By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

Sarbanes-Oxley Act (SOX) makes reference to the Securities Act of 1933 and the Securities Exchange Act of 1934 for purposes of defining what is and is not a security. Both acts contain similar definitions. The 1933 Act uses the following language:

[T]he term “security” means any note, stock, treasury stock, bond, debenture, security, future, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement . . ., pre-organization certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security . . . or warrant or right to subscribe to or purchase, any of the foregoing.

There has long been confusion about the term investment contract as it’s used in the definition of a security along with all the other terms. The use of this particular phrase has really extended the scope of transactions that the statute covers.

Those words don’t have any real meaning in a commercial context, so the courts have had to interpret them in deciding when an agreement between two or more parties constitutes an investment contract that’s subject to the registration and reporting requirements of federal securities law.

A famous Supreme Court case in the 1940s, SEC v. WJ Howey Co., made it clear that federal securities law covers a broad scope of commercial transactions. In this case, the court held that companies that offered sections of orange groves for sale along with contracts to harvest the oranges and distribute the profits were indeed selling investment contracts subject to federal securities law and had to register such contracts with the SEC.

In the Howey case, the Supreme Court stated that the test to determine whether the securities laws apply in a given transaction is “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”

Although this is a pretty broad definition, not all investments are considered securities under SOX. For example, courts have also held that transactions such as purchasing a share in a cooperative housing project or participating in a pension plan funded solely by employers (with no employee contribution) aren’t securities.

Under the Howey case, the key questions to ask in determining whether a particular transaction may be a security subject to SOX include the following:

  • Is there an investment of money?

  • Is this a common enterprise?

  • Is there expectation of profits?

  • Do profits come solely from the investments of others?