Anyone who has studied securities regulation since 1946 should be familiar with the U.S. Supreme Court’s definition of a “security” as enunciated by Justice Frank Murphy in S.E.C. v. Howey Co., 328 U.S. 293 (1946). That test asks “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others”. California courts also apply what is known as the “risk capital” as articulated by Justice Roger J. Traynor in Silver Hills Country Club v. Sobieski, 55 Cal.2d 811 (1961).
And the first shall be last . . .
Although Silver Hills postdates Howey by some 15 years, the risk capital test actually predates Howey. The reason for this temporal anomaly is that Justice Traynor didn’t invent the risk capital test when he penned Silver Hills. He was, in fact, quoting a 1945 law review article by California lawyer T.W. Dahlquist:
“as a general rule, the sale of ‘securities’ that is condemned by the courts involves an attempt by an issuer to raise funds for a business venture or enterprise; an indiscriminate offering to the public at large where the persons solicited are selected at random; a passive position on the part of the investor; and the conduct of the enterprise by the issuer with other people’s money.”
Dahlquist, Regulation and Civil Liability Under the California Securities Act, 33 Cal.L.Rev. 343, 360.
But what is the significance of Howey in light of Silver Hills when determining whether a security exists under the California Corporate Securities Law of 1968? Does the existence of a California test derogate the application of the federal test? In a recent criminal case, the California Court of Appeal said “no”. People v. Black, 2017 Cal. App. LEXIS 130 (Cal. App. 6th Dist. Feb. 16, 2017) (“We accordingly reject any implication in Black’s argument that the relevance of the federal test is muted by the risk capital test in California”). The Court of Appeal went on to decide whether promissory notes were securities under the CSL. I’ll have more to say about that in a future post.