Both Section 2(1) of the Securities Act of 1933 and Section 25019 of the Corporate Securities Law of 1968 provide extensional definitions of the term “security”. That is, they each list everything within the term being defined. See Why the Word “Includes” Conflates the Separation of Powers“. In each statute, the twelfth item listed is “investment contract”. In the famous case of Securities & Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946), Justice Frank Murphy defined the term “investment contract” as follows:
The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.
Strictly speaking, Justice Murphy did not define a “security”, but simply one type of security – an “investment contract”.
In Silver Hills Country Club v. Sobieski, 55 Cal. 2d 811 (1961), California Supreme Court Justice Roger J. Traynor defined the term “beneficial interest in title to property” which was included in the definition of “security” in former Corporations Code Section 25008. This definition became known as the “risk capital” definition. Unlike the Howey definition, the “risk capital” definition does not require an expectation of profit but instead focuses on the following questions:
- Are the funds being raised for a business venture or enterprise?
- Is the offering being made indiscriminately to the public?
- Are the investors substantially powerless to affect the enterprise’s success?
- Is the investor’s money at risk due to inadequate security?
In 1968, the legislature enacted the current Corporate Securities Law and moved the definition of “security” to Section 25019 of the Corporations Code. Although the term “beneficial interest in title to property” is no longer included in the laundry list of items constituting a “security”, Justice Traynor’s risk capital definition lives on as California courts have applied both the Howey and the Silver Hills definitions either separately or alone. See Marsh & Volk, Practice Under the California Securities Laws § 5.19[d] for a listing of cases.
Although the SEC is itself in violation of the law by failing to have adopted rules implementing the JOBS Act crowdfunding exemption, it has (with no apparent sense of irony) reminded “issuers that any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws.” In the meantime, some may be trying to crowdfund by avoiding the sale of investment contracts as defined in Howey. In essence, they take the position that there is no expectation of profit. Whatever the merits of this position under Howey, these early birds are not likely to get the worm in California if they have failed to consider the Silver Hills definition.