher whose performance of these services is solely incidental to their profession — the LATE exclusion; a broker-dealer or its agent whose advice is solely incidental to its brokerage business and who receives no special compensation for it; a publisher of a bona fide newspaper, newsletter or financial publication that does not render advice based on the specific situation of each client; and a federal covered adviser.

The broker-dealer exclusion is the one that decides a great many questions. A representative who gives advice incidental to executing trades and is paid only by commission is not an investment adviser. A representative who charges a separate fee for advice — special compensation — is.

An investment adviser representative is a partner, officer, director or other individual employed by or associated with a registered or required-to-be-registered investment adviser, or who has a place of business in the state and is associated with a federal covered adviser, and who makes recommendations or renders advice regarding securities, manages accounts, determines what advice should be given, solicits or sells advisory services, or supervises anyone who does.

A federal covered adviser is one registered with the SEC under section 203 of the Investment Advisers Act; a federal covered security is one covered under section 18(b) of the Securities Act of 1933. Both are categories NSMIA created to pre-empt state registration, and both remain subject to state anti-fraud authority and to notice filing requirements.