What it means
Securities laws exist to protect people who hand over money in the hope of a return and have to rely on others for information. They usually require the seller to register the offer or qualify for an exemption, provide disclosure documents and avoid misleading statements.
If an arrangement is a non-security, these obligations do not apply in the same way. Typical examples of things that are often treated as non-securities include ordinary bank deposits, commercial loans between a bank and a borrower, insurance policies, direct ownership of a house or a car, and a general partnership where each partner is actively involved.
Which side of the line an item falls on is a legal question and is not decided by the label the parties choose. In the United States, courts have long used a test from a famous case about orange groves.
Broadly, an arrangement is an investment contract, and so a security, if people invest money in a common enterprise and expect profits mainly from the efforts of someone else. Other countries apply their own tests, though many look at similar features.
The classification matters to businesses raising money. If an offer is a security, the issuer may have to file documents, use licensed intermediaries and accept liability for what it says.
Calling something a membership, a token or a revenue share does not remove it from the rules if the economic reality looks like an investment. Regulators and courts continue to debate new products, such as certain digital assets and crowdfunding arrangements.
Because the outcome can change from case to case, businesses should seek legal advice before assuming that a product sits outside the securities rules. Getting this wrong can be costly.
Selling an unregistered security can lead to fines, orders to refund investors and, in serious cases, personal liability for the people who ran the offer, so a short legal opinion at the planning stage is usually money well spent.
In practice
Real-world examples.
Example
A bank lends $500,000 to a family-owned manufacturer under a standard commercial loan agreement. The loan is a private arrangement between two parties and is generally not treated as a security. The bank relies on its own credit checks and the borrower's contract, not on a public disclosure document.
Example
A founder sells 10 memberships in a private club for $5,000 each, giving members the right to use the facilities. Because buyers are paying to use a service and are not expecting profits from the founder's efforts, the memberships are likely to be a non-security. The founder still has to describe the facilities honestly and honour the membership terms under ordinary consumer law.
Example
A start-up offers online buyers a share of the profits from a new app in return for $1,000 each, promising to do all the work. This looks like an investment contract, so it is probably a security despite the founder describing it as a participation scheme. The founder would need to register the offer or rely on an exemption, and give buyers proper risk disclosures.
Case study
Seen in the real world.
Brightmoor Ventures is a fictional crowdfunding company invented to illustrate this idea. It offered the public a chance to put $2,000 each into a new coffee roastery in return for a share of future revenue, and described the product as a customer loyalty scheme rather than a share offer.
A lawyer reviewing the plan pointed out that investors would expect returns from the founders' efforts and would have no role in running the business. That made the arrangement look like an investment contract, so the offer would probably count as a security and need to be registered or fall within an exemption.
Brightmoor redesigned the offer. It restructured it as a regulated crowdfunding round with proper disclosures, and replaced the loyalty language with a clear description of the risks, which took longer to launch but avoided a regulatory challenge. Brightmoor's lawyer estimated that the delay cost about six weeks, which was far cheaper than defending an enforcement action.
Watch out
Common mistakes.
- Assuming that a label settles the question. Regulators look at the economic substance of the deal, not the name given to it.
- Believing non-securities are completely unregulated. Other laws, such as consumer protection, lending and fraud rules, may still apply.
- Copying another business's structure without checking the facts. A small difference in who does the work or who expects the profit can change the result.
Questions
People also ask.
Is a bank deposit a security?
Usually not, because it is a debt owed by the bank to the depositor, though some deposit-type products are treated differently in different countries.
Can the same asset be a security in one place and not in another?
Yes, since each country sets its own definitions and tests.
Who decides whether something is a security?
In the end, courts and regulators decide, so businesses with doubts should take legal advice before raising money.
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